Regulatory Studies Program  Mercatus Center at George Mason University 1 

Public Interest Comment on 

Investment Advice – Participants and Beneficiaries1

RIN 1210-AB35 

________________________________________________________________________ 

The Regulatory Studies Program (RSP) of the Mercatus Center at George Mason 

University is dedicated to advancing knowledge of the impact of regulation on society. 

As part of its mission, RSP conducts careful and independent analyses employing 

contemporary economic scholarship to assess rulemaking proposals from the perspective 

of the public interest. Thus, this comment on the Employee Benefits Security 

Administration’s (EBSA) proposed rule2

 does not represent the views of any particular 

affected party or special interest group, but is designed to assist the Department of Labor 

as it seeks to expand the amount of investment advice available to investors while 

protecting them from advisors’ potential conflicts of interest. 

I. Introduction 

Investment advisors face a potential conflict of interest when their compensation varies 

based on the investments their clients choose. An advisor may have incentives to steer 

investors toward investments that generate higher fees for the advisor but are not 

necessarily the best choice for the investor. 

Federal law recognizes this conflict and provides special protections for participants and 

beneficiaries of defined-benefit retirement plans (such as 401ks) and Individual 

Retirement Accounts (IRAs). The Employee Retirement Income Security Act (ERISA) 

prohibits fiduciaries that offer these plans from giving investment advice to plan 

participants or beneficiaries that would result in the payment of additional fees to the 

fiduciary or an affiliate. 

Such prohibitions are not costless for investors. As the department’s 2008 Regulatory 

Impact Analysis notes, “These provisions effectively preclude participants from obtaining 

 

1

 Prepared by Jerry Ellig, senior research fellow, and Christina Forsberg, graduate fellow, Mercatus Center 

at George Mason University. This comment is one in a series of Public Interest Comments from the 

Mercatus Center’s Regulatory Studies Program and does not represent an official position of George 

Mason University. 

2

 Department of Labor, Employee Benefits Security Administration, “Investment Advice—Participants and 

Beneficiaries,” Proposed Rule, 75 Fed. Reg. 9360 (March 2, 2010). 
Regulatory Studies Program  Mercatus Center at George Mason University 2 

advice under arrangements that are widely used by other investors.”3 They may protect 

investors from advisors’ conflicts of interest, but they also diminish the amount of advice 

available to investors. 

In 2006, Congress sought to expand the amount of investment advice available to plan 

participants and beneficiaries by enacting a statutory exemption to ERISA’s prohibition. 

On January 21, 2009, the Labor Department issued a final rule implementing this 

statutory exemption. The exemption permits fiduciaries to offer certain types of 

investment advice if (1) neither the fiduciary nor the person providing the advice receives 

any type of fee or other compensation that varies based on the investment selected, or (2) 

the advice is generated by a computer model meeting certain requirements. In either case, 

certain auditing, disclosure, and recordkeeping policies must also be followed. 

The January 2009 final rule also included a “class exemption” that permitted fiduciaries 

to provide individualized investment advice even in some situations there the fiduciary or 

the person giving the advice could receive fees that vary based on the investor’s choice of 

investments. The class exemption included several provisions intended to prevent 

conflicts of interest that might motivate the advisor to recommend inferior investments. 

During 2009, the department extended the implementation date of the regulations several 

times and sought additional comments on the legal and policy issues. This new proposed 

rule essentially implements the statutory exemption from the January 2009 final rule but 

declines to implement the class exemption. 

The department should not deprive investors of the class exemption’s potential benefits 

without a clear theory and evidence indicating that the proposed safeguards are 

insufficient to protect investors from advisors’ conflicts of interest. Unfortunately, neither 

the department’s previous notices regarding the class exemption, nor the comment letters 

cited in the most recent notice, contain evidence-based analysis demonstrating whether 

the safeguards in the proposed exemption are sufficient or insufficient to protect 

investors. Therefore, the department’s decision to nix the class exemption is premature. 

Before making a final decision, the department should conduct rigorous, evidence-based 

analysis to assess whether the class exemption would create incentives for advisors to 

cheat investors, and if so, whether the safeguards would prevent advisors from acting on 

those incentives. 

II. Assessing the class exemption 

The class exemption would go beyond the statutory exemption by permitting fiduciaries 

to offer investment advice under two circumstances: 

 

3

 Department of Labor, Employee Benefits Security Administration, “Investment Advice—Participants and 

Beneficiaries,” Proposed Rule, 73 Fed. Reg. 49896 (Aug, 22, 2008) at 49905. 
Regulatory Studies Program  Mercatus Center at George Mason University 3 

(1) Fee-leveling: The individual offering the advice receives no fee or other form of 

compensation that varies based on the investments chosen. This requirement 

applies only to the individual advisor, not to the fiduciary or its affiliates. 

(2) Computer modeling: Even if the individual offering advice receives compensation 

that varies based on the investments chosen, he or she can offer advice after the 

investor has received investment recommendations generated by a computer 

model, or other specified investment education materials if computer modeling is 

not feasible. 

1. Fee-leveling 

It is difficult to imagine how an advisor whose compensation is unaffected by the 

investments the investor selects would have much of an incentive to offer biased 

investment advice. The department’s definition of relevant compensation is quite broad; 

it includes “salary, bonuses, awards, promotions, or other things of value ... received, 

directly or indirectly by any employee, agent, or registered representative that provides 

investment advice on behalf of a fiduciary advisor...”4

 Discussion in the January 2009 

final rule indicates just how broadly the concept applies. In response to commenters who 

asked if bonus programs based on the overall profitability of a fiduciary advisor would 

violate the fee-leveling requirement, the department stated: 

[A]lmost every form of remuneration that takes into account the 

investments selected by participants and beneficiaries would likely violate 

the fee-leveling requirement of the final rule. On the other hand, it is 

conceivable that a compensation or bonus arrangement that is based on the 

overall profitability of an organization may be permissible to the extent 

that it can be established that the individual account plan and IRA 

investment advice and investment option components were excluded from, 

or constituted a negligible portion of, the calculation of the organization’s 

profitability.5

 [emphasis added] 

The fiduciary employing the individual advisor, or its affiliates, might wish the advisor 

would offer biased advice that favors the mutual funds or other investments they sell. But 

if the fiduciary or affiliate cannot offer the individual advisor any type of compensation 

for steering business their way, the advisor has no clear incentive to do so. 

The class exemption did permit fiduciaries and their affiliates to receive compensation 

that varies based on the investments chosen by plan participants. A rigorous analysis of 

the potential for investor harm would start by articulating a logical theory, consistent with 

human behavior, that explains why an investment advisor would steer investors into 

 

4

 Investment Advice Proposed Rule, supra note 3, at 49897. 

5

 Department of Labor, Employee Benefits Security Administration, “Investment Advice—Participants and 

Beneficiaries,” Final Rule, 74 Fed. Reg. 3822 (Jan. 21), at 3823. 
suboptimal investments offered by the fiduciary or its affiliates, when he or she receives 

no compensation for doing so. The analysis would then investigate actual evidence that 

demonstrates whether, or to what extent, investment advisors under fee-leveling 

arrangements actually do recommend investments that increase profits of the fiduciary or 

its affiliates but are not the best choice for the investor. 

2. Computer modeling 

The class exemption outlines some conditions under which individual advisors could 

offer advice even if their compensation varies based on the investments selected. The 

investor must first receive advice from a computer model that meets specified 

requirements or receive specified investment education materials if computer modeling is 

not possible. Computer models must be based on “generally accepted investment 

theories,” cannot be biased in favor of investment offered by the fiduciary advisor or 

affiliate, and must explicitly state all facts and assumptions. Several additional 

requirements apply: 

• The investment advice arrangement must be authorized by the plan fiduciary or 

IRA beneficiary. 

• The advisor must disclose potential conflicts of interest to the investor. 

• The investment advice must be based on “generally accepted investment 

theories,” must take into account investment management fees and expenses, and 

must take into account certain information furnished by the plan participant, such 

as age, time horizon, risk tolerance, other investments, and related factors. 

• The advisor must explain to the investor the basis for the advice, why the advice 

recommends options with higher fees (if applicable), and how the advice deviates 

from or relates to the advice from the computer model or educational materials 

furnished before the advice was given. 

• The fiduciary must maintain written policies and procedures designed to ensure 

compliance with the conditions attached to the exemption. 

• The fiduciary must arrange for an independent compliance audit at least annually. 

IRA beneficiaries must receive the auditor’s report, and the auditor must report 

and noncompliance to the Department of Labor. 

• The fiduciary must maintain records necessary to evaluate its compliance for six 

years. 

Regulatory Studies Program  Mercatus Center at George Mason University 4 
Regulatory Studies Program  Mercatus Center at George Mason University 5 

• The advisor must document the basis of any advice given, and the fiduciary must 

keep this information as part of the records retained for six years.6

Allowing an individual whose compensation varies based on the investments chosen to 

offer advice has the potential to create conflicts of interest, since the advisor could 

receive greater compensation by steering the investor into investments that pay higher 

fees to the advisor but produce worse performance for the investor. The attached 

conditions seek to mitigate the conflict of interest by ensuring that investors are informed 

about the possibility, giving investors access to unbiased advice from computer models or 

other educational materials before they receive personalized advice, circumscribing the 

nature of the advice that can be given, and requiring a compliance audit and retention of 

records. In short, they rely on disclosure, consumer education, and compliance audits to 

counter the advisor’s incentive to bias his or her advice. 

An additional factor comes into play with IRAs. Because these are individual accounts 

established by individuals, investors can easily shop among a wide variety of fiduciaries 

who offer IRAs. Investors can track the performance of their IRAs and compare their 

results with those achieved by friends and relatives who may have IRAs with different 

fiduciary advisors. Indeed, fiduciaries vying for new business eagerly furnish information 

on past performance so that investors can compare their own IRA’s performance with 

what they might have achieved with another fiduciary. As the department’s 2008 

Regulatory Impact Analysis acknowledges in a footnote, “IRA beneficiaries’ 

vulnerability to risks attendant to conflicts of interest may be mitigated by their ability to 

make rational and well informed purchases in a vibrant, competitive markets for 

investment advice and other financial products and services, in which some vendors will 

offer unconflicted advice.”7

 In other words, competition can play a powerful role in 

disciplining advisors’ conflicts of interest. 

Competition at the level of the individual investor is perhaps less robust for definedcontribution plans. Except in the case of government or large, private employers that 

offer a choice of multiple plan providers, an individual dissatisfied with an account’s 

performance would have to convince an employer to switch its plan to a different 

fiduciary. This might be a practical remedy if most employees are dissatisfied with a 

fiduciary which has a consistent pattern of giving biased investment advice to most plan 

participants, but it would not be a very effective constraint on the provision of biased 

advice to a few individual clients by a few individual advisors. 

Whether competition or the regulatory requirements in the class exemption are sufficient 

to protect investors from advisors’ potential conflicts of interest is an open question. The 

department’s decision on this aspect of the class exemption should be based on research 

that identifies whether disclosure, education, and compliance requirements—or 

competition—effectively protect investors. One huge “laboratory” for such research is 

 

6

 Investment Advice Final Rule, supra note 5, at 3850–52. 

7

 Investment Advice Proposed Rule, supra note 3, at 49910. 
Regulatory Studies Program  Mercatus Center at George Mason University 6 

the universe of investment accounts not covered by ERISA’s restrictions, such as 

ordinary mutual fund and brokerage accounts. In the absence of such research, the 

decision to withdraw the class exemption is premature. 

III. The Absence of Analysis 

Unfortunately, the department conducted no rigorous analysis of the issues we discuss 

above before it decided to withdraw the class exemption. None of the Regulatory Impact 

Analyses prepared for the statutory exemption and the class exemption determined 

definitively whether these exemptions would create or mitigate conflicts of interest. 

These analyses did a reasonable job of demonstrating the very large benefits to investors 

of more widespread investment advice, and they estimated the effects of the department’s 

decisions on the benefits and costs of investment advice. But the original 2008 analysis, 

the final 2009 analysis, and the revised 2010 analysis largely took the department’s 

decisions about exemptions as given, then proceeded to calculate benefits and costs. 

The 2008 analysis does cite several studies that reach conflicting conclusions on whether 

investment advisors have conflicts of interests that harm investors. The analysis notes 

that the conditions attached to the class exemption are intended to guard against selfdealing, then warns in a footnote, “The department has no basis to estimate how much 

risk might remain.”8

 It explicitly assumes that investors who receive advice make fewer 

errors than other investors, and “The remaining errors reflect possible flaws in some 

advice...”9 “Flaws” might include biased advice motivated by conflicts of interest. 

The 2009 final regulatory analysis states that “the RIA assumed that advice arrangements 

operating pursuant to the proposals would be as effective as arrangements operating 

without the need for exemptive relief, notwithstanding the conflicts that are attendant to 

the former.”10 But this is just an assumption, not a proven fact. It is the critical issue that 

should be addressed with evidence-based analysis before the department can determine 

whether the class exemption would help or harm plan participants. 

The department’s March 2, 2010 notice, which proposes to implement the statutory 

exemption without the class exemption, contains no new analysis of conflicts of interest. 

It merely states that some comments received in response to its February 4, 2009 notice 

claimed that the class exemption would create conflicts of interest and contains 

insufficient safeguards to mitigate them.11 The comments themselves contain arguments 

to this effect, but they present no evidence demonstrating that the class exemption will, in 

fact, create conflicts of interest that are unmitigated by the proposed safeguards. The 

comments below are representative of assertions not backed by evidence-based analysis: 

 

8

 Investment Advice Proposed Rule, supra note 3, at 49910. 

9

 Investment Advice Proposed Rule, supra note 3, at 49910. 

10 Investment Advice Final Rule, supra note 5, at 3839. 

11 Investment Advice Proposed Rule, supra note 2, at 9363. 
Regulatory Studies Program  Mercatus Center at George Mason University 7 

It’s hard to believe that you are even considering allowing representatives 

of mutual fund companies to provide investment advice to 401K 

participants. They cannot be unbiased if they get a paycheck from a fund 

company. You will save yourselves a lot of problems going forward if you 

just insist on fee-only independent advisers. If you get a commission on a 

product, your opinion is tainted by definition.12

Vendor personnel have vested interests in promoting their own funds, 

asset allocation products and services. Blatant financial conflicts of 

interest may be muted, understated or undisclosed. No amount of industry 

regulation will be able to eliminate the many different types of “conflicts 

of interest” that these arrangements contain and no rules or governing 

body will be able to assure compliance with any potential stop gap 

measures designed to “police” vendor personnel from promoting their own 

interests through “deemed object/independent” advice arrangements. The 

only truly independent and objective investment advice arrangement 

comes from highly trained, licensed investment professionals who have no 

financial or moral “conflicts of interest.”13

In an effort to provide easier access to investment advice legislators 

penned into law inherent conflicts of interest in that advice. Fee-only, 

independent, third party advisors were providing 401(k) investment advice 

on a discretionary basis long before the PPA. Because their compensation 

was never driven by the investments they were recommending, they never 

ran afoul of ERISA.14

While conflicts of interest have been at the heart of many financial 

scandals, retirement accounts have been better-protected thanks to the 

prohibition against conflicts of interest that is part of ERISA. The new 

rules would shift emphasis from avoiding conflicts to managing and 

disclosing them. The class exemption is bad policy introduced at the worst 

possible time. It contributes to a perception that regulators favor the 

interests of financial services companies over those of investors.15

ERISA’s long-standing requirements for fiduciaries to act in the sole 

interests of the plan participants preserves the distinction between 

 

12 Comments of Joe Lyons, EBSA Docket 08-11 (Feb. 9, 2009), available at 

http://www.dol.gov/ebsa/pdf/cmt-02190905.pdf. 

13Comments of Stace Hilbrant, Managing Director, Investment Advisor Representative, Accredited 

Investment Fiduciary, 401(k) Advisors, LLC, EBSA Docket 08-11 (Feb. 10, 2009), available at 

http://www.dol.gov/ebsa/pdf/cmt-02190906.pdf. 

14Comments of David Kudla, Chief Executive Officer, Mainstay Capital Management, LLC, EBSA Docket 

08-11 (Feb. 16, 2009), available at http://www.dol.gov/ebsa/pdf/cmt-02190908.pdf. 

15Comments of Blaine F. Aikin, CEO, Fiduciary360, EBSA Docket 08-11 (Feb. 26, 2009), available at 

http://www.dol.gov/ebsa/pdf/cmt-03060901.pdf. 
Regulatory Studies Program  Mercatus Center at George Mason University 8 

fiduciary relations and ordinary commercial transactions—a distinction 

which should be maintained.16

The final regulation excludes affiliates of the fiduciary adviser from the 

fee-leveling requirement while the class exemption limits it to the 

particular employee, agent or registered representative providing the 

investment advice. These provisions, both restricting the scope of the 

statutory exemption, raise significant questions of law and policy ...17

Without stronger participant protections, the published Class Exemption 

and regulation will lead us down a road of conflict of interest problems 

that ERISA has long sought to prevent.18

The class exemptions do not counter the opportunity for self-dealing with 

effective controls and should be withdrawn... a. Limited audits based 

upon self-imposed policies and procedures cannot provide adequate 

protection against self-dealing investment advisers... b. The disclosure 

requirements do not protect participants from conflicts of interest... c. 

There is no single structure to monitor compliance and protect participants 

from self-dealing investment advisers... d. Participant investment advice 

is available from independent providers, or through the statutory 

exemption...19

We searched the comments for references to any empirical studies that demonstrated 

whether the class exemption would create conflicts of interest or mitigate them if they 

occur. One comment cites several law review articles, including one by SEC 

Commissioner Troy Paredes, which suggest that information disclosure alone is 

insufficient to protect investors, because investors do not read and process all of the 

information.20 Indeed, excessively detailed disclosure may lead to “information 

overload.” Yet even Paredes’ article calls for more empirical research on the topic and 

suggests that a better disclosure regime might involve less disclosure, with greater 

 

16Comments of Diahann Lassus, Chair; Ellen Turf, CEO, and Susan MacMichael John, Chair, Industry 

Issues Committee, National Association of Personal Financial Advisors, EBSA Docket 08-11 (Mar. 6, 

2009), available at http://www.dol.gov/ebsa/pdf/cmt-03090901.pdf. 

17Comments of Thea Lee, Policy Director, American Federation of Labor and Congress of Industrial 

Organizations (AFL-CIO), EBSA Docket 08-11 (Mar. 6, 2009), available at 

http://www.dol.gov/ebsa/pdf/cmt-03090902.pdf. 

18 Comments of David Certner, Legislative Counsel and Legislative Policy Director, American Association 

of Retired Persons (AARP), EBSA Docket 08-11 (Mar. 6, 2009), available at 

http://www.dol.gov/ebsa/pdf/cmt-03090904.pdf. 19Comments of Cynthia Milstead, Senior ERISA Counsel, Hewitt Associates, LLC, EBSA Docket 08-11 

(Mar. 6, 2009), available at http://www.dol.gov/ebsa/pdf/cmt-03090905.pdf. 

20 Comments of Diahann Lassus et. al, supra note 16, at 4-5. 
Regulatory Studies Program  Mercatus Center at George Mason University 9 

sensitivity about the ways investors process information.21 This line of research implies 

that the disclosures the department requires should be crafted with an understanding of 

how investors will actually use the information and that the department should be 

cautious about relying upon disclosure alone to mitigate conflicts of interest. But these 

sound insights hardly prove that the class exemption will create unresolvable conflicts of 

interest. 

The only study using data cited was a working paper by Nicolaj Siggelkow that found 

mutual fund providers maximize profits by shifting expenses to fund investors when they 

can.

22 Nothing in this paper addresses investment advice offered by mutual fund 

companies. Thus, the comments the department cited as the only justification for 

withdrawing the class exemption provide some assertions but very little evidence about 

its likely effects. 

IV. Conclusion 

The class exemption offers two different scenarios under which investment advisors 

could offer individualized advice to participants and beneficiaries in defined-contribution 

plans and IRAs. Under the fee-leveling requirement, it is difficult to imagine how an 

individual advisor would have direct incentives to offer tainted investment advice. Under 

the computer modeling requirement, allowing an advisor whose compensation varies 

based on the investments chosen to offer advice poses greater potential danger to 

investors, since individuals offering advice under that option could receive compensation 

that could reward them for giving biased advice. However, this provision also includes 

greater safeguards intended to keep advisors honest. 

Perhaps both aspects of the class exemption would give investors access to quality advice 

while controlling any potential conflicts of interest. Perhaps neither would. Or perhaps 

only the fee-leveling requirement would. These are the central issues to consider, but the 

record contains insufficient evidence to determine which of these possibilities is more 

likely true. 

To best protect investor interests, the department’s decision on the class exemption 

should rely on evidence-based research that offers a clear theory of investor harm and 

evaluates whether that harm would in fact be likely to occur. Neither the prior Regulatory 

Impact Analyses nor the comments cited in the department’s most recent notice provide 

any definitive analysis on this issue. Therefore, the department should conduct this 

research before making a final decision on the class exemption. 

 

21 Troy Paredes, “Blinded by the Light: Information Overload and its Consequences for Securities 

Regulation,” Washington University in St. Louis School of Law Faculty Working Paper 03-02-02 (June 1, 

2003), http://papers.ssrn.com/sol3/papers.cfm?abstract_id=413180 at 47-53. 

22Nicolaj Siggelkow, “Caught Between Two Principals,” undated paper, Wharton School, 

http://knowledge.wharton.upenn.edu/papers/1280.pdf. 
Appendix 

RSP Checklist 

Element Agency Approach RSP Comments 

1. Has the agency 

identified a 

significant 

market failure? 

The department identifies a large body 

of research demonstrating that 

individuals would benefit if 

investment advice were more widely 

available. 

Grade: A 

This is not a market 

failure, but the systemic 

problem is that ERISA 

creates barriers that 

discourage fiduciaries 

from offering advice. 

2. Has the agency 

identified an 

appropriate 

federal role? 

Since the source of the problem is 

ERISA, altering ERISA regulations is 

the appropriate solution. 

Grade: A 

3. Has the agency 

examined 

alternative 

approaches? 

Three main alternatives are 

considered: no change, statutory 

exemption only, or adopt both the 

statutory exemption and the class 

exemption. Some additional tweaks on 

the statutory exemption are also 

considered. 

Grade: B+ 

Examination of alternatives 

outside this “box” might shed 

light on the central issue of 

whether proposed restrictions are 

sufficient to protect investors 

from advisor conflicts of interest. 

4. Does the agency 

attempt to 

maximize net 

benefits? 

In both 2009 and 2010, the department 

chose the alternative that maximized 

net benefits to investors as calculated 

in the RIA. However, the RIA did not 

explicitly determine whether 

safeguards are sufficient, so it is not 

really clear if the chosen alternative 

really maximized net benefits to 

investors. 

Grade: C 

It is unclear whether the 

department was really making 

decisions based on net benefits to 

investors, or sacrificing net 

benefits to achieve other 

objectives. 

Regulatory Studies Program  Mercatus Center at George Mason University 10 
Regulatory Studies Program  Mercatus Center at George Mason University 11 

Element Agency Approach RSP Comments 

5. Does the 

proposal have 

a strong 

scientific or 

technical 

basis? 

RIAs calculate benefits and costs but 

do not offer definitive analysis of 

whether regulatory safeguards are 

adequate to control conflicts of interest. 

Grade: C 

This is the critical issue that must be 

settled before decisions whether the 

proposed class exemption will help 

or harm investors. 

6. Are 

distributional 

effects clearly 

understood? 

The analysis largely focuses on total 

benefits and costs, rather than 

incidence. 

Grade: C 

7. Are individual 

choices and 

property 

impacts 

understood? 

The potential for participant/ 

beneficiary choice in a competitive 

market to discipline advisor selfdealing is considered only in a 

footnote. 

Grade: C 

Consumers’ role as active choosers 

is important in many markets and 

should have been analyzed 

thoroughly. This should have 

received much more attention—

especially since some of the 

proposed requirements involve 

information disclosure to investors, 

which presumably empowers them 

to evaluate the quality of advice 

they receive and shop around.