On August 17, 2006 President Bush signed into law H.R. 4, the Pension Protection Act of 2006. It marked the end of a long journey that created a new “classification” of independent investment advisors—namely those who are not actually independent, but who can SAY they are independent, as long as they “disclose their potential conflicts of interest.”

Sound confusing? For most people, it is.

Let the buyer beware

Starting now, if you are enrolled in a 401(k) plan, the old warning “let the buyer beware” takes on new importance. If you’re a plan trustee, Congress has just handed you another new burden.

Congressional leaders took more than two years to move this bill through their influence-laden halls and committee rooms, demonstrating once again that time in creation is not only a measure of an issue’s complexity, it is also a function of diverse and intense lobbying to influence an eventual outcome.

Previous safeguard

The U.S Department Of Labor has responsibility for enforcing pension laws under ERISA (the landmark Employee Retirement Income Security Act). Until now, the DOL has strongly recommended that 401(k) plan trustees use “independent” registered investment advisors as part of the “prudent process” to select investment options for 401(k) plans and monitor those options on a continuous basis.

In fact, since 2004 the DOL has conducted seminars around the country to better educate business owners and executives about their fiduciary responsibilities as retirement plan trustees.

In the past, Section 406(b) of ERISA strictly prohibited investment advisers and other fiduciaries from “engaging in transactions that give the appearance of self-dealing and/or conflict of interest.” This had been interpreted as prohibiting people or organizations who are com-pensated for selling investment products to also offer advice about investment options in the plan.

Prohibited parties included representatives of mutual fund companies, brokers who are compensated by mutual fund companies, and banks that sponsor mutual funds. All were seen as having potential conflicts of interest. Thus, companies that had 401(k) plans were often reluctant to allow these parties to provide investment advice to participants in their plans.

Today, with the decline of corporate pension plans and the growing popularity of 401(k) plans, Congress believed that 401(k) plan participants needed investment advice, and sought to fill the void with H.R. 4.

BUT THIS IS WERE IT ALL BROKE DOWN!

The end of independence

Although the Department of Labor had advocated that 401(k) plans use “independent” registered investment advisors to provide advice to participants, what emerged from Congress was a law that now permits people who are compensated for recommending investment products to offer investment advice, as long as they state they are in a potential conflict of interest for offering that advice!

New burden for trustees

Although various disclosure, qualification, and other self-dealing and conflict safe-guards are part of the new law, Congress has placed a huge burden on 401(k) plan trustees who will now need to make certain that any “potential” conflicts-of-interest do not become “real” conflicts — namely, future lawsuits by plan participants.

Widespread disbelief

It didn’t take long for a cross-section of pension experts to voice their concern about this new law.

“The bill eviscerates the long standing prohibition against conflicts of interest between plan trustees, brokers and others who have dealings with plans,” said Karen Ferguson, director of the Washington, DC-based Pension Rights Center.

Bill Novelli, CEO of the American Association of Retired Persons (AARP), said “employees may be at greater risk of receiving conflict-tainted investment advice from financial service firms.”

Even some mutual fund executives questioned the logic of Congress. “Any firm that has its brand of mutual funds in a 401(k) plan that it also manages can’t provide the same level of comfort” to the employer as does independent advice, said Charles Vieth, president of T. Rowe Price Retirement Services in Baltimore, in a statement to the Wall Street Journal.

The lobbyists won

It was no surprise that another Wall Street Journal story discussing the passage of H.R. 4 was titled “Pension Bill Promises Windfall for Fund Firms.”

For now, it appears financial service industry lobbyists won their battle in the halls and back rooms of Congress.

JUST THINK HOW MUCH SIMPLIER IT WOULD HAVE BEEN FOR CONGRESS TO REQUIRE TRUE INDEPENDENCE!

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Editor’s Addendum:

The Partners of Midwest Investment Management are not impartial on this issue.

Just like the people who originally crafted ERISA, we believe strongly that the best way to serve the interests of 401(k) plan participants and trustees is to offer investment advice that is completely independent. Thus we have never received compensation in any form from the mutual funds we recommend to 401(k) plans, nor do we plan to.

If you are enrolled in a 401(k) plan managed by our firm, you can trust in our independent advice, recommendations, and oversight today and in the future.