GAO Warns of 401(k) Service Provider Conflicts of Interest

By Stephen Miller Mar 7, 2011

Concerns over the impartiality of investment advice provided to defined contribution plan sponsors and participants were highlighted by the U.S. Government Accountability Office (GAO) in a report issued in March 2011.

The report, 401(K) Plans: Improved Regulation Could Better Protect Participants from Conflicts of Interest, was requested by the U.S. Department of Labor (DOL), which is in the process of finalizing significant new regulations affecting defined contribution plans including the following:

Expanded definition of fiduciary. The DOL announced it intends to issue a final rule by year-end 2011 to require those offering investment advice within the context of 401(k) and other defined contribution plans to adhere to fiduciary standards under the Employee Retirement Income Security Act (ERISA). (See the SHRM Online article "DOL's Proposed Definition of 'Fiduciary' Draws Fire, Support.")

Fee disclosure by service providers to plan sponsors.Under a DOL interim final rule, plan service providers must begin providing plan sponsors with standardized fee disclosure reports by January 2012 (see the SHRM Online article "DOL Issues Interim Final Rule on Disclosing Retirement Plan Fees").

Fee disclosure from plan sponsors to participants.Under a DOL final rule, for plan years beginning after Oct. 31, 2011, (in most cases this means Jan. 1, 2012), plan sponsors must provide participants with quarterly standardized reports on plan and investment fund fees (see the SHRM Online article "Final Rule on 401(k) Fee Disclosure to Participants Seen as 'Reasoned Approach' ").

Circumstances where service providers might have conflicts of interest in providing assistance related to the selection of investment options were a key focus of the GAO. For example, providers who help sponsors to establish and maintain their plans might:

Structure their relationships with sponsors in a manner that avoids being subject to fiduciary standards under ERISA. Fiduciaries are required to act solely in the plan participants' best interests, a stricter standard than merely recommending "suitable" investments. Many sponsors, particularly those of small plans, do not understand whether or not providers to the plan are subject to ERISA fiduciary standards.

Receive third-party payments from investment fund companies. So-called revenue-sharing payments create a conflict of interest because the provider might receive greater compensation from certain high-expense funds. Such conflicts could lead to higher plan costs, which typically are borne by participants.

Skewed 'Education'

Although investment education is defined as generalized investment information, here, too, participants encounter providers that have a conflicted financial interest, the report found. For example:

Providers might highlight their own funds as examples of investments available within asset classes, even though they might have a financial interest in the funds.

Providers stand to gain higher profits from marketing investment productsoutside of plans to participants, a practice known as cross-selling. For instance, if participants use their plan provider for Individual Retirement Account (IRA) rollovers, they might not understand, because of insufficient disclosures, that fees often are higher for products offered outside the plan and that the provider might not be serving as a fiduciary advisor.

GAO Recommendations

To help ensure that plan sponsors and participants can rely on impartial information in making investment decisions, the GAO recommended that the secretary of labor direct the Employee Benefits Security Administration (EBSA) to:

Amend and finalize proposed regulations to change the definition of a fiduciary for purposes of investment advice. Specifically, the secretary should amend the proposed regulations to require that service providers' written disclosures specifying that they are not undertaking to provide impartial investment advice be provided to the plan sponsor in a consistent and prominent manner.

Amend and finalize interim final regulations regarding disclosure of service providers' compensationto ensure inclusion of revenue-sharing from plan investments and to ensure that disclosures of compensation, whether direct or indirect, be provided in a consistent and summary format.

Evaluate and revise the DOL's interpretive bulletin on investment educationregarding standards that permit a service provider to highlight in educational materials certain investment alternatives such as proprietary funds that might result in greater revenue to the service provider. The DOL could consider a variety of steps to address this potential conflict of interest, such as requiring service providers to disclose that they might have a financial interest in the options highlighted or prohibiting them from using proprietary funds as examples.

Amend the DOL's proposed disclosure ruleto require that service providers, when recommending the purchase of investment products outside retirement plans, inform plan participants that fees applicable outside their plans might be higher than fees applicable within their plans.

Require that service providers, when assisting participants with the purchase of investment products offered outside of their plan,disclose in a consistent and prominent manner any financial interest they might have in the outcomes of such transactions and inform participants as to whether their assistance is subject to ERISA fiduciary standards.

Overall, the GAO stated, the DOL and Treasury Department have agreed to consider its recommendations as they evaluate comments received on pending regulations.

Stephen Miller, CEBS,is an online editor/manager for SHRM.​​

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