DOL fiduciary rule will cause retirement plan advisers to outsource liability

Outsourced investment advisory services for 401(k) plans stand to reap the benefits of the Labor Department’s proposed rule to raise investment advice standards in retirement accounts.

The rule would make fiduciaries of any 401(k) adviser giving investment advice, and advisers who take on more liability by constructing and monitoring a plan’s investment lineup as a result of the regulation may look to offload some of that risk.

“Post-DOL, I imagine [outsourced services] will become even more popular,” said Anthony Domino Jr., managing principal at Associated Benefit Consultants.

FUND RECOMMENDATIONS

The services in question are referred to as 3(21) and 3(38) fiduciary investment services, as defined by the Employee Retirement Income Security Act of 1974. A 3(21) fiduciary adviser serves as a co-fiduciary, making fund recommendations for a 401(k) lineup but giving plan sponsors ultimate discretion to implement changes. With 3(38), advisers take on even more fiduciary liability, because they have full discretion to implement changes.

Retirement plan advisers can outsource such responsibility to firms such as Morningstar Inc., Mesirow Financial Holdings Inc. and Wilshire Associates Inc., some of the most prominent players, to reduce or eliminate fiduciary liability when building plan lineups.

(More: Recent class-action surge ups the ante for 401(k) advice)

RISK TRANSFER

“There’s going to be more risk to transfer, and there’s a tremendous opportunity [for advisers] to transfer that risk to these big companies,” Mr. Domino said.

Here’s how the outsourced services generally work: The providers contract with record-keeping firms, which then offer the services to all defined contribution plans on their platform. Under the 3(21) service, outsourced providers screen the funds available over a record keeper’s platform, and narrow those down to a handful of funds in certain asset categories that advisers and plan sponsors can then use to build a final 401(k) lineup. In the 3(38) offering, the providers — not the plan adviser or employer — choose the ultimate combination of funds.

These services have grown more popular over the last several years. Morningstar, for example, now advises on $29 billion in DC assets through more than 12,000 plans, up from $10.3 billion and 2,300 plans in 2009.

The growth is due to several factors, such as working with more record keepers and advantageous market performance, as well as more demand created by heightened fiduciary awareness, according to Jim Licato, senior product manager for fiduciary services at Morningstar.

Industry watchers expect even more uptake if the DOL rule becomes final, in part because these outsourced services tend to be used mostly in the small and micro 401(k) market.

“There’s definitely going to be heightened liability in serving [401(k)] plans, especially smaller plans,” said Scott Cooley, Morningstar’s director of policy research. (Of course, he added, this depends on the text of the final rule, which is likely to come out this month or early April.)

The small-market niche is the one in which the non-retirement-specialist advisers and brokers tend to operate. Indeed, non-fiduciary brokers are the traditional users of Mesirow’s service, according to Vincent Vicidomini, the company’s vice president of business development. (Mesirow advises on nearly $40 billion in more than 20,000 DC plans through its outsourced offering.)

These brokers arguably will be hardest hit by the DOL rule, which would hold them to the more-stringent fiduciary standard rather than the current suitability standard.

“Just raising the bar on that standard may make advisers reach out and say we need an extra level of care, a fiduciary level of care,” said Brooks Herman, head of data and research at BrightScope Inc. “One avenue to do that is through these 3(21), 3(38) providers.”

Furthermore, 401(k) specialist advisers may come down-market to fill the hole left by advisers who exit the small 401(k) market post-DOL rule, and using an outsourced product could help them scale their practice efficiently, Mr. Vicidomini said.

(Related fiduciary read: Congress poised for its last stand against DOL rule)

NOT A ‘PANACEA’

Jason Roberts, chief executive of the Pension Resource Institute, also believes that third-party services will gain more popularity, but cautions that while these offerings can limit fiduciary responsibility for advisers at the plan level, advisers could still be exposed at the participant level.

“So it’s maybe not the panacea people may be led to believe,” Mr. Roberts said. Advisers making investment recommendations to participants would be held to a fiduciary standard, he added.

Financial planning discussions around such topics as helping participants understand retirement goals, their gaps in getting there and the level of deferrals needed to help close those gaps would not constitute a fiduciary act under the proposed rule, Mr. Roberts said.