Model Portfolio Guidance Should Not Be Ignored

All the controversy regarding the Department of Labor’s (DOL’s) guidance about fee disclosures for brokerage windows may have overshadowed its guidance for model portfolios. 

In July, the DOL’s Employee Benefits Security Administration (EBSA) issued Field Assistance Bulletin (FAB) No. 2012-02R (see “DOL Issues Clarification to Participant Fee Disclosure Guidance”), which superseded Field Assistance Bulletin No. 2012-02 and eased some concerns about the DOL’s guidance for brokerage windows (see “DOL’s Answer in Fee Disclosure Guidance ‘Surprising’”). Question 28 about model portfolios, however, may have been overlooked by the adviser community, said Fred Reish, chairman of the financial services ERISA team at Drinker Biddle & Reath LLP, during “Inside the Beltway,” a broadcast series hosted by the firm.

“I just think people are missing a significant issue here, and it could blow up somewhere down the road,” Reish said, adding that question 28 of the FAB calls for additional information to be sent to participants explaining model portfolios.

Question 28 in FAB No. 2012-02R asks: “If a plan offers 10 designated investment alternatives (DIAs) and also offers three model portfolios (labeled conservative, moderate and growth) made up of different combinations of the plan’s DIAs, is each model portfolio a DIA under the participant fee disclosure regulation?”  The DOL responded by saying that a model portfolio ordinarily is not required to be treated as a DIA under the regulation if it is clearly presented to the participants and beneficiaries as merely a means of allocating account assets among specific designated investment alternatives.

On the other hand, the DOL said that if in choosing a model portfolio, the participant “acquires an equity security, unit participation, or similar interest in an entity that, itself, invests in some combination of the plan’s designated investment alternatives, such model portfolio ordinarily would be a DIA.”  The guidance also advised that a model portfolio “made up of investments not separately designated under the plan … would have to be treated as a DIA.”

“Too many people seem to be missing the trees for the forest,” reading the disclosure to exempt model portfolios from DIA status but not focusing on the conditions required of such a model portfolio, Bradford Campbell, former assistant secretary of labor for the Employee Benefits Security Administration (EBSA) and currently of counsel, the Employee Benefits & Executive Compensation Practice Group at Drinker Biddle & Reath LLP, told PLANADVISER. 

“The DOL guidance essentially creates a new disclosure category for these non-DIA model portfolios because there are three required, but not well-explained disclosure conditions,” Campbell said.  The model portfolio is not a DIA “if it is clearly presented to participants as merely a means of allocating assets among specific plan DIAs.”  Further, Campbell said, the guidance provides that the plan administrator “must clearly explain how the portfolio differs from the plan DIAs" and “should clearly explain” how each model portfolio functions.

Reish and Campbell explained that allocating to other plan DIAs alone will not prevent a model portfolio from itself being a DIA and that certain information must be clearly presented and explained. “It’s pretty clear that in DOL’s view, this is a requirement,” Campbell said, but he believes the Department should clarify these standards in additional guidance.

Question 28 presents some interesting issues for plan sponsors and advisers to consider, Reish said. For example, who is going to create the participant statements explaining how the model portfolio functions and how it differs from the plan’s DIAs?

This information must be distributed to participants before they direct their investments, as well as annually, Reish added. The plan sponsor must also determine who will be sending this information to participants.