'Special' Treatment

Our industry has long disparaged the apparent “overindulgence”¹ of participants in the stock of their employer as a retirement investment. However, for plan fiduciaries – and those who advise them – there may be a more pressing concern.

Anyone who has been paying attention to 401(k) plan litigation these past several years knows that a common trigger – perhaps the most common trigger – for litigation is the presence of company stock in the plan; more specifically, the presence of company stock that has sharply declined in value. In fact, these days no sooner does some big earnings surprise or unanticipated business calamity make the headlines than the plaintiffs’ bar is out “trolling” for potential clients. And let’s face it, a 401(k) plan is a class action litigant’s dream – potentially thousands of similarly situated and comparably injured plaintiffs in one place (so to speak).  

But if the instances of litigation have been numerous, the odds of success – for plaintiffs – have been anything but.

Prudent ‘Presumptions’

For a long while, these claims failed to clear a “presumption of prudence.” Now, one needn’t scour ERISA’s text to discern the boundaries of this legal construct; indeed, that would be a futile effort. Rather, it is a concept gleaned by the courts (and subsequently enshrined in legal precedent) from their understanding of the black letter of the law. It is a concept that found its footing in a 1995 case called Moench v. Robertson. Now, in that case, as in many of the new generation of “stock drop” cases (drawing their name from the fact that the action arises after the value of the stock drops), a plan participant sued a plan committee for breaching its fiduciary duty based on its continued investment in employer stock after the employer’s financial condition “deteriorated.” In the aftermath of the Moench ruling, nearly every court district court that considered the issue of prudence of employer stock holding had rejected plaintiff claims based on this so-called “presumption of prudence.”

That was the “law of the land” in such matters until 2014 when the Supreme Court seemed truly concerned that the “presumption of prudence” standard basically established a standard that was effectively unassailable by plaintiffs outlined a new standard – a “more harm than good” standard that emerged with Fifth Third Bancorp v. Dudenhoeffer. The notion here was that a plan fiduciary might be excused from taking action with regard to company stock in the retirement plan – such as removing it as an option, or forcing a liquidation of those investments – if doing so would do “more harm than good.”

More Harm?

“Inspired” by this new standard, many of the so-called “stock drop” suits which hadn’t passed muster under the “presumption of prudence” threshold refiled. But ironically, those too had generally come up short of the new standard – though they did at least routinely get past the summary judgment stage. Which, of course, meant more time and expense for the fiduciary defendants – but no recovery for the plaintiffs (or the plaintiffs’ attorneys, who generally work on a contingent fee basis in these class actions).

At least that was the case until a recent district court decision (Jander v. Ret. Plans Comm. of IBM) was overturned by the U.S. Court of Appeals for the Second Circuit, which concluded that, in fact, the plaintiffs plausibly alleged facts showing that a prudent ERISA fiduciary “could not have concluded” that a corrective disclosure of an allegedly overvalued IBM business would have done “more harm than good to the fund.”

In fact, the plaintiff in that case – recently accepted by the Supreme Court – argued that no duty-of-prudence claim against an ESOP fiduciary has passed the motion-to-dismiss stage since the 2010 decision in Harris v. Amgen, nothing that “imposing such a heavy burden at the motion-to-dismiss stage runs contrary to the Supreme Court’s stated desire in Fifth Third to lower the barrier set by the presumption of prudence.”

What’s Next?

And yet, that same Second Circuit Court of Appeals whose decision teed up the issue that the nation’s highest court will now consider – within a week of that decision – found that a similar case lacked the “special circumstances” necessary to overcome the more harm than good bar.

As for what lies ahead, the forthcoming review by the U.S. Supreme Court could bring a new, more relaxed pleading standard to the fore. Or it might establish a “new” standard that doesn’t do anything more to improve plaintiffs’ prospects than the “more harm than good” did beyond the “presumption of prudence.”

In any event, plan fiduciaries who still maintain company stock as plan investment option (and according to the Plan Sponsor Council of America’s 61^st Annual Survey of Profit Sharing and 401(k) Plans, 12% of plans allow company stock as an investment option for both participant and company contributions, and 4% restrict it to company contributions only) might well want to spare themselves the cost and aggravation of litigation that seems inevitable when (if?) the value of that stock holding goes down.

In this day and age, a plan fiduciary unable to see the potential for employer-security-related litigation is perhaps unworthy of the role, and a dual-role plan/corporate fiduciary unable to appreciate the potential for a conflicted duty vis-à-vis his or her fiduciary responsibility to the retirement plan is surely living in a state of active denial.

Because while “special” circumstances may seem to warrant such consideration, ultimately, perhaps inevitably, the end result seems to eventually be putting not only prospective plaintiffs, but the plan fiduciaries, between a rock and a hard place.

 

- Nevin E. Adams, JD

 

1. Participants given an option to invest in company stock have long invested what professionals would deem an inappropriately large percentage of their portfolio there ( Vanguard’s How America Saves 2019 report notes that 4% of participants with the option to invest in company stock have more than 20% of their balance so invested) – arguably the least diversified investment option on the menu, and one that is inextricably tied to the success of their employer’s business (meaning that when the business slips, so might the prospects of their continued employment). On the other hand, an investment in their employer is seen by many as a mark of confidence and loyalty – and, for many, it’s doubtless the investment on that menu that they best understand. 

(Not) Standing Still

A recent headline screamed that 401(k) savings rates have “stagnated” – but that’s missing the point. Several of them, actually.

“Stagnated” in this case apparently means that the average savings rate in 2018 — both employee and employer contributions — was 10.6%, roughly the same as the 10.4% rate reported in the survey in 2004. The point seems to be that, despite roughly a decade of automatic enrollment and other plan design enhancements, Americans aren’t saving any more.

That’s a perfectly obvious point to draw from those two datapoints – in this case from the recent 2019 How America Saves report from Vanguard which, while it only covers plans recordkept by Vanguard, the experience of 1,900 plans and 5 million participants in the survey always provides some interesting insights.

First a couple of basics; what do you suppose the odds are that we have the same plans (and participants) in the 2004 and 2019 surveys? Exactly. So, while it may not be apples to oranges, it’s clearly not pure apples to apples, either. The Vanguard authors themselves at one point acknowledge that there has been an impact to the report averages due to bringing on new plans with lower account balances. Secondly – and I’ve written about this previously – averages are mathematically simple, but can gloss over individual details.

There is, however, much more going on behind the scenes than the average conveys[i]. The reality is that automatic enrollment, while it boosts participation, actually – initially – depresses average savings rates. Why? Because while it generally lifts the participation rate from 70% or so to 90% or so, at the same time it “creates” a whole new group of people saving at a default rate (typically 3%)[ii], whereas those who signed up voluntarily save at rates more than double that. Consequently, you might well expect that a decade of automatic enrollment plan designs might have done good things for participation, they might well have depressed savings rates – and yet, they haven’t.

Some of that can be attributed to improvements in those automatic designs; in 2018, echoing results from the Plan Sponsor Council of America’s 61st Annual Survey of Profit Sharing and 401(k) Plans, slightly more than half of plans chose a default rate of 4% or higher, whereas in 2008 only about a quarter (27%) of plans did. The report also notes that in 2018 23% of plans chose a default rate of 6% or more – more than double the percentage that did so in 2009. And while it has long been the “norm” to apply automatic enrollment provisions to new hires only, the newest Vanguard report finds that it has now been applied to all non-participants in half the plans.

Better still, two-thirds of the plans with automatic enrollment have now implemented automatic annual deferral rate increases, and as of 2018 that has served to narrow the spread between deferral rates for participants in voluntary enrollment plans and those with automatic enrollment to just 0.4 percentage points!

Not that there isn’t room for “improvement”; just one-in-five had a deferral rate of 10% or higher in 2018, and – to the point above, 3 in 10 had a deferral rate of less than 4%. Moreover, only 13% of participants capped out at the 402(g) limit ($18,500), and in plans that allow catch-up contributions for those aged 50 and more, only 15% took advantage of that opportunity in 2018. And – even among the highest paid workers, 6% of those eligible aren’t (yet) taking advantage of that opportunity.

The dictionary defines “stagnant” as “showing no activity; dull and sluggish.” Well, while one number may make it seem that retirement savings has been standing still, the reality is quite different – and not at all "stagnant". 

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[i] To their credit, the Vanguard report authors take pains in the space of the 112-page report to not only provide median, as well as average figures, but to break data down by tenure, salary, and in some cases, age, as well as for participants who have been consistently in their database over a period of time.

• [ii] The Vanguard report notes that even among individuals earning less than $30,000 in plans with automatic enrollment have a participation rate more than double that of those in plans with voluntary enrollment.

A Not-So-SECURE ‘Act’?

The headline in a recent New York Times piece cautions that “Confusing Options May Be Coming to Your 401(k). It Could Cost You.” 

Those “confusing options”? Retirement income. And, ironically, they might undermine support for the most significant piece of pro-retirement legislation in a decade.

In fairness, the article begins by acknowledging to its readers that there might soon be some “welcome changes to the rules governing their retirement savings plans,” but quickly moves on to take to task the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, which not only brings with it those welcome changes, but a key element that has some consumer advocates all atwitter (literally) – a fiduciary safe harbor for the selection of a lifetime income provider.

For years the retirement industry has bemoaned the lack of a lifetime income option in defined contribution plans. Indeed, for all the vaunted talk of the so-called “DB-ification” of DC plans, the latter has largely steered clear of embracing what is arguably one of the most compelling elements of DB plan design (aside from the completely employer-funded and managed aspects) – providing a pension, a stream of lifetime income.

Of course, in a DB plan, the cost and risk is on the employer, not only for the funding, but also for the provision of that pension benefit. DC plans have a very different dynamic, and DC plan sponsors have – largely – seen little upside in signing on for a decision that they see as carrying with it a liability that extends well beyond the employment relationship. Indeed, there have been any number of real and perceived reasons to avoid doing so (see 5 Reasons Why More Plans Don’t Offer Retirement Income Options).

The SECURE Act attempts to resolve some of that resistance – creating a legislative “safe harbor” in place of the one articulated by the Labor Department in 2008 and expanded upon in a 2015 Field Assistance Bulletin. Arguably, a legislative safe harbor is “safer” than one staked out by regulators, but plan fiduciaries hoping to find a fiduciary “free pass” won’t find one here, despite the concerns expressed in the Times.

‘Financially Capable’

The legislation states that a fiduciary is expected to engage “in an objective, thorough, and analytical search,” and that they must consider the financial capability of the insurer to satisfy its obligations, consider the cost (including fees and commissions) of the guaranteed income contract “in relation to the benefits and product features of the contract and administrative services to be provided under such contract,” and determine “at the time of the selection, the insurer is financially capable of satisfying its obligations under the guaranteed retirement income contract…”.

Now, unlike the regulatory safe harbor, the SECURE Act outlines some pretty specific criteria as to what would satisfy the financial capability tests, specifically that the fiduciary gets written confirmation from the insurer that they:

• are licensed to offer such products; 
• have operated under a certificate of authority from their state insurance commission at the time of selection, and for the immediately preceding seven years; 
• have filed audited financial statements in accordance with the laws of that state; 
• maintain reserves that satisfies those state requirements;
• have undergone, at least every five years, a financial examination (in accordance with those state requirements); and
• that they will “notify the fiduciary of any change in circumstances occurring after the provision of the representations” detailed above that “would preclude the insurer from making such representations at the time of issuance” of the contract. 

The SECURE Act goes on to clarify that while fees are a consideration, there is no requirement to select the lowest cost, and that the fiduciary may consider the value of the contract, including features and benefits and attributes of the insurer. It also states that the fiduciary will be deemed to have conducted the required “periodic” review if they receive the written representations from the insurer on an annual basis, unless they receive a contrary notice, or are aware of “facts that would cause the fiduciary to question such representations.”

Limit ‘Ed’

If all of those conditions are met, the SECURE Act goes on to limit the liability of the fiduciary for any losses “that may result to the participant or beneficiary due to an insurer’s inability to satisfy its financial obligations under the terms of such contract.”

While the fiduciary obligations to review and evaluate the insurer resonate with ERISA’s fiduciary admonitions, the concerns raised in the Times article seem to be twofold: that the mere existence of this new safe harbor will be touted as the free pass it most surely isn’t – and that the relative specificity of the conditions deemed to satisfy the financial capability test will result in a mere checkbox review – and that the checkbox – basically doing business in a state (and let’s remember that various states have varying requirements) while avoiding running afoul of those same state regulators – will serve as a back door for the annuity pitching “foxes” to enter the 401(k) “hen house” and those participant accounts to which they have long effectively been denied access.

Now, if in fact those results do flow from the SECURE Act’s implementation (and its integration with the Senate’s Retirement Enhancement and Savings Act (RESA)), there would be cause for concern. Certainly SECURE’s lifetime income provider fiduciary safe harbor is a more secure mooring for plan fiduciaries than the current landscape, if only because it provides some structure for the assessment of the financial capability of the product provider. That said, you could hardly be faulted, however it’s ultimately pitched, for not seeing a ton of daylight between that new safe harbor and the current fiduciary landscape. And the legislation, to my eyes, anyway, minces no words in reminding plan fiduciaries of the existing obligations under ERISA to assess, monitor, and review the conditions underlying the suitability of the lifetime income option as a prudent plan investment.  

Unless, of course, you’re reading the Times (instead of the actual legislation) – and you are concerned enough at the potential abuse that you’d consider withholding your support for the legislation, legislation it’s worth remembering passed the House by the kind of margin generally reserved for the naming of post offices.

Now, what the Times article gives voice to is a seed of distrust – viewing the safe harbor language not as a relatively modest means to encourage consideration of an option that experts have long said was needed, for which participants routinely express interest (in surveys, if not actual take-up rates), but that plan fiduciaries have nonetheless been reluctant to embrace.  

When all is said and done, this safe harbor may not be “enough” – but it is a step, and fear-mongering notwithstanding – it is arguably a step along a path to a retirement that is, indeed, more secure.

- Nevin E. Adams, JD
 
See also: Retirement Plans and Retirement Income: It’s Complicated.

'Lesson' Plans

Life has many lessons to teach us, some more painful than others – and some we’d just as soon be spared. But as graduates everywhere look ahead to the next chapter in their lives, it seems a good time to reflect on some lessons learned along the way.

It’s handy to know at least a little about sports and the weather.

Paying the minimum due on your credit cards is dumb.

Be willing to take all the blame – and to share the credit.

Know that there actually are stupid questions. Try not to be the one asking them.

Shun those who are cruel to others – and don’t laugh at their “jokes” – sooner or later, you’ll be a target.

Never say you’ll never.

“Bad” people eventually get what’s coming to them, though you may not be around to see it.

Always sleep on big decisions.

When it seems too good to be true, it’s generally not good nor true. 

Never let your schooling stand in the way of your education.

Sometimes the grass on the other side looks greener because of the amount of fertilizer applied.

Never email in anger – or frustration. And be extra careful when using the “Reply All” button.

If your current boss doesn’t want to hear the truth, it may be time to look for a new one.

Never miss a chance to say “thank you.”

Hug your parents – often.

If you wouldn’t want your mother to learn about it, don’t do it.

Bad news generally doesn’t age well.

There can be a “bad” time even for good ideas.

Your work attitude often affects your career altitude.

Comments that begin “with all due respect” generally aren’t.

Sometimes the questions are complicated, but the answer isn’t.

Remember as well that that 401(k) match isn’t really “free” money – but it won’t cost you a thing.

And don’t forget that you’ll want to plan for your future now – because retirement, like graduation, seems a long way off – until it isn’t.

Congratulations to all the graduates out there. We’re proud of you!

- Nevin E. Adams, JD
Got some to add? Feel free to comment below....

5 Things Your Retirement Can (Still) Learn From Game of Thrones

Whether you are a Game of Thrones aficionado – or haven’t watched a single episode – there are lessons to be learned nonetheless.

Last week I recounted some fiduciary admonitions from the HBO series. Turns out there are words of wisdom for individual retirement savers as well. Check these out.

“When you play the game of thrones, you win or you die. There is no middle ground.”

All the way back in Season 1, Cersei Lannister explained what has certainly been a theme for the series as a whole. That said, retirement isn’t a game of thrones, nor is it precisely a “win or die” scenario. We all die, eventually of course (no “wights” here), but there are those who “win,” at least if you consider those who have sufficient resources to fund retirement as “winning.”

The non-partisan Employee Benefit Research Institute (EBRI) has previously found that current levels of Social Security benefits, coupled with at least 30 years of 401(k) savings eligibility, could provide most workers – between 83% and 86% of them, in fact – with an annual income of at least 60% of their preretirement pay on an inflation-adjusted basis. Even at an 80% replacement rate, 67% of the lowest-income quartile would still meet that threshold – and that’s making no assumptions about the positive impact of plan design features like automatic enrollment and annual contribution acceleration.

When EBRI recently looked at an individual basis, the average Retirement Savings Shortfall for those ages 60–64 ranges from $12,640 per individual for widowers to $24,905 for single males and $62,127 for single females. Those looking for a big boost in the odds of success could find it in eligibility for a defined contribution plan. Consider that the average retirement deficit for individuals ages 35-39 with no future years of eligibility in a defined contribution plan is $78,046 per individual – more than five times the average retirement deficit for those fortunate enough to have at least 20 years of future eligibility in a defined contribution plan (where the average retirement deficit is $14,638).

Not that there isn’t plenty to worry about: reports of individuals who claim to have no money set aside for financial emergencies; the sheer number of workers entering their career saddled with huge amounts of college debt – and the enormous percentage of working Americans who (still) don’t have access to a retirement plan at work… and those important years of eligibility.

“A Lannister always pays his debts.”

While the official motto of the Lannister house is “Hear me roar!”, at several points throughout the series, the Lannisters are able to trade on their reputation for, by hook or by crook, fulfilling their debt obligations (though note, such “debts” are not always monetary in nature).  

Debt of any kind – and these days student debt seems to loom largest – certainly weighs on thinking, if not saving, for retirement. While younger workers’ balance sheets are clearly hurt by student debt, researchers have noted preliminary results that indicate that they do not substantially reduce retirement saving to compensate. Good news for their long-term prospects, anyway.

However, note that nearly two in three workers (63%) say debt is a problem for them, and the Employee Benefit Research Institute’s (EBRI) Retirement Confidence Survey has consistently found a relationship between debt levels and retirement confidence. In 2018, just 2% of workers with a major debt problem say they are very confident about having enough money to live comfortably in retirement, compared with a third (32%) of workers who indicate debt is not a problem – while 37% of workers with a major debt problem are not at all confident about having enough money for a financially secure retirement, compared with 6% of workers without a debt problem.

Now, confidence is one thing; reality is another. Paying off debt – or avoiding racking up serious amounts of it in the first place – is the wisest course when it comes to retirement preparations. But, as Tyrion Lannister observed in Season 3, “I’m quite good at spending money, but a lifetime of outrageous wealth hasn’t taught me much about managing it.”

”If you think this has a happy ending, you haven't been paying attention.” 

Ramsay Bolton’s Season 3 admonition to Theon Greyjoy (soon to be Reek, several seasons ahead of his eventual redemption) predicated what was surely one of the more uncomfortable sequences (certainly for Theon) – and proved to be prescient for viewers as well.

It is an observation that many retirement industry professionals would surely direct at the individuals that any number of consumer surveys suggest have set aside little or worse – nothing – not only for retirement, but for the relatively commonplace financial emergencies that seem to be part and parcel of life. Granted, some doubtless are living “paycheck to paycheck” not by choice, but necessity.

And yet, there’s plenty of evidence to suggest that these behaviors aren’t always constrained by economic reality, but by a very human inclination to sacrifice the long-term view for the exigency of today’s pleasure(s), if not an unhealthy confidence that the future will bring opportunities to remediate today’s decisions.

“The Lannisters send their regards.”

Game of Thrones may not have invented the notion of surprisingly (if not randomly) killing off key characters, but the series has arguably taken it to a whole new level. For my money, even in a series well-known for its plot twists, unanticipated shifts of loyalty and sheer mayhem, there’s nothing quite like the episode titled “The Rains of Castamere,” but more commonly known to fans as the “Red Wedding.”

We’ve all been to at least one wedding where the underlying tensions between families threatened to undermine the happiness generally associated with such proceedings, but I think it’s fair to say that the wedding of Edmure Tully and Roslin Frey had a conclusion far more dramatic than its participants (or viewers) anticipated (unless, of course, you read the book). That said, it’s not as though the Starks didn’t have a premonition about the trouble that would ultimately befall them. It’s just that, ultimately, they relied upon a certain amount of social decorum to prevail. Suffice it to say that the “decorum” that accompanied Roose Bolton’s infamous quote above wasn’t what the Starks had in mind.

The lesson for retirement savings is, of course, that it’s always prudent to be prepared in case planned events take an unexpected turn. That could come in many forms: an unexpectedly early retirement, a sudden illness or disability, a need to provide parental support, or even a sharp, sustained downturn in the markets.  

It might be a good time to check out “6 Things that Can Wreck a Retirement."

“Winter is coming.” 

This is perhaps the most iconic phrase from GoT, and while those who live in climates where the arrival of winter can mean significant change – snarled commutes, cancelled flights, or perhaps trips to the ski slopes – in the Game of Thrones it’s unequivocally a bad thing, though – as in making retirement preparations – there are some who think that arrival is further off than it actually turns out to be.

Retirement – or perhaps more precisely, the end of a full-time working career – though it’s often depicted with scenes of warmth and beaches – is “winter” of a sort, or might be if adequate preparations aren’t made. While there are varying degrees of concern about that impact, and the timing of that impact, it seems fair to note that Americans know that retirement, like winter in GoT, is coming.

Those who haven’t are well advised to bear in mind Tyrion Lannister’s caution, “The day will come when you think you are safe and happy, and your joy will turn to ashes in your mouth.”

Better counsel comes from Petyr Baelish, who in Season 6 noted, “The past is gone for good. You can sit here mourning its departure, or prepare for the future.” Because, as that same Petyr Baelish explains in Season 4, “a lot can happen between now and never.”

And here’s hoping it does – because it certainly can.

- Nevin E. Adams, JD