In response to many questions about the “investment advice” exemption (“Exemption”) of the Pension Protection Act of 2006 (“PPA”), the Department of Labor (“Department”) released Field Assistance Bulletin 2007-01 (“FAB”) (Feb. 2, 2007), addressing issues of particular importance to financial institutions servicing employee benefit plans and individual retirement accounts (“IRAs”) and plan sponsors. The FAB resolves some of the uncertainties created by the PPA and creates a new option for service providers that wish to provide investment advice without fee offsets or reliance on computer models.
This memorandum reviews –
- Pre-PPA common industry approaches to structuring investment advice programs, based on the Department’s advisory opinions and other guidance.
- The scope, requirements and the issues created by the Exemption.
What Your Peers Are Reading
- Issues resolved by the FAB.
- Open issues.
I. Background — Pre-PPA Approaches for Investment-Related Advice Services
The Employee Retirement Income Security Act of 1974, as amended (“ERISA”), imposes a number of substantial rules on “fiduciaries.” The term “fiduciary” generally would include persons providing investment advice for a fee to 401(k) and other retirement plans (“plans”). Fiduciaries must act prudently and for the benefit of plan participants and beneficiaries. ERISA ? 404. Fiduciaries also must avoid prohibited transactions, e.g., certain transactions between the plan and “parties in interest,” and transactions involving fiduciary self-dealing and conflicts of interest. ERISA ?406. Providing investment advice to plans, while receiving fees in connection with that advice, may subject financial institutions to liability under ERISA.
Prior to the PPA enactment in August 2006, the Department issued various forms of guidance concerning when a person would be a fiduciary by reason of rendering investment advice and when the provision of investment advice may result in prohibited transactions under ERISA. This guidance is briefly discussed below.
A. Interpretive Bulletin 96-1 — Educational Materials Approach
In Interpretive Bulletin 96-1, 29 CFR ? 2509.96-1 (“IB 96-1″), the Department identified safe harbors for four categories of educational information, the provision of which would not constitute investment advice.
B. “Fee Leveling or Offset” Approach — Frost Bank and COUNTRY Bank Opinions
One of the popular approaches to avoiding ERISA violations is the so-called “fee leveling or offset” approach, sanctioned by DOL in Advisory Opinion 97-15A (May 22, 1997) (Frost Bank). In Frost Bank, the Department opined that, where a fiduciary advises a plan to invest in mutual funds that pay additional fees to the advising fiduciary, the advising fiduciary generally would violate section 406(b)(1). However, to the extent that the fiduciary uses every dollar of fees the mutual funds pay the fiduciary to offset fees that the plan is otherwise legally obligated to pay the fiduciary (e.g., for trustee services), section 406(b)(1) will not be violated because the fiduciary is not considered to be dealing with plan assets for his own account. Similarly, DOL has stated that there is no violation of section 406(b)(3) if the fiduciary’s compensation is not received “for his personal account” and, instead, fees are received on behalf of a plan.
In the subsequent opinion issued to the COUNTRY Trust Bank, the Department confirmed that the “fee leveling or offset” approach may be applied where advisory services are delivered to an IRA and where fees are paid from either affiliated or unaffiliated mutual funds. DOL Adv. Op. 2005-10A (May 11, 2005) (COUNTRY Bank).
C. “Independent Financial Expert” — SunAmerica Approach
Another commonly used model for providing investment advice to plans originated with the Department’s Advisory Opinion issued to SunAmerica in 2001. DOL Adv. Op. 2001-09A (Dec. 14, 2001) (SunAmerica). In SunAmerica, the Department concluded that a financial services firm may serve as a fiduciary and offer an investment advisory program without violating section 406(b) of ERISA where the investment recommendations are under the control of an independent financial expert. The SunAmerica product involved affiliated and unaffiliated investment vehicles offered to participant-directed defined contribution plans. SunAmerica received varying levels of fees from affiliated and unaffiliated investment vehicles in connection with plan investments — there was no fee leveling. SunAmerica offered investment advice and discretionary management services to plan participants under the program in return for an additional asset based fee.
Under the program, an independent financial expert constructed a number of “model” portfolios suitable for individuals with different risk profiles and investment horizons by combining the plan’s investment options (selected by the plan’s named fiduciary). Although SunAmerica’s own representatives actually administered the program and recommended the portfolios, the Department concluded that, because the recommended portfolios were constructed by an independent party, SunAmerica would not commit a violation of the self-dealing and anti-kickback prohibitions under ERISA section 406(b) by offering the program and receiving various fees from investment options. SunAmerica representatives could not provide any investment recommendations not specified by the model.
II. The PPA Exemption
Congress added the Exemption to ERISA in order to foster new advice programs that did not exist under current law. However, a number of uncertainties exist in the statutory language, as finally passed. We discuss the Exemption and the issues below.
A. Scope of Relief
As amended by the PPA, new section 408(b)(14) of ERISA and section 4975(d)(17) of the Code provide relief for a “fiduciary adviser” for the following transactions:
- the provision of investment advice to participants and beneficiaries (not plan fiduciaries);
- the acquisition, sale or holding of any security or other property pursuant to such investment advice; and
- the direct or indirect receipt of compensation by the “fiduciary adviser or an affiliate thereof (or any employee, agent, or registered representative) in connection with the provision of the advice . . .”
A “fiduciary adviser” is defined to mean a person who is a fiduciary by reason of providing investment advice and who is a registered investment adviser, bank, insurance company, broker dealer, and any of their affiliates, and all of their employees and agents (including employees and agents of affiliates). ERISA ? 408(g)(11)(A).
B. Eligible Arrangements