© Copyright 2000 Rogers Media. The following article first appeared in the January 2001 edition of BENEFITS CANADA magazine.

Crossing the line

DC plan members need more than education to manage their retirement investments. Employers can offer access to financial advice, taking appropriate measures to ensure their interests and employees' assets are protected.

By Sandra Foster

Few Canadians graduate from high school or university with more than a rudimentary understanding of finances, let alone the tools to effectively manage an investment portfolio. The task of ensuring that defined contribution (DC) plan members are financially intelligent enough to make good investment choices is increasingly falling on the shoulders of plan sponsors.

With the growth of DC plans and intense pressure to attract and retain employees, organizations are wondering whether they should provide members with access to financial advice, and how they can limit their liability if they do.

While some employers believe they can limit their fiduciary responsibilities by refraining from providing members with financial advice, one school of thought suggests that DC plan sponsors are indeed responsible for ensuring members have the ability to manage their retirement savings in a prudent manner.

Plan sponsors need to find a way to give their employees the financial education and advice they require without being held liable for how members ultimately use that information. Unfortunately, there are few standards in place in Canada. The American Employee Retirement and Income Security Act (ERISA) has detailed regulations regarding the line between offering education and providing advice. Information it regards as educational falls into four categories and includes:

• Benefits of membership in the plan.
• Investment options available, including historical performance and risk and return characteristics.
• Asset allocation and sample portfolios for fictitious individuals with varying years until retirement and risk profiles, providing that: the models are based on modern portfolio theory; all assumptions used in the asset allocation are disclosed; and the assumptions used in each model portfolio are consistent.
• Questionnaires, worksheets and/or software to help members estimate how much income they will require in retirement from their portfolio and the annual return they might earn from the various model portfolios.

Some plan sponsors have investment firms provide basic financial education to their members. However, if the organization has chosen the lowest cost provider of investment options for the plan, or has a number of providers, services may not include any investment education or advice. Where the plan sponsor does not want to provide education itself, the organization will commonly turn to financial educators who are not licensed to sell products, or to advisers and planners who are licensed to sell products.

Certainly employees need to understand the benefits of building a well-diversified portfolio and the risks associated with investing. But making good investment decisions requires more than simply building a sound portfolio based on investment theories, or completing a short questionnaire that points to an ideal investment mix.

Members need to understand the impact of their decisions. This is a challenge considering many investors still select investments based on their recent performance. If they do not understand why they are building the portfolio and the market goes through a bad spell, they are more likely to take action against the plan sponsor. Employees should base their investment decisions on the need to build an income for retirement, rather than greed. However, many individuals need advice in order to do this.

Some plan sponsors don't want to venture into the world of financial advice. But providing generic education is not enough. If members do not know how to apply the education that the plan sponsor has given them to their own personal situation, they will not be able to make an informed investment choice.

OPTIONS TO CONSIDER

The plea for advice isn't a simple request to fulfil however. Employees' need for independent financial advice ranges from basic to sophisticated.

Organizations have two main options. They can pre-select a number of advisers based on an appropriate list of criteria and then enter into a formal written agreement with each party regarding their obligations and responsibilities. Members could then select an adviser from this list, with the employer monitoring their experience with different service providers.

If the plan sponsor prefers not to recommend a financial adviser, it could provide members with a list of criteria to help them select a financial professional on their own. The organization could then provide an employee benefit of up to $1,000 a year, for example, for financial advice provided by a qualified financial planner or adviser.

The safety from a liability standpoint is clearer with this latter approach. When an employee goes to a medical or dental practitioner of their choice for coverage under their extended health benefits, the employer is not normally held responsible for the treatment received.

There is such an array of qualifications, licensing and compensation methods for financial advisers today that it may not be easy to sort through this information (see "Finding a financial adviser," left). Reimbursing fees paid for independent financial advice may also seem like a simple way to deal with members' need for financial advice, when in reality there are a limited number of financial planners and educators who bill clients directly on a fee-for-service basis.

Some advisers bill clients directly based on the investments they recommend (often referred to as fee-only), and others bill clients indirectly based on the assets they recommend (often referred to as fee-based). Where the plan sponsor is providing the list of available investment options, fee-based or fee-only compensation may not be an appropriate solution because the employer wants the adviser to provide advice, not investment products.

The financial services industry is debating whether clients should pay for advice directly, or indirectly through the investments they hold. However, to suggest that members only work with an adviser who bills directly on a fee-for-service basis currently would not work for members who live and are employed in regions where there are few, if any, fee-for-service financial planners.

Many advisers working on a fee-and-commission basis may be willing to provide employees with specific services on a fee-for-service basis. But beware of financial advisers who provide their own products, particularly if they are willing to educate or advise members at a reduced fee.

These professionals may be willing to provide advice at a lower rate than a pure fee-for-service adviser or educator because it could open the door for them to manage the member's other assets, or even the locked-in assets if the member leaves the company down the road. The potential for a conflict of interest may increase plan sponsors' risk. Clearly, cost is not the only factor to consider.

Members are often ill-prepared for the financial choices they have to make. Some pension plan members have even started to day trade in their portfolios, which is completely contrary to the concept of building a sound investment portfolio for retirement.

Other members shun placing any of their plan assets in equities. Unless they receive independent advice tailored to their situation, these individuals risk not having enough money to retire. Employers also run the risk that the pension plan will be perceived negatively.

PLAN SPONSOR PROTECTION

In the investment world, investors are required to sign a client application form that documents their investment objectives and risk tolerance. All investment decisions are then monitored for compliance to stated objectives. DC plan sponsors would be well served if they had each member sign a statement which acknowledges that:

• The member assumes all investment risk for the investments they select for their portfolio.
• None of the investments are guaranteed (except for guaranteed investment certificates) and it is possible for the member to lose money on his investments.
• Members' pension income in retirement depends on their investments, as well as their returns--which could be negative. (It's better not to refer to returns as earnings because most people do not think of earnings in negative terms).
• Investing exclusively in fixed income investments or day-trading could result in a lower than anticipated income in retirement.
• All investment decisions are made by the member at his own discretion and risk.
• It is recommended that members obtain independent financial advice before investing.
• The plan sponsor offers regular education sessions and members are encouraged to attend.

As well as providing members with reports on the holdings in their investment portfolio (which should be done, at minimum, on a quarterly basis), the statement should also provide information outlining what employees should look for when reviewing their account.

The report should also compare the member's target asset mix and return, and state what employees can do when there is a variance between those targets. It's not enough to give members basic training and hope that they understand the decisions they have to make, as well as the impact of those decisions.

Organizations used to believe that they increased their risk when they offered employees any sort of financial education or advice. Over time, DC plan sponsors will see that they do indeed have an obligation to be proactive and ensure plan members have the ability to make solid financial decisions, particularly regarding their choices in the plan.

While this does not seem necessary when markets are strong, it will become increasingly clear that employees need education as well as access to independent financial advice as the markets inevitably sour. Education, advice and monitoring are required--not optional--tools for employees to have when making investment decisions.

Sandra Foster is a financial educator and planner and the author of You Can't Take It With You, Make the Most of What You've Got and Who's Minding Your Money: Financial IntelligenceforCanadian Investors. fosters@caratconnect.com.

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Finding a financial adviser

Here are some key points to consider when looking for objective, independent financial advice providers for DC plan members.

• Proficiency in financial planning currently demonstrated by one of a number of financial planning designations, or by the proposed financial planning proficiency exam.
• Method of compensation.
• The availability of a written financial planning agreement and financial plans, and if managing the investment portfolio, a written investment policy statement or agreement.
• Confirm that there are no charges of wrong-doing through the individual's professional association, and if they are licensed to offer products, through the securities regulators.
• Range of expertise.
• Professional liability insurance.
• Experience.
• Identify and resolve any potential conflicts of interest.
• Written agreements to help members understand the rules of engagement.

Advice American style

Two years ago the U.S. Department of Labor announced that plan sponsors there can legally offer investment advice to plan members. While plan sponsors will always be concerned with the liability issue, many organizations in the U.S. have made the decision to cross the line between offering education to providing advice.

U.S. plan sponsors have hired one of a handful of independent third-party investment advisers, registered with the Federal Securities and Exchange Commission. American investment advisory services tend to be Internet-based and their Web sites claim that large plan sponsors such as Fujitsu, Lands End, Airlines Pilots Association, Dole, 3Com and Goodyear are their clients.

These financial advice providers have entered into agreements with recordkeepers and pension consultants, ensuring the small- to mid-size plan sponsors are equally served. Some employers, like Pitney Bowes of Stamford, Conn., have taken a different tack and permit their employees to use their benefits plan's flex dollars to purchase financial and investment advice.

Plan sponsors that have signed on for advisory services dispel worries of possible litigation by fulfilling their responsibility under the Employee Retirement and Income Security Act (ERISA), which includes conducting due diligence on the adviser, ensuring the adviser's impartiality and having the provider formally accept fiduciary liability in its contract.

Some experts feel the liability issue is overblown and that the real issue is how to expand member access and improve personalized service (a smaller percentage of Americans are Internet literate compared to Canadians). Most agree that the true value of investment advice will not be apparent until it is offered in a one-on-one personal approach, something that will come in time.

Rob Jacobi is president of Waterloo, Ont.-based Tenzing Pension and Investment Services. rob.jacobi@gwl.ca.

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