Many 401(k) sponsors, providers and advisors eagerly await the DoL’s new advice proposal, which is due to be released within the next 30-45 days. In an effort to put in our two cents, we thought we would share our hopes for the proposal based on our experience in delivering advice, our understanding of other options in the marketplace, and the feedback we have received from employers and investors alike. Keep in mind most of our clients exist in the top end of the small market (250+ employees) to large sized employers (1,000+ employees).
Goal #1 – Advice Must be 100% Conflict-Free
For those of you that aren’t 401(k) geeks like us (it’s understandable), the DoL proposed advice regulations in January of ’09. The proposal received immediate backlash in the media and from the legal and advisor community, especially those that operate as fiduciaries. The issue resonated from the idea of being a “level fee” advisor.
- Level Fee Advisor – The idea here is that mutual funds have revenue sharing arrangements that are different on a fund by fund basis. For example, if you have three large cap funds in your plan from three different mutual fund companies, it is highly likely the revenue arrangement for each fund is different.
- Conflicted Level Fee Adviser – The DoL proposed to require the advisor to charge a level fee while not requiring the advisor’s affiliated firms (broker dealer, mutual fund company, insurance company, bank, etc.) to receive level compensation from the funds in the plan as well. Here is a secret of the advice industry: someone provides advice to the advisor, because understanding the markets, determining asset allocations, etc. is a full time job. Therefore, if the advisor is receiving the advice recommendations from the affiliated firms, the advice has the potential to be conflicted as the affiliated firms could steer the advisor towards funds that provide themselves a greater benefit than the participants receiving the advice.
- Conflict-Free Level Fee Adviser – Under the conflicted approach, employers would have to determine whether the advice the advisor/team is delivering to their participants is biased or not. A conflicted (even those that are “managed”…whatever that means) environment will likely create a barrier of entry for employers considering advice. Thus, the use of an outsourced third party or 100% fee-only advisor (not just fee-based, as that means they can collect fees and commissions) seems to be a more reasonable choice for those who wish to provide participant advice they can trust as well as a service they feel good about promoting.
Using the “Keep It Simple, Stupid” principle, here is a simple model that allows employers and participants to easily understand the business structure of the advice provider:
- No Compensation from Financial Institutions, Period – If the advice provider does not receive any compensation from any investment, insurance, or banking institution, it allows them to be objective in the advice that is delivered to 401(k) investors.
- No Under-the-Table Arrangements with Recordkeeper – There should be no undisclosed arrangements with the recordkeeper of the plan to use specific investments that may benefit the recordkeeper more than participants. We have heard rumblings about such arrangements, specifically under the SunAmerica Opinion, but have no concrete evidence. However, such discrepancies have been alluded to in discussions with regulatory bodies, with one example being a recent article by PlanSponsor.
- Annual Audit - Did you say audit? Yeah, we don’t like them either. However, when an advice provider is required to be audited by an independent, unrelated third party, that’s a huge benefit to the provider’s clients. How so? It provides peace of mind that a professional auditor is likely going to ask the questions an employer wouldn’t know to ask and look for disparities that have created or potentially could create conflict in the advice delivered to investors.
- Full Disclosure of Business Revenue Sources – Full disclosure to employers by service providers is seemingly going to make its way into reality (finally), so it would seem logical to have this enforced for advice providers as well. If there is any revenue coming from a mutual fund, insurance, recordkeeping, or TPA company coming to the provider, then they are conflicted. Period. Employers evaluating advice providers should be informed of any conflicts before making it available to their colleagues. Full disclosure can help provide employers the peace of mind that a service they communicate for the benefit of their participants is in their benefit, not the advice provider’s.
Benefits to Conflict-Free Advice
- Increased Availability to Investors – We would argue that it’s not a lack of advice solutions that has kept more employers from providing advice, but the need for it to be conflict free. The vast majority of employers want to do right by their participants, so they evaluate services offered on their merit, value, deliverables and cost.
- More Conversations About Advice by Providers/Advisors With Employers – Additionally, it our belief and experience that advice has not been discussed with a lot of employers because the provider/advisor is waiting for the ability to deliver it themselves in a “managed conflicts” manner. Once the advice requirements are defined, the companies that can and cannot deliver advice will as also be defined, allowing the smoke to clear and available solutions to come to the forefront. This will end the wait-and-see period for providers, brokers, and advisors and will instead allow such entities to look at conflict-free solutions that can help their clients’ employees better succeed in managing their 401(k) assets.
- Empower Employers to Focus on Service Options, Instead of Fearing PR Nightmare of Offering Conflicted Advice – If there is one thing we have noticed over our years, it’s that companies are very careful about the services and benefits they offer so to ensure they reflect the company in good light to their employees. Imagine a company delivering communication campaigns illustrating the benefits of 401(k) advice to their participants. The campaign is a reflection of the 401(k) committees’ due diligence, and it is intended to be a message the participants can trust. If the advice is conflicted, this could create dissent among employees wondering why such an offering was given the thumbs up.
In summary, we believe the foundation of 401(k) advice must be conflict-free before you even start talking about how the rest of it works. The beneficiaries include employers, their participants, and though they do not realize it yet, advisors, brokers and the mutual fund/insurance companies who provide 401(k) platforms. If the DoL starts with a conflict-free foundation, it will be a huge win for 401(k) investors.
The next edition of this series will come out early next week. We would welcome any comments.
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