Retirement Advice
Will New Rules Lead To Better Or Less 401(k) Advice?
By Ashlea Ebeling
May 05, 2010

There's an obscure battle raging in Washington that could have a big effect on how you invest for retirement. Officials at the Department of Labor have proposed new regulations that they say will protect 401(k) participants and Individual Retirement Account holders from greedy advisors who have conflicts of interest. But some financial industry participants insist the rules will backfire, leaving employees with less or incomplete advice.

Here's the story: Almost half of 401(k)s and other employee-directed retirement plans now offer investment advice to participants, often through computer models created by such outside vendors as Financial Engines, Inc., a newly public Palo-Alto firm cofounded by Nobel Prize winning economist Robert Sharpe. So, for example, if your 401(k) is administered by the Vanguard Group or T. Rowe Price and you want to know which Vanguard funds to buy, Financial Engines' computers will provide suggestions. Dozens of big corporate 401(k) plans, including those at IBM, Merck and Xerox offer employees Financial Engines' advice, sometimes at minimal or no cost.

A provision of the 2006 Pension Protection Act that was meant to make advice even more widely available, would allow the same financial services firms that manage the mutual funds and other investments offered to participants to also provide specific investment advice to those participants. The Department of Labor estimates this provision would open up advice to 21 million plan participants.

What about potential conflicts of interest? Wouldn't investment managers be tempted to favor their own funds over competitors' or to steer participants into higher-cost funds? To protect against that, the law required that when investment managers give advice it must be based on either "unbiased" computer models or a "level-fee" arrangement where advisers aren't paid based on the investments participants buy.

The Bush administration, on its last day in office, issued regulations to put those provisions into place--regulations that the Obama administration withdrew. On March 2 the Obama Labor Department issued its own proposed version of the rules and a series of questions suggesting what the final rules might say. The financial services industry is none too happy, saying that questions asked by the DOL indicate it's leaning toward final rules that would place onerous restrictions on in-house investment advice, gutting the intent of the 2006 law.

Comments from the industry were due today on such DOL questions as: "What are examples of investment theories that are not generally acceptable?"; "What historical data should be taken into account?"; and "Should a model ascribe different levels of risk to passively and actively managed investment options?"

These questions have raised fears in the financial services industry that the department will put a government stamp of approval on one type of investing--index mutual funds--and mandate that computer modeling ignore past performance, considering only past costs.

"Ignoring past performance is inconsistent with generally accepted investment practices and having the department opine on how plan assets should be invested would be a radical departure and a mistake," joint comments filed Tuesday by the lead industry groups, the American Benefits Council, the American Council of Life Insurers and the Investment Company Institute, assert. "We think it sets a dangerous precedent for the government to usurp the role of fiduciaries by placing its thumb on the scale for one kind of investment--index funds," the groups continue. Instead, the industry groups say, such decisions should be left to employers and the independent experts who certify the computer models.

"We need advice, and it needs to be unshackled," Thomas Kmak, chief executive of Fiduciary Benchmarks in Kansas City, Mo., told Forbes. His firm helps employers compare 401(k) plans. "If you have innovations in investment theory that can't be considered because it's a non-index option, how can that be a good thing? Why let the government stop innovation?"

Moreover, he says, if the choice is between providing advice that steers people to index funds with low fees and subpar performance, or not providing advice at all, a 401(k) provider may decide not to deliver advice at all.

In other filed comments, the Spark Institute, which represents companies that service 62 million plan participants, warns that the department's questions are so far reaching that they could have a negative spillover effect on existing third-party advice programs. "Advice providers will be hard pressed to ignore the views of the (Labor Department) regarding historical performance and, consequently, forced to make significant changes to their advice models," the Institute warns, adding, "Advice providers could potentially decide to shut down their services temporarily or permanently making advice services less available to participants."

Does advice matter? A recent study conducted by Hewitt Associates and Financial Engines found that 401(k) participants receiving advice earn almost 200 basis points a year more than those who don't. Unfortunately, most retirement savers make the same old mistakes--contributing too little, investing too much in their employers' stock and ignoring such crucial tasks as rebalancing their accounts.

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