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Print this pageComputer Model Investment Advice Programs
Employee Benefits Security Administration
U.S. Department of Labor
Testimony of
Jon Breyfogle
Managing Partner
Groom Law Group
July 31, 2007
Table of Contents
Introduction
The IRA Market
Feasibility of Computer Models in the IRA Market
Recommended Steps for the Department
Conclusion
Introduction
My name is Jon Breyfogle. I am the managing partner of the Groom Law Group and I have the pleasure of testifying on behalf of the Investment Company Institute. The Institute appreciates the opportunity to provide testimony on whether computer model advice programs are feasible for individual retirement accounts and other similar plans.
The interest of the Institute’s members in providing investment advice to IRA holders is substantial.1 Mutual funds are the investment vehicle of choice for IRAs. At year-end 2006, $2.0 trillion of the $4.2 trillion held in IRAs was invested in mutual funds.2 Mutual fund firms and their affiliates serve as providers of IRAs and related services, including investment advisory and management services. For years, the Institute supported legislation to increase the opportunities for participants in IRAs and ERISA plans to receive investment advice.
When Congress considered comprehensive pension reform legislation during the last Congress, it recognized the need to modify ERISA’s prohibited transaction rules to allow 401(k) and IRA investors to obtain investment advice from service providers that assume fiduciary status with respect to their advice and meet disclosure and other conditions. While the resulting statutory exemption for investment advice in the Pension Protection Act (“PPA”) presents significant interpretative challenges for the Department, it is clear that all policymakers expected the new exemption to foster advice programs that did not exist under current law.3 We think this policy objective – expanding available investment advice – should guide the Department in determining the feasibility of computer models and issuing other interpretive or regulatory guidance on the PPA exemption.
We greatly appreciate the important steps the Department took in Field Assistance Bulletin 2007-1 to confirm that the Department’s prior guidance on fee offsets (Frost Bank) and computer models (SunAmerica) remains viable, clarify the duties of plan fiduciaries that hire investment advice providers, and clarify the application of the fee leveling rules. But there is further work to be done if Congress’ goal of expanding available investment advice options is to be met. We think the Department should pursue the following dual tracks.
First, as explained more fully below, the Department should conclude that computer models that cover the full range of investments available to IRAs are not feasible and move promptly on issuing a class exemption. Second, the Department should issue clarifying regulations to facilitate use of the level fees option and, for ERISA plans, the computer model option. The Department should provide regulatory guidance that the “level fees” condition only applies to the fees paid to the person or entity that determines what investment advice is given to participants. The Department should also clarify that after a portfolio generated by a computer model for 401(k) participants has been presented, a fiduciary adviser may provide specific investment recommendations that deviate from the model at the request of the participant.
The IRA Market
The importance of providing flexible advisory programs in the IRA market cannot be understated, as the Institute’s extensive data on the IRA market illustrates. At the end of 2006, IRAs held more assets than all private defined contribution plans.4 IRAs held $4.2 trillion in assets in 2006, slightly more than a quarter of all assets set aside for retirement. Four out of ten, or 42.2 million, U.S. households had IRAs in 2006.5
Much of the growth in IRAs has been fueled by rollovers from employer plans. In 2004, the last year for which data are available, contributions to traditional IRAs were $12.3 billion, while $213.6 billion flowed into traditional IRAs in the form of rollovers. As of year-end 2004, about 45 percent of all IRA assets were held in traditional rollover IRAs.6
Americans use IRAs not only to accumulate assets for retirement but also to maintain their retirement savings in retirement. For example, Institute survey data found that in 2005 almost 70 percent of traditional IRA assets were held by households with a head of household age 50 or older.7 IRA owners, moreover, tend to preserve their assets well into retirement. In 2004, less than one-fifth of households owning traditional IRAs took withdrawals. For those that did, about three-quarters made the withdrawal to meet the Internal Revenue Code’s minimum distribution requirements, which require distributions to begin at age 70 1/2.8
When Americans roll their savings from 401(k) plans to IRAs they are faced with a new array of investment choices. Unlike most 401(k) plans, which have a limited menu of investment options selected by plan fiduciaries, IRAs are specifically permitted to invest in virtually anything other than collectibles and life insurance. While some IRA providers limit the number or kinds of investment options they make available, many providers permit IRA holders to invest in the full range of permitted investments. Institute data shows that over 6,200 mutual funds are available for IRA investors.9 There are over 5,000 U.S. publicly traded companies that offer stocks and debt securities.10 IRAs can also invest in foreign securities, currency instruments, futures, options, insurance products, hedge funds, limited partnerships, and group or collective trusts.
Given the importance of IRAs in accumulating and preserving retirement savings, and the array of investment choices for IRAs, the Institute believes that there is a compelling need to provide IRA investors with effective access to investment advisory services.
Feasibility of Computer Models in the IRA Market
The PPA amended ERISA and the Internal Revenue Code to provide a statutory exemption for the provision of investment advice to ERISA plans and IRAs. Under the Exemption, a “fiduciary adviser” may provide advice to participants and beneficiaries and receive direct or indirect compensation in connection with the advice under an “eligible investment advice arrangement.” There are two alternative means to offer an eligible arrangement. Either the arrangement must meet the “level fees” condition, or it must use a computer model that meets certain conditions.
Computer models are required to use generally accepted investment theories, use relevant participant information (which may include current age, retirement age, life expectancy, risk tolerance), operate in a manner that is not biased in favor of the fiduciary advisor or affiliated party, and be periodically “certified” by an “eligible investment expert” as meeting the requirements of the exemption.11 The statute also specifically requires that the model –
take[] into account all investment options under the plan in specifying how a participant’s account balance should be invested and is not inappropriately weighted with respect to any investment option. . . 12
Congress recognized that the computer model may not be suitable in the IRA market and called on the Department to determine whether such models are feasible. In making this determination, the Department must determine if there is -- any computer model investment advice program which . . . takes into account the full range of investments, including equities and bonds, in determining the options for the investment portfolio of the account beneficiary . . . 13
If the Department determines that there is no computer model that “takes into account the full range of investments” (and meets the other standards), then the Department is required to issue a class exemption that has terms generally consistent with the statutory exemption, but without the computer modeling condition.
The critical interpretive question for the Department in making this determination is what it means to “take[] into account the full range of investments, including equities and bonds.” We recognize that there may be different interpretations of the meaning of this phase, and we appreciate that the Department has some discretion in interpreting this provision. That said, the Institute believes that the most natural reading of the statute is that a computer model must consider each possible IRA investment.14 This would require a model to include equities and bonds, of which there are thousands, to evaluate all the investment options on an ongoing basis, and to continually update the model in light of market changes and the issuance of new securities. We think this reading is what Congress intended by the “takes into account the full range of investments, including equities and bonds” criterion.
There is no indication in the PPA that Congress contemplated that a computer model would meet the statutory criteria if it limited the universe of investments in providing IRA advice. In the exemption itself for IRAs and ERISA plans Congress stated that the model must “take into account all investment options under the plan . . .” In contrast, in the IRA feasibility provision, Congress was more specific about the range of investments that must be modeled. There are no words of limitation in that provision that would expressly allow an IRA program to take into account only the investment options or asset classes available from a particular IRA provider or available under a particular advisory program or model. It is a settled rule of statutory construction that differences in language are a clear indication that Congress intended different meanings.15
The question for the Department then is whether a computer model exists that takes into account the full range of IRA investments. The Institute conducted a survey of its members to determine if any members currently have such a program. The twenty Institute members that responded to the survey held over $4.2 trillion in mutual fund assets at the end of 2005, of which $831 billion were held in IRAs, about half of the IRA assets invested in mutual funds. The respondents include most of the Institute’s largest members, many of which have large retirement businesses and well-developed investor services programs. No respondent to the survey indicated that it has a computer model that takes into account the full range of IRA investments.
Recommended Steps for the Department
Based on our reading of the PPA’s requirements, and the results of the Institute’s survey, we believe there is no computer model that can account for all of the investment options generally available in the IRA market place. We urge the Department to reach this conclusion, to report its findings to Congress as soon as possible, and to begin work on a proposed IRA class exemption with a goal of proposing the exemption by year-end.
The Department’s class exemption for IRA investment advice should recognize that Congress understood that a separate exemption for IRAs was likely to be needed. Given the wide range of IRA investments, we think that the IRA class exemption should be considerably more flexible than the PPA’s statutory exemption for ERISA plans and should accommodate advice derived from computer models that limit the universe of modeled investment as well as advice that is not prescribed by a model. This approach would not constrain an IRA holder’s ability to choose to obtain advice either from a provider offering a limited IRA universe or from a provider making the full range of investments available. It also would not impede the ability of IRA providers to maintain their chosen business model. The key elements of a class exemption should be robust upfront and ongoing disclosures of the financial interests and investment affiliations of the fiduciary advisor. We will be pleased to provide specific recommendations on how the Department could craft an IRA class exemption that meets PPA standards.
Conclusion
The PPA places significant responsibility on the Department to determine how investment advice will be provided in the IRA market. In using its authority, the Department should keep in mind Congress’ clear intent to expand opportunities for IRA holders to receive advice from IRA providers and their affiliates. Because computer models do not exist that model the full range of IRA investments, the Department should promptly craft a class exemption for IRA advice that will provide an alternative means for IRA holders to receive investment advice.
Endnotes
1 ICI members include 8,766 open-end investment companies (mutual funds), 670 closed-end investment companies, 440 exchange-traded funds, and four sponsors of unit investment trusts. Mutual fund members of ICI have total assets of approximately $11.242 trillion (representing 98 percent of all assets of U.S. mutual funds); these funds serve approximately 93.9 million shareholders in more than 53.8 million households.
2 Investment Company Institute, “The U.S. Retirement Market, 2006,” Fundamentals, vol. 16, no. 3 (July 2007). Americans have dramatically shifted how they invest their IRAs. In 1990, 42 percent of IRA assets were held in banks and thrift deposits. In 2006, only 7 percent of IRA assets were held in such deposits. Over the same period, the percentage of IRA assets invested in mutual funds increased from 22 percent to 47 percent.
3 On the day the PPA was signed, President Bush stated that the Act “would provide greater access to professional advice about investing safely for retirement.” Senator Enzi, Chairman of the Conference Committee, lauded the Exemption as “providing much needed financial advice and guidance for the millions of workers and their families on how to invest their hard earned monies for retirement . . . .” 151 Cong. Rec. S8752 (Aug. 3. 2006). Senator Kennedy stated that “Workers who participate in retirement savings plans will have greater access to investment advice to help them manage their retirement savings.” Id. at S8754.
4 Investment Company Institute, “The U.S. Retirement Market, 2006,” Fundamentals, vol. 16, no. 3 (July 2007).
5 Investment Company Institute, 2007 Investment Company Fact Book, § 7.
6 Investment Company Institute, “The U.S. Retirement Market, 2006,” Fundamentals, vol. 16, no. 3 (July 2007).
7 Source: Investment Company Institute IRA Owners Survey.
8 Investment Company Institute, “The Role of IRAs in Americans’ Retirement Preparedness,” Fundamentals, vol. 15, no. 1 (January 2006).
9 Calculated based on confidential data submitted to the Institute for the monthly trends report; data as of November 2006.
10 World Federation of Exchanges (December 2006).
11 Numerous added conditions are imposed on all eligible arrangements, regardless of whether the arrangement uses the level fees or computer model approach.
12 ERISA § 408(g)(3)(B); Code § 4975(f)(8)(C)(ii)(V) (emphasis added).
13 PPA § 601(b)(3)(B)(ii) (emphasis added).
14 See Norman J. Singer, Statutes & Statutory Construction § 46:01 (2000) (“In the absence of a specific indication to the contrary, words used in the statute will be given their common, ordinary and accepted meaning, and the plain language of the statute should be afforded its plain meaning.”).
15 See id. § 46:06 (“When the legislature uses certain language in one part of the statute and different language in another, the court assumes different meanings were intended.”).
