Effective July 1, the Federal Reserve amended Regulation Z to exempt most plan loans from the reporting and disclosure requirements found in the Truth in Lending Act. Going forward, plans will no longer be required to report and disclose loan details as presently obligated by this law, provided that the loans are made in compliance with Section 72 of the Internal Revenue Code. The exemption covers employee benefit plans, whether or not they are subject to ERISA.
401(k) participants of Southern California Edison (SCE) won a key legal victory against their employer when Judge Stephen V. Wilson of the US District Court for the Central District of California ruled that the selection of three retail-class funds constituted a fiduciary breach. The case centered on the plan’s decision to choose a retail share class of funds rather than their less expensive institutional share-class alternatives. As background, SCE sponsored a $2 billion retirement plan that utilized Hewitt as its recordkeeper and Hewitt’s Financial Services Divisions to advise them on plan investment related matters. The Court determined that SCE and its fiduciaries violated ERISA’s duty of prudence by not accurately and thoroughly studying the differences between selecting retail shares instead of institutional shares.
The defense argued that no fiduciary breach was committed because they were acting on the advice of Hewitt Financial Services when they placed the retail share classes of the funds they chose in their plan. The court rejected this argument as well as the defense’s claim that they were not eligible for the institutional shares because of the higher mandatory investment minimums that they did not meet. The Judge ruled that SCE’s fiduciaries should have requested a waiver of the institutional share’s investment minimums and by failing to do so, were in breach of their ERISA duty of prudence.
After the ruling, Judge Wilson instructed the plaintiffs’ lawyers to calculate the monetary damages incurred (as measured by the difference in investment expenses) by the fiduciaries’ actions. Wilson further directed that the damages begin from the date the plan initially invested in the retail funds (around July 2002) until present.
In the ruling, the court’s decision was far less deferential to the plan fiduciaries’ decisions than other jurisdictions have been in other plan fee cases. Many previous lawsuits have centered on claims that fiduciaries breached their ERISA duties by opting to invest in funds with unreasonably high fees, failing to disclose those fees properly to participants. This case uniquely provides some lessons to plan fiduciaries to contemplate. The outcome provides guidance to fiduciaries in evaluating and negotiating 401(k) plan fees, such as:
- Large employers and retirement plans should make use of their economies of scale to negotiate for lower investment fees.
- Solely relying on the recommendations from independent investment advisors may not meet fiduciary standards of prudence.
- Plan fiduciaries should document their evaluation of fees and their investigation regarding the selection of 401(k) plan investment options. ERISA does not require fiduciaries to select the cheapest fund available rather they must select funds according to ERISA’s standard of prudence, placing importance on selection process and documentation.
- Changes in fund names, ownership or management should trigger a thorough review of the fund.
In July, the Department of Labor released its long-awaited, interim final regulations on plan fee disclosure. These rules amend the existing law under 408(b)(2) of ERISA that permits plan assets to be used to pay service provider fees, as long the services are necessary and the compensation for the service is reasonable. Originally released in 2008 by the Bush Administration and subsequently struck down on the first day of Obama’s presidency, the current rules differ slightly from the original. These rules become effective on July 16, 2011.
The regulation’s objective is to assist plan fiduciaries in understanding the complex compensation arrangements paid to their providers and have conflicts of interest disclosed to them that may affect the performance of services they receive. In brief, these rules require plan service providers to disclose fees, compensation and conflicts of interest to the responsible fiduciary of a covered retirement plan in order for the service provider’s compensation to be considered reasonable (and lawful). Under the new regulations, full disclosure is finally required.
The regulation’s defined the following:
- Covered Plans are defined contribution and defined benefit retirement plans covered by ERISA [for example, 401(k), 403(b) and defined benefit plans].
- Covered Service Providers are entities who expect to receive $1,000 or more in compensation from plan services [including recordkeepers, auditors, or RIAs].
Additionally, the new rules highlight the following:
Required Disclosure: There is no specific format of disclosure in the regulations, but it must be done in writing. Required content includes the descriptions of the services provided, the total compensation to be received and how it is to be received.
Timing of Disclosures: Disclosures for existing engagements must be made before July 16, 2011. New engagements must be provided reasonably in advance of the services start date. Changes to existing engagements can be made no later than 60 days after provider informed of change.
Requirements for Plan Fiduciaries: Fiduciaries must ensure that disclosures are provided, review them and request any missing information. If full information not provided, the fiduciary must notify the DOL.
The 408(b)(2) regulations are part of a broader three-part initiative by the DOL to address increased disclosure and plan transparency covering the fee’s service providers must report to plan sponsors and participants. These initiatives were:
- Part I: The revision of reporting requirements in Schedule C of the Form 5500 that was first effective for the 2009 plan year.
- Part II: This amendment to ERISA Section 408(b)(2) covering fees and other disclosures required from service providers to plan fiduciaries.
- Part III: Addresses disclosures to plan participants under defined contribution plans (final regulations were recently released on October 14).
North Pier has stated numerous times before that we believe we are on the proper path towards full disclosure. The long awaited 408(b)(2) Regulations are intended to provide greater transparency to plan sponsors to assist them in the effective evaluation of their plan’s service arrangements. Plan fiduciaries should begin to identify the information that will be presented to them to comply with these new rules. A challenge that may arise is the lack of a required uniform disclosure document. This may require fiduciaries to find an acceptable template in order to ensure compliance.
A recent poll conducted by LIMRA, an association that provides research, consulting and other services to the financial services community, suggests that (contrary to popular opinion) many retirement plan participants may not object to plan contributions automatically increasing every year. In fact, the survey showed that 22% of defined contribution participants acknowledged that they would prefer that their contributions be automatically increased by 1% each year beginning at age 45.
Furthermore, the online survey found that 45% of those earning $75,000 or more in annual household income were more likely to want their contributions to be automatically increased by a full 2% or more every year. The poll also revealed that employees who make use of automatic plan features are more amenable to the concept of automatic escalation beginning at age 45. A full 54% want the contribution increase to be 2% or more each year. Only 34% of those polled do not want their employer to automatically increase their contribution rate at all.
A separate contribution escalation study conducted by AARP discovered similar results. AARP’s study found that 84% of automatically enrolled respondents had either a ‘very positive’ or ‘somewhat positive’ impression towards automatic contribution escalation.
Clearly, the message is that the perceptions that many employers hold concerning instituting automatic contribution escalation may be unfounded. Perhaps now, employees realize that they are often their own worst enemy when it comes to saving and they can benefit from putting their retirement on auto-pilot. Automatic contributions escalation is a simple way to increase the amount participants are saving each year.
Vanguard stated its intention to increase the international equity exposure of its target retirement funds, LifeStrategy Funds, and STAR Fund from approximately 20% to approximately 30% of the equity allocations. The proportion of domestic equities in these funds will be reduced proportionally for the overall allocation in stocks to remain consistent.
As we reported in Q3 2009, Fidelity similarly elevated its international equity positions to a comparable level (as well as adding TIPS and commodities to its target date offerings). As two of the most prolific providers of retail investment products, these recently announced changes evidence of a meaningful evolution in Generally Accepted Investment Theory (G.A.I.T.) by incorporating a larger allocation to international assets.