When Bigger Isn’t Better

In the retirement plan marketplace, plan-provider bigness can mean a sub-optimal solution for both plan sponsors and plan participants.

W. Scott Simon


Many retirement plans in this country are sold by giant complexes of mutual fund families, insurance companies, stockbrokerage houses, independent broker/dealer firms, and the like. These entities very often have their names affixed to skyscrapers in large cities, creating an impression of bigness, solidity, and permanence.

These giant complexes are only too happy to crank out reams and reams of marketing and sales materials, various and sundry surveys, colorfully illustrated brochures printed on thick, glossy paper, all manner of white papers, blizzards of press releases, and the like. Some plan sponsors are virtually bowled over by this huge volume of material.

But the “stuff” created by the plan provider complexes is often so confusing to plan sponsors and takes them so much time to digest that many of them, in effect, throw up their hands and surrender to the complexes, which are content to keep their marketing departments cranking it out. This helps contribute to an ultimate goal of these complexes: impressing plan sponsors with the bigness of their efforts and the prestige of their organizations.

All this effort expended by the complexes can be very seducing to sponsors of retirement plans whether they are mom-and-pop operations or multi-billion dollar corporations. In some cases, it’s love at first sight: “Those folks at x, y or z who just came in here to meet with us sure are very impressive. We like everything about them–their dress/demeanor/speech/educational background–and we just cannot seem to get the imposing image they portray out of our minds. Their organization is so prestigious and big and solid that it will make us feel really good working with them. Those very qualities that make us feel so good about them are the very reasons why we just know they will provide us with a world-class plan.”

In other cases, sponsors are less smitten, settling for a plan offered by such providers that they realize is not a great plan but is one that’s good enough. Such sponsors want a retirement plan (surprisingly often not even a great retirement plan but just a plan) because they need one in their bag of employee benefits that will match (though usually not surpass) those offered by their competitors.

Bigger Isn’t Necessarily Better

In either kind of case, many (perhaps most?) sponsors believe that the giant service provider they have selected to provide all the pieces of their retirement plan will cover their back and protect them should anything go legally wrong with plan participants, the U.S. Department of Labor, or the Internal Revenue Service. This belief is often wrong. In fact, when things do go wrong, such providers ordinarily are not sued (given the contracts they have drafted for, and signed with, plan sponsors in which they ordinarily eschew any fiduciary responsibility to retirement plans). Even when they are sued, they rarely incur any serious liability. So any plan sponsor contemplating (or already) using these providers can take little comfort from any perceived legal advantage offered by, well, such bigness.

The giant complexes are always ready, of course, to recite the litany of benefits offered by the retirement plans they sell to plan sponsors. There’s just one problem with such recitations: in far too many cases, they are generally a lot of nonsense. This is due to the fact that these recitations are made in support of the “bundled” retirement plan model employed by complexes that’s offered to sponsors as a one-stop solution. A complex offering this bundled solution will include trustee, custodial, record-keeping, and third-party administration services as well as acting as the gatekeeper for the investment options offered to a plan.

(My June and July 2012 columns examined the bundled plan model in relation to the Tussey v. ABB litigation. This model is good for giant complexes of plan service providers because it allows them to effectively and efficiently distribute their proprietary investment products (such as mutual funds and stable value funds) in a very lucrative way. But this model is not good for plan sponsors or plan participants because it disguises where money is flowing from, where money is flowing to, and in what amounts. Without knowing such things, no sponsor can determine whether the costs of a retirement plan are necessary and reasonable in relation to the services for which they’re expended within the meaning of section 404(a) of the Employee Retirement Income Security Act (ERISA). This model often results in unnecessarily costly (and often under-diversified) plan investment options, which help contribute to a less secure and comfortable retirement lifestyle for plan participants (and their beneficiaries).

Relatively few plan sponsors understand the pernicious nature of this model and how the complexes often rely on it to hide their high fees. All they see is “bigness”–in the form of the thousands of plans serviced, the hundreds of thousands of participants enrolled, and the hundreds of billions of dollars managed–and assume that such bigness translates into delivery of an excellent retirement plan. That may be so in many other for-profit commercial endeavors, but in the retirement plan marketplace, bigness can mean a sub-optimal solution for both plan sponsors (because the complexes don’t provide them with fiduciary protection) and plan participants (because the complexes don’t provide them with low-cost and broadly diversified investment options). Plan sponsors just assume that a bigger plan provider complex is a better plan provider complex, and that all will be well as a result. As the old song goes, though, It Ain’t Necessarily So.

When Giant Complexes Are Scaredy Cats

The bundled model employed by giant complexes of plan service providers, as noted, is woefully inadequate in providing plan sponsors with fiduciary protection and plan participants with low-cost and broadly diversified investment options. One trend that further illustrates this inadequacy involves requests for proposal (RFP) issued by plan sponsors that seek to obtain the services of an ERISA section 3(38) investment manager whereby the manager assumes written fiduciary responsibility (and associated liability) for investing, monitoring, and (if necessary) replacing a plan’s investment options.

By way of example, the registered investment advisory firm owned by my partners and me has always served as an independent 3(38) fiduciary to all our retirement plan clients since inception of the firm. Our investment management contract is directly with the plan sponsor. In answering RFPs that seek the services of a 3(38), however, giant complexes of plan service providers will never assume the status of a 3(38), preferring instead to bring in an outside third party to be the 3(38). This failure makes such complexes appear to be acting like a bunch of “scaredy cats.” It also appears to be nothing more than a marketing gimmick–a way for the complexes to avoid being fiduciaries and yet provide a 3(38) “solution” under their own name. Plan sponsor: Do you, Giant Complex, provide 3(38) services? Giant Complex: Yes.

To be clear, when a giant complex answers an RFP that requires a 3(38), the complex won’t offer to provide such services itself but will bring in a third party to provide them. The third party 3(38) isn’t independent of the complex, though, because, in effect, it merely rubberstamps the investment options presented to it by the complex. For example, a complex will provide a would-be 3(38) third party with a menu of, say, 500 pre-screened, approved investment options from which the third party will select, say, 25 or 50 options. The third party knows–with a wink and a nod–the kinds (proprietary and non-proprietary), amounts, and mix of the investment options required by the complex to ensure that the complex earns the necessary revenue- sharing from the options on the menu. The third party has little ability to digress from selecting anything that’s not on the complex’s pre-screened, approved list. A rubberstamping 3(38), then, is distinctly different from, and sub-optimal to, a truly independent 3(38), which has the power to select any kind, amount, and mix of, say, mutual funds from the total universe of mutual funds available to provide a thoroughly prudent menu of investment options for plan participants.

How is the rubberstamping third-party 3(38) paid? In either case, whether it is paid by the giant complex or its services are offered at no additional cost (i.e., the 3(38)’s fee is included), the rubberstamping 3(38) for all intents and purposes is in the back pocket of the complex. This, of course, defeats the whole purpose of retaining a truly independent 3(38): to provide a thoroughly prudent menu of investment options to plan participants (and, by the way, off-load fiduciary responsibility and liability from plan sponsors).

There is no independence in cases where a giant scaredy cat complex brings in an outside entity to enable it to respond to an RFP requiring a 3(38). All that’s really happened is that a rubberstamping 3(38) has passed judgment on the complex’s pre- approved, pared-down list of investment options on the complex’s platform. The value of such a 3(38) that merely approves what a complex wants, then, is highly problematic. This process certainly doesn’t sound like the third-party 3(38) is making decisions in the “sole interest,” and for the “exclusive purpose,” of plan participants under ERISA section 404(a). (Could it be that this kind of arrangement will be challenged legally in the not-too-distant future?)

A plan sponsor that wants a 3(38) solution should retain an independent 3(38). In that scenario, the 3(38) will have unfettered access to all investment options and be free from outside influences to select whatever options it deems to be prudent. The real value in retaining a 3(38) lies in having a truly independent firm make the same kind of decisions that a well-informed plan sponsor would.

W. Scott Simon is an expert on the Uniform Prudent Investor Act, Restatement (Third) of Trusts and Title I of ERISA. He provides services as a consultant and expert witness on fiduciary investment issues in depositions, arbitrations and trials as well as in written opinions. Simon is the author of two books including The Prudent Investor Act: A Guide to Understanding. He is a member of the State Bar of California, a Certified Financial Planner® and an Accredited Investment Fiduciary Analyst™. Simon received the 2012 Tamar Frankel Fiduciary of the Year Award for his “contributions to advancing the vital role of the fiduciary standard to investors, capital markets and to society.” The author’s views expressed in this article do not necessarily reflect the views of Morningstar.

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