The risks of giving advice to 401(k) participants

401(k)-plan advisers are well-positioned to provide investment advice to participants, but it could prove legally treacherous

Oct 8, 2019 @ 3:05 pm

By Fred Reish

From time to time, advisers who serve as investment fiduciaries for 401(k) plans ask if they can also provide investment advice to participants. The answer is "Yes, if it's done properly." As that suggests, the devil is in the details.

The starting point in analyzing the issue is to acknowledge that if a plan adviser recommends itself (or an affiliate) to provide investment services for participants and will be paid for those services, there is a conflict of interest.

The recommendation, if accepted by the primary plan fiduciaries (e.g., the plan committee), will result in additional compensation for the plan adviser (or its affiliate). Under the securities laws, that conflict could be resolved by full and fair disclosure.

[More: 401(k) advisers may be this type of fiduciary — and not know it]

However, under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code, the issue is more complex, since many conflicts are also prohibited transactions. For example, if a fiduciary investment adviser uses its authority as a fiduciary to influence the committee to hire the investment adviser for participant services, that would be a prohibited transaction.

However, if the adviser simply introduces its participant services and provides information to the committee about those services, that would fall under the education and information (or "hire me") definition of nonfiduciary actions. In other words, if properly done, it would not be a recommendation that could result in a prohibited transaction. However, the information and education cannot be a disguised recommendation; it should be unbiased and complete. The information could include the adviser's qualifications, its experience in advising participants, and references from other plan sponsors.

[More: New rules make it easier to access 401(k) funds]

Similarly, there is a risk that, if the adviser monitored its activities as a participant investment adviser and recommended to the plan committee that it be retained in that capacity, that recommendation could also be a fiduciary prohibited transaction. To avoid that risk, the adviser should again provide information to the committee that would enable the committee to evaluate its advisory services to the participants but should not make statements that would be the equivalent of a recommendation to be retained.

For example, the plan adviser could provide information to the committee about the usage of its services by participants, and performance relative to relevant criteria (e.g., participants' indicated risk tolerances, fees relative to those for similar services, and so on). That information is, in effect, data that helps the committee to evaluate the adviser's participant services but does not amount to a recommendation to retain the adviser's services.

[More: Morgan Stanley adding 401(k) participant services to boost wealth business]

While this process would allow a plan fiduciary adviser to also provide fiduciary investment services to participants (as either a nondiscretionary 3(21) adviser or a discretionary 3(38) manager), it would be good risk management to document that the communications were in fact informational and educational, and not recommendations.

The first step in doing that is to develop a brochure that introduces and explains the participant services in a manner that is unbiased and factual. It would also be helpful to have an outline or rough script of the considerations to be discussed with committees. For the periodic reports after being hired, advisers should include factual information that would allow the committee members to determine that the services are being properly delivered, that the fees are reasonable and that the investment results are consistent with their objectives (e.g., that the conservative participants are invested conservatively and that the investment results are consistent with that). The periodic updates (e.g., annually) should also include information to show that the adviser continues to have competency for participant advisory services (e.g., registration, experience, certifications).

[Recommended video: Retirement advisers can boost business by focusing on participants in these ways]

Advisers to plans are often in the best position to understand the considerations for helping participants of the particular company. That includes the investments, the costs, the culture of the company, the needs of the covered workforce, and the educational levels and investment experience of the participants. As a result, they are in a position to provide valuable investment services to the participants. But, the legal waters, if not properly navigated, can be treacherous.

Fred Reish is a partner at the law firm Drinker Biddle & Reath.


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