Unbiased investment advice has turned into a hot commodity among some 401(k) plan participants.
As employees' account balances approach $100,000, the demand for investment advice grows rapidly, according to panelists at a Pensions & Investments' roundtable on investment advice versus investment education.
But the panel wrestled with a number of questions: Is it a disservice for plan sponsors to offer employees education without advice? Under what circumstances do service providers need prohibited transaction exemptions? How can providers guarantee that their advice is unbiased?
Sparks flew at one point when Roberta Watson, an ERISA attorney with Trenam, Kempker, Scharf, Barkin, Frye, O'Neill & Mullis in Tampa, told Robert Reynolds, president of Fidelity Investments Institutional Retirement Group, Boston, that to be recommending specific funds (which Fidelity does) without a prohibited transaction exemption is beyond the scope of the interpretive bulletin from the Department of Labor. "Every time your system recommends a Fidelity fund rather than something else, that is a potential prohibited transaction risk . . . from a plan sponsor's point of view, it is absolutely suicide," she declared.
Surprised by the remark, Mr. Reynolds shot back: "And I think you should be sued right now for malpractice. You're making a diagnosis without looking at the underlying program."
Ms. Watson replied since Mr. Reynolds wasn't her client, he didn't have the standards to say that.
The diverging viewpoints were typical of those expressed during a lively discussion. The other participants at the P&I roundtable were Scott Lummer, chief investment officer, 401(k) Forum, San Francisco; Don Sauvigne, program director, capital accumulation and retirement programs, IBM Corp, Sleepy Hollow, N.Y.; Jorgen H. Heidemann, senior vice president Benefit Capital Management Corp., the investment management unit of Union Carbide Corp, Danbury, Conn.; Brian Tarbox, senior vice president, defined contribution group, The TCW Group, Los Angeles, Calif.; and Jeff Maggioncalda, president and chief executive officer, Financial Engines, Palo Alto, Calif.
For some, like Union Carbide's Mr. Heidemann, differences between advice and education are clear: "I think if you go out and tell employees, 'You should do this,' and they go do that, then you're giving advice. If you're sitting down and saying, 'Here are the educational aspects; I'm giving you this information' from which they then could reach their own conclusion, then it's education."
However, the difference is fluid, he added, noting that as employees become more sophisticated, the differences between advice and education keep changing, too.
"There's a big difference between telling a sophisticated investor he should have a certain amount invested in equities and telling that to a guy who loads tank cars full of vessels somewhere, and who may wonder what is an equity, anyway."
But IBM's Mr. Sauvigne pointed out that plan sponsors don't want to take on a strong fiduciary responsibility for advice. "However, we do have to look at the education advice and be careful and not be concerned with this 'crossover' because if we don't, we'll do a disservice to the participants by worrying about what constitutes advice and what constitutes education."
Fidelity's Mr. Reynolds argued that providing recommendations and guidance is just extending education and does not constitute the legal term advice.
Ms. Watson predicted the difference will be decided, ultimately, by the courts.
Some of the participants, like Mr. Lummer of 401(k) Forum, contended that providers are doing a disservice by offering only education to participants. Plan participants probably are getting advice from friends and family, but that should really come from the plan sponsor, who should provide it with education, he said.
WAYS TO GIVE ADVICE
Ms. Watson, the attorney, recommended employees be given advice if it can be given prudently.
The best way is to do it with a mechanism that has a Department of Labor exemption, "because the chances of an employer sponsor being held liable for bad advice given pursuant to . . . a DOL exemption is as close to zero as you're ever going to get," she said.
The best legal structure is to have an integrated product with a system of funds and investment advice, so advisers know they have to be experts on that fund. The safer way to go is by choosing a product that has a prohibited transaction exemption, she said. "It means part of your investigation has already been done by the DOL . . . The Department of Labor has specified conditions under which the exemption must operate."
In the case of TCW, which has such an exemption, it can't pay an independent adviser any more than 5% the adviser's previous year's revenues.
TCW applied for an exemption, explained Mr. Tarbox, "because we were going to make recommendations that were going to include our funds, and the fees associated with that had different profits."
Mr. Reynolds argued that the situation for Fidelity was different, and that the company doesn't need an exemption because it's providing guidance and education, but not advice under the DOL guidelines.
"It's advice under the SEC, which we're comfortable with, but we're qualifying under reg 2510-3-21 and then the interpretive bulletin. Our product takes the existing fund options, including company stock, and helps the employee decide how much (he or she) should be saving, provides an asset allocation and then specific recommendations of (his or her) fund options and how one invests to get there. It's up to the participant to act on the recommendation . . . it's not discretionary."
WAR OF WORDS
Those comments precipitated the mini war of words that broke out between Ms. Watson and Mr. Reynolds. She insisted that recommending specific funds is beyond the scope of even the interpretive bulletin.
"Every time your system recommends a Fidelity fund rather than something else, that is a potential prohibited transaction risk, which won't give anyone a problem as long as the market stays high," she said.
"But if we get a crash and one of these things turns out to be held by a court to have happened, Fidelity is in trouble for owing a penalty tax through the prohibited transaction and being liable as a de facto fiduciary, even though you said you weren't a fiduciary. But the plan sponsor is liable for allowing a system that could happen that would have prohibited the transaction."
Ms. Watson said she and Mr. Tarbox believe it might be safer to provide investment advice for 401(k) plans rather than just providing investment education. "The conclusion we came to is that if you're going to do something other than nothing, which bears some liability risk, the safest thing to do is to hire a fiduciary working under an exemption."
For plan sponsors, there can also be a danger in not giving advice. To avoid that pitfall, IBM has hired two financial planning firms to provide new participants with advice that is personalized, not just generic, said Mr. Sauvigne.
Demand for advice, meanwhile, is strong. Mr. Sauvigne reported that some 25,000 of the 200,000 participants in IBM's 401(k) plan personally purchased advice from one of the new firms that IBM has hired and subsidized for the program. He believes that education is responsible for the increased interest in advice.
Mr. Tarbox observed that as participants' investible asset levels increase, and approach the $100,000 level, the demand for advice starts to grow significantly --a trend that is likely to continue as account balances rise. He stressed that if plan sponsors hire service providers who charge for delivering investment advice, they have to be certain most of the participants will use it.
"There is not a lot of pricing elasticity out there now, and to the extent you add it, plan sponsors will be less likely to absorb it," he said.
Not everyone is looking for advice, however. Union Carbide, for one, hasn't been seeing a big demand for education or advice, except among a small group of people who Mr. Heidemann described as "active." As the balances grow bigger, they want more choices, he said.
Most of the advice and education is coming from outside, he said, because providers recognize the needs. Plan sponsors see it as a valuable asset, especially if it will help participants at a low fee.
The Labor Department is looking carefully at what goes into those plans, according to Ms. Watson. "If investment advice is proven to be effective, one could argue it would be imprudent not to incur a small extra cost.
"The Department of Labor always thinks that the company should pay anything that may help, but if it's an issue of plan assets and it turns out that the advice is demonstratively in the participant's best interest, then you may have an obligation to do it even if it's coming from plan assets," she said.
All participants don't have to get involved, as long as it's in the best interests of the participants as a group, according to Ms. Watson. She believes there's a demand for advice among employers, but questions how much of a demand there is among participants.
Said Mr. Maggioncalda: "What we really need to do is put on the next logical step for the 401(k) plan, which is advice. The key here is establishing the fact that there will be a good bang for your buck. This is the component that's been missing that will make the 401(k) plan effective."
UNBIASED ADVICE KEY
Then, plan sponsors must grapple with the problem of whom they can find to provide unbiased advice. Mr. Reynolds pointed out that someone could be hired independently, but still have a bias in his or her model.
Mr. Lummer described data from surveys and focus groups he's studied that showed participants felt unbiased advice was a "very, very important part of the issue. . . . One hundred percent of the people felt that the fact advice was coming from an independent adviser was very important. No participant defended the idea that it was not important to come from an independent provider. There was a perception out there that the provider was tilting people toward the higher generating fee funds, so unbiased is a way of avoiding that, but not always."
The procedure used in selecting a provider requires following a prudent process, according to Ms. Watson. "If you're buying advice, you have to determine whether the provider has the capability of providing the advice and whether the process is one that's likely to work. There is a lot of tension between bias and knowledge . . . that the most independent person may not know the details of your funds," she said.
"But the people who are most intimately familiar with it are going to have a bias. So the employer must evaluate whether it's going to separate the two and make sure each component is qualified, or will it have an integrated system."