“What obvious mistakes are made by plan sponsors, investment committees and 401k advisors that drive you absolutely crazy?”
The question is meant to get a rise from Fred Reish, but the soft-spoken, even-keeled ERISA attorney with legal powerhouse Drinker Biddle is unfazed, as anyone who’s ever met him or seen him speak can attest.
It’s appreciated in the current craziness, as all things fiduciary once again ramp up. The SEC’s Reg BI is a central industry issue, with hints of (yet another) try from the DOL making noise in the background.
“My biggest frustration with plan sponsors is that they truly don’t understand what it means to be a fiduciary,” he answers somewhat surprisingly given all that’s happened. “They don’t understand in committee meetings that their duty of loyalty is to employees, not to the company. I can understand why, but it makes everybody’s job harder.”
Those that don’t understand better ramp up quick, as “there’s a lot going on” with fiduciary regs overall.
“Reg BI will probably be issued as a final regulation by the SEC in June or July. It won’t be applicable immediately, though. You’ll have a delayed implementation date anywhere from six to 12 months. During that time, I think the DOL will issue a prohibitive transaction that coordinates, or is based on, the SEC’s guidance and Reg BI.”
As most advisors know, the DOL currently has a “nonenforcement policy” in place, which says if an advisor is a fiduciary to a plan yet receives variable compensation—based on the investments recommended—they won’t enforce it as a prohibited transaction if the advisor satisfies the impartial conduct standard.
“If their compensation isn’t level, they’re traditionally subject to the prohibited transaction rules. But I believe the DOL wants to say that as long as the advice is of good quality and loyal to the participant, and the compensation is no more than a reasonable amount, that variable compensation could, therefore, be received,” Reish says.
So, despite the probable harmonization between Reg BI and the DOL, is it nonetheless possible the latter will once again try with a rule of their own?
“I don’t know,” Reish bluntly answers. “I do think though that there are several issues the DOL is concerned about. The most notable is the recommendations of rollovers.”
We hadn’t heard as much rollover hysteria been rolling over about $300 billion [from retirement plans] each year. It’s now at $400 billion and in a few years will be at $500 billion. They have to figure out how to live on the money generated by those IRAs for 20 or 30 years.”
Noting that his own mother recently passed away at age 101, 30 years of retirement from 65 to 95 is not outrageous, and he mentions the widely cited statistic that there’s close to a 50 percent probability that one individual of a couple now aged 65 will live to 90.
So, what should happen to make that money last for this uncertain life expectancy with equally uncertain markets, Reish rhetorically asks?
“Good investment advice is one thing. Reasonable expenses on those investments is another. Not having the bad effects of conflicts of interest is the third and help with appropriate withdrawal rates is the fourth. Those are the big advice factors that people need,” Reish says. “The question is, will they get it? And not just large accounts, but tens of millions of people with smaller accounts. This is the first generation of 401k retirees. It simply hasn’t happened before, so we don’t know. It’s an experiment.”
Which is the reason the regulatory powers-that-be—state and federal, investment and insurance—are all writing rules to increase the odds retirees get a fair shake.
Noting the outcry from fiduciary rule proponents over what they believe is a watered-down, industry-friendly Reg BI, we (somewhat leadingly) ask if they’ll ever be happy with it?
“The proposed Reg BI will be very close to the final Reg BI,” he soberly states. “It’s not what I necessarily want to happen, but it’s what I think is going to happen. Consumer advocates thought the DOL rule was appropriate; not only the fiduciary standard but also the best interest contract exemption.”
Not that it didn’t have “blemishes,” he admits, “because nothing that big will be perfect, but they felt that was the gold standard, and they now look at the SEC rule and say it provides much less protection. Reg BI says a broker can give advice and they don’t have to give advice again until the customer comes back. Well, what’s going to happen to people who are older and don’t know how to invest if they don’t initiate ongoing advice? So, I can see the basis for some of their objections.”
However, perhaps the most demanding part of the proposed Reg BI, in Reish’s opinion, is the requirement that broker-dealers mitigate material financial conflicts of interest. The question naturally arises, “What does ‘mitigate’ mean?”
“Interestingly, the SEC doesn’t define that, which is part of the reason that it’s giving indigestion to the broker-dealer community.”
What Reish thinks it means is that it should dampen the “incentive effect of compensation systems” that reward more money for one investment over another. In other words, they must ensure the advice provided by the registered rep is in the best interest of the investor, and not that of the broker-dealer.
“How do you do it? You make sure the compensation differentials aren’t that great; that’s one place to do it,” Reish says.
Which was all contained, in some form or fashion, within the DOL’s fiduciary rule.
Looking back, was he at all surprised by the Fifth Circuit Court of Appeals decision to strike it down?
Reish is refreshingly honest.
“I was shocked. I wasn’t surprised—I was shocked,” he says with a laugh. “People say they saw this coming, but the truth is, I don’t know anybody who, in a private conversation, wasn’t surprised by it. The advantage of hindsight is we all probably want to say we saw it coming, but I was alive and there at the time, and people were surprised.”
Moving from regulation to litigation, does he feel the tide is turning in lawsuit outcomes, in that increasingly more are decided in favor of defendants and against the Jerry Schlichters of the world?
“I would hope so, but I don’t think so,” he counters. “What I mean by that is I’m constantly shocked that, notwithstanding all the articles and all the headlines, I’m constantly surprised when I come across committees that haven’t really focused on it yet.”
He recently wrote an article that appears at 401kspecialist.com that, in so many words, said as much.
“Why do committees wait until they are sued to pay attention to these things?” Reish said in our interview. “The piece came directly out of my experience. Especially for big companies with committees and in-house lawyers and the money to hire outside ERISA experts, I don’t know why they’re still getting sued and why they haven’t figured it out.”
Noting a shift in targets to more private colleges and universities, he says they’re often a “mixed bag.”
“There have been some pretty big settlements but there have also been some losses, meaning cases where universities have won.
They’re also against companies that have their own investments in the plan, so it’d be, by definition, a company that has an affiliated insurance company or an affiliated mutual fund company. So that’s where a lot of all litigation is right now, and I think that will continue for a while.”
What’s especially vexing, he emphasizes, is that the rules “about which they’re now being sued” are far from new.
“The DOL wrote an exemption in 1977 about what a company had to do to have their own products in their retirement plan. Here we are 40-plus years later and there’s all kinds of litigation about it. If a committee wants to know how to avoid these problems I, or any good ERISA attorney, can tell them. It’s not unknown, it’s just not known to committees. I would fault people for not getting more fiduciary education, particularly if they’re big enough to afford the legal fees.”
Which brings us back to his original frustration with committees and their lack of fiduciary awareness.
The solution, of course, is also more education from advisors, something “quality, specialized advisors currently give their committees, as well as an expansion and diversification of the other services they offer,” Reish says. “There are all kinds of solutions advisors and recordkeepers can provide, like projections of retirement income, automatic enrollment, automatic deferral increases, investment management services (particularly for older employees), retirement education for employees age 50 and older, how do you claim Medicare and when should you claim it, etc.”
Historically, he adds, the big frustration was that sponsors wanted employees to think the plan was free, something revenue sharing, and similar tactics were used to make it appear. For obvious (and litigious) reasons, “there’s been a lot of improvement in the last five or 10 years.”
“I just wish that, across the board, there was more transparency; that employees had more transparency, the plan committee had the benefit of more transparency and the advisors were more transparent (although if they’re pure fee-for-service, they are transparent). It’s one thing to have disclosure, but disclosure on page 20 of a 40-page document is not transparency.”
For example, committees could be better about reporting to participants what it is they do to ensure investments and expenses are appropriate, so employees can understand what good committees do for them.
He believes well-run committees are already doing a good job in the area but wished they would spend more time on whether or not employees are accumulating enough money to retire and, if not, what can be done about it.
“There’s so much more to do beyond funds and fees. It’s time to move on. I understand the early preoccupation with both, and that’s where the litigation occurs. But for someone focused on their 401k plan that has a good advisor ERISA attorney, we know how to do that. We know how to minimize the risk of litigation.”