Another Perspective on the Shifting 401(k) Landscape
Barstein: Representatives of large plans are more sophisticated and knowledgeable buyers.
Size is not indicative of sophistication or knowledge and to presume that a buyer is more knowledgeable or more sophisticated when they represent a large plan is inconclusive. In fact, the only reliable observation we can make about large retirement plans is that economies of scale do apply. However, while it is true that large plans may pay a lower cost per unit or a lower cost for managing a larger pool of plan assets it is not consistent across all large plans. For example, many of the largest plans use retail mutual funds in their 401(k) plan no differently than small plans at the same price point. If a fiduciary of a large plan was more sophisticated you would think the fiduciary would hire investment managers to manage a pool of plan assets under a collective investment trust structure at a lower negotiated management fee.
Furthermore, if fiduciaries of a large plan have any advantage over small plans it is the deeper pockets they can draw from for capital resources to retain outside experts. However, this assumes the fiduciaries have the freedom to access those resources to acquire qualified independent expert support. Of course, if size matters, then how do we justify the failures of ENRON, Worldcom, and Arthur Anderson? Bottom line: fiduciaries of small plans can be just as sophisticated and just as knowledgeable as fiduciaries who serve large plans even though fiduciaries of smaller plans may pay a higher unit price or management fee for the same services.
Barstein: The cost of the broker overseeing the plan IS NOT included in the cost of the mutual fund.
This comment is problematic since it requires you to make an assumption as to its application. At first blush, as stated above, why would a large plan use a mutual fund with a pricing structure that is no different than the pricing structure for a small plan? This, of course, assumes no revenue sharing of any type and no administrative, advisory, or broker expense deducted from a participant's individual account. This may be what Fred is referencing.
On the other hand, this comment may be intended to communicate something different. For example, small plans typically use a broker, paid by commission, which is normally built into the mutual fund's operating expense ratio in the form of a 12b-1 fee. On the other end of the spectrum, the largest plans typically do not retain a broker unless it is a traditional broker processing buy and sell transactions for a pool of plan assets. However, large plans are known to retain an investment advisor that charges a flat fee or a percentage of the assets for investment consulting and advisory services. Of course, there are those large bundled service providers who solicit "direct business" in the large plan market. Many of those bundled providers will also provide investment advisory services as part of the package without formally accepting fiduciary liability for their investment research, recommendations, and ratings. This investment advice is provided to the client on an ongoing basis for both proprietary and non-proprietary investment options. In this scenario, there are no direct broker fees or commissions paid but the inherent conflict of interest is self-serving when offering research and recommendations on proprietary and non-proprietary funds where indirect and undisclosed revenue can be captured. This type of activity puts the plan in jeopardy of participating in a prohibited transaction.
Barstein: Smaller plans have higher distribution costs, whereas larger plans are easier to administer, service and sell.
Why would a plan with 15,000 participants be easier to administer than a plan with 15 participants. The easiest plan I ever administered, in my days as a Third Party Administrator, was a one person plan and the same applies to servicing and selling that plan. It takes less time to run compliance testing, calculate contributions, and even print reports for a small plan. At the same time, my one person plan had the highest per unit cost. Regardless of the technology used, the larger the plan the more time it takes to check your work but it is not proportional. In other words, it does not take ten times the amount of time to do a ten participant plan as it does a one person plan. There are economies in time associated with larger plans but that does not make them easier to administer or service.
With regard to distribution or marketing expense, the cost to sell and design the plan is the same regardless of the number of participants as long as you are dealing with one decision maker. However, as the company structure moves from closely held to publicly-traded the distribution costs increase. Although there are exceptions, the fact is, a large plan has a higher acquisition cost but that cost is spread over a larger universe of participants so that the cost per participant is less than it would be for a small plan.
Barstein: However, the record-keepers that service smaller 401k plans are sweating-- especially if the courts ultimately determine they are fiduciaries.
Many third party administrators (TPA) provide more than just recordkeeping services. It is when a TPA or any service provider positions itself as a source of investment advice that they can become a fiduciary. The guidelines for defining an investment advisor fiduciary are found in 29 C.F.R. § 2510.3-21(c). If a recordkeeper is delivering services to a plan sponsor as outlined in this regulation that recordkeeper becomes a functional fiduciary. Becoming a fiduciary is not prohibited but it does impose additional requirements and care to avoid conflicts of interest and self-dealing which can become the basis for a prohibited transaction. Bottom line, any one determined to be a fiduciary, regardless of size, should sweat if they are a fiduciary because the fiduciary obligations under ERISA are the highest known to law.
Barstein: Smaller plans are not in the crosshairs of the lawyers because there's not enough money involved
This has changed since the Supreme Court issued its opinion in LaRue and the DOL issued the proposed 408(b)(2) regulations. Although prior to these two events, plaintiff attorneys have had a growing interest in the prospect of suing small plan sponsors and service providers for fiduciary breaches according to my research. Let me explain. The statistics indicate the majority of the retirement plans in existence are small plans. With over 400,000 401(k) plans filing the annual IRS 5500 form, it seems logical to assume that the majority of those plans, once all the publicly traded companies that sponsor a 401(k) are ignored, are sponsored by small companies. In addition, we know that small plans lack the economies of scale; therefore, they pay more per unit cost than large plans. This assumption is supported by numerous articles, studies, and reports that indicate that smaller plans have a higher plan expense than large plans. This is a fact that I can attest to after living in a small town for thirteen years. It is also my experience that small plans in small towns are more likely to breach their fiduciary responsibility and engage in a prohibited transaction. Quite frankly, the small plan market is ripe for litigation and the service providers and advisers that serve that market are equally vulnerable. Law practices, in small towns, across America have a target rich environment available in their back yard. The relative benefit to a participant is small but meaningful and the plaintiff attorney stands to reap a substantial pay day for his or her efforts especially with the courts poised to award reasonable attorney's fees and costs according to ERISA 502(g)(1) regardless of the size of the claim. Bottom line, small plans, where the excess fee claim is most egregious, their service providers, and advisers are definitely in the crosshairs of the plaintiff bar.
Barstein: Small-to-mid size plans are not 404c compliant because they haven't disclosed all that is required under the safe harbor
Section 404(c) is not a safe harbor. The DOL has defined § 404(c) as "STATUTORY RELIEF" which is "earned" not "promised." The DOL made this clear in the Preamble which states, "As was the case with the 1987 proposal, a number of commentators on the 1991 proposal suggested that the Department adopt the regulation as a "safe harbor". After due consideration, the Department has decided not to adopt this suggestion, non-compliance merely results in the plan not being accorded the statutory relief described in § 404(c)." [See preamble to final regulation 57 Fed. Reg. 46907 (Oct. 13, 1992)] If a plan sponsor desires statutory protection for participant investment decisions, § 404(c) must be comprehensively adopted. It is an all or none proposition.
Barstein: A plan sponsor can fulfill its fiduciary responsibility to participants without being 404c compliant.
To meet the general fiduciary requirements of ERISA § 404 a fiduciary must act in the best interest of the participant and may defray reasonable expenses from plan assets. In addition, a fiduciary is obligated to provide a diversified portfolio to minimize the risk of large losses and to select and monitor those investment alternatives to ensure they are prudent. The general fiduciary requirements are not options they are obligations. On the other hand, compliance with § 404(c) is voluntary because § 404(c) protects the plan sponsor not the plan participant. The plan sponsor that chooses to ignore the § 404(c) fiduciary relief is playing Russian roulette with their personal and the plan sponsor's assets. Bottom line, compliance with the general fiduciary obligations is not a defense for participant losses.
Barstein: In my opinion, a lot of the disclosure requirements are unnecessary. Commonsense should be your guide.
Unfortunately, commonsense has never provided a fiduciary a reliable defense. Furthermore, when it comes to disclosure, the opinions that matter are Congress and the Courts. From the perspective of Congress, House Report No 93-533 (Oct. 2, 1973) provides two particular positions worth repeating.
"It was expected that the information disclosed would enable employees to police their plans." At the same time, the safeguarding effect of the fiduciary responsibility section will operate efficiently only if fiduciaries are aware that the details of their dealings will be open to inspection, and that individual participants and beneficiaries will be armed with enough information to enforce their own rights as well as the obligations owned by the fiduciary to the plan in general.
Section 404(c), as an example, provides relief conditioned upon meeting "all" the requirements. It is the only statutory relief provided for participant investment decisions. To secure the relief, participants must receive sufficient information (as described in the regulations) to make an informed decision. However, it is not a requirement unless you seek the protection § 404(c) affords.
Barstein: The requirement of physical delivery of a paper prospectus is not in keeping with the modern digital age.
In keeping with the modern digital age, the Department of Labor (DOL) published a notice on January 28, 1999 of proposed rulemaking and a request for public comment on electronic disclosure and recordkeeping issues (64 FR 4506). Shortly thereafter, on April 9, 2002, the DOL finalized their position by amending 29 CFR § 2520 of the regulations adopting the final "Rules Relating to Use of Electronic Communication and Recordkeeping Technologies by Employee Pension and Welfare Benefit Plans" covered by Title I of ERISA. This means that all plan sponsors now have a "safe harbor" provision under 29 C.F.R. § 2520.104(b)-1, for example, to secure fiduciary relief under § 404(c) using electronic media. Unfortunately, is it rare to find a plan sponsor or service provider that is familiar with or has adopted the safe harbor requirements promulgated in the regulation. As a result, most rely heavily on electronic communications but fail to comply with the safe harbor which causes the plan to fail to secure § 404(c) relief.
Barstein: I believe we need to make this simpler for participants. Too much disclosure will only confuse investors.
This position has been widely promoted by many plan sponsors, the associations representing plan sponsors, and service providers. However, what this statement infers is that participants are incapable of understanding the fees charged against their 401(k) account balance. How can it be that a participant is fully capable of understanding the structure of various mortgage arrangements when purchasing a home, or deciding whether it is better to lease or buy a car, or evaluating the terms, conditions and fees for credit cards or bank services yet they are incapable of understanding the fees charged to their 401(k) account balance? On the contrary, I believe plan sponsors need to adhere to the spirit of ERISA and exceed the current disclosure requirements to ensure participants have no excuse for their decisions. To argue in court that I did not give the participants information because I thought it would confuse them can easily turn into a position that assumes the participants are too stupid to understand. This is a dangerous assumption. Instead, it is much safer to argue that the plan sponsor gave participants everything required plus additional information the fiduciary felt was material so that participants could make informed decisions. It is an approach of evidence versus opinion.
Barstein: I don't believe lawsuits will be brought in the area of conflicts of interest because there are bigger targets out there.
A fiduciary is obligated to act in the best interest of the participants. To make a decision that compromises this legal obligation is in conflict with the interests of the participants that the fiduciary is required to protect. In essence, the best approach for a fiduciary is to avoid any action that can even be remotely argued it benefits the plan sponsor or the fiduciary. A fiduciary should analyze every decision to determine if a conflict of interest has or could occur. Only decisions that are clearly in the best interests of the participants should be made. When a fiduciary suspects a decision could be perceived as a conflict, the fiduciary should seek a written legal opinion for the file. It is cheap insurance and an exercise of prudence to seek legal counsel in questions of fiduciary obligations. However, there should be no doubt that every fiduciary breach claim filed against a plan sponsor or service provider will attempt to tie any perceived conflicts to the claim. Finally, the issue of "conflicts of interest" is clearly a concern as it is reflected in the proposed § 408(b)(2) regulations.
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