The Portman-Cardin Bill, the Retirement Security and Savings Act – 2019 introduces sweeping changes to 403(b) plans by expanding their investment universe. These changes, however, also required modification to the Securities Laws otherwise applicable to 403(b) plans in order for them to work. A few critical issues have gone unanswered in the legislation, and there are a number of transition issues which we will have to be addressed.

Technically, the Act expands 403(b) custodial account investments, permitting them to hold interests in 81-100 group trusts as well as mutual funds. (An 81-100 trust is a reference to Rev Ruling 81-100 which, as later expanded, permits the common investment of 403(b) funds and 401(a) funds in the same investment trust vehicle. It can include collective trusts). This change only works, as a practical matter, if the 81-100 trust is subject to the same securities law rules as 401(a) plans. Securities laws have always exempted 81-100 group trust interests issued in connection with 401(a) plans from registration. But that exemption has never applied to trust interest issued in connection to 403(b) plans. This has meant that any collective trust (such as those providing stable value funds or ETFs) would have to go through the expensive and burdensome process of registering (and maintaining itself) as an investment company subject to the Investment Company Act of 1940, the Securities Act of 1933 and the Securities Exchange Act of 1934.

The method the Portman Cardin drafters  chose to make this work is to introduce fundamental changes to the securities laws as they apply to 403(b) plan-across the board- effectively making all of the security law exemptions which have been available in the past to 401(a) plans also available to 403(b) plans.The practical effect? Should the legislation pass, 403(b) plans which (i) are governed by ERISA; (ii) if not an ERISA plan, the employer sponsoring the plan agrees to serve as a fiduciary with respect to the investments made available to plan participants; (iii) or is a governmental plan will be treated like 401(a) plats for Securities Law purposes. On a simple level, this means that the following investments would now be made available under 403(b) plans, where they have not been available in the past:

• non-insurance stable value funds (these are largely funded by 81-100 collective trusts;
• ETFs, which are also largely funded by 81-100 collective trusts;
• non-registered separate accounts under group annuity contracts-of the sort typically purchased by 401(k) plans; and
• because the 81-100 trusts are not required to own mutual funds, equity-based CITs will now be available as investments.

It also solves the “cash” problem 403(b) plans have always had. There has never been a simple way to handle stray cash in a 403(b) plan before this.

Simple seeming measures which are narrowly focused (here, it’s clear that collective trust interests have been the focus), often have unintended consequences when you take a broader view. A few things are conspicuously absent from the statute:

Who is the shareholder?  Exemption from registration is one thing. However, these newly authorized non-registered investments are still securities, still subject to a number of securities laws (for example, certain anti-fraud provisions). It has been a long-standing position of the SEC that the 403(b) individual participant is the shareholder who is protected by securities laws, even under group custodial accounts and group annuities. This is unlike 401(a) plans, where the SEC has traditionally viewed the plan fiduciary as the shareholder. This has forced prospectus, evergreen and proxy delivery to the individual 403(b) participant itself. Failure to comply with this rule is expensive: participants not receiving these disclosures are entitled to a 12-month put on their investments.

Portman Cardin needs to address this. If not, even under the new rules which do not require registration, the collective trustee (or the insure of the non-registered annuity) may still owe substantial legal duties to the individual participants under securities laws. Besides not addressing a long-standing securities law issue for 403(b) plans,  this could conceivably cause  a reluctance to engage in this new 81-100 business if this issue is not addressed.

Unitization under 403(b). The IRS has never answered the question as to whether or not you can pool permitted investments within the 403(b) plan and unitize that pool. For example, if you were to create an asset allocation model within the plan using the plan’s mutual funds and collective trusts, and created a daily value on that model, the new law pretty much makes it clear that that the pool will not have to be registered as an investment company (under current law, it has to be registerred unless you meet Rule 3a-4-and this another story). But it is nowhere clear that this unitization would pass muster under 403(b), as the unit of the pool would not be an 81-100 pool, it would not be a mutual fund and it would not be an interest in an insurance company separate account. Portman Cardin can simply address this.

Distributed annuities. The variety of law changes under RESA, SECURE and Portman Cardin put into play a number of rules would promote the distribution of annuities to provide lifetime income-including, for example, the authorization of the variable annuity QLAC. This used to be simple under 403(b)s, as they would all be registered. But what happens when you purchase a non-registered variable annuity within the plan, and then distribute it? Does it have to be registered? It does get complicated for the plan. Portman Cardin forces the issue, as we will have to address  this same problem in the 401(a) space.

Finally, there are a whole host of transition issues (well beyond the simple matter of collective trust registration) which really need to be vetted-and which typically are vetted through the regulation process. This will include answering intriguing questions related to how this would operate in state university and K-12 403(b) plans, which may have no fiduciary; won’t be subject to ERISA; but are governmental plans exempt from both ERISA and securities law registration. What investment information will participants now be required to be given?

Something which directs the SEC, IRS and DOL to draft regulations which address these issues would be helpful, as there certainly will be  a number of significant ones which arise- and the SEC seems to have been much more reluctant to issue regulatory guidance than the DOL and Treasury have in the past.