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3 Terrible Problems the New DOL Investment Advice Rule Poses to the 401k Fiduciary

April 06
22:32 2010

351774_5472_dice_snake_eyes_stock_xchng_royalty_free_300Did you know the Department of Labor’s proposed Investment Advice Rule may increase a 401k plan sponsor’s fiduciary liability? If a plan enters into a prohibited relationship with a vendor – or if an existing relationship now becomes prohibited – fiduciary liability rises. (See “Talking Points: Investment Advice Regulations,” Can the 401k fiduciary afford to ignore these critical issues?

  1. The Rule makes it too difficult for a viable business model without introducing conflicted advice (“Will Participant Advice Rules Create Too Many Obstacles for Participants to Receive Advice?” Fi360 Blog, March 29, 2010). No doubt many 401k plan sponsors, especially those of larger plans, were attracted by the apparent low cost of using brokers to deliver investment advice. The Rule now requires those brokers to change their business model or leave the business. In changing the way they do business, they may find it difficult to maintain the margins necessary to continue operating as they have been. While we must laud the DOL for forcing this issue, 401k fiduciaries must be prepared to find alternative vendors. While the market is large enough to provide for this, those plan sponsors may be disappointed to learn they may no longer be able to continue a long-standing relationship. Then again, that might be precisely the type of relationship the DOL frowns upon.
  2. The Rule doesn’t really overturn Frost. Recall, the DOL’s Frost Opinion exempts fiduciaries from the prohibited transaction rule (see “Readers Select Top Fiduciary Stories of 2009: #7 The SEC’s Statement on 12b-1 fees,”, January 25, 2010). Rather than eliminating this obvious conflict, the DOL proposes to require adviser who use investments that generate fees for their firms to use “audited” computer models (“New 401(k) Transparency Rules Proposed,” Financial Advisor, March 1, 2010). By requiring computer models, the DOL must bless only certain investment theories. If history of trust law is any guide, codification of any investment theory is likely to lead to conflicts once those theories became outdated. (This most recently occurred in the early 2000’s when the SEC endorsed Modern Portfolio Theory just as it was breathing its last gasps.) Here’s the conundrum for the 401k plan sponsor: when the theory goes stale, what should the fiduciary do – follow the law or do the right thing? It appears the computer model requirement materialized in order to continue to accommodate Frost. Here’s a compelling idea: Why not simply revoke Frost over a set time period and give those fiduciaries and vendors continued liability exemption until that time period expires?
  3. By emphasizing fees to the exclusion of performance, the Rule may give an inappropriate advantage to index funds, (“Labor Dept.’s 401(k) Proposal Could Rock Pension Advice Business,” Investment News, February 26, 2010). Of all the problems with the proposed Rule, this appears the most dangerous. Even the DOL, in a press conference on February 26, 2010, admits it does not want to get into the investment advisory business (one would presume the SEC would agree). Yet, by emphasizing fees and specifically prohibiting the use of historic performance, the DOL forces the fiduciary to select only low-cost mutual funds. We all know “low-cost” can easily translate to “index fund.” The proposed Rule therefore encourages plan fiduciaries to offer only (or mostly, or give undo preference to) index funds at a time when these funds are clearly underperforming their actively managed kin.

It’s important we understand we cannot throw out the baby with the bathwater. The companion article to this piece (“3 Great Ways the New DOL Investment Advice Rule Helps the 401k Fiduciary,”, April 6, 2010) outlines innovative ideas found in the rule that only those with a vested interest have complained about. We need some form of an Investment Advice Rule and what the DOL has offered has proven an excellent start. It has begun to create a framework that protects investors, but, as the above suggests, it hasn’t gone far enough in one sense (keeping the Frost Opinion) and too far in another (the de facto endorsement of a preference for index funds).

You have until May 5, 2010 to share your opinion with the DOL. The Notice of Proposed Rulemaking (NPRM) invites public comments from interested persons on the proposed regulation’s conditions applicable to investment advice arrangements. Public comments can be submitted electronically by email to or by using the Federal eRulemaking portal at All comments will be available to the public, without charge, online at and, and at the EBSA Public Disclosure Room.

About Author

Christopher Carosa, CTFA

Christopher Carosa, CTFA

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