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Firms Align with 401(k) Advice Providers


A growing number of fund companies are establishing alliances with third party 401(k) advisory firms in an effort to meet increasing demands for 401(k) advice.

Scudder Kemper Investments of Boston, Merrill Lynch of New York and Prudential Insurance Company of America of Newark, N.J. and Charles Schwab of San Francisco are some of the fund companies that have aligned with third-party advisers in the last three years to provide 401(k) investment advice.

"401(k) advice is the new must-have feature for 401(k) plans and traditional plans haven't met investors' fundamental need for advice," said Chris Jones, vice president of financial research and strategy for Financial Engines, a 401(k) advice firm in San Francisco.

The demand for advice is coming from plan sponsors and providers that want to transfer fiduciary responsibility for employees' 401(k) plans to an independent, third party, according to Gary Blank, a human resources consultant with William M. Mercer of New York.

"Employees aren't investing wisely," he said. "There is too much money in conservative investments like money market funds and employers are starting to realize some of their employees won't have enough money to retire. Many large employers have spent money on education efforts only to have employees come back and ask which fund should they invest in. Employers are now looking at third-party advice as a silver bullet to solve this problem."

But third-party advisors are not necessarily the definitive solution for fund companies, according to Michael C. Henkel, president of Ibbotson Associates of Chicago, a 401(k) advisory firm. The Employee Retirement Income Security Act (ERISA) requires fund companies and 401(k) advisors to remain separate entities. Fund companies can direct plan participants to a third party advisor, but they cannot collect fees for 401(k) advice or attach their brand name to the advisory service, he said. An alliance with an independent 401(k) advisor must have no direct benefits for fund companies other than offering its plan sponsors and participants an outside information source, Henkel said.

But, the U.S. Department of Labor, which oversees ERISA regulations, has not established a uniform policy on 401(k) advice.

"The DOL hasn't issued any rulings on this advice business and it hasn't been tested too much in the courts," Henkel said. "There is no written safeguard that says if you offer a third-party advisory service and pay for it, you are exempt from ERISA regulations."

Still, many fund companies are willing to take that risk, judging by the growing demand for 401(k) advice. The fund companies are employing different strategies to minimize their risk of liability.

Section 96-1 of ERISA allows plan providers to offer educational materials to plan participants. Fidelity Investments of Boston, for example, offers plan participants a 401(k) portfolio planning web page, but because the content is intended to educate, not advise, it complies with section 96-1 of ERISA, according to Blank of William M. Mercer. Participants can gain free access to Fidelity's portfolio planner, but they do not get the personalized service that they would get from a fee-based 401(k) advisor, according to Blank.

In 1997, TCW Group, asset managers of Los Angeles, in an effort to improve on what has become the conventional arrangement for partnerships between 401(k) providers and advisors, appealed to the U.S. Department of Labor for an exemption from ERISA regulations, according to Henkel of Ibbotson. The Department of Labor agreed, in October 1997, to allow TCW Group to offer 401(k) advice for a fee under the TCW brand name, provided that TCW Group assumed a fiduciary role and that it not invest more than five percent of its assets in the advisory service, Henkel said. With that exemption, TCW then hired Ibbotson to provide that advice.

While most plan providers shy away from assuming a fiduciary role, because of perceived liability risks, TCW Group's fiduciary status and its ERISA exemption provide adequate protection because lawsuits against fiduciaries can only be filed in federal courts and the agreement has the Department of Labor's approval, Henkel said.

Still, not all fund companies will want to get involved in the 401(k) advice market. For such companies, an alliance with a 401(k) advisor could be a good solution for these companies, said Fred Barstein, president and CEO of Insight In Formation of Lake Worth, Fla., a 401(k) plan rating service.

"Why you might see traditional fund managers turning to a third party 401(k) advisory firm is they don't want to be intermediaries or investment advisors," he said. "Outsourcing is a big trend today." It shifts the fiduciary responsibility from the plan provider to the 401(k) advice firm, he said.

But before the 401(k) advice industry can experience significant growth, it must address plan sponsors' and participants' aversions to paying added fees for advice, said Henkel of Ibbotson.

"For whatever reason, plan participants are not willing to take out their pocketbooks and credit cards to pay the $30 to $50 dollars a year for 401(k) advice," he said. Very few, if any, plan sponsors are willing to pick up the costs for their employees either, he said.

401(k) advice fees can range from $30 to $50 per participant and setting up 401(k) advice websites can cost plan sponsors up to $50,000, said David A. Peckman, vice president of mPower of Palo Alto, Calif, a 401(k) advisory firm.

But, Peckman believes plan sponsors are beginning to see the value of 401(k) advisory services and are more willing to include advisory services as a benefit to their employees.

"I think what has happened is you have had a slow development curve that is normal for any new product," Peckman said. "When you look at the money some companies spend on their employees' Christmas gifts, it is comparable to what they would pay for 401(k) advice."