3Q 2022 AMVR “Cheat Sheets”

At the end of each quarterly, I update the five and ten-year Active Management Value Ratio analyses for the non-index based mutual funds in the top ten funds in “Pensions & Investments” list of most commonly used mutual funds in U.S. defined contribution.

Given the recent performance of the markets, it should come as no surprise that the 5 and 10-Year AMVR analyses of the six most popular non-index mutual funds in U.S. defined contribution plans remain relatively unchanged.

Interesting to note that for both the 5 and 10-year period, only Vanguard PRIMECAP Admiral shares managed to qualify for an AMVR ranking.

Also interesting to note the importance of factoring in a fund’s risk-adjusted returns. On the 5-year AMVR analyses, factoring in risk-adjusted returns turned AF’s Washington Mutual Fund’s incremental return from (0.90) on nominal returns, to a positive 0.13. Admittedly, a small positive number, but still a significant change.

On the 10-year AMVR analyses slide, factoring in the fund’s risk-adjusted returns turned their incremental return from (0.57) (nominal) to 0.57 (risk-adjusted.) Likewise for Fidelity Contafund, where an incremental return of (0.79) (nominal) turned into a small, yet positive, 0.09.

Overall, the song remains the same, with the majority of actively managed funds being unable to overcome the combination of the weight of higher fees and cost and high r-squared/correlation of returns number to beat the index of comparable index funds

And so, we continue to see 401(k) actions alleging a breach of fiduciary duties by plan sponsors. Of note, we are seeing an increasing number of cases focusing on target date funds (TDFs). I expect to see more actions involving TDFs, as the AMVR provides compelling evidence of the imprudence of the active versions of such funds. I will post an updated analysis of the active and index versions of both the Fidelity Freedom and TIAA-CREF Lifestyle TDFs next week

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Record Keeping Costs and the War Against Transparency

Chris Tobe, CFA, CAIA

Somehow some judges are buying this fallacy that participants get better recordkeeping by paying substantially more for it.  They are accepting this myth without proof and are actually blocking the transparency which would expose this truth by denying discovery. 

Low-Cost recordkeeper Employee Fiduciary says “There are few industries where the phrase “you get what you pay for” is less applicable than the 401(k) industry. That’s because equally competent 401(k) providers can charge dramatically different fees for comparable administration services and investments.[i]   Employee Fiduciary comes out with an example weekly on huge savings in recordkeeping. [ii]

There are no material differences in quality of recordkeeping services    Fidelity at $30 a head is same service as Fidelity at $90 a head.  There are really no material differences that a participant can tell between any recordkeepers, they get statements and have access to a web site.    –

Smug articles gloat on how courts have blocked transparency of discovery for so called differences in record keeping quality that no participants or anyone in the industry can even measure. [iii]  As attorney James Watkins says “Requiring a plaintiff to plead specific information known only to the defendant, without an opportunity to discover such specifics, is obviously just an attempt to protect plans.”

In this absurd insult to justice and transparency, some judges are putting the initial burden of proof on participants where the plan is deliberately hiding the critical information needed to fulfill that burden.

In addition, revenue sharing is an another way to help hide excessive recordkeeping fees, as some judges ignore these obvious issues. A 2021 study by experts from the Federal Reserve and leading universities says higher fees are not associated with better performance; to the contrary, “The future performance of revenue-sharing funds is weaker than that of non-sharing funds.  The bulk of the under-performance is driven by higher fees, though revenue sharing funds display lower performance even after accounting for fees.”[iv]

Revenue sharing does not hold up during discovery and this has been confirmed by the fiduciary liability insurance industry, which put much higher litigation risk on plans with revenue sharing and either denying coverage or raising rates significantly. [v]

There are some instances of additional administrative services couched as education that can, in fact, be harmful to participants.   Especially insurance providers, and especially in hospitals which are known to provide commissioned salespeople who actually try to push participants into higher fee funds and cross-sell them on imprudent outside investments as well.

Competitive recordkeeping costs have been established at $30 to $50 per heard for plans over $200 million in assets.   There are no material differences in the quality of recordkeeping.  Judges are dismissing fees double to such fees for identical services. The fact that such fees are largely ignored because they are non-transparent in no way reduces the  significant harm they cause to participants.


[i] https://www.employeefiduciary.com/knowledge-center/dont-let-your-401k-provider-hide-the-cost-of-your-plan

[ii] https://www.employeefiduciary.com/sample-fee-comparisons/

[iii] https://www.natlawreview.com/article/light-dark-seventh-circuit-helps-clarify-new-pleading-standards-401k-fee-cases

[iv] Pool, Sialm, and Stefanescu, Mutual Fund Revenue Sharing in 401(k) Plans, May 14, 2021,  available at: https://ssrn.com/abstract=3752296

[v] https://www.plansponsor.com/factors-can-cut-cost-fiduciary-liability-insurance/

Predicting Future 401(k) Litigation Risk by Size of Plans

by Chris Tobe, CFA CAIA

The 401(k) market differs greatly by size.  85 percent of 401k plans (534 out of 631 thousand defined contribution plans) (DC Plans) are under $5 million in size.  The DOL is overwhelmed with the 534 thousand plans under $5 million, of which there are enough bad actors doing engaged in highly questionable activities, such as taking participants’ money for personal use, that they have not touched the excessive fees issue, leaving it to the legal community to address such concerns.  Less than 1 percent of DC Plans are over $200 million in assets and are generally cost effective to litigate.

However, less than 1 percent is still nearly 4000 plans with over $200 million each in assets.   However, within this 4000, differences vary greatly by size as well.   My best guess is that less than 500 actions have been filed according to what I have found.   I still believe there is room for around 2500 more actions to be filed over the next decade.      

An August 2022 Bloomberg article cites $150 million in settlements over the last 3 years. Bloomberg puts the number filed at around 200 since 2019 so my estimates may be conservative.[i]  Bloomberg notes that decisions issued in the seven months since the US Supreme Court Hughes decision have tended to favor plaintiffs over defendants. Bloomberg predicts that “employers negotiating future settlements may be facing higher price tags than the $1 million to $5 million range seen over the past few years.” This Bloomberg article shows a growing pace of ERISA litigation.

An August 2022 article by Fred Barstein of 401kTV also predicts the rapid growth of litigation in smaller 401(k) plans. [ii]

401(k) plans of $3 billion and more assets
According to my data base there are 334 plans over $3 billion in assets.  This has been the most litigated group, with well over 100 actions filed. There is still a high probability of 100 or more cases coming from this group, perhaps even more if there is double dipping, as many earlier litigating plans have gone halfway at best in lowering fees.

For larger plan administrative costs, fees above $50 a head, or even one high fee option, may be enough to trigger a suit. This could apply to plans that have already been litigated once and did not adequately cut costs the first time. Does every plan option have to been prudent even those who go through to the brokerage window?  If so, this could this be litigated as high fee funds and even Crypto Currency are in widely held brokerage windows.

Many of the largest plans unitize investments with defined benefit plans. Will the new level of transparency go through to target date funds with underlying alternatives like Private Equity?  Alternative contracts typically contain multiple fiduciary breaches, excessive fees along with liquidity and other breaches. 

401(k) plans of $1b – $3 billion

There are an estimated 717 plans between $1-$3 billion, with probably 200 that have been litigated, leaving room for maybe 300 more. 

There are lots of plans with administrative costs above $50 a head, or even more with at least one high fee option, along with all the other attributes like brokerage windows like the largest plans.

401(k) plans of $500m – $1 billion
There are 961 plans between $500m $1 billion, with probably only 50 or less cases litigated.  This area will probably have the most explosive growth, with well over 600 plans with high fee providers. There are many higher fee insurance recordkeepers in this group and conflicted consultants, along with share class violations in many funds.

401(k) plans of $200m – $500m
There are 2259 plans between $200-$500 million. 2022 will start to see a great growth in litigation in this area.      Plans in this group who start fixing their plans could greatly minimize their chances of litigation. I still guess that over 1500 plans could be subject to litigation. There are even more higher fee insurance recordkeepers in this group and conflicted consultants, along with share class violations in many funds.

403(b) plans
ERISA 403(b) plans include: not-for-profit hospitals, and not-for-profit universities, private not-for-profit K-12 schools. Non-ERISA 403(b) plans include public K-12 schools, public universities and some university related hospitals.

The largest 30 or so private universities 403(b)s have already been hit with litigation.  Northwestern is typical with 3 different recordkeepers Fidelity, Vanguard, & TIAA.  This portion of the 403(b) market with multiple recordkeepers is unique as almost all 401(k), which is more oriented toward single record keeper, so all could be litigated around administrative costs.   Fidelity and TIAA also have high-cost options and TIAA has high-cost higher risk annuity options as well.  The next 100 or so private universities will be at great risk of litigation.

The big wave of 403(b) litigation will probably be hospitals.   While they typically only have one recordkeeper, they are much more likely than 401(k) plans of the same size to use higher fee (especially insurance company) based platforms.

401(k) plans of $50m – $200m
There are an estimated 8646 plans between $50-$200 million. I predict litigation will be low in 2022 as there are so many larger targets.  However, over the next decade it could pick up.   This gives plans in this size range time to clean up their plans, giving maximum value to participants while minimizing litigation risk in the future.

Higher fee insurance recordkeepers, conflicted consultants along with multiple share class violations, are rampant in this group with much higher percentage.

401(k) plans of $20-$50m and $5-20m
There are an estimated 14915 plans between $20-$50 million and an estimated 69343 plans between $5-$20 million. I predict that litigation involving these plans will be rare during the next 5 years, as there are so many larger targets, but over the next decade it could pick up.   This gives plans in this size range time to clean up their plans, giving maximum value to participants while minimizing litigation risk in the future.

Parting Thoughts
401(k) litigation is only in its infancy, with only 15-20 percent of the 3000 potential largest complaints filed. This number could triple if the litigation goes down to plans from $50-$200 million.   All of the controversy now is mostly in the largest cases being litigated.   Most of these smaller cases are much more clear-cut regarding potential fiduciary violations.

Plans can fix themselves or wait to be sued. Unfortunately, many are close-minded, relying solely on conflicted advice from brokers and insurance agents that tell plans that they are OK when they actually are not. Many plans will be in for a rude awakening. 


[i] https://news.bloomberglaw.com/litigation/suits-over-401k-fees-nab-150-million-in-accords-big-and-small?context=search&index=0  
[ii] https://www.wealthmanagement.com/rpa-edge/why-lawsuits-against-rpas-smaller-dc-plans-are-inevitable

Contact Info: 542-648-1303, tobech348@gmail.com, christobe.com

The Conversation Every 401(k) and 403(b) Plan Needs to Have: The Plan Sponsor Liability Circle™

James W. Watkins, III, J.D., CFP®, AWMA®

Whenever plan sponsors and plan advisers talk about 401(k) litigation, they always point the finger at those bad ‘ol ERISA plaintiff attorneys. Since I am one of those bad folks, I respectfully disagree with such sentiments. I respectfully suggest that plan sponsors should look in the mirror to see the real party for such litigation. As the famous comic strip, “Pogo,” once said, “we have met the enemy and he is us.”

Whenever I talk with a CEO and or a 401(k) investment committee, this is the first graphic I show them. Most plan advisers insist on plan sponsors agree to an advisory contract that contains a fiduciary disclaimer clause. Many plan sponsors are not aware that they have agreed to such a provision since they are usually set out in legalese. But they are usually there.

When a plan sponsor agrees to such a clause, it waives important protections for both itself and the plan participants. With a fiduciary disclaimer clause, securities licensed advisers can claim to be subject to Regulation “Best Interest” (Reg BI) rather than the more demanding duties of loyalty and prudence required under a true fiduciary standard.

Reg BI claims that it requires brokers to always put a customer’s best interests first, including considering the costs associated with any and all recommendations. The Reg BI turns around and allows brokers to only consider “readily available alternatives,” which the SEC considers to be the cost-inefficient and consistently underperforming actively managed mutual funds and various annuity products. In whose best interests?

Unless a plan sponsor properly performs the investigation and evaluation required under ERISA, this usually results in 401(k) litigation and the plan sponsor settling for a significant amount. As we discussed in a previous post, when you consider that all of this can be easily avoided by a plan sponsor by performing a cost-efficiency analysis using our free Active Management Value Ratio, you have to wonder why plan sponsors do not better protect themselves by simplifying their plans and ensuring that they are ERISA-compliant.

My experience has been that most plan sponsors create unnecessary liability exposure for themselves due to a mistaken understanding of their true fiduciary duties. “The CommonSense 401(k) Plan”™ provides a simple solution that reduces both administration costs and potential liability exposure, resulting in a win-win situation for both plan participants and plan sponsors.

So, for plan sponsors and plan advisers, the next time you point a finger at ERISA plaintiff’s attorney and blame us for the number of 401(k) litigation cases, remember the words of my good friend, Charles Nichols, when you point at us, three of your remaining fingers point back at you. Then contact InvestSense for a free “The CommonSense 401(k) Plan” consultation at “CommonSense InvestSense.” (investsense.com)

Copyright InvestSense, LLC 2022. All rights reserved.

This article is for informational purposes only, and is neither designed nor intended to provide legal, investment, or other professional advice since such advice always requires consideration of individual circumstances.  If legal, investment, or other professional assistance is needed, the services of an attorney or other professional advisor should be sought.

401(k) Background Checks

By Chris Tobe, CFA, CAIA

I have looked at dozens of retirement committee meeting minutes working with both public and ERISA retirement plans and I have seen little or no discussion of vendor due diligence around lawsuits and regulatory issue.

When firms hire an employee, they usually do a background check.  From SHRM”

  • A background investigation generally involves determining whether an applicant may be unqualified for a position due to a record of criminal conviction, motor vehicle violations, poor credit history, or misrepresentation regarding education or work history. [i]

Given this exhaustive process for one new hire it makes sense to run the same type of background check on vendors for the employee’s retirement plan and It can be argued is the plans fiduciary duty to run one on each vendor.

In literally seconds you can find a list of violations for each firm at https://www.goodjobsfirst.org/violation-tracker

While a violation may not be an immediate reason to disqualify and terminate a vendor, it would be a good fiduciary process for the plan to ask the vendor to explain the violation and why it does not affect their ability to serve the plan.

A lot of plan fiduciaries would not be surprised by 401(k) litigation if they had followed this easy fiduciary process.    Many of the same firms caught by the SEC for share class violations for retail and other institutional funds are doing the same thing in 401(k) and it is showing up in litigation.  Many of these firms avoid fiduciary responsibility in their contracts multiplying this risk.

Violation tracker quickly shows: Prudential has 19 investor protection violations with fines totally over $744 million.[ii]  Wells Fargo has 223 overall violations 93 investor protection violations. Bank of America 264 overall violations 119 investor protection violations.

.Going to the SEC website under litigation you can easily find the following more detailed violations.

SEC  Merrill Lynch (B of A) –  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  TIAA July 2021 misleading statements failure to disclose conflicts of interest [i]
SEC  MML   Mass Mutual   Sept 21  Revenue Sharing Share class violations  
SEC  VALIC Financial Advisors Inc.  AIG-VALIC   July 28, 2020 Revenue Sharing Share class violations
SEC  VOYA Financial Advisors Inc ING-VOYA    Dec. 21, 2020 Share class   Revenue Sharing Share class violations
SEC  PRUCO Securities, LLC  (Prudential)  Dec 23, 2020   Rev Sharing Share class violations FINRA PIMS June 2020
SEC  PRINCIPAL Securities, Inc.  March 11, 2019 Revenue Sharing Share class violations
SEC  TRANSAMERICA  Sept 30, 2020 fee gauging    TA FINRA Share Class Variable 2020 annuities   2014 Fee Gauging   

A prudent ERISA fiduciary should be aware of these violations, and/or their consultants/attorneys should have brought this to their attention.  They should also be aware of any 401(k) litigation each vendor is involved in both directly and indirectly. 

Each vendor’s contracts should state they take fiduciary duty as to not shift it back to the plan.

 A background check for every vendor is essential for fiduciaries.

Notes
[i] https://www.shrm.org/resourcesandtools/tools-and-samples/toolkits/pages/conductingbackgroundinvestigations.aspx

[ii] https://www.goodjobsfirst.org/violation-tracker

[iii] http://www.sec.gov/litigation/admin/2021/33-10954.pdf

Brokerage Windows Exposed by Crypto

By Chris Tobe, CFA, CAIA  June 14, 2022

Crypto, trying to bribe its way into 401ks via Congress and with providers like Fidelity, has exposed a non-transparent dark area of 401(k) that has been on the back burner – brokerage windows.   A typical plan has 12 to 16 main options, but a brokerage window could add hundreds of additional choices that so far have escaped any oversight.  Fidelity stated they would put crypto as a main option and prompted this response from the DOL

“The plan fiduciaries responsible for overseeing [cryptocurrency] investment options or allowing such investments through brokerage windows should expect to be questioned about how they can square their actions with their duties of prudence and loyalty.”[i

The DOL advisory council put together a report on brokerage windows that basically said they are so immaterial, that the DOL needs to give little or no oversight to them since those in the brokerage window are aware of the additional risks.[v]

A report cites PSCSA that

23.2 percent of all retirement plans offer a brokerage window, and nearly 40 percent of those with more than 5,000 participants do. Even though brokerage windows are being offered in many plans, participants do not use them widely only 1.5 percent of plan assets are invested through brokerage windows. DOL states that custodians saw a usage ranged from .03 percent to 3 percent. [vi]

Because of their size, less attention has been paid to brokerage windows both by the DOL and the plaintiff’s bar.  But with the declaration by Fidelity to offer crypto as a main option within plans and the DOL doing its job by sounding concerns, people realized that there could be crypto investing already going on in brokerage windows, with most plans not having a clue.

Fidelity, who is the largest runner of brokerage windows and who cut the deal with bitcoin to put them on their platform, are most likely receiving millions of undisclosed dollars from the crypto crowd.

Crypto is pouring millions into DC lobbying, and seems shocked that DOL did their job and did not roll over like they did with private equity investments under Trump.

Bloomberg writes that

Under that guidance, which the DOL issued last month, employers could be responsible for risky crypto trades their workers make in workplace 401(k)s. The DOL’s employee benefits enforcement agency will launch what it’s calling “an investigative program” that requires plan officials to “square their actions with their duties of prudence and loyalty” if they allow crypto investments in self-directed accounts, according to the guidance.[vii]

“This is a very damning statement about brokerage windows,” said Lisa Tavares, a partner at Venable LLP and a former IRS attorney.”

Since almost all brokerage windows have excessive fees and many have excessive risks that do not pass fiduciary scrutiny, this opens up almost any plan with a brokerage window to potential litigation. 

Leading plaintiffs firm Keller Rohrback LLP is investigating whether employees and retirees have paid unnecessary fees in connection with their use of brokerage windows such as excessive fees, selecting funds based on the amount of fees shared with the brokerage firm, and selecting more expensive share classes despite the availability of less expensive classes of the same fund.   They have targeted particular large firms like Continental Airlines, Kimberly-Clarke, Lilly, and Caterpillar looking for plaintiffs.[viii]

In the article, “401(k)s with Bitcoin Should Expect Lawsuits: Lawyers,” trade publication “Ignites” quotes Jerry Schlichter as saying that

Any employer who would follow the Fidelity lead by offering cryptocurrency and 401(k) plan is exposing itself to very serious risk of a fiduciary breach…. As an unproven, highly volatile investment, Bitcoin would test the prudence standard under the Employee Retirement Income Security Act….The account will carry a fee of up to 90 basis points, plus undisclosed commission fees, which would be 20 times as much as a simple index fund.[ix]

The defense bar is trying to talk up a structure the digital accounts to qualify for 404(c) protections. Schlichter, however, suggested that 404(c) protections would not provide a safe harbor anyway. He pointed to a Supreme Court decision handed down in January that found that plan sponsors could not escape their responsibility for allowing imprudent investments in their plans even if they feature them alongside prudent ones. Schlichter represents the plaintiffs in that case, the plan participants in Northwestern University’s 403(b) plan. Quoting Schlichter,

“[The Supreme Court] said, ‘No, the employer plan sponsor has the duty to furnish only prudent options,’ and the same applies here.'”

Any 401(k) plans with a brokerage window will be subject to severe fiduciary liability unless they can prove they have provided 100% prudent options.  This will most likely lead to much more litigation and many more settlements, as the cost of proving 100% prudent options will be extremely expensive. 


[i] DOL Guidance Could Put a Crimp in 401(k) Brokerage Windows SHRM   https://www.shrm.org/resourcesandtools/hr-topics/benefits/pages/dol-guidance-could-crimp-401k-brokerage-windows.aspx.  

[ii] https://www.morningbrew.com/daily/stories/2022/05/27/crypto-money-is-shaking-up-us-politics.

[iii] https://news.bloomberglaw.com/crypto/yellen-says-crypto-is-very-risky-option-for-retirement-savers?context=search&index=4

[iv] https://news.bloomberglaw.com/daily-labor-report/401-crypto-investment-restrictions-eyed-by-labor-regulators?context=search&index=0

[v] DOL Advisory Council on Pension Benefit Plans Understanding Brokerage Windows in
Self-Directed Retirement Plans December 2021 (“Brokerage Windows”).

[vi] Brokerage Windows, supra.

[vii] https://news.bloomberglaw.com/daily-labor-report/new-crypto-guidance-rewrites-rules-on-401k-brokerage-windows.

[viii] https://krcomplexlit.com/the-newsroom/keller-rohrback-l-l-p-investigates-excessive-fees-401k-brokerage-window

[ix] https://www.ignites.com/lead/c/3622614/465124?referrer_module=t.cohttps://uselaws.com/media-turns-to-jerry-schlichter-for-guidance-following-fidelity-bitcoin-announcement/

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

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

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

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

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