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Research: Why have individual advisors (and the industry as a whole) been relatively slow to adapt to the post-2006 Pension Protection Act world?Davis: The PPA made substantial changes with respect to retirement plans. While there has been significant interest in implementing these changes, the industry has not been given the tools to do so. Additionally, many of the PPA changes do not take effect until 2008.

For example, the Department of Labor has only issued preliminary guidance on the PPA’s investment advice provisions. The guidance leaves a lot of questions unanswered, such as how to perform the required audit of investment advisors. Without this information, auditors are reluctant to offer these services. As a result, I don’t know of anyone who is providing these types of audits. Without the audits, persons interested in providing investment advice to participants cannot use the PPA options. Hopefully, guidance will be issued before these provisions go into effect in 2008.

What new value proposition does the PPA unleash?Many plans will be very interested in using default accounts, automatic enrollment and investment advice. The term “default account” is a term that is commonly used to describe an investment used by a plan for participants who do not pick any investments for their accounts. Fiduciaries are generally responsible for deciding how participant accounts will be invested. In participant-directed plans that comply with ERISA section 404(c), this responsibility can be shifted to participants if they select the investments for their accounts. Before the PPA, fiduciaries were responsible for the decision to put participants’ money in a default account. The PPA now provides that participants will be treated as if they chose the default account if a “qualified default investment alternative” is used. Preliminary guidance from the DOL indicates that lifecycle funds, lifestyle and other balanced funds and managed accounts may be used as qualified default investment alternatives. In order to get this protection, disclosures must also be made to participants.

How does investment advice work under the PPA?Investment advisors have three options for providing investment advice. The first option existed before the PPA and allows advisors to give advice if their compensation does not vary. For this option, the compensation received by their affiliates and persons in which they have an interest must not vary either.

The other two options were added by the PPA. They are limited level fee advice and the use of a computer model. Under limited level fee advice, the compensation received by the advisor and his employer may not vary. However, affiliates and persons in which they have an interest may have variable compensation. Under the computer model option, the compensation can vary as long as a computer model is used to provide the advice. Among other requirements, these options require an annual audit and the advisor to sign on as a fiduciary.

How can an advisor demonstrate that they’re a good fit for this?Fiduciaries need to use a prudent process when picking an advisor. That is, they need to gather relevant information about the potential advisors for their plan and then make a reasoned decision based on that information. Fiduciaries do not have to pick the least expensive advisor, but rather should compare the cost for the services with the value received.

Advisors can demonstrate that they are the best choice for a plan by letting fiduciaries know the value they can add. This can be done by educating companies about their experience and knowledge about the retirement industry and developments in the law. Additionally, they will want to provide detailed information about the value and quality they will provide for the total direct and indirect fees being charged.

What should advisors looking to get into the 401(k) space watch out for?401(k) plans are governed by the Employee Retirement Income Security Act (ERISA). Advisors who are not knowledgeable about ERISA’s requirements can inadvertently become fiduciaries or engage in prohibited transactions. If not handled properly, they could face personal liability as a result of their actions.

Fiduciaries are the persons who are responsible for plans. A person can become a fiduciary if he exercises discretion over the plan or its assets or provides investment advice to the plan or its participants. The duties for fiduciaries are among the highest known to the law. As a result, persons who do not want to be fiduciaries should learn about how to avoid fiduciary status. For example, persons who do not want to be fiduciaries should not provide investment advice to a plan or its participants. However, the line between providing guidance and investment advice is somewhat blurred. These advisors will want to understand the rules to make sure that their discussions with the fiduciaries or participants are clearly not investment advice.

Individuals who are interested in being fiduciaries should educate themselves about what ERISA requires in order to avoid liability. For example, fiduciaries generally may not receive variable compensation such as 12b-1 fees. If a person is interested in serving as a fiduciary, he should examine his options for structuring his compensation in a way that does not violate ERISA.

Advisors can also face liability if they engage in prohibited transactions — regardless of whether they are a fiduciary. Prohibited transactions, as the name implies, are transactions involving a plan that are strictly prohibited by ERISA unless an exception applies. A prohibited transaction can occur even if the plan benefits from it. Advisors can inadvertently become entangled in a prohibited transaction involving a plan if they are not aware of the rules.

If an advisor isn’t acting (even unofficially) in a fiduciary capacity yet, is there any real reason not to take that leap?Advisors will want to fully understand ERISA’s requirements before choosing to act in a fiduciary capacity. While there can be significant advantages to being a fiduciary, there are also additional rules that fiduciaries must comply with. Fiduciaries are held to higher standards than non-fiduciaries. As a result, it is a decision that should be made only after careful analysis.

Robert Scott Martin is a New York-based contributing editor of Research.


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