401(K) Plans: Improved Regulation Could Better Protect Participants from Conflicts of Interest
Published: 2011-01-28T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Recent volatility in financial markets highlights the need for prudent investment decisions if 401(k) plans are to provide an adequate source of retirement income. While plan sponsors and participants may receive help in assessing their investment choices, concerns have been raised about the impartiality of the advice provided. GAO was asked to describe circumstances where service providers may have conflicts of interest in providing assistance related to the selection of investment options for (1) plan sponsors and (2) plan participants, and (3) steps the Department of Labor (Labor) has taken to address conflicts of interest related to the selection of investment options.
section_title: What GAO Found
paragraphs: The sponsors of 401(k) plans face conflicts of interest from service providers assisting in the selection of investment options because of third-party payments and other business arrangements. For example, providers who help sponsors to establish and maintain their plans may receive third-party payments from investment fund companies. The payments, sometimes called revenue sharing, create a conflict of interest because the provider may receive greater compensation from certain funds. Moreover, providers are reported to commonly structure their relationships with sponsors in a manner that avoids being subject to fiduciary standards under the Employee Retirement Income Security Act (ERISA). According to several industry experts, many sponsors, particularly of smaller plans, do not understand whether or not providers to the plan are fiduciaries, nor are they aware that the provider's compensation may vary based on the investment options selected. Such conflicts could lead to higher costs for the plan, which are typically borne by participants. In certain situations, participants face conflicts of interest from providers that have a financial interest when providing investment assistance. For example, although investment education is defined as generalized investment information, providers may highlight their own funds as examples of investments available within asset classes even though they may have a financial interest in the funds. According to industry experts, participants perceive education as investment advice. Thus, participants may not understand that the provider is not a fiduciary adviser required to act solely in participants' best interests. Also, several industry experts expressed concerns that providers stand to gain higher profits from marketing investment products outside of plans to participants, a practice known as cross-selling. For example, if participants use their plan provider for Individual Retirement Account rollovers, they may not understand, because of insufficient disclosures, that fees are often higher for products offered outside the plan and that the provider may not be serving as a fiduciary adviser. Consequently, participants may choose funds that do not meet their needs and pay higher fees, which reduce their retirement savings. While Labor has taken steps to address the potential for conflicted investment advice provided to sponsors and participants, more can be done to ensure they receive impartial advice. In fiscal year 2007, the Employee Benefits Security Administration (EBSA) began a national enforcement project that focuses on the receipt of improper or undisclosed compensation by certain providers, but its enforcement efforts are constrained to fiduciary providers and limited by EBSA's approach for generating cases. In addition, EBSA issued regulations to revise the definition of an ERISA fiduciary and require enhanced disclosure of providers' compensation and fiduciary status. These regulations, as currently specified, would help EBSA and sponsors detect and deter conflicted investment advice. However, the regulations do not require that certain disclosures be made in consistent or summary formats, which may leave sponsors with information that is not sufficient or comparable.
section_title: What GAO Recommends
paragraphs: GAO recommends that Labor amend pending regulations to require that service providers disclose compensation and fiduciary status in a consistent, summary format and revise current standards, which permit a service provider to highlight investment options in which it has a financial interest. GAO also recommends that the Department of the Treasury amend proposed regulations to require disclosure that investment products outside a plan typically have higher fees than products available within a plan. Overall, Labor and Treasury generally agreed to consider our recommendations as they evaluate comments received on pending regulations.

section_title: Letter
paragraphs: In recent high-profile court cases, 401(k) plan participants allege they have  lost millions of dollars because of investment options that benefited the  plan’s service provider at the expense of participants. Plan sponsors and  participants may rely on investment education or advice from their service  provider to help them assess their investment choices at two key points:  first, when the plan sponsor decides which investment options to include  in the plan, and second, when each plan participant decides where to  invest his or her assets given the available options in the plan. However,  questions have been raised about the impartiality of the assistance  provided when the service provider has a conflict of interest. A conflict of  interest occurs when someone in a position of trust, like a pension plan  adviser, has competing professional or personal financial interests. For  example, the structure of advisers’ compensation and their other business  arrangements could create competing interests that may bias their  investment recommendations to plan sponsors or participants. If left  unchecked, conflicts of interest could lead plan sponsors or participants to  select investment options with higher fees or mediocre performance,  which, while beneficial to the service provider, could amount to a  significant reduction in retirement savings over a worker’s career.
The potential for financial harm to participants from conflicted investment  advice has raised questions about its nature and extent in 401(k) plans. To  better understand how conflicts of interest may arise in investment  assistance provided to plan sponsors or participants and to evaluate how  such conflicts are addressed by current and proposed regulations, you  asked us to address the following questions:  1.  What are circumstances where service providers may have conflicts of  interest in providing assistance related to the selection of investment  options by plan sponsors? 2.  What are circumstances where service providers may have conflicts of  interest in providing assistance related to the selection of investment  options by plan participants?  3.  What steps has the Department of Labor (Labor) taken to address  conflicts of interest related to the selection of investment options?
To answer these questions, we reviewed relevant research and federal  laws and regulations on investment advice arrangements for plan sponsors  and participants. We conducted interviews with 401(k) plan service  providers, government officials, and other industry experts to identify  different practices that may create conflicts of interest in the provision of  investment advice to plan sponsors and participants. In addition, we  reviewed relevant Securities and Exchange Commission (SEC) and Labor  enforcement cases and spoke with field investigators to examine revenue- sharing arrangements and other business practices where conflicts of  interest were identified. To identify current practices in participant-level  investment advice, we conducted a poll of plan sponsors and service  providers in partnership with the Society for Human Resource  Management (SHRM) and the Society of Professional Asset-Managers and  Record Keepers (SPARK). In addition, we obtained and analyzed data  from service providers, the Investment Company Institute (ICI), and the  Survey of Income and Program Participation (SIPP) to ascertain the  percentage of plan participants who have transferred or rolled 401(k) plan  assets into individual retirement accounts (IRA). We assessed the  reliability of the data we present and found the data to be sufficiently  reliable as used in this report. To determine the extent to which Labor’s  actions address the potential for conflicted investment advice, we  reviewed relevant federal laws and regulations and interviewed Labor’s  Employee Benefits Security Administration (EBSA) officials, including  Consultant/Adviser Project and field investigators, and industry experts. In  addition, we reviewed reports and interviewed officials from Labor’s  Office of Inspector General (OIG) who evaluated EBSA’s efforts to protect  pension plan assets from conflicts of interest in pension plan service  providers. We also interviewed service providers and industry experts on  the likely impact of recent regulations issued by Labor pertaining to  investment advice to participants and disclosure of compensation received  by service providers. For additional information on the methodology used  in this review, see appendix I.
We conducted this performance audit from January 2010 through January  2011 in accordance with generally accepted government auditing  standards. Those standards require that we plan and perform the audit to  obtain sufficient, appropriate evidence to provide a reasonable basis for  our findings and conclusions based on our audit objectives. We believe  that the evidence obtained provides a reasonable basis for our findings  and conclusions based on our audit objectives.
subsections: section_title: Background
paragraphs: In contrast to workers in a traditional defined benefit (DB) plan, workers  in a 401(k) plan, the predominant type of defined contribution (DC) plan in  the United States, have more control over their retirement assets, but also  bear greater responsibility and risk in the investment of assets. In a typical  401(k) plan, workers decide whether or not to make contributions into an  individual account. Contributions may also be made by their employer.  Participants direct these contributions to mutual funds and other financial  market investments to accumulate pension benefits, dependent on  investment returns net of fees. As we reported in 2006, investment fees are  usually paid by participants and administrative fees are often paid by  employers, but participants bear them in a growing number of plans.  Depending on contributions and net investment returns, participants  accumulate an account balance that will then be withdrawn at or after  retirement. Over the last decade, participation in DC plans among all  private industry employees has increased from 36 percent in 1999 to 43  percent in 2008. In 2008, about 49.8 million workers actively participated  in a 401(k) plan.
The degree of responsibility and risk borne by workers in 401(k) plans  underscores the need for prudent investment decisions if these plans are  to provide an adequate source of income in retirement. Poor investment  decisions—either by the plan sponsors when they decide which  investment options to offer in the plans, or by participants when, given  these options, they decide where to invest their assets—can result in lower  returns and correspondingly less retirement savings. Several studies have  found that, from 1988 to 2006, DC plans underperformed DB plans by 1  percentage point or more, which may be explained by higher fees in 401(k)  plans and a lack of diversification in participants’ investment allocations.  Numerous studies on financial literacy have also pointed to the need to  educate participants to improve their investment decision-making and  savings outcomes. For example, one study found that a large percentage  of American workers have not conducted meaningful retirement planning,  even when retirement is in the near future. Another study found that most  workers acknowledge they do not know as much as they should about  retirement planning and that many workers actually guessed at their  retirement savings needs.
To address the challenges of investment risk in 401(k) plans, both plan  sponsors and participants may seek assistance from service providers in  selecting investment options. At the plan sponsor level, many plans rely  heavily on the expertise and guidance of their advisers when making  investment decisions. The service providers that offer these advisory  services to plan sponsors can vary considerably in their business  arrangements. While some service providers operate as independent, “fee- only” advisers, who are compensated solely by their clients and do not  receive additional compensation contingent on the purchase or sale of a  financial product, other service providers offer affiliated services,  including brokerage and money management, in addition to advisory  services. As shown in figure 1, service providers can be used to provide a  number of services necessary to operate a 401(k) plan, which can be  bundled or unbundled with investment management services or advisory  services. Under a bundled service arrangement, the plan sponsor hires a  company that provides multiple services directly or through subcontracts.
At the participant level, advisory services can also be provided through a  variety of methods, including call centers or help desks, group seminars,  one-on-one sessions, computer models (e.g., software that estimates future  retirement income needs or asset allocation models), or brochures and  other printed materials provided by plan service providers. When  providing this assistance to participants, a service provider may furnish  either investment education or investment advice. As specified by EBSA,  investment education consists of general investment information,  including general information about the plan and asset allocation models  that is not tailored to the needs or interests of an individual plan  participant (see table 1). Investment advice, on the other hand, consists of  one or more individualized investment recommendations tailored to a  participant’s particular investment needs.
While plan sponsors and participants may rely on service providers for  assistance in making investment decisions, concerns have been raised  about the independence of the advice provided in some cases. A 2005 SEC  report noted that its examination of investment advisers providing pension  consultant services found that many such consultants provide services to  both plans and money managers, a situation that has the potential to  compromise the objectivity of the consultant’s recommendations to the  plan. Namely, the report states that concerns exist that consultants may  steer plans to hire certain money managers or other vendors based on the  consultant’s (or an affiliate’s) other business relationships and receipt of  fees from these firms, rather than because the money manager is best  suited to the plan’s needs. As we reported in 2007, no complete  information exists about the presence of conflicts of interest at pension  plan service providers. However, the 2005 SEC examination of the  activities of 24 pension consultants from 2002 through 2003 revealed that  13 out of 24 of the service providers examined failed to disclose significant  ongoing conflicts of interest, such as affiliated businesses or compensation  received from money managers.
subsections: section_title: Regulation of Investment Advice
paragraphs: Investment advice provided to plan sponsors and participants and any  related conflicts of interest are regulated under ERISA. ERISA states that a  person who renders investment advice for a fee or other compensation,  direct or indirect, with respect to any moneys or property of a plan or has  any authority or responsibility to do so is a fiduciary and thus is subject to  fiduciary standards outlined in the law and regulations. This statutory  definition of fiduciary for investment advice is currently subject to a five- part test, set forth in regulations, each element of which must be met for  an individual to be considered a fiduciary. Specifically, under this test, a  consultant or adviser is determined to be providing investment advice only  if the advice was provided for a fee either direct or indirect, and the advice  was provided  1.  as to the value of securities or other property or as to the advisability  of investing in, purchasing, or selling securities or other property;  2.  on a regular basis;  3.  pursuant to a mutual agreement, arrangement, or understanding;  4.  as a primary basis for investment decisions; and  5.  based on the particular needs of the plan.
Although plan sponsors often rely on consultants and other service  providers to assist them in asset management, which includes selecting  money managers and monitoring money managers’ performance and  brokerage transactions, not all of these consultants and service providers  are at all times fiduciaries under ERISA based on the application of the  five-part test.
For plan sponsors and other service providers who are fiduciaries, ERISA  requires they discharge duties solely in the interest of the participants and  beneficiaries with care, skill, prudence, and diligence. Although ERISA  generally prohibits fiduciaries from acting on conflicts of interest, certain  transactions are strictly precluded under prohibited transaction rules,  regardless of whether or not participants are harmed. In particular,  prohibited transaction rules preclude fiduciaries from “self-dealing,” which  includes an individual dealing with plan assets for his or her own benefit.  In addition, EBSA has explained that ERISA obligates fiduciaries to obtain  and consider information relating to the cost of plan services and potential  conflicts of interest presented by such service arrangements.
EBSA is responsible for enforcing these provisions of Title I of ERISA, as  well as educating and assisting plan participants, beneficiaries, and plan  sponsors. Fiduciaries that breach their plan duties are personally liable for  making up losses to the plan and restoring any profits made through the  use of plan assets. In addition, they may face removal as plan fiduciaries.  Participants may also seek recovery against nonfiduciaries in certain  circumstances. In addition to carrying out its enforcement  responsibilities, EBSA assists regulated parties in complying with ERISA  by issuing technical guidance, including advisory opinions and interpretive  bulletins, and educating plan participants, beneficiaries, and plan  sponsors.
subsections: section_title: Securities Laws
paragraphs: In addition to being regulated by ERISA, investment advice and conflicts  of interest are also regulated under securities laws. SEC regulates certain  money managers and pension consultants under the Investment Advisers  Act of 1940 (Advisers Act), which requires those firms meeting certain  criteria to register with the commission as investment advisers. For these  registered investment advisers, SEC requires that they disclose  information about affiliations, business interests, and compensation  arrangements to their advisory clients, primarily by providing a brochure  that meets the requirements of Part 2 of SEC’s Form ADV to new and  prospective clients. In addition, registered investment advisers must  annually deliver either an updated brochure with a summary of material  changes or a summary of material changes and offer to provide an updated  copy of the brochure. According to SEC, all investment advisers— whether registered with SEC or not—have a fiduciary obligation under the  Advisers Act to avoid conflicts of interest and, at a minimum, make full  disclosure of material conflicts of interest to their clients. When an adviser  fails to disclose information regarding material conflicts of interest, clients  are unable to make informed decisions about entering into or continuing  the advisory relationship. Failure to act in accordance with requirements  under the Advisers Act may constitute a violation. If SEC becomes aware  of conflicts of interest that are inadequately disclosed or pose harm to  investors, it can take enforcement action against the service provider.
SEC also regulates broker-dealers under the Securities Exchange Act of  1934 (Exchange Act), which requires that broker-dealers register with  SEC, unless an exception or exemption applies. In addition, broker-dealers  that deal with the public must become members of the Financial Industry  Regulatory Authority, Inc. (FINRA). Under the anti-fraud provisions of  the federal securities laws, including just and equitable principles of trade,  broker-dealers are required to deal fairly with their customers.  Salespersons of broker-dealers are subject to licensing requirements,  including examinations. Broker-dealers are held to a suitability standard  when rendering investment recommendations. When a broker-dealer  makes a recommendation to buy, exchange, or sell a security to a retail  investor, that broker-dealer must recommend only those securities that the  broker reasonably believes are suitable for the customer. In addition, a  broker-dealer must disclose all material information regarding the security  and the recommendation, including, among other things, any material  adverse facts or material conflicts of interest. However, according to  FINRA staff, up-front general disclosure of a broker-dealer’s business  activities and relationships that may cause conflicts of interest with retail  customers is not required. SEC staff has noted that, in practice, with  broker-dealers, required disclosures of conflicts have been more limited  than with investment advisers and apply at different points in the  relationship. Table 2 provides a comparison of the standards of conduct  required by ERISA, and those required of investment advisers and broker- dealers.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd- Frank), signed into law on July 21, 2010, includes provisions that amend  the Advisers Act and the Exchange Act that affect investment advisers and  broker-dealers. Under these provisions, SEC, among other things,  conducted a 6-month study on the effectiveness of existing standards of  care for broker-dealers and investment advisers and examined whether  there are legal and regulatory gaps, shortcomings, or overlaps in legal or  regulatory standards in the protection of retail customers. Based on its  review, SEC staff recommended that SEC propose rules that apply a  uniform standard of conduct which requires broker-dealers and  investment advisers, when providing personalized investment advice to  retail customers, to act in the best interest of the customer without regard  to the financial or other interest of the broker, dealer, or investment  adviser. SEC staff also recommended that SEC should facilitate the  provision of uniform, simple and clear disclosures to retail customers  about the terms of their relationships with broker-dealers and investment  advisers, including any material conflicts of interest.
section_title: Service Providers May Have Conflicts of Interest in Providing Investment Assistance to Plan Sponsors because of Third- Party Payments and Other Business Arrangements
subsections: section_title: Service Providers’ Business Arrangements May Create Conflicts of Interest in Investment Assistance Provided to Plan Sponsors
paragraphs: Several industry experts we spoke with cited third-party payments, also  known as revenue sharing, as a potential conflict of interest for service  providers involved in the fund selection process for a 401(k) plan.  Revenue sharing, in the pension plan industry, generally refers to indirect  payments made from one service provider, such as the investment fund  provider, to another service provider in connection with services provided  to the plan, rather than payments made directly by the plan sponsor for  plan services. According to industry experts, revenue sharing is a  widespread practice among 401(k) service providers. As we have  previously reported, revenue-sharing payments can be used to offset  expenses the plan has agreed to pay and thus be cost-neutral to the plan.  However, as shown in figure 2, revenue sharing may, depending on the  circumstances, also create a conflict of interest if it is not structured to be  cost-neutral to the plan and may result in increased compensation to  service providers. Industry experts we spoke with explained that this  situation creates an incentive for the service provider to suggest funds  with higher revenue-sharing payments. Because of these conflicts of  interest, the service provider may suggest funds that have poorer  performance or higher costs for participants compared with other  available funds. The amount of revenue-sharing payments can vary  considerably, both across investment funds and within a fund through  different share classes. Documentation we obtained showed revenue- sharing payments from hundreds of share classes of different investment  funds that ranged from 5 to 125 basis points (bps). Given this variation,  EBSA field investigators told us that a service provider might only  recommend or include fund share classes that pay higher revenue sharing  and exclude other fund share classes that pay lower or no revenue sharing.
As described in table 3, revenue sharing can include various forms of  payments, such as 12b-1 fees, that may create conflicts of interest for  service providers assisting with the selection of investment options for a  401(k) plan.
Besides creating a potential conflict of interest, using revenue sharing to  reimburse for record-keeping expenses can have other adverse effects on  the plan and participants. Service providers told us these payments are  often not clearly disclosed to the plan. As shown in figure 3, this could  result in participants paying a greater or lesser share of record-keeping  expenses depending on which funds they choose to invest their assets.  Further, because subtransfer agent fees are based on the amount of assets  under management, the record-keeping costs increase as the fund grows  and may get quite large if not revised. According to one service provider  we interviewed, these fees can result in the plan continuing to pay more  for record-keeping services as assets grow, although the cost of providing  record-keeping services tends to remain the same.
In addition to revenue-sharing payments from fund companies, payments  from brokerage firms, which execute trades for participants’ investment  funds, to other service providers can also create conflicts of interest  related to a 401(k) plan’s investments. For example, in a 2007 SEC case, an  investment adviser was alleged to have advised its pension plan clients,  including 401(k) plans, to use a specific brokerage firm under certain  circumstances. The brokerage firm allegedly paid the service provider  annual compensation based in part on the amount of commissions  generated, which the adviser failed to disclose to its pension plan clients  although the adviser was required to do so. The contingent compensation  from the brokerage firm to the investment adviser created an incentive for  the service provider to steer plans to use that particular brokerage firm.
In other cases, industry experts told us that, at the request of an  investment adviser, brokerage firms can use commission revenues from  trading shares to make payments to other service providers that can create  conflicts of interests if not handled properly. Under the Securities  Exchange Act of 1934, investment advisers are permitted to pay broker- dealers more than the lowest available commission rate for trading shares  under certain circumstances. The investment adviser can direct the  broker-dealer to use the commission revenues to pay the fees of other  service providers or to purchase services of value to investors, such as  investment research to improve the management of the fund. However, if  the commission revenues are not used for the benefit of the plan, it could  create a conflict of interest. A 2005 SEC report concerning examinations  of pension consultants identifies several areas of concern and examples of  poorly managed conflicts of interest. For example,    Using commission revenues to pay for another service provider’s fees,  (i.e., a “commission recapture” arrangement) such as for a pension  consultant, can result in greater compensation to that service provider,  because such arrangements may not be capped to terminate when fees  due to the service provider have been paid in full, resulting in the plan  overpaying for services.
These arrangements are not always well documented and raise concerns  that plans may not receive “best execution,” meaning that the plan’s  service provider may recommend that the plan use a broker-dealer with  whom it has such an arrangement even if the broker-dealer does not offer  the most favorable terms for the plan.
These arrangements can also create the incentive for the service provider  to recommend a more active trading strategy to increase the number of  transactions and, consequently, the amount of commissions.
subsections: section_title: Other Business Arrangements That May Create Conflicts of Interest
paragraphs: In addition to payments among service providers, other types of business  arrangements can also create conflicts of interest. As shown in table 4,  service providers may have affiliated businesses, such as proprietary  investment funds or a brokerage arm, that can profit from the investment  of plan assets. For example, a service provider that offers its own  investment funds has the incentive to steer plan sponsors to select these  proprietary funds even if other funds are available from different providers  that better suit the needs of the plan.
section_title: Many Service Providers Are Reported to Arrange Their Association with Plan Sponsors in a Manner That Avoids ERISA Fiduciary Responsibility
paragraphs: Although service providers that are subject to ERISA fiduciary standards  are prohibited from benefiting from the investment of plan assets, many  service providers that assist in selecting investment options are reported  to structure their relationships with plans to avoid being subject to these  standards. Under ERISA, a person who provides investment advice for  direct or indirect compensation is a fiduciary; however, the EBSA  regulations currently in effect establish a five-part test, each part of which  must be met, to determine if a service provider is a fiduciary for purposes  of providing investment advice. Many industry experts we spoke with  said that service providers often do not meet one or more parts of the test  and thus avoid being subject to ERISA fiduciary standards. Consequently,  these service providers may have a conflict of interest by increasing their  compensation based on the funds selected by the plan without violating  ERISA. Service providers may structure their association with a 401(k)  plan to avoid meeting one or more parts of the current five-part test, as  shown in figure 4. For example, an ERISA attorney said that although  service providers give investment recommendations, they will include a  provision in their contract that states that the investment  recommendations provided are not intended to be the primary basis for  decision making. A recent report by Labor’s OIG found that some service  providers included in their review and identified to have significant  undisclosed conflicts of interest attempted to avoid meeting the criteria  for ERISA fiduciary status under the current five-part test by simply  stating in their investment adviser contract that they were not fiduciaries.  The 2010 report examined EBSA’s handling of certain service providers,  acting as pension consultants, that were determined by SEC in a 2005 staff  report to have significant undisclosed conflicts of interest. According to  the SEC report, many plan sponsors rely heavily on these pension  consultants in making investment decisions. Other industry experts said  that a service provider can avoid meeting the criteria of the five-part test if  it offers investment recommendations as part of setting up the plan, rather  than on a regular, recurring basis (see table 5). According to EBSA  officials, it can easily be asserted by a service provider that advice given  on a onetime basis does not meet the five-part test.
When selecting investment options for the plan, plan sponsors can work  with various types of service providers subject to different regulations,  some of which may not be required to provide advice in the best interest  of the plan or disclose conflicts of interest. Several industry experts we  interviewed said that while some plan sponsors hire registered investment  advisers (RIA) who are subject to SEC regulations and often acknowledge  ERISA fiduciary responsibility, many other plan sponsors work with  broker-dealer or insurance company representatives who are not subject  to ERISA fiduciary responsibility and may also not be subject to SEC  regulations. Under the Advisers Act, RIAs must seek to avoid conflicts of  interest and, at a minimum, make full disclosure of material conflicts of  interest. However, other service providers, such as insurance company  representatives, may not be subject to ERISA fiduciary duty or certain  SEC regulations and thus may not be required to make recommendations  in the best interest of their clients, or to disclose all conflicts of interest.  Furthermore, plan sponsors may contract directly with a bundled service  provider that offers its own investment funds and does not provide formal  investment advice subject to ERISA or SEC regulations.
No comprehensive data are available to determine how many service  providers are ERISA fiduciaries for purposes of providing investment  advice. Although plan sponsors are required to provide certain information  about the plan and service providers in annual filings to EBSA, this  information does not include which service providers are acting as ERISA  fiduciaries. As we previously reported, ERISA requires that at least one  fiduciary be named in the plan documents provided to participants,  although others may be identified voluntarily. Consequently,  determinations as to ERISA fiduciary status of service providers may not  be made unless an investigation by EBSA is initiated or a lawsuit is filed  claiming that the plan has been harmed. Misunderstanding can also occur  because many large providers offer a range of services that a sponsor can  choose from, including some that involve fiduciary duties and others that  may not.
Despite reports indicating that many service providers are not acting as  ERISA fiduciaries in providing investment assistance, industry experts and  EBSA field investigators told us that plan sponsors are often not aware  when a service provider is not an ERISA fiduciary and often assume the  advice they receive from them is subject to these standards.  Consequently, plan sponsors may not be aware that service providers can  have a financial incentive to recommend certain funds that would be  prohibited if they were ERISA fiduciaries. As we previously reported, plan  sponsors may also assume they have delegated all of their fiduciary duties  to an outside professional hired to run the plan, even though the sponsor  always retains some fiduciary obligation. Several industry experts we  spoke with, including EBSA field investigators, indicated that there is a  considerable amount of confusion among plan sponsors about whether or  not they are receiving investment advice subject to ERISA fiduciary  standards. For example, unless disclosed on the schedule A of the annual  form 5500, they noted that, in their opinion, plan sponsors are generally  not aware, when dealing with service providers who are broker-dealers or  insurance company representatives, that the providers are not giving  formal investment advice subject to ERISA fiduciary standards and thus  may be earning sales-based compensation on fund sales. Contributing to  the confusion, broker-dealers or insurance company representatives can  refer to themselves as advisers even though they are not providing advice  as ERISA fiduciaries and are receiving sales-based compensation. A  service provider representative said that, from the plan sponsor’s  perspective, investment assistance provided by a nonfiduciary service  provider that may have conflicts of interest often looks very similar to  investment advice provided by an independent service provider with no  ties to investment funds.
Smaller plans may be more exposed to conflicts of interest on the part of  service providers because they are less likely than larger plans to receive  investment assistance from a service provider that is acting as a fiduciary.  Several industry experts we spoke with said that larger plans are much  more likely to employ RIAs who are subject to fiduciary standards under  the Advisers Act in providing investment advice. Larger plans may also  have sufficient resources and in-house expertise to make investment  decisions without assistance. Smaller plans, on the other hand, often lack  the resources to perform these tasks in-house or to hire an independent  adviser who will act as an ERISA fiduciary. Smaller plans also often  receive investment assistance from insurance brokers or broker-dealers,  who are not acting as ERISA fiduciaries and also may not be subject to  fiduciary standards under the Advisers Act, which requires the adviser to  act solely in the best interests of the client.
section_title: Conflicts of Interest in the Selection of Investment Options May Cause Problems for Plan Sponsors and Reduce Participants’ Savings for Retirement
paragraphs: The potential conflicts of interest described by industry experts we  interviewed could cause problems for plan sponsors if appropriate action is  not taken. Under ERISA, plan sponsors are obligated to take steps to  identify and address service providers’ potential conflicts of interest and  ensure that the plan is run in the best interest of participants. For example,  an advisory opinion issued by EBSA describes conditions under which  revenue-sharing payments received by a fiduciary are permissible under  ERISA. Specifically, the advisory opinion states that, in order for a fiduciary  to avoid a prohibited transaction, revenue-sharing payments should be fully  disclosed to the plan and used either to offset fees the plan is obligated to  pay, on a dollar-for-dollar basis, or else be rebated to the plan. In addition,  EBSA and SEC developed a list of questions to assist plan sponsors with  identifying and assessing service providers’ potential conflicts of interest  that is available on SEC’s Web site. The questions include inquiries about a  service provider’s compensation, affiliations, or other business relationships  with money managers, and ERISA fiduciary status. Representatives of  service providers and ERISA attorneys we spoke with also described steps  plan sponsors could take to address service providers’ potential conflicts of  interest. For example, plan sponsors could    examine a service provider’s direct and indirect compensation,    ensure that the investment options offered are diversified and not entirely  composed of the service provider’s proprietary funds,   negotiate for institutional fund share classes which do not have revenue- sharing payments so that fees are paid through direct charges to the plan, or   specify in their contract that the service provider will not receive any  compensation other than what is allowed for in the contract.
Although plan sponsors may take steps to address potential conflicts of  interest, several industry experts we spoke with said that the complexity of  service providers’ business arrangements and insufficient disclosures pose  challenges to plan sponsors who want to obtain information regarding  potential conflicts. Some of these conflicts might rise to the level of a  prohibited transaction, such as self-dealing. Even though revenue sharing is  reported to be a widespread practice among 401(k) service providers,  several industry experts we spoke with said that plan sponsors, especially of  smaller plans, may not fully understand or even be aware of these payments.  Further, some industry experts said that even if disclosures are provided,  they are very complicated and difficult to understand.
If not addressed, conflicts of interest could lead to 401(k) plans offering  investment funds with higher fees or mediocre performance, which can  substantially reduce the amount of savings available for retirement. A  service provider with a conflict of interest may steer plan sponsors toward  investment funds that increase the service provider’s compensation even if  other funds with better performance are available at equal or lower cost.  Several industry experts we interviewed said that the financial impact of  conflicts of interest can be considerable. For example, representatives from  one service provider we interviewed said fees for plans that have been  managed by service providers with conflicts of interest can be reduced by  30 percent or more. Similarly, a representative from an advisory firm that  does not accept payments from investment funds said that, in some cases,  fees for the firm’s 401(k) plan clients are reduced by 180 bps or more. As we  previously reported, however, a detailed financial audit would be necessary  to precisely estimate the financial impact of a conflict of interest in a  specific situation. While the financial harm from conflicted investment  advice is difficult to estimate, several studies provide a general sense of the  magnitude of the effect of an increase in fees for retirement savings over a  worker’s career. Based on a 1 percentage point increase in fees, projections  from EBSA, a prior GAO report, and an industry study range from a 17 to 28  percent decline in final account balances. The size of the impact varies  based on the time horizon, the projected rate of return, and other  assumptions made in the projection.
section_title: Participants May Receive Conflicted Investment Education and Advice from Service Providers in Certain Circumstances, but Enhanced Disclosure Could Help Mitigate Such Conflicts
subsections: section_title: Participants May Perceive Investment Education as Advice and May Be Unaware of Situations when Service Providers Have Conflicts of Interest
paragraphs: Participants may be unaware that service providers, when furnishing  education, may have financial interests in the investment options available  to participants. For example, investment education, which may be  provided to participants in brochures, other written materials, and  computer models, can include asset allocation models that highlight  specific investment options as examples of investments available under an  asset class. In particular, funds in which the service provider has a  financial interest can be highlighted and participants may perceive this  information as investment advice. In one case, representatives from a  service provider for many large 401(k) plans told us that because the  company can highlight its own funds as examples of investment options  under each asset class through investor education, it has no plans to offer  investment advice. While investment advice is subject to ERISA fiduciary  standards, which require that the advice must be in the participant’s best  interest and prohibit the adviser from having a financial interest in the  investment options recommended, investment education is not subject to  these standards. Thus, a provider furnishing education may do so despite  a conflict of interest, such as a financial stake in the outcome of  participants’ investment decisions. EBSA requires providers who highlight  proprietary funds as part of an asset allocation model to provide a  statement that other investment options may be available under a plan;  however, this statement may not sufficiently prevent participants from  construing information on investment alternatives as advice. For  example, the statement is not required to explain that the service provider  is not providing advice as an ERISA fiduciary who is required to act in the  participants’ best interests, and the provider may stand to profit from  participants’ investment decisions. Consequently, without the benefit of an  enhanced disclaimer that explicitly states that the highlighted funds are  not advice and that the service provider may have a financial interest in  the funds, participants may believe that providers are giving investment  advice that is in participants’ best interests, even in situations where this  may not be the case. In addition to furnishing asset allocation models,  some service providers may highlight specific investment funds in  communications with participants, as part of providing investment  education, by using language such as “you may wish to consider [this  investment fund]” instead of “I recommend,” which makes a subtle  differentiation between investment education and advice that most  participants will not understand. Moreover, agency field investigators said  that service providers who avoid rendering formal investment advice  subject to ERISA fiduciary standards may, nonetheless, refer to  themselves as investment advisers to participants. Participants who  confuse investment education for impartial advice may choose  investments that do not meet their needs, pay higher fees than with other  investment options, and have lower savings available for retirement.
Although several industry professionals said that providing investment  advice to participants through computer models, subject to ERISA  standards, has advantages in addressing potential conflicts of interest,  others said that these models could have biases that are difficult to detect.  While investment advice—through a direct service arrangement—can be  provided to participants through a computer model from a service  provider that does not have any affiliations with the investment options  offered, two other computer model arrangements are permitted, the  SunAmerica and the Pension Protection Act (PPA) eligible investment  advice arrangements, in cases where the service provider may have a  conflict of interest (see table 6). See appendix II for more information  regarding the common formats providers use to deliver investment  education and advice.
Several industry professionals we interviewed said these models ensure  consistency in the content of the advice rendered to multiple participants.
In addition, unlike a one-on-one consultation or group presentation, a  computer model may be audited to determine whether it is generating  impartial information. Despite these advantages of computer model- based advice, other industry professionals said that it is possible to build  biases into these models that may be difficult to detect. For example, a  computer model may be designed to exclude certain types of investment  options, which results in situations in which participants are receiving  advice that does not include all investment options available to  participants. In particular, representatives from one service provider told  us that a computer model’s exclusion of target date funds could allow a  provider to steer participants toward investment options that charge  higher fees, such as managed accounts.
Although a number of studies have been conducted about the availability  of investment assistance for participants, these studies do not always  discern whether participants are provided investment education or  advice. According to a poll of 401(k) plan sponsors and service providers  that we conducted in coordination with the Society of Human Resource  Management and the Society of Professional Asset-Managers and Record  Keepers, investment education is more commonly offered to participants  than investment advice, although many respondents offered both. Among  respondents, brochures or other written materials were one of the most  commonly used formats for delivering education and advice. Computer  modeling, including Web-based tools, was also one of the most common  methods of delivery reported.
section_title: Conflicts of Interest May Arise from Compensation to Service Providers for Cross-Selling Financial Products outside of Retirement Plans to Participants
paragraphs: Several industry experts we spoke with said that conflicts of interest also  arise for 401(k) service providers who sell nonplan products and services,  such as IRA rollovers, to participants outside their 401(k) plan, a practice  known as cross-selling, which can considerably increase the service  provider’s compensation. While IRAs may serve participants’ retirement  needs by assisting them in saving for retirement, industry professionals we  spoke to had concerns about the manner in which providers cross-sell IRA  rollovers and other products to participants. Cross-selling products  outside of a plan to participants can substantially increase a service  provider’s compensation, which creates an incentive for the service  provider to steer participants toward the purchase of these products even  though such purchases may not serve the participants’ best interests. For  example, products offered outside a plan may not be well suited to  participants’ needs or participants may be able to secure lower fees by  choosing investment funds within their plans comparable with products  offered outside their plans. Industry professionals we spoke with said  that cross-selling IRA rollovers to participants, in particular, is an  important source of income for service providers. For example, according  to an industry professional, a service provider could earn $6,000 to $9,000  in fees from a participant’s purchase of an IRA, compared with $50 to $100  in fees if the same participant were to invest in a fund within a plan.
Plan sponsors can take steps to preclude service providers from cross- selling nonplan products and services to plan participants. For example,  some plan sponsors require their plans’ service providers to sign  nonsolicitation agreements that prevent the service providers from  marketing nonplan products and services to participants, but such  agreements may not be widely used among plan sponsors. In addition,  some service providers do not directly cross-sell products and services  outside of a 401(k) plan to participants unless the service providers obtain  permission from plan sponsors to do so, or unless participants initiate the  discussion with service providers and inquire about products and services  that are outside of their plans’ investment offerings. According to our poll  of 401(k) plan sponsors and service providers, of the 475 SHRM  respondents who sponsored a 401(k) plan, 30 respondents explicitly  allowed providers to market, or cross-sell, nonplan products to  participants. Among the 30 respondents who allowed providers to engage  in cross-selling, IRA rollovers were the most common product marketed to  participants. However, the extent of cross-selling may be greater than  reflected by the poll responses because service providers may do so  without explicit permission. An industry professional told us that many  sponsors of small and midsized plans may not be aware that their  providers are cross-selling nonplan products and services to plan  participants; hence, sponsors would not know to ask their providers to  stop cross-selling nonplan products to participants.
Available data on IRA rollovers indicate that many participants choose to  roll their assets into an IRA rather than keep their assets in an existing  plan or roll them into a new employer’s plan. As shown in figure 5, from  1998 to 2007, more than 80 percent of funds flowing into IRAs came from  rollovers of lump-sum payments or account balances from defined benefit  and defined contribution plans.
According to data collected in 2006 from the Survey of Income and  Program Participation, a survey relating to income and related information  conducted by the U.S. Census Bureau, approximately 69 percent—or  approximately 4.87 million—survey respondents who received a lump-sum  distribution from their retirement plans rolled their distributed funds into  IRAs. Additionally, as shown in table 7, data from three large service  providers indicate that, among participants who terminated their DC plan,  between 42 and 48 percent of participants’ plan assets were rolled into  IRAs in the observed time periods.
An advisory opinion issued by EBSA states that ERISA fiduciary  standards do not apply to a service provider cross-selling an IRA rollover  to a participant unless the service provider is already servicing the plan  as an ERISA fiduciary. Consequently, unless the service provider is  already an ERISA fiduciary, the service provider may advise a participant  to roll his or her account funds into an IRA, even if such a transaction  may not be in a participant’s best interest. Without disclosures that  indicate whether the service provider’s assistance is subject to ERISA  fiduciary standards and whether the service provider has a financial  interest in the investment products, participants may mistakenly assume  that service providers are required to act in the participant’s best  interest. Furthermore, while final regulations may require a service  provider to furnish IRA fee disclosures—such as a disclosure statement  or a fee schedule—to participants, ERISA does not impose similar  disclosure requirements for IRAs. In particular, service providers are not  required to provide fee disclosures that specifically alert participants to  the difference in fees between comparable funds available in their plan  and funds offered by the plan’s service provider. As we reported in 2009,  owners of IRAs generally pay higher fees than participants in 401(k)  plans because an individual IRA’s account balance is usually not big  enough to purchase an amount of investments large enough to qualify for  volume discounts on fees. Representatives from a 401(k) record- keeping firm said that, typically, IRA owners pay higher fees in the range  of 25 to 30 bps and, in some cases, as high as 65 bps, which can be two to  three times higher than fees paid by plan participants for in-plan  investments. As a result of the lack of disclosure requirements on fees  associated with IRAs, participants may be unaware of the higher fees  associated with IRAs’ rollovers and may not understand that paying these  higher fees can reduce their retirement savings over time.
In March 2010, EBSA proposed a regulation that may improve fee  disclosure to participants by requiring ERISA fiduciary advisers to disclose  all fees or other compensation that they or their affiliates might receive in  connection with an IRA rollover before providing investment advice on  investment options for rollovers. However, the requirements would not  apply to nonfiduciaries that are providing advice to participants about IRA  rollovers or inform participants that fees for IRAs may actually be higher  than fees for investments in a plan. The U.S. Department of the Treasury  (Treasury) has proposed a separate regulation to require advisers to  provide notice to plan participants about the consequences of taking  money out of a retirement plan. Specifically, the disclosure would state  that, among other things, investment options available in a plan may not  be available for the same costs outside of a plan. However, without more  explicit disclosure that IRAs typically have higher fees than investments in  a plan, participants may not understand the difference in fees between  IRAs and investments in a plan or the implication of higher fees on  retirement savings over time.
section_title: EBSA’s Enforcement Program and Recent Regulatory Actions Take Steps to Address the Potential for Conflicted Investment Advice, but Further Changes Could Better Address Conflicts of Interest
subsections: section_title: EBSA’s Enforcement Efforts Do Not Address Potential Conflicts of Interest of Nonfiduciary Service Providers Involving the Selection of Investment Options
paragraphs: EBSA’s enforcement efforts regarding potential conflicts of interest  related to investment advice have not addressed potential violations by  non-ERISA fiduciary service providers. As we have previously reported,  EBSA’s ability to recover losses related to conflicts of interest by a service  provider through its enforcement program is largely limited by the extent  to which the service provider functions as a fiduciary under ERISA. For  EBSA to take action against an individual or entity, there generally must  be a breach of that fiduciary duty. This can be an obstacle for EBSA  given that many service providers structure their contracts with plans to  attempt to avoid meeting one or more of the five parts of the current  EBSA officials ERISA fiduciary definition reflected in EBSA regulations.noted that it was rare to find a pension consultant to an employee benefit  plan who acknowledged ERISA fiduciary status. Moreover, EBSA officials  told us that proving ERISA fiduciary status under the five-part test tends to be a difficult and complex task because it depends on the facts an circumstances of each case. These cases are usually very resource- intensive and involve interviewing plan sponsors and service providers  and reviewing a significant amount of documentation, which may need to  d  be subpoenaed. If EBSA is unable to determine that the service provider  was an ERISA fiduciary pursuant to the five-part test currently in effect, or  was otherwise an ERISA fiduciary, EBSA officials told us that they have  the authority to cite plan sponsors or other plan fiduciaries to take  corrective action for not prudently selecting and monitoring their service  providers. However, according to Labor’s OIG officials, EBSA does not  focus its enforcement activities on plan sponsors or other plan fiduciaries  that fail to detect conflicts of interest on the part of nonfiduciaries.
Indeed, although EBSA has taken steps to address conflicted investment  advice provided to plan sponsors or other plan fiduciaries by establishing  the Consultant/Adviser Project (CAP), this effort is constrained by the  current definition of an ERISA fiduciary investment adviser in its  regulations. EBSA launched CAP, a national enforcement effort, at the  beginning of fiscal year 2007 to investigate situations where ERISA  fiduciary pension consultants or advisers may have used positions of trust  with pension plans to generate improper, undisclosed fees for themselves  or their affiliates. Since its launch, EBSA has designated 40 CAP cases and,  as of August 2010, closed 16. Of these 16 cases, only 5 yielded results,  including restoration of plan assets and actions taken by ERISA fiduciaries  to ensure that the conflicts of interest did not occur again. However, EBSA  was unable to take action in other closed cases because it was unable to  prove that service providers were ERISA fiduciaries under the five-part  test or acted otherwise as fiduciaries. For example, EBSA investigated 12  of the 13 pension consultants identified in a 2005 SEC staff report for  failing to disclose significant ongoing conflicts of interest to their pension  fund clients—all 13 of which were considered fiduciaries under the  Advisers Act, which was used as a criterion in the SEC review—but EBSA  told us that many of the 13 pension consultants were adept at avoiding  fiduciary status under EBSA’s five-part test. As a result, Labor’s OIG  recently reported that EBSA was only able to take action on 2 of these 13  consultants because only those 2 consultants were determined to be  ERISA fiduciaries and were engaged in prohibited transactions. The OIG  report noted that without establishing ERISA fiduciary status, EBSA was  unable to enforce conflict of interest issues and did not take any further  action on these cases.
section_title: EBSA’s Approach for Initiating Enforcement Cases May Also Fail to Detect Some Conflict of Interest Violations by ERISA Fiduciaries
paragraphs: EBSA’s enforcement efforts through CAP may also miss violations by  some ERISA fiduciaries because EBSA’s approach for detecting violations  does not currently include routine compliance examinations, which could  help identify these violations. We reported in 2007 that EBSA does not  conduct routine compliance examinations to focus its enforcement efforts  the way other agencies do, and as a result, EBSA is not positioned to focus  its resources on key areas of noncompliance or have adequate measurable  performance goals to evaluate its impact on improving industry  compliance. For example, EBSA officials told us that they do not assess  overall service provider compliance with the SunAmerica advisory  opinion, which describes an appropriate method for providing one form of  advice to participants, and that they do not plan to assess compliance  with the Pension Protection Act’s eligible investment advice arrangement  provisions after they are finalized. Instead of routine compliance  examinations, CAP cases have been initiated based on a variety of sources,  including referrals from other agencies, spin-offs from regular  enforcement cases, tips, and media reports. According to EBSA, 18 of the  40 initiated CAP cases were based on referrals from external sources,  including the SEC staff report. While these leads may be specific and  detailed, EBSA may not be able to rely on consistent referrals from these  external sources because they may not always review the same topics. For  example, many of SEC’s referrals to EBSA, which resulted in CAP cases,  stemmed from a onetime review by SEC of pension consultants in 2005.  In addition, 9 CAP cases were initiated by EBSA investigators based on  leads from the media and participant complaints. While these sources are  important, such methods may not reveal violations that are more complex  or hidden. For example, it may be difficult for participants to detect  conflict of interest violations and submit complaints to EBSA, since  service providers’ business arrangements may be complicated and their  disclosures may be insufficient or difficult to understand. Finally, Labor’s  OIG told us that EBSA does not have a formal process for looking at  conflicts of interest regarding nonfiduciary service providers during  EBSA’s regular enforcement investigations—neither at the front end, when  a plan hires a service provider, nor later on during transactions of plan  assets. If EBSA’s investigators come across a potential conflict of interest  violation during their regular enforcement efforts, EBSA officials told us  that the investigators refer the conflict of interest portion of the  investigation to the CAP program. However, officials from Labor’s OIG  told us that, even though there have been numerous cases referred to the  CAP program in this manner, as of July 2010, none had progressed to a  CAP case in which EBSA took action against a service provider.
To address such limitations, we previously recommended EBSA consider  conducting routine compliance examinations. Specifically, we  recommended that EBSA evaluate the extent to which it could supplement  its current enforcement practices with strategies used by similar agencies,  such as routine compliance examinations and dedicating staff for risk  management. EBSA officials told us that, starting in fiscal year 2011, they  will implement routine compliance examinations.
section_title: Labor’s Recent and Proposed Regulations Address Some of the Potential for Conflicts of Interest in Investment Advice and Lack of Disclosure
paragraphs: In addition to its enforcement efforts, EBSA has recently announced  several regulatory initiatives that would address some potential conflicts  of interest on the part of service providers. These efforts include (1)  revising the definition of an ERISA fiduciary, (2) requiring enhanced  disclosure of providers’ direct or indirect compensation and fiduciary  status, and (3) establishing safeguards for PPA investment advice  arrangements. If the requirements specified in these regulations are  implemented as they are currently written, they may help EBSA and plan  sponsors detect and deter conflicted investment advice, but plan sponsors  and participants still would not have sufficient and comparable  information to identify potential conflicts of interest because disclosures  are not required to be provided in a consistent and summary format.
subsections: section_title: Fiduciary Definition Regulations
paragraphs: Proposed regulations by EBSA to amend the definition of an ERISA  fiduciary for purposes of investment advice, if implemented, would help  address potential conflicts of interest on the part of service providers by  encompassing a greater number of advisory relationships in which the  plan sponsor relies on the service provider when making investment  decisions. Existing regulations have been in effect for 35 years, and  EBSA officials told us they need to be revised based on knowledge and  experience EBSA has gained through its enforcement efforts, as well as  the evolution of the 401(k) industry.
In the preamble to the proposed regulations, EBSA acknowledges that the five-part test  takes a narrow approach to fiduciary status that “sharply limits” its ability to protect plans  and their participants and beneficiaries from conflicts of interest that may arise from the  diverse and complex fee practices existing in today’s retirement plan services market and  to devise effective remedies for misconduct when it occurs. Accordingly, the new proposed  regulations are intended to more broadly define the circumstances under which a person is  considered a fiduciary by reason of giving investment advice to a plan or its participants. 75  Fed. Reg. 65,263, 65,271.
OIG noted that the five-part test is narrow and hampers EBSA’s  enforcement efforts. In place of the five-part test, the proposed regulation  would establish ERISA fiduciary status based on a broader standard. In  particular, the proposed regulation makes the following key changes,  among others:    Acknowledgment or representation as an ERISA fiduciary is sufficient to  result in ERISA fiduciary status.
Advice does not need to be provided on a regular basis to be considered a  fiduciary act.
The parties do not need to have a mutual understanding that the advice  will serve as a primary basis for plan investment decisions.
Fulfilling any of the independent and alternative conditions specified in  the proposal would be sufficient to result in ERISA fiduciary status for  purposes of investment advice. By reducing the number of conditions  that need to be met to be deemed an ERISA fiduciary, the proposed  regulation would encompass a greater number of service providers  assisting plan sponsors with selecting investment options. In addition, the  revised standards more closely align with advisory relationships that  industry experts and service providers told us plan sponsors rely on to  make investment decisions. As a result, the proposed regulations should  help reduce confusion on the part of plan sponsors, many of whom are  reported to currently believe they are receiving impartial advice subject to  ERISA fiduciary standards when this is not the case. Moreover, the  regulation may aid EBSA’s enforcement efforts regarding conflicted  investment advice by simplifying the method EBSA uses to determine who  is an ERISA fiduciary. In addition to amending the five-part test, the  proposed regulations also state that selling or marketing investment  options to a plan sponsor does not constitute investment advice if it is  disclosed in writing that the person is not undertaking to provide impartial  investment advice. However, the proposed regulation does not specify  the format for this disclosure. Given that industry experts told us there is a  considerable amount of confusion among plan sponsors about whether or  not they are receiving investment advice subject to ERISA fiduciary  standards, some plan sponsors may continue to be unaware of the  distinction between ERISA fiduciary advice and sales or marketing  activities without a requirement that this disclosure be made in a  consistent and prominent manner. While the proposed regulations should  result in a greater number of advisory relationships being subject to ERISA  fiduciary standards, the regulation has yet to be finalized. If EBSA does  not finalize this regulation and replace the five-part test, many service  providers may continue to act outside of ERISA fiduciary standards and  EBSA’s enforcement efforts will remain limited.
section_title: Service Provider Disclosure Regulations
paragraphs: Interim final regulations released by EBSA in July 2010 require enhanced  service provider disclosure of compensation and ERISA fiduciary status.  These regulations, effective on July 16, 2011, for both new and existing  arrangements between service providers and ERISA plans, specify that a  contract between a covered plan and a covered service provider is not  reasonable unless certain disclosures are made to the responsible plan  fiduciary. Required disclosures include descriptions of the services to be  provided to the plan and the compensation the provider expects to receive  for those services. In addition, if service providers expect to provide  ERISA fiduciary services to plans, they are required to make a statement  to such effect. Industry experts indicated that this regulation should help  plan sponsors identify conflicts of interest and assess whether they are  causing harm to participants’ balances. In addition the new disclosure  requirements will allow EBSA to exercise enforcement authority over  service providers who refuse to disclose direct and indirect  compensation. As shown in table 8, disclosures required by this  regulation would provide plan sponsors with valuable information and  could enhance their ability to evaluate compensation arrangements and  potential conflicts of interest.
While these disclosures may help plan sponsors and EBSA detect and  deter conflicted investment advice, they may leave out important  information that could help plan sponsors compare compensation  arrangements and assess the potential for conflicts of interest.  Specifically, the interim final regulations do not specify that these  disclosures be made in any particular manner or format. As a result, the  disclosures may be made through multiple documents, which could  reduce their usefulness for plan sponsors and EBSA in detecting conflicts  of interest given that, as industry experts told us, such disclosures can be  very complicated and difficult to understand. As part of the comment  process on these interim final regulations, EBSA solicited comments about  the feasibility of requiring the disclosures to be reported in a consistent  and summary format, such as taking the form of a summary document,  limited to one or two pages, that would include key information intended  to provide an overview for the responsible plan fiduciary of the  information required to be disclosed. The summary also would be  required to include a road map for the plan fiduciary describing where to  find the more detailed elements of the disclosures required by the  regulation. EBSA plans to examine the comments received before it  includes this kind of requirement in the final regulations. Without being  presented in a consistent summary format, the disclosure regulations may  not be as effective as intended.
Another limitation of these interim final regulations is that they do not  require that service providers specifically disclose whether they have  conflicts of interest. Since many conflicts result from the payment of  money or other items of monetary value, EBSA and others have argued  that the direct and indirect compensation disclosures required by this  interim regulation will reveal some conflicts of interest. But, while these  regulations may provide more compensation information to plan sponsors,  Labor’s OIG told us that the regulations do not necessarily ensure that plan  sponsors understand how the compensation translates into business  arrangements with potential conflicts of interest. In a recent report,  Labor’s OIG found that the disclosures required by EBSA’s interim final  regulation would not require that conflicts from two of the cases identified  in the 2005 SEC study be disclosed. They pointed to these two cases as  examples to show how conflicts of interest could go undetected under the  interim final regulations. As a result, OIG recommended that EBSA require  the disclosure of all conflicts of interest. In response, EBSA stated that it  felt that the interim final regulation may already provide this requirement  through the detailed disclosures of direct and indirect compensation and  that it was in the process of providing clarifying interpretations. Given that  plan sponsors must assess conflicts of interest when selecting service  providers, it is important that such conflicts be clearly disclosed.
In addition, the interim final regulation requires service providers to  disclose information to plan sponsors, but not participants. While some  of these disclosures may make it to participants through various  communications by plan sponsors, complete information on service  provider compensation is not readily available to participants. As an  attempt to remedy this, EBSA also published final regulations on October  20, 2010, designed to improve participant-level fee disclosure by requiring  that plan sponsors provide participants core information about  investments available under the plan, including performance and fee  information, in a chart or similar format designed to facilitate investment  comparisons.
section_title: PPA Eligible Investment Advice Arrangement Regulations
paragraphs: Many industry experts we interviewed said that investment advice  arrangements permitted under the PPA should make investment advice  more widely available to participants; however, some industry experts said  the established safeguards may not sufficiently address potential conflicts  of interests on the part of service providers. ERISA generally precludes  service providers with conflicts of interest from furnishing investment  advice. However, in an effort to expand the availability of investment  advice to more participants, the PPA created two eligible investment  advice arrangements that allow service providers who have a conflict of  interest to furnish advice to plan participants. Specifically, under the PPA,  an otherwise conflicted service provider may furnish investment advice  using either a computer model arrangement or a level fee arrangement.
EBSA proposed regulations in March 2010 to administer these  requirements of the PPA and received comments from industry  professionals and other interested parties. Several industry professionals  and service providers submitted comments in support of EBSA’s efforts to  increase participants’ access to unbiased investment advice and minimize  the effects of service providers’ potential conflicts of interests. However,  some industry professionals we interviewed expressed concerns about  whether the PPA advice arrangements sufficiently minimize the risks  posed by service providers’ conflicts of interest since it is possible to  embed investment biases into computer models, which may be difficult to  detect even when computer models are audited. For example, an industry  representative said that adequate monitoring and auditing of computer  models may be costly and that auditors may not be aware of the various  ways in which computer models could be manipulated. In addition,  computer models may be designed to exclude certain types of investment  options, such as target date funds. If basic investment options offered in a  plan are excluded from the computer model, the advice provided will be  based on an incomplete analysis of investment options or holdings the  participant may have in his or her 401(k) account. The exclusion of certain  investment options from computer models may have the effect of steering  participants toward options that may involve higher fees. Furthermore,  even in the situation where a service provider’s profits do not vary  depending on participants’ investment decisions, the service provider may  nonetheless exhibit a natural bias toward its proprietary funds when  furnishing fund recommendations to participants.
section_title: Conclusions
paragraphs: While there are no comprehensive data on the prevalence or impact of  service providers’ conflicts of interest, available evidence suggests that  there are a broad range of potential conflicts of interests that may harm  participants and beneficiaries. Numerous industry experts we spoke with  identified a wide variety of arrangements, often, but not always, complex,  where conflicts of interest can occur to the possible detriment of plans  and their participants. The arrangements are often designed in a way that  makes it difficult for conscientious plan sponsors to detect them.  Participants rely on the plan and its fiduciaries to review the investment  options and services provided through the plan. Given the potential for  financial harm to participants, it is important to ensure that plan sponsors,  as fiduciaries, are aware of whether a conflict of interest exists and that  the actions of service providers are appropriate. Conflicts of interest  related to the plan’s investment options can negatively affect 401(k)  participants through higher fees and lower investment returns, which,  ultimately, reduce their income in retirement. When service providers  stand to gain from a plan sponsor or participant’s selection of investment  options, it is important to ensure that those providers do not have an  undue influence over the plan sponsor or participant’s selection process— or participants’ balances could suffer. However, the complexity of  business arrangements with service providers presents significant  challenges for plan sponsors to fulfill their obligation to identify and  mitigate potential conflicts of interest and ensure that the plan is operated  in the best interest of participants. This may be particularly problematic  for smaller plans, which do not have the resources to hire an independent  adviser to review their options. The presence of conflicts of interest and  the potential for financial harm hinder participants’ retirement security  and call into question the integrity of the 401(k) system, and may  undermine participants’ trust and willingness to save for retirement.
EBSA has a pivotal role in helping plan sponsors ensure that plans are  operated in participants’ best interests. In order to make prudent  investment decisions, plan sponsors and participants need to understand  when a service provider is acting in the role of a salesperson rather than a  fiduciary adviser, required by law to act in the best interests of the plan  and its participants. It is especially important for plan sponsors and  participants to know if a service provider stands to gain from the selection  of particular investment options. EBSA has recently taken several  important steps to address the potential for conflicts of interest in  investment advice. In particular, EBSA’s interim final regulations, which  require service providers to give enhanced disclosure of compensation  arrangements, could help plan sponsors more clearly identify potential  conflicts of interest and the fiduciary status of service providers. These  regulations should help address the challenges faced by plan sponsors and  participants. However, unless the disclosures are presented in a format  that allows for a consistent comparison across investment options, it will  inhibit the effectiveness of these regulations. If changes are not made to  current disclosures, plan sponsors will not be able to make meaningful  comparisons among different funds and providers. In addition, given that  EBSA’s enforcement efforts for conflicts of interest focus on service  providers rather than plan sponsors, EBSA should finalize its proposed  regulations to revise the current five-part test to better ensure that service  providers that recommend investment options are subject to ERISA’s  fiduciary standard, and enhance disclosure to plan sponsors when  investment assistance is not impartial. If the five-part test is not changed,  service providers may still make investment recommendations to plan  sponsors without being subject to ERISA fiduciary standards, and EBSA’s  ability to take enforcement actions will continue to be limited. Moreover,  if disclosures to plan sponsors are not required to be made in a consistent  and prominent manner, some plan sponsors may continue to be unaware  of the distinction between ERISA fiduciary advice and sales or marketing  activities.
Additional measures are also needed to better ensure that participants are  protected from the potential consequences of conflicted investment  advice. To better ensure that participants are not improperly swayed by  educational communications, requirements for guidance to participants on  the difference between education and advice may need to be evaluated.  Without a change in current standards, participants may continue to  perceive education as advice and make decisions on the basis of  information communicated by service providers with a financial interest in  the investment funds. Improved disclosures may also be needed to help  participants understand whether their service provider is acting as a  salesperson rather than a fiduciary adviser when providing assistance to  participants in acquiring financial products outside of the plan, such as an  IRA rollover. Otherwise, participants will continue to be unaware if their  plan’s service provider is not required to provide advice in the best interest  of the participant and may be earning a commission from these product  sales. Efforts for improved disclosure may be strengthened through  coordination with the Department of the Treasury on proposed regulations  designed to help participants understand the potential consequences of  moving assets outside of their plan. If no action is taken and conflicts of  interest persist, participants’ confidence and willingness to save in the  401(k) system may be weakened and an untold number of 401(k)  participants may pay unnecessarily high costs, through investment fees  and IRA rollovers; accrue lower investment returns; and have  correspondingly less savings available for retirement.
section_title: Recommendations for Executive Action
paragraphs: To better ensure that plan sponsors and participants can rely on impartial  information in making investment decisions, we recommend that the  Secretary of Labor direct the Assistant Secretary for EBSA to take the  following actions:    Amend and finalize proposed regulations to change the definition of a  fiduciary for purposes of investment advice. Specifically, the Secretary  should amend the proposed regulations to require that service providers’  written disclosures specifying that they are not undertaking to provide  impartial investment advice be provided to the plan sponsor in a  consistent and prominent manner.
Amend and finalize interim final regulations regarding disclosure of  service providers’ direct and indirect compensation from plan investments  and fiduciary status to require that the information be provided in a  consistent and summary format.
Evaluate and revise Labor’s interpretive bulletin on investment education,  which is important in helping participants and beneficiaries make  investment decisions. Specifically, in light of current practices, the  Secretary should revise current standards, which permit a service provider  to highlight certain investment alternatives, such as proprietary funds,  which may result in greater revenue to the service provider, in educational  materials. Labor could consider a variety of steps to address this potential  conflict of interest, such as requiring service providers to disclose that  they may have a financial interest in the options highlighted or prohibiting  them from using proprietary funds as examples.
Require that service providers, when assisting participants with the  purchase of investment products offered outside of their plan, disclose in  a consistent and prominent manner, either before or at the point of sale,  any financial interests they may have in the outcomes of such transactions  and inform participants as to whether their assistance is subject to ERISA  fiduciary standards.
In addition, to better ensure that plan participants have sufficient  information when deciding whether to move plan funds into investment  alternatives outside their plan, we recommend that the Secretary of the  Treasury amend the applicable requirements of its proposed disclosure  rule to specifically require that service providers, when recommending the  purchase of investment products outside retirement plans, inform plan  participants that fees applicable outside their plans may be higher than  fees applicable within their plans.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to the Department of Labor, SEC, and  Treasury for their review. Treasury generally agreed with our  recommendation to amend its proposed disclosure rule to specify that fees  applicable for investment products outside of plans may be higher than  fees applicable within plans. Treasury and SEC also provided technical  comments, which we have incorporated where appropriate.
Overall, Labor generally agreed with our findings and to consider our  recommendations as it conducts a review of these issues and evaluates  public comments received on pending regulations. Labor noted that the  interim final regulation to require enhanced disclosure of service  providers’ compensation arrangements represents significant progress and  disagreed with our conclusion that these disclosures will not be effective  unless they are presented in a format that allows for a consistent  comparison across investment options. We concur that the disclosures  required by this regulation would provide plan sponsors with valuable  information and could enhance their ability to evaluate potential conflicts  of interest. However, industry experts we spoke with noted that such  disclosures can be very complicated and difficult to understand.  Furthermore, as Labor has previously pointed out in the interim final rule  regarding fee disclosure (75 Fed. Reg. 41,600), in the absence of a  summary format, a service provider can fulfill this requirement by  providing different documents from separate sources. Providing  disclosures in multiple formats in different documents will inhibit the  effectiveness of this regulation, particularly for plans that do not have the  requisite expertise or the resources to hire an independent adviser to  review their options.
Additionally, Labor noted that GAO did not conduct a cost-benefit analysis  of recommendations to address potential conflicts of interest. GAO  conducts its work in response to congressional requests for information  and employs a variety of qualitative and quantitative methodologies in  carrying out our mission. We choose these methodologies based on a  variety of factors and constraints, such as the scope of our research  objectives, availability of reliable data, costs and time constraints, as well  as other considerations. We acknowledge that there are a number of  options Labor could consider for the format of a summary disclosure and  we agree that this requirement should be implemented at minimal cost to  service providers and sponsors. We support Labor’s following the  appropriate administrative procedures in conducting its regulatory  reviews and initiatives, including conducting a cost-benefit analysis. In this  context, we wish to reiterate our past concerns about the harm plan  participants can experience from undisclosed conflicts of interest. For  example, as we reported in 2007, our analysis of available data on pension  consultants and DB plans revealed a statistical association between  inadequate disclosure of conflicts of interest and lower investment returns  for ongoing plans. We also note that disclosing potential conflicts of  interest in a manner that is readily apparent could benefit EBSA’s  oversight and enforcement efforts. Further, if Labor found the cost to  service providers in preparing a summary document to be significant, this  would also point to the difficulty that plan sponsors would have in  extracting this information from multiple documents to obtain consistent  information to allow for comparisons across different investment options  and providers.
Labor also noted, regarding our recommendation to revise the interpretive  bulletin on investment education, that current standards take a number of  steps to limit the potential for abuse and Labor would need to evaluate  several factors in considering any changes. While we concur that the  interpretive bulletin includes several requirements to address the potential  for conflicts of interest, it does not specifically alert participants when the  service provider has a financial interest in investment options highlighted  as examples, nor does it state that these examples do not constitute  investment advice. Without an explicit disclaimer to this effect,  participants may believe that providers are giving investment advice that is  in participants’ best interests, even in situations where this may not be the  case. We look forward to Labor’s evaluation of this issue and options to  address it.
Finally, Labor noted that it may not have the authority to act on our  recommendation to require service providers to disclose financial interests  they may have in the sale of financial products outside of the plan, such as  IRA rollovers. In the recently proposed regulation to amend the definition  of an ERISA fiduciary, Labor noted concerns that participants may not be  adequately protected from advisers who provide distribution  recommendations that subordinate participants’ interests to the advisers’  own interests and solicited comments on possible actions to take to  address this issue. We look forward to Labor’s evaluation of whether or  not it has the authority to address conflicts of interest related to the sale of  financial products outside of the plan. If Labor determines that it does not  have the authority to act in this area, it may be appropriate for Congress to  consider possible legislative remedies. In the absence of any action to  address this issue, participants may continue to be unaware when their  plan’s service provider stands to gain from the sale of IRA rollovers and  other financial products outside of the plan.
Labor also provided technical comments on the draft report, which we  have incorporated where appropriate.
As arranged with your office, unless you publicly announce its contents  earlier, we plan no further distribution of this report until 30 days from the  date of this letter. At that time, we will send copies to the Secretary of  Labor, Secretary of the Treasury, and Chairman of the Securities and  Exchange Commission.
If you or your staff have any questions concerning this report, please  contact me at (202) 512-7215. Contact points for our Office of  Congressional Relations and Office of Public Affairs may be found on the  last page of this report. GAO staff that made major contributions to this  report are listed in appendix V.
section_title: Appendix I: Scope and Methodology
paragraphs: To determine the circumstances where conflicted investment advice may  be provided to plan sponsors, we analyzed available research and  documentation, including a report from the Securities and Exchange  Commission (SEC), industry white papers, and documentation from the  Department of Labor (Labor) and SEC cases pertaining to service provider  conflicts of interest. We also interviewed industry professionals; pension  consulting firms and other service providers; officials from Labor, SEC,  the Department of the Treasury, the Financial Industry Regulatory  Authority, and the Securities Industry and Financial Markets Association;  and other relevant organizations. To determine how the fiduciary duty of  the Employee Retirement Income Security Act of 1974 (ERISA) applies to  investment advice provided to plan sponsors and the scope of ERISA’s  prohibited transactions rule, we reviewed relevant laws, including ERISA  securities laws, regulations, and Labor advisory opinions, and interviewed  industry professionals. As part of our research, we reviewed available  information, including a report from Labor’s Office of Inspector General,  and conducted interviews with industry professionals and Labor officials  to determine the extent to which advisers to plan sponsors are considered  ERISA fiduciaries.
To determine the circumstances where conflicted investment advice may be  provided to plan participants, we reviewed available literature and  interviewed industry professionals and plan service providers. Additionally,  we reviewed relevant statutes, including ERISA and the Pension Protection  Act of 2006 (PPA), as well as regulations promulgated by Labor to  understand where applicable law draws the distinction between investment  education and advice. To determine what is known about the extent to  which plan participants have access to investment education and advice,  and to identify the common formats for furnishing such information, we  reviewed available data from industry studies and conducted a poll of plan  sponsors and service providers, as described below:    We reviewed data from the Profit Sharing/401(k) Council of America’s  (PSCA) 2008 survey of retirement plans (published in 2009, but reflecting  2008 plan experience). The results of PSCA’s 2008 survey are based on the  experiences of 908 plans—including 28 profit-sharing plans, 607 401(k)  plans, and 273 combination profit-sharing/401(k) plans—with 7.4 million  participants. The plans that participated in PSCA’s survey range in size  from 1 participant to 5,000-plus participants. PSCA is a nonprofit  association of 1,200 companies that sponsor defined contribution plans for  5 million employees. PSCA represents the interests of its members and  offers assistance with profit-sharing and 401(k) plan design,  administration, investment, compliance, and communication.
In addition to reviewing industry data to assess the availability of  investment education and advice for plan participants, we created an  online questionnaire in coordination with the Society of Human Resource  Management (SHRM) and the Society of Professional Asset-Managers and  Record Keepers (SPARK). In the questionnaire, we asked plan sponsors  that are members of SHRM and service providers that are members of  SPARK whether investment education and advice are provided to plan  participants, the format for delivering such information, and whether  investment products and services unrelated to plans are marketed to  participants. We implemented the Web-based questionnaire with SPARK  members using our Web application, while SHRM implemented the  questionnaire with its members using SHRM’s Web application. SHRM and  SPARK officials solicited responses from their members by distributing, to  their members, our e-mail introducing the study, describing the question  topics, and directing members to an Internet address for the questions.  SHRM and SPARK officials also sent out periodic reminders about the  questionnaire over several weeks between July 2010 and August 2010.  SHRM distributed the introductory e-mail among 2,698 of its members, and  SPARK distributed the e-mail among its board members, which included  representatives from every SPARK member organization (over 250  companies). In total, 700 members—627 from SHRM and 73 from  SPARK—responded to the questionnaire. The survey results are not  representative of the general plan sponsor and service provider  populations because our respondent population excludes plan sponsors  that are not members of SHRM and service providers that are not  members of SPARK. Because of the methodological limitations associated  with deploying these questions, information obtained represents only the  views of the respondents, not the overall population of 401(k) plan  sponsors and service providers. In addition, we took steps in the  development of the questions to minimize the variability of survey results.  Prior to administering the questionnaire, the questions were reviewed by  an independent survey expert in our methodology group and officials from  SHRM and SPARK. We made changes to the content and format of the  questionnaire based on reviewers’ feedback.
To analyze the incidence of IRA rollovers among plan participants, a  circumstance in which conflicted investment assistance may be provided  to plan participants, we collected and analyzed industry data from three  sources to determine the frequency with which plan participants are  rolling plan funds into IRAs:   The Survey of Income and Program Participation (SIPP), which is a  survey conducted by the U.S. Census Bureau. The main objective of  the SIPP is to provide accurate and comprehensive information  about the income and program participation of individuals and  households in the United States. The SIPP is conducted on a  continuous series of national panels, with durations from 2 ½ to 4  years, with sample size ranging from approximately 14,000 to 36,700  interviewed households. The SIPP sample is a multistage-stratified  sample of the U.S. civilian, noninstitutionalized population. We used  data from the 2004 topical module 7 survey and extracted survey  responses to determine the percentage of survey respondents who  took cash distributions from their retirement plans and rolled  distributed funds into individual retirement accounts (IRA). In  particular, we used variables EPREVLMP (for survey respondents  who have ever received a lump-sum payment from a pension or  retirement plan from a previous job, including any lump sums that  may have been directly rolled over to another plan or to an IRA) and  ELMPWHER, answer choice IRA (for survey respondents who  rolled lump-sum payments into IRAs). The 2004 SIPP survey results  are based on responses from people surveyed in different waves  over a 2 ½-year period, with survey interviews lasting into 2006.  Specifically, for wave 7, interviews were conducted from February  2006 to May 2006. Results are generalizable to the population at the  time of survey.
The Investment Company Institute (ICI) is the national association  of U.S. investment companies, and it works to promote public  understanding of mutual funds and other investment companies. ICI  publishes statistics on the U.S. retirement market every quarter as  an information resource for mutual fund companies, the media,  policymakers, and researchers. ICI combines data from its own  mutual fund survey database and from other trade associations with  data from the U.S. Department of Labor, the Federal Reserve Board,  and the Internal Revenue Service (IRS) to compile detailed IRA  asset information, including the portions of funds flowing into IRAs  from rollovers and contributions. Total IRA market assets are  derived from tabulations of total IRA assets provided by the IRS  Statistics of Income Division for tax years 1989, 1993, 1996-2002,  and 2004; with preliminary data provided for 2006 and 2007.  Tabulations are based on a sample of IRS returns. GAO did not  conduct any direct analysis of ICI data.
Three service providers that service defined contribution plans also  compiled proprietary data on what happens to plan participants’  defined contribution plan funds when participants terminated their  retirement plans. Results from service provider 1 were based on  976,600 terminated participants in the provider’s defined  contribution retirement plan services from March 1, 2005, through  May 31, 2010. Results from service provider 2 were based on 9,790  terminated participants in the provider’s retirement plan services  401(k) plans from January 1, 2008, through March 31, 2009. Results  from service provider 3 were based on participants with termination  dates in 2008. The universe consisted of more than 3 million  participants from more than 2,200 plans. In addition, the proprietary  data from plan service providers are not generalizable to the  universe of retirement plan participants. However, the results are  consistent with and corroborate each other.
We assessed the reliability of the data we present and found the data to be  sufficiently reliable as used in this report.
To describe the steps that Labor has taken to address conflicts of interest,  we reviewed documentation of Labor’s enforcement activities related to  conflicted investment advice practices. We also reviewed past GAO and  Labor Inspector General reports and interviewed Labor officials to  evaluate the adequacy of Labor’s enforcement efforts to prevent conflicted  investment advice. In addition, we reviewed documentation from Labor  and industry participants related to three recent or soon-to-be-released  Labor regulations: (1) a proposed rule amending the definition of ERISA  fiduciary duty regarding investment advice (published in October 2010),  which would amend the regulatory definition of the fiduciary duty for plan  investment advisers to include pension consultants and other plan  advisers who do not fall under the current regulatory definition; (2) an  interim final rule regarding service provider disclosures of direct and  indirect compensation to plan sponsors (issued in July 2010); and (3) PPA  eligible investment advice arrangements (issued in March 2010), which fall  under a statutory exemption to the ERISA prohibited transactions rule.  Finally, we interviewed Labor officials to discuss the scope of each  regulation and key features that may mitigate conflicts of interest.
We conducted our review from January 2010 through January 2011 in  accordance with generally accepted government auditing standards. Those  standards require that we plan and perform the audit to obtain sufficient,  appropriate evidence to provide a reasonable basis for our findings and  conclusions based on our audit objectives. We believe that the evidence  obtained provides a reasonable basis for our findings and conclusions  based on our audit objectives.
section_title: Appendix II: Common Formats for Delivering Investment Education and Advice
paragraphs: Investment education and advice may be provided to participants in  different formats, most commonly through brochures or other written  materials and computer modeling. Other formats for providing education  or advice include one-on-one sessions with service providers and seminars  and workshops. A number of studies have been conducted about the  availability of investment assistance for participants; however, these  studies do not always discern whether participants are provided  investment education or advice. According to a poll of 401(k) plan  sponsors and service providers that we conducted in coordination with  SHRM and SPARK, investment education is more commonly offered than  investment advice, although many respondents offered both. As shown in  figure 6, of the 475 SHRM respondents who sponsored a 401(k) plan, 380  provided investment education and 215 provided investment advice. Of  these respondents, 202 provided both education and advice. Among  respondents, brochures or other written materials were the most  commonly used formats for delivering education and advice. Computer  modeling, including Web-based tools, was the second most common  method of delivery reported. Industry research by an organization of  401(k) and profit-sharing plans yielded similar results, with 51.8 percent of  plans providing investment advice to plan participants and with 28.3  percent of participants using advice when it was offered. Among plans  providing investment advice, the most common methods of delivery are  one-on-one counseling sessions, Internet providers (including those with  computer modeling programs), and telephone hotlines. Industry survey  results also indicate that smaller plans with fewer than 50 participants are  more likely to use one-on-one counseling sessions, while larger plans of  5,000-plus participants tend to use Internet providers.
section_title: Appendix III: Types of Computer Model Advice Arrangements
paragraphs: Computer models can be used to render investment advice to participants  in three different arrangements: (1) the direct service arrangement, (2) the  SunAmerica arrangement, and (3) the PPA computer model arrangements.  As shown in figure 7, the direct service arrangement is utilized when a  plan sponsor contracts directly with an independent advisory firm, which  develops a computer model that renders advice to plan participants. The  independent advisory firm should not be affiliated with any investment  fund or accept payments from funds that its model recommends as  investment options. Accordingly, the firm should operate without a vested  interest in its recommendations and not incur any conflicts of interest.
For advice arrangements where providers offer their own investment  funds and thus have a conflict of interest, Labor has set forth specific  requirements under which these providers may offer investment advice. As  shown in figure 8, the SunAmerica arrangement allows the service  provider to contract with an independent advisory firm to develop and  administer a computer model to provide investment advice. Because the  primary service provider may have a conflict of interest for certain  investment options offered to participants, Labor requires that, among  other things, the independent financial expert—who is not the primary  service provider—develop and maintain the computer model that renders  advice to participants solely in the interest of plan participants.
As shown in figure 9, the PPA computer model arrangement, on the other  hand, allows the service provider to develop the computer model in-house,  subject to certain requirements the PPA has established to address the  service provider’s conflict of interest.
Labor has proposed regulations that would allow a primary service  provider to develop and maintain the computer model that renders advice  to participants if, among other things, the model has been certified by an  independent financial expert and undergoes annual audits. Therefore,  unlike the direct service or SunAmerica arrangements, where an  independent advice provider is the creator of a computer model that  renders advice to participants, the PPA computer model arrangement  bypasses the independent advice provider and allows the primary service  provider to create the computer model that renders advice to participants.  In addition to permitting the use of the computer modeling advice  arrangement, the PPA also permits a level fee advice arrangement, which  allows a provider who may otherwise have a conflict of interest—such as a  provider whose proprietary funds are part of a plan’s investment lineup— to furnish investment advice to participants. Specifically, Labor’s proposed  regulations specify that a provider may furnish advice to participants if the  provider’s fees do not vary depending on participants’ investment  decisions. A Labor publication indicates that the level fee requirement  applies to the service providers’ representatives and their employers, but  not their affiliates.
section_title: Appendix IV: Comments from the Department of Labor
section_title: Appendix V: GAO Contacts and Acknowledgments
subsections: section_title: GAO Contact
section_title: Acknowledgments
paragraphs: In addition to the contact named above, Tamara Cross, Assistant Director;  Sharon Hermes, Analyst-in-Charge; Jessica Gray; and Kun-Fang Lee made  important contributions throughout this report.
Susan Baker, James Bennett, Susan Bernstein, Rachel DeMarcus, Cody  Goebel, Ying Long, Sheila McCoy, Karen O’Conor, Roger Thomas, and  Walter Vance also provided key support.
section_title: Related GAO Products
paragraphs: Private Pensions: Changes Needed to Provide 401(k) Plan Participants and the  Department of Labor Better Information on Fees. GAO-07-21. Washington, D.C.:  November 16, 2006.
Employee Benefits Security Administration: Enforcement Improvements Made but  Additional Actions Could Further Enhance Pension Plan Oversight. GAO-07-22.  Washington, D.C.: January 18, 2007.
Defined Benefit Pensions: Conflicts of Interest Involving High Risk or Terminated  Plans Pose Enforcement Challenges. GAO-07-703. Washington, D.C.: June 28, 2007.
Private Pensions: Fulfilling Fiduciary Obligations Can Present Challenges for  401(k) Plan Sponsors. GAO-08-774. Washington, D.C.: July 16, 2008.
Private Pensions: Conflicts of Interest Can Affect Defined Benefit and Defined  Contribution Plans. GAO-09-503T. Washington, D.C.: March 24, 2009.
Retirement Savings: Better Information and Sponsor Guidance Could Improve  Oversight and Reduce Fees for Participants. GAO-09-641. Washington, D.C.:  September 4, 2009.
Defined Contribution Plans: Key Information on Target Date Funds as Default  Investments Should be Provided to Plan Sponsors and Participants. GAO-11-118.  Washington, D.C.: January 25, 2011.