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Important 401(k) Safety Tip

Times change. Court rulings change. Double check again your liabilities regarding the employee retirement plan.

Registered investment adviser Doug McLeod

Registered investment adviser Doug McLeod

Doug McLeod is a founding member and managing director of Mitchell, McLeod, Pugh & Williams, a registered investment adviser firm based in Mobile. 

We spoke with him about the legal liabilities that companies and their owners face in handling employee retirement plans. In recent years, the courts made it clear that companies that sponsor 401(k) plans will be held increasingly liable for making good decisions about how their employees’ money is being invested and knowing when investment advice may not be in their employees’ best interest.     

Plan sponsors are fiduciaries to the retirement plan. But plan sponsors, frankly, don’t understand what that means. Essentially they are managing money for the plan participants. A fiduciary is the highest standard under the law. They must put the interests of the clients ahead of their own interests. And most people don’t get that.

Plan sponsors can now surely be sued, as a result of a Supreme Court ruling in 2008 (LaRue v. DeWolff), which affirms the individual’s right to sue the plan sponsor, the company. And under the Employee Retirement Income Security Act, the liability extends to the company officers personally. It’s not absorbed by the entity. The courts can attach personal assets.

In 2008, most people predicted that ruling would open the doors to more and more suits, and that has proven to be the case. The amount of liability depends on the plan. CIGNA, a big plan, settled a suit for $34 million. Since that ruling, the lawyers have been trying to figure out how to litigate other cases. The litigation appears to be coming down the food chain. The reality is that there are thousands of retirement plans out there, and, once the lawyers get the formula right, they will be filing suits against smaller companies. 

In another Supreme Court ruling, Tibbie v. Edison International (February, 2015), the court also addressed the statute of limitations. The actions went past the six years of the statute of limitations, and that told the industry the limitations do not necessarily exist in such cases. 

Anthem Blue Cross and Blue Shield (Georgia) is currently being sued over 5 basis points, because it means a lot of money for that plan. Basically that lawsuit is telling the plan sponsor, you have to be diligent. As you become eligible for better pricing, then you’ve got to wake up and be diligent re-evaluating the cost structure from a performance standpoint. 

If you go to the Department of Labor website, there is a section that explains that if your plan is paying 2 percent of their assets instead of 1 percent, that those additional fees over a period of 25 to 30 years can erode an account by 25 to 30 percent. 

To some extent, establishing a 401(k) plan, you can call different financial institutions and they’ll walk in the door and offer you a canned type of product and ask you to sign a few places, and you communicate to the participants that you have one available and then you have one up and running. Not a lot of the particulars are explained to the sponsor, and a lot of those are not acting in a fiduciary capacity.  

There are two types of investment provider — one is a non-fiduciary and another will act in a fiduciary capacity. ERISA is clear on that. I’m not picking on the brokerage industry, but very few of them act as fiduciaries. Banks can act in that capacity, but not necessarily. The plan sponsor has a difficult time distinguishing between who is and is not. There is only one way to tell for sure. Ask them: “Are you acting in a fiduciary capacity?” Whether you’re a 10-person company with $1 million in assets or a 500-employee company with $50 million in assets, you ought to ask the same question. And, further, have the provider acknowledge in writing in a contract that they are acting in a fiduciary capacity.

The proposal to make brokers come under fiduciary standards did not pass Congress. It was the securities industry that fought it. They did not and do not want to act in a fiduciary capacity. Someone who works for a brokerage firm is a fiduciary for the brokerage firm and not their client.

The litigation over the last few years has focused on fees: fees that are excessive or the way the fees are paid. The bull’s eye is the industry practice called revenue sharing — embedded fees in the investment products, mutual funds. These fees are an inherent conflict of interest. The person choosing the funds is getting paid by the fund that they are helping you to choose.

Some plan sponsors don’t have any guide. They buy products off the shelf and plug into them. Some hire organizations as advisers and benchmark plans, which is something most people recommend. Every several years, you compare your plan to other plans of a similar size. If you’re paying 3.5 percent in fees and everyone else is paying 3 percent, you know something’s wrong. A lot of plan sponsors that received very little advice have little understanding of how these products work and who pays the fees.  

Banks have these products and insurance companies, and they have their reps out there selling them. XYZ bank has a platform and is using all their proprietary investments and the rep sells the product, and the funds are not selected in an unbiased way. The products are being selected because they are the funds of XYZ bank and that’s how the person selling them gets paid. Mutual funds tend to have high expenses, and the performance is less than compelling. 

The alternative is that there are providers out there who act in a fiduciary capacity. They help you select an investment on its merits, and the administrator of the platform charges a flat fee. It’s an open architecture. You can put any fund in your plan that you want, selected from the universe of mutual funds. The fees are not attached to which investments are selected. A firm that is a registered investment adviser under the Investment Advisers Act of 1940 has to be paid by the client only. 

Insurance companies and banks can act in the same capacity under section 3(38) of the ERISA. Brokerage firms typically cannot. If you have an investment adviser who qualifies as a fiduciary under section 3(38) of the ERISA law, you have offloaded your liability for the investments to that adviser.

With a fiduciary, you get a higher level of service, and, generally speaking, the cost is less than the platforms that have revenue sharing. Those types of structures are much more expensive.

Chris McFadyen is the editorial director of Business Alabama.

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