The Rosenbaum Law Firm P.C. Blog

I recently wrote an article about how financial advisors can start or grow their 401(k) plan book of business. The lament of a couple of advisors that I know is that plan sponsors are apathetic when it comes to following the fiduciary process and about plan costs. So these advisors would rather let the frustration and pessimism get the better of them.

To be honest, I am a recovering pessimist.  Whether I was born that way or trained that way, for a good chunk of my life, I looked at the bleak side of things.  I can remember when I thought that I would never become a lawyer or ever get a job as a lawyer because my time at law school looked so bleak to me. What changed? Maturity helped a bit, but achieving a level of success that inspired some confidence in me. It also helped being away from supervisors who were so sparse in their praise and so full of scorn. I can remember that a former Managing Director of a certain third party administration firm that shall remain nameless who laughed about 7 years ago when I suggested that I could help sell. I don’t think he’s laughing now.

The lament I hear from financial advisors is reasonable. There are many retirement plan sponsors that have fiduciary defects, administration defects, and excessive costs and simply don’t care.  They don’t feel the need to be lectured on the hidden pitfalls of being a plan sponsor and the concept of fiduciary liability.

You can look at the glass half full and you look at the glass half empty. Having been in this industry for the last 12 years, I prefer to see the glass half full. When I first learned of revenue sharing, no one questioned whether that arrangement was appropriate and I don’t think any plan sponsors knew their funds paid them and if they did know, probably didn’t know what their third party administration firm (TPA) did with it. Plan sponsors didn’t think about hidden costs and in 1998-1999, fiduciary liability wasn’t much of a concern because everyone in the market was making money.

Thanks to two bad bear markets, the Intenet explosion of information, more knowledgeable retirement plan advisors,  the emergence of websites like Brightscope, and successful participant lawsuits have forced many plan sponsors to become more informed and more diligent in their duties. Twelve years ago, there was such a thing as an ERISA §3(38) fiduciaries, but I never met one who did that for a living. Now I have plan sponsors who have hired me to do Retirement Plan Tune-Up reviews and ask me about ERISA independent fiduciaries without any prompting.  

Plan sponsors are becoming more informed and that’s a good thing. I don’t know if we will ever know a time where all plan sponsors will be diligent in their fiduciary responsibility perhaps that will be the day after we achieve world peace. Yet as time passes by, I am convinced that as a whole, plan sponsors will become more sophisticated over time because I doubt that will all the information and litigation out there, that will get less diligent in their duties.

In what I think is one of the greatest movies of all time, The Shawshank Redemption, Morgan Freeman’s character, Red said: “Oh, Andy loved geology. I imagine it appealed to his meticulous nature. An ice age here, million years of mountain building there. Geology is the study of pressure and time. That’s all it takes really, pressure, and time.” I guess Red would say the same thing about the knowledge of plan sponsors, it will grow because of pressure (bear markets, more litigation, and more retirement plan information) and time.

In Star Wars Episode 3: Revenge of the Sith, Obi-Wan Kenobi tells Anakin Skywalker who is on the path to become Darth Vader that “Only the Sith deals in absolutes.” While I haven’t bumped into Emperor Palpatine or any Sith Lord, you run into people who make blanket statements about absolutes in the retirement plan industry.

The fact is that when it comes to the retirement plan industry, there are no absolutes. You hear financial advisors and unbundled providers chafe at the thought of an insurance company provider and how their fees are hidden, but the fact is that insurance company providers can be a terrific proposition for the 401(k) plan on the micro-level.  Even the payroll provider TPAs that I ripped for their shoddy work can be a great fit for some clients on the administration and cost level.

Automatic enrollment is a great feature for most plans, but based on the demographics on a specific employer, it might not be a great fit for some. I love automatic eligibility for salary deferral portion of a 401(k) plan, but it can be a problem for plans that are top heavy.

ERISA §3(38) fiduciaries are an excellent development in the retirement plan industry, but may too cost prohibitive for smaller plans.

So the lesson to be learned is that there are no absolutes in the retirement plan business because what may work most of the time may not work all of the time.

2011 is a year of change for the retirement industry. Fee disclosure, the definition of fiduciary, and changes in the marketing of target date funds are on the minds of everyone in the industry, including yours truly.

So much has been written about all of the proposed changes and what kind of impact that they will have in the retirement business. While so much has been written about fee disclosure and target date funds, I believe that the proposed changes to the definition of fiduciary, if finalized, will have the greatest impact on the retirement plan industry.

While some have stressed that fee disclosure will be the greatest game changer in the industry since the advent of daily valued 401(k) plans, fee disclosure in my mind is overrated. Fee disclosure is like the Internet, all it is, is the release of information. If a plan sponsor takes a fee disclosure statement from their plan providers and puts it in the drawer and never looks at it again like the warranty card of your DVD player, that’s the end of its impact. Fee disclosure has no effect if a plan sponsor doesn’t take the statement of fees and compares to what is out there in the industry. So fee disclosure is all about regulating and requiring the dispensation of information. Sure it regulates service providers to provider information, but it doesn’t regulate behavior. Service providers can still charge excessive fees, it will only be up to the plan sponsor to discover whether those fees are excessive.

The regulation of target date funds, while nowhere near finalized, is all about regulating how these funds are marketed plan participants. It will allow plan participants to get a little more knowledge as to what each specific target date funds has. The mutual fund companies weren’t bad actors, but were bad marketers. They marketed funds without giving participants any insight to determine which fund if appropriate for them.

That leaves the proposed rule on the changes to the definition of fiduciary. I believe it’s a game changer, because it creates a level playing field for brokers and advisors. It will also put the needs of plan sponsors and participants first and pushing a specific product or platform second.  It will also regulate third party administration (TPA) firms, especially the payroll providers, who have been skirting the rules for years.  The payroll provider TPAs who administer plans with no advisors, yet develop fund lineups and make “suggestions” to plan sponsors on which funds to pick and which plan sponsors can’t rely on, will have to regulate their behavior. The producing TPA who disclaimed any fiduciary role, yet pushed revenue sharing funds to lower their fees and had access to the plan sponsor’s trust account to pay those fees will also have to look at what they do.

For plan providers who didn’t have to put the needs of the plan sponsor first because they didn’t have to be a fiduciary will have that bill come due. For those plan providers who didn’t believe being a fiduciary was part of the bargain can exit stage left and I think a lot of brokers from broker-dealers who don’t feel  the role of fiduciaries fits the role of the broker will make that quick exit.

The new definition of fiduciary will create a level playing field for all advisors who would be required to meet the requirements of being plan fiduciary, so it will regulate the behavior of plan providers more so than the other changes coming down the pike.

My latest newsletter can be found here.

My latest article on JDSupra can be found here.

People say that there are no stupid questions. Apparently, those people never worked for my old third party administration (TPA) firm. In order to get ready for the weekend, here are the 5 stupidest questions I was asked while working as the Director of ERISA Legal Services for that TPA named later. These are just some of the hilarious outtakes that will be featured in a book that I may finish one day.

5. A 401(k) plan administrator asked why I thought it was inappropriate to reconcile a daily valued 401(k) plan on a quarterly basis.

4. Another 401(k) plan administrator asked me about the non-resident alien exclusion, where you can exclude non-resident aliens who receive no U.S. source income from the retirement plan without an effect on the Section 410(b) coverage test.  The administrator then asked if that exclusion included Puerto Rico (of course Puerto Rico is a U.S. commonwealth). When I told about Puerto Rico’s status and that they use dollars, he asked me if they use Puerto Rican dollars.

3. A client relationship manager (who visited the client and reviewed funds) asked me what’s the difference between an age 60 in-service distribution and an age 59 ½ in service-distribution. Of course, the answer I gave, six months.

2. That same client relationship manager was at a meeting with a potential client and their lobbyist. She said she was from Yonkers. The lobbyist said Yonkers was the second largest city in New York State. She asked what was the largest city in New York State?

1. A salesman asked me whether with a new client that sponsored 401(k) plan with a large illegal alien employee base, whether it was appropriate for illegal aliens to defer in the 401(k) plan with fake social security numbers. Yes, you read that right.  Of course I told him that even if it wasn’t illegal, it was still unlikely illegal aliens would defer money into a 401(k) plan based on their income and legal status.

Have a great weekend.

A friend of mine who is a financial advisor asked me about a third party administration (TPA) firm that is actually about a village over from where I live in Long Island. My friend has this prospect with a defined benefit plan handled by this TPA.

The name of the TPA brought a smile to my face and I quickly gave him a call. While I was the Director of ERISA Legal Service at a medium size producing TPA in New York City, I did interview at this TPA in question when my son was born almost 6 years ago.

The owner of the TPA interviewed me and said that the TPA I worked for was not in the TPA business, but in the asset gathering business and he was in the TPA business. He advised me the position would pay the same as my current job, but I would actually report to a paralegal as my supervisor.  The owner of the TPA advised me that they battle quite a bit with the Internal Revenue Service (IRS) because they tend to push the envelope in plan design.

Between the lack of a pay increase and the fact that the company appeared to be small potatoes, I politely declined the job offer.

A year or so later, my TPA was going to take over a defined benefit plan and a 401(k) plan from a Kosher food wholesaler.  I reviewed the 401(k) plan and the plan was in order. The defined benefit plan had an issue, the plan listed the normal retirement age of 35! This was prior to the IRS implementing a rule that any retirement age in a defined benefit plan less than 62 was suspect, unless facts about the specific industry that the employer was in showed that this was the standard retirement age in the industry. This is done to ensure that companies don’t make the defined benefit plan into an excuse to make excessive tax deductible employer contributions.

So I remarked to my boss that an age 35 retirement age in the food industry is unreasonable. I stated that it would be reasonable if it was a pension plan for Major League Baseball Players. Actually, a financial advisor who works with athletes proved me wrong, he said their retirement age is 42.

As it turns out, many advisors and other TPAs told me that the TPA down the road for me is really an insurance mill. All the plans are less retirement vehicle, and more like insurance holding entities. So while my firm was in the asset gathering business, the owner of that TPA was in the insurance selling business.

Insurance in a retirement plan is like drinking alcohol, moderation is key. A little plain vanilla, whole life insurance can be a great asset for any retirement plan. It is when I have seen plan sponsors forfeiting whole life policies because they no longer meet the huge premiums of the policies in the Plan, only to discover that their agent puts his needs instead of his clients.

It is no surprise that the IRS has been cracking down on abusive insurance funded, retirement plan vehicles.

I stick to what I know, so I don’t provide financial advice or administer plans. So I think insurance sellers masking as TPAs should stick to what they know, selling insurance.

In the movie Casino, Robert Deniro’s character Lefty Rosenthal warns Joe Pesci’s character Nicky Santoro that his actions will get him into the Gaming Control Board’s “Black Book”, which means he would be banned from all casinos. Nicky doesn’t take the threat seriously and states that there are only two people in the book and one of them is Al Capone. Of course, Nicky was wrong. There are a lot of people in the black book.

When it comes to retirement plans, the ultimate sanction which is the Internal Revenue Service’s (IRS) penalty or black book for non-compliant plans is “plan disqualification.” Plan disqualification would cause immediate taxation of retirement benefits to participants and disallowance of previous employer deductions. It is the death penalty or neutron bomb for retirement plans.

So often you will hear that failing to follow the plan document can be a disqualifying event or allowing in-service distributions of 401(k) plans prior to a participant attaining age 59 ½.  Threats of plan disqualification are like some of the threats my parents made against me. I’m still scratching my head on my mother’s claim that radishes will grow on my feet if I didn’t clean the dirt from them.

The fact is that plan disqualification is rarely used. It sounds good as a threat, but the Internal Revenue Service would be hard pressed to declare all of the retirement benefits of rank and file employees to be immediately taxable. While I’m sure that plans have been disqualified, I have yet to see one. I’ve had defined benefits plans where all the benefits were invested in Bernie Madoff, or plans where plan sponsors stole, or when owners of the S Corporation  took out excessive loans even though in 2000, they were not allowed to take out loans. None of these plans were disqualified.

The IRS does not want to be in the business of disqualifying plans and depriving participants of retirement savings. That is why they have voluntary compliance programs to correct plan errors and defects. The IRS wants to make plans compliant and will do all they can to make that so.

I once was recommended by a registered investment advisor to help with his client who was reviewing the plan’s operation. The problem was that the client already had an ERISA attorney. Unfortunately, I was asked to draft a notice to interested parties because the plan was being submitted to the IRS. I used boilerplate language that I use for all my plans. The ERISA attorney claimed that there were one or two sentences from the IRS model language (which were not applicable). This ERISA attorney, hoping to upstage me, claimed that the notice would cause the plan to be disqualified. Since the client was being represented by counsel, I had to ask out of the arrangement because I could not believe that this attorney would use the plan disqualification event on something so petty. Of course, the client suffered and had spent their entire $100,000 ERISA budget on this attorney who was using the retirement plan equivalent of yelling fire in a crowded theater.

When it comes to my practice as an ERISA attorney, I am very big on plan sponsors taking pro-active stances to minimize liability, basically good plan fiduciary practices like knowing plan fees, implementing an investment policy statement (IPS), and ensuring that plan participants get the education they need, Letting plan sponsors know about the hidden pitfalls of being a plan fiduciary is not trying to sell fear, it’s about selling preventative practices. That’s like claiming a dentist who tells you to floss is selling fear. Quite honestly a dentist who tells their patients to floss regularly may lose out on some periodontal work in the future. So pushing for plan sponsors to implement good fiduciary practices may avoid some large legal bills down that road, so it’s hardly selling fear. Claiming a plan sponsor will suffer plan disqualification for failing to implement an IPS is selling fear because that will never happen.

Let us not discount plan errors and defects, but let us not make plan disqualification threats that won’t happen.

My latest newsletter can be found here.

My latest article can be found here.