Investment Advice-Participants and Beneficiaries, 49896-49923 [E8-19272]

Agencies

• Employee Benefits Security Administration
• DEPARTMENT OF LABOR

[Federal Register Volume 73, Number 164 (Friday, August 22, 2008)]
[Proposed Rules]
[Pages 49896-49923]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E8-19272]



[[Page 49895]]

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Part V





Department of Labor





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Employee Benefits Security Administration



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29 CFR Parts 2550



Investment Advice--Participants and Beneficiaries; Proposed Class 
Exemption for the Provision of Investment Advice to Participants and 
Beneficiaries of Self-Directed Individual Account Plans and IRAs; 
Proposed Rule; Notice

Federal Register / Vol. 73, No. 164 / Friday, August 22, 2008 / 
Proposed Rules

[[Page 49896]]


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DEPARTMENT OF LABOR

Employee Benefits Security Administration

29 CFR Part 2550

RIN 1210-AB13


Investment Advice--Participants and Beneficiaries

AGENCY: Employee Benefits Security Administration, DOL.

ACTION: Proposed rule.

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SUMMARY: This document contains proposed regulations implementing the 
provisions of the statutory exemption set forth in sections 408(b)(14) 
and 408(g) of the Employee Retirement Income Security Act, as amended 
(ERISA or the Act), and parallel provisions in the Internal Revenue 
Code of 1986, as amended (Code), relating to the provision of 
investment advice described in the Act by a fiduciary adviser to 
participants and beneficiaries in participant-directed individual 
account plans, such as 401(k) plans, and beneficiaries of individual 
retirement accounts (and certain similar plans). Section 408(b)(14) 
provides an exemption from certain prohibited transaction provisions in 
ERISA with respect to the provision of investment advice, the 
investment transaction entered into pursuant to the advice, and the 
direct or indirect receipt of fees or other compensation by the 
fiduciary adviser or an affiliate in connection with the provision of 
advice or the transaction pursuant to the advice. Section 408(g) 
describes the conditions under which the investment advice-related 
transactions are exempt. Upon adoption, the regulations will affect 
sponsors, fiduciaries, participants and beneficiaries of participant-
directed individual account plans, as well as providers of investment 
and investment advice-related services to such plans.

DATES: Written comments on the proposed regulations should be submitted 
to the Department of Labor on or before October 6, 2008.

ADDRESSES: To facilitate the receipt and processing of comment letters, 
the Employee Benefits Security Administration (EBSA) encourages 
interested persons to submit their comments electronically by e-mail to 
e-ORI@dol.gov (Subject: Investment Advice Regulations), or by using the 
Federal eRulemaking portal at https://www.regulations.gov (follow 
instructions for submission of comments). Persons submitting comments 
electronically are encouraged not to submit paper copies. Persons 
interested in submitting paper copies should send or deliver their 
comments to the Office of Regulations and Interpretations, Employee 
Benefits Security Administration, Attn: Investment Advice Regulations, 
Room N-5655, U.S. Department of Labor, 200 Constitution Avenue, NW., 
Washington, DC 20210. All comments will be available to the public, 
without charge, online at https://www.regulations.gov and https://
www.dol.gov/ebsa and at the Public Disclosure Room, N-1513, Employee 
Benefits Security Administration, U.S. Department of Labor, 200 
Constitution Avenue, NW., Washington, DC 20210.

FOR FURTHER INFORMATION CONTACT: Fred Wong, Office of Regulations and 
Interpretations, Employee Benefits Security Administration, (202) 693-
8500. This is not a toll-free number.

SUPPLEMENTARY INFORMATION:

A. Background

    Section 3(21)(A)(ii) of ERISA includes within the definition of 
``fiduciary'' a person that renders investment advice for a fee or 
other compensation, direct or indirect, with respect to any moneys or 
other property of a plan, or has any authority or responsibility to do 
so.\1\ The prohibited transaction provisions of ERISA and the Code 
prohibit an investment advice fiduciary from using the authority, 
control or responsibility that makes it a fiduciary to cause itself, or 
a party in which it has an interest that may affect its best judgment 
as a fiduciary, to receive additional fees. As a result, in the absence 
of a statutory or administrative exemption, fiduciaries are prohibited 
from rendering investment advice to plan participants regarding 
investments that result in the payment of additional advisory and other 
fees to the fiduciaries or their affiliates.
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    \1\ See also Code section 4975(e)(3)(B); 29 CFR 2510.3-21(c).
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    With the growth of participant-directed individual account plans, 
there has been an increasing recognition of the importance of 
investment advice to participants and beneficiaries in such plans. Over 
the past several years, the Department of Labor (Department) has issued 
various forms of guidance concerning when a person would be a fiduciary 
by reason of rendering investment advice and when the provision of 
investment advice might result in prohibited transactions.\2\ Most 
recently, Congress and the Administration, responding to the need to 
afford participants and beneficiaries greater access to professional 
investment advice, amended the prohibited transaction provisions of 
ERISA and the Code, as part of the Pension Protection Act of 2006 
(PPA),\3\ to permit a broader array of investment advice providers to 
offer their services to participants and beneficiaries responsible for 
investment of assets in their individual accounts and, accordingly, for 
the adequacy of their retirement savings.
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    \2\ See Interpretative Bulletin relating to participant 
investment education, 29 CFR Sec.  2509.96-1 (Interpretive Bulletin 
96-1); Advisory Opinion (AO) 2005-10A (May 11, 2005); AO 2001-09A 
(December 14, 2001); and AO 97-15A (May 22, 1997).
    \3\ Public Law 109-280, 120 Stat. 780 (Aug. 17, 2006).
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    Specifically, section 601 of the PPA added a statutory exemption 
under sections 408(b)(14) and 408(g) of ERISA. Parallel provisions were 
added to the Code at section 4975(d)(17) and 4975(f)(8).\4\ Section 
408(b)(14) sets forth the investment advice-related transactions that 
will be exempt from the prohibitions of section 406 if the requirements 
of section 408(g) are met. The transactions described in section 
408(b)(14) are: The provision of investment advice to the participant 
or beneficiary with respect to a security or other property available 
as an investment under the plan; the acquisition, holding or sale of a 
security or other property available as an investment under the plan 
pursuant to the investment advice; and the direct or indirect receipt 
of compensation by a fiduciary adviser or affiliate in connection with 
the provision of investment advice or the acquisition, holding or sale 
of a security or other property available as an investment under the 
plan pursuant to the investment advice.
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    \4\ Under Reorganization Plan No. 4 of 1978 (43 FR 47713, 
October 17, 1978), 5 U.S.C. App.1, 92 Stat. 3790, the authority of 
the Secretary of the Treasury to issue rulings under section 4975 of 
the Code has been transferred, with certain exceptions not here 
relevant, to the Secretary of Labor. Therefore, the references in 
this notice to specific sections of ERISA should be taken as 
referring also to the corresponding sections of the Code.
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    On December 4, 2006, the Department published a Request for 
Information (RFI) in the Federal Register soliciting information to 
assist the Department in the development of regulations under sections 
408(b)(14) and 408(g).\5\ Specifically, the Department invited 
interested persons to address the qualifications for the ``eligible

[[Page 49897]]

investment expert'' that is required to certify that computer models 
used in connection with the statutory exemption meet the requirements 
of the statutory exemption. The Department also invited interested 
persons to provide information to assist the Department in developing 
procedures to be followed in certifying that a computer model meets the 
requirements of the statutory exemption. The Department also invited 
suggestions for a model disclosure form for purposes of the statutory 
exemption. In response to the RFI, the Department received 24 letters 
addressing a variety of issues presented by the statutory exemption. 
These comments have been taken into account in developing the proposed 
regulations.
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    \5\ 71 FR 70429, Dec. 4, 2006. The Department, on the same date, 
also published a Request for Information in the Federal Register 
soliciting information to assist the Department in determining the 
feasibility of using computer models in connection with individual 
retirement accounts, as required by PPA section 601(b)(3). 72 FR 
70427, Dec. 4, 2006.
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    On February 2, 2007, the Department issued Field Assistance 
Bulletin 2007-01 addressing certain issues presented by the new 
statutory exemption. This Bulletin affirmed that the enactment of 
sections 408(b)(14) and (g) did not invalidate or otherwise affect 
prior guidance of the Department relating to investment advice and that 
such guidance continues to represent the views of the Department.\6\ 
The Bulletin also confirmed the applicability of the principles set 
forth in section 408(g)(10) [Exemption for plan sponsor and certain 
other fiduciaries] to plan sponsors and fiduciaries who offered 
investment advice arrangements with respect to which relief under the 
statutory exemption is not required. Finally, the Bulletin addressed 
the scope of the fee-leveling requirement for purposes of an eligible 
investment advice arrangement described in section 408(g)(2)(A)(i). The 
Department's views on that issue are set forth in the discussion of the 
proposed regulations that follows.
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    \6\ In this regard, the Department cited the following: August 
3, 2006 Floor Statement of Senate Health, Education, Labor and 
Pensions Committee Chairman Enzi (who chaired the Conference 
Committee drafting legislation forming the basis of H.R. 4), 
regarding investment advice to participants in which he states, ``It 
was the goal and objective of the Members of the Conference to keep 
this advisory opinion [AO 2001-09A, SunAmerica Advisory Opinion] 
intact as well as other pre-existing advisory opinions granted by 
the Department. This legislation does not alter the current or 
future status of the plans and their many participants operating 
under these advisory opinions. Rather, the legislation builds upon 
these advisory opinions and provides alternative means for providing 
investment advice which is protective of the interests of plan 
participants and IRA owners.'' 152 Cong. Rec. S8,752 (daily ed. Aug. 
3, 2006) (statement of Sen. Enzi).
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    The proposed regulations contained in this notice would, upon 
adoption, implement the provisions of the statutory exemption for the 
provision of investment advice to participants and beneficiaries under 
sections 408(b)(14) and 408(g). In this regard, the Department notes 
that, in an effort to ensure broad availability of investment advice to 
both participants and beneficiaries in individual account plans and 
beneficiaries with individual retirement accounts, the Department also 
is publishing a proposed class exemption for the provision of 
investment advice to such individuals. The proposed class exemption 
appears in the Notice section of today's Federal Register.

B. Overview of Proposed Sec.  2550.408g-1

1. General

    In general, proposed Sec.  2550.408g-1 tracks the requirements 
under section 408(g) that must be satisfied in order for the investment 
advice-related transactions described in section 408(b)(14) to be 
exempt from the prohibitions of section 406.
    Paragraph (a) of the proposal sets forth the general scope of the 
statutory exemption and regulation as providing relief from the 
prohibitions of section 406 of ERISA for transactions described in 
section 408(b)(14) of ERISA in connection with the provision of 
investment advice to a participant or a beneficiary if the investment 
advice is provided by a fiduciary adviser under an ``eligible 
investment advice arrangement.'' Paragraph (a) also notes that the Code 
contains parallel provisions at section 4975(d)(17) and (f)(8).
    Paragraph (b) of the proposal provides that, for purposes of 
sections 408(g)(1) of ERISA and section 4975(f)(8) of the Code, an 
``eligible investment advice arrangement'' shall mean an arrangement 
that meets either the requirements of paragraph (c) [describing 
investment advice arrangements that use fee-leveling] or paragraph (d) 
[describing investment advice arrangements that use computer modeling] 
of the proposal or both.

2. Fee-Leveling

    With respect to arrangements that use fee-leveling, paragraph (c) 
of the proposal requires that any investment advice be based on 
generally accepted investment theories that take into account the 
historic returns of different asset classes over defined periods of 
time, although nothing in the proposal is intended to preclude 
investment advice from being based on generally accepted investment 
theories that take into account additional considerations. Paragraph 
(c) also requires that any investment advice take into account 
information furnished by a participant or beneficiary relating to age, 
life expectancy, retirement age, risk tolerance, other assets or 
sources of income, and investment preferences, although nothing in the 
proposal is intended to preclude a fiduciary adviser from taking into 
account additional information that a participant or beneficiary may 
provide. While section 408(g)(2)(A)(i) does not specifically reference 
such conditions, the principles are so fundamental to the provision of 
informed, individualized investment advice that a failure on the part 
of a plan fiduciary to insist on such conditions in the selection of an 
investment adviser for plan participants would, in the Department's 
view, raise serious questions as to the fiduciary's exercise of 
prudence. For this reason, the Department determined that such 
conditions are sufficiently significant that they should be included in 
the regulation implementing the statutory exemption for investment 
advice.
    With regard to compensation and fees for the provision of 
investment advice, paragraph (c)(1)(iii) provides that any fees or 
other compensation (including salary, bonuses, awards, promotions, 
commissions or other things of value) received, directly or indirectly, 
by any employee, agent or registered representative that provides 
investment advice on behalf of a fiduciary adviser does not vary 
depending on the basis of any investment option selected by a 
participant or beneficiary. Paragraph (c)(1)(iv) provides that any fees 
(including any commission or other compensation) received by the 
fiduciary adviser for investment advice or with respect to the sale, 
holding, or acquisition of any security or other property for purposes 
of investment of plan assets do not vary depending on the basis of any 
investment option selected by a participant or beneficiary.
    The individual compensation requirement in paragraph (c)(1)(iii) is 
designed to safeguard against a firm's creation of incentives for 
individuals to recommend certain investment products. It appears that, 
while an individual may have a general interest in the overall success 
of his or her employing firm, this interest, by itself, would not be 
inconsistent with the individual compensation requirement. This would 
not be the case, however, if the individual's direct or indirect 
compensation or benefits vary based on the selection of particular 
investment options. In order to determine whether more precise guidance 
can be developed, we request public comment on the types and 
formulations of direct and indirect compensation arrangements being 
utilized, and how they may operate under this provision.

[[Page 49898]]

    With regard to the foregoing, the Department, in interpreting the 
scope of the fee-leveling requirement for purposes of section 
408(g)(2)(A)(i), expressed its view, in Field Assistance Bulletin 2007-
01 (February 2, 2007), that only the fees or other compensation of the 
fiduciary adviser may not vary. In contrast to other provisions of 
section 408(b)(14) and section 408(g), the Department explained, 
section 408(g)(2)(A)(i) references only the fiduciary adviser, not the 
fiduciary adviser or an affiliate. Inasmuch as a person, pursuant to 
section 408(g)(11)(A), can be a fiduciary adviser only if that person 
is a fiduciary of the plan by virtue of providing investment advice, an 
affiliate of a registered investment adviser, a bank or similar 
financial institution, an insurance company, or a registered broker 
dealer will be subject to the varying fee limitation only if that 
affiliate is providing investment advice to plan participants and 
beneficiaries. The Department further noted that, consistent with past 
guidance, if the fees and compensation received by an affiliate of a 
fiduciary that provides investment advice do not vary or are offset 
against those received by the fiduciary for the provision of investment 
advice, no prohibited transaction would result solely by reason of 
providing investment advice and thus there would be no need for a 
prohibited transaction exemption.\7\ The Department, therefore, 
concluded that Congress did not intend for the requirement that fees 
not vary depending on the basis of any investment options selected to 
extend to affiliates of the fiduciary adviser, unless, of course, the 
affiliate is also a provider of investment advice to a plan. This 
continues to be the view of the Department.
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    \7\ See AO 2005-10A; AO 97-15A.
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    The Department also noted in the Bulletin that, although section 
408(g)(11)(A) generally limits ``fiduciary advisers'' to certain types 
of entities, it also permits employees, agents, or registered 
representatives of those entities to also qualify as fiduciary advisers 
if they satisfy the requirements of applicable insurance, banking, and 
securities laws relating to the provision of the advice. See section 
408(g)(11)(A)(vi). As with affiliates, such an individual must, for 
purposes of section 408(g)(11)(A), not only be an employee, agent, or 
registered representative of one of those entities, but also must 
provide investment advice in his or her capacity as employee, agent, or 
registered representative. The Department, therefore, concluded that 
the language of section 408(g)(11)(A) required a finding that, for 
purposes of the statutory exemption, when an individual acts as an 
employee, agent or registered representative on behalf of an entity 
engaged to provide investment advice to a plan, that individual, as 
well as the entity, must be treated as the fiduciary adviser for 
purposes of section 408(g)(11)(A) and, accordingly subject to the 
limitations of section 408(g)(2)(A)(i). In an effort to accommodate a 
wider variety of business structures and practices, making investment 
advice more available while protecting participants and beneficiaries, 
the Department is proposing a class exemption addressing fee leveling 
requirements for employees, agents and registered representatives, also 
appearing in today's Federal Register.
    In addition to the foregoing, fiduciary advisers utilizing 
investment advice arrangements that employ fee-leveling must comply 
with the requirements of paragraphs (e) [authorization by plan 
fiduciary], (f) [audits], (g) [disclosure], (h) [miscellaneous], and 
(i) [maintenance of records] of the proposal, each of which is 
discussed in more detail below.

3. Computer Models

    Paragraph (d) of the proposal addresses the requirements applicable 
to investment advice arrangements that rely on computer models. In this 
regard, paragraph (d) provides, consistent with the provisions of 
section 408(g)(3)(B), (C) and (D), that an arrangement shall be an 
eligible investment advice arrangement if the only investment advice 
provided under the arrangement is advice that is generated by a 
computer model described in paragraphs (d)(1) and (2) of this section 
under an investment advice program, and with respect to which the 
requirements of paragraphs (e) [authorization by plan fiduciary], (f) 
[audits], (g) [disclosure], (h) [miscellaneous], and (i) [maintenance 
of records] of the proposal are met and any acquisition, holding or 
sale of a security or other property pursuant to such advice occurs 
solely at the direction of the participant or beneficiary.
    Paragraph (d)(1), consistent with section 408(g)(3)(B)(i)-(v), sets 
forth the standards applicable to computer models. Specifically, 
paragraph (d)(1) requires that a computer model be designed and 
operated to: apply generally accepted investment theories that take 
into account the historic returns of different asset classes over 
defined periods of time, although nothing in the proposal is intended 
to preclude a computer model from applying generally accepted 
investment theories that take into account additional considerations; 
utilize information furnished by a participant or beneficiary relating 
to age, life expectancy, retirement age, risk tolerance, other assets 
or sources of income, and investment preferences, although nothing in 
the proposal precludes a computer model from taking into account 
additional information that a plan or a participant or beneficiary may 
provide; and utilize appropriate objective criteria to provide asset 
allocation portfolios comprised of investment options available under 
the plan. See paragraph (d)(1)(i)-(iii) of the proposal.
    In addition to the foregoing, a computer model, consistent with 
section 408(g)(3)(B)(iv),\8\ must be designed and operated to avoid 
investment recommendations that: inappropriately favor investment 
options offered by the fiduciary adviser or a person with a material 
affiliation or material contractual relationship with the fiduciary 
adviser over other investment options, if any, available under the 
plan; or inappropriately favor investment options that may generate 
greater income for the fiduciary adviser or a person with a material 
affiliation or material contractual relationship with the fiduciary 
adviser. In order to determine if further guidance can be developed 
with respect to this provision, the Department seeks public comment on 
circumstances under which it would be appropriate or inappropriate to 
favor particular investment options. For example, the Department 
believes that favoring a higher-cost investment alternative over an 
otherwise identical investment alternative with lower cost would be 
inappropriate.
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    \8\ Pursuant to section 408(g)(3)(B)(iv), a computer model must 
operate ``in a manner that is not biased in favor of investments 
offered by the fiduciary adviser or a person with a material 
affiliation or contractual relationship with the fiduciary 
adviser.''
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    As reflected in the language, a computer model would not fail to 
meet this requirement merely because the only investment options 
offered under the plan are options offered by the fiduciary adviser or 
a person with a material affiliation or material contractual 
relationship with the fiduciary adviser. The language also makes clear 
that models cannot be designed and operated to inappropriately favor 
those investment options that generate the most income for the 
fiduciary adviser or a person with a material affiliation or material 
contractual relationship with the fiduciary adviser. The proposal 
defines

[[Page 49899]]

a ``material affiliation'' and ``material contractual relationship'' at 
paragraphs (j)(6) and (j)(7), respectively.
    Paragraph (d)(1) further requires, consistent with section 
408(g)(3)(B)(v),\9\ that computer models take into account all 
``designated investment options'' available under the plan without 
giving inappropriate weight to any investment option. See paragraph 
(d)(1)(v) of the proposal. The term ``designated investment option'' is 
defined in paragraph (j)(1) of the proposal, to mean any investment 
option designated by the plan into which participants and beneficiaries 
may direct the investment of assets held in, or contributed to, their 
individual accounts. The term ``designated investment option'' does not 
include ``brokerage windows,'' ``self-directed brokerage accounts,'' or 
similar plan arrangements that enable participants and beneficiaries to 
select investments beyond those designated by the plan.
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    \9\ Section 408(g)(3)(B)(v) provides that computer models must 
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.''
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    Paragraph (d)(1)(v) also provides that a computer model shall not 
be treated as failing to take all designated investment options into 
account merely because it does not take into account an investment 
option that constitutes an investment primarily in qualifying employer 
securities. Any such limitation on the investment advice to be 
generated by the computer model, however, must be disclosed to 
participants and beneficiaries under paragraph (g)(1)(vi) of the 
proposal, discussed below. Information received by the Department in 
response to both of its RFIs indicated that there are challenges 
attendant to developing computer models, which generally are based on 
underlying theories that rely on diversified asset classes, that 
address a single undiversified security, such as qualifying employer 
securities, in connection with generating investment recommendations 
that would enable a participant to construct a well-diversified 
investment portfolio. The Department is concerned that extending this 
requirement to qualifying employer securities might discourage 
arrangements based on utilization of a computer model, or otherwise 
limit their availability.\10\ Accordingly, the Department has excluded 
investments primarily in qualifying employer securities from the 
requirement of paragraph (d)(1)(v) of the proposal.
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    \10\ It should be noted that, even in the absence of 
individualized advice, participants are reminded on a quarterly 
basis, via their pension benefit statements, of the importance of 
maintaining a diversified portfolio. Model language for purposes of 
this disclosure was set forth in Field Assistance Bulletin 2006-03 
(Dec. 20, 2006). Among other things the model language provides that 
``[I]f you invest more than 20% of your retirement savings in any 
one company or industry, your savings may not be properly 
diversified. Although diversification is not a guarantee against 
loss, it is an effective strategy to help you manage investment 
risk.''
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    Paragraph (d)(2) of the proposal requires that, prior to 
utilization of the computer model, the fiduciary adviser obtain a 
written certification that the computer model meets the requirements of 
paragraph (d)(1), discussed above. If the model is modified in a manner 
that may affect its ability to meet the requirements of paragraph 
(d)(1), the fiduciary adviser, prior to utilization of the modified 
model, must obtain a new certification. With regard to the 
certification, paragraph (d)(2) requires that the fiduciary adviser 
obtain a certification that meets the requirements of paragraph (d)(4) 
from an ``eligible investment expert,'' within the meaning of paragraph 
(d)(3).
    Paragraph (d)(3) of the proposal defines an ``eligible investment 
expert'' to mean a person that, through employees or otherwise, has the 
appropriate technical training or experience and proficiency to 
analyze, determine and certify, in a manner consistent with paragraph 
(d)(4), whether a computer model meets the requirements of paragraph 
(d)(1) of this section; except that the term eligible investment expert 
does not include any person that has any material affiliation or 
material contractual relationship with the fiduciary adviser, with a 
person with a material affiliation or material contractual relationship 
with the fiduciary adviser, or with any employee, agent, or registered 
representative of the foregoing. After consideration of the public 
comments, the Department has concluded that it would be very difficult 
to define a specific set of academic or other credentials that would 
serve to define the appropriate expertise and experience for an 
eligible investment expert.
    Accordingly, under the proposal, it is the fiduciary adviser who is 
responsible for determining whether an eligible investment expert, 
itself or its employees, possesses the requisite training and 
experience to certify whether a given computer model meets the 
requirements of paragraph (d)(1) in a manner consistent with paragraph 
(d)(4) of the proposal. Paragraph (d)(5) of the proposal provides that, 
for purposes of the statutory exemption, the selection of the eligible 
investment expert by the fiduciary adviser is a fiduciary act governed 
by section 404(a)(1) of ERISA.
    The Department notes that, although the proposal gives latitude to 
a fiduciary adviser in selecting an eligible investment expert to 
certify a computer model, as the party seeking prohibited transaction 
relief under the exemption, the fiduciary adviser has the burden of 
demonstrating that all applicable requirements of exemption are 
satisfied with respect to its arrangement. We also note that section 
404 of ERISA requires the fiduciary adviser to act reasonably and 
prudently in its selection.
    Paragraph (d)(4) of the proposal provides that a certification by 
an eligible investment expert shall be in writing and contain the 
following: an identification of the methodology or methodologies 
applied in determining whether the computer model meets the 
requirements of paragraph (d)(1) of this section; an explanation of how 
the applied methodology or methodologies demonstrated that the computer 
model met the requirements of paragraph (d)(1) of this section; and a 
description of any limitations that were imposed by any person on the 
eligible investment expert's selection or application of methodologies 
for determining whether the computer model meets the requirements of 
paragraph (d)(1). In addition the certification is required to contain 
a representation that the methodology or methodologies were applied by 
a person or persons with the educational background, technical training 
or experience necessary to analyze and determine whether the computer 
model meets the requirements of paragraph (d)(1); and a statement 
certifying that the eligible investment expert has determined that the 
computer model meets the requirements of paragraph (d)(1). Finally the 
certification must be signed by the eligible investment expert.
    With regard to the certification described in paragraph (d)(4) of 
the proposal, public comments suggested a number of different 
approaches that could be followed in determining computer model 
consistency with the statutory criteria. The comments did not, however, 
suggest a single suitable approach. The Department, therefore, is wary 
of mandating a methodology under the proposal. The Department also 
believes that as computer models and their use under investment advice 
arrangements continue to develop, experts may need the flexibility to 
develop new methodologies for examining those models. Accordingly, 
paragraph (d)(4) does not require a particular methodology to be 
applied for purposes of certification.

[[Page 49900]]

4. Authorized by a Plan Fiduciary

    Consistent with the section 408(g)(4) of ERISA, the proposal 
provides, at paragraph (e), that the arrangement pursuant to which 
investment advice is provided to participants and beneficiaries must be 
expressly authorized by a plan fiduciary (or, in the case of an IRA, 
the IRA beneficiary) other than: the person offering the arrangement; 
any person providing designated investment options under the plan; or 
any affiliate of either. The proposal further provides that for 
purposes of such authorization, an IRA beneficiary will not be treated 
as an affiliate of a person solely by reason of being an employee of 
such person, thereby enabling employees of a fiduciary adviser to take 
advantage of investment advice arrangements offered by their employer 
under the exemption.

5. Annual Audit

    Paragraph (f) addresses the audit requirements of section 408(g)(6) 
of ERISA. Specifically, paragraph (f)(1) provides that the fiduciary 
adviser shall, at least annually, engage an independent auditor, who 
has appropriate technical training or experience and proficiency, and 
so represents in writing to the fiduciary adviser, to conduct an audit 
of the investment advice arrangements for compliance with the 
requirements of the proposal and within 60 days following completion of 
the audit, issue a written report to the fiduciary adviser and, except 
with respect to an arrangement with an IRA, to each fiduciary who 
authorized the use of the investment advice arrangement, consistent 
with paragraph (e) of the proposal, setting forth the specific findings 
of the auditor regarding compliance of the arrangement with the 
requirements of the proposal.
    Given the significant number of reports that an auditor would be 
required to send if the written report was required to be furnished to 
all IRA beneficiaries, the Department framed an alternative requirement 
for investment advice arrangements for IRAs. This alternative is set 
forth in paragraph (f)(2) of the proposal. The alternative provides 
that, with respect to an arrangements with an IRA, the fiduciary 
adviser shall, within 30 days following receipt of the report from the 
auditor, furnish a copy of the report to the IRA beneficiary or make 
such report available on its website, provided that such beneficiaries 
are provided information, along with other required disclosures (see 
paragraph (g) of the proposal), concerning the purpose of the report, 
and how and where to locate the report applicable to their account. 
With respect to making the report available on a website, the 
Department believes that this alternative to furnishing reports to IRA 
beneficiaries satisfies the requirement of section 104(d)(1) of the 
Electronic Signatures in Global and National Commerce Act (E-SIGN) \11\ 
that any exemption from the consumer consent requirements of section 
101(c) of E-SIGN must be necessary to eliminate a substantial burden on 
electronic commerce and will not increase the material risk of harm to 
consumers. The Department solicits comments on this finding. Paragraph 
(f)(2) also provides that, when the report of the auditor identifies 
noncompliance with the requirements of the regulation, the fiduciary 
adviser must send a copy of the report to the Department. As proposed, 
the fiduciary adviser must submit the report to the Department within 
30 days following receipt of the report from the auditor. The 
submission of this report will enable the Department to monitor 
compliance with the statutory exemption in those instances where there 
is no authorizing ERISA plan fiduciary to carry out that function.
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    \11\ 15 U.S.C. 7004(d)(1) (2000).
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    For purposes of paragraph (f) of the proposal, an auditor is 
considered independent if it does not have a material affiliation or 
material contractual relationship with the person offering the 
investment advice arrangement to the plan or any designated investment 
options under the plan. The terms ``material affiliation'' and 
``material contractual relationship'' are defined in paragraphs (j)(6) 
and (7) of the proposal.
    With regard to the scope of the audit, paragraph (f)(4) provides 
that the auditor shall review sufficient relevant information to 
formulate an opinion as to whether the investment advice arrangements, 
and the advice provided pursuant thereto, offered by the fiduciary 
adviser during the audit period were in compliance with the regulation. 
Paragraph (f)(4) further provides that it is not intended to preclude 
an auditor from using information obtained by sampling, as reasonably 
determined appropriate by the auditor, investment advice arrangements, 
and the advice pursuant thereto, during the audit period. The proposal, 
therefore, does not require an audit of every investment advice 
arrangement at the plan or fiduciary adviser-level or of all the advice 
that is provided under the exemption. In general, the proposal leaves 
to the auditor the determination as to the appropriate scope of their 
review and the extent to which they can rely on representative samples 
for determining compliance with the exemption.

6. Disclosure

    The disclosure provisions are set forth in paragraph (g) of the 
proposal and generally track the disclosure provisions of the statutory 
exemption at section 408(g)(6) of ERISA. In this regard, the proposal, 
at paragraph (g)(1), requires that the fiduciary adviser provide to 
participants and beneficiaries, prior to the initial provision of 
investment advice with regard to any security or other property offered 
as an investment option, a written notification describing: the role of 
any party that has a material affiliation or material contractual 
relationship with the fiduciary adviser in the development of the 
investment advice program, and in the selection of investment options 
available under the plan; the past performance and historical rates of 
return of the designated investment options available under the plan, 
to the extent that such information is not otherwise provided; all fees 
or other compensation relating to the advice that the fiduciary adviser 
or any affiliate thereof is to receive (including compensation provided 
by any third party) in connection with the provision of the advice or 
in connection with the sale, acquisition, or holding of the security or 
other property; and any material affiliation or material contractual 
relationship of the fiduciary adviser or affiliates thereof in the 
security or other property.
    The notification to participants and beneficiaries also is required 
to explain: the manner, and under what circumstances, any participant 
or beneficiary information provided under the arrangement will be used 
or disclosed; the types of services provided by the fiduciary adviser 
in connection with the provision of investment advice by the fiduciary 
adviser, including, with respect to an arrangement described in 
paragraph (d) utilizing a computer model, any limitations on the 
ability of the model to take into account an investment primarily in 
qualifying employer securities, as provided for in paragraph (d)(1)(v) 
of the proposal; that the adviser is acting as a fiduciary of the plan 
in connection with the provision of the advice; and that a recipient of 
the advice may separately arrange for the provision of advice by 
another adviser that could have no material affiliation with and 
receive no fees or other compensation in connection with the security 
or other property.

[[Page 49901]]

    Paragraph (g)(2) of the proposal requires that the notification 
furnished to participants and beneficiaries be written in a clear and 
conspicuous manner and in a manner calculated to be understood by the 
average plan participant and must be sufficiently accurate and 
comprehensive to reasonably apprise such participants and beneficiaries 
of the information required to be provided in the notification.
    The appendix to the proposal contains a model disclosure form that 
may be used for purposes of satisfying the fee and compensation 
disclosure requirement of paragraph (g)(1)(iii), as well as the 
requirements of paragraph (g)(2), of the proposal. The proposal makes 
clear, however, that the use of the model disclosure form is not 
mandatory.
    Paragraph (g)(3) makes clear that the required disclosures may be 
provided in written or electronic form.
    Paragraph (g)(4) of the proposal, like section 408(g)(6)(B) of 
ERISA, sets forth miscellaneous recordkeeping and furnishing 
responsibilities of the fiduciary adviser. Specifically, paragraph 
(g)(4) provides that, at all times during the provision of advisory 
services to the participant or beneficiary pursuant to the arrangement, 
the fiduciary adviser must: Maintain the information described in 
paragraph (g)(1) in accurate form; provide, without charge, accurate 
information to the recipient of the advice no less frequently than 
annually; provide, without charge, accurate information to the 
recipient of the advice upon request of the recipient; and provide, 
without charge, accurate information to the recipient of the advice 
concerning any material change to the information required to be 
provided to the recipient of the advice at a time reasonably 
contemporaneous to the change in information.

7. Other Conditions

    Paragraph (h) of the proposal, like section 408(g)(7) of ERISA, 
sets forth additional conditions applicable to the provision of advice 
under the statutory exemption. These requirements are as follows: The 
fiduciary adviser must provide appropriate disclosure, in connection 
with the sale, acquisition, or holding of the security or other 
property, in accordance with all applicable securities laws; the sale, 
acquisition, or holding occurs solely at the direction of the recipient 
of the advice; the compensation received by the fiduciary adviser and 
affiliates thereof in connection with the sale, acquisition, or holding 
of the security or other property is reasonable; and the terms of the 
sale, acquisition, or holding of the security or other property are at 
least as favorable to the plan as an arm's length transaction would be.

8. Maintenance of Records

    Paragraph (i) of the proposal sets forth the record maintenance 
requirements. Consistent with section 408(g)(9) of ERISA, paragraph (i) 
of the proposal provides that the fiduciary adviser must maintain, for 
a period of not less than 6 years after the provision of investment 
advice pursuant to the arrangement, any records necessary for 
determining whether the applicable requirements of the proposal have 
been met. Also, paragraph (i), as with section 408(g)(9), makes clear 
that a prohibited transaction shall not be considered to have occurred 
solely because the records are lost or destroyed prior to the end of 
the 6-year period due to circumstances beyond the control of the 
fiduciary adviser.

9. Definitions

    Paragraph (j) of the proposal sets forth a number of definitions 
relevant to the statutory exemption and this proposed regulation.
    Paragraph (j)(1), as discussed earlier, defines the term 
``designated investment option.'' Paragraph (j)(2) sets forth the 
definition of ``fiduciary adviser,'' as it appears in section 
408(g)(11)(A) of ERISA. With regard to that part of the fiduciary 
adviser definition that treats persons who develop computer models or 
market investment advice programs or computer models as a fiduciary of 
the plan by reason of providing investment advice and as a fiduciary 
adviser for purposes of section 408(b)(14), the Department is proposing 
a separate regulation (Sec.  2550.408g-2), discussed below, pursuant to 
which a single fiduciary adviser may elect to be treated as a fiduciary 
with the respect to the plan.
    Paragraph (j)(3) of the proposal adopts the statutory definition of 
``registered representative'' set forth in ERISA section 408(g)(11)(C), 
which states that a registered representative of another entity means a 
person described in section 3(a)(18) of the Securities Exchange Act of 
1934 (15 U.S.C. 78c(a)(18)) (substituting the entity for the broker or 
dealer referred to in such section) or a person described in section 
202(a)(17) of the Investment Advisers Act of 1940 (15 U.S.C. 80b-
2(a)(17)) (substituting the entity for the investment adviser referred 
to in such section).
    Paragraph (j)(4), consistent with section 601(b)(3)(A)(i) of the 
Pension Protection Act of 2006, defines the term ``Individual 
Retirement Account'' to mean plans described in paragraphs (B) through 
(F) of section 4975(e)(1) of the Code, as well as a trust, plan, 
account, or annuity which, at any time, has been determined by the 
Secretary of the Treasury to be described in such paragraphs.
    Paragraph (j)(5) of the proposed rule defines the term 
``affiliate.'' For purposes of the proposal, an ``affiliate'' of 
another person means: Any person directly or indirectly owning, 
controlling, or holding with power to vote, 5 percent or more of the 
outstanding voting securities of such other person; any person 5 
percent or more of whose outstanding voting securities are directly or 
indirectly owned, controlled, or held with power to vote, by such other 
person; any person directly or indirectly controlling, controlled by, 
or under common control with, such other person; and any officer, 
director, partner, copartner, or employee of such other person. 
Consistent with ERISA section 408(g)(11)(B), this definition is based 
on the definition of an ``affiliated person'' of an entity as contained 
in section 2(a)(3) of the Investment Company Act of 1940 (ICA), except 
that it does not reflect clauses (E) and (F) thereof. The Department 
has initially determined that including provisions similar to clauses 
(E) and (F) is unnecessary, because these clauses appear to focus on 
persons who exercise control over the management of an investment 
company.\12\ Also, such parties will nonetheless be treated as an 
affiliate because they would be a person directly or indirectly 
controlling, controlled by, or under common control with, such other 
person. See paragraph (j)(5)(iii) of the proposal. Additionally, the 
Department is concerned that including provisions similar to clauses 
(E) and (F), which focus on functions involving investment companies, 
but not other types of vehicles in which plans may invest, could have 
the unintended consequence of possibly subjecting persons associated 
with investment companies to different requirements under these 
proposed regulations. Therefore, the Department is proposing to define 
affiliate without regard to clauses (E) and (F) of section 2(a)(3) of 
the ICA.
---------------------------------------------------------------------------

    \12\ ICA section 2(a)(3)(E) and (F) include in the definition of 
affiliated person: If the other person is an investment company, any 
investment adviser thereof or any member of an advisory board 
thereof; and if such other person is an unincorporated investment 
company not having a board of directors, the depositor thereof. 15 
U.S.C. 80a-2(a)(3)(E)-(F).
---------------------------------------------------------------------------

    In a variety of places in the regulation reference is made to 
persons with

[[Page 49902]]

``material affiliations'' and ``material contractual relationships.'' 
See paragraphs (d)(1)(iv), (d)(3), (f)(3), (g)(1)(i), (g)(1)(iv) and 
(g)(1)(viii) of the proposal. For purposes of this regulation, those 
terms are defined in paragraphs (j)(6) and (j)(7), respectively.
    Paragraph (j)(6) of the proposal describes a person with a 
``material affiliation'' with another person as: Any affiliate of such 
other person; any person directly or indirectly owning, controlling, or 
holding, 5 percent or more of the interests of such other person; or 
any person 5 percent or more of whose interests are directly or 
indirectly owned, controlled, or held, by such other person. In 
determining ``interest,'' paragraph (j)(6)(ii) provides that an 
``interest'' means with respect to an entity: The combined voting power 
of all classes of stock entitled to vote or the total value of the 
shares of all classes of stock of the entity if the entity is a 
corporation; the capital interest or the profits interest of the entity 
if the entity is a partnership; or the beneficial interest of the 
entity if the entity is a trust or unincorporated enterprise.
    Paragraph (j)(7) of the proposal provides that persons shall be 
treated as having a ``material contractual relationship'' if payments 
made by one person to the other person pursuant to written contracts or 
agreements between the persons exceed 10 percent of the gross revenue, 
on an annual basis, of such other person. The Department believes that 
one person's receipt of more than 10 percent of gross revenue from 
another person is sufficiently significant to be considered material. 
However, the Department specifically invites comments on whether the 
percentage test should be higher or lower and, if so, why.
    The proposal, at paragraph (j)(8), defines ``control'' to mean the 
power to exercise a controlling influence over the management or 
policies of a person other than an individual.

C. Overview of Proposed Sec.  2550.408g-2

    Proposed Sec.  2550.408g-2, as indicated above, addresses the 
requirements for electing to be treated as a fiduciary and fiduciary 
adviser by reason of developing or marketing a computer model or an 
investment advice program used in an eligible investment advice 
arrangement. See section 408(g)(11)(A).
    Section 408(g)(11)(A) provides that, with respect to an arrangement 
that relies on use of a computer model to qualify as an ``eligible 
investment advice arrangement,'' a person who develops the computer 
model, or markets the investment advice program or computer model, 
shall be treated as a fiduciary of a plan by reason of the provision of 
investment advice referred to in ERISA section 3(21)(A)(ii) to the plan 
participant or beneficiary, and shall be treated as a ``fiduciary 
adviser'' for purposes of ERISA section 408(b)(14) and (g). Section 
4975(f)(8) of the Code contains a parallel provision to ERISA section 
408(g)(11)(A). Proposed Sec.  2550.408g-2 sets forth requirements that 
must be satisfied in order for one such fiduciary adviser to elect to 
be treated as a fiduciary under such an eligible investment advice 
arrangement. See paragraph (a) of Sec.  2550.408g-2.
    Paragraph (b)(1) of Sec.  2550.408g-2 provides that if an election 
meets the requirements of paragraph (b)(2) of the proposal, then the 
person identified in the election shall be the sole fiduciary adviser 
treated as a fiduciary by reason of developing or marketing a computer 
model, or marketing an investment advice program, used in an eligible 
investment advice arrangement. Paragraph (b)(2) requires that the 
election be in writing and that the writing: Identify the arrangement, 
and person offering the arrangement, with respect to which the election 
is to be effective; and identify the person who is the fiduciary 
adviser, the person who develops the computer model or markets the 
computer model or investment advice program with respect to the 
arrangement, and the person who elects to be treated as the only 
fiduciary, and fiduciary adviser, by reason of developing such computer 
model or marketing such computer model or investment advice program. 
Paragraph (b)(2) of Sec.  2550.408g-2 also requires that the election 
be signed by the person acknowledging that it elects to be treated as 
the only fiduciary and fiduciary adviser; that a copy of the election 
be furnished to the plan fiduciary who authorized use of the 
arrangement; and that the writing be retained in accordance with the 
record retention requirements of Sec.  2550.408g-1(i).

D. Effective Date

    The Department proposes that the regulations contained in this 
notice will be effective 60 days after publication of the final 
regulations in the Federal Register. The Department invites comments on 
whether the final regulations should be made effective on a different 
date.

E. Request for Comments

    The Department invites comments from interested persons on the 
proposed regulations. To facilitate the receipt and processing of 
comment letters, the Employee Benefits Security Administration (EBSA) 
encourages interested persons to submit their comments electronically 
by e-mail to e-ORI@dol.gov (Subject: Investment Advice Regulations), or 
by using the Federal eRulemaking portal at https://www.regulations.gov 
(follow instructions for submission of comments). Persons submitting 
comments electronically are encouraged not to submit paper copies. 
Persons interested in submitting paper copies should send or deliver 
their comments to the Office of Regulations and Interpretations, 
Employee Benefits Security Administration, Attn: Investment Advice 
Regulations, Room N-5655, U.S. Department of Labor, 200 Constitution 
Avenue, NW., Washington, DC 20210. All comments will be available to 
the public, without charge, online at https://www.regulations.gov and 
https://www.dol.gov/ebsa and at the Public Disclosure Room, N-1513, 
Employee Benefits Security Administration, U.S. Department of Labor, 
200 Constitution Avenue, NW., Washington, DC 20210.
    The comment period for the proposed regulations will end 45 days 
after publication of the proposed rule in the Federal Register. The 
Department believes that this period of time will afford interested 
persons an adequate amount of time to analyze the proposals and submit 
comments. Written comments on the proposed regulations should be 
submitted to the Department of Labor on or before October 6, 2008.

F. Regulatory Impact Analysis

Summary

    The Department anticipates that this proposed regulation and 
proposed class exemption, by extending quality, expert investment 
advice to more retirement plan participants, together will improve 
their investment results by approximately $14 billion or more annually, 
at a cost of $4 billion, thereby producing a net financial benefit of 
$10 billion or more. The improved investment results will reflect 
reductions in investment errors such as payment of higher than 
necessary fees and expenses, poor trading strategies, and inadequate 
diversification. The provisions of this proposed regulation and the 
conditions attached to this proposed class exemption reflect the 
Department's efforts to ensure that the advice provided pursuant to 
them will be affordable and of high quality.

Introduction

    Workers' retirement security increasingly depends on their 
investment decisions. Unfortunately

[[Page 49903]]

there is evidence that many participants and beneficiaries in 
participant-directed defined contribution (DC) plans and beneficiaries 
of individual retirement accounts (IRAs) (collectively hereafter, 
``participants''), beset by flawed information or reasoning, make poor 
investment decisions. These participants may pay higher fees and 
expenses than necessary for investment products and services, engage in 
excessive or poorly timed trading or fail to rebalance their 
portfolios, inadequately diversify their portfolios and thereby assume 
uncompensated risk, take more or less than optimal levels of 
compensated risk, and/or pay unnecessarily high taxes. Financial losses 
(including foregone earnings) from such mistakes likely amount to more 
than $100 billion per year. These losses compound and grow larger as 
workers progress toward and into retirement.
    Such mistakes and consequent losses historically can be attributed 
at least in part to provisions of federal law that effectively preclude 
a variety of arrangements whereby financial professionals might 
otherwise provide retirement plan participants with expert investment 
advice. These ``prohibited transaction'' provisions of ERISA and the 
Internal Revenue Code prohibit fiduciaries from dealing with DC plan or 
IRA assets in ways that advance their own interests. These provisions 
prohibit plan fiduciaries from exercising the authority, control, or 
responsibility that makes such persons fiduciaries when they have an 
interest which may conflict with the interests of the plan for which 
they act. Under these provisions financial advisers who have a direct 
or indirect stake in participants' investment decisions generally may 
not provide them with investment advice. In recognition that certain 
transactions could nonetheless be beneficial to plans and their 
participants and beneficiaries, subject to safeguards appropriate to 
protect against potential abuses, Congress enacted a number of 
statutory prohibited transaction exemptions, and also gave the 
Department conditional authority to grant prohibited transaction 
exemptions. In this regard, the prohibited transaction exemption for 
the provision of investment advice added by the Pension Protection Act 
of 2006 (PPA) opened the door to more types of investment advice 
arrangements by conditionally permitting arrangements where the 
fiduciary adviser or an affiliate thereof has a financial stake in the 
advised participants' investment decisions. The Department is proposing 
a regulation to further specify the PPA's applicable conditions, 
together with a class exemption to establish alternative conditions 
under which such arrangements may operate. Together these actions are 
intended to increase the availability of investment advice.
    The results of this proposed regulation and proposed class 
exemption will depend on their impacts on the availability, cost, use, 
and quality of participant investment advice. The Department expects 
that, as a result of these actions, quality, affordable advice will 
proliferate, producing significant net gains for participants.

Investment Mistakes

    The Department believes that many participants make costly 
investment mistakes and therefore could benefit from receiving and 
following good advice. In theory, investors can optimize their 
investment mix over time to match their investment horizon and personal 
taste for risk and return. But in practice many investors do not 
optimize their investments, at least not in accordance with generally 
accepted financial theories.
    Some investors fail to exhibit clear, fixed and rational 
preferences for risk and return. Some base their decisions on flawed 
information or reasoning. For example some appear to anchor decisions 
inappropriately to plan features or to mental accounts or frames, or to 
rely excessively on past performance measures or peer examples. Some 
suffer from overconfidence, myopia, or simple inertia.\13\
---------------------------------------------------------------------------

    \13\ See, e.g., Richard H. Thaler & Shlomo Benartzi, The 
Behavioral Economics of Retirement Savings Behavior, AARP Public 
Policy Institute White Paper 2007-02 (Jan. 2007); and Jeffrey R. 
Brown & Scott Weisbenner, Individual Account Investment Options and 
Portfolio Choice: Behavioral Lessons from 401(k) Plans, Social 
Science Research Network Abstract 631886 (Dec. 2004).
---------------------------------------------------------------------------

    Such informational and behavioral problems translate into at least 
five distinct types of investment mistakes,\14\ which together generate 
financial losses (including foregone earnings) of $109 billion or more 
annually \15\ for DC plan and IRA participants, the Department 
estimates.
---------------------------------------------------------------------------

    \14\ It should be noted that much of the research documenting 
investment mistakes does not account for whether advice was present 
or not. At least some of the mistakes may have been made despite 
good advice to the contrary; some may have been made pursuant to bad 
advice. There is evidence both that advice sometimes is not 
followed, and that it sometimes is bad. This is explored more below.
    \15\ As discussed below, this estimate is subject to wide 
uncertainty.
---------------------------------------------------------------------------

Fees and Expenses

    Investors sometimes pay higher fees and expenses than necessary for 
investment products and services. There is evidence that mutual funds 
with poorer gross performance (that is performance before deducting 
fees) also have higher fees. This suggests that higher fees sometimes 
do not reflect value added by managers. Investors often pay inadequate 
attention to fee differences, even in connection with highly comparable 
products like competing S&P 500 index funds.\16\
---------------------------------------------------------------------------

    \16\ A number of studies conclude that investors often pay 
higher fees than necessary.
    Javier Gil-Bazo & Pablo Ruiz-Verd[uacute], Yet Another Puzzle? 
Relation Between Price and Performance in the Mutual Fund Industry, 
Social Science Research Network Abstract 947448 (March 2007) find 
that funds with worse before-fee performance charge higher fees. 
They suggest that funds faced with insensitive investors charge 
higher fees, finding that even after controlling for performance 
sensitivity, funds with lower expected performance set higher fees. 
They hypothesize that lower performing funds lose sophisticated 
investors to higher performing funds, then are left with relatively 
unsophisticated investors who are not as responsive to price.
    According to Ali Hortacsu & Chad Syverson, Product 
Differentiation, Search Costs, and Competition in the Mutual Fund 
Industry: A Case Study of S&P 500 Index Funds, Social Science 
Research Network Abstract 405642 (April 2003), 75 percent of S&P 500 
Index Funds have expense ratios in excess of 47 basis points, 50 
percent in excess of 72 basis points and 25 percent in excess of 149 
basis points. The highest cost fund charged annualized investor fees 
that were nearly 30 times greater than the lowest-cost fund (268 vs. 
9.5 basis points). Low-cost funds have a dominant market share, but 
the asset share of the low-cost funds has fallen consistently since 
1995.
    Paul G. Mahoney, Manager-Investor Conflicts in Mutual Funds, The 
Journal of Economic Perspectives, Volume 18, Number 2 (2004) extends 
the Ali Hortacsu & Chad Syverson, Product Differentiation, Search 
Costs, and Competition in the Mutual Fund Industry: A Case Study of 
S&P 500 Index Funds, Social Science Research Network Abstract 405642 
(April 2003) result of two classes of investors, the experienced 
that buy low-cost no-load funds, and the novice who uses a broker 
and buys high-cost load funds. He finds that, even after separating 
the expense ratio into administrative fees and 12b-1 fees, funds 
with loads still have administrative fees 15 basis point higher than 
the no-load funds.
    Brad M. Barber et al., Out of Sight, Out of Mind, The Effects of 
Expenses on Mutual Fund Flows, Journal of Business, Volume 79, 
Number 6 2095, 2095-2119 (2005) find that investors are sensitive to 
load fees. They argue that front-end load fees are generally 
observable as a dollar amount on the first statement while the 
effects of administrative fees