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House Education and Labor Committee approves fee, advice and DB funding legislation

Jul 13, 2009

On June 24, 2009, the House Education and Labor Committee reported out a bill (H.R. 2989), requiring enhanced 401(k) plan fee disclosure, limiting the ability of investment managers and their affiliates to provide investment advice to 401(k) plan participants and providing (limited) defined benefit (DB) plan funding relief. The fee and advice provisions of the bill basically incorporate Congressman Miller's (D-CA), Chairman of the House Education and Labor Committee, 401(k) fee proposal and Congressman Andrews's (D-NJ), Chairman of the House Education and Labor Committee's Health, Employment, Labor and Pensions Subcommittee, advice proposal, in each case with some modifications. The DB funding proposals are new.

In this article we will review the bill's DB proposals in detail and will highlight the changes made to the Andrews advice and Miller fee proposals by the Committee. Our articles Chairman Miller re-introduces fee bill and Advice legislation introduced provide detail on those proposals.

DB funding proposals

The DB funding proposals in the bill have not been reported to be controversial and do not provide the relief hoped for by many plan sponsors and practitioners. The key elements are the following:

Allow sponsors to re-elect a smoothed yield curve for 2010

The combination of new, stricter Pension Protection Act (PPA) DB funding requirements and the fourth quarter 2008 financial downturn (and related decline in asset values) has put considerable stress on many DB plan sponsors. And, obviously, that stress is in addition to the stress put on those sponsors' businesses generally by the financial crisis.

As discussed in our article IRS publishes asset valuation guidance, in March, the IRS stated that it will allow, for 2009, the use of "spot rates" for any of the five "applicable lookback months" (rather than only for the month preceding the valuation date) to value 2009 defined benefit plan liabilities. Under this approach, calendar year plans can use the October 2008 PPA full yield curve for 2009 valuations, significantly reducing 2009 funding requirements. For many sponsors, this "rule" fixes DB funding concerns for 2009.

But a key question remains: Will sponsors be allowed, for 2010, to switch back to 24-month valuation interest rate smoothing? Doing so would be beneficial in a couple of ways. First, smoothing generally enhances predictability, reduces volatility and increases companies' ability to plan. And second, in this particular case, smoothing will allow consideration, again (in the 24-month average), of the "super-high" October and November 2008 interest rates.

It's not clear, however, whether the IRS will allow such a switchback to smoothing for plans that used October 2008 "spot rates" to value liabilities for 2009. H.R. 2989 would allow such a switchback, one time, in 2010.

Reasonable interpretation for 2009

The IRS has proposed rules implementing new PPA DB funding requirements, but it is unknown when those rules will be finalized. There are a number of controversial areas, and a number of areas where practitioners, generally, regard the approach taken by the IRS as impractical. As discussed in our article PPA effective dates, in Notice 2008-21, the IRS allowed (with certain limits) sponsors to adopt a reasonable interpretation of PPA rules for compliance in 2008. Here's the key language:

For plan years beginning during 2008, taxpayers must follow applicable statutory provisions and can rely on the proposed regulations for compliance with those statutory provisions. Taking into account [certain specific rules provided in the notice], the Service will not challenge a reasonable interpretation of an applicable statutory provision under [new PPA funding rules] or [new PPA funding-based benefit restriction rules] for plan years beginning during 2008.

With regulations still not finalized, a question remains about compliance in 2009. H.R. 2989 would, in effect, extend this reasonable interpretation treatment to include 2009. It also provides that the effective date of final regulations can be no earlier than 2010.

Investment expenses not part of target normal cost

Included in the Worker, Retiree, and Employer Recovery Act of 2008" (WRERA) was a requirement that a plan's target normal cost should be increased by "the amount of plan-related expenses expected to be paid from plan assets during the plan year." After WRERA passed, a number of practitioners raised questions about the application of this provision, pointing out that investment-related expenses have not historically been included as part of normal cost and, further, may not be explicitly reflected in trust returns for some investments, potentially producing inconsistent recognition of these costs for different investments. In essence, while explicit investment-related expenses would show up in current year funding requirements as part of the target normal cost, implicit expenses would generally be amortized over seven years. H.R. 2989 would provide "clarification" that the WRERA provision intended to increase normal cost by "plan-related administrative expenses" only.

Expanding the 4010 gateway

PPA changed the rules for ERISA section 4010 reporting. The issues of who must make a 4010 filing and what it must include are complicated and are treated in detail in our article PBGC finalizes rules for 4010 reporting.

PPA changed the rules for who must make a 4010 filing. The old rule provided for a filing if at the end of the preceding plan year the "aggregate unfunded vested benefits" of the DB plans of a controlled group of corporations (considering only those plans which were underfunded) exceeded $50 million. PPA replaced that rule with a requirement of a 4010 filing if at the end of the preceding plan year the funding target attainment percentage of a plan maintained by the contributing sponsor or any member of its controlled group is less than 80%.

H.R. 2989, in effect, adds to the new PPA test the old pre-PPA test: that is, under the bill, you have to make a 4010 filing if you would have had to under either the old test or the new one. The result: under the bill more companies will have to make 4010 filings.

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As we said, the DB funding relief in H.R. 2989 is not dramatic. Arguably it is not relief at all; it just mandates a flexible application of IRS proposed regulations. And the last item noted, the proposed new 4010 filing rule, is not relief; it's a tightening of the reporting standards.

Other members of Congress are considering more extensive DB funding relief, including a widening of the asset smoothing 110% corridor and a delay in amortization of 2008 asset losses. And, indeed, the proposals in H.R. 2989 may be regarded as a "placeholder" for more significant DB funding relief.

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Testing

Advice proposal

The full Education and Labor Committee generally adopted the advice proposal originally introduced by Congressman Andrews (D-NJ). Our article Congressman Andrews introduces advice legislation reviews that proposal in detail. Summarizing, and ignoring the nuances, Congressman Andrews's original proposal would have prohibited any advice, other than strictly model-driven advice, by any adviser that manages, or is affiliated with a person that manages, 401(k) investments. It appeared to go much further than even pre-PPA rules.

Since the bill was introduced in April, industry representatives and policymakers have been in conversations about whether the Andrews proposal went too far. A Health, Employment, Labor and Pensions Subcommittee markup was produced in early June that would have preserved certain exemptions and advisory opinions issued by the Department of Labor (DOL) under pre-PPA law. H.R. 2989 adopted some of the clarifying language from the subcommittee bill but, most significantly, did not adopt the language "blessing" pre-PPA exemptions and advisory opinions.

Here, as we see it, are the key changes made by H.R. 2989 to the Andrews bill as originally introduced:

Adviser independence

The Andrews bill would have required that, in order for an adviser to be "independent," the adviser (and any affiliate) could not provide or manage any investments in which plan assets of any individual account plan are invested.

H.R. 2989 makes two changes to this rule: First, it includes language that might be read as only requiring that the adviser (and any affiliate) not provide or manage any investments in which assets of the particular plan in question are invested.

And second, H.R. 2989 (following the subcommittee proposal) adds a new definition of “independent investment advisor” for the level fee provision (note this definition does not apply to the computer model, but does apply to the fee-based model).  The advisor may not be a “plan investment provider,” and specifically excludes:

investments managed by the plan sponsor

"any person who makes the investment available to the plan, or any participant or beneficiary in the plan, as a part of a portfolio of investment options, to the extent that the investment options are created and managed by a person who is not an affiliate of the person making such portfolio available." This language appears to treat as "independent" the managers of funds actually offered under the plan so long as they (and any affiliate) were not involved with the construction of the fund menu.

any managed account situation where the party exercising control is not affiliated to the underlying investment fund manager.

Additional model driven advice rules

H.R. 2989 would add additional requirements for model-driven advice programs. Under the bill, in addition to the requirements already in Andrews’ original proposal, such a program must:

operate so that it does not, directly or indirectly, in any manner act to benefit the investment adviser (or any affiliate) at the expense of plan participants

take into account the fees associated with each investment option

conform to such other requirements as shall be prescribed by DOL to ensure that it operates in the best interest of plan participants

Sponsor fiduciary protection

For sponsors implementing an advice program, a key question is: what will be my fiduciary responsibility, e.g., under what circumstances might I be liable for "bad advice?" Congressman Andrews' bill originally provided that sponsors are responsible for the "general prudence" of the advice program but – so long as the program is generally prudent – are not liable for one-off instances of "bad advice."

H.R. 2989, in effect, re-emphasizes these principles by adding the following language:

With regard to the prudent selection and periodic review of advisers:

[A]ny such requirement shall not be construed to preclude reasonable reliance by the plan sponsor or other person on the representation of any person that such person making the representation meets the requirements of section 3(43)(A).

With regard to the plan fiduciary not having a duty to monitor the specific investment advice given to a particular recipient:

[The fiduciary] shall not be liable under this title for any loss, or by reason of any breach, which results from such specific investment advice given by the independent investment adviser.

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Fee legislation

We summarized Congressman Miller's original (2009) 401(k) fee proposal in our article Chairman Miller re-introduces fee bill. The new version of that proposal included in H.R. 2989 includes a number of (generally minor) changes but remains unchanged in its fundamentals.

As a general matter, we analyze 401(k) fee disclosure legislation as applying to two different disclosure/information flows: (1) disclosures from providers to sponsors; and (2) disclosures from sponsors to participants.

Summarizing the highlights of H.R. 2989:

Provider-sponsor disclosure

The bill still requires providers to provide sponsors a service disclosure statement breaking down direct and indirect expenses into four categories – administrative, transaction-based, investment management and other.

With respect to "free" or discounted services, providers must still "specify the manner in which, the extent to which, and the amount by which consideration is otherwise obtained ... by means of any charges against the plan."

Some of the broader and more potentially problematic language concerning disclosure of conflicts has been dropped, but significant questions still remain about just how far disclosure of conflicts must go.

Language previously included that allowed reliance on information given by a government regulated entity has been eliminated.

The model provider-sponsor statement provided for in the original bill was eliminated.

Sponsor-participant disclosure

With respect to information on the required fee comparison chart, H.R. 2989 allows the use of a formula (such as a percentage of assets) – the bill introduced by Congressman Miller in April required that fees be described only as a dollar amount. And, the DOL, in consultation with the Securities and Exchange Commission, is tasked with determining "appropriate and consistent benchmarks, indices, or other points of comparison that may be used by beneficiaries to compare each investment option's historical returns, net of fees and expenses …." A provision for a DOL study of benchmarking was also added.

With respect to the enhanced quarterly statement provision, language requiring description of the "net return" on an account was eliminated.

Minimum investment option requirement

One of the more heatedly discussed elements of Congressman Miller's fee proposals has been a provision mandating the inclusion in the plan fund menu of a (presumably low-fee) passive investment option. The provision for that option in Congressman Miller's bill introduced in April was regarded by many commentators as problematic. It was revised in H.R. 2989; under the new bill, each plan wishing to maintain 404(c) protection must provide at least one investment option:

(A) which is a passively managed investment with a portfolio of securities that is designed to be representative of the United States investable equity market (including representation of small, mid, and large cap stocks) or the United States investment grade bond market (including Treasury, agency, non-agency, and corporate issues), or a combination thereof, and

(B) which is described in the terms of the plan as offered without any endorsement of the Government or the plan sponsor.

An investment shall not fail to satisfy the requirements of subparagraph (A) in connection with either market described in subparagraph (A) solely by reason of a failure to invest in all or substantially all equities or bonds (as applicable) in such market, if the methodology used to select the equities or bonds is designed to approximate in a reasonable manner the broad experience of such market.

While this language may have solved some of the concerns with this proposal, it remains a topic for considerable debate.

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The issues addressed in this bill are not at the top of Congress's priority list, or even the priority list for this committee. Health care reform is certainly getting more attention right now. Congressman Pomeroy (D-SD) has issued a "Discussion Draft of Pension Plan Funding Proposals," which go well beyond the DB funding proposals included in H.R. 2989. And, with respect to 401(k) fee disclosure, there are competing proposals in the House (most significantly from Congressman Neal (D-MA)). So – just how these proposals stand politically is unclear. We will continue to follow these issues.