William Simon, Managing Director, Retirement Plan Services at Brinker Capital, joins David Franceski, Partner, Stradley Ronon Stevens & Young LLP in answering some frequently asked questions about contemplated regulatory changes impacting the retirement landscape.
As the employee-sponsored retirement plan landscape evolves, what regulatory changes are on the horizon?
Dave: The most immediate changes – affecting plan sponsors, plan administrators and plan participants and beneficiaries – will be the new and more robust disclosures required under ERISA sections 404(a)(5) and 408(b)(2) and under the Department of Labor regulations applicable to them. In brief, Section 408(b)(2) will require plan administrators to provide plan sponsors aggregate plan fee disclosures that specify the fees paid by each service provider to the plan, the services rendered and the fiduciary status of each provider. This information is designed to assist plan sponsors in meeting their new Section 404(a)(5) obligations, which include (1) disclosing in detail on a quarterly basis to all plan participants all plan expenses, both direct and indirect, allocated to the participants and (2) disclosing at least annually and when changes occur all investment expenses, both direct and indirect, including offsets such as 12(b)-1 fees. Originally scheduled to go into effect in April and May of this year, their effective date has recently been pushed back three months. When these new disclosure requirements do become effective, however, it can be expected that they will have a significant effect on the retirement plan marketplace – in terms both of compliance costs and future business models for offering retirement plan services and of investment advice. DOL estimates compliance costs for Section 408(b)(2) will be $135 million in the first year and $37 million each year thereafter, and for Section 404(a)(5) $2 billion. Section 404(a)(5) is also projected to generate another $14.9 billion in lower participant fees and expenses once retirement plan fee structures are better understood and factored into the competitive milieu of retirement planning. Looking further down the line, DOL continues to revise the regulations defining investment advice under ERISA Section 3(21), and the SEC is moving forward on a uniform fiduciary standard for all financial professionals as commanded by Dodd-Frank.
How are fiduciaries defined now?
Bill: ERISA generally defines a fiduciary as anyone who exercises discretionary authority or control over a plan’s management or assets, including anyone who provides investment advice to the plan.
ERISA 3(21): Anyone can serve as a fiduciary under Section 3(21) as long as the person meets or performs specific functions, including having control over the management of the plan or disposition of its assets, rendering advice for a fee or having any discretionary responsibility for the plan. Because this is a functional definition, advisers may think they are acting in the role of a solicitor, but because of certain actions, they may unknowingly become a fiduciary. Therefore a clear understanding of ERISA 3(21) is critical.
ERISA 3(38): Section 3(38) concerns an “investment manager,” by definition a fiduciary. A 3(38) manager has discretion over the control and authority of plan assets. When a plan sponsor selects a 3(38) manager, the sponsor can delegate a significant portion of the responsibility and liability the sponsor would have as a fiduciary to the 3(38) manager. A 3(38) manager can be a bank, an insurance company or a registered investment adviser subject to the IAR Act of 1940.
How might those definitions change?
Bill: Recognizing that the rules have largely gone unchanged since 401(k)s were introduced more than 30 years ago, the DOL has proposed new rules regarding fiduciary responsibility. Because the landscape has shifted away from defined benefit plans to defined contribution plans with thousands of investment options and open architecture, the need for advice and guidance has grown dramatically. The DOL is seeking to protect IRA holders where currently no fiduciary protection exists. Because the definition of a fiduciary is expanding, more firms and advisers will have to determine what they wish their role and responsibility to be. This could have a big impact on what products and services an investment firm will provide.
What fundamental values do these changes impose upon fiduciaries?
Dave: The hallmark of a fiduciary by any measure is first and foremost to act in the best interest of the client – the plan, its participants and its beneficiaries. This dates back to the very foundation of the common law of trusts, from which both fiduciary status and ERISA are derived. In practice, of course, this means, among other things, avoiding conflicts of interest whenever possible and thoroughly disclosing them when they can’t be avoided; understanding which conflicts are waivable and which are not; operating transparently and with full disclosure of all matters of material importance to the client and updating those disclosures when necessary, especially as to matters of compensation, both direct and indirect; avoiding what ERISA calls prohibited transactions, the most troubling species of nonwaivable conflicts; being aware of the conduct of co-fiduciaries and taking responsibility for reporting or taking other action to prevent activity when it lapses into misconduct; and, in this day and age, understanding that Dodd-Frank and other laws have created strong incentives for whistleblowers to come forward when fiduciaries are not operating with these values in mind.
Will tightening up a definition result in much change?
Bill: In general, the definition of “advice” would be treated more broadly than it is currently, meaning an adviser could find itself acting in the capacity of fiduciary more readily. This could create challenges for commission-oriented brokers and potentially shift or benefit investment advisory representatives, who almost always act as a fiduciary. IRAs and their fiduciary status are expected to remain unchanged at this time.
How will a shift in investment manager disclosure statements impact plan sponsors and plan participants?
Dave: As DOL rightly points out, an informed consumer will always demand value for service. Plan sponsors can expect the new disclosure statements to generate questions about whether participants are getting the best value for service, and that will likely lead them to question whether better value would produce better returns – and indeed whether they have been getting the best returns. That is likely to generate downward pressure on plan fees and expenses (as noted by DOL in its cost-saving estimates, above); efforts by providers to bring cost-saving measures to plan sponsors, with the competitive advantage going to providers with low-cost solutions; new and different pricing options being provided to plans and their participants; increased use of “brokerage windows” to allow more choice and move expenses directly to the participant; and perhaps some reductions in plan options, such as limitations on plan types and plan minimums, as well as new or revised plan minimums. Plan sponsors will also likely look to plan administrators and other plan fiduciaries for greater assistance in meeting their own disclosure obligations to plan participants. The retirement plan industry will surely respond to the new competitive landscape in these and other important ways.
Who is likely to be impacted the most if these changes go through?
Bill: The greatest impact will be felt by firms and/or advisers who are acting in the capacity of solicitors. Because plan sponsors are fiduciaries, they will need to assess, among other issues, fees and compensation being paid to an adviser acting as a solicitor and the role the adviser plays within a plan. A solicitor can have a critical role in facilitating the relationship between the plan and the investment manager and administrator. A solicitor can be vital for ongoing employee education and for providing information pertaining to different investment strategies. However, solicitors will need to be even more aware of their role within a plan and what would constitute their becoming a fiduciary.
Will these changes result in higher costs to plan sponsors and ultimately consumers?
Bill: The DOL is sensitive to President Barack Obama’s executive order to revisit regulations that place unjust costs or burdens on an industry, so it is hoped that if there are additional regulatory or other costs, they will be kept to a minimum. If a fiduciary standard is applied to individual retirement accounts, there is the likelihood that there could be incremental new costs associated with any change. However, with the implementation of sections 408(b)(2) and 404(a)(5), there should be greater transparency in all costs associated with a plan, allowing the plan sponsor greater latitude in managing overall plan costs.
Should plan sponsors do anything differently in anticipation of the change?
Dave: First and foremost, plan sponsors should re-examine their relationships with their plan administrators and with other plan fiduciaries to ensure that they are getting the information they need and the service and performance they deserve. Particular attention should be paid to investment cost and how that relates to investment performance. They should also evaluate whether their investment management relationships are meeting the goals they have set for the plan and the plan participants. Those goals may not be simply performance goals. They should also consider whether they are confident and comfortable in their relationships with other plan fiduciaries, and they should satisfy themselves that they have the tools necessary to meet their new disclosure obligations. Many of those tools may actually originate with other plan fiduciaries, but plan sponsors cannot absolve themselves of their own fiduciary and regulatory obligations by delegating or outsourcing, so they need to be prepared to – or have other professionals – do some “peeking under the tent.” Ultimately all of their actions will be judged by a very rigorous standard – whether they have acted solely in and for the best interests of their plan participants and beneficiaries – and that standard will be applied liberally, and their conduct examined closely, with an eye toward reimbursing the plan for any perceived loss.
How would a plan sponsor know whether the investment manager is equipped to respond to the charge for greater accountability and stewardship?
Dave: Careful due diligence is certainly critical. But one of the best measures at the start will be the reputation and history of the investment manager. With the Internet, plan sponsors have many tools at their disposal. Check out the investment manager’s Form ADV and other publicly available information at the SEC and, if they are dually registered, with FINRA and the various state securities commissions. Some states are more aggressive and have better databases than exist at the federal level. Request references. Use Google, social media such as Facebook and LinkedIn and other search tools. While, as they say, “past performance is no predictor of the future” (and indeed investment performance should never be the only measure), investment managers that have the organization, experience and culture for acquitting their fiduciary obligations should top the list. Ask to take a look at the manager’s compliance policies and procedures with respect to fiduciary issues and the firm’s Code of Ethics. Transparency – on costs, fees, performance and services – is also key. If a plan sponsor cannot easily reach a comfort level with plan co-fiduciaries, then it’s probably time to make a change. And if that’s the case, then of course, begin with my friend and colleague Bill Simon.
Published February 24, 2012.
