Investment Advice: Understanding the Rules
In response to great demand, the Pension Protection Act of 2006 (PPA) authorized the providing of investment advice to participants by advisers, including situations where their compensation could involve potential conflicts of interest. And yet, few advisers have decided to offer this service to plans. Why? Because the rules are unclear, at best.
ERISA prohibits fiduciaries from using plan assets for their own benefit or receiving consideration from another party for their benefit in transactions that involve plan assets. However, the PPA includes an exemption from these prohibitions for the providing of investment advice to participants if: (i) the advice is provided through a computer model; or (ii) the fiduciary adviser receives level fees. For the computer model, the fees may vary, but the advice must only be given by an unbiased computer program.
In order to satisfy the level fee requirements, the adviser’s compensation must not vary as a result of the investments he recommends. The DOL stated in Field Assistance Bulletin (FAB) 2007-01 that fees received by affiliates of advisers do not have to be level, unless the affiliate is also considered to be providing the investment advice. However, the DOL explained that both the individual and the affiliated company will be considered fiduciary advisers to a plan “when an individual acts as an employee, agent or registered representative on behalf of an entity engaged to provide investment advice to a plan….” Thus, under these circumstances, the compensation received by both the individual and their affiliated company would need to be level.
For both the computer model and level fee advice arrangements: (i) the compensation received must be reasonable, (ii) the providing of the advice must be approved by a plan fiduciary other than the person providing the advice (such as the plan sponsor), (iii) the adviser must make disclosures, including details regarding its compensation as well as the fact that it is a fiduciary, and (iv) the adviser must be “audited” annually to ensure that he is complying with the PPA. [For additional information, see The Pension Protection Act of 2006: Investment Advice Provisions at http://www.reish.com/publications/article_detail.cfm?ARTICLEID=609]
In addition to these two categories of investment advisers, investment advice may also be provided by totally level fee advisers. That is, persons whose fees do not vary may provide investment advice if the compensation received by their affiliates also does not vary. These types of advisers typically level their fees by: (i) only offering investments that provide the same amount of compensation to them; or (ii) charging a set fee to the plan and then offsetting that fee by any other compensation (such as revenue sharing) that it receives. Although the PPA does not address this type of adviser, prior DOL guidance indicates that these arrangements are not prohibited by ERISA. The DOL states in FAB 2007-01:
[C]onsistent with past Departmental guidance…if the fees and compensation received by an affiliate of a fiduciary that provides investment advice do not vary or are offset against those received by the fiduciary for the provision of investment advice, no prohibited transaction would result solely by reason of providing investment advice and thus there would be no need for a prohibited transaction exemption.
Thus, totally level fee advisers will not need to comply with the PPA requirements.
Given the variety of options for providing advice, more companies will be likely to start offering investment advice to participants once additional guidance is issued by the DOL that interprets the PPA’s requirements. However, until then, totally level fee advisers should feel comfortable providing advice given the DOL’s recent guidance.
Any U.S. federal income tax advice contained in this communication (including any attachments) is neither intended nor written to be used, and cannot be used, to avoid penalties under the Internal Revenue Code or to promote, market or recommend to anyone a transaction or matter addressed herein.
© 2007
Reish Luftman Reicher & Cohen. All rights reserved. The ADVISER REPORT is published as a general informational source. Articles are general in nature and are not intended to constitute legal advice in any particular matter. Transmission of this report does not create an attorney-client relationship. Reish Luftman Reicher & Cohen does not warrant and is not responsible for errors or omissions in the content of this report.
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