Annuities are Prohibited Transactions

/ ChrisTobe / 1 Comment

I have been writing extensively on my blog about annuities not meeting the criteria for exemptions from being classified as ERISA Prohibited Transactions.  https://commonsense401kproject.com/2025/05/10/annuities-flunk-prohibited-transactions-exemption-scotus-ruling-will-open-floodgates-of-litigation/

 

First I started with the four pillars of the DOL’s Impartial Conduct Standards under PTE 2020‑02:

A. Care Obligation
B. Loyalty Obligation
C. Reasonable Compensation
D. No Materially Misleading Statements (including omissions)

Many annuity sales into ERISA plans currently fail one or more of these obligations, particularly with respect to:

  • Hidden spread compensation,
  • Inadequate due diligence on the general account backing the annuity,
  • Opaque or omitted disclosures,
  • And advisors who do not formally acknowledge fiduciary status in writing.

Have Any Annuity Contracts Accepted ERISA Fiduciary Responsibility?

✅ Very Few — and Almost Never in the Contract Itself

In general:

  • Group annuity contracts (e.g., used in 401(k) plans or defined benefit de-risking) may be accompanied by side agreements or representations from advisors, but:
    • The insurance contract itself typically does not declare the insurer (or even the selling agent) as a fiduciary.
    • Fiduciary acknowledgments, if they exist, come in the form of separate representations or appendices (required under PTE 2020-02 or 84-24).

🟥 In Most Cases:

  • Insurers explicitly disclaim fiduciary status in contracts.
  • Brokers or agents resist fiduciary acknowledgments—unless they’re affiliated RIAs under pressure.
  • Disclosure documents are vague, omitting spread compensation or how crediting rates are determined.

Examples of Industry Practice:

1. Disclaiming Fiduciary Status

Many annuity providers include contract clauses like:

“The insurer and its agents are not acting in a fiduciary capacity under ERISA or any applicable law in connection with the sale of this product.”

2. Delegating Due Diligence to the Plan Sponsor

Even in group annuity settings (e.g., stable value GICs, fixed annuity options), the language often places full fiduciary duty on the plan sponsor, e.g.:

“The Plan Fiduciary represents that it has independently evaluated the investment and insurance features of this contract.”

3. PTE 84-24 Acknowledgments—But Weakly Enforced

Some insurers may have separate PTE 84‑24 disclosure forms, which technically acknowledge:

  • Reasonable compensation,
  • Advisor acting in the best interest,
  • No misleading info.

But in practice, these are often:

  • Not thoroughly explained to the plan,
  • Signed by non-fiduciary agents,
  • Not integrated into the contract,
  • Poorly documented or monitored.

Recommendations for Plan Sponsors

If a plan is considering an annuity product under ERISA, the following should be required:

  1. Fiduciary Acknowledgment Letter — from the advisor or insurer.
  2. PTE 2020-02 or 84-24 Compliance Certificate — signed and included with plan records.
  3. Full Disclosure Statement — fees, conflicts, and spread compensation outlined clearly.
  4. Contract Review — ensure it doesn’t disclaim fiduciary responsibility while shifting burden to the sponsor.

———————————————————————————————————–

CONCLUSION

I am hopeful that the new SCOTUS decision will guide judges to compel them to disclose in discovery https://commonsense401kproject.com/2025/04/21/scotus-9-0-erisa-decision-in-cunningham-v-cornell-university-case-confirms-my-view-on-annuities-as-prohibited-transactions/. These spreads, which I feel in most cases are excessive, could be used to measure damages. 

Annuities flunk Prohibited Transactions Exemption – SCOTUS ruling will open floodgates of litigation.

/ ChrisTobe / Leave a comment

Annuities have always flunked but no one has ever challenged them because of their total lack of transparency.  Now with SCOTUS Cornell decision, the burden of proof has shifted to the plans to defend why they think annuities are exempt from being prohibited transactions, and for the most part they are clueless.

Most annuities in most DC plans are labeled “parties in interest” because they have a relationship with the administrator/recordkeeper.   This relationship creates a potential conflict of interest and labeled a Prohibited Transaction.  A Prohibited Transaction Exemption (PTE) must be used to include the annuities in the plan.

PTE’s are subject to the ERISA Impartial Conduct Standards which are a set of requirements for fiduciaries providing investment advice to retirement investors, ensuring they act in the best interest of the client, receive reasonable compensation, and avoid making misleading statements. 

Annuities for decades have claimed Prohibited transaction exemptions behind PTE 84-24 and more recently PTE 2020-02 with few challenges or any accountability.[1]  However, the recent SCOTUS decision clearly says plans are responsible for verifying that their investments qualify for the prohibited transaction exemptions.  The PTEs that apply to the insurance products they put in their plans where most are “parties in interest” must meet the Impartial Conduct Standards.[2]     

Judge Lynn when ruling on Fixed Index Annuities in 2017 stated   Because “insurers generally reserve rights to change participation rates, interest caps, and fees,” FIAs can “effectively transfer investment risks from insurers to investors.”[3]  this control by insurers clearly violates Impartial Conduct Standards.[4]  

ERISA PTE 84-24, which is based on the Restatement of Trust, states the annuities must meet the following requirements called the Impartial Conduct Standards and Written Disclosures and Policies and Procedures backing up these standards.  Most annuities I have seen do not even come close.

The Impartial Conduct Standards have 4 major obligations.   A. Care Obligation    B. Loyalty Obligation C. Reasonable compensation limitation D. No materially misleading statements (including by omission)

Care Obligation This obligation reflects the care, skill, prudence, and diligence – similar to Prudent Person Fiduciary standard.   Diversification is one of the most basic fiduciary duties. Under the CFA pension trustee standard for acting with prudence and reasonable care the plan should seek appropriate levels of diversification.[5]    Fixed annuities flunk this diversification test with single entity credit and liquidity risk. [6] 

The Federal Reserve in April 2025 said “Life insurers continued to hold a significant share of risky and illiquid assets on their balance sheets” [7]  Under the CFA pension trustee standard Principle #3 to Act with skill competence and diligence it cites need for awareness of investments liquidity, and any other risks.  Certain types of investments …necessitate more thorough investigation and understanding than do fundamental investments, such as straightforward and transparent equity, fixed-income, or mutual fund products   Annuities call for more diligence by sponsors which needs to be fully documented by plans.  Plan sponsors could mitigate this credit and liquidity risk in their annuity contracts with downgrade clauses which allow liquidity at book value if the annuity issuer is downgraded but these type clauses have not been adopted for most plans.[8]

Loyalty Obligation Annuity contracts are designed to avoid all fiduciary obligation with no loyalty to participants. Diligence is nearly impossible with misleading, nontransparent contracts, and the lack of plan/participant ownership of securities. Secret kickbacks and commissions place the financial interests of the Insurers and their affiliates over those of retirement investors.  The new fiduciary rule requires the advisor to show their loyalty with a “Fiduciary Acknowledgement Disclosure.” which has been strongly opposed by the Annuity industry.   Plans typically agree to Annuity contracts that avoid any fiduciary language or responsibility on the part of the issuer. [9]   The Federal Reserve in 1992 exposed the varying weak state regulatory and reserve claims and most plans are not even aware of which state issued their annuity contract.[10]

Reasonable compensation limitation Annuities have a total lack of disclosure of profits, fees and compensation – effectively denying any chance for a prospective purchaser to make an “informed decision.”  CFA Institute Global Investment Performance Standards (GIPS) are transparency standards on performance and fees. Annuities typically do not comply with CFA GIPS standards.[11]

Noted Morningstar analyst John Rekenthaler said in April 2022 that in selecting 401(k) investment options, “inappropriate are investments that don’t price daily.”  Annuities typically do not price daily and do not provide valuation transparency.[12]

A number of lawsuits have settled with claims of excessive secret fees and spreads in annuities. An insurance executive bragged at a conference of fees over 200 basis points (2%) in 2013. [13]  In a report, Morningstar acknowledges that annuities fees inside 401(k) plans are challenging to understand.  ‘No insurer tells you what is in the spread.’    ‘Insurance firms collect a spread”[14]     I was quoted on NBC that the TIAA Fixed Annuity made spread fees of around 120 basis points.  TIAA makes $billions in undisclosed profits on their fixed annuity products. TIAA annuity has been called the company’s profit “engine” driving $46.2  in bonuses to their top five executives.[15]    These IPG fixed annuity contracts have been characterized by DC plan group NAGDCA as having serious fiduciary issues with hidden fees.  “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 “ [16] 

No materially misleading statements (including by omission) Annuities have numerous material misleading statements in their contracts, including the total lack of disclosure of spread/fees.   Under the CFA pension trustee standard for policies Trustees should … draft written policies that include a discussion of risk tolerances, return objectives, liquidity requirements.[17] Plans with annuities many times do not have Investment Policy Statements or weak IPS that do not provide transparency or accountability for the annuities.[18]

The Annuity industry thrives on secret commissions.[19]  The GAO and Senator Warren reported on these commissions.[20] The annuity industry has fought the so-called Biden Fiduciary rule which would expose many annuity commissions in 401(k) plans.   The annuity industry trade group that coordinates weak state insurance commissioners National Association Insurance Commissioners (NAIC) best interest rule was ridiculed by a DOL Official “compensation is not considered a conflict of interest,” All 50 State Insurance Commissioners have rejected Fiduciary standards by adopting the NAIC best interest rules.[21]

Annuities claim principal protection, but some fixed annuity contracts recently have “broken the buck” and violated their contracts by forcing significant losses on participants.  The written disclosures under weak state regulations omit critical information on risks and fees also prevents any opportunity for an “informed decision.”

Conclusion

Annuities clearly flunk all 4 major obligations of the Impartial Conduct Standards and are not exempt as Prohibited Transactions. 

Plans with annuities have huge fiduciary liabilities which grow larger each year.  With the new Supreme Court Case CunninghamV.Cornell the risk of litigation, and potential damages have grown greatly. [22]  Within 2 weeks of the decision a case of annuities as prohibited transactions has already been filed.

Plan sponsors should amend their Annuity contracts to at least stop the growth of fiduciary liability.

1. A Most Favored Nation (MFN) clause to make sure they have the best rate/largest payouts/ lowest spread fees of all the annuity providers similar clients

2. A downgrade clause that allows liquidity at full book value if the insurance company issuing the annuity is downgraded.

3. Annuity provider agrees to be ERISA Fiduciary

If they cannot get these 3 clauses – the plan must demand that the annuity provider let them out of the contract, and if not consider legal action against the insurance company.

[1] https://commonsense401kproject.com/2024/11/19/burden-of-proof-is-on-plan-sponsors-hoping-to-qualifyfor-annuity-prohibited-transactions-exemption/

[2] https://news.bloomberglaw.com/daily-labor-report/high-courts-cornell-ruling-stands-to-supercharge-401k-suits

[3] Chamber of Commerce of the United States, et. al. v Hugler, 231 F. Supp. 3d 152 (N.D. Tex. 2017) (Lynn decision), 187

[4] Attorney James Watkins writes on the Fiduciary Risks of Annuities

Plan Sponsor and RIA Alert: Navigating the 78(3) Fiduciary Liability “Gotcha”

[5] https://rpc.cfainstitute.org/codes-and-standards/pension-trustee-code

[6] “Safe” Annuity Retirement Products and a Possible US Retirement Crisis   Dr. Tom Lambert and Chris Tobe  https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4761980

[7] https://www.federalreserve.gov/publications/files/financial-stability-report-20250425.pdf

[8] American Academy of Actuaries Report of the GIC With Credit Rating Downgrade  October 1999 https://www.actuary.org/sites/default/files/pdf/life/gic.pdf

[9] https://commonsense401kproject.com/2024/11/19/burden-of-proof-is-on-plan-sponsors-hoping-to-qualifyfor-annuity-prohibited-transactions-exemption/

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

[11] https://rpc.cfainstitute.org/-/media/documents/book/rf-publication/2017/rf-v2017-n3-1.pdf

https://www.cfainstitute.org/en/membership/professional-development/refresher-readings/gips-overview

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

[13] Annuity Executive brags on 200bps 2% fees https://www.bloomberg.com/news/articles/2013-03-06/prudential-says-annuity-fees-would-make-bankers-dance?embedded-checkout=true

[14] https://riabiz.com/a/2024/5/11/fidelity-voya-and-boa-smooth-blackrocks-launch-of-guaranteed-paycheck-etfs-but-401k-plan-participants-may-yet-balk-at-high-unseeable-fees-and-intangibility-of-benefits

[15] https://www.nbcnews.com/investigations/tiaa-pushes-costly-retirement-products-cover-losses-whistleblower-rcna161198

[16] http://www.nagdca.org/documents/StableValueFunds.pdf_ The National Association of Government Defined Contribution Administrators, Inc. (NAGDCA) September 2010

[17][17] https://rpc.cfainstitute.org/codes-and-standards/pension-trustee-code

[18] https://commonsense401kproject.com/2023/03/12/investment-policy-statements-crucial-to-fiduciary-duty/

[19] Consumer Federation of America on Biden Annuity Rule https://consumerfed.org/annuity-industry-kickbacks-cost-retirement-savers-billions/

[20] https://www.gao.gov/products/gao-24-104632   and Senator Warrens reported on Annuity kickbacks.[xiii]   https://www.warren.senate.gov/imo/media/doc/senator_warrens_annuity_report_-_sept_2024.pdf

[21] https://401kspecialistmag.com/all-50-states-now-on-board-with-naic-best-interest-annuity-rule/

[22]   https://commonsense401kproject.com/2025/04/21/scotus-9-0-erisa-decision-in-cunningham-v-cornell-university-case-confirms-my-view-on-annuities-as-prohibited-transactions/

SCOTUS’ 9-0 ERISA decision in Cunningham v. Cornell University case– confirms my view on Annuities as Prohibited Transactions

/ jwatkins / Leave a comment

SCOTUS 9-0 ERISA decision – confirms my view on Annuities as Prohibited Transactions

By Chris Tobe, CFA, CAIA

The Supreme Court ruled unanimously in favor of 401(k) Transparency, while also placing the burden of proof on plan sponsors alleging that they are protected under an exception to the Prohibited Transaction rules.  This rule facilitates forcing disclosures on conflicts of interest and hidden fees.[i]  Investments that the managers have the potential for a conflict of interest are labeled “Parties of Interest” in the DOL/IRS 5500 forms attached financials for ERISA plans.  These parties in interest have the burden of proof that they have an exemption from the Prohibited Transactions rules. 

Fixed Annuities, known as IPG’s, are prevalent in large ERISA DC plans.  The largest IPG is TIAA Retirement Choice Annuity which is central in the Cornell plan and, along with Fidelity, the focus of the SCOTUS decision.

I believe that all annuities are prohibited transactions due to the inherent conflict of interest issues, and in most cases, the annuity issuer and annuity salesperson  are labeled in plans as parties in interest.  Prohibited transaction exemptions are subject to meeting certain requirements.  But the DOL does not even attempt to enforce them.   Many plans just blindly accept the claims of annuity salesmen that these contracts have a “get out of jail free card” in the form of a PTE.

Prohibited Transactions Exemption PTE 84-24

Annuities for decades have claimed Prohibited transaction exemptions behind PTE 84-24.  However, plans are responsible for verifying that the prohibited transaction exemptions apply to the insurance products they put in their plans.   This SCOTUS decision and future similar cases may force accountability for the first time.

ERISA PTE 84-24, which is  based on the Restatement of Trust,  states the annuities must meet the following requirements called the Impartial Conduct Standards and Written Disclosures and Policies and Procedures backing up these standards.  Most annuities I have seen do not even come close.

The Impartial Conduct Standards have 4 major obligations.   A. Care Obligation    B. Loyalty Obligation C. Reasonable compensation limitation  D. No materially misleading statements (including by omission)

Care Obligation This obligation reflects the care, skill, prudence, and diligence – similar to Prudent Person Fiduciary standard.   Diversification is one of the most basic fiduciary duties.  Fixed annuities flunk this with single entity credit and liquidity risk. Diligence is nearly impossible with misleading, nontransparent contracts, and the lack of plan/participant ownership of securities.[ii] The Federal Reserve in 1992 exposed the weak state regulatory and reserve claims.[iii]

Loyalty Obligation Annuity contracts are designed to avoid all fiduciary obligation with no loyalty to participants.   Secret kickbacks and commissions place the financial interests of the Insurers and their affiliates over those of retirement investors. In most cases, the annuity investor has little chance of even breaking even on the investment. The exemption requires the advisor to show their loyalty with a “Fiduciary Acknowledgement Disclosure.”   Annuity contracts avoid any fiduciary language or responsibility.

Reasonable compensation limitation Annuities have a total lack of disclosure of profits, fees and compensation – effectively denying any chance for a prospective purchaser to make an “informed decision.” They also have secret kickback commissions.[iv]   A number of lawsuits have settled with claims of excessive secret fees and spreads. An insurance executive bragged at a conference of fees over 200 basis points (2%) in 2013. [v]

No materially misleading statements (including by omission) Annuities have numerous material misleading statements, including the total lack of disclosure of spread/fees.  They claim principal protection, but some fixed annuity contracts recently have “broken the buck” and violated their contracts.  The written disclosures under weak state regulations omit critical information on risks and fees also prevents any opportunity for an “informed decision.”

GOING FORWARD

While Annuities are by far the largest area involved, I believe SCOTUS’ Cunningham decision will result in some significant consequwemces:

  1.  ERISA class action 401k litigation will explode especially against conflicted products like annuities[vi]
  2. Plans are now talking about taking legal action against vendors, who tricked them into these non-transparent products[vii]
  3. Plans will be more reluctant to take on non-transparent products like annuities[viii]
  4. Plans will be more reluctant to take on non-transparent products like crypto and private equity[ix]
  5. Plans will be more reluctant to do non-transparent administrative practices like revenue sharing[x] 

Plan Sponsors with fixed annuity contracts should demand
: 1. A MFN clause to make sure they have the best rate. A MNF (Most Favored Nation) clause is a clause that states that money managers are getting the lowest fee for their pension clients.
2. A downgrade lause that allows liquidity at full book value if the insurance company issuing the annuity is downgraded.

Annuities are clearly prohibited transactions that do not qualify for an exemption but have used their lobbying power in Washington and in states, to exempt themselves from all accountability.  This recent SCOTUS decision  may  help get accountability and transparency in plans through litigation.

[i] https://www.fingerlakes1.com/2025/04/18/supreme-court-cornell-erisa-401k-fees-decision-2025

[ii] https://commonsense401kproject.com/2024/03/26/just-how-safe-are-safe-annuity-retirement-products-new-paper-shows-annuity-risks-are-too-high-for-any-fiduciary/

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

[iv] https://consumerfed.org/annuity-industry-kickbacks-cost-retirement-savers-billions/

[v] https://www.bloomberg.com/news/articles/2013-03-06/prudential-says-annuity-fees-would-make-bankers-dance?embedded-checkout=true

[vi] https://commonsense401kproject.com/2024/11/19/burden-of-proof-is-on-plan-sponsors-hoping-to-qualifyfor-annuity-prohibited-transactions-exemption/

[vii] https://commonsense401kproject.com/2024/07/31/chris-tobe-dol-testimony/

[viii] https://fiduciarywise.com/cunninghamvcornelluniversity/

[ix] https://www.linkedin.com/pulse/retirement-plan-sponsors-investment-advisors-should-take-ron-rhoades-zfp8c/?trackingId=cl6WVzR8TvCNYE2H6M59WQ%3D%3D

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

Cerulli Study Exposes Guaranteed Income Annuities on Fiduciary Issues

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By Chris Tobe, CFA, CAIA

A recent Cerulli Study exposes Guaranteed Income Annuities not only as unnecessary, but as creating ERISA Fiduciary Issues.[i]  I warned of this in my 2022 blog post on how income annuities are a fiduciary minefield.[ii]

“Cerulli Edge—U.S. Retirement Edition,” finds that as of 2024, 91% of asset managers believe guaranteed lifetime income options carry a negative stigma.  “Annuities continue to face perception issues due to high fees, complexity, lack of transparency, and concerns about insurer solvency, all of which deter plan participants,” says Idin Eftekhari, a senior analyst at Cerulli. “The tradeoff between liquidity and a guaranteed income stream is unappealing for many participants.[iii]

The argument that you need annuities to provide lifetime income is debunked as well.

Cerulli also points to lower cost transparent liquid methods of providing monthly income called “structured drawdown strategies” as superior alternatives to annuities.[iv] 

Annuities are a Fiduciary Breach

I wrote in 2022 that all annuities are a fiduciary breach [v]  While Guaranteed Income Annuities are still small in 401(k)s, I believe they are being used to justify even worse annuity products like IPG Fixed Annuities and Index annuities. Immediate Participation Guarantee (IPG)  is a Group fixed annuity contract (GAC) written to a group of investors in a DC Plan and not individuals. [v]  

IPG group annuities have no maturity, and set whatever rate they want without a set formula.

https://www.dfs.ny.gov/system/files/documents/2021/04/out_ipg_da_2000.pdf

Annuities are contracts that are an ERISA Prohibited Transaction.   Annuity providers claim their products are subject to Prohibited Transaction Exemption 84-4, but I have found that most annuities I have seen do not qualify for the exemption.[vi]

Annuity contracts are regulated by weak state insurance commissioners, and most plan sponsors are clueless to that fact.   The National Association of Insurance Commissioners (NAIC) sets weak national standards, but some state insurance commissioners have even weaker regulations.  NAIC’s prime goal is to prevent any national regulation or transparency as evidenced in this letter to Congress. [vii]   NAIC is currently trying to hide insurers Risk Based Capital (RBC) scores to hide significant risk from consumers. [viii]

There is an attempt to hide annuities in Target Date Funds in weak state regulated CIT’s in which I testified on to the DOL Advisory Committee in July 2024.[ix]

Annuity contracts shift all the fiduciary burden from themselves to the plan.   Thus, the burden of proof is on plan sponsors regarding if their plan annuity qualifies for an exemption from being classified as a prohibited transaction.[x]

 Annuities Credit & Liquidity Risk High & Getting Higher

A recent Federal Reserve paper exposes poor state & offshore regulation of Life Insurance companies that issue Annuities.  The FED’s main problem is the hiding and understating of credit, liquidity & leverage risks.[xi]

The FED economists contend that life and annuity issuers make investments in what amount to loans to risky firms look stronger by funneling the weak loans through arrangements — such as business development companies, broadly syndicated loan pools, collateralized loan obligations, middle-market CLOs and joint venture loan funds — that qualify for higher credit ratings.[xii]  “These arrangements seek to shift portfolio allocations towards risky corporate debt while exploiting loopholes stemming from rating agency methodologies and accounting standards.”[xiii]

Insurance risk experts Larry Rybka, Thomas Gober, Dick Weber Michelle Gordon highlight the addition of risks from Reinsurance in a recent trade publication.  Rybka says  The life insurance and annuities industry, he said, has become “like the Wild West.” Carriers are abusing reinsurance,”[xiv]  “It’s a shell game and, in general, the regulators are not paying attention,” said Dick Weber,[xv]  Gober says It’s not just offshore reinsurers that can largely skirt U.S. accounting standards, he said. There are also “captive” reinsurance companies within the U.S. mostly in Vermont, South Carolina, and Delaware.  “The lack of transparency with these affiliated reinsurance companies, both captive and offshore, is the single biggest threat to U.S. policyholders and annuitants,” said Gober.[xvi]

Michelle Gordon says that advisors should check the creditworthiness of any insurance companies they recommend to clients, she said, though most don’t or can’t because of lax ratings standards. “The non-codification of insurance advisement results in sub-optimization of consumer protections,” she said.[xvii]

Fiduciaries should be aware of these risks and have a duty to defend and justify these risks if they put annuities in their plans.

[i] https://401kspecialistmag.com/offering-guaranteed-income-not-as-essential-as-initially-perceived/

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

[iii] https://401kspecialistmag.com/offering-guaranteed-income-not-as-essential-as-initially-perceived/

[iv] https://401kspecialistmag.com/offering-guaranteed-income-not-as-essential-as-initially-perceived/

[v] https://www.dfs.ny.gov/system/files/documents/2021/04/out_ipg_da_2000.pdf

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

[vii]  https://commonsense401kproject.com/2024/10/10/annuities-exposed-as-prohibited-transaction-in-401k-plans/

[viii] https://content.naic.org/sites/default/files/naic2025federalfinancialprioritiesletter.pdf

[ix] https://insurancenewsnet.com/innarticle/state-regulators-want-insurers-to-downplay-key-financial-strength-figure

[x] https://commonsense401kproject.com/2024/07/31/chris-tobe-dol-testimony/

[xi] https://commonsense401kproject.com/2024/11/19/burden-of-proof-is-on-plan-sponsors-hoping-to-qualifyfor-annuity-prohibited-transactions-exemption/

[xii] https://www.federalreserve.gov/econres/notes/feds-notes/life-insurers-role-in-the-intermediation-chain-of-public-and-private-credit-to-risky-firms-20250321.html

[xiii] https://www.thinkadvisor.com/2025/03/24/fed-researchers-see-life-insurers-filling-up-on-junk-assets/

[xiv] https://www.federalreserve.gov/econres/notes/feds-notes/life-insurers-role-in-the-intermediation-chain-of-public-and-private-credit-to-risky-firms-20250321.html

[xv] https://www.fa-mag.com/news/annuities-and-life-insurance-are-at-risk–advisors-warn-81810.html?section=303

[xvi] https://www.fa-mag.com/news/annuities-and-life-insurance-are-at-risk–advisors-warn-81810.html?section=303

[xvi] https://www.fa-mag.com/news/annuities-and-life-insurance-are-at-risk–advisors-warn-81810.html?section=303 [1] https://www.fa-mag.com/news/annuities-and-life-insurance-are-at-risk–advisors-warn-81810.html?section=303

Private Equity in 401k Plans- A Fiduciary Minefield for Plan Sponsors

/ jwatkins / Leave a comment

By Christopher B. Tobe, CFA, CAIA

Economic and Policy Research’s Eileen Appelbaum said “Much as private equity firms may wish it were different, they have been mostly unable to worm their way into workers’ 401(k)s and abscond with their retirement savings,”[i]

The Private Equity industry’s limited success and future success depends on Private Equity and related contracts like Private Debt finding tricks that block transparency to hide their excessive fees and risks, and inferior performance in ERISA plans.

The first trick is to exempt the actual Private Equity contact itself exempt from ERISA by a loophole of commingling it with non-ERISA public pensions and other non-ERISA plans.

In the context of a Private Equity contract, a “20% ERISA exemption” generally refers to a situation where a fund is considered exempt from full ERISA regulations if less than 20% of its total investor base consists of “benefit plan investors” (like retirement plans), meaning that the fund doesn’t need to adhere to the stricter rules of ERISA as long as the percentage of ERISA-regulated money invested remains below 20% of the total fund size.[ii] 

The second trick is to domicile the Private Equity contract in a place with lax laws.   Roughly a third of the private equity contracts are domiciled in the Cayman Islands and much of the rest in the State of Delaware.[iii]

The third trick is one I warned the DOL ERISA Advisory council in July 2024.   I focused on the hiding of Private Equity and other illiquid contracts buried in Target Date Funds.[iv]   SEC registered Mutual funds require too much transparency on fees and risks so Private Equity has avoided them.   Federal OCC regulated Collective Investment Trusts (CIT’s) also require too much transparency.  Instead, the Private Equity Industry needs a weak regulator that requires minimum transparency, and they have found it by cherry picking the laxest of 50 state banking regulators.   In May 2023, SEC chair Gary Gensler sounded the alarms on CIT’s “Rules for these funds lack limits on illiquid investments and minimum levels of liquid assets. There is no limit on leverage, or requirement for regular reporting on holdings to investors”[v]

Private Equity DOL Guidance

DOL guidance seems to shift with the political winds.  Around 4 years ago Forbes Columnist Ted Siedle wrote “Trump DOL throws 401k Investors to the Wolves” [vi]   At Berkshire Hathaway annual meeting  (2019) Buffett stated, “We have seen a number of proposals from private equity firms where the returns are not calculated in a manner that I would regard as honest… If I were running a pension fund, I would be very careful about what was being offered to me.” Other publications warned of Leading U.S. Retirees ‘Lik Lambs to the Slaughter’[vii]

This was due to the trade press and Private Equity industry interpreting a June 2020 DOL letter as a “get out of jail free card” for plan sponsors to load up on Private Equity if it is buried in Target Date Funds.   What the letter says is that theoretically the perfect Private Equity fund with a high level of transparency and independent verifiable valuation could be included in a diversified Target Date Fund.

  I do not thing this perfect Private Equity contract investment exists, and the burden of proof is on the plan sponsor to prove that it does exist when they went into the contract and to continually monitor the contract to make sure it stays “perfect”. [viii]
 

Morningstar asks Can the presence of a largely illiquid fund comply with DC ERISA regulation?  An answer arrived in a June 2020 “Information Letter” in which the Department of Labor addressed a proposal by Pantheon Ventures LP, and Partners Group, Inc. to put private equity within a target-date fund. The DOL letter states that this would not violate ERISA provided the vehicle resided within a diversified managed solution like a target-date fund or managed account, and that it was otherwise walled off to participants. Additionally, the fund within which the illiquid investment resides must have a “sufficient” level of liquidity—that is, investment in public-market vehicles to meet likely participant demands. These are guidelines rather than specific rules, but they appear sufficiently actionable for a competent fiduciary.[ix]

But if you look at the actual information letter, you can see this part was cherry picked to spin a positive story for sneaking in Private Equity 401(k).[x]  The DOL in full, warns plan sponsors of numerous potential fiduciary issues.   Statements like plan fiduciaries have duties to prudently select and monitor any designated investment alternative under the plan, and liability for losses resulting from a failure to satisfy those duties.[xi] In evaluating … fiduciary must engage in an objective, thorough, and analytical process[xii]  Warns of typically, higher fees and that you must evaluate the risks and benefits returns net of fees including management fees, performance compensation, or other fees or costs that would impact the returns received)…, including cost, complexity, disclosures, and liquidity, and has adopted features related to liquidity and valuation designed to permit the asset allocation fund to provide liquidity for participants [xiii] Ensure that private equity investments be independently valued according to agreed-upon valuation procedures. [xiv]   DOL also shows a duty to monitor “The fiduciary also must periodically review whether the investment vehicle continues to be prudent[xv]    DOL also talks about the requirement to be fully transparent to participants whether plan participants will be furnished adequate information regarding the character and risks of the investment alternative to enable them to make an informed assessment [xvi] Especially noted a higher level of fiduciary duty for a qualified default investment alternative (QDIA) [xvii]

The DOL clarified these requirements early in the Biden Administration in late 2021. [xviii] “Cautions plan fiduciaries against the perception that private equity is generally appropriate as a component of a designated investment alternative in a typical 401(k) plan. [xix] The DOL letter did not endorse or recommend PE investments.[xx]

During the Trump administration, Private Equity is expecting a friendlier DOL on messaging.   The DOL has never really engaged in any broad investment enforcement, and I expect we will see more of the same during the Trump administration.

Private Equity Does not meet exemptions standards for being a Prohibited Transaction.

Plan sponsors do not need to fear the DOL, but they do need to fear litigation if they invest in Private Equity.   Looking at all the ERISA attributes that Private Equity needs to be exempted from Prohibited Transactions – Private Equity flunks all the impartial conduct standards in numerous ways.

Private equity offering documents generally prominently state (in capital, bold letters) that an investment in a private equity fund is speculative, involves a high degree of risk, and is suitable only for persons who are willing and able to assume the risk of losing their entire investment.  Most contracts that PE can engage in borrowing, or leverage, on a moderate or unlimited basis.  There is no assurance of diversification since funds generally reserve the right to invest 100 percent of their assets in one investment.  There are also heightened legal, regulatory, operational and custody risk. [xxi]      

Private Equity has a myriad of conflicts of interest, self-dealing practices. The investment manager determines the value of the securities held by the fund. Such a valuation affects both reported fund performance as well as the calculation of the management fee and any performance fee payable to the manager. [xxii]    

Private Equity has business practices that violate ERISA in many ways. Private equity fund offering documents often disclose that investors agree to permit managers to withhold complete and timely disclosure of material information regarding assets in their funds. Further, the fund may have agreed to permit the investment manager to retain absolute discretion to provide certain mystery investors with greater information and the managers are not required to disclose such arrangements. As a result, the fund you invest in is at risk that other unknown investors are profiting at its expense—stealing from you. [xxiii] 

A Private Equity-like structure technically private debt has cost JP Morgan over $400 million in damages in 401(k) litigation.  This private debt was put in a state regulated JP Morgan CIT, which was put in JPM broad bond CIT, with was put in a JPM stable value CIT.[xxiv] 

Plan sponsors will have a tough time justifying Private Equity as being exempted as a prohibited transaction given these facts.   

Private Equity Performance and Valuation Issues

With such a lack of controls over the contracts, reliable valuation and performance in Private Equity is almost impossible and benchmarks are mostly useless.[xxv]

The entire justification Fiduciaries must rely on is the superior performance of Private Equity which has been proven to be mostly false after excessive fees.[xxvi] A report by University of Oxford professor Ludovic Phalippou shows that in the last 15 years, private equity firms generally have not provided better returns to investors than low-fee stock index funds. Prof. Phalippou has shown excess mostly hidden fees and expenses to exceed 6% killing net returns.[xxvii]   

Noted founder of investment consulting firm Richard Ennis in quoting Beath & Flynn 2020 study says that private equity (as a class of investment) in fact ceased to be a source of value-added more than a decade ago. [xxviii] Jeff Hooke of Johns Hopkins book the “Myth of Private Equity” goes into detail on the asset class and its numerous fiduciary flaws.  He documents that many performance claims are made up by the managers with no independent verification and are greatly exaggerated. [xxix]   Academic Wayne Lim finds Fees and Expenses totaling over 6-8%     The corresponding fee drag on gross-to-net total value to paid-in capital is 0.1x to 0.7x and 5% to 8% in annualized terms. [xxx]

Conclusion

Private Equity along with other illiquid contract investments are a potential Fiduciary Time Bomb for plans and their participants.   Does the fiduciary even know if the Private Equity contract is subject to ERISA or exempt.  Is the contract domiciled in the Cayman Islands?  If its buried in a target date fund, is it in a mutual fund, or a poorly regulated state CIT?

A lack of transparency makes it impossible for fiduciaries to prove that Private Equity contracts are worthy of a Prohibited Transaction exemption.   Worse, most have excessive fees and risks which cause real damages to participants.   While the Private Equity industry may be able to prevent regulation, the real threat of litigation will lead to prudent fiduciaries keeping Private Equity out of ERISA plans.

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

[ii] https://www.wlrk.com/webdocs/wlrknew/AttorneyPubs/WLRK.25307.15.pdf https://www.ropesgray.com/-/media/files/prax-pages/erisa/erisa-compliance-2019.pdf

[iii] https://www.sec.gov/files/investment/private-funds-statistics-2023-q4.pdf

[iv] https://commonsense401kproject.com/2024/07/31/chris-tobe-dol-testimony/   In addition  Annuity providers bury mostly Private Debt in their weak state insurance regulators.

[v] https://www.sec.gov/newsroom/speeches-statements/gensler-etam-051624

[vi] https://www.forbes.com/sites/edwardsiedle/2020/06/13/dol-throws-401k-investors-to-the-wolves/

[vii]

[viii] Hal.Ratner@morningstar.com   Private Equity and Private-Market Funds in Managed Defined Contribution Plans  https://www.morningstar.com/business/insights/research/private-market-funds-dc-plans?utm_source=referral&utm_medium=center&utm_campaign=private-market-funds-dc-plans

[ix] Hal.Ratner@morningstar.com   Private Equity and Private-Market Funds in Managed Defined Contribution Plans  https://www.morningstar.com/business/insights/research/private-market-funds-dc-plans?utm_source=referral&utm_medium=center&utm_campaign=private-market-funds-dc-plan

[x] https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/information-letters/06-03-2020

[xi] See, e.g., 29 CFR 2550.404c-1(d)(2)(iv) and 29 CFR 2550.404c5(b).

[xii] https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/information-letters/06-03-2020

[xiii] https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/information-letters/06-03-2020

[xiv] that satisfy the Financial Accounting Standards Board Accounting Standards Codification (ASC) 820, “Fair Value Measurements and Disclosures,”9 and require additional disclosures needed to meet the plan’s ERISA obligations to report information about the current value of the plan’s investments.

[xv] https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/information-letters/06-03-2020

[xvi] https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/information-letters/06-03-2020

[xvii] for the plan under 29 CFR 2550.404c-5. Moreover, as noted above, the fiduciary responsible for including the fund on the plan’s investment menu always retains responsibility for ensuring that the decision to retain the fund is consistent with the fiduciary responsibility provisions of Section 404 of ERISA.

[xviii] https://www.dol.gov/newsroom/releases/ebsa/ebsa20211221

[xix] https://www.dol.gov/newsroom/releases/ebsa/ebsa20211221

[xx] https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/information-letters/06-03-2020-supplemental-statement

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

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

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

[xxiv] https://www.nytimes.com/2012/03/23/business/jpmorgan-discloses-it-lost-in-arbitration-to-american-century.html

[vii] https://casetext.com/brief/whitley-v-jp-morgan-chase-co-et-al_memorandum-of-law-in-opposition-re-49-motion-to-dismiss-first-amended

[viii] 

[xxv] https://commonsense401kproject.com/2024/11/29/crypto-private-equity-annuity-contracts-are-impossible-to-benchmark/

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

[xxvii] https://blogs.cfainstitute.org/investor/2024/11/22/a-reality-check-on-private-markets-part-iii/  https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3623820  an Inconvenient Fact Private Equity Returns U.of Oxford  Ludovic Phalippou

[xxviii]  https://richardmennis.com/blog/how-to-improve-institutional-fund-performance

[xxix] https://cup.columbia.edu/book/the-myth-of-private-equity/9780231198820

[xxx] https://rpc.cfainstitute.org/research/financial-analysts-journal/2024/accessing-private-markets-what-does-it-cost

Pension Risk Transfer Annuities should be Prohibited.  The Burden of proof is on plan sponsors to justify that they are prudent

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By Christopher B. Tobe, CFA, CAIA

Pension Risk Transfer Annuities (PRT’s) replace a solid diversified defined benefit plan with federal (PBGC) insurance, with a high single entity risk annuity with higher risks and weak state regulation. 

Pension Risk Transfers (PRT’s) shift the risk off the plan sponsor onto the backs of the participants.   This allows plan sponsors to lower costs and insurance companies billions at the expense of participants and retirees.

It appears that large pension plans have been in a hurry to close Pension Risk Transfer deals, before their victims the participants wake up and see the raw deal they are getting.[i] Regulators, to my knowledge, have never tested this risk with actuarial analysis.  Under industry pressure they came up after the Executive Life defaults IB95-1 a weak rule to pick the “safest available annuity”.  I think the premise of a least risky annuity would is like a less risky plane crash.

However, plan sponsors are not off the hook, due to the ability of plaintiffs to recover these losses through litigation.   The Burden of proof is on plan sponsors that their plan PRT Annuity contract has low enough risk to be exempted from being a Prohibited Transaction and is at a reasonable cost.

Fiduciary Breaches of PRT Annuity Contracts

PRT Annuity Contracts are a Fiduciary Breach for 4 basic reasons.[ii] 

  1. Single Entity Credit Risk[iii]  
  2. Single Entity Liquidity Risk in illiquid investments [iv]   
  3. Hidden fees spread and expenses [v]  
  4. Structure -weak cherry-picked state regulated contracts, not securities and useless reserves [vi]    

These breaches make it impossible for most annuity products to qualify for exemptions to Prohibited Transactions.[vii]  

The Federal Reserve in 1992 exposed the weak state regulatory and reserve claims of Fixed annuities in retirement plans.[viii]   In 2008 Federal Reserve Chairman Ben Bernanke said about these annuity products “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.”[ix]  In the major stable value annuity source book,  single annuity like PRTs are shown to have 10 times the risk of a diversified fixed portfolio. [x]

.

The Burden of proof is on plan sponsors that they have documented due diligence on these risk issues and that their PRT Annuity contract is exempted from being a Prohibited Transactions. [xi]  

Fiduciary Transparency Conflicts Tests – Loyalty Excessive Compensation

As a plan sponsor you should put all products through these fiduciary transparency tests, I contend that annuities almost always flunk this basic level of care.

Annuities avoid transparency with poor state regulated structures which allow them to hide excessive risks and fees.    Annuity providers fight hard to avoid any Federal Regulations usually favoring state regulation in their home states where they are major employers and have higher political influence. Even industry insiders admit hidden fees are problematic to adopting annuities.[xii]

After the 2008 financial crisis several Insurers were forced into Federal Regulation under SIFI (too big to fail) they did everything to get out of the higher transparency and higher capital requirements.[xiii] 

Annuity contracts have been characterized by retirement group NAGDCA as having serious fiduciary issues.  “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.

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 “  [xiv]

Plans need to put their Loyalty to plan participants first which is their fiduciary duty.   They do not have loyalty to vendors such as money managers and annuity providers.

Annuities have an Inherent conflict because investment dollars leave the ownership of the plan and participants and become part of the balance sheet of the insurance company.   

Annuity contracts are designed to avoid all fiduciary obligation with no loyalty to participants.   Most annuity providers refuse to sign a “Fiduciary Acknowledgement Disclosure.” 

DOL official Khawar said. “” Under the National Association of Insurance Commissioners’ model rule, for example, “compensation is not considered a conflict of interest,” [xv]

Annuities have a total lack of disclosure of profits, fees and compensation.  They have secret kickback commissions.    How can a plan claim any of the compensation annuity provider receives is reasonable if it is secret and not disclosed.

Current Cases – Worst of Worst Athene-Apollo

PRTs have been operating under a weak DOL rule to pick the “safest available annuity”.  Over decades traditional insurers have made millions.  While default risk is present with traditional insurers, they do want to sustain the business long-term and avoid default.  When Private Equity players got involved, with their short-term mentality, they are set to strip billions in profits, not afraid to bankrupt companies and “kill the Golden Goose” for the traditional part of the business.

With these significant differences in risks and profit for the private equity insurers, it has created measurable damages that has jump started litigation. 

From Piercy v. AT&T filed on 3/11/24 says, AT&T turned its back on its retired workers, choosing to put the pensions of almost 100,000 AT&T retirees in peril, to secure AT&T an enormous profit. AT&T stood to gain—and did gain—more than $360 million in profit from this scheme The only losers in the transaction were AT&T’s retirees, who face the danger—now and in the future—that their lifelong pensions will go unpaid while they have lost all the protections of federal law.

As pointed out above the standard PRT is at least 10 times that of a diversified portfolio, but that an even riskier single entity credit risk like private equity backed Athene could have 20 times the risk. [xvi]

Most of the current PRT cases are against Apollo owned Athene.   Apollo is infamous with over

684 regulatory violations. [xvii]  Fines range from the DOJ $210 million fine for accounting fraud, to $53 Million by the SEC for misleading investors on fees. [xviii]   Other claims against Apollo are around investor protection violations, consumer protection violations, and the false claims act.

In early 2021 Apollo founder & CEO Leon Black resigned after paying $158 million in “tax advice” to Jeffrey Epstein.[xix]   In 2015 Apollo was involved in a massive pay to play scheme involving a trustee and CEO of CALPERS the US largest public pension.  The CALPERS CEO Buenrostro was sent to prison and the trustee Villalobos committed suicide before serving his term.[xx] 

Conclusion

In a submitted academic paper on Annuity risks it touts the risks of PRT’s.   It states the “Emperor has no Clothes” as the life insurance industry has poured billions of dollars into advertising, lobbying, commissions & trade articles with misinformation on annuities with everyone afraid to call out the obvious.[xxi]

The ultimate responsibility and the burden of proof goes on to the plan sponsor to prove this annuity purchase was for the benefit of participants.  Those who have pulled the trigger on these questionable annuity deals will probably face litigation. 

[i] https://www.chicagofed.org/publications/economic-perspectives/2024/5   https://www.chicagofed.org/publications/chicago-fed-letter/2024/494

[ii] https://commonsense401kproject.com/2022/05/11/annuities-are-a-fiduciary-breach/   https://commonsense401kproject.com/2024/11/29/crypto-private-equity-annuity-contracts-are-impossible-to-benchmark/

[iii] https://commonsense401kproject.com/2024/03/26/just-how-safe-are-safe-annuity-retirement-products-new-paper-shows-annuity-risks-are-too-high-for-any-fiduciary/  https://www.thinkadvisor.com/2024/11/20/yes-life-and-annuity-issuers-can-suddenly-collapse-treasury-risk-tracker-warns/ 

[iv] https://www.chicagofed.org/publications/economic-perspectives/2024/5   https://www.chicagofed.org/publications/chicago-fed-letter/2024/494

[v] https://www.bloomberg.com/news/articles/2013-03-06/prudential-says-annuity-fees-would-make-bankers-dance?embedded-checkout=true   TIAA https://www.nbcnews.com/investigations/tiaa-pushes-costly-retirement-products-cover-losses-whistleblower-rcna161198

[vi] Federal Reserve Bank of Minneapolis Summer 1992  Todd, Wallace  SPDA’s and GIC’s http://www.minneapolisfed.org/research/QR/QR1631.pdf  https://www.chicagofed.org/publications/economic-perspectives/1993/13sepoct1993-part2-brewer 

[vii] https://commonsense401kproject.com/2024/10/10/annuities-exposed-as-prohibited-transaction-in-401k-plans/

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

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

[x] The Handbook of Stable Value Investments 1st Edition by Frank J. Fabozzi 1998 Jacquelin Griffin Evaluating Wrap Provider Credit Risk in Synthetic GICs pg. 272  https://www.amazon.com/Handbook-Stable-Value-Investments/dp/1883249422

[xi] https://commonsense401kproject.com/2024/11/19/burden-of-proof-is-on-plan-sponsors-hoping-to-qualifyfor-annuity-prohibited-transactions-exemption/

[xii] https://riabiz.com/a/2024/5/11/fidelity-voya-and-boa-smooth-blackrocks-launch-of-guaranteed-paycheck-etfs-but-401k-plan-participants-may-yet-balk-at-high-unseeable-fees-and-intangibility-of-benefits

[xiii] https://www.stanfordlawreview.org/online/the-last-sifi-the-unwise-and-illegal-deregulation-of-prudential-financial/

[xiv] http://www.nagdca.org/documents/StableValueFunds.pdf_ The National Association of Government Defined Contribution Administrators, Inc. (NAGDCA) September 2010.

[xv] https://www.thinkadvisor.com/2024/10/07/top-dol-official-sees-a-nonsensical-reality-at-heart-of-fiduciary-fight/

[xvi] The Handbook of Stable Value Investments 1st Edition by Frank J. Fabozzi 1998 Jacquelin Griffin Evaluating Wrap Provider Credit Risk in Synthetic GICs pg. 272  https://www.amazon.com/Handbook-Stable-Value-Investments/dp/1883249422

[xvii] https://violationtracker.goodjobsfirst.org/?company=Apollo

[xviii] https://www.ai-cio.com/news/apollo-fined-53-million-over-fees/

[xix] https://www.nytimes.com/2021/01/26/business/jeffrey-epstein-leon-black-apollo.html

[xx] https://www.latimes.com/business/la-fi-villalobos-suicide-20150115-story.html 

[xxi] Lambert, Thomas E. and Tobe, Christopher B., “Safe” Annuity Retirement Products and a Possible US Retirement Crisis (March 18, 2024). Available at SSRN: https://ssrn.com/abstract=4763269

More 401(k) Cases Will Survive Dismissal

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By Chris Tobe, CFA, CAIA

The recent Sixth Circuit decision in Johnson v. Parker-Hannifin Corp. indicates a possible 2025 trend in fiduciary litigation in favor of plan participants according to attorney Jim Watkins in his latest piece. [i]  The ruling confirms that in most cases participants do not have adequate information and disclosure until discovery and that premature dismissal is unfair to participants.

The lack of transparency and disclosures in 401(k) plans requires the discovery process to give plan participants a fair shot at recovery of damages from poorly managed plans.    This decision seems to recognize these facts and puts the burden of proof to show a prudent fiduciary process on the plan sponsor, which requires discovery.

The 401(k) type plans being litigated are a small fraction of the total 700,000 plans in the U.S.   Around 7,000 or 1% are $100 million or more in assets which are the ones currently large enough to litigate.  Of this 7000 around 5000 are low (Vanguard) to below average cost (Fidelity) recordkeepers.    This leaves around 2000 that are worth while litigating for plaintiff attorneys.  The DOL EBSA is understaffed having to cover 700,000 plans, so many participants rely on litigation or the threat of it to drive better outcomes.   My analysis is limited to these top 1% of plans.

Current Disclosures

The IRS/DOL 5500 form and accompanied financial statement is the major and primary form of public disclosure.   It lists total assets of the plan and the number of participants.  It lists an aggregate total of administrative costs.  Financials usually have a list of investment options, but does not disclose their fees, or even what share class they are so you can look up the fees.  It usually lists the recordkeeper.   Plaintiffs’ attorneys to narrow down potential poorly managed cases primarily rely on their ability to spot high fee recordkeepers and high fee funds just by their names.  There is no disclosure of administrative or fund fees or performance, so no data to show the level of damages.      

Participant statements are a mixed bag.  Some have partial fee information, some do not.  in 2012, the DOL mandated annual 404a-5 participant disclosures due to this lack of information.   Some plans include these with their quarterly statements, but many firms send it out in a separate not easy to understand piece of paper and participants typically throw it away.  However, participants can request these 404a-5 disclosures without discovery.

404a-5 disclosures essentially only provide an accurate description by ticker for the SEC registered mutual funds in the fund.  This is a small step forward because some plans do not even provide ticker (which shows share classes) on statements (or 5500) which has only one real purpose – to hide fee information.  Once the ticker is disclosed, data like performance and fees can be easily found on the internet.  So the disclosure of fees and performance on the 404a-5 is merely creating an impression of additional transparency.

I believe target date funds in SEC registered mutual funds were designed to hide fees and manipulate performance.  They bundle funds into other funds, and without sub-fund level detail,  it is nearly impossible to evaluate their performance and fees.  The aggregate fee & performance data from the 404a-5 disclosure statements is a start, but far from a complete means of evaluating funds.

404a-5 statements have totally inadequate disclosure on administrative and recordkeeping costs.  Manipulative games like Revenue Sharing makes the costs for participants nearly impossible to ascertain.   

404a-5 statements have totally inadequate disclosure on collective investment trusts (CITs), a growing sector in the large plan market, especially with target date funds. CITs often have inadequate state oversight and regulation, which requires little or no disclosure.[ii]

404a-5 statements also have totally inadequate disclosure on insurance products, especially with regard to IPG Fixed Annuities, but also regarding index annuities,and the new fad lifetime annuities.[iii]

 The 404a-5 disclosures only cover the most recent 10 year period. SEC mutual fund share class violations constitute a small fraction of the damages in current cases.

Discovery Basic

It is the current inadequate disclosures from the 5500 and 404a-5 statements that makes discovery essential.   Most of what plaintiffs need in discovery is information that really should have been disclosed already in both the 5500 and 404a-5 statements..

For the state-regulated insurance products and CIT’s, a plaintiff needs the same level of information on fees/spreads that you would receive in a SEC registered Mutual Fund.   Defense attorneys want to block this information since it can reveal prohibited transactions and hidden fees.[iv]

The 6th Circuit stated that “The ultimate question is whether the fiduciary engaged in a reasoned decision-making process.”  [v]   401(k) plan fiduciaries hold monthly or quarterly meeting.  To determine if this was a prudent process, at a minimum, you need the minutes and materials from these meetings.    Defense attorneys want to block access to this information because it almost always reveals flaws in a plan’s oversight.   

According to attorney Watkins:

“Based upon my experience, I submit the real reason that the plans oppose any type or amount of discovery is to conceal the fact that (1) the investment committee never developed a prudent process for managing the plan, but rather blindly accepted the recommendations of the plan adviser or other conflicted, and (2) the fact that the plan never conducted the independent investigation and evaluation required under ERISA, but blindly accepted the recommendations of others.”  [vi]    

In my ownexperience, I regularly find a clueless committee without even an investment policy, driven by blind reliance on a conflicted broker or consultant who receives undisclosed hidden compensation from recommending high fee high risk products.[vii] 

This information is readily and easily available at a minimal cost to the plan and should have already been disclosed.

Additional Discovery

Administrative costs, which include record keeping costs, are totaled on the 5500 form, and you can divide this number by the amount of participants.   Many lpaintiff firms may file a claim if they find a number above $40 a participant per year.   The defense’s argument is often that number is not correct, basically that they lied on their DOL/IRS form, offering convoluted and self-serving reasons for the alleged error.    They basically want the court to take the story that what they really charged was less than what they told the DOL/IRS, hoping that the3 plaintiff and the court will take their word for it without documentation.    The participants have no access to any information on these administrative costs.   This information is convoluted and complex, so much so that few committees understand it. It needs extensive discovery to get to the details. 

Because of the lack of transparency in administrative costs. plaintiff’s need at least some limited discovery. In a recent Sixth Circuit case, Forman v. TriHealth 40 F.4th 443, 450},, Judge Sutton of the Sixth Circuit spoke out in this issue, stating that too many ERISA actions alleging a breach of fiduciary duties were being inequitably and prematurely dismissed without allowing plaintiffs any discovery whatsoever:

This is because “[n]o matter how clever or diligent, ERISA plaintiffs generally lack the inside information necessary to make out their claims in detail unless and until discovery commences. . . . If plaintiffs cannot state a claim without pleading facts which tend systemically to be in the sole possession of defendants, the remedial scheme of the statute will fail, and the crucial rights secured by ERISA will suffer.” “Plausibility requires the plaintiff to plead sufficient facts and law to allow ‘the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.. Because imprudence “is plausible, the Rules of Civil Procedure entitle” the plaintiffs “to pursue [their imprudence] claim . . . to the next stage.”

Sponsors many times select vendors that cherry-pick their own state regulator for both insurance products and most collective investment trusts (CIT)s.[viii]  Sponsors typically do not have any documentation that these products are exempt from prohibited transaction restrictions. You need extensive discovery to get the details on fees and risks in these products.  

Most discovery needed by plaintiffs is information that should be public or at least accessible to plaintiffs already, so it is essential to have it in most cases.    Some more detailed discovery is needed to accurately compute the damages. 

It is unfair to put the burden of proof on Plaintiffs who are blocked from seeing the information they need to prove damages.    The burden of proof needs to be on the plan sponsor who controls all the information. [ix]

[i] https://fiduciaryinvestsense.com/2024/11/28/fudamental-unfairness-sixth-circuit-decision-addresses-the-premature-dismissal-of-erisa-actions/

[ii] https://commonsense401kproject.com/2024/07/31/chris-tobe-dol-testimony/

[iii] https://commonsense401kproject.com/2024/11/19/burden-of-proof-is-on-plan-sponsors-hoping-to-qualifyfor-annuity-prohibited-transactions-exemption/

[iv] https://commonsense401kproject.com/2024/11/29/crypto-private-equity-annuity-contracts-are-impossible-to-benchmark/

[v] https://fiduciaryinvestsense.com/2024/11/28/fudamental-unfairness-sixth-circuit-decision-addresses-the-premature-dismissal-of-erisa-actions/

[vi] https://fiduciaryinvestsense.com/2024/11/28/fudamental-unfairness-sixth-circuit-decision-addresses-the-premature-dismissal-of-erisa-actions/

[vii] https://commonsense401kproject.com/2023/03/12/investment-policy-statements-crucial-to-fiduciary-duty/

[viii] https://commonsense401kproject.com/2024/10/10/annuities-exposed-as-prohibited-transaction-in-401k-plans/

[ix] https://commonsense401kproject.com/2024/11/19/burden-of-proof-is-on-plan-sponsors-hoping-to-qualifyfor-annuity-prohibited-transactions-exemption/

Crypto, Private Equity, Annuity Contracts Are Impossible to Benchmark

/ jwatkins / Leave a comment

By Christopher B. Tobe, CFA, CAIA

Crypto, Private Equity, and Annuity contracts are impossible to Benchmark because of a lack of transparency accountability and liquidity.   Valid Benchmarks require investable securities.   These issues make it nearly impossible for any of these contracts to be exempted from being a prohibited transaction in an ERISA plan. [i]

According to the CFA Institute, a valid benchmark should meet the following criteria:

  • Specified in advance: The benchmark is defined before the evaluation period begins. 
  • Measurable: The benchmark’s return can be calculated regularly and in a timely manner. 
  • Unambiguous: The identities and weights of the securities in the benchmark are clearly defined. 
  • Reflective of current investment opinions: The manager is knowledgeable about the securities in the benchmark and their factor exposures. 
  • Accountable: The manager is aware of and accepts responsibility for the benchmark’s performance and constituents. 
  • Investable: The assets of the underlying index are available for purchase by investors. 

These attributes are impossible for contract-based investments like Crypto, Private Equity, and Annuities since you do not own any securities.  There is no accountability, they are ambiguous and use different forms of accounting than securities. 


Benchmarks can work when you compare a security-based active investment fund with a security-based index fund as highlighted in Brotherston vs. Putnam.[ii]

These are one sided contracts, not securities, in favor of the vendor and to the detriment of the investor.    Looking at these from an ERISA particularly 401(k) context these contracts have severe fiduciary issues which I feel prevent them from an exemption from prohibited transaction rules.  The Burden of Proof is on the Plan Sponsor to document that these contracts are not Prohibited Transactions.[iii]

 I think the conflicted contract nature of these investments allows them to manipulate or avoid benchmarks altogether.    While plan sponsors should never have entered into these contracts in the first place, how do you hold them accountable for the damages they have caused participants.   If you compare them against benchmarks to the lower risk investments they should have invested in, it conceals the damages.   You must find comparable contracts with the same types of high risk to find the actual damages.

Annuity Contracts

I wrote last month that Annuities should not be allowed in 401(k)s as Prohibited Transactions.  Annuities are a Fiduciary Breach for 4 basic reasons. [iv]

  1. Single Entity Credit Risk [v] 
  2. Single Entity Liquidity Risk in illiquid investments [vi]
  3. Hidden fees spread and expenses [vii]
  4. Structure -weak cherry-picked state regulated contracts, not securities and useless reserves [viii] 

These breaches make it impossible for most annuity products to qualify for exemptions to Prohibited Transactions which need to fill these 4 major obligations.  [ix]

A. Care Obligation

B. Loyalty Obligation

C. Reasonable compensation limitation

D. No materially misleading statements (including by omission

I do not believe few if any annuities meet these 4 obligations, and the

burden of proof is on the plan sponsor that the annuities they use in their ERISA plans have a valid exemption. [x]

I have extensive experience showing damage by annuity contracts in large 401(k) and 403(b) plans.   These are primarily fixed annuity IPG contracts within the broad category of stable value with no maturity and discretion by the insurer to pay rates that maximize their profits, at the detriment of participants.   Some Fixed Annuity providers will claim money markets as a benchmark, despite having over 20 times the risk.   The Federal Thrift Savings Plan has a high-quality stable value product, the G fund which they state is impossible to benchmark. [xi]    

Single entity Fixed annuity providers have attempted to compare to the diversified Hueler Stable Alue Index despite having 10 times the risk.  The proper comparable has been to other IPG fixed annuities with single entity risk, which has used in over a dozen cases specifically comparables like TIAA and MassMutual cited in detail in 2 ERISA Hospital Cases: Columbus, GA and Norton Hospital.

Private Equity Contracts

Private Equity contracts have mostly been contained in non-ERISA plans but this may be changing.  Economic and Policy Research’s Eileen Appelbaum said “Much as private equity firms may wish it were different, they have been mostly unable to worm their way into workers’ 401(k)s and abscond with their retirement savings,”[xii]

Private Equity flunks all the impartial conduct standards in numerous ways.

Private equity offering documents generally prominently state (in capital, bold letters) that an investment in a private equity fund is speculative, involves a high degree of risk, and is suitable only for persons who are willing and able to assume the risk of losing their entire investment.  Can engage in borrowing, or leverage, on a moderate or unlimited basis.  No assurance of diversification since funds generally reserve the right to invest 100 percent of their assets in one investment.  Heightened offshore legal, regulatory, operational and custody risk.[xiii]  

Private Equity has a myriad of conflicts of interest, self-dealing practices. The investment manager determines the value of the securities held by the fund. Such a valuation affects both reported fund performance as well as the calculation of the management fee and any performance fee payable to the manager. [xiv]

Private Equity has business practices that may violate ERISA. Private equity fund offering documents often disclose that investors agree to permit managers to withhold complete and timely disclosure of material information regarding assets in their funds. Further, the fund may have agreed to permit the investment manager to retain absolute discretion to provide certain mystery investors with greater information and the managers are not required to disclose such arrangements. As a result, the fund you invest in is at risk that other unknown investors are profiting at its expense—stealing from you. [xv]

Plan sponsors will have a tough time justifying Private Equity as being exempted as a prohibited transaction given these facts.   With such a lack of controls on the contracts, benchmarks are mostly useless.

Private Equity Benchmarks have been manipulated in U.S. public pensions to get higher bonuses not only for the Private Equity managers but for public government staff.  [xvi]   Private Equity benchmarks typically add a premium of 2%-6% to small cap index for leverage and liquidity.  I think the high end of this range could be appropriate for damage comparisons given the fiduciary issues of the assets.  

Crypto Contracts

Crypto has not been used extensively in ERISA plans as of now, but it is increasing.[xvii]

It was first discovered in Brokerage Windows, in which plans feel they have less fiduciary accountability.   Companies running Brokerage Windows have been paid $millions by Crypto companies to put their options on their Brokerage Window Platform. In the article, “401(k)s with Bitcoin Should Expect Lawsuits: Lawyers,” the trade publication “Ignites” quotes Jerry Schlichter as saying that.  Any employer who would follow the Fidelity lead by offering cryptocurrency and a 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. 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. [xviii]   

Burden of proof is on plan sponsors that Prohibited Transactions crypto in their plans qualify for a Prohibited Transaction Exemption.  I have seen no evidence that any form of Crypto has met the qualifications for an exemption. 

The Department of Labor in 2022 severely questions the reliability and accuracy of cryptocurrency valuations.  A major concern is that cryptocurrency market intermediaries may not adopt consistent accounting treatment and may not be subject to the same reporting and data integrity requirements with respect to pricing as other intermediaries working with more traditional investment products.[xix]   Under that guidance, which the DOL issued last month (April 22), 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.[xx]

The CFA institute writes.  The unfortunate reality is that none of the proposed valuation models are as sound or academically defensible as traditional discounted cash flow analysis is for equities or interest and credit models are for debt. This should not come as a surprise. Crypto assets are more similar to commodities or currencies than to cash-flow producing instruments, such as equities or debt, and valuation frameworks for commodities and currencies are challenging.  Custody is challenging and there is significant technological risk.  As recently as 2018, researchers uncovered a bug in the bitcoin code that, if left unchecked and exploited, could have led to significant (theoretically infinite) inflation in the issuance of new bitcoin [xxi]

The lack of any valuation parameters makes benchmarks impossible.  Comparisons should be flexible.  One of the main comparisons should be the most popular Crypto asset Bitcoin. 

Corrupt Structures

Crypto, Private Equity and Annuities in ERISA plan are mostly hidden in corrupt structures.    Besides brokerage windows poorly state regulated separate account annuity products and Collective investment Trusts are places to hide these prohibited assets.  

Over 50% of 401(k) assets are in Target Date Funds which are made up of underlying funds.  This allows for less transparency of the underlying funds. 

However, historically the largest structure for Target Date Funds has been SEC registered Mutual Funds.   Mutual Funds have transparency and fiduciary standards that do not allow Crypto, Private Equity and Annuities. [xxii]    Federal OCC regulated Collective Investment Trusts (CITs) have transparency and fiduciary standards that do not allow Crypto, Private Equity and Annuities.[xxiii]  However, many state regulated CIT’s have weak or no transparency or fiduciary standards, so you can allow Crypto, Private Equity and Annuities.

Currently I believe the biggest threat of prohibited investments like Crypto, Private Equity and Annuities will be hidden in target date funds structured as state regulated CIT’s that I outlined in my DOL Advisory testimony in July 2024.[xxiv] 

Conclusions

 Since Crypto, Private Equity, Annuity contracts are impossible to Benchmark you need to use Comparables.     To make valid comparisons you have to compare them to other prohibited transactions that are materially similar, and looking at those similar funds with the best performance is valid for damages.    

[i] https://commonsense401kproject.com/2024/10/10/annuities-exposed-as-prohibited-transaction-in-401k-plans/

[ii] 117https://www.plansponsor.com/supreme-court-will-not-weigh-burden-proof-index-fund-comparison/ https://401kspecialistmag.com/brotherston-v-putnamsfar-reaching-401k-fallout/

[iii] https://commonsense401kproject.com/2024/11/19/burden-of-proof-is-on-plan-sponsors-hoping-to-qualifyfor-annuity-prohibited-transactions-exemption/

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

[v] https://commonsense401kproject.com/2024/03/26/just-how-safe-are-safe-annuity-retirement-products-new-paper-shows-annuity-risks-are-too-high-for-any-fiduciary/  https://www.thinkadvisor.com/2024/11/20/yes-life-and-annuity-issuers-can-suddenly-collapse-treasury-risk-tracker-warns/ 

[vi] https://www.chicagofed.org/publications/economic-perspectives/2024/5   https://www.chicagofed.org/publications/chicago-fed-letter/2024/494

[vii] https://www.bloomberg.com/news/articles/2013-03-06/prudential-says-annuity-fees-would-make-bankers-dance?embedded-checkout=true   TIAA https://www.nbcnews.com/investigations/tiaa-pushes-costly-retirement-products-cover-losses-whistleblower-rcna161198

[viii] Federal Reserve Bank of Minneapolis Summer 1992  Todd, Wallace  SPDA’s and GIC’s http://www.minneapolisfed.org/research/QR/QR1631.pdf  https://www.chicagofed.org/publications/economic-perspectives/1993/13sepoct1993-part2-brewer 

[ix] https://commonsense401kproject.com/2024/10/10/annuities-exposed-as-prohibited-transaction-in-401k-plans/

[x] https://commonsense401kproject.com/2024/11/19/burden-of-proof-is-on-plan-sponsors-hoping-to-qualifyfor-annuity-prohibited-transactions-exemption/  https://fiduciaryinvestsense.com/2024/09/25/chief-judge-of-the-5th-circuit-calls-out-his-brethren-on-decision-to-stay-the-dols-retirement-security-rule/#:~:text=As%20to%20coverage%20under%20the,of%20whether%20advice%20is%20given.

[xi] https://www.tsp.gov/funds-individual/g-fund/      https://www.frtib.gov/pdf/reading-room/InvBMarks/2017Oct_Benchmark-Evaluation-Report.pdf     

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

[xiii] https://www.sec.gov/comments/s7-03-22/s70322-267369.htm 

[xiv] https://www.sec.gov/comments/s7-03-22/s70322-267369.htm 

[xv] https://www.sec.gov/comments/s7-03-22/s70322-267369.htm 

[xvi] https://www.nakedcapitalism.com/2022/04/calpers-consultant-global-governance-advisors-recommends-further-overpaying-grossly-underperforming-calpers-staff.html

[xvii] https://commonsense401kproject.com/2022/06/18/brokerage-windows-exposed-by-crypto/

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

[xix] https://www.dol.gov/agencies/ebsa/employers-and-advisers/plan-administration-and-compliance/compliance-assistance-releases/2022-01

[xx] https://www.dol.gov/agencies/ebsa/employers-and-advisers/plan-administration-and-compliance/compliance-assistance-releases/2022-01

[xxi] http://www.coindesk.com/the-latest-bitcoinbug-was-so-bad-developers-kept-its-full-details-a-secret.

Click to access 20200806.pdf

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

[xxiii] https://www.occ.treas.gov/topics/supervision-and-examination/capital-markets/asset-management/collective-investment-funds/index-collective-investment-funds.html

[xxiv] https://commonsense401kproject.com/2024/07/31/chris-tobe-dol-testimony/

Burden of Proof is on Plan Sponsors Hoping to Qualify for Annuity Prohibited Transactions Exemption

/ jwatkins / Leave a comment

By Christopher B. Tobe, CFA, CAIA

The burden of proof is on plan sponsors regarding their plan annuity qualifies for an exemption from being classified as a prohibited transaction.  Likewise, they are also liable for proving that any annuity option or investment option that contains annuities qualifies for a prohibited ransaction Exemption,

I believe that most annuities in 401(k) and other ERISA plans do not fully qualify for a prohibited transaction exemption. [i]  The primary basis for my opinion is that the single entity credit and liquidity risk in annuity contracts violates one of the most basic standards of care diversification.[ii]    CFA Investment Standards lay out specific standards for 401(k) and other defined contribution (D.C.) plans. Diversification—each investment option, as a standalone investment, must be sufficiently diversified that plan participants, if they chose only that option would not be at serious risk of unsustainable investment losses because of a relatively small segment of the capital markets experiencing distress [iii]

Assuming that as plan sponsor that you can get over the single entity credit and liquidity risk, how can you justify any connection to annuities.   Perhaps your advisors will talk you into smaller amounts buried and hidden in a target date fund or in a lifetime income option.  It is common term in the financial world that “Annuities are sold not bought”.

I contend that annuities violate fiduciary standards in so many ways that it is very difficult for a plan sponsor to prove that these contracts qualify for a prohibited transaction exemption.


Fiduciary Transparency Tests of Care

As a plan sponsor you should put all products through these fiduciary transparency tests, I contend that annuities almost always flunk this basic level of care.

Is the annuity in a well-regulated transparent structure like a SEC registered mutual fund?

Most likely the answer is “no,” as annuities, with their lack of transparency around fees, are typically not allowed in SEC registered mutual funds.  Many plans avoid this issue by using SEC registered mutual funds.   SEC registered mutual funds have transparent fees and performances, have uniform federal regulations and are the gold standard for the 401(k).  SEC registered mutual funds do not allow annuities for the same reasons that I think most annuities flunk prohibited transaction exemptions.

CFA Institute Global Investment Performance Standards (GIPS) also have transparency standards on performance and fees.[iv]  Annuities typically do not comply with CFA GIPS standards. [v]  

Another way for plans to have Transparency and fiduciary control are achieved in a plan by an Investment Policy Statement (IPS).  However, plans with annuities avoid an IPS because they usually cannot comply with one.  [vi]

Noted Morningstar analyst John Rekenthaler said in April 2022 that in selecting 401(k) investment options, “inappropriate are investments that don’t price daily.  Annuities typically do not price daily and do not provide valuation transparency.[vii]  

Annuities avoid transparency with poor state regulated structures which allow them to hide excessive risks and fees.    Annuity providers fight hard to avoid any federal regulations, especially those imposing on them any type of true fiduciary standard and/or transparency, usually favoring state regulation in their home states where they are major employers and have higher political influence. Even industry insiders admit hidden fees are problematic to adopting annuities.[viii]

After the 2008 financial crisis several insurers were forced into federal regulation under SIFI (too big to fail) they did everything to get out of the higher transparency and higher capital requirements.[ix] 

Fiduciary Conflicts Tests – Loyalty and Excessive Compensation

Plans need to put their loyalty to plan participants first, which is their fiduciary duty.   They do not have loyalty to vendors such as money managers and annuity providers.

Annuities have an inherent conflict because upon annuitization, a common prerequisite to receiving the alleged benefit – guaranteed stream of income for life – investment dollars leave the ownership of the plan and participants, and become part of the balance sheet of the insurance company.   

Annuity contracts are designed to avoid all fiduciary obligation with no loyalty to participants.   Most annuity providers refuse to sign a “Fiduciary Acknowledgement Disclosure.” 

DOL official Khawar said. “” Under the National Association of Insurance Commissioners’ model rule, for example, “compensation is not considered a conflict of interest,” [x]

Reasonable Compensation Limitation

Annuities have a total lack of disclosure of profits, fees and compensation.  They have secret kickback commissions.    How can a plan claim any of the compensation annuity provider receives is reasonable if it is secret and not disclosed?

Secret kickback and commissions place the financial interests of the insurers and their affiliates over those of retirement investors.[xi]  In summer 2024 the GAO report on Self-Dealing [xii],  and Senator Warrens reported on Annuity kickbacks.[xiii]

A number of lawsuits have settled with claims of excessive secret fees and spreads. An insurance executive bragged at a conference of secret fees r3agrding spreads of over 200 basis points (2%) in 2013. [xiv]   Most observers of 401(k) plans do not feel that 200 basis points of compensation is reasonable.

Fixed Annuity Applications

In 1992, The Federal Reserve exposed the weak state regulatory and reserve claims of fixed annuities in retirement plans.[xv]   In 2008, Federal Reserve Chairman Ben Bernanke said about these annuity products “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.”[xvi]

The version of annuity that is most common in DC plans larger than $100mm in total assets or 1000 employees is the Immediate Participation Guarantee (IPG)  which is a group annuity contract (GAC) written to a group of investors in a defined contribution (DC) plan, not to individuals.[xvii]   The largest IPG is the TIAA Traditional Annuity with over $290 billion in assets, making it one of the largest options in DC plans in the United States. [xviii]

These IPG contracts have been characterized by DC plan group NAGDCA as having serious fiduciary issues.  “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 “  [xix]

The industry defense on prohibited transactions is a bait and switch around a hyped politically popular concept of lifetime annuities which, in reality, do not hold material assets in DC plans.  The industry also uses language realtive to Pension Risk Transfers that apply to DB plans not DC plans.   

My estimates, based on looking at 100s of DC plans over $100mm in assets, is that overall around 12% of plans currently have any type of annuity. Of those with an annuity,  less than 1% is in lifetime annuities and variable annuities, 5% is in miscellaneous insurance company Separate Account products,  83% in Fixed Annuities IPG General account accumulation group annuity contracts, and 11%  in Fixed Annuities IPGs Separate account accumulation group annuity contracts

While I believe that lifetime income and pension risk transfers in DB plans have fiduciary issues,  plan sponsors do not really have any defense for the IPG type fixed annuities that make up the bulk of prohibited assets in larger Defined Contribution plans. https://www.metlife.com/retirement-and-income-solutions/insights/final-clarification-annuity-selection-safe-harbor/

Plan sponsors who choose to use IPG annuities in their 401(k) plans clearly need to document why they believe it deserves a prohibited transaction exemption.

[i] https://commonsense401kproject.com/2024/10/10/annuities-exposed-as-prohibited-transaction-in-401k-plans/

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

[iii] https://rpc.cfainstitute.org/-/media/documents/book/rf-publication/2017/rf-v2017-n3-1.pdf

[iv] https://www.cfainstitute.org/en/membership/professional-development/refresher-readings/gips-overview

[v] https://commonsense401kproject.com/2023/02/01/401k-plan-sponsors-should-look-to-cfa-code-for-investment-governance/

[vi] https://commonsense401kproject.com/2023/03/12/investment-policy-statements-crucial-to-fiduciary-duty/

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

[viii] https://riabiz.com/a/2024/5/11/fidelity-voya-and-boa-smooth-blackrocks-launch-of-guaranteed-paycheck-etfs-but-401k-plan-participants-may-yet-balk-at-high-unseeable-fees-and-intangibility-of-benefits

[ix] https://www.stanfordlawreview.org/online/the-last-sifi-the-unwise-and-illegal-deregulation-of-prudential-financial/

[x] https://www.thinkadvisor.com/2024/10/07/top-dol-official-sees-a-nonsensical-reality-at-heart-of-fiduciary-fight/

[xi] https://consumerfed.org/annuity-industry-kickbacks-cost-retirement-savers-billions/

[xii] https://www.gao.gov/products/gao-24-104632

[xiii] https://www.warren.senate.gov/imo/media/doc/senator_warrens_annuity_report_-_sept_2024.pdf    Secret kickback commissions

[xiv] https://www.bloomberg.com/news/articles/2013-03-06/prudential-says-annuity-fees-would-make-bankers-dance?embedded-checkout=true

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

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

[xvii] https://www.dfs.ny.gov › ipgdac_word_20121214  

[xviii] https://www.tiaa.org/public/plansponsors/investment-solutions/lifetime-income/tiaa-traditional-overview

https://www.nbcnews.com/investigations/tiaa-pushes-costly-retirement-products-cover-losses-whistleblower-rcna161198

[xix] http://www.nagdca.org/documents/StableValueFunds.pdf_ The National Association of Government Defined Contribution Administrators, Inc. (NAGDCA) September 2010.

Annuities Exposed as Prohibited Transaction in 401(k) Plans

/ jwatkins / Leave a comment

By Christopher B. Tobe, CFA, CAIA

Annuities should not be allowed in 401(k)s.   ERISA created the concept of Prohibited Transactions to prohibit any investments with clear Conflicts of Interest.  I testified to the ERISA Advisory Council – US Department of Labor in July of 2024 on the danger of allowing annuities to be hidden inside of Target Date Funds. [i]   I have co-written a paper with Economics Professor Tom Lambert on the excessive risks of annuities.[ii]

Perhaps with the exception of Crypto and Private Equity no investment better describes what should be a prohibited transaction more than annuity contracts.

Annuities are a Fiduciary Breach for 4 basic reasons.[iii]

  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

So why do we still see annuities in 401k plans?  The reason is intense lobbying by the insurance industry, that has blocked any transparency or oversight.

Annuity providers claim to be barely legal by relying on an Prohibited Transaction Exemption (PTE 84-4) a “get out of jail free card” obtained by $millions of lobbying by the insurance industry.


Biden Fiduciary Rule

The new Biden Fiduciary rule would provide transparency that would further expose these annuity products’ conflicts of interests.  The insurance industry has forue shopped in Texas in the Fifth Circuit for judges who agree with blocking transparency to block it for now.

At the Certified Financial Planner Board of Standards Connections Conference in Washington October 2024, DOL officials called out annuities as prohibited transactions. [iv]  Ali Khawar, principal deputy assistant secretary for the Employee Benefits Security Administration, laid out the reasons why the Biden Labor Department continues to fight for a fiduciary rule ““To me it continues to be kind of nonsensical that you’re expecting any of your clients to walk into someone’s office and have in their head: ‘I’m dealing with this person who’s going to sell insurance to me, this person is relying on [Prohibited Transaction Exemption] PTE 84-24, not [PTE] 2020-02. Those things shouldn’t mean anything to the average American. And we shouldn’t expect them to.”

broker-dealer space transformed what it means to be in the advice market,” Khawar said. “When we looked at the insurance market, though, we didn’t quite see the same thing.”

Under the National Association of Insurance Commissioners’ model rule, for example, “compensation is not considered a conflict of interest,” Khawar said.  “So there are pretty stark differences between what you see in the CFP standard, the Reg BI standard, and what has now been adopted by almost every state, one notable exception of New York, which has adopted a standard that is significantly tougher than the NAIC model rule.” [v]  That process is “the CFP standard, the DOL standard, it’s the SEC standard for investment advisors and it’s Reg BI,” Reish continued. What it’s not? “The NAIC model rule,” Reish said.

“The NAIC model rule does not require the comparative analysis[vi]

Khawar added: “It’s not going to matter whether you’re providing advice about an annuity, a variable annuity, fixed income annuity, indexed annuity, security or not.” The goal with the 2024 rule, Khawar added, is to “have a common standard across the retirement landscape so that all retirement investors would be able to make sure that when someone is marketing up front best-interest advice, that that’s the standard they’d be held to by the regulator and the customer.”

Under the Employee Retirement Income Security Act, “being a fiduciary is critical to the central question of whether or not the law or consumer protections have fully kicked in or not,” Khawar added.

The Government Accounting Office wrote a piece in August in support of the Biden Fiduciary rule. They saw the problem as so severe that they suggested that IRS step in to help the DOL Better Oversee Conflicts of Interest Between Fiduciaries and Investors especially in the Insurance Annuity Area. [vii]  Senator Elizabeth Warren in defense of the Biden Fiduciary rule prepared a report on the numerous conflicts of interest in annuity commissions and kickbacks. [viii]

Annuities days of hiding behind PTE 84-4 are over

Prohibited transaction exemptions are subject to meeting certain requirements.  They include

  1. The Impartial Conduct Standards.
  2. Written Disclosures.
  3. Policies and Procedures
  4. Annual Retrospective Review and Report

The Impartial Conduct Standards have 4 major obligations. 

A. Care Obligation

B. Loyalty Obligation

C. Reasonable compensation limitation

D. No materially misleading statements (including by omission)

Care Obligation

This obligation reflects the care, skill, prudence, and diligence – similar to Prudent Person Fiduciary standard.   Diversification is one of the most basic fiduciary duties.  Fixed annuities flunk this with single entity credit and liquidity risk.  Diligence is nearly impossible with misleading nontransparent contracts, and the lack of plan/participant ownership of securities. The Federal Reserve in 1992 exposed the weak state regulatory and reserve claims.[ix]

Loyalty Obligation

Annuity contracts are designed to avoid all fiduciary obligation with no loyalty to participants.   Secret kickback and commissions place the financial interests of the Insurers and their affiliates over those of retirement investors.[x] 

The exemption requires the advisor to show their loyalty with a “Fiduciary Acknowledgement Disclosure.”   Annuity contracts avoid any fiduciary language or responsibility.

Reasonable compensation limitation

Annuities have a total lack of disclosure of profits, fees and compensation.  They have secret kickback commissions.

A number of lawsuits have settled with claims of excessive secret fees and spreads. An Insurance executive bragged at a conference of fees over 200 basis points (2%) in 2013. [xi]

No materially misleading statements (including by omission)

Annuities have numerous material misleading statements, including the total lack of disclosure of spread/fees.  They claim principal protection, but some fixed annuity contracts recently have broken the buck and violated their contracts.  The written disclosures under weak state regulations omit critical information on risks and fees.

Most plans with annuities do not have Investment policy statements, since most fixed annuities would flunk them on diversity and transparency and not be allowed.  Annuities cannot provide the transparency to follow CFA Institute Global Performance Standards (GIPS) so they do not comply.[xii]  Most 401(k) committees with insurance products do not review such annuity products, since they clueless on what they are.  Consultants for plans with annuities do not review the annuities most of the time since they are conflicted and they themselves receive kickbacks from annuity providers.

Annuities as a Prohibited Transaction

Annuities hide most of their compensation.   They are typically secret no bid contracts with no transparency and numerous conflicts of interest.  They are subject to weak state regulations (sometimes categorized as NAIC guidelines). Many times they are a party of interest and shift profits from annuities to make other fees appear smaller.

Annuities are clearly prohibited transactions, but have used their lobbying power in Washington and in states to exempt themselves from all accountability.

[i] https://commonsense401kproject.com/2024/07/31/chris-tobe-dol-testimony/

[ii] https://commonsense401kproject.com/2024/03/26/just-how-safe-are-safe-annuity-retirement-products-new-paper-shows-annuity-risks-are-too-high-for-any-fiduciary/

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

[iv] https://www.thinkadvisor.com/2024/10/07/top-dol-official-sees-a-nonsensical-reality-at-heart-of-fiduciary-fight/

[v] https://www.thinkadvisor.com/2024/10/07/top-dol-official-sees-a-nonsensical-reality-at-heart-of-fiduciary-fight/

[vi] https://www.thinkadvisor.com/2024/10/07/top-dol-official-sees-a-nonsensical-reality-at-heart-of-fiduciary-fight/

[vii] GAOJuly24  Retirement Investments: Agencies Can Better Oversee Conflicts of Interest Between Fiduciaries and Investors

Click to access FiduciaryConflictsofInterest_OMB.pdf

https://www.thinkadvisor.com/2024/08/28/conflicted-ira-advice-widespread-as-fiduciaries-lack-oversight-watchdog-finds/
https://www.gao.gov/products/gao-24-104632

[viii] Warren Study –  Annuity kickbacks

Secret kickback commissions https://consumerfed.org/annuity-industry-kickbacks-cost-retirement-savers-billions/

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

[x] https://consumerfed.org/annuity-industry-kickbacks-cost-retirement-savers-billions/

[xi] https://www.bloomberg.com/news/articles/2013-03-06/prudential-says-annuity-fees-would-make-bankers-dance?embedded-checkout=true

[xii] https://commonsense401kproject.com/2023/02/01/401k-plan-sponsors-should-look-to-cfa-code-for-investment-governance/