In the summer of 1999, I left my position as in-house counsel for an insurance company and returned to the private practice of law. As a result, I rolled the funds held in my 401k plan into an IRA. I was a complete novice when it came to investing at the time but had recently heard a commentator on NPR claim the rise of the Internet represented a paradigm shift in the global economy. Based upon this information, I moved half of my retirement funds into a “New Economy Fund” and the other half into a “ContraFund.” When the dot.com bubble burst a year later, I realized I could have fared just as well if I had flushed half of my money down the toilet and stuck the other half under my mattress.
Several years later, one of my friends – a Vice President in the Claims Department of my prior employer – decided to retire. The company was owned by General Electric at the time, and its 401(k) plan offered a surprisingly paltry array of investment options – most of which were dogs. Because the price of GE stock had skyrocketed under Jack Welsh’s leadership, my friend chose to roll all of his retirement plan funds into GE stock. A year later, he too would have been in about the same shape as if he had flushed half his funds down the toilet.
Needless to say, my friend and I would have benefited greatly from the counsel of an investment professional at the time we made these decisions. However, no advisor reached out to us and, now that I have spent the past several years providing legal counsel to advisors in the retirement plan industry, I understand why.
To begin with, most advisors will not to touch any account subject to ERISA with a 10-foot pole. With regard to providing advice to 401(k) participants, that reluctance was only solidified with the passage of the Pension Protection Act and its ominous references to certification requirements, the necessity of relying upon pre-approved computerized models, and the expense of annual independent audits. However, once a separation event occurs and a participant’s account is safely outside the grasp of ERISA, those same previously reluctant advisors will fall fight tooth-and-nail to win the right to manage those funds.
That fact alone should be a clear signal that current regulations are preventing employees from getting advice they need to avoid making obvious mistakes as they try to build their retirement nest egg. However, the DOL has also worked to prevent employees transitioning into retirement from receiving investment advice as they roll their funds out of the plan and into an IRA.
To begin with, because most advisors refuse to be associated with qualified plans due to ERISA, they cannot proactively respond when an employee experiences a separation event. More importantly, though, many employees incorrectly assume the plan’s fiduciaries – including its investment advisor – will help guide them as they pull their funds out of the plan and invest them in an IRA. This often does not occur, however, because the DOL strongly discourages fiduciaries from providing this critical assistance.
Specifically, in Advisory Opinion 2005-23A, the Department of Labor took the position that, if an individual who is already acting as a plan fiduciary “responds to participant questions concerning the advisability of taking a distribution or the investment of amounts withdrawn from the plan,” the act of assisting the participant would be deemed to be the exercise of “discretionary authority respecting management of the plan.” Furthermore, if the fiduciary derives any monetary benefit in exchange for that assistance, then the act will likely be deemed the use of plan assets for the fiduciary’s own benefit in violation of §406(b)(1) of ERISA.
In other words, an advisor will be held to a fiduciary standard when responding to a participant’s request for assistance but may face significant penalties if he or she dares to seek compensation for incurring that duty by providing professional advice. Given that position, I can understand why retirement plan advisors might wish to refuse to help newly-retired participants – no matter how loudly they beg for assistance.
To be fair, I can understand the DOL’s concern from a purely theoretical standpoint. If an advisor being paid 25 basis points to provide advice to the plan could charge participants 100 basis points to manage their investments outside of the plan, the advisor would have a financial incentive to encourage participants to pull their investments out of the plan.
While this is certainly possible, real world considerations greatly lessen the probability that most advisors would actually attempt such a scheme. To begin with, the plan would quickly terminate the advisors contract and, the advisor would encounter difficulty in attracting future plan clients. Furthermore, if the advisor acted with a malicious intent and in violation of his fiduciary duties, the plan and its participants would have a legal claim against him.
However, malicious intent does not even appear to be a consideration under Advisory Opinion 2005-23A. In other words, even if the plan’s investment advisor reluctantly gave into a retired employee’s pleas for help in rolling her funds into an appropriate IRA and charged a fee for the service that everyone agreed was reasonable, the DOL appears to indicate that the advisor’s actions could still be deemed a prohibited transaction.
As in-house counsel for a broker-dealer that catered to retirement plan consultants, I sought advice from some of the top attorneys in the industry as to whether that interpretation of the DOL’s position was accurate. I was initially advised that a plan’s investment advisor could handle rollover accounts if a myriad of safeguards were in place to ensure that the participant acknowledged that he or she initiated the request for assistance and had only done so after already completing the rollover of the funds, etc., etc., etc. However, when I pressed, the attorneys always included the caveat that, even with all of these safeguards in place, allowing a plan’s investment advisor to handle any participant rollovers was extremely risky given the DOL’s position.
As a result, I always had to inform our advisors that they were not permitted to assist participants in rolling over their funds into an IRA – even if the participant specifically requested the assistance and even though I knew other plan advisors (who were not affiliated with our firm) were handling participant rollover accounts on a routine basis. Therefore, if this truly is the DOL’s position, then its lax enforcement is only harming those who chose to play by the rules.
However, if the DOL truly wants to protect employees who participate in their companies’ 401(k) plans, it needs to recognize that constructing barriers to prevent those employees from receiving professional advice actually does more harm than good. In most cases, the greatest danger plan participants face is not an unscrupulous investment advisor seeking to manage their IRA. Instead, the greatest risk plan participants face is their own ignorance in making important investment decisions.