New Pension Law Expands Investment Advice Options

By Catherine Gordon, Toolkit Staff Writer

The recently enacted Pension Protection Act of 2006 is a massive piece of legislation that will likely affect almost all of us in some respect when it comes to retirement planning. A good example of the Act’s impact is the new exemption allowing certain retirement plan fiduciaries to offer investment advice to retirement plan participants.

Current ERISA law and the Internal Revenue Code require employee benefit plans, including 401(k) and other employer-sponsored plans, to name one or more fiduciaries responsible for maintaining and administering the plan. In addition to the named fiduciaries, investment advisers are also considered to be fiduciaries. As a general rule, fiduciaries are prohibited from engaging in specified transactions involving plan assets.

But all that's about to change. Beginning in 2007, under the Act’s new exemption for prohibited transactions, qualified fiduciary advisers can offer personally tailored professional investment advice to assist participants in managing their 401(k) plans and certain other plans. The exemption allows a fiduciary adviser to be affiliated with the investment funds offered in a 401(k) plan, although the adviser must meet certain disclosure, qualification, and other self-dealing safeguards.

The key to these safeguards is an eligible investment advice arrangement. This type of arrangement requires investment advice to be provided either through an unbiased computer model certified and audited by an independent third party, or by fiduciary advisers whose investment advice service fees and commissions do not vary depending on the investment option chosen by the participant.

Who exactly qualifies as a fiduciary adviser? The advisor must be named as a plan fiduciary providing investment advice to a participant or beneficiary, and must also be one of the following:

• registered as an investment adviser under the Investment Advisers Act of 1940 or under laws of the state in which the fiduciary maintains its principal office and place of business
• a bank, a similar financial institution supervised by the United States or a state, or a savings association, but only if the advice is provided through a trust department subject to periodic examination and review by federal or state banking authorities
• an insurance company qualified to do business under state law
• registered as a broker or dealer under the Securities Exchange Act of 1934
• an affiliate under the Investment Company Act of 1940, of any of the preceding
• an employee, agent or registered representative of any of the preceding who satisfies the requirements of applicable insurance, banking and securities laws relating to the provision of advice

To qualify as an eligible investment advice arrangement, it must use a qualified computer model under an investment advice program that:

• applies generally accepted investment theories which take into account the historic returns of different asset classes over defined periods of time
• uses relevant information about the participant, which may include age, life expectancy, retirement age, risk tolerance, other assets or sources of income, and preferences as to certain types of investments
• uses prescribed objective criteria to provide asset allocation portfolios comprised of investment options available under the plan
• operate in a manner not biased in favor of investments offered by the fiduciary adviser or a person with a material affiliation or contractual relationship with the fiduciary adviser
• take into account all investment options under the plan in specifying how a participant's account balance should be invested, and not be inappropriately weighted with respect to any investment option

In addition, an eligible investment expert, qualified by the Department of Labor, must certify the computer model. This expert must not bear any material affiliation or contractual relationship with any investment adviser or a related person, including any employee, agent or registered representative of the investment adviser or related person.

The advice provided by any program must be the only advice generated by the computer model, and it must occur solely at the direction of the participant or beneficiary. A participant or beneficiary can request other investment advice, but only if the request has not been solicited by any person connected with carrying out the eligible investment advice arrangement.

Before investment advice is given about securities or other property offered as an investment option, the fiduciary adviser is required to provide to a participant or beneficiary written notification (which may be in electronic form), including information about the role of any related party with respect to the development of the advice, the selection of available investment options, and the past performance and historical rates of return for each option offered under the plan. This notice must also cover the participant's or beneficiary's rights to enter into a separate arrangement with another adviser that has no material affiliation with, and receives no compensation with respect to, the security or other property.

The financial adviser is required to disclose any fees or other compensation the adviser or its affiliates receive in connection with an investment transaction. In addition, the adviser must provide the necessary disclosure in accordance with all relevant securities laws. Further, any compensation received by the adviser or its affiliate in connection with an investment transaction must be reasonable. The terms of the transaction must be no less favorable to the plan than the terms offered through similar investments outside of the plan.

Finally, it’s important to note that while employers or plan sponsors are not obligated to monitor the specific advice given to any particular participant or beneficiary, they do have a responsibility to prudently select and monitor advice providers. On the other hand, fiduciary advisers are personally liable for the investment advice that they provide.