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Department of Labor Releases Final Rule Implementing Pension Protection Act Statutory Exemption

October 31, 2011

 

After a delayed start, the Department of Labor (“DOL”) released a final rule on October 24, 2011 designed to offer guidance in providing investment advice to plan participants. The new rule, effective December 27, 2011, implements provisions of the Pension Protection Act of 2006 (“PPA”), which created a statutory exemption from the prohibited transaction rules for investment advisers who are fiduciaries. The exemption permits them to provide investment advice to plan participants of defined contribution plans and holders of Individual Retirement Accounts (“IRAs”) and to receive compensation under certain conditions. DOL previously issued a Field Assistance Bulletin affirming that the exemption did not change DOL's prior guidance relating to investment advice. The exemption is intended as an alternative means of providing investment advice.

As described in the exemption and new regulation, fiduciary investment advisers may receive compensation if the investment advice they provide is based on a computer model certified as unbiased. An outside auditor must examine whether the model is set up according to generally accepted investment principles. The exemption also would apply if the investment adviser’s compensation is made on a “level-fee” basis, meaning that such compensation does not depend on the investments participants select. To fit within the exemption, the adviser must comply with conditions outlined in the regulation, including authorization by a plan fiduciary, annual audits of the computer model or level-fee advice arrangements, and disclosures to plan participants.

The final rule comes on the heels of previous efforts by DOL to enact a similar rule. In January 2009, under the Bush Administration, DOL published final rules which were to be effective in March 2009. The Obama Administration delayed the regulations for further study and comment, ultimately withdrawing the final rule based on public comments that it did not provide sufficient protection against conflicts of interest. The republished rule does not differ materially from the earlier version, with the exception of a proposed class exemption for individualized investment advice. Under the rule as originally proposed, a fiduciary adviser providing investment advice to a participant or beneficiary after a certified computer model has made an investment recommendation would have been exempted from ERISA's prohibited transaction sections. After commenters raised concerns that the class exemption could permit the fiduciary adviser to benefit from providing advice that varied from the recommended advice, DOL opted not to include it in the new rule.

The rule, as reproposed on March 2, 2010, raised concerns, as had the earlier version, that DOL was indicating a preference for index funds over actively managed funds by emphasizing that investment advice must take into account historical performance, management fees, and other expenses. The final rule clarifies that the computer model must be designed and operated to appropriately weigh factors used in estimating future returns. Under the final rule, advisers may consider “generally accepted investment theories” or other additional considerations in forming their advice. DOL declined to identify particular theories, although it did agree that the modern portfolio theory satisfied the standard. This lack of guidance could present considerable uncertainty in determining whether the computer model is appropriately designed.

Notably, the final rule varies from the proposal, which excluded the requirement that the computer model must include qualifying employer securities and target date or life cycle funds (called “asset allocation funds” in the rule). DOL believes that a computer model can be designed to address investments in employer stock and asset allocation funds, and that participants can benefit from advice about overconcentration or other advice that would take these investment options into account. These investments must now be included within the computer model. The model can be expected to recommend against large positions in single securities, if the plan offers other, diversified options, which will be inconsistent with Congress' desire to encourage employee ownership and the employees' own desire to invest in their employers' stock. Given the already heavy administrative and disclosure burden of the rule, this change may discourage some plan sponsors from making use of computer-based advice models.

Another change in the final rule clarifies that, consistent with DOL's earlier FAB, the limitation on a fiduciary adviser's fee relates only to fees that vary based on selected investment options. These fees were viewed as potentially creating an incentive for the fiduciary adviser to favor certain investments. An aspect that remained unchanged is that the fee and compensation limitation applies to the adviser and is not extended to the adviser's affiliates, despite comments to the contrary. It's worth noting, however, that the adviser may not receive fees from any party, including an affiliate, if the fees vary due to investment selections.

Finally, on a related housekeeping matter, since DOL's participant-level disclosures touch on the new rule, some service providers had expressed concern that the disclosures could be considered an advertisement for securities, implicating SEC Rule 482. On October 27, 2011, DOL and SEC confirmed that satisfying DOL's annual participant disclosure regulation (which becomes effective May 31, 2012) will also satisfy the requirements of SEC Rule 482.