Financial services firms will face new compliance challenges in the coming months as they start offering investment advice to 401(k) plan participants as a result of legislation that passed last month.

President George W. Bush signed the Pension Protection Act of 2006 in August. The law makes some key changes to how Americans save for retirement and education. One key provision allows firms to provide advice investors whose retirement plans they administer.

Previously, firms could offer an independent third party’s advice, but now they can offer that advice themselves. While that may save the firms some money, it isn’t without a price.

“There is additional liability that firms are going to have to think about,” said Liz Varley, vice president and director of retirement policies at SIA. “If they [firms] decide to get into this business they will be looking at a different set of criteria.”

Firms are going to have to make sure that whatever advice they provide is in the best interest of the client and that they can support and document that advice. Varley added that firms who are intent on dealing directly with retirement plan participants will want to use their more experienced advisors, because they will be floating in uncharted waters.

Financial institutions who don’t plan on sending advisors to work with plan participants can give those investors a computer model that matches the client with their ideal investment plan. The program can be proprietary, but a third-party firm must certify it, to ensure that it functions in the best interest of the client, according to the new law.

In coordination with the Pension Bill, the Department of Labor is finalizing guidelines that firms must adhere to if they want to dispense advice.

“This guidance will say that if you jump through these hoops and put in these types of investments then you won’t have any additional liability,” said Jan Jacobson, director of Retirement Policy at the American Benefits Council.

Not only is the Department of Labor authoring the guidance, it will take the lead in enforcing it as well. The SEC will be limited to monitoring and enforcing penalties on any securities violations. But the two entities have worked together on cases before and most observers see no reason for that to change now.

The new law allows investment firms to charge a fee for the advice they give. But the DOL still needs to clarify how the fees can be assessed, including who gets charged, and what charges are reasonable.

Varley believes that the government is leaning toward a level fee for the advise provider and a variable fee for the firm. The fee would be charged according to the plan, mostly based on the amount of assets in that plan.

Compliance departments also face more concerns about the new requirement that says firms must issue quarterly reports to investors. Most firms voluntarily do this already, but the new rule will add another level of scrutiny to the process, said David Wray, president of the Profit Sharing/401(k) Council of America.

The DOL is also putting together a model of how to structure the form. Wray and Varley feel that this will quash any creativity in the statements because firms will not want to deviate from the model.

The plan provider will have to issue the statement, but the responsibility will ultimately fall on the plan sponsor if the statement does not go out. Wray added that if the statement was late in the past, it was an honest mistake. Now, that honest mistake could result in a significant fine, he warned.

Another aspect of the pension bill gives employers the option of creating automatic enrollment into 401(k) plans. As reported in CCH WallStreet.com in May, the plan will allow an employer to automatically enroll into a plan without the employee having to fill out any paperwork. The employee must specify in writing if they don’t want into the plan . (See story, click here)

Once again the DOL is close to releasing guidance on the types of investments that employers can use as the default option. The agency will release that document within the next few months. The release will not list specific funds or even specific types of funds, but state its decision in general guidelines.

Most observers feel that this provision will not open firms up to any additional liability, even if the employer decides that the guidance the DOL provides is not conducive to the demographics of its employees.

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