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This report was produced by the Advisory Council on Employee Welfare and
Pension Benefit Plans, which was created by ERISA to provide advice to the
Secretary of Labor. The contents of this report do not necessarily
represent the position of the Department of Labor.
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November 7, 2003
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In our first meeting on May 9, 2003, Vice Chairperson
David Wray suggested that the biggest change in the Defined Contribution
Plan design area was the move to optional professional management. He
suggested that the question should be: Is there a role for the Department of
Labor in the movement?
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From this early discussion, thoughts of identifying the
fiduciary issues in professional management where the employees do not want
to make these investment decisions, don’t feel qualified to do so, and
want to turn these decisions over to a professional to manage in a
discretionary manner were discussed.
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It was clear that we should not focus on investment
advice, but rather professional management where employees sits down and
counsel with the professional manager about their goals, their age, risk
tolerance, and everything. Then the investment manager actually takes the
money and invests it for the employees.
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At the meeting it was suggested that sometimes people at
the lower end of the income scale might really be more desirous of having
someone take the responsibility for the management than the typical
highly-paid employees. It was also suggested that the employer has the
obligation to act in the sole interest of the plan participants in choosing
the advisors for the plan, that their obligation is a fiduciary obligation
under the Employee Retirement Income Security Act (ERISA).
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Several members thought it might be premature in taking
on these issues, but the Council believed it would be useful in identifying
issues and problems and bringing them to the attention of the Department of
Labor with recommendations and findings.
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At the onset, the Working Group decided it should proceed
with caution so as not to expose participants’ assets to undue risk or
unreasonable expense, and that plan sponsors are protected from unreasonable
costs and potentially hidden liabilities associated with adding this
service.
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It soon became apparent that there were two different
platforms that needed to be researched and discussed. One being where the
plan sponsors chose the professional managers and the other platform being
where the plan sponsor lets the participants have total control over the
assets of the plan and they, the participants, choose a manager to invest
the money.
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The Working Group put together a list of questions that
went to the heart of finding the areas of problems and barriers that plan
sponsors have in implementing the option of having a professional manager
available for the employees and what potential safeguards were needed to be
in place for the participants.
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It was decided to have as the first witnesses a diverse
group of service providers that were already in the business of giving
management services to plan sponsors and participants. After that, we asked
plan designers for their views on the logistics of drafting plan documents
that would allow such a service to be offered.
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As we moved to the July meeting and having the benefit of
the testimony and discussions of the earlier meetings, we expanded our
hearings to include plan sponsors and risk managers, as well as acquiring
some statistical input from consultants and asking for written testimony
from industry groups.
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At the first meeting on June 27, 2003, the working group
heard testimony from Sherrie Grabot, President and Chief Executive Officer
of GuidedChoice, Inc.; Carl Londe, Chief Executive Officer of ProManage,
Inc.; Richard P. Magrath, President, ProNvest, Inc.; panel discussion with
Ms. Grabot, Mr. Londe, Mr. Magrath, and Mr. Fine; Ken Fine, Ex. Vice
President of Financial Engines, Inc.; Scott D. Miller, Principal of
Actuarial Consulting Group and Bob Wuelfing, President of RGWuelfing, Inc.
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At our second meeting on July 25, 2003, the working group
heard testimony from Lori Lucas, CFA and a Defined Contribution Consultant
with Hewitt Associates; William E. Robinson, an Attorney and Partner with
Miller & Martin, LLP; Shaun O’Brien, Assistant Director of the AFL-CIO
Public Policy Department; Rhonda Prussack, a Vice President & Product
Manager of Fiduciary Liability with National Union; and David C. John, a
Research Fellow with The Heritage Foundation. After hearing testimony, the
working group discussed other issues that might be germane to this and began
to outline areas of potential consensus for possible recommendations.
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Written response to questions received on July 31,2003,
by Michael Falk, CFA of ProManage, Inc.
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At our third meeting on September 22, 2003, the working
group discussed in more detail areas of potential consensus and areas where
we could not agree on a consensus. We also received written testimony from
Thomas T. Kim, Associate Counsel of the Investment Company Institute.
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Questions Given to Each Witness From Working Group and
Answers Where Directly Addressed:
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Optional Professional Management (OPM) in Defined
Contribution Plans: Plan sponsors are beginning to incorporate in their plan
design the opportunity for participants to delegate the investment
allocation/implementation of their plan assets to professional investment
advisors and managers. The Working Group will examine the advantages,
disadvantages, fiduciary implications, and industry practices of this
emerging plan design practice.
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Legend to Responses |
Summary |
Summary of witness(es) responses to questionnaire |
Dissenting |
Dissenting opinion by witness(es) to
questionnaire |
(FE) |
Response by Financial Engines |
(Pro) |
Response by ProNvest |
(NUFIC) |
Response by National Union Fire Insurance Company |
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Questions and Answers
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Should plan sponsors be encouraged
to provide access to professional investment management services, education,
or advice to participants in self-directed accounts plans? If so, how?
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Summary: Yes, however, there needs to be clarification
from the Department on the “Safe Harbor” procedures the plan sponsor
could follow in properly structuring, selecting and monitoring a menu of
investment advisors and managers for use by plan participants. Such
clarification could also produce the collateral benefit of encouraging plan
sponsors to provide such access.
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Dissenting: None noted..
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(FE) Yes. Although a change in the law is not actually
needed, it appears that many sponsors would benefit from additional official
assurances that they will not be liable for the recommendations of a
properly retained advisor or manager. We suggest that the DOL issue
additional statements along the lines of those the DOL has previously
issued. However, we believe that these statements would have more impact if
they were made in the form of an Information Letter, which is a formal
statement explaining a point of law that is issued by the Employee Benefits
Security Administration (the former Pension and Welfare Benefits
Administration). An Information Letter that explained the law on this point
in plain terms could be very encouraging to plan sponsors.
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Current law permits these services to be provided and, at
least arguably, ERISA’s general fiduciary standard encourages the plan
sponsor to provide these services to the extent that participants seem to
need them. Representatives of the Department of Labor have made public
statements on a few occasions encouraging the provision of advice. For
example, in a 401(k) Alert Special Issue on Advice (volume 1, number 4, May
1998), in an article entitled “Washington Update: DOL Sets the Record
Straight On Investment Advice,” the then-Assistant Secretary wrote:
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“At the DOL, we’re very concerned about the
widespread misunderstanding among 401(k) plan sponsors regarding
investment advice for participants. Let’s clear this up once and for
all: investment advice is perfectly legal. In fact, the DOL wants
participants to have as much assistance as possible, and we encourage plan
sponsors to offer participants investment advice if that’s what they
determine their participants need to make informed decisions.”
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On July 17, 2001, Assistant Secretary Ann L. Combs gave
testimony on the subject of “Retirement Security Advice Legislation” to
the Working Group on Employer-Employee Relations of the House Committee on
Education and the Workforce. Ms. Combs noted that
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“[m]eaningful comprehensive investment advice is more
important now than it has ever been” and that “[i]nvestment education,
while important, is simply not enough.”
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Despite statements like these and the clear terms of
ERISA and formal DOL guidance stating that a plan sponsor is not liable for
the content of investment recommendations provided by a properly designated
investment advisor or manager, and the fact that services like these have
been adopted by many sponsors, surveys appear to indicate that many other
plan sponsors hesitate to offer any investment assistance beyond education
because of liability concerns. This is a mistaken impression about the
current state of the law. In her testimony referred to in the preceding
paragraph, Ms. Combs confirmed that although guidance had been given by the
DOL on the subject, many sponsors still feared liability for the advisor’s
recommendations.
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If a plan sponsor selects an investment educator, advisor
or manager to make available to participants, what due diligence should be
done? Are there any special standards that should be met before someone
should be allowed to provide such services to plan participants?
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(FE) As is discussed in some of the items above, there is
an option for the sponsor to select an advisor or manager to act as a
fiduciary to the plan. (A provider of investment education, as contrasted
with advice or management, is not an ERISA fiduciary, even if appointed by
the plan sponsor.) The selection and retention of an investment manager is a
fiduciary function. As with the selection and retention of any service
provider to the plan, the plan sponsor is required to make a prudent
selection that is in the best interests of participants and beneficiaries.
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DOL pronouncements and court decisions establish a
general framework for the prudent selection of investment managers and other
plan service providers. These authorities indicate that a plan fiduciary
retaining an investment manager generally has an obligation to take steps
similar to the following:
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Determine the needs of the plan’s
participants;
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Assess the qualifications of the
service provider;
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Review the services provided and fees
charged by different providers;
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Select the provider whose service
level, quality and fees best match the plan’ s needs and financial
situation; and
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Once a provider has been hired, review
the provider’s performance at reasonable intervals so as to ensure
that the provider is complying with the terms of the plan and statutory
standards, and is satisfying the needs of the plan.
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For background on due diligence requirements, see
generally, § 2509.96-1; § 2509.75-8, Q-FR-17; Liss v. Smith, 991 F. Supp.
278, 300 (S.D.N.Y. 1998); Whitfield v. Cohen, 682 F.Supp.188, 195 (S.D.N.Y.
1988). See also, guidelines set forth in a settlement agreement to which the
DOL was a party in In re Masters, Mates & Pilots Pension Plan Litig.,
No. 85 Civ. 9545 (VLB) (S.D.N.Y.), discussed in Serota, ERISA Fiduciary Law
(1995) at 124. More specifically regarding due diligence procedures, see 29
C.F.R. § 2509.75-8, Q-FR-17 (“No single procedure will be appropriate in
all cases; the procedure adopted may vary in accordance with the nature of
the plan and other facts and circumstances relevant to the choice of the
procedure.”).
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(Pro) We do believe that such encouragement is needed.
The DOL has expressly stated that it is a policy goal to provide
participants with more access to education and advice. However, plan
sponsors remain concerned about the potential for fiduciary liability for
arrangements made between these service providers and the participants in
their plans. They feel caught between the potential for liability if they
choose not to arrange for investment services for their participants and the
potential for being held responsible for actual advice or management
services provided. While in our view the first should be of more concern
than the second, a review of current law and guidance does not make that
clear. The reason for this is that the DOL will not come right out and say
that there is no liability for a plan sponsor for investment advice or
management services provided to plan participants. This is probably because
there is really no direct statutory authority to support such a statement.
Therefore, we believe that such a statutory basis should be created.
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An exemption should be created to ERISA fiduciary
liability that clarifies that a plan sponsor has no ERISA fiduciary
liability for the actual education, advice, or management services provided
by a professional investment educator, advisor, or manager.
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Of course, such an exemption should be conditioned on the
professional meeting certain standards. First, such a professional should
meet the requirements set forth in ERISA Section 3(38)(B) (definition of “investment
manager”). These are the standards for persons who may be designated an
investment manager of a plan, and are applied to persons who manage large
sums of money for defined benefit plans and other collective trusts. These
standards include the requirement to be registered as an investment adviser
under the Investment Advisers Act of 1940.
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Second, the participant must have the freedom whether and
to what extent he or she will utilize the education, advisory, or managerial
services of the investment professiIn addition, when a participant hires a
professional advisor or manager, there should be a written asset management
agreement between the participant and the professional. The Plan Sponsor
should be required to receive and retain a copy. The professional should be
required to acknowledge in the agreement that it accepts fiduciary
responsibility as an investment manager. This is also a requirement of ERISA
Section 3(38)(C).onal.
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Finally, the professional should be independent of any
funds offered under the plan. This will insure that there is no potential
that this exemption will result in prohibited transactions being
inadvertently sanctioned by this exemption from fiduciary liability.
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Some may argue that the forgoing proposal is already
provided within current ERISA law. This argument is not without merit (see
the response to Question 6), but there are
ambiguities within the law that result from the fact that these provisions
were written at a time when most plans were managed under a single
collective trust. The proliferation of investment funds and the ability for
participants to manage their retirement assets presents a whole new set of
situations, and the language of ERISA should be revised to unambiguously
state its applicability.
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Moreover, we would not propose the above exemption as an
absolute requirement; rather it should be a safe harbor such that if a plan
is set up to meet the requirements set forth, the plan sponsor would be
deemed to meet the fiduciary requirements of ERISA with respect to
education, advise, or management services provided by the investment
professional. There may well be other arrangements, which would not result
in fiduciary liability for the plan sponsor because they meet the general
ERISA fiduciary standards.
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What has been the interest from
Plan Sponsors in offering professional investment managers and advisors?
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Summary: There is strong interest – motivated in part
by plan sponsors who believe their fiduciary liability will be reduced, and
by others who believe that optional professional management, as well as
specific investment advice from professional investment advisors will help
to increase rates of participation, contribution and investment returns.
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Dissenting: There was a strong opinion from one witness
that the demand is being generated by the vendors, not the plan sponsors or
participants. (Wuelfing).
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(FE) Plan sponsors have demonstrated substantial interest
in offering advisory and management solutions that meet the needs of
investors with little time and interest in investing. Optional Professional
Management solutions are specifically designed for that investor segment.
Financial Engines met with about 50 plan sponsors between September 2002 and
June 2003 to obtain feedback on optional professional management as a viable
option for their participants. We found that most sponsors are receptive to
the concept and eager to see this solution deployed broadly in the market.
Here are a couple of representative quotes from these 50 meetings:
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Over the years since 401(k) plans have become the
dominant form of employer-sponsored retirement plans, plan sponsors have
become increasingly concerned about plan participants’ ability or desire
to manage their plan accounts appropriately for retirement. Best efforts at
investment education have not solved this problem. It is clear that while
some participants are self-starters in this area, most need and want either
investment advice or management.
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No changes are needed in current law to permit a plan
sponsor to designate one or more investment managers to act as plan
fiduciaries for the purpose of investing the individual account of any
participant who decides to use the manager option. And it is desirable that
plan sponsors take this step, so that plan participants are given the
opportunity to use professional service providers whose qualifications have
been vetted by the sponsor.
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Plan sponsors can obtain a fiduciary benefit from
providing these services. Data indicate that users of these services tend to
increase their savings rates and wind up with better-diversified investment
accounts. Although the need for these services is apparent, and the benefits
are clear, some sponsors hesitate to retain fiduciary investment advisors
and managers, out of a mistaken belief that ERISA makes them liable for the
investment professional’s recommendations or selections. We believe that
both sponsors and participants would benefit from the Department of Labor’s
issuance of an Information Letter explaining that if the sponsor makes a
prudent selection of an investment advisor or manager, and monitors the
prudence of that selection regularly, then the sponsor will not be liable
for the professional’s recommendations or selections.
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(Pro) There has been great interest from plan sponsors in
offering professional investment advisors. The greatest barrier to Sponsors
implementing an advice solution is fear of incurring fiduciary liability. To
the extent that Sponsors can be relieved of that fear, participants will be
able to benefit from professional investment help.
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When the professional investment
manager or advisor is offered as an option, what percentage of the
participants has selected the option?
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Summary: Initial attempts to market such services have
yielded participation rates between 15 – 37%. It is too early to know
whether these would be representative of long-term experience.
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Dissenting: None noted..
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(FE) Financial Engines’ current testing of its planned
optional professional management service (which is ongoing with two large
public companies) indicates that 10-15% of participants enrolled in that
offering within the first one-three months offered with minimal marketing.
Expected enrollment rates when offered over a full year with more active
communications are expected to be in the 15-25% range. We believe that
enrollment rates can be further enhanced when such an option is integrated
directly into the 401(k) enrollment process.
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(Pro) The percentage of employees that register to use
our service depends on how the Plan Sponsor wishes to implement our
solution. When a plan participant registers to use our advice (which in the
ProNvest model is provided free to both sponsor and participant), 37% of
those participants have hired ProNvest to manage their 401(k)/retirement
plan or other assets.
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Has there been an uptick in plan
participation when professional investment managers and/or advisors have
been offered?
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Summary: Inconclusive, but there is an intuitive logic
that participation would pick up if participants had more confidence in
their investment process and how the plan assets are invested.
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Dissenting: None noted..
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(FE) Financial Engines is currently testing its optional
professional management offering with two large companies. That testing is
focused on validating demand for this service among employees who are
currently participating in the plan rather than those who are not
participating. Anecdotal evidence has indicated that some participants
resist plan participation due to the perceived complexity of making
investment selections. If an optional professional management offering were
integrated with the actual 401(k) enrollment process, higher participation
rates may be expected. That being said, many employees resist plan
participation for other reasons, such as budgetary constraints. Optional
professional management would not likely overcome all such participation
barriers.
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(Pro) Each plan we are involved with has experienced an
increase in the breadth (number of active participants in the plan) and
depth (contribution amount of active participants) of plan participants.
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Has there been an uptick in the
plan participant’s contribution percentage when professional investment
managers and/or advisors have been offered?
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Summary: Yes, there is evidence that the contribution
rate increases.
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Dissenting: None noted.
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(FE) Financial Engines has found that offering advisory
services has a material impact on contribution percentages. For example, 20%
of Financial Engines’ online advice users have increased their
contribution rate (by 40%) since their first session. For those employees
that interact via a call center, 50% increase their savings rates (by over
100%). Employees with lower incomes (less than $25K) have tended to increase
their savings rates the most, on average by 92%.
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In conjunction with an optional professional management,
we believe it is useful for the sponsor to offer a “Save More Tomorrow”
option, whereby participants can elect to have their savings rates increased
gradually over time (e.g., 1% per year), starting at a specified future
date. Survey feedback has indicated a very high interest in participating in
that program. Also, findings from behavioral finance experts Shlomo Benartzi
and Richard Thaler have validated participant willingness to participate in
such “managed savings” programs.
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(Pro) Please see the response to Question
4.
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Should there be a requirement for
a plan to provide investment education to participants, either generally or
as a precondition to being allowed to self-direct their plan assets?
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Summary: No, 404 (c) is sufficient in providing
encouragement to provide investment education.
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Dissenting: None noted.
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(FE) When one considers that the employer-sponsored
retirement plan system in this country is a voluntary regime, it may be best
to continue to rely upon an incentive to provide investment information,
such as in the 404(c) regulations, rather than a mandate. It might be
helpful, however, if the DOL were to issue an advisory (an Information
Letter, for example) reiterating the current ERISA law that plan sponsors
are generally not liable for the recommendations or choices of a designated
investment advisor or manager and, perhaps, confirming Mr. Reish’s view
(as described below) that ERISA’s general fiduciary standard requires the
plan fiduciary to provide investment assistance to the employees that is
appropriate to their needs.
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Current law does not explicitly require investment
education to be provided before permitting participants to invest their own
accounts. However, for a participant-directed retirement plan to be
considered to be a 404(c) plan, according to DOL regulations, the
participant must be “provided or has the opportunity to obtain sufficient
information to make informed decisions with regard to investment
alternatives available under the plan,” which includes “a description of
the investment alternatives available under the plan and, with respect to
each designated investment alternative, a general description of the
investment objectives and risk and return characteristics of each such
alternative,” and “a description of any transaction fees and expenses
which affect the participant’s or beneficiary’s account balance.” The
regulation lists other investment-related information that must be provided
automatically, as well as additional information that must be supplied upon
request.
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The vast majority of sponsors of self-directed plans aim
to comply with 404(c). It is also worth taking into account that the basic
fiduciary responsibility rules of ERISA come into play here. ERISA section
404(a)(1)(B) requires that all plan fiduciaries exercise their
responsibilities “with the care, skill, prudence and diligence under the
circumstances then prevailing that a prudent man acting in a like capacity
and familiar with such matters would use in the conduct of an enterprise of
a like character and with like aims.” (Emphasis added.)
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As Fred Reish points out in his article in the December
2002 issue of Plan Sponsor magazine, given the “circumstances then
prevailing” language of the fundamental ERISA rule, “[i]f a plan sponsor
knows the workforce is unsophisticated about investing, . . . [then] under
the general prudence rule an argument could be made that the plan
fiduciaries cannot fulfill their duty to act prudently if they do not make
investment advice available.” Although Mr. Reish was specifically
addressing the issue of investment advisory services, his argument can just
as easily apply to investment education or professional management services.
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A plan sponsor, as a fiduciary, will not incur liability
for a participant’s investment of his or her account if it complies with
ERISA Section 404(c). Section 404(c) does not require a plan sponsor to
provide investment education or access to a professional investment advisor
or manager for such protection to apply. Should such actions be required for
404(c) protection and to what extent?
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(Pro) It is probably not practical to consider imposing a
requirement upon plan sponsors to provide investment education either
generally or as a pre-condition to being allowed to self-direct plan assets.
However, we do feel that the provision of investment education is an
important policy goal that should be encouraged in every means possible. For
example, legislation, or an opinion or regulation issued by the Department
of Labor, indicating that a plan sponsor is not liable for the investment
education, advice, or management services provided by a professional
investment educator, advisor, or manager would be very helpful. Any such
legislation or guidance should also address the interaction with ERISA
Section 404(c), as there appears to be a great deal of confusion among the
plan sponsor community with respect to the interplay of the rules under that
section and general ERISA fiduciary duties when an investment advisor or
manager is made available to participants.
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(NUFIC) At a bare minimum, plan sponsors should provide
basic investment education to plan participants, such as describing the
risks associated with certain investments and the importance of portfolio
diversification. I would view as a positive development a company offering
investment advice to participants in self-directed plans, as long as such
investment advice was generated by an independent third party. If the
investment advice were generated either internally (for instance by an
employee of the employer) or by the same company that provides the
investments for the plan, I'd have concerns about allegations of conflict of
interest, self-dealing, profiting from the plan, etc.
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A plan sponsor, as a fiduciary,
will not incur liability for a participant's investment of his or her
account if it complies with ERISA Section 404(c). Section 404(c) does not
require a plan sponsor to provide investment education or access to a
professional investment advisor or manager for such protection to apply.
Should such actions be required for 404(c) protection and to what extent?
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Summary: No, however, there is a misconception among some
plan sponsors that the selection of an investment manager and/or advisor to
work with plan participants does cause the loss of 404 (c) protection. A
clarification by the Department would be helpful.
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Dissenting: None noted.
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(FE) See Question 6.
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(Pro) Although such a requirement would not be
inconsistent with the purposes of Section 404(c), it seems difficult to see
a requirement of a professional investment advisor or manager as being
necessary in all situations. Section 404(c) provides an exemption from
fiduciary liability for a fiduciary with respect to investment decisions
made by a participant or beneficiary in a plan. There are already a number
of requirements that must be met to fall within that exemption. Examples in
the Section 404(c) regulations indicate that selection of an advisor or
manager by the participant does not result in the loss of Section 404(c)
protection if all requirements are met. Given that, and because the need to
offer investment education or advice, or even management services, to
participants involves a matter of judgment with respect to the needs of a
plan sponsor’s particular employee population, it seems that it would be
difficult to impose a requirement that education or advice be provided in
order for 404(c) to apply in all cases. Rather, the provision of investment
advice and education should be encouraged through a separate exemption from
liability using a “safe harbor approach,” as set forth under Question
8.
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What due diligence should the Plan
Sponsor use to select and monitor the professional investment manager and/or
advisor?
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Summary: The seminal due diligence process developed by
the 1996 ERISA Advisory Council still seems to be the most comprehensive
process.
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Dissenting: None noted.
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(Pro) In 1996, the ERISA Advisory Council formed a
working group to prepare guidance on the selection and monitoring of service
providers to ERISA plans. As a part of their report, the working group
prepared the following issues and questions to be used with respect to
selection and monitoring, which provide a good basis for due diligence in
selecting an educator, advisor or manager for a plan.
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Issues For Fiduciaries Who Are Hiring A Service
Provider
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What service or expertise does the plan need? Is the
service or expertise necessary and/or appropriate for the functioning of the
plan?
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Does this service provider propose to provide the service
that is necessary or appropriate for the plan?
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Does this service provider have the objective
qualifications to properly provide the service that is necessary and/or
appropriate for the plan? Generally, the fiduciary should seek the following
information that will vary with the type of service provider being retained:
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Business structure of the candidate
-
Size of staff
-
Identification of individual who will
handle the plan's account
-
Education
-
Professional certifications
-
Relevant training
-
Relevant experience
-
Performance record
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References
-
Professional registrations, if
applicable
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Technical capabilities
-
Financial condition and capitalization
-
Insurance/bonding
-
Enforcement actions; litigation
-
Termination by other clients and the
reasons
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Are the service provider's fees reasonable when compared
to industry standards in view of the services to be performed, the
provider's qualifications and the scope of the service provider's
responsibility?
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Does the plan have a conflict of interest policy that
governs business and personal relationships between fiduciaries and service
providers and among service providers? Does the plan require disclosure of
relationships, compensation and gifts between fiduciaries and service
providers and among service providers?
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Does a written agreement document the services to be
performed and the related costs?
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Additional Issues When Hiring An Investment Manager
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Does the Plan have a Statement of
Investment Policy? Some or all of the following issues may be addressed
by a Statement of Investment Policy (See Department of Labor
Interpretive Bulletin 94-2):
-
Evaluation of the specific needs
of the plan and its participants
-
Statement of investment objectives
and goals
-
Standards of investment
performance/benchmarks
-
Classes of investment authorized
-
Styles of investment authorized
-
Diversification of portfolio among
classes of investment, among investment styles and within classes of
investment
-
Restrictions on investments
-
Directed brokerage
-
Proxy voting
-
Standards for reports by
investment managers and investment consultants on performance,
commission activity, turnover, proxy voting, compliance with
investment guidelines.
-
Policies and procedures for the
hiring of an investment manager
-
Disclosure of actual and potential
conflicts of interest
-
What is the position to be filled? Why
is the Plan hiring an additional investment manager? Is the Plan
replacing a terminated manager with a manager of the same investment
style or hiring an additional manager with a different investment style?
Is the hiring of this manager consistent with the Statement of
Investment Policy?
-
Does the Investment Manager have the
objective qualifications for the position being filled? (See questions
concerning qualifications above.) Does the candidate qualify as an
investment manager pursuant to ERISA section 3(38)?
-
How does the investment manager manage
money? What is the manager's performance record and how does the manager
achieve his performance? What are the risks of the investment manager's
style and strategy compared to other styles and strategies? Do you
understand what the manager does and the risks involved? Is this risk
level acceptable in view of the return? How do this manager's investment
style and strategy fit into the portfolio as a whole? (See Department of
Labor Regulation 29 CFR § 2550.404a-1 Investment Duties and Letter from
Olena Berg, Assistant Secretary for Pension and Welfare Benefits
Administration, to Honorable Eugene A. Ludwig, Comptroller of the
Currency concerning the Department of Labor's views with respect to the
utilization of derivatives in the portfolio of pension plans subject to
the Employee Retirement Income Security Act.)
-
How does the investment manager
measure and report performance? Does the process ensure objective
reporting?
-
Is the investment manager a qualified
professional asset manager? What is the investment manager's process to
comply with the prohibited transactions provisions of ERISA?
-
What is the investment manager's
process to insure compliance with the plan's investment policy and
guidelines?
-
What is the investment manager's
record with respect to turnover of personnel?
-
Has the manager's investment style
been consistent?
-
Has the investment manager been
terminated by plan clients within a relevant time period and why?
-
Has the ownership of the investment
manager changed within a relevant time period and how will this affect
the ability of the manager to perform the services needed by the plan?
-
What are the investment manager's
fees? Are the fees reasonable in comparison with industry standards for
the type and size of the investment portfolio? Does the fee structure
encourage undue risk taking by the investment manager?
-
Does the investment manager have a
personal or business relationship with any of the plan fiduciaries, or
with another service provider recommending the investment manager? If a
relationship does exist, how does it impact on the evaluation of the
objective qualifications of the investment manager and the
recommendation?
-
If the plan has adopted a directed
brokerage arrangement with a broker affiliated with the plan's
investment consultant, how does the investment manager determine when to
use broker affiliated with the investment consultant? What are the per
share transaction costs?
-
Does the investment manager have
insurance, which would permit recovery by the plan in the event of a
breach of fiduciary duty by the investment manager? What is the amount
of the insurance? Who is the insurance carrier?
|
Additional Issues In Monitoring Service Providers
|
-
Who is responsible for monitoring the
service provider?
-
What is the process to monitor the
service provider?
-
Are written reports provided by the
service provider? With What frequency are the written reports provided?
-
Do the written reports describe the
performance of the service provider as compared to the applicable
written guidelines and/or contract?
-
Do the written reports provide
sufficient information to adequately evaluate the performance of the
service provider compared to benchmarks or industry standards?
-
Is there a process in place to either:
(a) correct any non-conformance with guidelines/contract, benchmarks or
industry standards; or (b) to terminate the service provider and retain
a successor?
-
Has the responsibility for monitoring
a service provider been delegated to an individual or another service
provider?
-
If the responsibility to monitor a
service provider has been delegated, has the individual or service
provider to whom the delegation has been made accepted fiduciary
responsibility in writing for the monitoring?
|
(NUFIC) The Plan Sponsor should regularly determine that
the professional investment advisors' credentials are unchanged, that the
fees charged are reasonable, and that the advice being given is sound.
|
What disclosure should the
professional investment manager or advisor provide (a) the Plan Sponsor and
(b) participant, regarding conflicts of interest and compensation (both hard
and soft dollars)?
|
Summary: The advisor should be required to provide full
disclosure of potential conflicts of interest and all forms of revenue and
compensation (both hard and soft) generated from working with the plan, plan
participants, and any of the plan’s service vendors.
|
Dissenting: Some witnesses said disclosure was not a
substitute for independence.(FE) The investment manager should provide full
disclosure to both the sponsor and the participant of (1) its investment
philosophy, (2) all material assumptions underlying its investment choices,
(3) the professional credentials of those who are responsible for making
investment decisions and/or deciding the criteria through which decisions
are made, (4) actual or potential conflicts of interest presented by
ownership or compensation arrangements and (5) its compensation.
|
(Pro) Full disclosure should be required regarding all
compensation received by the professional investment advisor for services
rendered. Conflicts of interest should not be permitted – these are
prohibited transactions in the context of an ERISA-governed retirement plan.
|
(NUFIC) Since I believe that the investment advisor
should be an independent third party, there should be no conflict of
interest. If there is an appearance of a conflict, when in actuality there
is no conflict, such appearance should be explained in plain English
mailings, both through standard mail and electronic. Compensation to
investment advisors should be similarly explained.
|
What information should the
participant receive in terms of the qualifications of the professional
investment manager and/or advisor, and the procedures that are to be
followed by the professional investment manager and/or advisor?
|
Summary: Participants should have access to all relevant
information about the advisor.
|
Dissenting: None noted.
|
(FE) See Question 9.
|
(Pro) Participants should have access to relevant
information discussed in the response to Question 9
regarding due diligence for hiring a service provider to a plan.
|
(NUFIC) Participants should periodically receive
plain-English descriptions of the investment advisor's qualifications, as
well as any changes to those qualifications, and should be apprised, at
least upon enrollment in the plan, of the selection process for such
advisors.
|
Should professional investment
managers and/or advisors be required to demonstrate qualifications that
exceed the minimum requirements specified by their respective regulatory
body?
|
Summary: There was general agreement from the witnesses
that the regulatory bodies do an adequate job.
|
Dissenting: None noted.
|
(FE) The current legal and regulatory rules provide a
good framework. Providing managed accounts to the retirement plan market
will be competitive. Because sponsors will be making a fiduciary decision
when retaining an advisor for the plan, there will be an incentive for
managers to ensure that their firms and their personnel are highly
qualified. If it is desirable to specify additional qualifications in this
area, the Department of Labor’s QPAM exemption (PTE 84-14) provisions
regarding a qualified investment manager might be a good starting place for
guidance on appropriate qualification rules.
|
(Pro) Perhaps it would be reasonable to require such
professionals to undergo some training in ERISA fiduciary duties and
responsibilities before being allowed to provide services to an ERISA plan.
|
(NUFIC) I would certainly look more favorably upon plan
sponsors that hire investment advisors that substantially exceed the minimum
requirements set forth by their respective regulatory bodies.
|
What circumstances, if any, ever
justify a fund manager offering investment funds to a plan to provide
investment education, advice or management services to participants in that
plan? Does the model set forth in the SunAmerica opinion adequately protect
participants and plan sponsors from conflicts of interest? Would disclosure
of potential and real conflicts of interest adequately protect participants
and plan sponsors, as proposed in the Boehner Bill?
|
Summary: The DOL has provided two forms of relief from
the prohibited transaction rules: (1) Prohibited Transaction Class Exemption
77-4, which says that where “fee leveling” between the participant level
fees and the investment funds fees has taken place, serving in the dual
roles will not be enforced as a prohibited transaction; and, (2) SunAmerica
opinion, which requires all investment choices/recommendations to be
generated by an independent third party, free of the editorial control of
the fund manager.
|
Dissenting: The witnesses disagreed about whether the
Boehner bill (HR 1000) would adequately protect participants from conflicts
of interest with some witnesses testifying that this kind of disclosure
conflict in the Boehner Bill was sufficient to protect participants and
others feeling it was insufficient to protect participants.
|
(FE) ERISA requires a fund manager to eliminate real or
potential conflicts of interest in order to avoid violating the prohibited
transaction rules. One way to attack the conflicts presented by fund-level
fees paid to fund managers is through fee leveling or offsets. (See, for
example, PTE 77-4.) A newer way is to use the structure set out in the
SunAmerica opinion (Advisory Opinion 2001-09A), which requires all
investment choices/recommendations to be generated by an independent third
party, free of the editorial control of the fund manager.
|
We believe this model does protect participants and plan
sponsors. Acting as a prudent ERISA fiduciary, the plan sponsor wishing to
designate a fund manager to provide advice or management services should
conduct a due diligence inquiry as to the relationship between the fund
manager and the third party, should satisfy itself that the third party’s
recommendations are truly independent and should require the fund manager to
provide it with a formal opinion of outside counsel that the arrangement
between the fund manager and the third party satisfies the requirements of
Advisory Opinion 2001-09A.
|
We believe that all qualified individuals should be able
to provide investment advice and management services to plans and
participants. The DOL’s prior PTEs and the SunAmerica opinion currently
permit fund managers to provide these services. Several fund managers now
provide advice and/or management services under the current law and
regulatory regime. For example, leading fund managers/plan providers like
CitiStreet and Merrill Lynch provide advice under SunAmerica arrangements.
Fidelity recently announced management services provided under PTE 77-4 and
later announced that it may also provide management services using a
SunAmerica arrangement. Under these arrangements, as well as others of fund
managers and independent providers, plan participants are today receiving
advice and management services online and by telephone and in person.
|
By contrast, the Boehner Bill would remove the legal
requirement for fund managers to eliminate real or potential conflicts of
interest. This would be a very significant departure from one of the
longstanding, bedrock principles of ERISA. We question whether it is
necessary for such a radical departure, given that current law already
effectively permits fund managers to remove conflicts and provide these
services and, in fact, growing numbers of fund managers are taking advantage
of these opportunities. We do not believe that disclosure of conflicts alone
adequately protects participants and plan sponsors. There are significant
questions as to the willingness or ability of many participants to read and
understand the implications of any such disclosures. And, in the retirement
plan realm, participants do not have a simple opportunity to “vote with
their feet” by retaining an unconflicted advisor/manager on the same terms
as a fund manager advisor/manager that may have been designated by the plan
sponsor.
|
Finally, we wonder whether the Boehner Bill would lighten
the responsibilities of plan sponsors. The Boehner Bill changes only ERISA’s
prohibited transaction rules. It has no effect on the general ERISA
fiduciary rules that require the plan sponsor to act prudently and in the
best interests of participants in designating a fiduciary advisor or
manager. It also has no effect on the “cofiduciary” rules of ERISA
section 405, which make the plan sponsor potentially liable for the acts of
another fiduciary if the plan sponsor did not adequately fulfill its
fiduciary duties in its decisions to retain the advisor or manager. If the
Boehner Bill becomes law, the plan sponsor will have to wonder whether it
can be prudent and in the best interests of participants to designate a fund
manager as an advisor or manager, given the fund manager’s real or
potential conflicts of interest. If the answer turns out to be no (in
general or in a specific case), then the plan sponsor could end up being
liable for any breach of fiduciary duty of the fund manager by way of ERISA’s
cofiduciary liability provisions.
|
The Pension Protection and Expansion Act of 2003 (S.9,
the “PPEA”), which is currently pending in the Senate, includes Section
305, which is applicable to fiduciary advisor services. Unlike the Boehner
Bill, the PPEA would make no changes to ERISA’s prohibited transaction
rules. Instead, Section 305 of the PPEA sets forth due diligence safe harbor
rules for retaining an unconflicted investment advisor which, if followed,
would explicitly relieve the plan sponsor of any potential liability
(including cofiduciary liability under ERISA Section 405) for the content of
the advisor’s recommendations or for any breach of fiduciary duty by the
advisor. In our experience, these are the issues that seem to be of most
concern to plan sponsors. That being the case, if any legislation at all in
this area is deemed necessary or desirable, something like Section 305 of
the PPEA seems more likely to result in advice services becoming more widely
available to participants.
|
(Pro) It does not seem that there would be any real
problem with a fund manager offering investment education to plan
participants. With respect to investment advice or participant level
investment management, however, the dual role (often played by two
affiliated companies or individuals, which are treated as one) creates a
conflict of interest and therefore a prohibited transaction under ERISA.
|
The DOL, however, has given relief from the prohibited
transaction rules in two situations. The first is in a Prohibited
Transaction Class Exemption 77-4, which says that where fee leveling between
the participant level fees and the investment funds fees has taken place,
serving in the dual roles will not be enforced as a prohibited transaction.
Second is the SunAmerica opinion, wherein the DOL said that if there is a
truly independent expert designing computer modeling to develop investment
recommendation based upon data input by the participant, the provision of
such advice is not a prohibited transaction. Although the breadth of the
SunAmerica opinion has yet to be tested, one fear is that it will be
construed to include situations in which the independent modeling has been
compromised or bypassed. However, the SunAmerica opinion does give a roadmap
through the ERISA prohibited transaction maze that has the aim of providing
independent advice to plan participants.
|
The Boehner Bill, by contrast, would broaden the
SunAmerica opinion by allowing conflicts of interest to exist, so long as
they are disclosed to participants. It is questionable whether such a bill
will actually serve to protect participants from potential abuses that the
ERISA prohibited transaction rules are designed to guard against. Many
participants will not understand what a conflict of interest is, much less
what it could mean to their retirement accounts. In short, the purposes of
ERISA are best served by giving participants access to independent advisors
and money managers who only have incentives to increase participants’
money for retirement.
|
(NUFIC) The provision of basic investment education is
always warranted. However, an insured that demonstrates to me through the
offering of independent investment advice that it is concerned about the
welfare of its employees and plan participants scores more points than an
otherwise similar insured that offers no such advice. What I like about the
SunAmerica model is that the advice is generated by an expert independent of
the investment provider. The Boehner model, on the other hand, would seem to
allow, and even condone, conflicts of interest, provided that the plan
participants are apprised of them. Assuming that the plan participants
actually read the conflict notice, would they be provided any other options
for investment advice? Apart from this problematic conflict issue, which I
believe could generate more litigation, I think the Boehner bill is a step
in the right direction, providing plan participants much needed advice, and
providing plan fiduciaries relief from liability.
|
What procedures should the
professional investment manager and/or advisor follow in:
-
Determining each participant’s asset
allocation
-
Selecting investment options to
implement the participant’s strategy
-
Monitoring the participant’s
investment strategy
-
Controlling the participant’s
investment expenses?
|
Summary: The procedures outlined in the following
responses provide a good basis for defining general fiduciary duties, and
the practices that define the details of these duties need to be
communicated to both plan sponsors and investment advisors through education
and training.
|
Dissenting: None noted.
|
(FE) The professional investment advisor should select
investment options that control a client’s expenses and achieve an asset
allocation consistent with a client’s risk tolerance. Once the initial
portfolio is constructed, ongoing monitoring is vital to keeping a client
on-track towards their goals. Providing investment advice or investment
management requires consideration of the following four basic tasks:
-
Assessing Risk Tolerance;
-
Understanding The Total Portfolio;
-
Fund Selection/Asset Allocation; and
-
Ongoing Monitoring
|
Assessing Risk Tolerance
|
Every portfolio has both short-term and long-term risk
properties. Investors should be aware of not only the short-term possibility
of loss, but also the long-term potential for growth. Armed with this
information, investors are able to make the appropriate tradeoffs and select
a risk desirable risk level.
|
Understanding The Total Portfolio
|
An investor enjoys a comfortable retirement based on the
performance of all their retirement assets, which may go beyond a single
employer-sponsored account. As such, it is important for an advisor to
consider all retirement assets. For example, suppose a client has a
significant bond portfolio inside an IRA. While the advisor may only be
selecting 401(k) investments, knowledge of the IRA helps guide prudent
401(k) advice. In this case, since the client already has substantial bond
holdings, prudent advice for the 401(k) will likely include fewer bond
recommendations.
|
Fund Selection/Asset Allocation
|
Assessing risk tolerance and understanding the total
portfolio help put the fund selection process in context. The actual fund
selection also should depend on an analysis of the specific fund options
available. Mutual funds differ substantially in their risk and return
properties. The baseline risk and return properties are determined by a fund’s
asset allocation (e.g. cash/bonds/stocks). Adjustments should then be made
to both the risk and return assumptions based on specific fund
characteristics.
|
Risk adjustments are necessary when the asset allocation
risk is insufficient to describe the risk of holding the particular fund.
For example, funds that have concentrated holdings in a particular industry
or only hold a relatively few number of stocks tend to be higher risk than a
more diversified fund with similar asset allocation.
|
Since expenses and transaction costs directly impact
return, return adjustments are necessary to reflect the differential costs
associated with owning different mutual funds. These costs not only include
the explicit expense ratio, but also implicit trading costs arising from
fund turnover.
|
When determining the recommended portfolio, it is
important to weigh all three factors (baseline asset allocation, risk
adjustments and return adjustments). Once the risk and return properties are
understood for the available investments, an appropriate portfolio can be
selected considering the investor’s risk tolerance and total portfolio.
|
Ongoing Monitoring
|
Markets change and client needs change. An investment
manager should periodically review the client’s portfolio to determine if
adjustments are necessary. The types of events that could trigger an
adjustment include:
-
Portfolio requires rebalancing due to
market movements;
-
Updated assessments of the funds in
the plan
-
New investment options available
-
Updated client situation (e.g. risk
tolerance, total portfolio, etc)
|
An investment manager can implement appropriate changes
in an ongoing fashion. While an investment advisor may not be able to
directly implement changes, the advisor should encourage the client to
periodically review their situation. If possible, the advisor should
proactively alert their clients to situations that likely warrant an
advisory session.
|
(Pro) A professional investment advisor or manager should
use information from the participant to generate a risk-return profile for
the participant. Investments should be selected in a manner that meets that
profile, and the professional should then monitor the performance of the
selected assets and rebalance periodically to keep them true to the
risk-return profile. Further, the professional should contact the
participant regularly to update the participant’s information and
regenerate the risk-return profile. In an ERISA plan, expenses must be kept
reasonable, but investments should be made with loads that are appropriate
for the risk-return and time horizon determined for the particular
participant.
|
Should participants in ERISA
plans be allowed to choose any investment educator, advisor, or manager that
they desire? If not, who should choose? Should they be open to the universe
of investments or be limited to investment funds selected by a fiduciary?
|
Summary: Plan participants have always been free to
retain their own investment managers and/or advisors outside the plan. In
regard to the open universe, the witnesses who spoke to this felt that the
open universe of investments would not improve the ability to manage their
accounts appropriately.
|
Dissenting: None noted.
|
(FE) A participant may retain his or her own educator,
advisor or manager at any time. As a practical matter, this can be done
without the knowledge or involvement of the plan sponsor, administrator or
fiduciaries. For example, in the case of a plan that uses an automated
PIN/password-based system to allow participants to make investment changes
by telephone, online or other automated method, the participant would only
need to share his or her PIN/password with his or her chosen educator,
advisor or manager. For plans that use other methods, such as a paper-based
system, a participant may give a third party a power of attorney that
permits the designee to make investment elections on the participant’s
behalf.
|
In our experience, if a power of attorney that is
effective under applicable law is provided to the plan administrator, the
designee will be permitted to make investment elections. If a participant
independently retains an educator, advisor or manager, outside the terms of
the plan, that designee is not an ERISA fiduciary to the plan (though the
designee may be a fiduciary to the participant).
|
By contrast, the plan sponsor may designate one or more
individuals as fiduciary advisors or managers to the plan, and participants
may choose to use one of those individuals, to use their own nonfiduciary
advisors or managers or not to use an advisor or manager at all.
|
ERISA provides incentives for the plan sponsor to choose
a “main menu” of funds that satisfies the requirements of ERISA section
404(c), and the vast majority of sponsors do this. In response to
participant demand, some sponsors also permit participants to choose their
own investments through a brokerage or mutual fund “window” option. In
our experience, it is only in very rare cases that sponsors have an open
universe, with no main menu of funds. This tends to happen only in the case
of smaller plans with predominantly professional employees as participants,
such as doctor and lawyer groups. In our view, ERISA’s current
incentive-based system serves participants well and it is unnecessary to
mandate what investment options should be made available.
|
(Pro) There should be no change in the ability for
participants to choose the investment educator, advisor or manager they
desire. Plan participants may be sophisticated investors or have existing
relationships with an advisor or manager and should not be precluded from
obtaining such services, in a plan set up for such arrangements. For many
other plan participants, however, choosing a professional to provide such
services may be a daunting task. In this latter case, it may be better for a
plan fiduciary to select an educator, advisor, or manager that participants
may use. A range of such service providers could also be provided for
participants to choose. All of these arrangements should be possible and
remain permitted under the law. However, there is no clear guidance on the
variations that are permissible or the fiduciary responsibilities that go
along with these different choices and upon whom they fall. Such
clarification would be welcome among the plan sponsor community and would
have the effect of increasing the availability of this service to plan
participants.
|
With respect to the investment alternatives offered for a
plan, again these should be left up to the decision of the plan designers
and fiduciaries. Obviously a main menu of mutual funds fits best with those
plans wishing to take advantage of Section 404(c), but limiting plans to
such a scenario is not a mandate that should be implemented.
|
(NUFIC) I'd feel more comfortable with investment
advisors that have been carefully vetted by the plan sponsor. I'm also
uncomfortable with completely unlimited investments. Left on their own, plan
participants may select improper investments, or fail to rebalance or
revisit their portfolios as circumstances warrant. They might then be
inclined to blame the plan sponsor for failing to properly educate them, or
allege that plan fiduciaries breached their duty by failing to monitor
investments.
|
If a participant in a
self-directed individual account plan seeks out and hires a professional
investment manager for his or her account, should the plan sponsor have any
responsibility to monitor the investment selections being made? Should the
trustee?
|
Summary: Generally, as covered under 404(c), No.
|
Dissenting: The witnesses who spoke to this felt that
actively monitoring investment selections made by investment managers hired
by participants is an unreasonable burden for employers to bear. Some
witnesses felt that there was clarification needed by DOL about if this duty
does or does not, in fact, exist.
|
(FE) No. The ERISA 404(c) regulations include an example
of a situation in which a plan provides the participant with total
discretion to choose his or her own investment manager and, pursuant to this
provision, a participant causes the plan fiduciary to appoint an investment
manager of his choosing for him. The manager invests imprudently. The
example states that in this circumstance, not only does the plan fiduciary
not have liability for the manager’s actions (under the ERISA principle
that the plan fiduciary is generally not liable for the actions of another
fiduciary), the plan fiduciary is also under no duty to determine the
suitability of the manager in this circumstance, because the plan fiduciary
did not use its discretion to appoint the manager. (See 29 CFR
2550.404c-1(f)(9).) If the sponsor has no liability in this circumstance, it
seems that it should be an even easier case that it has no liability when
the participant has chosen a manager entirely on his own.
|
(Pro) Under current guidance, it appears that they do
not, but this should be clarified.
|
In the context of a plan meeting the standards of ERISA
Section 404(c), there is an example in the 404(c) regulations that seems to
indicate that a participant designated investment manager does not cause
another fiduciary to incur liability for the imprudent investment decisions
of an investment manager designated by a participant or beneficiary. 29 CFR
2550.404c-1(f)(9). However, careful examination of this example reveals it
is only saying three things:
-
That the investment manager is subject
to fiduciary liability (i.e. not subject to 404(c) protection) for his
imprudent decisions because the decisions were not the direct and
necessary result of the participant’s selection of the manager,
-
That other fiduciaries of the plan
have no co-fiduciary liability under ERISA Section 405 for the imprudent
decisions of the participant designated manager, and
-
That other fiduciaries of the plan
have no direct fiduciary liability under ERISA Section 404(a) because
there is no duty to provide advice to participants under Section 404(c)
and because the plan itself is not making the designation of the
investment advisor.
|
What the example does not address, however, is whether
there may be direct fiduciary liability for making arrangements for
investment advisors to be available to participants and beneficiaries.
|
Although not directly applicable to the investment
manager situation posed in this question, it is worth noting that in
Interpretive Bulletin 96-1 the DOL has recognized that where a participant
or beneficiary of a plan seeks out and selects his or her own investment
professional to provide either investment education or advice, a plan
sponsor or other fiduciary does not incur liability for the actions of that
professional so long as the sponsor or other fiduciary neither endorses nor
makes arrangement for the provision of such services to the participant. 29
CFR 2509.96-1(e). This could be what the DOL was thinking when it crafted
the 404(c) regulation above: that the other plan fiduciaries had no
involvement in the arrangement or selection of the investment manager in the
question, and did not endorse that manager.
|
Regardless, there is a large grey zone in which plan
sponsors and other plan fiduciaries cannot determine the correct direction
to proceed in order to manage their liability. Indeed, the current structure
seems to provide a perverse incentive: throwing participants on their own
into the world of investments provides the best shield from potential future
liability. Therefore, clarification of these issues will serve both
participants and plan fiduciaries.
|
(NUFIC) If a plan provides the option of an
open-brokerage account, with no restrictions on investments, and an
individual participant seeks out and hires an investment advisor to manage
that account, then it would be unfair to require the plan sponsor to monitor
such investments. However, I don't think such accounts should be offered in
the absence of independent investment advice.
|
ERISA regulations currently allow
Section 403(b) annuity providers and IRA providers to solicit individual
participants at an employer without creating an ERISA plan, so long as the
employer does not endorse the provider. Should a similar rule exist that
allows providers of investment education, advice, and management services to
solicit individual participants without the plan sponsor incurring any ERISA
fiduciary responsibility, so long as it does not endorse the provider? What
actions would or would not constitute an endorsement by a plan sponsor?
|
Summary: Interpretive Bulletin 96-1 provides limited
guidance in this area. However, the witnesses said the ideal would be to
encourage plan sponsors to make available professional investment managers
that have been properly vetted by the plan sponsor.
|
Dissenting: None noted.
|
(FE) We believe that plan sponsors and plan participants
are best served when the sponsor designates one or more investment
professionals as plan fiduciaries, and the participant may then choose to
use a designee, or to use his or her own expert (or to use no professional
at all). Most participants lack the expertise and/or desire to choose an
investment professional. If this task is left to the participant, we are
likely to continue seeing large numbers of employees who do not save enough
for retirement and who do not appropriately diversify their retirement plan
portfolios.
|
It is possible, however, to have providers solicit 401(k)
participants’ business without creating any ERISA relationship with the
plan sponsor or the plan. In the Summary to Interpretive Bulletin 96-1, the
DOL refers to the possibility that a plan sponsor “may be viewed as having
fiduciary responsibility by virtue of endorsing a third party” to provide
advice. The Summary further states that whether there has been an
endorsement depends upon all the facts and circumstances. In other words,
the sponsor has no fiduciary responsibility at all for the activities of a
third party that it does not, in fact, endorse.
|
(Pro) Such a rule already exists under Interpretive
Bulletin 96-1. Section (e) of that document provides that where a
participant or beneficiary of a plan seeks out and selects his or her own
investment professional to provide either investment education or advice, a
plan sponsor or other fiduciary does not incur liability for the actions of
that professional so long as the sponsor or other fiduciary neither endorses
not makes arrangement for the provision of such services to the participant.
29 CFR 2509.96-1(e). In the preamble to 96-1, the DOL noted that making
available office space and similar facilities to such providers would not be
considered either endorsement or arranging for the provision of such
services. Beyond that, however, what “endorsement” means is unclear.
|
Clearly, endorsement would include statements relating to
a particular investment professional recommending or requiring that
participants use that professional, indicating that the professional is
better than other professionals, or indicating that the plan has chosen the
provider for the participants to use. However, if the goal is to encourage
plan sponsors to allow participants access to professional investment
educators, advisors, and managers, the definition of endorsement should stop
there. Specifically, “endorsement” should not include the following:
-
A sponsor allowing an investment
manager to solicit investment management business from individual
participants, or even providing the means to solicit the participants
(such as names, work email addresses, etc.);
-
Actions taken by a sponsor or other
fiduciary to determine the credentials of the soliciting professional
and actions taken by a plan sponsor to set minimum credentials and
prohibit professionals who do not meet those standards from approaching
their participants; or
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The performance of administrative and
recordkeeping functions by the sponsor or other fiduciary to facilitate
the provision of investment services, such as keeping copies of
investment management and other agreements between the participant and
the professional, keeping lists of participants utilizing the services,
and certifying to a trustee participants who are using a the services of
a professional for the purpose of disbursing fee payments to the service
provider from the participant’s account.
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The foregoing “gate keeping” activities are of the
type already allowed in DOL regulations for employers with respect to 403(b)
plans and IRAs without subjecting the plan to ERISA fiduciary duties at all.
See 29 CFR 2510.3-2(d) and (f). Note that defining “endorsement” as
suggested above has the same result as the proposed safe harbor exemption
explained in the response to Question 8.
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Should participants be allowed to
direct whether fees for independent professional investment management,
education, or advice be paid from their accounts? If so, does the plan
sponsor or trustees have an obligation to monitor the reasonableness of
these fees, or negotiate fees on behalf of the participants?
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Summary: Yes, as a matter of policy, participants should
be allowed to direct fees for investment advice and/or be permitted to have
the fees paid from pre-tax income. No, plan sponsors should not have the
obligation to monitor the fees, other than to confirm the fee is in fact for
investment advice.
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Dissenting: None noted.
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(FE) In our view, it would be inconsistent with current
law to make the plan sponsor or trustees responsible for monitoring the
reasonability of management fees in the case of a manager who is designated
by the participant and not as a fiduciary manager by the plan sponsor. By
“independent,” in this question, we assume a reference is intended to
what we have called nonfiduciary professionals, not those designated by the
sponsor on behalf of participants and the plan. In the case of independent
professionals, it may be fairly difficult and burdensome to set up the
mechanisms to allow for payment out of individual accounts, given that there
could be any number of such individuals, none of whom would have established
any relationship with the employer. Members of the Council who are familiar
with the operation of retirement plan trusts could speak to this question.
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(Pro) It should be permissible for plans to allow
participants to choose to pay for professional investment services from
their plan accounts. This will have the effect of encouraging participants
to use these services for their retirement plan assets.
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Where participants and beneficiaries select their own
educator, advisor, or manager for their account, it is not necessary to
impose an obligation on the plan sponsor or trustee to monitor the
reasonableness of the fees charged to a participant for these services. To
the extent that these activities are being performed by fiduciaries
(providing education is not a fiduciary function per Interpretive Bulletin
96-1), the charging of reasonable fees is enforceable under Section 406 of
ERISA and Section 4975 of the Income Tax Code. A fiduciary that causes a
plan to pay more than a reasonable fee for services to the plan has
committed a “prohibited transaction” under these sections. Prohibited
transactions are subject to enforcement actions by the DOL against the
fiduciary, as well as excise taxes under the tax code.
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However, if a plan sponsor or other fiduciary designates
one or more investment educator, advisor, or manager for participants and
beneficiaries to use, there would be an obligation to monitor or set the
fees for such services paid from the plan.
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(NUFIC) If fees for independent investment advice are
paid from plan assets, the plan sponsor should take responsibility for
monitoring those fees and negotiating fees on behalf of participants. If
they don't, they open themselves up to accusations of failing to look out
for the best interests of the plan and plan participants.
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How are professional investment
advisors compensated – out of plan assets, or paid by participants
electing the option?
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Summary: Both methods are in use.
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Dissenting: None noted.
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(FE) Either one is legally permitted. The norm, though,
is for investment managers to charge basis-point fees against plan assets.
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(Pro) ProNvest is compensated from the accounts of those
participants who elect to use ProNvest as an investment manager. It is
possible to also let the participant pay an advisor or manager directly,
outside of the plan. There are also situations where the advisor or manager
is paid out of general plan assets – i.e., across all participant
accounts, regardless of which participants actually use the services. The
issues relating to allocation of expenses to plan participants has been
recently addressed by the DOL in Field Assistance Bulletin 2003-3 issued in
May 2003.
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Does the selection of an
investment advisor constitute a fiduciary act by the Plan Sponsor?
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Summary: Yes, if the plan sponsor makes the selection.
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Dissenting: None noted..
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(FE) Yes, if the advisor is designated as a fiduciary
advisor by the plan sponsor, in its role as named fiduciary for management
of plan assets. See other items, particularly Question
7 and Question 9.
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Under ERISA, the governing documents of a plan may
provide that a named fiduciary of the plan may appoint an investment manager
to manage any assets of the plan. A “named fiduciary” is a plan
fiduciary named in the plan documents or pursuant to a procedure specified
in the plan documents. The named fiduciaries of a plan jointly and severally
have authority (and responsibility) to control and manage the operation and
administration of the plan. If the named fiduciary appoints an investment
manager, the named fiduciary is not liable for the acts or omissions of the
manager designated, if (i) the named fiduciary acts prudently in designating
the investment manager and in continuing the designation, and (ii) the named
fiduciary is not otherwise liable for a breach of duty committed by the
designee under the co-fiduciary liability rules described below. In this
connection, a fiduciary generally is not deemed to control (and thereby be
responsible for) the acts or omissions of another person merely because the
fiduciary has the power to appoint the other person to perform fiduciary
functions.
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The general principles summarized above apply also to a
plan described in ERISA Section 404(c) that permits participants to exercise
control over the assets of their Accounts and meets certain additional
requirements. The DOL has indicated that, if a fiduciary of such a plan (a
“404(c) Plan”) designates one or more investment managers whom
participants may appoint to manage the assets of their Accounts, an
investment manager selected by a participant to manage the participant’s
Account is a fiduciary of the plan, and the employer or other fiduciary
designating the investment manager acts as a fiduciary in so doing.
(Preamble to the 404(c) regulations.) In this regard, it is important to
note that the employer’s duty should not extend to monitoring the manager’s
specific investment decisions with respect to participant accounts. (See
H.R. 2269, The Retirement Security Advice Act: Hearing Before the
Subcommittee on Employer-Employee Relations of the Committee on Education
and the Workforce, 107th Cong., 48, 51 (2001) (H.R. 2269 “clarifies that
[the duties of a fiduciary appointing a fiduciary investment adviser] do not
extend to monitoring the specific advice given by the fiduciary adviser to
any particular participant.” (Statement of Ann L. Combs, Assistant
Secretary of Labor, PWBA, DOL)); see also, Leigh v. Engle, 727 F.2d 113, 135
(7th Cir. 1984) (appointing fiduciaries need not examine every action of
appointee fiduciaries, but engaged in breach because they failed to review
any actions of appointee)). For example, DOL regulations indicate that,
although the fiduciary responsible for designating an investment manager for
a 404(c) Plan should take into account any breach committed by the manager
in determining whether to continue the designation, the fiduciary ordinarily
will not be liable for the “imprudence” or other breach of duty
committed by the investment manager. (See 29 C.F.R. § 2550.404c-1 (f)
examples (8)).
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(Pro) Generally, yes. However, as described in the
responses to Question 10 and Question
11, there are circumstances in which allowing a plan participant or
beneficiary to select an investment professional does not constitute a
fiduciary act. As also noted above, the circumstances under which this is
true are unclear and the Advisory Council should recommend changes to
clarify these circumstances. Suggested changes are discussed in the response
to Question 8.
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Does the offering of a
professional investment advisor potentially decrease the Plan Sponsor’s
fiduciary liability?
|
Summary: Yes, however, this is not the general perception
of plan sponsors who believe that the offering of an investment advisor
would increase their liability. Several witnesses confirmed the need for the
Department to provide “Safe Harbor” rules for the selection and
implementation of investment advisors to belay the fears of plan sponsors.
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Dissenting: None noted.
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(FE) Yes. If the plan sponsor/fiduciary knows that
participants in its participant-directed retirement plan need help with
investing for retirement, the fiduciary should provide the needed help,
whether it is education, advice, professional management, or all of the
above. An excellent perspective on the liability benefits of offering these
services can be seen in two short articles by Fred Reish in Plan Sponsor
magazine’s November and December 2002 issues. Interestingly, it appears
that the plan sponsor fiduciary insurance industry is beginning to take the
view that advice reduces the sponsor’s fiduciary liability:
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“Ann Longmore, fiduciary liability practice leader at
insurance broker Willis Group Holdings, says that carriers are more
willing to provide fiduciary liability coverage if advice is provided. ‘The
fact that advice is being offered at this point is being seen as a strong
mitigating factor against problems’ arriving down the road, she says.
Companies that are currently being sued in relation to company stock
holdings in the 401(k) plans would be in a better position had they
provided advice, Longmore says, because the employees that are suing would
be ‘far less sympathetic if they were told by a professional that it’s
not in the best interest of their portfolio to have such a concentration.’”
(Treasury & Risk Management Magazine, May 2003)
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This comment was in the context of advice, not
management, but it should apply equally to professional management services.
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(Pro) It seems like it would have this effect. The
general fiduciary duty of prudence and acting in the best interests of plan
participants always applies to plan fiduciaries. If a plan sponsor knows
that the plan participants are unsophisticated with respect to investing,
and allows them to direct their retirement accounts, this would seem to be a
potential breach of these fiduciary duties. Providing an investment advisor
or manager, even with the added due diligence that should be done beforehand
and to monitor the provider’s activities, would seem to be a good way to
mitigate that potential for liability.
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(NUFIC) Yes it does, provided that the investment advisor
is independent, has no conflict of interest, has been carefully vetted, and
is regularly monitored for performance and reasonableness of fees.
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Must the professional investment
advisor have discretion over the participant’s assets in order to be
considered a professional investment advisor?
|
Summary: No, the investment advisor does not have to have
discretion. ERISA defines an investment advisor as anyone who “renders
investment advice for a fee or other compensation.”
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Dissenting: None noted.
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(FE) ERISA draws a distinction between an investment
advisor and an investment manager. (This is not necessarily the case under
federal securities laws.) Under ERISA section 3(38), the key distinction is
that an investment manager “has the power to manage, acquire, or dispose
of any asset of a plan.” At Financial Engines, when we act as an
investment advisor, we provide investment recommendations to individual
participants, who are then free to accept our recommendations entirely, in
part or not at all. To the extent they accept the recommendations, they
follow the plan’s usual procedures for making investment changes. On the
other hand, when we act as investment manager under our professional
management program, so long as the individual participant has elected to
have his or her account professionally managed, we have the discretion to
makes trades on his or her behalf to achieve the goals of the portfolio we
construct for the participant. It is important to note, however, that under
our professional management program, our portfolios are constructed entirely
from fund options already being offered under the plan’s main menu of
investment funds. In other words, the plan sponsor has selected the
investment options, and we construct portfolios for individual participants
using those sponsor-selected funds.
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(Pro) Under ERISA, an investment advisor does not have to
have actual control over the participant’s account to be considered an “investment
advisor.” If he does have such control, he is an “investment manager.”
See ERISA Sec. 3(38). One of the alternative prerequisites to being an
investment manager under ERISA is to be registered as an investment adviser
under the Investment Advisers Act of 1940.
|
In fact, “investment advisor” is not a directly
defined term in ERISA. Rather, ERISA Section 3(21) states that a fiduciary
is anyone who “renders investment advice for a fee or other compensation.”
This is expanded in the DOL regulations to include both 1) persons who have
discretionary authority or control over investment of plan assets (i.e.,
managers) and 2) persons who make individualized recommendations about how
plan assets should be invested with the understanding that the
recommendations will be the primary basis for investment decisions for plan
assets (i.e., advisors). The second part of the regulation includes
situations where the recommendations are made, but the participant (or other
asset manager) is free to disregard those recommendations. Therefore, the
ERISA concept of “investment advisor” includes both managers and
advisors.
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How have Plan Sponsor’s offered
professional investment managers and/or advisors to participants? For
example, is the investment manager and/or advisor shown as an additional
option to the Plan’s other investment options?
|
Summary: When offered, the investment manager/advisor is
provided as an added option to existing investment options.
|
Dissenting: None noted..
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(FE) Yes. In our experience, the norm is for the sponsor
to continue offering participants a lineup of investment options. The
participants are offered the opportunity to make their own decisions how to
allocate their account among those options or, as an alternative, are
offered the option to use a professional investment manager to make those
decisions for them.
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(Pro) Typically the plan will offer a group of funds or
other investment alternatives to plan participants. The investment advisor
is then made available to either assist participants in allocating their
accounts among those investment alternatives or to actually make the
allocations for the participant. In other words, the investment advisor is
an added service to participants, not an alternative to investment in the
investments offered by the plan. In some instances, the participant may
simply select the manager option at enrollment, who then directs the
investment decision within the universe of funds made available by the plan
sponsor.
|
How does the professional
investment manager/advisor option impact plan design?
|
Summary: It appears that it does not have an impact since
most plan documents already have a provision for the designation of one or
more investment managers.
|
Dissenting: None noted.
|
(FE) In our experience, most plans’ governing documents
already include language authorizing the named fiduciary for management of
plan assets to designate one or more investment managers.
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Technical Note: FE assumes that the questions are
generally intended to refer to the OPM; i.e., the option to have
professional management of the participant’s account, as distinguished
from advice that the participant may or may not act upon as he or she sees
fit. For example, although the first question refers to a “professional
investment advisor,” FE assumes that is intended to mean someone who
functions as a professional investment manager (though he or she may be
registered as an investment advisor).
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(Pro) Most standard plan document and/or trust agreement
language includes authorization for a fiduciary to designate an investment
manager or managers for the plan. From time to time, trustees will want
specific language authorizing payment of fees from a participant’s account
for an investment manager selected by a particular participant. Otherwise,
the plan design of a defined contribution plan remains basically unchanged
with respect to participant contributions and investment options.
|
In your experience, have you seen
plan documents that make plan participants “named fiduciaries” within
the meaning of ERISA? Are participants given the authority under a plan
document to designate an Investment Manager (as defined in ERISA) for his or
her account only?
|
Summary: Inconclusive, however it appears to be
counter-intuitive to the regulatory intent of ERISA and the practice should
be reviewed by the Department.
|
Dissenting: None noted.
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(FE) We have heard of, but have not seen, such cases. In
our experience, the norm is for the plan sponsor to designate one or more
fiduciary investment managers, and for participants to choose to use or not
use a designated manager. Where there is no fiduciary investment manager,
our experience is that a participant may choose a manager, but this is not
done as part of a plan provision making the participant a named fiduciary.
Instead, it is done as described in Question 7.
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(Pro) We have not actually seen documents, which
accomplish this. However, under ERISA, it seems like this should be
possible. ERISA Section 402(c)(3) provides that an investment manager must
be appointed by a named fiduciary of the plan. A named fiduciary is any
person named in the plan document as a fiduciary. Therefore, it would be
straightforward to name a participant as a fiduciary with respect to his or
her account under the plan and allow that person to designate an investment
manager for his or her account. Interestingly, however, is the interplay
with ERISA Section 404(c). ERISA Section 404(c) expressly provides that a
participant in a plan that complies with ERISA 404(c) is not a fiduciary.
While Section 402(c)(3) and Section 404(c) can be read to use the word
fiduciary in different contexts, clarification in the law that this is a
permissible arrangement would be very helpful to plan sponsors.
|
What fiduciary issues are
associated with this topic? Who is responsible for insuring that the best
interests of the participants are protected?
|
Summary: This is the proverbial “kitchen sink”
question meant to catch any related fiduciary issues not previously covered.
Fiduciary issues involve monitoring, selection and monitoring, as already
discussed in response to previous questions.
|
Dissenting: None noted..
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(FE) As is described in more detail above, when the plan
sponsor designates a fiduciary investment manager, the plan sponsor acts as
an ERISA fiduciary in selecting and monitoring the investment manager. The
sponsor must be prudent and act in the best interests of participants in
this endeavor. Certainly, as discussed above, thorough due diligence is part
of this process, and all the matters described under Q&A 9 above are, in
turn, a material part of the due diligence process. In addition, once
retained, the investment manager is an ERISA fiduciary and must act
prudently and in the best interests of participants. It is particularly
important that the manager or its affiliates not receive compensation that
is contingent on the content of the manager’s investment choices.
Otherwise, it would be impossible to know whether the manager’s decisions
are based upon merit or upon self-interest.
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(Pro) This topic implicates fiduciary duties in all of
its aspects. Ultimately, the fiduciaries of the plan are charged with
protecting the best interests of participants. The goal of any
recommendations that the Advisory Council makes at the conclusion of its
study of this subject should not be to provide an escape from fiduciary
responsibility for any aspect of this topic. Rather, it should aim to place
fiduciary responsibility into the hands of the fiduciary or fiduciaries most
capable of handling a particular aspect. Plan sponsors are worried about
being tagged with liability for investment advice given by an investment
advisor or manager that they provide for their participants. Sponsors,
however, generally are not in the business of giving investment advice, and
shouldn’t have liability for advice given by a professional. Sponsors do,
however, know their participant population, and thus it is reasonable to
charge a sponsor with the duty to diligently choose the best provider(s) for
those participants, and to monitor that the provider is continuing to meet
those participants’ needs. But the line between those functions should be
clarified. We think legislation along the lines presented in the response to
Question 8 would accomplish this. Such a line will
help sponsors to know where they stand and serve to encourage them to offer
these needed services to their participants.
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(NUFIC) Fiduciary issues would include (but are probably
not limited to) disclosure (of fees, relationships, conflicts, etc.), acting
solely in the interest of the plans, the prudent man rule, investment
diversification, accuracy and adequacy of plan documents (do the plan
documents permit the use of plan assets for investment advice). Plan
sponsors, fiduciaries, and ultimately, the DOL, should ensure that plan
participants' interests are protected. Plan participants themselves should
be encouraged to take a more active role in protecting their plan assets.
|
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-
The Department of Labor should offer
an additional “default” option to existing safe harbor provisions,
which provides for a “life-stage fund” or a “diversified balanced
portfolio.”
-
The Department of Labor should provide
clarification for plan sponsors that the use of professional management
for plan participants of self-directed defined contribution/401 (k)
plans might actually reduce their overall fiduciary liability.
-
The Department of Labor should develop
new safe harbor provisions for selecting and monitoring service
providers of Optional Professional Management. This safe harbor should
take into account the limited ability of small-to-medium size plans to
independently assess and monitor the qualifications and performance of
these service providers.
-
The Department of Labor should clarify
the extent to which a plan sponsor has fiduciary responsibility when
allowing a participant to select their own investment advisor/manager
for their plan assets when the plan pays the advisor’s or manager’s
fees.
|
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Summary of Testimony of Sherrie Grabot
|
Sherri Grabot is the CEO for Guided Choice. She explained
the company’s business model is as an Advice Provider and Account Manager
for 401(k) plans. An asset or investment manager does not pay them fees, and
so Ms. Grabot believes Guided Choice to be an objective third party as a
result.
|
Ms. Grabot described how Guided Choice provides three
levels of service: education, advice, and managed accounts. She stated as a
result of Guided Choice’s service, employee participation rates rise in
the plan, as do the average savings rates. Since participation and savings
rates are impacted by plan design according to Ms. Grabot, Guided Choice
works with plan providers to adjust their plan design to achieve results.
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According to Ms. Grabot, 95% of participants have little
to no idea of how much risk they are taking. Most believe company stock is
low risk, she stated. On average, she said they hold 1.7 – 2 asset
classes. Ms. Grabot stated that Guided Choice and other financial advisors
are not so great at helping the little guy whom she defined as younger, not
as educated, or lower income.
|
Guided Choice believes it should be a shared
responsibility, among government, plan sponsor, and the employee, to help
employees prepare for retirement, Ms. Grabot commented. She also stated she
believes conflict in financial guidance won’t be solved by written
disclosures because participants won’t read them. Ms. Grabot stated that
plan sponsors do need liability relief. Larger plan sponsors can get expert
help, she said, but smaller plan sponsors don’t with respect to picking
and monitoring investment advisors. Performance of advice can only be
measured by changes in allocation, such as reduction in Company stock
holdings, and changes in savings and participation rates, according to Ms.
Grabot. She believes there are no real benchmarks for a managed account
performance.
|
Ms. Grabot said Guided Choice provides services for 1500
plans covering ¼ million participants, and her comments were based on her
experience with these plans.
|
|
Summary of Testimony of Carl Londe
|
Carl Londe is the Chairman, CEO, and spokesman for
ProManage, Inc. Mr. Londe has over 26 years of management, financial, and
human resources experience. His responsibilities with ProManage include
identifying opportunities and solutions related to the use of company stock
in defined contribution plans.
|
Mr. Londe stated that ProManage believes a well defined,
professional management program is an absolutely essential benefit for
defined contribution plan participants, because approximately 85% of
participants in defined contribution plans do not actively manage their plan
accounts, and their plan accounts are neither diversified nor rebalanced on
a recurring basis. Mr. Londe cited a Watson Wyatt study showing
professionally managed retirement plan assets outperformed
participant-managed retirement plan assets by 2% per year for five
consecutive years. He also cited a State of Nebraska 30-year study showing
that the state’s defined benefit plan investment performance exceeded the
aggregated participant-directed investment performance of the defined
contribution plan by 4% per year.
|
ProManage coined the phrase “reluctant investor” to
describe these plan participants who do not have the time, the desire, or
the knowledge to do their own investing. Although ERISA Section 404(c)
permits plan sponsors to transfer to plan participants the responsibility as
well as the privilege of directing the investment of plan assets, reluctant
investors do not want to accept either the privilege or the responsibility.
These reluctant investors benefit most from professional management of their
retirement plan assets.
|
Mr. Londe described the service ProManage offers to
defined contribution plan sponsors. Under this program, ProManage accepts
fiduciary responsibility as an investment advisor under ERISA 405(d) and
builds an investment portfolio for each participant in the plan. In response
to questions, Mr. Londe stated that the asset allocation for each
participant is based solely on information provided by the plan sponsor –
the participant’s age, salary, any defined benefit plan benefits, and any
supplemental executive benefits. The asset allocation does not reflect the
participant’s risk tolerance, because of the difficulty in measuring risk
tolerance, but substitutes a suitability analysis. Outside retirement assets
and spouse’s assets are also not reflected in a participant’s asset
allocation. This method institutionalizes the asset allocation process and
reduces costs. The existing investment options available under the plan are
used to construct the participant’s investment portfolio. The investment
of the participant’s plan account is recalculated and rebalanced at least
annually.
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According to Mr. Londe, the key criteria for an
investment adviser for participants in a defined contribution plan are
experience, independence, willingness to take fiduciary status, and results
measured on an individual basis. The standard for an investment adviser to
satisfy is that of a prudent expert, with potential damages being the
difference between what the investment adviser did and what prudent expert
would have done. When a plan sponsor engages an investment adviser with
these characteristics, the plan sponsor’s exposure is significantly
reduced (although not to zero).
|
Mr. Londe acknowledged that although the plan sponsor or
plan administrator must prudently monitor an investment adviser; there is no
clear guidance on how to prudently monitor an investment adviser providing
this type of service. The test is not purely investment performance. Other
than subjective participant satisfaction, the only measure is whether the
investment adviser’s actions were prudent under the circumstances, which
cannot usually be quantified. The investment adviser’s performance must be
measured on an individual participant basis, not on an aggregate plan basis.
|
In response to questions, Mr. Londe stated that charges
for these investment management services range between 10 and 65 basis
points depending on the plan design and the bells and whistles selected by
the plan sponsor. The typical charge is 35 basis points on the first $100
million under management and 10 basis points on assets over that. With few
exceptions, the fees are charged directly to participants’ accounts and
clearly identified on participants’ plan statements.
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Mr. Londe also offered the Working Group 10 suggestions
with respect to the Working Group’s development of recommendations on
optional professional management. One of those suggestions was to not
confuse disclosure to plan participants with substantive protection for plan
participants, because the reluctant investors do not read or understand the
disclosures. Mr. Londe advocates an independence requirement for an
investment adviser.
|
Other suggestions include not confusing utilization of
these services with actual utilization of these services, being wary of
traditional performance measurements, and realizing that the participants
with the smallest account balances are the individuals who most need
assistance in investing their retirement plan assets.
|
|
Summary of Testimony of Richard P. Magrath
|
Richard P. Magrath is one of the founders of ProNVest and
currently serves as its president. Prior to joining ProNVest, he was the
managing director of Platform One, a joint venture with Marsh focusing on
delivering state-of-the-art employee benefit services and solutions. Before
his tenure with Platform One, Mr. Magrath served Marsh for over 20 years in
various capacities, including sales, marketing, client relationship
management, and senior management positions.
|
Mr. Magrath told the Working Group that the challenge
facing plan sponsors is to give plan participants access to investment
education, advice, and management while protecting plan assets and
protecting plan sponsors from liability. He stated that most plan sponsors
want to do the right thing and help plan participants understand and
appreciate their retirement plan and how it works.
|
Citing a Watson Wyatt survey, Mr. Magrath stated that
defined contribution plan participants generally do not sufficiently
diversify their plan investments, either across investment classes or
individual investments, and typically invest too large a portion of their
plan assets in company stock. Most plan participants also do not make
changes to their plan investments with sufficient frequency. As a result, a
significant majority of defined contribution plan participants are not on
track to achieve their retirement income goals.
|
Mr. Magrath attributed participants’ investment failure
to the fact that most participants cannot or will not actively participate
in the investment management of their retirement assets. However, even
though they recognize that participants need professional help to achieve
their retirement income goals, plan sponsors do not provide investment
advice or management services to plan participants because they fear the
accompanying fiduciary liability.
|
Plan sponsors generally want to help plan participants
achieve their retirement income goals while minimizing or avoiding fiduciary
liability and reducing or eliminating plan administrative costs. Plan
sponsors also want to provide investment help to participants that can be
applied to the full spectrum of employees, across all ages as well as across
levels of financial resources and sophistication.
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Under the ProNvest model, ProNvest is engaged by a plan
sponsor to provide investment management services to two specific groups of
plan participants. First, former employees with plan account balances can
engage and pay ProNvest to provide assistance in rolling over the
participant’s distribution to an IRA and in managing the investment of the
IRA. Second, current employees who have accounts in a former employer’s
plan can engage and pay ProNvest to provide assistance in rolling over the
distribution to an IRA and in managing the investment of the IRA.
|
As part of its model, ProNvest also offers to provide
investment management services to current plan participants at no charge.
ProNvest claims that by not directly charging a fee for these services,
ProNvest is not acting as a fiduciary, under the definition of a fiduciary
in ERISA Section 3(21)(A)(ii). Correspondingly, the plan sponsor is not
subject to fiduciary liability for retaining ProNvest to provide these
services to current plan participants, because ProNvest is not acting as a
fiduciary. ProNvest bases its position on Interpretive Bulletin 96-1, 29
C.F.R. §2509.96-1, and also has an Advisory Opinion request pending before
the Department of Labor. Members of the Working Group did question whether
ProNvest’s position on this question could be successfully defended
against legal action.
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Mr. Magrath also suggested that the Department of Labor
establish a safe harbor under which a plan sponsor would not incur fiduciary
liability for allowing a professional asset manager to solicit business from
current plan participants or for any education, advice, or management
services provided by the professional. The safe harbor should require that
the participant freely elects to engage the professional asset manager, and
that the professional asset manager meet specific minimum standards. Those
standards should require:
-
The professional asset manager to be
independent of the investments recommended by the professional asset
manager;
-
The professional asset manager to be
registered as an investment adviser under the Investment Advisers Act of
1940;
-
A written asset management agreement
between the participant and the professional asset manager (with a copy
retained by the plan sponsor); and
-
The professional asset manager to
acknowledge in writing that it accepts fiduciary responsibility as an
investment manager.
|
|
Round Table Discussion With Sherrie Grabot, Carl Londe,
Richard P. Magrath, Ken Fine
|
The Working Group asked these witnesses to describe the
types of assistance providers of optional professional management services
need from the Department of Labor. Ms. Grabot stated that the Department
could help by removing the liability barrier for plan sponsors, which she
and the other witnesses indicated is the primary barrier they encounter. Mr.
Londe stated plan sponsors are concerned with the fiduciary liability issues
associated with providing participants with investment advice and education
services. He also noted that there are many positives to having good, strong
safeguards in place.
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Mr. Fine, Ms. Grabot, Mr. Londe, and Mr. McGrath all
stated that current law governing fiduciary liability is acceptable and
adequately protects plan participants, but plan sponsors do not clearly
understand the current law requirements or their effects, and this causes
confusion, worry, and angst for plan sponsors. Mr. Fine stated that
inconsistent opinions from plan sponsors’ outside legal counsel regarding
potential fiduciary liability is a problem in encouraging plan sponsors to
make these services available to plan participants.
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When asked if the Department can help by clarifying
current law on fiduciary liability, all of the witnesses agreed. Ms. Grabot
stated that the ability of a plan sponsor to understand the potential
fiduciary liability is a barrier that must be lowered. She and Mr. Londe
agreed that plan sponsors have been told for many years that they cannot
offer investment advice, but now are being told that they can, even though
the law hasn’t changed, and plan sponsors are confused. Ms. Grabot stated
that the Department can help by getting out a clear message to plan sponsors
about the fiduciary liability associated with providing these services. Mr.
McGrath agreed that current law clearly imposes fiduciary liability on plan
sponsors when selecting service providers, and plan sponsors are aware of
this liability. Plan sponsors are afraid of having more liability if they
select an investment advice or management service provider.
|
Mr. Londe also strongly advised the Working Group that
the independence of investment advisers and managers should be safeguarded.
He stated that the Department, in any guidance or safe harbors, should not
substitute disclosure for independence, because disclosure doesn’t work
for most of the people for whom these services are most valuable.
|
The Working Group asked the witnesses if their services
could be applied to a prototype plan already in place. Mr. McGrath stated
that because his company is neutral as to who has custody of the plan’s
assets, most custodians do not object to their providing services to these
types of plans. Mr. Londe stated that virtually every plan asset custodian
his company has approached would at least accommodate his company. He noted
that directed trustees are often required to work with his company as a part
of their contractual functions for the plan.
|
Mr. Fine stated that his experience has been that plan
sponsors in the “jumbo” market are extremely independent and make their
own decisions regarding his services based on their own research. However,
decisions by plan sponsors with small plans (less than 1,000 participants)
tend to be driven more by the financial institutions and providers already
engaged by the plan.
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The Working Group questioned whether these services are
not accessible by lower income participants, because they have less of an
ability to pay for the services, even though these are the participants who
need the services the most. Ms. Grabot stated that her service fees are
asset based, so a participant with lower plan assets pays lower fees. She
also noted that many plan sponsors with low-income participants subsidize
the fees for low income or low balance participants. Mr. Londe agreed that,
because his service fees are also asset based, the fees generally are not a
barrier based on the size of a participant’s account. Mr. Fine noted that
his company’s asset-based fees for management services have generated
sizeable enrollments among lower balance participants, who pay a lower fee.
Mr. Fine stated that when his company is engaged to provide advisory
services, the plan sponsor often pays the fees.
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The Working Group asked the witnesses whether plans that
offer employer stock as an investment presented any specific problems or if
the plan sponsors tend to resist engaging their services. Mr. Londe stated
that he can present a range of alternatives to these plan sponsors, from
carving out the employer stock and managing around it, to selling down
participants’ employer stock holdings to a level either set by the plan
sponsor or set by his company in light of the facts and circumstances. His
experience has been that even when plan participants are advised to not
concentrate their plan accounts in employer stock, the participants
generally do not independently divest their plan accounts of significant
employer stock holdings. Applying a managed approach to these plans and
participants allows an expert to divest the employer stock in a more
disciplined and effective way.
|
Mr. Fine stated that a plan’s inclusion of employer
stock can create a demand for his services or be an obstacle to his selling
his services. Some companies hire him to reduce the amount of employer stock
held in the plan, while other companies don’t hire him because they don’t
want to decrease the amount of employer stock held in plan. But he has
observed a trend toward reducing concentrations of employer stock held in
plans.
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The Working Group asked if there are any statistics
available to show that the witnesses’ services add significant value to
participants’ accounts. Mr. Londe stated that it is tough if not
impossible to measure their performance, because they provide services at
the individual participant level. He has noted a halo effect, however, in
that plans using his services generally have increases in the
diversification of participant accounts. Ms. Grabot stated that the measure
is whether participants are better off, after looking at where they were
before and where they are after, but she agreed that statistical measurement
is impossible. Participants whose plan accounts are diversified because of
these services will under perform when the market is up and over perform
when the market is down. But over time the participant’s losses are
mitigated and the participant gets the highest rate of return. She did note,
however, that the basic problem facing plan participants is their savings
rate, and the services provided by any of the witnesses generally do not
directly affect participants’ savings rates.
|
|
Summary of Testimony of Ken Fine
|
Ken Fine is the Vice President of Product Marketing for
Financial Engines. Financial Engines was founded in 1996 by Bill Sharpe to
market to individual investors in self-directed plan accounts the expertise
acquired in terms of investment approach, methodology and technology in the
management of large defined benefit and defined contribution pension plans.
Financial Engines provides services to 900 plan sponsors covering 3.2
million plan participants. The services consist of investment education,
personalized advice, and, for the last nine months, investment management.
These services are delivered online, in print, and via telephone. Mr. Fine
has led Financial Engines in developing the professional investment
management component of the company’s product line.
|
The experience of Financial Engines is that participants
are increasingly demanding, feeling the need for assistance in their
investment of their plan assets. This is driven by the aging of the
workforce population, the volatility of the investment markets in the last
few years and a widespread belief among plan participants that they
generally lack the time and interest to self-invest their plan assets. At
the same time, most plan sponsors are concerned about the lack of
appropriate diversification they see within the portfolios of their plan
participants.
|
Plan participants generally segment into three groups
with distinctly different investment characteristics. The first group,
consisting of approximately 15-20% of a participant population can be
characterized as the “do-it-yourselfers.” These participants enjoy
investing, actively plan, tend to be confident and typically save the
maximum amount. When investment information and assistance is provided, this
group uses it, but does so as a “second opinion.”
|
The second group may be characterized as the “motivated
but uncertain” group. It consists of approximately 30% to 50% of a
participant population. This group has less time and interest than the
first, but is concerned that assets need to be properly invested. However,
members of this group lack a belief that they can make good investment
decisions. Information and investment advice tends to work well for this
group of investors. They appreciate the advice and education and often
implement the recommended strategies completely.
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The third group is composed of the “reluctant
investors.” Approximately 30% to 50% of a plan participants fall into this
group. This group has the least amount of time and interest in investing
plan assets. The portfolios of members of this group tend to be naively
invested, either in the original default allocation, or in high
concentration in particular funds or in extreme dispersal among funds
without a clear basis for the dispersion. This group is most benefited by
professional management.
|
Plan sponsors today believe that discretionary management
or professional management needs to be available to plan participants as one
option. The general sense of plan sponsors and of plan participants is that
professional management should be provided by “independent entities.”
|
About 15-25% of plan participants sign up for
professional management when this option is fully communicated over a
one-year period. If offered at the outset of plan enrollment, this
percentage would likely be much higher. The enrollees tend to be those with
lower balances of less than $100,000 or less than $50,000. Those reluctant
to enroll primarily express concern over “losing control of their account.”
The potential market for professional management services appears to be
about 80% of the participant population.
|
The fees for investment management by Financial Engines
are still in the developmental stage as the service is tested and matures.
They are less than 100 basis points per year of a plan participant’s asset
base. These fees are disclosed as a line item on the participant’s
statement. In providing the service, Financial Engines accepts
responsibility as a named fiduciary. The potential market for professional
management services appears to be about 80% of the participant population.
|
In providing professional management, a manager must be
able to take into account outside assets of an individual participant.
Financial Engines does so, but does not provide any investment management as
to those outside investments. (Participants may, of course, use the general
information and allocation models provided by Financial Engines is their own
investment of their outside assets. Also, on occasion, an employer may
specifically contract for a broader range of services to be provided,
including management of outside assets.) The information provided to
Financial Engines concerning a participant’s outside investments is
confidential participant information under Financial Engines’ privacy
policy. Such information will not be provided to the plan sponsor.
|
The professional management service provided by Financial
Engines is premised upon and dictated by its allocation models. Individual
investors are provided information sufficient to assess their risk
tolerance. Where a participant has returned minimum risk tolerance
information, communications are directed to the participant before an
investment is made, alerting the participant to the risk profile of the
default risk tolerance selection and the options for investments with
different risk tolerance levels.
|
Participants who have enrolled for professional
management are always entitled to personal telephonic communications with
Financial Engines representatives. Statistically, about 20% of the
participants place such calls during a year. The average call lasts
approximately 15-20 minutes.
|
The Department of Labor could facilitate promulgation of
professional management and other investment services by reducing confusion
among plan sponsors and their legal counsel as to the meaning of the
fiduciary responsibilities imposed on plan sponsors. The obligation to
oversee selection of providers and the obligation to monitor them could be
better explained to enable a plan sponsor to know with certainty whether or
not they have satisfied and are continuing to satisfy these obligations as
time passes.
|
|
Summary of Testimony of Scott D. Miller
|
Scott Miller is a principal of the Actuarial Consulting
Group, an employee benefits consulting firm with 25 years of experience in
the employee benefits and compensation consulting field. He is president of
the American Society of Pension Actuaries, a Fellow of the Conference of
Consulting Actuaries and a member of the American Academy of Actuaries.
|
Mr. Miller appears to present the views of the American
Society of Pension Actuaries, ASPA, a national organization of over 5,000
retirement plan professionals that provide consulting and administrative
services for qualified retirement plans, the vast majority of which are
maintained by small businesses.
|
The 401(k) plan has become the dominant retirement plan
for the American work force, particularly for workers at small to mid-sized
companies.
|
In a 401(k) plan, unlike in a defined benefit plan, it is
the participant who bears the risk of any 401(k) account investment losses.
It is also the participant who bears the responsibility in most cases to
invest plan assets, and who tends to do so without the assistance of
professional investment expertise. Consequently, the retirement security of
a large segment of the American work force is inherently at risk.
|
The law currently contains restrictions on the ability of
participants to gain access to professional investment expertise. Policy
makers must recognize the need to change both the law and regulations where
necessary in order to provide 401(k) plan participants with access to the
proper tools to allow them to save effectively for retirement. Currently, in
response to Department of Labor regulations, advice available to
participants tends to be only general investment education, and not
individual advice. Retirement plan service providers, even those
unaffiliated with retirement investment companies, receive fees from plan
assets. Thus, they must resist giving advice, because that further act
renders them a fiduciary and violates current prohibited transaction rules.
|
Increasingly, plan participants desire either (1) advice
that includes recommendations as to actual investment choices and that will
constitute the primary basis for the participant’s investment decisions or
(2) the ability to delegate discretion to an investment manager over the
participant’s account. Under Interpretative Bulletin 96-1, the Department
of Labor has deemed both activities sufficient to render the provider a
fiduciary.
|
Independent advisors with no other relationship to a plan
or plan sponsor exist to provide such advice. However, their cost is
frequently prohibitive on a per-participant basis.
|
Computer-based advice tools exist that can be extremely
effective and relatively cost-efficient in providing these types of
fiduciary assistance. However, they are not used currently in the retirement
plan marketplace to any significant extent. This is because their setup cost
is fairly high and because their use poses the risk of fiduciary liability
for the employers that are the plan sponsors.
|
One of the primary features of a 401(k) plan for
employers is the protection it provides from the plan sponsor acquiring
fiduciary liability. Currently, the selection of an investment advisor
constitutes a fiduciary act by a plan sponsor. The sponsor then has the
responsibility to monitor the activities of that investment advisor. Surveys
by the Institute of Management and Administration consistently show that
potential fiduciary responsibility is by far the major reason employers
choose not to offer investment advice to their employees.
|
Some legislation has been introduced in response to these
employer concerns. Last year, Senate Bills, S.1971 and S.1972, proposed
creating a fiduciary liability safe harbor for employers who designated an
investment advisor for the plan. These bills relieved the employer of
liability for losses resulting from such investment advice. The employer was
also relieved of the obligation to monitor the specific investment advice
being given to any particular participant. To qualify, the employer had to
engage a qualified investment advisor and the qualified investment advisor
had to conduct itself in accordance with various procedures to avoid
conflicts. The House of Representatives passed legislation taking a
different approach to a safe harbor. This permitted various conflicts
provided disclosure was given. The House Bill has been opposed as being too
broadly crafted.
|
ASPA believes certain prohibited transaction relief
provided under the House Bill would be appropriate. For example, where an
investment advisor receives fees from plan assets, but the fee is a flat
percentage of account assets and the advisor is otherwise unaffiliated with
the investment management company, no conflict of interest really exists.
Similarly, if investment advice is based on an independent computer model,
the fact that an investment advisor may actually be affiliated with an
investment management company need not be prohibited under conditions
similar to those granted by the Department of Labor to SunAmerica.
|
ASPA believes other circumstances are likely to exist
where prohibited transaction relief would be appropriate despite the
technical existence of conflicts.
|
ASPA further believes that any legislation to promote
participant investment advice should also address and resolve plan sponsor
concerns about potential employer fiduciary liability. Until this is
addressed, investment advice will not be offered to any great degree.
|
ASPA is also concerned that the development of investment
management as distinct from investment advice poses further risks to plan
sponsors that should be addressed and resolved. An investment advisor and an
investment manager are both fiduciaries. The manager exercises discretion to
make an actual investment. The advisor does not. The costs for providing
investment management are greater than those for providing investment
advice. If investment management is made available primarily to participants
more highly compensated with larger account balances, a technical risk of
discrimination arises under Internal Revenue Code § 401(a)(4). This occurs
because the definition of benefit rights and features includes “all
optional forms of benefits”, including “other rights and features” of
meaningful value to an employee. Current Treasury regulations lists --
within the definition of “rights and features” -- the rights to direct
investments or the right to a particular form of investment. Further, this
definitional list is not all-inclusive. ASPA believes that clarification is
in order to establish how qualified plan non-discrimination rules will be
applied to investment management alternatives.
|
Prohibited transaction issues also arise with respect to
investment manager alternatives. Under ERISA § 406(b)(1), an investment
manager is prohibited from using its authority to cause the plan to pay
additional fees to the manager unless the manager fits within an exception
to the rule. Investment managers with relationships to mutual funds need
certainty as to when the inter-related transactions are and are not exempt
from the prohibited transaction rules. For example, where mutual funds are
used and some have one level of commission and other funds have another
level of commission, prohibited transactions might be deemed to occur that
were otherwise inadvertent.
|
Any uncertainty in whether investment managers and
advisors may run afoul of nondiscrimination or prohibited transaction rules
further discourages plan sponsors from making such fiduciaries available to
plan participants. Plan sponsors fear that they will be found liable along
with such fiduciaries in the event of litigation over losses that may occur.
|
ASPA believes relief must be made available to plan
sponsors to encourage the provision of fiduciary services to plan
participants. The type of education provided to plan participants under
existing Department of Labor guidelines is not what plan participants seek.
As one who sits in front of them during these talks, Mr. Miller watches the
eyes of many glaze over within five minutes. Plan participants don’t want
education. They want to know “what should I do?” The Department of Labor
needs to put rules and regulations in place that will encourage plan
sponsors to provide that type of advice and management to plan participants.
|
|
Summary of Testimony of Bob Wuelfing
|
Testimony June 27, 2003; presented by Robert G. Wuelfing,
founder of RG Wuelfing & Associates, and Steven Saxon, Esq. a principal
of the Groom Law Group.
|
Mr. Wuelfing began his testimony by providing a short
introduction on The Spark Institute (“Spark”). Spark, the Society of
Professional Administrators and Record Keepers, has a membership of more
than 250 organizations which in turn provide 401(k) services to
approximately 97% of all 401(k) participants. His testimony was based
primarily on research conducted by Spark.
|
Mr. Wuelfing’s first point proved to be one of the most
provocative statements heard during the course of the hearings. The commonly
quoted 401(k) participant balance of $40,000 is a very misleading number. If
the largest (top 10%) account balances are removed from the calculation, the
average account balance is reduced to $9,000, with this same remaining
participant universe carrying an average of $7,000 in credit card debt. His
comment was meant to reinforce the point that:
|
“… You cannot asset allocate your way to
retirement. It’s not going to matter how you do your asset allocation.
You can only save your way to retirement and the savings rate within the
401(k) industry is quite low and isn’t going to be enough to make it to
retirement.”
|
The major findings of Spark, as reported by Mr. Wuelfing,
include:
-
Only 3% of 401(k) participants have
stopped contributing during the bear market.
-
The number of participants attending
401(k) informational meetings has dropped by 50%, primarily as a result
of the plan sponsor’s reluctance to allocate work time for educational
meetings.
-
Demand from participants for
investment advice continues to rise; with 82% responding that they
believe investment advice is either “important” or “somewhat
important” to their retirement.
-
61% of plan sponsors do not currently
offer participants advice. However, 80% of this universe indicated a
willingness to provide advice “… if the law was changed allowing
them to do so… there is a perception amongst plan sponsors … that,
in fact, they cannot give advice to their participants.”
-
When participants were asked about
their primary source for their asset allocation decision, 50% indicated
they made their decision on their own; 19% obtained assistance from a
professional advisor; 16% received assistance from friends, co-workers,
and family; 12% from employers; and, 3% from on-line tools.
-
When participants were asked about the
importance of advice, 85% responded that advice was important.
-
Participants indicated that the
preferred method for receiving advice was with face-to-face meetings
with a professional. Second, in order of preference, was telephone
support, and Internet tools were ranked third. The challenge with
face-to-face interviews with a professional is cost – who was going to
pay the bill? With regards to the Internet tools, studies indicate
participants begin to use the tools, but drop out before actually
implementing the advice provided.
-
When participants were asked who they
would like to receive advice from, the preferred choice was an advisor
the participant already had a relationship with; the second choice was
an advisor selected by the record keeper; and, the third was an advisor
selected by the plan sponsor.
|
Mr. Saxon then presented information on the legal
implications of providing professional advice, beginning with the three
primary models of investment choice. The first is self-directed brokerage
where the participant has the flexibility and freedom to pick virtually any
investment. The second model is where the participant is provided advice and
education to develop their own investment strategy from a defined list of
investment options. And, the third model is when the participant delegates
investment decisions to a professional – the topic of these hearings.
|
There are significant legal implications when the
participant delegates investment decisions to a professional advisor (the
advisor is given discretion over the portfolio). For the plan sponsor there
is the fiduciary responsibility for selecting the advisor. Though the
selection of an advisor has the specter of increased liability, the prudent
selection and monitoring of an advisor may actually reduce the overall
liability of the plan sponsor because the investment results may prove to be
more satisfactory than if the decisions were participant-directed. Reference
was made to the Safe Harbor provisions of Section 405(d) (1) of ERISA.
|
The second significant legal issue is the advisor’s
potential conflicts of interest. When the advisor is recommending affiliated
funds, Prohibitive Transaction 77-4 does not permit the advisor from
receiving sales commissions or redemption fees. With respect to unaffiliated
funds, Prohibitive Transaction 75-1 and the SunAmerica advisory opinion
should guide the advisor.
|
One of the more provocative statements made by Mr. Saxon
dealt with his opinion as to why the professional advice models were the
subject of increased interest. He, as well as Mr. Wuelfing, believe the
professional advice products are being created by 401(k) vendors that are
looking for ways to distinguish themselves from their competitors and not
necessarily because there is participant demand.
|
The Chairman, Mr. Gardenhire, asked both Mr. Wuelfing and
Mr. Saxon if they believed there was any potential for abuse with the
professional advice model. Mr. Wuelfing reiterated that 401(k) plans were
never intended to be a participant’s primary retirement vehicle. Tools
provided to participants in the nineties tended to support the notion that
participants could asset allocate their way to retirement, and deemphasized
the need to save. Mr. Saxon cited two major potential areas for abuse: the
plan sponsor that does a poor job of selecting the advisor; and, the advisor
that does a poor job of avoiding prohibitive transactions (advice is
compromised by compensation).
|
Committee person, Mr. Szczur, who asked whether a
diversified default option fit within the context of these discussions,
posed a final question. Mr. Wuelfing believed it would help, somewhat, but
the key is to convince the participant that they need save and they need to
seek advice on how to invest their assets properly. Mr. Saxon pointed out
that the protection of 404c requires the participant to make an affirmative
election and the default option may not meet the provisions of 404c.
|
|
Summary of Testimony of Lori Lucas
|
Lori Lucas, a Chartered Financial Analyst and a Hewitt DC
Plan Consultant, is a recognized expert on 401(k) investment structures,
trends and communications, DC Plan participant behavior, and investment
policy selection and monitoring. Ms Lucas presented information based on
statistical analyses done by Hewitt using its recordkeeping data as well as
surveys of both plan sponsors and employees. The recordkeeping data, from
2002, includes 2 million eligible employees participating primarily in large
plans.
|
Barriers to Appropriate Saving and Investing. Ms.
Lucas identified the following barriers: (1) concentrated account holdings
(the average participants holds only 3.6 funds and, where available, has 42%
of DC account invested in employer stock); (2) ongoing failure to rebalance
(1 of 6 rebalanced in 2002); (3) market behavior, not rebalancing
(participants who do make changes tend to engage in a momentum strategy);
and (4) failure to understand the role of certain investment options (the
average number of investments held by people with Lifestyle Funds is 4.8).
|
Considerable Growth in Offering Investment Advice.
Among the large plan sponsors that are Hewitt's clients, one in three offer
on line investment advice. Substantial numbers of large plan sponsors
indicate interest in offering investment advice. However, fear of liability
tends to constrain behavior. In a 2001 survey across about 450 plan
sponsors, the most common reason that people said that they were not
offering advice was that they were not sure how to provide advice given
current regulations.
|
Automatic Enrollment. Ms Lucas reported that there
is still a lot of uncertainty around automatic enrollment, and the liability
associated with that, so for the most part, plan sponsors have cooled on the
idea of offering automatic enrollment. There was very little growth in the
number of plan sponsors that offer it between 2001 and 2003. Among those
that do, they are being very, very conservative in their choices, and using
stable value as the default fund and a very low default contribution rate of
2 or 3 percent is not uncommon.
|
Questions: In response to questions, Ms. Lucas
stated that the DOL could help encourage plan sponsors to offer investment
advice by providing guidance on the process, which should be used to
prudently select the advice provider. Plan sponsors would like to see
examples of prudent process and the limits of liability if a prudent process
is used. When asked whether she believed a safe harbor would be useful, Ms.
Lucas said: “I don't think plan sponsors are looking for a list
necessarily – ‘these are the five things or ten things or whatever the
number is that you should do.’ But here's a model, that if you follow this
model, that you will have a safe harbor for selecting the investment advice
provider and the liability that's around that.”
|
Ms. Lucas opined, “The majority of investors in 401(k)
plans tend to be fairly disengaged investors.” Therefore, it is critical
to a successful investment advice program for the plan sponsor to promote
the use of advice. Accordingly, Ms. Lucas said that: “ I think from that
perspective, advice that's provided through the plan sponsor is likely to
have a deeper penetration and more usage than something that's provided
outside of the plan sponsor, just because there's more opportunities for the
plan sponsor to promote it. And if they're promoting it, it's going to be
used.”
|
When asked about the comparative costs of Lifestyle Funds
and investment advice, Ms. Lucas stated that: “The type of Lifestyle Fund
offered is obviously part of the equation. We have a number of plan sponsors
that offer Lifestyle Funds, either a retail mutual fund or an institutional
mutual fund that might run around 80 basis points all together, so that's
not only the investment management fee of the Lifestyle Fund, but the fund
cost of managing the funds, as well.” Alternatively, Lifestyle Funds can
be created within an existing core fund lineup and have no additional
management fees.
|
For participants with relatively low account balances,
Ms. Lucas indicated that Lifestyle Funds might be a better choice than
individualized investment advice. But, she also said that: “Now conversely
with the people that are in the highly motivated category, just the opposite
is true. Lifestyle Funds are not suitable for them for the most part. I know
certain high net worth individuals like to delegate, and they'll put money
in Lifestyle Funds. They'll be satisfied with that. But many are interested
in taking into account their whole financial situation, not just their
401(k). And for them, they're going to want one on one financial counseling.”
|
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Summary of Testimony of William E. Robinson
|
William E. Robinson is a partner and practice group
leader of Miller & Martin LLP’s ERISA/Employee Benefit Practice.
Miller & Martin LLP is a regional law firm of 165 attorneys with offices
in Chattanooga, Atlanta and Nashville.
|
Mr. Robinson began by describing the Miller & Martin
Profit Sharing Plan. Professional investment managers invest assets in the
Miller & Martin Profit Sharing Plan. When a participant attains age 35,
he or she may voluntarily elect to self-direct all or any portion of his or
her account. A participant who elects to self-direct may choose among the
universe of investment vehicles.
|
He recommends that the Council consider requesting the
Department of Labor to provide further guidance on the rules under Section
404(c) of ERISA, to clarify that a plan which does not limit participants to
a menu of mutual funds, but instead allows them to self direct their account
balances among the universe of investments, is covered by the protection
offered by being a 404(c) Plan.
|
He stated that currently the regulations under Section
404(c) of ERISA are designed to be used by plans that provide a menu of
mutual funds for participants to choose among and the rules do not easily
translate to a plan such as the Miller & Martin Profit Sharing Plan.
Current regulations require an identifiable plan fiduciary to provide
participants with a substantial amount of information that is not helpful or
is impossible to provide in the context of a plan, which allows participants
to self direct among the universe of investments. As an example, regulations
require the plan fiduciary to provide self directing participants with “a
description of the investment alternatives available under the plan, and
with respect to each designated investment alternative, a general
description of the investment objectives, risk and return characteristics of
each such alternative.” Such a requirement cannot easily be met by a plan
that allows participants to direct the investment of their plan assets among
the universe of investments.
|
These requirements should be clarified to allow plans
that make the universe of investments available to self directing
participants to comply with Section 404(c) of ERISA without incurring undue
hardship.
|
Mr. Robinson does not think the plan administrator of the
Miller & Martin Profit Sharing Plan should have any liability with
respect to self-directed brokerage accounts because participants who
self-direct their accounts do so voluntarily. When asked if the plan
administrator monitors what is in the individual’s self-directed brokerage
account, Mr. Robinson said he does not think it should make any difference
whether the plan administrator knows what’s in the account or not.
Further, he does not think the plan administrator should have any investment
or any fiduciary liability because of not knowing that information.
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Mr. Robinson said that in a case where a brokerage window
is a part of a menu of mutual funds and no real education or advice is given
to the participants, then he thinks the fiduciary is as responsible for
investments made through the brokerage window as it is for the choices that
are made on the mutual funds.
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When asked if the broker handling the participant’s
account under the self-directed brokerage arrangement has any liability, Mr.
Robinson thought the broker should know his customer and understand the
customer’s circumstances. In that regard, if a person decides to make his
own choices about investing in a self directed account, there’s
responsibility on the broker to know what the participant wants, and to
understand that he’s investing retirement funds.
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When asked if plan sponsors that designate a menu of
mutual funds for participants to choose from have limited their liability,
he said most plan sponsors think they should offer a menu of mutual funds
rather than hire a professional investment manager to manage the entire
trusts. Once they’ve done that, he was not sure they realize that they
continue to have fiduciary liability.
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When asked about future litigation problems down the
road, he thinks that unless employers begin to provide investment education,
there are going to be situations that would result in litigation against an
employer. For instance, two people may work in an unskilled job together,
and one is being advised how to invest his retirement plan money by a
relative or friend, while the other one is afraid of the market and puts
everything into a money market fund or bond fund. The two people retire at
the same time and one of them has substantially more money in his account
than the other, neither of which because of anything the employer did. If
one of them realizes that the other one has a substantially higher account
balance, he’s going to look to the employer and want to know why and that
scenario can result in litigation.
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When asked if he considers the investment manager
selected by the individual who directs his account also to be a fiduciary of
a plan who should be required to acknowledge that, he said that once a
participant chooses a manager who has discretion to suggest assets, or give
investment advice for a fee, that person is a fiduciary. ERISA says that
person is a fiduciary whether he acknowledges he’s one or not. But plan
administrators don’t try to determine whether participants are hiring
investment advisors or investment managers or whether each participant is
doing it all on his own by reading the Wall Street Journal and looking at
the Internet, or whether they’re talking to their next door neighbor and
he’s giving them advice. He thinks there may be a need to consider making
sure that if the plan sponsor sees that someone is paying investment
management fees out of their account that the plan sponsor should have that
participant get the investment manager to sign an agreement that
acknowledges that he’s a fiduciary and make sure he is not a party of
interest.
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Summary of Testimony of Shaun O'Brien
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Shaun O’Brien is the Assistant Director of the AFL-CIO
Public Policy Department, where he had previously been senior policy analyst
for retirement income issues. Mr. O’Brien participates in the development
and implementation of AFL-CIO policies on healthcare, retirement, labor
standards, and other issues.
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Mr. O’Brien indicated that the issue of professionally
managed defined contribution accounts has not yet become a major issue for
union-negotiated plans. Part of the reason for this is that defined
contribution plans are often supplemental plans, especially in the world of
multi-employer bargaining. Moreover, in that latter world, such plans tended
not to be self-directed, although that is changing.
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Mr. O’Brien directed most of his comments to the
problems of plan sponsors making available investment advice to employees.
Mr. O’Brien noted that employers can under current law provide investment
advice by prudently selecting and monitoring an investment advisor -- if
they do so, they will not incur liability simply because the investment
advice did not yield predicted results for the employee. Mr. O’Brien
endorsed the DOL’s Sun America opinion, but notes that employers relying
on it must follow it and not chip away at the firewall that the letter
contemplates.
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Mr. O’Brien indicated that the Department of Labor
bears some responsibility for any confusion about the ability of employers
to contract with third parties to provide investment advice. He noted that a
senior Department official publicly stated “the current ERISA law has
barriers that prevent employers and investment firms from providing
individual investment advice to workers.” Mr. O’Brien notes that this
statement has not been helpful in clarifying that current law permits firms
to contract to provide investment advice to participants. He suggests that
the Department of Labor provide guidance indicating that they may provide
investment advice “from an outside independent firm and that so long as
they meet the general standards for selecting service providers, that they
are not going to be held liable for the specific content of their advice.”
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The AFL-CIO is, however, concerned about legislative
proposals that would permit firms that have conflicts of interest to give
participants investment advice, so long as there is disclosure of the
conflict. Such an approach would depart from ERISA basic protective
structure for workers for a securities-type regulatory scheme, which
contemplates individuals having meaningful choices. In retirement plans,
that is not likely to be true, where the investment advice services are
contracted for at the plan level and the participants will not generally
have many choices. Moreover, the participants may well pay for the
conflicted services, even if they choose not to use them. Recent events,
moreover, should caution us about relying on securities-law type protections
for participants in pension plans. They require more substantive
protections.
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In contrast, Mr. O’Brien believes that building a
fiduciary safe harbor to provide independent investment advice meets both
employers need for clarity, certainty, and comfort, while providing
participants with adequate substantive protections.
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Summary of Testimony of Rhonda Prussack
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Rhonda Prussack is the Vice President and Product Manager
for Fiduciary Liability Insurance at National Union Fire Insurance Company,
a member company of American International Group (AIG). Her office is
located in Pittsburgh, PA. The sub-committee requested her testimony as a
representative from the insurance industry to determine whether underwriting
standards were impacted by the plan fiduciary’s use (or non-use) of
professional money managers. [Fiduciary liability insurance is intended to
defend and protect plan fiduciaries, other than third-party investment
advisors, administrators, and record keepers, against allegations of breach
of fiduciary duty under ERISA.] Ms. Prussack was provided, in advance, the
working group’s standard list of questions, and she chose to structure her
testimony around her responses to the questions.
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In summarizing, Ms Prussack indicated that the following
acts and/or activities by the plan fiduciary would be viewed as a “positive
development” [positive in the eyes of the insurance carrier]:
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The plan fiduciary offering investment
advice to participants, but only if the advice was prepared by an
independent third-party. Ms. Prussack expressed concern with the portion
of the Pension Security Act (H.R. 1000) [Ms Prussack referred to the Act
as the Boehner Bill], which did not require that the advice provider be
independent.
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The plan fiduciary making available to
plan participants one or more investment advisors that have been
carefully vetted by the plan fiduciary. This approach is preferred over
allowing participants to each select their own advisor.
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The plan fiduciary that offers a
limited number of investment options.
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The plan fiduciary that takes
responsibility for monitoring investment-related fees and expenses,
particularly if fees are being paid from plan assets.
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Later on in her testimony, Ms Prussack was asked “Does
the offering of a professional investment advisor potentially decrease the
plan sponsor’s fiduciary liability?” Her response, “Yes, provided the
advisor is independent, has no conflict of interest, has been carefully
vetted, and is regularly monitored for performance and reasonableness of
fees.”
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Ms Prussack was asked whether her insurance carrier
differentiated between a plan that was trustee-directed versus a plan that
participant-directed. She responded that there was no differential. In
either case, the factor that impacted the plan fiduciary’s insurance
premium was whether there was evidence of prudent diversification.
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Ms Prussack was asked whether plan fiduciaries that
adopted 404 (c) were less prone to litigation. Her response was that there
was no correlation; they were just as prone to litigation.
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When asked about what the DOL could be doing to assist
the insurance industry, her reply was that: (1) mandating a cap on company
stock would help reduce the severity and frequency of litigation; and (2)
defining safe harbor procedures for the selection of investment advisors
would also be beneficial.
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Summary of Testimony of David C. John
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David John has been involved in Washington's top policy
debate for more than 25 years. He continues a career at the Heritage
Foundation, a lead analyst on issues relating to Social Security reform.
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John examined the experience that a series of Social
Security systems with personal retirement account options overseas have had
in providing independent funds managers. In particular, he discussed the
Swedish, Australian and British systems.
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In the case of Sweden, two and a half percent of their
annual income goes into what is essentially a national 401(k) plan that does
allow the use of independent funds managers. The individual selects, but
only from a group of funds managers that have passed government muster. The
agency that administers these accounts has already examined both the
financial stability of the funds manager and negotiated with them to ensure
that the individual will receive the lowest administrative cost possible.
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In Sweden, there is also a default account, which is
optimal for the individual's age. The funds are distributed among the
managers who offer that particular default account. The majority of workers
this changes from year to year, but the majority of workers basically do not
take that option. They vote with inaction, and they take the default option.
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The Australian system differs in that a worker’s fund
go to a fund based upon his or her industry, but once again there is an
element of choice. For the most part, each industry fund is invested in a
widely diversified portfolio, but the worker has the option of moving his or
her money to one of a series of a pre-screened alternatives. The most
popular one at the moment happens to be a green fund similar to some of the
ones that we have seen in the United States.
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Despite this being available under the existing system,
only about five percent of the workforce has taken advantage of the
alternate investments. In addition, Australia is currently debating a
proposal that would allow workers to choose among at least three different
funds. Thus, a journalist, who is currently limited to the journalists’
fund, might also be able to move his or her money to the steel fund or the
retail workers fund. The Australian system has worked very effectively. The
problems that have come out are have to do with areas such as tax policy,
which have nothing to do with the investment management.
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Last, but not least, is the U.K., which has a two tiered
pension system including a flat amount state basic pension and an income
related pension. Workers have the option to receive a rebate of a portion of
their Social Security taxes that would go into the income related part of
their Social Security system that would go from the government to the funds
manager of the workers choice.
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Unfortunately, this system has had mixed results due to a
series of design flaws, problems with investment returns, and a regulatory
system that allowed an early scandal. Workers who took advantage of the opt
out plan discovered in many cases that by doing so, they were missing on
matching funds since the money is no longer cycled through the employer
pension.
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These three overseas pension systems have aspects that
the United States should consider in discussing changes to its system. All
three offer lessons – positive and negative – that Americans can use in
reshaping our system.
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Summary of Testimony of Michael Falk
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Mr. Falk responded to questions from the Council on June
27, 2003, in written form, when ask to outline potential abuses within
Optional Professionally Managed Accounts.
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He outlined 10 (ten) areas of potential abuses.
Unqualified advisors were first on his list. These included non-registered
advisors within the states that they give advise or have discretion.
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Others areas were misleading performance illustrations,
tying, not letting go on accounts, asking for liability waivers,
self-dealing, excessive fees, discrimination on size of accounts, hidden
charges, and performance fees.
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Summarized by Todd Gardenhire
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Summary of Testimony of Thomas T. Kim
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Thomas T. Kim, Associate Counsel for the Investment
Company Institute, attended the Council’s July 25, 2003 meeting as an
observer. During the meeting, members of the Council asked Mr. Kim if he
wanted to provide comments on the topics being discussed by the Working
Group on Optional Professional Management. He graciously agreed to provide
the Council with written testimony in the form of a letter (dated September
17, 2003), which was submitted to the Executive Secretary for review by
members of the Working Group at the September 22 meeting. The following is a
summary of the letter.
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With regard to 401(k) and other
defined contribution plans that permit participants to direct their plan
investments, it is paramount that participants have access to tools that
will enable them to prudently invest and diversify their plan accounts.
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Such plans offer participants
flexibility in managing their retirement savings by providing multiple
investment alternatives, various distribution options and portable
account balances, each of which enable the plan to satisfy the needs of
differently-situated individuals.
-
Employees and employers have found
mutual funds to be well suited for 401(k) plans because, among other
things, they offer diversified portfolios, professional asset management
and daily valuation of shares held in plan accounts.
-
According to research conducted
jointly by the Investment Company Institute and the Employee Benefit
Research Institute (EBRI), 401(k) plan participants, generally and in
the aggregate, are investing their plan balances appropriately. Young
participants tend to invest more heavily in equities while older
participants are more likely to invest in fixed-income securities. In
addition, 401(k) plans appear to be effective across all income
categories. The ratio of account balance to salary for low and
moderate-income 401(k) participants is similar to the ratio for higher
income individuals.
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The Department’s guidance in
SunAmerica was a positive step toward helping individuals better manage
their retirement savings. Plan designs and services developed under the
guidance will provide additional tools for participants to reach their
retirement goals.
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The managed account approach, however,
should not be viewed as a comprehensive solution to participants’ need
for professional advisory services. As noted by several witnesses at the
Working Group’s meetings, participant characteristics, attitudes and
behaviors vary significantly, thereby creating a need for multiple
channels of advice delivery. Moreover, the investment control and
flexibility offered by participant-directed plans remain attractive
features for participants.
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Accordingly, while managed accounts
may be useful for some, many others will find that the service is not
suitable for them. Thus, to assist plan participants, policymakers
should encourage greater access to and availability of professional
investment advice, such as through the enactment of the investment
advice legislation sponsored by Chairman John Boehner of the House
Education and Workforce Committee.
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Advisers under this legislation must
assume fiduciary status under the stringent standards for fiduciary
conduct set forth in ERISA that would, among other things, require
advisers to act solely in the interests of plan participants and
beneficiaries. In addition, only specifically identified, qualified
entities already largely regulated under federal or state law would be
qualified as advisers under the bill, and extensive disclosures designed
specifically to be understandable to the average participant must be
provided to the advice recipient.
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Moreover, given the diverse needs and
characteristics of plan participants, policymakers should consider the
importance of the employer’s role as a plan fiduciary in prudently
selecting and monitoring services offered to its plan participants.
Thus, proposals that would establish distinct legal standards governing
managed accounts should be closely scrutinized, as they may have the
effect of creating incentives for plan designs or services that may not
be appropriate for employees (or a segment of employees) of some
employers.
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More generally, any proposal in this
area should be carefully reviewed to determine its impact on the
employer’s fiduciary oversight under ERISA — the cornerstone of our
pension laws.
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June 27, 2003: Working Group on Optional Professional Management In Defined Contribution Plans
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Agenda
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Official Transcript
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Questions Posed by Chair/Vice Chair
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“Investments in Self-Directed
Account Retirement Plans: A Summit with Many Faces” by Richard P.
Magrath, President, ProNvest and PowerPoint Presentation
-
Optional Professional Management in
Defined Contribution Plans Presentation, by Carl Londe, Chairman &
CEO, ProManage, Inc, also a list of potential abuses/responses
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Testimony of Scott D. Miller,
Principal, Actuarial Consulting Group, on behalf of the American Society
of Pension Actuaries
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Slide Presentation by Robert G.
Wuelfing, RGWuelfing & Associates, on behalf of the SPARK Institute
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Retirement Security for All Employees
PowerPoint Presentation by Ken Fine, Executive Vice President, Financial
Engines, Inc. as well as a Q&A on the topic
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Power Point Presentation Slides from
Testimony of Sherrie Grabot, Chief Executive Officer, Guided Choice,
Inc.
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July 25, 2003: Working Group on Optional Professional Management In Defined Contribution Plans
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Agenda
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Official Transcript
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Optional Professional Management
Slides by Lori Lucas, CFA, Defined Contribution Consultant, Hewitt
Financial Services, LLC
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Written Testimony of Rhonda Prussack,
Vice President and Product Manager for Fiduciary Liability Insurance at
National Union Fire Insurance Company
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Statement of the AFL-CIO on OPM in
Defined Contribution Plans, prepared by Damon Silvers, Office of the
General Counsel, presented by his colleague Shaun O’Brien of the
Office of Policy
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Statement of William E. Robinson,
Miller & Martin Profit Sharing Plan
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2003 ERISA Advisory Council Proposal
Draft of a DOL Information Letter Requested to Provide Guidelines for
Employers
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September 22, 2003: Working Group on Optional Professional Management In Defined Contribution Plans
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Agenda
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Official Transcript
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Flip Chart Notes Provided for
Discussion of Group’s Final Report
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Letter of September 17, 2003, from
Thomas T. Kim, Associate Counsel, Investment Company Institute on the
Issue
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R. Todd Gardenhire, Chair of the
Working Group
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Donald B. Trone, Vice Chair of the
Working Group
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Ronnie Sue Thierman, Council Chair and
ex-officio member of all working groups
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David Wray, Council Vice Chair and
ex-officio member of all working groups
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Mary Maguire
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John S. Miller, Jr.
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Dana Muir
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Antoinette “Toni” Pilzner
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Norman Stein
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John Szczur
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Michele Weldon
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Judy Weiss
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