49896 Federal Register / Vol. 73, No. 164 / Friday, August 22, 2008 / Proposed Rules 

1See also Code section 4975(e)(3)(B); 29 CFR 

2510.3–21(c). 

2See Interpretative Bulletin relating to participant 

investment education, 29 CFR § 2509.96–1 

(Interpretive Bulletin 96–1); Advisory Opinion (AO) 

2005–10A (May 11, 2005); AO 2001–09A (December 

14, 2001); and AO 97–15A (May 22, 1997). 

3Public Law 109–280, 120 Stat. 780 (Aug. 17, 

2006). 

4Under Reorganization Plan No. 4 of 1978 (43 FR 

47713, October 17, 1978), 5 U.S.C. App.1, 92 Stat. 

3790, the authority of the Secretary of the Treasury 

to issue rulings under section 4975 of the Code has 

been transferred, with certain exceptions not here 

relevant, to the Secretary of Labor. Therefore, the 

references in this notice to specific sections of 

ERISA should be taken as referring also to the 

corresponding sections of the Code. 

5 71 FR 70429, Dec. 4, 2006. The Department, on 

the same date, also published a Request for 

Information in the Federal Register soliciting 

information to assist the Department in determining 

the feasibility of using computer models in 

connection with individual retirement accounts, as 

required by PPA section 601(b)(3). 72 FR 70427, 

Dec. 4, 2006. 

DEPARTMENT OF LABOR 

Employee Benefits Security 

Administration 

29 CFR Part 2550 

RIN 1210–AB13 

Investment Advice—Participants and 

Beneficiaries 

AGENCY: Employee Benefits Security 

Administration, DOL. 

ACTION: Proposed rule. 

SUMMARY: This document contains 

proposed regulations implementing the 

provisions of the statutory exemption 

set forth in sections 408(b)(14) and 

408(g) of the Employee Retirement 

Income Security Act, as amended 

(ERISA or the Act), and parallel 

provisions in the Internal Revenue Code 

of 1986, as amended (Code), relating to 

the provision of investment advice 

described in the Act by a fiduciary 

adviser to participants and beneficiaries 

in participant-directed individual 

account plans, such as 401(k) plans, and 

beneficiaries of individual retirement 

accounts (and certain similar plans). 

Section 408(b)(14) provides an 

exemption from certain prohibited 

transaction provisions in ERISA with 

respect to the provision of investment 

advice, the investment transaction 

entered into pursuant to the advice, and 

the direct or indirect receipt of fees or 

other compensation by the fiduciary 

adviser or an affiliate in connection 

with the provision of advice or the 

transaction pursuant to the advice. 

Section 408(g) describes the conditions 

under which the investment advicerelated transactions are exempt. Upon 

adoption, the regulations will affect 

sponsors, fiduciaries, participants and 

beneficiaries of participant-directed 

individual account plans, as well as 

providers of investment and investment 

advice-related services to such plans. 

DATES: Written comments on the 

proposed regulations should be 

submitted to the Department of Labor on 

or before October 6, 2008. 

ADDRESSES: To facilitate the receipt and 

processing of comment letters, the 

Employee Benefits Security 

Administration (EBSA) encourages 

interested persons to submit their 

comments electronically by e-mail to eORI@dol.gov (Subject: Investment 

Advice Regulations), or by using the 

Federal eRulemaking portal at http:// 

www.regulations.gov (follow 

instructions for submission of 

comments). Persons submitting 

comments electronically are encouraged 

not to submit paper copies. Persons 

interested in submitting paper copies 

should send or deliver their comments 

to the Office of Regulations and 

Interpretations, Employee Benefits 

Security Administration, Attn: 

Investment Advice Regulations, Room 

N–5655, U.S. Department of Labor, 200 

Constitution Avenue, NW., Washington, 

DC 20210. All comments will be 

available to the public, without charge, 

online at http://www.regulations.gov 

and http://www.dol.gov/ebsa and at the 

Public Disclosure Room, N–1513, 

Employee Benefits Security 

Administration, U.S. Department of 

Labor, 200 Constitution Avenue, NW., 

Washington, DC 20210. 

FOR FURTHER INFORMATION CONTACT: Fred 

Wong, Office of Regulations and 

Interpretations, Employee Benefits 

Security Administration, (202) 693– 

8500. This is not a toll-free number. 

SUPPLEMENTARY INFORMATION: 

A. Background 

Section 3(21)(A)(ii) of ERISA includes 

within the definition of ‘‘fiduciary’’ a 

person that renders investment advice 

for a fee or other compensation, direct 

or indirect, with respect to any moneys 

or other property of a plan, or has any 

authority or responsibility to do so.1

The prohibited transaction provisions of 

ERISA and the Code prohibit an 

investment advice fiduciary from using 

the authority, control or responsibility 

that makes it a fiduciary to cause itself, 

or a party in which it has an interest that 

may affect its best judgment as a 

fiduciary, to receive additional fees. As 

a result, in the absence of a statutory or 

administrative exemption, fiduciaries 

are prohibited from rendering 

investment advice to plan participants 

regarding investments that result in the 

payment of additional advisory and 

other fees to the fiduciaries or their 

affiliates. 

With the growth of participantdirected individual account plans, there 

has been an increasing recognition of 

the importance of investment advice to 

participants and beneficiaries in such 

plans. Over the past several years, the 

Department of Labor (Department) has 

issued various forms of guidance 

concerning when a person would be a 

fiduciary by reason of rendering 

investment advice and when the 

provision of investment advice might 

result in prohibited transactions.2 Most 

recently, Congress and the 

Administration, responding to the need 

to afford participants and beneficiaries 

greater access to professional 

investment advice, amended the 

prohibited transaction provisions of 

ERISA and the Code, as part of the 

Pension Protection Act of 2006 (PPA),3

to permit a broader array of investment 

advice providers to offer their services 

to participants and beneficiaries 

responsible for investment of assets in 

their individual accounts and, 

accordingly, for the adequacy of their 

retirement savings. 

Specifically, section 601 of the PPA 

added a statutory exemption under 

sections 408(b)(14) and 408(g) of ERISA. 

Parallel provisions were added to the 

Code at section 4975(d)(17) and 

4975(f)(8).4 Section 408(b)(14) sets forth 

the investment advice-related 

transactions that will be exempt from 

the prohibitions of section 406 if the 

requirements of section 408(g) are met. 

The transactions described in section 

408(b)(14) are: The provision of 

investment advice to the participant or 

beneficiary with respect to a security or 

other property available as an 

investment under the plan; the 

acquisition, holding or sale of a security 

or other property available as an 

investment under the plan pursuant to 

the investment advice; and the direct or 

indirect receipt of compensation by a 

fiduciary adviser or affiliate in 

connection with the provision of 

investment advice or the acquisition, 

holding or sale of a security or other 

property available as an investment 

under the plan pursuant to the 

investment advice. 

On December 4, 2006, the Department 

published a Request for Information 

(RFI) in the Federal Register soliciting 

information to assist the Department in 

the development of regulations under 

sections 408(b)(14) and 408(g).5

Specifically, the Department invited 

interested persons to address the 

qualifications for the ‘‘eligible 


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6 In this regard, the Department cited the 

following: August 3, 2006 Floor Statement of Senate 

Health, Education, Labor and Pensions Committee 

Chairman Enzi (who chaired the Conference 

Committee drafting legislation forming the basis of 

H.R. 4), regarding investment advice to participants 

in which he states, ‘‘It was the goal and objective 

of the Members of the Conference to keep this 

advisory opinion [AO 2001–09A, SunAmerica 

Advisory Opinion] intact as well as other preexisting advisory opinions granted by the 

Department. This legislation does not alter the 

current or future status of the plans and their many 

participants operating under these advisory 

opinions. Rather, the legislation builds upon these 

advisory opinions and provides alternative means 

for providing investment advice which is protective 

of the interests of plan participants and IRA 

owners.’’ 152 Cong. Rec. S8,752 (daily ed. Aug. 3, 

2006) (statement of Sen. Enzi). 

investment expert’’ that is required to 

certify that computer models used in 

connection with the statutory 

exemption meet the requirements of the 

statutory exemption. The Department 

also invited interested persons to 

provide information to assist the 

Department in developing procedures to 

be followed in certifying that a 

computer model meets the requirements 

of the statutory exemption. The 

Department also invited suggestions for 

a model disclosure form for purposes of 

the statutory exemption. In response to 

the RFI, the Department received 24 

letters addressing a variety of issues 

presented by the statutory exemption. 

These comments have been taken into 

account in developing the proposed 

regulations. 

On February 2, 2007, the Department 

issued Field Assistance Bulletin 2007–

01 addressing certain issues presented 

by the new statutory exemption. This 

Bulletin affirmed that the enactment of 

sections 408(b)(14) and (g) did not 

invalidate or otherwise affect prior 

guidance of the Department relating to 

investment advice and that such 

guidance continues to represent the 

views of the Department.6 The Bulletin 

also confirmed the applicability of the 

principles set forth in section 408(g)(10) 

[Exemption for plan sponsor and certain 

other fiduciaries] to plan sponsors and 

fiduciaries who offered investment 

advice arrangements with respect to 

which relief under the statutory 

exemption is not required. Finally, the 

Bulletin addressed the scope of the feeleveling requirement for purposes of an 

eligible investment advice arrangement 

described in section 408(g)(2)(A)(i). The 

Department’s views on that issue are set 

forth in the discussion of the proposed 

regulations that follows. 

The proposed regulations contained 

in this notice would, upon adoption, 

implement the provisions of the 

statutory exemption for the provision of 

investment advice to participants and 

beneficiaries under sections 408(b)(14) 

and 408(g). In this regard, the 

Department notes that, in an effort to 

ensure broad availability of investment 

advice to both participants and 

beneficiaries in individual account 

plans and beneficiaries with individual 

retirement accounts, the Department 

also is publishing a proposed class 

exemption for the provision of 

investment advice to such individuals. 

The proposed class exemption appears 

in the Notice section of today’s Federal 

Register. 

B. Overview of Proposed § 2550.408g–1 

1. General 

In general, proposed § 2550.408g–1 

tracks the requirements under section 

408(g) that must be satisfied in order for 

the investment advice-related 

transactions described in section 

408(b)(14) to be exempt from the 

prohibitions of section 406. 

Paragraph (a) of the proposal sets 

forth the general scope of the statutory 

exemption and regulation as providing 

relief from the prohibitions of section 

406 of ERISA for transactions described 

in section 408(b)(14) of ERISA in 

connection with the provision of 

investment advice to a participant or a 

beneficiary if the investment advice is 

provided by a fiduciary adviser under 

an ‘‘eligible investment advice 

arrangement.’’ Paragraph (a) also notes 

that the Code contains parallel 

provisions at section 4975(d)(17) and 

(f)(8). 

Paragraph (b) of the proposal provides 

that, for purposes of sections 408(g)(1) 

of ERISA and section 4975(f)(8) of the 

Code, an ‘‘eligible investment advice 

arrangement’’ shall mean an 

arrangement that meets either the 

requirements of paragraph (c) 

[describing investment advice 

arrangements that use fee-leveling] or 

paragraph (d) [describing investment 

advice arrangements that use computer 

modeling] of the proposal or both. 

2. Fee-Leveling 

With respect to arrangements that use 

fee-leveling, paragraph (c) of the 

proposal requires that any investment 

advice be based on generally accepted 

investment theories that take into 

account the historic returns of different 

asset classes over defined periods of 

time, although nothing in the proposal 

is intended to preclude investment 

advice from being based on generally 

accepted investment theories that take 

into account additional considerations. 

Paragraph (c) also requires that any 

investment advice take into account 

information furnished by a participant 

or beneficiary relating to age, life 

expectancy, retirement age, risk 

tolerance, other assets or sources of 

income, and investment preferences, 

although nothing in the proposal is 

intended to preclude a fiduciary adviser 

from taking into account additional 

information that a participant or 

beneficiary may provide. While section 

408(g)(2)(A)(i) does not specifically 

reference such conditions, the 

principles are so fundamental to the 

provision of informed, individualized 

investment advice that a failure on the 

part of a plan fiduciary to insist on such 

conditions in the selection of an 

investment adviser for plan participants 

would, in the Department’s view, raise 

serious questions as to the fiduciary’s 

exercise of prudence. For this reason, 

the Department determined that such 

conditions are sufficiently significant 

that they should be included in the 

regulation implementing the statutory 

exemption for investment advice. 

With regard to compensation and fees 

for the provision of investment advice, 

paragraph (c)(1)(iii) provides that any 

fees or other compensation (including 

salary, bonuses, awards, promotions, 

commissions 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 adviser 

does not vary depending on the basis of 

any investment option selected by a 

participant or beneficiary. Paragraph 

(c)(1)(iv) provides that any fees 

(including any commission or other 

compensation) received by the fiduciary 

adviser for investment advice or with 

respect to the sale, holding, or 

acquisition of any security or other 

property for purposes of investment of 

plan assets do not vary depending on 

the basis of any investment option 

selected by a participant or beneficiary. 

The individual compensation 

requirement in paragraph (c)(1)(iii) is 

designed to safeguard against a firm’s 

creation of incentives for individuals to 

recommend certain investment 

products. It appears that, while an 

individual may have a general interest 

in the overall success of his or her 

employing firm, this interest, by itself, 

would not be inconsistent with the 

individual compensation requirement. 

This would not be the case, however, if 

the individual’s direct or indirect 

compensation or benefits vary based on 

the selection of particular investment 

options. In order to determine whether 

more precise guidance can be 

developed, we request public comment 

on the types and formulations of direct 

and indirect compensation 

arrangements being utilized, and how 

they may operate under this provision. 


rwilkins on PROD1PC63 with PROPOSALS4
49898 Federal Register / Vol. 73, No. 164 / Friday, August 22, 2008 / Proposed Rules 

7See AO 2005–10A; AO 97–15A. 

8Pursuant to section 408(g)(3)(B)(iv), a computer 

model must operate ‘‘in a manner that is not biased 

in favor of investments offered by the fiduciary 

adviser or a person with a material affiliation or 

contractual relationship with the fiduciary adviser.’’

With regard to the foregoing, the 

Department, in interpreting the scope of 

the fee-leveling requirement for 

purposes of section 408(g)(2)(A)(i), 

expressed its view, in Field Assistance 

Bulletin 2007–01 (February 2, 2007), 

that only the fees or other compensation 

of the fiduciary adviser may not vary. In 

contrast to other provisions of section 

408(b)(14) and section 408(g), the 

Department explained, section 

408(g)(2)(A)(i) references only the 

fiduciary adviser, not the fiduciary 

adviser or an affiliate. Inasmuch as a 

person, pursuant to section 

408(g)(11)(A), can be a fiduciary adviser 

only if that person is a fiduciary of the 

plan by virtue of providing investment 

advice, an affiliate of a registered 

investment adviser, a bank or similar 

financial institution, an insurance 

company, or a registered broker dealer 

will be subject to the varying fee 

limitation only if that affiliate is 

providing investment advice to plan 

participants and beneficiaries. The 

Department further noted that, 

consistent with past guidance, 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.7 The Department, therefore, 

concluded that Congress did not intend 

for the requirement that fees not vary 

depending on the basis of any 

investment options selected to extend to 

affiliates of the fiduciary adviser, unless, 

of course, the affiliate is also a provider 

of investment advice to a plan. This 

continues to be the view of the 

Department. 

The Department also noted in the 

Bulletin that, although section 

408(g)(11)(A) generally limits ‘‘fiduciary 

advisers’’ to certain types of entities, it 

also permits employees, agents, or 

registered representatives of those 

entities to also qualify as fiduciary 

advisers if they satisfy the requirements 

of applicable insurance, banking, and 

securities laws relating to the provision 

of the advice. See section 

408(g)(11)(A)(vi). As with affiliates, 

such an individual must, for purposes of 

section 408(g)(11)(A), not only be an 

employee, agent, or registered 

representative of one of those entities, 

but also must provide investment advice 

in his or her capacity as employee, 

agent, or registered representative. The 

Department, therefore, concluded that 

the language of section 408(g)(11)(A) 

required a finding that, for purposes of 

the statutory exemption, when an 

individual acts as an employee, agent or 

registered representative on behalf of an 

entity engaged to provide investment 

advice to a plan, that individual, as well 

as the entity, must be treated as the 

fiduciary adviser for purposes of section 

408(g)(11)(A) and, accordingly subject to 

the limitations of section 408(g)(2)(A)(i). 

In an effort to accommodate a wider 

variety of business structures and 

practices, making investment advice 

more available while protecting 

participants and beneficiaries, the 

Department is proposing a class 

exemption addressing fee leveling 

requirements for employees, agents and 

registered representatives, also 

appearing in today’s Federal Register. 

In addition to the foregoing, fiduciary 

advisers utilizing investment advice 

arrangements that employ fee-leveling 

must comply with the requirements of 

paragraphs (e) [authorization by plan 

fiduciary], (f) [audits], (g) [disclosure], 

(h) [miscellaneous], and (i) 

[maintenance of records] of the 

proposal, each of which is discussed in 

more detail below. 

3. Computer Models 

Paragraph (d) of the proposal 

addresses the requirements applicable 

to investment advice arrangements that 

rely on computer models. In this regard, 

paragraph (d) provides, consistent with 

the provisions of section 408(g)(3)(B), 

(C) and (D), that an arrangement shall be 

an eligible investment advice 

arrangement if the only investment 

advice provided under the arrangement 

is advice that is generated by a 

computer model described in 

paragraphs (d)(1) and (2) of this section 

under an investment advice program, 

and with respect to which the 

requirements of paragraphs (e) 

[authorization by plan fiduciary], (f) 

[audits], (g) [disclosure], (h) 

[miscellaneous], and (i) [maintenance of 

records] of the proposal are met and any 

acquisition, holding or sale of a security 

or other property pursuant to such 

advice occurs solely at the direction of 

the participant or beneficiary. 

Paragraph (d)(1), consistent with 

section 408(g)(3)(B)(i)–(v), sets forth the 

standards applicable to computer 

models. Specifically, paragraph (d)(1) 

requires that a computer model be 

designed and operated to: apply 

generally accepted investment theories 

that take into account the historic 

returns of different asset classes over 

defined periods of time, although 

nothing in the proposal is intended to 

preclude a computer model from 

applying generally accepted investment 

theories that take into account 

additional considerations; utilize 

information furnished by a participant 

or beneficiary relating to age, life 

expectancy, retirement age, risk 

tolerance, other assets or sources of 

income, and investment preferences, 

although nothing in the proposal 

precludes a computer model from taking 

into account additional information that 

a plan or a participant or beneficiary 

may provide; and utilize appropriate 

objective criteria to provide asset 

allocation portfolios comprised of 

investment options available under the 

plan. See paragraph (d)(1)(i)–(iii) of the 

proposal. 

In addition to the foregoing, a 

computer model, consistent with 

section 408(g)(3)(B)(iv),8 must be 

designed and operated to avoid 

investment recommendations that: 

inappropriately favor investment 

options offered by the fiduciary adviser 

or a person with a material affiliation or 

material contractual relationship with 

the fiduciary adviser over other 

investment options, if any, available 

under the plan; or inappropriately favor 

investment options that may generate 

greater income for the fiduciary adviser 

or a person with a material affiliation or 

material contractual relationship with 

the fiduciary adviser. In order to 

determine if further guidance can be 

developed with respect to this 

provision, the Department seeks public 

comment on circumstances under 

which it would be appropriate or 

inappropriate to favor particular 

investment options. For example, the 

Department believes that favoring a 

higher-cost investment alternative over 

an otherwise identical investment 

alternative with lower cost would be 

inappropriate. 

As reflected in the language, a 

computer model would not fail to meet 

this requirement merely because the 

only investment options offered under 

the plan are options offered by the 

fiduciary adviser or a person with a 

material affiliation or material 

contractual relationship with the 

fiduciary adviser. The language also 

makes clear that models cannot be 

designed and operated to 

inappropriately favor those investment 

options that generate the most income 

for the fiduciary adviser or a person 

with a material affiliation or material 

contractual relationship with the 

fiduciary adviser. The proposal defines 


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Federal Register / Vol. 73, No. 164 / Friday, August 22, 2008 / Proposed Rules 49899 

9Section 408(g)(3)(B)(v) provides that computer 

models must take ‘‘into account all investment 

options under the plan in specifying how a 

participant’s account balance should be invested 

and is not inappropriately weighted with respect to 

any investment option.’’

10 It should be noted that, even in the absence of 

individualized advice, participants are reminded on 

a quarterly basis, via their pension benefit 

statements, of the importance of maintaining a 

diversified portfolio. Model language for purposes 

of this disclosure was set forth in Field Assistance 

Bulletin 2006–03 (Dec. 20, 2006). Among other 

things the model language provides that ‘‘[I]f you 

invest more than 20% of your retirement savings in 

any one company or industry, your savings may not 

be properly diversified. Although diversification is 

not a guarantee against loss, it is an effective 

strategy to help you manage investment risk.’’

a ‘‘material affiliation’’ and ‘‘material 

contractual relationship’’ at paragraphs 

(j)(6) and (j)(7), respectively. 

Paragraph (d)(1) further requires, 

consistent with section 408(g)(3)(B)(v),9

that computer models take into account 

all ‘‘designated investment options’’

available under the plan without giving 

inappropriate weight to any investment 

option. See paragraph (d)(1)(v) of the 

proposal. The term ‘‘designated 

investment option’’ is defined in 

paragraph (j)(1) of the proposal, to mean 

any investment option designated by the 

plan into which participants and 

beneficiaries may direct the investment 

of assets held in, or contributed to, their 

individual accounts. The term 

‘‘designated investment option’’ does 

not include ‘‘brokerage windows,’’ ‘‘selfdirected brokerage accounts,’’ or similar 

plan arrangements that enable 

participants and beneficiaries to select 

investments beyond those designated by 

the plan. 

Paragraph (d)(1)(v) also provides that 

a computer model shall not be treated 

as failing to take all designated 

investment options into account merely 

because it does not take into account an 

investment option that constitutes an 

investment primarily in qualifying 

employer securities. Any such 

limitation on the investment advice to 

be generated by the computer model, 

however, must be disclosed to 

participants and beneficiaries under 

paragraph (g)(1)(vi) of the proposal, 

discussed below. Information received 

by the Department in response to both 

of its RFIs indicated that there are 

challenges attendant to developing 

computer models, which generally are 

based on underlying theories that rely 

on diversified asset classes, that address 

a single undiversified security, such as 

qualifying employer securities, in 

connection with generating investment 

recommendations that would enable a 

participant to construct a welldiversified investment portfolio. The 

Department is concerned that extending 

this requirement to qualifying employer 

securities might discourage 

arrangements based on utilization of a 

computer model, or otherwise limit 

their availability.10 Accordingly, the 

Department has excluded investments 

primarily in qualifying employer 

securities from the requirement of 

paragraph (d)(1)(v) of the proposal. 

Paragraph (d)(2) of the proposal 

requires that, prior to utilization of the 

computer model, the fiduciary adviser 

obtain a written certification that the 

computer model meets the requirements 

of paragraph (d)(1), discussed above. If 

the model is modified in a manner that 

may affect its ability to meet the 

requirements of paragraph (d)(1), the 

fiduciary adviser, prior to utilization of 

the modified model, must obtain a new 

certification. With regard to the 

certification, paragraph (d)(2) requires 

that the fiduciary adviser obtain a 

certification that meets the requirements 

of paragraph (d)(4) from an ‘‘eligible 

investment expert,’’ within the meaning 

of paragraph (d)(3). 

Paragraph (d)(3) of the proposal 

defines an ‘‘eligible investment expert’’

to mean a person that, through 

employees or otherwise, has the 

appropriate technical training or 

experience and proficiency to analyze, 

determine and certify, in a manner 

consistent with paragraph (d)(4), 

whether a computer model meets the 

requirements of paragraph (d)(1) of this 

section; except that the term eligible 

investment expert does not include any 

person that has any material affiliation 

or material contractual relationship with 

the fiduciary adviser, with a person 

with a material affiliation or material 

contractual relationship with the 

fiduciary adviser, or with any employee, 

agent, or registered representative of the 

foregoing. After consideration of the 

public comments, the Department has 

concluded that it would be very difficult 

to define a specific set of academic or 

other credentials that would serve to 

define the appropriate expertise and 

experience for an eligible investment 

expert. 

Accordingly, under the proposal, it is 

the fiduciary adviser who is responsible 

for determining whether an eligible 

investment expert, itself or its 

employees, possesses the requisite 

training and experience to certify 

whether a given computer model meets 

the requirements of paragraph (d)(1) in 

a manner consistent with paragraph 

(d)(4) of the proposal. Paragraph (d)(5) 

of the proposal provides that, for 

purposes of the statutory exemption, the 

selection of the eligible investment 

expert by the fiduciary adviser is a 

fiduciary act governed by section 

404(a)(1) of ERISA. 

The Department notes that, although 

the proposal gives latitude to a fiduciary 

adviser in selecting an eligible 

investment expert to certify a computer 

model, as the party seeking prohibited 

transaction relief under the exemption, 

the fiduciary adviser has the burden of 

demonstrating that all applicable 

requirements of exemption are satisfied 

with respect to its arrangement. We also 

note that section 404 of ERISA requires 

the fiduciary adviser to act reasonably 

and prudently in its selection. 

Paragraph (d)(4) of the proposal 

provides that a certification by an 

eligible investment expert shall be in 

writing and contain the following: an 

identification of the methodology or 

methodologies applied in determining 

whether the computer model meets the 

requirements of paragraph (d)(1) of this 

section; an explanation of how the 

applied methodology or methodologies 

demonstrated that the computer model 

met the requirements of paragraph (d)(1) 

of this section; and a description of any 

limitations that were imposed by any 

person on the eligible investment 

expert’s selection or application of 

methodologies for determining whether 

the computer model meets the 

requirements of paragraph (d)(1). In 

addition the certification is required to 

contain a representation that the 

methodology or methodologies were 

applied by a person or persons with the 

educational background, technical 

training or experience necessary to 

analyze and determine whether the 

computer model meets the requirements 

of paragraph (d)(1); and a statement 

certifying that the eligible investment 

expert has determined that the 

computer model meets the requirements 

of paragraph (d)(1). Finally the 

certification must be signed by the 

eligible investment expert. 

With regard to the certification 

described in paragraph (d)(4) of the 

proposal, public comments suggested a 

number of different approaches that 

could be followed in determining 

computer model consistency with the 

statutory criteria. The comments did 

not, however, suggest a single suitable 

approach. The Department, therefore, is 

wary of mandating a methodology under 

the proposal. The Department also 

believes that as computer models and 

their use under investment advice 

arrangements continue to develop, 

experts may need the flexibility to 

develop new methodologies for 

examining those models. Accordingly, 

paragraph (d)(4) does not require a 

particular methodology to be applied for 

purposes of certification. 


rwilkins on PROD1PC63 with PROPOSALS4
49900 Federal Register / Vol. 73, No. 164 / Friday, August 22, 2008 / Proposed Rules 

11 15 U.S.C. 7004(d)(1) (2000). 

4. Authorized by a Plan Fiduciary 

Consistent with the section 408(g)(4) 

of ERISA, the proposal provides, at 

paragraph (e), that the arrangement 

pursuant to which investment advice is 

provided to participants and 

beneficiaries must be expressly 

authorized by a plan fiduciary (or, in the 

case of an IRA, the IRA beneficiary) 

other than: the person offering the 

arrangement; any person providing 

designated investment options under 

the plan; or any affiliate of either. The 

proposal further provides that for 

purposes of such authorization, an IRA 

beneficiary will not be treated as an 

affiliate of a person solely by reason of 

being an employee of such person, 

thereby enabling employees of a 

fiduciary adviser to take advantage of 

investment advice arrangements offered 

by their employer under the exemption. 

5. Annual Audit 

Paragraph (f) addresses the audit 

requirements of section 408(g)(6) of 

ERISA. Specifically, paragraph (f)(1) 

provides that the fiduciary adviser shall, 

at least annually, engage an 

independent auditor, who has 

appropriate technical training or 

experience and proficiency, and so 

represents in writing to the fiduciary 

adviser, to conduct an audit of the 

investment advice arrangements for 

compliance with the requirements of the 

proposal and within 60 days following 

completion of the audit, issue a written 

report to the fiduciary adviser and, 

except with respect to an arrangement 

with an IRA, to each fiduciary who 

authorized the use of the investment 

advice arrangement, consistent with 

paragraph (e) of the proposal, setting 

forth the specific findings of the auditor 

regarding compliance of the 

arrangement with the requirements of 

the proposal. 

Given the significant number of 

reports that an auditor would be 

required to send if the written report 

was required to be furnished to all IRA 

beneficiaries, the Department framed an 

alternative requirement for investment 

advice arrangements for IRAs. This 

alternative is set forth in paragraph (f)(2) 

of the proposal. The alternative provides 

that, with respect to an arrangements 

with an IRA, the fiduciary adviser shall, 

within 30 days following receipt of the 

report from the auditor, furnish a copy 

of the report to the IRA beneficiary or 

make such report available on its 

website, provided that such 

beneficiaries are provided information, 

along with other required disclosures 

(see paragraph (g) of the proposal), 

concerning the purpose of the report, 

and how and where to locate the report 

applicable to their account. With respect 

to making the report available on a 

website, the Department believes that 

this alternative to furnishing reports to 

IRA beneficiaries satisfies the 

requirement of section 104(d)(1) of the 

Electronic Signatures in Global and 

National Commerce Act (E–SIGN) 11 that 

any exemption from the consumer 

consent requirements of section 101(c) 

of E–SIGN must be necessary to 

eliminate a substantial burden on 

electronic commerce and will not 

increase the material risk of harm to 

consumers. The Department solicits 

comments on this finding. Paragraph 

(f)(2) also provides that, when the report 

of the auditor identifies noncompliance 

with the requirements of the regulation, 

the fiduciary adviser must send a copy 

of the report to the Department. As 

proposed, the fiduciary adviser must 

submit the report to the Department 

within 30 days following receipt of the 

report from the auditor. The submission 

of this report will enable the 

Department to monitor compliance with 

the statutory exemption in those 

instances where there is no authorizing 

ERISA plan fiduciary to carry out that 

function. 

For purposes of paragraph (f) of the 

proposal, an auditor is considered 

independent if it does not have a 

material affiliation or material 

contractual relationship with the person 

offering the investment advice 

arrangement to the plan or any 

designated investment options under 

the plan. The terms ‘‘material 

affiliation’’ and ‘‘material contractual 

relationship’’ are defined in paragraphs 

(j)(6) and (7) of the proposal. 

With regard to the scope of the audit, 

paragraph (f)(4) provides that the 

auditor shall review sufficient relevant 

information to formulate an opinion as 

to whether the investment advice 

arrangements, and the advice provided 

pursuant thereto, offered by the 

fiduciary adviser during the audit 

period were in compliance with the 

regulation. Paragraph (f)(4) further 

provides that it is not intended to 

preclude an auditor from using 

information obtained by sampling, as 

reasonably determined appropriate by 

the auditor, investment advice 

arrangements, and the advice pursuant 

thereto, during the audit period. The 

proposal, therefore, does not require an 

audit of every investment advice 

arrangement at the plan or fiduciary 

adviser-level or of all the advice that is 

provided under the exemption. In 

general, the proposal leaves to the 

auditor the determination as to the 

appropriate scope of their review and 

the extent to which they can rely on 

representative samples for determining 

compliance with the exemption. 

6. Disclosure 

The disclosure provisions are set forth 

in paragraph (g) of the proposal and 

generally track the disclosure provisions 

of the statutory exemption at section 

408(g)(6) of ERISA. In this regard, the 

proposal, at paragraph (g)(1), requires 

that the fiduciary adviser provide to 

participants and beneficiaries, prior to 

the initial provision of investment 

advice with regard to any security or 

other property offered as an investment 

option, a written notification describing: 

the role of any party that has a material 

affiliation or material contractual 

relationship with the fiduciary adviser 

in the development of the investment 

advice program, and in the selection of 

investment options available under the 

plan; the past performance and 

historical rates of return of the 

designated investment options available 

under the plan, to the extent that such 

information is not otherwise provided; 

all fees or other compensation relating 

to the advice that the fiduciary adviser 

or any affiliate thereof is to receive 

(including compensation provided by 

any third party) in connection with the 

provision of the advice or in connection 

with the sale, acquisition, or holding of 

the security or other property; and any 

material affiliation or material 

contractual relationship of the fiduciary 

adviser or affiliates thereof in the 

security or other property. 

The notification to participants and 

beneficiaries also is required to explain: 

the manner, and under what 

circumstances, any participant or 

beneficiary information provided under 

the arrangement will be used or 

disclosed; the types of services provided 

by the fiduciary adviser in connection 

with the provision of investment advice 

by the fiduciary adviser, including, with 

respect to an arrangement described in 

paragraph (d) utilizing a computer 

model, any limitations on the ability of 

the model to take into account an 

investment primarily in qualifying 

employer securities, as provided for in 

paragraph (d)(1)(v) of the proposal; that 

the adviser is acting as a fiduciary of the 

plan in connection with the provision of 

the advice; and that a recipient of the 

advice may separately arrange for the 

provision of advice by another adviser 

that could have no material affiliation 

with and receive no fees or other 

compensation in connection with the 

security or other property. 


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12 ICA section 2(a)(3)(E) and (F) include in the 

definition of affiliated person: If the other person 

is an investment company, any investment adviser 

thereof or any member of an advisory board thereof; 

and if such other person is an unincorporated 

investment company not having a board of 

directors, the depositor thereof. 15 U.S.C. 80a–

2(a)(3)(E)–(F). 

Paragraph (g)(2) of the proposal 

requires that the notification furnished 

to participants and beneficiaries be 

written in a clear and conspicuous 

manner and in a manner calculated to 

be understood by the average plan 

participant and must be sufficiently 

accurate and comprehensive to 

reasonably apprise such participants 

and beneficiaries of the information 

required to be provided in the 

notification. 

The appendix to the proposal 

contains a model disclosure form that 

may be used for purposes of satisfying 

the fee and compensation disclosure 

requirement of paragraph (g)(1)(iii), as 

well as the requirements of paragraph 

(g)(2), of the proposal. The proposal 

makes clear, however, that the use of the 

model disclosure form is not mandatory. 

Paragraph (g)(3) makes clear that the 

required disclosures may be provided in 

written or electronic form. 

Paragraph (g)(4) of the proposal, like 

section 408(g)(6)(B) of ERISA, sets forth 

miscellaneous recordkeeping and 

furnishing responsibilities of the 

fiduciary adviser. Specifically, 

paragraph (g)(4) provides that, at all 

times during the provision of advisory 

services to the participant or beneficiary 

pursuant to the arrangement, the 

fiduciary adviser must: Maintain the 

information described in paragraph 

(g)(1) in accurate form; provide, without 

charge, accurate information to the 

recipient of the advice no less 

frequently than annually; provide, 

without charge, accurate information to 

the recipient of the advice upon request 

of the recipient; and provide, without 

charge, accurate information to the 

recipient of the advice concerning any 

material change to the information 

required to be provided to the recipient 

of the advice at a time reasonably 

contemporaneous to the change in 

information. 

7. Other Conditions 

Paragraph (h) of the proposal, like 

section 408(g)(7) of ERISA, sets forth 

additional conditions applicable to the 

provision of advice under the statutory 

exemption. These requirements are as 

follows: The fiduciary adviser must 

provide appropriate disclosure, in 

connection with the sale, acquisition, or 

holding of the security or other 

property, in accordance with all 

applicable securities laws; the sale, 

acquisition, or holding occurs solely at 

the direction of the recipient of the 

advice; the compensation received by 

the fiduciary adviser and affiliates 

thereof in connection with the sale, 

acquisition, or holding of the security or 

other property is reasonable; and the 

terms of the sale, acquisition, or holding 

of the security or other property are at 

least as favorable to the plan as an arm’s 

length transaction would be. 

8. Maintenance of Records 

Paragraph (i) of the proposal sets forth 

the record maintenance requirements. 

Consistent with section 408(g)(9) of 

ERISA, paragraph (i) of the proposal 

provides that the fiduciary adviser must 

maintain, for a period of not less than 

6 years after the provision of investment 

advice pursuant to the arrangement, any 

records necessary for determining 

whether the applicable requirements of 

the proposal have been met. Also, 

paragraph (i), as with section 408(g)(9), 

makes clear that a prohibited 

transaction shall not be considered to 

have occurred solely because the 

records are lost or destroyed prior to the 

end of the 6-year period due to 

circumstances beyond the control of the 

fiduciary adviser. 

9. Definitions 

Paragraph (j) of the proposal sets forth 

a number of definitions relevant to the 

statutory exemption and this proposed 

regulation. 

Paragraph (j)(1), as discussed earlier, 

defines the term ‘‘designated investment 

option.’’ Paragraph (j)(2) sets forth the 

definition of ‘‘fiduciary adviser,’’ as it 

appears in section 408(g)(11)(A) of 

ERISA. With regard to that part of the 

fiduciary adviser definition that treats 

persons who develop computer models 

or market investment advice programs 

or computer models as a fiduciary of the 

plan by reason of providing investment 

advice and as a fiduciary adviser for 

purposes of section 408(b)(14), the 

Department is proposing a separate 

regulation (§ 2550.408g–2), discussed 

below, pursuant to which a single 

fiduciary adviser may elect to be treated 

as a fiduciary with the respect to the 

plan. 

Paragraph (j)(3) of the proposal adopts 

the statutory definition of ‘‘registered 

representative’’ set forth in ERISA 

section 408(g)(11)(C), which states that 

a registered representative of another 

entity means a person described in 

section 3(a)(18) of the Securities 

Exchange Act of 1934 (15 U.S.C. 

78c(a)(18)) (substituting the entity for 

the broker or dealer referred to in such 

section) or a person described in section 

202(a)(17) of the Investment Advisers 

Act of 1940 (15 U.S.C. 80b–2(a)(17)) 

(substituting the entity for the 

investment adviser referred to in such 

section). 

Paragraph (j)(4), consistent with 

section 601(b)(3)(A)(i) of the Pension 

Protection Act of 2006, defines the term 

‘‘Individual Retirement Account’’ to 

mean plans described in paragraphs (B) 

through (F) of section 4975(e)(1) of the 

Code, as well as a trust, plan, account, 

or annuity which, at any time, has been 

determined by the Secretary of the 

Treasury to be described in such 

paragraphs. 

Paragraph (j)(5) of the proposed rule 

defines the term ‘‘affiliate.’’ For 

purposes of the proposal, an ‘‘affiliate’’

of another person means: Any person 

directly or indirectly owning, 

controlling, or holding with power to 

vote, 5 percent or more of the 

outstanding voting securities of such 

other person; any person 5 percent or 

more of whose outstanding voting 

securities are directly or indirectly 

owned, controlled, or held with power 

to vote, by such other person; any 

person directly or indirectly controlling, 

controlled by, or under common control 

with, such other person; and any officer, 

director, partner, copartner, or employee 

of such other person. Consistent with 

ERISA section 408(g)(11)(B), this 

definition is based on the definition of 

an ‘‘affiliated person’’ of an entity as 

contained in section 2(a)(3) of the 

Investment Company Act of 1940 (ICA), 

except that it does not reflect clauses (E) 

and (F) thereof. The Department has 

initially determined that including 

provisions similar to clauses (E) and (F) 

is unnecessary, because these clauses 

appear to focus on persons who exercise 

control over the management of an 

investment company.12 Also, such 

parties will nonetheless be treated as an 

affiliate because they would be a person 

directly or indirectly controlling, 

controlled by, or under common control 

with, such other person. See paragraph 

(j)(5)(iii) of the proposal. Additionally, 

the Department is concerned that 

including provisions similar to clauses 

(E) and (F), which focus on functions 

involving investment companies, but 

not other types of vehicles in which 

plans may invest, could have the 

unintended consequence of possibly 

subjecting persons associated with 

investment companies to different 

requirements under these proposed 

regulations. Therefore, the Department 

is proposing to define affiliate without 

regard to clauses (E) and (F) of section 

2(a)(3) of the ICA. 

In a variety of places in the regulation 

reference is made to persons with 


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49902 Federal Register / Vol. 73, No. 164 / Friday, August 22, 2008 / Proposed Rules 

‘‘material affiliations’’ and ‘‘material 

contractual relationships.’’ See 

paragraphs (d)(1)(iv), (d)(3), (f)(3), 

(g)(1)(i), (g)(1)(iv) and (g)(1)(viii) of the 

proposal. For purposes of this 

regulation, those terms are defined in 

paragraphs (j)(6) and (j)(7), respectively. 

Paragraph (j)(6) of the proposal 

describes a person with a ‘‘material 

affiliation’’ with another person as: Any 

affiliate of such other person; any 

person directly or indirectly owning, 

controlling, or holding, 5 percent or 

more of the interests of such other 

person; or any person 5 percent or more 

of whose interests are directly or 

indirectly owned, controlled, or held, by 

such other person. In determining 

‘‘interest,’’ paragraph (j)(6)(ii) provides 

that an ‘‘interest’’ means with respect to 

an entity: The combined voting power 

of all classes of stock entitled to vote or 

the total value of the shares of all classes 

of stock of the entity if the entity is a 

corporation; the capital interest or the 

profits interest of the entity if the entity 

is a partnership; or the beneficial 

interest of the entity if the entity is a 

trust or unincorporated enterprise. 

Paragraph (j)(7) of the proposal 

provides that persons shall be treated as 

having a ‘‘material contractual 

relationship’’ if payments made by one 

person to the other person pursuant to 

written contracts or agreements between 

the persons exceed 10 percent of the 

gross revenue, on an annual basis, of 

such other person. The Department 

believes that one person’s receipt of 

more than 10 percent of gross revenue 

from another person is sufficiently 

significant to be considered material. 

However, the Department specifically 

invites comments on whether the 

percentage test should be higher or 

lower and, if so, why. 

The proposal, at paragraph (j)(8), 

defines ‘‘control’’ to mean the power to 

exercise a controlling influence over the 

management or policies of a person 

other than an individual. 

C. Overview of Proposed § 2550.408g–2 

Proposed § 2550.408g–2, as indicated 

above, addresses the requirements for 

electing to be treated as a fiduciary and 

fiduciary adviser by reason of 

developing or marketing a computer 

model or an investment advice program 

used in an eligible investment advice 

arrangement. See section 408(g)(11)(A). 

Section 408(g)(11)(A) provides that, 

with respect to an arrangement that 

relies on use of a computer model to 

qualify as an ‘‘eligible investment 

advice arrangement,’’ a person who 

develops the computer model, or 

markets the investment advice program 

or computer model, shall be treated as 

a fiduciary of a plan by reason of the 

provision of investment advice referred 

to in ERISA section 3(21)(A)(ii) to the 

plan participant or beneficiary, and 

shall be treated as a ‘‘fiduciary adviser’’

for purposes of ERISA section 408(b)(14) 

and (g). Section 4975(f)(8) of the Code 

contains a parallel provision to ERISA 

section 408(g)(11)(A). Proposed 

§ 2550.408g–2 sets forth requirements 

that must be satisfied in order for one 

such fiduciary adviser to elect to be 

treated as a fiduciary under such an 

eligible investment advice arrangement. 

See paragraph (a) of § 2550.408g–2. 

Paragraph (b)(1) of § 2550.408g–2 

provides that if an election meets the 

requirements of paragraph (b)(2) of the 

proposal, then the person identified in 

the election shall be the sole fiduciary 

adviser treated as a fiduciary by reason 

of developing or marketing a computer 

model, or marketing an investment 

advice program, used in an eligible 

investment advice arrangement. 

Paragraph (b)(2) requires that the 

election be in writing and that the 

writing: Identify the arrangement, and 

person offering the arrangement, with 

respect to which the election is to be 

effective; and identify the person who is 

the fiduciary adviser, the person who 

develops the computer model or 

markets the computer model or 

investment advice program with respect 

to the arrangement, and the person who 

elects to be treated as the only fiduciary, 

and fiduciary adviser, by reason of 

developing such computer model or 

marketing such computer model or 

investment advice program. Paragraph 

(b)(2) of § 2550.408g–2 also requires that 

the election be signed by the person 

acknowledging that it elects to be 

treated as the only fiduciary and 

fiduciary adviser; that a copy of the 

election be furnished to the plan 

fiduciary who authorized use of the 

arrangement; and that the writing be 

retained in accordance with the record 

retention requirements of § 2550.408g–

1(i). 

D. Effective Date 

The Department proposes that the 

regulations contained in this notice will 

be effective 60 days after publication of 

the final regulations in the Federal 

Register. The Department invites 

comments on whether the final 

regulations should be made effective on 

a different date. 

E. Request for Comments 

The Department invites comments 

from interested persons on the proposed 

regulations. To facilitate the receipt and 

processing of comment letters, the 

Employee Benefits Security 

Administration (EBSA) encourages 

interested persons to submit their 

comments electronically by e-mail to 

e-ORI@dol.gov (Subject: Investment 

Advice Regulations), or by using the 

Federal eRulemaking portal at http:// 

www.regulations.gov (follow 

instructions for submission of 

comments). Persons submitting 

comments electronically are encouraged 

not to submit paper copies. Persons 

interested in submitting paper copies 

should send or deliver their comments 

to the Office of Regulations and 

Interpretations, Employee Benefits 

Security Administration, Attn: 

Investment Advice Regulations, Room 

N–5655, U.S. Department of Labor, 200 

Constitution Avenue, NW., Washington, 

DC 20210. All comments will be 

available to the public, without charge, 

online at http://www.regulations.gov 

and http://www.dol.gov/ebsa and at the 

Public Disclosure Room, N–1513, 

Employee Benefits Security 

Administration, U.S. Department of 

Labor, 200 Constitution Avenue, NW., 

Washington, DC 20210. 

The comment period for the proposed 

regulations will end 45 days after 

publication of the proposed rule in the 

Federal Register. The Department 

believes that this period of time will 

afford interested persons an adequate 

amount of time to analyze the proposals 

and submit comments. Written 

comments on the proposed regulations 

should be submitted to the Department 

of Labor on or before October 6, 2008. 

F. Regulatory Impact Analysis 

Summary 

The Department anticipates that this 

proposed regulation and proposed class 

exemption, by extending quality, expert 

investment advice to more retirement 

plan participants, together will improve 

their investment results by 

approximately $14 billion or more 

annually, at a cost of $4 billion, thereby 

producing a net financial benefit of $10 

billion or more. The improved 

investment results will reflect 

reductions in investment errors such as 

payment of higher than necessary fees 

and expenses, poor trading strategies, 

and inadequate diversification. The 

provisions of this proposed regulation 

and the conditions attached to this 

proposed class exemption reflect the 

Department’s efforts to ensure that the 

advice provided pursuant to them will 

be affordable and of high quality. 

Introduction 

Workers’ retirement security 

increasingly depends on their 

investment decisions. Unfortunately 


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13See, e.g., Richard H. Thaler & Shlomo Benartzi, 

The Behavioral Economics of Retirement Savings 

Behavior, AARP Public Policy Institute White Paper 

2007–02 (Jan. 2007); and Jeffrey R. Brown & Scott 

Weisbenner, Individual Account Investment 

Options and Portfolio Choice: Behavioral Lessons 

from 401(k) Plans, Social Science Research Network 

Abstract 631886 (Dec. 2004). 14 It should be noted that much of the research 

documenting investment mistakes does not account 

for whether advice was present or not. At least 

some of the mistakes may have been made despite 

good advice to the contrary; some may have been 

made pursuant to bad advice. There is evidence 

both that advice sometimes is not followed, and 

that it sometimes is bad. This is explored more 

below. 

15As discussed below, this estimate is subject to 

wide uncertainty. 

16A number of studies conclude that investors 

often pay higher fees than necessary. 

Javier Gil-Bazo & Pablo Ruiz-Verdu ́, Yet Another 

Puzzle? Relation Between Price and Performance in 

the Mutual Fund Industry, Social Science Research 

Network Abstract 947448 (March 2007) find that 

funds with worse before-fee performance charge 

higher fees. They suggest that funds faced with 

insensitive investors charge higher fees, finding that 

even after controlling for performance sensitivity, 

funds with lower expected performance set higher 

fees. They hypothesize that lower performing funds 

lose sophisticated investors to higher performing 

funds, then are left with relatively unsophisticated 

investors who are not as responsive to price. 

According to Ali Hortacsu & Chad Syverson, 

Product Differentiation, Search Costs, and 

Competition in the Mutual Fund Industry: A Case 

Study of S&P 500 Index Funds, Social Science 

Research Network Abstract 405642 (April 2003), 75 

percent of S&P 500 Index Funds have expense 

ratios in excess of 47 basis points, 50 percent in 

excess of 72 basis points and 25 percent in excess 

of 149 basis points. The highest cost fund charged 

annualized investor fees that were nearly 30 times 

greater than the lowest-cost fund (268 vs. 9.5 basis 

points). Low-cost funds have a dominant market 

share, but the asset share of the low-cost funds has 

fallen consistently since 1995. 

Paul G. Mahoney, Manager-Investor Conflicts in 

Mutual Funds, The Journal of Economic 

Perspectives, Volume 18, Number 2 (2004) extends 

the Ali Hortacsu & Chad Syverson, Product 

Differentiation, Search Costs, and Competition in 

the Mutual Fund Industry: A Case Study of S&P 500 

Index Funds, Social Science Research Network 

Abstract 405642 (April 2003) result of two classes 

of investors, the experienced that buy low-cost noload funds, and the novice who uses a broker and 

buys high-cost load funds. He finds that, even after 

separating the expense ratio into administrative fees 

and 12b–1 fees, funds with loads still have 

administrative fees 15 basis point higher than the 

no-load funds. 

Brad M. Barber et al., Out of Sight, Out of Mind, 

The Effects of Expenses on Mutual Fund Flows, 

Journal of Business, Volume 79, Number 6 2095, 

2095–2119 (2005) find that investors are sensitive 

to load fees. They argue that front-end load fees are 

generally observable as a dollar amount on the first 

statement while the effects of administrative fees on 

the account balance are hidden by the volatility of 

fund returns. They find evidence of learning; repeat 

mutual fund purchasers pay on average about half 

the load fees of first time mutual fund purchasers. 

Todd Houge & Jay W. Wellman, The Use and 

Abuse of Mutual Fund Expenses, Social Science 

Research Network Abstract 880463 (Jan. 2006) 

present evidence that less knowledgable investors 

pay consistently higher asset management fees than 

more knowledgable investors holding similar funds. 

Less sophisticated investors are more likely to 

invest in funds with loads. Load funds on average 

have annual expense ratios that are 50 basis points 

higher than no-load funds. While a large part of the 

higher expense ratio is composed of 12b–1 fees, 

load funds also have higher asset management fees. 

They conclude that ‘‘Load fund shareholders often 

pay high fees to market and grow the fund, but the 

Continued 

there is evidence that many participants 

and beneficiaries in participant-directed 

defined contribution (DC) plans and 

beneficiaries of individual retirement 

accounts (IRAs) (collectively hereafter, 

‘‘participants’’), beset by flawed 

information or reasoning, make poor 

investment decisions. These 

participants may pay higher fees and 

expenses than necessary for investment 

products and services, engage in 

excessive or poorly timed trading or fail 

to rebalance their portfolios, 

inadequately diversify their portfolios 

and thereby assume uncompensated 

risk, take more or less than optimal 

levels of compensated risk, and/or pay 

unnecessarily high taxes. Financial 

losses (including foregone earnings) 

from such mistakes likely amount to 

more than $100 billion per year. These 

losses compound and grow larger as 

workers progress toward and into 

retirement. 

Such mistakes and consequent losses 

historically can be attributed at least in 

part to provisions of federal law that 

effectively preclude a variety of 

arrangements whereby financial 

professionals might otherwise provide 

retirement plan participants with expert 

investment advice. These ‘‘prohibited 

transaction’’ provisions of ERISA and 

the Internal Revenue Code prohibit 

fiduciaries from dealing with DC plan or 

IRA assets in ways that advance their 

own interests. These provisions prohibit 

plan fiduciaries from exercising the 

authority, control, or responsibility that 

makes such persons fiduciaries when 

they have an interest which may 

conflict with the interests of the plan for 

which they act. Under these provisions 

financial advisers who have a direct or 

indirect stake in participants’

investment decisions generally may not 

provide them with investment advice. 

In recognition that certain transactions 

could nonetheless be beneficial to plans 

and their participants and beneficiaries, 

subject to safeguards appropriate to 

protect against potential abuses, 

Congress enacted a number of statutory 

prohibited transaction exemptions, and 

also gave the Department conditional 

authority to grant prohibited transaction 

exemptions. In this regard, the 

prohibited transaction exemption for the 

provision of investment advice added 

by the Pension Protection Act of 2006 

(PPA) opened the door to more types of 

investment advice arrangements by 

conditionally permitting arrangements 

where the fiduciary adviser or an 

affiliate thereof has a financial stake in 

the advised participants’ investment 

decisions. The Department is proposing 

a regulation to further specify the PPA’s 

applicable conditions, together with a 

class exemption to establish alternative 

conditions under which such 

arrangements may operate. Together 

these actions are intended to increase 

the availability of investment advice. 

The results of this proposed 

regulation and proposed class 

exemption will depend on their impacts 

on the availability, cost, use, and quality 

of participant investment advice. The 

Department expects that, as a result of 

these actions, quality, affordable advice 

will proliferate, producing significant 

net gains for participants. 

Investment Mistakes 

The Department believes that many 

participants make costly investment 

mistakes and therefore could benefit 

from receiving and following good 

advice. In theory, investors can optimize 

their investment mix over time to match 

their investment horizon and personal 

taste for risk and return. But in practice 

many investors do not optimize their 

investments, at least not in accordance 

with generally accepted financial 

theories. 

Some investors fail to exhibit clear, 

fixed and rational preferences for risk 

and return. Some base their decisions 

on flawed information or reasoning. For 

example some appear to anchor 

decisions inappropriately to plan 

features or to mental accounts or frames, 

or to rely excessively on past 

performance measures or peer 

examples. Some suffer from 

overconfidence, myopia, or simple 

inertia.13

Such informational and behavioral 

problems translate into at least five 

distinct types of investment mistakes,14

which together generate financial losses 

(including foregone earnings) of $109 

billion or more annually 15 for DC plan 

and IRA participants, the Department 

estimates. 

Fees and Expenses 

Investors sometimes pay higher fees 

and expenses than necessary for 

investment products and services. There 

is evidence that mutual funds with 

poorer gross performance (that is 

performance before deducting fees) also 

have higher fees. This suggests that 

higher fees sometimes do not reflect 

value added by managers. Investors 

often pay inadequate attention to fee 

differences, even in connection with 

highly comparable products like 

competing S&P 500 index funds.16


rwilkins on PROD1PC63 with PROPOSALS4
49904 Federal Register / Vol. 73, No. 164 / Friday, August 22, 2008 / Proposed Rules 

fund’s advisor is the most likely beneficiary of this 

growth.’’

Edwin J. Elton et al., Are Investors Rational? 

Choices Among Index Funds, Social Science 

Research Network Abstract 340482 (June 2002) find 

that buying S&P 500 index mutual funds using 

expenses as the predictor of future success leads to 

picking funds with better returns. They find that the 

ten percent of funds with the lowest expenses out 

performs the ten percent of funds with the highest 

expenses by 0.92 percent a year. They find that for 

S&P 500 index mutual funds, the incentive for 

brokers and financial planners to push the fund (as 

represented by loads) is more important for new 

flows than is avoiding high cost and poorly 

performing funds. They are unable to find any effect 

of the quality of services on flows. 

James J. Choi et al., Why Does the Law of One 

Price Fail? An Experiment on Index Mutual Funds, 

National Bureau of Economic Research Working 

Paper W12261 (May 2006) offer experimental 

evidence that index fund investors are largely 

insensitive to fees. 

Some other studies suggest, however, that fee 

levels may in fact be competitive and efficient. 

Many studies fail to measure potential nonfinancial benefits investors might derive from 

professional investment advice. Victoria LeonardChambers & Michael Bogdan, Why Do Mutual Fund 

Investors Use Professional Financial Advisers?, 

Investment Company Institute Research 

Fundamentals, Volume 16, Number 1 (April 2007) 

present results of a survey ‘‘that identifies the 

benefits investors say they receive from using 

professional financial advisers,’’ and contrast this 

perspective with that of studies that rely on 

‘‘performance and other publicly available 

measures to examine the value’’ of such advice. 

Other studies find that investors with more 

intelligence or financial literacy often pay similar 

fees as those with less, and suggest this is consistent 

with the hypothesis that fees are competitive and 

efficient (see, e.g., Sebastian Miller & Martin Weber, 

Financial Literacy and Mutual Fund Investments: 

Who Buys Actively Managed Funds?, Social Science 

Research Network Abstract 1093305 (Feb. 2008); 

and Mark Grinblatt et al., Are Mutual Fund Fees 

Competitive? What IQ-Related Behavior Tells Us, 

Social Science Research Network Abstract 1087120 

(Nov. 2007)). 

The Department understands that some of what 

might otherwise appear to be higher than necessary 

fees paid by investors pursuant to advice may in 

fact reflect indirect payment of the reasonable cost 

of the advice itself. 

17 DC plan participants’ investment choices 

typically are limited to a menu selected by a plan 

fiduciary who is responsible for ensuring that the 

associated fees and expenses are reasonable. 

However, such participants may pay more overall 

than would be optimal if they do not appropriately 

consider fees and expenses when allocating their 

assets across available investments. 

18 ‘‘Higher than necessary’’ here means that the 

participant could have obtained equal value 

without incurring the expense. This calculation 

assumes that participants on average pay 11 or more 

basis points in unnecessary fees and expenses, in 

the form of expense ratios or loads. This 

assumption is likely to be conservative in light of 

evidence on the distribution of investor expense 

levels presented in Deloitte Financial Advisory 

Services LLP, Fees and Revenue Sharing in Defined 

Contribution Retirement Plans (Dec. 6, 2007) 

(unpublished, on file with the Department of 

Labor); Brad M. Barber et al., Out of Sight, Out of 

Mind, The Effects of Expenses on Mutual Fund 

Flows, Journal of Business, Volume 79, Number 6 

2095, 2095–2119 (2005); Edwin J. Elton et al., Are 

Investors Rational? Choices Among Index Funds, 

Social Science Research Network Abstract 340482 

(June 2002); James J. Choi et al., Why Does the Law 

of One Price Fail? An Experiment on Index Mutual 

Funds, National Bureau of Economic Research 

Working Paper W12261 (May 2006); and Sarah 

Holden & Michael Hadley, The Economics of 

Providing 401(k) Plans: Services, Fees and Expenses 

2006, Investment Company Institute Research 

Fundamentals, Volume 16, Number 4 (Sept. 2007). 

This estimate of excess expense does not take into 

account less visible expenses such as mutual funds’

internal transaction costs (including explicit 

brokerage commissions and implicit trading costs), 

which are sometimes larger than funds’ expense 

ratios (Deloitte Financial Advisory Services LLP, 

Fees and Revenue Sharing in Defined Contribution 

Retirement Plans (Dec. 6, 2007) (unpublished, on 

file with the Department of Labor); Jason Karceski 

et al., Portfolio Transactions Costs at U.S. Equity 

Mutual Funds, University of Florida Working Paper 

(2004), at http://thefloat.typepad.com/the_float/

files/2004_zag_study_on_mutual_fund_trading_

costs.pdf). 

19Conversely, there is evidence that some higher 

than necessary expense currently is a direct result 

of what might be called bad advice, meaning certain 

marketing activities carried out by intermediaries 

such as brokers as well as direct consumer 

advertising by vendors of funds and competing 

financial products. 

20See, e.g., Takeshi Yamaguchi et al., Winners 

and Losers: 401(k) Trading and Portfolio 

Performance, Michigan Retirement Research Center 

Working Paper WP2007–154 (June 2007). 

21This estimate is derived from the risk adjusted 

returns attributed to participants with different 

trading strategies, see id. 

22See, e.g., Dalbar Inc., Quantitative Analysis of 

Investor Behavior 2007 (2007). 

23See, e.g., Rene Fischer & Ralf Gerhardt, 

Investment Mistakes of Individual Investors and the 

Impact of Financial Advice, Science Research 

Network Abstract 1009196 (Aug. 2007); Julie Agnew 

& Pierluigi Balduzzi, Transfer Activity in 401(k) 

Plans, Social Science Research Network Abstract 

342600 (June 2006); and George Cashman et al., 

Investor Behavior in the Mutual Fund Industry: 

Evidence from Gross Flows, Social Science Research 

Network Abstract 966360 (Feb. 2007). 

24See, e.g., Olivia S. Mitchell & Stephen P. Utkus, 

The Role of Company Stock in Defined Contribution 

Plans, National Bureau of Economic Research 

Working Paper W9250 (Oct. 2002); and Jeffrey R. 

Brown & Scott Weisbenner, Individual Account 

Investment Options and Portfolio Choice: 

Behavioral Lessons from 401(k) Plans, Social 

Science Research Network Abstract 631886 (Dec. 

2004). 

25This comparison should be viewed as an outer 

bound. Full diversification of the same assets might 

not be feasible if companies are unwilling to alter 

the compensation mix in this way (see, e.g., Olivia 

S. Mitchell & Stephen P. Utkus, The Role of 

Company Stock in Defined Contribution Plans, 

National Bureau of Economic Research Working 

Paper W9250 (Oct. 2002)). It also neglects some 

potential tax benefits of employer stock investments 

that might offset losses from reduced diversification 

(see, e.g., Mukesh Bajaj et al., The NUA Benefit and 

Optimal Investment in Company Stock in 401(k) 

Accounts, Social Science Research Network 

Abstract 965808 (Feb. 2007)). 

26Following findings reported in Lisa K. 

Meulbroek, Company Stock in Pension Plans: How 

Costly Is It?, Social Science Research Network 

Abstract 303782 (Mar. 2002), this estimate reflects 

losses amounting to 14 percent of the employer 

stock’s value, assuming 10 percent of DC plan assets 

are held in employer stock, the DC plan is one-half 

of total wealth, and the holding period is 10 years. 

For comparison, following findings reported in 

Krishna Ramaswamy, Company Stock and Pension 

Plan Diversification, in The Pension Challenge: Risk 

Transfers and Retirement Income Security 71, 71–

88 (Olivia S. Mitchell & Kent Smetters eds., 2003), 

the annualized cost of an option to receive the 

higher of the return on a typical company stock or 

the return on a fully diversified equity portfolio 

over a three-year horizon would amount to 

approximately $24 billion, the Department 

estimates. This measure probably exaggerates the 

loss to participants, however, insofar as it would 

preserve for the participant the potential upside of 

a company stock that outperforms the market. 

27These estimates neglect any behavioral impact 

full diversification might have on asset allocation. 

There is some evidence that investing in employer 

stock increases participants’ exposure to equity 

overall, which might increase average wealth (see, 

e.g., Jack L. Vanderhei, The Role of Company Stock 

in 401(k) Plans, Employee Benefit Research 

Institute T–133 Written Statement for the House 

Education and Workforce Committee, 

Subcommittee on Employer-Employee Relations, 

Hearing on Enron and Beyond: Enhancing Worker 

Retirement Security (Feb. 2002), at http:// 

www.ebri.org/pdf/publications/testimony/t133.pdf). 

The Department estimates that DC 

plan participants 17 and IRA 

beneficiaries together recently paid fees 

and expenses that were higher than 

necessary by $8 billion or more 

annually on aggregate.18 Good advice 

could eliminate some of this 

unnecessary expense.19

Poor Trading Strategies 

There is evidence that some 

participants trade excessively, while 

many more trade too little, failing even 

to rebalance. In DC plans, participant 

trading often worsens performance, and 

those with automatic rebalancing 

generally fare best.20 Relative to 

automatic rebalancing, inferior trading 

strategies recently cost participants 

perhaps $56 billion or more annually, 

the Department estimates.21 Among 

inferior strategies, it is likely that active 

trading aimed at timing the market 

generates more adverse results than 

failing to rebalance. Many mutual funds 

investors’ experience badly lags the 

performance of the funds they hold 

because they buy and sell shares too 

frequently and/or at the wrong times.22

Investors often buy and sell in response 

to short-term past returns, and suffer as 

a result.23 Good advice is likely to 

discourage market timing efforts and 

encourage rebalancing, thereby 

ameliorating adverse impacts from poor 

trading strategies. 

Inadequate Diversification 

Investors sometimes fail to diversify 

adequately and thereby assume 

uncompensated risk and suffer 

associated losses. For example, DC plan 

participants sometimes concentrate 

their assets excessively in stock of their 

employer.24 Relative to full 

diversification,25 employer stock 

investments recently cost DC plan 

participants perhaps $3 billion 26

annually, the Department estimates.27

Other lapses in diversification may 

involve omission from portfolios of 


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28See, e.g., Edwin J. Elton et al., The Adequacy 

of Investment Choices Offered By 401(k) Plans, 

Social Science Research Network Abstract 567122 

(Mar. 2004), which finds that menus are frequently 

inadequate, and Ning Tang and Olivia S. Mitchell, 

The Efficiency of Pension Plan Investment Menus: 

Investment Choices in Defined Contribution 

Pension Plans, University of Michigan Retirement 

Research Center Working Paper WP 2008–176 (June 

2008), at http://www.mrrc.isr.umich.edu/ 

publications/papers/pdf/wp176.pdf, which finds 

that most menus are efficient. 29See, e.g., Laurent E. Calvet et al., Down or Out: 

Assessing the Welfare Costs of Household 

Investment Mistakes, Harvard Institute of Economic 

Research Discussion Paper No. 2107 (Feb. 2006). 30See id. This estimate assumes annual return 

decrements from inadequate diversification of 0.3 

percent of invested assets for investors that are 

already investing in risky assets (like stocks and 

mutual funds) and 3.3% for investors that are not 

yet investing in risky assets. The Department 

estimates that in the U.S. about 85% of investors 

include risky assets in their portfolios. 

31The potential financial effects of changes in 

asset allocation hint at the likely magnitude of these 

welfare effects. The Department previously has 

estimated that movement of DC plan default 

investments from stand-alone, low-risk capital 

preservation instruments to diversified portfolios 

that include equities will improve investment 

results for a large majority of affected individuals, 

increasing aggregate account balances by an 

estimated $5 billion to $7 billion in 2034 (See 72 

FR 60,452, 60,466 (Oct. 24, 2007)). 

32See, e.g., Daniel B. Bergstresser & James M. 

Poterba, Asset Allocation and Asset Location: 

Household Evidence from the Survey of Consumer 

Finances, Journal of Public Economics, Volume 88 

1893, 1893–1915 (2004). 

33For example, tax-exempt municipal bonds are 

available, and actively managed equity mutual 

funds are not always tax-efficient (see, e.g., James 

M. Poterba et al., Asset Location for Retirement 

Savers, in Public Policies and Private Pensions 290, 

290–331 (John B. Shoven et al. eds., 2004); and John 

B. Shoven & Clemens Sialm, Asset Location in TaxDeferred and Conventional Savings Accounts, 

Journal of Public Economics, Volume 88 (2003)). 

Using historical returns data and tax rate data for 

the period 1962–98, James M. Poterba et al., Asset 

Location for Retirement Savers, in Public Policies 

and Private Pensions 290, 290–331 (John B. Shoven 

et al. eds., 2004) find that when investing in 

actively managed mutual funds, and with the 

availability of tax-exempt bonds, households would 

have more after-tax wealth in most cases if they had 

first placed equities in the tax-deferred account. 

Gene Amromin, Portfolio Allocation Choices in 

Taxable and Tax-Deferred Accounts: An Empirical 

Analysis of Tax-Efficiency, Social Science Research 

Network Abstract 302824 (May 2002) describes how 

accessibility restrictions on assets in tax-deferred 

retirement accounts create a tension between 

making tax-efficient placements and the risk of 

having to make costly withdrawals in the event of 

a bad labor income shock. He presents empirical 

evidence that holding apparently tax-inefficient 

portfolios is related to accessibility restrictions and 

to precautionary motives. Lorenzo Garlappi & 

Jennifer C. Huang, Are Stocks Desirable in TaxDeferred Accounts?, Journal of Public Economics, 

Volume 90 2257, 2257–2283 (July 2006) explain 

how a tax-deferred account essentially confers a tax 

subsidy onto its holdings. While the level of the tax 

subsidy may be maximized by first placing bonds 

in the tax-deferred account, this strategy may lead 

to a more volatile tax benefit. Risk-averse 

households may wish to smooth this volatility by 

holding a mix of equities and bonds in both taxdeferred and taxable accounts, as some are observed 

to do in practice. Robert M. Dammon et al., Optimal 

Asset Location and Allocation with Taxable and 

Tax-Deferred Investing, The Journal of Finance, 

Volume LIX, Number 3 999, 999–1037 (2004) find 

that even when tax-exempt bonds are available and 

even when there are liquidity shocks, for most 

investors it is best to put taxable bonds in the taxdeferred account and equity in the taxable account. 

asset classes such as overseas equity or 

debt, small cap stocks, or real estate. 

Such lapses may sometimes reflect 

limited investment menus supplied by 

DC plans.28 Yet even where adequate 

choices are available and company stock 

is not a factor, investors sometimes fail 

to diversify adequately.29 Inadequate 

diversification other than excessive 

concentration in company stock 

recently cost participants perhaps $42 

billion annually, the Department 

estimates.30 Good advice should address 

over concentration in employer stock 

and other failures to properly diversify. 

Inappropriate Risk 

Investors who avoid the foregoing 

three mistakes might be said to invest 

efficiently, in the sense that they 

generally can expect the maximum 

possible return given their level risk. 

However, they may still be making a 

costly mistake: they may fail to calibrate 

the risk and return of their portfolio to 

match their own risk and return 

preferences. As a result, their 

investments may be too risky or too safe 

for their own tastes. The Department 

lacks a basis on which to estimate the 

magnitude of such mistakes, but 

believes they may be common and large. 

A diversified portfolio’s risk and return 

characteristics generally is determined 

by its allocation across asset classes. As 

noted above, there is ample evidence 

that participants’ asset allocation 

choices often are inconsistent with fixed 

or well behaved risk and return 

preferences. If participants’ true 

preferences are in fact fixed or well 

behaved, then observed asset 

allocations, which often appear to shift 

in response to seemingly irrelevant 

factors (or fail to shift in response to 

relevant ones), certainly entail large 

welfare losses.31 Good advice might 

help participants calibrate their asset 

allocations to match their true 

preferences. 

Excess Taxes 

It is likely that many households pay 

excess taxes as a result of disconnects 

between their investment and tax 

strategies. Households saving for 

retirement must decide not only what 

assets to hold, but also whether to locate 

these assets in taxable or tax-deferred 

accounts. For example, households may 

be able to maximize their expected aftertax wealth by first placing heavily taxed 

bonds in their tax-deferred account and 

then placing lightly taxed equities in 

their taxable account. A significant 

number of households do not follow 

this practice, however. By one estimate, 

to fully implement this practice in 1998, 

U.S. households would have had to 

relocate some $251 billion in assets.32 It 

is not clear, however, whether such 

households are in fact making 

investment mistakes. In practice, this 

simple asset location rule may fail to 

minimize taxes.33 As a result the 

Department has no basis to estimate the 

magnitude of excess taxes that might 

derive from DC plan and IRA 

participants’ investment mistakes. In 

any event it is unclear whether or to 

what extent investment advisers would 

be positioned to provide advice on tax 

efficiency. 

Promoting Investment Advice 

Permissible Arrangements 

Federal law limits the variety of 

arrangements whereby participants may 

obtain investment advice. Specifically, 

ERISA and the Internal Revenue Code 

generally prohibit fiduciaries from 

dealing with DC plan or IRA assets in 

ways that advance their own interests. 

These provisions effectively preclude 

participants from obtaining advice 

under arrangements that are widely 

used by other investors. For example, 

under many common arrangements, the 

adviser may receive a commission or 

other consideration when the investor 

enters into a transaction pursuant to the 

advice. The adviser’s employer or an 

affiliate thereof may receive a sales load 

or other consideration in connection 

with the transaction. Stated generally, 

many common investment advice 

arrangements present financial advisers 

with opportunities to self deal. 

While generally prohibiting 

arrangements that present such 

opportunities, federal law also provides 

for conditional exemptions whereby 

otherwise prohibited transactions are 

permitted. Some exemptions are 

contained in the statute. The 

Department has authority to grant 

others. The conditions attached to such 

exemptions serve to mitigate the adverse 

effects of the conflicts of interest that are 

present and thereby protect participants’

interests. However, the Department 

invites suggestions for other safeguards 

against conflicts of interest that would 

be consistent with the goal of making 

quality advice more widely available. 

The Pension Protection Act of 2006 

opened the door to more types of 

investment advice arrangements by 

conditionally permitting arrangements 

where the fiduciary adviser or an 

affiliate thereof has a financial stake in 


rwilkins on PROD1PC63 with PROPOSALS4
49906 Federal Register / Vol. 73, No. 164 / Friday, August 22, 2008 / Proposed Rules 

the advised participants’ investment 

decisions. The Department is proposing 

a regulation to further specify the PPA’s 

applicable conditions, together with a 

class exemption to establish alternative 

conditions under which such 

arrangements may operate. Table 1 

summarizes the effect of the PPA and 

this proposed class exemption on 

permissible investment advice 

arrangements. 

The Department calibrated this 

proposed regulation to in an effort to 

protect participants while promoting the 

affordability of investment advice 

arrangements operating pursuant to the 

PPA’s statutory exemptive relief, in 

order that such arrangements will 

proliferate and thrive, to the benefit of 

participants. 

The PPA’s relief (listed at B. in table 

1) is conditioned in part on audits. In 

order to promote the affordability of 

advice, this proposed regulation 

provides that audits may rely on a 

representative sample of similar 

arrangements. In order to protect 

participants, this proposed regulation 

requires that audit reports identifying 

noncompliance in connection with 

advice provided to IRA beneficiaries be 

furnished to the Department. 

1—PERMISSIBLE INVESTMENT ADVICE ARRANGEMENTS

Is it permissible for compensation to vary 

depending on participants’ investment decisions? 

Person 

providing 

advice 

Fiduciary 

adviser entity 

Fiduciary 

advisers’ 

affiliates 

A. Absent any exemptive relief: 

1. Except as described at 2. below .......................................................................................... No ................ No ................ No. 

2. Advice is determined solely by a computer model that is provided by an independent entity and over which the fiduciary adviser has no control.N/a * ............. Yes ............... Yes. 

B. Under PPA statutory exemption: 

1. Subject to conditions including authorization by a separate fiduciary, independent audits, 

disclosure, and recordkeeping.

No ................ No ................ Yes. 

2. Subject to conditions listed above at 1., and advice is provided by a computer model that 

is certified by an independent expert and satisfies conditions including conformance to investment theories and objectivity.

N/a * ............. Yes ............... Yes. 

C. Under proposed class exemption: 

1. Subject to conditions including conformance to investment theories, authorization by a 

separate fiduciary, independent audits, disclosure, and recordkeeping.

No ................ Yes ............... Yes. 

2. Subject to conditions listed above at 1. and additional conditions including prudence and 

loyalty, advance provision of benchmark recommendations or educational material, and 

documentation.

Yes ............... Yes ............... Yes. 

* Under these arrangements, the investment advice is formulated exclusively by use of the computer model. 

The PPA’s statutory exemptive relief 

for investment advice arrangements that 

use computer models (listed at B.2. in 

table 1) is conditioned in part on 

independent expert certification of such 

models. The expert must meet 

requirements specified by the Secretary 

and certifications and renewals thereof 

must be completed in accordance with 

rules established by the Secretary. This 

proposed regulation establishes such 

requirements and rules. 

In advance of formulating these 

requirements and rules the Department 

invited and considered extensive public 

input on the nature, functions, and 

performance of existing models. The 

Department also closely examined and 

road tested some popular models with 

particular attention to the criteria set 

forth in section 408(g)(3)(B) of ERISA. 

The Department came to the conclusion 

that existing computer models can take 

into account various information about 

individuals, their preferences and 

available investment options and, in its 

limited attempt to examine whether 

recommendations provided were 

optimal, the Department did not find 

evidence of computer models 

recommending investment portfolios 

that have risk return profiles inferior to 

any individual investment alternative 

available. 

On these bases the Department 

understands that models capable of 

satisfying the exemption’s conditions 

are various and evolving. The variety 

and evolution reflect healthy 

competition to develop superior 

products that deliver more value to 

participants. 

The Department sought to calibrate 

this proposed regulation to nurture such 

competition while keeping advice 

affordable and protecting participants’

interests. This proposed regulation 

consequently provides for transparency 

and procedural rigor but generally does 

not attempt to specify precise and fixed 

substantive standards. For example, 

pursuant to the proposed regulation the 

experts’ qualifications will be reviewed 

by a fiduciary, and each certification 

will be documented in detail. The 

proposed regulation also provides that 

models may be certified once for similar 

applications across multiple DC plans or 

IRAs, rather than separately for each 

individual application, thereby 

promoting affordability of arrangements 

using models. 

The Department likewise sought to 

calibrate this proposed class exemption 

to protect participants while promoting 

the affordability of investment advice 

arrangements operating pursuant to it, 

in order that such arrangements 

likewise will proliferate and thrive, to 

the benefit of participants. As detailed 

below, the proposed class exemption, by 

relaxing bars against arrangements that 

place fiduciary advisers in positions 

where they have potential conflicts of 

interest, will increase the variety of 

investment advice arrangements that are 

available and potentially lower the cost 

and promote the marketing of such 

arrangements, to the benefit of 

participants. Conditions attached to the 

proposed class exemption will mitigate 

the adverse impact of the conflicts and 

thereby ensure the quality of advice 

provided pursuant to it. 

Availability and Use 

Participants have always had the 

option of obtaining permissible 

investment advice services directly in 

the retail market. DC plan sponsors 

likewise have had the option of 

obtaining such services in the 

commercial market and making them 

available to plan participants and 

beneficiaries in connection with the 

plan. 

Prior to the 2006 enactment of the 

PPA, a substantial fraction of DC plan 

sponsors already made investment 

advice available to plan participants and 


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34This assessment is based on the Department’s 

reading of Hewitt Associates LLC, Survey Findings: 

Hot Topics in Retirement, 2007 (2007); Profit 

Sharing/401(k) Council of America, 50th Annual 

Survey of Profit Sharing and 401(k) Plans (2007); 

and Deloitte Development LLC, Annual 401(k) 

Benchmarking Survey, 2005/2006 Edition (2006). In 

addition to investment advice, a majority of 

sponsors also provide one or more other types of 

support to participants’ investment decisions. Other 

types of support include providing general 

investment education via seminars or written 

materials, offering one-stop, pre-mixed investment 

alternatives such as lifestyle funds, and offering 

managed accounts. 

35Eighty-two percent of mutual fund 

shareholders who hold funds outside of DC plans 

purchase some or all of their funds from a 

professional financial adviser such as a full-service 

broker, independent financial planner, bank or 

savings institution representative, insurance agent, 

or accountant (see, e.g., Victoria Leonard-Chambers 

& Michael Bogdan, Why Do Mutual Fund Investors 

Use Professional Financial Advisers?, Investment 

Company Institute Research Fundamentals, Volume 

16, Number 1 (April 2007)). Because families 

owning IRAs outnumber those owning pooled 

investment vehicles outside of retirement accounts 

(see, e.g., Brian K. Bucks et al., Recent Changes in 

U.S. Family Finances: Evidence from the 2001 and 

2004 Survey of Consumer Finances, Federal Reserve 

Bulletin 92 A1, A1–A38 (2006)), it is reasonable to 

conclude that a large majority of IRA beneficiaries 

who invest in mutual funds purchase them via such 

professionals. The Department has no basis to 

estimate the fraction of these beneficiaries that 

receive true investment advice from such 

professionals, however. It is possible that some 

make their purchase decisions without receiving 

any recommendation or material guidance from the 

professional making the sale. 

36Alternatives including advice of peers, written 

plan materials, print media, television and radio, 

seminars, software, on-line information or advice, 

and retirement benefit statements were all less 

likely to be characterized as ‘‘most helpful.’’

37See, e.g., Employee Benefit Research Institute, 

2007 Retirement Confidence Survey, Wave XVII, 

Posted Questionnaire (Jan. 2007). 

38The statutory exemptive relief for investment 

advice provided by the PPA generally became 

effective for advice provided after December 31, 

2006. In February 2007 EBSA issued guidance on 

the new statutory exemptive relief for arrangements 

using fiduciary advisers whose affiliates’ revenue 

might vary depending on the fiduciary advisers’

fiduciary acts. It is likely that some such 

arrangements exist today, and that more will in the 

future. The PPA also provided relief for 

arrangements that provide advice via independently 

certified computer models. The PPA withheld this 

exemptive relief in connection with IRAs, however, 

unless and until the Department found and reported 

to Congress that a model satisfying certain criteria 

exists. Concurrent with issuance of this proposed 

class exemption, the Department has reached this 

finding and reported it to Congress. Therefore 

statutory relief for this latter type arrangement is 

just now being extended to IRAs. In addition, the 

PPA provides that the Department will by 

regulation specify the process by which computer 

models will be certified. Concurrent with issuance 

of this proposed class exemption, the Department 

is proposing such a regulation. Given this timing it 

is unlikely that many such latter type arrangements 

yet exist. 

39Such complexity can include the need to enlist 

an adviser who is independent of or merely 

affiliated with the plan’s or IRA’s investment 

manager, in order to avoid direct exposure of the 

adviser to potential conflicts. 

40As discussed below, arrangements that avoid 

potential conflicts may entail higher or more visible 

costs. 

41 In one survey of DC plan sponsors, among 

those offering investment advice, ‘‘access to 

financial counselors in person’’ was rated most 

effective, followed by ‘‘access to financial 

counselors via telephone.’’ ‘‘Web-based’’ advice 

received the lowest effectiveness ratings (see, e.g., 

Deloitte Development LLC, Annual 401(k) 

Benchmarking Survey, 2005/2006 Edition (2006)). 

This finding is corroborated by another survey, in 

which in-person advice appears to be used by 

participants more often than advice delivered via 

the Internet (see, e.g., Profit Sharing/401(k) Council 

of America, Investment Advice Survey 2001 (2001)). 

42Where investment advice is available to DC 

plan participants, only one in four uses it, 

according to one plan sponsor survey (see, e.g., 

Profit Sharing/401(k) Council of America, 50th 

Annual Survey of Profit Sharing and 401(k) Plans 

(2007)). On-line advice appeals more to highersalaried, full-time workers (see, e.g., Julie Agnew, 

Personalized Retirement Advice and Managed 

Accounts: Who Uses Them and How Does Advice 

Affect Behavior in 401(k) Plans?, Center for 

Retirement Research Working Paper 2006–9 (2006)). 

In one survey, two-thirds of workers and 85 percent 

of retirees expressed discomfort with ‘‘obtaining 

advice from financial professionals on-line. This 

raises the possibility that many participants, 

perhaps especially lower-paid, part-time 

participants, may be underserved if the regulatory 

environment excessively favors on-line advice. 

43See, e.g., Profit Sharing/401(k) Council of 

America, Investment Advice Survey 2001 (2001). 

44Both the PPA and this proposed class 

exemption extend conditional relief from ERISA’s 

prohibited transaction provisions, but neither 

relieves plan fiduciaries of their general obligations 

under ERISA. 

45The cost of advice is discussed further 

immediately below. 

46Other fiduciary concerns, cited more frequently 

and rated more important, are not addressed by this 

proposed class exemption. 

47See, e.g., Deloitte Development LLC, Annual 

401(k) Benchmarking Survey, 2005/2006 Edition 

(2006). 

beneficiaries. Today, as the PPA’s 

implementation progresses, many more 

have begun providing or are gearing up 

to provide such advice. It is likely that 

40 percent or more of DC plan sponsors 

currently provide access to investment 

advice either on line, by phone, or inperson. Where offered, approximately 

25 percent of participants use advice. 

In-person advice seems to be offered by 

the most plan sponsors. On-line advice 

and to a lesser degree telephone advice 

are favored more by large sponsors. 

Smaller plan sponsors appear to offer 

advice generally and in-person advice in 

particular more frequently than larger 

plan sponsors.34

Investment advice is also already used 

by a substantial fraction of IRA 

participants, the Department believes. A 

majority of IRA participants that invest 

in mutual funds purchase some or all of 

their funds via a professional financial 

adviser.35 Overall 60 percent of U.S. 

workers and retirees say they use the 

advice of a financial professional when 

making retirement savings and 

investment decisions; 40 percent say 

this advice was more helpful to them 

than alternatives.36 It is not clear how 

recently this advice was obtained, 

however: In the same survey just 28 

percent say that in the past year they 

obtained investment advice from a 

professional financial adviser who was 

paid through fees or commissions.37

The new statutory exemptive relief 

provided by the PPA is expected to 

increase the availability of advice, but it 

is too early to observe by how much.38

The Department believes that absent 

this proposed class exemption some 

segments of the plan and participant 

market will lack adequate access to 

quality, affordable investment advice. 

Some potential fiduciary advisers will 

be deterred from entering the market by 

the complexity of advice arrangements 

that conform to the conditions of the 

PPA’s statutory exemptive relief.39

Some plan sponsors and participants 

will be deterred by the cost of such 

arrangements,40 or by dissatisfaction 

with the types of advice arrangements 

that are available at lower costs, such as 

automated computer investment advice 

programs.41 As a result some DC plan 

sponsors will not offer advice, and 

where it is offered some participants 

will not use it.42 IRA beneficiaries may 

face similar obstacles to obtaining 

affordable, quality investment advice. 

From the point of view of DC plan 

sponsors, the PPA and this proposed 

class exemption could help relieve 

certain concerns that have impeded 

some from providing investment advice 

in the past. A few years prior to the 

enactment of the PPA less than one in 

four surveyed DC plan sponsors 

provided advice, according to one 

survey.43 Those not providing advice 

were asked to cite reasons and rate the 

reasons’ importance on a 0-to-5 scale. 

Two reasons cited by large majorities 

and rated moderately important might 

be ameliorated by this proposed class 

exemption: ‘‘Fiduciary concern about 

ensuring that the advice provider has no 

conflict of interest’’ 44 (cited by 84 

percent and rated 3.1) and ‘‘cost of 

providing advice’’ 45 (cited by 69 

percent and rated 2.0).46 In another prePPA survey 35 percent of DC plan 

sponsors not offering advice cited cost 

as a reason.47

From the point of view of prospective 

fiduciary advisers whose business 

models involve conflicts—e.g., who are 

compensated by the companies that 

manufacture, manage, and/or trade the 

investment products that they 

recommend—the PPA and this 

proposed class exemption grant 

conditional access to a very large and 


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48Combined participant directed DC plan and 

IRA assets exceed $7 trillion. 49The Department based its assumptions on its 

reading of Hewitt Associates LLC, Survey Findings: 

Hot Topics in Retirement, 2007 (2007); Profit 

Sharing/401(k) Council of America, 50th Annual 

Survey of Profit Sharing and 401(k) Plans (2007); 

and Deloitte Development LLC, Annual 401(k) 

Benchmarking Survey, 2005/2006 Edition (2006). 

50See, e.g., Profit Sharing/401(k) Council of 

America, 50th Annual Survey of Profit Sharing and 

401(k) Plans (2007); and Julie Agnew, Personalized 

Retirement Advice and Managed Accounts: Who 

Uses Them and How Does Advice Affect Behavior 

in 401(k) Plans?, Center for Retirement Research 

Working Paper 2006–9 (2006). 

51See, e.g., Employee Benefit Research Institute, 

2007 Retirement Confidence Survey, Wave XVII, 

Posted Questionnaire (Jan. 2007). In practice this 

might translate into a high rate of compliance with 

recommendations, if recommendations turn out not 

to diverge too much from participants’ own ideas. 

52See, e.g., Employee Benefit Research Institute, 

2008 Retirement Confidence Survey, Wave XVIII, 

Posted Questionnaire (Jan. 2008). 

53This assumes that the use rate for where in 

person advice is available is approximately 50 

percent higher (30 percent) as where only on-line 

or telephone advice is available (20 percent) (see, 

e.g., Employee Benefit Research Institute, 2007 

Retirement Confidence Survey, Wave XVII, Posted 

Questionnaire (Jan. 2007)). 

54See, e.g., Profit Sharing/401(k) Council of 

America, Investment Advice Survey 2001 (2001). 

55One survey found that 64 percent of workers 

already use professional financial advice when 

making retirement savings and investment 

decisions, and that 54 percent are very or somewhat 

likely to use advice if offered by their employer in 

connection with a DC plan (see, e.g., Employee 

Benefit Research Institute, 2007 Retirement 

Confidence Survey, Wave XVII, Posted 

Questionnaire (Jan. 2007)). This seems to suggest a 

higher baseline rate of advice use than assumed 

here. However, because the latter fraction is smaller 

than the former, it is unclear whether this suggests 

that this proposed class exemption would increase 

DC plan participants’ use of advice by more or less 

than assumed here. 

56 In particular, participants should be able to 

adequately compare the prices offered by advisers 

fast growing new market segment.48

These advisers might be in a position to 

offer their services at low or no direct 

cost to the companies’ DC plan and IRA 

clients (relying instead on compensation 

from the companies). They might 

market their services to the companies’

clients more actively than have 

independent advisers historically. 

For purposes of this impact 

assessment, the Department anticipates 

that owing to the statutory exemptive 

relief provided by the PPA, advice of 

some type (on-line, telephone and/or in 

person) will soon be available to 

perhaps one-half of DC plan 

participants, with in-person advice 

available to perhaps one in four. This 

proposed class exemption will boost 

these fractions to perhaps 60 percent 

and 35 percent, respectively. The 

Department’s assumptions are 

summarized in Table 2.49

2—AVAILABILITY OF ADVICE TO DC 

PLAN PARTICIPANTS

Policy context 

Any advice 

(computer 

or live) 

(percent) 

Live advisor 

(percent) 

Pre-PPA ............ 40 20 

PPA ................... 50 25 

Class exemption 60 35 

The effect of investment advice 

depends not merely on its availability 

but on its use by DC plan and IRA 

participants. Do the participants seek 

advice, and if so do they follow it? 

According to one survey, among DC 

plan participants offered investment 

advice, approximately one in four uses 

it. There is some evidence that 

historically in-person advice has 

achieved higher use rates than on-line 

advice, with on-line advice appealing 

more to higher-income participants.50 In 

another survey large fractions of 

workers say they would be very likely 

(19 percent) or somewhat likely (35 

percent) to take advantage of advice 

provided by the company that manages 

their employer’s DC plan. Of these, twothirds said they would implement only 

those recommendations that were in 

line with their own ideas; 21 percent 

said they would implement all of the 

recommendations as long as they 

trusted the source.51 In a subsequent 

survey, among those obtaining 

investment advice, 36 percent say they 

implemented ‘‘all’’ of the advice, 58 

percent ‘‘some,’’ and just 5 percent 

‘‘none.’’ 52

The PPA and this proposed class 

exemption together could boost DC plan 

participants’ use of advice where 

offered, in at least two ways. First, 

because it appears that in-person advice 

arrangements are more heavily used 

than automated computer advice 

programs, wider availability of inperson advice programs wherein 

advisers can exercise discretion in 

formulating personalized advice (rather 

than merely communicate the 

recommendations of a computer 

model)—a likely consequence of this 

proposed class exemption—might be 

expected to boost use rates. The shift 

anticipated by the Department 

(discussed immediately above) would 

increase the use rate slightly from 25 

percent to 26 percent.53 Second, if the 

cost of advice falls, participants who 

must pay for advice will become more 

inclined to use it. However, historically 

employers have usually paid directly for 

advice, or passed the cost to all 

participants whether they use advice or 

not,54 and as explained below it is 

unclear by how much the cost of advice 

will fall. Therefore for purposes of this 

impact assessment the Department did 

not take into account any cost-driven 

increase in use of advice by DC plan 

participants, but assumed that this 

proposed class exemption will increase 

the fraction of DC plan participants 

using advice where available from 25 

percent to 26 percent.55 Given the 

Department’s assumptions regarding 

availability of advice to DC plan 

participants, this translates into an 

increase in the incidence of advice due 

to this proposed class exemption from 

10 percent to 16 percent. 

The PPA and this proposed class 

exemption could also boost IRA 

participants’ use of advice. As noted 

above, advisers doing business pursuant 

to this class exemption are likely to 

actively market advice services to IRA 

participants and to offer them reduced 

prices for such services. The reduced 

prices will reflect both the availability 

to advisers of other compensation and 

possible cost saving in the production 

and delivery of advice. Advisers doing 

business pursuant to this proposed class 

exemption may thereby attract business 

both from IRA participants who 

otherwise would be without advice and 

from IRA participants who otherwise 

would obtain advice through an 

arrangement that does not require the 

relief provided by this proposed class 

exemption. IRA participants who would 

otherwise be without advice may obtain 

advice in response to such marketing 

and pricing activity because the activity 

reduces their search cost to find and 

select an adviser, and/or because the 

reduced price falls below their 

reservation price. Likewise, IRA 

participants who would otherwise have 

obtained advice via some other 

arrangement may switch to an 

arrangement pursuant to the PPA or this 

proposed class exemption (and may 

increase the amount of advice services 

they use) because the advisers’

marketing activity broadens their search 

and/or in pursuit of lower prices. 

In proposing this class exemption the 

Department considered carefully the 

importance of transparency in pricing. 

Participants’ decisions whether and 

where to obtain advice should be well 

informed with respect to the cost 

associated with alternative 

arrangements. As a condition of this 

proposed class exemption an adviser 

must disclose to the participant certain 

information regarding other revenue 

sources. This condition is intended to 

enable participants to decide whether, 

where, and how much advice to obtain, 

in light of the associated direct and 

indirect costs to them.56 Therefore the 


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doing business pursuant to this exemption with 

those offered by other advisers such as those 

offering their services for a flat fee. 

57These assumptions are based on the 

Department’s reading of Employee Benefit Research 

Institute, 2007 Retirement Confidence Survey, Wave 

XVII, Posted Questionnaire (Jan. 2007); Hewitt 

Associates LLC, Survey Findings: Hot Topics in 

Retirement, 2007 (2007); Profit Sharing/401(k) 

Council of America, 50th Annual Survey of Profit 

Sharing and 401(k) Plans (2007); and Deloitte 

Development LLC, Annual 401(k) Benchmarking 

Survey, 2005/2006 Edition (2006). There are a 

number of reasons to believe that use of advice will 

be higher among IRA beneficiaries than DC plan 

participants. The aforementioned survey reports, 

read together, generally support this conclusion. In 

addition, relative to IRA beneficiaries, DC 

participants may have less need for advice and/or 

easier access to alternative forms of support for 

their investment decisions. DC plan participants’

choice is usually confined to a limited menu 

selected by a plan fiduciary, and the menu may 

include one-stop alternatives such as target date 

funds that may mitigate the need for advice. Their 

plan or employer may provide general financial and 

investment education in the form of printed 

material or seminars. They often make initial 

investment decisions (sometimes by default) before 

contributing to the plan so the decisions’ impact 

may seem small. Finally, the availability of advice 

in connection with the plan is intermediated by the 

plan sponsor and fiduciary. In contrast, IRA 

beneficiaries generally have wider choice and are 

more likely to be without employer-provided 

support for their decisions. Decision points may 

more often occur when account balances are large, 

such as when rolling a large DC plan balance into 

an IRA or when retiring. Finally, the availability of 

advice to IRA beneficiaries is not intermediated by 

an employer—rather IRA beneficiaries interface 

directly with the retail market and will thereby be 

more directly affected by the exemptive relief 

provided by the PPA and by this proposed class 

exemption. For all of these reasons IRA 

beneficiaries may use advice more frequently than 

DC plan participants. 

58For example, an adviser employed by an asset 

manager can share the manager’s research instead 

of buying or producing such research 

independently. 

59There is no single, complete, universally 

accepted theory of optimal investment. Instead 

there are competing and evolving theories which 

have much in common (what might be called 

‘‘generally accepted’’ theories) but also important 

differences (see, e.g., Martin Wallmeier & Florian 

Zainhofer, How to Invest Over the Life Cycle: a 

Review, Social Science Research Network Abstract 

951167 (Dec. 2006); and Deloitte Financial 

Advisory Services LLP, Generally Accepted 

Investment Theories (July 11, 2007) (unpublished 

memorandum, on file with the Department of 

Labor)). In practice this means that different experts 

may give different advice; often the differences will 

be small but occasionally they might be large. 

There is some evidence of lapses in the quality 

of investment advice. Investment advisers’ advice 

does not always conform to generally accepted 

investment theories. For example, they sometimes 

neglect investors’ debt, or exhibit ‘‘home bias’’

toward domestic investment. Home bias may be 

larger in advice given to more risk averse investors; 

this conflicts with theory insofar as home bias 

reduces diversification and therefore increases risk. 

Investment advisers in some sense have two 

functions: to provide investment advice and to 

provide investor advice. The former ought to 

conform to financial theories, while the latter 

involves helping investors overcome behavioral 

biases and errors. Together these functions may 

result in a nuanced balance between what the 

investor theoretically ‘‘should’’ choose and what 

the investor is comfortable choosing (see, e.g., Elisa 

Cavezzali & Ugo Rigoni, Investor Profile and Asset 

Allocation Advice, Social Science Research 

Network Abstract 966178 (Feb. 2007)). Some advice 

computer models and educational material may 

furnish misleading information regarding risk and 

consequently may do harm (see, e.g., Zvi Bodie, An 

Analysis of Investment Advice to Retirement Plan 

Participants, in The Pension Challenge: Risk 

Transfers and Retirement Income Security 19, 19–

32 (Olivia S. Mitchell & Kent Smetters eds., 2003)). 

Advice computer models generally fail to 

coordinate financial investments with financial 

risks associated with individuals’ jobs, homes, and 

health (see, e.g., John Ameriks & Douglas Fore, 

Financial Planning: On the Issue of Advice, Benefits 

Quarterly, Fourth Quarter 6, 6–14 (2002)). While it 

is widely agreed that such coordination is 

important, theories about how this should be done 

Continued 

Department intends that any cost-driven 

increase in use of advice by IRA 

participants will be driven by overall 

cost decreases and not solely by direct 

price reductions. 

As noted above there is evidence that 

a large fraction of IRA participants 

already use advice. For purposes of this 

assessment the Department assumes that 

as a result of the PPA and this proposed 

class exemption the proportion of IRA 

beneficiaries using advice will increase 

from one-third to two-thirds. The 

Department’s assumptions regarding use 

of advice are summarized in table 3.57

3—USE OF ADVICE BY DC PLAN AND IRA PARTICIPANTS

Policy context 

DC plans 

IRA 

Dollars 

advised 

($trillions) Where offered 

(percent) 

Overall 

(percent) 

Pre-PPA ........................................................................................................... 25 10 33 $1.7

PPA .................................................................................................................. 25 13 50 2.5 

Class exemption .............................................................................................. 26 16 67 3.2 

It seems likely that in practice a large 

proportion of participants who receive 

advice will follow that advice either in 

whole or in part. This is especially 

likely if the advice turns out to be 

broadly in line with the participants’

own thinking. Nonetheless, some advice 

will not be followed, and as a result 

some investment errors will not be 

corrected. For purposes of this analysis, 

the Department has assumed that 

advised participants make investment 

errors at one-half the rate of unadvised 

participants. The remaining errors 

reflect participant failures to follow 

advice (together with possible flaws in 

some advice, as discussed immediately 

below). 

Cost 

As noted above the PPA and this 

proposed class exemption are expected 

to make advice available to participants 

at a lower direct price, because advisers 

will be able to rely on alternative 

revenue sources to compensate their 

efforts. More importantly, however, the 

Department believes that the total cost 

of the advice to participants will be 

reduced. Bars against transactions 

wherein fiduciary advisers’ and 

participants’ interests may conflict carry 

costs. Faced with such bars advisers 

may forgo certain potential economies 

of scale in production and distribution 

of financial services that would derive 

from more vertical and horizontal 

integration.58 And to avoid such 

conflicts they must carefully monitor 

and calibrate their relationships and 

compensation arrangements, or incur 

the opportunity cost associated with 

exclusive reliance on level fees. The 

Department therefore expects the PPA 

and this proposed class exemption to 

produce cost savings by harnessing 

economies of scale and by reducing 

compliance burdens. The Department is 

unaware of any available empirical basis 

on which to determine whether or by 

how much costs might be reduced, 

however. 

Quality 

The effect of investment advice also 

depends on its quality. Good advice can 

reduce investment errors, steering 

investors away from higher than 

necessary expenses and toward optimal 

trading strategies, broad diversification, 

and asset allocations consistent with the 

investors’ tastes for risk and return. The 

Department believes that, although there 

is no universally accepted single and 

complete theory of optimal investing, 

and although there is some evidence of 

lapses in the quality investment 

advice,59 professional advisers’


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continue to evolve (see, e.g., Gu ̈nter Franke et al., 

Non-Market Wealth, Background Risk and Portfolio 

Choice, Social Science Research Network Abstract 

968096 (Mar. 2007)). Typical advice as reflected in 

target-date funds conforms to some financial 

theories but conflicts with others (see, e.g., Luis M. 

Viceira, Life-Cycle Funds, Social Science Research 

Network Abstract 988362 (May 2007)). 

60Rene Fischer & Ralf Gerhardt, Investment 

Mistakes of Individual Investors and the Impact of 

Financial Advice, Science Research Network 

Abstract 1009196 (Aug. 2007) ‘‘present financial 

advice as (potentially) correcting’’ a variety of 

investment mistakes that left uncorrected ‘‘lead to 

considerable welfare losses.’’

61These risks consist of the possibility that some 

advisers will pursue profit by dispensing advice 

that increases their own revenue at the expense of 

participants’ interests. 

Consideration of these risks is especially 

important because advice pursuant to this proposed 

class exemption, while extending to many 

participants who otherwise would invest without 

guidance or support, may also extend to many 

others who absent this class exemption would have 

benefited from alternative forms of support for their 

investment decisions, such as alternative 

permissible advice arrangements, target-date funds, 

managed accounts, or automatic rebalancing. 

In considering these risks the Department 

devoted separate attention to the application of this 

proposed class exemption to IRAs. In contrast to DC 

plan participants, IRA participants may be more 

vulnerable to risks attendant to conflicts of interest 

insofar as they: (1) May include more retirees, who 

may be in greater need of advice, but who also may 

be more vulnerable to abusive practices (see, e.g., 

Phyllis C. Borzi & Martha Priddy Patterson, 

Regulating Markets for Retirement Payouts: 

Solvency, Supervision and Credibility, Pension 

Research Council Working Paper PRC WP2007–21 

(Sept. 2007)); (2) are not represented by a plan 

fiduciary, independent of the adviser and 

connected to their interests via an employment 

relationship, who selects and monitors the advice 

arrangement and pre-screens the menu of 

investment options for quality; and (3) may not, 

under the conditions of this proposed class 

exemption, have the benefit of specific advice 

provided by an independent or independentlycertified computer model to compare with (and 

possibly follow in lieu of) advice delivered 

pursuant to the proposed class exemption. In 

addition, while advisers to DC plan participants are 

subject to standards of fiduciary conduct and 

attendant liability under Title I of ERISA, advisers 

to IRA beneficiaries are not. Finally, the 

Department’s authority to enforce the conditions of 

this proposed exemption generally extends only to 

DC plans and not to IRAs. On the other hand, 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 market for 

investment advice and other financial products and 

services in which some vendors will offer 

unconflicted advice. 

The Department believes that absent effective 

controls conflicts can sometimes bias advice, 

although it is unclear how much or in exactly what 

ways. Biased advice may be less beneficial to 

investors than unbiased advice, or possibly even 

harmful in some cases. 

There is a theoretical basis to believe that 

investors may be harmed (or may benefit less) 

where managers pay intermediary advisers for 

inflows, and that such payments may increase the 

role of intermediaries (fewer investors may invest 

directly) (see, e.g., Neal M. Stoughton et al., 

Intermediated Investment Management, Social 

Science Research Network Abstract 966255 (Mar. 

2007)). This suggests that advisers whose fees are 

not level relative to their clients’ investment 

elections may give biased advice that enriches 

managers at investors’ expense (the motivation for 

and potential to profit from conflicts and bias may 

attach more to the manager who compensates the 

adviser than to the adviser). It also suggests that 

advisers doing business pursuant to this proposed 

class exemption might displace alternative forms of 

investment decision support. 

According to one empirical study, ‘‘there exists 

conflict of interests between load fund investors 

and brokers and financial advisers: brokers and 

financial advisers apparently serve their own 

interests by guiding investors into funds with 

higher loads, which generate higher income to the 

brokers and financial advisers but increase the 

expenses of investors.’’ High load funds have larger 

inflows than low load funds with otherwise similar 

performance. Recent increases in fund loads suggest 

that funds are seeking favor from brokers and 

advisers (see, e.g., Xinge Zhao, The Role of Brokers 

and Financial Advisors Behind Investment Into 

Load Funds, China Europe International Business 

School Working Paper (Dec. 2005), at http:// 

www.ceibs.edu/faculty/zxinge/brokerrole-zhao.pdf). 

Another study reaches similar conclusions. 

‘‘Relative to direct-sold funds, broker-sold funds 

deliver lower risk-adjusted returns, even before 

subtracting distribution costs. * * * Further, 

broker-sold funds exhibit no more skill at aggregatelevel asset allocation than do funds sold through 

the direct channel.’’ Even before accounting for the 

higher distribution expenses, the underperformance 

cost investors $4.6 billion in 2004. Brokers devote 

more effort to selling funds that generate more 

revenue for them (see Daniel B. Bergstresser et al., 

Assessing the Costs and Benefits of Brokers in the 

Mutual Fund Industry, forthcoming in The Review 

of Financial Studies). 

Yet another study finds that ‘‘investors who 

transact through investment professionals that are 

compensated through conventional distribution 

channels incur substantially poorer timing 

performance than investors who purchase pure no 

load funds.’’ The underperformance amounts to 

approximately 100 or 150 basis points (see, e.g., 

Mercer Bullard et al., Investor Timing and Fund 

Distribution Channels, Social Science Research 

Network Abstract 1070545 (Dec. 2007)). 

Some other studies are less conclusive. For 

example, one finds that captive brokers add more 

value for investors in purchasing funds, while 

unaffiliated brokers add the most value in 

redeeming them. Direct, no-load investors’

redemptions are the least sensitive to performance. 

This study also finds that higher payments from 

fund companies to unaffiliated brokers buys some 

inflows for funds (see, e.g., Susan Christoffersen et 

al., The Economics of Mutual-Fund Brokerage: 

Evidence from the Cross Section of Investment 

Channels, Social Science Research Network 

Abstract 687522 (Dec. 2005)). 

62The Department has no basis to estimate how 

much risk might remain. However the Department 

notes that the safeguards associated with the PPA 

and this class exemption are likely to be stronger 

than those associated with available research 

studies, cited above, that quantify substantial losses 

to investors. First, advisers to DC plan participants 

are subject to ERISA’s fiduciary standards. Second, 

the PPA and this class exemption provide 

substantive conditions including unbiasedness, 

together with procedural protections such as 

provision of advice generated by computer models 

that are certified by independent experts, 

documentation of bases for advice, and audits of 

investment advice programs’ conformance to 

applicable substantive conditions. Such protections 

generally are not provided in other U.S. contexts. 

For a discussion of protections applicable where 

advice is delivered by investment advisers or 

brokers to investors outside of IRAs and ERISAcovered retirement plans, see Angela A. Hung et al., 

Investor and Industry Perspectives on Investment 

Advisers and Broker-Dealers, RAND Corporation 

Technical Report (2008), at http://www.sec.gov/ 

news/press/2008/2008–1_randiabdreport.pdf. 

63Whether advice corrects errors depends on 

whether the advice is followed and whether it is 

good. There is reason to believe that many people 

receiving advice will follow it. In a 2008 survey, 

among those obtaining investment advice, 36 

percent say they implemented ‘‘all’’ of the advice, 

58 percent ‘‘some,’’ and just 5 percent ‘‘none’’

(Employee Benefit Research Institute, 2008 

Retirement Confidence Survey, Wave XVII, Posted 

Questionnaire (Jan. 2008)). There is also reason to 

believe that good advice will be available. 

According to Bluethgen, et al., High-Quality 

Financial Advice Wanted!, Social Science Research 

Network Abstract 1102445 (Feb. 2008), ‘‘There is a 

high degree of heterogeneity in quality among 

financial advisors * * * the extent to which 

advisors receive compensation in the form of fixed 

fees instead of sales commissions as well as the 

extent to which advisors exhibit a high degree of 

rationality in decision making are predictive of 

high-quality financial advice.’’ According to 

Bluethgen, et al., Financial Advice and Individual 

Investors’ Portfolios, Social Science Research 

Network Abstract 968197 (Mar. 2008), ‘‘advice 

enhances portfolio diversification, makes investor 

portfolios more congruent with predefined model 

portfolios, and increases investors’ fees and 

expenses. Our empirical evidence is broadly in line 

with honest financial advice.’’

recommendations are likely to be 

superior to unadvised participants’

investment practices.60 It is therefore 

likely that participants who obtain and 

follow advice, including advice 

provided pursuant to the PPA or this 

proposed class exemption and advice 

provided under alternative permissible 

arrangements, will substantially reduce 

their investment mistakes and thereby 

derive substantial financial benefits and 

improve their welfare. 

In its effort to ensure the quality of 

advice, the Department carefully 

considered the substantial risks 

attendant to opportunities for selfdealing that may exist among fiduciary 

advisers doing business pursuant to the 

PPA or this proposed class exemption. 

There is evidence that advisers 

sometimes seize such opportunities and 

thereby reap profit at investors’

expense.61 The provisions of this 

proposed regulation and conditions 

attached to this proposed class 

exemption are intended to guard against 

these risks while keeping advice 

affordable.62

For purposes of this analysis, the 

Department has assumed that advised 

participants make investment errors at 

one-half the rate of unadvised 

participants. The remaining errors 

reflect possible flaws in some advice 

(together with participant failures to 

follow advice, discussed immediately 

above).63 Additionally for purposes of 

this analysis the Department assumes 

that all permissible advice arrangements 

(including those operating pursuant to 

exemptive relief provided by the PPA 

and those operating pursuant to this 

proposed class exemption) deliver 


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64The Department notes that costs probably often 

will not be distributed across advised participants 

in proportion to the size of their accounts. Rather, 

it is likely that some costs of providing advice are 

fixed relative to account size, so the cost borne by 

small account holders probably will be larger in 

relation to account size than that borne by large 

account holders. The average estimates reported in 

table 4 are dollar weighted. For the average 

participant, the basis point cost will be higher than 

this dollar weighted average, and the amount by 

which investment errors are reduced per dollar of 

advice will be lower. 

advice of similar quality and 

effectiveness. 

Benefits 

The Department expects the PPA and 

this proposed class exemption to reduce 

investment errors to the benefit of 

participants. As noted above, prior to 

implementation of the PPA, investment 

mistakes cost participants $109 billion 

or more annually. Increased use of 

investment advice under the PPA will 

reduce such mistakes by $7 billion, and 

this proposed class exemption will 

reduce them by another $7 billion, the 

Department estimates. Altogether after 

implementation of this proposed class 

exemption, use of investment advice by 

DC plan and IRA participants will 

eliminate $29 billion worth of 

investment errors annually. The 

Department’s estimates of investment 

errors and reductions from investment 

advice are summarized in table 4. 

4—INVESTMENT ERRORS AND IMPACT OF ADVICE ($BILLIONS, ANNUAL) 

Policy context Remaining 

errors 

Errors eliminated by advice 

Incremental Cumulative 

No advice ..................................................................................................................................... $124 $0 $0 

Pre-PPA advice only .................................................................................................................... 109 15 15 

PPA .............................................................................................................................................. 102 7 22 

Class exemption .......................................................................................................................... 95 7 29 

Costs 

Participant gains from investment 

advice must be weighed against the cost 

of that advice. Different types of advice 

may come with different costs. For 

example, advice generated by an 

automated computer program may be 

less costly than advice provided by a 

personal adviser. For purposes of this 

analysis the Department assumed that in 

the context of a DC plan, computer 

generated advice costs 10 basis points 

annually, while adviser provided advice 

costs 20 basis points. In connection with 

an IRA the corresponding assumptions 

are 15 and 30 basis points. These 

assumptions are reasonable in light of 

information available to the Department 

about the cost of various existing advice 

arrangements. On this basis the 

Department estimates the cost of advice 

as summarized in table 5.64

5—COST OF ADVICE

Pre-PPA PPA Class 

exemption 

Incremental: 

Advice cost ($billions) ..................................................................................................... $3 .8 $1 .8 $2 .3 

Advice cost rate (bps, average) ..................................................................................... 23 23 29 

Error reduced per $1 of advice, average ....................................................................... $3 .90 $3 .80 $3 .10 

Cumulative (combined with policies to the left): 

Advice cost ($billions) ..................................................................................................... $3 .8 $5 .6 $7 .9 

Advice cost rate (bps, average) ..................................................................................... 23 23 24 

Error reduced per $1 of advice, average ....................................................................... $3 .90 $3 .90 $3 .70 

Alternatives 

In formulating this proposed 

regulation and proposed class 

exemption, the Department considered 

several alternative approaches. 

Specific Substantive Standards for 

Model Certification 

This proposed regulation provides 

mostly procedural standards for the 

certification of computer models 

pursuant to PPA’s statutory exemptive 

relief. In crafting these provisions the 

Department carefully considered 

whether to establish specific substantive 

standards as well. 

Computer models are evolving, driven 

by advances in information technology 

and financial theories, and by market 

competition. A recipe for testing the 

robustness of one current technology 

might not be effective when applied to 

a future technology. Ongoing 

refinements and revisions to financial 

theories, the product of healthy 

competition among ideas, would soon 

belie any specification of generally 

accepted theory that might be enshrined 

in regulation. The Department therefore 

believes that a substantive standard 

generally would not serve to protect 

participants but instead might diminish 

the benefits of the PPA’s relief for 

arrangements using models. However, 

the Department invites comments on the 

advantages and disadvantages of a more 

substantive standard than what is 

proposed, and asks for suggestions for 

what a more substantive standard might 

include. 

Deferring Action on Class Exemption 

The Department considered deferring 

proposing a class exemption for a year 

or more in order to observe the market 

impact of the exemptive relief provided 

by the PPA. This might have provided 

fuller information on the degree to 

which some market segments would 

remain underserved by advice and on 

the barriers responsible for such 

ongoing under service, and thereby 

assisted the Department’s effort to 

determine whether and how to provide 

additional exemptive relief. 

However, the Department is 

concerned that deferring action might 

delay the proliferation of advice and 

prolong correctable investment errors 

and believes that the need for additional 

exemptive relief is already adequately 


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49912 Federal Register / Vol. 73, No. 164 / Friday, August 22, 2008 / Proposed Rules 

65See, e.g., Victoria Leonard-Chambers & Michael 

Bogdan, Why Do Mutual Fund Investors Use 

Professional Financial Advisers?, Investment 

Company Institute Research Fundamentals, Volume 

16, Number 1 (April 2007); and Employee Benefit 

Research Institute, 2007 Retirement Confidence 

Survey, Wave XVII, Posted Questionnaire (Jan. 

2007). 

66See paragraph (f). 

67The alternative condition is at paragraph (e). 

Paragraph (d) provides that the two are alternatives. 

68See paragraph (e)(1). 

69See paragraph (e)(2). 70The incidence and magnitude of investment 

errors is uncertain. Because errors are generally 

measured with reference to some optimal 

benchmark, the evolving character of investment 

theory contributes to this uncertainty. For a given 

level of incidence and effectiveness of advice, the 

reduction in errors will be proportionate to the 

errors reduced. The Department did not attempt to 

estimate the magnitude of losses from inappropriate 

risk or excess taxes, so its estimate of this proposed 

class exemption’s impact omit potential reductions 

in such errors. As noted above, the Department’s 

estimate of higher than necessary expenses is 

conservative in light of referenced literature and 

omits certain less visible expenses such as mutual 

funds’ internal transaction costs. Its estimates of 

losses from poor trading strategies and inadequate 

diversification are moderate, if not conservative, 

taking account of the losses that were measured in 

the referenced studies. The Department believes 

that the combined magnitude of investment errors, 

and therefore of the reduction in such errors that 

can be expected from wider use of advice, is at least 

as large as reported here, and possibly much larger. 

clear. The exemptive relief provided by 

the PPA does not embrace business 

models that occupy large parts of the 

non-IRA retail market,65 and therefore 

may leave major segments of the DC 

plan and IRA markets underserved. In 

addition, by excluding popular business 

models, the PPA’s exemptive relief by 

itself would tilt the playing field in 

favor of other business models, which 

may sometimes be more expensive or 

less beneficial. This raises the 

possibility that some segments of the 

market would be inefficiently served. 

This proposed class exemption will 

level the playing field for competing 

business models and thereby promote 

efficiency in the market for investment 

advice. 

Level Fee Condition 

The PPA provides conditional 

exemptive relief for advice 

arrangements wherein the revenue of a 

fiduciary adviser’s affiliates varies on 

the basis of advised participants’

investment decisions, but not to 

arrangements wherein the revenue of 

the fiduciary adviser itself so varies. 

This proposed class exemption extends 

conditional relief to the latter. 

The Department considered including 

as a mandatory condition of this 

proposed class exemption a requirement 

that the compensation received by the 

person providing the advice on behalf of 

the fiduciary adviser does not vary on 

the basis of participants’ investment 

decisions. Such a condition might ease 

enforcement of the exemption’s 

conditions, and might reduce the risks 

attendant to conflicts of interest that 

may exist among advisers doing 

business pursuant to the proposed class 

exemption. But it also would exclude 

from exemptive relief popular business 

models that are well established in the 

non-IRA retail market and that operate 

without similar compensation 

requirements, and therefore might 

unduly impair the availability of advice. 

Therefore Department elected to make 

this ‘‘level fee’’ condition 66 one of two 

alternative conditions,67 thereby 

allowing the person’s compensation to 

vary as long as the other condition is 

met. The other condition provides 

alternative protections against the risks 

attendant to conflicts of interest. 

Model Generated Advice for IRA 

Beneficiaries 

The Department considered including 

as part of the immediately 

aforementioned alternative condition a 

requirement that IRA beneficiaries 

always be provided with specific, model 

generated investment recommendations, 

similar to those which under the 

condition must be provided to DC plan 

participants.68 However the Department 

believes that such a requirement 

sometimes might be neither practical 

nor effective as applied to IRAs. It might 

not be practical because, while such 

models exist, their availability, 

affordability and effectiveness are not 

yet proven in all segments of the IRA 

market. It might not be effective because 

the wide range of investment options 

open to most IRA beneficiaries could 

make comparisons of model generated 

advice with the advisers’

recommendations difficult for 

beneficiaries. Therefore the conditions 

of this proposed class exemption allow 

that IRA beneficiaries may under certain 

circumstances be provided with 

educational material or 

recommendations on asset allocation 

across asset classes rather than with 

specific, model generated investment 

recommendations.69

Uncertainty 

The Department is highly confident in 

its conclusion that investment errors are 

common and often large, producing 

large avoidable losses (including 

foregone earnings) for participants. It is 

also confident that participants can 

reduce errors substantially by obtaining 

and following good advice. While the 

precise magnitude of the errors and 

potential reductions therein are 

uncertain,70 there is ample evidence 

that that magnitude is large. 

The Department is also confident that 

this proposed class exemption, by 

relaxing rules governing arrangements 

under which advice can be delivered, 

will promote wider use of advice. 

However, the Department is uncertain to 

what extent advice will reach 

participants and to what extent advice 

that does reach them will reduce errors. 

To illustrate that uncertainty, the 

Department conducted sensitivity tests 

of how its estimates of the reduction in 

investment errors attributable to the 

PPA and this proposed class exemption 

would change in response to alternative 

assumptions regarding the availability, 

use, and quality of advice. Table 6 

summarizes the results of these tests. 

6—UNCERTAINTY IN ESTIMATE OF INVESTMENT ERROR REDUCTION

Primary estimates 

denoted * Impact of PPA 

Impact of 

class 

exemption 

Impact of all 

advice 

Remaining 

errors 

Advice eliminates: 

50% of errors * .......................................................................................... $7 $7 $29 $95 

75% of errors ............................................................................................ 11 11 47 86 

25% of errors ............................................................................................ 3 3 14 102 

After PPA/class exemption, advice reaches: 

13%/16% of DC and 50%/67% of IRA * ................................................... 7 7 29 95 

15%/21% of DC and 60%/80% of IRA ..................................................... 11 9 35 89 

11%/13% of DC and 40%/50% of IRA ..................................................... 3 4 22 102 


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Federal Register / Vol. 73, No. 164 / Friday, August 22, 2008 / Proposed Rules 49913 

71EBSA requests comments on the 

appropriateness of the size standard used in 

evaluating the impact of these proposed rules on 

small entities. EBSA has consulted with the SBA 

Office of Advocacy concerning use of this 

participant count standard for RFA purposes. See 

13 CFR 121.903(c). 

The Department is uncertain whether 

the magnitude and incidence of 

investment errors and the potential for 

correction of such errors in the context 

of IRAs might differ from that in the 

context of ERISA-covered DC plans. If a 

DC plan’s menu of investment options 

is efficient then the incidence and/or 

magnitude of errors might be smaller 

than in the IRA context. If it is 

inefficient then errors might be more 

numerous and/or larger, but the 

potential for correcting them might be 

constrained. As noted earlier, evidence 

on the efficiency of existing menus is 

mixed. 

The Department is uncertain about 

the mix of advice and other support 

arrangements that will compose the 

market, and about the relative 

effectiveness of alternative investment 

advice arrangements or other means of 

supporting participants’ investment 

decisions. For example, to what extent 

will arrangements pursuant to this 

proposed class exemption displace 

alternative arrangements? Will advice 

arrangements operating pursuant to this 

proposed class exemption be more, less, 

or equally effective as alternative 

arrangements? 

This analysis has assumed that all 

types of advice arrangements are equally 

effective at reducing investment errors, 

and that none will increase errors (there 

will be no very bad advice). This 

assumption may not hold, however, for 

a number of reasons. For example, as 

illustrated above in table 1, advisers 

operating pursuant to different 

exemptive relief may be subject to 

different levels of conflicts of interest. 

Individuals providing advice pursuant 

to this proposed class exemption may 

face particularly direct conflicts, in the 

form of opportunities to tailor advice to 

directly profit themselves at 

participants’ expense. The Department’s 

consideration of this risk was detailed 

above. 

The conditions attached to exemptive 

relief under the PPA and this proposed 

class exemption are intended to control 

this risk while keeping advice 

affordable. The Department notes that if 

users of advice are fully informed and 

rational then more cost effective 

arrangements will dominate the market. 

This proposed class exemption 

establishes conditions to ensure that 

prospective users of advice available 

pursuant to it will have the opportunity 

to become fully informed. 

The Department is uncertain about 

the potential magnitude of any 

transitional costs associated with this 

proposed regulation and proposed class 

exemption. These might include costs 

associated with efforts of prospective 

fiduciary advisers to adapt their 

business practices to the applicable 

conditions. They might also include 

transaction costs associated with initial 

implementation of investment 

recommendations by newly advised 

participants. 

Another source of uncertainty 

involves potential indirect downstream 

effects of this proposed regulation and 

proposed class exemption. Investment 

advice may sometimes come packaged 

with broader financial advice, which 

may include advice on how much to 

contribute to a DC plan. The Department 

has no basis to estimate the incidence of 

such broad advice or its effects, but 

notes that those effects could be large. 

The opening of large new markets to a 

variety of investment advice 

arrangements to which they were 

heretofore closed may affect the 

evolution of investment advice products 

and services and related technologies 

and their distribution channels and 

respective market shares. Other possible 

indirect effects that the Department 

lacks bases to estimate include financial 

market impacts of changes in investor 

behavior and related macroeconomic 

effects. 

The Department invites comments on 

how to improve this analysis, with 

particular attention to the assessment 

and explanation of attendant 

uncertainty, and how such analysis 

could be carried out. Comments that 

include specific suggestions or data to 

help support our analysis of impacts 

and the characterization of uncertainty 

would be especially useful. 

Executive Order 12866 

Under Executive Order 12866, the 

Department must determine whether a 

regulatory action is significant and 

therefore subject to the requirements of 

the Executive Order and review by the 

Office of Management and Budget 

(OMB). This action, comprising this 

proposed regulation and proposed class 

exemption, is economically significant 

under section 3(f)(1) of the Executive 

Order because it is likely to have an 

effect on the economy of $100 million 

or more in any one year. Accordingly, 

the Department undertook the foregoing 

analysis of the actions’ impact. On that 

basis the Department believes that the 

actions’ benefits justify their costs. 

Regulatory Flexibility Act 

The Regulatory Flexibility Act (5 

U.S.C. 601 et seq.) (RFA) imposes 

certain requirements with respect to 

Federal rules that are subject to the 

notice and comment requirements of 

section 553(b) of the Administrative 

Procedure Act (5 U.S.C. 551 et seq.) and 

are likely to have a significant economic 

impact on a substantial number of small 

entities. For purposes of analysis under 

the RFA, the Department proposes to 

continue its usual practice of 

considering a small entity to be an 

employee benefit plan with fewer than 

100 participants.71 The Department 

estimates that approximately 100,000 

small plans, a significant number, will 

voluntarily begin offering investment 

advice to participants as a result of this 

proposed regulation and proposed class 

exemption. 

The primary effect of this proposed 

regulation and proposed class 

exemption will be to reduce 

participants’ investment errors. This is 

an effect on participants rather than on 

plans. The impact on plans generally 

will be limited to increasing the means 

by which they may make advice 

available to participants, and this 

impact will be similar and proportionate 

for small and large plans. Therefore the 

Department certifies that the impact on 

small entities will not be significant. 

Pursuant to this certification the 

Department has refrained from 

preparing an Initial Regulatory 

Flexibility Analysis of this proposed 

regulation and proposed class 

exemption. The Department invites the 

public to comment on its definition of 

small entities and its certification. 

Notwithstanding this certification, the 

Department did separately consider the 

impact of this proposed regulation and 

proposed class exemption on 

participants in small plans. 

As noted earlier, prior to 

implementation of the PPA smaller plan 

sponsors offered advice generally, and 

in-person advice in particular, more 

frequently than larger plan sponsors. 

The Department believes that exemptive 

relief provided by both the PPA and this 

proposed class exemption will promote 

wider offering of advice by small and 

large plans sponsors alike. Accordingly 

the Department estimated the impacts 

on small plans assuming that they 

generally will be proportionate to those 

on large plans. However, because 

smaller plan sponsors are more likely to 

offer in-person advice, their average cost 

for advice and the proportion of 

participants using advice may both be 

higher. The Department estimates that 

the PPA and this proposed class 

exemption will reduce small DC plan 

participant investment errors 


rwilkins on PROD1PC63 with PROPOSALS4
49914 Federal Register / Vol. 73, No. 164 / Friday, August 22, 2008 / Proposed Rules 

respectively by $105 million or more 

and $126 million or more, at respective 

costs of $22 million and $28 million. 

The estimated impacts on small plans 

and their participants are summarized 

on table 7. 

7—SMALL DC PLAN PARTICIPANT IMPACTS

Pre-PPA PPA Class 

exemption 

Dollars advised ($ billions) .................................................................................................... $47 $59 $73 

Investment errors ($ billions) ................................................................................................. $8 .0 $7 .9 $7 .8 

Incremental: 

Errors reduced by advice ($ millions) ............................................................................ $421 $105 $126

Advice cost ($ millions) .................................................................................................. $86 $22 $28 

Advice cost rate (bps, average) ..................................................................................... 18 18 20 

Error reduced per $1 of advice, average ....................................................................... $4 .88 $4 .88 $4 .46 

Cumulative (combined with policies to the left): 

Errors reduced by advice ($ millions) ............................................................................ $421 $526 $652

Advice cost ($ millions) .................................................................................................. $86 $108 $136 

Advice cost rate (bps, average) ..................................................................................... 18 18 19 

Error reduced per $1 of advice, average ....................................................................... $4 .88 $4 .88 $4 .79 

Congressional Review Act 

This notice of proposed rulemaking is 

subject to the Congressional Review Act 

provisions of the Small Business 

Regulatory Enforcement Fairness Act of 

1996 (5 U.S.C. 801 et seq.) and, if 

finalized, will be transmitted to the 

Congress and the Comptroller General 

for review. 

Unfunded Mandates Reform Act 

For purposes of the Unfunded 

Mandates Reform Act of 1995 (Pub. L. 

104–4), as well as Executive Order 

12875, the notice of proposed 

rulemaking does not include any federal 

mandate that will result in expenditures 

by state, local, or tribal governments in 

the aggregate of more than $100 million, 

adjusted for inflation, or increase 

expenditures by the private sector of 

more than $100 million, adjusted for 

inflation. 

Federalism Statement 

Executive Order 13132 (August 4, 

1999) outlines fundamental principles 

of federalism and requires the 

adherence to specific criteria by federal 

agencies in the process of their 

formulation and implementation of 

policies that have substantial direct 

effects on the States, the relationship 

between the national government and 

the States, or on the distribution of 

power and responsibilities among the 

various levels of government. This 

proposed rule does not have federalism 

implications because it has no 

substantial direct effect on the States, on 

the relationship between the national 

government and the States, or on the 

distribution of power and 

responsibilities among the various 

levels of government. Section 514 of 

ERISA provides, with certain exceptions 

specifically enumerated, that the 

provisions of Titles I and IV of ERISA 

supersede any and all laws of the States 

as they relate to any employee benefit 

plan covered under ERISA. The 

requirements implemented in this 

proposed rule do not alter the 

fundamental provisions of the statute 

with respect to employee benefit plans, 

and as such would have no implications 

for the States or the relationship or 

distribution of power between the 

national government and the States. 

Paperwork Reduction Act 

As part of its continuing effort to 

reduce paperwork and respondent 

burden, the Department of Labor 

conducts a preclearance consultation 

program to provide the general public 

and Federal agencies with an 

opportunity to comment on proposed 

and continuing collections of 

information in accordance with the 

Paperwork Reduction Act of 1995 (PRA) 

(44 U.S.C. 3506(c)(2)(A)). This helps to 

ensure that the public understands the 

Department’s collection instructions; 

respondents can provide the requested 

data in the desired format, reporting 

burden (time and financial resources) is 

minimized, collection instruments are 

clearly understood, and the Department 

can properly assess the impact of 

collection requirements on respondents. 

Currently, EBSA is soliciting 

comments concerning the proposed 

information collection request (ICR) 

included in the Proposed Class 

Exemption for the Provision of 

Investment Advice to Participants and 

Beneficiaries of Self-Directed Individual 

Account Plans and IRAs and in the 

Proposed Investment Advice Regulation 

(Proposed Investment Advice Initiative). 

A copy of the ICR may be obtained by 

contacting the PRA addressee shown 

below or at http://www.RegInfo.gov. 

PRA Addressee: Gerald B. Lindrew, 

Office of Policy and Research, U.S. 

Department of Labor, Employee Benefits 

Security Administration, 200 

Constitution Avenue, NW., Room N–

5718, Washington, DC 20210. 

Telephone: (202) 693–8410; Fax: (202) 

219–5333. These are not toll-free 

numbers. 

The Department has submitted a copy 

of the Proposed Investment Advice 

Initiative to the Office of Management 

and Budget (OMB) in accordance with 

44 U.S.C. 3507(d) for review of its 

information collections. The 

Department and OMB are particularly 

interested in comments that: 

• Evaluate whether the collection of 

information is necessary for the proper 

performance of the functions of the 

agency, including whether the 

information will have practical utility; 

• Evaluate the accuracy of the 

agency’s estimate of the burden of the 

collection of information, including the 

validity of the methodology and 

assumptions used; 

• Enhance the quality, utility, and 

clarity of the information to be 

collected; and 

• Minimize the burden of the 

collection of information on those who 

are to respond, including through the 

use of appropriate automated, 

electronic, mechanical, or other 

technological collection techniques or 

other forms of information technology, 

e.g., permitting electronic submission of 

responses. 

Comments should be sent to the 

Office of Information and Regulatory 

Affairs, Office of Management and 

Budget, Room 10235, New Executive 

Office Building, Washington, DC 20503; 

Attention: Desk Officer for the 

Employee Benefits Security 

Administration. OMB requests that 

comments be received within 30 days of 

publication of the Proposed Investment 

Advice Initiative to ensure their 


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Federal Register / Vol. 73, No. 164 / Friday, August 22, 2008 / Proposed Rules 49915 

72The Department assumes that all advisory firms 

use both the statutory exemption and the class 

exemption. 

73All costs associated with model certification 

are assigned to the statutory exemption. 

74All costs associated with composing written 

policies and procedures are assigned to the class 

exemption. 

75This estimate is derived from Current 

Population Survey October 2003 School 

Supplement probit equations applied to the 

February 2005 Contingent Worker Supplement. 

These equations show that approximately 81 

percent of workers aged 19 to 65 had internet access 

either at home or at work in 2005. The Department 

further assumes that one percent of these 

participants will elect to receive paper documents 

instead of electronic, thus 20 percent of participants 

receive disclosures through paper media. 

76The Department assumes that plans will deliver 

disclosures electronically in compliance with the 

Department’s rules relating to the use of electronic 

media (29 CFR 2520.104b–1(c)). The Department 

has not estimated any additional burden for plans 

to receive affirmative consents from participants to 

receive required disclosures electronically. The 

Department welcomes comments on this 

assumption. 

77Hourly wage estimates are based on data from 

the Bureau of Labor Statistics Occupational 

Employment Survey (May 2005) and the Bureau of 

Labor Statistics Employment Cost Index (Sept. 

2006). All hourly wage rates include wages and 

benefits. Clerical wage and benefits estimates are 

based on metropolitan wage rates for executive 

secretaries and administrative assistants. Financial 

manager wage and benefits estimates are based on 

metropolitan wage estimates for financial managers. 

Legal professional wage and benefits estimates are 

based on metropolitan wage rates for lawyers. 

Computer programmer wage and benefits estimates 

are based on metropolitan wage rates for 

professional computer programmers. 

78Unless otherwise noted, numbers are rounded 

to the nearest 1,000. 

79This estimate is derived from Angela A. Hung 

et al., Investor and Industry Perspectives on 

Investment Advisers and Broker-Dealers, RAND 

Corporation Technical Report (2008), at http:// 

www.sec.gov/news/press/2008/2008- 

1_randiabdreport.pdf. 

80To be conservative, the Department assumes 

that all 16,000 advisory firms give advice pursuant 

to both the statutory and class exemptions as they 

all will have some clients who request only level 

fee or computer model advice under the statutory 

exemption and other clients who request off-model 

advice under the class exemption. The Department 

estimates that there are approximately 209,000 DC 

plans that are currently offering advice (prestatutory exemption advice), that after the statutory 

exemption is published approximately 261,000 DC 

plans will offer advice and that after the class 

exemption is published approximately 314,000 DC 

plans will offer advice. The Department cannot 

determine which of these plans will be offering 

advice under pre-statutory exemption, statutory 

exemption or class exemption conditions; thus the 

Department decided to apply costs to the statutory 

and class exemptions based on the incremental 

change in the number of DC plans offering advice. 

This method is also applied to the number of IRA 

beneficiaries receiving advice; the Department 

estimates that approximately 16.8 million IRA 

beneficiaries received advice under pre-statutory 

exemption conditions, approximately 25.5 million 

will receive advice under statutory exemption 

conditions and approximately 34.0 will receive 

advice under class exemption conditions. The 

Department welcomes comments on this 

assumption. 

consideration. Please note that 

comments submitted to OMB are a 

matter of public record. 

The Department notes that a federal 

agency cannot conduct or sponsor a 

collection of information unless it is 

approved by OMB under the PRA, and 

displays a currently valid OMB control 

number, and the public is not required 

to respond to a collection of information 

unless it displays a currently valid OMB 

control number. Also, notwithstanding 

any other provisions of law, no person 

shall be subject to penalty for failing to 

comply with a collection of information 

if the collection of information does not 

display a currently valid OMB control 

number. EBSA will publish a notice of 

OMB’s action at the final rule stage. 

In order to use the statutory 

exemption and/or the class exemption 72

to provide investment advice to 

participants and beneficiaries in 

participant-directed defined 

contribution (DC) plans and 

beneficiaries of individual retirement 

accounts (IRAs) (collectively hereafter, 

‘‘participants’’), investment advisory 

firms would be required to make 

disclosures to participants and hire an 

independent auditor every year. 

Investment advice firms following the 

conditions of the exemption based on 

disclosure of computer model-generated 

investments would be required to obtain 

certification of the model from an 

eligible investment expert.73 The class 

exemption conditions relief on 

establishing written policies and 

procedures and both exemptions impose 

recordkeeping requirements.74 These 

paperwork requirements are designed to 

safeguard the interests of participants in 

connection with investment advice 

covered by the exemptions. 

The Department has made several 

specific basic assumptions in order to 

establish a reasonable estimate of the 

paperwork burden of this information 

collection: 

• The Department assumes that 80% 

of disclosures 75 will be distributed 

electronically via means already in 

existence as a usual and customary 

business practice and the costs arising 

from electronic distribution will be 

negligible.76

• The Department assumes that 

investment advisory firms will use 

existing in-house resources to prepare 

the policies and procedures and most 

disclosures and to maintain the 

recordkeeping systems. This assumption 

does not apply to the computer model 

certification, the audit or the computer 

program used to generate disclosures for 

IRA participants. 

• The Department assumes a 

combination of personnel will perform 

the information collections with an 

hourly wage rate for 2008 of $79 for a 

financial manager, $21 for clerical 

personnel, $109 for a legal professional, 

and $67 for a computer programmer.77

The Statutory Exemption 

The Department assumes that 

approximately 16,000 investment 

advisory firms 78 (including brokerdealers) will take advantage of this 

statutory exemption to provide advice to 

participants.79 The number of 

investment advisory firms using this 

statutory exemptive relief is assumed to 

be constant over time. The Department 

estimates that under the statutory 

exemption approximately 52,000 DC 

plans will seek to provide advice to 

their participants and beneficiaries. 

These DC plans represent approximately 

6,611,000 participants and beneficiaries, 

of which approximately 1,487,000 will 

seek advice from the investment 

advisory firm servicing their employersponsored retirement investment plan. 

IRAs can also make use of this statutory 

exemption, and the Department 

estimates that approximately 8.7 million 

IRA beneficiaries will seek advice under 

this statutory exemption.80

Disclosures to Participants 

In general, under section 2550.408(g)–

1(g) of the proposal, a fiduciary adviser 

is required to furnish detailed 

information to a participant about an 

advice arrangement before initially 

providing investment advice, annually, 

upon participant request and if there is 

any material change to the information. 

The information includes the following: 

The relationship between the adviser 

and the parties that developed the 

investment advice program or selected 

the investment options available under 

the DC plan or IRA; to the extent such 

information is not otherwise provided, 

the past performance and historical 

rates of return of investments available 

under the DC plan or IRA; all fees and 

other compensation the fiduciary 

adviser or any affiliate is to receive in 

connection with the provision of 

investment advice or in connection with 

the investment; the fiduciary adviser’s 

material relationship, if any, to any 

investment under the arrangement; the 

types of services the fiduciary adviser 

provides in connection with the 

provision of investment advice; the 

manner in which participant 

information may be used or disclosed; 

an acknowledgement that the fiduciary 

adviser is acting as a fiduciary of the DC 

Plan or IRA in connection with 

providing the investment advice; and 

notice that the recipient of the advice 

may separately arrange for advice from 


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49916 Federal Register / Vol. 73, No. 164 / Friday, August 22, 2008 / Proposed Rules 

81The following disclosures are assumed to be 

constant for all participants advised: The material 

affiliation or material contractual relationships, use 

of participant information, type of services 

provided by the fiduciary adviser, acknowledgment 

that the adviser is acting as a fiduciary of the DC 

plan or IRA, and a statement that the participant 

can arrange for advice from an adviser who does not 

receive fees in connection with the investment or 

has no material affiliation with the investments 

recommended. The following disclosures are 

assumed to be constant for each participant of an 

individual DC plan: The fees and compensation the 

adviser receives in connection with the suggested 

investments and the material affiliation to the 

suggested investments. As discussed below these 

last two disclosures are also the only disclosures 

that are specific to the IRA beneficiary, and as such 

will require the adviser to generate individual 

disclosures for each IRA beneficiary advised using 

the computer model generated by the service 

providers. 

82The Department assumes that investment 

advisory firms will distribute the same disclosures 

throughout the year and that they only update their 

disclosure content for the annual disclosures. The 

Department further assumes that few disclosures 

are requested each year (one per firm on average) 

and most requested disclosures are distributed 

either electronically at a negligible cost or in person 

at small costs. The Department welcomes comments 

on these assumptions. 

83The Department has based this cost estimate on 

limited industry data. 

84Eighty percent of disclosures are assumed to be 

distributed electronically. In addition, the 

Department assumes that one half of all paper 

disclosures are delivered in person and one half are 

delivered through the mail. 

85The USPS increased the cost of First Class 

Postage to $0.42 as of May 2008. 

86Based on limited information with respect to 

the investment computer model industry, the 

Department estimates that there are six companies 

that produce investment advice computer models. 

another adviser that could have no 

relationship to, and receive no fees in 

connection with, the investments. If 

applicable, the fiduciary adviser also 

furnishes in writing to the DC plan 

fiduciary an election, as permitted 

under the regulation, to be treated as the 

sole fiduciary providing investment 

advice through a computer model to an 

ERISA-covered DC plan participant. The 

Department assumes that investment 

advisory firms will compile all of these 

notices into a single four-page 

disclosure package for each participant 

given advice. As these disclosures are to 

be given to the participants and are 

based upon the investments that are 

recommended, the Department further 

assumes that these disclosures will be 

generated at three levels: The 

investment advisory firm level, the DC 

plan level and the IRA beneficiary level. 

The firms will generate a template for 

each of these disclosures levels.81

Preparation of Statutory Exemption 

Disclosure Package 

For the first year (initial) disclosures, 

the Department assumes that it takes a 

legal professional approximately six 

hours per investment advisory firm to 

prepare disclosures that are common to 

all of their participants, about 100 hours 

per investment advisory firm to assist an 

out-sourced computer programmer in 

creating computer software that will 

generate disclosure notices for IRA 

beneficiaries, and approximately two 

and one-half hours per DC plan to 

prepare disclosures that are common to 

all DC plan participants and 

beneficiaries in the same DC plan. These 

hours add up to an hour burden of 

approximately 1,779,000 hours; at a 

wage rate of $109 for a legal professional 

the equivalent cost is approximately 

$194,792,000. 

For the annual updating of 

disclosures required by Section 

2550.408g–1(g)(4)(ii), the Department 

assumes that the preparation time 

needed for updating the notices that are 

the same for all participants will be 

about three hours for each of the 16,000 

investment advisory firms.82 The 

Department assumes that updating 

notices that are the same for all DC plan 

participants and beneficiaries is 

estimated to take on average one hour 

and a half for each of over 52,000 DC 

plans. The preparation time needed for 

individualized notices for IRAs is 

estimated to average 50 hours for each 

of 16,000 investment advisory firms. 

Thus the annual hour burden for 

preparation is estimated to be 

approximately 903,000 hours with an 

equivalent cost of approximately 

$98,829,000. 

The Department assumes that all 

firms will outsource the creation of a 

computer program to enable them to 

prepare disclosures for IRA participants. 

This computer model will be used to 

generate disclosures to participants 

under both the statutory exemption and 

the class exemption. The Department 

estimates that a computer programmer 

will charge on average $1,200 per firm 

in the first year and $600 each 

subsequent year.83 Thus the cost 

burden, given there are almost 16,000 

investment advisory firms, will be 

approximately $18,662,000 in the first 

year and approximately $9,331,000 in 

all subsequent years. 

Distribution of Statutory Exemption 

Disclosure Package 

The Department assumes that a 

clerical professional will be required to 

spend one minute per page (four 

minutes per disclosure package) to 

photocopy the 20 percent of disclosure 

packages that are delivered in paper and 

one minute per disclosure package to 

prepare the ten percent of disclosures 

that are mailed each year.84 These hours 

add up to an hour burden of 

approximately 864,000 hours; at a wage 

rate of approximately $21 for a clerical 

professional the equivalent cost is 

approximately $3,225,000. 

The Department assumes that the 

paper and photocopy costs are five cents 

per page; thus, given that there are 

approximately 2,030,000 participants 

receiving paper disclosures, the 

associated cost burden for paper and 

photocopying under the statutory 

exemption is estimated to be $406,000 

annually. Under the basic United States 

Postal Service postage at a cost of 

$0.42 85 per disclosure package for 

approximately 1,015,000 participants 

receiving mailed disclosures, the 

postage costs are estimated at about 

$426,000 annually. Thus the cost 

burden associated with distributing 

disclosures to participants is $832,000 

per year. 

Independent Certification 

If the fiduciary adviser provides the 

investment advice through use of a 

computer model, then before providing 

the advice, Section 2550.408g–1(d)(2) of 

the proposed regulation would require 

the fiduciary adviser to obtain the 

certification of an eligible investment 

expert as to the computer model’s 

compliance with certain standards (e.g., 

applies generally accepted investment 

theories, unbiased operation, objective 

criteria) set forth in the regulation. The 

Department assumes that there are six 

companies that will provide the 

investment advice computer model 86

and that legal professionals working at 

these six companies supply in-house 

support by providing documentation 

and other information to the eligible 

investment expert who certifies the 

company’s investment advice computer 

model. These legal professionals are 

assumed to spend about 40 hours for 

each of the six investment advice 

computer model providers and on 

average 40 hours for each of the almost 

16,000 investment advisory firms to 

whom the computer model providers 

supply their models. Thus, the 

investment advice computer model 

providers have an hour burden of 

approximately 622,000 hours for an 

equivalent cost of about $68,125,000. 

The Department assumes that the 

investment advisory firm will need inhouse legal professionals to provide 

documentation and other information to 

the eligible investment expert who 

certifies the investment advisory firm’s 

investment advice computer model. 

These legal professionals will spend on 

average ten hours for each of over 

52,000 DC plans and on average 50 


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87Audit firms are expected to transmit the final 

audit report to the advisory firm through electronic 

means at no additional costs. The advisory firms 

must either furnish a copy of the audit report to IRA 

beneficiaries or make the audit report available on 

their Web site and inform IRA beneficiaries of the 

purpose of the report and how and where to locate 

the report applicable to their account with the other 

disclosures discussed above. The Department 

assumes that all advisory firms will make the audit 

report available on their Web site and add a few 

sentences to the single disclosure package at 

negligible costs. Any advisory firm whose audit 

report identifies noncompliance with the 

requirements of the statutory or class exemption 

must send a copy of the report to the Department 

within 30 days following receipt of the report. The 

Department assumes that the majority of advisory 

firms will comply with the exemption; therefore, 

the costs associated with sending the audit reports 

to the Department are expected to be negligible. The 

Department welcomes comments on this 

assumption. 

88The Department has based this cost estimate on 

limited industry data. 

89See footnote 51 above for an explanation of the 

number of entities affected by the regulation. The 

Department assumes that these DC plans are 

offering, and DC participants and beneficiaries, and 

IRA beneficiaries are receiving advice under the 

class exemption but not the statutory exemption. 

hours for each of the almost 16,000 

investment advisory firms. Thus the 

hour burden in the first year for the 

certification of the investment advice 

computer model is approximately 

1,924,000 hours with an equivalent cost 

of about $210,571,000. 

The Department assumes that in 

subsequent years the hours required for 

any investment advice computer model 

recertification will be approximately 

half of the first certification and that 

investment advisory firms will have 

their investment advice computer model 

recertified on average once a year. Thus 

in the subsequent years the hour burden 

is approximately 962,000 hours with an 

equivalent cost of approximately 

$105,286,000. 

Recordkeeping Requirements 

Consistent with the statutory 

exemption, section 2550.408g–1(i) of the 

proposed regulation would require 

fiduciary advisers to maintain records 

with respect to the investment advice 

provided in reliance on the regulation 

necessary to determine whether the 

applicable requirements of the 

regulation have been satisfied. The 

Department assumes that all investment 

advisory firms maintain recordkeeping 

systems as part of their normal business 

practices. The Department assumes that 

all records that are required to be 

maintained will be kept electronically 

under normal business practices; 

therefore, no printing and negligible 

holding costs are anticipated to be 

associated with records maintenance. 

Audit Requirement 

Any fiduciary adviser relying on the 

exemption would be required to engage, 

at least annually, an independent 

auditor to conduct an audit of the 

investment advice arrangement for 

compliance with the conditions of the 

exemption pursuant to section 

2550.408g–1(f)(1) of the proposed 

regulation. All firms are assumed to 

outsource this service but use some 

internal clerical and legal professional 

time to assist the auditor. 87 The clerical 

staff is expected to spend about three 

hours per advisory firm and on average 

ten minutes per participant to gather 

documentation and other information. 

The in-house legal professional is 

expected to need approximately four 

hours per advisory firm to assist the 

auditor with the statutory exemption 

audit. The Department estimates that 

about one percent of participants will be 

audited per year, resulting in 

approximately 101,000 audits. Overall, 

the annual in-house hour burden for the 

annual audit requirement is estimated at 

126,000 hours, with equivalent costs of 

approximately $8,157,000. 

The Department assumes that the 

statutory exemption audits will be 

outsourced to an independent legal 

professional for each of the almost 

16,000 investment advisory firms and 

will cost on average $18,000.88 Thus the 

annual cost burden will be 

approximately $279,936,000. 

Summary of Statutory Exemption Hour 

and Cost Burden 

In summary, the third-party 

disclosures, computer model 

certification, and audit requirements for 

the statutory exemption require 

approximately 3,981,000 burden hours 

with an equivalent cost of 

approximately $416,745,000 and a cost 

burden of approximately $579,367,000 

in the first year. In each subsequent year 

the total labor burden hours are 

estimated to be approximately 2,143,000 

hours with an equivalent cost of 

approximately $215,497,000 and the 

cost burden is estimated at 

approximately $430,067,000 per year. 

The Class Exemption 

The Department assumes that all of 

the 16,000 investment advisory firms 

that take advantage of the statutory 

exemption will also provide advice that 

relies on the class exemption. As 

mentioned above, all investment 

advisory firms provide advice under 

both DC plans and IRAs, and the 

number of investment advisory firms 

using this class exemptive relief is 

assumed to be constant over time. The 

Department estimates that under the 

class exemption approximately 52,000 

DC retirement plans will seek to provide 

advice to their participants and 

beneficiaries. These plans represent 

approximately 6,611,000 participants 

and beneficiaries, of which 

approximately 2,016,000 will seek 

advice from the investment advisory 

firm employed on behalf of their 

employer sponsored retirement 

investment plan. IRAs can also make 

use of this class exemption, and the 

Department estimates that 

approximately 8.5 million IRA 

beneficiaries will seek advice under this 

class exemption.89

Disclosures to Participants 

In general, section III(g)(1) of the Class 

Exemption requires a fiduciary adviser 

to furnish detailed information to a 

participant about an advice arrangement 

before initially providing investment 

advice, annually, upon participant 

request, and if there is any material 

change to the information. The 

information to be provided is the same 

under the class exemption as the 

statutory exemption (see Section I(a) 

above for a listing of all required 

disclosures). Additional disclosures 

required before providing investment 

advice would depend on which 

alternative conditions the arrangement 

is designed to satisfy. If the investment 

advice arrangement is based on the 

disclosure of computer-generated 

investment selections, the fiduciary 

adviser is required to furnish those 

selections to the participant. If the 

fiduciary adviser determines computer 

modeling of the number and types of 

investment choices available to an IRA 

is reasonably precluded, the fiduciary 

adviser may instead furnish asset class 

allocation models to the participant. 

Alternatively, such disclosures may not 

be required if a fiduciary adviser 

satisfies the condition that would 

require that the compensation of the 

person providing advice on behalf of the 

fiduciary adviser may not vary based on 

the particular investments selected. The 

Department assumes that investment 

advisory firms will compile all notices 

into a single five-page disclosure 

package for each participant given 

advice under the class exemption and 

that these disclosures will be prepared 

at the investment advisory firm, DC 

plan, and IRA beneficiary levels. 

Preparation of Class Exemption 

Disclosure Package 

The Department assumes that 

disclosures that are common to all of the 

advisory firm’s client participants as 

well as the computer program used to 


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90The Department estimates that most of the 

investment advisory firms that take advantage of the 

class exemption will determine that computer 

modeling of the number and types of investment 

choices available to an IRA is not possible, and will 

instead furnish asset class allocation models to the 

beneficiaries. As such, the disclosure package for 

participants who receive advice pursuant to the 

class exemption is estimated as being five pages in 

length, instead of four. 

91Based on limited information on the type of 

advice given to participants, the Department 

estimates that ten percent of DC plan participants 

and 30 percent of IRA beneficiaries will receive offModel Advice. 

generate disclosures to IRA beneficiaries 

will have been prepared to conform to 

the requirements of the statutory 

exemption and will not impose any 

additional burden on respondents. 

For the first year disclosures, the 

Department assumes that the 16,000 

investment advisory firms might require 

a legal professional to work on average 

80 hours each to assist an out-sourced 

computer programmer in creating 

computer software that will generate 

individualized disclosure notices for 

IRA participants, and approximately 

two hours per DC plan to prepare 

disclosures that are common to all 

participants in the same DC plan. These 

hours add up to an hour burden of 

approximately 1,349,000 hours; at a 

wage rate of $109 for a legal professional 

the equivalent cost is approximately 

$147,662,000. 

For the annual updating of 

disclosures the Department assumes 

that the preparation time needed for 

updating the notices will be on average 

one hour per DC plan (for DC plan 

individualized disclosures) and on 

average 40 hours for each investment 

advisory firms (for IRA beneficiary 

individualized disclosures). Thus, the 

annual hour burden is estimated to be 

approximately 674,000 with an 

equivalent cost of approximately 

$73,831,000. 

Distribution of Class Exemption 

Disclosure Package 

The Department assumes that a 

clerical professional will spend five 

minutes 90 to photocopy each of the 

approximately 2,102,000 disclosure 

packages that are delivered in paper and 

one minute to prepare each of the 

1,051,000 disclosures that are mailed 

each year. These hours add up to an 

hour burden of approximately 193,000 

hours; at a wage rate of $21 for a clerical 

professional the equivalent cost is 

approximately $4,082,000. 

Using a paper and photocopy cost of 

five cents per page, the associated cost 

burden for paper and photocopying 

under the class exemption is estimated 

to be $525,000 annually. Under the 

basic USPS postage at a cost of $0.42 per 

disclosure package, the cost burden of 

the mailing disclosures under the class 

exemption will be approximately 

$441,000 annually. Thus the overall cost 

burden associated with distributing 

disclosures to participants is estimated 

at about $967,000 per year. 

Independent Certification 

The entire costs of the certification 

requirements are accounted for under 

the statutory exemption. 

Policies and Procedures 

Section III(i) of the Class Exemption 

requires investment advisory firms that 

wish to provide investment advice 

pursuant to the class exemption to 

develop written policies and procedures 

that insure the firm follows all of the 

class exemption requirements. The 

Department estimates that updating the 

written policies and procedures will 

generally require no additional costs. It 

is assumed that the preparation of these 

policies and procedures will require on 

average seven hours of legal 

professional time for each of the almost 

16,000 investment advisory firms. This 

leads to an hour burden in the first year 

of about 109,000 hours with an 

equivalent cost of approximately 

$11,917,000. 

Recordkeeping Requirements 

Section III(n) of the proposed class 

exemption requires fiduciary advisers to 

maintain records with respect to the 

investment advice provided in reliance 

on the exemption necessary to 

determine, explain or verify compliance 

with the conditions of the exemption, 

including those records necessary to 

determine that the disclosures described 

above have been made. In this 

connection, the fiduciary adviser would 

be required to maintain records 

necessary to determine, among other 

things, that an independent fiduciary 

has provided express authorization of 

the arrangement under which the 

investment advice is provided, that, if 

applicable, an eligible investment expert 

has provided the requisite certification, 

that the compensation to the fiduciary 

adviser and its affiliates in connection 

with the investments is reasonable, that 

the terms of the purchase sale or 

holding of the investment are at least as 

favorable to the plan or IRA as those in 

an arm’s length transactions would be, 

and in cases where the advice is not 

provided after disclosure of computer 

generated investments or an asset class 

allocation model, the fees or other 

compensation received by an employee, 

agent or registered representative 

providing investment advice on behalf 

of the fiduciary adviser does not vary 

depending on the option. The 

Department assumes that all investment 

advisory firms maintain recordkeeping 

systems to satisfy these information 

collections requirements. 

A fiduciary adviser may provide 

individualized investment advice to 

participants or beneficiaries (‘‘off-model 

advice’’) following the furnishing of 

investment advice generated by a 

computer model as described in section 

III(e)(1) of the Class Exemption, or in the 

case of beneficiaries of IRAs described 

in section III(e)(2), following the 

furnishing of investment education-type 

materials (graphs, pie charts, etc) that 

produce or reflect asset allocation 

models. However, section III(e)(4) of the 

Class Exemption requires that, with 

respect to any off-model advice that 

recommends investment options that 

may generate for the adviser or certain 

other parties greater income than other 

investments in the same asset class, the 

individual who provides investment 

advice on behalf of the fiduciary 

adviser, not later than 30 days after 

providing the advice, must document 

the basis for concluding that the 

recommendation is in the best interest 

of the participant or beneficiary. The 

Department assumes that such off 

-model advice will be provided in ten 

percent of the possible DC plan cases, 

and 30 percent of the possible IRA 

beneficiary cases. Thus, of the 

approximately 2,016,000 DC 

participants and approximately 8.5 

million IRA beneficiaries receiving 

advice under the class exemption, 

almost 202,000 DC plan participants 

and 2.5 million IRA beneficiaries will 

receive off-model advice.91

The Department further assumes that 

each participant receiving advice will 

receive this advice an average of four 

times per year (once a quarter), resulting 

in almost 10,996,000 reports. The 

Department assumes that each 

investment advisor who provides offmodel advice will need approximately 

15 minutes to write this report. 

Generating these reports is estimated to 

result in approximately 2,749,000 

annual burden hours for the financial 

manager with an associated equivalent 

cost of $217,125,000. 

Audit 

Any fiduciary adviser relying on the 

class exemption also would be required 

to engage, at least annually, an 

independent auditor to conduct an audit 

of the investment advice arrangement 

for compliance with the class exemption 

and written policies and procedures (as 

described below) designed to assure 


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92The Department has based this cost estimate on 

limited industry data. 

compliance with the conditions of the 

exemption. The fiduciary adviser would 

be required to issue a written report to 

each plan fiduciary who authorized the 

use of the investment advice 

arrangement, and to IRA beneficiaries, 

setting forth the auditor’s findings. With 

respect to IRA’s, the fiduciary adviser 

may instead make the report available 

on its Web site. Also with respect to an 

arrangement with an IRA, if the auditor 

finds noncompliance with the 

exemption, the fiduciary adviser must 

file the report with the Department of 

Labor. 

All firms are assumed to outsource 

this service but use some internal 

clerical and legal professional time to 

assist the auditor. As an audit is 

required under the statutory exemption, 

the fixed in-house hours are attributed 

to the statutory exemption and only the 

variable clerical hours are divided 

between the statutory and class 

exemption. Under the class exemption 

clerical staff is expected to spend on 

average ten minutes per audited 

participant to pull each audited 

participant’s files or to provide other 

documentation or information. The 

Department estimates that about 

105,000 participants will be audited 

annually. Overall, the annual in-house 

hour burden for the audit requirement is 

estimated at 18,000 hours with 

equivalent costs of approximately 

$371,000. 

The Department assumes that the 

class exemption audits will be 

outsourced to an independent legal 

professional for each of the almost 

16,000 investment advisory firms and 

will cost on average $4,000 per year for 

each investment advisory firm.92 Thus 

the annual cost burden will be 

approximately $62,208,000. 

Summary of Class Exemption Hour and 

Cost Burden 

In summary, the third-party 

disclosures, written policies and 

procedures, recordkeeping and audit 

requirements for the class exemption are 

estimated to require a total of 

approximately 4,417,000 burden hours 

with an equivalent cost of 

approximately $381,157,000 and a total 

cost burden of approximately 

$63,175,000 in the first year. In each 

subsequent year the total burden hours 

are estimated at approximately 

3,634,000 hours with an equivalent cost 

of approximately $295,409,000 and a 

total cost burden of approximately 

$63,175,000 per year. 

Overall Exemption Hour and Cost 

Burden Summary 

In summary, the third-party 

disclosures, computer model 

certification, written policies and 

procedures, recordkeeping and audit 

requirements for the statutory and class 

exemptions require approximately 

8,398,000 burden hours with an 

equivalent cost of approximately 

$797,903,000 and a cost burden of 

approximately $642,541,000 in the first 

year. The labor burden hours in each 

subsequent year are approximately 

5,776,000 hours with an equivalent cost 

of approximately $510,906,000 and the 

cost burden in each subsequent year is 

approximately $493,242,000 per year. 

These paperwork burden estimates 

are summarized as follows: 

Type of Review: New collection 

(Request for new OMB Control 

Number). 

Agency: Employee Benefits Security 

Administration, Department of Labor. 

Titles: (1) Proposed Class Exemption 

for the Provision of Investment Advice 

to Participants and Beneficiaries of SelfDirected Individual Account Plans and 

IRAs and (2) Proposed Investment 

Advice Regulation. 

OMB Control Number: 1210–NEW. 

Affected Public: Business or other forprofit. 

Estimated Number of Respondents: 

16,000. 

Estimated Number of Annual 

Responses: 20,656,000. 

Frequency of Response: Initially, 

Annually, Upon Request, when a 

material change. 

Estimated Total Annual Burden 

Hours: 8,398,000 hours in the first year; 

5,776,000 hours in each subsequent 

year. 

Estimated Total Annual Burden Cost: 

$642,541,000 for the first year; 

$493,242,000 for each subsequent year. 

List of Subjects in 29 CFR Part 2550 

Employee benefit plans, Exemptions, 

Fiduciaries, Investments, Pensions, 

Prohibited transactions, Reporting and 

recordkeeping requirements, and 

Securities. 

For the reasons set forth in the 

preamble, the Department proposes to 

amend Chapter XXV, subchapter F, part 

2550 of Title 29 of the Code of Federal 

Regulations as follows: 

Subchapter F—Fiduciary Responsibility 

Under the Employee Retirement Income 

Security Act of 1974 

PART 2550—RULES AND 

REGULATIONS FOR FIDUCIARY 

RESPONSIBILITY 

1. The authority citation for part 2550 

is revised to read as follows: 

Authority: 29 U.S.C. 1135; and Secretary of 

Labor’s Order No. 1–2003, 68 FR 5374 (Feb. 

3, 2003). Sec. 2550.401b–1 also issued under 

sec. 102, Reorganization Plan No. 4 of 1978, 

43 FR 47713 (Oct. 17, 1978), 3 CFR, 1978 

Comp. 332, effective Dec. 31, 1978, 44 FR 

1065 (Jan. 3, 1978), 3 CFR, 1978 Comp. 332. 

Sec. 2550.401c–1 also issued under 29 U.S.C. 

1101. Sec. 2550.404c–1 also issued under 29 

U.S.C. 1104. Sec. 2550.407c–3 also issued 

under 29 U.S.C. 1107. Sec. 2550.404a–2 also 

issued under 26 U.S.C. 401 note (sec. 657, 

Pub. L. 107–16, 115 Stat. 38). Sec. 

2550.408b–1 also issued under 29 U.S.C. 

1108(b)(1) and sec. 102, Reorganization Plan 

No. 4 of 1978, 3 CFR, 1978 Comp. p. 332, 

effective Dec. 31, 1978, 44 FR 1065 (Jan. 3, 

1978), and 3 CFR, 1978 Comp. 332. Sec. 

2550.412–1 also issued under 29 U.S.C. 1112. 

2. Add § 2550.408g–1 to read as 

follows: 

§ 2550.408g–1 Investment Advice—

Participants and Beneficiaries. 

(a) General. Section 408(g)(1) of the 

Employee Retirement Income Security 

Act, as amended (ERISA), provides an 

exemption from the prohibitions of 

section 406 of ERISA for transactions 

described in section 408(b)(14) of ERISA 

in connection with the provision of 

investment advice to a participant or a 

beneficiary if the investment advice is 

provided by a fiduciary adviser under 

an ‘‘eligible investment advice 

arrangement.’’ Section 4975(d)(17) and 

(f)(8) of the Internal Revenue Code, as 

amended (the Code), contain parallel 

provisions to ERISA section 408(b)(14) 

and (g)(1). 

(b) Eligible investment advice 

arrangement. For purposes of section 

408(g)(1) of ERISA and section 

4975(f)(8) of the Code, an ‘‘eligible 

investment advice arrangement’’ means 

an arrangement that meets either the 

requirements of paragraph (c) of this 

section or paragraph (d) of this section, 

or both. 

(c) Arrangements that use fee-leveling. 

For purposes of this section, an 

arrangement is an eligible investment 

advice arrangement if—

(1)(i) Any investment advice is based 

on generally accepted investment 

theories that take into account the 

historic returns of different asset classes 

over defined periods of time, although 

nothing herein shall preclude any 

investment advice from being based on 

generally accepted investment theories 


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that take into account additional 

considerations; 

(ii) Any investment advice takes into 

account information furnished by a 

participant or beneficiary relating to age, 

life expectancy, retirement age, risk 

tolerance, other assets or sources of 

income, and investment preferences, 

although nothing herein shall preclude 

any investment advice from taking into 

account additional information that a 

participant or beneficiary may provide; 

(iii) Any fees or other compensation 

(including salary, bonuses, awards, 

promotions, commissions 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 adviser does not vary 

depending on the basis of any 

investment option selected by a 

participant or beneficiary; 

(iv) Any fees (including any 

commission or other compensation) 

received by the fiduciary adviser for 

investment advice or with respect to the 

sale, holding, or acquisition of any 

security or other property for purposes 

of investment of plan assets do not vary 

depending on the basis of any 

investment option selected by a 

participant or beneficiary; and 

(2) The requirements of paragraphs 

(e), (f), (g), (h), and (i) of this section are 

met. 

(d) Arrangements that use computer 

models. For purposes of this section, an 

arrangement is an eligible investment 

advice arrangement if the only 

investment advice provided under the 

arrangement is advice that is generated 

by a computer model described in 

paragraphs (d)(1) and (2) of this section 

under an investment advice program 

and with respect to which the 

requirements of paragraphs (e), (f), (g), 

(h), and (i) are met, and any acquisition, 

holding or sale of a security or other 

property pursuant to such advice occurs 

solely at the direction of the participant 

or beneficiary. 

(1) A computer model shall be 

designed and operated to—

(i) Apply generally accepted 

investment theories that take into 

account the historic returns of different 

asset classes over defined periods of 

time, although nothing herein shall 

preclude a computer model from 

applying generally accepted investment 

theories that take into account 

additional considerations; 

(ii) Utilize information furnished by a 

participant or beneficiary relating to age, 

life expectancy, retirement age, risk 

tolerance, other assets or sources of 

income, and investment preferences, 

although nothing herein shall preclude 

a computer model from taking into 

account additional information that a 

plan or a participant or beneficiary may 

provide; 

(iii) Utilize appropriate objective 

criteria to provide asset allocation 

portfolios comprised of investment 

options available under the plan; 

(iv) Avoid investment 

recommendations that: 

(A) Inappropriately favor investment 

options offered by the fiduciary adviser 

or a person with a material affiliation or 

material contractual relationship with 

the fiduciary adviser over other 

investment options, if any, available 

under the plan; or 

(B) Inappropriately favor investment 

options that may generate greater 

income for the fiduciary adviser or a 

person with a material affiliation or 

material contractual relationship with 

the fiduciary adviser; 

(v) Take into account all designated 

investment options, within the meaning 

of paragraph (j)(1) of this section, 

available under the plan without giving 

inappropriate weight to any investment 

option; except that a computer model 

shall not be treated as failing to meet 

this requirement merely because it does 

not take into account an investment 

option that constitutes an investment 

primarily in qualifying employer 

securities. 

(2) Prior to utilization of the computer 

model, the fiduciary adviser shall obtain 

a written certification, meeting the 

requirements of paragraph (d)(4) of this 

section from an eligible investment 

expert, within the meaning of paragraph 

(d)(3) of this section, that the computer 

model meets the requirements of 

paragraph (d)(1) of this section. If, 

following a certification, a computer 

model is modified in a manner that may 

affect its ability to meet the 

requirements of paragraph (d)(1), the 

fiduciary adviser shall, prior to 

utilization of the modified model, 

obtain a new certification from an 

eligible investment expert that the 

computer model, as modified, meets the 

requirements of paragraph (d)(1). 

(3) The term ‘‘eligible investment 

expert’’ means a person that, through 

employees or otherwise, has the 

appropriate technical training or 

experience and proficiency to analyze, 

determine and certify, in a manner 

consistent with paragraph (d)(4) of this 

section, whether a computer model 

meets the requirements of paragraph 

(d)(1) of this section; except that the 

term ‘‘eligible investment expert’’ does 

not include any person that has any 

material affiliation or material 

contractual relationship with the 

fiduciary adviser, with a person with a 

material affiliation or material 

contractual relationship with the 

fiduciary adviser, or with any employee, 

agent, or registered representative of the 

foregoing. 

(4) A certification by an eligible 

investment expert shall—

(i) Be in writing; 

(ii) Contain—

(A) An identification of the 

methodology or methodologies applied 

in determining whether the computer 

model meets the requirements of 

paragraph (d)(1) of this section; 

(B) An explanation of how the applied 

methodology or methodologies 

demonstrated that the computer model 

met the requirements of paragraph (d)(1) 

of this section; 

(C) A description of any limitations 

that were imposed by any person on the 

eligible investment expert’s selection or 

application of methodologies for 

determining whether the computer 

model meets the requirements of 

paragraph (d)(1) of this section; 

(D) A representation that the 

methodology or methodologies were 

applied by a person or persons with the 

educational background, technical 

training or experience necessary to 

analyze and determine whether the 

computer model meets the requirements 

of paragraph (d)(1); 

(E) A statement certifying that the 

eligible investment expert has 

determined that the computer model 

meets the requirements of paragraph 

(d)(1) of this section; and 

(iii) Be signed by the eligible 

investment expert. 

(5) The selection of an eligible 

investment expert as required by this 

section is a fiduciary act governed by 

section 404(a)(1) of ERISA. 

(e) Arrangement must be authorized 

by a plan fiduciary. The arrangement 

pursuant to which investment advice is 

provided to participants and 

beneficiaries pursuant to this section 

must be expressly authorized by a plan 

fiduciary (or, in the case of an 

Individual Retirement Account (IRA), 

the IRA beneficiary) other than: the 

person offering the arrangement; any 

person providing designated investment 

options under the plan; or any affiliate 

of either. Provided, however, that for 

purposes of the preceding, in the case of 

an IRA, an IRA beneficiary will not be 

treated as an affiliate of a person solely 

by reason of being an employee of such 

person. 

(f) Annual audit. (1) The fiduciary 

adviser shall, at least annually, engage 

an independent auditor, who has 

appropriate technical training or 

experience and proficiency, and so 


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represents in writing to the fiduciary 

adviser, to: 

(i) Conduct an audit of the investment 

advice arrangements for compliance 

with the requirements of this section; 

and 

(ii) Within 60 days following 

completion of the audit, issue a written 

report to the fiduciary adviser and, 

except with respect to an arrangement 

with an IRA, to each fiduciary who 

authorized the use of the investment 

advice arrangement, consistent with 

paragraph (e) of this section, setting 

forth the specific findings of the auditor 

regarding compliance of the 

arrangement with the requirements of 

this section. 

(2) With respect to an arrangement 

with an IRA, the fiduciary adviser: 

(i) Within 30 days following receipt of 

the report from the auditor, as described 

in paragraph (f)(1)(ii) of this section, 

shall furnish a copy of the report to the 

IRA beneficiary or make such report 

available on its website, provided that 

such beneficiaries are provided 

information, with the information 

required to be disclosed pursuant to 

paragraph (g) of this section, concerning 

the purpose of the report, and how and 

where to locate the report applicable to 

their account; and 

(ii) In the event that the report of the 

auditor identifies noncompliance with 

the requirements of this section, within 

30 days following receipt of the report 

from the auditor, shall send a copy of 

the report to the Department of Labor at 

the following address: Investment 

Advice Exemption Notification—

Statutory, U.S. Department of Labor, 

Employee Benefits Security 

Administration, Room N–1513, 200 

Constitution Ave., NW., Washington, 

DC, 20210. 

(3) For purposes of this paragraph (f), 

an auditor is considered independent if 

it does not have a material affiliation or 

material contractual relationship with 

the person offering the investment 

advice arrangement to the plan or any 

designated investment options under 

the plan. 

(4) For purposes of this paragraph (f), 

the auditor shall review sufficient 

relevant information to formulate an 

opinion as to whether the investment 

advice arrangements, and the advice 

provided pursuant thereto, offered by 

the fiduciary adviser during the audit 

period were in compliance with this 

section. Nothing in this paragraph shall 

preclude an auditor from using 

information obtained by sampling, as 

reasonably determined appropriate by 

the auditor, investment advice 

arrangements, and the advice pursuant 

thereto, during the audit period. 

(g) Disclosure. (1) The fiduciary 

adviser must provide, without charge, to 

a participant or a beneficiary before the 

initial provision of investment advice 

with regard to any security or other 

property offered as an investment 

option, a written notification—

(i) Of the role of any party that has a 

material affiliation or material 

contractual relationship with the 

fiduciary adviser in the development of 

the investment advice program, and in 

the selection of investment options 

available under the plan; 

(ii) Of the past performance and 

historical rates of return of the 

designated investment options available 

under the plan, to the extent that such 

information is not otherwise provided; 

(iii) Of all fees or other compensation 

relating to the advice that the fiduciary 

adviser or any affiliate thereof is to 

receive (including compensation 

provided by any third party) in 

connection with the provision of the 

advice or in connection with the sale, 

acquisition, or holding of the security or 

other property; 

(iv) Of any material affiliation or 

material contractual relationship of the 

fiduciary adviser or affiliates thereof in 

the security or other property; 

(v) Of the manner, and under what 

circumstances, any participant or 

beneficiary information provided under 

the arrangement will be used or 

disclosed; 

(vi) Of the types of services provided 

by the fiduciary adviser in connection 

with the provision of investment advice 

by the fiduciary adviser, including, with 

respect to a computer model 

arrangement referred to in paragraph (d) 

of this section, any limitations on the 

ability of a computer model to take into 

account an investment option that 

constitutes an investment primarily in 

qualifying employer securities, as 

provided for in paragraph (d)(1)(v) of 

this section; 

(vii) That the adviser is acting as a 

fiduciary of the plan in connection with 

the provision of the advice; and 

(viii) That a recipient of the advice 

may separately arrange for the provision 

of advice by another adviser that could 

have no material affiliation with and 

receive no fees or other compensation in 

connection with the security or other 

property. 

(2)(i) The notification required under 

paragraph (g)(1) of this section must be 

written in a clear and conspicuous 

manner and in a manner calculated to 

be understood by the average plan 

participant and must be sufficiently 

accurate and comprehensive to 

reasonably apprise such participants 

and beneficiaries of the information 

required to be provided in the 

notification. 

(ii) The appendix to this section 

contains a model disclosure form that 

may be used to provide notification of 

the information described in paragraph 

(g)(1)(iii) of this section. Use of the 

model form is not mandatory. However, 

use of an appropriately completed 

model disclosure form will be deemed 

to satisfy the requirement of paragraphs 

(g)(1) and (2)(i) of this section with 

respect to such information. 

(3) The notification required under 

paragraph (g)(1) of this section may, in 

accordance with 29 CFR 2520.104b–1, 

be provided in written or electronic 

form. 

(4) At all times during the provision 

of advisory services to the participant or 

beneficiary pursuant to the arrangement, 

the fiduciary adviser must—

(i) Maintain the information described 

in paragraph (g)(1) of this section in 

accurate form and in the manner 

described in paragraph (g)(2) of this 

section, 

(ii) Provide, without charge, accurate 

information to the recipient of the 

advice no less frequently than annually, 

(iii) Provide, without charge, accurate 

information to the recipient of the 

advice upon request of the recipient, 

and 

(iv) Provide, without charge, accurate 

information to the recipient of the 

advice concerning any material change 

to the information required to be 

provided to the recipient of the advice 

at a time reasonably contemporaneous 

to the change in information. 

(h) Other Conditions. The 

requirements of this paragraph are met 

if—

(1) The fiduciary adviser provides 

appropriate disclosure, in connection 

with the sale, acquisition, or holding of 

the security or other property, in 

accordance with all applicable 

securities laws, 

(2) The sale, acquisition, or holding 

occurs solely at the direction of the 

recipient of the advice, 

(3) The compensation received by the 

fiduciary adviser and affiliates thereof 

in connection with the sale, acquisition, 

or holding of the security or other 

property is reasonable, and 

(4) The terms of the sale, acquisition, 

or holding of the security or other 

property are at least as favorable to the 

plan as an arm’s length transaction 

would be. 

(i) Maintenance of Records.—The 

fiduciary adviser must maintain, for a 

period of not less than 6 years after the 

provision of investment advice pursuant 

to the arrangement, any records 

necessary for determining whether the 


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49922 Federal Register / Vol. 73, No. 164 / Friday, August 22, 2008 / Proposed Rules 

93See 29 CFR 2550.408g–1. 

applicable requirements of this section 

have been met. A transaction prohibited 

under section 406 of ERISA shall not be 

considered to have occurred solely 

because the records are lost or destroyed 

prior to the end of the 6-year period due 

to circumstances beyond the control of 

the fiduciary adviser. 

(j) Definitions. For purposes of this 

section: 

(1) The term ‘‘designated investment 

option’’ means any investment option 

designated by the plan into which 

participants and beneficiaries may 

direct the investment of assets held in, 

or contributed to, their individual 

accounts. The term ‘‘designated 

investment option’’ shall not include 

‘‘brokerage windows,’’ ‘‘self-directed 

brokerage accounts,’’ or similar plan 

arrangements that enable participants 

and beneficiaries to select investments 

beyond those designated by the plan. 

(2) The term ‘‘fiduciary adviser’’

means, with respect to a plan, a person 

who is a fiduciary of the plan by reason 

of the provision of investment advice 

referred to in section 3(21)(A)(ii) of 

ERISA by the person to the participant 

or beneficiary of the plan and who is—

(i) Registered as an investment adviser 

under the Investment Advisers Act of 

1940 (15 U.S.C. 80b–1 et seq.) or under 

the laws of the State in which the 

fiduciary maintains its principal office 

and place of business, 

(ii) A bank or similar financial 

institution referred to in section 

408(b)(4) of ERISA or a savings 

association (as defined in section 3(b)(1) 

of the Federal Deposit Insurance Act (12 

U.S.C. 1813(b)(1)), but only if the advice 

is provided through a trust department 

of the bank or similar financial 

institution or savings association which 

is subject to periodic examination and 

review by Federal or State banking 

authorities, 

(iii) An insurance company qualified 

to do business under the laws of a State, 

(iv) A person registered as a broker or 

dealer under the Securities Exchange 

Act of 1934 (15 U.S.C. 78a et seq.), 

(v) An affiliate of a person described 

in any of clauses (i) through (iv), or 

(vi) An employee, agent, or registered 

representative of a person described in 

paragraphs (j)(2)(i) through (v) of this 

section who satisfies the requirements 

of applicable insurance, banking, and 

securities laws relating to the provision 

of advice. 

(vii) Except as provided under 29 CFR 

2550.408g–2, a fiduciary adviser 

includes any person who develops the 

computer model, or markets the 

computer model or investment advice 

program, utilized in satisfaction of 

paragraph (d) of this section. 

(3) A ‘‘registered representative’’ of 

another entity means a person described 

in section 3(a)(18) of the Securities 

Exchange Act of 1934 (15 U.S.C. 

78c(a)(18)) (substituting the entity for 

the broker or dealer referred to in such 

section) or a person described in section 

202(a)(17) of the Investment Advisers 

Act of 1940 (15 U.S.C. 80b–2(a)(17)) 

(substituting the entity for the 

investment adviser referred to in such 

section). 

(4) ‘‘Individual Retirement Account’’

or ‘‘IRA’’ means—

(i) An individual retirement account 

described in section 408(a) of the Code; 

(ii) An individual retirement annuity 

described in section 408(b) of the Code; 

(iii) An Archer MSA described in 

section 220(d) of the Code; 

(iv) A health savings account 

described in section 223(d) of the Code; 

(v) A Coverdell education savings 

account described in section 530 of the 

Code; or 

(vi) A trust, plan, account, or annuity 

which, at any time, has been determined 

by the Secretary of the Treasury to be 

described in any of paragraphs (j)(4)(i) 

through (v) of this section. 

(5) An ‘‘affiliate’’ of another person 

means—

(i) Any person directly or indirectly 

owning, controlling, or holding with 

power to vote, 5 percent or more of the 

outstanding voting securities of such 

other person; 

(ii) Any person 5 percent or more of 

whose outstanding voting securities are 

directly or indirectly owned, controlled, 

or held with power to vote, by such 

other person; 

(iii) Any person directly or indirectly 

controlling, controlled by, or under 

common control with, such other 

person; and 

(iv) Any officer, director, partner, 

copartner, or employee of such other 

person. 

(6)(i) A person with a ‘‘material 

affiliation’’ with another person 

means—

(A) Any affiliate of the other person; 

(B) Any person directly or indirectly 

owning, controlling, or holding, 5 

percent or more of the interests of such 

other person; 

(C) Any person 5 percent or more of 

whose interests are directly or indirectly 

owned, controlled, or held, by such 

other person. 

(ii) For purposes of paragraph (j)(6)(i) 

of this section, ‘‘interest’’ means with 

respect to an entity—

(A) The combined voting power of all 

classes of stock entitled to vote or the 

total value of the shares of all classes of 

stock of the entity if the entity is a 

corporation; 

(B) The capital interest or the profits 

interest of the entity if the entity is a 

partnership; or 

(C) The beneficial interest of the 

entity if the entity is a trust or 

unincorporated enterprise. 

(7) Persons have a ‘‘material 

contractual relationship’’ if payments 

made by one person to the other person 

pursuant to written contracts or 

agreements between the persons exceed 

10 percent of the gross revenue, on an 

annual basis, of such other person. 

(8) ‘‘Control’’ means the power to 

exercise a controlling influence over the 

management or policies of a person 

other than an individual. 

Appendix to § 2550.408g–1 

Fiduciary Adviser Disclosure 

This document contains important 

information about [enter name of Fiduciary 

Adviser] and how it is compensated for the 

investment advice provided to you. You 

should carefully consider this information in 

your evaluation of that advice. 

[enter name of Fiduciary Adviser] has been 

selected to provide investment advisory 

services for the [enter name of Plan]. [enter 

name of Fiduciary Adviser] will be providing 

these services as a fiduciary under the 

Employee Retirement Income Security Act 

(ERISA). [enter name of Fiduciary Adviser], 

therefore, must act prudently and with only 

your interest in mind when providing you 

recommendations on how to invest your 

retirement assets. 

Compensation of the Fiduciary Advisor and 

Related Parties 

[enter name of Fiduciary Adviser] (is/is 

not) compensated by the plan for the advice 

it provides. (if compensated by the plan, 

explain what and how compensation is 

charged (e.g., asset-based fee, flat fee, per 

advice)). (If applicable, [enter name of 

Fiduciary Adviser] is not compensated on the 

basis of the investment(s) selected by you.) 

Affiliates of [enter name of Fiduciary 

Adviser] (if applicable enter, and other 

parties with whom [enter name of Fiduciary 

Adviser] has a material affiliation or material 

contractual relationship 93) also will be 

providing services for which they will be 

compensated. These services include: [enter 

description of services, e.g., investment 

management, transfer agent, custodial, and 

shareholder services for some/all the 

investment funds available under the plan.] 

When [enter name of Fiduciary Adviser] 

recommends that you invest your assets in an 

investment fund of its own or one of its 

affiliates and you follow that advice, [enter 

name of Fiduciary Adviser] or that affiliate 

will receive compensation from the 

investment fund based on the amount you 

invest. The amounts that will be paid by you 

will vary depending on the particular fund in 

which you invest your assets and may range 

from l% to l%. Specific information 


rwilkins on PROD1PC63 with PROPOSALS4
Federal Register / Vol. 73, No. 164 / Friday, August 22, 2008 / Proposed Rules 49923 

concerning the fees and other charges of each 

investment fund is available from [enter 

source, such as: Your plan administrator, 

investment fund provider (possibly with 

Internet Web site address)]. This information 

should be reviewed carefully before you 

make an investment decision. 

(if applicable enter, [enter name of 

Fiduciary Adviser] or affiliates of [enter 

name of Fiduciary Adviser] also receive 

compensation from non-affiliated investment 

funds as a result of investments you make as 

a result of recommendations of [enter name 

of Fiduciary Adviser]. The amount of this 

compensation also may vary depending on 

the particular fund in which you invest. This 

compensation may range from l% to l%. 

Specific information concerning the fees and 

other charges of each investment fund is 

available from [enter source, such as: Your 

plan administrator, investment fund provider 

(possibly with Internet Web site address)]. 

This information should be reviewed 

carefully before you make an investment 

decision. 

(if applicable enter, In addition to the 

above, [enter name of Fiduciary Adviser] or 

affiliates of [enter name of Fiduciary Adviser] 

also receive other fees or compensation, such 

as commissions, in connection with the sale, 

acquisition of holding of investments 

selected by you as a result of 

recommendations of [enter name of 

Fiduciary Adviser]. These amounts are: 

[enter description of all other fees or 

compensation to be received in connection 

with sale, acquisition or holding of 

investments]. This information should be 

reviewed carefully before you make an 

investment decision. 

Investment Returns 

While understanding investment-related 

fees and expenses is important in making 

informed investment decisions, it is also 

important to consider additional information 

about your investment options, such as 

performance, investment strategies and risks. 

Specific information related to the past 

performance and historical rates of return of 

the investment options available under the 

plan (has/has not) been provided to you by 

[enter source, such as: Your plan 

administrator, investment fund provider]. (if 

applicable enter, If not provided to you, the 

information is attached to this document.) 

For options with returns that vary over 

time, past performance does not guarantee 

how your investment in the option will 

perform in the future; your investment in 

these options could lose money. 

Parties Participating in Development of 

Advice Program or Selection of Investment 

Options 

Name, and describe role of, affiliates or 

other parties with whom the fiduciary adviser 

has a material affiliation or contractual 

relationship that participated in the 

development of the investment advice 

program (if this is an arrangement that uses 

computer models) or the selection of 

investment options available under the plan. 

Use of Personal Information 

Include a brief explanation of the 

following—

What personal information will be 

collected; 

How the information will be used; 

Parties with whom information will be 

shared; 

How the information will be protected; and 

When and how notice of the Fiduciary 

Adviser’s privacy statement will be available 

to participants and beneficiaries. 

Consider Impact of Compensation on Advice 

The fees and other compensation that 

[enter name of Fiduciary Adviser] and its 

affiliates receive on account of assets in 

[enter name of Fiduciary Adviser] (enter if 

applicable, and non-[enter name of Fiduciary 

Adviser]) investment funds are a significant 

source of revenue for the [enter name of 

Fiduciary Adviser] and its affiliates. You 

should carefully consider the impact of any 

such fees and compensation in your 

evaluation of the investment that [enter name 

of Fiduciary Adviser] provides to you. In this 

regard, you may arrange for the provision of 

advice by another adviser that may have not 

material affiliation with or receive 

compensation in connection with the 

investment funds or products offered under 

the plan. This type of advice is/is not 

available through your plan. 

Should you have any questions about 

[enter name of Fiduciary Adviser] or the 

information contained in this document, you 

may contact [enter name of contact person 

for fiduciary adviser, telephone number, 

address]. 

3. Add § 2550.408g–2 to read as 

follows: 

§ 2550.408g–2 Investment advice—

fiduciary election. 

(a) General. Section 408(g)(11)(A) of 

the Employee Retirement Income 

Security Act, as amended (ERISA), 

provides that a person who develops a 

computer model or who markets a 

computer model or investment advice 

program used in an ‘‘eligible investment 

advice arrangement’’ shall be treated as 

a fiduciary of a plan by reason of the 

provision of investment advice referred 

to in ERISA section 3(21)(A)(ii) to the 

plan participant or beneficiary, and 

shall be treated as a ‘‘fiduciary adviser’’

for purposes of ERISA section 408(b)(14) 

and (g). Section 4975(f)(8) of the Internal 

Revenue Code, as amended (the Code), 

contains a parallel provision to ERISA 

section 408(g)(11). This section sets 

forth requirements that must be satisfied 

in order for one such fiduciary adviser 

to elect to be treated as a fiduciary with 

respect to a plan under an eligible 

investment advice arrangement. 

(b)(1) If an election meets the 

requirements in paragraph (b)(2) of this 

section, then the person identified in 

the election shall be the sole fiduciary 

adviser treated as a fiduciary by reason 

of developing or marketing the 

computer model, or marketing the 

investment advice program, used in an 

eligible investment advice arrangement. 

(2) An election satisfies the 

requirements of this subparagraph with 

respect to an eligible investment advice 

arrangement if the election is in writing 

and such writing—

(i) Identifies the investment advice 

arrangement, and the person offering the 

arrangement, with respect to which the 

election is to be effective; 

(ii) Identifies a person who—

(A) Is described in any of 29 CFR 

2550.408g–1(j)(2) (i) through (v), 

(B) Develops the computer model, or 

markets the computer model or 

investment advice program, utilized in 

satisfaction of 29 CFR 2550.408g–1(d) 

with respect to the arrangement, and 

(C) Acknowledges that it elects to be 

treated as the only fiduciary, and 

fiduciary adviser, by reason of 

developing such computer model, or 

marketing such computer model or 

investment advice program; 

(iii) Is signed by the person identified 

in paragraph (b)(2)(ii) of this section; 

(iv) Is furnished to the fiduciary who 

authorized the arrangement, in 

accordance with 29 CFR 2550.408g–1(e); 

and 

(v) Is maintained in accordance with 

29 CFR 2550.408g–1(i). 

Signed at Washington, DC, this 15th day of 

August, 2008. 

Bradford P. Campbell, 

Assistant Secretary, Employee Benefits 

Security Administration, Department of 

Labor. 

[FR Doc. E8–19272 Filed 8–21–08; 8:45 am] 

BILLING CODE 4510–29–P 


rwilkins on PROD1PC63 with PROPOSALS4