I recently wrote an article for JP Morgan about the fiduciary process for implementing investment policy statements . . . with particular emphasis on the monitoring of investments and investment managers in participant-directed plans. The article outlines a step-by-step approach for identifying investments to be placed on a watch list, the use of the watch list, and the process for determining whether to remove and replace the investment. I believe that the article is both a good outline of ERISA’s requirements for a prudent process and an educational piece for plan fiduciaries. It can be found under the publications section of my blog, here: http://fredreish.wpengine.com/publications/, or directly at http://bit.ly/1MayGaf.
Category Archives: fiduciary
Did you know…?
Little has been written about how a plan fiduciary should prudently select insurance companies and guaranteed retirement income for participants. There’s a DOL “safe harbor” regulation, but it doesn’t give fiduciaries a checklist for compliance. To address this, Lincoln Financial hired us to work with an insurance consultant to develop a set of criteria that fiduciaries or their advisors can use to make those decisions. Bruce Ashton and I have written an article about the checklist that can be found here: Did you know…About the Fiduciary Requirements for Selecting a Lifetime Income Provider? The article has links to the white paper and the checklist.
ERISA Issues for Solicitor’s Fees
Not much has been written about ERISA considerations for referring investment managers to retirement plans . . . and the receipt of solicitor’s fees for a referral.
However, there are a host of legal issues.
First, the person making the referral is receiving “indirect” compensation (that is, the solicitor’s payment by the investment manager), which makes that person a “covered service provider” or “CSP.” As a CSP, he must make 408(b)(2) disclosures (i.e., services, status and compensation). The failure to make timely disclosures is a prohibited transaction.
Second, the compensation cannot be more than a reasonable amount . . . as measured by the value of the services to the plan. But, what if the CSP doesn’t provide any ongoing services to the plan? Does the “compensation” become unreasonable after five years of payments? Ten years? I am not aware of any guidance on that point.
Third, the referral can result in the CSP becoming an ERISA fiduciary adviser. The DOL takes the position that a referral to a discretionary manager is the same as the recommendation of an investment. If it is individualized, based on the particular needs of the plan (or a participant), the DOL says it’s a fiduciary act. For example, in the preamble to its participant advice regulation, the DOL said: “. . .the Department has long held the view that individualized recommendations of particular investment managers to plan fiduciaries constitutes the provision of investment advice within the meaning of section 3(21)(A)(ii) in the same manner as recommendations of particular securities or other property. The fiduciary nature of such advice does not change merely because the advice is being given to a plan participant or beneficiary.” That conclusion means that the CSP should engage in a prudent process and its compensation must be “level” (that is, cannot vary depending on which investment manager is recommended). I am not aware of any enforcement activity on these issues. However, the DOL position is clear.
While I have opinions about these unanswered questions, the purpose of this article is to alert people about the issues and risks.
Aging Boomers and Rollovers to IRAs
As baby boomers approach retirement in a defined contribution world, the regulators are focusing on distributions and rollovers to IRAs. The SEC, FINRA, DOL and GAO have all spoken on the subject. Their conclusion appears to be that plan fiduciaries, advisors and recordkeepers need to reconsider their current practices and, in some cases, change their practices.
Why? The reason is relatively straightforward. As large numbers of 401(k) and 403(b) participants approach retirement, regulators are becoming increasingly aware that they will be moving from a plan environment where they are “bubble wrapped” by plan fiduciaries . . . and have the benefit of being able to select from investments that have been vetted by the fiduciaries and that are, as a result, good quality and relatively low-cost investments. Based on current practices, most of those participants will rollover into IRAs with investments and advisors that are using retail pricing.
In addition, participants will go from a fiduciary environment that is protected from conflicts of interest into a retail environment that allows conflicts of interest. (Note that there is a difference between a conflict of interest and “succumbing” to a conflict of interest. In my experience, most—but not all—advisors provide good advice at reasonable costs.)
The regulators are asking, “Does it make sense for participants to leave the protected environment of retirement plans and go into the retail environment of IRAs?”
To create a worse-case scenario, imagine a 401(k) participant who is defaulted into a target date fund and stayed there during his working career. In effect, the participant has never selected an investment, and it is possible that the participant never learned anything about mutual funds. At retirement, that participant is encouraged to rollover his money into a retail market.
So, where does that leave us? For plan sponsors, I think that it means that they should consider allowing participants to stay in the plan, even after retirement, and should provide flexible distribution alternatives through their recordkeeper. For advisors and recordkeepers, I think that it means that they need to create meaningful educational materials and help participants make the right decisions, depending on the participants’ needs and preferences.
This is just the beginning of this story. There is too much at stake for it to end here. For example, it is estimated that over two trillion dollars will become eligible for distribution between January 1, 2014 and December 31, 2018.
Re-Proposal of DOL Fiduciary Advice Regulation
As you have undoubtedly heard, the Department of Labor has pushed back the date for the re-proposal of the fiduciary advice regulation to January of next year. In addition, the SEC is working with the DOL to help determine the impact of an expanded fiduciary advice regulation on the ability of investors to continue to receive adequate investment services. Finally, the White House is also evaluating the potential impact of a regulation that expands the definition of fiduciary advice. The big question, of course, is what does all of this mean?
As you might expect, everyone has an opinion on that subject. So, depending upon your personal beliefs, you can find opinions that either agree or disagree with your position. But, the truth is that the people who know aren’t talking, and the people who are talking don’t know.
One plausible explanation is that the controversy concerning the regulation has risen to the point that it is a political liability. In other words, that line of reasoning holds that these activities are signs that the re-proposal is in danger.
However, another line of reasoning is that the regulation remains viable, and probable, but that the politicians and the regulators want to make sure that they get it right. (If that is the case, then “right” probably means that appropriate prohibited transaction exemptions are crafted so that valuable services and quality products are not prohibited.)
If I were a betting man (and, for this purpose, I am), my bet would be that the second scenario is the more likely. I have a hard time believing that all of this political and regulatory effort is being made for a proposal that will be killed. In other words, I think that there is a good chance that the DOL will issue a proposed regulation in the first half of next year. I also think that there is a good chance that the proposed prohibited transaction exemptions that accompany the guidance will be more thoughtful and practical than might be expected.
In any event, if and when we get the proposal, the first thing that I will look at is . . . the proposed prohibited transaction exemption concerning fiduciary investment advice to IRAs. In particular, I want to see what it says about variable compensation and about proprietary investments and products.
Advisory Opinion 2013-03A
In Advisory Opinion 2013-03A, the Department of Labor said: “This letter also does not address any fiduciary issues that may arise from the allocation of revenue sharing among plan expenses or individual participant accounts . . .”
In effect, the DOL was saying that it has not issued any guidance—and is not prepared to issue guidance—concerning the allocation of revenue sharing. That is a reminder that there isn’t any explicit guidance on how to allocate revenue sharing. As a result, fiduciaries need to engage in a prudent process to make that decision.
In most cases, revenue sharing is used to pay the cost of recordkeeping. In effect, it is arguable that, when the recordkeeper keeps the money, it is a pro rata allocation among the participants’ accounts. That is because the most common way of allocating expenses (for example, recordkeeping or RIA charges) among participants’ accounts is the pro rata method. So, when a recordkeeper keeps the revenue sharing, participants benefit on a pro rata basis. (“Pro rata” means that amounts are allocated among the participant’s account balances in proportion to the value of the account balances.)
A consequence of the 408(b)(2) disclosures and the DOL’s guidance on revenue sharing is that fiduciaries need to pay more attention to revenue sharing. For example, do fiduciaries want the recordkeepers to keep the revenue sharing or do they want to allocate the revenue sharing to participants (along with the charges for recordkeeping)? Should part of the cost of recordkeeping be allocated to participants who are invested in individual brokerage accounts or who hold company stock . . . or should the participants who invest in mutual funds bear the full cost of the recordkeeping for the plan? Those are fiduciary decisions. In the past, most plan fiduciaries have simply accepted the method used by the recordkeeper. However, even then, that was a fiduciary decision. It’s just that the fiduciaries didn’t, in many cases, know that they were making it. Going forward, there undoubtedly will be greater accountability for these fiduciary “decisions”. . . since fiduciaries have been provided with information about revenue sharing as a part of the 408(b)(2) disclosures. Forewarned is forearmed.
408(b)(2) Guide and More
The DOL recently issued a proposal to require a 408(b)(2) “guide.” The guide has also been referred to as a roadmap. But I think of it as an index to the disclosures.
This is the DOL’s response to their review of provider disclosures and problems the DOL has seen. The DOL has at least two more significant concerns.
The proposal is that plan sponsors be given a stand-alone guide or index to provide directions to where each of the 408(b)(2) disclosures is found in the disclosure documents. It will only apply where covered service providers use multiple or lengthy documents. As a result, it will primarily impact recordkeepers and broker-dealers (as opposed to other covered service providers, such as RIAs and TPAs).
There is time to comment on the proposal. Hopefully, the comments will enable the DOL to find the “fine line” between meaningful disclosure, on the one hand, and overly burdensome requirements on the other.
But, that’s not the end of the story. I have heard of two other DOL concerns. The first is that some covered service providers are not giving fiduciaries information that specifically applies to their plan. For example, the disclosures might instead provide a list of services or compensation amounts that might or might not apply to a particular plan. The Department’s view is that the disclosures should include only the services and compensation for the plan receiving the disclosures. The second concern is that service providers are using overly-broad ranges to make disclosures. For example, if a service provider were to disclose that the fees will be somewhere between 0% and 5%, the Department would likely take the position that the information was not specific enough to enable the responsible plan fiduciaries to evaluate the compensation of the adviser relative to the services being provided.
That’s it for now. But, be forewarned, there is more to come.
As a footnote to these comments, we anticipate that the DOL will begin their first wave of 408(b)(2) investigations in the second half of this year.
To read the Client Alert I co-wrote on this subject in March 2014, visit the Drinker Biddle website here: DOL Proposed Regulation on 408(b)(2) “Guide” – Impact on Service Providers.
Capturing Rollovers: A Changing Environment
Recent developments suggest that FINRA, the SEC and the DOL are working together…or, perhaps, have independently reached the same conclusions.
In the past few months, FINRA has discussed rollover IRAs in five publications. The most important of those being Regulatory Notice 13-45, which creates a fiduciary-like process for recommendations about distributions and IRA rollovers. (By the way, I believe FINRA’s Investor Alert on rollovers is helpful and should be given to prospective rollover customers.) Then, to put an exclamation point on that guidance, both FINRA and the SEC listed rollovers to IRAs as one of its 2014 Examination Priorities for broker-dealers.
Finally, it is commonly expected that the DOL will issue its proposed regulation on the definition later this year…and that the proposal will expand its prior guidance on “capturing” rollovers. Fiduciary status alone increases the scope of the DOL’s jurisdiction and implicates it’s prior guidance (see Advisory Opinion 2005-23A). As a result, a broader definition of fiduciary advice will subject more advisers and providers to that guidance. In addition, it is possible that the Department will try to label any recommendation to take distribution as fiduciary advice (by saying, e.g., that a recommendation to take a distribution is inherently also a recommendation to liquidate a participant’s 401(k) investments – similar to what FINRA has done).
To make this even more “interesting,” we are seeing SEC examinations of RIAs where the SEC is finding ERISA prohibited transactions and asserting compliance violations by RIAs. The question is, will that theme carry over into IRA rollovers?
These changes impact broker-dealers, RIAs and their representatives. Less obviously, they also impact the rollover services of recordkeepers.
Bottom line… the rules are changing. Much more attention must be given to practices and disclosures in the distribution and rollover process.
For those of you who are interested in following me on Twitter, I can be found @fredreish, or copy and paste this URL into your browser: https://twitter.com/fredreish
Investment Policy Statement: Friend or Enemy
The ABB case has been thoroughly analyzed and widely discussed. Most of that analysis and discussion, though, has been about expenses and revenue sharing. This email focuses on the duty to follow the terms of investment policy statements (IPS). More technically, section 404(a)(1)(D) of ERISA requires that fiduciaries follow the terms of the documents governing the operation of the plan, unless it would be imprudent to do so. The IPS is one of the documents governing the operation of the plan.
As background, the trial court found that the ABB plan committee violated several of its fiduciary duties. One of those was the duty to follow the terms of the IPS. In the IPS, the committee was obligated to follow certain procedures concerning the removal and replacement of a fund, including placing a fund on the watch list before removing it. The court found that the committee failed to follow the procedures in its IPS and, as a result, breached its fiduciary duties. That was unfortunate, since the committee could have amended the IPS to change the procedure. However, it failed to do so… perhaps because the committee had forgotten the terms of the IPS or perhaps because it believed its exercise of discretion would override the terms of the IPS.
So, is the IPS a friend or an enemy of plan committees? The answer is, depending on how it is done, it can be either.
Unfortunately, we see too many IPS’ that contain absolute and/or unnecessarily restrictive provisions. Those provisions can mandate a certain number of meetings, require a specified investment removal process, insist on a particular series of steps for some decisions, and so on. None of that is required by law… nor, in my opinion, by good judgment. Instead, an IPS should be a set of guidelines, and the plan committee members should be expected to exercise discretion and good judgment for the benefit of the participants.
Is there an alternative to the IPS being an “enemy?” Yes, of course.
If an IPS is properly drafted, it can serve as an educational tool for the committee and as a set of non-binding guidelines. In that way, the focus can be kept on the real job of the committee… to exercise its discretion. But the nonbinding guidelines in the IPS will be a helpful “map” for consistent and thoughtful decisions.
The moral to this story is that, if an IPS is going to be rigidly drafted as a series of requirements, then the committee should review the IPS before it acts and amend the IPS, if need be. On the other hand, and a better solution, the IPS could be better drafted. My experience is that, while the investment community is good at determining the criteria and other information to be included in an IPS, the investment community does not have the same risk management skills as attorneys. It is probably best if each does its “day job,” and the investment consultants focus on IPS’ as an investment tool, while the lawyers view them as risk management documents.
IMPORTANT NOTE: This case was heavily disputed and there may be disagreement about the facts. This article uses the facts as laid out in the court’s opinion and, based on my experience in other cases, the actual facts can be different.
Target Date Retirement Funds–Tips for ERISA Plan Fiduciaries
In my last post—about the selection and monitoring of target date funds (TDFs), I said that I would also discuss the DOL’s recent guidance on that subject… here it is.
Earlier this year, the DOL published “Target Date Retirement Funds—Tips for ERISA Plan Fiduciaries.” You should read the full Tips (at http://www.dol.gov/ebsa/pdf/fsTDF.pdf), but here are a few key points:
- It is important that fiduciaries understand the asset allocations, glidepaths and expenses—and compare them to other TDFs. How many fiduciaries do that?
- In selecting a TDF suite, fiduciaries should consider their participant demographics and other factors, for example, participation in other plans (e.g., pension plans or ESOPs), salary levels, turnover rates, contribution rates and withdrawal patterns. In other words, there is no such thing as a “one-size-fits-all” TDF. How many fiduciaries do that?
- Plan sponsors are encouraged to consider “custom” TDFs. That would include managed accounts and asset allocation models. These vehicles have the advantage of being designed to consider the particular needs and demographics of the covered workforce.
The point of my italicized questions is that there is a significant gap between what the DOL expects plan fiduciaries (eg, plan committees) to do… and what they are actually doing. As a general premise, these kinds of “gaps” are usually red flags, and those flags are signaling changes to plan sponsors.
Of course, the DOL says more than that—and explains it in more detail. This post is just an “appetizer.” Read the Tips.