ERISA

Toxic Target Date – Case Study of the Worst of the Worst

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by Chris Tobe

50 percent of all 401(k) assets are in target date funds.   I believe Target Date Funds were created to sustain higher fees.    The least transparent Target Date Funds are those that are not SEC registered mutual funds.  Many are in poorly state regulated annuities either in whole or in part.   Many are in poorly state regulated Collective Investment Trusts (CIT)s    Many CIT’s can hide private equity or annuities and their many hidden fees and risks.  Many, if not most, CIT based Target Date Funds and all annuity TDF’s are a fiduciary breach based on the higher risks alone, not to mention the excessive fees.[i]

Weak Regulation
There is a general assumption that CIT’s are regulated by the Federal Government Office of Comptroller of the Currency (OCC).  Some CIT’s are regulated by the OCC while many others are regulated by one of 50 state bank regulators.   This allows CITs to choose their own state regulator who may have the laxest oversight. [ii]  While the SEC mutual fund regulations are not perfect, they do control for a lot of risks and provide a good amount of transparency

Prudential Day One Target Date funds provide this disclosure to plans:

Unlike mutual funds, the Day One Funds, as insurance company separate accounts or collective investment trusts, are exempt from Securities and Exchange Commission registration under both the Securities Act of 1933 and the Investment Company Act of 1940 but are subject to oversight by state banking or insurance regulators, as applicable. Therefore, investors are generally not entitled to the protections of the federal securities laws.[iii]

Principal provides this disclosure:  

The CITs are not mutual funds and are not registered with the Securities and Exchange Commission, the State of Oregon, or any other regulatory body.

The Collective Trust and the Funds intend to qualify for the exclusion from the definition of an “investment company” under the 1940 Act provided for by Section 3(c)(11) of the 1940 Act. The Section 3(c)(11) exclusion is available for collective investment funds maintained by a bank consisting solely of assets of certain employee benefit plans. Accordingly, Participating Trusts will not have the benefit of the protections afforded by the 1940 Act (which, among other things, requires investment companies to have governing boards of directors with a majority of disinterested directors and regulates the relationship between the adviser and the investment company). The offering of units of the Funds (each, a “Unit”) has not been registered under the U.S. securities laws or the laws of any applicable jurisdiction. Therefore, Participating Trusts will not have the benefit of the protections afforded by the Securities and Exchange Commission (“SEC”) under the Securities Act of 1933 (the “1933 Act”) (which, among other things, requires specified disclosure in connection with the offering of securities). Neither the SEC nor any state securities commission has approved or disapproved of the Units or determined if this document is accurate or complete. Any representation to the contrary is a criminal offense

In these cases, it appears these target date funds are avoiding SEC and any kind of federal regulation.   The only state regulator with any standards close to the SEC is New York and most of these funds avoid NY regulation whenever possible.

How can any fiduciary subject to Federal ERISA laws use for its main investment options target date funds that go out of their way to avoid Federal oversight?

Toxic Assets
A major reason to avoid SEC oversight is to put in investments which are not allowed in SEC registered mutual funds because of risk.  The other reason is to load up on assets with hidden fees which will not be disclosed under the current weak regulation.

Private equity, along with other illiquid contract investments like hedge funds, private debt, real estate is a potential fiduciary time bomb for plans and their participants. In target date funds even a small allocation to a Target Date Fund, with the excessive risk, lack of outperformance and excessive fees seem to make it a fiduciary risk. [iv]   

A disclosure from Principal:

A differentiating aspect…..is exposure to alternatives (hedge fund strategies).[v]   ….. Given the managers approach to asset allocation (more equities and alternatives)…. Exposure to nontraditional (commodities, natural resources, and real estate) and alternative (hedge fund strategies) asset classes is a differentiating aspect from a style perspective relative to the peer group

Principal LifeTime Hybrid CITs may invest in various types of investments including Principal Funds, Inc. institutional class shares, Principal Life

Insurance Company Separate Accounts and other collective investment trusts and mutual funds.The risks associated with derivative investments include …that there may be no liquid secondary market, Investing in real estate  securities, subjects the Fund to the risks associated with the real estate market (which are similar to the risks associated with direct ownership in real estate), including declines in real estate values, loss due to casualty or condemnation, property taxes, interest, rate changes, increased expenses, cash flow of underlying real estate assets, regulatory changes (including zoning, land use and rents) and environmental problems, as well as to the risks related to the management skill and creditworthiness of the issuer.

Like high-risk hedge funds Prudential, Principal and others have the contractual right to put up gates and restrict liquidity if they are downgraded or in danger of default.  They can refuse to give the plan/participant their money at any time which would be illegal in a SEC registered mutual fund

Annuities
I spent 7 years at Transamerica making insurance annuity 401k products   Anytime an insurance company puts something in an annuity form, they take ownership of the underlying securities put it on their balance sheet and squeeze out another 150 bps or more in spread fees.  Anytime something is put in an insurance company Separate Account, same thing they take ownership and lock in a spread. 

These annuities do not have SEC mutual fund oversight, and the plan does not own the underlying SEC registered securities, the insurance company does.   I make the argument that any annuity is a fiduciary breach. [vi]

Prudential Day One Funds may be offered as: (i) insurance company separate accounts available under group variable annuity contracts issued by Prudential Retirement Insurance and Annuity Company (PRIAC),

Sub-Advised Investment Options include Separate Accounts available through a group annuity contract with Principal Life Insurance Co.

Fees
Target Date Funds are so opaque that the actual fees and profits are hard to pin down.  I estimate that many could approach 200 basis points or more.  

Principal Target dates have 13 underlying funds 5 insurance company separate accounts (annuities), 4 CIT’s, 4 proprietary mutual funds, for a total of 25 share classes.

The disclosed fees are even way above most providers, so any plan using these is not trying to minimize fees.

Conclusion
Any plan sponsor who invests in one of these black hole CIT funds deserves to be sued.   I guess that in many cases there is a so-called consultant receiving a huge undisclosed insurance commission.

One of my favorite disclosures:

The ultimate decision as to whether a Principal LifeTime Hybrid CIT is an appropriate investment option for a plan and whether a target date fund can serve as a QDIA belongs to the appropriate retirement plan fiduciaries.

interpret this disclosure as the insurance company way of saying “if you are stupid enough to buy our high fee high risk products, it is on you, not us.”

[i] https://commonsense401kproject.com/2022/04/30/problems-with-target-date-funds/

[ii] https://commonsense401kproject.com/2022/02/22/cits-collective-investment-trusts-in-401k-the-good-and-the-bad/

[iii] https://www.prudential.com/advisors/investments/day-one-target-date-funds/cit-funds

[iv] https://commonsense401kproject.com/2022/02/15/private-equity-in-401k-plans-a-ticking-time-bomb/

[v] ADM-Ferguson 00172, ADM-Ferguson 001712 among 81

[vi] https://commonsense401kproject.com/2022/05/11/annuities-are-a-fiduciary-breach/

 

Annuities Are a Fiduciary Breach

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By Chris Tobe, CFA, CAIA

Annuities issued by a single insurance company are a Fiduciary Breach.  They can be called guaranteed income, they can be called GIC’s or fixed accounts, or index annuities.   I am focused on the institutional annuity products mostly used in 401(k)s.   There are many more fiduciary breaches in retail and variable annuities, as noted by attorney James Watkins in his recent article.

There are breaches in institutional annuities for 4 basic reasons

  1. Single Entity Credit Risk
  2. Single Entity Liquidity Risk
  3. Hidden fees spread and expenses
  4. Structure -weak cherry-picked state regulated contracts not securities and useless reserves

A 1992 Federal Reserve paper notes that the so-called insurance safety net is much weaker than most realize. [i] 

Annuities are in the news as insurance companies are pouring millions of dollars into lobbying and PR and advertising trying to trick people into buying them.

The insurance industry spends millions of dollars trying to abolish and weaken fiduciary standards because they do not come close to meeting them.

Insurance companies are especially frustrated with 401(k) plans because they have not only the strongest fiduciary standards, but an enforcement mechanism in 401(k) litigation.   While they have lobbied the US Department of Labor to ignore most of their enforcement duties on excessive fees on 401(k), they have not been able to block court action, and the latest Supreme Court ruling has reinforced this.

Annuities in 401(k) plans have traditionally been in 401(k) plans though a stable value of fixed annuity option. [ii]  In recent years they are trying to expand into hiding annuities in target date funds,[iii] mostly under the guise of Lifetime Income.[iv]

The Insurance industry’s huge push into 401(k) has even had some plan fiduciary consultants sounding words of caution.  A commentary in Benefits Pro by Mitch Shames is titled “Annuities: The Straw That Breaks the Back of Retirement Plan Fiduciaries.”[v]

Annuity contracts, however, are not investment securities. Instead, they are individually negotiated contracts entered into between an insurance company and the annuity-holder. …… the fiduciary will also need to be a prudent expert in the selection of the annuity. That is a pretty tall order. Retirement plan fiduciaries are on notice.   Annuity contracts may be the straw that breaks the back of the fragile fiduciary infrastructure employed by plan sponsors under ERISA.[vi]

Single Entity Credit Risk
Single Entity Credit Risk – Diversification is one of the most basic Fiduciary duty and annuities totally ignore this.  Like a single stock or a single bond is a clear fiduciary breach so is an investment 100% reliant on one entities credit like an insurance contract.

For over 20 years fiduciaries in the know, like large 401(k) plans, fled fixed annuity products backed by the general account of a single insurance company.  This was due to concerns about single entity credit and liquidity risk. Many attribute this to the 1992 and 1993 defaults by Executive and Confederation Life, as documented by the Federal Reserve Bank 1992 article. [vii]

In 2005 AIG was AAA rated and some in the trade press said that AIG was as safe as the Government by 2008 it was in default. In 2008 Federal Reserve Chairman Ben Bernanke said that “workers whose 401(k) plans had purchased $40 billion of insurance from AIG against the risk that their stable-value funds would decline in value would have seen that insurance disappear.” [viii]  Many investment professionals believe that a plan sponsor is taking a severe fiduciary risk by having a single contract with any one entity, such as AIG. It can be argued that a plan is taking less risk by assuming that the single insurance company backing the stable value option is too big to fail and has an implied government guarantee.

The Federal reserve for several decades bought fixed annuities in their stable value option in there 401(k) option for their employees. They limited credit exposure to 5% per insurance company.  In the late 2000’s there were not the 20 issuers needed for diversification so they shut the fund down.    Even the few diversified annuity structures still have 25% or 33% single entity exposure which is considered high by fiduciary diversification norms.

Taking 100 perentsingle entity credit risk is a clear breach of fiduciary duty. 

Single Entity Liquidity Risk
Single Entity Liquidity Risk – A fiduciary managing a bond portfolio sells a bond when it is downgraded to a level allowed in the investment policy.  Most Annuities are not allowed to be sold when they are downgraded.  They have no liquidity if the firm is downgraded multiplying the credit risk as a participant has to ride it down to default.  

Noted Morningstar analyst John Reckenthalrer said in April 2022 that in selecting 401(k) investment options, “inappropriate are investments that don’t price daily.” [ix]

Annuities do not price or mark to market daily. There is a secondary market for retail annuities provided by firms like JG Wentworth and Peachtree, which many times only pay 80 percent on the dollar.  So, if you bought an annuity and wanted to sell it the next day on the secondary market, you would take a 20 percent loss. There are annuity products that provide some limited liquidity, what they call benefit responsive, but is always a major fiduciary risk. 

Hidden fees spread and expenses
Prudential in a 2013 conference documented by Bloomberg bragged that they had secret hidden spread fees of over 200 basis Points.[x]

This loophole allows insurance companies to hide as much 2% or 200 basis points (bps) in yearly spread profits.   I was quoted in the Wall Street Journal’s Marketwatch, stating that

“These excessive profits, even if called spread, act like fees and are used like fees,” [xi]     

In addition they continue to pay commissions out of the hidden spread which drive even more sales.

The National Association of Government Defined Contribution Administrators, Inc. (NAGDCA) in September 2010 created a brochure with this characterization of insurance company general account stable value that got beyond the high risks and right to fee disclosure.  

Due to the fact that the plan sponsor does not own the underlying investments, the portfolio holdings, performance, risk, and management fees are generally not disclosed. This limits the ability of plan sponsors to compare returns with other SVFs [stable-value funds]. It also makes it nearly impossible for plan sponsors to know the fees (which can be increased without disclosure) paid by participants in these funds—a critical component of a fiduciary’s responsibility.[xii] 

It is hard to comprehend why the DOL lets these products escape disclosure.  However, there is already ERISA litigation in which spread fees have been important in settlement negotiations.

Structure -Weak Cherry-Picked State Regulated Contracts and Useless Reserves
When you purchase an annuity, you do not get to own any securities, you just get a piece of paper.  

Whereas securities (and the firms issuing, offering or underwriting the instruments) are governed by the federal securities laws and regulated by the Securities and Exchange Commission, insurance companies and the contracts they enter into are governed by the States – 50 different regulators and bodies of law. Once again, the variety can be staggering. This is the world that retirement plan fiduciaries are being forced into. [xiii]

A 1992 Federal Reserve paper notes that the so-called insurance safety net is made of 50 different state regulators with a wide variety of regulations and is much weaker than most realize.  This allows companies to shop for insurance regulation among the 50 states to find the ones that have the softest regulations. [xiv]  In 2017, The European Union showed concern with the weakness of state regulators of insurance companies. [xv]

Investors are mostly unaware of this risk based on flimsy state guarantees which the Federal Reserve has said have little worth. [xvi] These guarantee fund balances are typically a joke with $0 as they pass the hat to other insurers if one goes under. 

Required Fiduciary Questions
What should a fiduciary document and become comfortable with before investing in an annuity.

1.Which state issues the annuity, what is their record, do they have conflicts of interest with the insurance company?

2.What is their minimum capital requirement in basis points for this annuity product in the state your contract is issues in? 

3.What is the current solvency of that states guarantee pool.

4. Get full fee disclosure all internal spreads (200+) before expenses and then with expenses and profits broken down?

5. Does the Annuity contract have a downgrade provision to get out if the company is downgraded?

All annuities flunk at least one of these fiduciary tests, most flunk all. By and large the Fortune 500 largest US Corporations have avoided these insurance company products in their 401(k) plans since 1992. This is not because of fear of regulators, but because of fear of lawsuits filed by employees under the Employee Retirement Income Security Act of 1974 (ERISA). Thus, many of these non-transparent insurance products are in smaller company plans which are not cost effective for plaintiff bars to litigate individually.  However, as litigation goes downstream there are over 9 thousand plans from $100mm to $3 billion out of the top 500 many of which have annuity assets.  It is these mid to large plans who need to resist the annuity marketing push into guaranteed income mostly hidden in target date funds.

[i] Pg. 6   Federal Reserve Bank of Minneapolis Summer 1992  Todd, Wallace  SPDA’s and GIC’s

[ii] https://commonsense401kproject.com/2022/02/28/stable-value-the-goood-the-bad-and-the-ugly-avoiding-litigation/ 

[iii] https://commonsense401kproject.com/2022/04/30/problems-with-target-date-funds/

[iv] https://commonsense401kproject.com/2022/02/10/401k-lifetime-income-a-fiduciary-minefield/

[v] https://www.benefitspro.com/2022/05/03/annuities-the-straw-that-breaks-the-back-of-retirement-plan-fiduciaries/

[vi] https://www.benefitspro.com/2022/05/03/annuities-the-straw-that-breaks-the-back-of-retirement-plan-fiduciaries/

[vii]  Federal Reserve Bank of Minneapolis Summer 1992  Todd, Wallace  SPDA’s and GIC’s http://www.minneapolisfed.org/research/QR/QR1631.pdf

[viii] http://www.federalreserve.gov/newsevents/testimony/bernanke20090324a.htm

[ix] https://www.morningstar.com/articles/1090732/what-belongs-in-401k-plans

[x] http://www.bloomberg.com/news/2013-03-06/prudential-says-annuity-fees-would-make-bankers-dance.html

[xi] _http://www.marketwatch.com/story/these-funds-give-retirement-savers-stabili
ty-2012-10-16_

[xii] http://www.nagdca.org/documents/StableValueFunds.pdf_

[xiii] https://www.benefitspro.com/2022/05/03/annuities-the-straw-that-breaks-the-back-of-retirement-plan-fiduciaries/

[xiv] Pg. 6   Federal Reserve Bank of Minneapolis Summer 1992  Todd, Wallace  SPDA’s and GIC’s

[xv] https://www.nytimes.com/2017/03/31/business/dealbook/will-overseas-regulators-trust-the-states-to-watch-insurers.html

[xvi]  Federal Reserve Bank of Minneapolis Summer 1992  Todd, Wallace  SPDA’s and GIC’s http://www.minneapolisfed.org/research/QR/QR1631.pdf

Problems With Target Date Funds

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by Chris Tobe, CFA, CAIA

Target Date Funds now are above 50% of all 401(k) assets.[i]   They are the most non-transparent plan investment option and the easiest to hide fees and play performance games.   They are also the dominant default option or QDIA (Qualified Default Investment Alternatives) resulting in the highest level of fiduciary responsibility.    Despite the high level of fiduciary risk, they are specifically designed to avoid accountability and thus need the most scrutiny. 

A 2021 study shows that in general Target Date funds cause participants to “lose 21%” over career to primarily excessive fees from proprietary funds.[ii]  A 2020 study finds that asset managers exploit reduced investor attention (i.e. lack of transparency) to deliver lower performance.[iii]

HISTORY
The history of the Target Date Fund, I believe, is mainly a story about Fidelity.   I think around 2002 they saw Vanguard and indexing as their biggest threat.  Fidelity needed a new vehicle to hide the fees for active mutual funds and created the Target Date Fund. 

With heavy lobbying by Fidelity, in 2006 the Pension Protection Act was passed. This act allowed for auto-enrollment of target-date funds into defined contribution plans and set the stage for QDIAs (Qualified Default Investment Alternatives), which strongly supported the growth of these funds.[iv] 

Fidelity had Target Date Funds ready to go before the legislation was passed and dominated in market share immediately, and still keep the highest levels today.  This gave them basically a 10-year ride from 2006-16 in which they could load-up their higher fee active funds in target date funds with little or no pushback.   Starting around 6 years ago there has been a shifting inside Fidelity’s target date funds toward greater indexing. 

USING THE RECORDKEEPER
After choosing a record keeper or administrator, most plans automatically default to the Target Date Funds of that company.   A prudent process would be to have a competitive bid, but most 401(k) committees make selections based on informal processes and relationships. 

Many times, the target date and administrative fees are commingled in the Target Date funds using revenue sharing to create a total lack of transparency.[v]

This record keeping default fuels the 2021 study showing that Target Date funds cause participants to “lose 21%” of their end-returns over their career due primarily to excessive fees from proprietary funds [vi]

A 2020 study found that the average higher-cost actively managed target date funds failed to perform as well as the cheaper indexed competition in the 2015-2019 period.[vii] Some of the actively managed funds did very well in relative terms, but most did not. We found that past performance is only weakly predictive of future performance. The implication is that even an active fund with a superior record has an expected future return below the passive alternative TDFs.

However, even within a record keeper’s Target Date Fund selections, there can be a wide variety of fee levels (especially with market leader Fidelity) in which 401(k) committees can make better fiduciary decisions. The burden is on the plan fiduciary to show why they are not selecting an index fund for the Target Date Fund the QDIA. 

HIDING HIGH RISKS & FEES IN TARGET DATE FUNDS
The least transparent Target Date Funds are those that are not SEC registered mutual funds.  Many are in poorly state regulated annuities either in whole or in part.   Many are in poorly state regulated Collective Investment Trusts (CIT)s. [viii]  There are a few good CITs like the Fidelity, Vanguard, T. Rowe Price that are clones of their SEC mutual funds at a lower cost.   Many CIT’s can hide private equity or annuities and their many hidden fees and risks. [ix]

Many, if not most, CIT based Target Date Funds and all the annuity TDF’s are a fiduciary breach based on the higher risks alone, not to mention the excessive fees.

GAMING THE BENCHMARK
Many plans rely on consultants to guide them in the selection of Target Date Funds.  However, some consultants have conflicts in which they are compensated more for high fee non-index funds in backdoor payments.  Plans blaming consultants on poor Target Date Fund choices does not absolve them from fiduciary liability, but in some cases they have been able to get conflicted consultants to pay a portion of the settlement. [x]

High fee Target Date Funds typically justify their existence by some manipulation of a benchmarks.   They may hold investments which are not in the benchmark, which create different performance and risk characteristics.   They may use different allocations, mostly to higher equity positions, to create the appearance of higher returns. 

A 2020 study shows Target Date Funds ‘Create a Lack of Accountability”[xi] For example a 2040 T. Rowe or American Fund can appear to outperform a 2040 Vanguard fund because it has a 90/10 equity allocation compared to 80/20 with Vanguard.   “Target Date Fund managers engage in fee-skimming by charging higher fees on the less observable, more opaque underlying funds” [xii]  Opaque funds can be illiquid high-risk alternatives like private equity and hedge funds & annuities.

In some cases, the courts have given active managers the benefit of the doubt on their claim that it is conceivable they could outperform index plans, especially in down markets. The validity of this market-based argument has become harder. The recent Supreme Court decision letting the appeal in Brotherston vs Putnam Investments, LLC stand upholds the use of index funds for benchmarking purposes in calculating damages – regardless of performance.[xiii]

PLAN ACTIONS
Plans should always document in their 401(k) plan minutes the following regarding Target Date Funds:

  • The plan’s investment policy statement should include provisions on selecting and monitoring Target Date Funds.  Does it address each asset class involved in the plan including inside the Target Date Funds?
  • Each asset class in each Target Date Fund should be fully evaluated in terms of risk, fees, and performance as if they were a standalone option. 
  • Assets that are not SEC registered mutual funds or registered securities such as private equity, annuities need additional scrutiny and documentation.
  • Additional documentation, including a Request For Proposals (RFP), should be required if the plan is using a recordkeeper vendor’s proprietary Target Date Funds.
  • Select an appropriate benchmark to evaluate each asset class in the funds.  Compare and justify the attributes of your fund if it has differences with the benchmark
  • Understand the different fees and compare fund family fees, bearing in mind that Target Date Funds have multiple layers of fees.
  • Do a RFP for Target Date Funds at least every 5 years.
  • Carefully document the reasons that the fund was selected.
  • Regularly monitor the funds.
  • Document any and all reasons for not removing retained funds if performance has lagged peer funds.

Target Date Funds are now above 50% of all 401(k) assets.[xiv] They deserve a 50% level of fiduciary oversight or even more because of their lack of transparency. 

[i]  https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3729750

[ii] https://www.kiplinger.com/investing/mutual-funds/602705/the-disturbing-conflicts-of-interest-in-target-date-funds

[iii] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3729750

[iv] https://mutualfunds.com/retirement-channel/history-target-date-funds/

[v] https://commonsense401kproject.com/2022/04/02/revenue-sharing-in-401k-plans/

[vi] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3729750

[vii] AN ANALYSIS OF THE PERFORMANCE OF TARGET DATE FUNDS John B. Shoven and Daniel B. Walton, https://www.nber.org/system/files/working_papers/w27971/w27971.pdf   Oct.2020

[viii] https://commonsense401kproject.com/2022/02/22/cits-collective-investment-trusts-in-401k-the-good-and-the-bad/

[ix] https://commonsense401kproject.com/2022/02/15/private-equity-in-401k-plans-a-ticking-time-bomb/

[x] https://commonsense401kproject.com/2022/03/09/conflicted-401k-consultants-should-plan-sponsors-fire-them-sue-them-or-both/

[xi] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3729750

[xii] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3729750

[xiii] https://www.plansponsor.com/supreme-court-will-not-weigh-burden-proof-index-fund-comparison/
https://401kspecialistmag.com/brotherston-v-putnams-far-reaching-401k-fallout/

[xiv] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3729750

Healthcare 401(k)/403(b) Plans: A Growing Target of Litigation

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by Chris Tobe, CFA, CAIA

Floodgates are opening after US Supreme Court Northwestern 403(b)Case. [i] Most Hospitals not affiliated with public universities are subject to ERISA laws.  Hospitals tend to have a higher percentage of high fee funds and a much higher risk of litigation.

Why are hospitals at such high risk?  My take is that the 403(b) culture with its mix of ERISA and non-ERISA plans tends to have higher fee providers especially those associated with insurance companies.   My other theory is that Hospitals face so much litigation on health care issues that this litigation is not seen as material by senior management.  GAO recently did a report confirming that 403(b) s are not as sensitive to fees. [ii]

Here is the list of the 21 ERISA class actions I have found against hospital and health care 403(b)s and 401(k)s.  Columbus GA Regional Hospital, Aurora Health WI Iowa Healthcare, Henry Ford 401k , Henry Ford 403b, Spectrum Health, Mercy Hospital Health IL Kalenda NY Barnabas Health. Rush University Medical Center, MedStar Health  MD, Boston Children’s Hospital Corporation, Froedherdt WI,  B.Braun Medical Inc.PA, Allina Health plan, Emory Healthcare, Bon Secours.   Settlements I have found include Norton Ky ($5mm),  Southcoast MA Hospitals Group ($2mm), Bronson Healthcare ($3mm),  Novant Health ($32mm).

Many hospitals do not have independent consultants and one Lockton actually paid $2.5mm of the $5mm Norton Hospital settlement. [iii]  Many hospitals still use revenue sharing which is a magnet for litigation. [iv]  Hospitals are also high users of annuities. [v]

For most hospitals who have not paid attention and lowered fees already substantially it is only a matter of time before they face litigation.  Even larger physician groups will soon be subject to litigation as well.  Plans doing half fixes will not avoid litigation and some who have already settled may be sued a 2nd time.

[i] https://commonsense401kproject.com/2022/03/04/brave-new-world-how-hughes-v-northwestern-the-fiduciary-responsibility-trinity-and-the-active-management-value-ratio-are-changing-the-401k-landscape/

[ii] https://www.financial-planning.com/list/gao-study-examines-403b-plans

[iii] https://commonsense401kproject.com/2022/03/09/conflicted-401k-consultants-should-plan-sponsors-fire-them-sue-them-or-both/

[iv]  https://commonsense401kproject.com/2022/04/02/revenue-sharing-in-401k-plans/

[v] https://commonsense401kproject.com/2022/02/28/stable-value-the-goood-the-bad-and-the-ugly-avoiding-litigation/

Conflicted 401(k) Consultants-Should Plan Sponsors Fire Them, Sue Them…Or Both?

/ jwatkins / 4 Comments

Many if not most 401(k) consultants for 401(k) plans under $1 billion have serious conflicts of interests which in itself can be a fiduciary breach and contribute to excessive fees.  While the number of conflicted consultants and level of conflicts in mega plans is still significant it is less prevalent.   A Plan Fiduciary with a conflicted consultant takes on much greater fiduciary risk of getting sued. 

Ignorance of conflicts is no excuse.  Even comedians like John Oliver have done videos on 401(k) advisor conflicts and if you have not seen it please watch at  https://www.youtube.com/watch?v=gvZSpET11ZY  

As the number of plans being litigated under $1billion grows, this issue will come out front.  Already in the Norton Hospital Case the conflicted consultant Lockton ended up pay half of the $5.75mm settlement. 
https://www.planadviser.com/lockton-norton-healthcare-agree-pay-5-75m-erisa-settlement/

Attorney James Watkins states that Consultants/Advisors recommending cost-inefficient/imprudent investment options to a plan sponsor, knowing that the plan is held to a fiduciary standard, violates duty of fair dealing, which is actionable as a breach of contract per SCOTUS (Shaw v. Delta Air Lines).

Jennifer Cooper published a report on the US consultant industry in 2013 based on the ADV report filed by RIA’s.[i]

They found numerous conflicts.   The most common being dually registered consultant/advisors who are also brokers or have affiliated brokers. [ii] 

Dr. Nicole Boysen of Northeastern University in Boston has written a paper that shows consultant/advisors (RIAs) that both charge fees and commissions (dual registration) use higher fee lower performing mutual fund families that kick them back the most in “revenue sharing” Boysen created a list of high fees underperforming mutual funds preferred by dual registered RIAs, which include the American Funds, JP Morgan, MFS Fidelity, PIMCO.[iii]   Conflicted consultants are also known to manipulate statistics using cherry-picked benchmarks to make higher fee funds look better.

From a Forbes story by former SEC attorney Edward Siedle:

In recent years the U.S. Department of Labor, the Securities and Exchange Commission, and the General Accountability Office have all advised companies sponsoring retirement plans that conflicts of interest related to investment consultants to plans are widespread and that these conflicts have resulted in reduced returns, as well as higher fees for retirement investors. [iv]……..

While every investment consultant I’ve ever met claims to provide objective, independent advice, the industry is rife with conflicts. If the gatekeepers vetting and recommending money managers to plans are corrupt, then the plan’s entire investment program may be tainted. [v]…………

In fact, consultant conflicts are more pervasive than ever today and, with the growth of alternative investments, consultant secret profits, as well as damages, related to these conflicts have skyrocketed. Most plan sponsors, even  the largest, haven’t a clue about the abuses and, unfortunately, aren’t looking for answers. [vi]

The SEC and FINRA from 2018-20 fined dozens of Dual Registered RIA firms for excessive mutual fund fees around Share Class violations and Revenue Sharing in 401(k) and retail accounts. [vii]

·       SEC – Merrill Lynch (Bank of America) –  Share Class Violation April 17, 2020

·       SEC- Wells Fargo  (Bridgehaven) Share Class March 11, 2018

·       SEC JP Morgan Share Class January 9, 2020

·       SEC  Morgan  Stanley (Greystone) Share Class  November 7, 2019

·       SEC LPL  3/11/19  (Fiduciary First)

·       FINRA AxaEquitable 19

·       SEC MML   Mass Mutual   Sept 21  Rev Sharing Share class violations  

·       SEC VALIC Financial Advisors Inc.  AIG-VALIC   July 28, 2020 Rev Sharing Share class violations

·       SEC VOYA Financial Advisors Inc ING-VOYA    Dec. 21, 2020 Share class   Rev Sharing Share class violations

·       SEC PRUCO Securities, LLC   Dec 23, 2020   Rev Sharing Share class violations

·       FINRA PIMS  (Prudential) June 2020

·       SEC PRINCIPAL Securities, Inc.  March 11, 2019 SEC  Rev Sharing Share class violations

·       SEC TRANSAMERICA  Sept 30, 2020 fee gauging    TA FINRA Share Class Variable 2020 annuities   2014 Fee Gauging    

Any fiduciary who used these so-called consultants in the last 6 years has some serious fiduciary liability in a court case.

Any fiduciary who did not fire these so-called consultants after these SEC fines could have additional liability.

The following consultants have the ability to participate in conflicted activities like revenue sharing.  Not every plan especially some of the largest ones, may have direct conflicts at a given point in time.  This is especially true of Strategic Advisors a Fidelity affiliate as Fidelity has thousands of conflicted and non-conflicted plans.  

LARGE CONFLICTED CONSULTANTS ie DUALlY REGISTERED

  • CAPTRUST Cammock
  • Lockton
  • Sageview
  • Newport Capital
  • CBIZ
  • ADVISED ASSET GROUP LLC owned by Empower (formerly known as Great Western    Strategic Advisors owned by Fidelity).

Plan Sponsors should look at the independence of their advisor/consultants and their regulatory record.  Do they take ERISA fiduciary liability in their contracts? 

If the consultant is lacking in fiduciary responsibility they should be fired.   If these conflicts caused damage you should  consider legal action.  

[i] US Pension Investment Consultants A Report for Fiduciaries, Internal Audit and Risk Management Professionals in 2013[i] Diligence Review Corporation led by Jennifer Cooper, CF

[iii] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3360537

[iv] Forbes, Edward Siedle 6/1/2013 https://www.forbes.com/sites/edwardsiedle/2013/06/18/conflict-free-retirement-plan-advisers-remain-hard-to-find/?sh=4c46e9ee1f24

[v] Forbes, Edward Siedle 6/1/2013 https://www.forbes.com/sites/edwardsiedle/2013/06/18/conflict-free-retirement-plan-advisers-remain-hard-to-find/?sh=4c46e9ee1f24

[vi] Forbes, Edward Siedle 6/1/2013 https://www.forbes.com/sites/edwardsiedle/2013/06/18/conflict-free-retirement-plan-advisers-remain-hard-to-find/?sh=4c46e9ee1f24

[vii] Quote on SEC action in Voya, Valic, Prudential,Principal etc.

https://www.financial-planning.com/news/ameritas-ria-settles-sec-disclosure-case-for-4-6m

Stable Value: The Good, the Bad and the Ugly-Avoiding Litigation

/ jwatkins / Leave a comment

By Christopher B. Tobe, CFA, CAIA    

I contend that the Good version of Stable Value is still the best low risk investment for 401(k) plans.  With an estimated $700 billion in assets, Stable value is typically 15% to 30% of assets in many DC plans.    Stable Value’s popularity with participants is well deserved.  It’s combination of principal protection like a money market and solid returns closer to an intermediate bond fund are unmatched among 401(k) choices.  Stable Value in recent years has had yields nearly triple that of Money Market. A recent Wharton study has confirmed the superior risk/return profile of stable value funds compared to money market and bond funds. [i]

There has already been litigation against firms that did not offer stable value at all and only offered money market.  Plans who want to avoid litigation need to get the Good versions of Stable value which are the diversified synthetic GIC based products.

All Stable Value funds use Guaranteed Investment Contracts (GIC’s) to provide them book value accounting, which allows for a smoothing of returns and no negative periods.  There are 3 basic categories of stable value:  1. the original General Account or Traditional GIC (Ugly) 2.  Insurance Company Separate Account GIC (Bad) 3. Synthetic GIC sometimes known as a wrap. (Good)

Mega ERISA 401(k) plans abandoned General account GIC’s almost 30 years ago after the Executive Life and Confederation Life defaults of 1992.   Large ERISA plans for the most part abandoned Insurance company Separate Account stable value 20 years ago and have almost all converted to Synthetic GIC’s.  Many mid-size and multi-employer plans access synthetic stable value via over 30 Stable Value Pooled Funds which are Bank Collective Trusts with well-known names such as Fidelity, Vanguard, T. Rowe Price, and others since stable value is not offered in mutual funds.    With synthetic GIC’s the plan owns the underlying bonds usually 95% to 100% of the total value, while with the insurance company separate account and general account the plan does not own any securities but owns a contract with the insurance company.    All the large independent consultants recommend synthetic stable value as evidenced in this recent February 2022 article in Plan Sponsor quoting Willis Towers Watson.[ii]

NAGDCA the association representing public DC plans in a September 2010 brochure had the following characterization of General Account stable value. Due to the fact that the plan sponsor does not own the underlying investments, the portfolio holdings, performance, risk, and management fees are generally not disclosed...[i]

Ben Bernanke spoke in 2008 in defending the AIG bailout saying, “Workers whose 401(k) plans had purchased $40 billion of insurance from AIG against the risk that their stable value funds would decline in value would have seen that insurance disappear.”  I contend that an ERISA plan should not take on the single entity credit risk and liquidity risk of an insurance Company especially in the aftermath of AIG and in the so-called end of too big to fail?  

The largest providers of the Bad and Ugly versions of Stable Value are Prudential, Principal, Lincoln, TIAA, MetLife, NYLife, MassMutual,John Hancock, Great West, Transamerica.   You tend to still find them in 403(b)s, smaller 401(k)s and of course 457 plans which are exempt from ERISA.  These bad and ugly versions of stable value are litigation magnets with their hidden fees many times in excess of 200 basis points (2%) along with high single entity credit risk.

Synthetic stable value options which are transparent, diversified and have low fees are widely available for any 401(k) plan over $50 million in size.  Using bad stable value or skipping stable value increases your litigation risk.   Even then with good stable value you still need to look at fees between options.   

Chris Tobe, CFA, CAIA is a leading expert on Stable Value http://www.christobe.com/stablevalue/    writing dozens of articles and the only book “The Consultants Guide to Stable Value” published this century.

[i] http://fic.wharton.upenn.edu/fic/papers/09/p0925.htm

[ii] https://www.plansponsor.com/in-depth/role-stable-value-funds-qdias-otherwise/

[i] http://www.nagdca.org/documents/StableValueFunds.pdf

NAGDCA 2010GADownload

The “Fiduciary Prudence Trinity”: ERISA Fiduciary Law After the Hughes/Northwestern Decision

/ jwatkins / Leave a comment

SCOTUS recently announced its much anticipated decision in the case of Hughes v. Northwestern University.1The significance of the decision cannot be overstated, as it dramatically changes the “rules of the game” for 401(k) and 403(b) retirement plans,

Hughes was the last piece of what I am referring to as the “Fiduciary Responsibility Trinity.” The trinity is composed of three key ERISA related decisions-Tibble v. Edison International2, Brotherston v. Putnam Investments, LLC3, and Hughes. Given the heavy reliance that the Supreme Court and the First Circuit Court of Appeals, as well as the Solicitor General, placed on the common law of trusts, an argument can be made that the logic set out in the trinity decisions is equally applicable to all investment fiduciaries.

So why are the trinity so important? Here are key quotes from each decision.

Tibble:

We have often noted that an ERISA fiduciary’s duty is ‘derived from the common law of trusts.’ In determining the contours of an ERISA fiduciary’s duty, courts often must look to the law of trusts.4

The Restatement (Third) of Trusts is a restatement of the common law of trusts. So, the Court is recognizing the Restatement as a legitimate resource in addressing fiduciary questions.

Under trust law, a trustee has a continuing duty to monitor trust investments and remove imprudent ones. This continuing duty exists separate and apart from the trustee’s duty to exercise prudence in selecting investments at the outset…. Rather, the trustee must ‘systematic[ally] conside[r] all the investments of the trust at regular intervals’ to ensure that they are appropriate….In short, under trust law, a fiduciary normally has a continuing duty of some kind to monitor investments and
remove imprudent ones.5

Brotherston:

Congress sought to offer beneficiaries, not fiduciaries, more protection than they had at common law.6

[A]ny fiduciary of a plan such as the Plan in this case can easily insulate itself by selecting well-established, low-fee and diversified market index funds. And any fiduciary that decides it can find funds that beat the market will be immune to liability unless a district court finds it imprudent in its method of selecting such funds, and finds that a loss occurred as a result. In short, these are not matters concerning which ERISA fiduciaries need cry “wolf.”7

[T]he Restatement specifically identifies as an appropriate comparator for loss calculation purposes ‘return rates of one or more. . . suitable index mutual funds or market indexes (with such adjustments as may be appropriate).’8

In Brotherston, the lower court had ruled that the plan participants’ expert could not calculate alleged damages by comparing actively managed funds within the plan with comparable index funds, the copurt ruling that that would constitute comparing “apples to oranges.” The First Circuit’s decision effectively discredits the “apples to oranges” argument.

Hughes:

The Seventh Circuit erred in relying on the participants’ ultimate choice over their investments to excuse allegedly imprudent decisions by respondents. In Tibble, this Court explained that, even in a defined-contribution plan where participants choose their investments, plan fiduciaries are required to conduct their own independent evaluation to determine which investments may be prudently included in the plan’s menu of options…. If the fiduciaries fail to remove an imprudent investment from the plan within a reasonable time, they breach their duty.9

The Seventh Circuit had dismissed the plan participants’ case on the basis of the “menu of options” argument, which said a mixture of both prudent and imprudent investment options within a plans was permissible, as it provided plan participants with more choices. SCOTUS effectively discredited the “menu of options” defens

Going Forward
Bottom line, the combined impact of the trinity decisions is that cases will now be decided based on their merits, not on legal fictions such as the “apples and oranges” and “menu of options” defenses. This should result in more protection for plan participants in the form of fewer dismissals of 401(k)/403(b) …as long as the attorneys for plan participants properly plead such cases to meet SCOTUS’ plausibility standard for pleading.

Notes
1. Hughes v. Northwestern University, 19-1401 (2022).
2. Tibble v. Edison International, 135 S. Ct. 1823 (2015).
3. Brotherston v. Putnam Investments, LLC, 907 F.3d 17 (2018).
4. Tibble, 1828.
5. Tibble, 1828-29.
6. Brotherston, 37.
7. Brotherston, 39.
8. Brotherston, 31.
9. Hughes, Ibid.

James W. Watkins, III, is a licensed attorney (41 years), specializing in securities and ERISA law, a Certified Financial Planner™ professional (32 years) and an Accredited Wealth Management Advisor.™ He has extensive experience in evaluating the legal prudence of various types of investments, including mutual funds, and advising 401(k)/403(b) pension plans on both designing and monitoring plans to ensure legal compliance.