DOL Fiduciary Rule Set To Shake Up Retirement Marketplace

Myself along with a few others were interviewed last week by LifeHealthPro.com author, Lynn Brackpool Giles.  The topic of discussion on the table was the forthcoming Department of Labor's (DOL) Conflict of Interest Rule aka 'The Uniform Fiduciary Standard'.  Some of the main concerns expressed in the article by the author and those interviewed surrounded the onerous nature of complying with the new rules, the potential aggregate costs associated with advisor compliance and the potential impact, re: shake-up of the retirement plan landscape.  The article is linked here.
 
DOL Fiduciary Rule Set To Shake Up Retirement Marketplace



In addition to the thoughts that I expressed within the article, I thought I’d share some of what didn’t make it in.  Specifically, my opinion is that over time the industry and the advisors will absorb this highly onerous set of rules and a new “business as usual” will result.  We will see new retirement plan business models created. 

One such model that I’ve already started to see take hold is that of the ‘Retirement Plan Specialist’ partnering with unaffiliated non-specialist advisors, almost like an advisor “wholesaling” to another advisor.  These new independent specialists will be those that can run effective conflict-of-interest-free retirement plan practices at a profit without the need to work with individuals beyond the plan relationship.  If they partner with referring or non-affiliated wealth management advisors, a true symbiosis can occur and stay within the boundaries of the new rules.
 
Under this new model, the specialists will need to be scalable and efficient in their business practices, and their plans will need to be designed to be altruistic in nature favoring improving outcomes as the primary goal of the plans. There is nowhere better than Unified Trust in the industry at improving outcomes and we, as Discretionary Corporate Trustee and Named Plan Fiduciary are taking a large amount of the fiscal, investment and monetary burden off the shoulders of the plan sponsor and advisor.  In conclusion, our services enable the advisor to be highly scalable, allows the advisor and employer to demonstrate that their plan is actually driving better retirement readiness and as an added benefit, significantly reduces financial and fiduciary risk for all involved. 

 


-Jason Grantz

"The Government Does Not Do It Better" - Brian Graff, and he's dead on right about that!

Over the last few weeks I've been doing a bit of thinking regarding the state of the retirement plan industry, where it is now, where it's heading.  A lot of the noise that's out there right now seems to be centered around retirement plan litigation, mainly the spate of recent excessive fee lawsuits that have settled and the many more recently filed.  Further still is more negative energy and interest surrounding the forthcoming finalized rules for the Conflict of Interest Rule (aka the new fiduciary definition).  While these topics are important and certainly bear observation and reaction as they play out, to me, the biggest threat on the horizon is a bit closer to home, at the state level.

While the industry is looking left at all this fee and fiduciary stuff, the DOL was on the right, quietly creating a major threat to the private sector by giving a significant advantage to publicly offered (by the state.....so far) employer facilitated retirement plans.  This isn't new stuff, it's been percolating through the system for quite some time.  It gained steam, however, over the summer.  In May, Senate Democrats put pressure on the Obama administration to clarify some legal issues surrounding state run retirement programs.  In particular was whether or not these new programs would be covered by or run afoul of ERISA.  In July, the president responded directing the DOL to facilitate the implementation of state laws protecting the states.  Finally, on November 16th, the DOL released comprehensive guidance creating a road map to the creation of state-run private sector retirement programs that would have different (frankly better) rules than that of the private sector.  Many states have already started down the path to creating these.

These new rules have created a safe harbor for payroll deducted IRA programs run through the state without offering an equal safe harbor for the private sector.  It also allows for the states to proceed with creating an "Open MEP" type program while simultaneously not providing similar guidance for the private sector.  This will foster extreme competition to the private sector in the next few years from the states, and in my opinion, also opens the door for the federal government to follow suit with a national program similar to what was done with health care.  This is the real threat to the private sector retirement system, NOT the Conflict of Interest Rule which is mainly going to be an inconvenience that we'll all figure out how to work with. 

Brian Graff wrote a great piece on it in the latest Plan Consultant Magazine.  It's a MUST-READ for anyone in the industry.  It's linked here.

The Government Does Not Do It Better

- Jason Grantz

What’s in a name?

I received this great piece from a colleague of mine, Joe Reese, who kindly offered to post it on our blog.  Thanks Joe - Jason G.

Recently, we were competing for a law firm and were told by the Plan Sponsor that the insurance company service providers we were competing with “can assume being named the Plan Trustee.”  We are a discretionary plan trustee – it was clear the insurance company service providers were offering a directed trustee solution. While a discretionary trustee and a directed trustee are both trustees and both fiduciaries, they are not one in the same. 

After days of back and forth, reviewing documents, etc. the law firm requested 3rd party information highlighting the difference between a discretionary trustee and directed trustee. The following was our response.

First, some context…

ERISA Section 402(a) provides that a written plan document must include one or more ‘‘named fiduciaries’’ who control and manage the plan’s operation and ad-ministration. ERISA Section 403(a) states that plan assets generally are held in trust, managed by trustees either named in the trust instrument or appointed by the plan’s named fiduciary. Trustees typically have authority to manage and control plan assets unless the plan expressly provides that the trustees are subject to the direction of the named fiduciary or delegates such authority to an investment manager.

Then in the DOL’s own words…

DOL Field Assistance Bulletin 2004-3: Fiduciary Responsibilities of Directed Trustees

http://www.dol.gov/ebsa/regs/fab_2004-3.html

Here are a couple key parts of the above Field Assistance Bulletin:

• The duties of a directed trustee under section 403(a)(1) are therefore significantly narrower than the duties generally ascribed to a discretionary trustee under common law trust principles.
• The named fiduciary has primary responsibility for determining the prudence of a particular transaction, whether the transaction involves buying, selling or holding particular assets. Accordingly, as the courts and the Department have long recognized, the scope of a directed trustee’s responsibility is significantly limited. A directed trustee does not, in the view of the Department, have an independent obligation to determine the prudence of every transaction. The directed trustee does not have an obligation to duplicate or second-guess the work of the plan fiduciaries that have discretionary authority over the management of plan assets and does not have a direct obligation to determine the prudence of a transaction.  See In re WorldCom ERISA Litig., 263 F. Supp. 2d at 761;  Herman v. NationsBank Trust Co., 126 F.3d at 1361-62, 1371 (directed trustee does not have a direct obligation of prudence under ERISA section 404; its obligation is simply “to make sure” the “directions were proper, in accordance with the terms of the plan, and not contrary to ERISA”).

And finally, Case Law…

Federal courts have typically held that a retirement plan’s directed trustee can’t be held liable if it followed the investment directions of the plan’s named fiduciary. Below is a summary of cases dealing with directed trustee liability.

Renfro v. Unisys Corp., 671 F. 3d 314 - Court of Appeals, 3rd Circuit 2011

“Fidelity's limited role as a directed trustee, delineated in the trust agreement, does not encompass the activities alleged as a breach of fiduciary duty—the selection and maintenance of the mix and range of investment options included in the plan.”

“As we have explained, a directed trustee is essentially "immune from judicial inquiry" because it lacks discretion, taking instructions from the plan that it is required to follow.”  

Fidelity maintained that it was not a fiduciary with respect to the conduct constituting the alleged fiduciary breach. The trial court granted Fidelity's motion to dismiss, ruling that Fidelity and its related entities were not fiduciaries with respect to the challenged conduct because they did not exercise control over the selection and inclusion of investment options in the plan.

Tussey v. ABB, Inc., Case 2:06-CV-04305, 2010 Document 103

“By the plain language of the Trust Agreement, Fidelity Trust has no responsibility for reviewing the merits of fund choices made by the Pension Review Committee. 

Thus, Fidelity Trust had no responsibility to prevent the addition of the Fidelity Freedom Funds to the Plan’s investment line-up.  For these reasons, the Court finds that Fidelity Trust cannot be held liable for ABB’s breaches under ERISA Section 405(a)(2).” 

Fidelity’s reaction to the Tussey v. ABB court’s decision regarding Fidelity not being responsible as a directed trustee:  “We are pleased with the decision today by the court of appeals,” Vincent Loporchio, a Fidelity spokesman wrote in an email. “Fidelity’s actions were in all respects consistent with our fiduciary duties to our clients and all legal requirements. With this decision on appeal, Fidelity has prevailed on all claims asserted against it in court.” 

In re Cardinal Health Inc. ERISA Litigation, S.D. Ohio, No. C2-04-643, 3/31/06

The US District Court for the Southern District of Ohio dismissed a claim against Putnam Fiduciary Trust Co. as directed trustee of Cardinal Health employees' retirement plan in a case involving company stock investments.  The court found that Putnam was a directed trustee with limited fiduciary duties. The judge also refused to dismiss the employees' claim that some of the Cardinal Health defendants breached their ERISA fiduciary duties by failing to monitor those they had appointed to act as plan fiduciaries, and said Cardinal Health may be liable under the doctrine of respondeat superior for its board of directors' failure to monitor those they appointed to act as plan fiduciaries.

Donovan v. Cunningham14 (S.D. Texas 1982)

This early case briefly discussed the ‘‘limited role’’ of the directed trustee. The court noted that a directed trustee couldn’t be liable for breach of fiduciary duty where its activities ‘‘at all times remained within the limited role of a directed trustee.’’

Maniace v. Commerce Bank of Kansas City18 (8th Cir. 1994)

The Eighth Circuit ruled that a bank serving as directed trustee of an ESOP didn’t violate its fiduciary duties in allowing the plan to continue to hold large amounts of employer stock despite the stock’s declining value. The court found that, as a directed trustee, the bank wasn’t an ERISA fiduciary with respect to employer stock held by the ESOP because it lacked discretion over plan assets. According to the court, ‘‘the obligations of a directed trustee are something less than that owed by typical fiduciaries.’’

Grindstaff v. Green20 (6th Cir. 1998)

The Sixth Circuit ruled that a directed trustee isn’t a fiduciary to the extent it doesn’t control the management or disposition of plan assets. The court rejected ESOP participants’ claim that the ESOP’s directed trustee had a duty to investigate the merits of any directives given to it by the plan’s named fiduciary. The court noted that the trustee had no discretion pertaining to voting the ESOP stock and could only act at the direction of the named fiduciary.

In re McKesson HBOC Inc. ERISA Litigation21 (N.D. Cal. 2002)

A California federal district court dismissed ESOP participants’ claim that the plan’s directed trustee breached its ERISA fiduciary duties by allowing plan fiduciaries to continue to invest in employer stock when it allegedly knew that such an investment was imprudent. The court found that as a directed trustee, the trustee was obligated to follow the investment instructions given by the named fiduciaries and thus couldn’t be held liable for any losses that resulted from performance of its duty to follow those instructions. The court noted in a footnote, however, that if the participants could demonstrate that the trustee knew that the investment directives violated ERISA, then the trustee wouldn’t be relieved of ERISA liability by following such imprudent directives.

Lalonde v. Textron Inc.22 (D. R.I. 2003)

In this case, the district court dismissed ESOP participants’ claim that the plan’s directed trustee breached its fiduciary duties by not rejecting the named fiduciary’s directive to invest in the plan sponsor’s stock. The court found that the directed trustee had no discretionary authority, and hence no fiduciary status. The First Circuit subsequently upheld the district court’s decision after concluding that, even if it were to assume that the trustee wasn’t a true directed trustee, there was nothing in the participants’ complaint that would permit an inference that the trustee abused any discretion it might have had.

Yes, discretionary trustees and directed trustees are both fiduciaries, and trustees…but the role they play are not the same. A Plan Sponsor who confuses the two does so at his or her own peril.

Generation Lost: Millenials and how to best serve them regarding Retirement

 A colleague of mine, Lee Topley, forwarded this to me with some interesting thoughts.  I felt it good a good idea to share those here.  Full Disclosure: this post references a service my firm, Unified Trust provides called The UnifiedPlan (UP), a managed account service engineered specifically for 401(k) plans.

A client of ours recently inquired with us about how to communicate to Millennials.  See this linked white paper that was done by BNY Mellon on this group.  Generation Lost: Millennials and Finance Several of their key findings are below, and some thoughts on how we can impact 3 of the 4 summary findings.

Findings:

1. Millennials have little understanding of just how big a task they face in providing for their retirement.  This lack of knowledge is not due to a lack of interest.  Rather they feel they have not been told the reality of their situation.  The UP tells them exactly where they are (they don’t have to ask, we automatically give it to them)…they are in the Green (on track) or in the Red (underfunded)…and how much they have to save to become green if they are red.  Plus, the UP provides all types of flexibility to customize their solution if they want to re-model different scenarios.
2. Most Millennials want financial services providers to be brutally honest with them about the bleak future they will face if they do nothing to build an adequate retirement income.  They want financial service providers to use more shocking messaging and to speak to them in language they understand.  The above response…Red versus Green is pretty frank on a participant's statement.  In addition if we use pointed communications focusing on the impact of greater savings, this would be the direct style that millennials are looking for. 
3. Social Finance has a very strong appeal to Millennials, yet they do not feel that adequate impact oriented investment are accessible.  This is the one area that we aren't totally in sync on.  I wonder about this part of their concern.  Socially Responsible funds could be added, but due to prudence, would not be part of the glide paths.  So we could help here, but will this really help them achieve an adequate benefit at retirement or just make them feel better about how their money is invested?  This is the one finding that I think the UP doesn’t automatically cover. 
4. Millennials feel today’s financial services products are not tailored to their needs.  They want new products to dovetail with the paths their lives are likely to take, not those of their parents.  Later in this paper the findings relate to the ability to access the money for buying a house, an illness, etc., so they may not be completely understanding the tax deferred aspect of their 401(k) money.  However, the plan can be set-up so they have access if the sponsor chooses to do so.

 Shortly after the summary on page 1 it states:

“These findings paint a picture of a generation that is ignorant of financial matters because it is being ignored. It is a generation that wants financial services providers to tell the truth”  A named Plan Fiduciary is bound by law to tell the truth and to always have their best interest as the #1 goal.

I found this dialogue interesting, and maybe gives the reader a little look under the hood at what professional fiduciaries are thinking about when discussing internally how to best serve clients.  

- Jason Grantz

Mailbag; What about Hedge Fund companies using their own hedge funds in their own 401(k) Plan?

Occasionally, we will receive a reader question that requires a little digging into.  When we get one like this, we feel like we should put it up for all to see.

Question from Steve: We have a client who is the CFO of a Hedge Fund company.  100% of their employer match is being automatically put into their own hedge fund.  We believe that this presents a real fiduciary risk for our client, but I was hoping you could site a lawsuit or DOL guidance?

Our Response:  Steve, there are several situations that I think apply to this directly, and specifically with regard to hedge funds.  The first issue is a recent case, Sulyma vs. Intel; reference article here Former Employee Sues Intel Over Hedge Fund.  This lawsuit is ongoing and only alleges imprudent investing in hedge funds meaning that it does not allege a conflict of interest which would be a violation of duty of loyalty to the participants (ERISA §404(a)).  I believe your group would have both the imprudent investing problem as well as a conflict of interest; a possible Self-Dealing violation of ERISA §406(b). So they would be potentially violating two sections of ERISA §404(a) and have a non-exempt Prohibited Transaction under §406(b)(2).

ERISA § 404(a)(1) to act solely in the interest of the participants and beneficiaries of the plans they serve and “(A) for the exclusive purpose of: (i) providing benefits to participants and their beneficiaries; and (ii) defraying reasonable expenses of administering the plan” and (B) to discharge their duties “with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.”

In the Intel lawsuit it almost implies that a plan can never invest outside of the current norm (Modern Portfolio Theory, “normal” asset classes, etc.).  So the question is: “How does innovation occur in the prudent world of ERISA plans?”  This is something the industry will have to address at some point.

I also wanted to dig into whether or not there would/could be a Prohibited Transaction Exemption (PTE) for this.  For example, there are PTEs for mutual fund companies selecting their own funds for their employees 401(k) Plan.  Actually American Express tried to cite this PTE when they were sued a few years ago by their employees and when ruled they didn't meet the PTE, Amex settled the case for $15m.  Not to be too technical here but I don't think many of the PT exemptions (listed below) are going to be available to this group.  As mentioned, there is, in fact, a DOL opinion that deals with mutual funds, but, because the hedge fund is specifically not a registered investment company under the Investment Company Act of 1940, I believe they have much less room to act.

The potential conflicts of interest that could arise are numerous.  Here’s just a few.  Are they receiving any fees? Are the plan assets giving them some kind of economy of scale? Are the plan assets used as seed money for a new fund?  Here is full piece on the matter published by Groom Law Group, but the excerpt I clipped out below is what’s applicable.  See the yellow highlighted area.

http://www.groom.com/media/publication/145_erisa_for_security.pdf

Investing Plan Assets in Proprietary Mutual Funds. To the extent that a plan fiduciary also serves as investment adviser to a registered, open-end investment company, the fiduciary’s investment of plan assets in the mutual fund may involve one or more fiduciary conflicts. PTE 77-4 (for client plans) and PTE 77-3 (for the fiduciary’s own, in-house, plans) provide relief for such investments provided that certain conditions are satisfied, including disclosure and consent, and taking steps to avoid double fees. Similar relief is granted under PTE 79-13 for in-house plans of closed-end investment companies (but not for client plans, which effectively prevents most registered hedge fund managers from relying on these exemptions). PTE 84-24 also exempts, among other things, a plan’s investment in a mutual fund where the fund’s adviser or principal underwriter is also a directed trustee, prototype plan sponsor, or other service provider with respect to a plan (but not a discretionary investment manager or trustee, nor the plan sponsor), where an

affiliate of the fund’s adviser or principal underwriter will receive a sales commission with respect to the transaction. For this purpose, sales commissions generally include 12b-1 distribution fees. The PTE does not explicitly authorize the receipt of fund-level advisory and other fees (in contrast to PTEs 77-3 and 77-4), though it appears to do so implicitly. (Note that PTE 84-24 is not limited to the marketing of proprietary funds, though it is often used for that purpose.)

Steve, thank you for the excellent question and the chance to flex our research muscles.

- Jason Grantz

 

Retirement Income Options - In Plan vs. Out of Plan, Revisited

 In a recent post on NAPA.net, author Nevin Adams posited five reasons why Retirement Plan Sponsors aren't offering retirement income options inside the plan.  Link to article here:

5 Reasons Why More Plans Don't Offer Retirement Income Options

The reasons offered are:

1. There is no legal requirement to provide a lifetime income option.
2. The safe harbor for selecting an annuity provider doesn’t feel very “safe.”
3. Operational and cost concerns linger.
4. Participants don’t take advantage of the option when offered.
5. Participants aren’t asking for it. 

I think that this is an interesting take.  If no one is asking for it, it isn't required and when offered isn't used, that's a pretty good way of saying that there isn't any demand.  So if no demand, logically why would one supply.  But I think there's a bigger issue which is in Item #3.

Even with the Safe Harbor of offering an annuity option in a plan, many (most?) in-plan solutions are quite expensive.  Since we are in an era of fee compression, or as I call it the race to zero.  Putting an expensive option into a plan seems like a bad idea, especially when income solutions are readily available post retirement outside of the plan.  The other issue has to do with portability concerns which there are various different types that come into play making these types of investments dangerous to put into plans.

Dr. Greg Kasten and I tackled this issue in a Journal of Compensation and Benefits piece back in 2013 titled 'Retirement Income - In-Plan vs. Out-of-Plan Solutions, Which is Better?'.  At the conclusion of our piece, it was determined that until this marketplace matures and all practical, fiduciary and operational issues are resolved (not to mention cost), the right format to utilize retirement income products is outside of the plan sponsored retirement plan.

- Jason Grantz

   

New COLA for 2016 - Err, there is NO COLA since there was no increase in the index

The IRS has now announced the qualified plan limitations for 2016. These limitations are determined based on annual increases in the cost of living index. Because there was no increase in the index, plan limits will remain the same as in 2015.

Staying the same in 2016 (not all, but main limits of interest):

• The maximum annual benefit payable from a defined benefit plan remains at $210,000.
• The 401(k) deferral limit will remain at $18,000.
• The catch-up contribution for participants who have attained age 50 will remain at $6,000.
• The compensation-based definition of highly compensated employee (HCE) will remain at $120,000.  Thus, an employee who earns more than $120,000 in 2015 will be deemed an HCE in 2016.
• The maximum amount of compensation taken into account for plan purposes will remain at $265,000.
• The maximum amount that can be contributed by and for a participant to a defined contribution plan (i.e. profit sharing or 401(k) plan) remains at $53,000 (this amount does not include catch-up contributions).

In addition, the Social Security taxable wage base will remain at $118,500.

- Jason