Compliance March 7, 2007
Investment Advice Exemptions Have Unresolved Issues
It is not easy to be in compliance with the new investment advice exemptions under the Pension Protection Act (PPA).
Reported by Alison Cooke
The PPA added a whole new layer of hurdles for advisers and broker/dealers looking to offer advice, Taylor Hammons, Director of Retirement Consulting at Morgan Keegan & Co., a regional B/D with about 1,000 advisers, said last week at the Securities Industry and Financial Markets Association (SIFMA) Savings and Retirement Symposium. Hammons said that he would like to be able to continue to provide investment advice, but wasn’t sure it would be under the new Pension Protection Act (PPA) model.
General conditions for offering advice as a fiduciary adviser under the PPA include the requirement of an annual audit by an independent auditor, something that was not addressed in the most recent interpretive guidance by the Department of Labor (DoL), Melanie Nussdorf, Partner at Steptoe & Johnson, said. “What do you audit?’ she asked; it could be every single trade, the fees and costs for trading, or the process in general.
Further, Nussdorf asked, how does an adviser deal with the new disclosure requirements, including information on the role of any party affiliated with the advisor, past performance and historical rates of return on options under the plan, all fees or other compensation that the fiduciary is to receive, including payments from third parties and other significant disclosures? Issues with disclosures could also arise involving fees, brokerage windows within plans, and whether or not the current ADVs contain enough info to satisfy disclosure on affiliates.
Fee Leveling
The new fiduciary adviser model requires, among other things, that the person giving advice has level fees that do not vary based on what investment is selected, unless that advice is based on a computer model. Hammons said Morgan Keegan & Co. has looked at fee leveling and has been able to level at the adviser level, but not at the b/d level. Since advisers are considered employees of Morgan Keegan & Co. and not independents, Hammons said the consensus at the firm was that they had to level fees at the B/D level as well as the adviser level.
But keeping fees level at the B/D level is nearly impossible, Nussdorf agreed, saying that she has been considering a model in her head that might work but would be “extremely impractical.’ If a B/D sets up another entity so that advisers there can work under a flat fee arrangement, are the biggest and best advisers going to be interested in doing that, or will the B/D have to run a dual compensation structure depending on whether the adviser is doing plan and IRA business or personal business, she asked.
There is still much uncertainty about the fee leveling, Nussdorf commented, and although the DoL’s Field Assistance Bulletin (FAB) 2007-1 provided some interpretative guidance, there are still some issues (see DOL Releases Guidelines for PPA’s Fiduciary Adviser). If anything is clear from the FAB, she said, “how you set up your business is critical.’ If the adviser alone signs the document permitting him to give advice, then he could be the only fiduciary adviser; if he is an employee of a B/D but the B/D isn’t mentioned in the document, then the adviser could be the only fiduciary too, she said. However, she cautioned that the B/Ds might have to look at securities laws too, because under those the B/D might be responsible for the adviser.
Computer Model
“We avoid a lot of the hassle if we go to the computer model,’ Hammons said; however, there are still issues surrounding using a computer model to give advice that haven’t been yet clarified by the DoL, panelists concurred.
One issue around the use of a computer model is the requirement of its certification. Nussbaum said that the regulation says the model must be certified by an eligible investment expert who has no material contractual relationship or affiliation with an investment adviser or related entity, something she referred to as the “where’s Waldo of affiliations,’ saying she was hoping the department provides some guidance on understanding better the regulations around affiliates. Further, the guidelines around what or who is considered an eligible investment expert have not yet been given.
When using the model, the PPA says that advice must only come from the model and all decisions are made by the participant. However, Nussdorf said, this might be a problem if the participant doesn’t like the advice; the adviser will have to change the input to get a different outcome from the computer, because the adviser won’t be allowed to tailor the computer model’s outcome verbally. Further, compliance around this will be difficult, she predicted, because if the participant does something not recommended by the computer, how is an adviser going to prove he didn’t say something that the participant then used.
The two areas not impacted by the new regulations are advice to the plan sponsor and giving advice to plan participants under the SunAmerica model (see DoL Lowers Another Advice Barrier) – and it’s hard to argue that the model set forth in the SunAmerica decision is not an easier or more straightforward approach, Nussdorf said.