Business of Benefits : Employee Benefits Lawyer & Attorney : Law Office of Robert J. Toth, Jr. : 403(b) Plans, Annuity & Insurance Law : Business of Benefits Blog

I drafted the following article for the DCPI Weekly Exchange as the first of an ongoing series of comments on fiduciary issues.  DCPI's newsletter can be accessed (with a free subscription) at http://www.dcpinstitute.com.

Okay, I will admit it.  I have not spent my entire legal career focused upon ERISA.  In fact, before joining National Retirement Partners as in-house counsel to its broker-dealer and registered investment advisory firm, I served as counsel to an insurance company and, yes, as a plaintiff's attorney. 

However, having such varied experience can sometimes provide a more nuanced perspective.  Take, for example, the ongoing debate regarding the benefits and drawbacks of serving as an investment advisor to ERISA-qualified plans under section 3(21)(a)(ii) or as an investment manager under section 3(38). 

If you were to merely read ERISA, you would likely conclude there are significant differences in the potential liability being assumed under each role.  After all, an investment advisor, by definition, merely provides advice to the ultimate decision-maker.  By contrast, an investment manager manages the fund's assets on a discretionary basis.  In fact, section 405(d)(1) of ERISA specifically provides immunity to plan trustees for the acts or omissions of an appointed investment manager. 

Unfortunately, some commentators have attempted to use these statutory differences to assert that investment advisors have no legal liability because they are providing nondiscretionary advice, while investment managers completely shield plan sponsors from legal liability by acting with discretion.  Upon closer inspection, however, these theoretical distinctions quickly break down. 

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But, first, another note of introduction......

It is with great pleasure to announce that my friend and fellow pink-shirted compatriot (many of our industry colleagues may fondly remember THAT story!) Sandy Koeppel has decided to join us as Of Counsel, and to have some fun following his illustrious career at Prudential.  Together with myself, Phil Troyer and Conni Toth, we intend to continue to contribute helping make the U.S. retirement system - which we are all so passionate about - work better. Sandy brings a tremendous wealth of experience in guaranteed lifetime income from employer plans to the marketplace (I invite you to read his bio), and intends to continue to carry this torch. Between us all, we offer substantial knowledge of the design, marketing and distribution of these products.

Sandy, as he mentions below, has also formed Plan Income Consulting & Evaluation Services, LLC (PLICES), a consulting firm which has affiliated with this firm and which provides advisors, vendors and employers consulting services related to guaranteed income products.  

Drop Sandy a note at sek@rtothlaw.com.

Now, his first blog:

The shift from Defined Benefit to Defined Contribution plans as the primary workplace retirement vehicle has eroded the confidence and jeopardized the retirement security of a vast number of American workers and their families. The recently published EBRI 2011 Retirement Confidence Survey finds that confidence among workers in their ability to have a comfortable retirement has dropped to an all-time low. According to the EBRI survey,

"the percentage of workers not at all confident about having enough money for a comfortable retirement grew from 22 percent in 2010 to 27 percent, the highest level measured in the 21 years of the RCS. At the same time, the percentage very confident shrank to the low of 13 percent." The RCS further states that "56 percent of workers expect to receive benefits from a defined benefit plan in retirement, only 37 percent report that they and/or their spouse currently have such a benefit with a current or previous employer. Therefore, up to 19 percent of workers may be expecting to receive the benefit from a future employer—a scenario that is becoming increasingly unlikely, since private-sector employers, in particular, have been cutting back on their defined benefit offerings."

These findings along with other results of this survey are disturbing and demonstrate that American workers not only are uninformed but feel challenged, concerned, and threatened about potential declines in their future lifestyle in retirement.

 With the passage of the Pension Protection Act, Congress recognized the need to instill defined benefit-like outcomes into the defined contribution plan universe. The PPA enables plan sponsors to include in their DC plans features such as automatic enrollment, automatic contribution escalation and gain fiduciary protection by offering qualified default investment alternatives deploying professional money management. These important first steps do much to replicate for workers the defined benefit plan experience in the asset accumulation stage. However, up to now, most DC plans do not offer the critical and essential missing piece to assure retirement security: guaranteed lifetime income. There are many reasons for this failure. Chief among them include: legal uncertainty about the rules and standards that apply to the choice of providers; unsettled tax issues (e.g. applicability of qualified joint and survivor annuity rules) associated with new and innovative forms of guaranteed lifetime income; cost and administrative burdens; lack of demand among participants; lack of guidance from the Department of Labor delineating between advice and education for distribution planning and the availability of out-of-plan (retail) vs in-plan (institutional) guaranteed lifetime income solutions if it is desired.    

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Working through the technical terms of 408(b)(2) is not much different than putting together a picture puzzle. There are a lot of pieces which fit together in some very precise ways. But, in the end, the disclosures which are required are pretty straightforward and-even given the work needed to describe certain ”wrapped” services and estimating their costs- can be made very simply. Keep in mind Asimov’s concept of “Minimum Necessary Change," upon which I blogged a while back.

Long pages of disclosure are not necessary or warranted. 

There are certain keys to making it work, and making the disclosure simple. Keep a few things in mind:

•  Are you really a “Covered Service Provider” (CSP) that has to make a disclosure (see, for example, my piece on annuity investment accounts)? Remember, a CSP has a direct contract or arrangement with the plan, and that is the party that has to disclose-and only certain service providers are subject to disclosure rules. So, for example, a TPA which doesn't maintain the financial records (such as where a 401(k) plan is funded with allocated group annuity contracts; or for most 403(b) plans which are funded with individual annuity and custodial contracts);  whose fees are paid directly by the employer or the plan; and for which the TPA doesn't receive 12b-1 fees, commissions, or other indirect compensation are not CSPs and need not disclose under the new reg.

• Are you an affiliate or a subcontractor? If so, you don’t need to disclose, but the CSP needs to disclose what they pay you. This generally may include insurance agents who sell annuity contracts to 401(k) or 403(b) plans, and who are likely to be "subcontractors" because of their servicing the contract with things like enrollment services.The caution to those folks: make sure you understand what the actual CSP is saying about you.

• Make sure you are a “recordkeeper” before you commit to making financial disclosures. Many TPA’s are not 408(b)(2) recordkeepers on much of their business.

• Keep the disclosures simple, short and sensible. Check existing documents first, as most of the required disclosures may already be in the existing service agreement, policy or other existing agreement.

• For those who will receive indirect comp from a number of sources, try to standardize what you say about them, and create a short disclosure statement. Only send to those plans which generate that comp.

•  Over-disclosure is as bad as under-disclosure. Review and edit the description of indirect comp programs that others give you, to make sure it actually applies to you and properly describes your role in it all.

• Tweak your contract form to accommodate what you say in the disclosure, if necessary. Many existing contracts will not need to be changed to meet the rules.  Even then, however, consider incorporating some helpful changes when renewing the contract.

It does get a bit messier where data on the underlying investment needs to be disclosed, but even this is straightforward and can be simply made from existing data from accessible sources, and can be made in a standardized format.

Follow these guidelines, and you may be surprised with how simple the 408b2 disclosures may really be.

___________________________

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 Generally unnoticed in the DOL’s proposed fiduciary reg was the implicit recognition that the commissioned based sales function is important to the operation of the market, and that you can “sell” until the cows come home (a good friend tells me, by the way, that the cows actually do eventually come home),  or until you become a fiduciary.  Anyone familiar with the successful salesperson knows that they are only able to sell once they establish a level of trust with the plan fiduciary, which is why trade organizations are taking the DOL to task on the requirement that the salesperson, in order to be recognized as not being a fiduciary, must then advise the fiduciary (with whom a relationship is being forged) that he or she may have adverse interests to the plan.

However that language is eventually finalized, it raises an important question that hasn't really been addressed well, being a sort of red-haired stepchild of ERISA: Just what is “sales”and how are commissions treated? Finding your way through it can be trying, as if its a practice in ERISA metaphysics, mysticism and alchemy.

It starts with the basic question of whether or not “sales” is considered a service. It does seems almost metaphysical, and would be amusing if it didn't have a very real impact.   Commissions from pure sales of an investment product to a plan from a party without an existing relationship to a plan (either on its own or through an affiliate) does not seem to be governed either by 408(b)(2) or by the prohibited transaction rules.  “Sales,” by itself does not seem to be a service covered by 408(b)(2), and the payment of a commission to a someone who is not a party of interest may raise fiduciary concerns if too much is paid, but it is NOT, in itself, a prohibited transaction.  But there are times where sales and the payment of commission may eventually be considered services, where there becomes an ongoing, supportive relationship.

Lets go over some “pure sales” scenarios, with the impact of “sales as service” perhaps being handled in a future blogs:

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Unless you have been living under a rock for the past two weeks, you are probably aware of the pitched battle currently taking place in several states over proposed changes to the rights and benefits currently extended to state employees. In fact, Democrat legislators from Wisconsin and my own home state of Indiana have fled to Illinois (apparently, the asylum hot spot for lawmakers on the lamb) in an attempt to deny their state’s legislatures the quorum necessary to enact the proposed reforms.

While I rarely shy away from expressing my opinion on the political issues of the day, it is not my intent to weigh in on the broader debate regarding the role of public employee unions. In fact, I would note that Bob Toth (with whom I practice) and I come from decidedly different sides of the political spectrum. However, as attorneys focused on retirement plan issues, there is one aspect of the current debate on which we agree; namely, that states, like most private employers before them, need to shelve their current approach of handling their defined benefit plans.

This is not a new issue for either of us. Bob actually penned an article and a follow-up noting the limitations of traditional pension plans back in 2009 and, in 2010, I based my campaign for the Indiana General Assembly on a pledge to address our state’s public retirement plans (which were estimated to face a funding gap of almost $47 billion). While my run for public office was unsuccessful, I was recently asked to testify in favor of a bill (SB 524), which would require the state to study the prospect of switching to a defined contribution plan to provide retirement benefits for public employees and teachers.

According to a recent article in the New York Times entitled “Pension Funds Strained, States Look at 401(k) Plans,” Indiana is not alone in realizing the risks posed by promising lifetime payments to public employees without proper funding. Furthermore, this trend is bound to continue as taxpayers become educated regarding the huge deficits currently faced by many public pension plans. As I noted in my testimony to the Indiana Senate Committee on Pensions and Labor, unlike private plans, public pension funds have been permitted to discount future liabilities based upon projected future annual investment returns. 

For example, Indiana’s retirement funds assume a 7.25% annual return when projecting the current funding necessary to provide promised benefits to future retirees. However, according to Standard & Poor’s, the total return of S&P 500 over the past five years was just 2.4%! Furthermore, according to Joshua D. Rauh, who is with the Kellogg School of Management at Northwestern University, even if Indiana’s retirement funds were to achieve an average annual return of 8% on their investments, they would still run out of cash by 2019 (assuming cost of living adjustments based upon a 3% inflation rate).

Unfortunately, few state legislators know how to manage their own retirement portfolios, let alone the complex requirements of a multi-billion pension fund. However, as noted, the potential risk to future state finances posed by these plans is enormous. Our firm has offered its expertise to Indiana lawmakers to assist them in designing a program that will assist public employees in achieving income security at retirement while also protecting state taxpayers. In this regard, we are fortunate to have associations with several prominent think tanks from which we can derive additional support.

We would urge other retirement plan professionals to do the same; namely, take a look at the public retirement plans in your own state to determine if they are in need of additional professional guidance. As the saying goes, “The cobbler’s children go unshod.” However, let’s not let this maxim apply to the retirement plans managed by our state and local governments when we can offer assistance - either directly or through referrals to qualified experts. Our own financial future may depend upon helping them manage their way out of this current crisis.

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