Andrews Bill Raises Questions
In April, Congressman Rob Andrews (D-New Jersey) introduced the Conflicted Investment Advice Prohibition Act of 2009, legislation that seems likely to resurrect concerns about the fate of the final investment advice regulations published earlier this year by the Department of Labor (DoL) in accordance with the Pension Protection Act (PPA).
Those regulations essentially codified a means by which advisers who provided participant-level advice for a fee could receive compensation that could vary based on the investments recommended without running afoul of ERISA’s prohibited transaction restrictions, if they adhered to specific procedures and disclosures. Those regulations, published in final form the same week the Bush Administration left office, were held back by the Obama Administration, which pushed the original effective date from March 23 to May 22 to November 18 “to allow additional time for the Department to evaluate questions of law and policy concerning the rules.”
Andrews has been an outspoken critic of those regulations, specifically the class exemption, which his new bill effectively eliminates. It also would eliminate the fee-leveling rule for financial institutions, says Brian Graff, Executive Director and Chief Executive Officer of the American Society of Pension Professionals and Actuaries (ASPPA). Additionally, it makes clear that, under the legislation, the only way financial institutions that manufacture investments will be allowed to offer investments is through a computer model—a provision included in the DoL regulations and subsequently incorporated in the Andrews bill. So-called “off-model” advice will not be allowed from those firms that manufacture product, Graff says. In many respects, Graff says, for those institutions, this is a return to prior law. That prior law was conceptually embodied by the so-called “SunAmerica rule.”
The Andrews Bill
The new bill, which also provides an exemption to the prohibited transaction rules, cites the impact of the recent market turmoil on retirement savings, and notes that, with more than two-thirds of the assets in 401(k)-style defined contribution plans invested in equities (either directly or through mutual funds) “participants are exposed to increased risk and lack meaningful access to independent investment advice to help them better plan for their retirement.” The bill goes on to say that “currently, 401(k) plan accountholders have access to a self-interested or conflicted investment adviser,” and then cites a Government Accountability Office report that concluded that “conflicts of interest can have an adverse affect on defined benefit and defined contribution plans.”
Although it is still early to tell what will become of the proposed advice legislation, its introduction nonetheless raises practical application questions for advisers and advisory firms. As introduced, the Andrews bill would achieve the goal of limiting conflicts, notes Jason Roberts, an attorney with Los Angeles-based Reish & Reicher. However, he says, the practical question is whether it increases the number of financial firms willing to get into the business of offering advice, and thus, he asked, will it really expand access to advice, as the bill purports to do?
The majority of the bill, about 95% of the language, according to Roberts, is lifted directly from the PPA, most notably with respect to the computer model, audit requirement, and certification. Disclosures are also very similar, although there has been some “tweaking,” he says.
Besides the lack of an ERISA prohibited transaction class exemption, the most notable difference may well lie in the reality that, “in one line, they knock out all of the fiduciary adviser” provisions of the PPA, Roberts says. He says that everything that has been worked on around participant advice over the last couple of years has been under the structure of an understanding of the fiduciary adviser provision and the eligible investment advice arrangement. “To say the least, this is going to be disruptive.” Noting that there are many firms that had built out models in anticipation of the final regulations, Roberts expects questions to arise around what will now happen to those existing relationships and advice arrangements if the Andrews bill were to become law.
In effectively dismantling the fiduciary adviser framework, the Andrews bill substitutes the term “independent investment adviser,” who must be either a registered investment adviser (RIA) under the Investment Advisers Act of 1940, or under the laws of the state in which the adviser maintains a principal office and place of business; a bank or similar financial institution (provided the investment advice provided is provided through a trust department subject to periodic examination and review by federal or state banking authorities), or any other persons if they are registered representatives.An “independent investment adviser” is one who is a fiduciary of the plan by virtue of the advice he provides to the plan. The bill also says that a plan sponsor/fiduciary for a defined contribution plan that allows participants to direct their investments “shall not appoint, contract with, or otherwise arrange for an investment adviser to provide investment advice…unless the investment adviser is an independent investment adviser” as defined in the proposed legislation. An independent investment adviser must not “provide or manage” any plan assets in the individual accounts for which the advice is being provided, and the fees received for that advice cannot be received from those that “market, sell, manage, or provide investments in which plan assets of any individual account plan are invested.”
The advice must be provided pursuant to a written agreement with the participant that must, among other things, provide that: the investment adviser is a fiduciary of the plan with respect to the provision of the advice; the advice be provided “only by registered representatives of the investment adviser or an affiliate thereof”; the adviser discloses whether the investment adviser has any material financial, referral, or other relationship or arrangement with an entity “that creates or may create” a conflict of interest for the adviser and, if so, discloses that arrangement.
The bill also allows for the provision of advice using a computer model that meets specific standards, as do the pending regulations from the DoL.
Ultimately, as is the case under current law, this legislation confirms that a plan fiduciary has a responsibility to prudently select and “periodically review” the “independent investment adviser,” but “has no duty…to monitor the specific investment advice given by the independent investment adviser to any particular recipient of the advice.” Additionally, the legislation also notes that nothing in the Act “shall be construed to preclude the use of plan assets to pay for reasonable expenses in providing investment advice.”
Roberts says another large difference between the Andrews bill and the PPA is that the former outlines exactly how fees can be charged, building the procedures for compliance and the hurdles that must be overcome into the definition of the independent investment adviser and advice itself, rather than as an amendment. In addition to stating that the fees must not vary based on the advice provided, the bill also says they must be calculated pursuant to one or more of the following: flat-dollar, flat percentage of plan assets, per-participant basis, or a written agreement.
Potential Models
For RIAs, the rules are fairly straightforward, asserts Roberts. For other advisers, however, the question remains: How will—and should—they qualify as “independent investment advisers”?
According to Roberts, if wirehouses or independent broker/dealers wanted to allow their advisers to pursue offering investment advice under the Andrews bill, they would have to do the following: The registered rep would have to acknowledge fiduciary status; the firm for which the representative works could not provide or manage investment options in the plan; and the registered rep (and any affiliates) could not receive fees based on the investment options, either directly or indirectly.
Another model that might emerge from this, Roberts predicts, would be for a retirement plan adviser who does not want to meet individually with participants (or, because of broker/dealer restrictions, cannot meet the requirements above) but has a sponsor client interested in advice for participants to link with a trust department to bring in bank Certified Financial Planners (CFPs) to the client to offer individual investment advice.
One thing that should be noted, Roberts added, is that although the prior regulations applied to advice offered to individuals with individual retirement accounts (IRAs) as well as those in qualified plans, this new legislation only applies to the latter.
Plan-Level Issue
Roberts points to one area that seemingly is glanced over, but might be a potential issue for some advisers and advisory firms. The section is entitled “Fiduciary Duties with Respect to Investment Advice,” and it would amend ERISA section 404(a), adding that “The fiduciary of an individual account plan that permits a participant or beneficiary to direct the investment of assets in the individual account shall not appoint, contract with, or otherwise arrange for an investment adviser to provide investment advice…to the plan or the participant or beneficiary unless the investment adviser is an independent investment adviser.”
The word of note in the paragraph, says Roberts, is plan. This paragraph purports to limit those who provide investment advice not just to participants but to plans, to firms that meet the requirements of the bill. Consequently, he notes, any adviser with a broker/dealer or other affiliation with one that either manages or provides investments that are included within a plan or receives direct or indirect compensation (12b-1s, revenue-sharing, etc.) from one who does, would, under this interpretation, apparently be prohibited from rendering any advice unless all compensation received by such affiliates was level or delivered through the computer model exemption provided by the regulation.
This does, however, only apply to those advisers who are fiduciaries because they are providing individualized investment advice. Although it does not force brokers or advisers to become fiduciaries, Roberts says, once you have crossed that line of offering investment advice, this applies. For advisers falling under this regulation, it would mean that, if they are not pure level-fee RIAs, they will have to shut down or make level all 12b-1s or revenue-sharing payments not just to the adviser, but also to the firm.Therefore, he notes, advisers still could play the “broker game” and say they are not providing investment advice to the plan under ERISA and therefore are not subject to this provision. The broker then would have to provide objective analysis that would not be individualized to the needs of the plan.
Although some firms were comfortable not setting up to deliver participant advice under the PPA’s fiduciary adviser model, those firms could be affected significantly if their advisers are prohibited from rendering plan-level advice. However, other than the mention of plan-level advice in that paragraph, the bill itself does not address the plan-level issues, Roberts says.
Roberts notes that, although the regulations are restrictive about the particulars of level compensation requirements, there is a section that allows for the Secretary of Labor to “issue regulations providing that an investment adviser can still be considered as meeting the requirements of section 3(43)(B) despite the receipt of de minimis amount of compensation that fails to meet the requirements…due to the existence of previously existing contracts.” Therefore, Roberts says, it is conceivable that the DoL could determine that a certain threshold of compensation received by affiliates of the adviser to be de minimis and relax the level fee analysis by issuing regulations whereby only the compensation received by the individual adviser and the adviser’s firm must be level. This would be similar to those in the final investment advice regulations tabled by President Obama and similar to Field Assistance Bulletin 2007-1, he says.
Legislation vs. Regulation
Regardless of the outcomes of the regulations and investment advice legislation, Graff says there were still many retirement plan issues being dealt with in Washington, both by regulatory bodies and the legislators. As for which voice will be more active in the future, Graff says the industry will just have to wait and see what gets through first.