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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DOL Proposed Regulation Sent to OMB


408(b)(2), DOL, fiduciary

The Office of Management and Budget (OMB) has posted that it received a proposed regulation from the Department of Labor. Unfortunately, it is not the much-anticipated proposed regulation on fiduciary advice. Instead, it is a regulation that addresses the development of a “Guide or Similar Requirement for Section 408(b)(2) Disclosures.”

Even though this is not the fiduciary advice regulation, it could have a material impact on the retirement plan community. We don’t know what the proposed regulation will say—and we won’t know for about three months (when the OMB approves and releases the proposed regulation). However, the DOL has previously given us an idea about their thinking.

When the DOL issued the final 408(b)(2) regulation on February 3, 2012, it included a Sample Guide to Initial Disclosures. The Sample Guide was not mandated, but instead was offered as an aide. The DOL explained, in the preamble to the final regulation: “Although the Department is not adopting such a requirement [for a guide] at this time, the Sample Guide published today may be useful, on a voluntary basis, to covered service providers as a format to assist responsible plan fiduciaries with the required disclosures.”

We have heard that, based on the DOL’s review of 408(b)(2) disclosures, the Department has concluded that plan fiduciaries may, in some cases, have difficulty understanding the required disclosures because of the lengthy, technical and/or multiple disclosure documents that are being distributed. As a result, we believe that the proposed regulation may require a guide (or table of contents) for the 408(b)(2) disclosures.

The Sample Guide provided for the disclosure of information at a detailed level. For example, the Guide had references to page and section numbers in specific documents. For example, under indirect compensation, the Guide provided a number of categories, including one entitled “Compensation ABC will receive from other parties that are not related to ABC (‘indirect compensation’).” The Guide then referred to “Master Service Agreement §3.3, p. 4, and Stable Value Offering Agmt §3.1, p. 4.”

If the DOL’s proposed regulation is similar to the Guide—which it may be, and if, for example, a broker-dealer makes disclosures by delivery of prospectuses, that would require references to each of the mutual fund prospectuses, together with the section and page numbers where the description of 12b-1 fees and other compensation appear. Based on our experience, most covered service providers are not providing disclosures that are that detailed or specific.

In other words, this could be a big change, which could result in additional administrative work and expense.

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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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Limiting the 401(k) Finder’s Fee


General

Fred Reish was quoted in a New York Times article on June 21. The article, titled, “Limiting the 401(k) Finder’s Fee” takes a look into the fees behind employee’s 401(k)’s as they begin to replace pensions.

A series of lawsuits are making their way through the courts, which have raised questions about whether employees are being overcharged for their accounts. The lawsuits and new federal rules have helped bring fees down to a more reasonable level. While some employers have begun to adopt arrangements with less fees that more clearly separates what they are paying for, fees that workers pay can still vary widely and be hard to recognize or understand.

“It’s unfortunate that it took litigation to focus attention on costs, but it has,” said Fred.

The link to the article can be found on the Drinker Biddle website, here.

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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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GAO Report on IRA Rollovers


General

Periodically I will be posting information or materials from external resources, such as government agencies, that I think will be useful. This is the first of those posts. These materials will be linked on the blog to the “External Resources” page of the blog.

The GAO just issued a report on IRA rollovers. The title is: “401(k) PLANS: Labor and IRS Could Improve the Rollover Process for Participants.” You can find a copy of the 71-page report here.

While the GAO Report recommends a number of changes to improve the rollover process and experience for participants, it is remarkable for the comments that it makes about the IRA rollover services of some providers. For example, at one point, it states: “Plan participants are often subject to biased information and aggressive marketing of IRAs when seeking assistance and information regarding what to do with their 401(k) plan savings when they separate or have separated from employment with the plan sponsor. In many cases, such information and marketing comes from plan service providers.” Look at the portion of the linked report beginning on page 22.

Based on this report and on the response by the DOL, it seems almost certain that the fiduciary advice proposal (that is due in July 2013) will contain provisions that further regulate the IRA rollover process.

Fred Reish (fred.reish@dbr.com)

 

 

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