Four Checklists for Retirement Plan Fiduciaries

By John Sullivan May 8, 2008

Recent years have brought increased litigation revolving around the management of employer-provided defined contribution retirement plans. Plan sponsors are learning that most of those with whom they work in the financial services industry have no legal or regulatory obligation to “put the client’s interests first” or to disclose conflicts of interest. It comes as a surprise to many that the typical “plan financial advisor” is a salesperson.

With so much litigation pending in this area (Google “401k lawsuits” or “403b lawsuits”), it can be challenging to come to any conclusions regarding just what plan sponsors must do to meet their fiduciary responsibilities. However, those responsible for employer retirement plans should certainly be asking some questions.

Below are four checklists consisting of a "big picture" challenge and a series of "drill down" questions to help plan sponsors chart their path. As fortune would have it, the same road that will help avoid litigation will improve the retirement income security of plan participants.

Checklist No. 1.

Is there a process in place to manage the plan that is written, current, properly executed, and consistent with the “prudent man” rule? In other words, is the retirement plan managed as well as your business and with the same care?

Drill down:

      1. Is there an investment committee?

      2. Is there an investment policy statement?

      3. Are activities related to the plan monitored and documented?

      4. Is there a system of checks and balances?

      5. Is there a written “quality control” procedure?

      6. Are there standards by which the success of the plan is measured?

      7. Is there accountability and periodic review?

      8. Is there cost control, and is it known where the money is going?

      9. Has anyone in the process accepted fiduciary responsibility in writing?

      10. Has anyone in the process submitted a written code of ethics?

      11. Are conflicts of interest disclosed, explored and documented?

      12. Can you, as the sponsor of the plan, stand behind your company retirement plan with the same confidence with which you stand behind your products or services?

Checklist No. 2.

Are the plan assets used solelyfor the benefit of the participants and their beneficiaries?

Drill down:

      1. Are the plan assets used unnecessarily and needlessly for the benefit of the financial firms involved in the plan? Are costs justified?

      2. Is the plan associated with any kind of personal relationship—friend, neighbor, relative, your own financial advisor (if so, put a “sue me” sign on your back.)

      3. Has the plan been used as a bargaining chip with a bank to secure free checking or better loan terms for the employer or some such benefit?

      4. Has the plan been used as a bargaining chip with an insurance company or any supplier for some other benefit to the employer that is unrelated to the plan?

      5. Do the plan fiduciaries allow the provider to use plan assets to open accounts or to sell its funds or other investment choices?

The financial firms involved in the plan cannot be blamed for doing the best for themselves. It is their job to maximize sales and profits. An inexpensive fund with a high expense ratio is good for the fund company.

Checklist No. 3.

Are the investment choices prudent?

Drill down:

      1. Who chose the investment options, and where is their interest? For example, were they chosen by the reps of a financial firm whose duty is to maximize income for their company, or by the employer with the duty to maximize return for employees?

      2. Is there revenue sharing between the financial firms? Where and how much?

      3. Can each investment option be classified as prudent selection?

      4. Are there special retirement class fund shares with lower returns and higher expenses? Is this necessary? Where does the money go?

      5. Are there special relationships between the provider and fund companies included in the plan? Why, and to whose benefit? Is revenue sharing involved?

      6. Who gets the 12b-1 fees (if any)? Are they different for different choices?

      7. Is there a finder’s fee on new money? Who gets it? Who pays it?

      8. What are the proper criteria for choosing funds or subaccounts?

      9. Do the participants, who provide their money and take all the risk, get the majority of the return?

      10. Are the investment options actively managed funds or low-cost index funds?

      11. Are there asset allocation funds among the options (by whatever name they use—balanced funds, target-date funds, lifestyle or lifecycle funds). Just what is inthese funds?

      12. Could the fund choices be viewed in terms of overall asset allocation, and would that asset allocation offer participants a solid historical return?

      13. What is the overall return of the plan after all expenses?

      14. How much of the investment return goes to the participants, and how much goes to the financial firms involved?

      15. If the plan provider chooses the investment options, is there any reason to expect that he or she would choose a better option for the participants rather than a more profitable one for his or her firm? Has he or she accepted fiduciary responsibility in writing?

This is an interesting area and one that provides the grist for most litigation, especially in the area of plan expenses. For example, consider the issue of actively managed funds vs. index funds. Actively managed funds tend to have high expenses and high trading costs, while index funds have low expenses and low trading costs. Yet only a fraction of actively managed funds beat the index in any given year, and few of those funds make their way into retirement plans. Is there reason to believe that the investment options in your plan carry the expectation that they might beat their respective index?

Are the fees generated by higher expense ratios used by fund managers for revenue sharing with other financial firms in the chain—to the detriment of the plan participants? Even worse, are any of the actively managed funds in your plan actually shadow index funds that are almost indistinguishable from low-cost index funds except for a high expense ratio?

And what of balanced asset-allocation funds and target-date funds, which have received the U.S. Department of Labor's stamp of approval as qualified default investment alternatives (QDIAs)? Considering that the financial firms associated with the plan are charged with maximizing income for their firms, just how would we come up with such a fund? One would expect that the fund would be a fund of funds—why go to the expense of a separate fund when one could just blend existing ones? If a single fund has hidden costs, what of a fund of funds? And why not use a blend of funds that are high margin and make more money rather that less? And why not use funds that give the most in soft dollars—the dollars that are hidden?

Is it any wonder that most asset allocation funds usually have low returns and that fund companies have been drooling over QDIAs?

Checklist No. 4.

Does the plan provide retirement income security for employees?

Drill down:

    1. Are the participants getting good returns on a risk-adjusted basis?

    2. Do the participants get meaningful education regarding financial planning, and is this education driving higher participation rates and higher contribution levels?

    3. Is the education independent and unbiased?

    4. Have we aligned the goals of the plan providers with the goals of the participants?

    5. Have we demanded that those profiting by the plan take fiduciary responsibility in writing?

    6. Are the participants happy with the plan?

Shortcomings in the management of retirement plans seem to follow the path of failure of plan sponsors to monitor and failure to inform (themselves and plan participants). Part of the problem is, no doubt, simply a lack of understanding of fund structure on the part of those responsible for the plan. Many plans are probably there only because “we have to have one.” And a company retirement plan is easy to ignore in the rush and crush of business.

But wouldn't it be a real plus to let employees know that these duties are being met and that their retirement is important to the employer?

No one wants a lawsuit. Instead, why not make it the employer’s business to investigate its retirement plan, to do everything possible to make it serve the participants, and to set up a process to monitor the plan that will ensure continued performance. Demand that all costs be disclosed and that all conflicts of interest be documented; obtain impartial financial advice for the participants by someone with the qualifications to do so; and take the retirement income security of your employees to heart.

Remove self-serving behavior on the part of any party to the plan. Insist that they act as fiduciaries, disclose any conflicts of interest and put the client’s interests first. Make it clear to your employees that their retirement income security is too important to allow anything but full attention to their interests. Embrace this retirement plan model, and demand that those being paid by the plan embrace it as well.

John Sullivan is a Certified Financial Planner practitioner, Chartered Financial Consultant, Chartered Life Underwriter, and an Accredited Investment Fiduciary with World Equity Group, a brokerage firm and Registered Investment Advisor based in Arlington Heights, Ill.

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