Proposed 401(k) Reforms Stir Debate

(Dow Jones) If the U.S. Labor Department has its way, the rules governing who can give Americans investment advice about their 401(k)s and IRAs, and how that advice gets delivered and paid for, soon will change. But financial advisors and others disagree dramatically on whether the proposed rules will help or harm investors.

The Obama administration's aim is to eliminate the problem of advisors with hidden conflicts of interest giving slanted advice to unsuspecting retirement savers. But will the proposed rules achieve that goal? Like many things in life, it depends on who you ask.

Most independent, fee-only advisors who make a living giving investment advice to 401(k) plan participants and IRA owners are praising the proposed rules. Broker-dealers, meanwhile, are apoplectic. Others are somewhere in between.

According to Vice President Joe Biden, who unveiled the new rules at the White House last week, "the first of the two rules would ensure workers receive unbiased advice about how to invest in their individual retirement accounts or 401(k) plans.

"If the rule is adopted, it would put in place safeguards preventing investment advisors from slanting their advice for their own financial benefit. Investment advisors also would be required to disclose their fees, and computer models used to offer advice would have to be certified as objective and unbiased," he said.

The Labor Department estimates that 2 million workers and 13 million IRA holders would benefit from this rule-to the tune of $6 billion.

But there are plenty of opportunities for missteps with the new rules, some say.

"How this new regulation is going to be interpreted is critical-there are conditions that hang on the precipice; it's not going to take much of a misinterpretation to send the regulations over the edge," said Don Trone, chief ethos officer at Strategic Ethos.

Others point to enforcement as a potential issue.

More, Not Less, Investment Advice Needed

The Bush administration, in its waning days, issued new rules that made it easier for brokers to give advice to 401(k) plan participants. But the Obama administration put the kibosh on those rules and has now issued rules more to its liking.

Not to Bradford P. Campbell who served as the assistant secretary of labor heading the department's Employee Benefit Security Administration from 2006 to 2009, where he promulgated the prior rule that was then withdrawn by the current administration and replaced by this proposal.

"I am disappointed that this proposal eliminates the face-to-face advice permitted by the class exemption, depriving more than 10 million workers of access to this valuable form of advice," said Campbell, now an attorney with Schiff Hardin LLP.

Bruce Johnston, president of DBJ Associates, a consulting firm in the financial industry, said, "I find it incredible that the Labor Department would further penalize the American worker by failing to suggest or implement legislation that would actually allow them to receive investment guidance versus eliminate it. If the past few years aren't proof enough that plan participants need additional investment advice, not less, I don't know what sign the DOL might be looking for."

"They are putting up hurdles for advisors with no incentive to employers," said Louis S. Harvey, president and founder of Dalbar. "This is a market killer. We must have some incentive for employers to offer level-fee advice or this will die."

Others had a different take on the matter.

Compensation Skews Advice

According to a White House briefing document on the subject, "if investment advisors get a commission or other compensation for steering workers into investment options with high fees and expenses, they face conflicts of interest that can undermine the reliability of their advice."

There are plenty who feel the same way.

Roger Wohlner, a fee-only financial advisor with Asset Strategy Consultants, said it's great that advisors cannot benefit financially from any recommended investments under the proposed rules.

"Allowing advisors to steer participants into funds [or] investments from which the advisor stands to directly benefit-via sales loads, trailing fees, and the like-is a recipe for conflicted and likely sub-par advice for 401(k) participants," he said.

For his part, Edward M. Lynch, Jr., managing director of the 401(k) Advisors Group, said, "If you look at the broad intent, the Labor Department is effectively recognizing a fiduciary standard-[non-conflicted] advice only in the best interests of the plan and plan participants-as opposed to a less rigorous business or 'suitability' standard, which is a far lesser and potentially biased or conflict-of-interest ridden standard.

"The administration gets that people are upset about the conflicts rife within the industry and that, at least in this arena, is trying to raise the bar for good practices," Lynch said.

In the end, Lynch and others think it's possible that plan sponsors-the companies that sponsor 401(k) firms as opposed to plan providers-may decide to work only with advisors who are not associated with selling products in any way.

Wohlner and others also said advisors to 401(k) participants should disclose all fees.

"Advisors and their affiliates should be required to disclose all fees and forms of compensation from both giving advice and any other related revenues they make off of the plan," he said. "Full and complete disclosure with no loopholes or exceptions."

New Rules On Using Computer Models

Of course, some of the details are devilish and confusing. Take the rule that lets advisors use computer models to give investment advice under certain conditions.

The proposal tightens up the rules on such advice, said C. Frederick Reish, an attorney with Reish & Reicher.

"Under the withdrawn regulation, if an advisor gave advice to a participant, but the participant asked for more advice, the advisor could give his advice, that is, non-computer model advice. Under the new proposed regulation, the advisor cannot give his personal advice in any circumstance."

The rule also says that if an advisor uses a computer model, it needs to be certified as objective and unbiased. But advisors aren't clear on what that means and how it will be enforced.

What's Past Is Past

Likewise, advisors are confused about a proposed provision that disallows the use of historical data.

"Clearly historical data should not be the criteria for fund selection in and of itself," said Wohlner. "But ignoring it totally, or any other aspect of fund data such as expenses, relative risk, risk-adjusted performance, and the like is a mistake. I love index funds, but they are not the right answer in all cases."

Campbell and others agree. "I am very concerned that the Labor Department is considering defining 'generally accepted investment theories' and mandating or prohibiting investment practices," Campbell said.

"Debates over active or passive management, whether to consider past investment performance in the model, and similar matters should be decided by fiduciaries, not the government," he said. "Such unprecedented regulatory micromanagement of fiduciary decision-making would be dangerous, and not in the best interests of participants."

Said Johnston: "I find it frightening that the Labor Department...took upon themselves to consider and question the value of prior performance before releasing their proposed regulations."

Some say this provision opens up a Pandora's box of problems.

"The proposal is looking to hide past performance of individual funds, opening the door for every failed scheme and Madoff look-alike to get into IRAs and 401(k)s as long as the expenses are low," Harvey said. "This is crazy."

Confusion About IRAs

Another big area of debate and confusion concerns what advisors can and can't do when giving investment advice to IRA owners.

"Of particular importance is the impact the regulations are going to have on brokers who advise IRA rollovers, which is just about any broker who is serving wealth management clients," Trone said. "It seems that a vast majority of brokers will now have to become dually registered if they are going to advise either qualified pension plans or IRA rollovers." Dually registered advisors are registered both with the Financial Industry Regulatory Authority and the Securities and Exchange Commission.