A Little More Knowledge on Reducing 401(k) Plan Sponsor Liability

As I have mentioned several times, I believe that the current environment presents investment advisors with a perfect opportunity to enter the 401(k) arena and prove the value added proposition that they can provide. The DOL’s recently announced fiduciary standard only increases the value of the opportunity.

In our experience, the fiduciaries of most [404(c)] plans believe they have [complied with 404(c)] but in most cases they have not.

Those words of warning come from Fred Reish, one of the nation’s leading ERISA attorneys. The relevance of the quote lies in the fact that ERISA plan sponsors face unlimited personal liability if they fail to comply with all of Section 404(c)’s requirements.

As I read various financial publications, I see a large number of articles trumpeting the goal of “retirement readiness.” Toward that goal, the articles usually stress the value of increasing participation in a company’s 401(k) plan by automatic enrollment and automatic contribution programs.

As an ERISA attorney who regularly performs forensic portfolio analyses of 401(k), 457(b) and 403(b) plans, I’m not sure that plan sponsors realize the personal liability exposure that they may be creating for themselves by forcing employees into non-compliant and imprudent plans and forcing such employees into plans whose investment options are actually costing the plan participants to lose money.

I believe that an area that is going to be receiving more attention in the excessive fees and imprudent investments litigation arena is private colleges and universities. Private colleges and universities do not enjoy the same protection from ERISA that government-run colleges and universities do.

I recently completed a forensic investment analysis on the 403(b), 457(b) and Optional Retirement Program of a major Southern university. Of the 126 mutual funds I reviewed, only 16 of the funds passed my prudence analysis based on their nominal returns, and only 6 passed my prudence analysis based on their risk-adjusted returns.

My analysis did not include an analysis of the sub-accounts within the variable annuities which were offered as part of the plans. However given the fact that the sub-accounts were basically higher priced versions of some of the same company’s mutual funds that failed my forensic analysis, inclusion of the sub-accounts would have assuredly resulted in even more discouraging results.

In performing my forensic analyses, I rely on several proprietary metrics, most notably the active Management Value Ratio™ 2.0 (AMVR) and the Fiduciary Prudence Compliance Score. A list of the metrics I use in preparing my forensic fiduciary prudence analyses is available here.

To be honest, the AMVR is usually enough alone to expose mutual funds that are imprudent due to failing to provide a positive incremental return for a plan participant and/or being cost inefficient, both of which actually cost plan participants money. I am not sure how a plan sponsor would successfully argue the prudence of either situation.

And that presents yet another opportunity for fee-only investment advisors to prove their value added proposition to ERISA plan sponsors. Most plan sponsors blindly rely entirely on service providers who are either stockbrokers, broker-dealers, insurance agents or insurance companies.

However, the courts have repeatedly stated that plan sponsors cannot blindly rely on such parties given their inherent conflicts of interest. In order for plan sponsors to justifiably rely on the advice of third parties, such third parties must be independent and unbiased. As one court stated in denouncing blind reliance on service providers and stressing a plan sponsor’s duty to perform an independent investigation and evaluation of a plan’s investment options,

blind reliance on a broker whose livelihood [is] derived from the commissions he [is] able to garner — is the antithesis of such independent investigation.

Liss v. Smith
, 991 F. Supp 278, 299 (S.D.N.Y. 1998)

So truly objective and independent investment advisors can both educate plan sponsors and provide such sponsors with the valuable advice that they need in attempting to be 404(c) compliant and attempting to promote their goal of “retirement readiness” for their plan participants. Plan sponsors will then need to consult with ERISA attorneys or consultants to ensure compliance with the other non-investment related 404(c) requirements.

Carpe diem!

About jwatkins

I am a securities and ERISA attorney. I am a CFP Board Emeritus™ member and an Accredited Wealth Management Advisor™. I am a 1977 graduate of Georgia State University and a 1981 graduate of the University of Notre Dame Law School. I am the author of "CommonSense InvestSense: The Power of the Informed Investor" and " The 401(k)/403(b) Investment Manual: What Plan Sponsors and Plan Participants REALLY Need To Know. " As a former compliance director, I have extensive experience in evaluating the legal prudence of various types of investments, including mutual funds and annuities. My goal is to combine my legal and compliance experience in order to help educate investors on sound, proven investment strategies that will help them protect their financial security.
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