The fight over 401(k) advice: Will anyone win?

In trying to clarify who can give advice to 401(k) plan participants and under what circumstances, the Department of Labor appears to have antagonized just about everybody.

A wide swath of respondents — service providers, trade organizations, consumer groups — found something to dislike about proposed rules on providing investment advice and avoiding conflicts of interest in delivering the advice, according to comments filed recently with the Labor Department.

While praising the DOL for trying to protect consumers and to establish acceptable boundaries of advice-giving, respondents raised questions about specific investment advice issues such as using computer models, establishing fees and determining the relationship between advisers and affiliates.

Some also expressed concern, in written comments and in interviews with Pensions & Investments, that the proposed regulations could take on a life of their own unless they were further clarified.

“In a system as big and complicated as the 401(k), unintended consequences lurk in the shadows of every regulatory change,” David Wray, president of the Profit Sharing/401(k) Council of America, Chicago, said in an interview.

“The Department of Labor is trying to figure out how advice can be provided without participants being taken advantage of,” Ross A. Bremen, a partner at investment consultant NEPC LLC, Cambridge, Mass., said in an interview. “In an attempt to solve this dilemma, the department has come up with something that is simplistic and potentially flawed.”

Both Mr. Wray’s organization and the Defined Contribution Institutional Investment Association — a group that represents institutional investment managers, record keepers, insurers, trust companies, consultants and plan sponsors that has Mr. Bremen as its chairman of the public policy and legal committee — filed formal comments asking for adjustments or revisions in the proposed regulations.

The proposed rules relate to the Pension Protection Act of 2006, which created some statutory exemptions to ERISA’s prohibitions against certain investment advice for participants in 401(k) plans and individual retirement accounts.

“In general, investment advice given by an investment adviser to plan participants that pay additional fees to the adviser or its affiliates can violate” sections of ERISA and the Internal Revenue Code, the DOL said when it unveiled the proposed rules in March. “This has limited the types of investment advice arrangements available to participants in 401(k) plans and IRAs.”

The DOL’s proposed rules seek to establish an exemption for advice that uses a “computer model certified as unbiased.” Another exemption covers advice given on a level-fee basis, in which fees are the same regardless on the investment selected by a participant.

Such exemptions would be subject to several requirements, the DOL said. For example, the plan fiduciary must select the computer model or fee-leveling arrangement independent of an investment adviser or the adviser’s affiliates; computer models used in providing advice must be certified in advance as “unbiased”; experts who certify the computer-model validity will be subject to certain qualifications; and fee-leveling deals must prohibit investment advisers from receiving payments from affiliates “on the basis of their recommendations.”
Second time around

This is the second time the DOL has issued advice-giving regulations. The Bush administration’s rules, scheduled to take effect March 2009, were delayed by the Obama administration on the grounds that officials wanted more public comment and more time to review the regulations.

In November, the Labor Department withdrew the regulations, saying a portion of the Bush-endorsed rules didn’t adequately guard against conflicts of interests involving investment advisers and affiliates.

When the DOL offered its revised rules in March, officials said they were nearly identical to the Bush administration’s regulations. Comments from industry participants, however, point to potential problems.

When Mr. Wray used the words “unintended consequences,” he was referring to fears by his organization and by several others that the new rules could be interpreted as requiring certain computer models or investment theories as acceptable advice. “The consequences can be quite broad — beyond the context of the regulation,” he said.

The PSCA, the U.S. Chamber of Commerce and the ERISA Industry Committee told the Labor Department that the government should refrain from recommending investment theories as part of the advice-giving regulation. “In the preamble to the proposed rule, the DOL requests comments on whether it should provide regulations on what constitutes generally accepted investment theories,” their jointly filed written comments stated.

“These questions are limited to the computer model, but any finding by the department will have repercussions beyond that,” they added. “We emphatically urge the DOL to reject this idea.”

If the Labor Department starts recommending investment theories, they warned, “then it will override the fiduciary obligations of the plan sponsors and the professionals.”

Computer modeling provoked testy comment letters. “The department seems to be expressing a preference for a particular type of investment strategy, which is unprecedented and inconsistent with past DOL positions,” wrote David Certner, legislative counsel and legislative policy director for AARP, Washington.

Noting that the DOL rule allows computer models to exclude advice on certain types of investments — including annuities and target-date funds — Mr. Certner argued that “a competent recommendation on investments cannot be made without … taking into account all investment options.”
Vanguard objects

Vanguard Group, Malvern, Pa., objected to a passage in the Labor Department’s discussion of its proposed rules that asked if restrictions should be placed on information used in creating the computer advice models. Restrictions could include historical risks and returns of different asset classes, information about participants, expenses for each investment option or the asset allocation for each option, the department said.

“Presumably, by limiting a computer model to a consideration of only these factors, it would be difficult to compare actively managed funds in the same asset class, thus establishing a strong preference for index vs. actively managed funds in an acceptable computer model,” wrote managing directors R. Gregory Barton and George U. Sauter.

Although Vanguard is a strong proponent of index funds, “we also believe that there is clearly a role for actively managed funds in an acceptable computer model,” they added.

Active vs. passive was the issue that prompted the words “simplistic” and “flawed” from Mr. Bremen of NEPC. “If the DOL stipulates that inclusion of low-cost investment options are appropriate and that more expensive active management funds are less appropriate for the advice model, there’s a danger that these regulations could impact other plan sponsor decisions,” he said in an interview.

For example, sponsors might worry about using active or passive investments “as part of their core lineup or what kinds of target-date funds to offer,” said Mr. Bremen.

The DCIIA raised several red flags in its comments. Because investment models and theories change over time, “it would be counter-productive to narrowly define the way in which models are created or to mandate the use of specific models,” the association wrote. “Plan fiduciaries, including investment advisers and plan sponsors, should be encouraged to take into account a broad range of considerations including fees, risk and historical investment performance” in preparing an investment menu.