401k Advisors: New Potential Pitfall under Proposed DoL Fiduciary Rule


As I have written before, advisers have largely been absent from lawsuits in the 401k arena. But, as the song goes, it appears that times they are a changin’.

In a conversation last week, another opportunity for an adviser to become embroiled in a suit dawned on me: Advisors who cause their clients to pay for services they don’t need could find themselves facing a lawsuit under proposed rules from the Department of Labor.

Currently, providers are finding themselves under the proverbial microscope. Lawsuits are beginning to analyze the correlation between cost and services provided. Suits like the one recently filed by Schlichter, Bogard & Denton against Chevron identify a rate for which the provider is willing to provide a set of services and allege a breach when revenue rises (rising markets and accounts with asset based charges are responsible) without a corresponding increase in services.

The proposed Fiduciary Rule from the Department of Labor is currently with the OMB and aims to make a fiduciary out of any advisor working on a plan. Once the new fiduciary status rule is effective, an advisor will be prohibited from causing a plan to pay for services that are not essential to the operation of the plan or fees that could be deemed excessive due to the advisor’s new fiduciary status. This liability could cover fees related to any recommended service providers as well as the advisor’s own fees.

Quoting Prohibited Transactions of ERISA directly:

(a) Transactions between plan and party in interest Except as provided in section 1108 of this title:

(1) A fiduciary with respect to a plan shall not cause the plan to engage in a transaction, if he knows or should know that such transaction constitutes a direct or indirect—

… (C) furnishing of goods, services, or facilities between the plan and a party in interest; [29 U.S. Code § 1106]

Section 1108 goes on to discuss the how a plan can engage a service provider under the exemptions to the prohibited transaction listed above, namely only paying for those services which are necessary and paying fees which are reasonable [29 U.S. Code § 1108(b)(2)]. Common examples of services could include recordkeeping, employee education (404.c type services), and fund monitoring.

As a fiduciary to the plan under the new Fiduciary Rule, an advisor cannot cause the plan to engage in a prohibited transaction. Therefore, it becomes necessary for the advisor to understand completely which services the plan needs and differentiate from the services he can provide. The services that are not utilized by the plan fiduciaries or participants should be carved from the offering, and the corresponding fees should also be cut.

While this may seem pretty basic, the twist is that the advisor would be responsible for the reasonableness of his own fees/commissions as well.

Said another way, an advisor could be on the hook for forcing the plan to pay him more than is reasonable given the services provided. What is unreasonable? That is tough, but this post shows what is undisputedly unreasonable.

Failure to properly mitigate unnecessary or excessive fees could be construed as a fiduciary breach by the adviser. Currently, only responsible plan fiduciaries have to worry about this aspect of ERISA. The change of fiduciary status for advisors will open them to potential liability for the same issue. There is no doubt that advisors and their compliance departments should be actively seeking solutions to provide a process for understanding plan level needs as well as the monitoring of the fluid relationship between fees and service.

As usual, I am not an attorney or an accountant, so please take this piece for what it is worth.

This is repost. The original can be found here.

Kicking Hitchcock Out of ERISA Plans


Alfred Hitchcock was a master of suspense. The beauty of his cinema and the reason it still captivates viewers is not what he shows you; rather, it is what he does not show you. Hitchcock left your imagination to do the dirty work. He knew that your imagination could fill in expertly placed gaps.

With his films, we simply get a bit of a start. But when there are gaps left in ERISA plans, we end up with much worse than just a start. We end up with a lawsuit. A quick troll through the Department of Labor website gives us a rundown of enforcement action. Gaps in contributions. Gaps in proper administration.

Lawyers are also looking for these gaps. They look for gaps in logic or action. This lawsuit against MassMutual is the most recent example. No one can know how the suit will end. But, like viewers with their popcorn watching a Hitchcock film, I am sure that compliance departments across the country are on edge. Their minds race to fill in the gaps left between the suit and the practices of their advisers. What other gaps are out there? Could our advisors put us on the hook if they recommended a provider employing a similar structure? Are our disclosures sufficient? Are our policies setting us up for a similar suit?

One of the gaps that continually scares me is the gap in determining the reasonableness of fees for covered service providers. As we are all aware, it is part of a fiduciary’s duty under ERISA to insure that all fees paid from plan assets are reasonable for the level of service being provided. It is commonplace to compare the fees and a checklist of services against those of other plans around the country. Honestly, that scares me. It scares me because checking to see if your answer is the same as someone else’s seems like a poor basis for reasonable. For example, you may be paying the same fee for education services; however, does this standard benchmarking evaluate the amount of education? Or the time spent working with participants on education? The same example holds true for other services as outlined in the fee disclosures mandated under 408(b)(2). I have discussed some of my concerns in another post. And this gap in what is promised and what has occurred is another Hitchcock nail-biter. As we have seen in other suits recently, the potential liability is not in the decision.  Instead, it is in the process.

So how do covered service providers eliminate these Hitchcock gaps?

First, it is important to recognize that liability that is already out there cannot be put back in the bottle. Rather, we must seek to systematically eliminate the liability going forward. Recognizing that reasonableness of fees is under scrutiny right now, you should employ a process that definitively measures committed resources relative to fees. Comparing your fees to the guy’s down the street does not insure reasonableness.

Second, employ a process to insure that you have done and are doing what you promised you would do. Comparing a list of activities performed for your clients compared to a list of services stated in 408(b)(2) disclosures is a good start. Any discrepancy between the two is a Hitchcock gap that will leave compliance sleepless and lawyers licking their chops.

Finally, employ a system to utilize exemptions in the proposed Department of Labor Fiduciary Rule. For example, the proposal exempts education from the scope of fiduciary. Use the exemption. Track your activities that fall under that provision. But remember, all of your documentation can also be used against you. As a former mentor used to say, “If you don’t want it on the front page of the Wall Street Journal, leave it out.”

In short, QPSteno can help with all of these strategies. If there is anything that I can do to help, please reach out (jbaltes@qpsteno.com). Remember: With a complete plan, there is little to fear.

Activity Tracking to Become a Necessity under the DOL Fiduciary Rule


Much has been written about the proposed DOL Fiduciary proposal. Some write in favor of it; some are adamantly opposed to it. But, given the proposed status, very few are offering suggestions on how to abide by the proposal as written. From my vantage point, a couple of things are clear. First, this is going to happen. Second, 8 months is not a lot of time to get a comprehensive process implemented, so it is better to start now and tweak the process as you go. That being said, one piece of the proposal has stuck with me since the Department of Labor first released the proposal in April of last year. In an effort to make the proposal more workable, the DOL has inserted certain exemptions from the regulation. Most notably, standard financial education is categorically exempted from the rule and from the definition of advice. Education would include conversations about general plan information, general financial and retirement information, asset allocation models, and interactive investment materials (options meaning the functioning of the plan, not specific investments as it appears that IB 96-1 will be superseded if the proposal is implemented as proposed). From the DOL comments to the voluminous feedback, we know that the education carve out will not be going away.

For an advisor working in this space, it should be clear that the intent is to make a majority of your actions fall under the fiduciary laws. The key for advisers is how to mitigate potential exposure given the exemptions. As with other exemptions under ERISA, it would appear that the burden of proof will fall on the entity claiming exemption. This means that you will need to keep diligent records regarding your meetings with participants. You will need to track which meetings were fiduciary in nature and which meetings qualify for the education exemption. This tracking should include who was present at the meeting, what topics were discussed, ideally any materials that were used (presentations, literature, etc.), and whether the meeting should be considered educational in nature. Just like a game of chess, you must balance proactively cutting off avenues of liability exposure while actively working to build retirement security for your participants.

Compliance departments should also be interested as the proposed regulations change the exposure for a fiduciary breach. Under the proposal, an adviser can be named in a class action suit at the state level. This represents an unprecedented expansion of legal liability that also includes activities involved in the service of IRA accounts. By isolating activities that are explicitly named as carve outs from the definition, the adviser is limiting his liability exposure. This process can also help to establish credibility to the adviser and his professionalism. While in the past it was potentially advantageous to minimize how much the adviser had in his file in the event of a law suit, the proposed rule will turn that thinking on its head overnight. Compliance departments should be enabling processes that allow advisers to continue their business while mitigating the exposure of the firm.

This tracking is not solely in the interest of the firm. A procedure that is well built will allow the adviser to continue to deliver the services for which they were hired, while protecting the firm. After all, if an adviser is tied up in depositions, arbitration, and court proceedings, then he is not serving his other clients. Clients who do not feel served tend to go elsewhere or look for reasons to complain. And complaints can lead to more suits. Like the loss of a pawn, this chain of events can snowball for the adviser and the firm.

The recent rash of lawsuits highlights the importance of this tracking. Multi-million dollar suits are the norm for fiduciary breaches today. While those are for some of the largest cases out there, it is not going to be long before a sufficient body of case law exists that litigation costs will be affordable enough for smaller players. Due to increased exposure, E&O rates are almost guaranteed to rise as this rule is implemented. (We have had conversations with a specific carrier about how to receive preferential rates using QPSteno; contact me for information: jbaltes@qpsteno.com.)

The chess pieces are in motion. Advisers, broker/dealers, and RIAs should start to protect themselves for the benefit of their clients.

As a 401k Plan Sponsor, You Have a Fiduciary Obligation to Monitor the Activities of Providers


It was almost a year ago that we announced QPSteno, a service that monitors and aggregates retirement plan service provider activities. In that 12 months, I have heard varying reactions. People have told me how great the idea is (“Finally, something to show me exactly what people are doing and what they get paid.”) and people have told me that I am crazy. Recently, I had someone tell me that unless I could provide him with documentation explicitly saying that he is required to monitor the activities of his service providers I could go pound salt.

Well, here it is: straight from the Department of Labor- the reason a Fiduciary has an obligation to monitor the activities of the service providers.

“It is the view of the Department (of Labor) that compliance with the duty to monitor necessitates proper documentation of the activities that are subject to monitoring.” (29 CFR 2509.08-2)

First, let us establish a couple of assumptions. The first assumption is that you have outsourced some of the operations of the plan. You have either hired a broker, a TPA, a recordkeeper, or a fiduciary of some variation. You are paying one or all of those parties with assets from the plan. As outlined in the Employee Retirement Income Security Act (ERISA), using plan assets to pay service providers is a prohibited transaction. There are exemptions to that transaction so long as we have determined that the services are necessary for the operation of the plan and the fees are reasonable for the services provided. In order to insure that the services are required and the fees are reasonable, there is a certain level of monitoring required.

Let’s break out the DOL statement into its individual components for better understanding.

Duty to Monitor. We established that plan sponsors who outsource any operation of the plan to a third party and pay with plan assets have a duty to monitor the covered service provider, if for no other reason than to determine that the services are necessary and the fees are reasonable. So according to the Department, the outsourcing of services creates a duty to monitor.

Proper Documentation of Activities. The DOL could have used words like “results” or “output”. But they specifically chose the word activities. It makes sense when you consider what goes into any particular service that is outsourced by the fiduciary. Fund evaluation is not simply printing a report. The report is the culmination of several other job functions. If you read much of ERISA, the term process is used repeatedly. The DOL asks for an Investment Policy Statement (a written process) in its audits. It is clear that the focus is on the prudence of path to get to the destination. In Donovan v. Cunningham, the 5th Circuit Court opined, “[ERISA’s] test of prudence…is one of conduct”. While this case and the quoted Interpretive Bulletin focus on the prudence of the investments, the Court discusses the process, not the result. It should be further considered that the courts consider facts and circumstances when evaluating prudence. It would be difficult to argue a prudent process for a service if you did not have a mechanism to track that the services and associated activities were performed as outlined.

It does not seem that the intent is to have you document every trade of every fund held in your plan as the same Interpretive Bulletin discusses cost benefit analysis of decisions not to proxy vote. Specifically, it is acceptable to forgo proxy voting if the determination is made that cost to prudent do so will outweigh the potential benefits. But the IB explicitly states that the decision and evaluation should be documented. Other services may require close monitoring. For example, many advisors disclose in 408(b)(2) documentation that they provide education to plan participants. If the broker is paid with plan assets through an arrangement like a wrap fee, a responsible plan fiduciary has an obligation to track the activities of that broker as they relate to the service of educating the participant.

In summary, if you outsource any portion of your retirement plan to a third party, you have an obligation to track and document the activities of those parties.

Getting Compliance More Comfortable Around Your ERISA Practice


Many compliance departments seem to wish that their advisors would just stay out of the ERISA space. And it is not exactly without merit. Let’s be honest: ERISA is complicated and somewhat convoluted in practice. Take the simple concept of paying someone for his services. ERISA explicitly says it is not permissible. But then goes back to add categorical exemptions if certain criteria are met. Necessary, reasonable…you know what they are.

From a compliance perspective, there are some significant areas in which even a well-intentioned advisor can run afoul. Recently we have seen several cases with staggering settlements hit some of the big players. It doesn’t take a genius to overlay what happened in medicine to our beloved field. The litigation typically starts with the low hanging fruit and the deepest pockets. It then works its way through the rest of the market using fear and prior cases to strengthen its position. And I see three current situations that would give some cause for concern. They are excessive fees, 408(b)(2) disclosure of statement of services, and false security under 404(c).

Excessive fees are a matter of perspective. Some people say that a Mercedes Benz is far too expensive; but the company’s continued sales numbers support the position that others are clearly willing to pay for it knowingly. And 401(k) fees are a subject that any prudent fiduciary should closely be examining. But as compliance people, shouldn’t we be looking at ways to defend the fees of our advisors in the field instead of knee jerk requests for them to slash their paychecks? I would suggest that a platform to demonstrate to the plan sponsor that the fees are clearly justified given all of the work and expertise that goes into a plan. After all, a fiduciary is not charged with hiring the cheapest provider.

The second issue that could be cause for concern is having a 408(b)(2) disclosure containing a list of services intended that conflicts with the services actually provided. Under this section of our beloved Code, a fiduciary has an obligation to collect a disclosure from every covered service provider and to justify that the fees charged are commensurate with the level of service being provided. But what worries me is a situation in which a disclosure outlines that the advisor, for example, will provide a given service and fails to do so in practice. But, realistically, how is a compliance department going to track to make sure that everything matches?

Right now our clients have false security under 404(c). Hate it or love it, this code section comes up all the time. My first exposure was an advisor preaching to me that actual protection was impossible, so don’t even try (you don’t want to say something on the 5500 that you can’t back up). I have heard some say it is better to try and fall short because it shows that you are trying. And there are service providers who push hard for it. From my vantage point, the real trick with 404(c) is documenting that all of these parts are happening. I’ll give you an example. If you think you are compliant, prove to me beyond a shadow of a doubt that a participant was provided appropriate education (a low minimum of mutual fund 1 page fact sheets) at enrollment. Show me a calendar that had attendance and a dated copy of the enrollment book. My fear is that those who cannot provide this documentation may be in for a surprise when they try to invoke coverage in court. It would be a shame to cover so many pieces of 404(c) to fall short (and pay big) due to lack of documentation.

Before those of you in compliance go running out to buy a case of Pepto to work through these issues, we have a way to solve these problems. QPSteno.

QPSteno allows a service provider to track his time, activity, and interactions with a given plan. When you marry this information about time spent with fees earned (which the system does), you get an effective hourly rate or project rate. That is more defensible than a gross number. And it is good PR for the advisor and the firm. You now have a chance to showcase to your client everything that your firm does for him, not just what he sees in the board room. Additionally, compliance can rest easy knowing that we are not inadvertently putting the firm at risk with our actions.

Secondly, by tracking the actual activities, you can compare the information back to the 408(b)(2) disclosures to be sure that the advisors are providing the services stated. This allows for a midyear correction, for example, before there is any conflict/violation at the end of the year. It is also allows the firm to update the disclosure if there are additional services that are being provided, thus creating a potential opportunity for an advisor to negotiate a new compensation agreement for his increased services. And compliance can feel confident that we are living what we sold the client.

Finally, documentation of activities for 404(c) is easier. I agree that satisfying this section of the code is tough. However, given the right systems, it is attainable and worth attempting. QPSteno allows for the tracking of activities and interactions. Thus, an enrollment meeting, for example, could be tracked with attendance and an electronic copy of the enrollment kit. In documenting this activity, a plan sponsor now has the final piece required for exemption under 404(c). As the litigation against 401k plans continues, our clients are going to be tested. And compliance is going to be happy when a suit can be potentially dismissed in discovery, rather than a lengthy and expensive legal battle.

Much of this probably seems basic. As service providers, we all know what our time and skills are worth. And we know what services we provide to include on disclosures. And we know that the education component is covered. But as one of my former bosses used to say, “If you don’t mark it, it didn’t happen”. Taking the time to show our clients that we are diligent in our endeavors can only help cement our positions as the professionals that we are.