Fund Democracy

Consumer Federation of America

Consumer Action

National Association of Personal Financial Advisors

May 5, 2010

FILED ELECTRONICALLY

Office of Regulations and Interpretations

Employee Benefits Security Administration

Room N-5655

Department of Labor

200 Constitution Avenue

Washington, DC 20210

Re: Investment Advice – Participants and Beneficiaries

Dear Mr. Wong, 

We are writing on behalf of Fund Democracy, the Consumer Federation of 

America, Consumer Action and National Association of Personal Financial Advisors in 

response to the Department’s request for comments on its proposed regulation regarding 

investment advice provided by fiduciaries to participants in participant-directed 

individual account plans (collectively, “401(k) plans”). We support the Department of 

Labor’s efforts to correct deficiencies in the rules adopted in January 2009 and applaud 

its new, improved restrictions on conflicted advice provided to 401(k) plan participants.

The Pension Protection Act of 2006 (“PPA”) created two safe harbors from 

ERISA’s conflict of interest provisions. The first permits advice provided by conflicted 

advisers as long as the adviser’s fees do not vary on the basis of beneficiaries’ investment 

selections. This is known as the fee-leveling requirement. The second permits advice 

generated by a computer model that satisfies certain requirements that are intended to 

ensure that the advice is unbiased. We recognize that these safe harbors, especially the 

fee-leveling provision, expand the opportunities for advisers to provide beneficiaries with 

conflicted advice and appreciate the Department’s efforts to minimize the risk to 

beneficiaries. On the whole, the proposed rule achieves a reasonable balance between the 

express requirements of the Act and the beneficiary-protection provisions of ERISA. 

Nonetheless, we believe that there are significant areas where the proposal can be 

improved, which are summarized below:

• Fee-Leveling. The Department has made it clear that the fee leveling 

requirement is not limited to the individual who advises the beneficiary, 

but also applies to the fiduciary adviser and its other personnel. We 
2

believe that there remains some ambiguity, however, regarding whether a 

variation in a fiduciary adviser’s compensation must have been expressly 

designed to result from beneficiaries’ investment selections in order for 

that variation to run afoul of the fee-leveling requirement. Congress made 

it clear that the adviser’s fees may not vary based on the investment 

selection, regardless of whether that variation is intentional. The 

Department should revise the rule to reflect this position. 

• Off-Model Advice. The Department also should clarify that any advice 

that is not specifically generated by the computer model must comply with 

the fee-leveling provision in order to qualify for a safe harbor. Congress 

did not create the fee-leveling safe harbor only to allow it to be 

circumvented by providing off-model advice. All off-model advice 

should be subject to fee-leveling. 

• Generally Accepted Investment Theories. The Department should clarify 

that computer models are required to incorporate generally accepted 

investment theories beyond theories that relate to the investment returns of 

asset classes. Moreover, the Department should provide further guidance 

regarding generally accepted investment theories that computer models are 

required to include. For example, computer models should incorporate 

theories based on the persistence of asset class investment returns, the

nature of active management risk, the predictive power of fees, and the 

role of diversification. 

• Unauthorized Exclusion of Investment Options from Computer Models. 

The Department should not permit computer models to exclude 

recommendations relating to the acquisition, holding or sale of investment 

options comprising employer stock, asset allocation funds or annuities. 

First, this exclusion is not consistent with Congress’s express requirement 

that computer models “take into account all investment options under the 

plan.” Second, a computer model that excludes these options cannot 

satisfy Congress’s requirement that computer models apply generally 

accepted investment theories. Third, a computer model cannot make a 

reasonable recommendation without the recommendation itself taking all 

investment options into account, especially if the beneficiary already has 

allocated all or part of his assets to one or more of the excluded options.

The remainder of this letter is organized as follows:

I. Fee-Leveling and Compensation to Affiliates . . . . . . . . . 3

II. Fee-Leveling and Adviser’s Intent . . . . . . . . . . . . . . . 4 

III. Off-Model Advice . . . . . . . . . . . . . . . . . . . . . . . 6
3

IV. Generally Accepted Investment Theories. . . . . . . . . . . . 7

V. Mandatory GAITs in Computer Models . . . . . . . . . . . . 7

VI. Unauthorized Exclusions from Computer Models . . . . . 10

A. Accounting for All Investment Options . . . . . . 10

B. Employer Stock . . . . . . . . . . . . . . . . . . . 12

C. Asset Allocation Options . . . . . . . . . . . . . . 14

D. Annuities. . . . . . . . . . . . . . . . . . . . . . . 16

V. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

I. Fee-Leveling and Compensation to Affiliates

A significant deficiency in the rule adopted in January 2009 was that it permitted 

an adviser’s employer to receive compensation that varied based on the investment option 

selected by a beneficiary. As previously stated by the Department regarding the nowrescinded January 2009 rule:

[U]nlike the statutory exemption, the final class exemption, like the 

proposal, applies the fee-leveling limits solely to the compensation 

received by the employee, agent or registered representative providing the 

advice on behalf of the fiduciary adviser, as distinguished from 

compensation received by the fiduciary adviser on whose behalf the 

employee, agent or registered representative is providing such advice.1

We and other commentators noted that this position directly contradicted Congress’s 

intent to reduce advisers’ financial incentives to recommend investments based on the 

best interests of his employer rather than the best interests of the beneficiary.2 The rule 

would have permitted an adviser’s employer to be paid on a sliding scale based on the 

profits generated by the investment options selected, the employer’s executives and the 

adviser’s immediate supervisor to be paid bonuses on the same basis, and the adviser to 

be paid a fixed salary – without the arrangement violating the fee-limiting provision. 

The record of sales abuses in the mutual fund industry shows that, in such 

circumstances, advisers’ employers will find ways to reward the advisers for 

recommending the investment options that maximize the employer’s profits and its 

 1 Investment Advice—Participants and Beneficiaries, 74 F.R. 3822 (Jan. 21, 2009).

2 See Testimony of Mercer Bullard on behalf of Fund Democracy and the Consumer Federation of America 

before the Subcommittee on Health, Employment, Labor and Pensions, Committee on Education and 

Labor, U.S. House of Representatives (Mar. 24, 2009) (“CFA/Fund Democracy Testimony”); Letter from 

Senator Jeff Bingaman, Senator Charles E. Grassley, and Senator Edward M. Kennedy to Bradford 

Campbell, Assistant Secretary of Labor, Employee Benefits Security Administration (Oct. 6, 2008) (“By 

not considering fees received by affiliates, the proposed regulation opens the door to conflicted advice.”)

available at http://www.dol.gov/ebsa/pdf/cmt-10170824-ex.pdf.
4

executives’ income.

3

 As stated by members of the U.S. Senate, advisers will be rewarded 

for providing conflicted advice through stock options, positive evaluations, pay raises and 

other means that cannot practicably be traced to the advisers’ selection of investment 

options but that nonetheless will produce conflicted advice.4

The Department’s current proposal corrects this problem by clearly establishing 

that: 

the receipt by a fiduciary adviser of any payment from any party 

(including an affiliate of the fiduciary adviser), or used for the benefit of 

such fiduciary adviser, that is based, in whole or part, on investments 

selected by participants or beneficiaries would be inconsistent with the 

fee-leveling requirement of the statutory exemption.5

The text of the proposed rule further clarifies that the prohibition also applies to a 

fiduciary adviser’s receipt of differential economic benefits from affiliates. The rule 

states that the direct or indirect receipt of any kind of compensation from an affiliate 

would be inconsistent with the rule if it were “based in whole or in part on a participant’s 

or beneficiary’s selection of an investment option.”6

II. Fee-Leveling and Adviser’s Intent 

We have some remaining concerns, however, regarding the extent to which a 

causal relationship between the compensation and the investment selection must be 

intentional to run afoul of the fee-leveling provision. The Department states that it 

intends to prohibit “any provision of financial or economic incentives by an affiliate . . . 

to favor certain investments.” The Department’s use of the terms “incentives” and 

“favor,” along with the rule’s phrase “that is based . . . on,” however, might be interpreted 

(incorrectly, we believe) to apply only when the additional benefit received by the 

fiduciary adviser can be shown to have been specifically intended by the adviser or its 

affiliates to be triggered by an investment selection. 

For example, if an affiliate realized higher profits from some investment options 

than from others (e.g., an investment in a stock fund rather than a bond fund), and the 

 3 See CFA/Fund Democracy Testimony, supra, at 5 - 10.

4 See Letter from Senators Bingaman, Grassley, and Kennedy, supra (advisers’ affiliates “may be held 

under the same holding company or corporate parent as the fiduciary adviser – and their fortunes may rise 

and fall together. In this case, the investment adviser could have a powerful incentive (including holdings 

in company stock options, opportunities for promotion, and informal quid pro quo arrangements stemming 

from ongoing business arrangements) to recommend investment options that provide greater benefit to an 

affiliate.”).

5 Investment Advice—Participants and Beneficiaries, 75 F.R. 9360 (Mar. 2, 2010).

6

 We recommend that the Department expressly rescind the position taken in its January 2009 adopting 

release that “negligible” compensation that varies based on the investment option selected satisfies the feeleveling provision. Congress did not include any carve-out for negligible compensation.
5

fiduciary adviser recommended that beneficiaries invest in those options, then the feeleveling requirement would not be satisfied if the financial performance of the affiliate 

directly or indirectly benefited the fiduciary adviser. It should not be necessary to show 

any level of intent regarding the causal relationship between the fiduciary’s benefit and 

beneficiaries’ investment selections. The mere fact that the investments selected 

positively affected the fiduciary adviser’s finances should be sufficient.

This non-intent-based standard is reflected in the statute, which states that the 

fiduciary adviser’s fees may “not vary depending on the basis of any investment option 

selected.” This passive language arguably contrasts with the rule’s more active “that is 

based . . . on” phrasing and, in particular, the Department’s explanatory references to 

“incentives” and “favoring.” When an administrative agency chooses to use phrasing in 

rulemaking and interpretive guidance that differs from related statutory phrasing, courts 

often assume that the agency’s choice was intentional and that the different phrasing 

means something different. In this case, a court might view the Department’s decision to 

use different phrasing as interpreting the statute to require that some degree of intent 

accompany a variance in fees that results from beneficiaries’ investment selections. 

While we agree that the mere fact that an affiliate’s fees may vary based on the 

selection of investment options should not, by itself, be viewed as inconsistent with the 

fee-limiting provision, we do not agree that this variance may be permitted to affect the 

finances of the fiduciary adviser, whether or not the variance appears to be produced by 

express design. What appears to be chance is too often the hidden residue of design. We 

therefore recommend that the Department revise the rule’s phrase quoted above to reflect 

the text of the statute that it implements and refer to any compensation “that varies 

depending on the basis of any investment option selected.” We also urge the Department 

to clarify that it is the effect of the investment selection, not the intent of the investment 

recommendation, that determines whether the fee-leveling standard has been met. 

A narrow reading of the fee-leveling provision is important to the protection of 

beneficiaries because, as the Department is aware, the conflicts of interest permitted by 

the PPA cannot be entirely eliminated. An adviser will feel an inherent affinity for 

investment products sponsored by his employer’s affiliates, regardless of whether any 

related financial benefit to the adviser can be identified. Moreover, the financial services 

industry has demonstrated a resilient capacity to circumvent conflict-mitigation rules and 

incentivize advisers to favor higher‐fee options offered by affiliates. The only way to 

achieve reasonable assurance that an adviser will not have an economic incentive to 

recommend higher‐fee investment options to participants is to require the maximum 

possible economic separation of the adviser’s employer from the affiliate that sponsors 

the options. The structure and amount of the adviser’s compensation must be completely 

segregated from the economic performance of any affiliate whose fees vary depending on 

the investment option selected.
6

III. Off-Model Advice

We have significant concerns regarding the Department’s interpretation of the 

computer model exemption. As the Department is aware, the computer model exemption 

is not subject to the fee-leveling provision. This means that incentives paid to advisers 

with respect to any advice provided under the guise of a computer model are exempt 

from ERISA’s conflict-of-interest provisions. Unfortunately, the PPA makes the 

exemption available for any “arrangement” that “uses” or provides advice “under” or 

“pursuant to” a computer model.7 It also refers to the permissibility of off-model advice 

if requested by the beneficiary.8 These provisions could be interpreted to permit such 

expansive off-model advice that the computer model exemption could be used to 

completely bypass the fee-leveling provision.

In contrast, the PPA mandates that “the only investment advice provided under 

the program is the advice generated by the computer model.” 29 U.S.C. § 

1108(g)(3)(D)(i). This statutory text is reflected in the rule’s proviso that the computer 

model exemption is only available “if the only investment advice provided under the 

arrangement is advice that is generated by a computer model.” We believe that these 

provisions correctly reflect the permissible scope of the computer model exemption. The 

computer model exemption must be read consistent with Congress’s intent to apply feeleveling to off-model advice. To interpret the computer model exemption to permit nonfee-level advice would eviscerate the fee-leveling provision. 

We urge the Department to state expressly in its adopting release that any

investment advice that is not specifically produced by the computer model must satisfy 

the fee-leveling provision to be exempt from ERISA’s general conflict-of-interest 

provisions. This clarification should include the understanding that the following 

reference in the PPA reference to off-model advice --

Nothing in the preceding sentence shall preclude the participant or beneficiary 

from requesting investment advice other than that [produced by the computer 

model]

-- refers to advice provided under the fee-leveling provision or is subject to ERISA’s

conflict-of-interest provisions. The fee-leveling provision demonstrates Congress’s 

intent that advice provided by conflict-susceptible advisers, in contrast with presumably 

conflict-free computer models, should be exempt only if subject to fee-leveling. The 

Department should make it clear that arguably inartful legislative drafting cannot be read 

to unravel an entire statutory scheme.

 7

 29 U.S.C. §1108(g)(2)(A)(i) (“an arrangement . . . which . . . uses a computer model”) & 3(b) (“advice 

provided under the investment advice program provided pursuant to a computer model”).

8 See 29 U.S.C. § 1108(g)(3)(D) (“Nothing in the preceding sentence shall preclude the participant or 

beneficiary from requesting investment advice other than that described in subparagraph (A)”).
7

IV. Generally Accepted Investment Theories

We are also concerned about the Department’s interpretation of the computer 

model exemption’s generally accepted investment theories (“GAIT”) requirement. We 

interpret the PPA’s requirement that computer models “appl[y] generally accepted 

investment theories that take into account the historic returns of different asset classes 

over defined periods of time,” 29 U.S.C. § 1108(g)(3)(B)(i), to mandate that the models 

apply all GAITs, rather than to limit GAITs to those that are related to the role of past 

asset class investment performance.9 In other words, computer models must apply 

GAITS beyond those that relate to the use of the past investment performance of asset 

classes. This reading is required by the inclusion of other aspects of GAITs in 

subparagraphs (ii), (iii) and (v) of section 1108(g)(3)(B), which make it clear that the 

GAITs referenced in subparagraph (i) are not limited.

One reason that we are concerned about this issue is the rule’s proviso that 

“nothing herein shall preclude any investment advice from being based on generally 

accepted investment theories that take into account additional considerations.” Proposed 

Rule 408(g)-1(b)(4)(i)(A). This phrasing could be interpreted to mean that the 

incorporation of GAITs is somehow optional or that a model could incorporate only 

theories relating to historical risks and returns.10 While we agree that the PPA cannot be 

read to make plan sponsors responsible for ensuring that a computer model incorporates 

every conceivable GAIT, we believe that the model must reflect certain additional 

considerations, especially to the extent that such considerations are stated or implied in 

the statute itself. For example, the statute requires that the model use information such as 

a beneficiary’s age and life expectancy, see 29 U.S.C. § 1108(g)(3)(B)(ii), which would 

require that the model incorporate GAITs relating to the appropriateness of different 

mixes of asset classes depending on these factors.

V. Mandatory GAITs in Computer Models

We also believe that there are certain GAITs that a computer model must 

incorporate under the safe harbor. First, we believe that it is a GAIT that a properly 

diversified investment portfolio should be based on the risk and return characteristics of 

different asset classes. This is implied by the statute’s express inclusion of the 

 9

 The suggestion by some that computer models be permitted to ignore even the most settled GAITs, see, 

e.g., Letter from The SPARK Institute, Inc. to the Employee Benefits Security Administration (Apr. 29, 

2010)(SPARK Letter) available at http://www.sparkinstitute.org/contentfiles/File/SPARK%20Inst%20%20Comment%204-29-10%20FINAL.pdf, directly contradicts Congress’s 

express command that the computer models “apply” GAITs and is flatly inconsistent with the Department’s 

longstanding role in incorporating substantive investment theory into its rules regarding the operation of 

401(k) plans. See Letter from Fund Democracy, Consumer Action and Consumer Federation of America to 

the Employee Benefits Security Administration at pages 3 – 11 (May 3, 2010).

10 We note that the rule uses the term “historic” returns, presumably because that is the term used in the 

statute. We recommend that the rule use the term “historical,” however. Although the rule itself may be 

“historic,” the returns that it references are not.
8

“historic[al] returns of different asset classes over defined periods of time”11 as a 

necessary component of a computer model that “applies generally accepted investment 

theories.” The Department appears to agree, as reflected in its statement that “[a]sset 

classes, in contrast [with investment options within a single asset class], can more often 

be distinguished from one another on the basis of differences in their historical risk and 

return characteristics.” It would be preferable for the Department to make its position 

more explicit. 

Second, we agree with the Department in the converse view: the performance of 

investment options within a single investment class is not persistent and therefore could 

not form the basis of a computer model’s recommendations. The rule requires that a 

computer model not “[i]nappropriately distinguish among investment options within a 

single asset class on the basis of a factor that cannot confidently be expected to persist in 

the future.” It is not clear, however, what purpose the term “inappropriately” serves in 

this context. As stated by the Department, 

[w]hile some differences between investment options within a single asset 

class, such as differences in fees and expenses or management style, are 

likely to persist in the future and therefore to constitute appropriate criteria 

for asset allocation, other differences, such as differences in historical 

performance, are less likely to persist and therefore less likely to constitute 

appropriate criteria for asset allocation.

We believe that it is more than “less likely” that distinguishing among investment options 

based on their performance could be appropriate. If the Department envisions that such 

distinctions could be appropriate, it should identify exactly what those circumstances 

might be.

Third, we strongly recommend that the Department extend the logical conclusion 

of its position on the persistency of single investment option performance and recognize 

the GAIT that active management entails investment risks that are not present with 

respect to passive investment management, and that a plan that offered only active 

management options violates this component of GAITs. This position is implicit in the 

Department’s recognition of GAITs as they relate to persistency of the performance of 

asset classes. The reason that it would inappropriate to distinguish investment options, 

rather than asset classes, on the basis of performance is that, within a given asset class, 

the performance of investment options is unpredictable.12 In other words, the 

performance of investment options entails the risk that performance will be much lower 

 11 We believe that the term “returns” in context refers not just to raw investment returns, but to the broader 

concept of investment returns considered in the context of the risks taken to achieve those returns. It is 

generally accepted investment theory that raw investment returns by themselves mean little without taking 

risk into account. 

12 Remarkably, it appears that there are members of the financial services industry who reject established 

science regarding the relative predictability of the investment performance of an asset class compared with 

that of funds within an asset class. We note that their conclusory position lacks any empirical basis. See, 

e.g., SPARK Letter, supra note 9.
9

than the performance of the asset class. To the extent that a passive investment option 

mirrors an asset class, the persistence of the performance of the investment option, in 

contrast with that of an actively managed investment option within the same asset class, 

will be persistent. 

In our view, a computer model that did not incorporate active management risk 

would not satisfy Congress’s mandate that computer models reflect GAITs. If a plan 

includes actively managed investment options and asset-class-matching passive 

investment options, then the model must set forth the additional active management risk 

entailed by the active management option in providing recommendations. Indeed, we 

believe that a plan sponsor has a fiduciary duty not to require that beneficiaries assume 

active management risk by excluding passive investment management options from its 

menu of investment options. It is inconsistent for the Department to provide a safe 

harbor for plans that offer three distinct investment options while ignoring the importance 

of offering a passively managed version of each. 

Indeed, there is a strong case to be made that, even assuming that some active 

managers can beat market – already a largely discredited view – there is no evidence that 

those managers can be identified prospectively, especially by beneficiaries, plan 

sponsors, plan administrators or investment consultants. If that proposition does not 

qualify as a GAIT, then at a minimum the Department must recognize the ineluctable 

logic of its own position vis a vis the persistence of asset class performance and reject the 

view that computer models can pretend that active management risk does not exist. Any 

computer model that does not recognize and incorporate active management risk violates 

Congress’s requirement that computer models apply GAITs and increases the risk that 

beneficiaries will be directed into actively managed funds because they are more 

profitable to an adviser’s affiliates.

Fourth, we believe that fees have independent predictive value. In other words, 

holding all other factors constant, lower fees are positively correlated with higher 

performance. This is not to say that, between any two funds, it is a GAIT that fees 

therefore are dispositive as to the superior recommendation. What is generally accepted 

is that fees, unlike past investment performance, have a scientifically proven correlation 

with performance. This assertion is a truism in that it simply stands for the proposition 

that, for any two investment options with identical gross performance and other 

characteristics, the investment option with lower fees is extremely likely to generate 

superior performance net of fees in the future. A computer model therefore must

distinguish investment options based on their fees (within a given asset class) in order to 

satisfy the requirement that it apply GAITs.

Fifth and finally, we believe that it is a GAIT that an investment portfolio should 

be diversified. It is a corollary GAIT that an investor should not hold a significant 

concentration of assets in the securities of a single private issuer, especially when that 

issuer is also the investor’s primary source of employment income. This corollary is 

codified with respect to assets of defined benefit plans, of which no more than 10 per cent 
10

may be invested in the plan sponsor’s stock.13 The Department requires that plans offer 

at least three distinct investment options, and it has estimated that beneficiaries have lost 

more than $85 billion in their plans due in part to inadequate diversification. See

Proposal at Part G. Thus, diversification is not only a GAIT, but also established federal 

policy. Any computer model that did not recognize the conflict between concentrated 

holdings in employer stock and GAITs could not satisfy the statutory requirements for 

the computer model exemption. 

VI. Unauthorized Exclusions from Computer Models

A. Accounting for All Investment Options

Our final concern is that the Department’s rule violates Congress’s plain 

requirement that computer models “take into account all investment options under the 

plan.” This means that, if employer stock, asset allocation funds or annuities are offered 

as investment options in a plan, the computer model must take them into account. This 

statutory text leaves no regulatory discretion to the Department to remove these options 

from incorporation into a qualifying computer model.

Nonetheless, this is precisely what the Department appears to have done. The 

Department acknowledges in the rule that a computer model must “take into account all 

designated investment options” only to reverse course and permit the omission of 

“recommendations relating to the acquisition, holding or sale of an investment option 

that:”

(i) Constitutes an investment primarily in qualifying employer securities;

(ii) Constitutes an investment fund, product or service that allocates the 

invested assets of a participant or beneficiary to achieve varying degrees 

of long-term appreciation and capital preservation through equity and 

fixed income exposures, based on a defined time horizon (such as 

retirement age or life expectancy) or level of risk of the participant or 

beneficiary, provided that, contemporaneous with the provision of 

investment advice generated by the computer model, the participant or 

beneficiary is also furnished a general description of such funds, products 

or services and how they operate; or

(iii) Constitutes an annuity option with respect to which a participant or 

beneficiary may allocate assets toward the purchase of a stream of 

retirement income payments guaranteed by an insurance company, 

provided that, contemporaneous with the provision of investment advice 

 13 See 29 U.S.C. § 1107(a). As of December 31, 2000, 62 percent of Enron Corporation’s 401(k) assets 

were invested in Enron stock. See Patrick Purcell, The Enron Bankruptcy and Employer Stock in 

Retirement Plans, Congressional Research Service Report for Congress at 3 (Mar. 22, 2002) available at

http://fpc.state.gov/documents/organization/9102.pdf.
11

generated by the computer model, the participant or beneficiary is also 

furnished a general description of such options and how they operate.

It is not possible for a computer model to “take into account” all options without 

incorporating all options in its recommendations. Making “recommendations” is 

precisely how computer models “take into account” various investment options. By not 

making recommendations regarding certain investment options, computer models will not 

be taking into account all investment options as required by Congress.

Even if the Department had the authority to exclude recommendations regarding 

these investment options, it would be imprudent to do so. As a general matter, any 

computer model that comported with GAITs could only provide recommendations that 

accounted for a beneficiary’s full range of investments. Ignoring an equity allocation, 

such as an investment in employer stock, a contractual income stream (such as a fixed 

annuity), or an asset allocation fund would be inconsistent with GAIT’s mandate that 

asset allocations be based on a beneficiary’s entire portfolio. 

To illustrate, consider the recommendation that a GAIT-compliant computer 

might generate for a 50-year-old beneficiary. A computer model might appropriately 

recommend a 60/40, equity/debt asset allocation on the assumption that the 60 percent 

allocated to equities would be invested in a diversified pool of stocks. If the beneficiary 

already had 40 percent of his account invested in employer stock, a computer model that 

ignored this holding might recommend a 60/40 allocation, which would leave the 

beneficiary with an overall 76 percent equity allocation of which more than half would be 

concentrated in a single stock. The recommendation would not be consistent with 

GAITs, yet it arguably would be consistent with the rule because taking the employer 

stock into account could reasonably be considered to be making a “recommendation 

relating to” the holding of the employer stock and therefore excludable under the 

Department’s position. 

The Department seems to disagree with this interpretation of its proposal. It states 

that, while a computer model is permitted to exclude “recommendations relating to” the 

three excluded investments, a computer model nonetheless “must take into account the 

fact that the participant or beneficiary has such an investment.”14 While this is a possible 

interpretation of the rule’s text, it is not sufficiently clear. If the model took the employer 

stock “into account,” one could reasonably argue that the model would be making at least 

an implicit “recommendation[] relating to the acquisition, holding or sale” with respect to 

the stock. At a minimum, the text of the rule needs clarification.

Even if the Department’s interpretation holds as a matter of law, however, it 

cannot work as a matter of practice. To illustrate, assume again the 50-year-old 

beneficiary described above. If the computer model made a recommendation regarding 

the non-employer-stock investment options that “took into account” the 40 percent, 

employer stock holding but made no recommendation about holding the stock, then 

GAITs would militate that the risk of the 60/40 allocation be reduced to accommodate the 

 14 Investment Advice—Participants and Beneficiaries, 74 F.R. 3822 (Jan. 21, 2009).
12

heightened risk presented by the high employer stock concentration. The recommended 

debt percentage would be substantially increased to reflect both the pre-existing stock 

allocation and the concentration of that allocation in a single company’s stock. But 

requiring a model to make this adjustment without requiring that it also incorporate some 

GAIT-based evaluation of the 40 percent employer stock allocation commits a fraud on 

the beneficiary. The model will have produced a recommendation that standing alone, 

without any contextual explanation, makes no sense. Moreover, for a purportedly GAITcompliant model to remain silent on the inadvisability of a 40 percent allocation to 

employer stock makes a mockery of GAITs. It allows GAITs to be used as covers for a 

contra-GAIT asset allocation.

We believe that there is no practical space between “taking into account” an 

allocation to employer stock and making a “recommendation” regarding the “acquisition, 

holding or sale” of employer stock, an asset allocation fund or an annuity. It is 

distinction without a difference. Either the rule provides that GAIT-compliant advice be 

given or it does not. A computer model cannot be said to provide a recommendation that 

is GAIT-compliant if the impact of a beneficiary’s allocation to an excludable option is 

not incorporated into the recommendation. With respect to beneficiaries’ current 

investment in plan investment options, the Department concedes that this factor is 

“fundamental to meaningful investment advice” but does not even require that computer 

models incorporate this factor when making recommendations. While we agree that it 

would be impracticable to require models to incorporate all non-plan allocations 

(although advisers must ask for information about them), it would be imprudent not to 

require models to incorporate all of a beneficiary’s investments within a plan.

The way in which employer stock, asset allocation options and annuities are 

“taken into account” by computer models should be left to the experts who design the 

models. The Department should not attempt detailed engineering of the particular 

content of computer models by deciding on its own that certain types of options need not 

be the subject of recommendations. The providers of these models are well aware of the 

nuances of managing a wide range of plan investment options. They are in the best 

position to determine the most effective means of implementing Congress’s mandate that 

the models comport with GAITs and, in one way or another, “take into account” all 

investment options consistent with the nature of the options. The Department should not 

substitute its particular views regarding the capacity or appropriateness of computer 

models to incorporate particular investment options into the models’ recommendations 

beyond providing direction regarding the fundamental GAITs that the models must 

reflect. 

B. Employer Stock

It is particularly important that computer model recommendations incorporate 

allocations to employer stock. One of the most fundamental GAITs is that a diversified 

pool of investments not include a heavy concentration in the stock of a single company, 

much less of one’s employer. The fate of the many Enron employees who bet both their 

income security and retirement security on a single company is a reminder of why 
13

employees should never hold more than a small percentage of their portfolios in their 

employer’s stock.15 For a computer model to comply with GAITs, it would have to 

advise that investments in employer stock above a certain percentage range is imprudent 

and recommend that the beneficiary consider additional diversification. If the beneficiary 

insisted on an over-concentration in employer stock, a GAIT-compliant model must be 

able to incorporate that allocation into the recommendation it provides as to the 

beneficiary’s remaining assets.

It is with regard to employer stock that employers have a direct conflict of interest 

with their employees and the protections of ERISA are most important.16 Management 

benefits when employees hold large blocks of stock because the employees provide a 

more stable, friendly shareholder base. Employee ownership of stock is commonly 

considered an effective defense against acquisitions and a way to maintain a higher share 

value that pumps up executive compensation.17 These concerns are reflected in antifraud securities regulation that is specifically targeted at companies’ conflict of interest 

when purchasing their own stock.18 Research shows that beneficiaries’ overconcentration in employer stock driven partly by the implied endorsement of this 

 15 As of December 31, 2000, 62 percent of Enron Corporation’s 401(k) assets were invested in Enron stock. 

See Patrick Purcell, The Enron Bankruptcy and Employer Stock in Retirement Plans, Congressional 

Research Service Report for Congress at 3 (Mar. 22, 2002) at

http://fpc.state.gov/documents/organization/9102.pdf; Enron Employee Ride Stock to Bottom, CNN.com 

(Jan. 14, 2002) at http://archives.cnn.com/2002/LAW/01/14/enron.employees/. Twelve percent of 

employees whose plans offer employer stock have at least 60 percent of their plan assets invested in that 

option. See Jason Zweig, Wall Street Lays Egg With Its Nest Eggs, Wall St. J. (Sep. 28, 2008).

16 It is ironic that this conflict of interest is actually the Department’s justification for this exclusion. In its 

2008 proposal, the Department explained that the exclusion was necessary so as not to “discourage 

arrangements based on utilization of a computer model.” Investment Advice—Participants and 

Beneficiaries, 73. F.R. 49895 at text accompanying note 10 (Aug. 22, 2008). In other words, the 

Department recognized that employers would put their own interests ahead of their employees’ interests 

and decline to offer a computer model if doing so would expose employees’ over-investment in employers’ 

stock as ill-advised. It is patently inconsistent with the public interest to permit models to give distorted 

recommendations in order to protect the self-interest of employers. The Department justifies its position on 

the ground that quarterly benefits statements refer to the dangers of over-investing in the securities of one 

company, but that disclosure makes no reference to the special conflict of interest when the employer’s 

securities are at issue or the special vulnerability to investments in employers’ stock to which the 

behavioral finance literature shows employees are susceptible. See generally Shlomo Benartzi, Richard 

Thaler, Stephen Utkus and Cass Sunstein, Company Stock, Market Rationality, and Legal Reform, Chicago 

Working Paper Series No. 218 (July 2004) (“Company Stock”); James Choi, David Laibson & Brigitte 

Madrian, Are Empowerment and Education Enough? Under-Diversification in 401(k) Plans at 24 (2005) 

available at

http://www.brookings.edu/es/commentary/journals/bpea_macro/forum/200509bpea_laibson.pdf.

17 See generally Joshua Rauh, Own Company Stock in Defined Contribution Pension Plans: A Takeover 

Defense? 81 J. Fin. 379 (2006).

18 See Exchange Act Rule 10b-18 (anti-manipulation rule applicable to companies’ purchase of their own 

stock); see also Purchases of Certain Equity Securities by the Issuer and Others, Exchange Act Release No. 

61414 (Jan. 25, 2010) (“an issuer may have an incentive to manipulate the price of its securities”).
14

allocation by their employers.19 Federal law prohibits defined benefit plans from 

investing more than 10 percent of their assets in employer stock to combat precisely the 

employer’s conflict of interest that the Department’s proposal ignores as to individual 

beneficiaries. The incidence of high concentrations of employer stock ownership in 

defined contribution plans is a significant threat to millions of Americans’ financial 

security.20 It is unclear why the Department would contradict the express requirement of 

the statute that computer models account for all investment options when the risk to 

beneficiaries in this respect is so great.

It is unconscionable that computer models could be permitted to ignore the risks 

of investing in employer stock. Any rationally designed model that addressed employer 

stock would strongly recommend against it comprising more than 10 or 20 percent of a 

beneficiary’s portfolio.21 Allowing qualified computer models to remain silent on this 

issue sends the implicit message that it is not an area of concern and fails to reflect the 

GAITs that the models are required to apply. The employer stock exclusion disregards 

the express requirements of the statute, exceeds the Department’s authority, and creates 

the impression of being designed to elevate the interests of employers over the interests 

of plan beneficiaries. 

C. Asset Allocation Options

We also strongly disagree with the Department’s proposal to permit computer 

models to exclude asset allocation funds from recommendations. The Department states, 

with respect to asset allocation options, that,

where an investment fund, product or service is itself designed to maintain 

a particular asset allocation taking into account the time horizons 

(retirement age, life expectancy) or risk level of a participant, such fund 

should not be required to be included in the computer modeled investment 

advice.

Whether a particular option it designed to take into account a beneficiary’s time 

horizon is not the issue as to the recommendations generated by a computer model. 

Neither an investment option nor an asset allocation is itself a recommendation or even 

investment advice. An asset allocation within an investment option exists independent of 

the beneficiary for whom the investment option might or might not be appropriate. It is 

 19 See Shlomo Benartzi, Excessive Extrapolation and the Allocation of 401(k) Accounts to Company Stock, 

56 J. Fin. 1747 (2001) (finding that “employees interpret the allocation of the employer’s contributions as 

implicit investment advice”).

20 See Company Stock, supra note 15 (11 million plan participants hold more than 20%, and 5 million over 

60%, of their balances in employer stock).

21 See id. (“Encouraging or forcing employees to invest in a single stock, as opposed to a diversified fund 

such as a mutual fund, violates the first principle of investing—diversify!”).
15

the role of the computer model to advise the beneficiary regarding the appropriateness of 

the investment option, not to advise the investment option sponsor on its asset allocation.

Consider a stock fund that holds a 70/30 allocation of large and small cap U.S. 

stocks. A computer model would provide a recommendation that took account of the fact 

that this option represented both large and small cap stocks and recommend a portfolio on 

that basis. If a fund held a 70/30 allocation between stocks and bonds, a computer model 

that viewed this allocation as appropriate for a 30-year-old would take that allocation into 

account while recommending that it be revisited as the beneficiary aged. In the same 

vein, if the fund changed its asset allocation to match the aging of the beneficiary (i.e., it 

operated as a target-date fund), then the computer model presumably would recommend 

that option as an appropriate investment for the period of the beneficiary’s employment. 

In each case, the computer model’s function is the same: to advise the beneficiary 

regarding the investment option or options that would be most appropriate for the 

beneficiary, regardless of the extent to which the recommendation itself combined 

different options to create the right degree of diversification and risk.

If, in the last example, the beneficiary had already purchased a fixed annuity, then 

the computer model might vary its recommendation regarding the appropriateness of the 

target-date fund. The annuity would make the beneficiary’s overall retirement portfolio 

more conservative. The computer model therefore might recommend a more aggressive 

target-date fund. If, in addition to the annuity, the beneficiary held 10% of his retirement 

assets in employer stock, then the computer model might recommend a more 

conservative target-date fund and/or one with a heavier international emphasis (assuming 

that the employer was a U.S. company). In this last example, the computer model’s role 

is the same with respect to all three plan options that the Department proposes to exclude 

as it would be with respect to any other type of option. It is not the model’s role to 

evaluate the particular investments inside an investment option as such, but to evaluate 

their role vis a vis each beneficiary based on the information about the beneficiary that is 

incorporated into the model.

The relevant advisory issue is not whether a particular asset allocation option’s 

internal allocation is appropriate, but whether the particular option is appropriate for the 

beneficiary. The fact that the option’s asset allocation may be fixed says nothing about 

the advisability of the allocation for a particular beneficiary. The Department must be 

acutely aware of this fact based on its current review of target-date funds. Target-date 

funds for any give target retirement year have been found to use an extraordinarily wide 

range of asset allocations.22 Just as a GAIT-compliant recommendation cannot be made 

without reflecting a beneficiary’s employer stock allocation, a GAIT-compliant 

recommendation cannot be made without reflecting the particular characteristics of an 

asset allocation fund. The Department’s logic would allow a model either to ignore a 65-

year-old’s investment in a 2050 target-date fund, or to adjust other investments to reflect 

the target-date fund but without making any recommendation as to the target-date fund 

 22 See Remarks of SEC Chairman Mary Schapiro before the Solutions Forum on Fraud, Washington, DC 

(Oct. 22, 2009) (“In 2008, target date funds for 2010 suffered losses of as little as 4 percent to as much as 

40 percent.”).
16

itself. This example illustrates why Congress required that computer models take all 

investment options into account. 

D. Annuities

We also object to the Department’s position on annuities. With respect to 

annuities, the Department states that:

where, in connection with an in-plan annuity option, with respect to which 

a participant may allocate a portion of his or her assets toward the 

purchase of an annuitized retirement benefit and those allocated assets are 

no longer available for investment at the time of the advice, the participant 

or beneficiary has, in effect, decided to treat those assets as no longer 

available for investment and, accordingly, such assets should not, in the 

view of the Department, be required to be modeled for purposes of buy, 

hold or sell recommendations.

Our first objection is that the exclusion covers investment options that, in practice, 

are not annuities. The exclusion applies to an investment options whereunder a 

beneficiary “may allocate assets toward the purchase of a stream of retirement income 

payments guaranteed by an insurance company.” This description would include, for 

example, a variable annuity, which interpretation is supported by the Department’s 

phrase “toward the purchase” (rather than “to purchase”) and the fact that the Department 

appears to have been responding to a request to accommodate “annuity purchase 

programs that serve as both accumulation and distribution options” (emphasis added). 

With respect to a variable annuity, the term “accumulation” generally refers to a 

period during which the purchase amount is invested in fixed, underlying investments. 

The investments are commonly mutual funds that are virtually indistinguishable from 

mutual funds offered by plans outside of an annuity wrapper. These investments are 

designed to be held, in theory, until the retirement date, when the beneficiary has the 

option of purchasing a fixed annuity. In fact, purchasers of variable annuities rarely 

convert their investments to an actual “stream of retirement income payments.” One 

study found that less then 0.8% of variable annuity purchasers actually converted to a 

fixed income annuity.23 As this data suggests, the use of the term “annuity” in “variable 

annuity” is more a reflection of salesmanship than reality.24

 23 See Jeffrey Brown, Rational and Behavioral Perspectives on the Role of Annuities in Retirement 

Planning, NBER Working Paper 13537 (2007) (less than 0.8% of variable annuities were converted to 

fixed life annuities, citing Dan Beatrice and Matthew Drinkwater, The 2003 Individual Annuity Market: 

Sales and Assets, LIMRA International (2004)).

24 Sales abuses are more common with respect to variable annuities than any other retail investment 

product, especially with respect to senior citizens. See Letter from AARP, North American Securities 

Administrators Association, Fund Democracy and Consumer Federation of America to Chairman 

Christopher Dodd and Ranking Member Richard Shelby, Committee on Banking, Housing and Urban 

Development, U.S. Senate (Feb. 2, 2010) (discussing abusive sales practices in sale of variable annuities to 

seniors), see also Protecting Senior Investors: Report of Examinations of Securities Firms Providing “Free 
17

Our second objection is that, even accepting the Department’s reasoning, it seems 

to apply only where the fixed annuity has already been purchased. The Department 

refers to the annuity assets as being “no longer available for investment” because the 

beneficiary has “decided to treat those asset as no longer available for investment.” This 

is not the case, however, when the issue is a recommendation as to whether to acquire a 

fixed annuity, yet the exclusion applies to a recommendation relating the “acquisition” of 

a fixed annuity, not just relating to the holding or sale of the annuity. If a fixed annuity is 

a plan investment option, a computer model certainly should be required to have 

considered the annuity in generating its recommendations.25 

Admittedly, recommendations as to holding or selling, as opposed to acquiring a 

fixed annuity are different because there may be punitive costs associated with a sale if a 

sale is even permitted. As with employer stock and asset allocation options, however, an 

allocation to a fixed annuity, irrevocable or not, still cannot be ignored when generating a 

GAIT-compliant recommendation regarding other plan investments. The computer 

model must include an analytical framework for evaluating the risk-return characteristics 

of a fixed annuity and then apply that framework in generating a recommendation as to 

other plan investments that is GAIT-compliant considering the allocation to the fixed 

annuity. 

As to asset allocation, employer stock and annuity options alike, the purpose of 

the computer model is to help the beneficiary make choices among plan options that 

make the most sense for the particular beneficiary. This requires that the model’s 

recommendations incorporate all plan options in its analysis. 

VII. Conclusion

In conclusion, we wish to re-emphasize the choice that Congress made in ERISA 

to prohibit conflicted advice by prohibiting fiduciaries from receiving fees for both 

 Lunch” Seminars, Securities and Exchange Commission, North American Securities Administrators 

Association and Financial Industry Regulatory Authority at 21-22 (2007); FINRA Investor Alert, “Should 

You Exchange Your Variable Annuity?” (last updated Mar. 2, 2006) (citing abusive sales practices); Joint 

SEC/NASD Report on Examination Findings Regarding Broker-Dealer Sales of Variable Insurance 

Products (June 2003); FINRA Investor Alert, “Variable Annuities: Beyond the Hard Sell” (last updated 

May 27, 2003); NASD Regulatory and Compliance Alert, “Advertising of Bonus Credit Variable 

Annuities” (Summer 2000) (warning against misleading sales practices); NASD Notice to Members 99-35, 

“The NASD Reminds Members of their Responsibilities Regarding the Sales of Variable Annuities” (May 

1999); NASD Notice to Members 96-86, “NASD Regulation Reminds Members and Associated Persons 

that Sales of Variable Contracts are Subject to NASD Suitability Requirements” (Dec. 1996). If variable 

annuities are singled out for special treatment, they should be subject to greater scrutiny rather than less. 

25 This confusion may reflect the common misperception that a fixed annuity is not an “investment.” This 

misperception is partly based on the illusion of the insurance guarantee. The holder of a fixed annuity is a 

creditor of the insurance company that sells it, which exposes the holder to the risk of that the insurer will 

fail to the extent that the annuity is not covered the applicable state guaranty fund. A fixed annuity may 

very well be a relatively safe investment, but it is no less an investment than any other kind of investment 

option for purposes of generating recommendations regarding the optimal allocation of a beneficiary’s 

retirement assets.
18

investment products and for providing advice about those products. The fee-leveling and 

computer model safe harbors must be understood as exceptions to this statutory scheme 

that should be interpreted narrowly, especially when considering the creativity 

demonstrated by many financial services firms in employing sales practices that are 

designed to maximize their profits rather than investors’ best interests. With the growth 

of defined contribution plans and the increasing importance of participants’ individual 

decision-making role, it has never been more critical that the investment advice that 

participants receive be free of conflicts of interest. 

We are encouraged by the significant improvements that the Department has 

made to the conflict advice rule and greatly appreciate your consideration of our 

comments.

Sincerely,

Mercer Bullard Barbara Roper

President and Founder Director of Investor Protection

Fund Democracy, Inc. Consumer Federation of America

 Ken McEldowney Ellen Turf

Executive Director Chief Executive Officer

Consumer Action National Association of Personal 

 Financial Advisors

cc by U.S. Mail: 

Honorable Hilda Solis, Secretary of Labor

Phyllis C. Borzi, Assistant Secretary of Labor (EBSA)

Andrew Donohue, Director, Division of Investment Management, SEC