Crypto in Retirement Plans? Come on…..

  They say that if you follow the history of baseball that it reflects what’s happening in America.  It’s funny, no one ever says anything like that about the retirement plan industry, but then again, most people don’t even know that retirement plans are an industry! I can make a case that retirement plans do, in fact, have a broader tie in to what’s happening in the country at large. Today, we have more women and minorities working in our space and many industry groups have formed to promote equality in our industry. Similarly, just as Environmental and Social change have become forefront, ESG funds have also become topical in retirement plans. So, like baseball, retirement plans can also be used as a mirror reflection of what’s happening in the country around us.

 

If the above is my thesis, the next part is another example which is Cryptocurrency (Crypto) in retirement plans???  So, yes, just as Bitcoin and all the other varieties are becoming more and more mainstream, naturally, people who view these as investable opportunities want them to be available where their money is, which for a lot of people is in retirement plans. Within the last few years, there has been a small number of very noisy providers responding to this demand which has now “forced” the Employee Benefits Security Administration (EBSA), an agency inside of the Department of Labor to take a position on Crypto as a potential investment for retirement plans. The result, Compliance Assistance Release 2022-01 in March of this year.

The reader can read all about it in the above link.  If we had to summarize what we see in this C.A.R. it’s basically a cautionary release. There’s not a lot of new ideas in there. EBSA Deputy Assistant Secretary for Program Operations, Tim Hauser has stated publicly that the release is more about the way these types of investments are being marketed, “I mean the thing that that most concerned us was, you know, fairly aggressive marketing...…of these investments to 401K plans at this moment”.

                

Aggressive Marketers Beware!!!!

It is also reminding Plan Sponsors of one of the primary fiduciary duties, the Prudent Person Rule of ERISA. In his interview with Brian Graff, CEO of the American Retirement Association on June 22, 2022, he reiterated that the obligation of Prudence is a Plan Fiduciaries job and that fiduciaries will need to be prepared to justify any decision to include Crypto in a plan saying “I think it is fair to say that as time goes by I would expect telling people that the issue are Prudence in this and this context is very very real and you need to take it very seriously and think hard about what you're doing here. That means, full analysis weighing all risks such as volatility, recordkeeping concerns and more."

This issue of prudence is very real and like in any other investment decision dealing with retirement plan assets, there isn’t an actual specific set of rules on what will pass muster and what won’t. It’s all facts and circumstances based. This is no different than what they’ve said previously with other “newer” investment ideas such as Private Equity. So, the question for plan fiduciaries is whether participant demand will be sufficient to consider using these funds and then, whether a prudent analysis of Crypto as a potential investment will yield a decision to add them to the plan and then, of course which one??

Let’s not forget that the prudent selection is not a one-time decision, the duty to monitor would also hold. Final thought, plan sponsors may choose to “punt” this plan decision by stewarding participants to use a Self-Directed Brokerage Account (SDBA) as the place to buy these instruments. However, a note of caution here as well. EBSA’s Field Assistance Bulletin 2012 - 02r says that SDBAs are still subject to ERISA 402(a)’s Fiduciary Standard’s of care. This means that the SDBA provider needs to be prudently selected and reasonable boundaries need to be built into the provider to restrict access to imprudent investments (ex. Municipal Securities, Level 2 options, etc.).

OUR TAKE: Over time Crypto may prove to be a viable new asset class OR it may prove to be a fad. I’ve even heard notions of Crypto or its’ underlying technology, blockchain technology, becoming a utility. However, it’s got a lot of uncertainty surrounding it and we would have a very difficult time as plan fiduciaries ourselves in advising a client that they’d be prudent to add to a menu of choices offered in a 401(k) Plan. If you have thoughts on this piece or want to discuss the topic further, please reach out to us! 

 

 

 

 

 

 

 

Jason Grantz is the Managing Director of Institutional Retirement Plans at Integrated Pension Specialists and a Retirement Plan Specialist at Integrated Wealth Concepts.  He can be reached at (978) 847-0140 ext. 820.

The Fiduciary Rule: Intentions vs. Results

I was recently contacted by Christopher Carosa of FiduicaryNews.com who was looking for insights on the recently released Department of Labor (DOL) Conflict of Interest Regulations.  I found it particularly interesting that his questions regarding the rule weren’t so much mechanical in nature, meaning how it will work, but rather whether or not the rule will have the desired impact.  More specifically, he wanted to know whether it would actually prevent conflicts of interest or allow conflicts of interest to  persist. 

To see the full  dialogue as well as thoughts from other industry professionals, click here:  http://www.fiduciarynews.com/2016/05/dol-fiduciary-rules-conflict-of-interest-split-personality/

Outside of the article, Chris was also interested in how retirement savers can be more aware of potential conflicts of interest.  I identified three questions they could ask their current or potential service provider to hopefully help ensure that conflicts of interest are being properly disclosed or mitigated entirely.

1. Do you (advisor or service provider) charge fees in a level manner neutral of any investment advice or recommendations you might make?
2. Do you have any formal or informal arrangements with any investment product or product manufacturer that would create a bias in the advice you give me?
3. Will you provide a simple summary that clearly defines all fees, services and investment recommendations in a format that is easily comprehendible?

A recommended best practice would be to have the service provider respond to these questions in writing so that it’s fully documented and the service provider can be held accountable.   My firm, Unified Trust has always operated as a fiduciary and taken a no conflict-of-interest approach.  Our strong fiduciary governance process focuses on improving the results and outcomes for our participant clients. 

However, the reality is that we are very different in the industry, and there are service providers in the industry who will continue to do business in a conflicted manner.  They will need to be prepared to be up front about any potentially inappropriate conflicts-of-interest that they might have.

It may be wishful thinking, but wouldn’t it be great if the industry took a different approach to the one taken when the fee disclosure rules came out?  Instead of being opaque and doing the minimum to comply, this time make clarity a priority, be direct with clients and do more than the minimum.

The DOL Conflict of Interest Rule is finally here! Some implications....

Implications of the Fiduciary Rule  After months of anticipation and years of debate, the Department of Labor (DOL) “Conflict of Interest Rule” has finally been released.  During the proposal process, the DOL fielded over 400,000 comments, some of which were in opposition to the rule while others were seeking clarification to specific areas within the rule.  The one thing there is little debate about is the intent of the rule.  There may be arguments around the government’s role in this process, or the nuances of what constitutes investment advice, but how do you argue that a rule requiring the industry to act in the best interest of their clients is a bad thing? It will likely take weeks, if not months, to fully dissect and understand the scope of the new fiduciary rule and how the landscape will change as it is phased into implementation.  Here are a few of my initial interpretations and what I think the potential implications are.    Potential Impact on Financial Advisors The registered investment advisors (RIAs) that have already been acting in a fiduciary capacity just saw their marketplace get considerably more crowded.  With the vast majority of advisors now being considered fiduciaries, RIAs will be forced to adjust their value proposition to distinguish themselves amongst their competitors.  My opinion is that the most impactful point of differentiation will be to not only improve outcomes for participants but to quantify those outcomes for the plan sponsors and retirement plan committees. Some broker-dealer registered reps may need to utilize the ‘education carve-out’ to limit or avoid fiduciary status.  However, the carve-out is going to be narrower than it previously was (per DOL Interpretive Bulletin 96-1) and the education provided under this approach will be limited and may be considered unsatisfactory to many plans.  Registered reps who wish to stay in the retirement plan industry using the education carve-out may ultimately need to rely on a very strong fiduciary partner to do so (a view shared by notable fiduciary expert Fred Reish in a recent blog post as an evolving “common solution” for 401k-focused registered reps in the wake of the new fiduciary rule). Potential Impact on Advisory Fees In recent years, fees have been compressing as a result of the DOL’s fee disclosure initiatives and the increasingly competitive nature of the marketplace—something that is expected to accelerate under the new fiduciary definition rule.  It’s also highly likely we’ll see increased litigation over the matter.   However, we don’t believe that there will be a bright-line test on fee reasonableness.  It’s not necessarily about the fee but rather what is being done to earn the fee.  For that reason we believe that an advisor’s business model will need to include greater fee transparency, a prudent documentation and monitoring process, and the ability to quantify participant level outcomes.  Advisors that can accomplish this will be in a better position to justify their fees and differentiate their services in a fiduciary environment where everyone is essentially viewed as an equal. Potential Impact on Compliance Compliance complexity and oversight will greatly increase.  For example, testimony to the DOL indicated in the first year the rule goes into effect financial institutions will have to produce more than 86 million written disclosures and notices.  This does not come without a cost.  Who will pay for this? Potential Impact on Vendors Many major vendors will be exempt from the fiduciary rule or attempt to structure relationships to avoid fiduciary status under the rule.  This means litigation that develops may be between the plan sponsor and the advisor since the vendors may not be a fiduciary—that is unless you are working with a vendor that is willing to accept fiduciary status such as my firm, Unified Trust who not only is willing to accept fiduciary status, we sign on as discretionary trustee, and thus a named plan fiduciary, in the plan document for every plan on our platform. The DOL Conflict of Interest Rule will no doubt have a sizable impact on the industry.  The extent of that impact will unfold over the coming months and years.  We do firmly believe that it will increase the need to have a fiduciary process that is not only accurate but also automated and algorithm-based.  In other words, it won’t be enough to say you’re a fiduciary, rather you will need to show prudent fiduciary processes are in place and in the best interest of the investor.  - Jason Grantz, QPA, AIFA

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

 

2014 ERISA settlements top $1.3 billion

The largest class-action settlements in claims brought under the Employee Income Retirement Security Act topped $1.3 billion in 2014, almost 10 times the sum of the biggest settlements from the previous year.

No other area of employment workplace law saw that kind of explosive growth last year. In fact, settlement numbers in other areas of workplace class-action claims were down, according to the 2015 Workplace Class Action Litigation Report, published by Seyfarth Shaw, a Chicago-based law firm.

The settlement figures for the biggest ERISA cases were higher in 2014 than at any other time in recent history. In 2011, sponsors settled nearly $900 million in the largest cases, the only time since 2009 when the figures were remotely close to last year’s record numbers.

Settlement figures for other areas of labor law paled in comparison: $215 million was settled in wage and hour class-actions, and about $228 million in employee discrimination cases.

By the close of 2014, ERISA lawsuits totaled 7,163, down marginally from 2013. Several “mega-settlements” pushed the ERISA tab for the 10 largest settlements beyond the billion-dollar mark. Among them: 

In August 2014, a $480 million settlement was reached in Meyers vs. Daimier Trucks North America LLC, in a class-action filed by retired UAW workers alleging the truck manufacturer illegally cut benefits. 

The next month, a $415 million settlement was approved in Healthcare Strategies Inc. vs. ING Life Insurance & Annuity Co. 

And in December, a tentative $140 million settlement was reached in Haddock vs. Nationwide after 13 years of litigation. It’s believed to be the largest ever in a service-provider revenue-sharing case. 

A couple of quick conclusions:

• The amounts here are staggering, especially from the perspective of class action attorneys.  Surely, this information will draw more attorneys into the fray.
• Based on these figures, litigation on ERISA cases seemingly is poised to increase in both quantity and voracity.
• As a result, one would naturally expect the number of players in the ERISA space to decrease due to the risks, with a natural result being those firms doing the right thing for their clients and those firms with a truly dominant position in the space where litigation can be fought or absorbed.

-Jason Grantz