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best prediction of the future. A weight of zero (in all cases) would be a strong and
controversial assumption.

3. Should specific practices be required?

The proposed regulation already includes requirements, as to the proprietary models of
affiliated advisors, for: (1) taking into account investment management and other fees and
expenses attendant to the recommended investments, (2) requesting from a participant, and,
if furnished, utilizing, information relating to age, time horizon, risk tolerance, current
investments in designated investment options, other assets or sources of income, and
investment preferences, (3) using appropriate objective criteria to provide asset allocation
portfolios comprised of investment options available under the plan, and (4) taking into
consideration all investment options without giving inappropriate weight to any (provided
that employer securities, target date funds, and annuities need not be considered), and,
furthermore, requires that the following be avoided (setting aside for the moment the
requirement that recommendations cannot 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): (1) investment recommendations that inappropriately favor investment options
offered by the advisor or affiliate or person with a material contractual relationship, and (2)
investment recommendations that inappropriately favor investment options that may generate
greater income for the advisor or affiliate or person with a material contractual relationship.

The Department could provide some additional high level guidance relative to taking into
consideration risks (for example, risks associated with active management). In addition, the
Department could clarify that a proprietary model of an affiliated advisor not be allowed to
arbitrarily exclude employer securities from consideration, if such securities are available as
a plan investment option.

Financial Engines believes that the requirement in the proposed regulation to request, and if
provided, take into consideration additional information such as outside holdings and risk
preferences, is appropriate and useful.

4. What historical data should be taken into account in determining the expectation of future
performance of asset classes and specific investment alternatives used by the proprietary
model of an affiliated advisor?

Historical data can be useful in determining estimates for a variety of inputs into a predictive
advisory model. For instance, most models use historical data for volatility and correlations,
as well as to estimate the investment style of a fund. However, it is important to recognize
that estimates of expected returns derived from historical returns are noisy. That is, the
potential error from any estimate derived from historical returns is large - you need a very
large number of years of data to accurately estimate the mean rate of return for equities.
Given, this fact, few institutional investors rely strictly on historical rates of return to drive
their asset allocation models. Usually, judgment or additional information is required to
properly calibrate expected return estimates drawn from historical data.


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requiring that the computer model be based on “generally accepted” theories is sufficient to
eliminate concerns of specious or highly unorthodox methods being applied. For instance,
mean-variance portfolio optimization theory would meet this standard, while astrology and
Elliot Wave theory would not. Generally, most academics and many institutional managers
are skeptical of technical trading rules,, charting techniques, and methods that lack a solid
foundation in the academic literature. By specifying that theories must be “generally
accepted,” it is not necessary to expressly prohibit any particular theory.

2. Is a fund’s past performance relative to the average for its asset class an appropriate
criterion for allocating assets to the fund?

A fund’s past performance can be an appropriate criterion as long as the weighting on this
information is appropriate given the other facts and circumstances for the investment. Other
factors (such as fees) can counter the impact of positive past performance. The question is
not “is past performance relevant?”, but “how relevant is it in this situation?” The appropriate
weight on past performance can be as low as zero in some circumstances, but generally most
investment models would attach some modest explanatory power to manager performance in
predicting future expected returns. However, in all cases the weight should be less than one
hundred percent as there is no evidence supporting the claim that past performance will be
repeated in the future with certainty. As long as there is uncertainty, the appropriate response
is to down-weight the impact of past performance in making predictions about the future.
However, assuming that the appropriate weight on past manager performance should be zero
in all cases represents a fairly aggressive position relative to the opinions of most institutional
money managers and financial economists.

When giving advice, it is important to recognize that you are always making assessments
about future quantities that are uncertain. Whether it is asset class expected returns, asset
class risks and correlations, fund-specific risk factors, or manager performance, all of these
quantities are uncertain and may not play out in the future the way they have played out in
the past. While fees are certainly easier to predict than manager performance, an advisor is
always faced with making informed judgments about uncertain variables when building
advice models. It is drawing an artificial distinction to say that asset class returns and risks
are easily estimated, while manager performance is highly uncertain. Both are challenging to
predict in the future with high accuracy. In fact the value-add of advice is to help participants
deal with estimating the impact of factors that cannot be confidently expected to persist in the
future.

Of course, the Department is prudent to focus on manager performance as a key
consideration in protecting participants from conflicts of interest. In deciding what weight to
place on historical performance, a conflicted advisor may have incentives to overstate this
factor to increase their investment income. However, it is widely accepted in money
management practice that historical performance (properly measured) may be useful in
selecting good investments provided its explanatory power is not exaggerated. The key
question in a given situation is how much weight should be placed on history to derive the


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5. What types of criteria are appropriate and objective bases for asset allocation pursuant to
subsection (b)(4)(i)(D), which requires that the proprietary computer model of an affiliated
advisor to objective criteria to provide asset allocation portfolios comprised of investment
options available under the plan?

There are no purely objective criteria that are the basis of asset allocation or investment
selection models. In general, well designed models will rely on historical data, accepted
economic theory, and properly conditioned estimates of expected returns, volatilities, and
correlations. Two areas that should be explicitly considered would be investment expenses
and active management risk (additional volatility due to active management decisions).
Designating certain criteria as not appropriate is risky, as there may be situations where such
information would be relevant.

6. Under what if any conditions would it be consistent with generally accepted investment
theories and with consideration of fees to recommend a fund with superior past performance
over an alternative fund in the same asset class with average performance but lower fees?

The degree to which past performance may offset the impact of fees in making predictions
depends on the statistical reliability of the manager performance estimate. In other words, it
depends on the weight attached to the past performance which is a function of how likely the
performance is to persist in the future. In general, past performance that has persisted for a
long period of time and shows low volatility is more likely to persist than more volatile and
shorter-term performance track records. If the difference in fees is modest, then past
performance might become a relevant variable on which to make a choice. However, if the
gap in expenses is large (e.g. greater than 100 basis points), then it is less likely that the
predictable component of past performance would be sufficient to warrant a bet on active
management. It is also important to recognize that not all generally accepted models rely on
the hierarchical asset allocation framework assumed in the question. Note that many funds
have multiple asset class exposures. For example, the Financial Engines model does not
categorize funds into a single asset class, but allows for a multitude of possible asset class
exposures.

7. How if at all should the proprietary model of an affiliated advisor take into account
investment management style?

Models should consider investment style and the differences between active and passive
products. Active management by its nature increases the uncertainty of future performance
by making active bets that introduce uncertainty in the future investment style of the fund.
Active funds have more risk than an equivalent index fund with the same style. Of course the
point of taking this active risk is to outperform a comparable index in the future.


financial
engines’

May 5, 2010

Filed Electronically
Office of Regulations and Interpretations

Employee Benefits Security Administration
Room N-5655

U.S. Department of Labor

200 Constitution Avenue, N.W.
Washington, D.C. 20210

Attn: Investment Advice Regulations

RE: Comments on 2010 Proposed Regulation on Investment Advice — Participants and
Beneficiaries, 29 CFR Part 2550

Ladies and Gentlemen:

Financial Engines respectfully submits the following comments in response to the Department of
Labor’s proposed regulation entitled Investment Advice — Participants and Beneficiaries,
published in the March 2, 2010 Federal Register. Financial Engines Advisors L.L.C., a wholly
owned subsidiary of Financial Engines, Inc., is a registered investment adviser that provides
personalized investment advice and management services directly to plan participants in 401(k)
and similar plans. Financial Engines is the leading provider of independent advisory services to
large plan sponsors, working with many of the nation’s largest employers and retirement service
providers.

We appreciate the opportunity to comment on the regulation and on the additional questions
posed in the regulation. The following comments are intended to assist the Department in
clarifying several key elements of the proposed regulation to further advance the goal of
providing plan participants with greater access to investment advice.

Financial Engines believes that the proposed regulation provides an opportunity to increase
participant access to investment advice, including by setting appropriate standards for advice
provided by affiliated advisors and by confirming the availability of existing investment advice
arrangements.

Participants who receive investment advice can reduce costly investment errors

Financial Engines strongly supports the Department’s conclusion that plan participants who
receive and follow quality investment advice can reduce costly investment errors. In fact, a
recent report confirms that offering investment help improves investment outcomes for

' Financial Engines offers retirement help, including investment advice and management services, to over 7 million
plan participants through leading employers and financial institutions, including 116 Fortune 500 companies, as of
December 31, 2009.

1804 Embarcadero Road Palo Alto, CA 94303 © Telephone: (650) 565-4900 « Fax: (650) 565-4905


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Employee Benefits Security Administration
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Conclusion

Financial Engines appreciates the opportunity to comment on the proposed regulation and may
provide additional comments as we continue to evaluate the proposal and discuss its impact with
plan fiduciaries. We welcome the opportunity to work with the Department and to provide any
further assistance that may be required. Please contact us should you have any questions.

Very truly yours,

Anne S, Tuttle
Executive Vice President and General Counsel

cc: Phyllis Borzi, Assistant Secretary, Employee Benefits Security Administration
Robert Doyle, Director, Office of Regulations and Interpretations, Employee Benefits
Security Administration
Louis Campagna, Division of Fiduciary Regulations and Interpretations, Employee
Benefits Security Administration
Fred Wong, Office of Regulations and Interpretations, Employee Benefits Security
Adminstration


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participants.” The main finding of this report is that 401(k) participants of all ages using
employer-provided, professional investment help — defined as target-date funds, managed
accounts, or online advice — are better off across a variety of market cycles than those who do
not use professional help. On average, the median annual return for participants receiving
investment help was almost 2% (186 basis points) higher than for participants not using
professional investment help, net of fees. In addition, participants receiving professional
investment advice had portfolios with risk levels that were both more appropriate for their
retirement horizons and more efficiently allocated among their plan's investment options. Of
particular concern, given their limited time to recover from costly investment mistakes, was that
the greatest variability in observed portfolio risk levels was found among retirees and near-
retirees not using professional investment help. The report covers the period between January 1,
2006 and December 31, 2008, and is based on a dataset of seven large plans representing more
than 400,000 individual participants and over $20 billion in assets.

Existing arrangements provide access to investment advice for millions of participants
Investment advice is available today to a significant number of plan participants through
investment advice arrangements that do not need to rely upon the statutory exemption in the
proposed regulation. For example, investment advice is provided by independent fiduciaries
who do not engage in acts described in ERISA section 406(b)(1), including arrangements that the
Department has permitted because the advisor does not cause the plan to pay additional fees for
the service furnished nor to pay a fee to any affiliate of the advisor. Investment advice is also
provided in accordance with the model described in the SunAmerica advisory opinion.*

It is therefore imperative that the existing permissible investment advice arrangements, under
which millions of plan participants receive unbiased investment advice, remain available. For
this reason, we commend and support the Department for maintaining in the regulation a
provision stating that none of the regulation, ERISA section 408(g)(1) or Code section 4975(f)(8)
invalidate or otherwise affect prior regulations, exemptions, interpretive or other guidance issued
pertaining to the provision of investment advice and circumstances under which such advice may
or may not constitute a prohibited transaction under section 406 of ERISA or section 4975 of the
Code.

Additional clarity as to impact on existing investment advice arrangements will increase
availability of advice

Participant access to quality investment advice (whether discretionary or non-discretionary) will
increase once plan sponsors and industry participants feel that there is clarity around the
requirements to provide investment advice. As a result, to support increased access to unbiased
investment advice, and to provide additional encouragement for plan sponsors to provide
investment advice to their plan participants, we respectfully suggest that the Department provide
additional clarification to further support §2550.408g-1(a)(3) of the proposed regulation, by re-
iterating that the requirements of the regulation are not the only acceptable means for providing

? Help in Defined Contribution Plans; Is It Working and for Whom? Financial Engines and Hewitt Associates joint

research, January 2010, available at:
http://www.hewittassociates. taBasi [AssetCache_/Assets/Articles/2010/DCI Report _Jan2010.pdf.

3 Advisory Opinion 2001-09A (Dec. 14, 2001)


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investment advice, and that the regulation is not applicable to discretionary investment
management. Industry participants and plan sponsors should understand that the requirements of
the regulation apply only to advice provided in reliance on the statutory exemption and that no
inference should be made regarding the provision of investment advice not addressed by the
regulation, or to discretionary investment management. Otherwise, we believe that the goal of
supporting increased access to unbiased investment advice (whether discretionary or non-
discretionary) could be significantly diminished.

In order to promote greater access to investment advice, the Department must clarify that the
defined term “eligible investment advice arrangement” is not meant to confer on advice
arrangements made possible by the proposed regulation any greater status or suitability than
other investment advice arrangements not needing the exemptions provided within the proposed
regulation”.

Independent advisors not impacted by regulation

It should be made clear that independent investment advisors are not required to comply with the
provisions of the proposed regulation, and that the requirements of the proposed regulation
should not create any inferences regarding the selection or monitoring of independent advisors.>
Further, we request that the Department expand upon the reference to Field Assistance Bulletin
2007-1 to additionally reference Regulation 29 C.F.R. §2550.408b-2(e)(2), which explains that a
fiduciary does not engage in an act described in section 406(b)(1) if the fiduciary does not use
any of the authority, control, or responsibility which makes such person a fiduciary to cause a
plan to pay additional fees for a service furnished by such fiduciary or to pay a fee for a service
furnished by a person in which such fiduciary has an interest which may affect the exercise of
such fiduciary’s best judgment as a fiduciary. The Department should designate a fiduciary
described under §2550.408b-2(e)(2) as an “independent advisor.”

Questions raised by the Department

1. For purposes of the requirement that the proprietary computer models of affiliated advisors
be designed and operated to apply generally accepted investment theories that take into
account the historic risks and returns of different asset classes over defined periods of time,
what investment theories are generally accepted?

Financial Engines believes that generally accepted investment theories are those
methodologies that enjoy broad support in institutional practice and among academic experts.
Having a precise and narrow definition of “generally accepted” will likely not result in
regulation which accommodates and supports innovation, as such theories tend to evolve
(albeit slowly) over time. The Department, plan participants and plan fiduciaries would not
be well-served to establish “approved” theories that would force plan fiduciaries and
investment advisers to rely on approaches that may become outdated. We believe that simply

‘ Many plan fiduciaries, ERISA counsel, and industry consultants believe incorrectly that advice provided under the
statutory exemption confers fiduciary protection not available with other investment advice arrangements.

5Many plan fiduciaries, ERISA counsel, and industry consultants believe incorrectly that investment advice for
participants is not permissible in the absence of a certification.