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DOL Rule Emphasizes Independent 401(k) Advice

Bona fide 401(k) investment advice could finally become standard practice in defined contribution plans, thanks to the Department of Labor's proposed rules limiting the actions of investment professionals who take commissions.

"The concern is that we don't want [workers] steered in a direction that may not be best for them simply because that's the way the adviser can make more money," said Phyllis Borzi, assistant secretary of the Employee Benefits Security Administration at the DOL.

The proposed rules will shield workers from potential conflicts of interest related to financial advisers and 401(k) administrators by only allowing them to give investment advice as long as they don't get a commission for steering workers into their own funds. Advisers would also be required to disclose their fees and could use computer models to offer advice, provided they are certified by the government as objective and unbiased.

The proposal is essentially identical to the DOL's Jan. 21, 2009 advice rule, which it later withdrew on Nov. 20, 2009-except for the certification requirement and the elimination of language referring to varying fees. Industry observers believe it successfully eliminates conflicts of interest and is an improvement in that it only permits flat fees.

Mercer Bullard, founder of Fund Democracy, said the proposed rules will finally give product providers an incentive to bundle advice into their plan features and allay sponsor concerns over fiduciary responsibilities and potential litigation.

Tremendous Impact

Half of large 401(k) plans currently offer either a default automatic component or advice, up from a mere 17% in 2000, according to Hewitt Associates.

Certainly, 401(k) investors and fund administrators stand to benefit tremendously from advice becoming de facto. A recent study by Hewitt Associates and Financial Enginesfound that 401(k) investors who are aided by professional investment advice typically earn two percentage points more a year than those who don't receive help. While that may not sound like a significant difference, a 45-year-old investor with the benefit of professional advice over 20 years would have a portfolio nearly double the size, 47% larger, than someone investing on their own.

Given the quality of the advice and conditions of the market, the impact could be even greater. Charles Schwab recently found that investors who took advantage of its independently administered GuidedChoice personal retirement planning tool earned three percentage points more than those who did not.

Distinction Among Advisers

The rule also eliminates the issue of various types of advisers, their compensation and responsibilities by only allowing truly independent, fee-based advisers to offer advice.

Regulators have long struggled with the issue of distinguishing the roles of financial planners, advisers and brokers, particularly in the minds of unsophisticated investors.

By definition, a broker trades mutual funds and securities on behalf of others, a dealer buys and sells securities for their own accounts, and an investment adviser is someone who provides advice. Fee-based advisers get a flat fee regardless of the advice they give, whereas broker/dealers are paid on commission.

In 2005, the Securities and Exchange Commission passed a rule called "Certain Broker-Dealers Deemed Not to Be Investment Advisers"-also known as the "Merrill Lynch Rule"-which would have allowed brokers to call themselves financial advisers and charge fees for information without being subject to the same regulations as independent advisers.

The Financial Planning Associationchallenged the regulation, and it was eventually overturned by a court of appeals, prompting the SEC to commission a study by the RAND Corp.'s Center for Corporate Ethics, Law and Governance.

The RAND report verified that the boundaries between broker/dealers and financial advisers have blurred in recent years and found that most investors don't understand the difference. Furthermore, the introduction of fee-based brokerage programs; interchangeable, generic titles such as adviser, financial adviser and financial consultant; and "we-do-it-all" advertisements make it increasingly difficult and confusing for investors.

"All too often, the worst-performing products with the highest fees and best commissions for financial service firms have been pushed by Wall Street on our nation's workers," said Reps. George Miller(D-Calif.), chairman of the House Education and Labor Committee, and Rob Andrews (D-N.J.), chairman of the pensions subcommittee, in a joint statement applauding the new DOL rules.

"We hope that this proposal will help to ensure that investment advice is based on what is best for a family's long-term retirement security, not the investment adviser's commissions," they said.

Reaction among the financial planning community has been predictable, with some commission-based advisers protesting that the rule will eliminate investment advice at a time when investors need it most.