Defined Contribution

Our View on the Final Participant Advice Rules

By Seth J. Masters November 10, 2011

In a reversal, the US Department of Labor’s final regulation requires computer-generated investment advice to include target-date funds when comparing the investment offerings provided by a defined contribution plan. But the hurdles to being compliant are high.As a result, many advisers may choose to provide advice in other, easier ways, as our ERISA attorney, Daniel Notto, explains below.

The Department of Labor’s (DOL’s) final regulation on providing investment advice to participants is welcome news. It closes the loop on this issue in the Pension Protection Act (PPA), which was passed five years ago. It’s also good for participants, especially those in midsize and smaller plans who probably don’t have much, if any, access to investment advice.

The final rule establishes new mechanisms that advisers can use to help participants choose among the specific investment options in a company’s defined contribution (DC) plan, while avoiding potential conflicts of interest if the adviser may have a vested interest in promoting one option.

We’ve written a synopsis of the final regulations. Here, I’d like to focus on two interesting changes made from the 2010 proposed rule to October’s final rules. The changes relate to advice generated by a computer model certified to be unbiased by an independent investment expert.

The initial proposal allowed these models to exclude asset-allocation funds, such as target-date funds, probably because computer programs would have difficulty comparing them with stand-alone funds. But that would have eliminated target-date funds from the modeling “contest” before it even began. And that might unfairly skew a participant’s eventual investment selection against target-date funds.

AllianceBernstein helped write comments that were sent to the DOL about the benefit of target-date funds. We believe that the comments contributed to the change in the final rule, which states that computer models must consider target-date funds if they’re on an investment menu.

The initial proposal also said that the computer-advice model couldn’t take into account the historical performance of investment options but must account for any fees or expenses. This would favor lower-cost index funds over actively managed funds, several comments noted.

While the debate over the merits of active versus passive investing may never end, the DOL clarified that it didn’t intend to ban consideration of historical performance: the computer models can take this into account when generating advice.

One big question remains: The final rule creates a lot of hurdles that advice providers would have to clear to be compliant. Among them is an annual audit of the advice model performed by an independent auditor. Since there are already other ways to provide advice, it’s unclear how much use this feature of the PPA will get.

The phrase “target date” in a fund’s name refers to the approximate year when a participant expects to retire and begin withdrawing from his or her account. Target-date funds gradually adjust their asset allocation, lowering risk as participants near retirement. Investments in target-date funds are not guaranteed against loss of principal at any time, and account values can be more or less than the original amount invested—including at the time of the fund’s target date. Also, investing in target-date funds does not guarantee sufficient income in retirement.

Our View on the Final Participant Advice Rules
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