New Rule Requires Many Conditions Met Before Plan Investment Advisors May Collect Compensation From Recommended Investments

Cynthia Marcotte Stamer JD
October 25, 2011 — 2,176 views  
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New Rule Allows Plans & Their Advisors Expanded Flexibility In How Investment Advice Is Provided To Participants & Beneficiaries

The new final regulation scheduled to take effect on December 27, 2011 implements a new statutory exemption to the prohibited transaction rules of the Code and ERISA created by the Pension Protection Act of 2006 which will allow a fiduciary investment adviser recommending plan investment options to receive additional fees from investment providers when the requirements of the final regulation are met without violating the prohibited transaction rules of ERISA.

ERISA and the Code generally prohibit fiduciary investment advisors from receiving compensation from the investment vehicles that they recommend to plan participants and beneficiaries and IRA holders except under very limited conditions.   Plan fiduciaries and advisors that allow investment advisors to be compensated in violation of these rules risk significant liability under the Code and ERISA.

The new statutory exemption allows fiduciary investment advisers to receive compensation from investment vehicles they recommend when the requirements of the regulation are met if either (1) the investment advice they provide is based on a computer model certified as unbiased and as applying generally accepted investment theories, or (2) the adviser is compensated on a "level-fee" basis (i.e., fees do not vary based on investments selected by the participant). 

Investment Advice Must Meet Specific Conditions To Qualify For Rule’s Relief

To qualify for the relief provided by the new statutory investments, the new statutory exemption also requires that investment advice provided under these types of arrangements also meet several other conditions, including the disclosure of the adviser’s fees and an annual audit of the arrangement for compliance with the regulation.  The final regulation provides guidance about the conditions and safeguards that must be met to qualify for the prohibited transaction exemption provided by the statutory exemption.  For instance, in order to qualify for the new statutory exemption, the final regulation:

  • Requires that a plan fiduciary (independent of the investment adviser or its affiliates) authorize the advice arrangement;
  • Imposes recordkeeping requirements for investment advisers relying on the exemption;
  • Requires that computer models must be certified in advance as unbiased and meeting the exemption’s requirements by an independent expert;
  • Establishes qualifications and a selection process for the investment expert who must perform the above certification;
  • Clarifies that the level-fee requirement does not permit investment advisers (including their employees) to receive compensation from any party (including affiliates) that vary on the basis of the investments participants select;
  • Establishes an annual audit of both computer model and level-fee advice arrangements, including the requirement that the auditor be independent from the investment advice provider; and
  • Requires specific disclosures by advisers to plan participants.

The new final regulation is separate from and does not affect the Labor Department’s proposed rule on the definition of fiduciary investment advice, which the EBSA recently announced plans to re-propose or the EBSA’s prior guidance on the application of the prohibited transaction rules and existing prohibited transaction exemptions to investment advice arrangements like that contained in Advisory Opinion Nos. 2011-08A, 2005-10A (Country Trust Bank), 2001-09A (SunAmerica Retirement Markets) and 1997-15A (Frost National Bank).

Plans, Fiduciaries & Advisors Wishing To Use Rules Must Confirm Conditions Met

Many individual account plans, their fiduciaries and advisors are likely to find the new flexibility that the final regulation allows for arranging for participants and beneficiaries in individual account plans to receive investment advice highly attractive.  To make use of this flexibility, however, plans, their fiduciaries and investment advisors will need to exercise care to verify that investment advice arrangements made in reliance on the new final rule meet all of the conditions required by the final regulation.  Plan fiduciaries and advisors that fail to meet these conditions risk incurring significant liability under the prohibited transaction rules of the Code and the prohibited transaction and fiduciary responsibility rules of ERISA.  Accordingly, plans, their fiduciaries and investment advisors should work with qualified legal counsel to conduct the required due diligence and implement the necessary arrangements to meet all of the requirements of the rule before allowing investment advisors to receive compensation in reliance upon the new final rule. 

For Help and Additional Resources

If you need help reviewing and updating your employee benefit plan investment advice arrangements or with other employee benefits, human resources or related matters, please contact the author of this update, Cynthia Marcotte Stamer. For important information concerning this communication click here. THE FOLLOWING DISCLAIMER IS INCLUDED TO COMPLY WITH AND IN RESPONSE TO U.S. TREASURY DEPARTMENT CIRCULAR 230 REGULATIONS.  ANY STATEMENTS CONTAINED HEREIN ARE NOT INTENDED OR WRITTEN BY THE WRITER TO BE USED, AND NOTHING CONTAINED HEREIN CAN BE USED BY YOU OR ANY OTHER PERSON, FOR THE PURPOSE OF (1) AVOIDING PENALTIES THAT MAY BE IMPOSED UNDER FEDERAL TAX LAW, OR (2) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY TAX-RELATED TRANSACTION OR MATTER ADDRESSED HEREIN.

©2011 Cynthia Marcotte Stamer, P.C.  Limited non-exclusive right to republish granted to HRResource.  All other rights reserved.


Cynthia Marcotte Stamer JD

Cynthia Marcotte Stamer PC

Ms. Stamer is labor and employment board certified, an American College of Employee Benefit Council Fellow, past ABA RPTE Employee Benefits & Other Compensation Group, ABA TIPS Employee Benefits Committee Vice-Chair, a ABA JCEB Council Rep.