EBSA Proposed Rules

Investment Advice--Participants and Beneficiaries   [8/22/2008]
[PDF]
FR Doc E8-19272
[Federal Register: August 22, 2008 (Volume 73, Number 164)]
[Proposed Rules]               
[Page 49895-49923]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr22au08-24]                         


[[Page 49895]]

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Part V





Department of Labor





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Employee Benefits Security Administration



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29 CFR Parts 2550



Investment Advice--Participants and Beneficiaries; Proposed Class 
Exemption for the Provision of Investment Advice to Participants and 
Beneficiaries of Self-Directed Individual Account Plans and IRAs; 
Proposed Rule; Notice


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DEPARTMENT OF LABOR

Employee Benefits Security Administration

29 CFR Part 2550

RIN 1210-AB13

 
Investment Advice--Participants and Beneficiaries

AGENCY: Employee Benefits Security Administration, DOL.

ACTION: Proposed rule.

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SUMMARY: This document contains proposed regulations implementing the 
provisions of the statutory exemption set forth in sections 408(b)(14) 
and 408(g) of the Employee Retirement Income Security Act, as amended 
(ERISA or the Act), and parallel provisions in the Internal Revenue 
Code of 1986, as amended (Code), relating to the provision of 
investment advice described in the Act by a fiduciary adviser to 
participants and beneficiaries in participant-directed individual 
account plans, such as 401(k) plans, and beneficiaries of individual 
retirement accounts (and certain similar plans). Section 408(b)(14) 
provides an exemption from certain prohibited transaction provisions in 
ERISA with respect to the provision of investment advice, the 
investment transaction entered into pursuant to the advice, and the 
direct or indirect receipt of fees or other compensation by the 
fiduciary adviser or an affiliate in connection with the provision of 
advice or the transaction pursuant to the advice. Section 408(g) 
describes the conditions under which the investment advice-related 
transactions are exempt. Upon adoption, the regulations will affect 
sponsors, fiduciaries, participants and beneficiaries of participant-
directed individual account plans, as well as providers of investment 
and investment advice-related services to such plans.

DATES: Written comments on the proposed regulations should be submitted 
to the Department of Labor on or before October 6, 2008.

ADDRESSES: To facilitate the receipt and processing of comment letters, 
the Employee Benefits Security Administration (EBSA) encourages 
interested persons to submit their comments electronically by e-mail to 
e-ORI@dol.gov (Subject: Investment Advice Regulations), or by using the 
Federal eRulemaking portal at http://www.regulations.gov (follow 
instructions for submission of comments). Persons submitting comments 
electronically are encouraged not to submit paper copies. Persons 
interested in submitting paper copies should send or deliver their 
comments to the Office of Regulations and Interpretations, Employee 
Benefits Security Administration, Attn: Investment Advice Regulations, 
Room N-5655, U.S. Department of Labor, 200 Constitution Avenue, NW., 
Washington, DC 20210. All comments will be available to the public, 
without charge, online at http://www.regulations.gov and http://
www.dol.gov/ebsa and at the Public Disclosure Room, N-1513, Employee 
Benefits Security Administration, U.S. Department of Labor, 200 
Constitution Avenue, NW., Washington, DC 20210.

FOR FURTHER INFORMATION CONTACT: Fred Wong, Office of Regulations and 
Interpretations, Employee Benefits Security Administration, (202) 693-
8500. This is not a toll-free number.

SUPPLEMENTARY INFORMATION:

A. Background

    Section 3(21)(A)(ii) of ERISA includes within the definition of 
``fiduciary'' a person that renders investment advice for a fee or 
other compensation, direct or indirect, with respect to any moneys or 
other property of a plan, or has any authority or responsibility to do 
so.\1\ The prohibited transaction provisions of ERISA and the Code 
prohibit an investment advice fiduciary from using the authority, 
control or responsibility that makes it a fiduciary to cause itself, or 
a party in which it has an interest that may affect its best judgment 
as a fiduciary, to receive additional fees. As a result, in the absence 
of a statutory or administrative exemption, fiduciaries are prohibited 
from rendering investment advice to plan participants regarding 
investments that result in the payment of additional advisory and other 
fees to the fiduciaries or their affiliates.
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    \1\ See also Code section 4975(e)(3)(B); 29 CFR 2510.3-21(c).
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    With the growth of participant-directed individual account plans, 
there has been an increasing recognition of the importance of 
investment advice to participants and beneficiaries in such plans. Over 
the past several years, the Department of Labor (Department) has issued 
various forms of guidance concerning when a person would be a fiduciary 
by reason of rendering investment advice and when the provision of 
investment advice might result in prohibited transactions.\2\ Most 
recently, Congress and the Administration, responding to the need to 
afford participants and beneficiaries greater access to professional 
investment advice, amended the prohibited transaction provisions of 
ERISA and the Code, as part of the Pension Protection Act of 2006 
(PPA),\3\ to permit a broader array of investment advice providers to 
offer their services to participants and beneficiaries responsible for 
investment of assets in their individual accounts and, accordingly, for 
the adequacy of their retirement savings.
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    \2\ See Interpretative Bulletin relating to participant 
investment education, 29 CFR Sec.  2509.96-1 (Interpretive Bulletin 
96-1); Advisory Opinion (AO) 2005-10A (May 11, 2005); AO 2001-09A 
(December 14, 2001); and AO 97-15A (May 22, 1997).
    \3\ Public Law 109-280, 120 Stat. 780 (Aug. 17, 2006).
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    Specifically, section 601 of the PPA added a statutory exemption 
under sections 408(b)(14) and 408(g) of ERISA. Parallel provisions were 
added to the Code at section 4975(d)(17) and 4975(f)(8).\4\ Section 
408(b)(14) sets forth the investment advice-related transactions that 
will be exempt from the prohibitions of section 406 if the requirements 
of section 408(g) are met. The transactions described in section 
408(b)(14) are: The provision of investment advice to the participant 
or beneficiary with respect to a security or other property available 
as an investment under the plan; the acquisition, holding or sale of a 
security or other property available as an investment under the plan 
pursuant to the investment advice; and the direct or indirect receipt 
of compensation by a fiduciary adviser or affiliate in connection with 
the provision of investment advice or the acquisition, holding or sale 
of a security or other property available as an investment under the 
plan pursuant to the investment advice.
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    \4\ Under Reorganization Plan No. 4 of 1978 (43 FR 47713, 
October 17, 1978), 5 U.S.C. App.1, 92 Stat. 3790, the authority of 
the Secretary of the Treasury to issue rulings under section 4975 of 
the Code has been transferred, with certain exceptions not here 
relevant, to the Secretary of Labor. Therefore, the references in 
this notice to specific sections of ERISA should be taken as 
referring also to the corresponding sections of the Code.
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    On December 4, 2006, the Department published a Request for 
Information (RFI) in the Federal Register soliciting information to 
assist the Department in the development of regulations under sections 
408(b)(14) and 408(g).\5\ Specifically, the Department invited 
interested persons to address the qualifications for the ``eligible

[[Page 49897]]

investment expert'' that is required to certify that computer models 
used in connection with the statutory exemption meet the requirements 
of the statutory exemption. The Department also invited interested 
persons to provide information to assist the Department in developing 
procedures to be followed in certifying that a computer model meets the 
requirements of the statutory exemption. The Department also invited 
suggestions for a model disclosure form for purposes of the statutory 
exemption. In response to the RFI, the Department received 24 letters 
addressing a variety of issues presented by the statutory exemption. 
These comments have been taken into account in developing the proposed 
regulations.
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    \5\ 71 FR 70429, Dec. 4, 2006. The Department, on the same date, 
also published a Request for Information in the Federal Register 
soliciting information to assist the Department in determining the 
feasibility of using computer models in connection with individual 
retirement accounts, as required by PPA section 601(b)(3). 72 FR 
70427, Dec. 4, 2006.
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    On February 2, 2007, the Department issued Field Assistance 
Bulletin 2007-01 addressing certain issues presented by the new 
statutory exemption. This Bulletin affirmed that the enactment of 
sections 408(b)(14) and (g) did not invalidate or otherwise affect 
prior guidance of the Department relating to investment advice and that 
such guidance continues to represent the views of the Department.\6\ 
The Bulletin also confirmed the applicability of the principles set 
forth in section 408(g)(10) [Exemption for plan sponsor and certain 
other fiduciaries] to plan sponsors and fiduciaries who offered 
investment advice arrangements with respect to which relief under the 
statutory exemption is not required. Finally, the Bulletin addressed 
the scope of the fee-leveling requirement for purposes of an eligible 
investment advice arrangement described in section 408(g)(2)(A)(i). The 
Department's views on that issue are set forth in the discussion of the 
proposed regulations that follows.
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    \6\ In this regard, the Department cited the following: August 
3, 2006 Floor Statement of Senate Health, Education, Labor and 
Pensions Committee Chairman Enzi (who chaired the Conference 
Committee drafting legislation forming the basis of H.R. 4), 
regarding investment advice to participants in which he states, ``It 
was the goal and objective of the Members of the Conference to keep 
this advisory opinion [AO 2001-09A, SunAmerica Advisory Opinion] 
intact as well as other pre-existing advisory opinions granted by 
the Department. This legislation does not alter the current or 
future status of the plans and their many participants operating 
under these advisory opinions. Rather, the legislation builds upon 
these advisory opinions and provides alternative means for providing 
investment advice which is protective of the interests of plan 
participants and IRA owners.'' 152 Cong. Rec. S8,752 (daily ed. Aug. 
3, 2006) (statement of Sen. Enzi).
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    The proposed regulations contained in this notice would, upon 
adoption, implement the provisions of the statutory exemption for the 
provision of investment advice to participants and beneficiaries under 
sections 408(b)(14) and 408(g). In this regard, the Department notes 
that, in an effort to ensure broad availability of investment advice to 
both participants and beneficiaries in individual account plans and 
beneficiaries with individual retirement accounts, the Department also 
is publishing a proposed class exemption for the provision of 
investment advice to such individuals. The proposed class exemption 
appears in the Notice section of today's Federal Register.

B. Overview of Proposed Sec.  2550.408g-1

1. General

    In general, proposed Sec.  2550.408g-1 tracks the requirements 
under section 408(g) that must be satisfied in order for the investment 
advice-related transactions described in section 408(b)(14) to be 
exempt from the prohibitions of section 406.
    Paragraph (a) of the proposal sets forth the general scope of the 
statutory exemption and regulation as providing relief from the 
prohibitions of section 406 of ERISA for transactions described in 
section 408(b)(14) of ERISA in connection with the provision of 
investment advice to a participant or a beneficiary if the investment 
advice is provided by a fiduciary adviser under an ``eligible 
investment advice arrangement.'' Paragraph (a) also notes that the Code 
contains parallel provisions at section 4975(d)(17) and (f)(8).
    Paragraph (b) of the proposal provides that, for purposes of 
sections 408(g)(1) of ERISA and section 4975(f)(8) of the Code, an 
``eligible investment advice arrangement'' shall mean an arrangement 
that meets either the requirements of paragraph (c) [describing 
investment advice arrangements that use fee-leveling] or paragraph (d) 
[describing investment advice arrangements that use computer modeling] 
of the proposal or both.

2. Fee-Leveling

    With respect to arrangements that use fee-leveling, paragraph (c) 
of the proposal requires that any investment advice be based on 
generally accepted investment theories that take into account the 
historic returns of different asset classes over defined periods of 
time, although nothing in the proposal is intended to preclude 
investment advice from being based on generally accepted investment 
theories that take into account additional considerations. Paragraph 
(c) also requires that any investment advice take into account 
information furnished by a participant or beneficiary relating to age, 
life expectancy, retirement age, risk tolerance, other assets or 
sources of income, and investment preferences, although nothing in the 
proposal is intended to preclude a fiduciary adviser from taking into 
account additional information that a participant or beneficiary may 
provide. While section 408(g)(2)(A)(i) does not specifically reference 
such conditions, the principles are so fundamental to the provision of 
informed, individualized investment advice that a failure on the part 
of a plan fiduciary to insist on such conditions in the selection of an 
investment adviser for plan participants would, in the Department's 
view, raise serious questions as to the fiduciary's exercise of 
prudence. For this reason, the Department determined that such 
conditions are sufficiently significant that they should be included in 
the regulation implementing the statutory exemption for investment 
advice.
    With regard to compensation and fees for the provision of 
investment advice, paragraph (c)(1)(iii) provides that any fees or 
other compensation (including salary, bonuses, awards, promotions, 
commissions or other things of value) received, directly or indirectly, 
by any employee, agent or registered representative that provides 
investment advice on behalf of a fiduciary adviser does not vary 
depending on the basis of any investment option selected by a 
participant or beneficiary. Paragraph (c)(1)(iv) provides that any fees 
(including any commission or other compensation) received by the 
fiduciary adviser for investment advice or with respect to the sale, 
holding, or acquisition of any security or other property for purposes 
of investment of plan assets do not vary depending on the basis of any 
investment option selected by a participant or beneficiary.
    The individual compensation requirement in paragraph (c)(1)(iii) is 
designed to safeguard against a firm's creation of incentives for 
individuals to recommend certain investment products. It appears that, 
while an individual may have a general interest in the overall success 
of his or her employing firm, this interest, by itself, would not be 
inconsistent with the individual compensation requirement. This would 
not be the case, however, if the individual's direct or indirect 
compensation or benefits vary based on the selection of particular 
investment options. In order to determine whether more precise guidance 
can be developed, we request public comment on the types and 
formulations of direct and indirect compensation arrangements being 
utilized, and how they may operate under this provision.

[[Page 49898]]

    With regard to the foregoing, the Department, in interpreting the 
scope of the fee-leveling requirement for purposes of section 
408(g)(2)(A)(i), expressed its view, in Field Assistance Bulletin 2007-
01 (February 2, 2007), that only the fees or other compensation of the 
fiduciary adviser may not vary. In contrast to other provisions of 
section 408(b)(14) and section 408(g), the Department explained, 
section 408(g)(2)(A)(i) references only the fiduciary adviser, not the 
fiduciary adviser or an affiliate. Inasmuch as a person, pursuant to 
section 408(g)(11)(A), can be a fiduciary adviser only if that person 
is a fiduciary of the plan by virtue of providing investment advice, an 
affiliate of a registered investment adviser, a bank or similar 
financial institution, an insurance company, or a registered broker 
dealer will be subject to the varying fee limitation only if that 
affiliate is providing investment advice to plan participants and 
beneficiaries. The Department further noted that, consistent with past 
guidance, if the fees and compensation received by an affiliate of a 
fiduciary that provides investment advice do not vary or are offset 
against those received by the fiduciary for the provision of investment 
advice, no prohibited transaction would result solely by reason of 
providing investment advice and thus there would be no need for a 
prohibited transaction exemption.\7\ The Department, therefore, 
concluded that Congress did not intend for the requirement that fees 
not vary depending on the basis of any investment options selected to 
extend to affiliates of the fiduciary adviser, unless, of course, the 
affiliate is also a provider of investment advice to a plan. This 
continues to be the view of the Department.
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    \7\ See AO 2005-10A; AO 97-15A.
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    The Department also noted in the Bulletin that, although section 
408(g)(11)(A) generally limits ``fiduciary advisers'' to certain types 
of entities, it also permits employees, agents, or registered 
representatives of those entities to also qualify as fiduciary advisers 
if they satisfy the requirements of applicable insurance, banking, and 
securities laws relating to the provision of the advice. See section 
408(g)(11)(A)(vi). As with affiliates, such an individual must, for 
purposes of section 408(g)(11)(A), not only be an employee, agent, or 
registered representative of one of those entities, but also must 
provide investment advice in his or her capacity as employee, agent, or 
registered representative. The Department, therefore, concluded that 
the language of section 408(g)(11)(A) required a finding that, for 
purposes of the statutory exemption, when an individual acts as an 
employee, agent or registered representative on behalf of an entity 
engaged to provide investment advice to a plan, that individual, as 
well as the entity, must be treated as the fiduciary adviser for 
purposes of section 408(g)(11)(A) and, accordingly subject to the 
limitations of section 408(g)(2)(A)(i). In an effort to accommodate a 
wider variety of business structures and practices, making investment 
advice more available while protecting participants and beneficiaries, 
the Department is proposing a class exemption addressing fee leveling 
requirements for employees, agents and registered representatives, also 
appearing in today's Federal Register.
    In addition to the foregoing, fiduciary advisers utilizing 
investment advice arrangements that employ fee-leveling must comply 
with the requirements of paragraphs (e) [authorization by plan 
fiduciary], (f) [audits], (g) [disclosure], (h) [miscellaneous], and 
(i) [maintenance of records] of the proposal, each of which is 
discussed in more detail below.

3. Computer Models

    Paragraph (d) of the proposal addresses the requirements applicable 
to investment advice arrangements that rely on computer models. In this 
regard, paragraph (d) provides, consistent with the provisions of 
section 408(g)(3)(B), (C) and (D), that an arrangement shall be an 
eligible investment advice arrangement if the only investment advice 
provided under the arrangement is advice that is generated by a 
computer model described in paragraphs (d)(1) and (2) of this section 
under an investment advice program, and with respect to which the 
requirements of paragraphs (e) [authorization by plan fiduciary], (f) 
[audits], (g) [disclosure], (h) [miscellaneous], and (i) [maintenance 
of records] of the proposal are met and any acquisition, holding or 
sale of a security or other property pursuant to such advice occurs 
solely at the direction of the participant or beneficiary.
    Paragraph (d)(1), consistent with section 408(g)(3)(B)(i)-(v), sets 
forth the standards applicable to computer models. Specifically, 
paragraph (d)(1) requires that a computer model be designed and 
operated to: apply generally accepted investment theories that take 
into account the historic returns of different asset classes over 
defined periods of time, although nothing in the proposal is intended 
to preclude a computer model from applying generally accepted 
investment theories that take into account additional considerations; 
utilize information furnished by a participant or beneficiary relating 
to age, life expectancy, retirement age, risk tolerance, other assets 
or sources of income, and investment preferences, although nothing in 
the proposal precludes a computer model from taking into account 
additional information that a plan or a participant or beneficiary may 
provide; and utilize appropriate objective criteria to provide asset 
allocation portfolios comprised of investment options available under 
the plan. See paragraph (d)(1)(i)-(iii) of the proposal.
    In addition to the foregoing, a computer model, consistent with 
section 408(g)(3)(B)(iv),\8\ must be designed and operated to avoid 
investment recommendations that: inappropriately favor investment 
options offered by the fiduciary adviser or a person with a material 
affiliation or material contractual relationship with the fiduciary 
adviser over other investment options, if any, available under the 
plan; or inappropriately favor investment options that may generate 
greater income for the fiduciary adviser or a person with a material 
affiliation or material contractual relationship with the fiduciary 
adviser. In order to determine if further guidance can be developed 
with respect to this provision, the Department seeks public comment on 
circumstances under which it would be appropriate or inappropriate to 
favor particular investment options. For example, the Department 
believes that favoring a higher-cost investment alternative over an 
otherwise identical investment alternative with lower cost would be 
inappropriate.
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    \8\ Pursuant to section 408(g)(3)(B)(iv), a computer model must 
operate ``in a manner that is not biased in favor of investments 
offered by the fiduciary adviser or a person with a material 
affiliation or contractual relationship with the fiduciary 
adviser.''
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    As reflected in the language, a computer model would not fail to 
meet this requirement merely because the only investment options 
offered under the plan are options offered by the fiduciary adviser or 
a person with a material affiliation or material contractual 
relationship with the fiduciary adviser. The language also makes clear 
that models cannot be designed and operated to inappropriately favor 
those investment options that generate the most income for the 
fiduciary adviser or a person with a material affiliation or material 
contractual relationship with the fiduciary adviser. The proposal 
defines

[[Page 49899]]

a ``material affiliation'' and ``material contractual relationship'' at 
paragraphs (j)(6) and (j)(7), respectively.
    Paragraph (d)(1) further requires, consistent with section 
408(g)(3)(B)(v),\9\ that computer models take into account all 
``designated investment options'' available under the plan without 
giving inappropriate weight to any investment option. See paragraph 
(d)(1)(v) of the proposal. The term ``designated investment option'' is 
defined in paragraph (j)(1) of the proposal, to mean any investment 
option designated by the plan into which participants and beneficiaries 
may direct the investment of assets held in, or contributed to, their 
individual accounts. The term ``designated investment option'' does not 
include ``brokerage windows,'' ``self-directed brokerage accounts,'' or 
similar plan arrangements that enable participants and beneficiaries to 
select investments beyond those designated by the plan.
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    \9\ Section 408(g)(3)(B)(v) provides that computer models must 
take ``into account all investment options under the plan in 
specifying how a participant's account balance should be invested 
and is not inappropriately weighted with respect to any investment 
option.''
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    Paragraph (d)(1)(v) also provides that a computer model shall not 
be treated as failing to take all designated investment options into 
account merely because it does not take into account an investment 
option that constitutes an investment primarily in qualifying employer 
securities. Any such limitation on the investment advice to be 
generated by the computer model, however, must be disclosed to 
participants and beneficiaries under paragraph (g)(1)(vi) of the 
proposal, discussed below. Information received by the Department in 
response to both of its RFIs indicated that there are challenges 
attendant to developing computer models, which generally are based on 
underlying theories that rely on diversified asset classes, that 
address a single undiversified security, such as qualifying employer 
securities, in connection with generating investment recommendations 
that would enable a participant to construct a well-diversified 
investment portfolio. The Department is concerned that extending this 
requirement to qualifying employer securities might discourage 
arrangements based on utilization of a computer model, or otherwise 
limit their availability.\10\ Accordingly, the Department has excluded 
investments primarily in qualifying employer securities from the 
requirement of paragraph (d)(1)(v) of the proposal.
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    \10\ It should be noted that, even in the absence of 
individualized advice, participants are reminded on a quarterly 
basis, via their pension benefit statements, of the importance of 
maintaining a diversified portfolio. Model language for purposes of 
this disclosure was set forth in Field Assistance Bulletin 2006-03 
(Dec. 20, 2006). Among other things the model language provides that 
``[I]f you invest more than 20% of your retirement savings in any 
one company or industry, your savings may not be properly 
diversified. Although diversification is not a guarantee against 
loss, it is an effective strategy to help you manage investment 
risk.''
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    Paragraph (d)(2) of the proposal requires that, prior to 
utilization of the computer model, the fiduciary adviser obtain a 
written certification that the computer model meets the requirements of 
paragraph (d)(1), discussed above. If the model is modified in a manner 
that may affect its ability to meet the requirements of paragraph 
(d)(1), the fiduciary adviser, prior to utilization of the modified 
model, must obtain a new certification. With regard to the 
certification, paragraph (d)(2) requires that the fiduciary adviser 
obtain a certification that meets the requirements of paragraph (d)(4) 
from an ``eligible investment expert,'' within the meaning of paragraph 
(d)(3).
    Paragraph (d)(3) of the proposal defines an ``eligible investment 
expert'' to mean a person that, through employees or otherwise, has the 
appropriate technical training or experience and proficiency to 
analyze, determine and certify, in a manner consistent with paragraph 
(d)(4), whether a computer model meets the requirements of paragraph 
(d)(1) of this section; except that the term eligible investment expert 
does not include any person that has any material affiliation or 
material contractual relationship with the fiduciary adviser, with a 
person with a material affiliation or material contractual relationship 
with the fiduciary adviser, or with any employee, agent, or registered 
representative of the foregoing. After consideration of the public 
comments, the Department has concluded that it would be very difficult 
to define a specific set of academic or other credentials that would 
serve to define the appropriate expertise and experience for an 
eligible investment expert.
    Accordingly, under the proposal, it is the fiduciary adviser who is 
responsible for determining whether an eligible investment expert, 
itself or its employees, possesses the requisite training and 
experience to certify whether a given computer model meets the 
requirements of paragraph (d)(1) in a manner consistent with paragraph 
(d)(4) of the proposal. Paragraph (d)(5) of the proposal provides that, 
for purposes of the statutory exemption, the selection of the eligible 
investment expert by the fiduciary adviser is a fiduciary act governed 
by section 404(a)(1) of ERISA.
    The Department notes that, although the proposal gives latitude to 
a fiduciary adviser in selecting an eligible investment expert to 
certify a computer model, as the party seeking prohibited transaction 
relief under the exemption, the fiduciary adviser has the burden of 
demonstrating that all applicable requirements of exemption are 
satisfied with respect to its arrangement. We also note that section 
404 of ERISA requires the fiduciary adviser to act reasonably and 
prudently in its selection.
    Paragraph (d)(4) of the proposal provides that a certification by 
an eligible investment expert shall be in writing and contain the 
following: an identification of the methodology or methodologies 
applied in determining whether the computer model meets the 
requirements of paragraph (d)(1) of this section; an explanation of how 
the applied methodology or methodologies demonstrated that the computer 
model met the requirements of paragraph (d)(1) of this section; and a 
description of any limitations that were imposed by any person on the 
eligible investment expert's selection or application of methodologies 
for determining whether the computer model meets the requirements of 
paragraph (d)(1). In addition the certification is required to contain 
a representation that the methodology or methodologies were applied by 
a person or persons with the educational background, technical training 
or experience necessary to analyze and determine whether the computer 
model meets the requirements of paragraph (d)(1); and a statement 
certifying that the eligible investment expert has determined that the 
computer model meets the requirements of paragraph (d)(1). Finally the 
certification must be signed by the eligible investment expert.
    With regard to the certification described in paragraph (d)(4) of 
the proposal, public comments suggested a number of different 
approaches that could be followed in determining computer model 
consistency with the statutory criteria. The comments did not, however, 
suggest a single suitable approach. The Department, therefore, is wary 
of mandating a methodology under the proposal. The Department also 
believes that as computer models and their use under investment advice 
arrangements continue to develop, experts may need the flexibility to 
develop new methodologies for examining those models. Accordingly, 
paragraph (d)(4) does not require a particular methodology to be 
applied for purposes of certification.

[[Page 49900]]

4. Authorized by a Plan Fiduciary

    Consistent with the section 408(g)(4) of ERISA, the proposal 
provides, at paragraph (e), that the arrangement pursuant to which 
investment advice is provided to participants and beneficiaries must be 
expressly authorized by a plan fiduciary (or, in the case of an IRA, 
the IRA beneficiary) other than: the person offering the arrangement; 
any person providing designated investment options under the plan; or 
any affiliate of either. The proposal further provides that for 
purposes of such authorization, an IRA beneficiary will not be treated 
as an affiliate of a person solely by reason of being an employee of 
such person, thereby enabling employees of a fiduciary adviser to take 
advantage of investment advice arrangements offered by their employer 
under the exemption.

5. Annual Audit

    Paragraph (f) addresses the audit requirements of section 408(g)(6) 
of ERISA. Specifically, paragraph (f)(1) provides that the fiduciary 
adviser shall, at least annually, engage an independent auditor, who 
has appropriate technical training or experience and proficiency, and 
so represents in writing to the fiduciary adviser, to conduct an audit 
of the investment advice arrangements for compliance with the 
requirements of the proposal and within 60 days following completion of 
the audit, issue a written report to the fiduciary adviser and, except 
with respect to an arrangement with an IRA, to each fiduciary who 
authorized the use of the investment advice arrangement, consistent 
with paragraph (e) of the proposal, setting forth the specific findings 
of the auditor regarding compliance of the arrangement with the 
requirements of the proposal.
    Given the significant number of reports that an auditor would be 
required to send if the written report was required to be furnished to 
all IRA beneficiaries, the Department framed an alternative requirement 
for investment advice arrangements for IRAs. This alternative is set 
forth in paragraph (f)(2) of the proposal. The alternative provides 
that, with respect to an arrangements with an IRA, the fiduciary 
adviser shall, within 30 days following receipt of the report from the 
auditor, furnish a copy of the report to the IRA beneficiary or make 
such report available on its website, provided that such beneficiaries 
are provided information, along with other required disclosures (see 
paragraph (g) of the proposal), concerning the purpose of the report, 
and how and where to locate the report applicable to their account. 
With respect to making the report available on a website, the 
Department believes that this alternative to furnishing reports to IRA 
beneficiaries satisfies the requirement of section 104(d)(1) of the 
Electronic Signatures in Global and National Commerce Act (E-SIGN) \11\ 
that any exemption from the consumer consent requirements of section 
101(c) of E-SIGN must be necessary to eliminate a substantial burden on 
electronic commerce and will not increase the material risk of harm to 
consumers. The Department solicits comments on this finding. Paragraph 
(f)(2) also provides that, when the report of the auditor identifies 
noncompliance with the requirements of the regulation, the fiduciary 
adviser must send a copy of the report to the Department. As proposed, 
the fiduciary adviser must submit the report to the Department within 
30 days following receipt of the report from the auditor. The 
submission of this report will enable the Department to monitor 
compliance with the statutory exemption in those instances where there 
is no authorizing ERISA plan fiduciary to carry out that function.
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    \11\ 15 U.S.C. 7004(d)(1) (2000).
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    For purposes of paragraph (f) of the proposal, an auditor is 
considered independent if it does not have a material affiliation or 
material contractual relationship with the person offering the 
investment advice arrangement to the plan or any designated investment 
options under the plan. The terms ``material affiliation'' and 
``material contractual relationship'' are defined in paragraphs (j)(6) 
and (7) of the proposal.
    With regard to the scope of the audit, paragraph (f)(4) provides 
that the auditor shall review sufficient relevant information to 
formulate an opinion as to whether the investment advice arrangements, 
and the advice provided pursuant thereto, offered by the fiduciary 
adviser during the audit period were in compliance with the regulation. 
Paragraph (f)(4) further provides that it is not intended to preclude 
an auditor from using information obtained by sampling, as reasonably 
determined appropriate by the auditor, investment advice arrangements, 
and the advice pursuant thereto, during the audit period. The proposal, 
therefore, does not require an audit of every investment advice 
arrangement at the plan or fiduciary adviser-level or of all the advice 
that is provided under the exemption. In general, the proposal leaves 
to the auditor the determination as to the appropriate scope of their 
review and the extent to which they can rely on representative samples 
for determining compliance with the exemption.

6. Disclosure

    The disclosure provisions are set forth in paragraph (g) of the 
proposal and generally track the disclosure provisions of the statutory 
exemption at section 408(g)(6) of ERISA. In this regard, the proposal, 
at paragraph (g)(1), requires that the fiduciary adviser provide to 
participants and beneficiaries, prior to the initial provision of 
investment advice with regard to any security or other property offered 
as an investment option, a written notification describing: the role of 
any party that has a material affiliation or material contractual 
relationship with the fiduciary adviser in the development of the 
investment advice program, and in the selection of investment options 
available under the plan; the past performance and historical rates of 
return of the designated investment options available under the plan, 
to the extent that such information is not otherwise provided; all fees 
or other compensation relating to the advice that the fiduciary adviser 
or any affiliate thereof is to receive (including compensation provided 
by any third party) in connection with the provision of the advice or 
in connection with the sale, acquisition, or holding of the security or 
other property; and any material affiliation or material contractual 
relationship of the fiduciary adviser or affiliates thereof in the 
security or other property.
    The notification to participants and beneficiaries also is required 
to explain: the manner, and under what circumstances, any participant 
or beneficiary information provided under the arrangement will be used 
or disclosed; the types of services provided by the fiduciary adviser 
in connection with the provision of investment advice by the fiduciary 
adviser, including, with respect to an arrangement described in 
paragraph (d) utilizing a computer model, any limitations on the 
ability of the model to take into account an investment primarily in 
qualifying employer securities, as provided for in paragraph (d)(1)(v) 
of the proposal; that the adviser is acting as a fiduciary of the plan 
in connection with the provision of the advice; and that a recipient of 
the advice may separately arrange for the provision of advice by 
another adviser that could have no material affiliation with and 
receive no fees or other compensation in connection with the security 
or other property.

[[Page 49901]]

    Paragraph (g)(2) of the proposal requires that the notification 
furnished to participants and beneficiaries be written in a clear and 
conspicuous manner and in a manner calculated to be understood by the 
average plan participant and must be sufficiently accurate and 
comprehensive to reasonably apprise such participants and beneficiaries 
of the information required to be provided in the notification.
    The appendix to the proposal contains a model disclosure form that 
may be used for purposes of satisfying the fee and compensation 
disclosure requirement of paragraph (g)(1)(iii), as well as the 
requirements of paragraph (g)(2), of the proposal. The proposal makes 
clear, however, that the use of the model disclosure form is not 
mandatory.
    Paragraph (g)(3) makes clear that the required disclosures may be 
provided in written or electronic form.
    Paragraph (g)(4) of the proposal, like section 408(g)(6)(B) of 
ERISA, sets forth miscellaneous recordkeeping and furnishing 
responsibilities of the fiduciary adviser. Specifically, paragraph 
(g)(4) provides that, at all times during the provision of advisory 
services to the participant or beneficiary pursuant to the arrangement, 
the fiduciary adviser must: Maintain the information described in 
paragraph (g)(1) in accurate form; provide, without charge, accurate 
information to the recipient of the advice no less frequently than 
annually; provide, without charge, accurate information to the 
recipient of the advice upon request of the recipient; and provide, 
without charge, accurate information to the recipient of the advice 
concerning any material change to the information required to be 
provided to the recipient of the advice at a time reasonably 
contemporaneous to the change in information.

7. Other Conditions

    Paragraph (h) of the proposal, like section 408(g)(7) of ERISA, 
sets forth additional conditions applicable to the provision of advice 
under the statutory exemption. These requirements are as follows: The 
fiduciary adviser must provide appropriate disclosure, in connection 
with the sale, acquisition, or holding of the security or other 
property, in accordance with all applicable securities laws; the sale, 
acquisition, or holding occurs solely at the direction of the recipient 
of the advice; the compensation received by the fiduciary adviser and 
affiliates thereof in connection with the sale, acquisition, or holding 
of the security or other property is reasonable; and the terms of the 
sale, acquisition, or holding of the security or other property are at 
least as favorable to the plan as an arm's length transaction would be.

8. Maintenance of Records

    Paragraph (i) of the proposal sets forth the record maintenance 
requirements. Consistent with section 408(g)(9) of ERISA, paragraph (i) 
of the proposal provides that the fiduciary adviser must maintain, for 
a period of not less than 6 years after the provision of investment 
advice pursuant to the arrangement, any records necessary for 
determining whether the applicable requirements of the proposal have 
been met. Also, paragraph (i), as with section 408(g)(9), makes clear 
that a prohibited transaction shall not be considered to have occurred 
solely because the records are lost or destroyed prior to the end of 
the 6-year period due to circumstances beyond the control of the 
fiduciary adviser.

9. Definitions

    Paragraph (j) of the proposal sets forth a number of definitions 
relevant to the statutory exemption and this proposed regulation.
    Paragraph (j)(1), as discussed earlier, defines the term 
``designated investment option.'' Paragraph (j)(2) sets forth the 
definition of ``fiduciary adviser,'' as it appears in section 
408(g)(11)(A) of ERISA. With regard to that part of the fiduciary 
adviser definition that treats persons who develop computer models or 
market investment advice programs or computer models as a fiduciary of 
the plan by reason of providing investment advice and as a fiduciary 
adviser for purposes of section 408(b)(14), the Department is proposing 
a separate regulation (Sec.  2550.408g-2), discussed below, pursuant to 
which a single fiduciary adviser may elect to be treated as a fiduciary 
with the respect to the plan.
    Paragraph (j)(3) of the proposal adopts the statutory definition of 
``registered representative'' set forth in ERISA section 408(g)(11)(C), 
which states that a registered representative of another entity means a 
person described in section 3(a)(18) of the Securities Exchange Act of 
1934 (15 U.S.C. 78c(a)(18)) (substituting the entity for the broker or 
dealer referred to in such section) or a person described in section 
202(a)(17) of the Investment Advisers Act of 1940 (15 U.S.C. 80b-
2(a)(17)) (substituting the entity for the investment adviser referred 
to in such section).
    Paragraph (j)(4), consistent with section 601(b)(3)(A)(i) of the 
Pension Protection Act of 2006, defines the term ``Individual 
Retirement Account'' to mean plans described in paragraphs (B) through 
(F) of section 4975(e)(1) of the Code, as well as a trust, plan, 
account, or annuity which, at any time, has been determined by the 
Secretary of the Treasury to be described in such paragraphs.
    Paragraph (j)(5) of the proposed rule defines the term 
``affiliate.'' For purposes of the proposal, an ``affiliate'' of 
another person means: Any person directly or indirectly owning, 
controlling, or holding with power to vote, 5 percent or more of the 
outstanding voting securities of such other person; any person 5 
percent or more of whose outstanding voting securities are directly or 
indirectly owned, controlled, or held with power to vote, by such other 
person; any person directly or indirectly controlling, controlled by, 
or under common control with, such other person; and any officer, 
director, partner, copartner, or employee of such other person. 
Consistent with ERISA section 408(g)(11)(B), this definition is based 
on the definition of an ``affiliated person'' of an entity as contained 
in section 2(a)(3) of the Investment Company Act of 1940 (ICA), except 
that it does not reflect clauses (E) and (F) thereof. The Department 
has initially determined that including provisions similar to clauses 
(E) and (F) is unnecessary, because these clauses appear to focus on 
persons who exercise control over the management of an investment 
company.\12\ Also, such parties will nonetheless be treated as an 
affiliate because they would be a person directly or indirectly 
controlling, controlled by, or under common control with, such other 
person. See paragraph (j)(5)(iii) of the proposal. Additionally, the 
Department is concerned that including provisions similar to clauses 
(E) and (F), which focus on functions involving investment companies, 
but not other types of vehicles in which plans may invest, could have 
the unintended consequence of possibly subjecting persons associated 
with investment companies to different requirements under these 
proposed regulations. Therefore, the Department is proposing to define 
affiliate without regard to clauses (E) and (F) of section 2(a)(3) of 
the ICA.
---------------------------------------------------------------------------

    \12\ ICA section 2(a)(3)(E) and (F) include in the definition of 
affiliated person: If the other person is an investment company, any 
investment adviser thereof or any member of an advisory board 
thereof; and if such other person is an unincorporated investment 
company not having a board of directors, the depositor thereof. 15 
U.S.C. 80a-2(a)(3)(E)-(F).
---------------------------------------------------------------------------

    In a variety of places in the regulation reference is made to 
persons with

[[Page 49902]]

``material affiliations'' and ``material contractual relationships.'' 
See paragraphs (d)(1)(iv), (d)(3), (f)(3), (g)(1)(i), (g)(1)(iv) and 
(g)(1)(viii) of the proposal. For purposes of this regulation, those 
terms are defined in paragraphs (j)(6) and (j)(7), respectively.
    Paragraph (j)(6) of the proposal describes a person with a 
``material affiliation'' with another person as: Any affiliate of such 
other person; any person directly or indirectly owning, controlling, or 
holding, 5 percent or more of the interests of such other person; or 
any person 5 percent or more of whose interests are directly or 
indirectly owned, controlled, or held, by such other person. In 
determining ``interest,'' paragraph (j)(6)(ii) provides that an 
``interest'' means with respect to an entity: The combined voting power 
of all classes of stock entitled to vote or the total value of the 
shares of all classes of stock of the entity if the entity is a 
corporation; the capital interest or the profits interest of the entity 
if the entity is a partnership; or the beneficial interest of the 
entity if the entity is a trust or unincorporated enterprise.
    Paragraph (j)(7) of the proposal provides that persons shall be 
treated as having a ``material contractual relationship'' if payments 
made by one person to the other person pursuant to written contracts or 
agreements between the persons exceed 10 percent of the gross revenue, 
on an annual basis, of such other person. The Department believes that 
one person's receipt of more than 10 percent of gross revenue from 
another person is sufficiently significant to be considered material. 
However, the Department specifically invites comments on whether the 
percentage test should be higher or lower and, if so, why.
    The proposal, at paragraph (j)(8), defines ``control'' to mean the 
power to exercise a controlling influence over the management or 
policies of a person other than an individual.

C. Overview of Proposed Sec.  2550.408g-2

    Proposed Sec.  2550.408g-2, as indicated above, addresses the 
requirements for electing to be treated as a fiduciary and fiduciary 
adviser by reason of developing or marketing a computer model or an 
investment advice program used in an eligible investment advice 
arrangement. See section 408(g)(11)(A).
    Section 408(g)(11)(A) provides that, with respect to an arrangement 
that relies on use of a computer model to qualify as an ``eligible 
investment advice arrangement,'' a person who develops the computer 
model, or markets the investment advice program or computer model, 
shall be treated as a fiduciary of a plan by reason of the provision of 
investment advice referred to in ERISA section 3(21)(A)(ii) to the plan 
participant or beneficiary, and shall be treated as a ``fiduciary 
adviser'' for purposes of ERISA section 408(b)(14) and (g). Section 
4975(f)(8) of the Code contains a parallel provision to ERISA section 
408(g)(11)(A). Proposed Sec.  2550.408g-2 sets forth requirements that 
must be satisfied in order for one such fiduciary adviser to elect to 
be treated as a fiduciary under such an eligible investment advice 
arrangement. See paragraph (a) of Sec.  2550.408g-2.
    Paragraph (b)(1) of Sec.  2550.408g-2 provides that if an election 
meets the requirements of paragraph (b)(2) of the proposal, then the 
person identified in the election shall be the sole fiduciary adviser 
treated as a fiduciary by reason of developing or marketing a computer 
model, or marketing an investment advice program, used in an eligible 
investment advice arrangement. Paragraph (b)(2) requires that the 
election be in writing and that the writing: Identify the arrangement, 
and person offering the arrangement, with respect to which the election 
is to be effective; and identify the person who is the fiduciary 
adviser, the person who develops the computer model or markets the 
computer model or investment advice program with respect to the 
arrangement, and the person who elects to be treated as the only 
fiduciary, and fiduciary adviser, by reason of developing such computer 
model or marketing such computer model or investment advice program. 
Paragraph (b)(2) of Sec.  2550.408g-2 also requires that the election 
be signed by the person acknowledging that it elects to be treated as 
the only fiduciary and fiduciary adviser; that a copy of the election 
be furnished to the plan fiduciary who authorized use of the 
arrangement; and that the writing be retained in accordance with the 
record retention requirements of Sec.  2550.408g-1(i).

D. Effective Date

    The Department proposes that the regulations contained in this 
notice will be effective 60 days after publication of the final 
regulations in the Federal Register. The Department invites comments on 
whether the final regulations should be made effective on a different 
date.

E. Request for Comments

    The Department invites comments from interested persons on the 
proposed regulations. To facilitate the receipt and processing of 
comment letters, the Employee Benefits Security Administration (EBSA) 
encourages interested persons to submit their comments electronically 
by e-mail to e-ORI@dol.gov (Subject: Investment Advice Regulations), or 
by using the Federal eRulemaking portal at http://www.regulations.gov 
(follow instructions for submission of comments). Persons submitting 
comments electronically are encouraged not to submit paper copies. 
Persons interested in submitting paper copies should send or deliver 
their comments to the Office of Regulations and Interpretations, 
Employee Benefits Security Administration, Attn: Investment Advice 
Regulations, Room N-5655, U.S. Department of Labor, 200 Constitution 
Avenue, NW., Washington, DC 20210. All comments will be available to 
the public, without charge, online at http://www.regulations.gov and 
http://www.dol.gov/ebsa and at the Public Disclosure Room, N-1513, 
Employee Benefits Security Administration, U.S. Department of Labor, 
200 Constitution Avenue, NW., Washington, DC 20210.
    The comment period for the proposed regulations will end 45 days 
after publication of the proposed rule in the Federal Register. The 
Department believes that this period of time will afford interested 
persons an adequate amount of time to analyze the proposals and submit 
comments. Written comments on the proposed regulations should be 
submitted to the Department of Labor on or before October 6, 2008.

F. Regulatory Impact Analysis

Summary

    The Department anticipates that this proposed regulation and 
proposed class exemption, by extending quality, expert investment 
advice to more retirement plan participants, together will improve 
their investment results by approximately $14 billion or more annually, 
at a cost of $4 billion, thereby producing a net financial benefit of 
$10 billion or more. The improved investment results will reflect 
reductions in investment errors such as payment of higher than 
necessary fees and expenses, poor trading strategies, and inadequate 
diversification. The provisions of this proposed regulation and the 
conditions attached to this proposed class exemption reflect the 
Department's efforts to ensure that the advice provided pursuant to 
them will be affordable and of high quality.

Introduction

    Workers' retirement security increasingly depends on their 
investment decisions. Unfortunately

[[Page 49903]]

there is evidence that many participants and beneficiaries in 
participant-directed defined contribution (DC) plans and beneficiaries 
of individual retirement accounts (IRAs) (collectively hereafter, 
``participants''), beset by flawed information or reasoning, make poor 
investment decisions. These participants may pay higher fees and 
expenses than necessary for investment products and services, engage in 
excessive or poorly timed trading or fail to rebalance their 
portfolios, inadequately diversify their portfolios and thereby assume 
uncompensated risk, take more or less than optimal levels of 
compensated risk, and/or pay unnecessarily high taxes. Financial losses 
(including foregone earnings) from such mistakes likely amount to more 
than $100 billion per year. These losses compound and grow larger as 
workers progress toward and into retirement.
    Such mistakes and consequent losses historically can be attributed 
at least in part to provisions of federal law that effectively preclude 
a variety of arrangements whereby financial professionals might 
otherwise provide retirement plan participants with expert investment 
advice. These ``prohibited transaction'' provisions of ERISA and the 
Internal Revenue Code prohibit fiduciaries from dealing with DC plan or 
IRA assets in ways that advance their own interests. These provisions 
prohibit plan fiduciaries from exercising the authority, control, or 
responsibility that makes such persons fiduciaries when they have an 
interest which may conflict with the interests of the plan for which 
they act. Under these provisions financial advisers who have a direct 
or indirect stake in participants' investment decisions generally may 
not provide them with investment advice. In recognition that certain 
transactions could nonetheless be beneficial to plans and their 
participants and beneficiaries, subject to safeguards appropriate to 
protect against potential abuses, Congress enacted a number of 
statutory prohibited transaction exemptions, and also gave the 
Department conditional authority to grant prohibited transaction 
exemptions. In this regard, the prohibited transaction exemption for 
the provision of investment advice added by the Pension Protection Act 
of 2006 (PPA) opened the door to more types of investment advice 
arrangements by conditionally permitting arrangements where the 
fiduciary adviser or an affiliate thereof has a financial stake in the 
advised participants' investment decisions. The Department is proposing 
a regulation to further specify the PPA's applicable conditions, 
together with a class exemption to establish alternative conditions 
under which such arrangements may operate. Together these actions are 
intended to increase the availability of investment advice.
    The results of this proposed regulation and proposed class 
exemption will depend on their impacts on the availability, cost, use, 
and quality of participant investment advice. The Department expects 
that, as a result of these actions, quality, affordable advice will 
proliferate, producing significant net gains for participants.

Investment Mistakes

    The Department believes that many participants make costly 
investment mistakes and therefore could benefit from receiving and 
following good advice. In theory, investors can optimize their 
investment mix over time to match their investment horizon and personal 
taste for risk and return. But in practice many investors do not 
optimize their investments, at least not in accordance with generally 
accepted financial theories.
    Some investors fail to exhibit clear, fixed and rational 
preferences for risk and return. Some base their decisions on flawed 
information or reasoning. For example some appear to anchor decisions 
inappropriately to plan features or to mental accounts or frames, or to 
rely excessively on past performance measures or peer examples. Some 
suffer from overconfidence, myopia, or simple inertia.\13\
---------------------------------------------------------------------------

    \13\ See, e.g., Richard H. Thaler & Shlomo Benartzi, The 
Behavioral Economics of Retirement Savings Behavior, AARP Public 
Policy Institute White Paper 2007-02 (Jan. 2007); and Jeffrey R. 
Brown & Scott Weisbenner, Individual Account Investment Options and 
Portfolio Choice: Behavioral Lessons from 401(k) Plans, Social 
Science Research Network Abstract 631886 (Dec. 2004).
---------------------------------------------------------------------------

    Such informational and behavioral problems translate into at least 
five distinct types of investment mistakes,\14\ which together generate 
financial losses (including foregone earnings) of $109 billion or more 
annually \15\ for DC plan and IRA participants, the Department 
estimates.
---------------------------------------------------------------------------

    \14\ It should be noted that much of the research documenting 
investment mistakes does not account for whether advice was present 
or not. At least some of the mistakes may have been made despite 
good advice to the contrary; some may have been made pursuant to bad 
advice. There is evidence both that advice sometimes is not 
followed, and that it sometimes is bad. This is explored more below.
    \15\ As discussed below, this estimate is subject to wide 
uncertainty.
---------------------------------------------------------------------------

Fees and Expenses

    Investors sometimes pay higher fees and expenses than necessary for 
investment products and services. There is evidence that mutual funds 
with poorer gross performance (that is performance before deducting 
fees) also have higher fees. This suggests that higher fees sometimes 
do not reflect value added by managers. Investors often pay inadequate 
attention to fee differences, even in connection with highly comparable 
products like competing S&P 500 index funds.\16\
---------------------------------------------------------------------------

    \16\ A number of studies conclude that investors often pay 
higher fees than necessary.
    Javier Gil-Bazo & Pablo Ruiz-Verd[uacute], Yet Another Puzzle? 
Relation Between Price and Performance in the Mutual Fund Industry, 
Social Science Research Network Abstract 947448 (March 2007) find 
that funds with worse before-fee performance charge higher fees. 
They suggest that funds faced with insensitive investors charge 
higher fees, finding that even after controlling for performance 
sensitivity, funds with lower expected performance set higher fees. 
They hypothesize that lower performing funds lose sophisticated 
investors to higher performing funds, then are left with relatively 
unsophisticated investors who are not as responsive to price.
    According to Ali Hortacsu & Chad Syverson, Product 
Differentiation, Search Costs, and Competition in the Mutual Fund 
Industry: A Case Study of S&P 500 Index Funds, Social Science 
Research Network Abstract 405642 (April 2003), 75 percent of S&P 500 
Index Funds have expense ratios in excess of 47 basis points, 50 
percent in excess of 72 basis points and 25 percent in excess of 149 
basis points. The highest cost fund charged annualized investor fees 
that were nearly 30 times greater than the lowest-cost fund (268 vs. 
9.5 basis points). Low-cost funds have a dominant market share, but 
the asset share of the low-cost funds has fallen consistently since 
1995.
    Paul G. Mahoney, Manager-Investor Conflicts in Mutual Funds, The 
Journal of Economic Perspectives, Volume 18, Number 2 (2004) extends 
the Ali Hortacsu & Chad Syverson, Product Differentiation, Search 
Costs, and Competition in the Mutual Fund Industry: A Case Study of 
S&P 500 Index Funds, Social Science Research Network Abstract 405642 
(April 2003) result of two classes of investors, the experienced 
that buy low-cost no-load funds, and the novice who uses a broker 
and buys high-cost load funds. He finds that, even after separating 
the expense ratio into administrative fees and 12b-1 fees, funds 
with loads still have administrative fees 15 basis point higher than 
the no-load funds.
    Brad M. Barber et al., Out of Sight, Out of Mind, The Effects of 
Expenses on Mutual Fund Flows, Journal of Business, Volume 79, 
Number 6 2095, 2095-2119 (2005) find that investors are sensitive to 
load fees. They argue that front-end load fees are generally 
observable as a dollar amount on the first statement while the 
effects of administrative fees on the account balance are hidden by 
the volatility of fund returns. They find evidence of learning; 
repeat mutual fund purchasers pay on average about half the load 
fees of first time mutual fund purchasers.
    Todd Houge & Jay W. Wellman, The Use and Abuse of Mutual Fund 
Expenses, Social Science Research Network Abstract 880463 (Jan. 
2006) present evidence that less knowledgable investors pay 
consistently higher asset management fees than more knowledgable 
investors holding similar funds. Less sophisticated investors are 
more likely to invest in funds with loads. Load funds on average 
have annual expense ratios that are 50 basis points higher than no-
load funds. While a large part of the higher expense ratio is 
composed of 12b-1 fees, load funds also have higher asset management 
fees. They conclude that ``Load fund shareholders often pay high 
fees to market and grow the fund, but the fund's advisor is the most 
likely beneficiary of this growth.''
    Edwin J. Elton et al., Are Investors Rational? Choices Among 
Index Funds, Social Science Research Network Abstract 340482 (June 
2002) find that buying S&P 500 index mutual funds using expenses as 
the predictor of future success leads to picking funds with better 
returns. They find that the ten percent of funds with the lowest 
expenses out performs the ten percent of funds with the highest 
expenses by 0.92 percent a year. They find that for S&P 500 index 
mutual funds, the incentive for brokers and financial planners to 
push the fund (as represented by loads) is more important for new 
flows than is avoiding high cost and poorly performing funds. They 
are unable to find any effect of the quality of services on flows.
    James J. Choi et al., Why Does the Law of One Price Fail? An 
Experiment on Index Mutual Funds, National Bureau of Economic 
Research Working Paper W12261 (May 2006) offer experimental evidence 
that index fund investors are largely insensitive to fees.
    Some other studies suggest, however, that fee levels may in fact 
be competitive and efficient. Many studies fail to measure potential 
non-financial benefits investors might derive from professional 
investment advice. Victoria Leonard-Chambers & Michael Bogdan, Why 
Do Mutual Fund Investors Use Professional Financial Advisers?, 
Investment Company Institute Research Fundamentals, Volume 16, 
Number 1 (April 2007) present results of a survey ``that identifies 
the benefits investors say they receive from using professional 
financial advisers,'' and contrast this perspective with that of 
studies that rely on ``performance and other publicly available 
measures to examine the value'' of such advice. Other studies find 
that investors with more intelligence or financial literacy often 
pay similar fees as those with less, and suggest this is consistent 
with the hypothesis that fees are competitive and efficient (see, 
e.g., Sebastian Miller & Martin Weber, Financial Literacy and Mutual 
Fund Investments: Who Buys Actively Managed Funds?, Social Science 
Research Network Abstract 1093305 (Feb. 2008); and Mark Grinblatt et 
al., Are Mutual Fund Fees Competitive? What IQ-Related Behavior 
Tells Us, Social Science Research Network Abstract 1087120 (Nov. 
2007)).
    The Department understands that some of what might otherwise 
appear to be higher than necessary fees paid by investors pursuant 
to advice may in fact reflect indirect payment of the reasonable 
cost of the advice itself.

---------------------------------------------------------------------------

[[Page 49904]]

    The Department estimates that DC plan participants \17\ and IRA 
beneficiaries together recently paid fees and expenses that were higher 
than necessary by $8 billion or more annually on aggregate.\18\ Good 
advice could eliminate some of this unnecessary expense.\19\
---------------------------------------------------------------------------

    \17\ DC plan participants' investment choices typically are 
limited to a menu selected by a plan fiduciary who is responsible 
for ensuring that the associated fees and expenses are reasonable. 
However, such participants may pay more overall than would be 
optimal if they do not appropriately consider fees and expenses when 
allocating their assets across available investments.
    \18\ ``Higher than necessary'' here means that the participant 
could have obtained equal value without incurring the expense. This 
calculation assumes that participants on average pay 11 or more 
basis points in unnecessary fees and expenses, in the form of 
expense ratios or loads. This assumption is likely to be 
conservative in light of evidence on the distribution of investor 
expense levels presented in Deloitte Financial Advisory Services 
LLP, Fees and Revenue Sharing in Defined Contribution Retirement 
Plans (Dec. 6, 2007) (unpublished, on file with the Department of 
Labor); Brad M. Barber et al., Out of Sight, Out of Mind, The 
Effects of Expenses on Mutual Fund Flows, Journal of Business, 
Volume 79, Number 6 2095, 2095-2119 (2005); Edwin J. Elton et al., 
Are Investors Rational? Choices Among Index Funds, Social Science 
Research Network Abstract 340482 (June 2002); James J. Choi et al., 
Why Does the Law of One Price Fail? An Experiment on Index Mutual 
Funds, National Bureau of Economic Research Working Paper W12261 
(May 2006); and Sarah Holden & Michael Hadley, The Economics of 
Providing 401(k) Plans: Services, Fees and Expenses 2006, Investment 
Company Institute Research Fundamentals, Volume 16, Number 4 (Sept. 
2007). This estimate of excess expense does not take into account 
less visible expenses such as mutual funds' internal transaction 
costs (including explicit brokerage commissions and implicit trading 
costs), which are sometimes larger than funds' expense ratios 
(Deloitte Financial Advisory Services LLP, Fees and Revenue Sharing 
in Defined Contribution Retirement Plans (Dec. 6, 2007) 
(unpublished, on file with the Department of Labor); Jason Karceski 
et al., Portfolio Transactions Costs at U.S. Equity Mutual Funds, 
University of Florida Working Paper (2004), at http://
thefloat.typepad.com/the_float/files/2004_zag_study_on_mutual_
fund_trading_costs.pdf).
    \19\ Conversely, there is evidence that some higher than 
necessary expense currently is a direct result of what might be 
called bad advice, meaning certain marketing activities carried out 
by intermediaries such as brokers as well as direct consumer 
advertising by vendors of funds and competing financial products.
---------------------------------------------------------------------------

Poor Trading Strategies

    There is evidence that some participants trade excessively, while 
many more trade too little, failing even to rebalance. In DC plans, 
participant trading often worsens performance, and those with automatic 
rebalancing generally fare best.\20\ Relative to automatic rebalancing, 
inferior trading strategies recently cost participants perhaps $56 
billion or more annually, the Department estimates.\21\ Among inferior 
strategies, it is likely that active trading aimed at timing the market 
generates more adverse results than failing to rebalance. Many mutual 
funds investors' experience badly lags the performance of the funds 
they hold because they buy and sell shares too frequently and/or at the 
wrong times.\22\ Investors often buy and sell in response to short-term 
past returns, and suffer as a result.\23\ Good advice is likely to 
discourage market timing efforts and encourage rebalancing, thereby 
ameliorating adverse impacts from poor trading strategies.
---------------------------------------------------------------------------

    \20\ See, e.g., Takeshi Yamaguchi et al., Winners and Losers: 
401(k) Trading and Portfolio Performance, Michigan Retirement 
Research Center Working Paper WP2007-154 (June 2007).
    \21\ This estimate is derived from the risk adjusted returns 
attributed to participants with different trading strategies, see 
id.
    \22\ See, e.g., Dalbar Inc., Quantitative Analysis of Investor 
Behavior 2007 (2007).
    \23\ See, e.g., Rene Fischer & Ralf Gerhardt, Investment 
Mistakes of Individual Investors and the Impact of Financial Advice, 
Science Research Network Abstract 1009196 (Aug. 2007); Julie Agnew & 
Pierluigi Balduzzi, Transfer Activity in 401(k) Plans, Social 
Science Research Network Abstract 342600 (June 2006); and George 
Cashman et al., Investor Behavior in the Mutual Fund Industry: 
Evidence from Gross Flows, Social Science Research Network Abstract 
966360 (Feb. 2007).
---------------------------------------------------------------------------

Inadequate Diversification

    Investors sometimes fail to diversify adequately and thereby assume 
uncompensated risk and suffer associated losses. For example, DC plan 
participants sometimes concentrate their assets excessively in stock of 
their employer.\24\ Relative to full diversification,\25\ employer 
stock investments recently cost DC plan participants perhaps $3 billion 
\26\ annually, the Department estimates.\27\ Other lapses in 
diversification may involve omission from portfolios of

[[Page 49905]]

asset classes such as overseas equity or debt, small cap stocks, or 
real estate. Such lapses may sometimes reflect limited investment menus 
supplied by DC plans.\28\ Yet even where adequate choices are available 
and company stock is not a factor, investors sometimes fail to 
diversify adequately.\29\ Inadequate diversification other than 
excessive concentration in company stock recently cost participants 
perhaps $42 billion annually, the Department estimates.\30\ Good advice 
should address over concentration in employer stock and other failures 
to properly diversify.
---------------------------------------------------------------------------

    \24\ See, e.g., Olivia S. Mitchell & Stephen P. Utkus, The Role 
of Company Stock in Defined Contribution Plans, National Bureau of 
Economic Research Working Paper W9250 (Oct. 2002); and Jeffrey R. 
Brown & Scott Weisbenner, Individual Account Investment Options and 
Portfolio Choice: Behavioral Lessons from 401(k) Plans, Social 
Science Research Network Abstract 631886 (Dec. 2004).
    \25\ This comparison should be viewed as an outer bound. Full 
diversification of the same assets might not be feasible if 
companies are unwilling to alter the compensation mix in this way 
(see, e.g., Olivia S. Mitchell & Stephen P. Utkus, The Role of 
Company Stock in Defined Contribution Plans, National Bureau of 
Economic Research Working Paper W9250 (Oct. 2002)). It also neglects 
some potential tax benefits of employer stock investments that might 
offset losses from reduced diversification (see, e.g., Mukesh Bajaj 
et al., The NUA Benefit and Optimal Investment in Company Stock in 
401(k) Accounts, Social Science Research Network Abstract 965808 
(Feb. 2007)).
    \26\ Following findings reported in Lisa K. Meulbroek, Company 
Stock in Pension Plans: How Costly Is It?, Social Science Research 
Network Abstract 303782 (Mar. 2002), this estimate reflects losses 
amounting to 14 percent of the employer stock's value, assuming 10 
percent of DC plan assets are held in employer stock, the DC plan is 
one-half of total wealth, and the holding period is 10 years. For 
comparison, following findings reported in Krishna Ramaswamy, 
Company Stock and Pension Plan Diversification, in The Pension 
Challenge: Risk Transfers and Retirement Income Security 71, 71-88 
(Olivia S. Mitchell & Kent Smetters eds., 2003), the annualized cost 
of an option to receive the higher of the return on a typical 
company stock or the return on a fully diversified equity portfolio 
over a three-year horizon would amount to approximately $24 billion, 
the Department estimates. This measure probably exaggerates the loss 
to participants, however, insofar as it would preserve for the 
participant the potential upside of a company stock that outperforms 
the market.
    \27\ These estimates neglect any behavioral impact full 
diversification might have on asset allocation. There is some 
evidence that investing in employer stock increases participants' 
exposure to equity overall, which might increase average wealth 
(see, e.g., Jack L. Vanderhei, The Role of Company Stock in 401(k) 
Plans, Employee Benefit Research Institute T-133 Written Statement 
for the House Education and Workforce Committee, Subcommittee on 
Employer-Employee Relations, Hearing on Enron and Beyond: Enhancing 
Worker Retirement Security (Feb. 2002), at http://www.ebri.org/pdf/
publications/testimony/t133.pdf).
    \28\ See, e.g., Edwin J. Elton et al., The Adequacy of 
Investment Choices Offered By 401(k) Plans, Social Science Research 
Network Abstract 567122 (Mar. 2004), which finds that menus are 
frequently inadequate, and Ning Tang and Olivia S. Mitchell, The 
Efficiency of Pension Plan Investment Menus: Investment Choices in 
Defined Contribution Pension Plans, University of Michigan 
Retirement Research Center Working Paper WP 2008-176 (June 2008), at 
http://www.mrrc.isr.umich.edu/publications/papers/pdf/wp176.pdf, 
which finds that most menus are efficient.
    \29\ See, e.g., Laurent E. Calvet et al., Down or Out: Assessing 
the Welfare Costs of Household Investment Mistakes, Harvard 
Institute of Economic Research Discussion Paper No. 2107 (Feb. 
2006).
    \30\ See id. This estimate assumes annual return decrements from 
inadequate diversification of 0.3 percent of invested assets for 
investors that are already investing in risky assets (like stocks 
and mutual funds) and 3.3% for investors that are not yet investing 
in risky assets. The Department estimates that in the U.S. about 85% 
of investors include risky assets in their portfolios.
---------------------------------------------------------------------------

Inappropriate Risk

    Investors who avoid the foregoing three mistakes might be said to 
invest efficiently, in the sense that they generally can expect the 
maximum possible return given their level risk. However, they may still 
be making a costly mistake: they may fail to calibrate the risk and 
return of their portfolio to match their own risk and return 
preferences. As a result, their investments may be too risky or too 
safe for their own tastes. The Department lacks a basis on which to 
estimate the magnitude of such mistakes, but believes they may be 
common and large. A diversified portfolio's risk and return 
characteristics generally is determined by its allocation across asset 
classes. As noted above, there is ample evidence that participants' 
asset allocation choices often are inconsistent with fixed or well 
behaved risk and return preferences. If participants' true preferences 
are in fact fixed or well behaved, then observed asset allocations, 
which often appear to shift in response to seemingly irrelevant factors 
(or fail to shift in response to relevant ones), certainly entail large 
welfare losses.\31\ Good advice might help participants calibrate their 
asset allocations to match their true preferences.
---------------------------------------------------------------------------

    \31\ The potential financial effects of changes in asset 
allocation hint at the likely magnitude of these welfare effects. 
The Department previously has estimated that movement of DC plan 
default investments from stand-alone, low-risk capital preservation 
instruments to diversified portfolios that include equities will 
improve investment results for a large majority of affected 
individuals, increasing aggregate account balances by an estimated 
$5 billion to $7 billion in 2034 (See 72 FR 60,452, 60,466 (Oct. 24, 
2007)).
---------------------------------------------------------------------------

Excess Taxes

    It is likely that many households pay excess taxes as a result of 
disconnects between their investment and tax strategies. Households 
saving for retirement must decide not only what assets to hold, but 
also whether to locate these assets in taxable or tax-deferred 
accounts. For example, households may be able to maximize their 
expected after-tax wealth by first placing heavily taxed bonds in their 
tax-deferred account and then placing lightly taxed equities in their 
taxable account. A significant number of households do not follow this 
practice, however. By one estimate, to fully implement this practice in 
1998, U.S. households would have had to relocate some $251 billion in 
assets.\32\ It is not clear, however, whether such households are in 
fact making investment mistakes. In practice, this simple asset 
location rule may fail to minimize taxes.\33\ As a result the 
Department has no basis to estimate the magnitude of excess taxes that 
might derive from DC plan and IRA participants' investment mistakes. In 
any event it is unclear whether or to what extent investment advisers 
would be positioned to provide advice on tax efficiency.
---------------------------------------------------------------------------

    \32\ See, e.g., Daniel B. Bergstresser & James M. Poterba, Asset 
Allocation and Asset Location: Household Evidence from the Survey of 
Consumer Finances, Journal of Public Economics, Volume 88 1893, 
1893-1915 (2004).
    \33\ For example, tax-exempt municipal bonds are available, and 
actively managed equity mutual funds are not always tax-efficient 
(see, e.g., James M. Poterba et al., Asset Location for Retirement 
Savers, in Public Policies and Private Pensions 290, 290-331 (John 
B. Shoven et al. eds., 2004); and John B. Shoven & Clemens Sialm, 
Asset Location in Tax-Deferred and Conventional Savings Accounts, 
Journal of Public Economics, Volume 88 (2003)). Using historical 
returns data and tax rate data for the period 1962-98, James M. 
Poterba et al., Asset Location for Retirement Savers, in Public 
Policies and Private Pensions 290, 290-331 (John B. Shoven et al. 
eds., 2004) find that when investing in actively managed mutual 
funds, and with the availability of tax-exempt bonds, households 
would have more after-tax wealth in most cases if they had first 
placed equities in the tax-deferred account. Gene Amromin, Portfolio 
Allocation Choices in Taxable and Tax-Deferred Accounts: An 
Empirical Analysis of Tax-Efficiency, Social Science Research 
Network Abstract 302824 (May 2002) describes how accessibility 
restrictions on assets in tax-deferred retirement accounts create a 
tension between making tax-efficient placements and the risk of 
having to make costly withdrawals in the event of a bad labor income 
shock. He presents empirical evidence that holding apparently tax-
inefficient portfolios is related to accessibility restrictions and 
to precautionary motives. Lorenzo Garlappi & Jennifer C. Huang, Are 
Stocks Desirable in Tax-Deferred Accounts?, Journal of Public 
Economics, Volume 90 2257, 2257-2283 (July 2006) explain how a tax-
deferred account essentially confers a tax subsidy onto its 
holdings. While the level of the tax subsidy may be maximized by 
first placing bonds in the tax-deferred account, this strategy may 
lead to a more volatile tax benefit. Risk-averse households may wish 
to smooth this volatility by holding a mix of equities and bonds in 
both tax-deferred and taxable accounts, as some are observed to do 
in practice. Robert M. Dammon et al., Optimal Asset Location and 
Allocation with Taxable and Tax-Deferred Investing, The Journal of 
Finance, Volume LIX, Number 3 999, 999-1037 (2004) find that even 
when tax-exempt bonds are available and even when there are 
liquidity shocks, for most investors it is best to put taxable bonds 
in the tax-deferred account and equity in the taxable account.
---------------------------------------------------------------------------

Promoting Investment Advice

Permissible Arrangements

    Federal law limits the variety of arrangements whereby participants 
may obtain investment advice. Specifically, ERISA and the Internal 
Revenue Code generally prohibit fiduciaries from dealing with DC plan 
or IRA assets in ways that advance their own interests. These 
provisions effectively preclude participants from obtaining advice 
under arrangements that are widely used by other investors. For 
example, under many common arrangements, the adviser may receive a 
commission or other consideration when the investor enters into a 
transaction pursuant to the advice. The adviser's employer or an 
affiliate thereof may receive a sales load or other consideration in 
connection with the transaction. Stated generally, many common 
investment advice arrangements present financial advisers with 
opportunities to self deal.
    While generally prohibiting arrangements that present such 
opportunities, federal law also provides for conditional exemptions 
whereby otherwise prohibited transactions are permitted. Some 
exemptions are contained in the statute. The Department has authority 
to grant others. The conditions attached to such exemptions serve to 
mitigate the adverse effects of the conflicts of interest that are 
present and thereby protect participants' interests. However, the 
Department invites suggestions for other safeguards against conflicts 
of interest that would be consistent with the goal of making quality 
advice more widely available.
    The Pension Protection Act of 2006 opened the door to more types of 
investment advice arrangements by conditionally permitting arrangements 
where the fiduciary adviser or an affiliate thereof has a financial 
stake in

[[Page 49906]]

the advised participants' investment decisions. The Department is 
proposing a regulation to further specify the PPA's applicable 
conditions, together with a class exemption to establish alternative 
conditions under which such arrangements may operate. Table 1 
summarizes the effect of the PPA and this proposed class exemption on 
permissible investment advice arrangements.
    The Department calibrated this proposed regulation to in an effort 
to protect participants while promoting the affordability of investment 
advice arrangements operating pursuant to the PPA's statutory exemptive 
relief, in order that such arrangements will proliferate and thrive, to 
the benefit of participants.
    The PPA's relief (listed at B. in table 1) is conditioned in part 
on audits. In order to promote the affordability of advice, this 
proposed regulation provides that audits may rely on a representative 
sample of similar arrangements. In order to protect participants, this 
proposed regulation requires that audit reports identifying 
noncompliance in connection with advice provided to IRA beneficiaries 
be furnished to the Department.

                                  1--Permissible Investment Advice Arrangements
----------------------------------------------------------------------------------------------------------------
 Is it permissible for compensation
 to vary  depending on participants'      Person  providing        Fiduciary  adviser      Fiduciary  advisers'
        investment decisions?                  advice                    entity                 affiliates
----------------------------------------------------------------------------------------------------------------
A. Absent any exemptive relief:
    1. Except as described at 2.      No......................  No.....................  No.
     below.
    2. Advice is determined solely    N/a *...................  Yes....................  Yes.
     by a computer model that is
     provided by an independent
     entity and over which the
     fiduciary adviser has no
     control.
B. Under PPA statutory exemption:
    1. Subject to conditions          No......................  No.....................  Yes.
     including authorization by a
     separate fiduciary, independent
     audits, disclosure, and
     recordkeeping.
    2. Subject to conditions listed   N/a *...................  Yes....................  Yes.
     above at 1., and advice is
     provided by a computer model
     that is certified by an
     independent expert and
     satisfies conditions including
     conformance to investment
     theories and objectivity.
C. Under proposed class exemption:
    1. Subject to conditions          No......................  Yes....................  Yes.
     including conformance to
     investment theories,
     authorization by a separate
     fiduciary, independent audits,
     disclosure, and recordkeeping.
    2. Subject to conditions listed   Yes.....................  Yes....................  Yes.
     above at 1. and additional
     conditions including prudence
     and loyalty, advance provision
     of benchmark recommendations or
     educational material, and
     documentation.
----------------------------------------------------------------------------------------------------------------
* Under these arrangements, the investment advice is formulated exclusively by use of the computer model.

    The PPA's statutory exemptive relief for investment advice 
arrangements that use computer models (listed at B.2. in table 1) is 
conditioned in part on independent expert certification of such models. 
The expert must meet requirements specified by the Secretary and 
certifications and renewals thereof must be completed in accordance 
with rules established by the Secretary. This proposed regulation 
establishes such requirements and rules.
    In advance of formulating these requirements and rules the 
Department invited and considered extensive public input on the nature, 
functions, and performance of existing models. The Department also 
closely examined and road tested some popular models with particular 
attention to the criteria set forth in section 408(g)(3)(B) of ERISA. 
The Department came to the conclusion that existing computer models can 
take into account various information about individuals, their 
preferences and available investment options and, in its limited 
attempt to examine whether recommendations provided were optimal, the 
Department did not find evidence of computer models recommending 
investment portfolios that have risk return profiles inferior to any 
individual investment alternative available.
    On these bases the Department understands that models capable of 
satisfying the exemption's conditions are various and evolving. The 
variety and evolution reflect healthy competition to develop superior 
products that deliver more value to participants.
    The Department sought to calibrate this proposed regulation to 
nurture such competition while keeping advice affordable and protecting 
participants' interests. This proposed regulation consequently provides 
for transparency and procedural rigor but generally does not attempt to 
specify precise and fixed substantive standards. For example, pursuant 
to the proposed regulation the experts' qualifications will be reviewed 
by a fiduciary, and each certification will be documented in detail. 
The proposed regulation also provides that models may be certified once 
for similar applications across multiple DC plans or IRAs, rather than 
separately for each individual application, thereby promoting 
affordability of arrangements using models.
    The Department likewise sought to calibrate this proposed class 
exemption to protect participants while promoting the affordability of 
investment advice arrangements operating pursuant to it, in order that 
such arrangements likewise will proliferate and thrive, to the benefit 
of participants. As detailed below, the proposed class exemption, by 
relaxing bars against arrangements that place fiduciary advisers in 
positions where they have potential conflicts of interest, will 
increase the variety of investment advice arrangements that are 
available and potentially lower the cost and promote the marketing of 
such arrangements, to the benefit of participants. Conditions attached 
to the proposed class exemption will mitigate the adverse impact of the 
conflicts and thereby ensure the quality of advice provided pursuant to 
it.

Availability and Use

    Participants have always had the option of obtaining permissible 
investment advice services directly in the retail market. DC plan 
sponsors likewise have had the option of obtaining such services in the 
commercial market and making them available to plan participants and 
beneficiaries in connection with the plan.
    Prior to the 2006 enactment of the PPA, a substantial fraction of 
DC plan sponsors already made investment advice available to plan 
participants and

[[Page 49907]]

beneficiaries. Today, as the PPA's implementation progresses, many more 
have begun providing or are gearing up to provide such advice. It is 
likely that 40 percent or more of DC plan sponsors currently provide 
access to investment advice either on line, by phone, or in-person. 
Where offered, approximately 25 percent of participants use advice. In-
person advice seems to be offered by the most plan sponsors. On-line 
advice and to a lesser degree telephone advice are favored more by 
large sponsors. Smaller plan sponsors appear to offer advice generally 
and in-person advice in particular more frequently than larger plan 
sponsors.\34\
---------------------------------------------------------------------------

    \34\ This assessment is based on the Department's reading of 
Hewitt Associates LLC, Survey Findings: Hot Topics in Retirement, 
2007 (2007); Profit Sharing/401(k) Council of America, 50th Annual 
Survey of Profit Sharing and 401(k) Plans (2007); and Deloitte 
Development LLC, Annual 401(k) Benchmarking Survey, 2005/2006 
Edition (2006). In addition to investment advice, a majority of 
sponsors also provide one or more other types of support to 
participants' investment decisions. Other types of support include 
providing general investment education via seminars or written 
materials, offering one-stop, pre-mixed investment alternatives such 
as lifestyle funds, and offering managed accounts.
---------------------------------------------------------------------------

    Investment advice is also already used by a substantial fraction of 
IRA participants, the Department believes. A majority of IRA 
participants that invest in mutual funds purchase some or all of their 
funds via a professional financial adviser.\35\ Overall 60 percent of 
U.S. workers and retirees say they use the advice of a financial 
professional when making retirement savings and investment decisions; 
40 percent say this advice was more helpful to them than 
alternatives.\36\ It is not clear how recently this advice was 
obtained, however: In the same survey just 28 percent say that in the 
past year they obtained investment advice from a professional financial 
adviser who was paid through fees or commissions.\37\
---------------------------------------------------------------------------

    \35\ Eighty-two percent of mutual fund shareholders who hold 
funds outside of DC plans purchase some or all of their funds from a 
professional financial adviser such as a full-service broker, 
independent financial planner, bank or savings institution 
representative, insurance agent, or accountant (see, e.g., Victoria 
Leonard-Chambers & Michael Bogdan, Why Do Mutual Fund Investors Use 
Professional Financial Advisers?, Investment Company Institute 
Research Fundamentals, Volume 16, Number 1 (April 2007)). Because 
families owning IRAs outnumber those owning pooled investment 
vehicles outside of retirement accounts (see, e.g., Brian K. Bucks 
et al., Recent Changes in U.S. Family Finances: Evidence from the 
2001 and 2004 Survey of Consumer Finances, Federal Reserve Bulletin 
92 A1, A1-A38 (2006)), it is reasonable to conclude that a large 
majority of IRA beneficiaries who invest in mutual funds purchase 
them via such professionals. The Department has no basis to estimate 
the fraction of these beneficiaries that receive true investment 
advice from such professionals, however. It is possible that some 
make their purchase decisions without receiving any recommendation 
or material guidance from the professional making the sale.
    \36\ Alternatives including advice of peers, written plan 
materials, print media, television and radio, seminars, software, 
on-line information or advice, and retirement benefit statements 
were all less likely to be characterized as ``most helpful.''
    \37\ See, e.g., Employee Benefit Research Institute, 2007 
Retirement Confidence Survey, Wave XVII, Posted Questionnaire (Jan. 
2007).
---------------------------------------------------------------------------

    The new statutory exemptive relief provided by the PPA is expected 
to increase the availability of advice, but it is too early to observe 
by how much.\38\ The Department believes that absent this proposed 
class exemption some segments of the plan and participant market will 
lack adequate access to quality, affordable investment advice. Some 
potential fiduciary advisers will be deterred from entering the market 
by the complexity of advice arrangements that conform to the conditions 
of the PPA's statutory exemptive relief.\39\ Some plan sponsors and 
participants will be deterred by the cost of such arrangements,\40\ or 
by dissatisfaction with the types of advice arrangements that are 
available at lower costs, such as automated computer investment advice 
programs.\41\ As a result some DC plan sponsors will not offer advice, 
and where it is offered some participants will not use it.\42\ IRA 
beneficiaries may face similar obstacles to obtaining affordable, 
quality investment advice.
---------------------------------------------------------------------------

    \38\ The statutory exemptive relief for investment advice 
provided by the PPA generally became effective for advice provided 
after December 31, 2006. In February 2007 EBSA issued guidance on 
the new statutory exemptive relief for arrangements using fiduciary 
advisers whose affiliates' revenue might vary depending on the 
fiduciary advisers' fiduciary acts. It is likely that some such 
arrangements exist today, and that more will in the future. The PPA 
also provided relief for arrangements that provide advice via 
independently certified computer models. The PPA withheld this 
exemptive relief in connection with IRAs, however, unless and until 
the Department found and reported to Congress that a model 
satisfying certain criteria exists. Concurrent with issuance of this 
proposed class exemption, the Department has reached this finding 
and reported it to Congress. Therefore statutory relief for this 
latter type arrangement is just now being extended to IRAs. In 
addition, the PPA provides that the Department will by regulation 
specify the process by which computer models will be certified. 
Concurrent with issuance of this proposed class exemption, the 
Department is proposing such a regulation. Given this timing it is 
unlikely that many such latter type arrangements yet exist.
    \39\ Such complexity can include the need to enlist an adviser 
who is independent of or merely affiliated with the plan's or IRA's 
investment manager, in order to avoid direct exposure of the adviser 
to potential conflicts.
    \40\ As discussed below, arrangements that avoid potential 
conflicts may entail higher or more visible costs.
    \41\ In one survey of DC plan sponsors, among those offering 
investment advice, ``access to financial counselors in person'' was 
rated most effective, followed by ``access to financial counselors 
via telephone.'' ``Web-based'' advice received the lowest 
effectiveness ratings (see, e.g., Deloitte Development LLC, Annual 
401(k) Benchmarking Survey, 2005/2006 Edition (2006)). This finding 
is corroborated by another survey, in which in-person advice appears 
to be used by participants more often than advice delivered via the 
Internet (see, e.g., Profit Sharing/401(k) Council of America, 
Investment Advice Survey 2001 (2001)).
    \42\ Where investment advice is available to DC plan 
participants, only one in four uses it, according to one plan 
sponsor survey (see, e.g., Profit Sharing/401(k) Council of America, 
50th Annual Survey of Profit Sharing and 401(k) Plans (2007)). On-
line advice appeals more to higher-salaried, full-time workers (see, 
e.g., Julie Agnew, Personalized Retirement Advice and Managed 
Accounts: Who Uses Them and How Does Advice Affect Behavior in 
401(k) Plans?, Center for Retirement Research Working Paper 2006-9 
(2006)). In one survey, two-thirds of workers and 85 percent of 
retirees expressed discomfort with ``obtaining advice from financial 
professionals on-line. This raises the possibility that many 
participants, perhaps especially lower-paid, part-time participants, 
may be underserved if the regulatory environment excessively favors 
on-line advice.
---------------------------------------------------------------------------

    From the point of view of DC plan sponsors, the PPA and this 
proposed class exemption could help relieve certain concerns that have 
impeded some from providing investment advice in the past. A few years 
prior to the enactment of the PPA less than one in four surveyed DC 
plan sponsors provided advice, according to one survey.\43\ Those not 
providing advice were asked to cite reasons and rate the reasons' 
importance on a 0-to-5 scale. Two reasons cited by large majorities and 
rated moderately important might be ameliorated by this proposed class 
exemption: ``Fiduciary concern about ensuring that the advice provider 
has no conflict of interest'' \44\ (cited by 84 percent and rated 3.1) 
and ``cost of providing advice'' \45\ (cited by 69 percent and rated 
2.0).\46\ In another pre-PPA survey 35 percent of DC plan sponsors not 
offering advice cited cost as a reason.\47\
---------------------------------------------------------------------------

    \43\ See, e.g., Profit Sharing/401(k) Council of America, 
Investment Advice Survey 2001 (2001).
    \44\ Both the PPA and this proposed class exemption extend 
conditional relief from ERISA's prohibited transaction provisions, 
but neither relieves plan fiduciaries of their general obligations 
under ERISA.
    \45\ The cost of advice is discussed further immediately below.
    \46\ Other fiduciary concerns, cited more frequently and rated 
more important, are not addressed by this proposed class exemption.
    \47\ See, e.g., Deloitte Development LLC, Annual 401(k) 
Benchmarking Survey, 2005/2006 Edition (2006).
---------------------------------------------------------------------------

    From the point of view of prospective fiduciary advisers whose 
business models involve conflicts--e.g., who are compensated by the 
companies that manufacture, manage, and/or trade the investment 
products that they recommend--the PPA and this proposed class exemption 
grant conditional access to a very large and

[[Page 49908]]

fast growing new market segment.\48\ These advisers might be in a 
position to offer their services at low or no direct cost to the 
companies' DC plan and IRA clients (relying instead on compensation 
from the companies). They might market their services to the companies' 
clients more actively than have independent advisers historically.
---------------------------------------------------------------------------

    \48\ Combined participant directed DC plan and IRA assets exceed 
$7 trillion.
---------------------------------------------------------------------------

    For purposes of this impact assessment, the Department anticipates 
that owing to the statutory exemptive relief provided by the PPA, 
advice of some type (on-line, telephone and/or in person) will soon be 
available to perhaps one-half of DC plan participants, with in-person 
advice available to perhaps one in four. This proposed class exemption 
will boost these fractions to perhaps 60 percent and 35 percent, 
respectively. The Department's assumptions are summarized in Table 
2.\49\
---------------------------------------------------------------------------

    \49\ The Department based its assumptions on its reading of 
Hewitt Associates LLC, Survey Findings: Hot Topics in Retirement, 
2007 (2007); Profit Sharing/401(k) Council of America, 50th Annual 
Survey of Profit Sharing and 401(k) Plans (2007); and Deloitte 
Development LLC, Annual 401(k) Benchmarking Survey, 2005/2006 
Edition (2006).

            2--Availability of Advice to DC Plan Participants
------------------------------------------------------------------------
                                                 Any advice
                                                 (computer       Live
                Policy context                    or live)     advisor
                                                 (percent)    (percent)
------------------------------------------------------------------------
Pre-PPA.......................................           40           20
PPA...........................................           50           25
Class exemption...............................           60           35
------------------------------------------------------------------------

    The effect of investment advice depends not merely on its 
availability but on its use by DC plan and IRA participants. Do the 
participants seek advice, and if so do they follow it? According to one 
survey, among DC plan participants offered investment advice, 
approximately one in four uses it. There is some evidence that 
historically in-person advice has achieved higher use rates than on-
line advice, with on-line advice appealing more to higher-income 
participants.\50\ In another survey large fractions of workers say they 
would be very likely (19 percent) or somewhat likely (35 percent) to 
take advantage of advice provided by the company that manages their 
employer's DC plan. Of these, two-thirds said they would implement only 
those recommendations that were in line with their own ideas; 21 
percent said they would implement all of the recommendations as long as 
they trusted the source.\51\ In a subsequent survey, among those 
obtaining investment advice, 36 percent say they implemented ``all'' of 
the advice, 58 percent ``some,'' and just 5 percent ``none.'' \52\
---------------------------------------------------------------------------

    \50\ See, e.g., Profit Sharing/401(k) Council of America, 50th 
Annual Survey of Profit Sharing and 401(k) Plans (2007); and Julie 
Agnew, Personalized Retirement Advice and Managed Accounts: Who Uses 
Them and How Does Advice Affect Behavior in 401(k) Plans?, Center 
for Retirement Research Working Paper 2006-9 (2006).
    \51\ See, e.g., Employee Benefit Research Institute, 2007 
Retirement Confidence Survey, Wave XVII, Posted Questionnaire (Jan. 
2007). In practice this might translate into a high rate of 
compliance with recommendations, if recommendations turn out not to 
diverge too much from participants' own ideas.
    \52\ See, e.g., Employee Benefit Research Institute, 2008 
Retirement Confidence Survey, Wave XVIII, Posted Questionnaire (Jan. 
2008).
---------------------------------------------------------------------------

    The PPA and this proposed class exemption together could boost DC 
plan participants' use of advice where offered, in at least two ways. 
First, because it appears that in-person advice arrangements are more 
heavily used than automated computer advice programs, wider 
availability of in-person advice programs wherein advisers can exercise 
discretion in formulating personalized advice (rather than merely 
communicate the recommendations of a computer model)--a likely 
consequence of this proposed class exemption--might be expected to 
boost use rates. The shift anticipated by the Department (discussed 
immediately above) would increase the use rate slightly from 25 percent 
to 26 percent.\53\ Second, if the cost of advice falls, participants 
who must pay for advice will become more inclined to use it. However, 
historically employers have usually paid directly for advice, or passed 
the cost to all participants whether they use advice or not,\54\ and as 
explained below it is unclear by how much the cost of advice will fall. 
Therefore for purposes of this impact assessment the Department did not 
take into account any cost-driven increase in use of advice by DC plan 
participants, but assumed that this proposed class exemption will 
increase the fraction of DC plan participants using advice where 
available from 25 percent to 26 percent.\55\ Given the Department's 
assumptions regarding availability of advice to DC plan participants, 
this translates into an increase in the incidence of advice due to this 
proposed class exemption from 10 percent to 16 percent.
---------------------------------------------------------------------------

    \53\ This assumes that the use rate for where in person advice 
is available is approximately 50 percent higher (30 percent) as 
where only on-line or telephone advice is available (20 percent) 
(see, e.g., Employee Benefit Research Institute, 2007 Retirement 
Confidence Survey, Wave XVII, Posted Questionnaire (Jan. 2007)).
    \54\ See, e.g., Profit Sharing/401(k) Council of America, 
Investment Advice Survey 2001 (2001).
    \55\ One survey found that 64 percent of workers already use 
professional financial advice when making retirement savings and 
investment decisions, and that 54 percent are very or somewhat 
likely to use advice if offered by their employer in connection with 
a DC plan (see, e.g., Employee Benefit Research Institute, 2007 
Retirement Confidence Survey, Wave XVII, Posted Questionnaire (Jan. 
2007)). This seems to suggest a higher baseline rate of advice use 
than assumed here. However, because the latter fraction is smaller 
than the former, it is unclear whether this suggests that this 
proposed class exemption would increase DC plan participants' use of 
advice by more or less than assumed here.
---------------------------------------------------------------------------

    The PPA and this proposed class exemption could also boost IRA 
participants' use of advice. As noted above, advisers doing business 
pursuant to this class exemption are likely to actively market advice 
services to IRA participants and to offer them reduced prices for such 
services. The reduced prices will reflect both the availability to 
advisers of other compensation and possible cost saving in the 
production and delivery of advice. Advisers doing business pursuant to 
this proposed class exemption may thereby attract business both from 
IRA participants who otherwise would be without advice and from IRA 
participants who otherwise would obtain advice through an arrangement 
that does not require the relief provided by this proposed class 
exemption. IRA participants who would otherwise be without advice may 
obtain advice in response to such marketing and pricing activity 
because the activity reduces their search cost to find and select an 
adviser, and/or because the reduced price falls below their reservation 
price. Likewise, IRA participants who would otherwise have obtained 
advice via some other arrangement may switch to an arrangement pursuant 
to the PPA or this proposed class exemption (and may increase the 
amount of advice services they use) because the advisers' marketing 
activity broadens their search and/or in pursuit of lower prices.
    In proposing this class exemption the Department considered 
carefully the importance of transparency in pricing. Participants' 
decisions whether and where to obtain advice should be well informed 
with respect to the cost associated with alternative arrangements. As a 
condition of this proposed class exemption an adviser must disclose to 
the participant certain information regarding other revenue sources. 
This condition is intended to enable participants to decide whether, 
where, and how much advice to obtain, in light of the associated direct 
and indirect costs to them.\56\ Therefore the

[[Page 49909]]

Department intends that any cost-driven increase in use of advice by 
IRA participants will be driven by overall cost decreases and not 
solely by direct price reductions.
---------------------------------------------------------------------------

    \56\ In particular, participants should be able to adequately 
compare the prices offered by advisers doing business pursuant to 
this exemption with those offered by other advisers such as those 
offering their services for a flat fee.
---------------------------------------------------------------------------

    As noted above there is evidence that a large fraction of IRA 
participants already use advice. For purposes of this assessment the 
Department assumes that as a result of the PPA and this proposed class 
exemption the proportion of IRA beneficiaries using advice will 
increase from one-third to two-thirds. The Department's assumptions 
regarding use of advice are summarized in table 3.\57\
---------------------------------------------------------------------------

    \57\ These assumptions are based on the Department's reading of 
Employee Benefit Research Institute, 2007 Retirement Confidence 
Survey, Wave XVII, Posted Questionnaire (Jan. 2007); Hewitt 
Associates LLC, Survey Findings: Hot Topics in Retirement, 2007 
(2007); Profit Sharing/401(k) Council of America, 50th Annual Survey 
of Profit Sharing and 401(k) Plans (2007); and Deloitte Development 
LLC, Annual 401(k) Benchmarking Survey, 2005/2006 Edition (2006). 
There are a number of reasons to believe that use of advice will be 
higher among IRA beneficiaries than DC plan participants. The 
aforementioned survey reports, read together, generally support this 
conclusion. In addition, relative to IRA beneficiaries, DC 
participants may have less need for advice and/or easier access to 
alternative forms of support for their investment decisions. DC plan 
participants' choice is usually confined to a limited menu selected 
by a plan fiduciary, and the menu may include one-stop alternatives 
such as target date funds that may mitigate the need for advice. 
Their plan or employer may provide general financial and investment 
education in the form of printed material or seminars. They often 
make initial investment decisions (sometimes by default) before 
contributing to the plan so the decisions' impact may seem small. 
Finally, the availability of advice in connection with the plan is 
intermediated by the plan sponsor and fiduciary. In contrast, IRA 
beneficiaries generally have wider choice and are more likely to be 
without employer-provided support for their decisions. Decision 
points may more often occur when account balances are large, such as 
when rolling a large DC plan balance into an IRA or when retiring. 
Finally, the availability of advice to IRA beneficiaries is not 
intermediated by an employer--rather IRA beneficiaries interface 
directly with the retail market and will thereby be more directly 
affected by the exemptive relief provided by the PPA and by this 
proposed class exemption. For all of these reasons IRA beneficiaries 
may use advice more frequently than DC plan participants.

                                3--Use of Advice by DC Plan and IRA Participants
----------------------------------------------------------------------------------------------------------------
                                                             DC plans
                                                 --------------------------------                     Dollars
                 Policy context                    Where offered      Overall           IRA           advised
                                                     (percent)       (percent)                     ($trillions)
----------------------------------------------------------------------------------------------------------------
Pre-PPA.........................................              25              10              33            $1.7
PPA.............................................              25              13              50             2.5
Class exemption.................................              26              16              67             3.2
----------------------------------------------------------------------------------------------------------------

    It seems likely that in practice a large proportion of participants 
who receive advice will follow that advice either in whole or in part. 
This is especially likely if the advice turns out to be broadly in line 
with the participants' own thinking. Nonetheless, some advice will not 
be followed, and as a result some investment errors will not be 
corrected. For purposes of this analysis, the Department has assumed 
that advised participants make investment errors at one-half the rate 
of unadvised participants. The remaining errors reflect participant 
failures to follow advice (together with possible flaws in some advice, 
as discussed immediately below).

Cost

    As noted above the PPA and this proposed class exemption are 
expected to make advice available to participants at a lower direct 
price, because advisers will be able to rely on alternative revenue 
sources to compensate their efforts. More importantly, however, the 
Department believes that the total cost of the advice to participants 
will be reduced. Bars against transactions wherein fiduciary advisers' 
and participants' interests may conflict carry costs. Faced with such 
bars advisers may forgo certain potential economies of scale in 
production and distribution of financial services that would derive 
from more vertical and horizontal integration.\58\ And to avoid such 
conflicts they must carefully monitor and calibrate their relationships 
and compensation arrangements, or incur the opportunity cost associated 
with exclusive reliance on level fees. The Department therefore expects 
the PPA and this proposed class exemption to produce cost savings by 
harnessing economies of scale and by reducing compliance burdens. The 
Department is unaware of any available empirical basis on which to 
determine whether or by how much costs might be reduced, however.
---------------------------------------------------------------------------

    \58\ For example, an adviser employed by an asset manager can 
share the manager's research instead of buying or producing such 
research independently.
---------------------------------------------------------------------------

Quality

    The effect of investment advice also depends on its quality. Good 
advice can reduce investment errors, steering investors away from 
higher than necessary expenses and toward optimal trading strategies, 
broad diversification, and asset allocations consistent with the 
investors' tastes for risk and return. The Department believes that, 
although there is no universally accepted single and complete theory of 
optimal investing, and although there is some evidence of lapses in the 
quality investment advice,\59\ professional advisers'

[[Page 49910]]

recommendations are likely to be superior to unadvised participants' 
investment practices.\60\ It is therefore likely that participants who 
obtain and follow advice, including advice provided pursuant to the PPA 
or this proposed class exemption and advice provided under alternative 
permissible arrangements, will substantially reduce their investment 
mistakes and thereby derive substantial financial benefits and improve 
their welfare.
---------------------------------------------------------------------------

    \59\ There is no single, complete, universally accepted theory 
of optimal investment. Instead there are competing and evolving 
theories which have much in common (what might be called ``generally 
accepted'' theories) but also important differences (see, e.g., 
Martin Wallmeier & Florian Zainhofer, How to Invest Over the Life 
Cycle: a Review, Social Science Research Network Abstract 951167 
(Dec. 2006); and Deloitte Financial Advisory Services LLP, Generally 
Accepted Investment Theories (July 11, 2007) (unpublished 
memorandum, on file with the Department of Labor)). In practice this 
means that different experts may give different advice; often the 
differences will be small but occasionally they might be large.
    There is some evidence of lapses in the quality of investment 
advice. Investment advisers' advice does not always conform to 
generally accepted investment theories. For example, they sometimes 
neglect investors' debt, or exhibit ``home bias'' toward domestic 
investment. Home bias may be larger in advice given to more risk 
averse investors; this conflicts with theory insofar as home bias 
reduces diversification and therefore increases risk. Investment 
advisers in some sense have two functions: to provide investment 
advice and to provide investor advice. The former ought to conform 
to financial theories, while the latter involves helping investors 
overcome behavioral biases and errors. Together these functions may 
result in a nuanced balance between what the investor theoretically 
``should'' choose and what the investor is comfortable choosing 
(see, e.g., Elisa Cavezzali & Ugo Rigoni, Investor Profile and Asset 
Allocation Advice, Social Science Research Network Abstract 966178 
(Feb. 2007)). Some advice computer models and educational material 
may furnish misleading information regarding risk and consequently 
may do harm (see, e.g., Zvi Bodie, An Analysis of Investment Advice 
to Retirement Plan Participants, in The Pension Challenge: Risk 
Transfers and Retirement Income Security 19, 19-32 (Olivia S. 
Mitchell & Kent Smetters eds., 2003)). Advice computer models 
generally fail to coordinate financial investments with financial 
risks associated with individuals' jobs, homes, and health (see, 
e.g., John Ameriks & Douglas Fore, Financial Planning: On the Issue 
of Advice, Benefits Quarterly, Fourth Quarter 6, 6-14 (2002)). While 
it is widely agreed that such coordination is important, theories 
about how this should be done continue to evolve (see, e.g., 
G[uuml]nter Franke et al., Non-Market Wealth, Background Risk and 
Portfolio Choice, Social Science Research Network Abstract 968096 
(Mar. 2007)). Typical advice as reflected in target-date funds 
conforms to some financial theories but conflicts with others (see, 
e.g., Luis M. Viceira, Life-Cycle Funds, Social Science Research 
Network Abstract 988362 (May 2007)).
    \60\ Rene Fischer & Ralf Gerhardt, Investment Mistakes of 
Individual Investors and the Impact of Financial Advice, Science 
Research Network Abstract 1009196 (Aug. 2007) ``present financial 
advice as (potentially) correcting'' a variety of investment 
mistakes that left uncorrected ``lead to considerable welfare 
losses.''
---------------------------------------------------------------------------

    In its effort to ensure the quality of advice, the Department 
carefully considered the substantial risks attendant to opportunities 
for self-dealing that may exist among fiduciary advisers doing business 
pursuant to the PPA or this proposed class exemption. There is evidence 
that advisers sometimes seize such opportunities and thereby reap 
profit at investors' expense.\61\ The provisions of this proposed 
regulation and conditions attached to this proposed class exemption are 
intended to guard against these risks while keeping advice 
affordable.\62\
---------------------------------------------------------------------------

    \61\ These risks consist of the possibility that some advisers 
will pursue profit by dispensing advice that increases their own 
revenue at the expense of participants' interests.
    Consideration of these risks is especially important because 
advice pursuant to this proposed class exemption, while extending to 
many participants who otherwise would invest without guidance or 
support, may also extend to many others who absent this class 
exemption would have benefited from alternative forms of support for 
their investment decisions, such as alternative permissible advice 
arrangements, target-date funds, managed accounts, or automatic 
rebalancing.
    In considering these risks the Department devoted separate 
attention to the application of this proposed class exemption to 
IRAs. In contrast to DC plan participants, IRA participants may be 
more vulnerable to risks attendant to conflicts of interest insofar 
as they: (1) May include more retirees, who may be in greater need 
of advice, but who also may be more vulnerable to abusive practices 
(see, e.g., Phyllis C. Borzi & Martha Priddy Patterson, Regulating 
Markets for Retirement Payouts: Solvency, Supervision and 
Credibility, Pension Research Council Working Paper PRC WP2007-21 
(Sept. 2007)); (2) are not represented by a plan fiduciary, 
independent of the adviser and connected to their interests via an 
employment relationship, who selects and monitors the advice 
arrangement and pre-screens the menu of investment options for 
quality; and (3) may not, under the conditions of this proposed 
class exemption, have the benefit of specific advice provided by an 
independent or independently-certified computer model to compare 
with (and possibly follow in lieu of) advice delivered pursuant to 
the proposed class exemption. In addition, while advisers to DC plan 
participants are subject to standards of fiduciary conduct and 
attendant liability under Title I of ERISA, advisers to IRA 
beneficiaries are not. Finally, the Department's authority to 
enforce the conditions of this proposed exemption generally extends 
only to DC plans and not to IRAs. On the other hand, IRA 
beneficiaries' vulnerability to risks attendant to conflicts of 
interest may be mitigated by their ability to make rational and well 
informed purchases in a vibrant, competitive market for investment 
advice and other financial products and services in which some 
vendors will offer unconflicted advice.
    The Department believes that absent effective controls conflicts 
can sometimes bias advice, although it is unclear how much or in 
exactly what ways. Biased advice may be less beneficial to investors 
than unbiased advice, or possibly even harmful in some cases.
    There is a theoretical basis to believe that investors may be 
harmed (or may benefit less) where managers pay intermediary 
advisers for inflows, and that such payments may increase the role 
of intermediaries (fewer investors may invest directly) (see, e.g., 
Neal M. Stoughton et al., Intermediated Investment Management, 
Social Science Research Network Abstract 966255 (Mar. 2007)). This 
suggests that advisers whose fees are not level relative to their 
clients' investment elections may give biased advice that enriches 
managers at investors' expense (the motivation for and potential to 
profit from conflicts and bias may attach more to the manager who 
compensates the adviser than to the adviser). It also suggests that 
advisers doing business pursuant to this proposed class exemption 
might displace alternative forms of investment decision support.
    According to one empirical study, ``there exists conflict of 
interests between load fund investors and brokers and financial 
advisers: brokers and financial advisers apparently serve their own 
interests by guiding investors into funds with higher loads, which 
generate higher income to the brokers and financial advisers but 
increase the expenses of investors.'' High load funds have larger 
inflows than low load funds with otherwise similar performance. 
Recent increases in fund loads suggest that funds are seeking favor 
from brokers and advisers (see, e.g., Xinge Zhao, The Role of 
Brokers and Financial Advisors Behind Investment Into Load Funds, 
China Europe International Business School Working Paper (Dec. 
2005), at http://www.ceibs.edu/faculty/zxinge/brokerrole-zhao.pdf). 
Another study reaches similar conclusions. ``Relative to direct-sold 
funds, broker-sold funds deliver lower risk-adjusted returns, even 
before subtracting distribution costs. * * * Further, broker-sold 
funds exhibit no more skill at aggregate-level asset allocation than 
do funds sold through the direct channel.'' Even before accounting 
for the higher distribution expenses, the underperformance cost 
investors $4.6 billion in 2004. Brokers devote more effort to 
selling funds that generate more revenue for them (see Daniel B. 
Bergstresser et al., Assessing the Costs and Benefits of Brokers in 
the Mutual Fund Industry, forthcoming in The Review of Financial 
Studies).
    Yet another study finds that ``investors who transact through 
investment professionals that are compensated through conventional 
distribution channels incur substantially poorer timing performance 
than investors who purchase pure no load funds.'' The 
underperformance amounts to approximately 100 or 150 basis points 
(see, e.g., Mercer Bullard et al., Investor Timing and Fund 
Distribution Channels, Social Science Research Network Abstract 
1070545 (Dec. 2007)).
    Some other studies are less conclusive. For example, one finds 
that captive brokers add more value for investors in purchasing 
funds, while unaffiliated brokers add the most value in redeeming 
them. Direct, no-load investors' redemptions are the least sensitive 
to performance. This study also finds that higher payments from fund 
companies to unaffiliated brokers buys some inflows for funds (see, 
e.g., Susan Christoffersen et al., The Economics of Mutual-Fund 
Brokerage: Evidence from the Cross Section of Investment Channels, 
Social Science Research Network Abstract 687522 (Dec. 2005)).
    \62\ The Department has no basis to estimate how much risk might 
remain. However the Department notes that the safeguards associated 
with the PPA and this class exemption are likely to be stronger than 
those associated with available research studies, cited above, that 
quantify substantial losses to investors. First, advisers to DC plan 
participants are subject to ERISA's fiduciary standards. Second, the 
PPA and this class exemption provide substantive conditions 
including unbiasedness, together with procedural protections such as 
provision of advice generated by computer models that are certified 
by independent experts, documentation of bases for advice, and 
audits of investment advice programs' conformance to applicable 
substantive conditions. Such protections generally are not provided 
in other U.S. contexts. For a discussion of protections applicable 
where advice is delivered by investment advisers or brokers to 
investors outside of IRAs and ERISA-covered retirement plans, see 
Angela A. Hung et al., Investor and Industry Perspectives on 
Investment Advisers and Broker-Dealers, RAND Corporation Technical 
Report (2008), at http://www.sec.gov/news/press/2008/2008-1_
randiabdreport.pdf.
---------------------------------------------------------------------------

    For purposes of this analysis, the Department has assumed that 
advised participants make investment errors at one-half the rate of 
unadvised participants. The remaining errors reflect possible flaws in 
some advice (together with participant failures to follow advice, 
discussed immediately above).\63\ Additionally for purposes of this 
analysis the Department assumes that all permissible advice 
arrangements (including those operating pursuant to exemptive relief 
provided by the PPA and those operating pursuant to this proposed class 
exemption) deliver

[[Page 49911]]

advice of similar quality and effectiveness.
---------------------------------------------------------------------------

    \63\ Whether advice corrects errors depends on whether the 
advice is followed and whether it is good. There is reason to 
believe that many people receiving advice will follow it. In a 2008 
survey, among those obtaining investment advice, 36 percent say they 
implemented ``all'' of the advice, 58 percent ``some,'' and just 5 
percent ``none'' (Employee Benefit Research Institute, 2008 
Retirement Confidence Survey, Wave XVII, Posted Questionnaire (Jan. 
2008)). There is also reason to believe that good advice will be 
available. According to Bluethgen, et al., High-Quality Financial 
Advice Wanted!, Social Science Research Network Abstract 1102445 
(Feb. 2008), ``There is a high degree of heterogeneity in quality 
among financial advisors * * * the extent to which advisors receive 
compensation in the form of fixed fees instead of sales commissions 
as well as the extent to which advisors exhibit a high degree of 
rationality in decision making are predictive of high-quality 
financial advice.'' According to Bluethgen, et al., Financial Advice 
and Individual Investors' Portfolios, Social Science Research 
Network Abstract 968197 (Mar. 2008), ``advice enhances portfolio 
diversification, makes investor portfolios more congruent with 
predefined model portfolios, and increases investors' fees and 
expenses. Our empirical evidence is broadly in line with honest 
financial advice.''
---------------------------------------------------------------------------

Benefits

    The Department expects the PPA and this proposed class exemption to 
reduce investment errors to the benefit of participants. As noted 
above, prior to implementation of the PPA, investment mistakes cost 
participants $109 billion or more annually. Increased use of investment 
advice under the PPA will reduce such mistakes by $7 billion, and this 
proposed class exemption will reduce them by another $7 billion, the 
Department estimates. Altogether after implementation of this proposed 
class exemption, use of investment advice by DC plan and IRA 
participants will eliminate $29 billion worth of investment errors 
annually. The Department's estimates of investment errors and 
reductions from investment advice are summarized in table 4.

                          4--Investment Errors and Impact of Advice ($Billions, Annual)
----------------------------------------------------------------------------------------------------------------
                                                                                    Errors eliminated by advice
                         Policy context                              Remaining   -------------------------------
                                                                      errors        Incremental     Cumulative
----------------------------------------------------------------------------------------------------------------
No advice.......................................................            $124              $0              $0
Pre-PPA advice only.............................................             109              15              15
PPA.............................................................             102               7              22
Class exemption.................................................              95               7              29
----------------------------------------------------------------------------------------------------------------

Costs

    Participant gains from investment advice must be weighed against 
the cost of that advice. Different types of advice may come with 
different costs. For example, advice generated by an automated computer 
program may be less costly than advice provided by a personal adviser. 
For purposes of this analysis the Department assumed that in the 
context of a DC plan, computer generated advice costs 10 basis points 
annually, while adviser provided advice costs 20 basis points. In 
connection with an IRA the corresponding assumptions are 15 and 30 
basis points. These assumptions are reasonable in light of information 
available to the Department about the cost of various existing advice 
arrangements. On this basis the Department estimates the cost of advice 
as summarized in table 5.\64\
---------------------------------------------------------------------------

    \64\ The Department notes that costs probably often will not be 
distributed across advised participants in proportion to the size of 
their accounts. Rather, it is likely that some costs of providing 
advice are fixed relative to account size, so the cost borne by 
small account holders probably will be larger in relation to account 
size than that borne by large account holders. The average estimates 
reported in table 4 are dollar weighted. For the average 
participant, the basis point cost will be higher than this dollar 
weighted average, and the amount by which investment errors are 
reduced per dollar of advice will be lower.

                                                5--Cost of Advice
----------------------------------------------------------------------------------------------------------------
                                                                                                       Class
                                                                      Pre-PPA           PPA          exemption
----------------------------------------------------------------------------------------------------------------
Incremental:
    Advice cost ($billions).....................................           $3.8            $1.8            $2.3
    Advice cost rate (bps, average).............................           23              23              29
    Error reduced per $1 of advice, average.....................           $3.90           $3.80           $3.10
Cumulative (combined with policies to the left):
    Advice cost ($billions).....................................           $3.8            $5.6            $7.9
    Advice cost rate (bps, average).............................           23              23              24
    Error reduced per $1 of advice, average.....................           $3.90           $3.90           $3.70
----------------------------------------------------------------------------------------------------------------

Alternatives

    In formulating this proposed regulation and proposed class 
exemption, the Department considered several alternative approaches.

Specific Substantive Standards for Model Certification

    This proposed regulation provides mostly procedural standards for 
the certification of computer models pursuant to PPA's statutory 
exemptive relief. In crafting these provisions the Department carefully 
considered whether to establish specific substantive standards as well.
    Computer models are evolving, driven by advances in information 
technology and financial theories, and by market competition. A recipe 
for testing the robustness of one current technology might not be 
effective when applied to a future technology. Ongoing refinements and 
revisions to financial theories, the product of healthy competition 
among ideas, would soon belie any specification of generally accepted 
theory that might be enshrined in regulation. The Department therefore 
believes that a substantive standard generally would not serve to 
protect participants but instead might diminish the benefits of the 
PPA's relief for arrangements using models. However, the Department 
invites comments on the advantages and disadvantages of a more 
substantive standard than what is proposed, and asks for suggestions 
for what a more substantive standard might include.

Deferring Action on Class Exemption

    The Department considered deferring proposing a class exemption for 
a year or more in order to observe the market impact of the exemptive 
relief provided by the PPA. This might have provided fuller information 
on the degree to which some market segments would remain underserved by 
advice and on the barriers responsible for such ongoing under service, 
and thereby assisted the Department's effort to determine whether and 
how to provide additional exemptive relief.
    However, the Department is concerned that deferring action might 
delay the proliferation of advice and prolong correctable investment 
errors and believes that the need for additional exemptive relief is 
already adequately

[[Page 49912]]

clear. The exemptive relief provided by the PPA does not embrace 
business models that occupy large parts of the non-IRA retail 
market,\65\ and therefore may leave major segments of the DC plan and 
IRA markets underserved. In addition, by excluding popular business 
models, the PPA's exemptive relief by itself would tilt the playing 
field in favor of other business models, which may sometimes be more 
expensive or less beneficial. This raises the possibility that some 
segments of the market would be inefficiently served. This proposed 
class exemption will level the playing field for competing business 
models and thereby promote efficiency in the market for investment 
advice.
---------------------------------------------------------------------------

    \65\ See, e.g., Victoria Leonard-Chambers & Michael Bogdan, Why 
Do Mutual Fund Investors Use Professional Financial Advisers?, 
Investment Company Institute Research Fundamentals, Volume 16, 
Number 1 (April 2007); and Employee Benefit Research Institute, 2007 
Retirement Confidence Survey, Wave XVII, Posted Questionnaire (Jan. 
2007).
---------------------------------------------------------------------------

Level Fee Condition

    The PPA provides conditional exemptive relief for advice 
arrangements wherein the revenue of a fiduciary adviser's affiliates 
varies on the basis of advised participants' investment decisions, but 
not to arrangements wherein the revenue of the fiduciary adviser itself 
so varies. This proposed class exemption extends conditional relief to 
the latter.
    The Department considered including as a mandatory condition of 
this proposed class exemption a requirement that the compensation 
received by the person providing the advice on behalf of the fiduciary 
adviser does not vary on the basis of participants' investment 
decisions. Such a condition might ease enforcement of the exemption's 
conditions, and might reduce the risks attendant to conflicts of 
interest that may exist among advisers doing business pursuant to the 
proposed class exemption. But it also would exclude from exemptive 
relief popular business models that are well established in the non-IRA 
retail market and that operate without similar compensation 
requirements, and therefore might unduly impair the availability of 
advice. Therefore Department elected to make this ``level fee'' 
condition \66\ one of two alternative conditions,\67\ thereby allowing 
the person's compensation to vary as long as the other condition is 
met. The other condition provides alternative protections against the 
risks attendant to conflicts of interest.
---------------------------------------------------------------------------

    \66\ See paragraph (f).
    \67\ The alternative condition is at paragraph (e). Paragraph 
(d) provides that the two are alternatives.
---------------------------------------------------------------------------

Model Generated Advice for IRA Beneficiaries

    The Department considered including as part of the immediately 
aforementioned alternative condition a requirement that IRA 
beneficiaries always be provided with specific, model generated 
investment recommendations, similar to those which under the condition 
must be provided to DC plan participants.\68\ However the Department 
believes that such a requirement sometimes might be neither practical 
nor effective as applied to IRAs. It might not be practical because, 
while such models exist, their availability, affordability and 
effectiveness are not yet proven in all segments of the IRA market. It 
might not be effective because the wide range of investment options 
open to most IRA beneficiaries could make comparisons of model 
generated advice with the advisers' recommendations difficult for 
beneficiaries. Therefore the conditions of this proposed class 
exemption allow that IRA beneficiaries may under certain circumstances 
be provided with educational material or recommendations on asset 
allocation across asset classes rather than with specific, model 
generated investment recommendations.\69\
---------------------------------------------------------------------------

    \68\ See paragraph (e)(1).
    \69\ See paragraph (e)(2).
---------------------------------------------------------------------------

Uncertainty

    The Department is highly confident in its conclusion that 
investment errors are common and often large, producing large avoidable 
losses (including foregone earnings) for participants. It is also 
confident that participants can reduce errors substantially by 
obtaining and following good advice. While the precise magnitude of the 
errors and potential reductions therein are uncertain,\70\ there is 
ample evidence that that magnitude is large.
---------------------------------------------------------------------------

    \70\ The incidence and magnitude of investment errors is 
uncertain. Because errors are generally measured with reference to 
some optimal benchmark, the evolving character of investment theory 
contributes to this uncertainty. For a given level of incidence and 
effectiveness of advice, the reduction in errors will be 
proportionate to the errors reduced. The Department did not attempt 
to estimate the magnitude of losses from inappropriate risk or 
excess taxes, so its estimate of this proposed class exemption's 
impact omit potential reductions in such errors. As noted above, the 
Department's estimate of higher than necessary expenses is 
conservative in light of referenced literature and omits certain 
less visible expenses such as mutual funds' internal transaction 
costs. Its estimates of losses from poor trading strategies and 
inadequate diversification are moderate, if not conservative, taking 
account of the losses that were measured in the referenced studies. 
The Department believes that the combined magnitude of investment 
errors, and therefore of the reduction in such errors that can be 
expected from wider use of advice, is at least as large as reported 
here, and possibly much larger.
---------------------------------------------------------------------------

    The Department is also confident that this proposed class 
exemption, by relaxing rules governing arrangements under which advice 
can be delivered, will promote wider use of advice. However, the 
Department is uncertain to what extent advice will reach participants 
and to what extent advice that does reach them will reduce errors. To 
illustrate that uncertainty, the Department conducted sensitivity tests 
of how its estimates of the reduction in investment errors attributable 
to the PPA and this proposed class exemption would change in response 
to alternative assumptions regarding the availability, use, and quality 
of advice. Table 6 summarizes the results of these tests.

                            6--Uncertainty in Estimate of Investment Error Reduction
----------------------------------------------------------------------------------------------------------------
                                                                     Impact of
          Primary estimates  denoted *             Impact of PPA       class       Impact of all     Remaining
                                                                     exemption        advice          errors
----------------------------------------------------------------------------------------------------------------
Advice eliminates:
    50% of errors *.............................              $7              $7             $29             $95
    75% of errors...............................              11              11              47              86
    25% of errors...............................               3               3              14             102
After PPA/class exemption, advice reaches:
    13%/16% of DC and 50%/67% of IRA *..........               7               7              29              95
    15%/21% of DC and 60%/80% of IRA............              11               9              35              89
    11%/13% of DC and 40%/50% of IRA............               3               4              22             102
----------------------------------------------------------------------------------------------------------------


[[Page 49913]]

    The Department is uncertain whether the magnitude and incidence of 
investment errors and the potential for correction of such errors in 
the context of IRAs might differ from that in the context of ERISA-
covered DC plans. If a DC plan's menu of investment options is 
efficient then the incidence and/or magnitude of errors might be 
smaller than in the IRA context. If it is inefficient then errors might 
be more numerous and/or larger, but the potential for correcting them 
might be constrained. As noted earlier, evidence on the efficiency of 
existing menus is mixed.
    The Department is uncertain about the mix of advice and other 
support arrangements that will compose the market, and about the 
relative effectiveness of alternative investment advice arrangements or 
other means of supporting participants' investment decisions. For 
example, to what extent will arrangements pursuant to this proposed 
class exemption displace alternative arrangements? Will advice 
arrangements operating pursuant to this proposed class exemption be 
more, less, or equally effective as alternative arrangements?
    This analysis has assumed that all types of advice arrangements are 
equally effective at reducing investment errors, and that none will 
increase errors (there will be no very bad advice). This assumption may 
not hold, however, for a number of reasons. For example, as illustrated 
above in table 1, advisers operating pursuant to different exemptive 
relief may be subject to different levels of conflicts of interest. 
Individuals providing advice pursuant to this proposed class exemption 
may face particularly direct conflicts, in the form of opportunities to 
tailor advice to directly profit themselves at participants' expense. 
The Department's consideration of this risk was detailed above.
    The conditions attached to exemptive relief under the PPA and this 
proposed class exemption are intended to control this risk while 
keeping advice affordable. The Department notes that if users of advice 
are fully informed and rational then more cost effective arrangements 
will dominate the market. This proposed class exemption establishes 
conditions to ensure that prospective users of advice available 
pursuant to it will have the opportunity to become fully informed.
    The Department is uncertain about the potential magnitude of any 
transitional costs associated with this proposed regulation and 
proposed class exemption. These might include costs associated with 
efforts of prospective fiduciary advisers to adapt their business 
practices to the applicable conditions. They might also include 
transaction costs associated with initial implementation of investment 
recommendations by newly advised participants.
    Another source of uncertainty involves potential indirect 
downstream effects of this proposed regulation and proposed class 
exemption. Investment advice may sometimes come packaged with broader 
financial advice, which may include advice on how much to contribute to 
a DC plan. The Department has no basis to estimate the incidence of 
such broad advice or its effects, but notes that those effects could be 
large. The opening of large new markets to a variety of investment 
advice arrangements to which they were heretofore closed may affect the 
evolution of investment advice products and services and related 
technologies and their distribution channels and respective market 
shares. Other possible indirect effects that the Department lacks bases 
to estimate include financial market impacts of changes in investor 
behavior and related macroeconomic effects.
    The Department invites comments on how to improve this analysis, 
with particular attention to the assessment and explanation of 
attendant uncertainty, and how such analysis could be carried out. 
Comments that include specific suggestions or data to help support our 
analysis of impacts and the characterization of uncertainty would be 
especially useful.

Executive Order 12866

    Under Executive Order 12866, the Department must determine whether 
a regulatory action is significant and therefore subject to the 
requirements of the Executive Order and review by the Office of 
Management and Budget (OMB). This action, comprising this proposed 
regulation and proposed class exemption, is economically significant 
under section 3(f)(1) of the Executive Order because it is likely to 
have an effect on the economy of $100 million or more in any one year. 
Accordingly, the Department undertook the foregoing analysis of the 
actions' impact. On that basis the Department believes that the 
actions' benefits justify their costs.

Regulatory Flexibility Act

    The Regulatory Flexibility Act (5 U.S.C. 601 et seq.) (RFA) imposes 
certain requirements with respect to Federal rules that are subject to 
the notice and comment requirements of section 553(b) of the 
Administrative Procedure Act (5 U.S.C. 551 et seq.) and are likely to 
have a significant economic impact on a substantial number of small 
entities. For purposes of analysis under the RFA, the Department 
proposes to continue its usual practice of considering a small entity 
to be an employee benefit plan with fewer than 100 participants.\71\ 
The Department estimates that approximately 100,000 small plans, a 
significant number, will voluntarily begin offering investment advice 
to participants as a result of this proposed regulation and proposed 
class exemption.
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    \71\ EBSA requests comments on the appropriateness of the size 
standard used in evaluating the impact of these proposed rules on 
small entities. EBSA has consulted with the SBA Office of Advocacy 
concerning use of this participant count standard for RFA purposes. 
See 13 CFR 121.903(c).
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    The primary effect of this proposed regulation and proposed class 
exemption will be to reduce participants' investment errors. This is an 
effect on participants rather than on plans. The impact on plans 
generally will be limited to increasing the means by which they may 
make advice available to participants, and this impact will be similar 
and proportionate for small and large plans. Therefore the Department 
certifies that the impact on small entities will not be significant. 
Pursuant to this certification the Department has refrained from 
preparing an Initial Regulatory Flexibility Analysis of this proposed 
regulation and proposed class exemption. The Department invites the 
public to comment on its definition of small entities and its 
certification.
    Notwithstanding this certification, the Department did separately 
consider the impact of this proposed regulation and proposed class 
exemption on participants in small plans.
    As noted earlier, prior to implementation of the PPA smaller plan 
sponsors offered advice generally, and in-person advice in particular, 
more frequently than larger plan sponsors. The Department believes that 
exemptive relief provided by both the PPA and this proposed class 
exemption will promote wider offering of advice by small and large 
plans sponsors alike. Accordingly the Department estimated the impacts 
on small plans assuming that they generally will be proportionate to 
those on large plans. However, because smaller plan sponsors are more 
likely to offer in-person advice, their average cost for advice and the 
proportion of participants using advice may both be higher. The 
Department estimates that the PPA and this proposed class exemption 
will reduce small DC plan participant investment errors

[[Page 49914]]

respectively by $105 million or more and $126 million or more, at 
respective costs of $22 million and $28 million. The estimated impacts 
on small plans and their participants are summarized on table 7.

                                      7--Small DC Plan Participant Impacts
----------------------------------------------------------------------------------------------------------------
                                                                                                       Class
                                                                      Pre-PPA           PPA          exemption
----------------------------------------------------------------------------------------------------------------
Dollars advised ($ billions)....................................          $47             $59             $73
Investment errors ($ billions)..................................           $8.0            $7.9            $7.8
Incremental:
    Errors reduced by advice ($ millions).......................         $421            $105            $126
    Advice cost ($ millions)....................................          $86             $22             $28
    Advice cost rate (bps, average).............................           18              18              20
    Error reduced per $1 of advice, average.....................           $4.88           $4.88           $4.46
Cumulative (combined with policies to the left):
    Errors reduced by advice ($ millions).......................         $421            $526            $652
    Advice cost ($ millions)....................................          $86            $108            $136
    Advice cost rate (bps, average).............................           18              18              19
    Error reduced per $1 of advice, average.....................           $4.88           $4.88           $4.79
----------------------------------------------------------------------------------------------------------------

Congressional Review Act

    This notice of proposed rulemaking is subject to the Congressional 
Review Act provisions of the Small Business Regulatory Enforcement 
Fairness Act of 1996 (5 U.S.C. 801 et seq.) and, if finalized, will be 
transmitted to the Congress and the Comptroller General for review.

Unfunded Mandates Reform Act

    For purposes of the Unfunded Mandates Reform Act of 1995 (Pub. L. 
104-4), as well as Executive Order 12875, the notice of proposed 
rulemaking does not include any federal mandate that will result in 
expenditures by state, local, or tribal governments in the aggregate of 
more than $100 million, adjusted for inflation, or increase 
expenditures by the private sector of more than $100 million, adjusted 
for inflation.

Federalism Statement

    Executive Order 13132 (August 4, 1999) outlines fundamental 
principles of federalism and requires the adherence to specific 
criteria by federal agencies in the process of their formulation and 
implementation of policies that have substantial direct effects on the 
States, the relationship between the national government and the 
States, or on the distribution of power and responsibilities among the 
various levels of government. This proposed rule does not have 
federalism implications because it has no substantial direct effect on 
the States, on the relationship between the national government and the 
States, or on the distribution of power and responsibilities among the 
various levels of government. Section 514 of ERISA provides, with 
certain exceptions specifically enumerated, that the provisions of 
Titles I and IV of ERISA supersede any and all laws of the States as 
they relate to any employee benefit plan covered under ERISA. The 
requirements implemented in this proposed rule do not alter the 
fundamental provisions of the statute with respect to employee benefit 
plans, and as such would have no implications for the States or the 
relationship or distribution of power between the national government 
and the States.

Paperwork Reduction Act

    As part of its continuing effort to reduce paperwork and respondent 
burden, the Department of Labor conducts a preclearance consultation 
program to provide the general public and Federal agencies with an 
opportunity to comment on proposed and continuing collections of 
information in accordance with the Paperwork Reduction Act of 1995 
(PRA) (44 U.S.C. 3506(c)(2)(A)). This helps to ensure that the public 
understands the Department's collection instructions; respondents can 
provide the requested data in the desired format, reporting burden 
(time and financial resources) is minimized, collection instruments are 
clearly understood, and the Department can properly assess the impact 
of collection requirements on respondents.
    Currently, EBSA is soliciting comments concerning the proposed 
information collection request (ICR) included in the Proposed Class 
Exemption for the Provision of Investment Advice to Participants and 
Beneficiaries of Self-Directed Individual Account Plans and IRAs and in 
the Proposed Investment Advice Regulation (Proposed Investment Advice 
Initiative). A copy of the ICR may be obtained by contacting the PRA 
addressee shown below or at http://www.RegInfo.gov. PRA Addressee: 
Gerald B. Lindrew, Office of Policy and Research, U.S. Department of 
Labor, Employee Benefits Security Administration, 200 Constitution 
Avenue, NW., Room N-5718, Washington, DC 20210. Telephone: (202) 693-
8410; Fax: (202) 219-5333. These are not toll-free numbers.
    The Department has submitted a copy of the Proposed Investment 
Advice Initiative to the Office of Management and Budget (OMB) in 
accordance with 44 U.S.C. 3507(d) for review of its information 
collections. The Department and OMB are particularly interested in 
comments that:
     Evaluate whether the collection of information is 
necessary for the proper performance of the functions of the agency, 
including whether the information will have practical utility;
     Evaluate the accuracy of the agency's estimate of the 
burden of the collection of information, including the validity of the 
methodology and assumptions used;
     Enhance the quality, utility, and clarity of the 
information to be collected; and
     Minimize the burden of the collection of information on 
those who are to respond, including through the use of appropriate 
automated, electronic, mechanical, or other technological collection 
techniques or other forms of information technology, e.g., permitting 
electronic submission of responses.
    Comments should be sent to the Office of Information and Regulatory 
Affairs, Office of Management and Budget, Room 10235, New Executive 
Office Building, Washington, DC 20503; Attention: Desk Officer for the 
Employee Benefits Security Administration. OMB requests that comments 
be received within 30 days of publication of the Proposed Investment 
Advice Initiative to ensure their

[[Page 49915]]

consideration. Please note that comments submitted to OMB are a matter 
of public record.
    The Department notes that a federal agency cannot conduct or 
sponsor a collection of information unless it is approved by OMB under 
the PRA, and displays a currently valid OMB control number, and the 
public is not required to respond to a collection of information unless 
it displays a currently valid OMB control number. Also, notwithstanding 
any other provisions of law, no person shall be subject to penalty for 
failing to comply with a collection of information if the collection of 
information does not display a currently valid OMB control number. EBSA 
will publish a notice of OMB's action at the final rule stage.
    In order to use the statutory exemption and/or the class exemption 
\72\ to provide investment advice to participants and beneficiaries in 
participant-directed defined contribution (DC) plans and beneficiaries 
of individual retirement accounts (IRAs) (collectively hereafter, 
``participants''), investment advisory firms would be required to make 
disclosures to participants and hire an independent auditor every year. 
Investment advice firms following the conditions of the exemption based 
on disclosure of computer model-generated investments would be required 
to obtain certification of the model from an eligible investment 
expert.\73\ The class exemption conditions relief on establishing 
written policies and procedures and both exemptions impose 
recordkeeping requirements.\74\ These paperwork requirements are 
designed to safeguard the interests of participants in connection with 
investment advice covered by the exemptions.
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    \72\ The Department assumes that all advisory firms use both the 
statutory exemption and the class exemption.
    \73\ All costs associated with model certification are assigned 
to the statutory exemption.
    \74\ All costs associated with composing written policies and 
procedures are assigned to the class exemption.
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    The Department has made several specific basic assumptions in order 
to establish a reasonable estimate of the paperwork burden of this 
information collection:
     The Department assumes that 80% of disclosures \75\ will 
be distributed electronically via means already in existence as a usual 
and customary business practice and the costs arising from electronic 
distribution will be negligible.\76\
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    \75\ This estimate is derived from Current Population Survey 
October 2003 School Supplement probit equations applied to the 
February 2005 Contingent Worker Supplement. These equations show 
that approximately 81 percent of workers aged 19 to 65 had internet 
access either at home or at work in 2005. The Department further 
assumes that one percent of these participants will elect to receive 
paper documents instead of electronic, thus 20 percent of 
participants receive disclosures through paper media.
    \76\ The Department assumes that plans will deliver disclosures 
electronically in compliance with the Department's rules relating to 
the use of electronic media (29 CFR 2520.104b-1(c)). The Department 
has not estimated any additional burden for plans to receive 
affirmative consents from participants to receive required 
disclosures electronically. The Department welcomes comments on this 
assumption.
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     The Department assumes that investment advisory firms will 
use existing in-house resources to prepare the policies and procedures 
and most disclosures and to maintain the recordkeeping systems. This 
assumption does not apply to the computer model certification, the 
audit or the computer program used to generate disclosures for IRA 
participants.
     The Department assumes a combination of personnel will 
perform the information collections with an hourly wage rate for 2008 
of $79 for a financial manager, $21 for clerical personnel, $109 for a 
legal professional, and $67 for a computer programmer.\77\
---------------------------------------------------------------------------

    \77\ Hourly wage estimates are based on data from the Bureau of 
Labor Statistics Occupational Employment Survey (May 2005) and the 
Bureau of Labor Statistics Employment Cost Index (Sept. 2006). All 
hourly wage rates include wages and benefits. Clerical wage and 
benefits estimates are based on metropolitan wage rates for 
executive secretaries and administrative assistants. Financial 
manager wage and benefits estimates are based on metropolitan wage 
estimates for financial managers. Legal professional wage and 
benefits estimates are based on metropolitan wage rates for lawyers. 
Computer programmer wage and benefits estimates are based on 
metropolitan wage rates for professional computer programmers.
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The Statutory Exemption

    The Department assumes that approximately 16,000 investment 
advisory firms \78\ (including broker-dealers) will take advantage of 
this statutory exemption to provide advice to participants.\79\ The 
number of investment advisory firms using this statutory exemptive 
relief is assumed to be constant over time. The Department estimates 
that under the statutory exemption approximately 52,000 DC plans will 
seek to provide advice to their participants and beneficiaries. These 
DC plans represent approximately 6,611,000 participants and 
beneficiaries, of which approximately 1,487,000 will seek advice from 
the investment advisory firm servicing their employer-sponsored 
retirement investment plan. IRAs can also make use of this statutory 
exemption, and the Department estimates that approximately 8.7 million 
IRA beneficiaries will seek advice under this statutory exemption.\80\
---------------------------------------------------------------------------

    \78\ Unless otherwise noted, numbers are rounded to the nearest 
1,000.
    \79\ This estimate is derived from Angela A. Hung et al., 
Investor and Industry Perspectives on Investment Advisers and 
Broker-Dealers, RAND Corporation Technical Report (2008), at http://
www.sec.gov/news/press/2008/2008-1_randiabdreport.pdf.
    \80\ To be conservative, the Department assumes that all 16,000 
advisory firms give advice pursuant to both the statutory and class 
exemptions as they all will have some clients who request only level 
fee or computer model advice under the statutory exemption and other 
clients who request off-model advice under the class exemption. The 
Department estimates that there are approximately 209,000 DC plans 
that are currently offering advice (pre-statutory exemption advice), 
that after the statutory exemption is published approximately 
261,000 DC plans will offer advice and that after the class 
exemption is published approximately 314,000 DC plans will offer 
advice. The Department cannot determine which of these plans will be 
offering advice under pre-statutory exemption, statutory exemption 
or class exemption conditions; thus the Department decided to apply 
costs to the statutory and class exemptions based on the incremental 
change in the number of DC plans offering advice. This method is 
also applied to the number of IRA beneficiaries receiving advice; 
the Department estimates that approximately 16.8 million IRA 
beneficiaries received advice under pre-statutory exemption 
conditions, approximately 25.5 million will receive advice under 
statutory exemption conditions and approximately 34.0 will receive 
advice under class exemption conditions. The Department welcomes 
comments on this assumption.
---------------------------------------------------------------------------

Disclosures to Participants

    In general, under section 2550.408(g)-1(g) of the proposal, a 
fiduciary adviser is required to furnish detailed information to a 
participant about an advice arrangement before initially providing 
investment advice, annually, upon participant request and if there is 
any material change to the information. The information includes the 
following: The relationship between the adviser and the parties that 
developed the investment advice program or selected the investment 
options available under the DC plan or IRA; to the extent such 
information is not otherwise provided, the past performance and 
historical rates of return of investments available under the DC plan 
or IRA; all fees and other compensation the fiduciary adviser or any 
affiliate is to receive in connection with the provision of investment 
advice or in connection with the investment; the fiduciary adviser's 
material relationship, if any, to any investment under the arrangement; 
the types of services the fiduciary adviser provides in connection with 
the provision of investment advice; the manner in which participant 
information may be used or disclosed; an acknowledgement that the 
fiduciary adviser is acting as a fiduciary of the DC Plan or IRA in 
connection with providing the investment advice; and notice that the 
recipient of the advice may separately arrange for advice from

[[Page 49916]]

another adviser that could have no relationship to, and receive no fees 
in connection with, the investments. If applicable, the fiduciary 
adviser also furnishes in writing to the DC plan fiduciary an election, 
as permitted under the regulation, to be treated as the sole fiduciary 
providing investment advice through a computer model to an ERISA-
covered DC plan participant. The Department assumes that investment 
advisory firms will compile all of these notices into a single four-
page disclosure package for each participant given advice. As these 
disclosures are to be given to the participants and are based upon the 
investments that are recommended, the Department further assumes that 
these disclosures will be generated at three levels: The investment 
advisory firm level, the DC plan level and the IRA beneficiary level. 
The firms will generate a template for each of these disclosures 
levels.\81\
---------------------------------------------------------------------------

    \81\ The following disclosures are assumed to be constant for 
all participants advised: The material affiliation or material 
contractual relationships, use of participant information, type of 
services provided by the fiduciary adviser, acknowledgment that the 
adviser is acting as a fiduciary of the DC plan or IRA, and a 
statement that the participant can arrange for advice from an 
adviser who does not receive fees in connection with the investment 
or has no material affiliation with the investments recommended. The 
following disclosures are assumed to be constant for each 
participant of an individual DC plan: The fees and compensation the 
adviser receives in connection with the suggested investments and 
the material affiliation to the suggested investments. As discussed 
below these last two disclosures are also the only disclosures that 
are specific to the IRA beneficiary, and as such will require the 
adviser to generate individual disclosures for each IRA beneficiary 
advised using the computer model generated by the service providers.
---------------------------------------------------------------------------

Preparation of Statutory Exemption Disclosure Package
    For the first year (initial) disclosures, the Department assumes 
that it takes a legal professional approximately six hours per 
investment advisory firm to prepare disclosures that are common to all 
of their participants, about 100 hours per investment advisory firm to 
assist an out-sourced computer programmer in creating computer software 
that will generate disclosure notices for IRA beneficiaries, and 
approximately two and one-half hours per DC plan to prepare disclosures 
that are common to all DC plan participants and beneficiaries in the 
same DC plan. These hours add up to an hour burden of approximately 
1,779,000 hours; at a wage rate of $109 for a legal professional the 
equivalent cost is approximately $194,792,000.
    For the annual updating of disclosures required by Section 
2550.408g-1(g)(4)(ii), the Department assumes that the preparation time 
needed for updating the notices that are the same for all participants 
will be about three hours for each of the 16,000 investment advisory 
firms.\82\ The Department assumes that updating notices that are the 
same for all DC plan participants and beneficiaries is estimated to 
take on average one hour and a half for each of over 52,000 DC plans. 
The preparation time needed for individualized notices for IRAs is 
estimated to average 50 hours for each of 16,000 investment advisory 
firms. Thus the annual hour burden for preparation is estimated to be 
approximately 903,000 hours with an equivalent cost of approximately 
$98,829,000.
---------------------------------------------------------------------------

    \82\ The Department assumes that investment advisory firms will 
distribute the same disclosures throughout the year and that they 
only update their disclosure content for the annual disclosures. The 
Department further assumes that few disclosures are requested each 
year (one per firm on average) and most requested disclosures are 
distributed either electronically at a negligible cost or in person 
at small costs. The Department welcomes comments on these 
assumptions.
---------------------------------------------------------------------------

    The Department assumes that all firms will outsource the creation 
of a computer program to enable them to prepare disclosures for IRA 
participants. This computer model will be used to generate disclosures 
to participants under both the statutory exemption and the class 
exemption. The Department estimates that a computer programmer will 
charge on average $1,200 per firm in the first year and $600 each 
subsequent year.\83\ Thus the cost burden, given there are almost 
16,000 investment advisory firms, will be approximately $18,662,000 in 
the first year and approximately $9,331,000 in all subsequent years.
---------------------------------------------------------------------------

    \83\ The Department has based this cost estimate on limited 
industry data.
---------------------------------------------------------------------------

Distribution of Statutory Exemption Disclosure Package
    The Department assumes that a clerical professional will be 
required to spend one minute per page (four minutes per disclosure 
package) to photocopy the 20 percent of disclosure packages that are 
delivered in paper and one minute per disclosure package to prepare the 
ten percent of disclosures that are mailed each year.\84\ These hours 
add up to an hour burden of approximately 864,000 hours; at a wage rate 
of approximately $21 for a clerical professional the equivalent cost is 
approximately $3,225,000.
---------------------------------------------------------------------------

    \84\ Eighty percent of disclosures are assumed to be distributed 
electronically. In addition, the Department assumes that one half of 
all paper disclosures are delivered in person and one half are 
delivered through the mail.
---------------------------------------------------------------------------

    The Department assumes that the paper and photocopy costs are five 
cents per page; thus, given that there are approximately 2,030,000 
participants receiving paper disclosures, the associated cost burden 
for paper and photocopying under the statutory exemption is estimated 
to be $406,000 annually. Under the basic United States Postal Service 
postage at a cost of $0.42 \85\ per disclosure package for 
approximately 1,015,000 participants receiving mailed disclosures, the 
postage costs are estimated at about $426,000 annually. Thus the cost 
burden associated with distributing disclosures to participants is 
$832,000 per year.
---------------------------------------------------------------------------

    \85\ The USPS increased the cost of First Class Postage to $0.42 
as of May 2008.
---------------------------------------------------------------------------

Independent Certification

    If the fiduciary adviser provides the investment advice through use 
of a computer model, then before providing the advice, Section 
2550.408g-1(d)(2) of the proposed regulation would require the 
fiduciary adviser to obtain the certification of an eligible investment 
expert as to the computer model's compliance with certain standards 
(e.g., applies generally accepted investment theories, unbiased 
operation, objective criteria) set forth in the regulation. The 
Department assumes that there are six companies that will provide the 
investment advice computer model \86\ and that legal professionals 
working at these six companies supply in-house support by providing 
documentation and other information to the eligible investment expert 
who certifies the company's investment advice computer model. These 
legal professionals are assumed to spend about 40 hours for each of the 
six investment advice computer model providers and on average 40 hours 
for each of the almost 16,000 investment advisory firms to whom the 
computer model providers supply their models. Thus, the investment 
advice computer model providers have an hour burden of approximately 
622,000 hours for an equivalent cost of about $68,125,000.
---------------------------------------------------------------------------

    \86\ Based on limited information with respect to the investment 
computer model industry, the Department estimates that there are six 
companies that produce investment advice computer models.
---------------------------------------------------------------------------

    The Department assumes that the investment advisory firm will need 
in-house legal professionals to provide documentation and other 
information to the eligible investment expert who certifies the 
investment advisory firm's investment advice computer model. These 
legal professionals will spend on average ten hours for each of over 
52,000 DC plans and on average 50

[[Page 49917]]

hours for each of the almost 16,000 investment advisory firms. Thus the 
hour burden in the first year for the certification of the investment 
advice computer model is approximately 1,924,000 hours with an 
equivalent cost of about $210,571,000.
    The Department assumes that in subsequent years the hours required 
for any investment advice computer model recertification will be 
approximately half of the first certification and that investment 
advisory firms will have their investment advice computer model 
recertified on average once a year. Thus in the subsequent years the 
hour burden is approximately 962,000 hours with an equivalent cost of 
approximately $105,286,000.

Recordkeeping Requirements

    Consistent with the statutory exemption, section 2550.408g-1(i) of 
the proposed regulation would require fiduciary advisers to maintain 
records with respect to the investment advice provided in reliance on 
the regulation necessary to determine whether the applicable 
requirements of the regulation have been satisfied. The Department 
assumes that all investment advisory firms maintain recordkeeping 
systems as part of their normal business practices. The Department 
assumes that all records that are required to be maintained will be 
kept electronically under normal business practices; therefore, no 
printing and negligible holding costs are anticipated to be associated 
with records maintenance.

Audit Requirement

    Any fiduciary adviser relying on the exemption would be required to 
engage, at least annually, an independent auditor to conduct an audit 
of the investment advice arrangement for compliance with the conditions 
of the exemption pursuant to section 2550.408g-1(f)(1) of the proposed 
regulation. All firms are assumed to outsource this service but use 
some internal clerical and legal professional time to assist the 
auditor. \87\ The clerical staff is expected to spend about three hours 
per advisory firm and on average ten minutes per participant to gather 
documentation and other information. The in-house legal professional is 
expected to need approximately four hours per advisory firm to assist 
the auditor with the statutory exemption audit. The Department 
estimates that about one percent of participants will be audited per 
year, resulting in approximately 101,000 audits. Overall, the annual 
in-house hour burden for the annual audit requirement is estimated at 
126,000 hours, with equivalent costs of approximately $8,157,000.
---------------------------------------------------------------------------

    \87\ Audit firms are expected to transmit the final audit report 
to the advisory firm through electronic means at no additional 
costs. The advisory firms must either furnish a copy of the audit 
report to IRA beneficiaries or make the audit report available on 
their Web site and inform IRA beneficiaries of the purpose of the 
report and how and where to locate the report applicable to their 
account with the other disclosures discussed above. The Department 
assumes that all advisory firms will make the audit report available 
on their Web site and add a few sentences to the single disclosure 
package at negligible costs. Any advisory firm whose audit report 
identifies noncompliance with the requirements of the statutory or 
class exemption must send a copy of the report to the Department 
within 30 days following receipt of the report. The Department 
assumes that the majority of advisory firms will comply with the 
exemption; therefore, the costs associated with sending the audit 
reports to the Department are expected to be negligible. The 
Department welcomes comments on this assumption.
---------------------------------------------------------------------------

    The Department assumes that the statutory exemption audits will be 
outsourced to an independent legal professional for each of the almost 
16,000 investment advisory firms and will cost on average $18,000.\88\ 
Thus the annual cost burden will be approximately $279,936,000.
---------------------------------------------------------------------------

    \88\ The Department has based this cost estimate on limited 
industry data.
---------------------------------------------------------------------------

Summary of Statutory Exemption Hour and Cost Burden

    In summary, the third-party disclosures, computer model 
certification, and audit requirements for the statutory exemption 
require approximately 3,981,000 burden hours with an equivalent cost of 
approximately $416,745,000 and a cost burden of approximately 
$579,367,000 in the first year. In each subsequent year the total labor 
burden hours are estimated to be approximately 2,143,000 hours with an 
equivalent cost of approximately $215,497,000 and the cost burden is 
estimated at approximately $430,067,000 per year.

The Class Exemption

    The Department assumes that all of the 16,000 investment advisory 
firms that take advantage of the statutory exemption will also provide 
advice that relies on the class exemption. As mentioned above, all 
investment advisory firms provide advice under both DC plans and IRAs, 
and the number of investment advisory firms using this class exemptive 
relief is assumed to be constant over time. The Department estimates 
that under the class exemption approximately 52,000 DC retirement plans 
will seek to provide advice to their participants and beneficiaries. 
These plans represent approximately 6,611,000 participants and 
beneficiaries, of which approximately 2,016,000 will seek advice from 
the investment advisory firm employed on behalf of their employer 
sponsored retirement investment plan. IRAs can also make use of this 
class exemption, and the Department estimates that approximately 8.5 
million IRA beneficiaries will seek advice under this class 
exemption.\89\
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    \89\ See footnote 51 above for an explanation of the number of 
entities affected by the regulation. The Department assumes that 
these DC plans are offering, and DC participants and beneficiaries, 
and IRA beneficiaries are receiving advice under the class exemption 
but not the statutory exemption.
---------------------------------------------------------------------------

Disclosures to Participants

    In general, section III(g)(1) of the Class Exemption requires a 
fiduciary adviser to furnish detailed information to a participant 
about an advice arrangement before initially providing investment 
advice, annually, upon participant request, and if there is any 
material change to the information. The information to be provided is 
the same under the class exemption as the statutory exemption (see 
Section I(a) above for a listing of all required disclosures). 
Additional disclosures required before providing investment advice 
would depend on which alternative conditions the arrangement is 
designed to satisfy. If the investment advice arrangement is based on 
the disclosure of computer-generated investment selections, the 
fiduciary adviser is required to furnish those selections to the 
participant. If the fiduciary adviser determines computer modeling of 
the number and types of investment choices available to an IRA is 
reasonably precluded, the fiduciary adviser may instead furnish asset 
class allocation models to the participant. Alternatively, such 
disclosures may not be required if a fiduciary adviser satisfies the 
condition that would require that the compensation of the person 
providing advice on behalf of the fiduciary adviser may not vary based 
on the particular investments selected. The Department assumes that 
investment advisory firms will compile all notices into a single five-
page disclosure package for each participant given advice under the 
class exemption and that these disclosures will be prepared at the 
investment advisory firm, DC plan, and IRA beneficiary levels.
Preparation of Class Exemption Disclosure Package
    The Department assumes that disclosures that are common to all of 
the advisory firm's client participants as well as the computer program 
used to

[[Page 49918]]

generate disclosures to IRA beneficiaries will have been prepared to 
conform to the requirements of the statutory exemption and will not 
impose any additional burden on respondents.
    For the first year disclosures, the Department assumes that the 
16,000 investment advisory firms might require a legal professional to 
work on average 80 hours each to assist an out-sourced computer 
programmer in creating computer software that will generate 
individualized disclosure notices for IRA participants, and 
approximately two hours per DC plan to prepare disclosures that are 
common to all participants in the same DC plan. These hours add up to 
an hour burden of approximately 1,349,000 hours; at a wage rate of $109 
for a legal professional the equivalent cost is approximately 
$147,662,000.
    For the annual updating of disclosures the Department assumes that 
the preparation time needed for updating the notices will be on average 
one hour per DC plan (for DC plan individualized disclosures) and on 
average 40 hours for each investment advisory firms (for IRA 
beneficiary individualized disclosures). Thus, the annual hour burden 
is estimated to be approximately 674,000 with an equivalent cost of 
approximately $73,831,000.
Distribution of Class Exemption Disclosure Package
    The Department assumes that a clerical professional will spend five 
minutes \90\ to photocopy each of the approximately 2,102,000 
disclosure packages that are delivered in paper and one minute to 
prepare each of the 1,051,000 disclosures that are mailed each year. 
These hours add up to an hour burden of approximately 193,000 hours; at 
a wage rate of $21 for a clerical professional the equivalent cost is 
approximately $4,082,000.
---------------------------------------------------------------------------

    \90\ The Department estimates that most of the investment 
advisory firms that take advantage of the class exemption will 
determine that computer modeling of the number and types of 
investment choices available to an IRA is not possible, and will 
instead furnish asset class allocation models to the beneficiaries. 
As such, the disclosure package for participants who receive advice 
pursuant to the class exemption is estimated as being five pages in 
length, instead of four.
---------------------------------------------------------------------------

    Using a paper and photocopy cost of five cents per page, the 
associated cost burden for paper and photocopying under the class 
exemption is estimated to be $525,000 annually. Under the basic USPS 
postage at a cost of $0.42 per disclosure package, the cost burden of 
the mailing disclosures under the class exemption will be approximately 
$441,000 annually. Thus the overall cost burden associated with 
distributing disclosures to participants is estimated at about $967,000 
per year.

Independent Certification

    The entire costs of the certification requirements are accounted 
for under the statutory exemption.

Policies and Procedures

    Section III(i) of the Class Exemption requires investment advisory 
firms that wish to provide investment advice pursuant to the class 
exemption to develop written policies and procedures that insure the 
firm follows all of the class exemption requirements. The Department 
estimates that updating the written policies and procedures will 
generally require no additional costs. It is assumed that the 
preparation of these policies and procedures will require on average 
seven hours of legal professional time for each of the almost 16,000 
investment advisory firms. This leads to an hour burden in the first 
year of about 109,000 hours with an equivalent cost of approximately 
$11,917,000.

Recordkeeping Requirements

    Section III(n) of the proposed class exemption requires fiduciary 
advisers to maintain records with respect to the investment advice 
provided in reliance on the exemption necessary to determine, explain 
or verify compliance with the conditions of the exemption, including 
those records necessary to determine that the disclosures described 
above have been made. In this connection, the fiduciary adviser would 
be required to maintain records necessary to determine, among other 
things, that an independent fiduciary has provided express 
authorization of the arrangement under which the investment advice is 
provided, that, if applicable, an eligible investment expert has 
provided the requisite certification, that the compensation to the 
fiduciary adviser and its affiliates in connection with the investments 
is reasonable, that the terms of the purchase sale or holding of the 
investment are at least as favorable to the plan or IRA as those in an 
arm's length transactions would be, and in cases where the advice is 
not provided after disclosure of computer generated investments or an 
asset class allocation model, the fees or other compensation received 
by an employee, agent or registered representative providing investment 
advice on behalf of the fiduciary adviser does not vary depending on 
the option. The Department assumes that all investment advisory firms 
maintain recordkeeping systems to satisfy these information collections 
requirements.
    A fiduciary adviser may provide individualized investment advice to 
participants or beneficiaries (``off-model advice'') following the 
furnishing of investment advice generated by a computer model as 
described in section III(e)(1) of the Class Exemption, or in the case 
of beneficiaries of IRAs described in section III(e)(2), following the 
furnishing of investment education-type materials (graphs, pie charts, 
etc) that produce or reflect asset allocation models. However, section 
III(e)(4) of the Class Exemption requires that, with respect to any 
off-model advice that recommends investment options that may generate 
for the adviser or certain other parties greater income than other 
investments in the same asset class, the individual who provides 
investment advice on behalf of the fiduciary adviser, not later than 30 
days after providing the advice, must document the basis for concluding 
that the recommendation is in the best interest of the participant or 
beneficiary. The Department assumes that such off -model advice will be 
provided in ten percent of the possible DC plan cases, and 30 percent 
of the possible IRA beneficiary cases. Thus, of the approximately 
2,016,000 DC participants and approximately 8.5 million IRA 
beneficiaries receiving advice under the class exemption, almost 
202,000 DC plan participants and 2.5 million IRA beneficiaries will 
receive off-model advice.\91\
---------------------------------------------------------------------------

    \91\ Based on limited information on the type of advice given to 
participants, the Department estimates that ten percent of DC plan 
participants and 30 percent of IRA beneficiaries will receive off-
Model Advice.
---------------------------------------------------------------------------

    The Department further assumes that each participant receiving 
advice will receive this advice an average of four times per year (once 
a quarter), resulting in almost 10,996,000 reports. The Department 
assumes that each investment advisor who provides off-model advice will 
need approximately 15 minutes to write this report. Generating these 
reports is estimated to result in approximately 2,749,000 annual burden 
hours for the financial manager with an associated equivalent cost of 
$217,125,000.

Audit

    Any fiduciary adviser relying on the class exemption also would be 
required to engage, at least annually, an independent auditor to 
conduct an audit of the investment advice arrangement for compliance 
with the class exemption and written policies and procedures (as 
described below) designed to assure

[[Page 49919]]

compliance with the conditions of the exemption. The fiduciary adviser 
would be required to issue a written report to each plan fiduciary who 
authorized the use of the investment advice arrangement, and to IRA 
beneficiaries, setting forth the auditor's findings. With respect to 
IRA's, the fiduciary adviser may instead make the report available on 
its Web site. Also with respect to an arrangement with an IRA, if the 
auditor finds noncompliance with the exemption, the fiduciary adviser 
must file the report with the Department of Labor.
    All firms are assumed to outsource this service but use some 
internal clerical and legal professional time to assist the auditor. As 
an audit is required under the statutory exemption, the fixed in-house 
hours are attributed to the statutory exemption and only the variable 
clerical hours are divided between the statutory and class exemption. 
Under the class exemption clerical staff is expected to spend on 
average ten minutes per audited participant to pull each audited 
participant's files or to provide other documentation or information. 
The Department estimates that about 105,000 participants will be 
audited annually. Overall, the annual in-house hour burden for the 
audit requirement is estimated at 18,000 hours with equivalent costs of 
approximately $371,000.
    The Department assumes that the class exemption audits will be 
outsourced to an independent legal professional for each of the almost 
16,000 investment advisory firms and will cost on average $4,000 per 
year for each investment advisory firm.\92\ Thus the annual cost burden 
will be approximately $62,208,000.
---------------------------------------------------------------------------

    \92\ The Department has based this cost estimate on limited 
industry data.
---------------------------------------------------------------------------

Summary of Class Exemption Hour and Cost Burden

    In summary, the third-party disclosures, written policies and 
procedures, recordkeeping and audit requirements for the class 
exemption are estimated to require a total of approximately 4,417,000 
burden hours with an equivalent cost of approximately $381,157,000 and 
a total cost burden of approximately $63,175,000 in the first year. In 
each subsequent year the total burden hours are estimated at 
approximately 3,634,000 hours with an equivalent cost of approximately 
$295,409,000 and a total cost burden of approximately $63,175,000 per 
year.

Overall Exemption Hour and Cost Burden Summary

    In summary, the third-party disclosures, computer model 
certification, written policies and procedures, recordkeeping and audit 
requirements for the statutory and class exemptions require 
approximately 8,398,000 burden hours with an equivalent cost of 
approximately $797,903,000 and a cost burden of approximately 
$642,541,000 in the first year. The labor burden hours in each 
subsequent year are approximately 5,776,000 hours with an equivalent 
cost of approximately $510,906,000 and the cost burden in each 
subsequent year is approximately $493,242,000 per year.
    These paperwork burden estimates are summarized as follows:
    Type of Review: New collection (Request for new OMB Control 
Number).
    Agency: Employee Benefits Security Administration, Department of 
Labor.
    Titles: (1) Proposed Class Exemption for the Provision of 
Investment Advice to Participants and Beneficiaries of Self-Directed 
Individual Account Plans and IRAs and (2) Proposed Investment Advice 
Regulation.
    OMB Control Number: 1210-NEW.
    Affected Public: Business or other for-profit.
    Estimated Number of Respondents: 16,000.
    Estimated Number of Annual Responses: 20,656,000.
    Frequency of Response: Initially, Annually, Upon Request, when a 
material change.
    Estimated Total Annual Burden Hours: 8,398,000 hours in the first 
year; 5,776,000 hours in each subsequent year.
    Estimated Total Annual Burden Cost: $642,541,000 for the first 
year; $493,242,000 for each subsequent year.

List of Subjects in 29 CFR Part 2550

    Employee benefit plans, Exemptions, Fiduciaries, Investments, 
Pensions, Prohibited transactions, Reporting and recordkeeping 
requirements, and Securities.

    For the reasons set forth in the preamble, the Department proposes 
to amend Chapter XXV, subchapter F, part 2550 of Title 29 of the Code 
of Federal Regulations as follows:

Subchapter F--Fiduciary Responsibility Under the Employee Retirement 
Income Security Act of 1974

PART 2550--RULES AND REGULATIONS FOR FIDUCIARY RESPONSIBILITY

    1. The authority citation for part 2550 is revised to read as 
follows:

    Authority: 29 U.S.C. 1135; and Secretary of Labor's Order No. 1-
2003, 68 FR 5374 (Feb. 3, 2003). Sec. 2550.401b-1 also issued under 
sec. 102, Reorganization Plan No. 4 of 1978, 43 FR 47713 (Oct. 17, 
1978), 3 CFR, 1978 Comp. 332, effective Dec. 31, 1978, 44 FR 1065 
(Jan. 3, 1978), 3 CFR, 1978 Comp. 332. Sec. 2550.401c-1 also issued 
under 29 U.S.C. 1101. Sec. 2550.404c-1 also issued under 29 U.S.C. 
1104. Sec. 2550.407c-3 also issued under 29 U.S.C. 1107. Sec. 
2550.404a-2 also issued under 26 U.S.C. 401 note (sec. 657, Pub. L. 
107-16, 115 Stat. 38). Sec. 2550.408b-1 also issued under 29 U.S.C. 
1108(b)(1) and sec. 102, Reorganization Plan No. 4 of 1978, 3 CFR, 
1978 Comp. p. 332, effective Dec. 31, 1978, 44 FR 1065 (Jan. 3, 
1978), and 3 CFR, 1978 Comp. 332. Sec. 2550.412-1 also issued under 
29 U.S.C. 1112.

    2. Add Sec.  2550.408g-1 to read as follows:


Sec.  2550.408g-1  Investment Advice--Participants and Beneficiaries.

    (a) General. Section 408(g)(1) of the Employee Retirement Income 
Security Act, as amended (ERISA), provides an exemption from the 
prohibitions of section 406 of ERISA for transactions described in 
section 408(b)(14) of ERISA in connection with the provision of 
investment advice to a participant or a beneficiary if the investment 
advice is provided by a fiduciary adviser under an ``eligible 
investment advice arrangement.'' Section 4975(d)(17) and (f)(8) of the 
Internal Revenue Code, as amended (the Code), contain parallel 
provisions to ERISA section 408(b)(14) and (g)(1).
    (b) Eligible investment advice arrangement. For purposes of section 
408(g)(1) of ERISA and section 4975(f)(8) of the Code, an ``eligible 
investment advice arrangement'' means an arrangement that meets either 
the requirements of paragraph (c) of this section or paragraph (d) of 
this section, or both.
    (c) Arrangements that use fee-leveling. For purposes of this 
section, an arrangement is an eligible investment advice arrangement 
if--
    (1)(i) Any investment advice is based on generally accepted 
investment theories that take into account the historic returns of 
different asset classes over defined periods of time, although nothing 
herein shall preclude any investment advice from being based on 
generally accepted investment theories

[[Page 49920]]

that take into account additional considerations;
    (ii) Any investment advice takes into account information furnished 
by a participant or beneficiary relating to age, life expectancy, 
retirement age, risk tolerance, other assets or sources of income, and 
investment preferences, although nothing herein shall preclude any 
investment advice from taking into account additional information that 
a participant or beneficiary may provide;
    (iii) Any fees or other compensation (including salary, bonuses, 
awards, promotions, commissions or other things of value) received, 
directly or indirectly, by any employee, agent or registered 
representative that provides investment advice on behalf of a fiduciary 
adviser does not vary depending on the basis of any investment option 
selected by a participant or beneficiary;
    (iv) Any fees (including any commission or other compensation) 
received by the fiduciary adviser for investment advice or with respect 
to the sale, holding, or acquisition of any security or other property 
for purposes of investment of plan assets do not vary depending on the 
basis of any investment option selected by a participant or 
beneficiary; and
    (2) The requirements of paragraphs (e), (f), (g), (h), and (i) of 
this section are met.
    (d) Arrangements that use computer models. For purposes of this 
section, an arrangement is an eligible investment advice arrangement if 
the only investment advice provided under the arrangement is advice 
that is generated by a computer model described in paragraphs (d)(1) 
and (2) of this section under an investment advice program and with 
respect to which the requirements of paragraphs (e), (f), (g), (h), and 
(i) are met, and any acquisition, holding or sale of a security or 
other property pursuant to such advice occurs solely at the direction 
of the participant or beneficiary.
    (1) A computer model shall be designed and operated to--
    (i) Apply generally accepted investment theories that take into 
account the historic returns of different asset classes over defined 
periods of time, although nothing herein shall preclude a computer 
model from applying generally accepted investment theories that take 
into account additional considerations;
    (ii) Utilize information furnished by a participant or beneficiary 
relating to age, life expectancy, retirement age, risk tolerance, other 
assets or sources of income, and investment preferences, although 
nothing herein shall preclude a computer model from taking into account 
additional information that a plan or a participant or beneficiary may 
provide;
    (iii) Utilize appropriate objective criteria to provide asset 
allocation portfolios comprised of investment options available under 
the plan;
    (iv) Avoid investment recommendations that:
    (A) Inappropriately favor investment options offered by the 
fiduciary adviser or a person with a material affiliation or material 
contractual relationship with the fiduciary adviser over other 
investment options, if any, available under the plan; or
    (B) Inappropriately favor investment options that may generate 
greater income for the fiduciary adviser or a person with a material 
affiliation or material contractual relationship with the fiduciary 
adviser;
    (v) Take into account all designated investment options, within the 
meaning of paragraph (j)(1) of this section, available under the plan 
without giving inappropriate weight to any investment option; except 
that a computer model shall not be treated as failing to meet this 
requirement merely because it does not take into account an investment 
option that constitutes an investment primarily in qualifying employer 
securities.
    (2) Prior to utilization of the computer model, the fiduciary 
adviser shall obtain a written certification, meeting the requirements 
of paragraph (d)(4) of this section from an eligible investment expert, 
within the meaning of paragraph (d)(3) of this section, that the 
computer model meets the requirements of paragraph (d)(1) of this 
section. If, following a certification, a computer model is modified in 
a manner that may affect its ability to meet the requirements of 
paragraph (d)(1), the fiduciary adviser shall, prior to utilization of 
the modified model, obtain a new certification from an eligible 
investment expert that the computer model, as modified, meets the 
requirements of paragraph (d)(1).
    (3) The term ``eligible investment expert'' means a person that, 
through employees or otherwise, has the appropriate technical training 
or experience and proficiency to analyze, determine and certify, in a 
manner consistent with paragraph (d)(4) of this section, whether a 
computer model meets the requirements of paragraph (d)(1) of this 
section; except that the term ``eligible investment expert'' does not 
include any person that has any material affiliation or material 
contractual relationship with the fiduciary adviser, with a person with 
a material affiliation or material contractual relationship with the 
fiduciary adviser, or with any employee, agent, or registered 
representative of the foregoing.
    (4) A certification by an eligible investment expert shall--
    (i) Be in writing;
    (ii) Contain--
    (A) An identification of the methodology or methodologies applied 
in determining whether the computer model meets the requirements of 
paragraph (d)(1) of this section;
    (B) An explanation of how the applied methodology or methodologies 
demonstrated that the computer model met the requirements of paragraph 
(d)(1) of this section;
    (C) A description of any limitations that were imposed by any 
person on the eligible investment expert's selection or application of 
methodologies for determining whether the computer model meets the 
requirements of paragraph (d)(1) of this section;
    (D) A representation that the methodology or methodologies were 
applied by a person or persons with the educational background, 
technical training or experience necessary to analyze and determine 
whether the computer model meets the requirements of paragraph (d)(1);
    (E) A statement certifying that the eligible investment expert has 
determined that the computer model meets the requirements of paragraph 
(d)(1) of this section; and
    (iii) Be signed by the eligible investment expert.
    (5) The selection of an eligible investment expert as required by 
this section is a fiduciary act governed by section 404(a)(1) of ERISA.
    (e) Arrangement must be authorized by a plan fiduciary. The 
arrangement pursuant to which investment advice is provided to 
participants and beneficiaries pursuant to this section must be 
expressly authorized by a plan fiduciary (or, in the case of an 
Individual Retirement Account (IRA), the IRA beneficiary) other than: 
the person offering the arrangement; any person providing designated 
investment options under the plan; or any affiliate of either. 
Provided, however, that for purposes of the preceding, in the case of 
an IRA, an IRA beneficiary will not be treated as an affiliate of a 
person solely by reason of being an employee of such person.
    (f) Annual audit. (1) The fiduciary adviser shall, at least 
annually, engage an independent auditor, who has appropriate technical 
training or experience and proficiency, and so

[[Page 49921]]

represents in writing to the fiduciary adviser, to:
    (i) Conduct an audit of the investment advice arrangements for 
compliance with the requirements of this section; and
    (ii) Within 60 days following completion of the audit, issue a 
written report to the fiduciary adviser and, except with respect to an 
arrangement with an IRA, to each fiduciary who authorized the use of 
the investment advice arrangement, consistent with paragraph (e) of 
this section, setting forth the specific findings of the auditor 
regarding compliance of the arrangement with the requirements of this 
section.
    (2) With respect to an arrangement with an IRA, the fiduciary 
adviser:
    (i) Within 30 days following receipt of the report from the 
auditor, as described in paragraph (f)(1)(ii) of this section, shall 
furnish a copy of the report to the IRA beneficiary or make such report 
available on its website, provided that such beneficiaries are provided 
information, with the information required to be disclosed pursuant to 
paragraph (g) of this section, concerning the purpose of the report, 
and how and where to locate the report applicable to their account; and
    (ii) In the event that the report of the auditor identifies 
noncompliance with the requirements of this section, within 30 days 
following receipt of the report from the auditor, shall send a copy of 
the report to the Department of Labor at the following address: 
Investment Advice Exemption Notification--Statutory, U.S. Department of 
Labor, Employee Benefits Security Administration, Room N-1513, 200 
Constitution Ave., NW., Washington, DC, 20210.
    (3) For purposes of this paragraph (f), an auditor is considered 
independent if it does not have a material affiliation or material 
contractual relationship with the person offering the investment advice 
arrangement to the plan or any designated investment options under the 
plan.
    (4) For purposes of this paragraph (f), the auditor shall review 
sufficient relevant information to formulate an opinion as to whether 
the investment advice arrangements, and the advice provided pursuant 
thereto, offered by the fiduciary adviser during the audit period were 
in compliance with this section. Nothing in this paragraph shall 
preclude an auditor from using information obtained by sampling, as 
reasonably determined appropriate by the auditor, investment advice 
arrangements, and the advice pursuant thereto, during the audit period.
    (g) Disclosure. (1) The fiduciary adviser must provide, without 
charge, to a participant or a beneficiary before the initial provision 
of investment advice with regard to any security or other property 
offered as an investment option, a written notification--
    (i) Of the role of any party that has a material affiliation or 
material contractual relationship with the fiduciary adviser in the 
development of the investment advice program, and in the selection of 
investment options available under the plan;
    (ii) Of the past performance and historical rates of return of the 
designated investment options available under the plan, to the extent 
that such information is not otherwise provided;
    (iii) Of all fees or other compensation relating to the advice that 
the fiduciary adviser or any affiliate thereof is to receive (including 
compensation provided by any third party) in connection with the 
provision of the advice or in connection with the sale, acquisition, or 
holding of the security or other property;
    (iv) Of any material affiliation or material contractual 
relationship of the fiduciary adviser or affiliates thereof in the 
security or other property;
    (v) Of the manner, and under what circumstances, any participant or 
beneficiary information provided under the arrangement will be used or 
disclosed;
    (vi) Of the types of services provided by the fiduciary adviser in 
connection with the provision of investment advice by the fiduciary 
adviser, including, with respect to a computer model arrangement 
referred to in paragraph (d) of this section, any limitations on the 
ability of a computer model to take into account an investment option 
that constitutes an investment primarily in qualifying employer 
securities, as provided for in paragraph (d)(1)(v) of this section;
    (vii) That the adviser is acting as a fiduciary of the plan in 
connection with the provision of the advice; and
    (viii) That a recipient of the advice may separately arrange for 
the provision of advice by another adviser that could have no material 
affiliation with and receive no fees or other compensation in 
connection with the security or other property.
    (2)(i) The notification required under paragraph (g)(1) of this 
section must be written in a clear and conspicuous manner and in a 
manner calculated to be understood by the average plan participant and 
must be sufficiently accurate and comprehensive to reasonably apprise 
such participants and beneficiaries of the information required to be 
provided in the notification.
    (ii) The appendix to this section contains a model disclosure form 
that may be used to provide notification of the information described 
in paragraph (g)(1)(iii) of this section. Use of the model form is not 
mandatory. However, use of an appropriately completed model disclosure 
form will be deemed to satisfy the requirement of paragraphs (g)(1) and 
(2)(i) of this section with respect to such information.
    (3) The notification required under paragraph (g)(1) of this 
section may, in accordance with 29 CFR 2520.104b-1, be provided in 
written or electronic form.
    (4) At all times during the provision of advisory services to the 
participant or beneficiary pursuant to the arrangement, the fiduciary 
adviser must--
    (i) Maintain the information described in paragraph (g)(1) of this 
section in accurate form and in the manner described in paragraph 
(g)(2) of this section,
    (ii) Provide, without charge, accurate information to the recipient 
of the advice no less frequently than annually,
    (iii) Provide, without charge, accurate information to the 
recipient of the advice upon request of the recipient, and
    (iv) Provide, without charge, accurate information to the recipient 
of the advice concerning any material change to the information 
required to be provided to the recipient of the advice at a time 
reasonably contemporaneous to the change in information.
    (h) Other Conditions. The requirements of this paragraph are met 
if--
    (1) The fiduciary adviser provides appropriate disclosure, in 
connection with the sale, acquisition, or holding of the security or 
other property, in accordance with all applicable securities laws,
    (2) The sale, acquisition, or holding occurs solely at the 
direction of the recipient of the advice,
    (3) The compensation received by the fiduciary adviser and 
affiliates thereof in connection with the sale, acquisition, or holding 
of the security or other property is reasonable, and
    (4) The terms of the sale, acquisition, or holding of the security 
or other property are at least as favorable to the plan as an arm's 
length transaction would be.
    (i) Maintenance of Records.--The fiduciary adviser must maintain, 
for a period of not less than 6 years after the provision of investment 
advice pursuant to the arrangement, any records necessary for 
determining whether the

[[Page 49922]]

applicable requirements of this section have been met. A transaction 
prohibited under section 406 of ERISA shall not be considered to have 
occurred solely because the records are lost or destroyed prior to the 
end of the 6-year period due to circumstances beyond the control of the 
fiduciary adviser.
    (j) Definitions. For purposes of this section:
    (1) The term ``designated investment option'' means any investment 
option designated by the plan into which participants and beneficiaries 
may direct the investment of assets held in, or contributed to, their 
individual accounts. The term ``designated investment option'' shall 
not include ``brokerage windows,'' ``self-directed brokerage 
accounts,'' or similar plan arrangements that enable participants and 
beneficiaries to select investments beyond those designated by the 
plan.
    (2) The term ``fiduciary adviser'' means, with respect to a plan, a 
person who is a fiduciary of the plan by reason of the provision of 
investment advice referred to in section 3(21)(A)(ii) of ERISA by the 
person to the participant or beneficiary of the plan and who is--
    (i) Registered as an investment adviser under the Investment 
Advisers Act of 1940 (15 U.S.C. 80b-1 et seq.) or under the laws of the 
State in which the fiduciary maintains its principal office and place 
of business,
    (ii) A bank or similar financial institution referred to in section 
408(b)(4) of ERISA or a savings association (as defined in section 
3(b)(1) of the Federal Deposit Insurance Act (12 U.S.C. 1813(b)(1)), 
but only if the advice is provided through a trust department of the 
bank or similar financial institution or savings association which is 
subject to periodic examination and review by Federal or State banking 
authorities,
    (iii) An insurance company qualified to do business under the laws 
of a State,
    (iv) A person registered as a broker or dealer under the Securities 
Exchange Act of 1934 (15 U.S.C. 78a et seq.),
    (v) An affiliate of a person described in any of clauses (i) 
through (iv), or
    (vi) An employee, agent, or registered representative of a person 
described in paragraphs (j)(2)(i) through (v) of this section who 
satisfies the requirements of applicable insurance, banking, and 
securities laws relating to the provision of advice.
    (vii) Except as provided under 29 CFR 2550.408g-2, a fiduciary 
adviser includes any person who develops the computer model, or markets 
the computer model or investment advice program, utilized in 
satisfaction of paragraph (d) of this section.
    (3) A ``registered representative'' of another entity means a 
person described in section 3(a)(18) of the Securities Exchange Act of 
1934 (15 U.S.C. 78c(a)(18)) (substituting the entity for the broker or 
dealer referred to in such section) or a person described in section 
202(a)(17) of the Investment Advisers Act of 1940 (15 U.S.C. 80b-
2(a)(17)) (substituting the entity for the investment adviser referred 
to in such section).
    (4) ``Individual Retirement Account'' or ``IRA'' means--
    (i) An individual retirement account described in section 408(a) of 
the Code;
    (ii) An individual retirement annuity described in section 408(b) 
of the Code;
    (iii) An Archer MSA described in section 220(d) of the Code;
    (iv) A health savings account described in section 223(d) of the 
Code;
    (v) A Coverdell education savings account described in section 530 
of the Code; or
    (vi) A trust, plan, account, or annuity which, at any time, has 
been determined by the Secretary of the Treasury to be described in any 
of paragraphs (j)(4)(i) through (v) of this section.
    (5) An ``affiliate'' of another person means--
    (i) Any person directly or indirectly owning, controlling, or 
holding with power to vote, 5 percent or more of the outstanding voting 
securities of such other person;
    (ii) Any person 5 percent or more of whose outstanding voting 
securities are directly or indirectly owned, controlled, or held with 
power to vote, by such other person;
    (iii) Any person directly or indirectly controlling, controlled by, 
or under common control with, such other person; and
    (iv) Any officer, director, partner, copartner, or employee of such 
other person.
    (6)(i) A person with a ``material affiliation'' with another person 
means--
    (A) Any affiliate of the other person;
    (B) Any person directly or indirectly owning, controlling, or 
holding, 5 percent or more of the interests of such other person;
    (C) Any person 5 percent or more of whose interests are directly or 
indirectly owned, controlled, or held, by such other person.
    (ii) For purposes of paragraph (j)(6)(i) of this section, 
``interest'' means with respect to an entity--
    (A) The combined voting power of all classes of stock entitled to 
vote or the total value of the shares of all classes of stock of the 
entity if the entity is a corporation;
    (B) The capital interest or the profits interest of the entity if 
the entity is a partnership; or
    (C) The beneficial interest of the entity if the entity is a trust 
or unincorporated enterprise.
    (7) Persons have a ``material contractual relationship'' if 
payments made by one person to the other person pursuant to written 
contracts or agreements between the persons exceed 10 percent of the 
gross revenue, on an annual basis, of such other person.
    (8) ``Control'' means the power to exercise a controlling influence 
over the management or policies of a person other than an individual.

Appendix to Sec.  2550.408g-1

Fiduciary Adviser Disclosure

    This document contains important information about [enter name 
of Fiduciary Adviser] and how it is compensated for the investment 
advice provided to you. You should carefully consider this 
information in your evaluation of that advice.
    [enter name of Fiduciary Adviser] has been selected to provide 
investment advisory services for the [enter name of Plan]. [enter 
name of Fiduciary Adviser] will be providing these services as a 
fiduciary under the Employee Retirement Income Security Act (ERISA). 
[enter name of Fiduciary Adviser], therefore, must act prudently and 
with only your interest in mind when providing you recommendations 
on how to invest your retirement assets.

Compensation of the Fiduciary Advisor and Related Parties

    [enter name of Fiduciary Adviser] (is/is not) compensated by the 
plan for the advice it provides. (if compensated by the plan, 
explain what and how compensation is charged (e.g., asset-based fee, 
flat fee, per advice)). (If applicable, [enter name of Fiduciary 
Adviser] is not compensated on the basis of the investment(s) 
selected by you.)
    Affiliates of [enter name of Fiduciary Adviser] (if applicable 
enter, and other parties with whom [enter name of Fiduciary Adviser] 
has a material affiliation or material contractual relationship 
\93\) also will be providing services for which they will be 
compensated. These services include: [enter description of services, 
e.g., investment management, transfer agent, custodial, and 
shareholder services for some/all the investment funds available 
under the plan.]
---------------------------------------------------------------------------

    \93\ See 29 CFR 2550.408g-1.
---------------------------------------------------------------------------

    When [enter name of Fiduciary Adviser] recommends that you 
invest your assets in an investment fund of its own or one of its 
affiliates and you follow that advice, [enter name of Fiduciary 
Adviser] or that affiliate will receive compensation from the 
investment fund based on the amount you invest. The amounts that 
will be paid by you will vary depending on the particular fund in 
which you invest your assets and may range from --% to --%. Specific 
information

[[Page 49923]]

concerning the fees and other charges of each investment fund is 
available from [enter source, such as: Your plan administrator, 
investment fund provider (possibly with Internet Web site address)]. 
This information should be reviewed carefully before you make an 
investment decision.
    (if applicable enter, [enter name of Fiduciary Adviser] or 
affiliates of [enter name of Fiduciary Adviser] also receive 
compensation from non-affiliated investment funds as a result of 
investments you make as a result of recommendations of [enter name 
of Fiduciary Adviser]. The amount of this compensation also may vary 
depending on the particular fund in which you invest. This 
compensation may range from --% to --%. Specific information 
concerning the fees and other charges of each investment fund is 
available from [enter source, such as: Your plan administrator, 
investment fund provider (possibly with Internet Web site address)]. 
This information should be reviewed carefully before you make an 
investment decision.
    (if applicable enter, In addition to the above, [enter name of 
Fiduciary Adviser] or affiliates of [enter name of Fiduciary 
Adviser] also receive other fees or compensation, such as 
commissions, in connection with the sale, acquisition of holding of 
investments selected by you as a result of recommendations of [enter 
name of Fiduciary Adviser]. These amounts are: [enter description of 
all other fees or compensation to be received in connection with 
sale, acquisition or holding of investments]. This information 
should be reviewed carefully before you make an investment decision.

Investment Returns

    While understanding investment-related fees and expenses is 
important in making informed investment decisions, it is also 
important to consider additional information about your investment 
options, such as performance, investment strategies and risks. 
Specific information related to the past performance and historical 
rates of return of the investment options available under the plan 
(has/has not) been provided to you by [enter source, such as: Your 
plan administrator, investment fund provider]. (if applicable enter, 
If not provided to you, the information is attached to this 
document.)
    For options with returns that vary over time, past performance 
does not guarantee how your investment in the option will perform in 
the future; your investment in these options could lose money.

Parties Participating in Development of Advice Program or Selection of 
Investment Options

    Name, and describe role of, affiliates or other parties with 
whom the fiduciary adviser has a material affiliation or contractual 
relationship that participated in the development of the investment 
advice program (if this is an arrangement that uses computer models) 
or the selection of investment options available under the plan.

Use of Personal Information

    Include a brief explanation of the following--
    What personal information will be collected;
    How the information will be used;
    Parties with whom information will be shared;
    How the information will be protected; and 
    When and how notice of the Fiduciary Adviser's privacy statement 
will be available to participants and beneficiaries.

Consider Impact of Compensation on Advice

    The fees and other compensation that [enter name of Fiduciary 
Adviser] and its affiliates receive on account of assets in [enter 
name of Fiduciary Adviser] (enter if applicable, and non-[enter name 
of Fiduciary Adviser]) investment funds are a significant source of 
revenue for the [enter name of Fiduciary Adviser] and its 
affiliates. You should carefully consider the impact of any such 
fees and compensation in your evaluation of the investment that 
[enter name of Fiduciary Adviser] provides to you. In this regard, 
you may arrange for the provision of advice by another adviser that 
may have not material affiliation with or receive compensation in 
connection with the investment funds or products offered under the 
plan. This type of advice is/is not available through your plan.
    Should you have any questions about [enter name of Fiduciary 
Adviser] or the information contained in this document, you may 
contact [enter name of contact person for fiduciary adviser, 
telephone number, address].

    3. Add Sec.  2550.408g-2 to read as follows:


Sec.  2550.408g-2  Investment advice--fiduciary election.

    (a) General. Section 408(g)(11)(A) of the Employee Retirement 
Income Security Act, as amended (ERISA), provides that a person who 
develops a computer model or who markets a computer model or investment 
advice program used in an ``eligible investment advice arrangement'' 
shall be treated as a fiduciary of a plan by reason of the provision of 
investment advice referred to in ERISA section 3(21)(A)(ii) to the plan 
participant or beneficiary, and shall be treated as a ``fiduciary 
adviser'' for purposes of ERISA section 408(b)(14) and (g). Section 
4975(f)(8) of the Internal Revenue Code, as amended (the Code), 
contains a parallel provision to ERISA section 408(g)(11). This section 
sets forth requirements that must be satisfied in order for one such 
fiduciary adviser to elect to be treated as a fiduciary with respect to 
a plan under an eligible investment advice arrangement.
    (b)(1) If an election meets the requirements in paragraph (b)(2) of 
this section, then the person identified in the election shall be the 
sole fiduciary adviser treated as a fiduciary by reason of developing 
or marketing the computer model, or marketing the investment advice 
program, used in an eligible investment advice arrangement.
    (2) An election satisfies the requirements of this subparagraph 
with respect to an eligible investment advice arrangement if the 
election is in writing and such writing--
    (i) Identifies the investment advice arrangement, and the person 
offering the arrangement, with respect to which the election is to be 
effective;
    (ii) Identifies a person who--
    (A) Is described in any of 29 CFR 2550.408g-1(j)(2) (i) through 
(v),
    (B) Develops the computer model, or markets the computer model or 
investment advice program, utilized in satisfaction of 29 CFR 
2550.408g-1(d) with respect to the arrangement, and
    (C) Acknowledges that it elects to be treated as the only 
fiduciary, and fiduciary adviser, by reason of developing such computer 
model, or marketing such computer model or investment advice program;
    (iii) Is signed by the person identified in paragraph (b)(2)(ii) of 
this section;
    (iv) Is furnished to the fiduciary who authorized the arrangement, 
in accordance with 29 CFR 2550.408g-1(e); and
    (v) Is maintained in accordance with 29 CFR 2550.408g-1(i).

    Signed at Washington, DC, this 15th day of August, 2008.
Bradford P. Campbell,
Assistant Secretary, Employee Benefits Security Administration, 
Department of Labor.
 [FR Doc. E8-19272 Filed 8-21-08; 8:45 am]

BILLING CODE 4510-29-P