Decision “Points”

I have watched with increasing interest the growing furor over the Department of Labor’s proposed new fiduciary definition. My first impressions of the proposal were positive: generally speaking, IMHO, the more people who work with ERISA plans that conduct themselves as ERISA fiduciaries, the better. The notion that broadening that standard would serve to “run off” those not as committed to this business bothered me not at all.

However, and as is often the case with new regulations, areas of concern began to pop up. Those involved with the valuation of privately held stock in Employee Stock Ownership Plans (ESOPs) were initially most strident, though the work they do has a tremendous impact on thousands of employer and employee accounts. More recently, and of more interest to many advisers, the Department of Labor’s temerity in bringing IRA accounts under the ERISA fiduciary umbrella has drawn fire from “more than three thousand advisers,” according to the Financial Services Institute (FSI), which has led that charge. Indeed, having despaired of getting the ear of the Department of Labor, FSI says those letters have been directed to the White House itself. On Friday, The Wall Street Journal dedicated space on its editorial page to the issue (the author was opposed to the proposal).


Meanwhile, at a hearing at the House Subcommittee on Health, Employment, Labor, and Pensions last month, lawmakers on both sides of the aisle pressed Phyllis Borzi, Assistant Secretary of Labor and head of the Employee Benefits Security Administration (EBSA), to rethink the proposal, citing concerns that it cuts too broadly and that it could extract a financial toll as yet undetermined by the regulator (see Borzi Makes Case for Fiduciary Definition Change). And yet, by all accounts, at this point DoL remains unwilling to budge.

One ought not be too surprised, I suppose, at those lobbying so fiercely to preserve the status quo. For good or ill, this industry has grown up around the so-called five-part test for an ERISA fiduciary. Entire business practices and means of conducting business have been constructed with an eye toward avoiding becoming ensnared in ERISA’s web. Moreover, the compensation strictures imposed by ERISA would be problematic, at best, for many of those who currently serve the IRA market—even if a growing percentage of those assets have grown under ERISA’s auspices. Still, there’s an irony in the vehemence with which they protest the potential loss of valued counsel by investors—even as they refuse to embrace a standard that would require them to put the interests of those investors ahead of their own.

Proponents (and here I’m not just talking about the DoL) are nearly as unseemly in their rigid adherence to imposing change, ostensibly to protect investors who have had their retirement savings plundered by advisers operating outside ERISA’s strictures. For proof, they trot out, among other things, a dated study that claims to have discovered, based on a very limited sampling, that pension consultants might have a conflict of interest that could affect the advice they provide to plan sponsors. Or, one is tempted to add, they might not (see “IMHO: ‘Might’ Makes Right”). In Congressional testimony, Secretary Borzi cited research that purports to demonstrate a negative impact from potential conflicts of interest by the adviser, only to acknowledge “that none of this research evidence necessarily demonstrates abuse.”

Worse, while they acknowledge that the proposal in its current form might be poorly crafted to deal with certain specific issues, they seem to expect the industry to “trust” them to fix those problems after the regulation is issued via interpretative guidance, the issuance of prohibitive transaction exemptions, or the like.

Without doubt, ERISA’s fiduciary definition was crafted at a very different time, and the industry has undergone much change in the interim. One can understand the reluctance to embrace change that might transform a casual comment about a fund into a fiduciary obligation, and the hesitancy to extend ERISA’s reach to the individual IRA market. On the other hand, particularly when one considers how much of those funds originated under ERISA’s shield, the irony of withdrawing those protections at retirement—and at a point when those balances might be large enough to attract the attention of the unscrupulous—is, to my eyes anyway, striking.

The retirement industry (in large part) says it wants more time, thought, and analysis devoted to this proposal—and the Labor Department claims it continues to do just that.

It is hard to escape, however, a sense that the proposal’s opponents really just want it to go away—while for proponents, the decision has already been made.

—Nevin E. Adams, JD

'Wrong' Headed?

In this as, perhaps, many professional endeavors, it seems that the more you know, the more you know you don’t know. Moreover, the standards imposed on plan fiduciaries by the Employee Retirement Income Security Act (ERISA) are not only demanding, they may be the highest found in law—and with personal liability imposed, to boot.

About a year ago, I compiled a list of “10 things you're (probably) doing wrong as a plan fiduciary.” By all accounts, it was well-read, much forwarded, and useful in terms of helping plan sponsors and retirement plan advisers highlight areas of possible improvement with your plan sponsor clients.

The list that follows – think of it as “10 things you’re probably STILL doing wrong as a plan fiduciary” - is a compilation based on my experience, the experiences of a group of experts who conducted a panel by the same title at the PLANSPONSOR National Conference in June, and a list of “Common Plan Mistakes” from none other than the Internal Revenue Service itself. Once again, I hope you find this list informative—and that you draw insight and comfort from its contents.

1. Not following the terms of your plan document regarding the administration of loan provisions (maximum amounts, repayment schedules, etc.) or hardship withdrawals.

Plan documents routinely provide that hardship distributions can only be obtained for certain very specific reasons, and that participants first avail themselves of all other sources of financing before applying for hardship distributions (these conditions often are incorporated directly from the requirements of the law). Similarly, loans are permissible from these programs only when they comply with certain standards regarding the amount, purpose, and repayment terms.

Failure to ensure that these legal requirements are met can, of course, most obviously result in a distribution not authorized under the terms of the plan document—and, since these types of distributions are frequently quickly spent by participants (and thus not readily recoverable), it can be complicated and time-consuming to set the situation right.

2. Failure to follow plan document eligibility and vesting provisions

An employee’s rights to retirement benefits are determined by the correct application of service and/or age requirements of the plan regarding eligibility for participation, and also may be influenced by the proper application of the plan’s vesting schedule.

To properly comply with those requirements, you need to maintain accurate service records for all employees. If these records are incorrect, the benefits provided may be incorrect—either in excess of what is permissible or less than what was due to the participant. Note that the failure to properly follow the plan’s provisions can cause the plan to lose its qualified status.

The plan document serves as the foundation for plan operations; it is, quite simply, the operating manual for your program. Sometimes, particularly if you are relying on a document that has been prepared by a third-party service provider, certain “gaps” can emerge between what the document allows and how the plan is actually administered. As a result, it is a good idea to conduct a document/process “audit” every couple of years—don’t assume that “the way we’ve always done things” is supported by the legal document governing your plan.

3. Improperly managing forfeiture accounts

Many defined contribution plans require participants to complete a period of service before becoming fully vested in matching or non-elective employer contributions, and when a participant leaves the play before they are fully vested, their unvested account balance may be forfeited. Some plan administrators place these forfeited amounts into a plan suspense account, allowing them to accumulate over several years. However, the Internal Revenue Code does not allow this practice. Forfeitures must be used or allocated in the plan year incurred.

Revenue Ruling 80-155 states that a defined contribution plan will not be qualified unless all funds are allocated to participants’ accounts in accordance with a definite formula defined in the plan, and the IRS notes that this would preclude a plan from carrying over plan forfeitures to subsequent plan years, as doing so would defy the rule requiring all monies in a defined contribution plan to be allocated annually to plan participants. The plan document’s terms should have provisions detailing how and when a plan will exhaust plan forfeitures.

4. Not starting required minimum distributions (RMD) on time

A minimum payment must be made to the participant by the required beginning date (RBD) and for each following year. Normally, the RBD for a participant who is not a 5% owner is April 1 following the end of the calendar year in which the latter of two events occurs: either the participant reaches age 70½ or the participant retires (for 5% owners, the RBD is April 1 following the end of the calendar year in which they attain age 70½ regardless of their retirement date).

Plan sponsors often discover that required minimum payments either have not been paid timely or at all, especially when a non-5% owner continues working after reaching age 70½. Failure to follow the minimum payment rules as written in the plan document can lead to the loss of the plan’s tax-qualified status. If participants or beneficiaries do not receive their minimum distribution on time, they (not the plan) are subject to a 50% additional tax on the underpayment.

5. Not depositing contributions on a timely basis

The legal requirements for depositing contributions to the plan are perhaps the most widely misunderstood elements of plan administration. A delay in contribution deposits is also one of the most common flags that an employer is in financial trouble—and that the Labor Department is likely to investigate.

Note that the law requires that participant contributions be deposited in the plan as soon as it is reasonably possible to segregate them from the company’s assets, but no later than the 15th business day of the month following the payday. If employers can reasonably make the deposits sooner, they need to do so. Many have read the worst-case situation (the 15th business day of the month following) to be the legal requirement. It is not.

Editor’s Note: the other five things will appear in next week’s column.

No One to Blame

Like most of you, I have found the soaring price of gasoline to be enormously frustrating. Not that we haven’t dealt with this kind of thing before—but in the past, there generally seemed to be a reasonable explanation, whether it be a deliberate shift by OPEC, refineries shut down by a hurricane, or some kind of political turmoil in some far-off nation. This time, we have a series of potential “culprits”—the new economies in India and China, government taxes, greedy oil companies, irresponsible automobile manufacturers, unresponsive legislators, and, more recently, underinflated tires, and even speculative pension fund investments. It seems like everyone—and no one—is to blame for our current predicament (and, as painful as the current situation is, just wait until winter).

Some politicians have already picked up on the shift—and, with luck, their August recess will help them better understand just how angry the American people are about the situation. I wouldn’t for a minute suggest that our current energy pricing issues can be talked into submission—but it is intriguing how just talking about actually doing something in the short term has already served to bring down oil prices.

Talking Points

There are similar motivations at work in the DoL’s recent fee disclosure proposal (see “Know” Way). Not that speculation has (yet) been accused of driving up 401(k) fees—but the DoL specifically states that the proposal’s required disclosures “…[are] expected to result in the payment of lower fees for many participants.”

I’ll get to how much lower in a minute, but it’s worth considering just exactly how much it may cost us to achieve those savings—in no small part because most of the 103-page document that brought that proposal to light is consumed with outlining the various costs and benefits projected to result from the new rules. Suffice it to say, it’s going to be expensive. In fact, under Executive Order 12866, the DoL has determined that this action is “significant” because “it is likely to have an effect on the economy of more than $100 million in any one year.”

How much more? The present value of the costs over a 10-year period is projected to be more than $750 million. On the other hand, the present value of the projected benefits is expected to be about $6.9 billion.

The Costs

So far, so good. But only until you begin to explore the assumptions behind those numbers. First, there’s the cost of getting started. Because the DoL says that “plans may employ service providers for making disclosures and that these service providers are likely to spread fixed and start-up costs across many plan clients,” it applies an hourly legal review rate of $113, and assumes that every participant-directed plan will employ legal services upfront to review the regulation for 30 minutes. That adds up to $24 million, according to the DoL.

The DoL also assumes that each plan will spend 30 minutes of clerical time (at an hourly rate of $26) preparing the disclosures at a cost of $5.7 million. The DoL also assumes that it will take 15 minutes of legal time and 30 minutes of that clerical resource to review and update plan-related information; extrapolates those numbers across 59,000 new start-up plans, as well as 378,000 currently operating ($17.2 million); and assumes that costs associated with additional recordkeeping and of producing actual dollar disclosures will cost $26.5 million in year one, and $9.3 million in subsequent years, based on some 2001 GAO projections. They also incorporate average costs for individual plans to consolidate fee information from various providers (one hour per plan at $60/hour) for another $26 million in 2009 costs, and another $35 million that year to send all these disclosures out to participants (the DoL assumes it will take clerical staff an additional two minutes, and that 38% of disclosures will be sent electronically). Oh—and then there’s the cost of distributing the materials. The DoL assumes that the annual disclosure will be 13 pages for plans not already providing disclosures similar to section 404(c) disclosures, and an extra three pages for those who are. All told (making allowances again for 38% to be made electronically), that adds up to another $8.2 million in 2009. All in all, the DoL projects that their proposal will cost the industry $127 million (and change) in 2009—about $335/plan, if you buy into the DoL assumptions. It gets less expensive each year, but in its least expensive year (2018), it would cost nearly $53 million in today’s dollars, albeit spread across the entire participant-directed plan universe.

The Benefits

While there are certainly assumptions worth questioning on the cost side, the benefit side is where, IMHO, things get really “squishy.” The DoL starts by attributing $307 million in benefits (over a 10-year period) because participants will actually behave differently, now that they have different and/or easier-to-understand information (and assuming that they do, as the DoL assumes, pay 11 basis points more than they should). I think the former assumption is far too generous in terms of extrapolating participant response. On the other hand, the latter—that, on average, they pay just 11 basis points more than they should—strikes me as conservative.

The DoL also thinks that around 29% of participants (the number an EBRI study says acted on information they received from their retirement plans) will spend time researching their options, and will thus benefit from the increased clarity of the disclosures. How much? Well, EBRI claims these participants spent 19 hours per year, on average, researching retirement—and the DoL thinks that the new disclosures would save 90 minutes/year for non-404c compliant programs, and an hour/year for the rest. That adds up to 19 million hours—and, assuming an hourly rate of $31 (the value of a leisure hour), participants would save about $608 million in 2009.

Now, of course, nobody is writing a check for that savings in time—and whether it will save that many people that much time is still anybody’s guess (the DoL has solicited comments on both). But those “soft” cost savings of time combined with the savings attributed to changes in behavior wind up, in the DoL’s projections, to provide nearly $7 billion (yes, that’s a “b”) in savings over the 10-year period.

What’s Next?

Personally, I think the projected costs are too conservative, and the projected benefits far too optimistic, based on my experience working with retirement plan participants. That the gap between the two is narrower than projected, however, doesn’t mean there isn’t a gap, and surely shouldn’t suggest that there isn’t a net benefit to be found in the regulations proposed—or in a later, better version.

We may feel stuck between a rock and a hard place when it comes to fuel prices. But the Department of Labor has clearly laid out the basic requirements and, by my reckoning, made at least some attempt to leverage existing mediums and materials to mitigate the effort and expense. Their assumptions may be “wrong,” but we know what they are, and what they are based on. Their proposed timetable for implementation may be unrealistic, but we have a chance to express those concerns.

And if we don’t take advantage of that opportunity—if we let “others” take the lead in framing the final result—then, IMHO, we have no one to blame for the results but ourselves.

- Nevin E. Adams, JD

-----------------------
Editor’s Note: the Employee Benefits Security Administration (EBSA) encourages interested persons to submit their comments electronically by e-mail to e-ORI@dol.gov (enter into subject
line: Participant Fee Disclosure Project) or by using the Federal eRulemaking portal at http://www.regulations.gov.

Persons submitting comments electronically are encouraged not to submit paper copies. Persons interested in submitting paper copies should send or deliver their comments to the Office of Regulations and Interpretations, Employee Benefits Security Administration, Attn: Participant Fee Disclosure Project, Room N-5655, U.S. Department of Labor, 200 Constitution Avenue, NW., Washington, DC 20210.

All comments will be available to the public, without charge, online at http://www.regulations.gov and http://www.dol.gov/ebsa and at the Public Disclosure Room, N-1513, Employee Benefits Security Administration, U.S. Department of Labor, 200 Constitution Avenue, NW., Washington, DC 20210.

'Know' Way

Last week, the Department of Labor’s Employee Benefits Security Administration (EBSA) released its much-anticipated proposal regarding participant fee disclosures (see "EBSA Finishes Regulatory Package with Participant Disclosure Proposal".

The industry’s response, by and large, has been positive (a notable exception: Congressman George Miller, author and sponsor of the 401(k) Fair Disclosure for Retirement Security Act of 2007—see “Miller Fee Bill Cruises through House Committee”), though one got a sense that there would be a LOT of comments forthcoming on the proposal, not the least of which was timing. After all, the DoL is soliciting comments through September 8 (so much for vacation), and says it plans to have the new rules in place by January 1.

My first thoughts on opening the proposal doubtless mirrored many of yours—“Holy cow, 103 pages!” And then, also perhaps like many of you, I set it aside for a time when my brain could handle 103 pages of proposed government regulation (I realize some of you are still waiting for that time). Now, as it turns out, something like two-thirds of the document is spent analyzing the costs/benefits of the proposal. In fact, most of it is spent outlining the costs and the assumptions associated with complying with the new proposals.

The Proposal(s)

Despite those initial concerns, the proposal itself seems relatively straightforward: It purports to require disclosure of certain plan- and investment-related information (including fees and expenses, of course) to participant-directed account participants. It identifies three categories of annual disclosures (to be furnished on or before their eligibility date, and at least annually thereafter), and further requires a quarterly disclosure of specific dollar amounts charged to the participant’s account for specified administrative expenses.

In the case of the latter, the DoL says the information should be “sufficiently specific to inform the participants or beneficiaries of the actual charge(s) to their accounts and enable them to distinguish the administrative services from other charges and services that may be assessed against their accounts.” On the other hand, the DoL’s proposal calls only for the charges to be shown in total, noting that it “does not believe that it is necessary, or particularly useful, for participants to have administrative charges broken out and listed on a service-by-service basis.” (For more details on the disclosures, see “EBSA Finishes Regulatory Package with Participant Disclosure Proposal”.)

The proposal’s import notwithstanding, the DoL tossed in some extra “nuggets” worth mentioning.

First, it took the “opportunity to reiterate its long held position that the relief afforded by section 404(c)….does not extend to a fiduciary’s duty to prudently select and monitor designated investment managers and designated investment alternatives under the plan,” and that a “fiduciary breach or an investment loss in connection with the plan’s selection of a designated investment alternative is not afforded relief under section 404(c) because it is not the result of a participant’s or beneficiary’s exercise of control”—a comment that struck me as a shot across the bow of federal courts that have, in a number of the recent revenue-sharing cases, been a bit “generous” in their application of 404(c)’s protections.

The DoL also tossed in its belief, “as an interpretive matter, that ERISA section 404(a)(1)(A) and (B) impose on fiduciaries of all participant-directed individual account plans a duty to furnish participants and beneficiaries information necessary to carry out their account management and investment responsibilities in an informed manner.” Now, in my experience, plan fiduciaries have long attempted to provide participants with a host of materials designed to help them make good investment choices—and doing so is perhaps just a practical application of common-sense principles. However, I found it interesting that the DoL slipped in to the proposal a duty to do so.

The DoL also said that the lack of fee disclosure means that participants may underestimate the impact that fees and expenses can have on their account balances—and thus may undervalue the importance of the disclosures. Further, that if employees undervalue disclosure, plan sponsors might “under provide” it—a position that the DoL found support for in the “wide dispersion of fees paid in 401(k) plans” (though it acknowledges that some of the variation could be explained by the varying amounts of assets in plans and their accompanying economies of scale, as well as the fact that some plans might offer “more, or more expensive, plan features”).

Finally, despite the obvious increase in reporting effort and costs, the DoL thinks that “small plans will benefit from the proposal, because it will clarify what information must be disclosed to plan participants.”

Potential Impacts

Personally, I think that most plan participants will, as they always have, choose investments based on net returns, not fees specifically. And, though the DoL references the importance of evaluating more than fees in its proposal, it also states unequivocally that it expects the disclosures will result in the payment of lower fees for many participants—assuming that participants will more consistently pick the lower-cost comparable investment alternatives under their plans. However, they also estimate that (only) about a quarter (29%) of plan participants are “likely to benefit from reduced search time and corresponding reduced costs” in reviewing this information. It’s possible that even that modest assessment is optimistic since, IMHO, the fee disclosures illustrated in the DoL’s model comparison chart) are no more (and perhaps in the DoL’s defense, no less) useful than those currently found in most mutual fund prospectuses.

A more likely consequence, IMHO, is the DoL’s notion that the requirements may lead plan fiduciaries to give additional scrutiny to fees, and “consequently to select less expensive comparable investment alternatives.” The fact of the matter is, plan sponsors have a duty to know what these fees are, and, IMHO, participants have a right to know how much they are paying.

- Nevin E. Adams, JD

Comments on the proposed regulation should be directed to the U.S. Department of Labor, Employee Benefits Security Administration, Room N-5655, 200 Constitution Ave. N.W., Washington, D.C. 20210, Attention: Participant Fee Disclosure Project; electronically to e-ORI@dol.gov or via www.regulations.gov.