As competition intensifies, bundled 401(k) service providers are beginning to offer participant investment advice in an attempt to outshine the pack.
Since The TCW Group Inc., Los Angeles, received its Labor Department exemption in October, only four others have applied for prohibited transaction exemptions allowing them to offer investment advice.
But many other companies are pondering their options.
Some are waiting for clarification from their lawyers or the Labor Department before deciding whether to seek exemptions or try to find a way around the issue of self-dealing.
Companies on the fence are said to include Putnam Investments, Boston; Scudder Kemper Retirement Services, Boston; CIGNA Retirement & Investment Services, Hartford, Conn.; American Express Financial Advisors, Minneapolis; MassMutual Retirement Services, Springfield, Mass.; MFS Investment Management, Boston; United Asset Management/UAM Retirement Plan Services Inc., Boston; and The Vanguard Group of Investment Cos., Malvern, Pa.
Consultant and third-party record keeper Hewitt Associates LLC also is considering a partnership with an advice giver.
Others have gone ahead with such programs:
* Some, such as State Street Global Advisers, Boston, created programs that avoid self-dealing problems by leveling expense ratios when their own funds are used. (See related story on page 39.)
A spokeswoman at the Department of Labor, who asked not to be named, said the agency had "no comment" on whether SSgA needed a prohibited transaction exemption.
* Aetna Retirement Services, Hartford, last year bought brokerage Financial Network Investment Corp., Torrance, Calif., to provide investment advice to plan participants. The firm structured the program to avoid self-dealing by charging a flat service fee for the advice, rather than the more typical incentive fees paid for funds recommended by the adviser.
* Fidelity Investments, Boston, is beta testing its online, interactive PortfolioPlanner program, which uses a self-assessment questionnaire to point participants toward one of four optimized portfolios customized to each plan, rather than to each participant. Because Fidelity is confident its planning program falls into the realm of education under DOL Interpretative Bulletin 96-1, rather than advice, it doesn't need a prohibited transaction exemption, said John Kimpel, Fidelity's assistant general counsel.
* Some companies have hired third parties that will provide objective investment advice and, most importantly, assume the associated fiduciary liability for that advice. Ernst & Young LLP, New York, just announced it hired Financial Engines Inc., Palo Alto, Calif., for that purpose.
The 401(k) Forum Inc., San Francisco, is among the companies that have applied for prohibited transaction exemptions, said Gloria Della, a DOL spokeswoman.
David Peckman, vice president of marketing, said he was unable to comment on the application while it was still under review. Observers suspect The 401(k) Forum might be applying on behalf of a large money manager with which it intends to form a partnership.
Separately, MetLife's Defined Contribution Group, New York, partnered last year with both an online and a face-to-face financial advising firm.
Other pending applications are from The Bank of Oklahoma National Association, Tulsa; The Dreyfus Corp., New York; and Keystone Brokerage, Cleveland, Ms. Della said. She would not elaborate.
A smaller, but significant, number of investment managers -- NVest LP, Boston, and Federated Investors, Pittsburgh, for example -- plan to beef up educational programs, rather than offer investment advice of any kind.
But a DOL official warns plan sponsors to choose vendors with an advice exemption.
The DOL reportedly was disturbed by all the media attention paid to the TCW exemption, and Olena Berg, Assistant Secretary of Labor, Pension and Welfare Benefits Administration, wrote a piece published in the May issue of the 401(k) Alert newsletter that clarified the department's position on investment advice.
In her article, Ms. Berg wrote the DOL wants plan participants to have whatever help they need to make informed investment decisions, and encouraged plan sponsors to offer advice if they determine that is what participants need. She reminded plan sponsors that Interpretative Bulletin 96-1 explains exactly what constitutes investment advice: that it be regularly provided; that there is mutual understanding between the participant and the adviser that the advice will be the participant's primary basis for investment decisions; and that the advice be individualized to the participant.
Ms. Berg admonished plan sponsors to make very clear to any third-party advice giver they hire that the adviser is acting as a fiduciary for the plan in providing investment advice. She also warned that a prohibited transaction occurs, in violation of the Employee Retirement Income Security Act, when the compensation of a fund manager is influenced by the advice it is providing to 401(k) plan participants.
Ms. Berg was direct about what sponsors should do to avoid fiduciary complications caused by advice giving investment managers and self-dealing.
"If you want your service provider to give participants advice, you need to make sure that it has worked with the DOL to structure the investment advice so as to receive an exemption," she wrote.
LAWYERS URGE CAUTION
Attorneys interviewed said they are recommending to clients that they heed Ms. Berg's warning.
"If a client was to go with a program of advice from their investment manager, the conservative answer I would give is that they should choose a provider with a prohibited transaction exemption," said Fred Reish, managing partner at the law firm, Reish & Luftman PC, Los Angeles.
"The interpretative bulletin drew a line between advice and education, and I'd be very concerned about not following that line very closely. Everyone, all the vendors, are trying to get right up to the line with very robust education because people want advice. . . . Is it right or wrong? A court will one day decide that. But why get to the point where the court decides for you? I'd advise clients to stick to true education, or go for a provider with an exemption."
Interest is high among executives at 401(k) plans.
"Defined contribution plan sponsors are very interested in how you can deliver investment advice consistently over a large population. . . . Some issues important to sponsors are: whether advice giving is even an appropriate activity for a sponsor; what's an appropriate cost; who should pay it; should it be a software program, or should it be people-based," said Stacey Schaus, a principal at Hewitt Associates, Lincolnshire, Ill.
In fact, Hewitt will conduct three to five plan sponsor focus groups on the subject of investment advice this month at the request of clients.
Depending on the results of its focus groups, Hewitt might add an advice software program, which it will probably license.
But more complicated plan structures raise technical issues in the advice realm, Ms. Schaus said.
For example, she wonders whether or how an advice giver could provide an optimized asset allocation within a mutual fund window that offers potentially hundreds of fund choices. Many of Hewitt's large plan clients use a tiered, unbundled approach to investment options and offer a mutual fund window.
NO RUSH FOR EXEMPTIONS
Service providers so far seem to be holding off applying for prohibited transaction exemptions.
Rumored time delays may be one factor. "Two years is much too long to wait when your clients are clamoring for advice now," one source said.
Dreyfus is seeking an exemption because it wants to extend all aspects of its retail Lion Account to 401(k) plan investors, including investment advice, said Patrice Kozlowski, a Dreyfus spokeswoman.
Bank of Oklahoma will offer advice to participants through its mutual fund affiliates.
Like most bundled defined contribution plan vendors, senior management at CIGNA is struggling with what investment advice really means, said Michael T. Daley, senior vice president of strategy and marketing.
"I think you can give an optimized model portfolio to a plan participant without crossing the line into advice. Our legal counsel is thinking along these lines now. Our feel is that suggesting an optimized portfolio would be useful to participants, but now we'd stop short of personalized advice," Mr. Daley said.
"We're keenly interested in how far you can go. The legal issues here are crucial to most people in this business."
CIGNA expects to "have clarity" on the issue of advice this month and will roll out a range of advice services by next year, Mr. Daley said.
American Express also is working closely with its legal counsel to find a way to offer investment advice without an exemption, said Lisa M. Honey, vice president of employee education.
"We know what we want to do. We just don't know how."
"No one knows whether these advice programs are going to work," noted said John Mulligan, president of Retirement Plan Strategies Inc., Boston.
"I kind of have an idea that we have to have an advice program that really works, is demonstrably effective, before a lot of vendors are going to rush into developing a program of their own.
"But if these programs do work, then there will be a land-rush of vendors. If they like the idea of having an independent advice giver, then they may replicate the TCW model. But remember there are a lot more 401(k) plan vendors than capable financial advice givers, and I think there's a question of capacity if they try to imitate TCW," Mr. Mulligan said.
Another variation is for investment management consulting firms to give to participants the kind of advice they already give to institutional investors.
For example, Ibbotson Associates Inc., Chicago, is working on the asset allocation models that will be used in TCW's advice program. Ibbotson executives intend to make that a line of business.
But Michael Henckel, Ibbotson's president, said his company will not deliver advice to the plan sponsor or participant. Instead, it intends to partner with firms that have received prohibited transaction exemptions from the Labor Department, he said, "because we don't want to be left holding the bag if the market drops."
"What we do is very complicated financial science and it needs to be buried. It's not going to be particularly helpful to show it to participants. TCW is putting its own wrapper on our product and in general, that's what we think other people will do as well," he said.
The 401(k) Forum, which so far has worked directly with plan sponsors to provide defined contribution plan participants with an Internet delivered, interactive advice program, is being besieged by requests for information from financial services companies (See related story on page 19).
Scott Lummer, chief investment officer, attributes the interest to the lack of objective third-party advice givers.
"We're picking our spots," he said. "The only arrangements we've considered are those where we retain the fiduciary responsibility. It's our advice; we can't see how we wouldn't hold the cards for the advice we are providing."
He declined to comment on his company's application for a prohibited transaction exemption.
Financial Engines, the company started by Nobel Laureate William F. Sharpe, is attempting to bring high-level style analysis, sophisticated forecasting and cutting-edge asset allocation modeling to the level of individual investors.
Unlike other advice givers' models, Financial Engines offers individualized advice for each investor, rather than optimized portfolios at the plan level.
"We've found from participants in the beta testing we're doing with sponsor clients that if you don't offer explicit, individualized advice data for each person, they won't use it. Unless personalized, the person feels uncomfortable about the advice, they can tell it's a black box and they don't feel comfortable about implementing pre-canned advice," said Jeff Maggioncalda, president and chief executive officer.
Financial Engines has one partnership, with Ernst & Young. And the company has received many inquiries from bundled 401(k) plan vendors interested in mounting advice programs within the next six to 12 months, Mr. Maggioncalda said. He expects to make deals with a "wide range of vendor partners."