Category Archives: plan sponsors

What’s Hot . . . in the First Quarter of 2015?


408(b)(2), DOL, fiduciary, plan sponsors, recordkeeper

Over the last few months, the most common questions asked by clients . . . and most of my work . . . have been about three issues:

  • The DOL’s new fiduciary proposal . . . not surprising.
  • Capturing rollovers from retirement plans. Again, not surprising because of the large amount of money coming out of plans and in light of the attention being given to rollovers by the SEC, FINRA, DOL and GAO.
  • The use and allocation of revenue sharing in 401(k) plans.

I will be writing about the first two points in the future, so let’s focus on the third one now.

For about 20 years, mutual funds have paid revenue sharing to 401(k) recordkeepers for services provided to the mutual funds. That includes 12b-1 shareholder servicing fees, 12b-1 distribution fees, and subtransfer agency fees. The view was that the money was paid for services to the mutual funds . . . and only incidentally involved the plans. However, that is changing—at least partially because the 408(b)(2) regulation treated those payments as compensation to the recordkeeper for services to the plans. Because of that change, there is a growing perception that the revenue sharing payments belong to the plan, and not to the provider.

Regardless of those perceptions, the DOL’s position, and the 408(b)(2) regulation, treat the payments as compensation to recordkeepers for their services related to the plans and their investments. As a result, if the total compensation from revenue sharing exceeds the reasonable cost of recordkeeping services, the plan sponsor has a fiduciary obligation to be aware of that and to recoup the excess compensation for the benefit of the participants.

The “new news” is that some providers and some plan sponsors are allocating all of the revenue sharing back to the participants and then charging participants’ accounts for the recordkeeping costs. Why? The general answer is because it is seen as being fair. The more detailed answer is that fiduciaries have a duty to oversee the use of revenue sharing by the recordkeeper and, when they delve into the matter (in order to understand the issues and fulfill their fiduciary responsibilities), the fiduciaries often determine that the equitable allocation of revenue sharing, and then proper allocation of plan costs, produces a result that is fair and that manages the fiduciary risk.

That raises the obvious question . . . what fiduciary risk am I talking about? The risk is that there is no guidance from the DOL on the proper use and allocation of revenue sharing. In other words, plan sponsors, advisers and ERISA attorneys are operating in a vacuum. We are making educated guesses about what will ultimately happen in terms of DOL guidance or ERISA litigation. When “walking on thin ice,” it is often preferable to take a relatively conservative position. In this case, the conservative position is to allocate the revenue sharing back to the participants.

To give you an example, think about a large plan where 50% of the participants’ money is in revenue sharing mutual funds, 40% of the participants’ money is in non-revenue sharing mutual funds, and 10% is in a company stock fund (that does not pay any revenue for recordkeeping). In this case, the 50% of the participants in the revenue sharing mutual funds are carrying the cost of the whole plan. Expressed slightly differently, half of the participants are in the plan for free, because the other half are paying the cost of recordkeeping. If we assume that the half of the participants in the revenue sharing mutual funds are paying higher expense ratios, then the problem becomes obvious. Not only are those participants paying for the plan, but they are bearing a financial burden to do that.

A similar case could occur where some of the participants (probably high-compensated ones) are in stock brokerage accounts, while the rank-and-file employees are in mutual funds that pay revenue sharing. The brokerage accounts aren’t paying anything to support the plan, while the rank-and-file employees are bearing the full cost of the plan.

The fundamental question is, how should your plan sponsor clients be positioning themselves in light of the lack of DOL guidance and the potential risk?

 

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Aging Boomers and Rollovers to IRAs


DOL, fiduciary, plan sponsors, recordkeeper, registered investment advisers, service providers

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.

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Investment Policy Statement: Friend or Enemy


fiduciary, plan sponsors, prudent

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.

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Target Date Retirement Funds–Tips for ERISA Plan Fiduciaries


DOL, fiduciary, plan sponsors

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.

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Selection and Monitoring of Target Date Funds


General, plan sponsors

As I review investment policy statements for participant-directed plans, I see a number of common deficiencies. This email is about one of those—the selection and monitoring of target date funds (“TDFs”).

In my experience, most IPS’ say little or nothing about the criteria to be applied to TDFs. For example, an IPS might be completely silent on the issue or may simply say that they will be selected and monitored. But, in neither case is there a robust set of criteria. That is problematic.

One reason is that TDFs are capturing an increasingly large percentage of 401(k) assets. As more plans automatically enroll, that percentage will continue to grow. I can imagine a day, in the not-so-distant future, where over half of the assets in 401(k) plans will be in TDFs. That leads to the unfortunate conclusion that, based on the current practices of many advisers and committees, over one-half of the assets in the plan will be in a suite of investments that has not been subjected to close scrutiny, while the other investments – that hold less than half of the assets — will be subject to a rigorous evaluation process. That just doesn’t make sense. And, where a situation doesn’t make sense, it can lead to problems.

With that in mind, I recommend that you take a look at the evaluation criteria in DOL comments filed by the Investment Company Institute and the American Benefits Council. It is the most robust set of TDF criteria that I have seen. The ABC/ICI comments can be found at: http://www.americanbenefitscouncil.org/documents/tdf_abc-ici_letter-submission033010.pdf.

The criteria in those comments set a much higher standard than the common practices of advisers and plan committees. However, I think those comments may suggest the future — rather than reflecting the past.

For example, the comments suggest considering, among other things:

  • The performance of each of the mutual funds inside the TDF,
  • Appropriate benchmarks to evaluate TDF performance,
  • Participant demographics, and
  • Whether the plan sponsor also offers a pension plan.

In next month’s post, I will discuss the recent DOL guidance on the selection and monitoring of TDFs.

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Responsible Plan Fiduciaries and Disclosure Issues


408(b)(2), broker-dealers, fiduciary, plan sponsors, recordkeeper, registered investment advisers, service providers

The 408(b)(2) regulation requires that its service, status and compensation disclosures be made to “responsible plan fiduciaries” or “RPFs.” In the rush to make the 408(b)(2) disclosures, most recordkeepers, broker-dealers and RIAs sent their disclosure documents to their primary contact at the plan sponsor. In at least some of those cases, the primary contact was not the RPF. As a result, we added language to our clients’ disclosures to the effect that, if the recipient was not the RPF, the written disclosure should immediately be forwarded to the RPF.

The regulation defines RPF as “a fiduciary with authority to cause the covered plan to enter into, or extend or renew, the contract or arrangement.” In other words, it is the person or committee who has the power to hire and fire the particular service provider, e.g., the broker-dealer, recordkeeper or RIA.

Because of the work involved in making mass disclosures, any inadvertent errors in properly identifying the RFPs may be excusable. However, going forward, it may not be. Because of that, all future agreements, account opening forms, and so on, with ERISA plans should specify that the person signing on behalf of the plan is the RPF. Furthermore, we recommend that service providers obtain the email address and other contact information for the RPFs (and that they contractually require plan fiduciaries to inform them of any changes of the RPFs).

We do that for two reasons. First, as covered service providers bring in new plan clients, the documents need to be executed by the RPFs and the disclosures need to be delivered to the RPFs. Second, the information is also needed for existing clients. Fiduciaries who have already received disclosures, they will need to be provided “change” disclosures in the future within 60 days of any changes. And, it is likely that more requirements will be imposed on service providers in the future and, therefore, providers will need to have an efficient and effective way of communicating with the RPFs.

Now is the time to put these new procedures in place.

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The “Yale Professor” Letters on Fund Expenses


fiduciary, plan sponsors, prudent

This article was prepared by Fred Reish, Bruce Ashton and Josh Waldbeser.

Letters to 6,000 sponsors of 401(k) plans, sent out by a Yale law school professor several weeks ago, generated considerable comment and controversy.  Some of the letters we reviewed suggested that the recipients were operating a “potentially high-cost plan” and that the fiduciaries may have breached their fiduciaries duties.  We sent an article by email a couple of weeks ago describing these letters and giving you a link to our bulletin on the Drinker Biddle website.  (A copy of that email is at http://fredreish.wpengine.com/mass-mailing-to-plan-sponsors-about-excess-fund-fees/)

Since the last email, we have been able to do a more in-depth analysis of the professor’s underlying study and have concluded that it has material limitations.  As a result, it does not provide a valid basis for concluding that fiduciaries have breached their duties.  We have put together an “open letter” to the retirement plan community, together with a memorandum that supports our analysis.

Chief among the deficiencies are the use of stale data, the failure to consider the plan design and services being offered by the plan and, perhaps most important, the failure to take into account revenue sharing used to pay the costs of plan administration and/or to provide a return to the participants.

You can obtain a copy of the letter and memorandum at http://www.drinkerbiddle.com/resources/publications/2013/401k-controversial-yale-letters.

 

 

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Mass Mailing to Plan Sponsors About Excess Fund Fees


plan sponsors, prudent, recordkeeper

This article was prepared by Fred Reish, Bruce Ashton and Josh Waldbeser.

A Yale law professor is sending letters to many (perhaps thousands of) 401(k) plan sponsors telling them they may have breached their fiduciary duties because they are offering a potentially high-cost plan.   For example, in one letter, he said:  “Among plans of comparable size (measured by total net assets), your plan ranked worse than 78 percent of plans.”  He then added, “We wanted to inform you that we are planning to publicize the results of our study in the Spring of 2014.  We will make our results available to newspapers (including the New York Times and Wall Street Journal), as well as disseminate the results via Twitter with a separate hashtag for your company.”

His allegation is based on a study using data compiled by BrightScope, though we understand that BrightScope did not participate in the study.  Based on what we have heard, this professor’s reliance on interpretation of the BrightScope data may have been materially mis-placed, and the study fails to take into account a number of relevant factors, such as the quantity and quality of services being provided and the complexity and design of the particular plan.

The impact of the professor’s study could be unfortunate, possibly leading to participant complaints, Congressional inquiries and even litigation.  Recordkeepers, advisors and plans sponsors should take this seriously and take appropriate action.  Recordkeepers should consider communicating with their plan clients about the issues and inadequacies of the analysis it applies to specific plans, and should be prepared to respond to inquiries from plan sponsors about the costs of their plans.   Advisors should be talking with their plan clients about these letters and the study – and should be prepared to answer questions about their fees and the costs of the investments they recommend.  And if they have not already done so, plan sponsors should obtain benchmarking data on the cost of their plans and determine if the fees and costs are reasonable relative to the services being provided.

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Managing Plan Costs


404a-5, DOL, fiduciary, plan sponsors, recordkeeper, registered investment advisers, service providers

Many recordkeepers and bundled providers charge plans based on the number of participant accounts. Many others do not explicitly charge on a per-participant basis, but incorporate the number of accounts (and possibly the average account balances) into their pricing. It is likely that this practice will increase in the future . . . due to the new 404a-5 participant disclosures, which must be made to every eligible employee, as well as to every participant of an account balance.

With that in mind, advisers, recordkeepers and plan sponsors should consider mandatory distributions of small account balances (that is, $5,000 or less) to manage plan costs.

If a plan has the required provisions, and if the provisions have been appropriately communicated to eligible employees and beneficiaries through summary plan descriptions, plans can make distributions of account balances of $5,000 or less. If the participants don’t take those distributions, then the plans can directly roll the money over into IRAs for them. In either case, the effect of the mandatory distributions will be to improve the pricing for the plan . . . either because it reduces the number of accounts or, alternatively, because it increases the average account balance (due to the elimination of small accounts).

As you might expect, both the IRS and the DOL have issued guidance on how to do that. The combined effect of the guidance is that plan fiduciaries essentially have a safe harbor for making mandatory distributions of small accounts . . . if they follow the rules. Unfortunately, there are too many requirements for a short email like this. However, my partner, Bruce Ashton, and I have written a white paper that describes the requirements.

In writing that white paper, we took an approach that I think will be helpful to advisers and plan sponsors. The body of the white paper is a discussion of the benefits of mandatory distributions . . . in terms of plan pricing. Then, there are three appendices: the first two discuss the IRS and DOL guidance, respectively; and the third one covers adviser compensation related to a mandatory rollover program.

If this subject is interesting to you, you may want to look at the Inspira white paper. It is located at http://www.drinkerbiddle.com/resources/publications/2013/mandatory-distributions-white-paper?Section=Publications.

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Fiduciary Obligation to Select Appropriate Share Classes


fiduciary, plan sponsors, prudent

I imagine that, by now, you have heard about the Court of Appeals decision in Tibble v. Edison. While the court decided a number of issues, the most important one is that fiduciaries have an obligation to select appropriate share classes for their plans. Closely related to that is the trial court’s admonition that fiduciaries must ask about the available share classes.

ERISA imposes both a fiduciary rule and a prohibition on spending more than reasonable amounts for operating a plan, including the investment costs. The Tibble decision was about the reasonable expense ratios for plan investments. However, rather than looking at the evaluation of mutual fund expenses in the traditional way (that is, comparing expense ratios to those of other funds), the trial court found, and the appellate court agreed, that plans must use their purchasing power to select the appropriate share class. The practical consequence is that advisers should make recommendations based on the share classes available and must educate plan sponsors about the available share classes, including their costs, and plan sponsors (typically acting through their plan committees) must understand that multiple share classes may be available and must investigate which are best for their plan and participants.

That could be a daunting task. Just consider that some mutual funds may have 10 or more share classes. That could include, for example, A, B, C, I, R-1, R-2 shares, and so on. This will place an additional burden on advisers . . . and, in that sense, may favor advisers who focus on retirement plans.

But, it is more complicated than that. Share classes for mutual funds and separate account “classes” for group annuity contracts may, for these purposes, be virtually identical. If that is true, advisers will need to educate plan sponsors on the classes available in group annuity contracts. Then, advisers will need to help plan sponsors select the appropriate separate account class for that particular plan. Since some insurance companies offer group annuity contracts with 10 or even 15 separate account classes, advisers will need to be more attentive to the alternatives that are available and will need to work with plan sponsors to understand the share and separate account classes (including the revenue sharing and compensation aspects) and to select the appropriate classes based on the size and needs of the particular plan.

In the future, we could see litigation where advisers did not educate plan sponsors on the availability of alternative classes and do not make appropriate recommendations.

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