“Companies are concerned that even if they and their investment adviser doeverything right, they may be sued,” says David L. Wray, PSCA president. “Butnow employers are looking at the evidence, which indicates that they can provideinvestment advice in a prudent way without being sued. There is still somereluctance, but it is declining. Within the next five years, we will see half ofthe plans offering investment advice.”
Making the decision
Wray advises HR to consider two consequences when faced with the decisionabout whether to offer investment education, investment advice, or both. “Thefirst consequence is legal,” he notes. “There is no governmentalanticipation that employers will offer investment advice to 401(k) planparticipants, but there is an expectation that employers will provide investmenteducation. In fact, if you don’t provide education, you open yourself toliability, because you haven’t provided sufficient support to participants whomust make investment choices.” Wray believes that employers are more likely tobe sued for inadequate education and support than they are for advice-giving.
The second consequence is practical--a more important but more oftenoverlooked factor, Wray says. “The point of offering a 401(k) plan is to builda sense of partnership with employees. Companies spend a lot of money on theseplans. If you do not provide proper support and employees mismanage theiraccounts, the plan may become demotivating and will not produce a proper returnon the company’s investment in it. If you don’t provide advice, thepractical consequence is that you won’t receive the full value of the 401(k)plan. An effective advice program is one of the best ways to increaseparticipation and contribution rates and improve allocations.”
Although Wray believes that the fear of lawsuits arising from advice programsis largely misplaced, Christopher Kopka, counsel for American Express FinancialAdvisors in Minneapolis, notes that “down markets have a funny way ofincreasing litigation in our already litigious society. Employers should beconcerned about the risk of liability associated with providing advice, but moreand more they have to weigh that against the possibility of litigation flowingfrom uninformed or under-informed 401(k) participants.”
Allen Steinberg, a Hewitt Associates retirement and financial-managementconsultant in Lincolnshire, Illinois, advises HR managers to evaluate theirspecific workforce needs when deciding whether to add advice programs. “To theextent that employers have long-term employees, or want to have long-termemployees, employers have a stake in how employees manage their 401(k) accounts.Employers must ask, ‘How well are employees using the plan?’ If theallocations are good, the employer can stick with education alone.”
Freddie Mac feels less pressure to offer investment advice than many otheremployers. An impressive 94 percent of its employees participate in the 401(k)plan, and they invest 80 percent of their savings in equities. “This is aclear sign that our employees are investment savvy,” Herzog notes. The companyreviews employee investments in all 10 401(k) funds quarterly to monitor theappropriateness of allocations.
Freddie Mac offers an extensive 401(k) investment-education program throughtwo delivery methods--a secure Web site and quarterly workshops--and monitorsboth closely. “We meet on a quarterly basis with the third-party Web siteprovider to review the number of employees who use the site,” Herzog says. Themost recent review found that 80 percent of the plan participants had logged onto the site during the previous quarter.
The company measures the success of the workshops through employee surveysconducted immediately after the sessions. In addition, it conducts an annualemployee survey that includes questions about the 401(k) education program. SomeFreddie Mac employees have asked the company to add an advice program, but fornow, Herzog says, the company “is taking a wait-and-see attitude.”
Like Freddie Mac, the Tiller Corporation offers an extensive 401(k) educationprogram, but it takes a different approach to advice-giving. The company, whichproduces road-construction materials in Maple Grove, Minnesota, discovered thata large segment of its employees were poorly diversified, and brought in aninvestment adviser to help employees manage their accounts. “Througheducation, the adviser has been able to improve allocations,” says StevenSauer, Tiller’s vice president of finance. “Our employees receive one-on-oneinvestment advice, tailored to their specific issues and other financialholdings, at no charge.” If an employee does not enroll in the 401(k) plan,Sauer personally picks up the phone and calls the employee to explain thebenefits. Every one of the company’s 242 employees is enrolled in the company’s401(k) plan.
Tiller educates its employees about the 401(k) plan with meetings held atleast once a year. In addition, the company’s outside investment adviser prepares and distributes a customized quarterlynewsletter. “This newsletter describes what’s happening in the market ingeneral and specifically by fund,” Sauer says. “The adviser also constructsfour lifestyle funds--aggressive, moderate, conservative, and income-based--onthe funds available within our plan, and goes into greater detail on theperformance of these tracks.”
Tiller’s investment committee, composed of both management and employees,meets quarterly with the investment adviser and the plan administrator tomonitor the appropriateness of employee allocations. “We also monitorindividual fund performance, place funds on a watch list if their performancesuffers compared with their peer group or if they change managers, and drop oradd funds if necessary,” Sauer reports. “Our actions minimize any potentialfor major fiduciary issues.”
Investment education and investment advice are two different animals, and HRmust be able to distinguish between them and understand the different risksinvolved. Kopka suggests that HR professionals begin by closely examiningservice-provider contracts with their attorneys. “Investment-educationcontracts will most likely include references to the Department of Labor’sinvestment education safe-harbor guidelines,” he says, “and those contractswill likely say loudly and clearly, ‘I am not a fiduciary!’ By contrast,investment-advice contracts will typically acknowledge fiduciary status.”Employers that offer an advice program should receive a copy of Securities andExchange Commission Form ADV from the adviser, documenting the adviser’srequired SEC registration.
“If yousee something like, ‘We recommend you invest in XYZ mutual fund,’ theprogram is entering the world of investment advice.”
Kopka also advises HR to focus on one key point of differentiation: Does theprogram lead to a specific investment recommendation, or is it giving moregeneral information on model asset allocations, perhaps coupled with a breakdownof funds in the 401(k) plan that fall into those asset allocations? “If yousee something like, ‘We recommend you invest in XYZ mutual fund,’ theprogram is entering the world of investment advice,” Kopka warns.
Employers with education programs should follow the Department of Labor’sInterpretive Bulletin 96-1, says David R. Weaver, advanced planning attorney forEdward Jones, the St. Louis-based investment-education provider. IB 96-1 laysout the parameters for an investment-education program so it does not becomeinvestment advice. “It allows an education provider to go so far as to offerspecific sample asset-allocation models using investment choices available underthe plan,” Weaver notes. Employers should also seek protection by complyingwith ERISA 404(c), which helps shield the employer and trustees fromresponsibility for investment choices in self-directed plans, he adds.
Minimizing liability in advice programs is not as difficult as many employersbelieve. Weaver advises employers to select third-party providers with care, asthat selection is a fiduciary act. “The obligation is to use ‘prudence,’” he says. “Prudence requires making a sound decision and using theappropriate procedure, which should be documented. The concern is the competenceand appropriateness of the provider.”
As more employers offer investment-advice programs, pressure grows forCongress to settle the issue of whether the law should only allow independentadvisers or also allow companies that provide record-keeping services and mutualfunds to provide advice. “If Congress does not move beyond an independent-onlymodel,” Kopka believes, “the practical result will be a continuation of the‘advice gap’ between participants who want advice and employers who willcontinue to play it safe and err on the side of not offering advice. The endresult will be that participants will miss out on tools they need to help thembetter understand both the need to save and what to do with the money once theyhave set it aside for retirement.” Kopka favors the proposal advocated byRepresentative John Boehner, which goes beyond independent advice “but offersvery strong protections for 401(k) participants should an investment adviser befoolish enough to provide biased, self-serving advice.”
The demand for investment advice will continue to grow as 401(k) planparticipants face ongoing market volatility and account balances that may notprovide sufficient savings for retirement. HR can respond by evaluatingallocations and plan performance, finding the right mix of education and adviceto meet plan objectives, and following basic steps to minimize fiduciaryliability.
Seven Basic Steps for Minimizing Liability
The following list of ways to minimize fiduciary liability in 401(k)investment-education and advice programs is drawn from 401(k) experts and U.S.Labor Department documents:
1. If you don’t have an investment-education program, get one.Underinformed participants pose a risk.
2. Make sure your education program is specific to your 401(k) plan,periodically updated to reflect any plan or workforce changes, and monitored foreffectiveness.
3. Comply with ERISA 404(c) guidelines for self-directed plans and state yourcompliance in plan materials.
4. If your education program does not produce optimal participation,contributions, and allocations, consider adding an investment-advice program.
5. Select your investment adviser with the prudence required by ERISA, usingan objective process to determine the advice-provider’s qualifications, thequality of services offered, and reasonableness of the fees charged.
6. Document your adviser-selection process, paying particular attention tothe steps taken to avoid any adviser self-dealing, conflicts ofinterest, or other improper influence.
7. Periodically review the adviser, including any changes in the informationthat served as the basis for the initial selection, utilization of services bythe participants, and participant comments and complaints.
Workforce, October 2002, pp. 46-49 -- Subscribe Now!