Enhancing Transparency

New regulations make it easier for organizations to offer financial advice to retirement-plan participants as well as require transparency on investment decisions and potential conflicts of interest. The increased disclosures, however, could lead to information overload for the participants, especially those who are not financially sophisticated.

Tuesday, November 22, 2011
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The U.S Department of Labor's final regulations that make it easier for employees to receive improved 401(k)-type investment advice has received a generally positive reaction, although there was some concern about increased costs.

The regulation, issued by the Employee Benefits Security Administration, implements "a prohibited transaction exemption under an amendment to the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code (IRC) that is part of the Pension Protection Act (PPA) of 2006," according to the DOL.

Translation: Apart from better and more accessible information for employees, employers are given an added layer of protection from litigation resulting from plan participant investment results. It also will ensure transparency regarding fees to firms who provide both 401(k) plan products and fiduciary advice.

"Given the rise in participation in 401(k)-type plans and IRAs, the retirement security of millions of America's workers increasingly depends on their investment decisions," says EBSA Assistant Secretary Phyllis Borzi. "This rule will make high-quality fiduciary investment advice more accessible, while providing important safeguards to minimize potential conflicts of interest."

According to the DOL, the "prohibited transaction rules" in ERISA and the IRC generally prevent a fiduciary investment adviser from recommending plan-investment options if the adviser receives additional fees from the investment providers.

The new regulation implements an exemption that Congress enacted as part of the PPA to improve participant access to fiduciary investment advice, which contains certain safeguards and conditions to prevent investment advisers from providing biased advice that is not in a participant's best interest.  

To qualify for the exemption, investment advice must be given through the use of a computer model that is certified as unbiased by an independent expert or through an adviser compensated on a "level-fee" basis, meaning that the fees do not vary based on investments selected.

Both types of arrangements must also satisfy several other conditions, including the disclosure of the adviser's fees and an annual audit of the arrangement for compliance with the regulation. In this case, the auditor must be independent of the service provider.

Eric Keller, a partner at Paul Hastings, a Washington-based law firm, says the DOL regulation has been in the making since 2006, adding that it's a positive development.

"An employer might decide to make this program available to its plan participants in order to provide as much information as is available to help them make informed investment decisions," Keller says. "This is particularly important in light of the recent economic downturn and associated uncertainty in the economy and financial markets." 

Robyn Credico, the national leader of defined-contribution consulting at Towers Watson, in Arlington, Va., says that, for larger employers, the clarification of the rules and regulations is good news -- as many employers have wanted to offer advice, but were concerned about meeting fiduciary requirements.

"It's getting hard not to be sued these days in this area," Credico says. "While this regulation is not a huge change from the DOL guidelines employers have been using, this delivers much greater clarification. It gives the entire situation some finality. Employers try to do the right thing, so this provides closure."

Mark Wayne, president and CEO at Freedom One Financial Group, in Clarkston, Mich., calls the DOL announcement "very important," because the goal to improve employee access to advice is much needed.

On average, he says, an employee receiving expert advice will hold nine retirement-plan funds, compared to five funds for the self-directed employee.

"The diversity alone can help improve results," Wayne says, adding that employees receiving advice enjoy higher returns of between 2 percent and 2.7 percent each year.

"That can add up over 20 to 30 years," he says. "Research shows that about half the people in plans want advice, while about 20 percent are OK with a computer model. The DOL regulation will allow that to happen.

"Plus, the DOL now says if you follow these rules, then the employer won't be held liable for the consequences," Wayne adds. "I think it's great. It took five years to get it done, but it's a good regulation for participants, and helps the employer to stay out of trouble."

More and more, Keller says, employees are looking for help in making better investment decisions, noting that, while 401(k) plans have been around for 30 years, the vast majority of employees don't have the financial sophistication to develop solid, diversified investment portfolios.

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"This adds another service level that may be made available to an employer if they choose to offer it," Keller says, adding that the regulation, by its design, will minimize potential of conflicts either through a fee-leveling approach or because the advice will not be tainted by compensation arrangements with the adviser.

"Most of all, participants can receive investment advice that will give them more information and potentially enable better returns," he says.

While the intent of the DOL is good, says Indianapolis-based attorney Michael Paton, chair of the compensation and employee benefits practice at Barnes and Thornburg, one snag is that employers may face higher costs due to an increase in the already burdensome disclosure requirements to plan participants.

"Employees are about to get a lot more information, which is good," says Paton. "But the downside is it could lead to more information than the average employee is able to digest. With investment-plan matters, there are notices after notices and the employee may see it as overload and won't know what is important and what is not."

From an HR perspective, Paton says, the plethora of new disclosures could cause employees to tune out from the process.

"There are very sophisticated employees who want to know this stuff, but not everyone knows what a basis point is, for example," he says. "The spirit is good, and the DOL is trying to protect employees. If the DOL loosened the requirements for e-disclosures, it could go a long way to lessening costs for employers and the paper overload for employees."

Currently, the law requires disclosures be distributed on paper, he says. The rules on e-disclosures are still in flux.

In essence, Paton says, the DOL regulation, while well-intentioned, could be counterproductive due to expected information overload.

"The DOL has acknowledged that fact, but I am not sure they are prepared to do anything about it," Paton says. "For employers, the DOL regulation does minimize liability because the more you disclose the better off you are. But the downside is the cost associated with being prepared -- and distributing the disclosures can be steep."

"It's about balancing the cost and expense to the employer to the utility to the employee," he says. "Perhaps if the balance was more toward fewer disclosures, it would be more effective. Even with that, there could end up being a net benefit from the new regulation, but we are not completely optimistic right now."

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