New Regulations Will Enhance Disclosure for Your Pension Plans

These failures include outrageous costs that bear no resemblance to value provided, deeply embedded conflicts of interest, sustained underperformance of underlying investment vehicles, inadequate disclosure, inappropriate investment menus, defective plan design, insufficient participant education, and flawed default provisions. Cumulatively, these defects do all but guarantee the failure of the participant's outcome.

While there are many excellent plans, far too many are so expensive and perform so poorly that participants are often better served to invest their retirement savings elsewhere or at least invest no more than necessary to capture matching contributions.

It isn't unusual to find 401(k) plans with total costs paid by the participant exceeding 3% of account total annually, with investment choices limited to subpar proprietary funds, and with payments to the various providers not related to services rendered. Confusion about who provides what service, how much is their direct and indirect compensation, and whether or not the various parties are acting in a fiduciary capacity is the rule. The combined impact on participant accounts and retirement funding is devastating.

Despite a number of significant shortcomings, 401(k) plans are the backbone of the American retirement system, and we know that families that have 401(k) plans have a great deal higher net worth than those without access. So, it's critical to improve this vital retirement funding component.

New Regulations

After years of study, thousands of hours of congressional testimony, hundreds of hearings and uncountable public comments, the Department of Labor (“DOL”) issued Reg 408(b)2 and 404(a) (Who makes up these names, anyway?) designed to force better disclosure. With this better information, it is hoped that both plan providers and participants will make better decisions, leading to improved retirement preparation for America's workers. While the industry has been successful in delaying implementation, it appears that the changes will become effective in second quarter 2012. The DOL has recently released new rules regarding the ERISA 408(b)(2), ERISA 404(a), and electronic delivery. The 408(b)(2) regulations become effective April 1, 2012, while the new 404(a) participant disclosure rules become effective May 31, 2012.

The regulations expand the definition of fiduciary investment advice, and cause many consultants who are not currently fiduciaries to be considered fiduciaries. By mandating significantly higher levels of disclosure, the regulations will give previously unavailable key information to decision makers.

The flurry of enacted and proposed band-aid fixes will go part of the way toward improving the retirement landscape. But regulations, legislation and the threat of court action can only go so far. The various fixes provide information and guidance to plan fiduciaries, but by themselves can't make them better fiduciaries. The plan sponsor must either develop fiduciary practices and procedures or delegate them to someone who can.

Attorneys practice law and deliver services. Acting as a fiduciary and developing appropriate procedures and practices is generally outside their skill set, and a distraction from their primary interest of running a successful business. Frankly, few law firms rise and fall based on the quality of their 401(k) plan.

I'm not suggesting for a moment that they don't care. Nobody wants to have a crummy retirement plan. Most employers would want for their employees to receive maximum benefits for each dollar set aside. But wishing won't make it so. And leaving it to a product pusher that “takes care of it all” is unlikely to generate a quality plan.

The Employee Retirement Income Security Act (“ERISA”) requires that plan sponsors enter into only agreements with “reasonable” fees, and decisions must be made exclusively in the interest of the participant. However, absent disclosure requirements, plan sponsors had no feasible ability to determine the reasonableness of their fees, or the parameters for the decision-making process. In particular, the “bundled product” solution was appealing, but lacked any clarity. If the plan provider was not acting as a fiduciary, then the entire responsibility for the plan choices falls to the plan sponsor, the ultimate fiduciary.

Background

As background, when ERISA became effective in 1974, the pension world changed dramatically, and for the better. But reporting and record keeping became so complex that only giant institutions had or could afford the mainframe computer capacity to manage the accounts. Large insurance and mutual fund companies stepped up and provided the technology and systems, which enabled them to become the dominant players in the field. Remember, in 1974 computer time was more valuable than gold, and the machines filled giant warehouses.

For a while the giant institutions had the field all to themselves. The pitch was simple: We will do it all, record keeping, tax returns, compliance, participant education, investments and advice. And it's free! Well, free was a pretty compelling price point, and relieving plan sponsors of all those headaches was invaluable.

Of course, it wasn't free, and the “bundled product” solution provided cover for obscene charges paid by the participants and the perfect environment for breeding conflicts of interest. Additionally, bundled product providers seldom acknowledged fiduciary responsibility for their recommendations, leaving the entire liability for their decisions on the plan sponsors. Meanwhile the plan sponsors were led to believe that the provider was acting as a fiduciary. Disclosure ranged from opaque to nonexistent. Many plan sponsors and participants are simply stonewalled when requesting relevant information.

Long experience indicates that plan sponsors can't rely on the payroll service/insurance company/brokerage house/or fund company to overcome their deeply embedded conflicts of interest to fix their plans. Those sales entities have little interest and strong disincentives to fiduciary behavior. Most of them absolutely prohibit their agents from accepting fiduciary responsibility.

A number of unsavory practices quickly emerged:

• Restricting the investment choices to funds that shared management fees with the provider;
• Use of proprietary funds where better performing, lower cost alternatives existed;
• Mortality and expense charges with no economic benefit to the participants;
• Special class funds with additional fees over and above retail costs;
• Use of retail funds where lower-cost institutional class funds were available;
• Per account and per position fees assessed at each participant level; and
• Termination fees that effectively locked in plan sponsors from changing providers.

Individually and cumulatively these fees may easily exceed “reasonable” standards, and the decisions often violate the requirement to be in the participants' sole best interest.

Today, of course, your iPhone has more computer capacity than NASA had when it put a man on the moon. So most PCs could easily handle record keeping for hundreds of plans, and the Internet provides infrastructure for seamless communications between remote providers. The stranglehold that the giant institutions had on the market is effectively broken, and many excellent providers exist that can dramatically lower costs and improve every aspect of plan design.

However, without critical information, comparisons and informed decision making are impossible. The new regulations fix that.

Even the best intentioned, most diligent retirement plan sponsors and participants may have had difficulty extracting critical information from plan providers. That's about to change. The new DOL Disclosure Regulations could greatly benefit both plan sponsors and participants.

What to Expect

So, what can you expect?

If you are a plan sponsor, each service provider must supply you with a revised service agreement that provides you with:

• A complete description of the services it provides;
• A full disclosure of the cost of each service;
• A disclosure of any direct or indirect compensation it receives from associated providers;
• Whether it assumes fiduciary responsibility for each function. (Hint: If the service agreement does not specifically assume fiduciary responsibility for a function, it is unable or unwilling to assume that liability.);
• Any potential conflicts of interest and how they are managed and mitigated.

You must in turn share most of this information with your plan participants.

The expectation is that better information will lead inevitably to selection of better plans provided to the workforce.

But the benefits of disclosure are conditional on the willingness to actually review the provided information and take appropriate action on it. Be aware that as a plan sponsor you are a fiduciary, and reviewing the quality of your retirement plan is not optional. Failure to comply with the many detailed requirements of ERISA generates personal liability for the plan sponsors/fiduciaries.

Unfortunately, the new regulations suggest no appropriate benchmarks other than “reasonable” for costs and a general prohibition against undisclosed or unresolved conflicts of interest. So fiduciaries must either occasionally “test the market” through an open RFP process, or hire an independent fiduciary adviser to do it for them.

Red Flags

Red flags might include:

• A total cost for all services including investment advice, record keeping/administration, fund fees, transaction costs, custody or trustee fees, and any mortality and expense charges that exceed 1.5%;
• Any single fee disproportionate to services rendered or economic value;
• Direct or indirect compensation between the parties that might cause conflicts of interest;
• Revenue sharing not fully accounted for and credited back to the plan;
• Failure to specifically assume fiduciary status by investment advisers, consultants, and other plan providers; and
• Use of retail class fees rather than the lower cost institutional shares.

Outside Advisers

Fortunately, plan sponsors can delegate much of their responsibilities and shed most of their liability to an outside independent investment adviser that will accept fiduciary status in writing (technically ERISA 3(38) Fiduciary). As long as that adviser is prudently selected, accepts fiduciary responsibility in writing and is prudently monitored, the plan sponsor can relieve almost all of its responsibility and liability for investment design, fund selection, cost control, disclosure, resolution of any potential conflicts of interest, and participant education. Unless the plan sponsor has investment expertise and is willing to accept potential personal liability, ERISA requires that it delegate to a prudent expert.

Given that attorneys don't all practice ERISA law or have finance degrees, even with the new information, you may not feel qualified to perform a plan audit or make comparisons. However, a qualified fiduciary investment adviser will provide you with one for nominal or no cost. Hiring a competent plan fiduciary adviser will relieve you of significant personal liability while bringing discipline to the process of providing quality benefits at reasonable costs to your workforce.

When engaging a prudent expert, your expectation should be reduced costs, improved investment results, higher participant satisfaction, plan utilization, greater accumulations, and reduced personal liability for fiduciaries.

Alternatively, the courts, your employees, the SEC and/or the Department of Labor may administer a particularly costly and painful lesson.

It's time for pension plan sponsors to get serious about their fiduciary obligations. Simply put, the employer's obligation for a plan doesn't end when it writes the check. It begins.

Without any thought or planning, the 401(k) has become America's pension plan. The days of guaranteed retirement income for life are long gone, and along with them the financial security that the traditional pension plan provided.

However, to date the 401(k) solution is deeply flawed. The widespread failure of 401(k) plans to provide adequate retirement income security for American workers has caught the attention of the courts, regulators, the administration, Congress, academics and participants.

These failures include outrageous costs that bear no resemblance to value provided, deeply embedded conflicts of interest, sustained underperformance of underlying investment vehicles, inadequate disclosure, inappropriate investment menus, defective plan design, insufficient participant education, and flawed default provisions. Cumulatively, these defects do all but guarantee the failure of the participant's outcome.

While there are many excellent plans, far too many are so expensive and perform so poorly that participants are often better served to invest their retirement savings elsewhere or at least invest no more than necessary to capture matching contributions.

It isn't unusual to find 401(k) plans with total costs paid by the participant exceeding 3% of account total annually, with investment choices limited to subpar proprietary funds, and with payments to the various providers not related to services rendered. Confusion about who provides what service, how much is their direct and indirect compensation, and whether or not the various parties are acting in a fiduciary capacity is the rule. The combined impact on participant accounts and retirement funding is devastating.

Despite a number of significant shortcomings, 401(k) plans are the backbone of the American retirement system, and we know that families that have 401(k) plans have a great deal higher net worth than those without access. So, it's critical to improve this vital retirement funding component.

New Regulations

After years of study, thousands of hours of congressional testimony, hundreds of hearings and uncountable public comments, the Department of Labor (“DOL”) issued Reg 408(b)2 and 404(a) (Who makes up these names, anyway?) designed to force better disclosure. With this better information, it is hoped that both plan providers and participants will make better decisions, leading to improved retirement preparation for America's workers. While the industry has been successful in delaying implementation, it appears that the changes will become effective in second quarter 2012. The DOL has recently released new rules regarding the ERISA 408(b)(2), ERISA 404(a), and electronic delivery. The 408(b)(2) regulations become effective April 1, 2012, while the new 404(a) participant disclosure rules become effective May 31, 2012.

The regulations expand the definition of fiduciary investment advice, and cause many consultants who are not currently fiduciaries to be considered fiduciaries. By mandating significantly higher levels of disclosure, the regulations will give previously unavailable key information to decision makers.

The flurry of enacted and proposed band-aid fixes will go part of the way toward improving the retirement landscape. But regulations, legislation and the threat of court action can only go so far. The various fixes provide information and guidance to plan fiduciaries, but by themselves can't make them better fiduciaries. The plan sponsor must either develop fiduciary practices and procedures or delegate them to someone who can.

Attorneys practice law and deliver services. Acting as a fiduciary and developing appropriate procedures and practices is generally outside their skill set, and a distraction from their primary interest of running a successful business. Frankly, few law firms rise and fall based on the quality of their 401(k) plan.

I'm not suggesting for a moment that they don't care. Nobody wants to have a crummy retirement plan. Most employers would want for their employees to receive maximum benefits for each dollar set aside. But wishing won't make it so. And leaving it to a product pusher that “takes care of it all” is unlikely to generate a quality plan.

The Employee Retirement Income Security Act (“ERISA”) requires that plan sponsors enter into only agreements with “reasonable” fees, and decisions must be made exclusively in the interest of the participant. However, absent disclosure requirements, plan sponsors had no feasible ability to determine the reasonableness of their fees, or the parameters for the decision-making process. In particular, the “bundled product” solution was appealing, but lacked any clarity. If the plan provider was not acting as a fiduciary, then the entire responsibility for the plan choices falls to the plan sponsor, the ultimate fiduciary.

Background

As background, when ERISA became effective in 1974, the pension world changed dramatically, and for the better. But reporting and record keeping became so complex that only giant institutions had or could afford the mainframe computer capacity to manage the accounts. Large insurance and mutual fund companies stepped up and provided the technology and systems, which enabled them to become the dominant players in the field. Remember, in 1974 computer time was more valuable than gold, and the machines filled giant warehouses.

For a while the giant institutions had the field all to themselves. The pitch was simple: We will do it all, record keeping, tax returns, compliance, participant education, investments and advice. And it's free! Well, free was a pretty compelling price point, and relieving plan sponsors of all those headaches was invaluable.

Of course, it wasn't free, and the “bundled product” solution provided cover for obscene charges paid by the participants and the perfect environment for breeding conflicts of interest. Additionally, bundled product providers seldom acknowledged fiduciary responsibility for their recommendations, leaving the entire liability for their decisions on the plan sponsors. Meanwhile the plan sponsors were led to believe that the provider was acting as a fiduciary. Disclosure ranged from opaque to nonexistent. Many plan sponsors and participants are simply stonewalled when requesting relevant information.

Long experience indicates that plan sponsors can't rely on the payroll service/insurance company/brokerage house/or fund company to overcome their deeply embedded conflicts of interest to fix their plans. Those sales entities have little interest and strong disincentives to fiduciary behavior. Most of them absolutely prohibit their agents from accepting fiduciary responsibility.

A number of unsavory practices quickly emerged:

• Restricting the investment choices to funds that shared management fees with the provider;
• Use of proprietary funds where better performing, lower cost alternatives existed;
• Mortality and expense charges with no economic benefit to the participants;
• Special class funds with additional fees over and above retail costs;
• Use of retail funds where lower-cost institutional class funds were available;
• Per account and per position fees assessed at each participant level; and
• Termination fees that effectively locked in plan sponsors from changing providers.

Individually and cumulatively these fees may easily exceed “reasonable” standards, and the decisions often violate the requirement to be in the participants' sole best interest.

Today, of course, your iPhone has more computer capacity than NASA had when it put a man on the moon. So most PCs could easily handle record keeping for hundreds of plans, and the Internet provides infrastructure for seamless communications between remote providers. The stranglehold that the giant institutions had on the market is effectively broken, and many excellent providers exist that can dramatically lower costs and improve every aspect of plan design.

However, without critical information, comparisons and informed decision making are impossible. The new regulations fix that.

Even the best intentioned, most diligent retirement plan sponsors and participants may have had difficulty extracting critical information from plan providers. That's about to change. The new DOL Disclosure Regulations could greatly benefit both plan sponsors and participants.

What to Expect

So, what can you expect?

If you are a plan sponsor, each service provider must supply you with a revised service agreement that provides you with:

• A complete description of the services it provides;
• A full disclosure of the cost of each service;
• A disclosure of any direct or indirect compensation it receives from associated providers;
• Whether it assumes fiduciary responsibility for each function. (Hint: If the service agreement does not specifically assume fiduciary responsibility for a function, it is unable or unwilling to assume that liability.);
• Any potential conflicts of interest and how they are managed and mitigated.

You must in turn share most of this information with your plan participants.

The expectation is that better information will lead inevitably to selection of better plans provided to the workforce.

But the benefits of disclosure are conditional on the willingness to actually review the provided information and take appropriate action on it. Be aware that as a plan sponsor you are a fiduciary, and reviewing the quality of your retirement plan is not optional. Failure to comply with the many detailed requirements of ERISA generates personal liability for the plan sponsors/fiduciaries.

Unfortunately, the new regulations suggest no appropriate benchmarks other than “reasonable” for costs and a general prohibition against undisclosed or unresolved conflicts of interest. So fiduciaries must either occasionally “test the market” through an open RFP process, or hire an independent fiduciary adviser to do it for them.

Red Flags

Red flags might include:

• A total cost for all services including investment advice, record keeping/administration, fund fees, transaction costs, custody or trustee fees, and any mortality and expense charges that exceed 1.5%;
• Any single fee disproportionate to services rendered or economic value;
• Direct or indirect compensation between the parties that might cause conflicts of interest;
• Revenue sharing not fully accounted for and credited back to the plan;
• Failure to specifically assume fiduciary status by investment advisers, consultants, and other plan providers; and
• Use of retail class fees rather than the lower cost institutional shares.

Outside Advisers

Fortunately, plan sponsors can delegate much of their responsibilities and shed most of their liability to an outside independent investment adviser that will accept fiduciary status in writing (technically ERISA 3(38) Fiduciary). As long as that adviser is prudently selected, accepts fiduciary responsibility in writing and is prudently monitored, the plan sponsor can relieve almost all of its responsibility and liability for investment design, fund selection, cost control, disclosure, resolution of any potential conflicts of interest, and participant education. Unless the plan sponsor has investment expertise and is willing to accept potential personal liability, ERISA requires that it delegate to a prudent expert.

Given that attorneys don't all practice ERISA law or have finance degrees, even with the new information, you may not feel qualified to perform a plan audit or make comparisons. However, a qualified fiduciary investment adviser will provide you with one for nominal or no cost. Hiring a competent plan fiduciary adviser will relieve you of significant personal liability while bringing discipline to the process of providing quality benefits at reasonable costs to your workforce.

When engaging a prudent expert, your expectation should be reduced costs, improved investment results, higher participant satisfaction, plan utilization, greater accumulations, and reduced personal liability for fiduciaries.

Alternatively, the courts, your employees, the SEC and/or the Department of Labor may administer a particularly costly and painful lesson.