Canada: Your 401(k) Plan And The Shape Of The Earth

I used to work with a very smart lawyer who said that he could give a legal opinion that the world was flat if his qualifying language was not limited. In that case, he would have stated something on the order of: this opinion does not take into account developments after 1491 or the opinions of scientists and philosophers.

Last year, a Yale law professor publicized a forthcoming study of 401(k) plan fees (written with a University of Virginia co-author) that suffered from the same flaw as the "world is flat" opinion; he used data from 2009 and seemed uninformed about the impact of subsequent developments such as the implementation of mandatory fee disclosures, which studies (and here) have shown resulted in reductions in fees. This Yale-study and the letters that the professor sent to companies about their "high fee plans" (so-called due to the results of his old and incomplete data ), threatening to publicly identify those plan sponsors, justifiably generated much criticism by the benefits community.

Increased Focus on Plan Fees

All of us in the benefits community, however, know that the increased attention on plan sponsor responsibilities that resulted from the "world is flat" Yale-study is a good thing.

It's true that some plan fiduciaries don't take enough time to effectively monitor their plan's fees and investment menus. And some plan fiduciaries rely too much on plan vendors' so-called "fiduciary warranties", which look fancy but don't actually provide very much protection. Even Fidelity's own employees are suing because they claim that their own 401(k) plan is loaded with under-performing high fee Fidelity funds.

Certainly, we agreed with the Yale-study's authors that high fees unrelated to performance or service quality undermine participants' ability to save for retirement and could be breaches of fiduciary responsibility. We at Osler try to assist fiduciaries in doing this right, and despite our misgivings about whether this study targeted the right plans, we were interested to see the final conclusions.

The Yale Study

So finally, the Yale-study itself – that the benefits community (and myself) have been criticizing since it was pre-announced – has just been released in February 2014, and it seems as if it should have a disclaimer stating: this study does not reflect developments in the law after 2009.

The study describes Department of Labor fee disclosure regulations that became effective in 2012 as "proposed" and ignores the Department of Labor's proposed application of the ERISA fiduciary standard to brokers and recent case law. Incredibly, the study ends by proposing that participants in "high cost" plans be allowed to make penalty free IRA rollovers while employed (have the authors never heard of high fee investments in IRAs?).

Further, the study recommends that all plans be required to offer a low cost default fund "from an approved Department of Labor list" and that plans be able to rely on the ERISA Section 404 (c ) safe harbor even if that were the only fund they offered.

Another provocative proposal in that study is that participants should be required to pass an "investment sophistication test" before they would be allowed to make investment choices of their own. Those who could not pass would be locked into the plan's default investment whether they liked it or not. These proposals were made because the authors are pessimistic about the ability of fiduciaries to make the "right" investments available and they misunderstand the law as permitting fiduciaries to retain badly performing funds so long as they engage in a fiduciary process.

Even the law back in 2009 did not permit selecting funds without regard to their performance. No one has an investment crystal ball, and the prudent process cases mainly protect fiduciaries from having their decisions reviewed with "20/20 hindsight" if they appeared to be prudent choices when made.

Practical Solutions

There are several ways in which already-existing Department of Labor initiatives, if adopted, would improve the situation the professors describe without getting the government involved in designing plan menus and testing participants. Vendors, and not just individual plan fiduciaries, are responsible for the ways fees are set and how investments are chosen today. Rather than giving up on plan fiduciaries as the Yale-study professors do, consider the effect of:

  • Revising the fee disclosure regulations to require comparative disclosure of revenue sharing payments used for services such as recordkeeping together with the average cost of such services for plans of similar size. This benchmarking is not required by current fee disclosure rules and would allow fiduciaries to more effectively monitor revenue sharing. The Department of Labor is considering improvements to service provider fee disclosures, and it should add this requirement.
  • Subjecting vendors to fiduciary standards when they design investment menus as the Department of Labor urges in its Leumkuehler amicus brief.
  • Subjecting brokers to fiduciary standards when giving investment advice to plan fiduciaries, as the Department of Labor previously proposed in its 3(21) regulations.

When market practices that do not adequately control for conflicts of interest are reined in, fiduciaries such as investment committees will be able to provide better investment menus with lower fees without government mandates. Reforms such as subjecting participants to investment quizzes won't solve these problems, though we might consider requiring professors to pass a test demonstrating their knowledge of recent developments in the pension field before they publish recommendations for reform.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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