Good Advice for Plan Sponsors: Monitor Advisers

A new Department of Labor rule slated to take effect in April 2017 is aimed at eliminating conflicts of interest for those who provide financial advice to small retirement plans (those with less than $50 million in assets), individual participants of all plans, and IRA owners.

That’s mostly good news for the employer sponsors of small plans, which may not have sufficient financial wherewithal to make sound decisions regarding the plans. But executives responsible for overseeing these plans shouldn’t just sit back and relax; rather, they should reevaluate their agreements with their advisers, experts say. And there are implications for large plan sponsors as well.

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The DoL’s conflict of interest rule requires, with limited exceptions, that any person or entity that renders financial advice to small plans, plan members, or IRA owners, and receives fees or commissions for doing so, must act as a fiduciary in that capacity. That means their advice must be in the best interests of such parties.

Many external advisers to plans already commit in their contracts with their clients to act as fiduciaries. Some don’t, though, particularly those who advise small plans.

A commonplace scenario that the rule targets: a plan participant, upon termination of employment, opts to roll over the balance in his or her 401(k) plan to an IRA. The participant goes to the plan’s recordkeeper to inquire about doing so, and the recordkeeper recommends its own proprietary IRA, or that of a provider from which it receives fees or commissions, even if those options would not be in the participant’s best interest.

“If someone has hundreds of thousands of dollars in an account that gets shaved by 100 basis points instead of 50 basis points, that could really affect the person’s quality of life, for perhaps the next 30 years,” says Joseph Adams, a partner with McDermott Will & Emery.

While the new DoL rule applies to third-party advice given to plans with less than $50 million in assets, it also applies to advice rendered to participants of plans of any size. And plan sponsors, which after all intended to provide a benefit, “don’t want to see their employees’ pockets picked on their way out,” Adams says. The concern is less for those rolling over their balance to a new employer’s retirement plan, which will have fiduciaries in place to protect its new employee’s interests.

While the new rule specifically regulates the actions of third-party advisers, plan sponsors have a fiduciary responsibility to monitor whether advisers are in compliance.

On the downside, the rule could lead to consolidation in the recordkeeper market, which could trigger a general increase in plan fees. “It’s very difficult to make a profit just by recordkeeping, so most recordkeepers are in business to make downstream income from proprietary IRAs and other financial services,” notes Bill McClain, a principal with Mercer. Smaller providers that can no longer steer plan participants to those services may well exit the business.

Also, while the new rule specifically regulates the actions of third-party advisers, plan sponsors have a fiduciary responsibility to monitor whether advisers are in compliance.

The Sponsor’s Responsibility

Given the new rule, Adams says, plan sponsors should investigate whether its recordkeeper has a list of recommended IRA providers, and if so, what financial arrangements are in place with those providers.

Companies also should at this time evaluate all of their relationships with plan providers and consultants, says Greg Marsh, executive vice president and corporate retirement plan consultant at Bridgehaven Financial Advisors. They should ask: Are you acting in a fiduciary capacity? Are the proper agreements in place regarding that?

That’s because, most observers agree, it may prove difficult for the DoL to effectively police the rule.

To be sure, there are a number of ways a noncompliant adviser could be found out. For example, the department will do random audits and inspections, or a plan participant could complain to the DoL.

“But, could you also be operating out of compliance for the next 10 years and it goes completely undetected? Absolutely,” says Marsh. Adams, though, says that the DoL likely will “carefully pick the right case to make a good enforcement example.”

Either way, much of the “enforcement” effectively may be accomplished by private litigation. “Unfortunately, that is a likely outcome of this rule and a valid criticism of it,” says attorney Bradford Campbell of Drinker Biddle & Reath, a former Assistant Secretary of Labor for Employee Benefits.

Campbell notes that while advisers will have to make disclosures, exactly what’s required to be disclosed is subject to some interpretation. And they will have to implement policies and procedures related to conflicts of interest, but it’s inherently a judgment call as to whether any particular ones will be effective.

“As a result of those built-in ambiguities,” Campbell says, “it’s going to be a field day for the plaintiffs’ bar to bring lawsuits against financial institutions—and potentially against plans, with plaintiffs asserting that a plan sponsor played a role in enabling the financial institution to do the things they say were wrong.”

There’s already been litigation filed over the rule, in fact. A group of nine plaintiffs, including the U.S. Chamber of Commerce, the Securities Industry and Financial Markets Association, and the Financial Services Institute, are suing the DoL and Labor Secretary Thomas Perez in a federal court in Texas.

The plaintiffs claim that only the Securities and Exchange Commission has jurisdiction to promulgate a uniform fiduciary standard of care, and that the rule violates the First Amendment right to free speech.