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Investment Advice - Participants and Beneficiaries
Proposed Rule
Score: 33 / 60
RULE SUMMARY
This document contains a proposed rule under the Employee Retirement Income Security Act, and parallel provisions of the Internal Revenue Code of 1986, relating to the provision of investment advice to participants and beneficiaries in individual account plans, such as 401(k) plans, and beneficiaries of individual retirement accounts (and certain similar plans). Upon adoption, the proposed rule would implement provisions of a statutory prohibited transaction exemption, and would replace guidance contained in a final rule, published in the Federal Register on January 21, 2009, that was withdrawn by the Department pursuant to a Notice published in the Federal Register on November 20, 2009. Upon adoption, the proposed rule affects 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.
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, which includes a 2 page regulatory analysis section, is available via regulations.gov. A link to the proposed rule is 2 clicks away from Labor's home page; just click on EBSA, then "proposed rules." It's also available from the department's home page via a RIN search. Most of the 2010 regulatory analysis still depends on the analysis of the 2008 proposed rule. To get all of the underlying analysis, one must also locate the final 2009 rules on this topic and the 2008 proposed rules. Both are mentioned in the regulatory analysis section, but no explicit citations or links are given. They can be found 2 clicks from the Labor Department's home page that same way this proposed 2010 regulation can be found. The ease of finding the proposed regulation would normally qualify for a higher score, but the fact that the reader must search for several other documents justifies a lower score. | 4/5 |
| 2. How verifiable are the data used in the analysis? Original 2008 analysis cited sources extensively but did not always link them. The only new data in the 2010 analysis are the year-end 2008 values of IRA and defined-contribution plan assets. The RIA says these data were used for the recalculations of costs and benefits but provides no source. The RIA refers to prior RIAs but does not provide links. | 2/5 |
| 3. How verifiable are the models and assumptions used in the analysis? The 2008 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 2010, the department deleted its previous assumption that the proposed "class expemtion" would protect investors from advidors' conflicts of interest. No documentation is provided for this assumption other than an assertion that commenters cast doubt on it. The footwork here has been done in former analyses, so cross-referencing puts models and assumptions farther removed from the current analysis. | 3/5 |
| 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. It is very difficult to follow how the 2010 analysis reached its conclusions because, instead of presenting a revised RIA, the 2-page regulatory analysis section merely states how it is different from the RIA for the 2009 final rule, which in turn mostly refers back to the 2008 RIA for the proposed rule. Thus, the reader must cross-check three separate documents to understand the full analysis on which the 2010 proposal is based. | 2/5 |
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? Improved investment returns due to better investment advice. | 5/5 |
| Does the analysis identify how these outcomes are to be measured? Reduction in costs attributable to bad investment decisions. The RIA monetizes the prospective improvement investment returns, and has adjusted them to exclude the effect of the class exemption due to its withdrawal: "The Department has now updated its estimates of the costs and benefits of the proposed regulation to reflect the withdrawal of the class exemption... The estimates provided show three possible impacts for the proposed regulation: "low" estimates assume that all of those who would have received advice pursuant to the class exemption instead remain unadvised, "mid" estimates assume that one-half receive advice pursuant to the PPA statutory exemption, and "high" estimates assume that all receive such advice." The revised 2010 analysis estimates that the proposed exemptions will reduce investment errors by $5.5-10.9 billion annually at a cost of $1.5-3.1 billion, for net benefits of $3.9-7.8 billion. | 5/5 |
| Does the analysis provide a coherent and testable theory showing how the regulation will produce the desired outcomes? It presents a 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 2008 analysis considers uncertainty in rate of error reduction and the percent of investors the advice reaches. Analysis in the 2009 final rule admits much greater uncertainty, presenting the estimated effects as a "reasonable upper bound." The 2010 analysis adds a range of estimates that show the effects of varying assumptions about the effect of Labor's decision to eliminate the separate "class exemption." | 4/5 |
| 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? The analysis identifies two systemic problems: some investors make poor decisions due to "imperfect information, search costs, and behavioral biases," and investment advisors may have conflicts of interest that could taint the advice they give. The puzzle the regulation seeks to solve is how to permit advisors to provide more information while preventing them from biasing that information in ways that harm investors but generate more income for advisors. "As documented in the Department's regulatory impact analysis of the August 2008 proposed regulation, there is evidence that many participants in participant-directed defined contributions (DC) plans and beneficiaries of individual retirement accounts (IRAs) (collectively hereafter, "participants") make poor investment decisions due to flawed information or reasoning." 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? The conflict of interest problem is explained in terms of investment advisors' incentives. The investor information and behavior problems are postulated more than explained. | 4/5 |
| Does the analysis present credible empirical support for the theory? Cited research suggests that advice reduces error. A 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 2008 analysis assumed that the existence of the problem is certain but the size is uncertain, and it presented some ranges of benefits estimates. In the 2009 RIA, the department pulled back from its strong claim that the evidence shows investors pay inefficiently high prices for investments, admitting that may not be supported by the research. This is a greater acknowledgement of uncertainty about the problem than previously. | 3/5 |
| 7. How well does the analysis assess the effectiveness of alternative approaches? | 4/5 |
| Does the analysis enumerate other alternatives to address the problem? Three main alternatives are considered: no change, statutory exemption only, or adopt both the statutory exemption and the class exemption. Some additional tweaks on the statutory exemption are also considered, such as whether the department should establish more prescriptive standards for computer programs that give investment advice. The 2009 rule refers to the 2008 proposed rule, and the 2010 rule considers only 2 alternatives: one from the original 2008 proposed rule regarding the standards for computer model design, and the second regards the withdrawal of the class exemption. | 5/5 |
| 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)? Because there is a great deal of latitude in compliance, the range of alternatives is moderately broad. The option selected does leave a great deal of flexibility in compliance as proposed in the 2008 rule: "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." Additionally, the withdrawal of the class exemption is based on comments that the 2009 regulation was not sufficient to "adequately mitigate such conflicts," showing that the range of alternatives extends to the removal of an alternative based on further consideration. Broader still would be alternatives like full disclosure only, or a fee-leveling requirement only for individuals who provide investment advice, not their employers. | 4/5 |
| Does the analysis evaluate how alternative approaches would affect the amount of the outcome achieved? The 2008 RIA assesses benefits of statutory exemption with and without the additional class exemption. It also shows incremental vs. cumulative effects. The 2010 shows a revised calculation of costs, benefits, and net benefits for adopting the statutory exemption only. | 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? It assumes that the baseline is current practice, with no consideration of how the market might evolve under the no action scenario or with fewer restrictions on advisors. The analysis is careful not to count some errors that will be eliminated by other changes in the law as a benefit of this regulation. However, "...the Department stated that it was uncertain how changing market conditions might affect the incidence and magnitude of investment errors, as well as the availability, use, and effect of investment advice," which is why the class exemption was withdrawn. All told, the RIA acknowledges uncertainty about the baseline but provides little explicit analysis. | 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 major proposed alternatives. A table in the 2008 RIA shows incremental effects. One possible cost -- inefficiencies that stem from investment advisors' conflicts of interest -- is never quantified. It is assumed to be zero (in the 2008 RIA) or either zero or so high that the costs and benefits of one alternative are not even worth calculating (in the 2010 analysis). | 3/5 |
| Does the analysis identify all expenditures likely to arise as a result of the regulation? The analysis identifies expenditures to furnish investment advice, 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? The analysis identifies costs of information, but not costs associated with investment advice that exploits conflicts of interest. It 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 2008 RIA acknowledges this but simply says it is part of the cost of bad advice, or good advice not acted upon, with no justification for the size of the assumed effect. The 2010 RIA and proposed rule regard the possibility of conflicts of interest under the class exemption as so high that this alternative can be dismissed without calculating costs or benefits. | 3/5 |
| If costs are uncertain, does the analysis present a range of estimates and/or perform a sensitivity analysis? Yes, a table is provided with a sensitivity analysis of the uncertainty of costs, from low to high as addressed in comment 5B, as well as a net effect associated with each level, though the source of this information is vague. | 3/5 |
| Does the analysis identify the alternative that maximizes net benefits? The 2008 RIA clearly identifies which major approach offers the greatest net benefits. The 2010 RIA does not attempt to calculate net benefits of the class exemption that it rejected. | 3/5 |
| Does the analysis identify the cost-effectiveness of each alternative considered? A table in the 2008 RIA 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. No such table appears using the recalculated cost and benefit figures in 2010. | 2/5 |
| 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. Somewhat relevant content, but not followed through. The analysis recognizes that costs will be different for IRAs and defined benefit pension plans, and uses different cost figures for each for the 2008 and 2009 rules, but these are all combined in the 2010 analysis, with referral to the previous RIAs for additional information. Figures chosen are not well documented. | 1/5 |
| 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 in the 2008 RIA 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 department cites the regulatory analysis in support of the claim that investors make errors that could be prevented if they had more or better information. However, the statutory exemption was a forgone conclusion because it was in statute, so it is doubtful that the RIA affected the decision to implement this exemption. The other major decision for 2010 was the decision not to implement the class exemption. This was based on public comments claiming that the class exemption would still allow conflicts of interest. The RIA was updated to reflect the fact that the department is not implementing this exemption, but the decision was not driven by the regulatory analysis, but by the comments of some other factor. Perhaps the comments presented evidence of a type that could be incorporated into a regulatory analysis, but the 2010 notice gives no indication that this occurred. | 2/5 |
| 10. Did the agency maximize net benefits or explain why it chose another alternative? The 2008 RIA calculated net benefits, but assumed costs associated with advisor conflict of interests would be small. The 2010 RIA is ambiguous about whether Labor now believes the class exemption has smaller or negative net benefits, or if the net benefits are still there but the class exemption was rejected because it insufficiently controlled the conflict of interest problem. The 2010 RIA is so skeletal that it is not clear whether Labor believes its 2010 decision maximizes net benefits or not. The department provides insufficient information to judge the analytical content of the public comments it says changed its mind. Thus, it is unclear whether the department thought it was making a decision on net benefits grounds or sacrificing net benefits to achieve something else. | 2/5 |
| 11. Does the proposed rule establish measures and goals that can be used to track the regulation's results in the future? The agency 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? The agency 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 | 33 / 60 |
Additional details
- Agency
- Department of Labor
- Regulatory Identification Number
- 1210-AB35
- Agency Name
- Department of Labor
- Rule Publication Date
- 03/02/2010
- Comment Closing Date
- 05/05/2010