Take My Advice...Please

(Published September 15, 2008)

It's no secret that most employees don't have a clue about how to invest their 401(k) contributions. The 2006 Pension Protection Act (PPA) allows plan sponsors to hire outside investment advisors to provide one-on-one advice to plan participants and beneficiaries. Proposed regulations, which implement this PPA provision, won't become effective until 60 days after final regs are issued. However, plan sponsors who will be interacting with outside advisors should familiarize themselves with the regs' main provisions now.

Preliminary Matters  

The PPA allows plan sponsors to choose between in-person advice provided by an outside investment advisor, or advice driven by computer models. Regardless of how advice is provided, outside investment advisors must meet some basic standards. For example, prior to their dispensing any advice or firing up any computer model, the proposed regs would require outside investment advisors to make certain disclosures to plan participants.

The disclosures would require the outside advisor to describe the role of any party who has a material relationship with him/her; the past performance and historical rates of return of the plan's investment options; and all fees and compensation relating to the advice that the advisor or any affiliate will receive in connection with the advice. Disclosures would have to be written in a clear and conspicuous manner that the average participant could understand. Tip: When evaluating disclosures, put on your plan participant hat. If you're confused, odds are participants will be, too.

In-Person Advice  

Plan sponsors who bring in outside investment advisors should ensure that they meet these minimal standards, as enumerated in the proposed regs.

• The advice must be based on generally accepted investment theories that account for the historic returns of different asset classes over a defined period of time.
  
  
• The advice must also account for information furnished by participants, including their age, life expectancy, retirement age, risk tolerance, other assets or sources of income, and investment preferences.

The compensation and fees (including salaries, bonuses, awards, promotions, and commissions) received by employees, agents, or registered representatives who provide investment advice don't vary with the advice given. Also, fees (including commissions or other compensation) received by the investment advisor with respect to a disposition of any security don't vary. This is called fee-leveling.

Computer Models 

Investment advice may also be delivered through computer models. The proposed regs would require that investment advisors who use computer models have their models certified by an independent investment expert. This expert would also have to provide plan sponsors with written certification that the computer model met regulatory standards. In addition to securing this certification, plan sponsors should ensure that computer models meet these minimal standards.

• The model must be designed and operated to apply generally accepted investment theories that account for the historic returns of different asset classes over a defined period of time. The model must use information furnished by participants, including age, life expectancy, retirement age, risk tolerance, other assets or sources of income, and investment preferences. The model must also use appropriate objective criteria to provide asset allocation portfolios consisting of investment options available under the plan. 
  

• The model must be designed and operated to avoid investment recommendations that inappropriately favor investment options offered by the investment advisor, or inappropriately favor investment options that may generate greater income for the advisor.

Appendix A to the proposed regs includes a model notice outside advisors can use to satisfy their disclosure obligations. Plan sponsors should carefully scrutinize any notice that deviates from this model.

Click here to read the proposed regs, including Appendix A.

Related Topic(s): Benefits