Class Exemption for Provision of Investment Advice, Notice of Proposed Class Exemption

Class Exemption for Provision of Investment Advice, Notice of Proposed Class Exemption

Score
37 / 60
62%
Proposed Rule
RIN Number:
1210-ZA14
Release Date:
August 22, 2008
Agency:
Department of Labor

RULE SUMMARY

This document contains a notice of pendency before the Department of Labor (Department) of a proposed class exemption from certain prohibited transaction restrictions of the Employee Retirement Income Security Act of 1974, as amended (ERISA, or the Act), and from certain taxes imposed by the Internal Revenue Code of 1986, as amended (Code). If granted, the proposed exemption would permit the provision of investment advice described in section 3(21)(A)(ii) of the Act by a fiduciary adviser to a participant or beneficiary in an individual account plan or individual retirement accounts (and certain similar plans), the acquisition, holding or sale of a security or other property pursuant to the investment advice, and the direct or indirect receipt of fees or other compensation by the fiduciary adviser (or any employee, agent, registered representative or affiliate thereof) in connection with such transactions. The proposed exemption, if granted, would affect sponsors, fiduciaries, participants and beneficiaries of participant-directed individual account plans, as well as providers of investments and investment advice-related services to such plans. (This proposed exemption complements a companion regulation, 1210-AB13, which implements the statutory exemption.) Unlike the statutory exemption and proposed regulations, however, the class exemption would provide relief for individualized investment advice to individuals following the furnishing of recommendations generated by a computer model or, in the case of IRAs with respect to which modeling is not feasible, the furnishing of certain investment education material. Also, unlike the statutory exemption and proposed regulations, the class exemption, as discussed below, applies the fee-leveling limits solely to the compensation received by the employee, agent or registered representative providing the advice on behalf of the fiduciary adviser, as distinguished from compensation received by the fiduciary adviser on whose behalf the employee, agent, or registered representative is providing such advice.


METHODOLOGY

There are twelve criteria within our evaluation within three broad categories: Openness, Analysis and Use. For each criterion, the evaluators assign a score ranging from 0 (no useful content) to 5 (comprehensive analysis with potential best practices). Thus, each analysis has the opportunity to earn between 0 and 60 points.

Criterion Score

Openness

1. How easily were the RIA , the proposed rule, and any supplementary materials found online?
The proposed rule says the RIA is in the companion proposed statutory exemption rule, so the reader must do additional searching to find it. A link to both proposals is four intuitive clicks from the home page via the "laws and regulations" heading on EBSA's page. A search using the regulation's name and "proposed regulation" immediately produces links to the proposed regulation. The proposed rule is also available on regulations.gov.
2/5
2. How verifiable are the data used in the analysis?
Sources are extensively documented, though not always linked.
3/5
3. How verifiable are the models and assumptions used in the analysis?
The analysis uses extensive documentation with references to academic, industry, and government research. It takes pretty careful reading to discern whether the assumptions are just "assumptions" or actually grounded in evidence. For some assumptions, the RIA requests comment since it's a proposed rule.
4/5
4. Was the analysis comprehensible to an informed layperson?
Results are clear. The analysis uses some jargon, usually related to the law or regulation itself. It takes a very careful reading to discern how the statutory exemption is different from the class exemption and how the separate analysis of each is justified.
3/5

Analysis

5. How well does the analysis identify the desired outcomes and demonstrate that the regulation will achieve them?
4/5
Does the analysis clearly identify ultimate outcomes that affect citizens’ quality of life?
Yes, increased investment returns due to better investment advice.
5/5
Does the analysis identify how these outcomes are to be measured?
Yes, reduction in costs attributable to bad investment decisions. The RIA says, "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."
5/5
Does the analysis provide a coherent and testable theory showing how the regulation will produce the desired outcomes?
It makes the plausible argument that more information will reduce errors.
4/5
Does the analysis present credible empirical support for the theory?
Research and/or survey results are presented supporting the claims that more advice leads to better investment outcomes, advice is used, and some advice is not given due to current laws and regulations.
3/5
Does the analysis adequately assess uncertainty about the outcomes?
The analysis considers uncertainty in rate of error reduction and percent of investors the advice reaches. The RIA performs a sensitivity analysis of uncertainty in estimate of investment error reduction.
5/5
6. How well does the analysis identify and demonstrate the existence of a market failure or other systemic problem the regulation is supposed to solve?
4/5
Does the analysis identify a market failure or other systemic problem?
A systemic problem may be biased investment decisions. The analysis argues that regulatory barriers to information dissemination exacerbate this. "Such informational and behavioral problems translate into at least five distinct types of investment mistakes, which together generate financial losses (including foregone earnings) of $109 billion or more annually 15 for DC plan and IRA participants, the Department estimates." The identification of and explanation of several problems is a good practice.
4/5
Does the analysis outline a coherent and testable theory that explains why the problem (associated with the outcome above) is systemic rather than anecdotal?
See above.
4/5
Does the analysis present credible empirical support for the theory?
Research suggests that advice reduces error. The survey suggests that some advice is not given due to regulation.
4/5
Does the analysis adequately assess uncertainty about the existence or size of the problem?
The regulation assumes that the existence of the problem is not uncertain and that it won't clear itself up, but it doesn't explicitly say that. Therefore, there is no relevant or explicit content on the likelihood that the problem will occur. Ranges of estimates are often presented. This is reinforced by uncertainty analysis applied to benefits. So there is some acknowledgement of uncertainty about the size of the problem.
2/5
7. How well does the analysis assess the effectiveness of alternative approaches?
3/5
Does the analysis enumerate other alternatives to address the problem?
The analysis considers no action, or just issuance of the statutory exemption without the additional class exemption.
3/5
Is the range of alternatives considered narrow (e.g., some exemptions to a regulation) or broad (e.g., performance-based regulation vs. command and control, market mechanisms, nonbinding guidance, information disclosure, addressing any government failures that caused the original problem)?
The regulation itself does not consider a broad range of options, but the option selected does leave a great deal of flexibility in compliance: "This proposed regulation consequently provides for transparency and procedural rigor but generally does not attempt to specify precise and fixed substantive standards. For example, pursuant to the proposed regulation the experts’ qualifications will be reviewed by a fiduciary, and each certification will be documented in detail. The proposed regulation also provides that models may be certified once for similar applications across multiple DC plans or IRAs, rather than separately for each individual application, thereby promoting affordability of arrangements using models." Therefore, the range of options would appear to be broad versus narrow, recognizing the variety of models that could be certified in the future.
4/5
Does the analysis evaluate how alternative approaches would affect the amount of the outcome achieved?
The RIA assesses benefits of statutory exemption with and without the additional class exemption. It also shows incremental vs. cumulative effects.
4/5
Does the analysis adequately address the baseline? That is, what the state of the world is likely to be in the absence of federal intervention not just now but in the future?
The analysis assumes that the baseline is the current practice. It is careful not to count some errors that will be eliminated by other changes in the law as a benefit of this regulation. The categories of "No advice" and "Pre-PPA advice" appear to be comparisons for PPA and class exemptions as baselines. The baseline isn't explicitly stated however, achieving little relevant content.
1/5
8. How well does the analysis assess costs and benefits?
3/5
Does the analysis identify and quantify incremental costs of all alternatives considered?
The analysis considers costs of the proposed alternative.
3/5
Does the analysis identify all expenditures likely to arise as a result of the regulation?
The analysis identifies expenditures, though the justification for the number is vague.
3/5
Does the analysis identify how the regulation would likely affect the prices of goods and services?
It identifies cost of information, but not costs associated with investment advice that exploits conflicts of interest. The analysis identifies very clearly how the prices of the services offered would be affected in table form, but mostly in annual billions and not on an individual basis.
3/5
Does the analysis examine costs that stem from changes in human behavior as consumers and producers respond to the regulation?
Behavioral changes due to improved information are well analyzed. But investment advisor exploitation of conflicts of interest could be a significant consumer cost. The RIA acknowledges this but simply says it's part of the cost of bad advice, or good advice not acted upon, with no justification for the size of the assumed effect. The RIA has also asked for comments about behavioral effects: "The opening of large new markets to a variety of investment advice arrangements to which they were heretofore closed may affect the evolution of investment advice products and services and related technologies and their distribution channels and respective market shares. Other possible indirect effects that the Department lacks bases to estimate include financial market impacts of changes in investor behavior and related macroeconomic effects. The Department invites comments on how to improve this analysis, with particular attention to the assessment and explanation of attendant uncertainty, and how such analysis could be carried out. Comments that include specific suggestions or data to help support our analysis of impacts and the characterization of uncertainty would be especially useful." The content is therefore somewhat relevant as the RIA is seeking to improve its measurement of changes resulting from the regulation.
3/5
If costs are uncertain, does the analysis present a range of estimates and/or perform a sensitivity analysis?
No range of costs are presented.
0/5
Does the analysis identify the alternative that maximizes net benefits?
The approaches considered that are relevant to this particular class exemption are no action, issuance of just the statutory exemption, or issuance of the class exemption along with the statutory exemption. The RIA clearly identifies which approach offers the greatest net benefits.
5/5
Does the analysis identify the cost-effectiveness of each alternative considered?
Table 5 shows the value of investment error reduced per dollar of advice. But this is provided only for the alternatives chosen, not for all the alternative tweaks.
3/5
Does the analysis identify all parties who would bear costs and assess the incidence of costs?
It appears that the participants in the investment are both the bearers of the cost and the recipients of the benefits, with benefits still exceeding the cost. But it isn't explicitly mentioned that they're the only bearers. The analysis provides relevant content, but does not follow through. It recognizes costs will be different for IRAs and defined benefit pension plans and uses different cost figures for each. Figures chosen are not well documented.
2/5
Does the analysis identify all parties who would receive benefits and assess the incidence of benefits?
The analysis does not emphasize this. However, table 7 shows effects on participants in small defined-contribution plans.
2/5

Use

9. Does the proposed rule or the RIA present evidence that the agency used the analysis?
The proposed rule states that DOL chose the class exemption because it allows an additional segment of the advisory industry to offer significant benefits. The RIA quantified these benefits.
4/5
10. Did the agency maximize net benefits or explain why it chose another alternative?
See above.
4/5
11. Does the proposed rule establish measures and goals that can be used to track the regulation's results in the future?
It does not make a commitment to do this, but the RIA provides a good framework for developing measures and goals.
1/5
12. Did the agency indicate what data it will use to assess the regulation's performance in the future and establish provisions for doing so?
It does not make a commitment to do this, but data like those used in the RIA could be tracked in the future to assess the regulation.
2/5
Total 37 / 60
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