The U.S. Department of Labor (DOL) is focusing more on the fees paid for 401(k) services. New regulation under ERISA section 408(b)(2) is expected to be released in the fall of 2010 and take effect in 2011. One key consequence of these regulations is level pricing for financial advisers (FAs) who provide services to 401(k) plans. This will be a big challenge for FAs who are accustomed to receiving fees that vary by asset class, investment provider and other factors.

To survive, FAs need to understand the new regulation’s provisions and implications. In the short-term, FAs will need to adjust their fee arrangements. For the long-term, registered reps may find it necessary to work with—or become—registered investment advisors.

Essentials of the New Regulation: More Disclosure, Limits on Compensation

The DOL's new guidance requires extensive disclosures and imposes restrictions on compensation that make it more difficult for FAs to work with 401(k) plans.

FAs, who work with plan sponsors on issues such as selecting a core investment lineup, will need to update their service contracts. The DOL is requiring that FA contracts disclose all compensation sources and conflicts, the specific services provided, and a statement regarding whether the FA is accepting fiduciary responsibility.

For FAs providing investment advice to plan participants, 408(b)(2) will prohibit them from rendering advice that could impact their compensation or that of the firm. This is significant because many FAs serving 401(k) plans rely solely on mutual fund 12b-1 fees that vary by fund family and from fund to fund. However, the DOL is offering two exemptions that allow FAs to provide investment advice: (1) the level fee model and (2) the unbiased computer model.

Level fees
FAs must rework their compensation arrangements so that the FA and his firm’s compensation are both level regardless of the participants’ investment choices. If you go this route, the DOL also requires a periodic audit by an independent third party to confirm compliance.

Computer models

If you can’t ensure level compensation then you still have a second option whereby the FA can provide a conflict-free independent computer model to offer participant advice. These computer models must be certified and audited.

Your Long-Term Strategy


Your relationships with your 401(k) clients are safe in the short term, as long as you prepare yourself for the pricing and disclosure changes described above. Over the longer term, you may need to become a fiduciary. Or you may need to involve a registered investment advisor (RIA) if your broker/dealer—like many b/ds—prevents you from accepting fiduciary responsibility. RIAs can fill the gap by providing advice to plan participants.
FAs should make every attempt to re-tool their service offerings to qualify for fiduciary status, even though it involves additional responsibilities and risks. Why bother? FAs who don't become fiduciaries are likely to lose 401(k) clients over the long haul. Plan sponsors will eventually realize that anyone can offer a core fund list, which is what non-fiduciaries will be limited to. Non-fiduciary FAs will become commodities in the eyes of plan sponsors. Only FAs who are fiduciaries can provide specific investment advice.

Three Approaches To Consider


First, if you're an independent dually-registered FA with both a broker-dealer and an RIA, transition your 401(k) plan clients to the RIA side of your business. This should not present much of a problem for most FAs. Indeed, it will spare you the audit and documentation requirements described above because RIAs are not considered vulnerable to conflicts of interest. However you might have to revise your service contracts to comply with the DOL's requirement for stating the specific services you provide and your fiduciary status.

Second, if you're independent but not registered as a RIA, consider getting registered. The fiduciary movement may be nearing a tipping point for ERISA business and having an RIA option will give you a competitive advantage.
If neither of these options is appealing consider outsourcing the investment advice portion of your 401(k) services to an RIA who accepts fiduciary status. Depending on the final language of 408(b)(2), this may be an attractive option for FAs at large wire houses.

It’s imperative that broker dealers and FAs take 408(b)(2) very seriously. The DOL has announced an increased budget to adopt a rigorous regulatory enforcement policy and is also working more closely with the Security and Exchange Commission in sharing information. FAs who are proactive in adapting to these new regulations will be in a better compliance situation and have a competitive advantage over FAs who may be lackadaisical in adjusting to the new regulations.

Michael Stillman, AIF® provides ERISA investment consulting services with Cloud Capital LLC, a registered investment advisory firm in Dallas.