DOL's fiduciary proposal: significance for plan sponsors

August 18, 2015

We have posted three articles on Department of Labor's proposal to re-define who is an ERISA advice ‘fiduciary,’ reviewing the proposal generally and the seller's carve-out, the Best Interest PTE and the participant education carve out.

As we discussed in those articles, the DOL proposal may affect plan sponsors in three ways. First, sponsors and sponsor staff may be directly affected, that is, they may themselves in some cases be advice fiduciaries under the proposed rule. Second, sponsors may be affected as direct consumers of advice, when, for instance, they retain a consultant to advise them about which funds to put in a fund menu. Third, sponsors may be affected as indirect consumers of advice, when, for instance, they retain persons (educators, investment advisors or call center operators) to advise their participants.

In this article we review these issues in more detail. As we'll see, treatment of the first two issues under the proposal is relatively straightforward and non-problematic. The third issue – the effect of the proposal on advice (and education) provided to participants – is more complex.

Effect on sponsor employees

Under the new proposal, an employee who renders advice would not be a fiduciary so long as the employee "provides the advice to a plan fiduciary, and he or she receives no fee or other compensation, direct or indirect, in connection with the advice beyond the employee's normal compensation for work performed for the employer or employee organization." This ‘carve-out’ addresses an issue of some controversy in the original proposal, which some viewed as imposing fiduciary status on, e.g., lower level plan committee staff.

Some view this carve-out language as limited; it would not cover, for instance, ‘advice’ given to participants. If the provision is finalized as proposed, sponsors will want to review procedures for, e.g., staff responses to participant questions about plan investments and distributions.

Effect on sponsor advice – the seller's carve-out

As we discussed in our first article, for sponsors with at least 100 participants, while the proposal would add some additional process requirements, the seller's carve-out should permit continuation of most current adviser-sponsor relationships. Thus, the effect of the new rule on advice given to sponsors would be minimal.

Effect on participant education and advice

The proposal would generally make recommendations to participants about (i) plan investments and (ii) distributions ‘advice.’ In one of the more controversial changes to the original proposal, the seller's carve-out is not available for advice to participants. As we discussed in our article The DOL fiduciary proposal: investment education vs. advice, the proposal would also supersede current investment education rules (Interpretive Bulletin 96-1), replacing them with a much narrower carve-out.

As a result of these proposed changes, conflicted ‘educators’ (which would include more or less anyone affiliated with a firm offering investment products or services) would be limited – more limited than they are currently – in what they would be able to say to participants. That is because, generally, if their recommendations were considered ‘advice,’ they would risk ERISA self dealing and prohibited transaction violations. As we discussed in our article DOL proposed redefinition of ERISA fiduciary – Best Interest PTE, the exemption that DOL is offering for conflicted advisers is, at least as it is currently proposed, of limited utility.

Bottom line: DOL's proposed rule would change who can say what sorts of things to participants. Different sponsors will have different views on that result. Sponsors who currently rely on conflicted advisers would be most affected: the kind of ‘education’ (and other communications directed at participants) those advisers provide may change. As we understand it, some sponsors – frustrated with their ability to control what conflicted advisers say to their participants – would be happy with that result. Moreover, for sponsors concerned about unauthorized ‘advisers’ soliciting their participants, the new rule would generally be viewed as positive – bringing more transparency and ending some problematic practices.

Does participant education/advice matter?

With respect to plan asset allocation decisions (that is, participant decisions about how to invest money that is inside the plan), many would argue that defaults – e.g., to a target date fund – have done much more than education or advice to improve participant investment outcomes. In the context of widespread use of such defaults, advice is mainly used (and useful) to more sophisticated participants with higher balances, comfortable with making asset allocation decisions for themselves. Thus, for many sponsors, any disruption of the adviser-participant relationship that the proposal may cause may not matter that much, so long as the participant remains in the plan and thus has the advantage of plan defaults.

The significance of rollovers

In that context, it's understandable why DOL has been so focused on rollovers – on the decisions a participant makes as she exits the plan. Perhaps the biggest change in the proposal affecting qualified plan sponsors is the ‘fiduciary-ization’ of the rollover process. Recommendations about whether to take a rollover and how to invest money rolled over would under the proposal generally be advice, often triggering fiduciary status. That fiduciary status would, in many cases, make it illegal – a violation of ERISA's anti-self dealing and prohibited transaction rules – for a conflicted adviser to do anything but provide generic information.

The biggest impact here would probably be on call center operators affiliated with funds offered under the plan (or, more to the point, affiliated with funds offering rollover IRA products) and on terminating participants calling the call center with questions about "what to do with my 401(k) distribution." Under the proposal, those call center operators would be significantly restricted in what they could say (relative to what they can say today). Participants (particularly those with smaller balances) would get less coaching. As we have said before, DOL does not think that is necessarily a bad thing: according to the Council of Economic Advisers (CEA) such ‘conflicted’ advice costs participants 100 basis point per year.

Economic impact

Much of the concern with respect to this issue has focused on the question of whether it will be economically viable for advisers to provide un-conflicted advice to participants with smaller balances. In this regard, CEA argues that:

First, advisers can provide the same quality of advice while receiving non-conflict-based payments as they can when receiving a payment of equal amount based in conflict.

Second, the prevalence of conflicted payments today may actually interfere with low-balance savers' ability to get advice.

Finally, savers with modest balances today tend to become savers with larger balances tomorrow.

It is possible, however, to tell a different economic story: Mutual fund operators provide certain services (custody, record keeping, participant education/advice and call centers) as part of an ‘asset gathering’ strategy. As DOL reins in the fund companies' ability to gather assets via participant education and call centers, the incentive for the fund companies to offer those services (often at reduced prices) will go down. Theoretically that should drive the cost of participant education/advice and call centers up – that is, current asset gathering represents, in effect, a discount on the cost of those services.

That story is one reading of what CEA means when it says: "Ongoing developments in the financial industry are sharply reducing the cost of advice, but it may be difficult for new entrants providing quality, unconflicted, low-cost advice to compete on price when other advice erroneously appears to be free." Translation: unconflicted advisers cannot currently ‘compete on price’ = the ‘natural’ price of unconflicted advice is higher than the current price of advice generally. And, pursuing this logic, if you get rid of ‘cheap’ conflicted advice (and eliminate the competition it represents), the cost of advice (for everybody) is likely to go up.

None of the foregoing is, from the sponsor's point of view, necessarily a bad thing. In a sense, it is an example of the issue at stake in the discussion of the virtues of bundling/revenue sharing vs. explicit pricing of trust and record keeping services. DOL is (in effect and in CEA's view) simply proposing that educators, advisers and call centers charge explicitly for the real cost of their services, in a way that does not affect (and is not dependent on) participant asset allocation and rollover decisions.

Sponsors can decide for themselves which of the two models – ‘bundled services’ and possibly conflicted-and-compromised advice or explicit charges for advice services – they prefer. We would note that, currently, sponsors generally have the option to choose either approach. DOL would, in effect, take away that choice.

Improving outcomes

DOL and CEA believe that by purging the retirement investment world of conflicted participant advice they will dramatically improve participant outcomes. That is the gist of CEA's argument in its report – this policy innovation will save participants 100 basis points a year. We discuss CEA's report in our article Administration support for new conflict of interest rule; we discuss a counter-analysis provided by National Economic Research Associates in our article Response to Administration conflicted advice proposal. Before the DOL proposal is finalized there will be further analyses. There will be numerous comments from proponents and opponents. And there will be hearings.

If DOL's proposal is finalized it will change how advice-providers communicate and interact with participants. Sponsors will want to understand, based on the competing analyses, comments and testimony how those changes will affect their participants.

We will continue to follow this issue.

October Three Consulting, LLC is a full service actuarial, consulting and technology firm that is a leading force behind the reemergence of defined benefit plans across the country. A primary focus of the consultants at October Three is the design and administration of comprehensive retirement benefits to employees that minimize the financial risks and volatility concerns employers face.

Through effective plan design strategies October Three believes successful financial outcomes are achievable for employers and employees alike. A critical element of those strategies is the ReDB® plan design. The ReDefined Benefit Plan® represents an entirely new, design-based approach to retirement and to the management of both the employer’s and the employee’s financial risk, focusing on maximizing financial efficiency and employee value.

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