investment advice to 401(k) plan participants 1...ized investment advice to plan partici-pants...

ClientALERT

Februa r y 2 00 2

New DOL Guidance: Financial Services Firms Can Provide 401(k) PlanParticipants with Asset Allocation Advice Payable out of Plan Assets: Advicemay Result in Plan Investment in Funds Managed by the Adviser or its AffiliateMany employers would like to haveinvestment professionals provideguidance to 401(k) plan participantsin making investment decisions relat-ing to the employees’ individualaccounts, but do not do so because ofERISA prohibited transaction and lia-bility concerns. However, the U.S.Department of Labor (“DOL”) hasissued a new Advisory Opinion (the“Opinion”), which indicates that aninvestment adviser’s provision ofasset allocation services to 401(k) andsimilar individual account plan partici-pants would not result in a prohibitedtransaction under ERISA – evenwhere the asset allocation adviceresults in plan investments in fundsmanaged by the adviser or its affiliate.The DOL’s position is premised onthe condition that the asset allocationrecommendations are the product ofa computer program developed by anindependent financial expert. The feefor the asset allocation services maybe paid out of plan assets.

The Opinion provides comfort forfinancial services firms interested inproviding individualized investmentadvice to plan participants. TheOpinion is particularly timely in lightof employers’ heightened attention to401(k) plan investments in the wakeof Enron, and as Congress continuesto consider legislation that wouldamend ERISA to provide further

freedom for firms to offer individual-ized investment advice to plan partici-pants (without the need for an inde-pendent financial expert). While theOpinion does not appear to breaknew legal ground, it is nevertheless asignificant development as manyinvestment advisers and plan sponsorshave previously been reluctant tooffer individualized investment adviceto plan participants on a large scalebasis.

Description of the SunAmericaProgramThe Opinion was issued in responseto an application for an ERISA pro-hibited transaction exemption submit-ted on behalf of SunAmericaRetirement Markets, Inc.(“SunAmerica”). The DOL indicatedthat it issued an advisory opinion,rather than an exemption, because ofits determination that the transactionsdescribed in the application would notviolate section 406(b) of ERISA (theself-dealing rule under ERISA). Asdescribed in the Opinion,SunAmerica will offer its asset alloca-tion program to participant-directedindividual account plans. A plan fidu-ciary independent of SunAmerica willmake the decision to cause the plan toparticipate in the program (followingfull disclosure regarding the program).Under the program, individualized

model asset allocation portfolios willbe developed for each plan partici-pant, taking into account individual-ized participant data collected bySunAmerica or its representatives.

SunAmerica will offer two differenttypes of services under the program:a “discretionary” service and a “rec-ommended” service. If the plansponsor or other fiduciary selects the“discretionary” service, the modelallocations will be implemented auto-matically for each participant(although the participant may be per-mitted to elect out of the allocationin accordance with the plan’s invest-ment election procedures). If the“recommended” service is selected,the participant may choose whetheror not to implement the recommend-ed investment allocation. The modelportfolios are generated by computerprograms that apply a methodologydeveloped, maintained, and overseenby a financial expert that is independ-ent of SunAmerica. The independentexpert would be paid by SunAmerica,but its fees from SunAmerica couldnot exceed 5% of its total revenues.

SunAmerica’s fee for these services,payable out of plan assets, will be afixed percentage (up to 100 basispoints) of plan assets invested in theplan’s designated investment funds.SunAmerica may also receive up to

Paul, Hastings, Janofsky & Walker LLP

another 25 basis points as reimburse-ment of its direct expenses in con-nection with the arrangement. Theinvestment funds in which participantaccount assets would be investedcould include both SunAmerica fundsand other funds to be selected by theplan sponsor or other fiduciary (andnot by SunAmerica).

DOL’s Legal AnalysisSunAmerica sought “safe harbor”exemptive relief from ERISA’s self-dealing rules in connection with theprogram out of concern that a poten-tial ERISA self-dealing violationcould arise from the receipt bySunAmerica or its affiliates of com-pensation from the funds in whichparticipant account assets were invest-ed based on investment advicereceived under the program. TheDOL concluded, however, that no perse violation of section 406(b) ofERISA would result from this pro-gram because individual investmentdecisions would not be the result ofSunAmerica’s exercise of fiduciaryauthority, control, or responsibility(though SunAmerica would be a fidu-ciary in connection with the pro-gram). The DOL indicated that itsconclusion was premised on the factthat: (i) the plan fiduciaries responsi-ble for selecting the program wouldbe fully informed about and approvethe program; (ii) the investment rec-

ommendations would be developedby an independent expert; and (iii) noaspect of the relationship between theindependent expert and SunAmericawould be related to the fee incomethat SunAmerica would receive frominvestments made pursuant to theprogram.

It is important to note that DOL offi-cials have informally indicated that ifthe “discretionary” option is selected,the plan sponsor would not be able torely on ERISA section 404(c) protec-tion (whereby the plan sponsor wouldbe relieved of certain liabilities for theparticipant’s investment decisions).On the other hand, where the “rec-ommended” service is selected, thereseems to be no reason why section404(c) protection for the plan sponsorwould not be available.

Impact of the OpinionIn light of the opinion, many finan-cial services firms are consideringwhether to develop and market anadvisory service that is similar to theSunAmerica program, or to await theoutcome of ERISA investment advicelegislation currently pending inCongress. Under legislation proposedby Representative Boehner, a financialinstitution could provide investmentadvice to plan participants withoutemploying an independent expert todevelop the asset allocation recom-mendations. While some constituen-

cies have voiced opposition to the billbecause of conflict of interest con-cerns, there appears to be consider-able momentum on this issue inWashington at this time, particularlyin light of the Enron case and othercases involving 401(k) investmentlosses.

A copy of the Opinion is attached foryour reference.

If you have any questions regardingthis Advisory Opinion, please do nothesitate to contact any of the mem-bers of our ERISA – InvestmentManagement team.

Lawrence J. Hass (NY) (212) 318-6401

Ethan Lipsig (LA)(213) 683-6304

Anthony A. Dreyspool (NY) (212) 318-6601

Susan G. Curtis (NY) (212) 318-6919

Jocelyn M. Sturdivant (WDC) (202) 508-9567

Joshua H. Sternoff (NY) (212) 318-6011

Stephen H. Harris (LA) (213) 683-6217

Bethany Cheever (NY) (212) 318-6854

Nicole K. Watson (NY) (212) 318-6309

Client Alert is published solely for the interest of friends and clients of Paul, Hastings, Janofsky & Walker LLP and should in no way berelied upon or construed as legal advice. For specific information on recent developments or particular factual situations, the opinion oflegal counsel should be sought. Paul, Hastings, Janofsky & Walker LLP is a limited liability partnership.

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