The Prudent Fiduciary

Scott Pritchard | Principal

A look at the major issues that are shaping fiduciary best practices today.

In Praise of Accountability

May 2011

The U.S. Government Accountability Office (GAO) is not exactly the National Enquirer, so you probably won’t see its recent study on 401(k) plans on newsstands. But the report, titled “401(k) Plans: Improved Regulation Could Better Protect Participants from Conflicts of Interest,” does expose some interesting facts about which all fiduciaries need to be aware. While some may find these facts surprising, they are all too familiar to many of us on the front lines of the effort to improve 401(k) disclosure.

Among the findings:

1.       Biased Advice - Service providers sometimes guide plan sponsors and participants to investments that are in the service provider’s best interests, not the participants.

2.        Inappropriate “Education” – Under the guise of investor education, service providers often lead participants to investments that benefit the service provider, not the participant. While technically not considered advice, this “education” undoubtedly leads participants to select investments that benefit the provider and not the participant.

3.       Not all “advisors” are fiduciaries – Some service providers talk extensively about fiduciary issues, but structure their contracts to clearly disavow any responsibility to act solely in the best interests of plan participants.

4.       Fees are not transparent – Revenue-sharing arrangements can lead “advisors” to recommend investments or service providers that pay the advisor fees that are hidden from plan sponsors and participants.

5.       Pursuit of rollovers – Some “advisors” abuse their influence by persuading participants to roll assets out of a 401(k) plan into a service provider’s IRA product that ostensibly has higher fees, while the fees are not required to be disclosed to participants.

The report summarizes the impact of these obvious conflicts of interest by saying “If left unchecked, conflicts of interest could lead plan sponsors or participants to select investment options with higher fees or mediocre performance, which, while beneficial to the service provider, could amount to a significant reduction in retirement savings over a worker’s career.”

To its credit, the GAO was not satisfied with simply pointing out these conflicts of interest, going so far as to actually recommend specific actions by specific governmental agencies that could eliminate the conflicts:

·         Clarify the definition of “fiduciary” – The GAO endorses the efforts of the Department of Labor (DOL) to finalize regulations that would specify who is and who is not a fiduciary for the provision of investment advice. While the Wall Street lobby is aggressively fighting this one, the initiative seems to be moving forward.

·         Remove the “interim final” label from 408(b)2 – While resistance to full fee disclosure resulted in the effective date being pushed from July 16, 2011 to January 1, 2012, it appears that 408(b)2 is indeed poised to shed new light on fees in 2012 and beyond. (But I’ll believe it when I see it!)

·         Revise the definition of “investment education” – The DOL has finally caught on to Wall Street’s practice of “Class, please know that you should be diversified…and by the way, our shiny funds over here will help you do that…”, without any disclosure that those shiny funds just happen to pay the advisor more than other funds. The proposed changes would prohibit advisors from using their proprietary funds as examples when providing “education” and would require those “educators” to disclose their conflicts of interest.

·         Require better disclosure of conflicts of interest – Burying conflicts of interest in the fine print should no longer be acceptable. This proposed requirement would make those conflicts be clearly disclosed when advisors are discussing a participant’s investment options.

·         Stop abusive rollover tactics – While this proposed regulation would not necessarily end the unseemly practice of service providers convincing participants to roll their assets out of a plan and into an outside investment, it would at least require disclosure that the fees for doing so may be higher than those inside the plan.

It is refreshing to see that our Government Accountability Office (GAO) is taking its name seriously. The long-running, abusive practices of many service providers in the retirement plan industry are being exposed and accountability for fixing the problems has clearly been assigned.

For the future of retirement in America’s sake, let’s hope the DOL sticks to its guns and implements these proposed changes and holds retirement professionals to accountability.

The full, 80-page GAO report can be found here.

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