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.

Questions and Answers

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.

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.

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.

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.

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.

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.

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 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.

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.

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.

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.

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.

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.

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.

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.

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:

• 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,

• 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

• 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.

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.

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.

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.

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.

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.

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