ERISA attorney Fred Reish, partner with law firm Drinker Biddle & Reath LLP in Los Angeles, also encourages advisors to recommend the appropriate share class of mutual funds. “The ‘right’ share class depends on the circumstances,” he says, such as the amount of plan assets and the desire of the plan fiduciaries to use revenue sharing to pay for the cost of administering the plan.
With scrutiny increasing for plan costs and service provider compensation, he suggests advisors benchmark their own compensation to ensure it’s “within the ‘range of reasonableness,’” he says. He also suggests helping plan sponsors benchmark the costs and revenues of record-keepers. Without this information, it’s hard to know if a plan is overpaying, he says, particularly if record-keepers are compensated through payments from the investments.
Finally, “While proprietary investments are permissible and may be good choices,” says Reish, they’re likely to get closer scrutiny. “If they satisfy the plan’s investment policy statement and if the IPS is well crafted, there shouldn’t be a problem,” he says, “but make sure that they go through the same rigorous process that applies to the other investments.”
Advisor Insights
Ken Hoffman, managing director and partner at HighTower’s HSW Advisors in New York (AUM: approximately $2 billion), advocates being very transparent and conscious about fees, being very conscious about fund selection, and having the methodology to prove that funds are in the 401(k) plan menu for a good reason.
He notes that Duke University, now under fire, offered its plan participants more than 400 investment options. “Plan sponsors that offer many dozens of investment options probably have no process to select those options,” he says, “and the Department of Labor likes process.” The dozen 401(k) plans managed by HSW Advisors, which mostly range from $20 million to $50 million in assets, average about 25 investment options including target-date offerings, he says. He counts each target-date series as one option.
Although plan sponsors aren’t required to have an investment policy statement, it’s a good idea as long as it’s flexible and “the guidelines aren’t over the top,” says Hoffman. “Just make sure you don’t violate your investment policy statement.” To this point, he thinks it’s better to vaguely indicate meetings will be held periodically during the year. The document should also spell out a plan sponsor’s objective process for evaluating funds in a menu, such as replacing ones that perform in the bottom two quartiles for four quarters running, he says.
Hoffman strongly encourages plan sponsors to provide good education efforts—through meetings, webinars and well-developed 401(k) websites—that can help plan participants make decisions that match their risk appetite and are rational for them. Of course, plan sponsors and advisors can’t stop disgruntled plan participants from suing them. “All you can do is your best job to play by the rules so that if you are sued it’ll end up being a frivolous lawsuit,” he says.
Hoffman also suggests coming clean about any past mistakes and getting on the right track as soon as possible. “Don’t wait for regulations to come up and grab you,” he says. “Use your common sense.” He also encourages advisors to treat small plans as though they are big plans. Making the same mistakes with a small plan “might not have the same dollar implications,” he says, “but it has the same legal implications.”
Michael Cagnina, vice president and managing director for SEI’s Institutional Group in Chicago, which represents $76 billion in overall assets (including 50 to 60 DC institutional plans ranging in size from $30 million to several billion dollars), also emphasizes the need for transparency. This is especially important when revenue sharing is involved, he says.
“Explain things are beginning to unbundle,” he says. “I think you have to get over that first hurdle to start gaining the trust of plan participants and make sure they understand those component pieces, because in the past they might not have even known they existed.” This includes record-keeping, money management and advisory services.
It’s also a good idea, he says, for advisors to encourage plan sponsors to unbundle their programs and to disclose, either in a contract or a policy, the fiduciary status each contracted party has relative to the relationship.
Cagnina suggests that plan sponsors disseminate information to plan participants through the mail, online and during education sessions. “Providing more consistency and more methods of delivery should give you more full coverage,” he says. “Face to face should happen at some point in time to make sure people see the information who might not through other distribution methods.”
He also favors stepping back and simplifying plan options. “We believe that, and this depends on the [plan] demographics, you can have three to eight funds in your core menu,” he says. “On top of that, you’d probably have some sort of target-date series or asset allocation options that would be structured as well.”
Plans offering a white label product, which unitizes funds from multiple managers, should disclose information for each fund, says Cagnina. The white label trend, which he says is moving down-market to midsize plans, can simplify a plan menu and allow managers to hire and fire institutional money managers within the strategy without changing the menu or disrupting the plan participant.
Advisors also need to be more education-oriented and less advice-oriented with plan sponsors and plan participants, says Cagnina, and they should be careful not to cross that line. Rather than tell them what’s good for them, he says, “It’s better to say, ‘Here are the options and here’s how they work; now you make the decision.’”
Not every 401(k) lawsuit has teeth. Some have been dismissed, including one filed against Chevron Corp. by Schlichter. Still, it’s hard to ignore the flurry of litigation and stiffening industry regulations. “Plan sponsors, with the help of their investment advisors, should articulate their process, follow it and document it,” says Hoffman.