Advisory Council Report of the Working Group on Optional Professional Management in Defined Contribution Plans

This report was produced by the Advisory Council on Employee Welfare and Pension Benefit Plans, which was created by ERISA to provide advice to the Secretary of Labor.  The contents of this report do not necessarily represent the position of the Department of Labor.

November 7, 2003

Introduction and Overview

In our first meeting on May 9, 2003, Vice Chairperson David Wray suggested that the biggest change in the Defined Contribution Plan design area was the move to optional professional management. He suggested that the question should be: Is there a role for the Department of Labor in the movement?

From this early discussion, thoughts of identifying the fiduciary issues in professional management where the employees do not want to make these investment decisions, don’t feel qualified to do so, and want to turn these decisions over to a professional to manage in a discretionary manner were discussed.

It was clear that we should not focus on investment advice, but rather professional management where employees sits down and counsel with the professional manager about their goals, their age, risk tolerance, and everything. Then the investment manager actually takes the money and invests it for the employees.

At the meeting it was suggested that sometimes people at the lower end of the income scale might really be more desirous of having someone take the responsibility for the management than the typical highly-paid employees. It was also suggested that the employer has the obligation to act in the sole interest of the plan participants in choosing the advisors for the plan, that their obligation is a fiduciary obligation under the Employee Retirement Income Security Act (ERISA).

Several members thought it might be premature in taking on these issues, but the Council believed it would be useful in identifying issues and problems and bringing them to the attention of the Department of Labor with recommendations and findings.

At the onset, the Working Group decided it should proceed with caution so as not to expose participants’ assets to undue risk or unreasonable expense, and that plan sponsors are protected from unreasonable costs and potentially hidden liabilities associated with adding this service.

It soon became apparent that there were two different platforms that needed to be researched and discussed. One being where the plan sponsors chose the professional managers and the other platform being where the plan sponsor lets the participants have total control over the assets of the plan and they, the participants, choose a manager to invest the money.

The Working Group put together a list of questions that went to the heart of finding the areas of problems and barriers that plan sponsors have in implementing the option of having a professional manager available for the employees and what potential safeguards were needed to be in place for the participants.

It was decided to have as the first witnesses a diverse group of service providers that were already in the business of giving management services to plan sponsors and participants. After that, we asked plan designers for their views on the logistics of drafting plan documents that would allow such a service to be offered.

As we moved to the July meeting and having the benefit of the testimony and discussions of the earlier meetings, we expanded our hearings to include plan sponsors and risk managers, as well as acquiring some statistical input from consultants and asking for written testimony from industry groups.

Working Group Proceedings

At the first meeting on June 27, 2003, the working group heard testimony from Sherrie Grabot, President and Chief Executive Officer of GuidedChoice, Inc.; Carl Londe, Chief Executive Officer of ProManage, Inc.; Richard P. Magrath, President, ProNvest, Inc.; panel discussion with Ms. Grabot, Mr. Londe, Mr. Magrath, and Mr. Fine; Ken Fine, Ex. Vice President of Financial Engines, Inc.; Scott D. Miller, Principal of Actuarial Consulting Group and Bob Wuelfing, President of RGWuelfing, Inc.

At our second meeting on July 25, 2003, the working group heard testimony from Lori Lucas, CFA and a Defined Contribution Consultant with Hewitt Associates; William E. Robinson, an Attorney and Partner with Miller & Martin, LLP; Shaun O’Brien, Assistant Director of the AFL-CIO Public Policy Department; Rhonda Prussack, a Vice President & Product Manager of Fiduciary Liability with National Union; and David C. John, a Research Fellow with The Heritage Foundation. After hearing testimony, the working group discussed other issues that might be germane to this and began to outline areas of potential consensus for possible recommendations.

Written response to questions received on July 31,2003, by Michael Falk, CFA of ProManage, Inc.

At our third meeting on September 22, 2003, the working group discussed in more detail areas of potential consensus and areas where we could not agree on a consensus. We also received written testimony from Thomas T. Kim, Associate Counsel of the Investment Company Institute.

Findings

Questions Given to Each Witness From Working Group and Answers Where Directly Addressed:

Optional Professional Management (OPM) in Defined Contribution Plans: Plan sponsors are beginning to incorporate in their plan design the opportunity for participants to delegate the investment allocation/implementation of their plan assets to professional investment advisors and managers. The Working Group will examine the advantages, disadvantages, fiduciary implications, and industry practices of this emerging plan design practice.

Legend to Responses

Summary: Summary of witness(es) responses to questionnaire

Dissenting: Dissenting opinion by witness(es) to questionnaire

(FE): Response by Financial Engines

(Pro): Response by ProNvest

(NUFIC): Response by National Union Fire Insurance Company

Questions and Answers

Q1: Should plan sponsors be encouraged to provide access to professional investment management services, education, or advice to participants in self-directed accounts plans? If so, how?

Summary: Yes, however, there needs to be clarification from the Department on the “Safe Harbor” procedures the plan sponsor could follow in properly structuring, selecting and monitoring a menu of investment advisors and managers for use by plan participants. Such clarification could also produce the collateral benefit of encouraging plan sponsors to provide such access.

Dissenting: None noted.

(FE) Yes. Although a change in the law is not actually needed, it appears that many sponsors would benefit from additional official assurances that they will not be liable for the recommendations of a properly retained advisor or manager. We suggest that the DOL issue additional statements along the lines of those the DOL has previously issued. However, we believe that these statements would have more impact if they were made in the form of an Information Letter, which is a formal statement explaining a point of law that is issued by the Employee Benefits Security Administration (the former Pension and Welfare Benefits Administration). An Information Letter that explained the law on this point in plain terms could be very encouraging to plan sponsors.

Current law permits these services to be provided and, at least arguably, ERISA’s general fiduciary standard encourages the plan sponsor to provide these services to the extent that participants seem to need them. Representatives of the Department of Labor have made public statements on a few occasions encouraging the provision of advice. For example, in a 401(k) Alert Special Issue on Advice (volume 1, number 4, May 1998), in an article entitled “Washington Update: DOL Sets the Record Straight On Investment Advice,” the then-Assistant Secretary wrote:

“At the DOL, we’re very concerned about the widespread misunderstanding among 401(k) plan sponsors regarding investment advice for participants. Let’s clear this up once and for all: investment advice is perfectly legal. In fact, the DOL wants participants to have as much assistance as possible, and we encourage plan sponsors to offer participants investment advice if that’s what they determine their participants need to make informed decisions.”

On July 17, 2001, Assistant Secretary Ann L. Combs gave testimony on the subject of “Retirement Security Advice Legislation” to the Working Group on Employer-Employee Relations of the House Committee on Education and the Workforce. Ms. Combs noted that

“[m]eaningful comprehensive investment advice is more important now than it has ever been” and that “[i]nvestment education, while important, is simply not enough.”

Despite statements like these and the clear terms of ERISA and formal DOL guidance stating that a plan sponsor is not liable for the content of investment recommendations provided by a properly designated investment advisor or manager, and the fact that services like these have been adopted by many sponsors, surveys appear to indicate that many other plan sponsors hesitate to offer any investment assistance beyond education because of liability concerns. This is a mistaken impression about the current state of the law. In her testimony referred to in the preceding paragraph, Ms. Combs confirmed that although guidance had been given by the DOL on the subject, many sponsors still feared liability for the advisor’s recommendations.

If a plan sponsor selects an investment educator, advisor or manager to make available to participants, what due diligence should be done? Are there any special standards that should be met before someone should be allowed to provide such services to plan participants?

(FE) As is discussed in some of the items above, there is an option for the sponsor to select an advisor or manager to act as a fiduciary to the plan. (A provider of investment education, as contrasted with advice or management, is not an ERISA fiduciary, even if appointed by the plan sponsor.) The selection and retention of an investment manager is a fiduciary function. As with the selection and retention of any service provider to the plan, the plan sponsor is required to make a prudent selection that is in the best interests of participants and beneficiaries.

DOL pronouncements and court decisions establish a general framework for the prudent selection of investment managers and other plan service providers. These authorities indicate that a plan fiduciary retaining an investment manager generally has an obligation to take steps similar to the following:

• Determine the needs of the plan’s participants;
• Assess the qualifications of the service provider;
• Review the services provided and fees charged by different providers;
• Select the provider whose service level, quality and fees best match the plan’ s needs and financial situation; and
• Once a provider has been hired, review the provider’s performance at reasonable intervals so as to ensure that the provider is complying with the terms of the plan and statutory standards, and is satisfying the needs of the plan.

For background on due diligence requirements, see generally, § 2509.96-1; § 2509.75-8, Q-FR-17; Liss v. Smith, 991 F. Supp. 278, 300 (S.D.N.Y. 1998); Whitfield v. Cohen, 682 F.Supp.188, 195 (S.D.N.Y. 1988). See also, guidelines set forth in a settlement agreement to which the DOL was a party in In re Masters, Mates & Pilots Pension Plan Litig., No. 85 Civ. 9545 (VLB) (S.D.N.Y.), discussed in Serota, ERISA Fiduciary Law (1995) at 124. More specifically regarding due diligence procedures, see 29 C.F.R. § 2509.75-8, Q-FR-17 (“No single procedure will be appropriate in all cases; the procedure adopted may vary in accordance with the nature of the plan and other facts and circumstances relevant to the choice of the procedure.”).

(Pro) We do believe that such encouragement is needed. The DOL has expressly stated that it is a policy goal to provide participants with more access to education and advice. However, plan sponsors remain concerned about the potential for fiduciary liability for arrangements made between these service providers and the participants in their plans. They feel caught between the potential for liability if they choose not to arrange for investment services for their participants and the potential for being held responsible for actual advice or management services provided. While in our view the first should be of more concern than the second, a review of current law and guidance does not make that clear. The reason for this is that the DOL will not come right out and say that there is no liability for a plan sponsor for investment advice or management services provided to plan participants. This is probably because there is really no direct statutory authority to support such a statement. Therefore, we believe that such a statutory basis should be created.

An exemption should be created to ERISA fiduciary liability that clarifies that a plan sponsor has no ERISA fiduciary liability for the actual education, advice, or management services provided by a professional investment educator, advisor, or manager.

Of course, such an exemption should be conditioned on the professional meeting certain standards. First, such a professional should meet the requirements set forth in ERISA Section 3(38)(B) (definition of “investment manager”). These are the standards for persons who may be designated an investment manager of a plan, and are applied to persons who manage large sums of money for defined benefit plans and other collective trusts. These standards include the requirement to be registered as an investment adviser under the Investment Advisers Act of 1940.

Second, the participant must have the freedom whether and to what extent he or she will utilize the education, advisory, or managerial services of the investment professiIn addition, when a participant hires a professional advisor or manager, there should be a written asset management agreement between the participant and the professional. The Plan Sponsor should be required to receive and retain a copy. The professional should be required to acknowledge in the agreement that it accepts fiduciary responsibility as an investment manager. This is also a requirement of ERISA Section 3(38)(C).onal.

Finally, the professional should be independent of any funds offered under the plan. This will insure that there is no potential that this exemption will result in prohibited transactions being inadvertently sanctioned by this exemption from fiduciary liability.

Some may argue that the forgoing proposal is already provided within current ERISA law. This argument is not without merit (see the response to Question 6), but there are ambiguities within the law that result from the fact that these provisions were written at a time when most plans were managed under a single collective trust. The proliferation of investment funds and the ability for participants to manage their retirement assets presents a whole new set of situations, and the language of ERISA should be revised to unambiguously state its applicability.

Moreover, we would not propose the above exemption as an absolute requirement; rather it should be a safe harbor such that if a plan is set up to meet the requirements set forth, the plan sponsor would be deemed to meet the fiduciary requirements of ERISA with respect to education, advise, or management services provided by the investment professional. There may well be other arrangements, which would not result in fiduciary liability for the plan sponsor because they meet the general ERISA fiduciary standards.

Q2: What has been the interest from Plan Sponsors in offering professional investment managers and advisors?

Summary: There is strong interest – motivated in part by plan sponsors who believe their fiduciary liability will be reduced, and by others who believe that optional professional management, as well as specific investment advice from professional investment advisors will help to increase rates of participation, contribution and investment returns.

Dissenting: There was a strong opinion from one witness that the demand is being generated by the vendors, not the plan sponsors or participants. (Wuelfing).

(FE) Plan sponsors have demonstrated substantial interest in offering advisory and management solutions that meet the needs of investors with little time and interest in investing. Optional Professional Management solutions are specifically designed for that investor segment. Financial Engines met with about 50 plan sponsors between September 2002 and June 2003 to obtain feedback on optional professional management as a viable option for their participants. We found that most sponsors are receptive to the concept and eager to see this solution deployed broadly in the market. Here are a couple of representative quotes from these 50 meetings:

“This is excellent. I like this. I like the personalization.” – Manufacturing company

“I think we’ll do this in our company.” – Trucking company

Over the years since 401(k) plans have become the dominant form of employer-sponsored retirement plans, plan sponsors have become increasingly concerned about plan participants’ ability or desire to manage their plan accounts appropriately for retirement. Best efforts at investment education have not solved this problem. It is clear that while some participants are self-starters in this area, most need and want either investment advice or management.

No changes are needed in current law to permit a plan sponsor to designate one or more investment managers to act as plan fiduciaries for the purpose of investing the individual account of any participant who decides to use the manager option. And it is desirable that plan sponsors take this step, so that plan participants are given the opportunity to use professional service providers whose qualifications have been vetted by the sponsor.

Plan sponsors can obtain a fiduciary benefit from providing these services. Data indicate that users of these services tend to increase their savings rates and wind up with better-diversified investment accounts. Although the need for these services is apparent, and the benefits are clear, some sponsors hesitate to retain fiduciary investment advisors and managers, out of a mistaken belief that ERISA makes them liable for the investment professional’s recommendations or selections. We believe that both sponsors and participants would benefit from the Department of Labor’s issuance of an Information Letter explaining that if the sponsor makes a prudent selection of an investment advisor or manager, and monitors the prudence of that selection regularly, then the sponsor will not be liable for the professional’s recommendations or selections.

(Pro) There has been great interest from plan sponsors in offering professional investment advisors. The greatest barrier to Sponsors implementing an advice solution is fear of incurring fiduciary liability. To the extent that Sponsors can be relieved of that fear, participants will be able to benefit from professional investment help.

Q3: When the professional investment manager or advisor is offered as an option, what percentage of the participants has selected the option?

Summary: Initial attempts to market such services have yielded participation rates between 15 – 37%. It is too early to know whether these would be representative of long-term experience.

Dissenting: None noted..

(FE) Financial Engines’ current testing of its planned optional professional management service (which is ongoing with two large public companies) indicates that 10-15% of participants enrolled in that offering within the first one-three months offered with minimal marketing. Expected enrollment rates when offered over a full year with more active communications are expected to be in the 15-25% range. We believe that enrollment rates can be further enhanced when such an option is integrated directly into the 401(k) enrollment process.

(Pro) The percentage of employees that register to use our service depends on how the Plan Sponsor wishes to implement our solution. When a plan participant registers to use our advice (which in the ProNvest model is provided free to both sponsor and participant), 37% of those participants have hired ProNvest to manage their 401(k)/retirement plan or other assets.

Q4: Has there been an uptick in plan participation when professional investment managers and/or advisors have been offered?

Summary: Inconclusive, but there is an intuitive logic that participation would pick up if participants had more confidence in their investment process and how the plan assets are invested.

Dissenting: None noted..

(FE) Financial Engines is currently testing its optional professional management offering with two large companies. That testing is focused on validating demand for this service among employees who are currently participating in the plan rather than those who are not participating. Anecdotal evidence has indicated that some participants resist plan participation due to the perceived complexity of making investment selections. If an optional professional management offering were integrated with the actual 401(k) enrollment process, higher participation rates may be expected. That being said, many employees resist plan participation for other reasons, such as budgetary constraints. Optional professional management would not likely overcome all such participation barriers.

(Pro) Each plan we are involved with has experienced an increase in the breadth (number of active participants in the plan) and depth (contribution amount of active participants) of plan participants.

Q5: Has there been an uptick in the plan participant’s contribution percentage when professional investment managers and/or advisors have been offered?

Summary: Yes, there is evidence that the contribution rate increases.

Dissenting: None noted.

(FE) Financial Engines has found that offering advisory services has a material impact on contribution percentages. For example, 20% of Financial Engines’ online advice users have increased their contribution rate (by 40%) since their first session. For those employees that interact via a call center, 50% increase their savings rates (by over 100%). Employees with lower incomes (less than $25K) have tended to increase their savings rates the most, on average by 92%.

In conjunction with an optional professional management, we believe it is useful for the sponsor to offer a “Save More Tomorrow” option, whereby participants can elect to have their savings rates increased gradually over time (e.g., 1% per year), starting at a specified future date. Survey feedback has indicated a very high interest in participating in that program. Also, findings from behavioral finance experts Shlomo Benartzi and Richard Thaler have validated participant willingness to participate in such “managed savings” programs.

(Pro) Please see the response to Question 4.

Q6: Should there be a requirement for a plan to provide investment education to participants, either generally or as a precondition to being allowed to self-direct their plan assets?

Summary: No, 404 (c) is sufficient in providing encouragement to provide investment education.

Dissenting: None noted.

(FE) When one considers that the employer-sponsored retirement plan system in this country is a voluntary regime, it may be best to continue to rely upon an incentive to provide investment information, such as in the 404(c) regulations, rather than a mandate. It might be helpful, however, if the DOL were to issue an advisory (an Information Letter, for example) reiterating the current ERISA law that plan sponsors are generally not liable for the recommendations or choices of a designated investment advisor or manager and, perhaps, confirming Mr. Reish’s view (as described below) that ERISA’s general fiduciary standard requires the plan fiduciary to provide investment assistance to the employees that is appropriate to their needs.

Current law does not explicitly require investment education to be provided before permitting participants to invest their own accounts. However, for a participant-directed retirement plan to be considered to be a 404(c) plan, according to DOL regulations, the participant must be “provided or has the opportunity to obtain sufficient information to make informed decisions with regard to investment alternatives available under the plan,” which includes “a description of the investment alternatives available under the plan and, with respect to each designated investment alternative, a general description of the investment objectives and risk and return characteristics of each such alternative,” and “a description of any transaction fees and expenses which affect the participant’s or beneficiary’s account balance.” The regulation lists other investment-related information that must be provided automatically, as well as additional information that must be supplied upon request.

The vast majority of sponsors of self-directed plans aim to comply with 404(c). It is also worth taking into account that the basic fiduciary responsibility rules of ERISA come into play here. ERISA Section 404(a)(1)(B) requires that all plan fiduciaries exercise their responsibilities “with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.” (Emphasis added.)

As Fred Reish points out in his article in the December 2002 issue of Plan Sponsor magazine, given the “circumstances then prevailing” language of the fundamental ERISA rule, “[i]f a plan sponsor knows the workforce is unsophisticated about investing, . . . [then] under the general prudence rule an argument could be made that the plan fiduciaries cannot fulfill their duty to act prudently if they do not make investment advice available.” Although Mr. Reish was specifically addressing the issue of investment advisory services, his argument can just as easily apply to investment education or professional management services.

A plan sponsor, as a fiduciary, will not incur liability for a participant’s investment of his or her account if it complies with ERISA Section 404(c). Section 404(c) does not require a plan sponsor to provide investment education or access to a professional investment advisor or manager for such protection to apply. Should such actions be required for 404(c) protection and to what extent?

(Pro) It is probably not practical to consider imposing a requirement upon plan sponsors to provide investment education either generally or as a pre-condition to being allowed to self-direct plan assets. However, we do feel that the provision of investment education is an important policy goal that should be encouraged in every means possible. For example, legislation, or an opinion or regulation issued by the Department of Labor, indicating that a plan sponsor is not liable for the investment education, advice, or management services provided by a professional investment educator, advisor, or manager would be very helpful. Any such legislation or guidance should also address the interaction with ERISA Section 404(c), as there appears to be a great deal of confusion among the plan sponsor community with respect to the interplay of the rules under that section and general ERISA fiduciary duties when an investment advisor or manager is made available to participants.

(NUFIC) At a bare minimum, plan sponsors should provide basic investment education to plan participants, such as describing the risks associated with certain investments and the importance of portfolio diversification. I would view as a positive development a company offering investment advice to participants in self-directed plans, as long as such investment advice was generated by an independent third party. If the investment advice were generated either internally (for instance by an employee of the employer) or by the same company that provides the investments for the plan, I'd have concerns about allegations of conflict of interest, self-dealing, profiting from the plan, etc.

Q7: A plan sponsor, as a fiduciary, will not incur liability for a participant's investment of his or her account if it complies with ERISA Section 404(c). Section 404(c) does not require a plan sponsor to provide investment education or access to a professional investment advisor or manager for such protection to apply. Should such actions be required for 404(c) protection and to what extent?

Summary: No, however, there is a misconception among some plan sponsors that the selection of an investment manager and/or advisor to work with plan participants does cause the loss of 404 (c) protection. A clarification by the Department would be helpful.

Dissenting: None noted.

(FE) See Question 6.

(Pro) Although such a requirement would not be inconsistent with the purposes of Section 404(c), it seems difficult to see a requirement of a professional investment advisor or manager as being necessary in all situations. Section 404(c) provides an exemption from fiduciary liability for a fiduciary with respect to investment decisions made by a participant or beneficiary in a plan. There are already a number of requirements that must be met to fall within that exemption. Examples in the Section 404(c) regulations indicate that selection of an advisor or manager by the participant does not result in the loss of Section 404(c) protection if all requirements are met. Given that, and because the need to offer investment education or advice, or even management services, to participants involves a matter of judgment with respect to the needs of a plan sponsor’s particular employee population, it seems that it would be difficult to impose a requirement that education or advice be provided in order for Section 404(c) to apply in all cases. Rather, the provision of investment advice and education should be encouraged through a separate exemption from liability using a “safe harbor approach,” as set forth under Question 8.

Q8: What due diligence should the Plan Sponsor use to select and monitor the professional investment manager and/or advisor?

Summary: The seminal due diligence process developed by the 1996 ERISA Advisory Council still seems to be the most comprehensive process.

Dissenting: None noted.

(Pro) In 1996, the ERISA Advisory Council formed a working group to prepare guidance on the selection and monitoring of service providers to ERISA plans. As a part of their report, the working group prepared the following issues and questions to be used with respect to selection and monitoring, which provide a good basis for due diligence in selecting an educator, advisor or manager for a plan.

Issues for Fiduciaries Who are Hiring a Service Provider

What service or expertise does the plan need? Is the service or expertise necessary and/or appropriate for the functioning of the plan?

Does this service provider propose to provide the service that is necessary or appropriate for the plan?

Does this service provider have the objective qualifications to properly provide the service that is necessary and/or appropriate for the plan? Generally, the fiduciary should seek the following information that will vary with the type of service provider being retained:

• Business structure of the candidate
• Size of staff
• Identification of individual who will handle the plan's account
• Education
• Professional certifications
• Relevant training
• Relevant experience
• Performance record
• References
• Professional registrations, if applicable
• Technical capabilities
• Financial condition and capitalization
• Insurance/bonding
• Enforcement actions; litigation
• Termination by other clients and the reasons

Are the service provider's fees reasonable when compared to industry standards in view of the services to be performed, the provider's qualifications and the scope of the service provider's responsibility?

Does the plan have a conflict of interest policy that governs business and personal relationships between fiduciaries and service providers and among service providers? Does the plan require disclosure of relationships, compensation and gifts between fiduciaries and service providers and among service providers?

Does a written agreement document the services to be performed and the related costs?

Additional Issues when Hiring an Investment Manager

Does the Plan have a Statement of Investment Policy? Some or all of the following issues may be addressed by a Statement of Investment Policy (See Department of Labor Interpretive Bulletin 94-2):

• Evaluation of the specific needs of the plan and its participants
• Statement of investment objectives and goals
• Standards of investment performance/benchmarks
• Classes of investment authorized
• Styles of investment authorized
• Diversification of portfolio among classes of investment, among investment styles and within classes of investment
• Restrictions on investments
• Directed brokerage
• Proxy voting
• Standards for reports by investment managers and investment consultants on performance, commission activity, turnover, proxy voting, compliance with investment guidelines.
• Policies and procedures for the hiring of an investment manager
• Disclosure of actual and potential conflicts of interest

What is the position to be filled? Why is the Plan hiring an additional investment manager? Is the Plan replacing a terminated manager with a manager of the same investment style or hiring an additional manager with a different investment style? Is the hiring of this manager consistent with the Statement of Investment Policy?

Does the Investment Manager have the objective qualifications for the position being filled? (See questions concerning qualifications above.) Does the candidate qualify as an investment manager pursuant to ERISA section 3(38)?

How does the investment manager manage money? What is the manager's performance record and how does the manager achieve his performance? What are the risks of the investment manager's style and strategy compared to other styles and strategies? Do you understand what the manager does and the risks involved? Is this risk level acceptable in view of the return? How do this manager's investment style and strategy fit into the portfolio as a whole? (See Department of Labor Regulation 29 CFR § 2550.404a-1 Investment Duties and Letter from Olena Berg, Assistant Secretary for Pension and Welfare Benefits Administration, to Honorable Eugene A. Ludwig, Comptroller of the Currency concerning the Department of Labor's views with respect to the utilization of derivatives in the portfolio of pension plans subject to the Employee Retirement Income Security Act.)

How does the investment manager measure and report performance? Does the process ensure objective reporting?

Is the investment manager a qualified professional asset manager? What is the investment manager's process to comply with the prohibited transactions provisions of ERISA?

What is the investment manager's process to insure compliance with the plan's investment policy and guidelines?

What is the investment manager's record with respect to turnover of personnel?

Has the manager's investment style been consistent?

Has the investment manager been terminated by plan clients within a relevant time period and why?

Has the ownership of the investment manager changed within a relevant time period and how will this affect the ability of the manager to perform the services needed by the plan?

What are the investment manager's fees? Are the fees reasonable in comparison with industry standards for the type and size of the investment portfolio? Does the fee structure encourage undue risk taking by the investment manager?

Does the investment manager have a personal or business relationship with any of the plan fiduciaries, or with another service provider recommending the investment manager? If a relationship does exist, how does it impact on the evaluation of the objective qualifications of the investment manager and the recommendation?

If the plan has adopted a directed brokerage arrangement with a broker affiliated with the plan's investment consultant, how does the investment manager determine when to use broker affiliated with the investment consultant? What are the per share transaction costs?

Does the investment manager have insurance, which would permit recovery by the plan in the event of a breach of fiduciary duty by the investment manager? What is the amount of the insurance? Who is the insurance carrier?

Additional Issues in Monitoring Service Providers

Who is responsible for monitoring the service provider?

What is the process to monitor the service provider?

Are written reports provided by the service provider? With What frequency are the written reports provided?

Do the written reports describe the performance of the service provider as compared to the applicable written guidelines and/or contract?

Do the written reports provide sufficient information to adequately evaluate the performance of the service provider compared to benchmarks or industry standards?

Is there a process in place to either: (a) correct any non-conformance with guidelines/contract, benchmarks or industry standards; or (b) to terminate the service provider and retain a successor?

Has the responsibility for monitoring a service provider been delegated to an individual or another service provider?

If the responsibility to monitor a service provider has been delegated, has the individual or service provider to whom the delegation has been made accepted fiduciary responsibility in writing for the monitoring?

(NUFIC) The Plan Sponsor should regularly determine that the professional investment advisors' credentials are unchanged, that the fees charged are reasonable, and that the advice being given is sound.

Q9: What disclosure should the professional investment manager or advisor provide (a) the Plan Sponsor and (b) participant, regarding conflicts of interest and compensation (both hard and soft dollars)?

Summary: The advisor should be required to provide full disclosure of potential conflicts of interest and all forms of revenue and compensation (both hard and soft) generated from working with the plan, plan participants, and any of the plan’s service vendors.

Dissenting: Some witnesses said disclosure was not a substitute for independence.(FE) The investment manager should provide full disclosure to both the sponsor and the participant of (1) its investment philosophy, (2) all material assumptions underlying its investment choices, (3) the professional credentials of those who are responsible for making investment decisions and/or deciding the criteria through which decisions are made, (4) actual or potential conflicts of interest presented by ownership or compensation arrangements and (5) its compensation.

(Pro) Full disclosure should be required regarding all compensation received by the professional investment advisor for services rendered. Conflicts of interest should not be permitted – these are prohibited transactions in the context of an ERISA-governed retirement plan.

(NUFIC) Since I believe that the investment advisor should be an independent third party, there should be no conflict of interest. If there is an appearance of a conflict, when in actuality there is no conflict, such appearance should be explained in plain English mailings, both through standard mail and electronic. Compensation to investment advisors should be similarly explained.

Q10: What information should the participant receive in terms of the qualifications of the professional investment manager and/or advisor, and the procedures that are to be followed by the professional investment manager and/or advisor?

Summary: Participants should have access to all relevant information about the advisor.

Dissenting: None noted.

(FE) See Question 9.

(Pro) Participants should have access to relevant information discussed in the response to Question 9 regarding due diligence for hiring a service provider to a plan.

(NUFIC) Participants should periodically receive plain-English descriptions of the investment advisor's qualifications, as well as any changes to those qualifications, and should be apprised, at least upon enrollment in the plan, of the selection process for such advisors.

Q11: Should professional investment managers and/or advisors be required to demonstrate qualifications that exceed the minimum requirements specified by their respective regulatory body?

Summary: There was general agreement from the witnesses that the regulatory bodies do an adequate job.

Dissenting: None noted.

(FE) The current legal and regulatory rules provide a good framework. Providing managed accounts to the retirement plan market will be competitive. Because sponsors will be making a fiduciary decision when retaining an advisor for the plan, there will be an incentive for managers to ensure that their firms and their personnel are highly qualified. If it is desirable to specify additional qualifications in this area, the Department of Labor’s QPAM exemption (PTE 84-14) provisions regarding a qualified investment manager might be a good starting place for guidance on appropriate qualification rules.

(Pro) Perhaps it would be reasonable to require such professionals to undergo some training in ERISA fiduciary duties and responsibilities before being allowed to provide services to an ERISA plan.

(NUFIC) I would certainly look more favorably upon plan sponsors that hire investment advisors that substantially exceed the minimum requirements set forth by their respective regulatory bodies.

Q12: What circumstances, if any, ever justify a fund manager offering investment funds to a plan to provide investment education, advice or management services to participants in that plan? Does the model set forth in the SunAmerica opinion adequately protect participants and plan sponsors from conflicts of interest? Would disclosure of potential and real conflicts of interest adequately protect participants and plan sponsors, as proposed in the Boehner Bill?

Summary: The DOL has provided two forms of relief from the prohibited transaction rules: (1) Prohibited Transaction Class Exemption 77-4, which says that where “fee leveling” between the participant level fees and the investment funds fees has taken place, serving in the dual roles will not be enforced as a prohibited transaction; and, (2) SunAmerica opinion, which requires all investment choices/recommendations to be generated by an independent third party, free of the editorial control of the fund manager.

Dissenting: The witnesses disagreed about whether the Boehner bill (HR 1000) would adequately protect participants from conflicts of interest with some witnesses testifying that this kind of disclosure conflict in the Boehner Bill was sufficient to protect participants and others feeling it was insufficient to protect participants.

(FE) ERISA requires a fund manager to eliminate real or potential conflicts of interest in order to avoid violating the prohibited transaction rules. One way to attack the conflicts presented by fund-level fees paid to fund managers is through fee leveling or offsets. (See, for example, PTE 77-4.) A newer way is to use the structure set out in the SunAmerica opinion (Advisory Opinion 2001-09A), which requires all investment choices/recommendations to be generated by an independent third party, free of the editorial control of the fund manager.

We believe this model does protect participants and plan sponsors. Acting as a prudent ERISA fiduciary, the plan sponsor wishing to designate a fund manager to provide advice or management services should conduct a due diligence inquiry as to the relationship between the fund manager and the third party, should satisfy itself that the third party’s recommendations are truly independent and should require the fund manager to provide it with a formal opinion of outside counsel that the arrangement between the fund manager and the third party satisfies the requirements of Advisory Opinion 2001-09A.

We believe that all qualified individuals should be able to provide investment advice and management services to plans and participants. The DOL’s prior PTEs and the SunAmerica opinion currently permit fund managers to provide these services. Several fund managers now provide advice and/or management services under the current law and regulatory regime. For example, leading fund managers/plan providers like CitiStreet and Merrill Lynch provide advice under SunAmerica arrangements. Fidelity recently announced management services provided under PTE 77-4 and later announced that it may also provide management services using a SunAmerica arrangement. Under these arrangements, as well as others of fund managers and independent providers, plan participants are today receiving advice and management services online and by telephone and in person.

By contrast, the Boehner Bill would remove the legal requirement for fund managers to eliminate real or potential conflicts of interest. This would be a very significant departure from one of the longstanding, bedrock principles of ERISA. We question whether it is necessary for such a radical departure, given that current law already effectively permits fund managers to remove conflicts and provide these services and, in fact, growing numbers of fund managers are taking advantage of these opportunities. We do not believe that disclosure of conflicts alone adequately protects participants and plan sponsors. There are significant questions as to the willingness or ability of many participants to read and understand the implications of any such disclosures. And, in the retirement plan realm, participants do not have a simple opportunity to “vote with their feet” by retaining an unconflicted advisor/manager on the same terms as a fund manager advisor/manager that may have been designated by the plan sponsor.

Finally, we wonder whether the Boehner Bill would lighten the responsibilities of plan sponsors. The Boehner Bill changes only ERISA’s prohibited transaction rules. It has no effect on the general ERISA fiduciary rules that require the plan sponsor to act prudently and in the best interests of participants in designating a fiduciary advisor or manager. It also has no effect on the “cofiduciary” rules of ERISA Section 405, which make the plan sponsor potentially liable for the acts of another fiduciary if the plan sponsor did not adequately fulfill its fiduciary duties in its decisions to retain the advisor or manager. If the Boehner Bill becomes law, the plan sponsor will have to wonder whether it can be prudent and in the best interests of participants to designate a fund manager as an advisor or manager, given the fund manager’s real or potential conflicts of interest. If the answer turns out to be no (in general or in a specific case), then the plan sponsor could end up being liable for any breach of fiduciary duty of the fund manager by way of ERISA’s cofiduciary liability provisions.

The Pension Protection and Expansion Act of 2003 (S.9, the “PPEA”), which is currently pending in the Senate, includes Section 305, which is applicable to fiduciary advisor services. Unlike the Boehner Bill, the PPEA would make no changes to ERISA’s prohibited transaction rules. Instead, Section 305 of the PPEA sets forth due diligence safe harbor rules for retaining an unconflicted investment advisor which, if followed, would explicitly relieve the plan sponsor of any potential liability (including cofiduciary liability under ERISA Section 405) for the content of the advisor’s recommendations or for any breach of fiduciary duty by the advisor. In our experience, these are the issues that seem to be of most concern to plan sponsors. That being the case, if any legislation at all in this area is deemed necessary or desirable, something like Section 305 of the PPEA seems more likely to result in advice services becoming more widely available to participants.

(Pro) It does not seem that there would be any real problem with a fund manager offering investment education to plan participants. With respect to investment advice or participant level investment management, however, the dual role (often played by two affiliated companies or individuals, which are treated as one) creates a conflict of interest and therefore a prohibited transaction under ERISA.

The DOL, however, has given relief from the prohibited transaction rules in two situations. The first is in a Prohibited Transaction Class Exemption 77-4, which says that where fee leveling between the participant level fees and the investment funds fees has taken place, serving in the dual roles will not be enforced as a prohibited transaction. Second is the SunAmerica opinion, wherein the DOL said that if there is a truly independent expert designing computer modeling to develop investment recommendation based upon data input by the participant, the provision of such advice is not a prohibited transaction. Although the breadth of the SunAmerica opinion has yet to be tested, one fear is that it will be construed to include situations in which the independent modeling has been compromised or bypassed. However, the SunAmerica opinion does give a roadmap through the ERISA prohibited transaction maze that has the aim of providing independent advice to plan participants.

The Boehner Bill, by contrast, would broaden the SunAmerica opinion by allowing conflicts of interest to exist, so long as they are disclosed to participants. It is questionable whether such a bill will actually serve to protect participants from potential abuses that the ERISA prohibited transaction rules are designed to guard against. Many participants will not understand what a conflict of interest is, much less what it could mean to their retirement accounts. In short, the purposes of ERISA are best served by giving participants access to independent advisors and money managers who only have incentives to increase participants’ money for retirement.

(NUFIC) The provision of basic investment education is always warranted. However, an insured that demonstrates to me through the offering of independent investment advice that it is concerned about the welfare of its employees and plan participants scores more points than an otherwise similar insured that offers no such advice. What I like about the SunAmerica model is that the advice is generated by an expert independent of the investment provider. The Boehner model, on the other hand, would seem to allow, and even condone, conflicts of interest, provided that the plan participants are apprised of them. Assuming that the plan participants actually read the conflict notice, would they be provided any other options for investment advice? Apart from this problematic conflict issue, which I believe could generate more litigation, I think the Boehner bill is a step in the right direction, providing plan participants much needed advice, and providing plan fiduciaries relief from liability.

Q13: What procedures should the professional investment manager and/or advisor follow in?

• Determining each participant’s asset allocation
• Selecting investment options to implement the participant’s strategy
• Monitoring the participant’s investment strategy
• Controlling the participant’s investment expenses?

Summary: The procedures outlined in the following responses provide a good basis for defining general fiduciary duties, and the practices that define the details of these duties need to be communicated to both plan sponsors and investment advisors through education and training.

Dissenting: None noted.

(FE) The professional investment advisor should select investment options that control a client’s expenses and achieve an asset allocation consistent with a client’s risk tolerance. Once the initial portfolio is constructed, ongoing monitoring is vital to keeping a client on-track towards their goals. Providing investment advice or investment management requires consideration of the following four basic tasks:

• Assessing Risk Tolerance;
• Understanding The Total Portfolio;
• Fund Selection/Asset Allocation; and
• Ongoing Monitoring

Assessing Risk Tolerance

Every portfolio has both short-term and long-term risk properties. Investors should be aware of not only the short-term possibility of loss, but also the long-term potential for growth. Armed with this information, investors are able to make the appropriate tradeoffs and select a risk desirable risk level.

Understanding the Total Portfolio

An investor enjoys a comfortable retirement based on the performance of all their retirement assets, which may go beyond a single employer-sponsored account. As such, it is important for an advisor to consider all retirement assets. For example, suppose a client has a significant bond portfolio inside an IRA. While the advisor may only be selecting 401(k) investments, knowledge of the IRA helps guide prudent 401(k) advice. In this case, since the client already has substantial bond holdings, prudent advice for the 401(k) will likely include fewer bond recommendations.

Fund Selection/Asset Allocation

Assessing risk tolerance and understanding the total portfolio help put the fund selection process in context. The actual fund selection also should depend on an analysis of the specific fund options available. Mutual funds differ substantially in their risk and return properties. The baseline risk and return properties are determined by a fund’s asset allocation (e.g. cash/bonds/stocks). Adjustments should then be made to both the risk and return assumptions based on specific fund characteristics.

Risk adjustments are necessary when the asset allocation risk is insufficient to describe the risk of holding the particular fund. For example, funds that have concentrated holdings in a particular industry or only hold a relatively few number of stocks tend to be higher risk than a more diversified fund with similar asset allocation.

Since expenses and transaction costs directly impact return, return adjustments are necessary to reflect the differential costs associated with owning different mutual funds. These costs not only include the explicit expense ratio, but also implicit trading costs arising from fund turnover.

When determining the recommended portfolio, it is important to weigh all three factors (baseline asset allocation, risk adjustments and return adjustments). Once the risk and return properties are understood for the available investments, an appropriate portfolio can be selected considering the investor’s risk tolerance and total portfolio.

Ongoing Monitoring

Markets change and client needs change. An investment manager should periodically review the client’s portfolio to determine if adjustments are necessary. The types of events that could trigger an adjustment include:

• Portfolio requires rebalancing due to market movements;
• Updated assessments of the funds in the plan
• New investment options available
• Updated client situation (e.g. risk tolerance, total portfolio, etc)

An investment manager can implement appropriate changes in an ongoing fashion. While an investment advisor may not be able to directly implement changes, the advisor should encourage the client to periodically review their situation. If possible, the advisor should proactively alert their clients to situations that likely warrant an advisory session.

(Pro) A professional investment advisor or manager should use information from the participant to generate a risk-return profile for the participant. Investments should be selected in a manner that meets that profile, and the professional should then monitor the performance of the selected assets and rebalance periodically to keep them true to the risk-return profile. Further, the professional should contact the participant regularly to update the participant’s information and regenerate the risk-return profile. In an ERISA plan, expenses must be kept reasonable, but investments should be made with loads that are appropriate for the risk-return and time horizon determined for the particular participant.

Q14: Should participants in ERISA plans be allowed to choose any investment educator, advisor, or manager that they desire? If not, who should choose? Should they be open to the universe of investments or be limited to investment funds selected by a fiduciary?

Summary: Plan participants have always been free to retain their own investment managers and/or advisors outside the plan. In regard to the open universe, the witnesses who spoke to this felt that the open universe of investments would not improve the ability to manage their accounts appropriately.

Dissenting: None noted.

(FE) A participant may retain his or her own educator, advisor or manager at any time. As a practical matter, this can be done without the knowledge or involvement of the plan sponsor, administrator or fiduciaries. For example, in the case of a plan that uses an automated PIN/password-based system to allow participants to make investment changes by telephone, online or other automated method, the participant would only need to share his or her PIN/password with his or her chosen educator, advisor or manager. For plans that use other methods, such as a paper-based system, a participant may give a third party a power of attorney that permits the designee to make investment elections on the participant’s behalf.

In our experience, if a power of attorney that is effective under applicable law is provided to the plan administrator, the designee will be permitted to make investment elections. If a participant independently retains an educator, advisor or manager, outside the terms of the plan, that designee is not an ERISA fiduciary to the plan (though the designee may be a fiduciary to the participant).

By contrast, the plan sponsor may designate one or more individuals as fiduciary advisors or managers to the plan, and participants may choose to use one of those individuals, to use their own nonfiduciary advisors or managers or not to use an advisor or manager at all.

ERISA provides incentives for the plan sponsor to choose a “main menu” of funds that satisfies the requirements of ERISA Section 404(c), and the vast majority of sponsors do this. In response to participant demand, some sponsors also permit participants to choose their own investments through a brokerage or mutual fund “window” option. In our experience, it is only in very rare cases that sponsors have an open universe, with no main menu of funds. This tends to happen only in the case of smaller plans with predominantly professional employees as participants, such as doctor and lawyer groups. In our view, ERISA’s current incentive-based system serves participants well and it is unnecessary to mandate what investment options should be made available.

(Pro) There should be no change in the ability for participants to choose the investment educator, advisor or manager they desire. Plan participants may be sophisticated investors or have existing relationships with an advisor or manager and should not be precluded from obtaining such services, in a plan set up for such arrangements. For many other plan participants, however, choosing a professional to provide such services may be a daunting task. In this latter case, it may be better for a plan fiduciary to select an educator, advisor, or manager that participants may use. A range of such service providers could also be provided for participants to choose. All of these arrangements should be possible and remain permitted under the law. However, there is no clear guidance on the variations that are permissible or the fiduciary responsibilities that go along with these different choices and upon whom they fall. Such clarification would be welcome among the plan sponsor community and would have the effect of increasing the availability of this service to plan participants.

With respect to the investment alternatives offered for a plan, again these should be left up to the decision of the plan designers and fiduciaries. Obviously a main menu of mutual funds fits best with those plans wishing to take advantage of Section 404(c), but limiting plans to such a scenario is not a mandate that should be implemented.

(NUFIC) I'd feel more comfortable with investment advisors that have been carefully vetted by the plan sponsor. I'm also uncomfortable with completely unlimited investments. Left on their own, plan participants may select improper investments, or fail to rebalance or revisit their portfolios as circumstances warrant. They might then be inclined to blame the plan sponsor for failing to properly educate them, or allege that plan fiduciaries breached their duty by failing to monitor investments.

Q15: If a participant in a self-directed individual account plan seeks out and hires a professional investment manager for his or her account, should the plan sponsor have any responsibility to monitor the investment selections being made? Should the trustee?

Summary: Generally, as covered under 404(c), No.

Dissenting: The witnesses who spoke to this felt that actively monitoring investment selections made by investment managers hired by participants is an unreasonable burden for employers to bear. Some witnesses felt that there was clarification needed by DOL about if this duty does or does not, in fact, exist.

(FE) No. The ERISA 404(c) regulations include an example of a situation in which a plan provides the participant with total discretion to choose his or her own investment manager and, pursuant to this provision, a participant causes the plan fiduciary to appoint an investment manager of his choosing for him. The manager invests imprudently. The example states that in this circumstance, not only does the plan fiduciary not have liability for the manager’s actions (under the ERISA principle that the plan fiduciary is generally not liable for the actions of another fiduciary), the plan fiduciary is also under no duty to determine the suitability of the manager in this circumstance, because the plan fiduciary did not use its discretion to appoint the manager. (See 29 CFR 2550.404c-1(f)(9).) If the sponsor has no liability in this circumstance, it seems that it should be an even easier case that it has no liability when the participant has chosen a manager entirely on his own.

(Pro) Under current guidance, it appears that they do not, but this should be clarified.

In the context of a plan meeting the standards of ERISA Section 404(c), there is an example in the 404(c) regulations that seems to indicate that a participant designated investment manager does not cause another fiduciary to incur liability for the imprudent investment decisions of an investment manager designated by a participant or beneficiary. 29 CFR 2550.404c-1(f)(9). However, careful examination of this example reveals it is only saying three things:

1. That the investment manager is subject to fiduciary liability (i.e. not subject to 404(c) protection) for his imprudent decisions because the decisions were not the direct and necessary result of the participant’s selection of the manager,
2. That other fiduciaries of the plan have no co-fiduciary liability under ERISA Section 405 for the imprudent decisions of the participant designated manager, and
3. That other fiduciaries of the plan have no direct fiduciary liability under ERISA Section 404(a) because there is no duty to provide advice to participants under Section 404(c) and because the plan itself is not making the designation of the investment advisor.

What the example does not address, however, is whether there may be direct fiduciary liability for making arrangements for investment advisors to be available to participants and beneficiaries.

Although not directly applicable to the investment manager situation posed in this question, it is worth noting that in Interpretive Bulletin 96-1 the DOL has recognized that where a participant or beneficiary of a plan seeks out and selects his or her own investment professional to provide either investment education or advice, a plan sponsor or other fiduciary does not incur liability for the actions of that professional so long as the sponsor or other fiduciary neither endorses nor makes arrangement for the provision of such services to the participant. 29 CFR 2509.96-1(e). This could be what the DOL was thinking when it crafted the 404(c) regulation above: that the other plan fiduciaries had no involvement in the arrangement or selection of the investment manager in the question, and did not endorse that manager.

Regardless, there is a large grey zone in which plan sponsors and other plan fiduciaries cannot determine the correct direction to proceed in order to manage their liability. Indeed, the current structure seems to provide a perverse incentive: throwing participants on their own into the world of investments provides the best shield from potential future liability. Therefore, clarification of these issues will serve both participants and plan fiduciaries.

(NUFIC) If a plan provides the option of an open-brokerage account, with no restrictions on investments, and an individual participant seeks out and hires an investment advisor to manage that account, then it would be unfair to require the plan sponsor to monitor such investments. However, I don't think such accounts should be offered in the absence of independent investment advice.

Q16: ERISA regulations currently allow Section 403(b) annuity providers and IRA providers to solicit individual participants at an employer without creating an ERISA plan, so long as the employer does not endorse the provider. Should a similar rule exist that allows providers of investment education, advice, and management services to solicit individual participants without the plan sponsor incurring any ERISA fiduciary responsibility, so long as it does not endorse the provider? What actions would or would not constitute an endorsement by a plan sponsor?

Summary: Interpretive Bulletin 96-1 provides limited guidance in this area. However, the witnesses said the ideal would be to encourage plan sponsors to make available professional investment managers that have been properly vetted by the plan sponsor.

Dissenting: None noted.

(FE) We believe that plan sponsors and plan participants are best served when the sponsor designates one or more investment professionals as plan fiduciaries, and the participant may then choose to use a designee, or to use his or her own expert (or to use no professional at all). Most participants lack the expertise and/or desire to choose an investment professional. If this task is left to the participant, we are likely to continue seeing large numbers of employees who do not save enough for retirement and who do not appropriately diversify their retirement plan portfolios.

It is possible, however, to have providers solicit 401(k) participants’ business without creating any ERISA relationship with the plan sponsor or the plan. In the Summary to Interpretive Bulletin 96-1, the DOL refers to the possibility that a plan sponsor “may be viewed as having fiduciary responsibility by virtue of endorsing a third party” to provide advice. The Summary further states that whether there has been an endorsement depends upon all the facts and circumstances. In other words, the sponsor has no fiduciary responsibility at all for the activities of a third party that it does not, in fact, endorse.

(Pro) Such a rule already exists under Interpretive Bulletin 96-1. Section (e) of that document provides that where a participant or beneficiary of a plan seeks out and selects his or her own investment professional to provide either investment education or advice, a plan sponsor or other fiduciary does not incur liability for the actions of that professional so long as the sponsor or other fiduciary neither endorses not makes arrangement for the provision of such services to the participant. 29 CFR 2509.96-1(e). In the preamble to 96-1, the DOL noted that making available office space and similar facilities to such providers would not be considered either endorsement or arranging for the provision of such services. Beyond that, however, what “endorsement” means is unclear.

Clearly, endorsement would include statements relating to a particular investment professional recommending or requiring that participants use that professional, indicating that the professional is better than other professionals, or indicating that the plan has chosen the provider for the participants to use. However, if the goal is to encourage plan sponsors to allow participants access to professional investment educators, advisors, and managers, the definition of endorsement should stop there. Specifically, “endorsement” should not include the following:

• A sponsor allowing an investment manager to solicit investment management business from individual participants, or even providing the means to solicit the participants (such as names, work email addresses, etc.);
• Actions taken by a sponsor or other fiduciary to determine the credentials of the soliciting professional and actions taken by a plan sponsor to set minimum credentials and prohibit professionals who do not meet those standards from approaching their participants; or
• The performance of administrative and recordkeeping functions by the sponsor or other fiduciary to facilitate the provision of investment services, such as keeping copies of investment management and other agreements between the participant and the professional, keeping lists of participants utilizing the services, and certifying to a trustee participants who are using a the services of a professional for the purpose of disbursing fee payments to the service provider from the participant’s account.

The foregoing “gate keeping” activities are of the type already allowed in DOL regulations for employers with respect to 403(b) plans and IRAs without subjecting the plan to ERISA fiduciary duties at all. See 29 CFR 2510.3-2(d) and (f). Note that defining “endorsement” as suggested above has the same result as the proposed safe harbor exemption explained in the response to Question 8.

Q17: Should participants be allowed to direct whether fees for independent professional investment management, education, or advice be paid from their accounts? If so, does the plan sponsor or trustees have an obligation to monitor the reasonableness of these fees, or negotiate fees on behalf of the participants?

Summary: Yes, as a matter of policy, participants should be allowed to direct fees for investment advice and/or be permitted to have the fees paid from pre-tax income. No, plan sponsors should not have the obligation to monitor the fees, other than to confirm the fee is in fact for investment advice.

Dissenting: None noted.

(FE) In our view, it would be inconsistent with current law to make the plan sponsor or trustees responsible for monitoring the reasonability of management fees in the case of a manager who is designated by the participant and not as a fiduciary manager by the plan sponsor. By “independent,” in this question, we assume a reference is intended to what we have called nonfiduciary professionals, not those designated by the sponsor on behalf of participants and the plan. In the case of independent professionals, it may be fairly difficult and burdensome to set up the mechanisms to allow for payment out of individual accounts, given that there could be any number of such individuals, none of whom would have established any relationship with the employer. Members of the Council who are familiar with the operation of retirement plan trusts could speak to this question.

(Pro) It should be permissible for plans to allow participants to choose to pay for professional investment services from their plan accounts. This will have the effect of encouraging participants to use these services for their retirement plan assets.

Where participants and beneficiaries select their own educator, advisor, or manager for their account, it is not necessary to impose an obligation on the plan sponsor or trustee to monitor the reasonableness of the fees charged to a participant for these services. To the extent that these activities are being performed by fiduciaries (providing education is not a fiduciary function per Interpretive Bulletin 96-1), the charging of reasonable fees is enforceable under Section 406 of ERISA and Section 4975 of the Income Tax Code. A fiduciary that causes a plan to pay more than a reasonable fee for services to the plan has committed a “prohibited transaction” under these sections. Prohibited transactions are subject to enforcement actions by the DOL against the fiduciary, as well as excise taxes under the tax code.

However, if a plan sponsor or other fiduciary designates one or more investment educator, advisor, or manager for participants and beneficiaries to use, there would be an obligation to monitor or set the fees for such services paid from the plan.

(NUFIC) If fees for independent investment advice are paid from plan assets, the plan sponsor should take responsibility for monitoring those fees and negotiating fees on behalf of participants. If they don't, they open themselves up to accusations of failing to look out for the best interests of the plan and plan participants.

Q18: How are professional investment advisors compensated – out of plan assets, or paid by participants electing the option?

Summary: Both methods are in use.

Dissenting: None noted.

(FE) Either one is legally permitted. The norm, though, is for investment managers to charge basis-point fees against plan assets.

(Pro) ProNvest is compensated from the accounts of those participants who elect to use ProNvest as an investment manager. It is possible to also let the participant pay an advisor or manager directly, outside of the plan. There are also situations where the advisor or manager is paid out of general plan assets – i.e., across all participant accounts, regardless of which participants actually use the services. The issues relating to allocation of expenses to plan participants has been recently addressed by the DOL in Field Assistance Bulletin 2003-3 issued in May 2003.

Q19: Does the selection of an investment advisor constitute a fiduciary act by the Plan Sponsor?

Summary: Yes, if the plan sponsor makes the selection.

Dissenting: None noted..

(FE) Yes, if the advisor is designated as a fiduciary advisor by the plan sponsor, in its role as named fiduciary for management of plan assets. See other items, particularly Question 7 and Question 9.

Under ERISA, the governing documents of a plan may provide that a named fiduciary of the plan may appoint an investment manager to manage any assets of the plan. A “named fiduciary” is a plan fiduciary named in the plan documents or pursuant to a procedure specified in the plan documents. The named fiduciaries of a plan jointly and severally have authority (and responsibility) to control and manage the operation and administration of the plan. If the named fiduciary appoints an investment manager, the named fiduciary is not liable for the acts or omissions of the manager designated, if (i) the named fiduciary acts prudently in designating the investment manager and in continuing the designation, and (ii) the named fiduciary is not otherwise liable for a breach of duty committed by the designee under the co-fiduciary liability rules described below. In this connection, a fiduciary generally is not deemed to control (and thereby be responsible for) the acts or omissions of another person merely because the fiduciary has the power to appoint the other person to perform fiduciary functions.

The general principles summarized above apply also to a plan described in ERISA Section 404(c) that permits participants to exercise control over the assets of their Accounts and meets certain additional requirements. The DOL has indicated that, if a fiduciary of such a plan (a “404(c) Plan”) designates one or more investment managers whom participants may appoint to manage the assets of their Accounts, an investment manager selected by a participant to manage the participant’s Account is a fiduciary of the plan, and the employer or other fiduciary designating the investment manager acts as a fiduciary in so doing. (Preamble to the 404(c) regulations.) In this regard, it is important to note that the employer’s duty should not extend to monitoring the manager’s specific investment decisions with respect to participant accounts. (See H.R. 2269, The Retirement Security Advice Act: Hearing Before the Subcommittee on Employer-Employee Relations of the Committee on Education and the Workforce, 107th Cong., 48, 51 (2001) (H.R. 2269 “clarifies that [the duties of a fiduciary appointing a fiduciary investment adviser] do not extend to monitoring the specific advice given by the fiduciary adviser to any particular participant.” (Statement of Ann L. Combs, Assistant Secretary of Labor, PWBA, DOL)); see also, Leigh v. Engle, 727 F.2d 113, 135 (7th Cir. 1984) (appointing fiduciaries need not examine every action of appointee fiduciaries, but engaged in breach because they failed to review any actions of appointee)). For example, DOL regulations indicate that, although the fiduciary responsible for designating an investment manager for a 404(c) Plan should take into account any breach committed by the manager in determining whether to continue the designation, the fiduciary ordinarily will not be liable for the “imprudence” or other breach of duty committed by the investment manager. (See 29 C.F.R. § 2550.404c-1 (f) examples (8)).

(Pro) Generally, yes. However, as described in the responses to Question 10 and Question 11, there are circumstances in which allowing a plan participant or beneficiary to select an investment professional does not constitute a fiduciary act. As also noted above, the circumstances under which this is true are unclear and the Advisory Council should recommend changes to clarify these circumstances. Suggested changes are discussed in the response to Question 8.

Q20: Does the offering of a professional investment advisor potentially decrease the Plan Sponsor’s fiduciary liability?

Summary: Yes, however, this is not the general perception of plan sponsors who believe that the offering of an investment advisor would increase their liability. Several witnesses confirmed the need for the Department to provide “Safe Harbor” rules for the selection and implementation of investment advisors to belay the fears of plan sponsors.

Dissenting: None noted.

(FE) Yes. If the plan sponsor/fiduciary knows that participants in its participant-directed retirement plan need help with investing for retirement, the fiduciary should provide the needed help, whether it is education, advice, professional management, or all of the above. An excellent perspective on the liability benefits of offering these services can be seen in two short articles by Fred Reish in Plan Sponsor magazine’s November and December 2002 issues. Interestingly, it appears that the plan sponsor fiduciary insurance industry is beginning to take the view that advice reduces the sponsor’s fiduciary liability:

“Ann Longmore, fiduciary liability practice leader at insurance broker Willis Group Holdings, says that carriers are more willing to provide fiduciary liability coverage if advice is provided. ‘The fact that advice is being offered at this point is being seen as a strong mitigating factor against problems’ arriving down the road, she says. Companies that are currently being sued in relation to company stock holdings in the 401(k) plans would be in a better position had they provided advice, Longmore says, because the employees that are suing would be ‘far less sympathetic if they were told by a professional that it’s not in the best interest of their portfolio to have such a concentration.’” (Treasury & Risk Management Magazine, May 2003)

This comment was in the context of advice, not management, but it should apply equally to professional management services.

(Pro) It seems like it would have this effect. The general fiduciary duty of prudence and acting in the best interests of plan participants always applies to plan fiduciaries. If a plan sponsor knows that the plan participants are unsophisticated with respect to investing, and allows them to direct their retirement accounts, this would seem to be a potential breach of these fiduciary duties. Providing an investment advisor or manager, even with the added due diligence that should be done beforehand and to monitor the provider’s activities, would seem to be a good way to mitigate that potential for liability.

(NUFIC) Yes it does, provided that the investment advisor is independent, has no conflict of interest, has been carefully vetted, and is regularly monitored for performance and reasonableness of fees.

Q21: Must the professional investment advisor have discretion over the participant’s assets in order to be considered a professional investment advisor?

Summary: No, the investment advisor does not have to have discretion. ERISA defines an investment advisor as anyone who “renders investment advice for a fee or other compensation.”

Dissenting: None noted.

(FE) ERISA draws a distinction between an investment advisor and an investment manager. (This is not necessarily the case under federal securities laws.) Under ERISA Section 3(38), the key distinction is that an investment manager “has the power to manage, acquire, or dispose of any asset of a plan.” At Financial Engines, when we act as an investment advisor, we provide investment recommendations to individual participants, who are then free to accept our recommendations entirely, in part or not at all. To the extent they accept the recommendations, they follow the plan’s usual procedures for making investment changes. On the other hand, when we act as investment manager under our professional management program, so long as the individual participant has elected to have his or her account professionally managed, we have the discretion to makes trades on his or her behalf to achieve the goals of the portfolio we construct for the participant. It is important to note, however, that under our professional management program, our portfolios are constructed entirely from fund options already being offered under the plan’s main menu of investment funds. In other words, the plan sponsor has selected the investment options, and we construct portfolios for individual participants using those sponsor-selected funds.

(Pro) Under ERISA, an investment advisor does not have to have actual control over the participant’s account to be considered an “investment advisor.” If he does have such control, he is an “investment manager.” See ERISA Sec. 3(38). One of the alternative prerequisites to being an investment manager under ERISA is to be registered as an investment adviser under the Investment Advisers Act of 1940.

In fact, “investment advisor” is not a directly defined term in ERISA. Rather, ERISA Section 3(21) states that a fiduciary is anyone who “renders investment advice for a fee or other compensation.” This is expanded in the DOL regulations to include both 1) persons who have discretionary authority or control over investment of plan assets (i.e., managers) and 2) persons who make individualized recommendations about how plan assets should be invested with the understanding that the recommendations will be the primary basis for investment decisions for plan assets (i.e., advisors). The second part of the regulation includes situations where the recommendations are made, but the participant (or other asset manager) is free to disregard those recommendations. Therefore, the ERISA concept of “investment advisor” includes both managers and advisors.

Q22: How have Plan Sponsor’s offered professional investment managers and/or advisors to participants? For example, is the investment manager and/or advisor shown as an additional option to the Plan’s other investment options?

Summary: When offered, the investment manager/advisor is provided as an added option to existing investment options.

Dissenting: None noted..

(FE) Yes. In our experience, the norm is for the sponsor to continue offering participants a lineup of investment options. The participants are offered the opportunity to make their own decisions how to allocate their account among those options or, as an alternative, are offered the option to use a professional investment manager to make those decisions for them.

(Pro) Typically the plan will offer a group of funds or other investment alternatives to plan participants. The investment advisor is then made available to either assist participants in allocating their accounts among those investment alternatives or to actually make the allocations for the participant. In other words, the investment advisor is an added service to participants, not an alternative to investment in the investments offered by the plan. In some instances, the participant may simply select the manager option at enrollment, who then directs the investment decision within the universe of funds made available by the plan sponsor.

Q23: How does the professional investment manager/advisor option impact plan design?

Summary: It appears that it does not have an impact since most plan documents already have a provision for the designation of one or more investment managers.

Dissenting: None noted.

(FE) In our experience, most plans’ governing documents already include language authorizing the named fiduciary for management of plan assets to designate one or more investment managers.

Technical Note: FE assumes that the questions are generally intended to refer to the OPM; i.e., the option to have professional management of the participant’s account, as distinguished from advice that the participant may or may not act upon as he or she sees fit. For example, although the first question refers to a “professional investment advisor,” FE assumes that is intended to mean someone who functions as a professional investment manager (though he or she may be registered as an investment advisor).

(Pro) Most standard plan document and/or trust agreement language includes authorization for a fiduciary to designate an investment manager or managers for the plan. From time to time, trustees will want specific language authorizing payment of fees from a participant’s account for an investment manager selected by a particular participant. Otherwise, the plan design of a defined contribution plan remains basically unchanged with respect to participant contributions and investment options.

Q24: In your experience, have you seen plan documents that make plan participants “named fiduciaries” within the meaning of ERISA? Are participants given the authority under a plan document to designate an Investment Manager (as defined in ERISA) for his or her account only?

Summary: Inconclusive, however it appears to be counter-intuitive to the regulatory intent of ERISA and the practice should be reviewed by the Department.

Dissenting: None noted.

(FE) We have heard of, but have not seen, such cases. In our experience, the norm is for the plan sponsor to designate one or more fiduciary investment managers, and for participants to choose to use or not use a designated manager. Where there is no fiduciary investment manager, our experience is that a participant may choose a manager, but this is not done as part of a plan provision making the participant a named fiduciary. Instead, it is done as described in Question 7.

(Pro) We have not actually seen documents, which accomplish this. However, under ERISA, it seems like this should be possible. ERISA Section 402(c)(3) provides that an investment manager must be appointed by a named fiduciary of the plan. A named fiduciary is any person named in the plan document as a fiduciary. Therefore, it would be straightforward to name a participant as a fiduciary with respect to his or her account under the plan and allow that person to designate an investment manager for his or her account. Interestingly, however, is the interplay with ERISA Section 404(c). ERISA Section 404(c) expressly provides that a participant in a plan that complies with ERISA Section 404(c) is not a fiduciary. While Section 402(c)(3) and Section 404(c) can be read to use the word fiduciary in different contexts, clarification in the law that this is a permissible arrangement would be very helpful to plan sponsors.

Q25: What fiduciary issues are associated with this topic? Who is responsible for insuring that the best interests of the participants are protected?

Summary: This is the proverbial “kitchen sink” question meant to catch any related fiduciary issues not previously covered. Fiduciary issues involve monitoring, selection and monitoring, as already discussed in response to previous questions.

Dissenting: None noted..

(FE) As is described in more detail above, when the plan sponsor designates a fiduciary investment manager, the plan sponsor acts as an ERISA fiduciary in selecting and monitoring the investment manager. The sponsor must be prudent and act in the best interests of participants in this endeavor. Certainly, as discussed above, thorough due diligence is part of this process, and all the matters described under Q&A 9 above are, in turn, a material part of the due diligence process. In addition, once retained, the investment manager is an ERISA fiduciary and must act prudently and in the best interests of participants. It is particularly important that the manager or its affiliates not receive compensation that is contingent on the content of the manager’s investment choices. Otherwise, it would be impossible to know whether the manager’s decisions are based upon merit or upon self-interest.

(Pro) This topic implicates fiduciary duties in all of its aspects. Ultimately, the fiduciaries of the plan are charged with protecting the best interests of participants. The goal of any recommendations that the Advisory Council makes at the conclusion of its study of this subject should not be to provide an escape from fiduciary responsibility for any aspect of this topic. Rather, it should aim to place fiduciary responsibility into the hands of the fiduciary or fiduciaries most capable of handling a particular aspect. Plan sponsors are worried about being tagged with liability for investment advice given by an investment advisor or manager that they provide for their participants. Sponsors, however, generally are not in the business of giving investment advice, and shouldn’t have liability for advice given by a professional. Sponsors do, however, know their participant population, and thus it is reasonable to charge a sponsor with the duty to diligently choose the best provider(s) for those participants, and to monitor that the provider is continuing to meet those participants’ needs. But the line between those functions should be clarified. We think legislation along the lines presented in the response to Question 8 would accomplish this. Such a line will help sponsors to know where they stand and serve to encourage them to offer these needed services to their participants.

(NUFIC) Fiduciary issues would include (but are probably not limited to) disclosure (of fees, relationships, conflicts, etc.), acting solely in the interest of the plans, the prudent man rule, investment diversification, accuracy and adequacy of plan documents (do the plan documents permit the use of plan assets for investment advice). Plan sponsors, fiduciaries, and ultimately, the DOL, should ensure that plan participants' interests are protected. Plan participants themselves should be encouraged to take a more active role in protecting their plan assets.

Recommendations

The Department of Labor should offer an additional “default” option to existing safe harbor provisions, which provides for a “life-stage fund” or a “diversified balanced portfolio.”

The Department of Labor should provide clarification for plan sponsors that the use of professional management for plan participants of self-directed defined contribution/401 (k) plans might actually reduce their overall fiduciary liability.

The Department of Labor should develop new safe harbor provisions for selecting and monitoring service providers of Optional Professional Management. This safe harbor should take into account the limited ability of small-to-medium size plans to independently assess and monitor the qualifications and performance of these service providers.

The Department of Labor should clarify the extent to which a plan sponsor has fiduciary responsibility when allowing a participant to select their own investment advisor/manager for their plan assets when the plan pays the advisor’s or manager’s fees.

Summary of Testimony Received

Summary of Testimony of Sherrie Grabot

Sherri Grabot is the CEO for Guided Choice. She explained the company’s business model is as an Advice Provider and Account Manager for 401(k) plans. An asset or investment manager does not pay them fees, and so Ms. Grabot believes Guided Choice to be an objective third party as a result.

Ms. Grabot described how Guided Choice provides three levels of service: education, advice, and managed accounts. She stated as a result of Guided Choice’s service, employee participation rates rise in the plan, as do the average savings rates. Since participation and savings rates are impacted by plan design according to Ms. Grabot, Guided Choice works with plan providers to adjust their plan design to achieve results.

According to Ms. Grabot, 95% of participants have little to no idea of how much risk they are taking. Most believe company stock is low risk, she stated. On average, she said they hold 1.7 – 2 asset classes. Ms. Grabot stated that Guided Choice and other financial advisors are not so great at helping the little guy whom she defined as younger, not as educated, or lower income.

Guided Choice believes it should be a shared responsibility, among government, plan sponsor, and the employee, to help employees prepare for retirement, Ms. Grabot commented. She also stated she believes conflict in financial guidance won’t be solved by written disclosures because participants won’t read them. Ms. Grabot stated that plan sponsors do need liability relief. Larger plan sponsors can get expert help, she said, but smaller plan sponsors don’t with respect to picking and monitoring investment advisors. Performance of advice can only be measured by changes in allocation, such as reduction in Company stock holdings, and changes in savings and participation rates, according to Ms. Grabot. She believes there are no real benchmarks for a managed account performance.

Ms. Grabot said Guided Choice provides services for 1500 plans covering ¼ million participants, and her comments were based on her experience with these plans.

Summary of Testimony of Carl Londe

Carl Londe is the Chairman, CEO, and spokesman for ProManage, Inc. Mr. Londe has over 26 years of management, financial, and human resources experience. His responsibilities with ProManage include identifying opportunities and solutions related to the use of company stock in defined contribution plans.

Mr. Londe stated that ProManage believes a well defined, professional management program is an absolutely essential benefit for defined contribution plan participants, because approximately 85% of participants in defined contribution plans do not actively manage their plan accounts, and their plan accounts are neither diversified nor rebalanced on a recurring basis. Mr. Londe cited a Watson Wyatt study showing professionally managed retirement plan assets outperformed participant-managed retirement plan assets by 2% per year for five consecutive years. He also cited a State of Nebraska 30-year study showing that the state’s defined benefit plan investment performance exceeded the aggregated participant-directed investment performance of the defined contribution plan by 4% per year.

ProManage coined the phrase “reluctant investor” to describe these plan participants who do not have the time, the desire, or the knowledge to do their own investing. Although ERISA Section 404(c) permits plan sponsors to transfer to plan participants the responsibility as well as the privilege of directing the investment of plan assets, reluctant investors do not want to accept either the privilege or the responsibility. These reluctant investors benefit most from professional management of their retirement plan assets.

Mr. Londe described the service ProManage offers to defined contribution plan sponsors. Under this program, ProManage accepts fiduciary responsibility as an investment advisor under ERISA 405(d) and builds an investment portfolio for each participant in the plan. In response to questions, Mr. Londe stated that the asset allocation for each participant is based solely on information provided by the plan sponsor – the participant’s age, salary, any defined benefit plan benefits, and any supplemental executive benefits. The asset allocation does not reflect the participant’s risk tolerance, because of the difficulty in measuring risk tolerance, but substitutes a suitability analysis. Outside retirement assets and spouse’s assets are also not reflected in a participant’s asset allocation. This method institutionalizes the asset allocation process and reduces costs. The existing investment options available under the plan are used to construct the participant’s investment portfolio. The investment of the participant’s plan account is recalculated and rebalanced at least annually.

According to Mr. Londe, the key criteria for an investment adviser for participants in a defined contribution plan are experience, independence, willingness to take fiduciary status, and results measured on an individual basis. The standard for an investment adviser to satisfy is that of a prudent expert, with potential damages being the difference between what the investment adviser did and what prudent expert would have done. When a plan sponsor engages an investment adviser with these characteristics, the plan sponsor’s exposure is significantly reduced (although not to zero).

Mr. Londe acknowledged that although the plan sponsor or plan administrator must prudently monitor an investment adviser; there is no clear guidance on how to prudently monitor an investment adviser providing this type of service. The test is not purely investment performance. Other than subjective participant satisfaction, the only measure is whether the investment adviser’s actions were prudent under the circumstances, which cannot usually be quantified. The investment adviser’s performance must be measured on an individual participant basis, not on an aggregate plan basis.

In response to questions, Mr. Londe stated that charges for these investment management services range between 10 and 65 basis points depending on the plan design and the bells and whistles selected by the plan sponsor. The typical charge is 35 basis points on the first $100 million under management and 10 basis points on assets over that. With few exceptions, the fees are charged directly to participants’ accounts and clearly identified on participants’ plan statements.

Mr. Londe also offered the Working Group 10 suggestions with respect to the Working Group’s development of recommendations on optional professional management. One of those suggestions was to not confuse disclosure to plan participants with substantive protection for plan participants, because the reluctant investors do not read or understand the disclosures. Mr. Londe advocates an independence requirement for an investment adviser.

Other suggestions include not confusing utilization of these services with actual utilization of these services, being wary of traditional performance measurements, and realizing that the participants with the smallest account balances are the individuals who most need assistance in investing their retirement plan assets.

Summary of Testimony of Richard P. Magrath

Richard P. Magrath is one of the founders of ProNVest and currently serves as its president. Prior to joining ProNVest, he was the managing director of Platform One, a joint venture with Marsh focusing on delivering state-of-the-art employee benefit services and solutions. Before his tenure with Platform One, Mr. Magrath served Marsh for over 20 years in various capacities, including sales, marketing, client relationship management, and senior management positions.

Mr. Magrath told the Working Group that the challenge facing plan sponsors is to give plan participants access to investment education, advice, and management while protecting plan assets and protecting plan sponsors from liability. He stated that most plan sponsors want to do the right thing and help plan participants understand and appreciate their retirement plan and how it works.

Citing a Watson Wyatt survey, Mr. Magrath stated that defined contribution plan participants generally do not sufficiently diversify their plan investments, either across investment classes or individual investments, and typically invest too large a portion of their plan assets in company stock. Most plan participants also do not make changes to their plan investments with sufficient frequency. As a result, a significant majority of defined contribution plan participants are not on track to achieve their retirement income goals.

Mr. Magrath attributed participants’ investment failure to the fact that most participants cannot or will not actively participate in the investment management of their retirement assets. However, even though they recognize that participants need professional help to achieve their retirement income goals, plan sponsors do not provide investment advice or management services to plan participants because they fear the accompanying fiduciary liability.

Plan sponsors generally want to help plan participants achieve their retirement income goals while minimizing or avoiding fiduciary liability and reducing or eliminating plan administrative costs. Plan sponsors also want to provide investment help to participants that can be applied to the full spectrum of employees, across all ages as well as across levels of financial resources and sophistication.

Under the ProNvest model, ProNvest is engaged by a plan sponsor to provide investment management services to two specific groups of plan participants. First, former employees with plan account balances can engage and pay ProNvest to provide assistance in rolling over the participant’s distribution to an IRA and in managing the investment of the IRA. Second, current employees who have accounts in a former employer’s plan can engage and pay ProNvest to provide assistance in rolling over the distribution to an IRA and in managing the investment of the IRA.

As part of its model, ProNvest also offers to provide investment management services to current plan participants at no charge. ProNvest claims that by not directly charging a fee for these services, ProNvest is not acting as a fiduciary, under the definition of a fiduciary in ERISA Section 3(21)(A)(ii). Correspondingly, the plan sponsor is not subject to fiduciary liability for retaining ProNvest to provide these services to current plan participants, because ProNvest is not acting as a fiduciary. ProNvest bases its position on Interpretive Bulletin 96-1, 29 C.F.R. §2509.96-1, and also has an Advisory Opinion request pending before the Department of Labor. Members of the Working Group did question whether ProNvest’s position on this question could be successfully defended against legal action.

Mr. Magrath also suggested that the Department of Labor establish a safe harbor under which a plan sponsor would not incur fiduciary liability for allowing a professional asset manager to solicit business from current plan participants or for any education, advice, or management services provided by the professional. The safe harbor should require that the participant freely elects to engage the professional asset manager, and that the professional asset manager meet specific minimum standards. Those standards should require:

• The professional asset manager to be independent of the investments recommended by the professional asset manager;
• The professional asset manager to be registered as an investment adviser under the Investment Advisers Act of 1940;
• A written asset management agreement between the participant and the professional asset manager (with a copy retained by the plan sponsor); and
• The professional asset manager to acknowledge in writing that it accepts fiduciary responsibility as an investment manager.

Round Table Discussion With Sherrie Grabot, Carl Londe, Richard P. Magrath, Ken Fine

The Working Group asked these witnesses to describe the types of assistance providers of optional professional management services need from the Department of Labor. Ms. Grabot stated that the Department could help by removing the liability barrier for plan sponsors, which she and the other witnesses indicated is the primary barrier they encounter. Mr. Londe stated plan sponsors are concerned with the fiduciary liability issues associated with providing participants with investment advice and education services. He also noted that there are many positives to having good, strong safeguards in place.

Mr. Fine, Ms. Grabot, Mr. Londe, and Mr. McGrath all stated that current law governing fiduciary liability is acceptable and adequately protects plan participants, but plan sponsors do not clearly understand the current law requirements or their effects, and this causes confusion, worry, and angst for plan sponsors. Mr. Fine stated that inconsistent opinions from plan sponsors’ outside legal counsel regarding potential fiduciary liability is a problem in encouraging plan sponsors to make these services available to plan participants.

When asked if the Department can help by clarifying current law on fiduciary liability, all of the witnesses agreed. Ms. Grabot stated that the ability of a plan sponsor to understand the potential fiduciary liability is a barrier that must be lowered. She and Mr. Londe agreed that plan sponsors have been told for many years that they cannot offer investment advice, but now are being told that they can, even though the law hasn’t changed, and plan sponsors are confused. Ms. Grabot stated that the Department can help by getting out a clear message to plan sponsors about the fiduciary liability associated with providing these services. Mr. McGrath agreed that current law clearly imposes fiduciary liability on plan sponsors when selecting service providers, and plan sponsors are aware of this liability. Plan sponsors are afraid of having more liability if they select an investment advice or management service provider.

Mr. Londe also strongly advised the Working Group that the independence of investment advisers and managers should be safeguarded. He stated that the Department, in any guidance or safe harbors, should not substitute disclosure for independence, because disclosure doesn’t work for most of the people for whom these services are most valuable.

The Working Group asked the witnesses if their services could be applied to a prototype plan already in place. Mr. McGrath stated that because his company is neutral as to who has custody of the plan’s assets, most custodians do not object to their providing services to these types of plans. Mr. Londe stated that virtually every plan asset custodian his company has approached would at least accommodate his company. He noted that directed trustees are often required to work with his company as a part of their contractual functions for the plan.

Mr. Fine stated that his experience has been that plan sponsors in the “jumbo” market are extremely independent and make their own decisions regarding his services based on their own research. However, decisions by plan sponsors with small plans (less than 1,000 participants) tend to be driven more by the financial institutions and providers already engaged by the plan.

The Working Group questioned whether these services are not accessible by lower income participants, because they have less of an ability to pay for the services, even though these are the participants who need the services the most. Ms. Grabot stated that her service fees are asset based, so a participant with lower plan assets pays lower fees. She also noted that many plan sponsors with low-income participants subsidize the fees for low income or low balance participants. Mr. Londe agreed that, because his service fees are also asset based, the fees generally are not a barrier based on the size of a participant’s account. Mr. Fine noted that his company’s asset-based fees for management services have generated sizeable enrollments among lower balance participants, who pay a lower fee. Mr. Fine stated that when his company is engaged to provide advisory services, the plan sponsor often pays the fees.

The Working Group asked the witnesses whether plans that offer employer stock as an investment presented any specific problems or if the plan sponsors tend to resist engaging their services. Mr. Londe stated that he can present a range of alternatives to these plan sponsors, from carving out the employer stock and managing around it, to selling down participants’ employer stock holdings to a level either set by the plan sponsor or set by his company in light of the facts and circumstances. His experience has been that even when plan participants are advised to not concentrate their plan accounts in employer stock, the participants generally do not independently divest their plan accounts of significant employer stock holdings. Applying a managed approach to these plans and participants allows an expert to divest the employer stock in a more disciplined and effective way.

Mr. Fine stated that a plan’s inclusion of employer stock can create a demand for his services or be an obstacle to his selling his services. Some companies hire him to reduce the amount of employer stock held in the plan, while other companies don’t hire him because they don’t want to decrease the amount of employer stock held in plan. But he has observed a trend toward reducing concentrations of employer stock held in plans.

The Working Group asked if there are any statistics available to show that the witnesses’ services add significant value to participants’ accounts. Mr. Londe stated that it is tough if not impossible to measure their performance, because they provide services at the individual participant level. He has noted a halo effect, however, in that plans using his services generally have increases in the diversification of participant accounts. Ms. Grabot stated that the measure is whether participants are better off, after looking at where they were before and where they are after, but she agreed that statistical measurement is impossible. Participants whose plan accounts are diversified because of these services will under perform when the market is up and over perform when the market is down. But over time the participant’s losses are mitigated and the participant gets the highest rate of return. She did note, however, that the basic problem facing plan participants is their savings rate, and the services provided by any of the witnesses generally do not directly affect participants’ savings rates.

Summary of Testimony of Ken Fine

Ken Fine is the Vice President of Product Marketing for Financial Engines. Financial Engines was founded in 1996 by Bill Sharpe to market to individual investors in self-directed plan accounts the expertise acquired in terms of investment approach, methodology and technology in the management of large defined benefit and defined contribution pension plans. Financial Engines provides services to 900 plan sponsors covering 3.2 million plan participants. The services consist of investment education, personalized advice, and, for the last nine months, investment management. These services are delivered online, in print, and via telephone. Mr. Fine has led Financial Engines in developing the professional investment management component of the company’s product line.

The experience of Financial Engines is that participants are increasingly demanding, feeling the need for assistance in their investment of their plan assets. This is driven by the aging of the workforce population, the volatility of the investment markets in the last few years and a widespread belief among plan participants that they generally lack the time and interest to self-invest their plan assets. At the same time, most plan sponsors are concerned about the lack of appropriate diversification they see within the portfolios of their plan participants.

Plan participants generally segment into three groups with distinctly different investment characteristics. The first group, consisting of approximately 15-20% of a participant population can be characterized as the “do-it-yourselfers.” These participants enjoy investing, actively plan, tend to be confident and typically save the maximum amount. When investment information and assistance is provided, this group uses it, but does so as a “second opinion.”

The second group may be characterized as the “motivated but uncertain” group. It consists of approximately 30% to 50% of a participant population. This group has less time and interest than the first, but is concerned that assets need to be properly invested. However, members of this group lack a belief that they can make good investment decisions. Information and investment advice tends to work well for this group of investors. They appreciate the advice and education and often implement the recommended strategies completely.

The third group is composed of the “reluctant investors.” Approximately 30% to 50% of a plan participants fall into this group. This group has the least amount of time and interest in investing plan assets. The portfolios of members of this group tend to be naively invested, either in the original default allocation, or in high concentration in particular funds or in extreme dispersal among funds without a clear basis for the dispersion. This group is most benefited by professional management.

Plan sponsors today believe that discretionary management or professional management needs to be available to plan participants as one option. The general sense of plan sponsors and of plan participants is that professional management should be provided by “independent entities.”

About 15-25% of plan participants sign up for professional management when this option is fully communicated over a one-year period. If offered at the outset of plan enrollment, this percentage would likely be much higher. The enrollees tend to be those with lower balances of less than $100,000 or less than $50,000. Those reluctant to enroll primarily express concern over “losing control of their account.” The potential market for professional management services appears to be about 80% of the participant population.

The fees for investment management by Financial Engines are still in the developmental stage as the service is tested and matures. They are less than 100 basis points per year of a plan participant’s asset base. These fees are disclosed as a line item on the participant’s statement. In providing the service, Financial Engines accepts responsibility as a named fiduciary. The potential market for professional management services appears to be about 80% of the participant population.

In providing professional management, a manager must be able to take into account outside assets of an individual participant. Financial Engines does so, but does not provide any investment management as to those outside investments. (Participants may, of course, use the general information and allocation models provided by Financial Engines is their own investment of their outside assets. Also, on occasion, an employer may specifically contract for a broader range of services to be provided, including management of outside assets.) The information provided to Financial Engines concerning a participant’s outside investments is confidential participant information under Financial Engines’ privacy policy. Such information will not be provided to the plan sponsor.

The professional management service provided by Financial Engines is premised upon and dictated by its allocation models. Individual investors are provided information sufficient to assess their risk tolerance. Where a participant has returned minimum risk tolerance information, communications are directed to the participant before an investment is made, alerting the participant to the risk profile of the default risk tolerance selection and the options for investments with different risk tolerance levels.

Participants who have enrolled for professional management are always entitled to personal telephonic communications with Financial Engines representatives. Statistically, about 20% of the participants place such calls during a year. The average call lasts approximately 15-20 minutes.

The Department of Labor could facilitate promulgation of professional management and other investment services by reducing confusion among plan sponsors and their legal counsel as to the meaning of the fiduciary responsibilities imposed on plan sponsors. The obligation to oversee selection of providers and the obligation to monitor them could be better explained to enable a plan sponsor to know with certainty whether or not they have satisfied and are continuing to satisfy these obligations as time passes.

Summary of Testimony of Scott D. Miller

Scott Miller is a principal of the Actuarial Consulting Group, an employee benefits consulting firm with 25 years of experience in the employee benefits and compensation consulting field. He is president of the American Society of Pension Actuaries, a Fellow of the Conference of Consulting Actuaries and a member of the American Academy of Actuaries.

Mr. Miller appears to present the views of the American Society of Pension Actuaries, ASPA, a national organization of over 5,000 retirement plan professionals that provide consulting and administrative services for qualified retirement plans, the vast majority of which are maintained by small businesses.

The 401(k) plan has become the dominant retirement plan for the American work force, particularly for workers at small to mid-sized companies.

In a 401(k) plan, unlike in a defined benefit plan, it is the participant who bears the risk of any 401(k) account investment losses. It is also the participant who bears the responsibility in most cases to invest plan assets, and who tends to do so without the assistance of professional investment expertise. Consequently, the retirement security of a large segment of the American work force is inherently at risk.

The law currently contains restrictions on the ability of participants to gain access to professional investment expertise. Policy makers must recognize the need to change both the law and regulations where necessary in order to provide 401(k) plan participants with access to the proper tools to allow them to save effectively for retirement. Currently, in response to Department of Labor regulations, advice available to participants tends to be only general investment education, and not individual advice. Retirement plan service providers, even those unaffiliated with retirement investment companies, receive fees from plan assets. Thus, they must resist giving advice, because that further act renders them a fiduciary and violates current prohibited transaction rules.

Increasingly, plan participants desire either (1) advice that includes recommendations as to actual investment choices and that will constitute the primary basis for the participant’s investment decisions or (2) the ability to delegate discretion to an investment manager over the participant’s account. Under Interpretative Bulletin 96-1, the Department of Labor has deemed both activities sufficient to render the provider a fiduciary.

Independent advisors with no other relationship to a plan or plan sponsor exist to provide such advice. However, their cost is frequently prohibitive on a per-participant basis.

Computer-based advice tools exist that can be extremely effective and relatively cost-efficient in providing these types of fiduciary assistance. However, they are not used currently in the retirement plan marketplace to any significant extent. This is because their setup cost is fairly high and because their use poses the risk of fiduciary liability for the employers that are the plan sponsors.

One of the primary features of a 401(k) plan for employers is the protection it provides from the plan sponsor acquiring fiduciary liability. Currently, the selection of an investment advisor constitutes a fiduciary act by a plan sponsor. The sponsor then has the responsibility to monitor the activities of that investment advisor. Surveys by the Institute of Management and Administration consistently show that potential fiduciary responsibility is by far the major reason employers choose not to offer investment advice to their employees.

Some legislation has been introduced in response to these employer concerns. Last year, Senate Bills, S.1971 and S.1972, proposed creating a fiduciary liability safe harbor for employers who designated an investment advisor for the plan. These bills relieved the employer of liability for losses resulting from such investment advice. The employer was also relieved of the obligation to monitor the specific investment advice being given to any particular participant. To qualify, the employer had to engage a qualified investment advisor and the qualified investment advisor had to conduct itself in accordance with various procedures to avoid conflicts. The House of Representatives passed legislation taking a different approach to a safe harbor. This permitted various conflicts provided disclosure was given. The House Bill has been opposed as being too broadly crafted.

ASPA believes certain prohibited transaction relief provided under the House Bill would be appropriate. For example, where an investment advisor receives fees from plan assets, but the fee is a flat percentage of account assets and the advisor is otherwise unaffiliated with the investment management company, no conflict of interest really exists. Similarly, if investment advice is based on an independent computer model, the fact that an investment advisor may actually be affiliated with an investment management company need not be prohibited under conditions similar to those granted by the Department of Labor to SunAmerica.

ASPA believes other circumstances are likely to exist where prohibited transaction relief would be appropriate despite the technical existence of conflicts.

ASPA further believes that any legislation to promote participant investment advice should also address and resolve plan sponsor concerns about potential employer fiduciary liability. Until this is addressed, investment advice will not be offered to any great degree.

ASPA is also concerned that the development of investment management as distinct from investment advice poses further risks to plan sponsors that should be addressed and resolved. An investment advisor and an investment manager are both fiduciaries. The manager exercises discretion to make an actual investment. The advisor does not. The costs for providing investment management are greater than those for providing investment advice. If investment management is made available primarily to participants more highly compensated with larger account balances, a technical risk of discrimination arises under Internal Revenue Code § 401(a)(4). This occurs because the definition of benefit rights and features includes “all optional forms of benefits”, including “other rights and features” of meaningful value to an employee. Current Treasury regulations lists -- within the definition of “rights and features” -- the rights to direct investments or the right to a particular form of investment. Further, this definitional list is not all-inclusive. ASPA believes that clarification is in order to establish how qualified plan non-discrimination rules will be applied to investment management alternatives.

Prohibited transaction issues also arise with respect to investment manager alternatives. Under ERISA § 406(b)(1), an investment manager is prohibited from using its authority to cause the plan to pay additional fees to the manager unless the manager fits within an exception to the rule. Investment managers with relationships to mutual funds need certainty as to when the inter-related transactions are and are not exempt from the prohibited transaction rules. For example, where mutual funds are used and some have one level of commission and other funds have another level of commission, prohibited transactions might be deemed to occur that were otherwise inadvertent.

Any uncertainty in whether investment managers and advisors may run afoul of nondiscrimination or prohibited transaction rules further discourages plan sponsors from making such fiduciaries available to plan participants. Plan sponsors fear that they will be found liable along with such fiduciaries in the event of litigation over losses that may occur.

ASPA believes relief must be made available to plan sponsors to encourage the provision of fiduciary services to plan participants. The type of education provided to plan participants under existing Department of Labor guidelines is not what plan participants seek. As one who sits in front of them during these talks, Mr. Miller watches the eyes of many glaze over within five minutes. Plan participants don’t want education. They want to know “what should I do?” The Department of Labor needs to put rules and regulations in place that will encourage plan sponsors to provide that type of advice and management to plan participants.

Summary of Testimony of Bob Wuelfing

Testimony June 27, 2003; presented by Robert G. Wuelfing, founder of RG Wuelfing & Associates, and Steven Saxon, Esq. a principal of the Groom Law Group.

Mr. Wuelfing began his testimony by providing a short introduction on The Spark Institute (“Spark”). Spark, the Society of Professional Administrators and Record Keepers, has a membership of more than 250 organizations which in turn provide 401(k) services to approximately 97% of all 401(k) participants. His testimony was based primarily on research conducted by Spark.

Mr. Wuelfing’s first point proved to be one of the most provocative statements heard during the course of the hearings. The commonly quoted 401(k) participant balance of $40,000 is a very misleading number. If the largest (top 10%) account balances are removed from the calculation, the average account balance is reduced to $9,000, with this same remaining participant universe carrying an average of $7,000 in credit card debt. His comment was meant to reinforce the point that:

“… You cannot asset allocate your way to retirement. It’s not going to matter how you do your asset allocation. You can only save your way to retirement and the savings rate within the 401(k) industry is quite low and isn’t going to be enough to make it to retirement.”

The major findings of Spark, as reported by Mr. Wuelfing, include:

• Only 3% of 401(k) participants have stopped contributing during the bear market.
• The number of participants attending 401(k) informational meetings has dropped by 50%, primarily as a result of the plan sponsor’s reluctance to allocate work time for educational meetings.
• Demand from participants for investment advice continues to rise; with 82% responding that they believe investment advice is either “important” or “somewhat important” to their retirement.
• 61% of plan sponsors do not currently offer participants advice. However, 80% of this universe indicated a willingness to provide advice “… if the law was changed allowing them to do so… there is a perception amongst plan sponsors … that, in fact, they cannot give advice to their participants.”
• When participants were asked about their primary source for their asset allocation decision, 50% indicated they made their decision on their own; 19% obtained assistance from a professional advisor; 16% received assistance from friends, co-workers, and family; 12% from employers; and, 3% from on-line tools.
• When participants were asked about the importance of advice, 85% responded that advice was important.
• Participants indicated that the preferred method for receiving advice was with face-to-face meetings with a professional. Second, in order of preference, was telephone support, and Internet tools were ranked third. The challenge with face-to-face interviews with a professional is cost – who was going to pay the bill? With regards to the Internet tools, studies indicate participants begin to use the tools, but drop out before actually implementing the advice provided.
• When participants were asked who they would like to receive advice from, the preferred choice was an advisor the participant already had a relationship with; the second choice was an advisor selected by the record keeper; and, the third was an advisor selected by the plan sponsor.

Mr. Saxon then presented information on the legal implications of providing professional advice, beginning with the three primary models of investment choice. The first is self-directed brokerage where the participant has the flexibility and freedom to pick virtually any investment. The second model is where the participant is provided advice and education to develop their own investment strategy from a defined list of investment options. And, the third model is when the participant delegates investment decisions to a professional – the topic of these hearings.

There are significant legal implications when the participant delegates investment decisions to a professional advisor (the advisor is given discretion over the portfolio). For the plan sponsor there is the fiduciary responsibility for selecting the advisor. Though the selection of an advisor has the specter of increased liability, the prudent selection and monitoring of an advisor may actually reduce the overall liability of the plan sponsor because the investment results may prove to be more satisfactory than if the decisions were participant-directed. Reference was made to the Safe Harbor provisions of Section 405(d) (1) of ERISA.

The second significant legal issue is the advisor’s potential conflicts of interest. When the advisor is recommending affiliated funds, Prohibitive Transaction 77-4 does not permit the advisor from receiving sales commissions or redemption fees. With respect to unaffiliated funds, Prohibitive Transaction 75-1 and the SunAmerica advisory opinion should guide the advisor.

One of the more provocative statements made by Mr. Saxon dealt with his opinion as to why the professional advice models were the subject of increased interest. He, as well as Mr. Wuelfing, believe the professional advice products are being created by 401(k) vendors that are looking for ways to distinguish themselves from their competitors and not necessarily because there is participant demand.

The Chairman, Mr. Gardenhire, asked both Mr. Wuelfing and Mr. Saxon if they believed there was any potential for abuse with the professional advice model. Mr. Wuelfing reiterated that 401(k) plans were never intended to be a participant’s primary retirement vehicle. Tools provided to participants in the nineties tended to support the notion that participants could asset allocate their way to retirement, and deemphasized the need to save. Mr. Saxon cited two major potential areas for abuse: the plan sponsor that does a poor job of selecting the advisor; and, the advisor that does a poor job of avoiding prohibitive transactions (advice is compromised by compensation).

Committee person, Mr. Szczur, who asked whether a diversified default option fit within the context of these discussions, posed a final question. Mr. Wuelfing believed it would help, somewhat, but the key is to convince the participant that they need save and they need to seek advice on how to invest their assets properly. Mr. Saxon pointed out that the protection of 404c requires the participant to make an affirmative election and the default option may not meet the provisions of 404c.

Summary of Testimony of Lori Lucas

Lori Lucas, a Chartered Financial Analyst and a Hewitt DC Plan Consultant, is a recognized expert on 401(k) investment structures, trends and communications, DC Plan participant behavior, and investment policy selection and monitoring. Ms Lucas presented information based on statistical analyses done by Hewitt using its recordkeeping data as well as surveys of both plan sponsors and employees. The recordkeeping data, from 2002, includes 2 million eligible employees participating primarily in large plans.

Barriers to Appropriate Saving and Investing. Ms. Lucas identified the following barriers: (1) concentrated account holdings (the average participants holds only 3.6 funds and, where available, has 42% of DC account invested in employer stock); (2) ongoing failure to rebalance (1 of 6 rebalanced in 2002); (3) market behavior, not rebalancing (participants who do make changes tend to engage in a momentum strategy); and (4) failure to understand the role of certain investment options (the average number of investments held by people with Lifestyle Funds is 4.8).

Considerable Growth in Offering Investment Advice. Among the large plan sponsors that are Hewitt's clients, one in three offer on line investment advice. Substantial numbers of large plan sponsors indicate interest in offering investment advice. However, fear of liability tends to constrain behavior. In a 2001 survey across about 450 plan sponsors, the most common reason that people said that they were not offering advice was that they were not sure how to provide advice given current regulations.

Automatic Enrollment. Ms Lucas reported that there is still a lot of uncertainty around automatic enrollment, and the liability associated with that, so for the most part, plan sponsors have cooled on the idea of offering automatic enrollment. There was very little growth in the number of plan sponsors that offer it between 2001 and 2003. Among those that do, they are being very, very conservative in their choices, and using stable value as the default fund and a very low default contribution rate of 2 or 3 percent is not uncommon.

Questions: In response to questions, Ms. Lucas stated that the DOL could help encourage plan sponsors to offer investment advice by providing guidance on the process, which should be used to prudently select the advice provider. Plan sponsors would like to see examples of prudent process and the limits of liability if a prudent process is used. When asked whether she believed a safe harbor would be useful, Ms. Lucas said: “I don't think plan sponsors are looking for a list necessarily – ‘these are the five things or ten things or whatever the number is that you should do.’ But here's a model, that if you follow this model, that you will have a safe harbor for selecting the investment advice provider and the liability that's around that.”

Ms. Lucas opined, “The majority of investors in 401(k) plans tend to be fairly disengaged investors.” Therefore, it is critical to a successful investment advice program for the plan sponsor to promote the use of advice. Accordingly, Ms. Lucas said that: “ I think from that perspective, advice that's provided through the plan sponsor is likely to have a deeper penetration and more usage than something that's provided outside of the plan sponsor, just because there's more opportunities for the plan sponsor to promote it. And if they're promoting it, it's going to be used.”

When asked about the comparative costs of Lifestyle Funds and investment advice, Ms. Lucas stated that: “The type of Lifestyle Fund offered is obviously part of the equation. We have a number of plan sponsors that offer Lifestyle Funds, either a retail mutual fund or an institutional mutual fund that might run around 80 basis points all together, so that's not only the investment management fee of the Lifestyle Fund, but the fund cost of managing the funds, as well.” Alternatively, Lifestyle Funds can be created within an existing core fund lineup and have no additional management fees.

For participants with relatively low account balances, Ms. Lucas indicated that Lifestyle Funds might be a better choice than individualized investment advice. But, she also said that: “Now conversely with the people that are in the highly motivated category, just the opposite is true. Lifestyle Funds are not suitable for them for the most part. I know certain high net worth individuals like to delegate, and they'll put money in Lifestyle Funds. They'll be satisfied with that. But many are interested in taking into account their whole financial situation, not just their 401(k). And for them, they're going to want one on one financial counseling.”

Summary of Testimony of William E. Robinson

William E. Robinson is a partner and practice group leader of Miller & Martin LLP’s ERISA/Employee Benefit Practice. Miller & Martin LLP is a regional law firm of 165 attorneys with offices in Chattanooga, Atlanta and Nashville.

Mr. Robinson began by describing the Miller & Martin Profit Sharing Plan. Professional investment managers invest assets in the Miller & Martin Profit Sharing Plan. When a participant attains age 35, he or she may voluntarily elect to self-direct all or any portion of his or her account. A participant who elects to self-direct may choose among the universe of investment vehicles.

He recommends that the Council consider requesting the Department of Labor to provide further guidance on the rules under Section 404(c) of ERISA, to clarify that a plan which does not limit participants to a menu of mutual funds, but instead allows them to self direct their account balances among the universe of investments, is covered by the protection offered by being a 404(c) Plan.

He stated that currently the regulations under Section 404(c) of ERISA are designed to be used by plans that provide a menu of mutual funds for participants to choose among and the rules do not easily translate to a plan such as the Miller & Martin Profit Sharing Plan. Current regulations require an identifiable plan fiduciary to provide participants with a substantial amount of information that is not helpful or is impossible to provide in the context of a plan, which allows participants to self direct among the universe of investments. As an example, regulations require the plan fiduciary to provide self directing participants with “a description of the investment alternatives available under the plan, and with respect to each designated investment alternative, a general description of the investment objectives, risk and return characteristics of each such alternative.” Such a requirement cannot easily be met by a plan that allows participants to direct the investment of their plan assets among the universe of investments.

These requirements should be clarified to allow plans that make the universe of investments available to self directing participants to comply with Section 404(c) of ERISA without incurring undue hardship.

Mr. Robinson does not think the plan administrator of the Miller & Martin Profit Sharing Plan should have any liability with respect to self-directed brokerage accounts because participants who self-direct their accounts do so voluntarily. When asked if the plan administrator monitors what is in the individual’s self-directed brokerage account, Mr. Robinson said he does not think it should make any difference whether the plan administrator knows what’s in the account or not. Further, he does not think the plan administrator should have any investment or any fiduciary liability because of not knowing that information.

Mr. Robinson said that in a case where a brokerage window is a part of a menu of mutual funds and no real education or advice is given to the participants, then he thinks the fiduciary is as responsible for investments made through the brokerage window as it is for the choices that are made on the mutual funds.

When asked if the broker handling the participant’s account under the self-directed brokerage arrangement has any liability, Mr. Robinson thought the broker should know his customer and understand the customer’s circumstances. In that regard, if a person decides to make his own choices about investing in a self directed account, there’s responsibility on the broker to know what the participant wants, and to understand that he’s investing retirement funds.

When asked if plan sponsors that designate a menu of mutual funds for participants to choose from have limited their liability, he said most plan sponsors think they should offer a menu of mutual funds rather than hire a professional investment manager to manage the entire trusts. Once they’ve done that, he was not sure they realize that they continue to have fiduciary liability.

When asked about future litigation problems down the road, he thinks that unless employers begin to provide investment education, there are going to be situations that would result in litigation against an employer. For instance, two people may work in an unskilled job together, and one is being advised how to invest his retirement plan money by a relative or friend, while the other one is afraid of the market and puts everything into a money market fund or bond fund. The two people retire at the same time and one of them has substantially more money in his account than the other, neither of which because of anything the employer did. If one of them realizes that the other one has a substantially higher account balance, he’s going to look to the employer and want to know why and that scenario can result in litigation.

When asked if he considers the investment manager selected by the individual who directs his account also to be a fiduciary of a plan who should be required to acknowledge that, he said that once a participant chooses a manager who has discretion to suggest assets, or give investment advice for a fee, that person is a fiduciary. ERISA says that person is a fiduciary whether he acknowledges he’s one or not. But plan administrators don’t try to determine whether participants are hiring investment advisors or investment managers or whether each participant is doing it all on his own by reading the Wall Street Journal and looking at the Internet, or whether they’re talking to their next door neighbor and he’s giving them advice. He thinks there may be a need to consider making sure that if the plan sponsor sees that someone is paying investment management fees out of their account that the plan sponsor should have that participant get the investment manager to sign an agreement that acknowledges that he’s a fiduciary and make sure he is not a party of interest.

Summary of Testimony of Shaun O'Brien

Shaun O’Brien is the Assistant Director of the AFL-CIO Public Policy Department, where he had previously been senior policy analyst for retirement income issues. Mr. O’Brien participates in the development and implementation of AFL-CIO policies on healthcare, retirement, labor standards, and other issues.

Mr. O’Brien indicated that the issue of professionally managed defined contribution accounts has not yet become a major issue for union-negotiated plans. Part of the reason for this is that defined contribution plans are often supplemental plans, especially in the world of multi-employer bargaining. Moreover, in that latter world, such plans tended not to be self-directed, although that is changing.

Mr. O’Brien directed most of his comments to the problems of plan sponsors making available investment advice to employees. Mr. O’Brien noted that employers can under current law provide investment advice by prudently selecting and monitoring an investment advisor -- if they do so, they will not incur liability simply because the investment advice did not yield predicted results for the employee. Mr. O’Brien endorsed the DOL’s Sun America opinion, but notes that employers relying on it must follow it and not chip away at the firewall that the letter contemplates.

Mr. O’Brien indicated that the Department of Labor bears some responsibility for any confusion about the ability of employers to contract with third parties to provide investment advice. He noted that a senior Department official publicly stated “the current ERISA law has barriers that prevent employers and investment firms from providing individual investment advice to workers.” Mr. O’Brien notes that this statement has not been helpful in clarifying that current law permits firms to contract to provide investment advice to participants. He suggests that the Department of Labor provide guidance indicating that they may provide investment advice “from an outside independent firm and that so long as they meet the general standards for selecting service providers, that they are not going to be held liable for the specific content of their advice.”

The AFL-CIO is, however, concerned about legislative proposals that would permit firms that have conflicts of interest to give participants investment advice, so long as there is disclosure of the conflict. Such an approach would depart from ERISA basic protective structure for workers for a securities-type regulatory scheme, which contemplates individuals having meaningful choices. In retirement plans, that is not likely to be true, where the investment advice services are contracted for at the plan level and the participants will not generally have many choices. Moreover, the participants may well pay for the conflicted services, even if they choose not to use them. Recent events, moreover, should caution us about relying on securities-law type protections for participants in pension plans. They require more substantive protections.

In contrast, Mr. O’Brien believes that building a fiduciary safe harbor to provide independent investment advice meets both employers need for clarity, certainty, and comfort, while providing participants with adequate substantive protections.

Summary of Testimony of Rhonda Prussack

Rhonda Prussack is the Vice President and Product Manager for Fiduciary Liability Insurance at National Union Fire Insurance Company, a member company of American International Group (AIG). Her office is located in Pittsburgh, PA. The sub-committee requested her testimony as a representative from the insurance industry to determine whether underwriting standards were impacted by the plan fiduciary’s use (or non-use) of professional money managers. [Fiduciary liability insurance is intended to defend and protect plan fiduciaries, other than third-party investment advisors, administrators, and record keepers, against allegations of breach of fiduciary duty under ERISA.] Ms. Prussack was provided, in advance, the working group’s standard list of questions, and she chose to structure her testimony around her responses to the questions.

In summarizing, Ms Prussack indicated that the following acts and/or activities by the plan fiduciary would be viewed as a “positive development” [positive in the eyes of the insurance carrier]:

• The plan fiduciary offering investment advice to participants, but only if the advice was prepared by an independent third-party. Ms. Prussack expressed concern with the portion of the Pension Security Act (H.R. 1000) [Ms Prussack referred to the Act as the Boehner Bill], which did not require that the advice provider be independent.
• The plan fiduciary making available to plan participants one or more investment advisors that have been carefully vetted by the plan fiduciary. This approach is preferred over allowing participants to each select their own advisor.
• The plan fiduciary that offers a limited number of investment options.
• The plan fiduciary that takes responsibility for monitoring investment-related fees and expenses, particularly if fees are being paid from plan assets.

Later on in her testimony, Ms Prussack was asked “Does the offering of a professional investment advisor potentially decrease the plan sponsor’s fiduciary liability?” Her response, “Yes, provided the advisor is independent, has no conflict of interest, has been carefully vetted, and is regularly monitored for performance and reasonableness of fees.”

Ms Prussack was asked whether her insurance carrier differentiated between a plan that was trustee-directed versus a plan that participant-directed. She responded that there was no differential. In either case, the factor that impacted the plan fiduciary’s insurance premium was whether there was evidence of prudent diversification.

Ms Prussack was asked whether plan fiduciaries that adopted 404 (c) were less prone to litigation. Her response was that there was no correlation; they were just as prone to litigation.

When asked about what the DOL could be doing to assist the insurance industry, her reply was that: (1) mandating a cap on company stock would help reduce the severity and frequency of litigation; and (2) defining safe harbor procedures for the selection of investment advisors would also be beneficial.

Summary of Testimony of David C. John

David John has been involved in Washington's top policy debate for more than 25 years. He continues a career at the Heritage Foundation, a lead analyst on issues relating to Social Security reform.

John examined the experience that a series of Social Security systems with personal retirement account options overseas have had in providing independent funds managers. In particular, he discussed the Swedish, Australian and British systems.

In the case of Sweden, two and a half percent of their annual income goes into what is essentially a national 401(k) plan that does allow the use of independent funds managers. The individual selects, but only from a group of funds managers that have passed government muster. The agency that administers these accounts has already examined both the financial stability of the funds manager and negotiated with them to ensure that the individual will receive the lowest administrative cost possible.

In Sweden, there is also a default account, which is optimal for the individual's age. The funds are distributed among the managers who offer that particular default account. The majority of workers this changes from year to year, but the majority of workers basically do not take that option. They vote with inaction, and they take the default option.

The Australian system differs in that a worker’s fund go to a fund based upon his or her industry, but once again there is an element of choice. For the most part, each industry fund is invested in a widely diversified portfolio, but the worker has the option of moving his or her money to one of a series of a pre-screened alternatives. The most popular one at the moment happens to be a green fund similar to some of the ones that we have seen in the United States.

Despite this being available under the existing system, only about five percent of the workforce has taken advantage of the alternate investments. In addition, Australia is currently debating a proposal that would allow workers to choose among at least three different funds. Thus, a journalist, who is currently limited to the journalists’ fund, might also be able to move his or her money to the steel fund or the retail workers fund. The Australian system has worked very effectively. The problems that have come out are have to do with areas such as tax policy, which have nothing to do with the investment management.

Last, but not least, is the U.K., which has a two tiered pension system including a flat amount state basic pension and an income related pension. Workers have the option to receive a rebate of a portion of their Social Security taxes that would go into the income related part of their Social Security system that would go from the government to the funds manager of the workers choice.

Unfortunately, this system has had mixed results due to a series of design flaws, problems with investment returns, and a regulatory system that allowed an early scandal. Workers who took advantage of the opt out plan discovered in many cases that by doing so, they were missing on matching funds since the money is no longer cycled through the employer pension.

These three overseas pension systems have aspects that the United States should consider in discussing changes to its system. All three offer lessons – positive and negative – that Americans can use in reshaping our system.

Summary of Testimony of Michael Falk

Mr. Falk responded to questions from the Council on June 27, 2003, in written form, when ask to outline potential abuses within Optional Professionally Managed Accounts.

He outlined 10 (ten) areas of potential abuses. Unqualified advisors were first on his list. These included non-registered advisors within the states that they give advise or have discretion.

Others areas were misleading performance illustrations, tying, not letting go on accounts, asking for liability waivers, self-dealing, excessive fees, discrimination on size of accounts, hidden charges, and performance fees.

Summarized by Todd Gardenhire

Summary of Testimony of Thomas T. Kim

Thomas T. Kim, Associate Counsel for the Investment Company Institute, attended the Council’s July 25, 2003 meeting as an observer. During the meeting, members of the Council asked Mr. Kim if he wanted to provide comments on the topics being discussed by the Working Group on Optional Professional Management. He graciously agreed to provide the Council with written testimony in the form of a letter (dated September 17, 2003), which was submitted to the Executive Secretary for review by members of the Working Group at the September 22 meeting. The following is a summary of the letter.

With regard to 401(k) and other defined contribution plans that permit participants to direct their plan investments, it is paramount that participants have access to tools that will enable them to prudently invest and diversify their plan accounts.

Such plans offer participants flexibility in managing their retirement savings by providing multiple investment alternatives, various distribution options and portable account balances, each of which enable the plan to satisfy the needs of differently-situated individuals.

Employees and employers have found mutual funds to be well suited for 401(k) plans because, among other things, they offer diversified portfolios, professional asset management and daily valuation of shares held in plan accounts.

According to research conducted jointly by the Investment Company Institute and the Employee Benefit Research Institute (EBRI), 401(k) plan participants, generally and in the aggregate, are investing their plan balances appropriately. Young participants tend to invest more heavily in equities while older participants are more likely to invest in fixed-income securities. In addition, 401(k) plans appear to be effective across all income categories. The ratio of account balance to salary for low and moderate-income 401(k) participants is similar to the ratio for higher income individuals.

The Department’s guidance in SunAmerica was a positive step toward helping individuals better manage their retirement savings. Plan designs and services developed under the guidance will provide additional tools for participants to reach their retirement goals.

The managed account approach, however, should not be viewed as a comprehensive solution to participants’ need for professional advisory services. As noted by several witnesses at the Working Group’s meetings, participant characteristics, attitudes and behaviors vary significantly, thereby creating a need for multiple channels of advice delivery. Moreover, the investment control and flexibility offered by participant-directed plans remain attractive features for participants.

Accordingly, while managed accounts may be useful for some, many others will find that the service is not suitable for them. Thus, to assist plan participants, policymakers should encourage greater access to and availability of professional investment advice, such as through the enactment of the investment advice legislation sponsored by Chairman John Boehner of the House Education and Workforce Committee.

Advisers under this legislation must assume fiduciary status under the stringent standards for fiduciary conduct set forth in ERISA that would, among other things, require advisers to act solely in the interests of plan participants and beneficiaries. In addition, only specifically identified, qualified entities already largely regulated under federal or state law would be qualified as advisers under the bill, and extensive disclosures designed specifically to be understandable to the average participant must be provided to the advice recipient.

Moreover, given the diverse needs and characteristics of plan participants, policymakers should consider the importance of the employer’s role as a plan fiduciary in prudently selecting and monitoring services offered to its plan participants. Thus, proposals that would establish distinct legal standards governing managed accounts should be closely scrutinized, as they may have the effect of creating incentives for plan designs or services that may not be appropriate for employees (or a segment of employees) of some employers.

More generally, any proposal in this area should be carefully reviewed to determine its impact on the employer’s fiduciary oversight under ERISA — the cornerstone of our pension laws.

Additional Information Sources

June 27, 2003: Working Group on Optional Professional Management In Defined Contribution Plans

1. Agenda
2. Official Transcript
3. Questions Posed by Chair/Vice Chair
4. “Investments in Self-Directed Account Retirement Plans: A Summit with Many Faces” by Richard P. Magrath, President, ProNvest and PowerPoint Presentation
5. Optional Professional Management in Defined Contribution Plans Presentation, by Carl Londe, Chairman & CEO, ProManage, Inc, also a list of potential abuses/responses
6. Testimony of Scott D. Miller, Principal, Actuarial Consulting Group, on behalf of the American Society of Pension Actuaries
7. Slide Presentation by Robert G. Wuelfing, RGWuelfing & Associates, on behalf of the SPARK Institute
8. Retirement Security for All Employees PowerPoint Presentation by Ken Fine, Executive Vice President, Financial Engines, Inc. as well as a Q&A on the topic
9. Power Point Presentation Slides from Testimony of Sherrie Grabot, Chief Executive Officer, Guided Choice, Inc.

July 25, 2003: Working Group on Optional Professional Management In Defined Contribution Plans

1. Agenda
2. Official Transcript
3. Optional Professional Management Slides by Lori Lucas, CFA, Defined Contribution Consultant, Hewitt Financial Services, LLC
4. Written Testimony of Rhonda Prussack, Vice President and Product Manager for Fiduciary Liability Insurance at National Union Fire Insurance Company
5. Statement of the AFL-CIO on OPM in Defined Contribution Plans, prepared by Damon Silvers, Office of the General Counsel, presented by his colleague Shaun O’Brien of the Office of Policy
6. Statement of William E. Robinson, Miller & Martin Profit Sharing Plan
7. 2003 ERISA Advisory Council Proposal Draft of a DOL Information Letter Requested to Provide Guidelines for Employers

September 22, 2003: Working Group on Optional Professional Management In Defined Contribution Plans

1. Agenda
2. Official Transcript
3. Flip Chart Notes Provided for Discussion of Group’s Final Report
4. Letter of September 17, 2003, from Thomas T. Kim, Associate Counsel, Investment Company Institute on the Issue

Advisory Council Members

1. R. Todd Gardenhire, Chair of the Working Group
2. Donald B. Trone, Vice Chair of the Working Group
3. Ronnie Sue Thierman, Council Chair and ex-officio member of all working groups
4. David Wray, Council Vice Chair and ex-officio member of all working groups
5. Mary Maguire
6. John S. Miller, Jr.
7. Dana Muir
8. Antoinette “Toni” Pilzner
9. Norman Stein
10. John Szczur
11. Michele Weldon
12. Judy Weiss