Department of Labor Issues QDIA Guidance

The Department of Labor on April 29, 2008, once again waded into what has become controversial waters by issuing additional regulatory guidance on default investments.  The newest guidance – in the form of Field Assistance Bulletin 2008-03 and new regulatory text – seeks to answer some common questions raised about the Department's final qualified default investments alternative (QDIA) regulation.   That regulation, finalized on October 24, 2007, created a fiduciary safe harbor for certain types of default investments. 

Despite a fulsome notice-and-comment period in which much of the regulatory community participated, many interpretative and practical questions about the regulation have persisted.   Although the Department appears to have touched on several of the most common issues, this newest guidance did not put to rest all of the interpretative questions related, and may have even created new ones.

The guidance, in the form of 22 questions-and-answers, is broken down into six sections, with answers provided to questions on the: 1) scope of the QDIA regulation; 2) notice requirements; 3) 90-day limitation on fees and restrictions; 4) management and asset allocation of QDIAs; 5) temporary (120-day) capital preservation option; and 6) grandfather-type protection for stable value funds.   In addition to the Q-and-As, the Department released amendments to the regulatory text to conform with its position regarding the role of in-house investment managers, "round-trip" charges, and stable value funds.

1. Scope of the Regulations
Q-1 through Q-5 address some common questions regarding the scope of the QDIA regulations.  In response to comments from plan sponsors, Q-1 clarifies that a plan sponsor choosing to create and manage a QDIA can take advantage of the fiduciary relief under the regulation, provided the sponsor is the named fiduciary of the plan.  In Q-17, the Department also confirms that if a plan has named an in-house committee of company employees as the named fiduciary, the committee would also be permitted to get the fiduciary relief under the QDIA regulation.

Q-2 and Q-3 address the application of the QDIA regulation to default investment activity that occurred prior to the regulation's effective date.  In Q-2, the Department appears to extend very limited retroactive fiduciary relief with respect to assets invested in default investment funds or products that pre-dated the QDIA regulation.  The relief is only available for these pre-regulation default investments after all the requirements of the QDIA regulation have been satisfied.  Even then, the relief does not appear to extend to all fiduciary decisions.  In rather ambiguous guidance, after indicating that fiduciaries can "have the benefit of relief under the QDIA regulation for fiduciary decisions made" once all the requirements of the regulation are satisfied, the Department then writes in the following sentence that "relief is not available for fiduciary decisions made prior to the effective date of the QDIA regulation, such as decisions by the fiduciary to invest assets in a default investment."  This may be suggesting simply that certain types of fiduciary decisions – such as the initial decision to use a particular investment product as a QDIA – is never protected by the regulation's fiduciary safe harbor.  If that is the case, it is likely the Department will face a new round of requests to flesh out more precisely the scope of the safe harbor.

In  Q-3, the Department clarifies that relief under the regulation can extend to amounts that participants had elected to be invested in the plan's pre-regulation default investment option, and who fail to elect to move those investments out of the default fund later.   An ancillary point here is that plan administrators will have to provide all participants and beneficiaries invested in a plan's pre-regulation default investment option with notice and an opportunity to affirmatively choose another investment option in order for the pre-regulation default fund to qualify as a QDIA (assuming all other conditions of the regulation are also satisfied).

Apart from QDIAs, the Department confirms in Q-4 that participants must be given option to direct the investment of all amounts that will be invested in a QDIA, including amounts from sources such as qualified non-elective contributions or recoveries from litigation, in order for the regulation's relief to be available.  In addition, the Department confirms in Q-5 that the QDIA regulation is applicable to ERISA-covered section 403(b) plans.

2. Notice Requirements
The Department is in the midst of a separate regulatory initiative to enhance the disclosure of plan fees and expenses that flow to fiduciaries and plan participants.  We point that out here because there appears to be some cross-pollination of efforts when the Department addresses the QDIA regulation's notice requirements. For instance, Q-6 indicates that in the absence of further guidance in order to meet the notice requirements in the final QDIA regulations, plans must provide participants and beneficiaries information concerning: (1) the amount and a description of any shareholder-type fees such as sales loads, sales charges, deferred sales charges, redemption fees, surrender charges, exchange fees, account fees, purchase fees, and mortality and expense fees; and (2) the expense ratio for investments the performance of which may be expected to vary over the term of the investment. These types of fees have clearly been in the Department's disclosure cross-hairs for some time, and will likely be part of its fee disclosure regulations under ERISA section 408(b)(2) expected to be finalized later this year.

Because ERISA and the Internal Revenue Code require many different notices to be provided to participants and beneficiaries, Q-7 attempts to streamline and coordinate some of the notification efforts. In Q-7, for instance, the Department clarifies that the QDIA notices may be distributed in accordance with Department of Treasury electronic distribution regulations.  However, when it comes to pass-through investment materials, the Labor Department stops short of endorsing Treasury's rules, indicating instead that the DOL is "currently working on a separate regulatory initiative concerning the broader application of disclosure by electronic means." The Department's semi-annual regulatory agenda (published May 5, 2008) does not include such a regulatory project, so this reference may be to the participant-disclosure rules that are expected to be released in proposed form shortly.

In Q-8 and Q-9, the Department addresses the interaction between the notice requirement in the QDIA regulations and the separate notices required under rules governing qualified automatic enrollment arrangements (QACAs) under Code section 401(k)(13), and eligible automatic enrollment arrangements (EACAs) under Code section 414(w).   According to Q-8, the timing of the separate QACA and EACA notices may -- but are not required to -- be coordinated with the QDIA notice.  In Q-9, the Department further explores the timing interaction between the Code's notices and the QDIA notices, concluding that "plan sponsors could easily satisfy" the annual notice requirement for both sets of regulations by providing an appropriate notice at least 30 but no more than 90 days before the beginning of the plan year.  For plans that immediately cover new hires and wish to use a QDIA, however, the Department's guidance on the timing of notices suggests that the plan must also become an EACA.

Q-10 clarifies that the notice required under the pre-PPA safe harbor 401(k) plan (i.e. non-automatic enrollment safe harbor plan) can be combined with the QDIA notice as well.

3.  90-Day Limitations on Fees and Restrictions
The QDIA regulation prohibits for 90 days following a participant's first investment in a QDIA any restrictions, fees, or expenses being charged because of a transfer or withdrawal of assets from a QDIA.  In Q-11, 12, and 13, the Department addresses questions that have been raised with regard to that requirement.  Certain charges (e.g. surrender charges or redemption fees) may be levied according to provisions of annuity contracts between the plan sponsor and issuer, or between a mutual fund company and the plan.  The Department in Q-11 suggests that such charges will not affect a plan's compliance with the QDIA regulations, provided the plan sponsor or service provider pick up the charge that would otherwise be assessed against the participant's individual account.  Q-12 confirms that for participants who already were invested in a default fund prior to the QDIA regulation's effective date, the limitations on fees and restrictions do not apply.

In Q-13, the Department reverses its position with respect to "round-trip" restrictions.  Round trip restrictions generally prohibit participants from re-investing in an investment alternative shortly after the participant divests from or liquidates an investment.   In the preamble to the final QDIA regulation, the Department included round trip restrictions among a list of example fees and restrictions that the regulation limits.  Upon further consideration, and in response to comments from the plan sponsor community, the Department decided to change its position and excise the reference to round-trip restriction from the regulation's preamble.

4.  Management and Asset Allocation
In Q-14 through Q-17, the Department addresses common questions that have been raised regarding how QDIAs may be managed.  In Q-14, the Department narrowly interprets the statutory language Congress enacted in the PPA to forbid any QDIA from excluding any exposure to fixed income investments.  Conversely, the Department also rules out a QDIA in which the underlying assets were not invested at least partially in equities.  Simply stated, in order to be a QDIA, an investment must (among other things) "be designed to provide varying degrees of long-term appreciation and capital preservation through a mix of equity and fixed income exposures."

In Q-15, the Department reiterates guidance from the regulation's preamble to confirm that participants that are put into a QDIA are entitled to no better or more frequent distribution of investment materials than would be provided to participants who actively direct their investments.  Participants in QDIAs are, to be sure, entitled to the special QDIA notice, but with respect to the detailed disclosures required under the Department's section 404(c) regulation, QDIA-participants are to receive no more or less than any other participant in the plan. 

In Q-16, the Department indicates that a plan may have more than one QDIA, provided each meets all the requirements in the QDIA regulation.  We presume   that the Department is not suggesting there are questions about maintaining a short-term capital preservation QDIA along with one of the other three long-term QDIAs. Rather, Q-16 is more likely addressing plans that would like to install more than one long-term QDIA for different types of contributions to the plan.  Plan sponsors contemplating this course should be careful to engage in a prudent fiduciary process in determining the need for more than one QDIA, and whether the additional cost is justified. 

In Q-17, the Department returns to the issue discussed in Q-1regarding in-house QDIA management.  As noted above, Q-17 confirms that if a plan has named an in-house committee of company employees as the named fiduciary, the committee would also be deemed to be the "plan sponsor" for purposes of the QDIA regulation, and will get the benefit of the fiduciary relief provided under the QDIA regulation, assuming all other conditions of the regulation are met.

5.  120-Day Capital Preservation QDIA
One of the more controversial issues debated during the formulation of the final QDIA regulation was the role capital preservation or stable value products should play in automatic enrollment plans.  Those types of investments represented a large proportion of pre-QDIA default funds, yet the Department QDIA regulation in proposed form did not permit any fiduciary relief for default vehicles comprised of such conservative funds.  After intensive negotiations with the insurance and stable value industries, the Department acceded to permitting a temporary, 120-day capital preservation product to qualify as a QDIA.  Q-18 through Q-20 address lingering questions about how the temporary QDIA will work.

In Q-18, the Department confirms that the 120-day QDIA may only be used in conjunction with a plan that includes an EACA under Code section 414(w).  While not an entirely surprising outcome, the industry had been pushing for a broader interpretation of the regulation to permit the use of the temporary QDIA to hold, for instance, rollover contributions from an IRA or another plan.  The Department clearly rejects that as a permissible use for the temporary QDIA (at least for rollovers that occur after the 120-day period following the participant's first EACA contribution).  The Department also confirms in Q-19 that no plan is required to have a 120-day capital preservation QDIA (or any other QDIA for that matter).  In addition, the Department indicates that a plan sponsor will generally not be eligible to manage a 120-day QDIA on its own, since such products are required to be offered by a financial institution regulated by a state or federal agency.   The Department appears to have left the door open for such financial institutions – such as insurance companies and banks – to provide in-house management of 120-day QDIAs offered in the plans they sponsor for their own employees. 

6.  Grandfather-Type Relief for Stable Value Funds
The Department in its final regulation also acknowledged that a large number of plans already had existing default investments that, to a large degree, were held in stable value products.  To address the transition issues to the new regulation, the Department extended fiduciary protection with respect to assets in pre-existing investments stable value products, provided all of the regulation's other requirements are met.

One of those requirements of the regulation is to provide participants and beneficiaries with 30-day advance notice of a default investment.  Because the final regulation was effective just 60 days following publication of the final regulation, stable value issuers were concerned that they would not be able to meet the 30-day advance notice requirement, and perhaps as a result lose the regulation's protection forever.  Industry leaders asked the Department for clarification that fiduciary relief under the safe harbor would be available even if the 30-day notice was not provided until after the effective date of the regulation.

Q-21 confirms that fiduciary relief under the regulation will be available for stable value products as soon as all the requirements (including notice requirements) are met.  In other words, the Department indicates that for pre-existing stable value products, fiduciary protection will be extended with respect to assets held in them 30 days after notice is provided, even if that notice is provided after the regulation's effective date.  The Department also reiterates its position from the final regulation that the relief provided here is limited to assets that were invested in stable value products on or before the effective date of the regulation.

The final regulation also provided a description of the type of fund or product the Department had in mind when it created the limited stable value grandfather provision.  That description, which required that the stable value fund "guarantee" certain interest rates, elicited several questions from the regulated community and prompted the Department to clarify its definition of stable value fund. In Q-22 and in the amended regulatory text, the Department removes references to guarantees, and noted that it intended to have the grandfather provision apply broadly to different products and funds.

As amended, the regulatory text now provides relief with respect to "an investment product or fund designed to preserve principal; provide a rate of return generally consistent with that earned on intermediate investment grade bonds; and provide liquidity for withdrawals by participants and beneficiaries, including transfers to other investment alternatives."

FAB 2008-03 and the amended regulatory text are not likely to be the Department's last words on the topics of QDIAs.  Indeed, plan sponsors and service providers are already finding new questions to raise about the guidance, and still have lingering questions that the guidance did not address.  Companies wishing to take advantage of the QDIA safe harbor are encouraged to review this summary and the regulation to ensure all requirements of the regulation's safe harbor are met.