There is an emerging issue surrounding the efforts by plan advisers to sell additional products to plan participants (sometimes referred to as “up-selling”)1. For some financial advisers, one of the attractive features of giving advice about 401(k) accounts to plan participants is the opportunity to capture the participant as a client for other services–and products–outside the plan. But this opportunity also raises potential liability issues for which there is, as yet, no clear-cut answer.
As with many other opportunities in the retirement plan marketplace, there are advisers who will try to take unfair advantage of a good thing and sell inappropriate ideas and investments to participants. For example, we are aware of instances in which advisers have encouraged participants to defer less into the plan and invest the funds in speculative investments outside the plan or to take early distributions out of the plan and then invest that money in a speculative way.
Among other things, this raises an issue about liability for the plan sponsor. It is the plan sponsor who allowed the adviser on to the premises and who gave the adviser access to the employees. Whether or real or not, in the minds of the employees, this may imply an endorsement of the adviser and all of the products and services the adviser is trying to sell. And this implied (or perhaps even explicit) endorsement, in turn, raises the question, what due diligence responsibility does an employer have before allowing advisers access to its employees?
A cautious employer may want to limit the “extra-plan” activities of financial advisers giving advice to the participants. That is, they may require a contractual commitment on the part of the advisory firm and its representatives that they will not offer products and services to participants except for the advice on the allocation of their plan accounts. This would presumably make the plan somewhat less attractive for the adviser.
So how should an adviser respond? One alternative to the ban on such activities would be for the adviser to agree to limit the types of products or services that will be offered outside the plan so as not to interfere with participation in the plan. For example, the adviser might agree that it will not offer other investments to any participant that is not deferring at the maximum permissible rate into the plan. Alternatively, the adviser might agree to offer only advice for a fee–and no products at all–to participants who request it regarding their investments outside the plan. Another approach to address the inappropriate investment concern, would be for the adviser to commit that in giving advice outside the plan, it will apply generally accepted investment theories and prevailing industry practices, such as modern portfolio theory and multi-asset class portfolios consisting of well-diversified mutual funds. (Whatever the terms, the agreement would need to be disclosed to the employees.)
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Any discussion of tax matters contained herein is not intended or written to be used, and cannot be used, for the purpose of avoiding any penalties that may be imposed under Federal tax laws.