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January 21, 2002 12:00 AM

Nasty surprise: 404(c) SAFEGUARDS IMPERILED

PWBA official says sponsors following SunAmerica opinion could lose protection against liability for investment choices

Arleen Jacobius
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    WASHINGTON -The Labor Department's approval of professionally managed accounts for defined contribution participants has a downside for plan sponsors.

    Last month, the U.S. Department of Labor's Pension and Welfare Benefits Administration issued an advisory opinion allowing SunAmerica Retirement Markets Inc., and anyone else who follows the map set forth in the opinion, to offer managed accounts as part of a bundle of services for defined contribution plan sponsors.

    However, plan sponsors that include the service might be losing their protections under Section 404(c) of the Employee Retirement Income Security Act against liability for participants' investment decisions, a Labor Department official said last week.

    To qualify for 404(c) protection, "participants have to have control of their investment choices," said Lou Campagna, chief of the division of fiduciary interpretations in Pension and Welfare Benefits Administration's office of regulations and interpretations. "Section 404(c) requires participants to exercise independent control for plan sponsors to mount the defense that they have no liability for participants' individual decisions ... In my opinion, it would be difficult to imagine that in a managed account situation," he said.

    However, Mr. Campagna said 404(c) protection would be extended to sponsors when service providers offer investment advice to participants that the participants can ignore. Sponsors still retain fiduciary liability for the selection and monitoring of investment choices offered under the plan.

    The Labor Department in December said financial services conglomerates do not need special permission to offer plan participants one-stop investment management services -- investment advice, asset allocation and money management - as long as an independent financial expert makes the advice and asset allocation decisions (Pensions & Investments, Dec. 24). SunAmerica sought the opinion.

    Advice provider boost

    The SunAmerica opinion also makes it easier for independent investment advice providers to do business. Executives at both mPower.com Inc., a San Francisco investment advice provider, and Financial Engines, Palo Alto, Calif., have said the opinion allows them to receive payment from plan assets. (Financial Engines already was being paid from plan assets; mPower was not.) In addition, advice providers no longer will have to contract separately with plan sponsors. Instead, sponsors can contract solely with their bundled or semibundled providers for participant investment advisory services.

    "Before the opinion, we took the conservative approach that we were not comfortable getting paid from the fund," said Michelle Farmer, mPower's general counsel. "And if we follow the advisory opinion, we will not need a separate contract with the sponsor. I personally believe it will make it easier to sell" investment advice to plan sponsors.

    Although Financial Engines already is accepting payment out of plan assets, the opinion lets the bundled or semibundled provider take on the adviser role and contract directly with the plan sponsor for the advice services, said Mary Ellen Kazimer, associate general counsel.

    The SunAmerica opinion should quell the fears of plan sponsors concerned about paying for investment advice with plan assets, Ms. Kazimer noted. "There's not that much in the (SunAmerica) advisory opinion for the plan sponsor, but it gives them a little comfort in that direction," she said.

    Consultants already are scrambling to answer plan sponsors' questions about the SunAmerica opinion.

    "What I got from the DOL was the discretionary program would be consistent with 404(c) but that the no-decision-necessary program would not be consistent with 404(c)," said Lynn Phillips, a consultant with Washington-based Watson Wyatt Worldwide, who is also an ERISA attorney.

    The SunAmerica program offers professional investment management services that automatically rebalance participants' accounts as just another bundled service that is paid directly from plan assets, said Joshua Dietch, consultant with Cerulli Associates, Boston.

    "What will truly be interesting is if the Boehner bill is successful," Mr. Dietch said. "Will there be competing models to provide investment advice?"

    Boehner specifics

    The Boehner bill, sponsored by U.S. Rep. John Boehner, chairman of the House Education and Workforce Committee, would allow bundled or semibundled providers to offer advice to plan participants without going through a third-party provider. The bill also would give plan sponsors some protection against fiduciary liability for offering the advice.

    In a statement released last week, Mr. Boehner said the SunAmerica opinion does not eliminate the need for his bill.

    "The DOL opinion will not close the investment advice gap and does not increase worker access to quality investment advice or ease employer concerns about liability," the statement said. "Moreover, the generic computer models that SunAmerica will use are no substitute for face-to-face, individually tailored advice from the professionals best suited to provide investment guidance."

    Eventually, the SunAmerica opinion may have the effect of slicing into the business of online investment providers.

    "The formulation of advice will become a commodity, and online advice provider margins will become squeezed," said Brian Tarbox, an independent Minneapolis consultant who worked with SunAmerica in obtaining the opinion.

    "The real beneficiaries are the financial service institutions with substantial 401(k) assets," he added. "This letter permits them to leverage their existing relationships so, if they execute their strategy appropriately, they will control a much higher percentage of non-plan assets and rollovers than they do currently."

    Some bundled and semibundled providers already are trying to determine whether to offer a SunAmerica-type solution. Many see it as a way to use the defined contribution plan to get their hands on the entire investment portfolio and prevent leakage when employees change jobs or retire.

    First Union relationship

    First Union National Bank, Charlotte, N.C., for example, already has a relationship with mPower to provide its plan sponsor clients with investment advice.

    "mPower has their advice and we can't change it," said Joe Ready, director at First Union. "Based on our quick read of SunAmerica, we can continue independent advice, but we can use our broker-dealer network to physically deliver the advice. We could not only tell participants what to do, but give them someone to talk to and let them do it face-to-face instead of blindly delivering on the Web or by mail."

    Once participants establish relationships with broker-dealers through their 401(k)s, the broker-dealers would become trusted advisers who could steer them to other First Union products such as IRAs and brokerage accounts.

    First Union is waiting to see what legislation Congress passes, but it won't wait too long.

    "If we feel pretty good about the DOL opinion, we will go along with it," Mr. Ready said. "We'd like to do something this year."

    American Express Retirement Services, Minneapolis, also is waiting to see what happens in Washington.

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