What's best: 401 advice or education? Employers feel pressure to offer investment education, but fear increased fiduciary liability. Here are the pros and cons of each approach, and advice on minimizing the legal risks

Workforce, Oct, 2002 by Fay Hansen

Freddie Mac, a McLean, Virginia-based leader in the mortgage-finance industry, offers an award-winning array of benefits for its 3,900 employees, but investment advice is not part of the package. "We will not be leading the pack in this area, because of all the controversy surrounding the advice issue," says Teri Herzog, the company's defined-benefit manager in charge of the 401(k) plan. It is a sentiment echoed by many in HR. Although the vast majority of employers with 401(k) plans offer investment education, only about one in five offers investment advice, according to a recent Profit Sharing/401(k) Council of America survey. Almost all of those that do not offer advice cite fiduciary concern about liability that results in losses as the reason.

"Companies are concerned that even if they and their investment adviser do everything right, they may be sued," says David L. Wray, PSCA president. "But now employers are looking at the evidence, which indicates that they can provide investment advice in a prudent way without being sued. There is still some reluctance, but it is declining. Within the next five years, we will see half of the plans offering investment advice."

Making the decision

Wray advises HR to consider two consequences when faced with the decision about whether to offer investment education, investment advice, or both. "The first consequence is legal," he notes. "There is no governmental anticipation that employers will offer investment advice to 401(k) plan participants, but there is an expectation that employers will provide investment education. In fact, if you don't provide education, you open yourself to liabilily, because you haven't provided sufficient support to participants who must make investment choices." Wray believes that employers are more likely to be sued for inadequate education and support than they are for advice-giving.

The second consequence is practical--a more important but more often overlooked factor, Wray says. "The point of offering a 401(k) plan is to build a sense of partnership with employees. Companies spend a lot of money on these plans. If you do not provide proper support and employees mismanage their accounts, the plan may become demotivating and will not produce a proper return on the company's investment in it. If you don't provide advice, the practical consequence is that you won't receive the full value of the 401(k) plan. An effective advice program is one of the best ways to increase participation and contribution rates and improve allocations."

Although Wray believes that the fear of lawsuits arising from advice programs is largely misplaced, Christopher Kopka, counsel for American Express Financial Advisors in Minneapolis, notes that "down markets have a funny way of increasing litigation in our already 401(k) Advice or Education litigious society. Employers should be concerned about the risk of liability associated with providing advice, but more and more they have to weigh that against the possibility of litigation flowing from uninformed or under-informed 401(k) participants."

Allen Steinberg, a Hewitt Associates retirement and financial-management consultant in Lincolnshire, Illinois, advises HR managers to evaluate their specific workforce needs when deciding whether to add advice programs. 'To the extent that employers have long-term employees, or want to have long-term employees, employers have a stake in how employees manage their 401(k) accounts. Employers must ask, 'How well are employees using the plan?' If the allocations are good, the employer can stick with education alone?

Different needs

Freddie Mac feels less pressure to offer investment advice than many other employers. An impressive 94 percent of its employees participate in the 401(k) plan, and they invest 80 percent of their savings in equities. "This is a clear sign that our employees are investment savvy," Herzog notes. The company reviews employee investments in all 10 401(k) funds quarterly to monitor the appropriateness of allocations.

Freddie Mac offers an extensive 401(k) investment-education program through two delivery methods--a secure Web site and quarterly workshops--and monitors both closely. "We meet on a quarterly basis with the third-party Web site provider to review the number of employees who use the site," Herzog says. The most recent review found that 80 percent of the plan participants had logged on to the site during the previous quarter.

The company measures the success of the workshops through employee surveys conducted immediately after the sessions. In addition, it conducts an annual employee survey that includes questions about the 401(k) education program. Some Freddie Mac employees have asked the company to add an advice program, but for now, Herzog says, the company "is taking a wait-and-see attitude."

Like Freddie Mac, the Tiller Corporation offers an extensive 401(k) education program, but it takes a different approach to advice-giving. The company, which produces road-construction materials in Maple Grove, Minnesota, discovered that a large segment of its employees were poorly diversified, and brought in an investment adviser to help employees manage their accounts. "Through education, the adviser has been able to improve allocations," says Steven Sauer, Tiller's vice president of finance. "Our employees receive one-on-one investment advice, tailored to their specific issues and other financial holdings, at no charge." If an employee does not enroll in the 401(k) plan, Sauer personally picks up the phone and calls the employee to explain the benefits. Every one of the company's 242 employees is enrolled in the company's 401(k) plan.