The Rosenbaum Law Firm P.C. Blog

I will be taping a CE/CLE course on retirement plans for Lawline.com this afternoon. The course will be available for attorneys and accountants in multiple states. When available, I will let you know the details on how to sign up for this on-line course.

The Department of Labor issued new rules that will require employers to reveal the cost of the 401(k) plan and its performance to participants. These rules will take effect in 2012. That will certainly give the bad players in the industry enough time to invent ways to hide fees. But seriously, all fee disclosure is about the free flow of information and in a society like ours, that’s a good thing.

People in the industry will certainly predict the end of the 401(k) industry, but the industry will be strong enough to adapt to a full fee disclosure model. Service providers will thrive with the change, others will die. It happens in business all the time, look at Netflix and Blockbuster. The 401(k) business, based on a full fee disclosure model will be the survival of the fittest.

There will be unintended consequences, as there is with any change. The sky won’t fall, the industry will survive, and we will have to deal with any changes caused by this. No matter how you try to spin it, a business where fees where hidden from those who pay them (the participants) doesn’t sound like a business that should maintain the status quo.

I look forward to 2012. It won’t cure all the problems of the 401(k) industry, but it’s a good first step.

Years ago, Putnam Funds had a terrible reputation when it came to fees and a duty of care to its investors when it was implicated in a late trading scandal.  There was a Boilermakers Union Local that made over $4 million in profit for their pension plan through market timed trades.

Putnam lost many institutional clients as a result and implemented many changes to ensure that this issue would not happen again.

Boy, have times changed. Putnam, one of the leaders in the 401(k) business has announced that they will provide fee disclosure to participants in their administered plans before they will be required to by the regulations promulgated by the Department of Labor.

Putnam is proof that companies can change and old dogs can learn new tricks. They have embraced full fee disclosure to survive and so many third party administration firms that will not embrace fee disclosure will die.

Change is a hard concept, but if you don’t change with the times, the times will change you and rarely will that be a good thing.

My latest issue for 401(k) plan advisors is here.

In England, many of the top pubs are owned by British breweries because watering holes are an effective means of beer distribution. Pepsico (owners of Pepsi) used to own Yum brands (KFC, Taco Bell, Pizza Hut, etc.) for that very same reason.

The 401(k) industry is dominated by mutual funds, so it should come as no shock that many mutual funds companies offer services as a third party administrator (TPA) because it’s an effective means of distributing their mutual funds. Mutual funds distribution is extremely important for mutual funds companies because their bread and butter are the funds’ asset management fees and more assets under management equal more revenue for the mutual fund company.

While many mutual funds companies only offer TPA services for larger plans, they are a few mutual funds companies that have been rather aggressive in offering TPA services to small and medium size plans. While mutual fund companies do offer an attractive alternative as part of a one stop shop, plan sponsors are under misimpression that the mutual fund companies’ TPA services are free.

As stated in a previous article about 401(k) administration, there is no such thing as a free lunch or free 401(k) administration. Mutual fund companies make their money as a TPA through those very same mutual fund management fees that I had discussed earlier. Many of the same companies that offer TPA services are the very same mutual funds companies that offer revenue sharing or sub TA fees to TPAs for plans that use their funds. So by keeping plans under their roof, these mutual funds companies can keep their revenue sharing/ sub-TA fees to themselves. These mutual fund companies also guarantee the fees they make, by requiring that a percentage of a plan’s assets (up to 100%) be invested into their own proprietary mutual funds. I recently came across a 401(k) plan with T. Rowe Price as a TPA that offered 12 mutual funds to participants for directed investment and all 12 funds were T. Rowe Price. T. Rowe Price is an excellent fund company, but I find it hard to believe that out of 8,000+ mutual funds, only T. Rowe Price funds made the grade.

For plan sponsors and trustees who serve as fiduciaries under ERISA, it is a question of the prudence rule and whether it is prudent to offer investments into a specific mutual fund company, only because that mutual fund company is the TPA. While some mutual fund companies have sterling reputations, there are a still a number of mutual fund companies who have been tainted by the late trading scandals of the last decade, as well as poor performance and high fees. All plan sponsors that utilize a mutual fund company as a TPA should understand that there is a cost involved with their plan’s administration, as well as being advised as to the standing of the mutual fund company within the entire mutual fund industry to make sure it doesn’t become the next Steadman fund family.

Plan sponsors should consult with their 401(k) financial advisor to determine whether a mutual fund company as a TPA is the right fit for them. Mutual fund companies may be an attractive option for some, but plan that offer what is known as out of the box provisions may not be a good fit, as well as a plan sponsor that wants unbundled options in the selection of mutual funds.

Everyone knows my bias against third party administration (TPA) firms that have their own registered investment advisory (RIA) firm. A perfect example of the problems with that just came up.

A broker friend of mine advised me of a new client who loves the TPA, but wants to change the RIA. The problem is that the TPA is the RIA. I told the broker that it’s pretty hard to fire the TPA as the RIA because they will probably fight tooth and nail to keep that client for their RIA side. It’s like using a hairdresser who you use for color and a cut. If you select another hairdresser to your color while keeping the old one for a cut, the relationship becomes frayed as the old hairdresser will try to claim that hair coloring business again.

I saw this first hand with my old place. An RIA we worked with that did a great job with law firms took one of our clients on the RIA side while we still held the TPA slot. Needless to say, my boss wasn’t a happy camper and eventually had the client lie when they hired the new RIA, so we could maintain another two quarters of RIA fees.

Aside from the revenue sharing aspect of the TPA/RIA “monster”, my issues is that it’s very hard to replace one piece of the one stop TPA shop (whether it’s the legal, RIA, or TPA side) without hard feelings or the TPA trying to reclaim that lost business.

While I am sure there are some good TPAs who are RIAs, I just like avoiding the conflict and enjoy hiring an independent TPA and independent RIA so I don’t worry about hard feelings if I remove a giant piece from the one stop shop puzzle.

Three years ago, I left my job as an attorney for a TPA that was also an RIA because I thought fee disclosure was the future and the way we practiced business was part of the past. I knew that the times of excessive fees, improper share classes for larger plans, and hiding revenue sharing were going to end and three years later, I was right. I only wish I could have predicted the housing market implosion, credit crunch, and recession so I could have made a few bucks by shorting the market. Plus I could have invented Twitter if I foresaw the magnitude of tweets.

I saw the Blue Comet of the future of the 401(k) business and I decided to jump off the track to avoid being hit and hitched a ride.

A few months back, I was talking about the Edison case in California where in Federal court, 401(k) participants won a huge case when the judge made a ruling that without any malice on their part, Edison violated the ERISA prudence rule because it never sought to purchase institutional share classes when they were available for a plan of that size. I thought that case was going to be the future of litigation and just another headache for Plan sponsors to worry about.

Of course, the case has far reaching results. Apparently the Department of Labor read the decision and is currently arguing that the Unisys case in Pennsylvania that was thrown out should be reinstated because of the Edison argument. See here. Apparently, Unisys was using retail shares in their Fidelity plan when retail class shares when less expensive, institutional classes were available.  Slowly, but surely, the Edison case will increase the size of its effect as the decision will spread to Federal courts around the country.

Which reminds me of my old home, currently under Department of Labor investigation for many of the problems I was leery of. Their biggest client was a plan close to $75 million on the Fidelity platform.  A review of their funds indicate some expensive share classes when the Plan was moved from Fidelity’s 279 platform to the Fidelity 251 platform. Perhaps, the Edison case will be a wakeup call for them. Otherwise, the Blue Comet may hit them.