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Regulation and Compliance > Federal Regulation > DOL

The 2 biggest causes of fiduciary liability in 401(k)s

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The old adage goes: When it rains, it pours. However, that doesn’t necessarily imply a bad thing. All it means is that things happen in bunches. Good things. Bad things. Old things. New things. Borrowed things. Blue things. 

This autumn has been a series of rather fortunate events. Everyone has goals. Sometimes they’re ambitious. We call those dreams. When I started writing, I had several goals – achievements I could earn myself just with grit, determination and a handy keyboard. I also had dreams – accomplishments I could only earn by winning the respect of others. Among my dreams included speaking before the Academy of Behavioral Finance and Economics as well as speaking before a group of senior bank trust officials. Both of these represent my two different (but deep) professional roots. 

Related story: SEC fiduciary questionnaire is fatally flawed

And, by coincidence, both events occurred within weeks of each other this fall. I wrote about my experience in the wonderful world of behavioral finance a while back. This week I turn to what I discovered in route to outlining my session for The Fiduciary and Investment Risk Management Association (you can read about the topic in “401(k) Fiduciary Liability in a Multi-Vendor Environment,”, Oct. 15, 2013). Most of those in attendance at the first of two training sessions I was asked to speak at were trust auditors. 

This is a big deal.

I cut my fiduciary teeth in the bank trust business. I hold it dear to my heart. These are the folks that gave us what many advisors strive to achieve – the fiduciary duty of loyalty. Trust auditors take this fiduciary duty very seriously. Sometimes I think they take it more seriously than government regulators, but that’s another story. To be asked to speak as an authority before this esteemed group is an honor beyond description. 

As I was preparing my notes, I tried to find a theme that would link the potential fiduciary liability among nearly all types of 401(k) vendors. Since the DOL focuses on OPM (other people’s money), it was easy to uncover. A fiduciary breach, at least in the DOL’s mind (and possibly many others), occurs when there is a security breakdown in the money flow of the plan. 

Once this system had been identified, it became obvious there were two types of possible breaches. The first used to get all the press, but now seems innocuous compared to the second. The first can also be more easily mitigated by systematic changes that catch the breach more quickly and remedy it almost immediately. The second, well let’s just say there’s a certain opinion that says the second isn’t a breach at all. They call it a business model. 

Let’s review them one at a time. 

The first big cause of fiduciary liability in 401(k) plans is the time-honored “failure to take action in a timely manner.” This means not moving the money to its proper place within whatever chronological limits the industry has established as appropriate. It could be as simple as failure to transfer funds from the payroll processor to the plan’s account. It could mean the recordkeeper’s failure to process transactions when they ordered. It could mean the custodian failing to provide beneficiaries with funds they have a due right to. 

In all the above cases, a good system will flush out these timing misses long before any real damage can occur – or at least in time to minimize any real damage. These can generally be labeled as errors and omissions and — lo and behold — there’s actually a specific form of insurance one can obtain to offset the risk of these types of breaches. 

The same cannot be said of the second type of fiduciary liability. This risk occurs when a vendor engages in self-dealing transactions. While normally prohibited, the DOL does allow the camel’s nose to peak under the tent. There are certain self-dealing transactions the DOL exempts from prohibition. 

It is precisely this type of exemption that rankles the hide of a good trust auditor. There’s a reason why self-dealing transactions have been verboten in all forms of trust for centuries. It is because the action is too often misaligned with the best interests of the beneficiary. In the case of 401(k) plan participants, we see this in academic studies which show that funds using 12b-1 fees and revenue sharing (the primary source of legal 401(k) self-dealing) underperform by 3.6 percent versus funds that don’t involve self-dealing. 

That this is not currently defined by the DOL as a breach of one’s fiduciary duty does not mean the liability has been removed from the plan sponsor. Just ask International Paper (who settled for $30 million) and Cigna (who settled for $35 million). Both were accused of paying excessive fees – often code for investing in funds that offer 12b-1 fees and revenue sharing. 

And, don’t forget, when it rains, it pours. Both of these settlements have occurred just in the last few months. Might they be the beginning of a trend? If so, then plan sponsors beware.

See also:

The danger of risk tolerance questionnaires

401(k) trustee Matthew Hutcheson sentenced to 17 ½ years

SEC comments muddy the waters in fiduciary standard debate


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