The DOL fiduciary proposal: investment education vs. advice

August 10, 2015

The Department of Labor's proposed regulation re-defining who is an ERISA ‘fiduciary’ would, among other things, supersede current rules on investment education. DOL's participant education rules generally define when participant communications about investments (and, under the proposal, distributions) constitute ‘education’ or ‘advice.’ Communications that are advice may trigger fiduciary status; communications that are education generally do not.

In this article we provide background on the education vs. advice distinction and on the current rules. We then review the DOL proposal and conclude with a discussion of the issues it presents for sponsors. We begin, however, with a brief summary.


With respect to participant education, the new proposal would make two major changes to current practice:

1. The identification of specific investment funds in asset allocation recommendations would be treated as ‘advice’

One of DOL's main objectives with respect to participant investment education is to make ‘conflicted’ educators stop recommending their own funds. While it's not entirely clear, it appears DOL would allow an ‘educator’ to identify, e.g., all funds in a fund menu that are in an asset class. Specification of some funds (and not others) in an asset class would, however, be considered advice.

Independent fiduciaries and sponsors could continue to make asset allocation recommendations that identify specific funds, but those recommendations would constitute ‘advice,’ triggering fiduciary status. That result is not necessarily an obstacle for independent fiduciaries and sponsors, so long as they are satisfied that they can, e.g., meet ERISA's fiduciary standards in connection with the recommendation.

What effect these changes will have on education/advice practice is hard to guess. If some conflicted educators stop providing education services because of the changed rules, then the cost of participant education services might conceivably go up (‘at the margin,’ as economists say). That's not just because the supply of educators would be reduced. Conflicted educators are currently often willing to offer education at reduced prices. Some would also argue that the limitation of education to general asset allocation recommendations may reduce its effectiveness.

2. Recommendations as to distribution options would be treated as ‘advice’

The new proposal would include in the concept investment ‘advice’ certain communications about distribution options. The language in the proposal on this issue is quite broad. It appears that DOL's main objective is to stop ‘educators’ from recommending that participants take IRA rollovers. If it goes further, and in effect limits ‘education’ about distributions to the generic, it may limit efforts to improve participant distribution decisions.

Obviously DOL thinks any trade-offs are worth it if ‘conflicted advice’ can be eliminated. There is some evidence that, according to the Council of Economic Advisors, conflicted advice may cost participants 100 basis points per year.

* * *

Now let's turn to a detailed review of DOL's proposal.

Background – the significance of the education vs. advice distinction

Let's begin with why it matters whether a communication is investment ‘education’ or investment ‘advice.’ ‘Advice’ can trigger fiduciary status. Indeed, the DOL's re-definition of fiduciary proposal would significantly expand what is ‘advice’ and the situations in which giving a participant advice makes you a fiduciary. Characterization of a communication as ‘education,’ on the other hand, defines the communication as ‘not-advice’ and thus generally not subject to ERISA's fiduciary rules. The definition of investment ‘education’ thus functions as something like a safe harbor; if all you are doing is providing education, then you are generally not a fiduciary.

As we discussed in our article DOL proposed redefinition of ERISA fiduciary – Best Interest PTE, whether or not you are a fiduciary matters for three reasons: (1) if you are a fiduciary, then you are generally subject to duties of loyalty and prudence; (2) further, under ERISA's prohibited transaction rules, a fiduciary may not engage in self-dealing, have, or act for a person who has, an adverse interest, or receive a ‘kickback’; (3) finally, a fiduciary is an ERISA ‘party in interest,’ prohibited from dealing with a plan in many respects.

In the context of participant education/advice, sponsors are generally only concerned with issue (1). If a sponsor is providing ‘advice’ and as a result is a fiduciary, then it is subject to ERISA-imposed duties of loyalty and prudence.

Issues (2) (prohibition on self-dealing, etc.) and (3) (party-in-interest transactions) are generally relevant only to ‘conflicted’ outsider education/advice providers. If the outside provider is, for instance, affiliated with the manager of one or more funds in the 401(k) plan fund menu, the characterization of a communication as ‘advice’ may trigger fiduciary status and issues of, e.g., self-dealing.

Interpretive Bulletin 96-1

IB 96-1 currently provides the rules for determining whether a communication is ‘education’ or ‘advice.’ Under 96-1 the following are ‘education:’

Plan information: (i) information and materials that inform a participant or beneficiary about the benefits of plan participation, the benefits of increasing plan contributions, the impact of pre-retirement withdrawals on retirement income, the terms of the plan, or the operation of the plan; or (ii) information ... on investment alternatives under the plan (e.g., descriptions of investment objectives and philosophies, risk and return characteristics, historical return information, or related prospectuses).

General information: Information and materials that inform a participant or beneficiary about: (i) General financial and investment concepts, such as risk and return, diversification, dollar cost averaging, compounded return, and tax deferred investment; (ii) historic differences in rates of return between different asset classes (e.g., equities, bonds, or cash) based on standard market indices; (iii) effects of inflation; (iv) estimating future retirement income needs; (v) determining investment time horizons; and (vi) assessing risk tolerance.

Asset allocation models: Information and materials (e.g., pie charts, graphs, or case studies) that provide a participant or beneficiary with models, available to all plan participants and beneficiaries, of asset allocation portfolios of hypothetical individuals with different time horizons and risk profiles.

Interactive investment materials: Questionnaires, worksheets, software, and similar materials which provide a participant or beneficiary the means to estimate future retirement income needs and assess the impact of different asset allocations on retirement income.

Asset allocation models and interactive investment materials are subject to additional rules:

They must be based on generally accepted investment theories.

They must disclose material facts and assumptions on which they are based.

To the extent they identify specific investment alternatives (e.g., a specific fund), they must include a statement that "other investment alternatives having similar risk and return characteristics may be available under the plan and [must identify] where information on those investment alternatives may be obtained." (Let's call this the ‘other-alternatives disclaimer.’)

They must include a statement that participants should consider their other assets, etc.

Finally, with respect to any asset allocation model there must be "an objective correlation between the asset allocations generated by the materials and the information and data supplied by the participant.”

Current practice

The main target of the new proposal is the recommendation of specific funds in asset allocation models and interactive tools. As noted, under IB 96-1, such a recommendation is ‘education’ and not ‘advice’, so long as it is accompanied by the other-alternatives disclaimer.

The issue of ‘recommending some funds in an asset class but not others’ is particularly relevant to ‘conflicted’ educators. The theory of the approach in IB 96-1 is that someone affiliated with a particular fund family should only be expected to provide ‘education’ about – indeed would only have expertise as to – the funds of that family.

Some argue, in addition, that the recommendation of specific funds is more effective: that participants prefer to be told which funds to invest in, rather than to choose from among all the funds in an asset class.

To be clear about what we are talking about, let's work through a brief (and simplified) example.

Assume a plan with two asset classes (equity and fixed income) and two fund families (ABC and XYZ). A person affiliated with the ABC fund family is providing participant education services – software that, based on some simple participant inputs, outputs an asset allocation recommendation. Let's consider three cases.

In Case 1, ABC's asset allocation recommendation is that the participant invest 60% in equities. To implement this recommendation, the participant herself must review the fund descriptions to figure out which funds are equity funds.

In Case 2, ABC's asset allocation recommendation is that the participant invest 60% in equities, and the recommendations identifies both the ABC and XYZ Stock Funds as equity funds.

In Case 3, ABC's asset allocation recommendation is that the participant invest 60% in equities, and the recommendations identifies the ABC Stock Fund as an equity fund. That recommendation also includes the other-alternatives disclaimer.

Each of these communications is generally considered ‘education’ and not ‘advice’ under current rules (IB 96-1).

DOL proposal: prohibition on recommendations of specific funds or specific distribution options

DOL's proposal would (more or less) re-define any asset allocation recommendation that identifies specific funds, and any communication about distributions that recommends a specific form of distribution, as ‘advice.’ Under the DOL proposal, to be ‘education’ (and not be ‘advice’):

Plan information may not include any "reference to the appropriateness of any individual investment alternative or any individual benefit distribution option.”

General information may not "address specific investment products, specific plan or IRA alternatives or distribution options ... or specific alternatives or services offered outside the plan or IRA.”

Asset allocation models may not "include or identify any specific investment product or specific alternative.”

Interactive investment materials may not "include or identify any specific investment alternative available or distribution option ... unless such alternative or option is specified by the participant.”

Here is DOL's explanation of this proposed change:

The Department now believes that, even when accompanied by a statement as to the availability of other investment alternatives, these types of specific asset allocations that identify specific investment alternatives function as tailored, individualized investment recommendations, and can effectively steer recipients to particular investments, but without adequate protections against potential abuse.

Issues for sponsors – recommendations of specific funds would be advice not education

While it is not entirely clear, it appears that DOL would treat as education (and not ‘advice’) asset allocation recommendations that are either generic (Case 1 in our example) or that identify all funds in an asset class (Case 2). A recommendation that identified specific funds in an asset class, but not all funds, would be considered ‘advice’ (Case 3).

This change would have (at least) three consequences. First, ‘conflicted’ educators would no longer be able to make specific fund recommendations. Doing so would (or at least may) make them a fiduciary, and recommendations of specific funds with which the educator/adviser is affiliated would raise, e.g., self-dealing and prohibited transaction issues. As a result, the supply of educators may shrink, as some conflicted educators decide to stop providing education services. As we noted, DOL does not think that that is necessarily a bad thing.

Second, whoever is doing participant ‘education’ – conflicted or un-conflicted – would not be able to provide specific recommendations. As we noted, some believe that education which requires that the participant make a choice (e.g., between either the ABC or XYZ Stock Funds) may be less effective than education that tells the participant which specific fund to invest in (e.g., 60% in ABC or 60% in XYZ or even 30% in ABC and 30% in XYZ).

Third, a recommendation of specific funds might still be made, but it would constitute ‘advice’ and might trigger fiduciary status. While conflicted ‘educators’ would not be able to provide this sort of advice, sponsors and independent fiduciaries might be able to do so, so long as they were satisfied that they could, e.g., meet ERISA's fiduciary standards in connection with the recommendation.

And communications discussing specific distribution options may be advice, triggering fiduciary status

IB 96-1 doesn't discuss distributions, probably because few at the time would have considered communications about distributions to be investment advice. DOL's new proposal would change that. Quoting the proposal, advice would include:

[A] recommendation to take a distribution of benefits or a recommendation as to the investment of securities or other property to be rolled over or otherwise distributed from the plan or IRA ... [and] recommendations as to the management of securities or other property to be rolled over or otherwise distributed from the plan or IRA.

Thus, the proposal problematizes communications to participants about distributions. And the proposed participant education ‘carve out’ would, in effect, set the limits to what an ‘educator’ can say about distributions without triggering advice status. Clearly, you couldn't say anything favoring (‘recommending’) one distribution option over another. With respect to distributions from 401(k) plans, it's fair to say that DOL's main concern is persons recommending rollovers to IRAs. But recommending that a participant leave his assets behind in the plan or roll them over to his new employer's plan would also constitute ‘advice.’

We note that DOL's proposed language on both of these issues – asset allocation recommendations and distribution education – is very broad. We have given our best reading of their intention; hopefully the language of the rule can be clarified in the comment and hearing process.

* * *

How DOL's proposed prohibition will operate, and how ‘conflicted’ educators will respond to it, should become clearer as the regulatory process proceeds. We will continue to follow this issue.

October Three Consulting, LLC is a full service actuarial, consulting and technology firm that is a leading force behind the reemergence of defined benefit plans across the country. A primary focus of the consultants at October Three is the design and administration of comprehensive retirement benefits to employees that minimize the financial risks and volatility concerns employers face.

Through effective plan design strategies October Three believes successful financial outcomes are achievable for employers and employees alike. A critical element of those strategies is the ReDB® plan design. The ReDefined Benefit Plan® represents an entirely new, design-based approach to retirement and to the management of both the employer’s and the employee’s financial risk, focusing on maximizing financial efficiency and employee value.

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