United States: Another ERISA Fiduciary Duty Wake-Up Call

Does your company use a retirement plan consultant to help plan how best to invest the company’s pension or 401(k) plan money? If so, you need to take note of, and respond to, concerns raised by the government about conflicts of interest and potential bias in the retirement plan consultant and money management industry. ERISA plan fiduciaries who fail to act could be faced with questions about whether they are doing their jobs properly.

The staff of the Securities and Exchange Commission ("SEC") is concerned that something is wrong with the way registered investment advisors who provide pension consulting services conduct their business. On May 16, 2005, the SEC staff released a report titled "Staff Report Concerning Examinations of Select Pension Consultants" ("Report"), indicating that the investment advice some pension or 401(k) plan ("retirement plan") consultants sell may be biased. The ability of retirement plan consultants to give their clients detached and disinterested advice may be compromised due to the consultants’ economic ties to mutual fund and other money managers and stock brokerage houses. The SEC Report raises questions about the real price retirement plans pay for their investment advice.

Retirement plan fiduciaries should know by now that their actions, especially in the asset management area, will be scrutinized at the first suggestion of trouble. The Enron and WorldCom debacles, as well as the mutual fund industry’s market timing and late trading scandals, have eroded the government’s confidence in the ability of retirement plan fiduciaries to self-police the $7 trillion U.S. retirement plan system.¹ Lawsuits are filed routinely when the value of an employer’s stock in its retirement plans drops on disclosures of the company’s financial difficulties.

Failure to properly police the activities of, and fees paid to, retirement plan consultants could be the next area of challenge. Let’s look at what the government has done and what ERISA fiduciaries should now do.

Following the trail of New York Attorney General Eliot Spitzer’s investigation, the SEC staff began its inquiry into the practices of the retirement plan advice industry in December 2003. Twenty-four retirement plan consultants were contacted. The SEC staff noted that 1,742 registered investment advisors provide retirement plan consulting services. Of the 24 consultants interviewed, the SEC staff found that more than half of the firms were taking fees from retirement plan clients while at the same time selling services and products to money managers and stock brokerage houses. The SEC staff was particularly troubled that most retirement plan consultants failed to see this as a problem. Almost none disclosed these potential conflicts of interest to their clients.

The SEC Report found that:

1. More than half of the 24 retirement plan consultants investigated (13) actively provided products and services to both retirement plan advisory clients and money managers and mutual funds on an ongoing basis.
2. Many retirement plan consultants have affiliates that are in the business of providing other services to those same retirement plan clients. These relationships create additional disclosure and conflict-of-interest issues not yet addressed by retirement plan consultants.
3. Of the 19 retirement plan consultants or their affiliates that provided any products or services to money managers, three (or 16 percent) provided no disclosure of these other services, and 16 (or 84 percent) provided limited disclosure.

Retirement plan consultants should, according to the Report, enhance their compliance policies and procedures to ensure conflicts of interest are disclosed. Consultants, according to the SEC staff, should adopt policies and procedures to:

1. Ensure that the retirement plan consultant’s advisory activities are insulated from its other business activities, to eliminate or mitigate conflicts of interest.
2. Ensure that all disclosures required to fulfill fiduciary obligations are provided to prospective and existing advisory clients.
3. Prevent conflicts of interest or disclose material conflicts of interest with respect to the use of brokerage commissions, gifts, gratuities, entertainment, contributions, donations, and other things of value provided to clients or received from money managers.

Enforcement action against retirement plan consultants subject to the SEC staff investigation is looming. On May 25, 2005, the Department of labor ("DOL") issued a subpoena to Morningstar Associates, an investment advisor to 401(k) plans. Morningstar is also being investigated by New York Attorney General Eliot Spitzer and the SEC.² To underscore the seriousness of this situation, the DOL and the SEC on June 1 jointly released a set of 10 questions and "tips" to assist retirement plan fiduciaries in gauging whether their retirement plan consultants’ recommendations are objective. A copy of "Selecting and Monitoring Pension Consultants: Tips for Plan fiduciaries" is available on the DOL and SEC web sites at www.dol.gov/ebsa and www.sec.gov/investor/pubs/sponsortips.htm. In addition, the DOL’s Employee Benefits Security Administration announced on June 21, 2005, that it is undertaking a "major initiative" regarding the fees charged by employee benefit plan service providers.³ Robert J. Doyle, the DOL’s Director of Regulations and Interpretations, stated that service provider fee arrangements under ERISA must be "reasonable." He added that he did not think a service provider’s fee arrangement would be considered "reasonable" unless there is full disclosure of conflicts of interest.

What should retirement plan fiduciaries do in response to this government scrutiny? They should begin by gathering the information specified in the DOL/SEC Tips for Plan fiduciaries and by applying the lessons learned from recent history. The well-reported allegations of mutual fund abuses, including late trading and market timing, made newspaper headlines during the fall of 2003. The DOL promptly issued guidance on how plan fiduciaries should respond to the news of the mutual fund scandals. The DOL’s mutual fund scandal guidance now provides a useful framework for a review of the new allegations of retirement consultant abuses. This DOL guidance indicates that fiduciaries have a duty to assess the impact of the potential retirement plan consultant problems on their ERISA-regulated plans and to review their retirement plan consultants’ disclosure practices. Fiduciaries who use the services of retirement plan consultants should consider the following factors:

1. The nature of the alleged abuses.
2. The potential economic impact on the plan’s investment.
3. The steps taken by the consultant to limit the potential for future abuses.
4. The remedial action that should be taken to make the plan participants whole.

To be prudent under ERISA, a fiduciary must employ appropriate procedures and processes to protect the interests of the plan’s participants.⁴ To decide which procedures are appropriate, the fiduciary must understand the facts. Thus, fiduciaries should request full disclosures of all compensation arrangements from their existing retirement plan consultants, even if these retirement plan consultants are not currently under investigation. Plan fiduciaries should also carefully investigate whether the activities of their retirement plan consultants have had a material impact on the retirement plan’s investment returns and whether appropriate legal action is required. It is recommended that you review the DOL/SEC Tips for Plan fiduciaries, as well as the DOL’s guidance on mutual funds, and pose questions to each of your retirement plan service providers. In today’s highly charged litigation environment, not asking service providers what they really earn from your retirement plan may be hazardous to your financial health.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.