R. Gregory Barton George U. Sauter P.O. Box 2900

Managing Director Managing Director Valley Forge, PA 19482

Institutional Investor Group Chief Investment Officer 610-669-1000

www.vanguard.com

Submitted Electronically

May 5, 2010

Office of Regulations and Interpretations

Employee Benefits Security Administration

Attn: 2010 Investment Advice Proposed Rule

Room N-5655

U.S. Department of Labor

200 Constitution Avenue, NW

Washington, D.C. 20210

RE: 2010 Proposed Participant Investment Advice Rule

Dear Sir or Madam:

Vanguard appreciates the opportunity to submit these comments on the Department’s 

February 2010 proposed rule regarding the provision of investment advice to participants 

and beneficiaries under sections 408(b)(14) and 408(g) of ERISA. There continues to be a 

well-recognized and compelling need for participant investment advice programs. We hope 

our comments will help the Department craft final rules that allow for flexibility in the offering 

of responsible, fundamentally sound, and cost-effective participant investment advice 

programs.

Vanguard currently manages more than $1 trillion on behalf of millions of investors who,

through their Vanguard mutual fund investments, indirectly own Vanguard. Our investors 

include more than 3.5 million participants in 2,500 plans for which Vanguard provides a 

broad range of investment and administrative services to plan sponsors and participants. 

This range of services includes a complete menu of investment education and advice 

programs ranging from simple investor education questionnaires and allocation models, to 

nondiscretionary advice offerings implemented at participant direction, to full-service 

discretionary advisory programs and third-party advice through a partnership with an 

independent investment advice provider.
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Vanguard has a long-standing track record of being a vocal proponent of low-cost 

investing. We particularly believe that most investors should hold a significant portion of 

any long-term portfolio in low-cost, passively managed investments. At the same time, we 

believe that it may be reasonable for investors to assume limited exposure to active 

managers in their portfolios. For this reason, we offer a full suite of low-cost actively 

managed funds covering most asset classes in addition to a broad array of low-cost 

passively managed funds.

It is true that an all-passive portfolio can be an optimal strategy for many investors. In our 

view, however, active versus passive choices should be made by plan fiduciaries, 

investment advisers, and participants, and should not be mandated as a matter of public 

policy. 

Immediately below we provide answers to portfolio management-related questions raised 

by the Department in the preamble to the regulation, particularly with respect to: (1) the role 

of past performance in the asset allocation process; (2) the importance of the ongoing 

availability of actively managed funds in participant portfolios; and (3) what the 

Department’s role should be in defining practices that are considered consistent with 

“generally accepted investment theories.”

1. Historical performance is a relevant factor—but should not be the primary

factor—in the investment decision-making process.

In its proposed rule, the Department requested comments on how advice-giving models 

should use past performance data, and whether a fund’s past performance relative to the 

benchmark for its asset class is an appropriate criterion for allocating assets.

Vanguard’s view on this issue is clear: Past performance should never be the exclusive, or 

even the primary, basis for an investment decision or the provision of investment advice. 

That past performance is inadequate as a predictor of future investment performance is 

perhaps the most well-known maxim of all “generally accepted investment theories” (save 

perhaps “don’t put all your eggs in one basket”). We note that whenever fund performance 

information is presented in advertising materials, Financial Industry Regulatory Authority 

(“FINRA”) rules require mutual funds to include statements that past performance does not 

ensure future results.

Despite the unquestionable truth that past performance data can be an unreliable predictor 

of future performance, “unreliable” does not mean “useless.”1 Past performance data still 

play an essential role in most advice methodologies for the following three critical reasons:

 

1

 Indeed, regulatory agencies and policymakers have implicitly and explicitly acknowledged over the 

years that historical performance is a useful data point in the investment decision-making process. For 

example, the Securities and Exchange Commission requires one-, five- and ten-year return performance 

to be provided in the prospectus for mutual fund investors. Similarly, the Department’s own ERISA 
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· Modern computer-based advice services do not incorporate past performance 

naively, but instead use sophisticated statistical tests to interpret past performance 

as skill versus good or bad luck. Many factors—including both skill and luck—can 

combine to determine the value a manager adds during a particular performance period. 

Best-in-class computer-based advice models and algorithms currently use modern 

statistical procedures in an attempt to distinguish a manger’s skill from luck and to 

distinguish the value that a particular manager adds.

Such tools tend to place much greater emphasis in their evaluation of investments on 

quantifiable factors that are more predictable, such as investment expenses and 

quantitative estimates of “beta” (i.e., the number describing the relation of an investment’s 

return with that of the financial market as a whole). What is important is that quantitative 

tools or approaches that make use of past performance information in evaluating 

investments do so in a way that recognizes and takes into account the statistical 

uncertainty, or “noisiness,” of past performance data.

· Past performance is used to evaluate the asset allocation and security 

exposures of individual funds when the information is not otherwise available. It is 

important to note that investment advisers can, with some reliability, derive beta or asset 

class exposure from past performance data. Also, in our view, such information need not 

be 100% reliable to be useful. That said, we note that it is crucial to recognize the statistical 

uncertainty in such information and that emphasis on past performance data should not be 

given an inappropriate weight.

It is also important to note that in many cases a fund’s true “asset class” cannot be reliably 

determined without an analysis of past performance data. This is the case because many 

funds have holdings that may fall into certain specified asset class categories, but the fund 

will have performance characteristics that can deviate substantially from the average 

performance of that specified category (this divergence of a fund from its stated investment 

style or objective is called “style drift” by some in the industry and academia). Thus, past 

performance data is an important way to validate asset class exposures and to monitor 

unexpected changes in a manager’s portfolio, which may be the result of style drift.

While past performance has very low predictive power with respect to the level of future 

performance, past performance information can be critical in evaluating other important 

aspects of an asset class or investment or a manager. Specifically, past performance data 

is more reliable when used to help reveal patterns of relationships between managers or 

investment options. Past performance data can be helpful in validating or invalidating 

claims that are otherwise unverifiable about investment strategies (given the absence of 

 

section 404(c) regulation provides that historical performance is required to be disclosed to requesting 

participants in order for plan fiduciaries to be relieved of liability for investment decisions made by 

participants. Lastly, in the Pension Protection Act advice exemption itself, Congress requires that 

participants be provided with past performance and historical rates of return for a plan’s investment 

options.
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other information, such as detailed holdings or trading records). For example, recent 

studies have demonstrated that a thorough quantitative analysis of the past performance of 

Bernard Madoff’s investment returns did in fact present clear warning signs that something 

was amiss.2

· While past performance cannot predict future success, it can be a useful 

criterion in identifying underperforming managers that should be eliminated from 

consideration. If a manager has skill, it could be expected that—at a minimum—the 

manager’s past track record would not provide evidence suggesting that the manager has 

produced consistently subpar returns. A decent track record, by itself, should never be the 

sole basis for a portfolio recommendation, but a consistently and systematically poor record 

relative to peers or a benchmark over an extended period of time may be cause for 

removing a manager from further consideration. Consistency through time, combined with 

some degree of persistence in delivering excess returns, is crucial in evaluating 

performance records since short-term performance of even the most skilled managers can 

be subpar, and even the worst managers can occasionally get lucky.

2. Actively managed options should play a role in a computer model advice 

program.

In the preamble, the Department also raises the question of whether, in the context of 

developing a computer advice model, the model should be limited to “consider[ing] only the 

historical risks and returns of different asset classes as a whole, information about

participants, and the expenses and asset allocation of each investment option under the 

plan.” Presumably, by limiting a computer model to the consideration of only these factors, 

it would be difficult to compare actively managed funds in the same asset class (thus 

establishing a strong preference for index versus actively managed funds in an acceptable 

computer model).

While we are strong index management proponents and we believe there are big expense and 

predictability advantages with index funds, we also believe that there is clearly a role for actively 

managed funds in many participant portfolios. The issue comes down to the fact that there are 

different kinds of risks in active versus passive investing. While there are always some 

managers who outperform their peers or a benchmark, in hiring an active manager, an investor 

is always running a risk of underperformance. 

What an investment model can do is attempt to analyze an active manager’s past performance 

return patterns and other quantitative aspects of a portfolio to provide some, albeit imperfect, 

indication of what the future may hold for a particular actively managed investment. Under most 

conditions, the existence of manager skill is a statistical uncertainty, but that does not 

necessarily mean that it is right to assume that manager skill does not exist. It simply means 

that on the basis of that performance data alone, an investor cannot make a reliable 

 

2

See Bernard, Carole and Boyle, Phelim P., Mr. Madoff's Amazing Returns: An Analysis of the SplitStrike Conversion Strategy (May 14, 2009). Available at SSRN: http://ssrn.com/abstract=1371320
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determination that the manager is adding value, and models can factor in additional information 

to help provide effective advice.

While past academic studies have tended to conclude that there is little evidence that active 

managers can reliably add value above their fees on a risk-adjusted basis versus their index 

benchmarks, the statistical properties of the distribution of manager returns are not consistent 

with the notion that value added is random, and there is still a vigorous debate of the issue 

among academics and professionals.3 Thus, in our view, the Department should avoid 

mandating criteria as a matter of public policy that would make it unnecessarily difficult to offer 

computer model advice on actively managed funds.

3. The Department should avoid attempting to define and mandate the criteria that 

will be considered consistent with generally accepted investment theories.

In the proposed rule’s preamble, the Department asked about the level of specificity that 

should be in the regulation with respect to what models, methods, or procedures are 

consistent with “generally accepted investment theories.” For example, the Department 

asked if the regulation should dictate the bases for model parameters such as the 

probability distribution of future returns to asset classes or particular investments.

In this regard, Vanguard’s view is that it is not the role of regulators to dictate criteria or 

specific mechanisms for the provision of investment advice. There is, and has been for 

decades, great debate around the merits of various investment theories. The specific 

question raised in the preamble with respect to whether the Department should dictate a 

certain probability distribution of future returns to asset classes or particular investments is 

particularly revealing because there are huge differences of opinion in the investment 

community with respect to this question—not just around what “distribution” should be used 

in modeling, but how that distribution might change over time. 

Rather than specifying the parameters or specific techniques that must be used to make 

recommendations, we favor rules that encourage transparency with respect to the 

methodology that is being used. Ultimately, the most important question is not what exact 

technique was applied to generate advised allocations or return predictions, but rather 

whether those calculations and predictions are performed in a way that is consistent only 

with the best interests of the advised client in mind. Specifying techniques is highly unlikely 

to ensure that this most important, overriding objective is met.

 

3 Recent entries with differing points of view in this debate include: [i] Fama, Eugene F. and French, 

Kenneth R., Luck Versus Skill in the Cross Section of Mutual Fund Returns (December 14, 2009). Tuck 

School of Business Working Paper No. 2009-56; Chicago Booth School of Business Research Paper; 

Journal of Finance, forthcoming. Available at SSRN: http://ssrn.com/abstract=1356021; and [ii] Kosowski, 

Robert, Timmerman, Allan G., Wermers, Russ R., and White, Jr., Halbert L., 2006, Can Mutual Fund 

“Stars” Really pick Stocks? New Evidence from a Bootstrap Analysis, Journal of Finance, Forthcoming

61, 2551-2595. Available at SSRN: http://ssrn.com/abstract855425 or doi:10.2139/ssrn.414441
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* * *

The remainder of our comment letter will address certain legal and practical aspects of the 

Department’s proposed rule.

4. The Department’s affirmation of prior advice guidance will encourage the 

continued development and adoption of advice programs.

Plan participants need assistance in managing their investments, perhaps now more than 

ever before. Having come through the sharp declines and extreme volatility experienced by 

all investors in the economic downturn of 2008–2009, participants now seek to rebalance 

portfolios, rebuild accounts, and recover confidence that consistent, long-term savings and 

investment through employer-sponsored retirement plans will provide them with an avenue 

to retirement security.

Many participants now realize that they need to make better allocation decisions and 

exercise greater control over the investment of their accounts, yet they lack the knowledge 

and, all too often, the tools needed to match their investment allocations to their long-term 

goals. Professional investment advice can fill a critical gap for many investors and, through 

the proposed rule, the Department has taken a strong step toward ensuring that quality, 

expert advice is available to the greatest number of participants.

Importantly, the Department affirmed its view that nothing in the statutory prohibited 

transaction exemption or in the proposed rule invalidates or otherwise undermines 

programs established under prior Department guidance. Thus, plan sponsors and 

participants confidently may continue to utilize these well-established programs that already 

provide high-quality, cost-effective advice from qualified advisers. 

5. The Department properly excluded compensation received by an affiliate of 

the fiduciary adviser from the fee-leveling requirement.

The proposed rule once again affirms the Department’s conclusion that the fee-leveling 

requirement applies only to compensation received by the fiduciary adviser, as well as the 

fiduciary adviser’s employees, agents, and registered representatives. As first noted by the 

Department in Field Assistance Bulletin 2007-01, the fee-leveling requirement does not 

reach to the compensation received by an affiliate of the fiduciary adviser.

We believe this interpretation is entirely consistent with the intent of Congress in adding 

these participant advice rules to ERISA. Indeed, as the Department noted in the Field 

Assistance Bulletin, “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.” 
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This interpretation, combined with other safeguards under the proposed rule such as; (i) the 

adviser’s acceptance of ERISA fiduciary responsibility for the advice provided; (ii) the 

performance of an annual audit by an independent auditor; and (iii) the provision of detailed 

participant disclosures with respect to material affiliations of and fees received by the 

adviser, will help to ensure that responsible and cost-effective advice programs will be 

available to participants through the advice provider selected and approved by their 

employer.

6. Description of available target-date or life-cycle funds is best provided with 

the initial advice disclosures and contemporaneous with the advice generated 

by a computer model.

Under the proposed rule, the Department requires that “contemporaneous with the 

provision of investment advice generated by a computer model,” a participant must be 

furnished with a general description of any available target-date or life-cycle funds that are 

excluded from the advice recommendations. We wholeheartedly agree with the Department 

that participants should be made aware of these often lower-cost and simpler alternatives 

to an advice program.

However, we believe that it will be most effective if the disclosure describing target-date 

and life-cycle funds is provided before the participant and the fiduciary adviser have gone 

through all the steps necessary for the provision of advice (including solicitation and 

consideration of the participant’s information relating to age, time horizons, risk tolerance, 

current investments, other assets, or sources of income and investment preferences). This 

will allow the participant sufficient time to consider the target-date or life-cycle fund 

alternative to an advice program.

As such, we suggest that the Department require, both as part of the initial disclosures 

required to be furnished when an investment adviser is engaged (as outlined in paragraph 

(b)(7) of section 2550.408g-1 of the proposed rule) and then contemporaneous with the 

provision of the computer model investment advice, the participant be furnished with a 

general description of available target-date or life-cycle funds and how they operate.

7. Advice for IRA investors should not be required to model the entire universe 

of investment options.

The Department notes in the preamble to the proposed rule that its explanation of 

provisions in the preambles to the prior proposed and withdrawn final rule should be read 

as applicable to the new proposed rule. We encourage the Department when it issues the 

final rule to affirmatively restate comments made in the January 2009 preamble to the 

withdrawn final rule regarding advice for IRA beneficiaries.

In the January 2009 preamble, the Department noted that it is not reasonable to expect that 

all computer models will be capable of modeling the universe of investment options. Such 

models may focus on investments available through the IRA, while accommodating “hold” 
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and “sell” recommendations for investments not available through the IRA, provided that 

the IRA beneficiary is fully informed of the model’s limitations in advance of the 

recommendations, thereby enabling the recipient of the advice to assess the usefulness of 

the recommendations.

Many of our IRA clients come to Vanguard because they approve of our fundamental 

investment and business principles and thus they expect that we will be advising them 

within the available universe of Vanguard investment options. Vanguard strongly believes 

that the Department should permit IRA holders to preselect the funds to which the advice 

arrangement will apply in the same way that a plan fiduciary selects the menu of 

investment options within a plan. 

8. The Department should create a self-correction program for nonsubstantial 

operational failures.

As we have in our prior comments to the Department on the advice exemption, Vanguard 

encourages the Department to consider a self-correction approach for instances of 

noncompliance if the fiduciary adviser has made a good faith effort to comply with the 

requirements for eligible investment advice arrangements and any failure to do so is not 

substantial. The Department has retained the requirement that audit reports disclosing 

failures must be submitted to the Department, and we remain hopeful that the Department 

will utilize the information received in these reports as a basis for creating a self-correction 

program. 

* * *

Vanguard appreciates the opportunity to submit these comments and we would welcome 

the opportunity to continue working with the Department if we can be of additional 

assistance. If there are any aspects of our comments that you would like to explore in 

greater detail, please do not hesitate to contact Ann Combs at 610-503-6305 or Dennis 

Simmons at 610-669-4065.

Sincerely, 

R. Gregory Barton George U. Sauter