Many retirement plan sponsors don’t realize the significance of breaching their fiduciary responsibilities.
“Being a plan sponsor should not be taken lightly, and being a fiduciary especially should not be taken lightly. There can be, and have been, severe consequences for breach of fiduciary obligations,” says Rob Martin, ERPA, QPA, Senior Team Manager at Tegrit Group. “So, take them seriously and find sound professionals and service providers to guide you.”
Even though the company is sponsoring the plan, a fiduciary is a named individual. Therefore, with very egregious errors, the personal assets of the individual fiduciary could be at risk.
Smart Business spoke with Martin about handling fiduciary obligations.
What fiduciary obligations are retirement plan sponsors responsible for?
The fiduciary obligations are to look out for the best interests of the plan participants and to put their needs before any personal or employer needs. The plan sponsor must have a written investment policy statement that includes how the selection of fund offerings and service providers are made.
If one of the funds has a bad year, it doesn’t necessarily mean the sponsor didn’t do its job. As long as the process is in place to select that fund beforehand — a process that compares past history with benchmarks and other funds in that same category — then there will be no problems from a Department of Labor (DOL) standpoint.
What can happen if sponsors fail to meet their fiduciary obligations?
The DOL has made a point of emphasizing fiduciary obligations when it comes to auditing retirement plans. The DOL audits can occur randomly or if there’s been a complaint against the company.
If a DOL audit finds problems, the sponsor will need to correct them quickly. For egregious errors, the DOL will hold the fiduciary in violation and go through the legal system. Even if a fiduciary is found in good standing, it takes extra work and time, including possibly paying service providers, to find needed items.
Civil lawsuits are another danger if you’re not following DOL guidelines.
How should these obligations be managed?
One of the best places to find information is on the DOL’s Web page: Meeting Your Fiduciary Responsibility, www.dol.gov/ebsa/publications/fiduciaryresponsibility.html. Plan sponsors should call third-party investment administrators or investment advisors for further assistance.
Sponsors need to answer participant questions in a timely manner. Otherwise, participants may file a DOL complaint and/or lawsuit. Once a suit is filed, fiduciaries will have legal fees and face the consequences of the case’s outcome.
Plan sponsors should also have a default account, known as a Qualified Default Investment Alternative (QDIA). A QDIA protects the fiduciaries from participants who do not make an investment election or who fall short in making a full investment election.
What is the biggest hot button area to keep an eye on, as a fiduciary?
The hot button area right now is fees. Part of being a fiduciary is to provide the new fee disclosure notice to the participants. This started in 2012 and now must be provided annually or quarterly to the participants, depending on what’s being disclosed.
Another important fiduciary responsibility is making sure plans have reasonable plan expenses. The plan sponsor should have a process, as part of the investment policy statement, to examine service providers and see whether it pays reasonable plan expenses, by utilizing professionals who provide benchmarks for comparison.
Do late deposits remain a concern?
The DOL is still pursing this. These typically apply to making timely participant contributions and loan repayments — not employer contribution deposits. More specifically, for plans with fewer than 100 participants, the DOL considers timely to be within seven business days.
With all fiduciary obligations, the key is choosing professionals with a good understanding of the requirements, which can be investment advisors, third-party administrators or record keepers.
Rob Martin, ERPA, QPA is a Senior Team Manager at Tegrit Group. Reach him at (614) 458-2023 or firstname.lastname@example.org.
For additional retirement planning tips, visit Tegrit’s Advisor Resource Center at www.tegritgroup.com/arc.
Insights Retirement Planning Services is brought to you by Tegrit Group
Much attention has been given to the fees and expenses of qualified retirement plans. Many questions are being asked about the reasonableness and quality of the current 401(k) landscape.
For decades, service providers have been charging excessive, and often hidden, fees to a countless number of plan participants. Similarly, plan investment options came under fire shortly after the 2008 financial crisis, which saw millions of workers lose significant portions of their retirement savings. This unfortunate combination — excessive fees and poor returns — was the driving force behind the recent regulatory changes.
Smart Business spoke with Eric N. Wulff and Christopher D. Bart, managing directors and principals at Aurum Wealth Management Group, about the Department of Labor’s (DOL) plan to address these issues.
What are some of the company’s fiduciary responsibilities relating to their retirement plan?
The three main concerns revolve around fees, service and investments.
On Feb. 3, 2012, the DOL issued a final regulation under the Employee Retirement Income Security Act of 1974 (ERISA). This regulation requires a 401(k) plan’s service providers to disclose all fee and compensation arrangements, effectively known as ‘full fee disclosure.’
From a service perspective, companies are required by the DOL to determine the reasonableness of fees. Industry best practices indicate the most effective means by which you can evaluate the reasonableness is to place the plan out to bid. Conducting a request for proposal process allows you to compare not only the cost and compensation arrangements, but also the nature and level of the service. If the service provider does not provide a level of service commensurate to its fee, it is the company’s fiduciary duty to terminate the provider.
As for investments, companies are required to maintain a documented process on the selection and monitoring of the investments in the 401(k) plan. Specifically, the DOL recently put out an advisory bulletin on target date funds requiring them to evaluate the absolute risk of these types of investments. Target date funds became a popular investment strategy because plan sponsors were given fiduciary relief if they offered them as a qualified default investment alternative. This turned out to be somewhat problematic when the market crashed in 2008 and 401(k) participants saw their investments drop by 20 percent or more.
How can companies minimize their fiduciary responsibility?
There are different types of advisers companies can engage to assist them with their responsibilities, and companies can do a better job understanding those options.
The two most common levels of fiduciary status under ERISA are 3(21) and 3(38). As a 3(21) fiduciary, the adviser serves as a co-fiduciary to the plan; in this role, the adviser monitors plan investments and makes investment recommendations to the plan sponsor, but does not have discretionary control of plan assets. As a 3(38) fiduciary, the adviser takes control of plan assets, makes all investment decisions and insulates the plan sponsor from fiduciary liability as it relates to plan investments. Hiring a 3(38) fiduciary is the highest level of fiduciary protection under ERISA.
Where do participants stand in all of this?
With most retirement plans, a big problem is that participants are not allocating assets correctly. So, many 401(k) plans are starting to implement more help features for participants. Studies show the average participant can earn an additional 2 or 3 percent per year by getting professional help. Unfortunately, the average participant tends to chase performance when determining their investment allocation.
Hopefully, these increased responsibilities on plan sponsors will continue to bring much needed change to help fix the nation’s structural problem with retirement savings.
Aurum Wealth Management Group is an affiliate of Skoda Minotti.
Eric N. Wulff is a managing director and principal at Aurum Wealth Management Group. Reach him at (440) 605-1900 or email@example.com.
Christopher D. Bart is a managing director and principal at Aurum Wealth Management Group. Reach him at (440) 605-1900 or firstname.lastname@example.org.
Insights Accounting & Consulting is brought to you by Skoda Minotti
Employers have a sacred, fiduciary duty to treat benefit plans as if they were their own nest eggs. Therefore, such plans are heavily governed by the Department of Labor with numerous expectations, communication needs and filing rules.
“The dilemma today is that so many plans are underfunded,” says Bertha Minnihan, national leader, Employee Benefit Plan Services, at Moss Adams. “People have worked hard for their retirement, and if a sponsor should screw that up, they have nothing to fall back on.”
An aging population that needs its money to go further compounds the problem. When benefits aren’t administered properly, society struggles to care for the older generation, she says, and the younger generation suffers when older workers stay on the job longer.
Smart Business spoke with Minnihan about how to properly administer your benefit plan to help employees and how to avoid common regulation pitfalls.
What is the typical reporting structure for employee benefit plans?
There are several disclosures and reporting that are required to go to the participants, as they are the first consideration, and all entities are working to ensure that plans are administered properly for them. Additionally, plans must file a tax return annually to the DOL and the IRS, and those meeting additional requirements must be externally audited, as well. The Pension Benefit Guarantee Corp. also monitors benefit plans that have gone defunct or become underfunded by a certain percentage. The system is quite complex.
Who are the service providers in this space?
Internally, there may be the company sponsoring the plan and a committee delegated to oversee the day-to-day operations, as well as HR and payroll. Externally, benefit plans have investment custodians holding the funds and investing them at the participants’ direction and record keepers tracking plan activity. Record keepers can be a separate entity, or they can be an arm of the investment custodian. Other players include auditors, plan attorneys, actuaries for defined benefit plans, investment advisers and trustees.
What DOL hot button areas do sponsors need to consider when administering benefit plans?
One of the more common pitfalls is the timeliness of deposits into the trust. The DOL wants employee deferrals put into participant accounts quickly because employees deserve to start earning. It’s problematic when companies are careless or feel payroll taxes and other items are more important so they withhold withholdings and play cash flow games.
Compensation is another challenging area, especially when different types of bonuses are paid. The DOL’s hot button is whether the deferrals are being calculated on the correct costs and whether the right components are eligible. If you are missing income components and deferrals are understated, your company could be offering an understated match.
Then, if the employee is shorted, the employer has to make up the entire shortfall, which often surprises people. Some Fortune 500 and 1,000 companies in Silicon Valley have miscalculated compensation and now owe their plans millions of dollars from deferrals, earnings and unfunded matches.
The DOL is also very concerned with educating employees, whatever their demographic. As a business owner, you need to make an effort to get your employees to participate and to maximize their retirement savings.
What are some best practices for plan administrators?
Here are some best practices that could help mitigate risks, concerns and challenges.
- Appoint an oversight governing committee. If your board does not delegate, it is automatically the fiduciary, and the board is often not up to speed on the plan, HR, payroll and/or the Employee Retirement Income Securities Act (ERISA), the law governing benefit plans. Additionally, in private companies, a third-party trustee who is an internal officer is also at fiduciary risk, and a class-action suit could be brought against both the board and the trustee at a risk of personal liability.
- Have your oversight committee be timely with sending funds to the trust.
- Review your census data regularly and ensure databases are accurate. Changes, such as a termination date, reporting someone’s death or a wrong age need to be communicated to different departments.
- Ensure your personnel understand how the plan works. For example, if you hire a new payroll person, make sure that he or she has read and understood the summary plan description.
- Benchmark your fees and look at them regularly. With new federal disclosures, there is transparency by law, so pay attention and ask questions.
How should merger and acquisition groups approach benefit plans?
Whenever companies — small or large — fold or change ownership, a number of items can be missed, so keep this in the back of your mind as you go through the process. Have an ERISA expert advise you early on, as this is not just a matter of merging benefits. The acquired company could have a 401(k) plan that needs to be terminated, a defined benefit plan that is unfunded and frozen, or a deficient benefit plan that must be cleaned up before it can taint your plan on contact. M&A committees should have checklists to ensure employees do not lose their benefits and that the company is still protected and reporting in a timely manner.
How are governing entities dealing with work force globalization in this area?
Globalization is affecting benefits plans without businesses realizing they are possibly being sloppy. If you have U.S. employees working abroad or foreigners coming to your company to work, you need to consider how this will affect benefits. How is your plan written? Are employees still accruing benefits in a timely manner? What does your plan include or exclude, and is that what you intended to do? There is a lot of interest on the subject, and the IRS is working with other governments to ensure that documents are in order, that they understand what the U.S. is doing and that they know what to tell their citizens who come here.
Bertha Minnihan is the national leader, Employee Benefit Plan Services, at Moss Adams. Reach her at (408) 916-0585 or email@example.com.
Insights Accounting is brought to you by Moss Adams.
Whether the organization is publicly-traded, a family business or a not-for-profit, boards of directors deal with many universal issues. The central responsibility of a board member is to make sure the organization prospers and fulfills its strategic mission while ensuring nothing puts the organization’s existence in detriment.
“Board members should have a solid understanding of the basic fiduciary responsibilities that need to be fulfilled and how they are going to ensure that they do so at the particular organization they are serving,” says Bob Stillman, CPA, director, assurance and business advisory services at GBQ Partners LLC. “The top priority of board members is to strategically develop a high-level course of action to ensure the preservation, existence and continued success of the entity.”
Smart Business spoke with Stillman about the essentials of board member fiduciary responsibilities and other matters that affect board members and benefit their related organizations.
What are the key fiduciary responsibilities of a board member?
When advising my clients, I routinely refer to the guidance provided by the attorney general of Ohio, who identifies four primary fiduciary duties:
- Duty of care: meaning be active in the organization’s affairs, consistently attend meetings, keep yourself informed to determine if the policies established are appropriate and adhered to, understand how the organization functions, act diligently and in good faith, with knowledge and after adequate deliberations.
- Duty of loyalty: really relates to acting without self-interest and resolving conflicts of interest. This takes varying forms depending on whether the organization is a public corporation, closely-held/family-owned organization or a not-for-profit organization.
- Duty to manage accounts: relates to the financial accountability of the organization and checks to ensure appropriate internal control is established; records, reports and financial accounting are accurate, timely, sufficient, and monitored; appropriate activities are occurring to ensure sufficient funding resources and there is appropriate expenditures and risk management.
- Duty of compliance: relating to following articles of incorporation, by-laws, other operating documents, relevant laws, regulations and filing requirements.
It is imperative that both management of the organization and the board members understand what each of these duties encompass.
How can board members understand more about these duties and take better responsibility for their roles?
The organization should provide a sufficient level of board member training that is tailored for the particular organization. People join boards having past board experience ranging from none to extensive. Providing new board member training offers an opportunity to explain what’s expected of a board member. Management benefits significantly when their board members have a strong understanding of fiduciary responsibilities. The full board should receive a refresher annually about their basic fiduciary responsibilities.
Why is important for board members to understand and take control of their fiduciary responsibilities?
Many people view participating on a board as an opportunity to apply their personal and professional skills for the benefit of an organization and an opportunity to continue to develop their personal and professional network. However, the board’s collective decisions could have serious consequences for the organization that may reflect on individual board members. Clearly understanding the basic fiduciary responsibilities will help them be a more cognisant about that general risk as well as be a more effective board member.
You cannot abdicate your fiduciary responsibilities to another board member. Commonly, the CPA on the board takes the brunt of the details of the duty to manage accounts, but all other board members must have sufficient information to make their own decision.
Beyond fulfilling the basic fiduciary responsibilities, what other areas should a board member focus?
A well-informed and engaged board of directors will ensure an appropriate strategy is developed and implemented to enable the future success of the organization. Doing so inevitably requires the board to assess the leadership within management. This can be an uncomfortable position, however, a board member should expect to deal with this matter routinely. Also, key management personnel risk is becoming more prevalent with our aging society as professionals move toward retirement. The board needs to consider succession planning for key management personnel.
What skill sets should business leaders look for in a good board member?
A strong board needs to be well-balanced with people that possess specialized skills in certain common areas, such as legal, lending, investing, accounting, human resources, business development, insurance, human resources and technology. You also need members who will establish the tone at the top from an internal control standpoint and develop expectations with management about the quality they expect of the organization.
In the end, for any organization, reputation is its biggest asset and difficult to restore if it is damaged. Board members have a high responsibility to preserve, continue to promote and safeguard this. If they stumble, the organization could be open to negative exposure. You want people who are well respected with certain credentials who will continue to preserve and improve the organization’s
Bob Stillman, CPA, is director, assurance and business advisory services at GBQ Partners LLC. Reach him at (614) 947-5304 or firstname.lastname@example.org.
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Your responsibilities as the sponsor of a retirement plan are more significant than you may realize. It’s not enough anymore to simply hire a service provider to manage the plan and offer it to your employees. As a plan sponsor, there is a tremendous amount of fiduciary responsibility, and decision-makers are held to an expert standard in the eyes of the Department of Labor (DOL).
If they don’t have the skills to meet such stringent standards, plan sponsors need to retain outside experts to guide them through the decisions that must be made on a recurring basis, or risk running afoul of the law.
“Many plan sponsors rely on their providers to do everything for them,” says Andrew Gracan, retirement plan advisor at First Commonwealth Financial Advisors. “Because of this, not only is there a misunderstanding of their fiduciary obligations but the tendency is to run the plan on auto-pilot unless there is a major operational issue to be addressed. However, due to ramped-up enforcement and litigation surrounding retirement plans, it’s important for plan sponsors to understand their obligations and have processes in place to ensure their plans are compliant,” Gracan says.
Smart Business spoke with Gracan about key issues plan sponsors must address.
Why are plan sponsors most at risk right now?
Retirement plans and the activities of their fiduciaries are being placed under a microscope. No longer do participants have multiple plans to rely upon in retirement. The 401(k) plan is the primary retirement vehicle for the majority of today’s workforce, and the burden of savings rests on the employee. With personal savings rates and Social Security in a questionable state, a retirement epidemic is waiting in the wings.
Second, the financial crisis has exacerbated this potential epidemic and taken a toll on participant account balances, drastically changing retirement expectations and causing HR issues for companies in their workforce succession planning function. Finally, 401(k) participants bear the majority of the costs and risk associated with their plan, a dramatic change from the traditional defined benefit plan.
As a result, the government has enacted sweeping legislation through the Plan Sponsor and Participant Fee Disclosure regulations. The first wave of required fee disclosures goes into effect July 1, 2012, and with participant level fee disclosures going into effect Aug. 31, plan sponsors are assessing how their plans and their participants will be affected.
Plan sponsors also face the burden in a major increase of DOL investigations. For the past few years, the DOL has provided plan sponsors a comprehensive educational campaign focusing on helping them understand their fiduciary responsibilities. However, the time for enforcement has begun. In 2011, the EBSA closed 3,472 civil litigations, with 2,301 resulting in monetary settlements of $1.39 billion.
Why is now a critical time for business owners acting as plan sponsors?
Due to the increased government focus, litigation and negative publicity associated with retirement plans, it is important to understand the fiduciary obligations that go hand in hand with sponsoring a retirement plan. Plan sponsors are realizing it is important to be familiar with the fiduciary requirements that are placed upon them and the service providers they hire, as they are personally liable for these decisions. In addition, enforcement and legislative actions are forcing plan sponsors to take a proactive role in understanding the reasonableness of fees being charged to their plans and determining whether conflicts exist with the service providers.
What is the biggest mistake plan sponsors make with retirement plans?
The biggest mistake is not realizing that ignorance is not a viable defense. If plan sponsors don’t fully understand their fiduciary responsibilities or processes, it is their responsibility to hire a ‘prudent expert’ who does. Oftentimes sponsors view retirement plans as a product rather than a process and assume the service provider (or nonfiduciary broker or financial consultant) is giving them the necessary fiduciary guidance to mitigate risk. However, this is a major misconception, especially if the service providers are giving fiduciary advice but not taking written liability for it.
Completely understanding your fiduciary obligations, whether or not service providers are taking written fiduciary responsibility for their actions, and whether or not there are inherent conflicts of interest that exist with the service provider, are paramount to the process of being a prudent fiduciary.
How will the requirement of detailed fee disclosures affect plan sponsors?
The most imminent task will come from the plan sponsors disclosures scheduled to be delivered on July 1. The new regulations are designed to provide plan sponsors with a full disclosure of fees charged to the plan, and sponsors must ask if their fees are reasonable, how to determine whether fees are reasonable, and whether they should hire an expert to determine reasonableness.
How can plan sponsors mitigate risk?
Plan sponsors must fully understand their fiduciary responsibilities and the role their service providers play in their retirement plans. While most believe their responsibilities fall within remitting timely employee contributions, overseeing the record-keeper and monitoring investment options in the plan, these are only part of their core responsibilities. The key is for plan sponsors to be prepared to defend all of the decisions made concerning their retirement plan and to show that they have defined processes that can be measured and repeated. If you, as a fiduciary, do not understand your obligations, or don’t have the information or knowledge to run the plan for the exclusive benefit of participants, it is your responsibility to hire an expert who does.
Andrew Gracan is a retirement plan advisor at First Commonwealth Financial Advisors. Reach him at AGracan@fcbanking.com or (412) 690-4592.
Insights Wealth Management is brought to you by First Commonwealth Bank
Across the country, companies that sponsor 401(k) plans have been going about their business every day, unaware of an impending deadline for compliance with sweeping new government regulations.
When the deadlines pass, no alarm will sound. Instead, dire consequences will eventually befall plan sponsors without warning.
The silent alarm goes off July 1, by which time sponsors are required to be aware of all fees charged by their plan service providers and the services they’re receiving for these fees. (The original deadline was April 1.)
Moreover, they must determine whether these fees are reasonable for the services being provided — a complex undertaking that involves benchmarking the fees against comparable plans. Many sponsors will find that their plans are paying far too much for far too little.
Awareness of the new requirements and their comprehensiveness is astonishingly low. Few companies are doing much, if anything, to gear up for the new requirements. By remaining uninvolved, they’re unwittingly bringing on a world of hurt upon themselves.
Until now, sponsoring companies have been able to remain largely ignorant of the full extent of the fees coming out of their employees’ accounts, though federal rules have long required awareness of these matters.
New regulations from the U.S. Department of Labor seek to end this lack of compliance by reinforcing and expanding existing rules.
The quarterly account statements employees now receive from plan providers show returns net of fees. In the fall, these statements will show actual returns and fees in tabular form. As a result, employees will see for the first time how much their investments have earned and how much plan service providers have taken out of their accounts in fees.
Many employees will see red. They’ll line up outside the doors of HR offices, demanding to know why they’re paying so much.
Companies will get a rude awakening from the clamor of employees reacting to the news that big chunks of their retirement assets are lining the pockets of service providers. They’re going to share this pain with company executives.
The refrain of questions and expressions of outrage will seem never-ending: “How long has this being going on? Why didn’t you tell us? Why haven’t you taken steps to lower fees? Can’t we get lower fees elsewhere?”
This is only part of the pain. The DOL is ramping up staff to monitor — and, potentially, fine — plan sponsors who are tardy meeting these deadlines. It gets worse: Companies that fail to comply with the new regulatory regimen could have their entire plans disqualified, as every transaction conducted on the wrong side of the law could potentially be classified as prohibited.
Since plan sponsors have rigorous fiduciary obligations to their participants, this state of compliance disarray could be a springboard for lawsuits by employees. Indeed, many lawyers who specialize in this kind of action are doubtless licking their chops over the potential for lucrative class-action litigation. Unlike many employers, these attorneys are well aware of the new rules.
No less daunting is the potential for regulatory sanctions stemming from tips from employee whistle-blowers who learn about the new rules from friends at other companies.
If the capital markets act predictably, indications of shakeouts in the 401(k) plan provider marketplace may become readily apparent. Golf and tennis tournament broadcasts this summer may show ads from competitive plan providers seeking to take business away from high-fee providers. HR departments learning about their new burdens this way will be far behind in the extensive preparations required to fully comply with the new rules.
Some plan providers, including large financial services companies, have doubtless given plan sponsors generalized — and, notably, nonbinding — assurances that all will be well. Yet these large companies are committed to nothing because, as non-fiduciaries, they don’t have the same obligations as their sponsor clients, nor do they have any appreciable liability in the matter.
One of the goals of the new rules is to make a clear distinction between advisors and brokers. Although non-fiduciary brokers are prohibited from dispensing actual investment advice, many do. The rules don’t require plans to have an advisor per se, but if they do, this advisor should be a fiduciary. Such arrangements can enable sponsors to effectively outsource some of their fiduciary responsibility.
Moreover, plan sponsors must evaluate newly required compensation disclosures from service providers to determine the motivations involved in determining investment options for the plan. For example, many plan providers charge investment companies for shelf space, which makes such selections biased.
The new rules are designed to support the goal of transparency by helping employees (and company owners, who are in these plans themselves) keep more of their investor returns. Thus, they help everyone in a company achieve the goal of a more dignified retirement. Assuring compliance with these rules advances this mutual goal of labor and management.
Anthony Kippins is president of Retirement Plan Advisors, Ltd., a Cincinnati-based financial services company that provides retirement-plan fiduciary services and employee-benefit solutions to small companies. Kippins holds the AIFA (Accredited Investment Fiduciary Analyst) designation. He can be reached at email@example.com.
If you’re an employer who sponsors a 401(k) plan, April 1 is a date that you should circle on your 2012 calendar. This is the deadline for plan sponsors to obtain from plan advisors newly required disclosures stating specifically what services they’re providing and the cost of each.
To some sponsoring employers, this may sound like a bureaucratic requirement of little consequence. This is decidedly not the case. Beginning April 2, plan sponsors who can’t show that they met the April 1 deadline for disclosures — and the best way to do so is to get them in writing, with signatures — will be subject to federal fines, disqualification of their plans and employee lawsuits aimed at their personal assets.
This requirement is among many stemming from new rules from the Department of Labor (DOL) that go into effect in 2012. The intent of the rules is to protect participating employees from unreasonable service provider fees that shrink their 401(k) accounts. Unbeknownst to employees and many plan sponsors, many plans have long been charged excessive fees. Until now, disclosure of all fees has not been expressly required by federal rules.
In addition to obtaining the fee and service disclosures, the new rules also require sponsors to determine whether plan advisors are fiduciaries — a legal/regulatory status meaning that these advisors always put clients’ interests ahead of their own. (See “The 401(k) regulatory tsunami.”)
The combined content of the new advisor disclosures will have profound implications for sponsors’ compliance burdens stemming from new DOL rules, which expand or amplify longstanding requirements of the Employee Retirement Income Security Act (ERISA) of 1974.
Under ERISA, plan sponsors are themselves fiduciaries, with all of the attendant responsibility, accountability and liability. Many plan sponsors have always believed that their long-time advisors are fiduciaries, but this simply isn’t true. Typically, the dominant advisory role in a 401(k) plan is played by a broker, yet precious few brokers are fiduciaries.
Though ERISA rules prohibit non-fiduciaries from advising on the suitability of specific investments in these plans, enforcement over the years has been lax, allowing many brokers to cross the line between providing employee education and actually advising on the suitability of specific investment options.
Thus, they’ve engaged in the quintessential advisory role — one reserved by law for conflict-free fiduciaries who can share legal responsibilities with sponsors. By contrast, brokers may have conflicts of interest, such as business relationships with financial institutions that provide investments for the plan.
It is critical for plan sponsors to understand how the dynamics of these disclosures will put an increased regulatory and legal burden on them as fiduciaries: By making it a matter of record whether an advisor is or isn’t a fiduciary, the new DOL rules mean that sponsors will have no credibility in telling regulators that they believed they were outsourcing their own fiduciary responsibilities.
In many cases, details of the new advisor disclosures will trigger epiphanies for sponsors concerning fundamental inadequacies of their plans, bringing a growing awareness of some of the rigors that they must undergo to assure that these plans comply with the new DOL rules.
From the point of view of plan sponsors using a broker to service their plans, this epiphanic moment will often go something like this:
– The sponsor, aware of the importance of these disclosures, does some research and learns what services non-fiduciary advisors can and cannot legally provide.
– In disclosures from the broker, the advisor lists the fees that his or her company is charging and the services provided for these fees: selecting mutual funds for the plan’s investment options, making educational presentations to employees and enrolling them in the plan.
– The broker states unequivocally that he or she is not a fiduciary.
– The sponsor realizes that because plan-education presentations typically involve answering questions about specific investments, they can easily involve advisors’ rendering advice on investments — an activity prohibited for non-fiduciaries.
– Further, the sponsor realizes that this advisory scenario is even more likely at enrollment meetings.
– It dawns on the sponsor: The plan is getting far less actual service than previously believed. Hence, fees for the actual, legitimate services being provided are far higher than the sponsor thought.
These disclosures are intended to serve as a wake-up call for companies who may be paying far too much for far too little, so they can take steps to change their plans.
When doing so, sponsors should be careful not to make the same mistakes that got them into trouble in the first place. When non-fiduciary advisors pitched them business, they likely said, “We’ll be standing right behind you.”
By having fiduciaries as their plan advisors, sponsors can be assured that these advisors will be standing with them shoulder to shoulder, sharing their exposure to any incoming regulatory or legal fire.
Anthony Kippins is president of Retirement Plan Advisors LLC, a Cincinnati-based financial services company that provides retirement-plan fiduciary services and employee-benefit solutions to small companies. Kippins holds the AIFA (Accredited Investment Fiduciary Analyst) designation. He can be reached at firstname.lastname@example.org.
A regulatory tsunami is headed toward companies sponsoring 401(k) plans. It will arrive next year when new federal rules take effect, creating an unprecedented burden of accountability for employers.
More than ever, employers will be required to assure that fees associated with these plans are reasonable for the services being provided. To do so, they should move expeditiously to determine and evaluate all plan fees.
Employers are already required to exercise this due diligence by the Employee Retirement Income Security Act of 1974. Yet the fees charged by large financial institutions providing 401(k) plans vary widely and are extremely difficult for employers and employees to ascertain. Many aren’t aware that their fees may be too high because, until now, the government hasn’t required plan providers to voluntarily disclose all fees.
Nevertheless, by entering into arrangements with plan providers that involve unreasonably high fees, many employers have been failing to protect participating employees as required by ERISA. To remedy this lack of compliance and to help employees make more informed investing choices, the U.S. Department of Labor has issued the new rules, which reinforce and expand employers’ existing responsibilities as plan sponsors.
Effective in 2012, these rules will open up new terrain for potential federal fines — as the DOL is substantially increasing its investigative staff — as well as lawsuits from employees. This liability stems from employers’ role as plan fiduciaries, a regulatory/legal status meaning that they must consistently put plans’ and participants’ financial interests ahead of their own.
The new rules require plan providers to disclose fees to employees in chart format in quarterly statements. Currently, these statements show investment returns net of fees, so employees don’t know how much they’re paying plan providers or investment companies that supply products for their plans.
Though the rules require plan providers to disclose fees in an easily understandable format, there are indications that the revised account statements may turn out to be long, confusing documents — something on the order of a prospectus. Confusion will ensue, and employees will queue up at HR to ask what it all means.
After making sure employees understand the newly required disclosures — which is, itself, a fiduciary responsibility — employers will undoubtedly be lambasted with bitter complaints from employees who were unaware of the amounts of fees being deducted from their accounts and others who simply thought their actual investment returns were lower.
Accordingly, it’s imperative that employers act now to “X-ray” their plans or engage a qualified consultant for that purpose, so they understand precisely what fees are being charged for the services being provided. This will involve reviewing reams of plan documents and confronting plan providers to ascertain fee information.
But that’s only the beginning. The tsunami’s force is amplified by the “reasonableness” requirement: How can employers know whether fees are reasonable?
To do so, they must determine where their plans’ fees fall relative to industry norms, so employers must benchmark fees against the full spectrum of the national market for plans of the same size providing the same services. These data-intensive comparisons can be highly complex, especially for small firms that lack the necessary expertise in-house.
The new rules also put increased pressure on sponsoring employers to assure that anyone advising 401(k) plans or participating employees is a fiduciary. ERISA rules have long prohibited non-fiduciaries, including brokers, from advising employees on the suitability of specific investments — a scenario rife with potential conflicts of interest.
Yet, because of lax enforcement that the government is now trying to repair, brokers typically play a dominant role in servicing 401(k) plans. By contrast, fiduciaries — who must avoid even the appearance of conflicts — must comply with stringent regulatory standards that don’t apply to brokers. Moreover, fiduciary advisors are subject to substantially greater legal liability.
Hence, the new DOL rules require employers to determine whether plan consultants are fiduciaries. If they aren’t, fiduciary responsibility — and liability — for the plan resides with the employer.
Companies that proactively get out in front of the tsunami by lining their corporate doorsteps with due diligence sandbags will minimize the damage. They have no time to waste.
Anthony Kippins is president of Retirement Plan Advisors LLC, a Cincinnati-based financial services company that provides retirement plan fiduciary services and employee benefit solutions to small companies. He is an Accredited Investment Fiduciary Analyst.
Serving as a director or officer on a board can be complicated, especially if the business is floundering.
Directors have certain duties to the company they are serving, but when the business is financially distressed, the beneficiaries of those duties switches to the creditors, according to Shawn Riley, the Managing Member of the Cleveland office of McDonald Hopkins LLC and co-chair of its Business Restructuring Services Department.
“In normal situations, those duties exist for the benefit of the owners,” says Riley. “However, when a business starts to experience financial distress, the obligations shift. Two questions arise: ‘When do they shift? And, how do they shift — in other words, who are beneficiaries of those duties?’”
Smart Business spoke with Riley about shifting fiduciary responsibilities and how recent court rulings are changing the rules of the game.
How are directors’ and officers’ fiduciary responsibilities defined?
The fiduciary responsibilities that directors and officers owe a business, particularly a distressed business, have been evolving. Recent court decisions suggest that the responsibilities are not as stringent as people thought they were just a few years ago.
Generally speaking, directors and officers owe their fiduciary duties to the company itself, for the benefit of the owners. To meet their fiduciary duties, directors and officers are required to fulfill two primary obligations — the duty of care and the duty of loyalty. The duty of care means they must be well informed and must reach well-reasoned decisions with respect to the company and its assets. The duty of loyalty requires that directors and officers act without conflict of interest, without benefiting themselves to the detriment of the business.
When do those duties shift?
When a company is in financial distress, case law has suggested that directors and officers have to ignore the interests of the owners and instead focus exclusively on the interests of the creditors. They must think about how to maximize the value of the business so as to pay creditors. That is a pretty significant adjustment in thinking, because directors and officers up to that point will have been running the business for the benefit of the owners.
So when, exactly, do those duties shift? Some argue that it is at the first sign of trouble. Others argue that it is only at the time of filing a bankruptcy proceeding. For others, it is the period when the business is insolvent, whether or not it is in bankruptcy. Until recently, the uncertainty over questions such as these has caused directors and officers to tread carefully.
The uncertainty in the law has diminished recently as courts over the past couple of years have introduced a dose of reason to the process. The courts have begun to suggest that the shift of duties does not occur as early as people were arguing, but rather when there is very clear evidence of insolvency, when the business simply cannot pay its debts. At that point, directors have to start thinking about the interests of creditors.
How do those duties shift?
While it seemed the rule was that directors had to completely ignore the interest of the owners, others argued that creditors’ interests and shareholders’ interest should be given equal weight.
Again, recent case law indicates that directors, even in an insolvency situation, should not ignore the interests of the owners but rather should make their primary concern the interest of creditors, at least until the point where they can demonstrate that the business is solvent again.
The continuing issue for directors and officers, however, is that this is usually judged after the fact, with the benefit of 20/20 hindsight. It is not as if, in the middle of its efforts to right itself, a business can call a timeout and ask a judge what it or its board should do. If the board is unsuccessful in turning the business around, its actions will likely be second-guessed by creditors.
Who can sue directors and officers for breach of fiduciary duties?
It is the company itself that is supposed to sue those directors and officers that it believes have breached their fiduciary duties. But it would be pretty remarkable if those directors who run the business authorize counsel to file suit against them.
Courts allow shareholders (and creditors) to assert derivative standing, in which a group of shareholders — or a creditors’ committee in a bankruptcy — sue on behalf of the company in a situation in which it would be futile to ask the company to sue. Anything that is recovered against the directors’ and officers’ insurance policies would then be distributed to the shareholders or creditors. However, the courts have started to impose tighter restrictions on the circumstances under which a creditors committee in a bankruptcy can file derivative actions. In a recent case involving a limited liability company in Delaware, the court ruled that only owners or members of the LLC could sue derivatively, meaning that creditors are not authorized to pursue directors and officers. Even if creditors could demonstrate that directors and officers clearly did something wrong that resulted in damage to creditor interests, they have no standing to pursue claims.
This may reflect a recognition that perhaps the pendulum had swung too far in one direction, authorizing aggressive lawsuits by creditors against directors and officers for marginal claims under otherwise reasonable decision points for directors. The pendulum is swinging back and the courts are limiting not only the time period claims can cover, but also the types of claims and who can file them.
This ruling may make people more willing to serve on boards, as they can join a board less worried about the potential for being sued. It should also reduce the cost of directors’ and officers’ insurance.
Shawn Riley is the Managing Member of the Cleveland office of McDonald Hopkins LLC and co-chair of its Business Restructuring Services Department. Reach him at (216) 348-5773 or email@example.com.