Saturday, July 22, 2017

Are SDBAs the Next Litigation Target?

Back in the 1990s, the ability to support a self-directed brokerage account (SDBA) capability was a widely utilized means of winnowing the field in a 401(k) search, and more recently, the option seemed to hold promise as a foil for excess fee litigation charges. But that could be changing.

The SDBA option allowed participants to make investment choices outside the standard retirement plan menu – a big deal at a time when you could count the number of choices on two hands. Vanguard’s 2017 “How America Saves” report notes that one in six (17%) plans offer the SDBA option, though nearly a third (30%) of plans with more than 5,000 participants do. And while this amounts to nearly 3 in 10 Vanguard participants having access to the option, only 1% of these participants used the feature in 2016, and in those plans, only about 2% of plan assets were invested in the SDBA feature that year. PLANSPONSOR’s 2017 DC Survey pretty well mirrors those findings: 18.7% of plan sponsor respondents have the option, with nearly half of plans with more than $1 billion in assets choosing to do so.

Of course, with SDBAs, it has never been about how many used the option, but who – and for the very most part, the option has its greatest appeal among those whose balances (or financial acumen, real or perceived) calls for it, particularly among closely held small businesses and professional practices, such as lawyers and doctors.

Fee Litigation

In the early days of the so-called excessive fee litigation, at least one court (the 7th Circuit, in Hecker v. Deere) found compelling the notion that the existence of the SDBA gave participants access to a sufficient variety of reasonably priced funds to refute excessive fee claims against a plan that had a “regular” fund menu comprised of nothing by the proprietary funds of its recordkeeper.

However, and while it hasn’t been a primary focus of recent litigation, several of the more recent suits do raise concerns with the existence of the SDBA, but more importantly, how it was managed.

About a year ago, in a suit brought by American Century participants against their own plan, the plaintiffs took issue with how the SDBA was administered, and while they acknowledged that usage of the SDBA is higher within than industry statistics would suggest, they went on to state that that result was “no doubt due to Defendants’ imprudence and self-dealing” (less than 7% of the plan’s assets are held in SDBAs).

In a 2015 suit involving PIMCO, the plaintiffs argued that “…those who choose to utilize an SDBA are typically assessed an account fee and a fee for each trade” — fees that they said “often make an SDBA a much more expensive option compared to investing in the core options available within the Plan.” Additionally, they claimed that because “employees investing in mutual funds within an SDBA must invest in retail mutual funds, rather than the lower-cost institutional shares typically available as core investment options,” those who do use the option again pay higher fees.

And then, just this year, in a suit brought against Schwab, the participant-plaintiffs charged that not only that Schwab received revenue sharing payments from third-party ETF and mutual fund providers whose funds were made available to via the platform, but that the SDBA’s “byzantine complexity and confusing schedule of fees alone make it inadvisable for all but the most sophisticated of investors.” The plaintiffs framed the availability of the option to all participants (rather than just more sophisticated participants) as an issue, and charged that Schwab made no effort to determine: (a) if the SDBA was a prudent option at all, or (b) if another provider’s SDBA might have been better.

All of which should remind us that plan fiduciaries have a responsibility to carefully select and monitor their SDBA provider and these services. That could include:
  • the qualifications and qualify of the provider;
  • the reasonableness of the fees; and
  • the security of the account and stability of the provider.
And just like any provider of services to a qualified plan, if the brokerage window can’t be prudently selected, the plan should not offer that window.

Something on which the plaintiffs’ bar now seems to be focusing.

- Nevin E. Adams, JD

Saturday, July 15, 2017

What’s Wrong with Automatic Enrollment?

Automatic enrollment has long been touted – and proven – to be an effective way to overcome retirement savings inertia in 401(k) plans. But these days automatic enrollment plan design seems to be suffering from its own inertia.

For all the good press and positive results that automatic enrollment gets, one might well expect that every plan would embrace it. And yet today, nearly a decade after the passage of the Pension Protection Act, many still don’t. What’s wrong with automatic enrollment?

Everybody doesn’t do it.

Only the most na├»ve industry professional ever assumed that the Pension Protection Act of 2006, even with all its incentives and encouragement (and not a few barrier removals) would transform a voluntary savings system into something that all employers everywhere would feel comfortable – or would be able to afford – automatically enrolling every eligible worker.

And yet, more than a decade later, only about two-thirds of the largest employers have embraced automatic enrollment – and only about a quarter of the smallest programs, according to PLANSPONSOR’s 2017 DC survey. Oh, you see numbers that suggest the adoption rate is higher, but those surveys tend to skewer toward larger programs, where – as the numbers above indicate – automatic enrollment is much more common.

There are legitimate concerns, mind you. Anecdotally many plan sponsors – particularly small plan sponsors – are simply unwilling to impose another financial “draw” on their workers’ paychecks, and most will tell you that they have had those “you need to participate” conversations with their workers, only to have them decline. Moreover, the costs of an employer match when you’re talking about taking participation from a 70% (or thereabouts) level to 95% or higher can be significant.

For those who worry that a higher default would trigger a higher rate of opt-outs, surveys indicate that the “stick” rate with a 6% default is largely identical to 3%.

On the workforce management front, it’s worth noting that there are surveys that show that American workers are increasingly delaying retirement (or think they will be able to) due to concerns about retirement finances. Delayed retirements may also reduce the employer’s ability to hire new employees, reducing the flow of new ideas and talent into the organization.

But even when the plan includes automatic enrollment…

There’s a fault with the default.

While you see surveys suggesting that a greater variety of default contribution rates is emerging, the most common rate today – as it was prior to the PPA – is 3%. There is some interesting history on how that 3% rate originally came to be, but the reality today is that it has been chosen because it is seen as a rate that is small enough that participants won’t be willing to go in and opt-out – and, after the PPA, we have some law to sanction that as a target.

That said, nobody thinks 3% will be “enough” – neither to maximize the employer match in most plans, nor certainly to allow workers to accumulate sufficient funds for retirement. That wouldn’t be so bad – it’s a starting point, after all – except that…

The contribution rate is set – and never “reset.”

The authors of PPA’s automatic enrollment safe harbor knew that the 3% default wouldn’t be “enough,” and they had the wisdom to include a provision that called for an automatic “escalation” of that contribution rate – 1% a year (though, weirdly, they included a cap of 10% in the law). Plan sponsors – for many of the reasons that have slowed the adoption of automatic enrollment – have been even slower to embrace automatic escalation. The PLANSPONSOR DC Survey found that only about a third (35.7%) of the largest plan sponsors automatically escalate contributions unless the participant opts out (about the same amount allow the participants to choose to automatically escalate). However, once again smaller plan sponsors are significantly less likely to embrace this plan design.

But even then…

Only the newly hired are automatically enrolled.

For years now, the standard – even among employers who embrace automatic enrollment – is to extend it only to new hires – we’re talking only about a third of plans extend this to other than new hires. The rationale is that existing workers have had their opportunity – and in all likelihood many opportunities – to participate in the plan. Moreover, while the PPA doesn’t mandate going back to older workers, plan sponsors desirous of those safe harbor protections either have to, or have to be able to establish that they have.

Regardless of safe harbor concerns, it’s hard to imagine that plan sponsors who have cared enough to embrace automatic enrollment aren’t just as concerned about the retirement well-being of their more tenured workforce as they are about those recent hires.

However, even among the newly hired, some may have previously participated in another plan – and at a higher contribution rate. Automatically enrolling them certainly removes one of those “first day” new employee hassles – but may not be doing them any favors in terms of their retirement savings.
As with the default contribution rate, surveys have found positive movement on this front in recent years, particularly at the point of provider conversions (amongst a series of other plan changes).
Indeed, a small, but growing number of plans are…

Giving workers a second chance.

There’s a new-ish concept called reenrollment. Initially, it was a means by which plans could, at the point of conversion to a new platform, “reenroll” participants into a newly selected default investment fund, generally a balanced or target-date fund that had been chosen as the plan’s qualified default investment alternative, or QDIA (they were generally given time to opt-out of that decision before conversion). More recently, it has been expanded to basically treat all eligible non-participants as new hires – auto-enrolling them in the plan, and in some cases, reenrolling at the default rate if they happened to be contributing below that rate.

That said, this approach is not only new-ish, but not very common. Even among the largest plans (more than $1 billion in assets) responding to the PLANSPONSOR DC Survey, more than 86% don’t do any part of this.

There are, of course, good things with automatic enrollment, mostly that there are today many participants saving at 3% (and a match) who weren’t saving anything previously.

So, what’s wrong with automatic enrollment? Well, there are some participants who were auto-enrolled at 3% who would probably have enrolled at a higher rate, and some who change employers and are being auto-enrolled at a “start over” rate. In most cases the default contribution rate isn’t changed (by the employer, and certainly not by the participant), and auto-enrollment is still (mostly) limited to new hires.

What’s wrong with automatic enrollment? Nothing, once we remember that it’s (only) an effective starting point – and one that, like most good decisions, requires some follow-up.

- Nevin E. Adams, JD

See also, 3 Things You Should Know About Automatic Enrollment. And for some caveats on automatic enrollment, see Why the ‘Ideal’ Plan Isn’t.

Saturday, July 01, 2017

Fiduciary Lessons from the Founding Fathers

Anyone who has ever found their grand idea shackled to the deliberations of a committee, or who has had to kowtow to the sensibilities of a recalcitrant compliance department, can empathize with the process that produced the Declaration of Independence we’ll commemorate next week.

Indeed, there are any number of things that the experience of today’s investment/plan committees have in common with that of the forefathers who crafted and signed the document declaring our nation’s independence. Here are four:

It’s hard to break with the status quo.

By the time the Second Continental Congress convened in May of 1775, the “shot heard round the world” had already been fired at Lexington, but many of the 56 representatives there still held out hope for some kind of peaceful reconciliation, even as they authorized an army and placed George Washington at its helm. Little wonder that, even in the midst of hostilities, there was a strong inclination on the part of several key individuals to try and put things back the way they had been, to patch them over, rather than to declare independence and move into uncharted waters (not to mention taking on the world’s most accomplished military force).

As human beings we are largely predisposed to leaving things the way they are, rather than making abrupt and dramatic change. Whether this “inertia” comes from a fear of the unknown, a certain laziness about the extra work that might be required, or a sense that advocating change suggests an admission that there was something “wrong” before, it seems fair to say that plan sponsors are, in the absence of a compelling reason for change, inclined to rationalize staying put.

As a consequence, new fund options are often added, while old and unsatisfactory funds linger on the plan menu, there is a general reluctance to undertake an evaluation of long-standing providers in the absence of severe service issues, and committees often avoid adopting potentially disruptive plan features like automatic enrollment or deferral acceleration.

While many of the delegates to the Constitutional Convention were restricted by the entities that appointed them in terms of how they could vote, plan fiduciaries don’t have that “luxury.” Their decisions are bound to an obligation that those decisions be made solely in the best interests of plan participants and their beneficiaries – regardless of any other organizational or personal obligations they may have outside their committee role.

Selection of committee members is crucial.

The Second Continental Congress was comprised of representatives from what amounted to 13 different governments, with everything from extralegal conventions, ad hoc committees, and elected assemblies relied upon to name the delegates. Delegates who, despite the variety of assemblages that chose them, were in several key circumstances, bound in their voting by the instructions given to them. Needless to say, that made reaching consensus on the issues even more complicated than it might have been in “ordinary” circumstances (let’s face it – committee work is often the art of compromise).

Today the process of putting together an investment or plan committee runs the gamut – everything from simply extrapolating roles from an organization chart to a random assortment of individuals to a thoughtful consideration of individuals and their qualifications to act as a plan fiduciary. But if you want a good result, you need to have the right individuals – and if those individuals lack the requisite knowledge on a particular issue, they need to seek out that expertise from advisors who do.

It’s important to put it in writing.

While the Declaration of Independence technically had no legal effect, its impact not only on the establishment of the United States, but as a social and political inspiration for many throughout the world is unquestioned. Arguably putting that declaration – and the sentiments expressed – in writing gave it a force and influence far beyond its original purpose.

As for plan fiduciaries, there is an old ERISA adage that says, “prudence is process.” An updated version of that adage might be “prudence is process – but only if you can prove it.” To that end, a written record of the activities of plan committee(s) is an essential ingredient in validating not only the results, but also the thought process behind those deliberations. More significantly, those minutes can provide committee members – both past and future – with a sense of the environment at the time decisions were made, the alternatives presented and the rationale offered for each, as well as what those decisions were.

Committee members should understand their risks, as well as their responsibilities.

The men that gathered in Philadelphia that summer of 1776 to bring together a new nation came from all walks of life, but it seems fair to say that most had something to lose. True, many were merchants (some wealthy, including President of Congress John Hancock) already chafing under the tax burdens imposed by British rule, and perhaps they could see a day when their actions would accrue to their economic benefit. Still, they could hardly have undertaken that declaration of independence without a very real concern that in so doing they might well have signed their death warrants.

It’s not quite that serious for plan fiduciaries. However, as ERISA fiduciaries, they are personally liable, and may be required to restore any losses to the plan or to restore any profits gained through improper use of plan assets. And all fiduciaries have potential liability for the actions of their co-fiduciaries. So, it’s a good idea to know who your co-fiduciaries are – and to keep an eye on what they do, and are permitted to do.

Indeed, plan fiduciaries would be well advised to bear in mind something that Ben Franklin is said to have remarked during the deliberations in Philadelphia: “We must, indeed, all hang together or, most assuredly, we shall all hang separately.”

- Nevin E. Adams, JD