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Regulation and Compliance > Federal Regulation > DOL

Failure to Compute?

By Melanie Waddell

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Are computer models that meet the statutory requirements set out in the Pension Protection Act (PPA) an effective tool to use to provide investment advice to IRA owners and participants in 401(k) plans? The Securities Industry and Financial Markets Association’s (SIFMA) president and CEO, Marc Lackritz, told the Department of Labor (DOL) during a recent hearing that those computer models force individuals into a one-size-fits-all investing and advice approach that cannot offer the level of service provided by an investment advisor. The DOL is required to determine the feasibility of such computer models in the IRA marketplace and report its findings to Congress by year-end.

The PPA amended the Employee Retirement Income Security Act (ERISA) by adding a new prohibited transaction exemption that allows greater flexibility for investment advisors to give advice to participants in 401(k) plans and IRAs. Lackritz urged the DOL’s Employee Benefits Security Administration (EBSA) to issue a disclosure-based exemption for the provision of investment advice for IRAs. This means, in essence, says Liz Varley, managing director and retirement specialist at SIFMA, that an advisor “wouldn’t have to use a computer model at all.” SIFMA’s members, which include the more traditional wirehouse firms, “are using computer models,” but the model “is not the driver of what [solution] gets recommended,” she says. “That’s where the interaction with the advisor needs to come in.”

Computer models already exist for 401(k) plans. In 2002, DOL granted an advisory opinion to SunAmerica allowing the company to use a computer model created by a third-party provider for its 401(k) clients. It may be “feasible, but not very effective,” that a computer model could be used to help 401(k) participants, Varley says, because if a plan offers only 15 mutual funds, then “it’s not hard to have a model that takes into account those investment options.” However, when it comes to IRAs, owners can invest in anything–stocks, bonds, mutual funds, real estate, commodities, and so on.

An Argument That Doesn’t Hold Water

Don Trone, founder of fi360 and Fiduciary Analytics–which provides computer modeling based on defined fiduciary standards of care–says the argument that computer modeling is not suitable for IRAs because of the vast amount of investment selections that must be considered doesn’t hold water. “ERISA already makes clear that an investment advisor has to demonstrate the procedural prudence that they use to select any investment option,” Trone says. “That requirement alone has the effect of self-selecting regulated investment options.” He also argues that individuals could get adequate advice from computer models without help from an advisor if the modeling system adheres to ERISA standards that require “fiduciary rules-based technology,” which requires the system to exhibit “procedural prudence.”

While DOL’s proposal to Congress will only include recommendations on computer models for IRAs, Varley says it will be up to DOL to issue regulations that make 401(k) computer models “more usable.”

In a comment letter to DOL earlier this year, Jim Lang, compliance director of retirement and investor services at The Principal Financial Group, said no current computer model exists for IRAs that factors in “generally accepted investment theories that take into account the historical returns of different asset classes over defined periods of time; information about the beneficiary, including age, life expectancy, retirement age, and risk tolerance; and consideration of the full range of investments.” Lang said Principal “does not believe that it would be possible to develop a [computer] model that considers the full range of investment options or allows IRA beneficiaries to express qualitative personal preferences.” Lang said DOL should “replace the computer model with a class exemption that would allow IRA beneficiaries to receive investment advice without limitation,” and encouraged DOL “to establish criteria upon which the class exemption would be based, coupled with adequate disclosure, and allow the IRA beneficiary to determine whether the criteria are met.”

Washington Bureau Chief Melanie Waddell can be reached at [email protected].

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