Asset Allocation Models

Art by Tim Bower

ADVISER QUESTION: I’m an investment adviser to 401(k) plans. I construct and utilize asset allocation models in carrying out my services. Am I considered an ERISA [Employee Retirement Income Security Act] fiduciary when I utilize these models?

ANSWER: You will be considered an ERISA fiduciary if you’re using the models to provide investment advice to the plan or the participants based upon their particular needs or if you are managing a unitized model. But if the models are structured—and used—in a hypothetical format in accordance with the Department of Labor (DOL) guidance on investment education, you won’t be considered an ERISA fiduciary.

Asset allocation models can be used by a plan adviser in a number of ways, and each has different consequences under ERISA and the DOL rules. Here are three fairly common structures we see in our work with advisers to 401(k) plans.

1) Models Used to Provide Investment Education

An adviser may construct asset allocation models that are intended to provide investment education to plan participants. These models are based upon asset-allocation portfolios of hypothetical individuals with different time horizons and risk profiles. A participant can then assess the relevance of a particular model to his individual situation and determine whether to use it as a guide for investment allocation.

Under DOL guidance—Interpretive Bulletin 96-1—use of models will not be considered fiduciary advice if the following four requirements are met:

• All material facts and assumptions on which the models are based—e.g., retirement ages, income levels, financial resources, etc.—accompany the models;
• The model, if it identifies a specific plan investment option, includes a statement that other investment options having similar risk and return characteristics may be available under the plan and identifies where information on such other investments may be obtained; and
• The model is accompanied by a statement that, in applying particular asset allocation models to their individual situations, participants should consider their other assets, income and investments.

An adviser using models that meet these requirements will not be considered to be providing fiduciary advice. However, if he recommends a specific allocation or model to a participant, that is advice and not education.

2) Models Used to Provide Participant-Level Investment Advice

An adviser may use asset allocation models—whether developed by himself or a third party—to provide participant-level investment advice. With this service, the adviser recommends that a participant invest his account in accordance with the asset allocation model that aligns with his particular investment needs—e.g., based on the individual’s investment profile. In providing this service, the adviser is acting as a fiduciary under ERISA subject to the legislation’s rules, including the prudent man standard and duty of loyalty.

3) Models Made Available as Investment Options

Some plan advisers construct and manage asset allocation models that are unitized—i.e., treated as a single investment with a stated daily value—and made available as a 401(k) plan investment option. The adviser manages the model and makes decisions about the asset allocation and underlying investments. In that case, the adviser is an ERISA fiduciary for the allocations and the choice of investments.

These models are treated as designated investment alternatives (DIAs) under the DOL rules. This means they are subject to detailed participant disclosures—i.e., the 404a-5 disclosure rules—about expense ratios, performance history, portfolio turnover rates, benchmarks and more. In our experience, while most advisers don’t object to presenting this detailed investment information, not all recordkeepers have the system to capture and report it.

Plan advisers who use these models in 401(k) plans should consider how they intend to do so. Each approach has different consequences. If the adviser is managing the model as a unitized investment option or is using the model to make participant-level investment recommendations, he is an ERISA fiduciary and should ensure that he uses a prudent process for making investment and allocation decisions and that he documents the process.

Fred Reish is chair of the financial services ERISA practice at law firm Drinker Biddle & Reath LLP. A nationally recognized expert in employee benefits law, Reish has written four books and many articles on ERISA, pension plan disputes and audits by the IRS and Department of Labor. Joan Neri is counsel in the firm’s financial services ERISA practice, where she focuses on all aspects of ERISA compliance affecting registered investment advisers and other plan service providers.