The defined contribution (DC) retirement plan is more than 40 years old. There have been many material changes throughout its evolution, most of which have been beneficial to 401(a), 401(k), 403(b), and 457 plan participants.
Sadly, several recent developments related to the DC plan industry appear to be headed back to a practice that plan fiduciaries and their independent consultants fought hard to escape – monetization of plan assets and participants and the added risk/expense that comes with this.
Most DC plans are administered by insurance and mutual fund companies that maintain recordkeeping platforms in conjunction with managing and distributing proprietary investment products. That was the case many years ago, and it remains that way today. During the 1980s and 1990s – rather formative years for DC plans and providers – revenue sharing and other indirect compensation forms were often hidden or misunderstood.
Many plan sponsors thought of recordkeeping and administrative services as “free” due to that lack of fee transparency. It was also commonplace to find investment menus limited to proprietary investment products, often with high fees and poor performance relative to peers in similar asset classes.
These arrangements provided substantial sources of revenue to the providers but raised questions about the objectivity of the investment selection process. Many fiduciary advisors and consulting firms have emerged to help plan sponsors address these conflicts.
During the past 20 or so years, aided by the rollout of required fee disclosures, the industry has moved to an open architecture format that has largely diminished the utilization of proprietary investment products. Open architecture supports thorough due diligence, best-in-class investment selection, and much lower fee and expense profiles.
This has been a positive change for plan sponsors and the participants they support. But the resulting fee compression led many recordkeeping providers to seek other avenues to monetize plan assets, the most prominent at this time being managed account services.
Robo-advisors essentially administer managed accounts – investment advice derived by an algorithm applied to a set of input data, typically focused on time horizon and risk tolerance. While data may also allow for the inclusion of assets outside of the participant’s retirement plan – perhaps a spouse’s savings and investment information, as an example – this data is rarely input by the participants using these services.
The algorithm delivers an asset allocation model and fund recommendations utilizing funds available in the plan’s core investment menu, typically for a fee of 0.35% – 1.00% added to the investment management fees charged by the underlying mutual fund companies.
Managed account services are often sold to participants as a professionally managed portfolio solution that is superior to target date funds. The asset allocation advice, however, is frequently similar to that of the median glide path of target date funds with a much lower expense.
This cost/benefit disparity is garnering the attention of plaintiffs’ attorneys — managed account services are being challenged in the Guyes v. Nestle USA lawsuit[1] as one noteworthy example. We have also reviewed several prospective client fee disclosures and compliance forms where the vendor’s income from managed accounts outpaced their income from recordkeeping fees. The necessity for this service and the reasonableness of fees are being contested in several fiduciary breach cases, including Reichert v. Juniper[2].
There seemed, briefly, to be a consensus among fiduciary consultants to push back on managed account solicitation and question the reasonableness of the fees…at least, until recently. Despite many fiduciary advisors rightfully criticizing opaque and unfair arrangements related to revenue sharing and the recent push to distribute managed account services, some of these advisors are now recommending “advisor-managed” account services. These are similar to traditional managed accounts, except the portfolios are created by the consultant rather than a computer algorithm.
Many recordkeeping providers have created platforms that allow the consultant to receive asset-based compensation, thereby granting both the consultant and the recordkeeper an opportunity to monetize participant assets. Here again, such conflicted advice can be lucrative — compensation to the “fiduciary advisor” for managed accounts can surpass their consulting fee revenue from the plan.
Not coincidentally, the retirement plan advisor/consultant industry is seeing a dramatic increase in merger and acquisition activity. Large aggregator advisory firms, wirehouses, and insurance companies have been acquiring firms of all sizes at an alarming rate. Some are backed by private equity capital, and the multiples paid for firms have been substantial.
The profitability potential of these deals will depend upon the ability to leverage new revenue streams, including monetizing participant assets. Firms are already beginning to engage in a series of sales and marketing practices to ensure they meet their purchasers’ expectations.
Some consulting firms have also created proprietary investment products and wealth management services to market to participants, creating further opportunities to monetize participant assets. Fiduciary investment consultants creating proprietary investment products and recommending them to their clients seem to be an apparent conflict of interest and, potentially, self-dealing.
Fiduciary breach lawsuits have been filed asserting these accusations, as well. In Lauderdale v. NFP Retirement[3], plaintiffs allege that the consultant breached its fiduciary duties in providing advice concerning flexPATH target date funds offered through a related company.
Likewise, in Reetz v. Lowes[4], the plan’s consultant (Aon) recommended its own proprietary equity fund. Lowes settled for a reported $12.5 million even as Aon continued to fight the complaint. Earlier this year, a judge dismissed the charges against Aon, explaining that it did not violate ERISA in cross-selling its proprietary investment products, instead asserting that Lowes is a large, sophisticated corporation and is responsible for independently deciding to engage.
The outcome seems extremely unfair and unfortunate for the plan sponsor, who not only paid a large settlement but had ostensibly trusted their fiduciary advisor for objective guidance and advice.
In light of these developments, it does feel like we’re taking a step backward. Back to arrangements fraught with higher fees, conflicts of interest, and the potential for increased liability for plan sponsors. Given the recently settled and outstanding litigation related to advisor cross-selling, it seems imprudent for plan sponsors to engage in practices that may increase liability.
Rick Rodgers, AIFA, is Principal and Consultant with Denver, Colo.-based Innovest. Wendy Dominguez, MBA, is the President, Principal, and Co-Founder of the firm.
[1] Nestle ERISA Complaint (napa-net.org)
Rick Rodgers, AIFA, is Principal and Consultant with Denver, Colo.-based Innovest. Wendy Dominguez, MBA, is the President, Principal, and Co-Founder of the firm.
