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Will Reform Drive Brokers From 529 Sales?

It wasn't tainted research. It wasn't late trading. It wasn't even good for a lot of headlines. But it was another ugly moment for investment advisors when, in mid-2004, politicians and regulators began looking into 529 college savings plan sales practices. What they learned in Congressional hearings came as no surprise to anybody in the business: Fees were high and, often, registered reps who sold

It wasn't tainted research. It wasn't late trading. It wasn't even good for a lot of headlines. But it was another ugly moment for investment advisors when, in mid-2004, politicians and regulators began looking into 529 college savings plan sales practices. What they learned in Congressional hearings came as no surprise to anybody in the business: Fees were high and, often, registered reps who sold 529 plans were inclined to recommend programs that gave them the best compensation.

What emerged from these hearings was a proposal for new disclosure guidelines aimed at giving consumers more knowledge about various plan choices at the point of sale (in most cases, a broker's office). The unintended consequences, says David Pearlman, chairman of the College Savings Foundation (CSF), a nonprofit 529-advocacy group that represents the investment community, may be to drive reps and financial advisors out of the 529 business. “I don't think there's any issue that it would inhibit sales,” he says. “I think the biggest impact would be on the broker/dealer side. A lot would just stop offering them.”

Pearlman has spent the past six months lobbying against new disclosure guidelines proposed by the Municipal Securities Rulemaking Board (MSRB), a self-regulatory agency that oversees state-sponsored securities activities, including municipal bond sales and 529 plans. The group has proposed that reps go to particular lengths to justify putting 529 clients into out-of-state plans, which can deprive clients of in-state tax breaks.

What Pearlman and many reps object to is the extra burden the regulations might require: Hours to keep up with changes in performance and changes in all state programs, and then more hours with clients to make sure parents and grandparents understand the tradeoffs and are aware of the broker's potential conflicts.

And for what? “Look, if I have a client who puts $44,000 in a 529 plan, what's my commission? At best, I might make $200 with A shares or $100 a year with C shares. I am not selling them to get rich,” says Troy Miller, an independent broker with Linsco/Private Ledger (LPL) in Gold River, Calif.

As in all professional services, time equals money for financial advisors. If time spent on 529s is money lost, Pearlman predicts that many reps will delete that product from their repertoire, or pull back from a lot of states — at least that's the sense he's gotten from discussion with others members of the CSF. “And that's not necessarily good for the consumer,” he says. “If a firm or a broker pulls back from the marketplace, the consumer may not have any access to any plan from that source, which will make it harder for them to find.”

A Taxing Mess

Of course, the proposed guidelines were not cooked up simply to harass brokers. Regulatory groups, including the NASD, SEC and MSRB, have looked at what percentage of b/d 529 sales are out-of-state plans and how fees are structured. In 2003, the NASD reviewed the sales practices of five firms and found “that more than 90 percent of the sales of some of those firms were to out-of-state residents, despite the fact that about half of the states give a state tax deduction to their citizens for contributions to the home state's 529 plan,” said Mary Schapiro, NASD vice chairman and president of the regulatory policy and oversight group before the U.S. Senate's Committee on Governmental Affairs, in September 2004.

With 27 states offering in-state tax deductions, it's a concern if clients who are residents of those states are not informed about their possible deduction. “I agree that's at the root of the [MSRB]'s actions, and they're worried about abuse of it,” says Bruce Harrington, vice president and director of product development at MFS, a mutual fund complex that runs the program for Oregon.

While a broker may believe a plan in a state where his client doesn't live offers a better return on his investment, he still needs to make sure his client is aware of the state tax deduction he gives up if he moves his money out of state. The MSRB already has rules in place that require brokers to have program disclosure documents in a client's hands — not just in the mail — by the time the transaction closes.

The new guidelines would require the advisor to tell the client about all the differences among the plans that are deemed suitable. “It's just too much information,” says Miller, whose firm, LPL, has already started making their advisors act as if the new disclosure rulings are in effect. “It's good for the consumer, they should know all this. But they don't want to know it. And we have to spend 30 to 40 minutes going through a worksheet that's almost a waste of time.”

Harrington agrees that, even if the spirit of the guidelines is noble — to give consumers the information they should have — it may backfire: loading up clients with so much data that they are baffled into inaction. “It's confusing to the investor,” he says. “It's like saying, ‘Let me sell this to you for your grandchildren, but here's six pages about what's wrong with it.’ The result will be very negative, and to the detriment of the client.” Indeed, says Harrington, clients could be the big losers, “because the advisor won't even bring up a 529 plan if he knows it's going to lead him down the path of all this disclosure.”

It's no surprise that manufacturers and groups representing the financial services industry reacted harshly to the proposals. When the MSRB posted its proposals for comment in May, the responses were swift and sharp. “Needless to say they were not favorable,” says Ernesto Lanza, senior associate general counsel for the MSRB. “The board may go with some and not others. But the proposals were made because the board thinks there are serious issues that need to be addressed. Even if they agree this is an aggressive approach.”

Cleaning Up Its Act

The 529 industry has been on high alert since the Congressional hearings last year, when Chuck Toth, on behalf of the CSF and the Securities Industry Association, and Mary Schapiro of the NASD, among others, testified about confusion in the fee disclosure and performance data among the plans. Even within the industry there was little dispute over the key complaints: The plans seemed unnecessarily complicated, the fee structures were difficult to understand and consumers (and many advisors) were unable to wade through the differences among 80 different plans.

Making information about the plans easier to access is an idea that the MSRB, CSF and the College Savings Plan Network (CSPN), an advocacy group for administrators of state-run plans, have rallied behind. Following the Congressional hearings, the 529 industry, led by the CSPN, proposed its own self-governance guidelines. The key goal is to make data from the different plans more uniform and easier to mine, not just for investors, but for brokers as well.

In the meantime, at least one broker has built a tool that presents comparisons to different plans. Miller created The Financial Education Group, a Web site that offers simple comparison options on state plans, including fees, maximum contributions and how many portfolios are offered to investors. (He no longer runs the daily operations of the site.) Other brokers continue to rely on other independent information sources, such as Morningstar and, a site founded by 529 guru Joe Hurley. Hurley even offers seminars for brokers to help them navigate all the options.

Brokerage firms, however, have not done much to help advisors get up to speed on 529s. Corporate Insight, a market research firm based in New York, evaluated 17 different brokerage firm 529 information programs and found out-of-date pricing, difficult-to-read data and customer service representatives who were not knowledgeable about what 529 plans the firm was offering. “When you start asking for information, in some cases, the firms aren't really prepared,” says Michael Ellison, executive vice president with the group. “A lot of times the Web sites were confusing, especially when trying to compare apples to apples on plans.”

This is hardly breaking news to organizations like the American Council on Education (ACE), which represents universities and colleges across the country, and keeps track of every kind of college savings plan available. Although ACE is supportive of any tool that gets parents to save for higher education, the group has been critical of how the plans are being sold. “The problem is that information on these plans is often not available to the public at large,” says Washington, D.C.-based Sheldon Steinbach, general council for the ACE. “It takes a somewhat sophisticated investor to find that kind of information on 529 plans. But like any investment, it requires scrutiny of the existing offering and in-depth analysis; 529 plans aren't any different.”

Whether new guidelines will help more parents find a way to pay for college is the ultimate question. The MSRB's Lanza declines to say which proposals are likely to be endorsed by the group, but says the board will meet next in mid-November to discuss the comments at greater length then. However it's a given in the industry that greater disclosure will be required. “We believe these proposals are doable,” Lanza says. “They're all being seriously considered because they grow out of serious concerns. And some of the proposals will be adopted.”

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