Investment education under the Conflict of Interest regulation

The Department of Labor’s Conflict of Interest regulation, re-defining who is an ERISA “fiduciary,” supersedes current rules (under Interpretive Bulletin 96-1) on investment education. Under the new regulation, activities that come within the definition of “investment education” are not “recommendations” within the meaning of the new rule and thus do not trigger fiduciary status.

The new rule tracks IB 96-1 in many respects, but there are some key differences. In this article we begin with background on why the education vs. advice distinction matters. We then provide a brief summary of the changes made by the new rules. Finally, we discuss the new rules in detail.

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 new Conflict of Interest regulation significantly expands 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 on the Final Best Interest Contract Exemption, 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.

Sponsors are generally only concerned with issue (1) – whether ERISA duties of loyalty and prudence apply. In that regard, even if the sponsor is, e.g., making specific recommendations, if it is not receiving a fee for doing so, it generally will not be a fiduciary. (The Preamble to the final rule states: “In the Department’s view, since only investment advice for a fee or compensation falls within the fiduciary definition, the fact that employers do not generally receive compensation in connection with their educational communications provides employers with a high level of confidence that their educational activities would not constitute investment advice under the rule.”)

But even if a sponsor is a fiduciary, it will generally not have issues (2) (self-dealing, etc.) and (3) (prohibited transactions): those issues are generally relevant only to “conflicted” outside 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.

Thus, the education-advice distinction (and the education “safe harbor”) generally matters most to outside (and conflicted) providers.

Summary of changes in the new rule

Under the current rule (IB 96-1), education generally includes: (1) plan information; (2) general information; (3) asset allocation models; and (4) interactive investment materials (e.g., software). Subject to certain conditions, asset allocation models and interactive materials may identify specific investment alternatives.

The new rule follows this general approach (e.g., retaining the categories “plan information,” “general information,” etc.). But, tracking the new Conflict of Interest regulation, it expands the education vs. advice rules to cover recommendations about distributions and recommendations with respect IRAs. Unlike the proposal, subject to certain conditions the final regulation allows (that is, treats as “education” and not “advice”) asset allocation models and interactive materials to identify specific designated investment alternatives (DIAs). DIAs are defined in DOL’s 2010 participant disclosure regulations. Generally, they do not include investments only available in a brokerage window.

Final rule in detail

We review the final rule here in detail because it will be “the law of investment education” in the future (that is, when the new rule finally, fully applies).

Under the final rule, a “recommendation” does not include, and therefore investment advice fiduciary status is not triggered by, furnishing or making available any of the following categories of information:

Plan information – describing the terms or operation of the plan or IRA, the benefits of participation or of increasing contributions, the impact of preretirement withdrawals on retirement income, retirement income needs, varying forms of distributions, the advantages/disadvantages of different forms of distributions, or the product features, fees, trading restrictions, investment objectives and philosophies, risk and return characteristics, or historical return information of investment alternatives.

General financial, investment and retirement information – describing financial, investment, and retirement matters unrelated to specific investment alternatives/distribution options and describing general financial and investment concepts (e.g., risk and return, diversification, dollar cost averaging, compounded return, and tax deferred investment), the historic differences in rates of return between different asset classes, the effects of fees and expenses on rates of return, the effects of inflation, estimating future retirement income needs, determining investment time horizons, assessing risk tolerance, retirement-related risks (e.g., longevity risks), and general strategies for managing retirement assets (e.g., systematic withdrawals or annuitization).

Asset allocation models – information/materials (e.g., pie charts, graphs, or case studies) providing model asset allocation portfolios, provided: they are based on generally accepted investment theories; they are accompanied by all material facts and assumptions; and they are accompanied by a statement that, in applying particular asset allocation models to their individual situations, participants should consider their other assets, income, and investments.

Asset allocation models may not “include or identify any specific investment product or investment alternative” except that, with respect to a plan (but not an IRA), they may identify a DIA, provided the model: (1) identifies all other DIAs under the plan that have similar risk and return characteristics; and (2) is accompanied by a statement indicating that those other DIAs have similar risk and return characteristics and identifying where information on them may be obtained.

Interactive investment materials – questionnaires, worksheets, software, and similar materials, provided: they are based on generally accepted investment theories; there is an objective correlation between the asset allocations/income streams and the information and data supplied by the participant; they are accompanied by all material facts and assumptions; and they either take into account the participant’s other assets or are accompanied by an appropriate disclaimer.

Interactive materials may not “include or identify any specific investment alternative or distribution option,” unless either the alternative/option is specified by the participant or, with respect to a plan (but not an IRA), the alternative is a DIA, and the materials:

Identify all the other DIAs available under the plan that have similar risk and return characteristics; and

Are accompanied by a statement indicating that those other DIAs have similar risk and return characteristics and identifying where information on them may be obtained.

Except as noted above, “education” may not include specific investment/investment management recommendations.

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Participant investment education remains a useful tool in helping participants responsibly manage their 401(k) assets. The final regulation improves on the proposal in many respects, especially, with respect to asset allocation “education,” by allowing the identification of specific investments in certain circumstances.