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Pension Reform Act Allows Employees With 401(k)s To Obtain Investment Advice

In recognition of historic changes in worker retirement planning, Congress has passed pension reform legislation allowing companies to provide their employees with access to professional investment advice under fiduciary and disclosure safeguards. The Pension Protection Act (H.R. 4) includes a comprehensive investment advice provision allowing employers to provide rank-and-file workers with access to a qualified investment adviser who can inform them of the need to diversify and help them choose appropriate investments. The Act also includes tough fiduciary and disclosure safeguards to ensure that advice provided to employees is solely in their best interest.  The Pension Protection Act has the strong support of the Investment Company Institute, the Securities Industry Association, and the American Bankers Association. The provisions are generally effective with respect to investment advice provided after December 31, 2006.

The vehicle for the provision of this investment advice will be the fiduciary adviser, a new term in financial regulation, defined to mean a plan fiduciary who is also a registered investment adviser, registered broker dealer, bank trust department, or insurance company. The fiduciary adviser will provide the advice through an eligible investment advice arrangement.

This means that the Act includes important fiduciary safeguards and new disclosure protections to ensure that workers receive quality advice that is solely in their best interests. Under the measure, these qualified fiduciary advisers who are fully regulated by applicable banking, insurance, and securities laws, may offer investment advice; ensuring that only qualified individuals may provide advice. In turn, for the first time, qualified fiduciary advisers will be allowed to offer face-to-face, personally-tailored investment advice to help employees manage their 401(k) and other retirement options.

The Act recognizes that, as more and more employers provide 401(k) plans to their workers, rank-and-file employees are shouldering more of the risk of their investment. But, at the same time, these employees rarely have the time or knowledge to actively manage these investments and generally have no access to quality investment advice through their employer.

Moreover, the Employee Retirement Income Security Act (ERISA) prevents employers and investment intermediaries from providing individualized investment advice to workers. Arcane and highly complex ERISA rules severely limit the ability of mutual funds, banks, and others to provide investment advice to workers in the plans they service. Thus, currently, most financial services firms who provide services to 401(k) plans are unable to offer advice because of the application of restrictive prohibited transaction rules in ERISA. The measure would provide a statutory exemption from ERISA’s prohibited transaction rules for the provision of investment advice regarding plan assets subject to the direction of plan participants.

 In order to qualify for the exemption, an entity must be a fiduciary adviser and must meet a series of detailed requirements. As mentioned, under the Act, investment advice can only be offered by fiduciary advisers, which must be qualified entities already regulated under other federal and state laws. Fiduciary advisers can include registered investment advisers, the trust department of banks, and registered broker-dealers.

As additional protection, Congress commands that the terms of a recommended transaction must be at least as favorable to the plan as an arm's length transaction would be, and that the compensation received by the fiduciary adviser be reasonable. Fiduciary advisers must also comply with a six-year record-keeping requirement for records necessary to determine whether the conditions of the exemption have been met.

The Act spells out that a plan sponsor that arranges for a fiduciary adviser to provide investment advice has no duty to monitor the specific investment advice given by the adviser. But the plan sponsor retains the duty of prudent selection and periodic review of the fiduciary adviser. Plan assets may be used to pay for the expenses of providing investment advice.

The Act embodies a voluntary concept since it does not require any employer to contract with an investment adviser; and no employee is under any obligation to accept or follow any advice. Workers will have full control over their investment decisions.

More specifically, Section 601 provides a statutory exemption from the prohibited transaction rules of ERISA and the Internal Revenue Code for the provision of investment advice regarding plan assets subject to the direction of plan participants and beneficiaries and the sale, acquisition, or holding of securities or other property pursuant to such investment advice; as well as the receipt of fees or other compensation in connection with providing the advice.

In order to qualify for the exemption, an entity must be a fiduciary adviser as defined in the Act and must meet a series of detailed requirements.

Before the initial delivery of investment advice, the fiduciary adviser must provide a plan participant with written notification, which may be electronic, disclosing all fees that the adviser receives relating to the provision of investment advice, including from third parties; and of any interest of the fiduciary adviser in any security or other property recommended, purchased or sold.

Also disclosed must be the advisory services offered and the fact that the adviser is acting as a fiduciary of the plan in connection with the provision of such advice. Also subject to disclosure is the plan participant's right to seek advice from an unaffiliated adviser. The fiduciary adviser must also disclose the manner and circumstances under which information provided by the plan participant will be used or disclosed.

Finally, the fiduciary adviser must disclose the role of any related party in the development of the investment advice program or the selection of investment options under the plan; and past performance and rates of return for each investment option offered under the plan.

This information must be maintained in accurate form and must be provided to the recipient of the investment advice, without charge, on an annual basis, on request, or in the case of any material change.

Any notification must be written in a clear and conspicuous manner, calculated to be understood by the average plan participant, and sufficiently accurate and comprehensive so as to reasonably apprise participants of the required information. The Secretary of Labor is directed to issue a model form for the disclosure of fees and other compensation as required by the provision.

Fiduciary advisers must comply with a six-year record-keeping requirement (for records necessary to determine whether the conditions of the exemption have been met). A prohibited transaction will not be considered to have occurred solely because records were lost or destroyed before the end of six years due to circumstances beyond the adviser’s control.

Any investment advice provided to participants or beneficiaries may be implemented only at their direction. The terms of the securities transactions must be at least as favorable to the plan as an arm's length transaction would be, and the compensation received by the fiduciary adviser in connection with any transaction must be reasonable. The fiduciary adviser must also provide a written acknowledgement that it is acting as a fiduciary of the plan to the plan sponsor.

Section 601 creates a prohibited transaction exemption for investment advice provided to employer sponsored retirement plans, such as 401(k) plans, through a computer model that is certified by an independent party. An exemption for advice provided by an adviser whose compensation does not vary with the investments selected would be available to both employer-sponsored 401(k) plans and IRAs.

Fiduciary advisers for non-employer sponsored plans, such as IRAs, would have to charge a flat rate fee for one year, with no computer model.  During that time, the Department of Labor, in consultation with Treasury, will study whether a computer model exists to tailor professional investment advice to an individual’s own unique needs based on personal and subjective criteria about their financial and family circumstances, taking into account the full range of investment options available to IRAs, including equities and bonds.  If they cannot certify that such a model exists, then the advisers would be free to provide advice free from the prohibited transaction exemption as long as they certify in writing that the company has adopted written policies and procedures which ensure that the investment advice provided is in the employee’s best interest.

If the Department of Labor determines an appropriate model is available for IRAs, a certified computer model will be an option for providing investment advice to IRAs. If the Department of Labor determines that an appropriate model is not available, it will issue a prohibited transaction exemption that protects IRA account holders from biased advice without requiring fee-leveling or a computer model. This exemption will sunset on the later of two years after an appropriate IRA computer model becomes available, or three years after issuance of the exemption.

As seen, Section 601 adds a new category of prohibited transaction exemption under ERISA and the federal tax code in connection with the provision of investment advice through an eligible investment advice arrangement to participants and beneficiaries of a defined contribution plan, such as a 401(k) plan, who direct the investment of their accounts under the plan and to beneficiaries of IRAs.

If the requirements under the provision are met, the following are exempt from prohibited transaction treatment: (1) the provision of investment advice; (2) an investment transaction; and (3) the receipt of fees or other compensation in connection with the provision of the advice or an investment transaction pursuant to the advice.

The prohibited transaction exemptions provided under the provision do not in any manner alter existing individual or class exemptions provided by statute or administrative action.

Under the Act, an eligible investment advice arrangement is an arrangement that either provides that any fees or commissions received by the fiduciary adviser for investment advice or with respect to an investment transaction with respect to plan assets do not vary depending on the basis of any investment option selected, or uses a computer model under an investment advice program in connection with the provision of investment advice.

In the case of an eligible investment advice arrangement with respect to a defined contribution plan, such as 401(k) plans, the arrangement must be expressly authorized by a plan fiduciary other than the person offering the investment advice program or any person providing investment options under the plan.

If an eligible investment advice arrangement provides investment advice pursuant to a computer model, the model must:

 (1) apply generally accepted investment theories that take into account the historic returns of different asset classes over defined periods of time,

 (2) use relevant information about the participant or beneficiary,

 (3) use prescribed objective criteria to provide asset allocation portfolios comprised of investment options under the plan,

 (4) operate in a manner that is not biased in favor of any investment options offered by the fiduciary adviser or related person, and

 (5) take into account all the investment options under the plan in specifying how a participant's account should be invested without inappropriate weighting of any investment option.

An eligible investment expert must certify, before the model is used and in accordance with rules prescribed by the Secretary, that the model meets these requirements. The certification must be renewed if there are material changes to the model as determined under regulations. For this purpose, an eligible investment expert is a person who meets requirements prescribed by the Secretary and who does not bear any material affiliation or contractual relationship with any investment adviser or related person.

In addition, if a computer model is used, the only investment advice that may be provided under the arrangement is the advice generated by the computer model, and any investment transaction pursuant to the advice must occur solely at the direction of the participant or beneficiary. This requirement does not preclude the participant from requesting other investment advice, but only if the request has not been solicited by any person connected with carrying out the investment advice arrangement.

A person who develops the computer model or markets the investment advice program or computer model is treated as a person who is a plan fiduciary by reason of the provision of investment advice and is treated as a fiduciary adviser, except that the Secretary may prescribe rules under which only one fiduciary adviser may elect treatment as a plan fiduciary.

Other requirements

In order for the exemption to apply, the following additional requirements must be

satisfied:

(1) the fiduciary adviser must provide disclosures applicable under the securities laws;

(2) an investment transaction must occur solely at the direction of the recipient of the advice;

(3) compensation received by the fiduciary adviser or affiliates in connection with an investment transaction must be reasonable; and

(4) the terms of the investment transaction must be at least as favorable to the plan as an arm's length transaction would be.

Audit requirements

In the case of an eligible investment advice arrangement with respect to a defined contribution plan, such as 401(k) plans, an annual audit of the arrangement for compliance with applicable requirements must be conducted by an independent auditor (i.e., unrelated to the person offering

the investment advice arrangement or any person providing investment options under the plan) who has appropriate technical training or experience and proficiency and who so represents in writing. The auditor must issue a report of the audit results to the fiduciary that authorized use of the arrangement. In the case of an eligible investment advice arrangement with respect to IRAs, an audit is required at such times and in such manner as prescribed by the Secretary of Labor.