Putting out Fires with Gasoline
The DoL pulls controversial participant investment advice rules—what’s next?
Reported by Elayne Robertson Demby
The Pension Protection Act (PPA) amended the Employee Retirement Income Security Act (ERISA) to facilitate giving participants investment advice, and called for the DoL to issue guidelines. (PPA provided two prongs through which this advice could be given—fee leveling and computer modeling. Fee leveling does not require specific DoL regulation to go into effect, although the DoL did issue a Field Assistance Bulletin to help interpret the provision. Computer modeling cannot go into effect until the DoL issues regulations establishing the requirements to be an eligible investment expert and the certification process. Thus, PPA computer modeling cannot be used at the present time.) PPA allows investment advice to be given pursuant to computer modeling if it meets certain requirements, including certification by an independent party, says Janet Jacobson, the Senior Counsel, Retirement Policy, for the American Benefits Counsel in Washington. Alternatively, if an adviser is providing investment advice, its fees cannot vary based on which investments participants select, she adds.
Although the PPA was passed in 2006 and the investment advice regulations were proposed in August 2008, it was not until January 2009, at the tail end of the Bush administration, that the DoL published final rules implementing the investment advice rule. The effective date was 60 days following publication.
A storm of controversy followed. Critics, including the AFL-CIO and AARP, argued the rules were not in participants’ best interests and prone to abuse by the financial industry. Critics drowned out supporters. While the rules initially had support when proposed, by January 2009, because of the financial environment, supporters were not as vocal as before, notes Jason Roberts, an attorney with Reish & Reicher in Los Angeles.
On coming into office, President Obama’s Chief of Staff issued a memorandum delaying the effective date of all pending regulations, not specifically directed at the investment advice regulations. After review, however, the effective date of the investment advice regulations was further delayed.
On November 16, the DoL announced it was extending the effective date of the rules yet again, says Roberts. Then, three days later, on November 19, the DoL withdrew the rules. In the announcement, the DoL stated that it withdrew the rules “based on public comments that raised sufficient doubts as to whether the conditions of the final rule and the class exemption associated with the rule could adequately protect the interests of plan participants and beneficiaries.”
On a Web chat held in early December, Assistant Secretary of Labor Phyllis Borzi said, “In particular, we are concerned that the proposed regulation had permitted conflicted advice in a way that Congress had not intended when it carefully crafted legislation on the question.”
Not everything in the withdrawn rules was contentious. The first part of the regulations, implementing the PPA statutory exemption for computer-provided advice was not divisive. Essentially, the withdrawn rules allowed providers to have proprietary computer-driven investment advice products on their platforms if the program were certified by an independent third party as being unbiased. This was consistent with congressional intent, says Roberts.
It was the second part of the rules, however, that caused the storm. At the heart of the issue was the concept of fee leveling. The PPA does not specify where level compensation is supposed to begin or end, says Roberts. It is obvious that a producer’s compensation should not vary because it makes recommendations, he adds, but, after that, how far up the chain to go was questionable.
There are essentially three levels to which fee leveling can apply, explains Jacobson. The first level is investment advisory firm employees providing the advice. The second level is the employees and their employer firm. The third level is the employees, employer, and any entity affiliated with the employer.
The Bush administration, says Roberts, interpreted the PPA level compensation provisions narrowly. It took the position, he says, that, while a producer and registered investment adviser (RIA) had to have level compensation, the broker/dealer did not have to. The withdrawn rules provided that, even if there were an affiliated adviser down the line who does not receive level compensation, says Roberts, it is acceptable to give investment advice as long as the adviser’s and the RIA firm’s compensation was level.
For example, a financial firm could set up a separate, affiliate RIA firm to provide investment advice to participants, says Roberts. As long as the RIA and the RIA firm’s compensation was level, he says, the financial firm’s compensation did not have to be level. Additionally, if insurance-affiliated broker/dealers have level compensation from a group annuity contract, says Roberts, it would not matter if the insurance company’s compensation varied depending on which sub-accounts are chosen. The withdrawn rules also incorporated a new class exemption from ERISA’s prohibited transaction rules that would have allowed fee leveling only to apply to the employee if certain conditions were met, including fee leveling, authorization by a plan fiduciary, disclosures and annual audits, policies and procedures were in place, says Jacobson.
It was the Bush administration’s narrow interpretation of fee leveling that led to concerns that employees could get conflicted advice, says Jacobson. “People on the Hill and in the administration believed that the balance was not right to protect workers,” says Bradford Campbell, counsel in the Washington office of Schiff Hardin LLP, and former Assistant Secretary of Labor during the Bush Administration.
However, the Bush Employee Benefits Security Administration (EBSA) had a good reason for interpreting PPA this way, says Campbell. The class exemption was meant to address when additional advice could be provided, beyond the computer model, without there being a prohibited transaction, Campbell explains. The intention was to mitigate the conflict, and cover the situation where the participant has gotten advice from the computer model, but then asks for additional advice. For example, says Jacobson, what happens if an employee says “I don’t want to follow the advice the computer gave. I want to do X?”
Essentially, if the participant goes through the computer model and then wants more advice, the additional exemption said that it was all right, says Roberts. “[EBSA wanted to] make sure the information was unbiased, but available,” says Campbell.
However, the regulation’s withdrawal only stirred up more controversy. “They threw the baby out with the bath water,” says Campbell. He defends the withdrawn rules as having balanced workers’ interests, but acknowledges that people can disagree. It is understandable that the Obama administration may have disagreed with one part of the withdrawn rules, he says, but that is no reason to pull the entire package.
Participants, plan sponsors, and advisers all want the computer-driven portion of the regulations finalized, says Roberts. There is a tremendous participant demand for any kind of investment advice, he says, and sponsors are more comfortable with computer-generated advice because there is less chance for human error.
Additionally, says Roberts, advisers working in the small-plan market, $10 million and less, are anxious for the computerized advice rules to be finalized. Advisers on this level, he says, are more interested in opportunities in cross-selling other products to executives and participants than giving investment advice. Furthermore, advisers affiliated with broker/dealers, he adds, are more comfortable with computers providing the advice. “If the advice is being provided by a computer,” he says, “there’s no one who’ll be taking their clients out to lunch.”
The experts agree that the most likely course of action will be that the DoL will re-propose the rule implementing the computer model PPA statutory exemption. In the announcement withdrawing the rules, EBSA indicated that it intends to publish separately new proposed rules. New proposed rules are currently in the Office of Management and Budget, adds Jacobson. As for what the new proposed rules might look like, Borzi said on the Web chat that “the regulated community should expect a proposal which more closely follows the intent of Congress in establishing a statutory exemption from the conflict of interest provisions of (Employee Retirement Income Security Act) ERISA.”
When those new proposed rules will be finalized is questionable. Borzi noted that EBSA has targeted February 2010 for publication of the proposed regulation. “With the proposal in the final stages of the clearance process, we are working hard to get it published as soon as possible.”
For some advisers, however, not having the final rules in place is actually an opportunity. Pure level-fee advisers with no affiliations do not need an exemption to provide investment advice to participants, points out Roberts; they can deliver advice without it.
Not having the investment advisory rules obviously benefits independent investment advisers, says Campbell. It is probably a good time to be an independent adviser, he says, as sponsors want to provide participants with advice. It is now an attractive time to be making overtones to sponsors, he says.
Advisers with a broker/dealer or a provider affiliate, on the other hand, need to wait and see if the new regulations will allow them to operate with an exemption even though an affiliate two or three rungs up the ladder is not getting level compensation, says Roberts.
However, while a fully independent investment adviser, with no affiliations, now can provide investment advice to participants, notes Campbell, the problem is that almost two-thirds of small plans (those with fewer than 100 participants) use turnkey bundled products. Historically, he says, there has been low penetration of investment advice in these plans.
“How do we get a more effective delivery system for advice? How do we make it possible for a one-stop shop to offer investment advice?” asks Campbell. Many plans, especially smaller plans, are not going to take the time to negotiate separately with, and take the risk for selecting and monitoring, an advice provider. In the SunAmerica advisory opinion, the DoL made it somewhat easier by clarifying how an investment service provider to the plan can contract separately with an independent computer-model advice provider to pass through independent advice but, still, only a fraction of the marketplace uses this mechanism. To really serve workers in the real world, there needs to be a better way to let advice be a cost-effective part of ordinary plan services, even when purchased from a single provider. Campbell says, “I believe our final regulation achieved both objectives: It would have protected workers from conflicts with appropriate safeguards, and it would have allowed advice to be more widely adopted in plan design. The PPA advice statutory exemptions implemented by the final regulation , along with the class exemptions providing post-model advice, would have made it much easier for quality, professional investment advice to be offered to workers by plans’ existing service providers within a framework of appropriate safeguards.“
The big question at this point, says Jacobson, is how far up the chain any new rules will require fee leveling.
For some, more disturbing is the belief that the new administration is inclined to invalidate or narrow the SunAmerica ruling allowing for computer-provided advice from third parties. In September 2009, Borzi said, in a public statement, that she had heard from others on the Hill that SunAmerica was being interpreted “too broadly,” and indicated that, if that is the case, it should be reported to the DoL. “There is some concern that the new rules may invalidate these arrangements, leading to plan sponsors eliminating investment advice entirely,” says Jacobson.