Brooke’s Note: We keep publishing articles with oblique mentions of momentous changes at the DOL that will forever change the 401(k) business from one in which financial salespersons prosper to one in which friendly handshakes have little value. But we haven’t really looked into the black box where the specifics fester to see what exactly has changed and just what an advisor needs to know to succeed in this new regulatory environment. Sheldon Geller, a longtime industry veteran with no fear of the small print, has undertaken that task and we publish it here.
It’s no longer good enough for investment advisors to pick a few mutual funds for sponsors of 401(k) plans and then adjourn for lunch.
Financial advisors need to also consider it their jobs to protect 401(k) plan sponsor boards, corporate officers and other plan fiduciaries from an increasingly active and high ERISA bar. See: Why the DOL’s massive new 401(k) disclosure requirements are a 'very, very big deal’.
Liable to be liable
Recent court decisions have identified issues that investment advisors need to consider to effect prudent plan management and to protect their 401(k) plan clients from significant fiduciary liability. Plan sponsors are at risk and and thus investment advisors need to insulate them from a new wave of ERISA lawsuits, regulatory oversight and legislation. See: How Schwab is gearing up its RIAs to fight for 401(k) assets.
Plan sponsors will likely call upon investment advisors with ERISA experienced with the ins and outs of the Employee Retirement Income Security Act of 1974 to manage plan operation and fiduciary compliance. Investment advisors will need to do more than perform fund due diligence and provide fund recommendations. The marketplace will offer ever-expanding fiduciary service models, thus challenging investment advisors to expand their service deliverables for their 401(k) plan clients.
401(k) plan fiduciaries have been found to have breached their duties to plan participants and have been assessed significant damages for failing to monitor recordkeeping costs, negotiate rebates and prudently select and retain investment options. Many plan sponsors have relied upon non-fiduciary service providers for investment selection and fiduciary guidance in the absence of a fiduciary-overlay service or discretionary vendor.
Plan sponsor fiduciaries cannot rely upon a non-fiduciary service provider with a conflict of interest to accept responsibility for their service model and investment fund recommendations. Plan sponsors should become increasingly skeptical of non-fiduciary service providers’ managing plan assets and plan administration. Investment advisors need to educate plan fiduciaries who may not recognize a conflict of interest.
Investment advisor due diligence
There will be more claims against 401(k) plan fiduciaries who previously considered themselves immune based upon offering a broad selection of investment alternatives. It is critical for investment advisors to have the requisite skills and knowledge to uncover embedded fees, conflicts of interest, service incapabilities and contract limitations inherent in the retirement plan solutions they offer their 401(k) plan sponsor clients. See: DOL tells employers when they must fire advisors to 401(k) plans.
Courts have emphasized the importance of implementing and adhering to a deliberative process and focusing on the merits of employer decisions affecting plan participants. ERISA fee litigation cases emphasize that employers must follow established processes and act in the best interests of the plan and for the exclusive benefit of plan participants.
Accordingly, 401(k) plan sponsors rely on their investment advisors to establish these processes, to effect procedural prudence, to avoid conflicts and to document decisions.
Investment advisors need to become experts qualified in fiduciary standards of care and assessment. Most firms providing retirement plan administration services do not guarantee the completeness or accuracy of their services — they process the information plan sponsors provide to them.
Most employers do not have the internal controls in place to ensure operational compliance with plan terms in order to satisfy ERISA.
Consequences of noncompliance consume company staff time, increase legal costs and expose plan sponsors to liability and monetary sanctions. The current regulatory environment makes it difficult for an investment advisor to adequately represent plan sponsor interests unless the advisor is an ERISA fiduciary. See: Report of a possible delay in DOL’s fee disclosure rule sparks apprehension among advisors and industry observers.
Plan fiduciary best practices
Recent case law imposes new responsibilities upon plan sponsors. A wave of fiduciary lawsuits is creating new plan best practices. Plan sponsors must implement and maintain an objective strategy with predetermined procedures to remove subjectivity and comply with ERISA 's fiduciary requirement to act solely on behalf of participants.
Investment advisors need to implement and manage, among other best practices, the following plan fiduciary best practices to protect their 401(k) plan sponsor clients:
1. Revenue sharing and recordkeeping fees: Employers must monitor record-keeping fees and revenue sharing pursuant to a deliberative process demonstrating that committee decisions are in the best interest of plan participants. Service providers may not retain revenue sharing that far exceeds the market value of plan services.
2. Revenue sharing and fee offsets: Employers must negotiate revenue-sharing rebates with service providers to reduce the cost of providing administrative services to plan participants, if mutual fund expense ratios are excessive and unreasonable based upon a comparison in the marketplace. See: How giant advice provider Financial Engines can sweep the 401(k) field — or not.
3. Selection and de-selection of investments: Employers must document the process of evaluating the competitive market for comparable investment funds. Deleting a good performing fund or using alternative share classes to create more revenue sharing to offset fees violates investment policy statement criteria and the exclusive-benefit rule. Fund replacements must provide a reasonable investment advantage to participants.
4. Subsidization of corporate services: Employers must avoid the payment of fees that exceed the market costs for plan services in order to subsidize corporate services, including payroll processing, welfare benefit plan and defined benefit plan services.
5. Float Income: Float, the income and interest earned when contributions and disbursements are held temporarily during the transfer process constitutes plan assets and therefore must be allocated only among 401(k) plan participant accounts.
6. Fiduciary monitoring criteria: Employers must review custody statements monthly, compare manager performance quarterly, evaluate service provider quality annually and scrutinize service provider contract capabilities, services and fees every three years. See: Merrill Lynch jumps on the fiduciary bandwagon in retirement plans but critics see lingering conflicts.
7. Asset-based fees: It is imprudent to use asset-based fees to pay for administration services, as fees increase even though no additional services are provided.
8. Risk-sharing: It is imprudent to enable service providers to charge hard-dollar fees to replace lost revenue sharing resulting from declining plan asset values without determining the revenue-sharing amount, the market cost of comparable services and whether using revenue sharing to pay plan fees is in the participant’s best interest.
9. Investment policy statement: It is imprudent to maintain an investment policy statement without adhering to its fund replacement criteria and revenue-sharing application, as plan sponsors will be held liable for the failure to comply with same.
Plan sponsors must show their work
Plan sponsors may have to explain — if not defend — their actions in retaining service providers if they do not conduct a full request- for-proposal process to formally test the marketplace for retirement services every three years. Neither ERISA’s prudence requirement nor its exclusive-benefit rule support a rule of law requiring plan fiduciaries to conduct a competitive-bidding process to support a fee and avoid litigation. See: A Q&A with Phyllis Borzi, the DoL powerbroker aiming to remake the retirement market.
Recent lawsuits have alleged that plan sponsor boards, corporate officers and other fiduciaries have breached their fiduciary duties by failing to investigate plan transactions. Investment advisors need to help plan sponsor fiduciaries identify conflicts or potential conflicts and evaluate whether those conflicts affect the 401(k) plan and its participants. Further, investment advisors need to help plan sponsors protect the plan from any adverse effect of a conflict of interest.
Plan sponsors are advised to retain investment advisors who can be strong fiduciary partners to provide open-architecture solutions facilitating identification of best-in-class service models and lower-cost, best-performing fund lineups. ERISA anticipated that independent fiduciaries would manage retirement plans on behalf of plan sponsors, protecting boards of directors, corporate officers and other plan sponsor fiduciaries.
An independent ERISA fiduciary cannot be conflicted and is legally accountable to the plan sponsor client, which is indispensable when retaining service providers, approving fee arrangements and selecting investment funds. Plan sponsors need advice from an advisor with subject matter expertise to avoid ERISA violations, monetary sanctions and civil liability for corporate directors and corporate officers who fail to establish internal control procedures for monitoring operational compliance.
ERISA is a dynamic statute, requiring an advisor to have extensive fiduciary, regulatory, transactional and practical experience. The Department of Labor has significantly raised its enforcement effort against plan sponsors, targeting fiduciary negligence. Many plan sponsors are unaware that the Labor Department has jurisdiction over them and fail to understand their fiduciary responsibilities under ERISA. See: Proposed DOL regs expose more advisors to fiduciary liability.
fluent in ERISA
Plan fiduciaries must scrupulously identify, examine and, where possible, avoid, conflicts of interest and prohibited transactions. Recent legal decisions underscore the importance of adopting prudent operational compliance procedures and best-practice governance standards. Engaging non-fiduciary consultants and relying on their advice is not evidence of prudence and may cause the plan fiduciary to commit a breach.
Plan sponsors should retain independent ERISA fiduciaries who are worthy of a fiduciary mandate, having acknowledged fiduciary status in writing, to consistently apply fiduciary practices and make fiduciary decisions. It is imperative to implement a compliance strategy to manage plan sponsor fiduciary liability and a retirement plan solution to relieve officers and managers from plan administration decisions.
The fiduciary liability landscape includes litigation alleging breach of ERISA fiduciary duty for inappropriate 401(k) investment options, misrepresenting the risks of investing in employer securities, permitting excessive fees and expenses, and failing to administer plans in accordance with the terms set forth in plan documentation.
As the challenging economic environment prompts more lawsuits over retirement plan benefit losses, boards, chief financial officers and other plan fiduciaries should think carefully about the retention of advisors and attorneys with ERISA subject matter expertise to manage conflicts, avoid prohibited transactions and provide legal accountability.
There is a need for highly credentialed and independent ERISA professionals compensated by plan sponsors, not by custodians and fund companies, to serve and protect plan sponsor boards, CFOs, CEOs, corporate officers, human-resources managers and other plan fiduciaries.Sheldon M. Geller is the president of Stone Hill Fiduciary Management LLC.