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

 

Tibble v. Edison Ruling - Some potential impact to Advisors

 What Tibble v Edison International Ruling Means to Advisors

In the above linked article recently published on LifeHealthPro, the author discusses the Supreme Court’s recent decision on Tibble v. Edison International which centered on whether Edison International’s financial advisors and investment committee had breached their fiduciary duties by choosing retail share classes instead of institutional shares of specific mutual funds. It mainly focused on whether the ability to claim such a breach exceeded the six-year statue of repose mandated by the Employee Retirement Income Security Act (ERISA).

In mid-May, the high court handed down its unanimous opinion in Tibble v. Edison and said that “a fiduciary normally has a continuing duty of some kind to monitor investments and remove imprudent ones.”  This was expected and probably brought a widespread “no kidding” response from fiduciaries who have done just that from the get-go.

The Court vacated and remanded the lower court’s ruling; they went on to note in their opinion that the previous court’s ruling had “erred by applying a 6-year statutory bar based solely on the initial selection of the three funds without considering the contours of the alleged breach of fiduciary duty.”

The author posits the idea that some industry insiders are worrying that this may be the beginning of the Supreme Court’s interest in delving deeper into the fiduciary duties of those managing employee retirement plans and that the Court left just enough vagueness in its opinion to make advisors wonder what will be considered “reasonable” for due diligence and monitoring.

I was interviewed and quoted a few times in the article, specifically regarding the veracity of the decision and the likely consequence of minimizing the protection of the six-year statute of repose.

Another commenter suggested that this decision won't have much impact on keeping fees reasonable or a fiduciary duty to monitor since these ideas have already been in play for quite some time, but that it may cause some firms to take the idea of reviewing the plan's Investment Policy Statement (IPS) to ensure compliance with it.

 

At my firm, Unified Trust, we act as the plan trustee and in that role we are responsible for executing the plan's IPS, selecting and monitoring the investments and generally employing a prudent process that is thorough, regular and well documented.  One result from this ruling that I see happening more is a greater conscious effort from Retirement Plan Committees and their advisors in documenting their decision-making or outsourcing to firm's that will.

- Jason Grantz

Fiduciary, as easy as 1., 2., 3.,

A solid reminder piece was written and published today on NAPA-net.org.  The article was titled '3 Things Every Plan Committee Member should know'.  Here is the link.
 
3 Things Every Plan Committee Member Should Know

Here are the three things:
  

1. You are an ERISA fiduciary. Even as a small and relatively silent member of the committee, you’ll direct and influence retirement plan money — and it’s that influence over the plan’s assets that makes you an ERISA fiduciary. 

2. As an ERISA fiduciary, your liability is personal. How personal? Well, you may be required to restore any losses to the plan or to restore any profits gained through improper use of plan assets. You can obtain insurance to protect against that personal liability — but that’s probably not the fiduciary liability insurance you may already have in place, or the fidelity bond that is often carried to protect the plan against loss resulting from fraudulent or dishonest acts of those covered by the bond. If you’re not sure what you have, find out. Today. 

3. You are responsible for the actions of other plan fiduciaries. All fiduciaries have potential liability for the actions of their co-fiduciaries. For example, the Department of Labor notes that if a fiduciary knowingly participates in another fiduciary’s breach of responsibility, conceals the breach, or does not act to correct it, that fiduciary is liable as well. So, it’s a good idea to know who your co-fiduciaries are—and to keep an eye on what they do, and are permitted to do.

Besides the three basic's, which essentially say, being a fiduciary is serious, potentially hazardous and requires responsible caution, the article also raises a few very good points, namely:

- Many plan committee members come from staff of the employer and are frequently put on the committee for no other reason than that someone has to do it.  Background may not be part of the decision and expertise may be absent altogether.


- Fiduciaries are required to act solely (re: exclusively, i.e. ONLY) in the best interests of the plan participants and beneficiaries, and that they MUST act prudently, usually means they have process' in place for making important decisions.  It goes on to iterate the importance of investment diversification and ensuring that the plan pays only reasonable expenses for services.


Finally, the best point that the article makes, in my opinion, is that it's hard  to be a plan fiduciary.  This is especially true if the committee hasn't read plan documents, doesn't have any policies or procedures to follow or doesn't understand how much they are being charged, and for what or how the fees are being charged. 

Unfortunately, in my professional experience, often it is the case that the expert standard of care fiduciaries are bound to under ERISA is not realistic to expect of the plan committee.  Most plan committees are well intentioned, but not experts.   A wise person once told me that in the absence of expertise when expertise is needed, a prudent person will hire it.  Good advice for the majority of well intentioned, inexpert fiduciaries.

- 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

The "Real" Role of a 401(k) Plan Advisor - Good Thoughts Ary

Once in a while someone writes something and gets it right. .  Attached is a good read for Retirement Plan Advisors of all levels, beginner through expert.   Main theme is that overall comprehensive service and maximizing protection is where the value to the employer is, it's not all about picking funds, or really even a little.

See the article linked here.

http://www.jdsupra.com/legalnews/the-real-role-of-a-401k-plan-financi-67827/

Nice work Ary!

Let's Talk About Risk, Man.

Yesterday, I saw a good post from NAPA Net regarding the potential of triggering a Form 5500 type audit.  For those unaware, NAPA is the National Association of Plan Advisors.  I found particularly interesting the list of actual 5500 responses deemed likely to trigger an audit or investigation.  Specifically listed were: 

• line items that are left blank when the instructions require an answer
• inconsistencies in the data disclosed on the Form 5500 schedules
• a large drop in the number of participants from one year to the next
• a large dollar amount in the “Other” asset line on the Schedule H

*Other red flags include hard-to-value investments, non-marketable investments, and consistent late deposits of deferrals.  Included in this category would be Self Directed Brokerage Accounts and Employer Stock.

The reason that this post struck me as interesting has to do with a topic that we discuss often on this blog and when we're out consulting with clients.  Specifically, Risk Mitigation.  Regular readers of this blog know that my firm is a Discretionary Corporate Trustee and that one of the primary reasons we are hired, although not the exclusive one, is to provide relief from exposure to fiduciary liability risk. 

 

Risk mitigation is crucial to our story, but we are consciously aware that of the fact that while fiduciary based law suits are increasing, they are still relatively uncommon in the small plan marketplace where we find most of our clients. 

One area that I've been focusing on when meeting with clients is in risk categorization.  Generally, I view employer (plan sponsor) risk falling into three main areas of concern:

a.       High Risk/Low Probability – This is the risk of law suit.  It is unlikely to occur, but if it does, it will be unpleasant, expensive financially to defend and will have a reputation cost as well.

b.      Low Risk/High Probability – We've found that in 85% of the plans we take over, we catch some kind of administrative, fiduciary or document breach up front and correct them.  These types of issues are likely to pop up from time to time and are a quite common problem.  They are relatively inexpensive to correct but do cause aggravation to clients.   

c.       Medium Risk/Medium Probability – This is the audit risk.  In my opinion, I believe that this is ought to be the biggest area of concern for an employer.  The risk of audit is becoming greater and greater and in the political environment of today, with extreme governmental debt and tax reform coming, this is one area that the government can easily generate revenues in the form of excise taxes, penalties and fines.  It is this risk that is supported by NAPA's posting.

The lesson here for employers is to make sure that 5500's are completed with the same kind of care and attention to detail that a person would use when filling out their IRS 1040.  

The lesson for advisors is two-fold. 

1.) Providing a 5500 review to help clients avoid potential audit trigger's could/should be among your services.

2.) Try coaching clients to eliminate some of those difficult to value assets like employer stock or Self Directed Accounts because those plans are the low hanging fruit from an auditor's perspective.

Finally, some a little self serving here, it would be a good idea for employers to hire a professional fiduciary services provider, like a Discretionary Corporate Trustee.