Advice with a Price - Statistical Data Included

AS MORE COMPANIES OFFER WORKERS INTERNET GUIDANCE FOR 401(K) INVESTMENTS, QUESTIONS LINGER.

THE IDEA OF OFFERING online investment advice to its 401(k) participants grabbed 3Com Corp. from the moment it was first suggested two years ago.

For one thing, there was the appeal of the exciting little start-up that was behind the proposal--Financial Engines Inc. The company was founded by two prominent Stanford University professors in Palo Alto, California--close to 3Com's own Santa Clara headquarters--who seemed unusually suited for such an enterprise. Nobel laureate economist Bill Sharpe had devoted much of his career to simulating how investments might perform over time for institutional investors. And Joe Grundfest, a Stanford law professor, was a former commissioner with the Securities and Exchange Commission.

For another thing, the Web-based product had special appeal for a company like 3Com--maker of the Palm Pilot and networking gear--whose nearly 12,000 employees have a high level of personal Internet access. Finally, 3Com discovered that "we were one of the pioneers" considering Internet-based 401(k) investment advice for employees, says 3Com vice president and corporate treasurer Art Taylor.

Out of a quarter-million plans covering 31 million employees, fewer than 100 plans, with as many as a million participants, now include an online-advice benefit, according to Forrester Research Inc., of Cambridge, Massachusetts. Because of the "war for talent here in Silicon Valley," Taylor notes, useful new benefits can have appeal as competitive ammunition. And the benefits with the greatest appeal are those that, as in the case of Financial Engines's investment advice, are "very attractive on a cost-benefit basis."

While Taylor won't detail the cost 3Com is absorbing by offering the advice free to employees, experts in the field say providers typically charge around $30 a year per participant, although some recent plans price out as low as $10.

Last October, after a team of finance and human-resource executives picked Financial Engines over another Internet service that Taylor won't identify, 3Com kicked off its program. By March, 20 percent of its eligible 401(k) employees had chosen to use the service, considered a healthy signup rate for a new program. And, says the controller with some wonderment, "we're actually seeing portfolio changes occurring based on the modeling" the company did to support the case for helping employees make wise 401(k) investment decisions. At 3Com, a total of $400 million in 401(k) assets are held among 13 fund options from State Street Global Advisors, and can also be funneled into 200 mutual funds.

SOBERING QUESTIONS

In deciding to provide an Internet investment-advice service, though, 3Com and the relative handful of other companies signing up online advisers for their 401(k) participants must deal with sobering questions about the real value of the benefit to employees, and to the company itself.

One concern is that the online advice offered may be sub-par--a worry increased by the negative reviews some advisory services got in a comparison test by Forrester Research. "In general, most sites perform poorly, suffering from limited scope or impenetrable questions that make it difficult for customers to move through the process and actually get advice," says Jaime Punishill, senior analyst at Forrester.

Some companies worry that participants won't be able to learn to use the services in an appropriate manner. Financial Engines and other Internet advice providers, including mPower, TeamVest, Standard & Poor's, and Morningstar, take participants step-by-step through a series of questions about savings goals, time horizons, and risk-tolerance. The providers then develop asset-allocation formulas and select funds among available options to fit those allocations. But Punishill notes that many companies don't provide the context users need to understand the impact of changes they might make to their portfolios. Most consumers' lives, he suggests, are just too complex for the narrowly defined scenarios on which many online-advice providers base their investment recommendations.

And while a heavily wired company like 3Com may not have an issue with limited employee access to the Internet, many companies reject the online-advice benefit out of hand--because it might be seen as favoring a relatively small class of workers who are especially computer-literate.

There's also a debate over whether employees should pay part or all of the cost, which, though low compared with many other benefits, can still pack a wallop when spread over a large workforce. Indeed, $30 per employee is close to the cost of administering an entire 401(k) plan for many companies. (Companies offering 401(k) advice on a one-to-one basis often pay providers as much as $250 or more a year per participant.)

But certainly, every company considering online advice--or even "near advice," as some providers call educational 401(k) services that stop short of allocating assets to specific investment options-- needs to answer the sticky question of whether the company itself may be held liable as a fiduciary under the Employee Retirement Income Security Act (ERISA). And in addition to potential liability over plan performance, employers must be concerned also about choosing an adviser that is truly independent, and that doesn't, for example, have a conflict of interest with a mutual fund provider that would skew the adviser's recommendations.

"I think there are a lot of pitfalls in providing advice," says Mary Sue Dickinson, a worldwide partner at consultant William M. Mercer Inc. in New York. A major reason for the narrow reach of the benefit so far is that sponsors don't want to deal with such questions unless it is "absolutely required." Yet she believes that online investment advice is the "next big wave" in benefits.

PREDICTION: 9 MILLION CLIENTS IN FIVE YEARS

Why? Some experts suggest that the Internet-advice benefit is becoming irresistible to employers, in large part because of the proliferating number of providers, whose competitive pricing makes it tempting to offer advice.

Workers hearing about the new advice providers often generate employer interest just by asking about the availability of the benefit, even though "it is still not 100 percent clear that the need is there," says Fred Castellani, senior vice president at Mass-Mutual Retirement Services, in Springfield, Massachusetts, a bundled-plan provider. Activity "on the side of building [online-advice] products and pushing them into the marketplace" has outpaced understanding of the "needs on the sponsor's side and the participant's side," he says. "A lot more work needs to be done." For example, few providers have been asking, "What's the best way to approach different audiences in the program so that people learn and retain?" Still, some 20 to 30 percent of plan sponsors are seriously considering offering an advice provider for their 401(k) plan participants, according to Castellani. (Mass-Mutual, which doesn't currently offer investment advice to clients, is looking at whether it should in the future.)

Forrester's review of the service offered by a dozen online-advice providers finds most of them wanting, with none rated A. Morningstar and Financial Engines top the list with B and B- ratings, respectively. One--ASLO.com--scored an F (see table, above). The ASLO site is no longer operative. Forrester, though, expects online advisers to improve their offerings. And improvements, combined with growing access to the Internet, could cause the dispensing of automated advice of all kinds to explode over the next five years, from the 1.8 million people it reaches now to 20 million by 2005, it predicts. About 9 million of those will be 401(k) participants getting their guidance online.

The Web site Quicken.com, a division of Intuit Inc., both in Mountain View, California, has taken a giant step toward making online advice available to masses of 401(k) plan participants by teaming up with Charlotte, North Carolina-based TeamVest. As partners, the two companies have obtained data from plan sponsors for about 1,200 separate 401(k) plans, according to TeamVest vice president of advisory services David Evans.

LEAVING THE SAFE HARBORP

The issue of fiduciary liability, though, remains a huge stumbling block for employers. Some plan sponsors worry that providing advice, or even near-advice, might remove the safe harbor offered to them by Section 404(c) of ERISA. That section sets terms for relieving sponsors of liability for the investment choices of plan participants. And virtually all plans try to follow the mandates of 404(c), which also requires, for example, that a plan offer a minimum number of choices participants can make, and change, in a timely manner. Under ERISA, plan sponsors act as fiduciaries when they select and monitor providers of investment advice, as well as when they select the number and type of investments within a plan.

Under the ERISA law, only one provider offering online advisory services has won an exemption from self-dealing or prohibited transactions, but others are aiming for that goal--hoping to clearly establish their independence, and to give plan sponsors some further assurance that they will not be held liable for investment advice provided to plan participants. "This basically gets around the self-dealing issues for plan sponsors," notes Mike Henkel, president of Ibbotson Associates, of Chicago, a financial research and consulting firm that is attempting to win a blanket exemption.

Team Vest's Evans believes his company has solved the employer-liability issue this way. For one thing, TeamVest provides advice on its own at Quicken.com on the Internet, without involving plan sponsors, presumably leaving them free of fiduciary liability. Furthermore, he says, "if we contract with plan sponsors, we accept responsibility as ERISA fiduciary."

But skeptics note that there is no absolute protection for a plan sponsor when the provider assumes the role of ERISA fiduciary. "If the investment adviser provides bad advice, you don't get a release from fiduciary liability," says Joe Montanaro, executive director of the TWA Pilots Directed Account Plan, which has $1.7 billion in assets for 4,600 participants, but isn't considering the benefit. "There's no requirement to offer advice, so why would you stick your neck out?" He adds: "I'm not saying investment advice is not a good thing. It would be nice to provide it, and we will provide it when the road is clear."

Among potential 401(k) vendor problems, some vendors might treat revenue arrangements differently for various funds within their own fund family, or might adopt revenue terms that favor their own family over other mutual fund companies the plan offers. If that 401(k) vendor also offers investment advice, there is a potential conflict of interest, says Fred Green, a partner with Schulte Roth & Zabel LLP, in New York. A plan sponsor that hired this vendor to offer advice "could open itself up to a potential challenge" in the courts that could leave the sponsor on the hook, according to Green. "That's why it's important that there be independence between the 401(k) vendor and investment advisers."

The liability issue can also be raised for holders of equity stakes in the vendors. For example, many new start-up companies, such as Financial Engines, number among their equity investors some major financial firms that offer investment products that may be made part of a 401(k) menu. Some online providers structure themselves so that no equity holder in the company has more than 5 percent of the company's total equity, thus meeting the Labor Department's guidelines for determining independence. That's true at Financial Engines, where "none of these financial institutions [with equity investments] has a policy-making role" at the company, according to Ray Sims, Financial Engines's vice president and CEO.

FAVORABLE CASE LAW

Complex, too, is the case of those 401(k) vendors offering near-advice. While some vendors have designed investment assistance that fits within the definition of "investment education" under Labor Department guidance, their offerings remain "advice" under SEC rules, One notable vendor of near-advice is Fidelity Investments, whose educational program determines asset allocations and chooses funds within the plan that match its investment advice. Fidelity "offers indemnification for plan sponsors for any losses or problems that might arise from a defect in the investment methodology or a problem of ERISA's conflict-of-interest provisions if Fidelity's education is deemed by a court in the future to be advice under ERISA," says Margaret Raymond, Fidelity's assistant general counsel.

Plan providers that have signed on for advisory services point out that the small amount of case law in this area tends to favor employers. In a case involving Unisys Corp., the federal courts did not hold that company liable for the performance outcome of investments, because it had followed a prudent method of selecting the investments within the plan. "If you properly perform your duties as a fiduciary in selecting investments, you're not going to have a problem," says David Wray, president of the Chicago-based Profit Sharing/401(k) Council of America.

In 3Com's case, the company assigned both inside and outside counsel to study "where the line is drawn" on liability, according to Taylor, its treasurer. Under ERISA, the lawyers determined, 3Com's duty was to do due diligence in selecting the adviser, assure that the, adviser is impartial, and have the provider formally accept fiduciary liability in its contract. Watson Wyatt Worldwide was hired to help 3Com with due diligence, and the process was thoroughly documented. Taylor acknowledges that ERISA attorneys don't issue any blanket assurances. "In the law system, there's never anything black and white," he says. But "we did try to 'cookbook' this, and follow all the ERISA guidelines," he adds. "We felt comfortable we would not be liable if someone followed the advice and lost money."

Taylor also points out that two years ago the Labor Department said that plan sponsors can legally offer investment advice, dispelling worries by plan sponsors of possible illegality. And Ibbotson, like many other advice providers, thinks the green light from Labor may be only the beginning--and that plan sponsors may have more to worry about in the future if they refuse to provide investment education. There's a risk in the long term that a group of participants could retire with a 401(k) that has performed poorly, and "they may claim plan sponsors should have done more to help them achieve their retirement goals," says Ibbotson president Henkel.

"The sponsor community has not come to the realization that it is necessary," adds Ken Ennis, vice president of market development at Standard & Poor's Retirement Services, in New York. "Overtime, they will."

A MATTER OF ACCESS

Certain prickly issues still need to be worked out--such as how third-party investment advisers deal with stock purchase in an employee's own company when that is offered as a 401(k) option. TeamVest's Evans says that his firm simply doesn't make buy or sell recommendations for company stock--"it's tricky to do that prudently." he says--although TeamVest tells participants when stock concentrations may violate the generally accepted principles of asset allocation. (The principles suggest that no single investment constitute more than 10 percent of a portfolio.)

Some experts dismiss concerns about the liability of companies offering investment advice. "There's way too much negative hype about fiduciary responsibility," says Profit Sharing/401(k) Council's Wray. "Plan sponsors are overreacting." He points out that companies frequently hire investment advisers for preretirement workers in their 50s, without much worry about liability. The real issue is how to expand access and improve personalized service so that Internet advice can be effective, he says. Only 15 to 20 percent of 401(k) participants nationwide have basic Internet access now, he says. And in many cases, "the people who do have access don't really need advice."

Real effectiveness will remain elusive, Wray adds, until the steadily increasing stream of participants with Internet access are also able to extend their Internet advice into a face-to-face relationship--something that will come in time, he says.

Internet advisers are already getting involved in more-personal advice via the telephone. TeamVest, for one, offers Web-based advice participants an individual 401(k) investment review by an SEC-registered adviser for $49.95 per consultation, and will completely manage the entire 401(k) investment process for a fee that can range as high as $149.95 a quarter. "For plan participants, it's like getting their own institutional adviser," says Evans.

ROBERT STOWE ENGLAND IS A FREELANCE WRITER IN ARLINGTON, VIRGINIA.

                          ADVICE ON THE ADVISORS
                    How Forrester evaluates the leading
                             online providers
Name                  Comments
Morningstar           Great interactive risk/reward tool weak
                      consideration of non 401(k) assets.
Financial Engines     Strong advice on multiple asset classes.
                      Adjustments are not intuitive.
mPower                Supporting content is great, but the
                      interactive tools are barely usable
TeamVest              Offers more than 401(k) advice, but too
                      reliant on complex financial jargon.
Vanguard              Addresses a wide array of financial
                      issues, but offers only Vanguard funds.
Wiesenberger          Questionnaire is confusing, but advice
                      is clear and comprehensible.
American Express      No specific investment or product
                      recommendations.
Fidelity              A new version will be released shortly.
                      It can't happen soon enough.
S&P Rational Wealth   Great advice, if you can find it.
                      Too much disorganized content.
S&P Rational Investor Super content overshadowed by how
                      difficult it is to use or understand.
Direct Advice         You'll need a CFP to understand the
                      wealth of information assembled.
ASLO.com              It failed nearly every category; enough
                      said.
SOURCE: FORRESTER RESEARCH INC.

Online Advice: Pros & Cons

ADVANTAGES

* OBJECTIVITY

In principle, automated systems have no axes to grind, no favorite products, no "sales contests."

* CONSISTENCY

Given the same data and circumstances, automated solutions will provide the same advice.

* ANSWERS TO REAL-LIFE QUESTIONS

Good solutions address fundamental questions like, "Can I afford to send my kids to college?"

SHORTCOMINGS

* TOO SIMPLE

Some systems are too narrow to be useful. Most consumers have financial lives more complicated than the programs can address.

* TOO COMPLEX

Some programs ask questions laden with jargon, then provide advice based on confused answers.

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