Thursday, August 28, 2008

DOL Investment Advisory Proposals

On August 22, 2008 the DOL published proposals to implement the investment advice provisions of the pension protection Act of 2006. A good summary of the proposals is available here with additional commentary at Benefitsbizblog.

Overall, the intent of these proposals is to make “quality” and “affordable” investment advice more available and more broadly utilized by DC plan participants The proposals were designed to address what the DOL understands to be the primary reasons why plan sponsors have not adopted investment advisory offerings in any meaningful way. Namely, that they have fiduciary concerns about the conflicts of interest associated with many prospective advice providers and that the costs to both sponsor and participants in finding and monitoring purely independent advice could be prohibitive.

According to the DOL, the class exemption was specifically designed to embrace business models that occupy large parts of the defined contribution plan market which wouldn’t qualify under the broader level fee exemptive relief of the PPA. The proposed class exemption significantly expands the scope of the level fee relief by limiting the level fee requirement to the individual adviser, and not applying it to the fiduciary adviser employing the individual adviser. This is beneficial for many of the defined contribution businesses with proprietary fund platforms where the investment advice function and the investment product manufacturing functions are integrated in a single corporate entity.

From a cost perspective, DOL research indicates that a market price proxy for computer driven advice is 10 basis points while in person advice is 20 bpts. Similar IRA services are 15 bpts and 30 bpts respectively. They acknowledges that the class exemptions provide potentially conflicted advisors with access to a large and growing market segment however the tradeoff is that these advisors may be in a position to offer services at low or no direct cost since they may have other revenue and profit streams from a client relationship to subsidize advice provision.

It appears the DOL has tacitly acknowledged that, from an overall individual investor perspective, the gains to be had from customized asset allocation and a consistently applied investing strategy and discipline outweight any potential disadvantages from proprietary product or revenue bias that might slip through the controls and disclosures established in the proposed regulation. Their premise seems reasonable.

However, despite the overall benefit to the minority of advice utilizing plan participants, these arrangements may not gain as much traction as the DOL estimates. This is because plan fiduciaries face additional fiduciary responsibility and more importantly increase their fiduciary risk and exposure to potential litigation by adding advice components to their DC plans. As the majority of plan participants are forecast not to meet their retirement expectations regardless of how well their portfolio’s are managed, providing fiduciary underwriting for this kind of activity carries inestimable and largely uncompensated risk for many plan fiduciaries.