What The New Fiduciary Rule Means For 401(k) Plan Sponsors

by: Evan Powers

Summary

The DOL's new fiduciary rules are aimed mostly at IRAs, but 401(k) plan sponsors and advisors will also be affected.

It is widely expected that 401(k)-related lawsuits will continue to increase both in frequency and in scope.

The "best interests" standard has not yet been well defined by the courts, leaving room for interpretation.

Education and workplace financial planning efforts can help plan sponsors to limit their liability, while better understanding the needs and desires of plan participants.

Last week, the Department of Labor (DOL) issued its long-anticipated new fiduciary rule, which greatly expands the definition of which actions require stockbrokers and other investment advisors to act solely in the "best interests" of investors or clients. There has been no shortage of analysis on the new rules and their expected implications for the future of the retirement industry, and a full breakdown of the ramifications is probably best provided elsewhere.

In general, though, the new rules are expected to have the greatest impact on Individual Retirement Accounts (IRAs), and on the investment firms who have custody over them. However, what's becoming increasingly clear is that the increased public awareness of fiduciary responsibility within retirement plans - as evidenced by and enhanced by the new DOL rules - will continue to put pressure on 401(k) plan sponsors as well, many of whom have long approached their plans with a certain level of benign neglect.

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Even before the passage of the new rules, 401(k) plan participants (and their legal representation) had begun to step up their efforts to protect their rights as investors in those plans. Indeed, a list of recent lawsuits against 401(k) plan sponsors reads like a who's who of Fortune 100 firms: Boeing (NYSE:BA), Lockheed Martin (NYSE:LMT), Anthem (NYSE:ANTM), Oracle (NASDAQ:ORCL), and Chevron (NYSE:CVX), to name just a few. Not even investment-focused firms have been immune from scrutiny, as Fidelity, Putnam, and Citigroup (NYSE:C) have all faced lawsuits in recent years alleging excessive fees within their own company 401(k) plans.

In most cases, the class action suits have resulted in settlements before being fully adjudicated, so the courts have had few opportunities to indicate where they stand as to defining the scope of the "best interests" standard that is at the heart of the now-expanding fiduciary duty.

As yet, then, nobody really knows just how far that "best interests" standard should extend-clearly, charging excessive fees on the funds made available to participants falls within the definition; but what about "excessive mailings," which were the subject of one recent lawsuit, or a belief that general recordkeeping costs are too high? As the word "fiduciary" continues to grow in public recognition, there is a growing expectation that investor-led lawsuits will increase in frequency and in scope, as the industry tries to parse that definition.

In a recent opinion piece written for the National Association of Plan Advisors, employment attorney David Levine argued that ERISA lawsuits may have gone "off the rails" in recent months, with a loss of focus on the actual requirements of a plan sponsor's fiduciary duty. ERISA, Levine wrote, does not require that plan sponsors always minimize expenses at every turn, or that every plan design element or investment decision works out perfectly. "Instead," Levine wrote, "ERISA simply requires that fiduciaries utilize a prudent process."

So, what does that "prudent process" entail, and how can plan sponsors ensure that they are doing the best they can to operate in the "best interests" of plan participants, especially in light of the new DOL rules? We believe that the answer lies in improved participant education, expanded financial wellness programs, and a general shift toward a more collaborative employer-employee approach to retirement planning, rather than the somewhat detached, semi-paternalistic process that currently prevails at most employers.

The importance of 401(k) participant education

The ultimate legacy of the DOL's new rule - as with most new regulations - will not lie in its intentions, but in the responses of the various industry players. Public awareness has certainly been raised, which is generally a good thing - more investors and workers are now at least aware of the existence of the fiduciary standard and its importance, and they will now better know what sort of questions to ask. From the employer or plan sponsor's perspective, then, it will be important to be prepared to provide the right sort of answers.

That might require some adjustment of expectations, though. As recently as a decade ago, a comprehensive AllianceBernstein study found that a full 60% of 401(k) plan sponsors did not consider themselves to be serving in a fiduciary role (that number swelled to 79% for the smallest plans), and that 68% of firms spent a day or less each year thinking about issues of plan design. Hopefully, the recent attention has changed those numbers somewhat, but there's still likely a significant amount of room for improvement.

Educating plan participants can go a long way toward increasing employee goodwill, while also improving their financial decision-making. Indeed, the AllianceBernstein study found that 70% of plan participants who received advice through their workplace 401(k) plan implemented some or all of the recommendations they were given.

Improved employee education can also help protect the plan sponsor's bottom line, and not just by reducing the likelihood of future employee lawsuits. Research has consistently shown that employees who are more secure financially are less stressed, more productive, more successful, and less likely to leave for other job opportunities. In addition to helping to attract high-caliber talent, keeping existing employees happy and financially healthy can save an employer both time and money in the form of lower re-training costs.

But as the role of fiduciary continues to grow and evolve, we think that workplace financial education needs to expand beyond the traditional investment education and fund-selection conversation. Involving comprehensive financial planning in the process can help the employee immeasurably, while also helping the employer to better craft an overall retirement plan and thereby better meet its "best interests" standard as a fiduciary.

A role for financial planning

As the scope of the "best interests" standard (or at least, the scope of lawsuits targeting the standard) continues to expand, it's important that employers and employees work together to ensure that both sides know what those "best interests" actually look like.

After all, if a plan sponsor knows little or nothing about its participants' financial situations and goals, it's almost impossible for that sponsor to know whether or not their decisions are, in fact, operating in the participant's best interests. And yet, it's difficult for the plan sponsor to make any meaningful headway in that regard if the employees themselves do not know where they stand financially (and most do not). To the degree that the two parties can work together to improve those gaps, both sides can end up better off as a result.

Traditionally, an employee census has served as the basis for all 401(k) plan design efforts, providing basic information about participants' age, gender, and salary. But we'd argue that such basic information is insufficient. In choosing investment options and other plan specifics that meet the "best interests" standard, the entirety of an employee's financial situation can (and should) be considered relevant. Further information-gathering efforts to glean data about participants' living expenses, investment background and knowledge, risk tolerances, and overall financial goals can all help plan sponsors to design a plan that is nimble and flexible enough to meet a variety of participant needs.

Besides simply informing decisions about investment options, this kind of information-gathering can also inform plan design choices. For example, the strategy of using "stretched" matching contributions has become increasingly popular in recent years. In this kind of plan, instead of offering the standard dollar-for-dollar employer match up to a specified percentage of salary (say, 3%), a "stretched" match lowers the per-dollar match, but extends the range of matchable employee contributions - say, 50 cents per dollar up to 6% of salary, or 25 cents per dollar up to 12% of salary.

These kinds of arrangements have been shown to increase the amount of salary deferrals made by employees, which is generally a positive development. But for some participants who may be on a particularly tight budget, raising the bar for how much they need to contribute could produce significant resentment, and could in fact be acting contrary to their "best interests."

Knowing whether or not a participant has sufficient budgetary flexibility clearly requires more information than the typical employee census provides; these sorts of issues are at the crux of the "best interests" issue facing fiduciaries. The more information that plan sponsors are able to gather about participants' complete financial picture, the more capable they will be of designing an optimal plan that meets everyone's needs and goals.

Indeed, a 1999 paper written by Virginia Tech professor E. Thomas Garman concluded that an investment in comprehensive financial education would be more effective, less expensive and generally more appreciated than the alternative of increasing the available amount of employer "matching" funds within the 401(k) plan.

If plan sponsors are looking for ways to protect themselves -and to support their employees - in this brave new "fiduciary" world, then an expansion of workplace education via enhanced financial wellness programs and comprehensive planning efforts is a perfect place to start. The word "fiduciary" doesn't need to be scary. On the contrary, it should be viewed as an opportunity for plan sponsors to better serve investors everywhere.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.