BNA Pension and Benefits Blog

Thanksgiving Feast or Famine? - DOL Withdraws its Investment-Advice Regulation

The DOL has withdrawn its investment-advice regulation, culminating a process that began with a firestorm of objection regarding the DOL's attempt to implement the PPA's new investment-advice exemptions. The PPA's exemptions were controversial when passed, and became more controversial when the Department interpreted certain fee-leveling requirements in a manner that was perceived to be narrow. Then, in the final regulations, the Department added a new administrative exemption that narrowed the requirements still further, touching off congressional accusations that questioned the regulatory process itself.

The shrillness of some of the rhetoric was, to me (see my prior post on this), unfortunate, as efforts over a long and arduous regulatory process by dedicated public officials became characterized and impugned as special-interest gifts bestowed on the eve of a change in administrations. In an interesting rhetorical twist, which had the intended public-relations consequences, what I would have more neutrally called "inside" advice came to be referred to pejoratively as "conflicted" advice.

With the change in administrations, those upset with the regulations became empowered, and their influence within the DOL increased dramatically, as one might expect. The Department's actions now indicate that there will be some narrowing of the rules, but it remains to be seen whether a reproprosed rule will so narrowly interpret the statutory exemption that it will essentially marginialize it altogether. That could happen if, for example, the level-fee requirements were to be interpreted so as to require structures that are so sanitized that the structures don't involve self-dealing at all, in which case no exemption would be necessary. (I would expect the prior work done regarding the computer-model exemption to be relatively less controversial, and would be surprised if the Department would propose dramatically reversing that aspect of the regulations; we'll have to wait and see.)

To me, what amounts to a regulatory repeal of the statutory exemption would be unfortunate. The PPA struck a legislative balance given the legitimate and crying need that participants have for this advice, on the one hand, and conflicts that may arise, on the other. The Department's new proposals will hopefully not, by fiat, effectively repeal the fee-leveling exemption.

I think it is critically important that a wide range of professional advice be made available to 401(k) participants, who are in desperate need of professional advice. I think that one of the great deficiencies in current retirement policy is that, with the move to a focus on participant-directed defined contribution plans, which is the result of a confluence of events over time, what may be among the most important of investment assets - retirement assets - are left under the management of those (like me) often utterly untrained in how to invest those assets.

The PPA struck a balance that would have facilitated the provision of additional types of advice. Was the balance struck in the statute the precisely correct one? That, of course, is always open to discussion, but Congress did act. There now are proposals in Congress that would recut the rules, in effect eschewing any effort to balance the competing considerations and deciding that no conflict is tolerable, and the approach taken in those proposals is extreme. I think it would be unfortunate if Congress were altogether to take away from employers the ability to arrange for reasonably crafted inside advice delivered with proper safeguards (what I've called "conflict-safe," as opposed to "conflict-free," advice). In any event, though, the Department should credibly implement the rules that have passed, unless and until Congress reverses those rules.

And to what point does that bring us? At a minimum, I would expect the DOL to cut back or reverse the administrative exemption that goes beyond the statute; but we'll have to see how much farther they go in trying to narrow the statutory rules that are already there. At the end of the day, wherever it all lands, I hope that we wind up with a system that permits participants and beneficiaries to have a reasonable shot at accessing a wide range of professional advice to help them through the investment of their retirement nest eggs.

Glass Half Empty or 3/4 Full?

PBGC released its Annual Management Report for the fiscal year that ended September 30, 2009, and the headlines once more focus on the extent of PBGC's deficit, largely the $21.1 billion deficit in the single-employer program. Overlooked is the fact that PBGC's assets cover more than 75% of its liabilities. Also, that the deficit increase is largely a function of the interest rates used to discount PBGC's liabilities, which dropped almost 150 basis points.

Unlike the FDIC, PBGC doesn't have to pay out immediately when it takes over an underfunded plan. PBGC had positive cash flow, bringing in $2 billion more than it paid out.

Let's focus not on the short-term accounting measure but on PBGC's long-term ability to pay benefits. A sensible, diversified investment policy will go a long way over time to narrow the gap.

Participant's access to information in claims adjudications.

One of the purposes of ERISA was to provide participants with access to information so they could understand their rights and obtain their benefits from their plans.

One of the major problems that plaintiffs face is obtaining information and documents from insurance companies and third party administrators, when they do not comply with the US Department of Labor Claims regulations. For example, they do not provide the appropriate notices to the claimant about the specific sections they are relying upon in the plan documents or produce the documents relied upon in the claims adjudications.

These entities are not subject to penalties under ERISA unless they are designated as plan administrators, which rarely happens, and they can ignore their obligations to comply with ERISA.

I suggest that the statute and/or the claims regulations be amended to address these issues so that the insurance companies and TPAs will now have a financial incentive to comply with their obligations to the plans and the participants.

EEOC Issues Technical Assistance Document Explaining ADEA Waivers to Employees (and Employers)

For those of you who work on the compensation portion of employment agreements or the compensation payout (severance) provisions of employment termination agreements, you should be aware of a recent piece of guidance issued by the EEOC on ADEA waivers in exchange for severance payment agreements.

On July 15, the EEOC held an open hearing on recent developments in the ADEA area. Experts discussed enforcement problems highlighted in several recent cases and the courts’ failures to appreciate the significance of age-based stereotyping. Plaintiffs from several recent cases discussed their experiences. Last, but most significant, in this year of the monster recession, the Commission issued a technical assistance document, in question and answer format, that explains the rights and obligations of terminated employees who waive discrimination claims in exchange for severance pay.

The latter provides a question and answer guide for employees of the views of the EEOC on waivers. In addition to sixteen (16) pages of questions and answers, the guide contains an employee checklist for “What to do When [an] Employer Offers [a] Severance Agreement” and a Sample Waiver Agreement that can be used by employers to achieve an EEOC compliant ADEA waiver.

The materials are very timely given the large numbers of employment terminations and are useful tools for practitioners, employers, as well as employees.

How to Restart the Pension System By Giving Executives a Stake In It

In 1973, just before ERISA, we worried about individual workers losing their defined benefits because of insufficient funding, no plan termination guarantees, and little or no vesting.  Most of us did not worry about the whole system falling apart.   There were just too many disappointed expectations under the previous system.

Once we found a way to stabilize the security of the defined benefit (DB) system, however, we set about shredding a central feature of the DB system’s growth.  How?  We just about wiped out the senior executive’s primary stake in the qualified plan system.  We severely limited creditable “compensation” (IRC 401(a)(17)), while also setting a low maximum level of defined benefits under qualified plans (415), and then we piled on limit after limit (“QSLOB”s, “top heavy” rules, etc. etc. etc.). 

Originally, we relied upon the non-discrimination rules (IRC 401(a)(4) etc.) to achieve benefits for the “rank and file” by riding on the coat-tails of the executives’ interest in their own retirement benefits.  But what if executives lost (or severely diminished) their own interest – their own “stake” – in their own benefits under qualified plans? 

In fact, little by little, senior executives saw what was originally not so plain to see: If a highly paid senior executive wants to earn a pension commensurate with his/her total level of earnings, it must be done on a non-qualified basis.  And it wasn’t just the CEO and CFO who lost interest in qualified DB plans.  Perhaps more importantly, it was the Senior Vice President (SVP) for HR and/or Benefits (the source from which all blessings flow?).  The “clients” who oversaw all pension plan design discussions no longer saw themselves as having a primary personal pension stake in that qualified plan design.  And when the “clients” lost interest in qualified DB plans, their lawyers, actuaries, and consultants got the message(s): 401(k) plans, originally designed to “supplement” DB plans, began to supplant them instead; traditional DB plans converted into cash balance versions; other DB plans froze; other DB plans terminated.   And the ball game is just about over. 

In the meantime, a huge new plan design game mushroomed: Non-Qualified Deferred Compensation.  And DB plans, left behind, became moribund.  Why?  For many reasons.  We tend to blame various versions of “the perfect storm” – a combination of stock market decline and interest rate decline, large and sudden unexpected increases in required contributions to DB plans, fouling up corporate budgets and expected cash flow at just the wrong time.  But that was not inevitable.  It was mainly an inevitable result of using unreasonable actuarial assumptions (earnings assumptions too high, and other manipulations), which of course lead inevitably to a day of reckoning.  The day of reckoning always needs a villain – and the obvious  villain (in most cases wrongly accused!) was the DB plan itself, and not the actuarial games that exacerbated the funding crisis. 

In any event, the result was abandonment of the DB system, followed by much hand-wringing, sturm und drang, and insistence that we need to find a “replacement” for lost retirement security.

The most familiar “fix” currently being touted is a mandate – force employers, or require employees, to do something (mandatory IRAs, etc.), as if that would replace what we have lost.  It won’t be sufficient, it won’t work, and it may not be necessary.  

If we want the private system to work as it should, the people who design, implement and run the employer’s benefit plans must be given a major stake (their own retirements) in the employer-sponsored system.   Do that, and they will solve the problem for their employees.  Don’t do that, and they will not.

How can senior executives be given a sufficient personal stake in qualified DB pension plans to induce a resuscitation of the DB system?  It would love to be able to say “it’s simple.”  At least it’s possible.  And here are a few steps to get it started.

1.  Triple the maximum DB Plan benefit.

2.  Triple the maximum amount of creditable compensation under 401(a)(17).

3.  Search-and-find-and-adjust all other statutory and regulatory components of the barricade blocking sufficient executive DB benefits under qualified plans.

4.  Redesign the interface between qualified and non-qualified plans so as to reduce the attractiveness of non-qualified plans when compared to the expanded qualified DB plans.

5.  Amend the non-discrimination rules to assure that the lowest-compensated employees are not the “losers” as a result of using an unreasonably-low percentage-of-compensation DB benefit formula.  (In other words, use a “safe harbor” low-comp approach, when permitting the new expanded hi-comp limits).

Can we “afford” it?  A fair question, but not quite the right question.  We bemoan the “loss” of the old world of DB plans.  Suppose those plans had not frozen or terminated– what would have been the “cost” (tax revenue loss)?  Isn’t this the same amount as the assumed cost of restoring the system?  If so, then the “cost” is just the same as the “cost” of not having lost the old DB system.  If we’re serious about restoring retirement security, then that’s the inherent cost, as it always has been.  And we had better be prepared to pay it, because we’ll end up paying it (welfare for the elderly) one way or the other.

Frank Cummings
July 2009

A Modest Proposal Regarding Same-Sex Marriage

It is not being controversial to say that there is a trend in the states in favor of permitting same-sex marriage.  Previously, a broad array of employers had begun provide benefits for their employees' domestic partners.  See generally Libert, Oringer & Raskin, "Same-Sex Marriage and Employee Benefits: The Approaching Revolution," 63 Empl. Ben. Plan Rev. 22. 

As is well known, the tax laws have generally not been conformed to these evolving trends.  As a result, the treatment of benefits to same-sex spouses and and other domestic partners can be problematic, to say the least, to employers and employees alike.  One possible step that an employer might entertain in connection with resulting adverse tax consequences could be to make a tax gross-up payment in respect of the employee.  Cf., e.g., DOL Adv. Op'n 2001-05A.

I make no comment whatsoever here on the policy considerations underlying same-sex marriage, domestic partnerships or the provision of benefits in these settings.  I do think, however, that, once a jurisdiction decides to facilitate these relationships, it should explore ways in which any resulting ancillary difficulties are mitigated.

Similarly, I make no comment whatsoever here on the policy considerations underlying the question of whether an employer should take the unusual and possibly expensive step of making gross-up payments.  Rather, I am considering those cases in which, for whatever reason, the employer indeed chooses to do so.

So, with that background, I would make a very narrow and limited suggestion.  I suggest that, for those jurisdictions that permit same-sex marriage, any nondiscriminatory gross-up and similar payments made by the employer to help defray the adverse tax consequences to the employee and his or her same-sex spouse would be exempt from state income taxation and other state taxation.  My thinking is that a state might not want to include, as taxable income, payments made to an individual by a party to ameliorate the impact of the interplay between the state's human-rights policies, on the one hand, and another sovereign's (the federal government's) tax rules, on the other.  To me, that type of refinement is in the nature of a conforming change, consistent with what by hypothesis is the state's existing underlying decision to place same-sex marriage on an equal footing with historical marriage.  The ultimate economic impact to the state treasury of the refinement I suggest may well be small (for example, there may not be many employers willing to provide a gross-up), but I think that such a refinement would at least show an effort by the states in question to proceed in this evolving world in a comprehensive and consistent manner. 

Are Certain Reactions to the Investment-Advice Regulations Ill-Advised?

On January 16, 2009, the Department of Labor announced that it had finalized its work under Sections 408(b)(14) and 408(g) of ERISA, which set forth the PPA's new investment-advice exemptions.  The regulations were scheduled to be published in the Federal Register, and were so published, on January 21.  On January 20, the President's Chief of Staff issued a memorandum, for which there is prior precedent, affecting pending regulations, including regulations like the investment-advice regulations which had not yet gone into effect.  74 Fed. Reg. 4435 (Jan. 26, 2009).  The memorandum raises several possibilities relevant here, including the possibility of an extension of the effective date and a call for additional comments, which, if such steps were to transpire, would seemingly as a practical matter reconvert the regulations into proposals.

The final regulations, incorporating what had been a related proposed class exemption, came after a long, deliberative and consultational process.  On the same day as the DOL's January 16 announcement, Rep. George Miller (D-CA), the chairman of the House Education and Labor Committee, and Rep. Rob Andrews (D-NJ) issued a statement slamming the DOL's action.  Their concluding statement was that, “[a]s we transition to a new administration, we will use every tool at our disposal to block implementation of this harmful regulation.”

For myself, I think that the result is regrettable, and I believe that the regulatory efforts both reflect Congressional intent and provide an important basis for the provision of expert financial advice to participants and beneficiaries that historically may not have had ready access to such advice.  The fever pitch that certain members of Congress seem happy to generate by attacking the advisory community at a time when it may be relatively easy to do is to me unfortunate, to the extent that such a backdrop obscures the issues and makes rational discourse on them difficult or impossible.  I guess I shouldn't be surprised when an issue like this becomes politicized, but I can still be disappointed.  

The great irony here in my view is that the DOL personnel involved with the development of these rules were anything but pro-employer and pro-advisor.  There has arguably been a consistently pro-participant bent generally running throughout EBSA from the senior through the junior levels, notwithstanding that the administration of which the DOL has most recently been a part at the time was stridently Republican.  One need only look at the DOL's reaction to the PPA proposals and to the eventual enactment of the PPA, to the approaches taken in connection with the 5500s and 408(b)(2), etc., in order to get a sense of the DOL's concerns, approach and sensibilities.  Thus, the notion that the "Bush administration" was somehow here "still scrambling to give Wall Street a last-minute payback" on its way out the door seems quite unfair.  Rather, I think we more simply had diligent and committed DOL professionals who wanted to see the careful and balanced work they did in furtherance of implementing a statutory directive come to fruition, rather than evaporate in the wake of the inauguration. 

It is understandably the flavor du jour to vilify Wall Street, and, to be sure, there patently is a difference of opinion out there regarding the pros and cons of the investment-advice exemptions.  However, wherever one comes out on the PPA's new exemptions and the DOL's rulemaking in connection therewith, it seems hard to argue with the basic point that participants in participant-directed plans need high-level help and guidance regarding their management of these most-important investment assets.  I would prefer that the open questions on this critical matter get resolved by a careful examination of the statute and what informed it, not through highly charged, emotional descriptions of what we now have before us and how we got to this point.  But (with apologies for the grammar that's about to follow), that's just me . . .  
 

Automakers' Insolvency Opens All the Benefit Cutback Targets and Problems

    The insolvency (whether or not in Chapter 11 reorganization) of the three automakers brings “legacy costs” back to the center stage of ERISA cutback negotiation and litigation. 

    The automakers have already put themselves on the cutting edge of many of these issues outside of bankruptcy.   

    They have litigated retirees’ medical benefit cutbacks, arguing that retirees were not vested (Sprague v. General Motors Corp., 133 F.3d 388, 21 Employee Benefits Cases 2267 (6th Cir. 1998)). 

    They have negotiated VEBAs with the UAW and then sought to bind the retirees by class action settlements and court approval after a fairness hearing. International Union, United Auto., Aerospace, and Agr. Implement Workers of America [McKnight] v. General Motors Corp., 497 F.3d 615, 41 Employee Benefits Cases 1692 (6th Cir. 2007)   Still, further developments are inevitable, particularly in light of the recent VEBA history. 

    Some of the key “legacy cost” questions are these:

        1.  The first question, logically, is this: Are the retirees’ medical benefits “vested”?   The “vesting” of retiree medical benefits is certainly possible, and it depends on the words of the plan, the magic of language such as “for your lifetime,” the admissibility of parole evidence to clarify “ambiguities” in the plan and SPD, and so on. UAW v. Yard-Man, Inc., 716 F.2d 1476, 4 Employee Benefits Cases 2108 (6th Cir. 1983), cert. denied, 465 U.S. 1007 (1984); Sprague v. General Motors Corp., 133 F.3d 388, 21 Employee Benefits Cases 2267 (6th Cir. 1998); Yolton v. El Paso Tennessee Pipeline Co., 435 F.3d 571, 36 Employee Benefits Cases 2217 (6th Cir. 2006); Bland v. Fiatallis, 401 F.3d 779, 34 Employee Benefits Cases 1875 (7th Cir. 2005); Doubtless the rules need clarification, and the various circuits’ positions need reconciliation.

        2. If the case reaches the bankruptcy court, does “vesting” really matter?  The answer ought to be obvious, but if you read the actual language of the Bankruptcy Code (11 U.S.C. section 1114), the statute on its face never mentions vesting, instead requiring continuation of a “program” of  “retiree benefits” that was “maintained” before the bankruptcy filing (Sec. 1114(a)).

        3. If a union makes a cutback bargain, how does the union get to "represent" its retirees, when unions legally only represent actives? Allied Chem. & Alkali Workers v. Pittsburgh Plate Glass Co., 404 U.S. 157, 1 Employee Benefits Cases 1019 (1971).  A retirees’ medical benefit program would not be a mandatory bargaining subject under the NLRA if the bargaining issue did not affect any currently active employee. But that may be a non-problem because the bargaining topic frequently includes benefits for current employees, payable when they retire (which is certainly a mandatory bargaining subject). And in any event, there is an overriding reality in distress situations – the union has at least a little “muscle,” and the retirees ordinarily do not.

        4. In any event, how do you bind the retirees?  Typically, the court certifies a group of retirees as a Rule 23 class action representative.  International Union, United Auto., Aerospace, and Agr. Implement Workers of America [McKnight] v. General Motors Corp., 497 F.3d 615, 41 Employee Benefits Cases 1692 (6th Cir. 2007)

        5. What standard is used by the court to decide whether to force retirees to give up their claim against the employer in exchange for reliance on the VEBA? See the GM and Ford rulings. And while the Ford/GM standards are not (yet) actually under the Chapter 11 cutback devices (sections 1113 and 1114), the VEBA settlements previously approved by the district court were based on findings that the VEBA deals were less severe than the cutbacks the retirees might have lost in bankruptcy (497 F.2d at 628).  And yet only recently GM has backed out of its VEBA funding commitment.

        6.  How can you VEBA-ize a solution to legacy costs, when a VEBA can only accumulate one year’s worth of benefit costs?  A “garden variety” VEBA is allowed only a very limited pre-funding accumulation, but a collectively bargained VEBA is not so restricted. IRC §§ 419(c), 419A(f)(5)(A), 501(c)(9).

        7. What if the employer buys this deal in exchange for payments into the VEBA, and then the employer defaults or goes bankrupt before full payment?

        8. Is there some hidden logic in this -- an assumption that the VEBA only has to remain solvent for a few years, and then National Health will arrive in all its glory and bail out everyone?   How many years?  And in the meantime, what sort of “booking” treatment is allowed, in such situations, for financial statements of public corporations?

        9. Do the rules really change after a filing in Chapter 11?  Chapter 11 bankruptcy reorganization has its own collective bargaining provisions, which apply to changes in labor agreements (11 USC 1113) and even to retirees medical benefits (11 USC 1114). This special “last offer” bargaining lowers but does not ordinarily wipe out retirees medical benefits, because the court’s approval of the “bargain” depends upon a finding that the cut-back is the least severe change necessary to save the debtor.

        10.  And then there is the whole array of issues arising under the defined benefit pension plans.  Termination of these plans (“distress” or involuntary termination under ERISA 4041(c) or 4042), inevitably generates losses by surprise.  Employees and retirees are often surprised that they are not eligible for funded benefit levels as high as they expected, because of the calculation of “PC3" priority benefits under ERISA 4044(a)(3)), particularly after the funding level of the terminated plan is recalculated by the PBGC.  And even the guaranteed benefit level may not be as high as anticipated, given the obscure rules for ERISA Title IV guaranteed benefit calculations.  And the liability of the plan debtor/employer/sponsor may be higher than expected, given PBGC’s determination to argue and re-argue questions concerning their priorities in bankruptcy, even though PBGC seemingly has lost these arguments repeatedly.

    The core problems, however, concern conflicts of interest – conflicts by the union, by the employer, and by the PBGC – and these conflicts abound. 

    The union’s conflict:  It does seem clear that the UAW – now as in the past, all the way back to the seminal Studebaker case – will inevitably be faced with a terrible Hobson’s choice:  Save jobs by lowering costs (“selling out” the retirees)? Or fighting tenaciously for protection of retirees, and risk destruction of the enterprise?  Section 1114(c) of the Bankruptcy Code recognizes the conflict of interest of the incumbent union, but presumes that the conflict may be avoided or ignored.  And yet, inevitably, it is still there.

    The employer’s conflict: ERISA by its express terms makes the employer a presumptive fiduciary – even a named fiduciary – and plan administrator.  ERISA §§ 3(16)(A)(ii), 402(a)(2)(A).  The existence of the conflict is assumed by the statute, but the employer, even with a conflict, is prohibited from acting on the conflict (wearing “two hats” but not at the same time).  And in chapter 11, the employer has three hats – employer, fiduciary for the plan, and fiduciary for the creditors.  Again, the conflict is inherent in the situation.  In the ordinary course, the situation is manageable.  But the puzzles described above are not ordinary.

    And the PBGC’s conflict: The PBGC was invented to protect employees and retirees.  In recent years (decades?), however, the PBGC has often seemed more interested in protecting its balance sheet than its natural constituents.

    We shall see.

Frank Cummings

Election and Retirement Security

The election is now only days away and will occur within the context of a financial markets meltdown. The effect on retirement security has been significant. Public policy considerations must be addressed asap.

DB plan asset values have tanked and funding requirements for 2009 and thereafter will undoubtedly increase substantially. (Partial offsetting relief is experienced because of higher corporate bond rates.) Without some form of pension funding relief, more plan freezes can be expected. We could see some as early as 11/15/08 204(h) notices for 1/1/09 freezes. Several organizations have proposed various relief measures. An alternative simple proposal would be a measure that limited mandatory 2009 contributions to the amount of 2008 contributions with an accompanying rule that 2008 could be ignored for at risk plan status, etc. Hopefully, Congress could address this quickly during the upcoming lameduck session.

More long term, we need to evaluate how we can make 401(k) plans better vehicles for providing retirement security. Several suggestions (some of which have been conceptually addressed by others, e.g. Teresa Ghilarducci, in other conceptual frameworks) include:

1. Improve the market and regulatory rules regarding annuities- deferred annuities purchased throughout one's career, terminal annuities acquired at retirement, and longevity annuities that would commence in at some advanced age (e.g. 80). The first would allow for cost averaging of annuity purchases, the second (a market for which is slowly developing now) may need to be mandated for a portion of terminal account balance (if participant didn't acquire deferred annuities during active participation), and the third would guarantee a level of income for those that survive and allow the rest of one's account to be payable over a fixed period from date of retirement to longevity annuity starting date. Lump sum distributions would be limited to a specified percentage of account balance.
2. Require mandatory participation in some retirement vehicle. If an employee doesn't have a db plan, then they must participate in a 401(k) or similar vehicle. For those employers that don't want to sponsor, individuals should be able to participate in free-standing plans similar to 401(k) sponsored by current (and other) 401(k) vendors.
3. The investment responsibility should be moved from the participants to the sponsor or toher fiduciaries. Plans would only provide balanced, target date funds that employees participated in during their working lives and until distribution or annuitization. Protections for sponsors or vendors similar to 404(c) should apply as long as the manager of the target date funds was prudently selected and monitored.
4. A portion of 401(k) or other retirement plan distributions should be able to be used for retiree health costs on a pre-tax or other tax effective basis (e.g. very low tax rate).
5. For immediate assistance with current financial crisis and longer term thereafter, 10% excise tax on distributions for true financial hardships should be eliminated. It makes no sense to apply this tax to those suffering a financial emergency/hardship.

Investment Advice—ERISA’s Culture War

The DOL’s recent proposed class exemption for the provision of investment advice has re-ignited the debate over the need for and the role of investment advice in participant directed plans. The proposal would strike a good balance between the need to offer investment advice to plan participants and the importance of participant safeguards.

The genesis of the issue comes from DOL’s broad interpretation of the prohibition on self-dealing in section 406(b). DOL takes the position that a fiduciary engages in self-dealing if it uses its authority to affect the amount or timing of its compensation. This, according to DOL, is an automatic, per se violation regardless of the terms of the transaction and whether it is in the interests of plan participants.

This issue is important to financial institutions who sell investment products to plans and are fiduciaries because they provide investment advice. If the advice results in investments in mutual funds that pay varying fees to the advisor, then under the DOL view, the giving of the advice would be a 406(b) violation since the advisor would be using its fiduciary authority to affect the amount of its compensation.

For a number of years, the financial services industry tried unsuccessfully to convince DOL to grant a class exemption for the provision of investment advice. The industry then went to Congress. The House several times passed an advice exemption based on disclosure, but the Senate refused to take any action. Such an exemption finally was passed as part of the Pension Protection Act. The exemption contains relief for advice that is provided through computer models, or where the fees or other compensation paid to the advisor are not affected by the investments selected by the participant as a result of the advice – i.e. fee leveling. These two approaches are intended to minimize the possibility of self-dealing, but have limited utility. Using computer models is not an effective way to provide individualized advice, and fee leveling is not workable for many firms. As a result, DOL proposed a class exemption to cover advice arrangements that involve neither a computer remodel nor fee leveling.

The proposal goes substantially beyond the bill passed by the House that was criticized for not being protective of plan participants, and contains detailed conditions to deal with potential self-dealing. The participant or IRA holder must first receive a computer model or general asset-allocation models. Advice provided under the class exemption cannot generate greater income for the adviser than other options of the same class unless the advisor prudently concludes that the recommendation is in the best interests of the participant and explains this to the participant. In addition, the advisor must document the basis for such conclusion, including an explanation as to how the recommendation compares to the computer model or model portfolios previously furnished. The advisor must also provide detailed disclosure of the fees and other compensation it receives as well as of any material affiliation or contractual relationship with those persons who have a role in the selection of investment options. Finally, the advisor must adopt procedures designed to assure compliance with the exemption and must obtain an annual compliance audit.

DOL has made a good-faith effort to provide an advice exemption with adequate safeguards. However, it will likely be criticized by those who think advice with any potential for abuse is bad. Because participants acutely need advice, and the proposal contains many safeguards, DOL should adopt grant the advice exemption. However, in today’s environment, members of Congress may be inclined to condemn any regulatory action that relies on the prudence and good judgment of a financial institution. It would be unfortunate if the advice proposal were the victim of this environment. Participants would be the losers.