Why a prudent process is key for your fiduciary planning
Have you ever felt like you’re being punished for trying to do something thoughtful or that you figured would be unequivocally positive? When my children were preschool age, this happened all the time:
"I brought home ice cream for you guys!” Ice cream falls to the ground. Tears and tantrum.
"We’ve played with toy trucks for an hour. It’s time for lunch now.” Tears and tantrum.
I think you get the idea.
For those of you with fiduciary responsibility for one or more retirement plans, I wonder if this scenario resonates (hopefully without the tears and tantrums!): You invest considerable time and energy overseeing the plan, focusing on offering an appropriate fund lineup and a robust range of tools and services, all with a great participant experience and reasonable fees.
And the reward for your efforts? Ideally, a participant population that’s well prepared for retirement and a plan that stands out as a driver of employee attraction, retention, and satisfaction. But along the way, there’s also the inevitable squeaky wheel participant (Why can’t I buy Bitcoin in our 401(k) plan?) and the seemingly constant, and growing, worry about potential ERISA litigation.
Tyson: You’re right, Evan. The Ninth Circuit Court of Appeals 2023 decision in Bugielski v. AT&T Services, Inc., has sent a ripple through the retirement industry. This is mainly because (1) the court basically concluded that any time a plan sponsor modifies, or possibly even enters into, a contract with a service provider, it’s a prohibited transaction under ERISA, thereby requiring the plan sponsor to demonstrate that they have a prohibited transaction exemption,1 and (2) the Ninth Circuit’s decision contradicts the findings of other circuit courts, creating what appears to be a conflict of law.
Consultants and plan sponsors are concerned that this decision will increase the number of 401(k) lawsuits. At the very least, it has created some confusion. I think it’s important to recognize, though, that the AT&T case isn’t about the prudence of offering managed accounts. At its core, it’s about understanding that a prohibited transaction may arise if all compensation and fees received by a service provider are not disclosed to the plan sponsor.
Tyson: The short answer? Lower fees in relation to performance and increased fee transparency. In this case, AT&T amended its recordkeeping contracts to give plan participants access to brokerage and advisory services. The recordkeeper received compensation from both the brokerage and advice arrangements, and the plaintiffs alleged that by failing to consider this compensation, AT&T engaged in a prohibited transaction and caused the plaintiffs to pay excessive fees.
In a reversal of the lower court’s summary judgment in favor of AT&T, the Ninth Circuit agreed with the plaintiffs that AT&T violated ERISA’s prohibited transaction rules, stating that AT&T had a fiduciary duty to monitor the compensation that the recordkeeper received through the amended contracts.
The Ninth Circuit’s expansive view of what’s needed to show a prohibited transaction has been controversial. Because its holding conflicts with those of other circuit courts, the issue may ultimately be decided by the Supreme Court.
Tyson: First, I think it’s important to recognize that not all advice programs have the same structure and relationships between the plan sponsor, recordkeeper, and advice provider. In the AT&T case, AT&T contracted directly with an advice provider, and the recordkeeper, through its own arrangement with the provider, received fees connected to the furnishing of those advice services. As a point of comparison, Vanguard, in both of our available advice offers, contracts directly with the plan sponsor for advice and discloses all advice and recordkeeping compensation, both direct and indirect, to its plans.
Second, managed accounts can be incredibly valuable to plan participants’ efforts to prepare for retirement and other financial goals. Rather than overcorrecting to an individual case, fiduciaries should ensure that they’re following ERISA’s requirements. Remember, ERISA is a process-driven statute. This means that plan fiduciaries should maintain a prudent process for making and documenting decisions.
For example, fiduciaries should evaluate fees — direct and indirect — to ensure that only reasonable fees are paid by the plan. They should know what they’re paying for, and if they have questions about any information given to them by service providers or other parties, they should ask.
Fiduciaries should also hire an expert if needed. And if they’re modifying an existing contract to add new services, such as what happened in the AT&T case, they should evaluate those services separately and review the reasonableness of any direct or indirect compensation paid to the service provider or third parties.
For some additional perspective on this topic, you can check out my earlier blog on managed account oversight. And for an even deeper dive, you’ll want to take a look at Participant Advice: The Current State, a recent commentary from Vanguard Strategic Retirement Consulting. The authors take us through the evolution of advice and further make the case for following a prudent monitoring process, all in the name of increasing the availability of affordable, high-quality advice programs to meet participant needs.
What is the value of such programs? I love the no nonsense brevity of this description from another Vanguard research paper: "Most investors can get substantial value from reasonably priced advice that helps them make financial decisions consistent with their goals and aspirations.”2
Hopefully, this has helped with that unsettling feeling you may have about potentially being punished for trying to do something positive at work. I wish I could share some similarly helpful and actionable advice for confronting this phenomenon at home, but I’m not sure I’ve figured out very much. However, you’re more than welcome to try out the playbook I use with my kids: distraction, bribery, and a healthy dose of Netflix.
Comments?
Ideas for future blogs?
Sources:
1 ERISA prohibits plan fiduciaries from engaging in certain transactions. In the AT&T case, the prohibited transaction in question is the furnishing of goods or services between a plan and a party in interest, including a service provider. However, ERISA section 408(b)(2) provides an exemption for agreements with service providers if reasonable compensation is paid for those goods or services. For compensation to be considered reasonable, regulations require that the service provider disclose to the plan fiduciary any direct and indirect compensation it expects to receive in connection with those services.
2 Weber, Stephen M, Paulo Costa, Bryan Hassett, Sachin Padmawar, and Georgina Yarwood. The Value of Personalized Advice. Vanguard, 2022.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, in the U.S., which it awards to individuals who successfully complete the CFP Board's initial and ongoing certification requirements.
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