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.