The Quandaries of Being A Retirement Plan Fiduciary

Last week, the Department of Labor issued its final rule on what it means to be a fiduciary and on conflicts of interest. Virtually everyone in the retirement plan industry has been scurrying about to determine what the effect of the rule is. Some, including the US Chamber of Commerce, say it will lead to unnecessary litigation. Others say it will drive unknowledgeable advisers out of the retirement plan business.

If you're interested in the details of that regulation, every large consulting firm, law firm, and recordkeeper either has or will be publishing their take on it. Here, however, I want to address a different issue.

If you sit on the committee that oversees a retirement plan whether its called the Benefits Committee, the Investment Committee, or the Committee for All Things Good Not Evil, by virtue of that role, it is probable that you are a fiduciary. That means that both individually and as a member of that committee, when making decisions related to the plan (not your own account in the plan, but the plan generally), you have a requirement to act in a fiduciary manner and in the best interest of plan participants.

That's not a low bar.

Instead of bringing up situations that arise from the new final regulations (the other articles will present you with all of those that you need), let's instead consider an age old problem. Suppose your company sponsors a defined benefit plan and you are on the committee that oversees the plan. Let's complicate the situation a bit by adding in the following fact pattern:

• The plan is covered by the PBGC (Title IV of ERISA)
• The plan is frozen and the committee's minutes show that the intent of the committee is to terminate the plan whenever it becomes well enough funded
• Your company is subject to US GAAP; in other words, you account for the plan under ASC 715 (previously FAS 87).
• Your own personal incentive compensation is affected by corporate financial performance measured under US GAAP
• Over time, you have received a material amount of equity compensation from your employer meaning that you now hold a combination of shares of stock, stock options, and restricted stock in your employer

Your actuary comes to a meeting with your committee and informs you that you have three options related to a funding strategy:

• Option #1 will keep the ASC 715 pension expense down and will not result in a settlement (that would be a loss currently), but will result in the plan being less well funded
• Option #2 will produce a settlement loss, but will get the plan closer to termination and leave it currently better funded for remaining plan participants
• Option #3 will reduce ASC 715 pension expense and get the plan better funded and therefore closer to termination, but will have a material effect on the corporate balance sheet and could cause the company to violate certain loan covenants

You do have a quandary, don't you? Only Option #1 will help you to maximize your incentive pay. In my personal experience, in days gone by, for that particular reason, Option #1 would have gotten some votes. If you vote for Option #1, are you fulfilling your responsibilities as a fiduciary?

I'm not an attorney, so I'm not going to answer that question, but I'm sure you can find many who would be happy to weigh in.

Option #2 looks like it could be better for plan participants. Of course, that depends a little bit on what better means in this context. But, if the committee goes with Option #2, you know that your incentive payout could be smaller. If you vote against Option #2 (another question for the attorneys), are you fulfilling your fiduciary requirements?

And, then there's Option #3. How far do you have to go to fulfill your fiduciary requirements? Do you have to make decisions that are clearly not in the best interest of the company, but that may be in the best interests of plan participants? 

It's tricky, isn't it?

Now, let's consider a different situation that may not affect your personal compensation. Using Strategy #1, your company will pay PBGC premiums equal to about 10% of its free cash flow. Using Strategy #2, those same premiums will be reduced to about 3% of free cash flow. But, your actuary isn't familiar with Strategy #2. And, you do have a really good relationship with him. But, the people who brought you Strategy #2 say you can only implement it by using them.

What should you do? What must you do?

Is Your Executive Plan Top-Hat?

Most larger companies and some smaller ones provide many of their higher paid employees the opportunity to participate in a nonqualified retirement plan often referred to as a Supplemental Executive Retirement Plan or SERP. The rationale for having such a plan is spelled out in ERISA. The regulations specifically grants "top-hat" status to plans that are limited to a select group of management or highly compensated employees. The plan must also be unfunded (and for those people who say that lots of top-hat plans have assets set aside, that is informal funding in a rabbi trust or through insurance products or some other means).

Before going further, I'd be remiss if I did not mention that my motivation for posting this is a recent series on top-hat plan litigation in Mike Melbinger's blog.

So why should an employer or employee care if their plan is a top-hat plan or not? According to regulations under ERISA Section 104, top-hat plans are exempt from the participation, funding, vesting, and fiduciary rules under ERISA. As we shall see, this can be critically important, especially in the current statutory environment.

Backpedaling just a bit because this will help the less knowledgeable reader to understand why top-hat plans exist, let's consider what it could mean to be in a top-hat group. ERISA was enacted in 1974 to provide certain protections for employees in retirement and certain welfare benefit plans. When a plan is exempt from some of the key provisions of ERISA, it fails to provide those protections. So, being in a top-hat plan could alert a participant that he or she might not need those protections.

As some authors, mostly attorneys, have pointed out, the last year or two has seen more than the usual amount of litigation related to top-hat plans. In the typical situation, either an individual thinks that they were improperly excluded from a top-hat plan (in my completely non-legal view, this would be a tough claim to make) or because they were in a plan that was treated by their employer as being a top-hat plan, but they thought that it did not satisfy the criteria for being top-hat.

Depending on your viewpoint, the latter is either an easy claim or a difficult claim to make. Why is that? It's been more than 40 years since the passage of ERISA and we still don't have formal DOL guidance telling us what a top-hat group is. Some have argued that an individual may properly be in a top-hat group by being either management or highly compensated or both. Despite the current definition of highly compensated (Internal Revenue Code Section 414(q)) not existing until late 1986, some have argued that satisfying that criterion is sufficient. Many years ago, the DOL floated a concept that a person should be eligible for a top-hat group that a person would be eligible if their compensation was at least two times (three times in a separate informally floated concept) the Social Security Wage Base. And, finally, there is the concept that a person may rightfully be in a top-hat group if by the nature of their position, they have the ability to influence the design and amount of their compensation and benefits package.

So, knowing that we currently don't know what a top-hat group actually is, why do we care?

Suppose your company sponsors what it believes to be a top-hat plan and it turns out that it's not top-hat. Then, it's going to be subject to some fairly onerous provisions that could create massive current costs in some cases and unsolvable compliance issues in others.

Consider the following scenario.

Suppose you have a DB SERP with 20 participants. Further suppose that for whatever reason, this plan is found to not be a top-hat plan. Assuming that the company is large enough, then the plan will fail the minimum participation rules and it will necessarily (unless the company has only highly compensated employees) fail the minimum coverage tests. Full vesting must occur generally within 5 years of entry and that entry must occur not later than age 21 with 1 year of service. The plan must be funded according to ERISA's minimum funding rules. And, those plan assets must be invested according to ERISA's fiduciary standards. But, the plan will still not be a qualified plan as it doesn't meet all of the Internal Revenue Code's standards under Section 401(a).

If the plan is not qualified, it must be a nonqualified plan of deferred compensation. That makes the plan subject to Code Section 409A. So, let's throw in one more wrinkle. Let's suppose the company also sponsors a qualified DB plan and let's suppose that the qualified plan is less than 80% funded. Now, you are between a rock and a hard place. Setting aside assets (funding) for the nonqualified plan will violate Code Section 409A which will subject participants to a very large unplanned additional tax liability. (By the way, those participant will likely have to find a way to pay those taxes perhaps without having access to the deferred compensation assets in order to pay them.) Not funding the SERP will cause the plan to fail to meet minimum funding standards which will result in excise taxes under IRC 4971.

Ouch!

What should an employer do?

I've been told by more than one attorney that it is unlikely that you can get a formal legal opinion that your top-hat group is, in fact, a bona fide top hat group.

If you can't get a formal legal opinion, perhaps the best way to get comfort is to get an outsider with expertise in this area to assist with an independent analysis.

Looking at a history of case law and DOL opinion on the topic, one might consider these elements:

• The percentage of the workforce in the top-hat group
• The relative pay of the top-hat group as compared to the pay of those people not in the top-hat group
• Whether the top-hat group was selected by the Board as compared to being, for example, any employee with the title Vice President or higher
• Whether individuals in the top-hat group, especially those among the lower-paid in the group, have significant management responsibilities
• Whether individuals in the group need the protection of ERISA

Nobody really knows. But, having an independent analysis might show that an employer is acting in good faith in determining the group. Given the downside of getting it wrong, it may just be worth it to find out.

Finally, I want to reiterate that I am not an attorney and I have no qualifications to provide legal advice. As such, nothing in this post or anything else that I write should be construed as legal advice or as the practice of law.

You Run a Business -- Why Do You Choose to be in the Benefit Plan Business, Too?

You've been successful in the business world. You've made your way up through the ranks. Suddenly, because your title starts with the word "chief", you find yourself on the company's Benefits (or some other similar name) Committee.

You're an accidental fiduciary. You have no benefits training. You've never studied ERISA. In some cases, you've never heard of ERISA. What are you doing in this role and why?

Perhaps there is not a single person on your committee with a strong grounding in ERISA issues. But, you know that in order to compete for employees, you have to provide your employees with some benefits. It's likely that some or all of those benefit plans are covered by ERISA. And, ERISA coverage brings with it a myriad of rules and requirements.

Oh no, now I have you panicking. What should you do?

Let's consider one of the most common benefit plan offerings in 2015, the 401(k) plan. What is your committee responsible for? Do you know?

While one could argue that the list might be slightly different, here is a pretty decent summary:

• Plan design
• Selection of plan investment options
• Compliance (with laws, regulations, and other requirements)
• Plan administration
• Communication to participants and education of those participants

That's a lot to swallow. Look around your committee. Presumably, since the committee has responsibility for all of those elements, at the very least, you can find people in the room who, between them, have expertise in all of those areas,

You can't? 

Do you really want the responsibility that comes with being a member of that committee when you have just realized that the expertise to handle the committee's roles doesn't reside on the committee?

You have choices, or at least you might. You could resign from the committee. Frankly, that usually doesn't go over well.

You could engage an expert. Suppose you could find an individual who could function in the role that a committee Chair would play in a perfect world. We're likely talking about someone who doesn't work for your company. This person will bring you peace of mind and essentially serve as the quarterback for the committee. He or she won't have a vote, but will guide you through the processes so that 

• Your plan is well-designed for your population and budgets, 
• It has investment options for plan participants that are prudently chosen and monitored according to an Investment Policy Statement (sometimes called an IPS), 
• It gets and stays in compliance with applicable rules, 
• Is administered properly and the firm that administers it is well-monitored, and
• Is communicated to participants in a clear fashion that properly educates those participants as to the benefits of plan participation.

That sounds great, doesn't it?

If you don't currently have such a quarterback for your committee, perhaps you should. I can help you find one.

Academic Study Inflames 401(k) Community

Ian Ayres, a Professor of Law at Yale University recently inflamed the 401(k) community by sending roughly 6,000 letters to plan sponsors telling them, in essence, that the fees associated with their investment lineups are too high. They appear to use as a benchmark a family of index funds provided by Vanguard and the fees at which those funds could be available. Additionally, Mr. Ayres is doing working with Quinn Curtis, Associate Professor of Law at the University of Virginia School of Law. Messrs Ayres and Curtis have posted a draft of the paper they intend to publish on the topic. If you were to do an internet search on Ayres/Curtis papers, you would probably find it, but since the authors ask that the paper not be specifically cited, I will leave that to the reader (more hints to come).

Three attorneys at Drinker, Biddle & Reath LLP (Fred Reish, Bruce Ashton, and Joshua Waldbeser) have written a critical analysis directed to the 401(k) community as well as an accompanying "cover memo." If you choose to read them carefully, you might find a way to access the draft paper (Ayres/Curtis).

Essentially, Ayres [and Curtis] has concluded that most participant "losses" in 401(k) plans (losses are cumulative investment returns that are less than optimal) are what they call "menu excess fee losses." While it's not 100% clear to me, I think that they are comparing the cost of a plan's investment menu to the cost of an arguably (or not) comparable Vanguard menu.

FULL DISCLOSURE: I personally have no strong bias for or against Vanguard as compared to their competitors. I have at various times had money invested in Vanguard funds. I know people who work for Vanguard as well as many of their competitors.

There are many factors that the Ayres/Curtis work fails to consider. Reish et al discuss what I would consider to be the large majority of them. I could opine on my own, but for the moment, I will take a different tact.

Suppose you were buying a car. All cars will, at least for a while, provide a capable driver with transportation from one place to another. Some cars are less expensive than others. Should you always purchase the least expensive car that meets your minimum standards? Most readers, I believe, would say no.

Let's return to the real topic at hand. Often times, for a plan sponsor to negotiate the best recordkeeping fee arrangement for plan participants (remember that those fees may be charged back to participants in an ERISA plan), the sponsor must agree to include some of the recordkeeper's proprietary funds in their investment menu. Done properly, the sponsor will have worked with experts internally or externally who have evaluated each of those funds to ensure to their satisfaction that the funds are appropriate for a participant-directed ERISA plan. Presumably, funds that either have poor track records, lack of manager stability, or other red flags that would cause them to be suspect will either not be chosen, or at least placed on a watch list.

As Reish et al point out, most plan committees do strive to fulfill their fiduciary duties. One could surmise this to be the case from the number of lawsuits that have been filed alleging that they are not fulfilling those duties as compared to the number that have not been thrown out by the courts.

Further, the study gathered much of its data from Forms 5500 for the 2009 plan years. Schedule C to Form 5500 is the place where plan sponsors disclose certain fees paid from plan assets. To what extent can a researcher gather this data to determine menu excess fee losses? Do the authors know what Vanguard would be charging the same plan sponsor? Do they know how much the sponsor was paying to the investment firms for each fund? What happens where a plan uses multiple funds from the same vendor and those fees are all listed together? Suppose some of those funds use asset classes not available through Vanguard.

In the limited cases where plan sponsors have been judged to not be fulfilling their fiduciary obligations, I have been critical of them. Personally, however, if I were to perform a study of this sort, I believe that many commentators would tell me that I was fishing for opportunities to serve as an expert for plaintiffs bar. Perhaps Ayres and Curtis are simply performing a service to the 401(k) community. My own feeling though is that they and other academics will always be well-served to seek out the opinions of people who actually work in the field rather than relying entirely on raw data. Perhaps they have, but I have not found evidence.

If Messrs Ayres and Curtis happen to read this, I would be more than happy to allow them to respond to this post. And, to the extent that any of my assertions are incorrect, I will correct them.

DOL Provides Guidance on TDFs

In February 2013, the Department of Labor (DOL) issued a paper entitled “Target Date Retirement Funds – Tips for ERISA Plan Fiduciaries.” Clearly, this is a signal from DOL that this is an issue for plan sponsors and their plan committees to watch. But, there are other fiduciaries as well and some have a vested interest in a plan sponsor’s choice of target date funds (TDFs). In this article, we’ll examine the DOL paper and some of its implications, but first we provide some background for those who don’t live in this world on a daily basis.

In 1993, Barclay’s Global Investors introduced the first TDF. While there had been some dabbling in risk-based funds, this was the initial plunge into developing a fund targeted at an individual’s intended retirement date. The evolution of TDFs moved along fairly slowly for the next ten years or so, but in 2006, Congress passed and President Bush signed into law the Pension Protection Act (PPA) starting a veritable explosion in TDF usage in 401(k) and other defined contribution (DC) plans.

The impetus was a provision in PPA establishing the qualified default investment alternative (QDIA), the investment that a plan sponsor uses as a default for moneys in participants’ accounts not otherwise designated for investment. The law and its guidance established that QDIAs should be one of these:

•  A fund that takes the participant’s age or retirement date into account
•   An investment service (managed account) that takes the participant’s age or retirement date into account
• A balanced fund
• A money market fund, but this can only be used for the first 120 days

According to the 2012 Janus/Plan Sponsor survey, approximately 75% of all defined contribution plans have chosen target date funds as their QDIAs.

Today, there exist a wealth of TDFs of many shapes and sizes. Virtually all of them have in their name a year (multiple of five) that is intended to represent a participant’s expected retirement age. Often, that is where the similarities end. There are “to” funds and “through” funds so named because they are either intended to take a participant to retirement (the participant is expected to take a distribution when he or she retires) or through retirement (the participant is expected to keep his or her money in the plan and draw it down gradually through retirement). There are proprietary funds (those which are essentially a fund of funds run by the asset management institution that manages the TDF) and there are open-architecture (often custom) TDFs composed of those funds that the asset manager thinks are most appropriate for the fund regardless of the manager of the constituent funds. There are TDFs that are composed largely of actively managed funds (these usually have higher underlying expenses) and TDFs that are composed primarily of passively managed funds (usually having lower underlying expenses).

The DOL paper suggests factors that a plan sponsor should consider in its fiduciary decision to choose a family of target date funds, often as the QDIA. Specifically, the paper points out investment strategies, glide paths (this is the move from a more aggressive equity-heavy strategy far from retirement to a more conservative strategy closer to retirement), and investment-related fees.

Plan sponsors should consider this DOL guidance carefully. While there is nothing in the paper that suggests that a plan sponsor must follow the DOL’s suggested steps, one would certainly think that plan sponsors that do so may relatively well shield themselves from costly losses in litigation. No strategy is foolproof, but if I were on a jury or if I were a judge and I heard that a plan sponsor did exactly what the Department of Labor suggested, such evidence would often compel me.

The paper spells out these eight steps:

• ·         Establish a process to compare and select TDFs
• ·         Establish a process for periodic review
• ·         Understand the fund’s investments and how they will change over time
• ·         Review the fund’s fees and investment expenses
• ·         Ask about the availability and appropriateness of non-proprietary TDFs
• ·         Communicate with your employees
• ·         Use all available sources of information in evaluating and selecting your TDFs
• ·         Document the process

I am going to add two more items to this list. First, a number of defined contribution recordkeepers are affiliated with or owned by asset management firms. Some of them will only take on a new client if their own proprietary TDFs are used as the plan’s QDIA. It may be acceptable to begin by using these proprietary TDFs as the plan’s QDIA, but when you use recordkeepers of this sort, you will certainly have a contract for services for several years. The contract will offer you financial disincentives to change TDFs to those provided by another vendor. It aligns well with the DOL’s advice to not engage in such a contract. Doing so could put you in a poorly-performing family of funds that you cannot switch out of without incurring significant fees (usually passed on to the participants) or in a very expensive family of funds that are subsidizing hidden fees or both.

Second, the DOL’s final piece of advice (of the eight) is to document the process. Documentation of processes is an excellent idea. It’s especially an excellent idea if you follow your own processes. However, a number of companies (see for example, Tussey v ABB) have lost or settled litigation when they did not follow their own documented processes. Not having a documented process is bad, but documenting what you should and will be doing and then doing something else is probably much worse.

Several points that the DOL makes are particularly noteworthy. Consider, for example, a proprietary family of TDFs composed of high-expense actively-managed proprietary funds. While not all TDFs are set up this way, the following is a possible scenario:

• ·         Family of TDFs is composed of high-expense, actively-managed proprietary funds
• ·         The TDFs come with an underlying investment expense
• ·         Each of the underlying funds in the TDF provide a return net of expenses

In this case, the TDF is essentially double-charging the plan participants. Each of the underlying funds has a significant investment expense and, at the same time, the overall fund comes with an additional investment expense. The DOL paper points out how an account balance of $25,000 compounded at 7% per year for 35 years will accumulate to approximately 40% more than the same account balance compounded for 35 years at 6% per year. Put into more practical terms, for a younger employee, the 40% implicit cost of much higher investment fees may be insurmountable.

Finally, the paper points out the importance of defined benefit (DB) plans in selection of TDFs. While it is true that far fewer employees are covered by DB plans than were 25 years ago, a significant number still are. While the paper doesn’t use these words, it makes clear that plan sponsors that also provide broad-based DB plans might consider those defined benefit amounts as a fixed income investment for participants. In such cases, using a more aggressive TDF is likely appropriate.

The DOL paper is not formal guidance. It’s not part of a regulation on fiduciaries. Following the DOL’s advice in this case is not, per se, required. But, a word to the wise: other such pieces of informal guidance have been considered safe harbors by courts. Plan sponsors and their consultants might wish to consider this publication that way as well.

The Accidental Fiduciary

Lots of people in business aspire to be on a corporate board of directors. It's a position of power. It's a position of prestige. You get to rub elbows with movers and shakers. Depending upon whose board it is, you may get paid a lot of money. And, you may be an accidental fiduciary in a retirement plan.

What was that? What did you say, dear blogger author person? Did you just tell me that being on a corporate board could saddle me with fiduciary responsibilities in a corporate retirement plan? Doesn't that mean that I am mutually and severally responsible for ensuring that what goes on in the plan is done in the best interests of plan participants?

How in the world did this happen?

You may recall that earlier this month I posted about the dangers of boilerplate work. Back then, I did it in the context of providers bidding low amounts to provide services and then providing you with exactly the same work product they have given to everyone else. It's not just consultants, some attorneys do this as well.

Just last week, I was speaking with an attorney friend of mine (yes, even an actuary can have an attorney friend or two). He warned me that this was going on and while I was not surprised to hear it, I was a little surprised with regard to the specific context.

And, then I saw it. With my own two eyes, aided by some pretty spectacular reading glasses, I saw it.

The Plan Committee shall be responsible for the operation of the Plan. The Board of Directors, or if so specified by the Board of Directors the Compensation Committee of said Board, shall be responsible for the selection of said Committee.

Bam! That's how a Board member can become a plan fiduciary and be legally and financially responsible for the actions of that plan committee.

Maybe being a corporate board member has some downside, too.

Don't Overestimate the Value of Survey Data

I saw some interesting data this morning. According to their quarterly Retirement Pulse Survey, Charles Schwab found that 35% of investors consider protecting their retirement assets more important than increasing them. Conversely, 8% believe that increasing them is more important than protecting them. What about the other 57%?

Unfortunately, the write-up that I saw has only sparse data (not a Schwab write-up, so I am specifically not placing blame on Schwab).

In any event, the headline from the Plan Sponsor News Dash was "Americans Most Want to Protect Retirement Assets From Risk." While that may be true, the data is not conclusive to this. 57% gave some other answer and I don't know what those answers are.

One can easily rationalize. Older plan participants probably fall into 3 categories:

• Those who feel their assets are or will be sufficient to retire
• Those who think they are close to where they will have sufficient assets to retire
• Those who either think or know that their assets will not be sufficient to retire

That final group needs to increase their assets. There are exactly two ways to do this: save more and get better returns. Being risk-averse just won't cut it. This is not me advising them, this is common sense. 

The News Dash write-up suggests to me that younger plan participants are more risk-averse. Could this be because they have not seen the big market booms in their investing lifetimes. As an investor, even in good times, the 2000s have not been pleasant. While there have been lots of good months, there have been lots of bad months. At this point in my life, volatility is not my friend.

So, going back to the data, taken in chunks, it could be misleading. I would hope that without closer review that plan sponsors don't put too much credence in the headline.

However, would it not be worth it for a large plan sponsor to learn the attitudes of its own plan participants? Are they risk-averse? Or, are they risk-takers? Shouldn't the fund lineup be commensurate with the goals of plan participants? If it's stability they want, shouldn't the plan's Committee have a lineup with a higher propensity of lower volatility options? Conversely, if the company has a bunch of natural risk takers, is it not appropriate that the find lineup be reflective of that?

Perhaps? What is the role of the Committee? Ultimately, they are to act in the best interests of plan participants. Nobody knows exactly what that means. But, it seems to me that meeting the needs or perceived needs of plan participants is not contrary to that role.

So, don't overestimate the value of broadly available data. I suggest you collect your own.

401(k) Fee Case Decided on its Merits -- Plaintiffs Prevail !!

We knew that it was coming. Sooner or later, a 401(k) excessive fee case was going to be decided by a court of law on its merits rather than being settled before a court could rule. If you like, you can download a pdf of the decision in Tussey v ABB, Inc. here. This case may not be over, though. The ruling was made in the District Court for the Western Division of Missouri, Central Division. Missouri lies in the 8th Circuit, not one of the ones bemoaned by the legal profession for its entirely odd decisions.

So, what happened?

ABB, a company with significant US operations, but a Swiss parent, has maintained two 401(k) plans (union and non-union) in the United States. ABB and its 401(k) plans were fairly long-term recordkeeping clients of Fidelity. However, Fidelity was not only the recordkeeper, but also a 3(21) investment advisor. The plans offered primarily Fidelity investment options. Over time, Fidelity became not only the TPA for the 401(k) plans, but also for ABB's pension plan, its health care plans and its payroll services.

The judge in the case was Nanette Laughrey, a 1995 Clinton appointee. The Wikipedia article on her describes her as "a stern judge." Judge :Laughrey's decision is thick. It reads a full 81 pages and is not complimentary of the actions taken by defendants. In fact, in my reading, the only thing that I could find for which she did not berate defendants was that they did, in fact, have an investment policy statement (IPS). Whether this worked in their favor or against them is not clear.

On to the case itself. The Court gave significant weight to the testimony of an expert witness on fee issues. The expert analyzed the fees that the plans paid over a 6-year period. On average, according to testimony, those fees ranged from approximately $65 per participant to $180 per participant per year. The same expert found that a reasonable fee would have been in the range of $44 to $70. Paramount in the expert's comparison was that of the ABB plans to the Texa$aver Plan, a non-ERISA governmental plan. At the beginning of 2000, ABB's 401(k) plan assets were approximately $1.4 billion while the Texa$aver Plan had somewhere north of $1 billion.

It gets worse. ABB did the right thing, but made the right thing bad by ignoring its own process. In 2005, whether it was a serious fee check or merely to check a box on its IPS, ABB hired Mercer to review its fees. Mercer found three problems: 1) the fees that ABB was paying to Fidelity were excessive, 2) the fees paid by the plan were subsidizing other non-plan services that Fidelity was providing to ABB, and 3) when plan assets increased, ABB paid higher fees under a basis point arrangement, but when plan assets decreased, Fidelity charged additional hard dollars to make up the difference; in other words, Fidelity was collecting increased dollars for the same amount of services.

The words of the Court could be particularly troubling to ABB. While the opinion is relatively scathing from beginning to end, here are some of the most troubling issues cited:

• The IPS stated, "[a]t all times ... rebates will be used to offset or reduce [emphasis added] the cost of providing administrative services to plan participants." In failing to due this, ABB violated its own IPS and breached its fiduciary duty.
• In some cases, the plans used Fidelity share classes that were not the least expensive available to them. This was expressly in violation of language in the IPS saying that they would choose the share class with the lowest expenses. This, the Court found, violated their duty of fiduciary prudence.
• While the Court did not find revenue sharing, per se, to be problematic, it noted that ABB allowed Fidelity to take revenue sharing as a means of covering recordkeeping costs, but that it did not offset or reduce administrative costs, in direct violation of ABB's IPS. 
• In 2000, ABB removed the Vanguard Wellington Fund (a balanced fund) for poor performance. It replaced the Wellington Fund with Fidelity Freedom Funds (target date funds or TDFs). Again, their own IPS worked against them. It required a review of a 3-5 year performance (if that period existed) and if there were 5 years of underperformance, a fund went on the Watch List. After 6 more months, it could be removed. The Wellington Fund had a 70-year track record. That track record was exceptional. Additionally, over the 3-5 year monitoring period, it beat its Morningstar benchmark by more than 400 basis points.

To this, the Court noted "suspicions" about the "conflicted relationship" between ABB and Fidelity. The Court supposed that the relationship "infected far more than the specific instances" that plaintiffs had raised as fiduciary breaches. 

The Court found the following damages:

• $13.4 million in lost fees for failure to properly monitor recordkeeping costs
• $21.8 million in the mapping from the Wellington Fund to the Fidelity Freedom Funds
• $1.7 million against Fidelity for improperly retaining the float on plan benefits

Remember, the 408(b)(2) fee disclosure regulations will finally take force this summer. Data such as this will be much more transparent. Plaintiffs bar will be monitoring.

If I were an ERISA plan sponsor that was paying fees from an ERISA trust, I would do all of the following post haste:

• Ensure that an Investment Policy Statement is in place
• Ensure that the IPS is being followed
• Consider whether any fees that are asset-based rather than service-based satisfy the fiduciary duty of prudence
• Confirm that the IPS policies and procedures for monitoring of funds and replacing funds are being followed
• Benchmark your fees

DOL Finalizes Fee Disclosure Regulations.

It's been nearly two weeks since the Department of Labor (DOL) finalized its regulations under
Section 408(b)(2) of ERISA. For those of you who are more words people than numbers people, those are the fee disclosure regulations that require service providers (vendors) to inform plan fiduciaries just how and how much those vendors are getting paid for their services.

It's been interesting hearing some of the observations to the finalizing of this regulation. One experienced retirement practitioner noted to me that this regulation was the result of a recent law change. Hmm, ERISA, recent, Gerald Ford signed it into law and he died in 2006. He last signed a piece of federal legislation in 1977, not exactly recent in the benefits industry. Another experienced benefits practitioner remarked that these regulations were the result of a new government agency established under the Obama Administration. Well, for those of you who are not fans of our current president, there are many things that you could probably choose to blame him for, but I can assure you that President Obama did not create the Department of Labor.

On to the actual guidance ... I'm going to assume that if you are reading this that you have at least some knowledge of the history of this regulation. If not, you can certainly look in this blog under the label "Fees" or in thousands of other places on the internet. Or, you can read my take here or here.

Effective Date


The effective date is now July 1, 2012, postponed from April 1, 2012. Since an earlier DOL pronouncement synced the timing of the effective date of this regulation with the participant-level disclosures under ERISA Section 404(a)(5), the initial disclosures for calendar-year plans under those regulations will be due on or before August 30, 2012.

Electronic Delivery


The body of the regulation is silent. However, nerdy people like me who read a lot of regulations from the DOL and IRS know that in recent years, the preamble to regulations is often (read that as almost always) far more useful and informative than the regulation itself. The preamble, in this case, tells us that there is nothing in the regulation that would limit the ability of service providers to furnish fee disclosures electronically including making that information available on a website so long as participants are notified how they may access those disclosures. [Tell me, why doesn't the government do what a normal person would do and specify in the regulation what vendors can do to fulfill their requirements?] In any event, the regulation indicates the DOL's expectation that 50% of disclosures will be provided electronically. I expect that the DOL's margin of error in making that statement is not more than 50%.

The Disclosure Goesintas


For the uninformed, goesintas is an old term (I think it comes from 298th century BCE (we used to call that BC) Aramaic) for what goes in to something. The analogue for the really curious is the comesoutas. For the most part, this has not changed from earlier proposals. However, at some point in the future, the DOL may require service providers to give fiduciaries a guide to understanding the disclosures. For the time being, there is a sample guide in an appendix to the regulation. And, there is a placeholder in the regulations for such a guide.

For the curious, the sample has two columns. The first column lists services [to be] provided. The second column shows where in the service agreement (if you don't have a service agreement, you can't use this) that service can be found or where information related to investment fees and expenses can be found online.

Enhancing the Technical Details


Service providers will be required to provide to plan fiduciaries sufficient information to assess the reasonableness of both direct and indirect compensation. While the interim regulation required the service provider to at least estimate the amount of indirect compensation it expects to receive, the services for which that compensation is to be received, and from whom that compensation is to be received, the final regulations require that the relationship between the service provider and the payer be disclosed. So, for example, under the final regulations, the service provider might identify a payer as a subcontractor, an affiliate, or a subsidiary.

Certain investment products are often referred to as look through investments. In 401(k) plans, for example, perhaps the most common of these are collective investment trusts (CITs). Under the interim rule, the disclosures were required to contain:

1. compensation charged directly for acquisitions, sales, transfers, or withdrawals
2. annual operating expenses or expense ratio unless the product's return is fixed
3. ongoing expenses

Under the final regulations, a designated investment product (DIA) need not disclose numbers 2 and 3. Instead, it must disclose total annual operating expenses which in turn must be disclosed to participants under the disclosure regulations that apply to them.

What Brokers and Recordkeepers Have to Tell Fiduciaries

The change from the interim rules appears to be fairly subtle in this regard. For most organizations, I think it will be. Under the interim rules, recordkeepers with DIAs on their platforms were required to provide certain DIA information on their platforms. They could satisfy that requirement by passing through information from the issuer, typically a prospectus, but the materials had to be regulated by a governmental agency. The new rules change the government oversight. No longer do the materials need to be regulated, but instead, the issuer of the pass-through materials needs to be regulated. Further, the issuer may not be affiliated with the recordkeeper in order to use the pass-through rule, but the regulations indicate that the requirement can be met by replicating materials.

... time out for a rant ... what is the significance of copying and pasting as compared to just passing through? I don't think I am overly stupid, but this seems like burden for the sake of burden.

... now we return to our regularly scheduled programming ...

Information Requests

The interim rules required service providers to respond to requests (for Form 5500, for example) for additional information from fiduciaries within 30 days. The final regulation changes that to "reasonably in advance" of the governmental filing deadline.

Corrections

In keeping with the interim rule, the final rule says that corrections to disclosures must be provided within 30 days. The final rule, however, adds that such corrections must include errors and omissions, not just corrections.

Cost

Where there is an explicit fee agreement (e.g., contract) in place, this information must be disclosed. Where there is not, the final regulation specifies that reasonable estimates must be made and that any assumptions used to make those assumptions must be disclosed. Further, the final rule indicates that ranges may be used as a reasonable method of disclosure of compensation. However, the final rule states that where more precise information is available, it is to be disclosed.

So, that's about it. The remainder is generally unchanged. Since this is a final rule, and we haven't heard people screaming yet, it looks like disclosures will begin being provided by mid-year. That's not bad. ERISA was signed into law on September 2, 1974 (Labor Day). We get required disclosures in less than 38 years.

Of Course It's Time for a Better QDIA

The Pension Protection Act of 2006 (PPA) brought us lots of new terms and concepts. One of the more controversial has been the qualified default investment alternative or QDIA. Essentially, what it did was to require participants who did not make affirmative elections otherwise in defined contribution (DC) plans to be defaulted into a QDIA. On an ongoing basis, and oversimplifying somewhat, the Department of Labor (DOL) regulations give plan sponsors three broad alternatives in selecting their QDIAs:

1. Age-based funds
2. Risk-based funds
3. Managed accounts

Our observations suggest that the most prevalent have been age-based funds, largely in the label of Target Date Funds or TDFs. In a nutshell, a participant picks a year in which they expect to retire, rounds to the nearest multiple of five, and voila, they have a fund. Or, in the situation where a participant is defaulted into a TDF, the plan document uses the same algorithm and without the active consent of the participant, his or her money is in a fund.

The companies that serve as both DC recordkeepers and asset managers love this. To my knowledge, they all have TDFs that they actively market as part of their recordkeeping bundles, and each of these families of TDFs are proprietary funds of funds. In other words, a Fidelity TDF is composed of Fidelity funds and a Vanguard TDF is composed of Vanguard funds. The same could be said about the other asset management firms who are also DC recordkeepers. Perhaps there are one or two out there that do not fit the mold, but I am not aware of them.

This is not to denigrate the current state of TDFs, but I think we can do better. And, so, in fact, do plan sponsors. In a November 2010 study commissioned by PlanSponsor and Janus Capital, only 34% of plan sponsors (down from 57% in November 2009) thought a TDF was the best QDIA available for their DC plan. Or, stated differently, nearly two-thirds of plans (clients) don't like the product that is being pushed upon them. If you were a car manufacturer and two-thirds of potential consumers didn't like your product, you would likely need a bailout. If you made computers and two-thirds of the users thought your machines had the wrong features, you would need to re-think what you were producing.

Well, the large players in the market don't appear to see the motivation to re-invent the TDF, so as I am wont to do, I am going to consider the re-invention for them.

Today, when a participant is defaulted into a TDF, the sponsor (and recordkeeper) uses one data item to make that decision -- age. You would think that was the only data point they had. Well, if Bill Gates and I were both in the same DC plan, we would probably both be defaulted into the 2020 Fund. And, trust me, Bill Gates and I are not in the same financial circumstances. I know you find this shocking, but it just isn't so. The fact is that we do not have the same net worth as each other (I'll leave it up to my readers to work out who is worth more).

But, assuming that we were active participants in the same plan, here is some other data that our plan sponsor would have on us:

• Compensation
• Years of service with the company
• Account balance
• Rollover balance
• Savings rate
• Gender
• Whether our jobs are white-collar or blue-collar
• Accrued benefit in a defined benefit (DB) plan, if our employer sponsors one
• Whether we are eligible for company-provided equity

Each of these is likely to have an effect on our readiness for retirement at any point in time. Let's go through them quickly to see how.

Compensation. That's an easy one, but in general, the more money that an individual makes, the more likely it is that they will be able to retire earlier as compared to later.

Years of service. Continuity with the same company tends to result in larger DC account balances and larger DB accrued benefits making it more likely that a participant will be able to retire at a younger age.

Account balance and rollover balance. The bigger your balance, the closer you are to your retirement goal.

Savings rate. The more you are saving, the less time it will take you to get from where you are to your retirement goal.

Gender. Without regard to other factors such as health and family history, women will, on average, outlive similarly situated men, and therefore need a larger account balance to fund their retirements.

White-collar or blue-collar jobs. Studies done by the Society of Actuaries have shown that white-collar workers outlive blue-collar workers. This suggests that white-collar workers need larger account balances at the same retirement ages.

And, the other two elements may do more to affect the appropriate asset mix for a participant.

Accrued benefit in a DB plan. Accrued benefits in a DB plan can be thought of as a fixed income investment. That is, their value grows (largely) at a discount rate. Having a large DB accrued benefit means that the remainder of a participant's account balance could, and perhaps should, be invested more aggressively.

Access to company provided equity. If a meaningful portion of your compensation is in the form of equity, then you tend to possess a significant undiversified asset. This would suggest that your TDF should have significant diversification.

Again, who has this data? Your employer, the plan sponsor does. Combined with age, this list of parameters could give your employer ten data points with which to appropriately place you in a TDF instead of one. In the coming world of TDFs, this is what should happen.

Perhaps the TDFs of the future will not have years attached to their names, but instead will have letters, numbers, or some combination of the two. And, perhaps, these ten data items (or others like them) can be used as part of an algorithm to place participants into their proper TDFs. 

Finally, while we are redesigning, do we really think that any one asset management firm has a monopoly on all the best funds? I don't think so. Without naming names, I have an opinion on some of the best fixed income funds available in the marketplace. Surprisingly enough (not really), none of the firms that manages those fixed income funds also has, in my opinion, the best large cap equity funds, international equity funds, and real estate funds. So, wouldn't our new age TDFs be better if composed of funds from a variety of providers? I think so. And, if we suddenly had reason to believe that the great-performing real estate fund that we were using in our TDFs might no longer be as great (the main portfolio manager decided to retire), wouldn't we like to have the ability to change real estate funds? I think so.

It's time. Who is going to start the trend?

Prudence in Light of a Credit Downgrade

Paraphrased somewhat, ERISA tells us that a plan fiduciary should handle plan assets in the way that a prudent man would. Historically, many have found that to mean some or all of these:

• Don't take wild risks
• Generally invest in higher-quality fixed income instruments
• In tougher times, take the flight to quality as the returns that you may be giving up will more than be made up for by the comfort of knowing how safe those assets are

But, wait! The flight to quality, often seen as a movement to invest in US Treasuries, is producing negative returns that will likely get more negative as interest rates rise due to debt downgrade. But, you knew that was going to happen, didn't you?

So, did you pull your plan assets out of US Treasuries? If you didn't, was that prudent?

I don't know.

Think about it. Tell me what you think.

Troubling Defined Contribution Case Denied Summary Judgment -- George v Kraft Foods

I had a choice of three paths today: 1) I could opt not to blog; 2) I could blog about Senator Tom Coburn's (R-OK) 614 page proposal to cut $9 trillion from the federal budget over the next 10 years; or 3) I could blog about Northern District of Illinois Judge Ruben Castillo's partial denial of summary judgment on behalf of defendants in George v Kraft Foods. As I did not blog yesterday, I ruled out option #1. As Judge Castillo's decision weighing in at a mere 35 pages seems a far smaller burden on my precious eyes, I selected option #3 over option #2.

So, what's so important about George v Kraft Foods? I find it an interesting case for a few reasons. On the other hand, there is lots of legal wrangling going on there and as I have no formal legal training and offer no legal advice, there are lots of things that I leave out. If you want to know what Judge Castillo said about the oh so compelling concepts of res judicata and collateral estoppel, which I understand can also be referred to as doctrines of claim preclusion and issue preclusion, respectively, I am certain that you will be able to find highly skilled attorneys who will choose to write on these topics.

Here, we do not write about such things. First, we are not qualified. Second, and as important if we are to retain readers, we do not think that most of our readers will find this interesting (if you do, you may be in the wrong place). Here, what we do try to write about are things that regular people can associate with (our definition of regular people is far different from the definition that might be used by the supermarket tabloids, but we like our definition).

This case has been going on for quite a bit of time. As partial background, plaintiffs were participants in defined benefit and defined contribution plans sponsored by Kraft Foods and its successor companies. At some point in time, the Investment Committee for the defined benefit plan(s) elected to change the investment policy to hold 5 years worth of benefit payments in fixed income instruments and the remainder in S&P 500 Index funds. This was done after what appears to have been fairly comprehensive analysis that included the determination that large cap equity investments represent a fairly efficient market, and as such, a passively managed index fund is likely to outperform an actively managed fund in the same asset class, net of fees.

Concurrent to this analysis, the (I understand it to be the same one) Committee maintained a fairly rigorous process of monitoring the investment options available to participants in the defined contribution plan(s). The options made available to participants did not exclusively include passively managed funds. This was the basis for the most interesting of the plaintiff's claims.

Plaintiffs have asserted that the same ERISA standard of prudence applies to defined contribution plans as to defined benefit plans. In this assertion, they are undoubtedly correct. Plaintiffs further assert that Kraft and its Committee violated the ERISA standard of prudence by not offering low-cost, passively managed options in the defined contribution plan when they made that change in the defined benefit plan.

Defendants sought summary judgment. (At this point, we must insert our undereducated legal knowledge to explain.) In a motion for summary judgment, the Judge must consider that a jury will look at all of non-movers (Plaintiffs, in this case) claims in the most favorable light possible and still find no reasonable basis on which to rule in favor of non-movers. In this particular case, Judge Castillo has found that a jury could reasonably find in favor of Plaintiffs, so he denied summary judgment.

Is this a horrible ruling? I don't know. I haven't read all the pleadings of Plaintiffs and Defendants (and I'm not going to). It's the Judge's analysis, though, that bothers me. The Judge's own writing (in his opinion) underscores that Defendants engaged in a truly thorough and rational process of evaluating investment options in each type of plan. Clearly, Defendants do not have the ability to foresee or foretell the future. But, I have seen far lesser analysis from other Committees whose Counsel advised that they were acting prudently.

Defendants argued that "it makes no sense to judge fiduciaries' actions with regard to a defined contribution plan in light of actions taken with a Defined Benefit Plan." Further, Defendants asserted that "the prudence of a defined contribution plan fiduciary in selecting investment options to offer cannot be determined by
looking to his decisions as fiduciary for a Defined Benefit Plan-the two are not enterprises of 'like character and with like aims.'" Defendants finally claimed that while a shift in investments in the defined benefit plan may have made sense for that plan, such same shift may not have been appropriate for the defined contribution plan.

Judge Castillo either does not agree, or does not feel so strongly that a jury could not possibly disagree.

I do not know whether to struggle more with the Judge's ruling or with the arguments put forth by Defendants. There is a good reason for this -- I have not seen all of Defendant's arguments, only the ones cited by the court.

Here are some of my thoughts. A prudent person, when selecting the investment options for a retirement plan, must consider the obligations being supported by those assets. In a defined benefit plan, there is one pool of assets available for one consolidated (over all participants) pool of obligations. A defined benefit plan is assumed to be ongoing, essentially for perpetuity unless there is evidence to the contrary. A defined contribution plan, on the other hand, has as many pools of obligations as it has participants. So, in prudently selecting available investment options in a defined contribution plan, one could argue that there should be options available appropriate for each separate pool of obligations. This necessarily makes the analysis for defined benefit and defined contribution plans different.

While it may still be possible that a reasonable jury would rule against Defendants, I do not find the Judge's analysis to be reasonable.

For plan sponsors, at least those that maintain multiple plans that may have reason to have different investments to cover their obligations, this adds a significant wrinkle. I cannot recall ever having seen a company that sponsored both types of plans consider the investment strategy for its defined benefit plan(s) when choosing available investment options for its defined contribution plan(s).

For the time being, in light of Kraft, perhaps it would be advisable for Committees to specifically document why the DC investment options may not mirror the assets underlying the DB obligations. Frankly, this may mean that for a company that is a sponsor of both types of plans, a DC investment adviser who is not fully schooled in the vagaries of DB plans may not be sufficient. And, conversely, a DB investment adviser will need to be equally competent on the DC side of the spectrum. The number who can handle both is smaller than one may think. I know where you can find a few.

Choosing Your DC Fund Lineup

How do you choose your defined contribution (DC) fund lineup? Do you follow best practices? Do you know what best practices are? More importantly, does your plan have an investment policy, and if it does, do you follow it?

I took an informal poll of some people on DC plan committees. Here are the questions that I asked them:

1. Does your plan have an investment policy statement?
2. If it does, do you follow it?
3. Would an impartial, outside arbiter say that you were following it?

The answers that I got surprised me, but perhaps I shouldn't have been surprised. To question #1, 14 people said yes, 5 thought they had one, and 1 didn't think they had one. To question #2, of the 14 who said yes on question #1, 9 answered yes, 4 were non-committal, and 1 said no. To question #3, of the 4 non-committal to question #2, all said no, and of the 9 who answered yest to question #2, 8 said no.

Perhaps the Department of Labor (DOL) would be an impartial arbiter. Perhaps a judge or jury would be an impartial arbiter. Only 1 in 20 thought they would get a seal of approval from such a person or group. That's pretty frightening, and the fact that I told each person that I questioned that my tallying of votes would be with tick marks only got some honest answers. Even in retrospect, I know the results of my poll, but I couldn't tell you who answered how. And, even if I could, I wouldn't. I won't tell you company names, industry classifications, or even the blood types of my respondents.

I took some time to reflect on this poll -- actually, I didn't take very much time. But, I did think about it. From my experience, here are some areas where I think that plan committees fall might short in following their written investment policy.

• They are too slow to 'fire' a fund. If a fund has a good name or historically has performed well, but then has a significant period of time where it inexplicably underperforms, committees are slow to replace it.
• They bow to pressure from recordkeepers to use proprietary funds because of the 'credits' that they get for it (lower recordkeeping fees because of a larger offset).
• They don't look closely at style changes/style drifts in funds. Oversimplified, if the investment policy says to offer one mid-cap value fund and one mid-cap growth fund and the value fund has gradually drifted to growth, committees are slow to replace the no longer value fund.
• They don't follow the investment policy when choosing target date funds (this one deserves a longer write-up than just a bullet point).

So, what's the problem with target date funds (TDFs)? They are not inherently bad, but especially after PPA (2006) established the concept of a qualified default investment alternative (QDIA) for which TDFs fit the bill perfectly, they became the next big money maker for everyone who could find an angle. For proprietary TDFs, most are just funds of proprietary funds, but the level of fees is a bit higher than it would be for someone who just invested in the proprietary funds and rebalanced periodically themselves. I guess what the participant is paying extra for is the discipline of rebalancing.

If you decide to have TDFs in your plan lineup, but don't want to use proprietary funds, there are plenty of people out there who will design TDFs for you. They will tell you that they will choose from among only the best performers in each asset class to create these custom TDFs. And, for that, they will often charge you a pretty penny. This, of course, will be in addition to the fees that participants get charged. From what I have observed, most of the providers who are offering this service don't have the discipline that the proprietary TDFs do. They may not rebalance quite on schedule. They may make bets on the market that are probably inappropriate.

At the end of the day, though, when you, as a committee member, are evaluating candidates to be the TDFs for your plan lineup, do you consider the plan's investment policy statement? Will you change TDFs if they are underperforming? For that matter, what does it mean for a TDF to underperform? Does your plan's investment policy statement tell you? Do you have a way of monitoring whether the TDF is staying true to its stated style, its stated goals? If you do have that way, do you use it?

In theory, TDFs are a wonderful idea. In practice, however, in my opinion, generally, they remain flawed. Some are better than others. And, they do tend to avoid haphazard practices such as market timing, but I have not seen one yet that some smart, unbiased person couldn't poke holes in. Does this mean that you, as a fiduciary, are in trouble once you put a family of TDFs in your fund lineup? It could, but it doesn't have to. Make sure your investment policy statement is clear with regard to TDF selection and TDF monitoring. Then, follow that policy statement, and document it. Did you read that part? Document that you have followed the investment policy statement.

Doing as They are Doing, Not as They are Saying

Trivia buffs could tell you that the only X-rated movie ever to win the Oscar for Best Picture was Midnight Cowboy (I know, it wouldn't have been X-rated 10 years later, but they had different standards back then). Many who know that would know the theme song from the movie, but paraphrased slightly and with apologies to Harry Nilsson, it could also be the theme for today's defined contribution (DC) plan sponsors:

Everybody's talking at us, But we don't here a word there saying, only the echoes in our minds

Great song if you're one of the six people who has never heard it. But, why, you might ask is this lunatic who hasn't been blogging this week (I talk some time off for the birth of a granddaughter) writing about a 40+ year-old song? Aon Hewitt did a survey of DC plan sponsors and found that only 3% plan to add in-plan annuity or insurance products to their plan in 2011. But, in other surveys, those same plan sponsors are saying that such products are a hot topic and that they are on of their highest DC plan priorities.

Get the song reference now?

Instead of going down what they are hearing and even know is the right path,

They're going where the sun keeps shining, through the pouring rain, they're going with what's closest to their nose

The simple fact is that nobody wants to be first. Yeah, I know, somebody has to be first, but that is often a road fraught with mine fields. But, there was a first 401(k) plan. There was a first cash balance plan. There was once a first target date fund, and now, flawed as they are, very few sponsors are afraid to walk that road once less traveled.

So what are the holdups? In my opinion, it all falls under the category of risk. Once upon a time, if there was no regulatory guidance, the prevailing strategy was to just go out and do it, but no more. With apologies to The Shadow, who knows what evil lurks in the hearts and minds of plaintiff's bar? Litigation is rampant. As a plan sponsor, even if you know you can win, the cost of defense may be prohibitive.

And, look at the guidance that we do have.While we don't have to worry about the safest available annuity rules for DC plans since PPA, the DOL's annuity guidelines for DC plans don't leave much more room for exploration. Having one of these products in your plan is a fiduciary decision. Title I of ERISA is fruitful ground for litigation. Is your plan ready to be the test case?

What happens when your employees leave your company? Can they actually roll these new-fangled products into their new employer's plan? That's a tough one, but as of today, the answer is probably that in most cases, they will have to find a way to keep that option when they leave.

So, everybody seems to want something, but nobody's doing it yet. What might change that?

1. A safe harbor for these products in DC plans so that fiduciaries going down this path will have less worry of regulatory or even litigation issues.
2. A more fertile field of products which will only come when more plan sponsors adopt these sorts of products for their plans.
3. A requirement that DC plans have some sort of lifetime income option as compared to just lump sums (taken by virtually all participants) and installment options. Of course, participants, even those who know that a lump sum has no longevity protection, are currently unlikely to consider anything else.
4. Reasonable fees. The risk for insurers in offering products of this sort are high, especially when there is anti-selection among the group of people electing them. Insurance companies are not in business to lose money, so fees and expenses are currently high. As the market becomes larger, so perhaps will fees and expenses become more competitive.

We're not there yet, but to complete your lyrical madness for the day, perhaps sometime soon, plan sponsors will be moving from where they are and 

Backing off of the lump sum wind, sailing on annuity breeze, skipping over ERISA like a stone ...

DC Plan Investment Prudence -- How About Your Own Funds?

I think we may have the first fiduciary litigation of a slightly new style. Barbara Fuller, a former 38-year employee of SunTrust Banks, has filed suit against the company, its president, members of the Board who served on the Compensation Committee, and the bank's investment and capital management subsidiaries.

Here is the new twist: the suit alleges that SunTrust monitored non-SunTrust funds carefully, and terminated those managers who underperformed or whose fees were unreasonable, except for one. That one was funds that were managed by SunTrust or a subsidiary. In other words, according to the complaint, when a SunTrust fund underperformed or charged excessive fees, it was not terminated. Ms. Fuller asserts that this mismanagement resulted in losses in the tens of millions of dollars due to excessive fees and poor investment performance. A spokesman for SunTrust said that "[W]e believe the suit to be without merit and we will vigorously defend ourselves."

Let's step back for a second and consider, without attempting to consider the merits of this particular litigation, the issue here. I suspect that all large banks and other investment management firms in the US face this particular dilemma. Probably all of these companies sponsor a 401(k) plan. Further, I believe that all of these companies, or certainly most of them, have funds which they seek to have chosen as investment options in defined contribution plans. The plan Committee is under a fiduciary obligation to monitor all of the plan's investment options, and presumably, to monitor all of them in the same fashion.

We are about to go into a hypothetical. While some of these hypothetical facts and circumstances may resemble those in the SunTrust plan  in question, such resemblance is purely accidental. As such, this is not intended to place blame on the SunTrust Committee, nor is it intended to absolve them of such blame.

Now, let's put you, dear reader, in the shoes of one of the Committee members. You are looking at your most recent quarterly reports for all of the funds offered in your plan. Let's say that there are 25 of them. Of the 25, let's assume that 15 offer no good reason for removal; that is, they have consistently been top or second quartile performers, net of fees, and there are no red flags (such as manager change or style change) that suggest that there is reason for new concern. That leaves 10 funds that deserve some scrutiny.

For sake of identity, we're going to call your company Really Big Investment Management People, or RBIMP. As you are performing your Committee function, you notice that of the 10 funds on your 'I need to look at this group of funds really carefully' list, 6 are RBIMP funds. Ouch!

If the RBIMP 401(k) Plan fires its own funds, word will probably get out. And if that happens, those funds may lose other mandates, and if that happens, RBIMP's profits may go down, and if that happens, your bonus is going to be smaller, and those stock options that you already have are going to be worth less.

Uh oh.What are you going to do?

Now, I know that if you are one of my readers that you will take the high road and look at RBIMP's funds exactly as you look at all the rest of the funds. So, at the next meeting, you vote (on the record, of course) to terminate two of those six RBIMP funds and to put three of the other four on a watch list. You argue that the remaining fund has changed managers as a result of poor performance and that it deserves a few quarters to see if it will turn things around (yes, maybe it should go on a watch list as well, but that's not your vote). But, the vote comes down and a few of your Committee colleagues do not hold themselves to quite as high a standard as you do, and the votes are to not even put any of the six on a watch list. Next quarter, when you reconvene, the five funds that concern you have underperformed again, and the Committee still decides to take no action with regard to them.

Is this outside the realm of possibility? I don't think so. Do I think this is happening for real? I don't know, I've never done a study to see whether this practice actually occurs. Do I think this could happen? Absolutely!

This case was just filed on March 11, so there are as of yet no interesting twists and turns, but as this appears to be the first of a genre, I thought you should read about it here.

Top Concerns for Pension Plan Sponsors

An SEI 'Quick Poll' found that controlling funding status volatility is the number one priority for defined benefit plan sponsors. When I look at the Top 10, however, a common theme emerges: Managing Risk.

Here are the Top 10 (in traditional as compared to Letterman order):

1. Controlling funded status volatility
2. Providing senior management with long-term pension strategies
3. Improving plan's funded status
4. Conducting an asset-liability study
5. Effectively managing duration moving forward
6. Implementing a liability-driven investment (LDI) strategy using long bonds
7. Defining fiduciary responsibilities for trustees and investment consultants
8. Changing funding policies and timelines
9. Stress-testing the portfolio to gauge its ability to withstand extreme macroeconomic environments
10. Implementing a plan design change such as closing the plan to new entrants or freezing accruals in already closed plans

It's time to make a few comments on this list. First, who comes up with these choices? #9 was clearly the brainchild of someone with too much time on their hands trying to sound smart. Isn't that what you do as part of #4? Second, all ten of them address some element of risk management. Third, of the companies that chose #8, I wonder for how many of them, changing funding policies is the same thing as actually having a funding policy.

401(k) Participants Want More Advice

Do you sponsor a 401(k) plan? Do you participate in a 401(k) plan? I would bet that if you live in the US that at least one of these is true, otherwise you wouldn't be reading this.

NEWS FLASH: A recent Wells Fargo survey indicates that many participants do not know how much money they will need for retirement. However, 79% said they want more advice from their employers. Further, large numbers (spanning all 5 generations, presumably Boomer, X, Y, Millennial, and Z) would favor legislative and or regulatory change to facilitate the provision of such advice by employers.

82% of respondents said that a lifetime income option should be made available. Why is it then that in situations where the plan does not offer such an option, virtually nobody buys their own annuities? Could annuity design be bad? Is pricing bad? Are the participants from the ' do as I say not as I do mold?

Perhaps most alarming is that 56% of 50-somethings are confident or very confident that they will have the money they need to maintain their existing lifestyle in retirement, yet the median retirement savings of those aged 50-59 is just $29,000 according to the survey. I agree that this is alarming -- very alarming. But, I am going to call out Wells Fargo on this one. How do you know that their median retirement savings are only $29,000? Do they have all their retirement savings with your bank? Are you sure? I have one 401(k) account balance with something less than $15,000 in it at the age of 53. Does that make me unprepared? Does whoever would be researching me know if I have any pensions? Do I have any IRAs? Outside investments? Other 401(k)s? I've seen this sort of statement many times from most (perhaps all) of the big players in the recordkeeping business. Shame on all of them.

I'll go back to being nicer now. I agree with most of Wells Fargo's conclusions. The current system isn't working. Congress needs to be part of the solution and IMHO, they have more frequently been a big part of the problem.

Life on an Investment Committee

Nevin Adams, editor-in-chief of Plan Sponsor and its News Dash publication writes a great little "IMHO" piece about being on a plan's investment committee. To sum up:

• If you are on an ERISA plan's Investment Committee, you are an ERISA fiduciary
• Once you are an ERISA fiduciary, you have a personal liability
• On the Investment Committee, you are responsible not only for your own decisions, but the decisions of others

You can read Nevin's article here: http://www.plansponsor.com/IMHO__Liability_Driven.aspx

There are several court cases out there right now that rely on this theory. Unfortunately, I am temporarily precluded from writing about the most interesting of the bunch of them.

Do You Know if You are a Retirement Plan Fiduciary?

Everyone who works with a retirement plan should act in a fiduciary manner, but many have claimed over time that they are not fiduciaries. Why? They don't want the obligations, they don't want the responsibilities, they don't want the liability.

Until recently, it was fairly easy for outsiders (3rd party providers) to stay outside of the definition of fiduciary under ERISA, but DOL proposed regulations issued on October 21 will pull many under the umbrella of the fiduciary label.

Are you one of the "new fiduciaries" who didn't know you were? http://www.aon.com/attachments/fiduciary_redef_nov2010.pdf