A plan sponsor has certain fiduciary responsibilities to plan participants. This includes acting solely in the interest of plan participants and their beneficiaries, with the exclusive purpose of providing benefits to them, carrying out their duties prudently, following the plan documents, diversifying plan investments and paying only reasonable plan expenses.
Lack of diversification has generated lawsuits against fiduciaries with increasing frequency in the last few years. As plans with participant-directed accounts become the norm, plan sponsors need to ensure the investment offerings within the plan adequately meet the needs of the participants.
The fiduciary role that the plan sponsor assumes requires expertise in a number of areas, including investments. Assuming the plan sponsor lacks the appropriate expertise, an appropriate investment advisor should be selected by the plan sponsor. Careful documentation of this selection process and the criteria, with which the advisor is compared, is an important part in limiting potential future liabilities.
When the expertise is in house or an affiliate of the plan sponsor is utilized, the investment selection process should also be carefully documented with a focus on how the plan participants are best served by the menu of options selected. Plans with auto-enrollment features must invest those contributions in investment vehicles that meet specific Labor Department regulations. Those participants must be presented with the opportunity to allocate their contributions upon entrance into the plan and then notified annually thereafter.
Portfolio diversification helps mitigate the risks of large portfolio losses from which most lawsuits arise. Under Labor Department regulations, participants in participant-directed plans must have at least three investment options allowing participants to diversify their investments within an investment category.
Plans must annually provide participants with the necessary information allowing them to make informed investment decisions. This typically includes providing the funds’ prospectuses to participants or making them readily available for review, also providing information in a chart format to ease comparisons amongst options available to them. Examples of model charts are available from the Labor Department. Plan participants must also be given the ability to modify their allocations at least once per quarter.
When a service provider is hired by a plan sponsor, the plan sponsor can set up an agreement that transfers certain liabilities to the service provider. Service providers such as banks, insurance companies and registered investment advisors can assume the fiduciary responsibility for investment selections; however, the plan sponsor must adequately monitor the service provider’s services to ensure investments are handled prudently and in accordance with the agreement.
When selecting a service provider, the plan sponsor should consider the identity, experience and qualifications of the professionals who will be responsible for the plan. They should inquire as to whether any litigation or enforcement actions have been brought against the provider. The plan sponsor should assess the provider’s financial condition. A general understanding of how investment options will be managed and how investment directions will be handled should also be obtained. Fees then need to be assessed as whether they are reasonable. These assessments need to continue for the length of the relationship.
As part of the monitoring process, plan sponsors need to have procedures to follow up on participant complaints that document the complaints and resolutions. Plan sponsors are required to read any reports they are provided, particularly notices regarding changes to the service provider’s compensation.
The service provider’s performance should be reviewed against identified benchmarks with particular attention paid to trading frequency, investment turnover and proxy voting. Special considerations should be taken whenever “party in interest” transactions occur.
A party in interest is defined by the Labor Department as “a party that has the ability to exercise improper influence over the plan.” This is most commonly seen when investment advisors select funds they or their affiliates actively manage in the investment options available to plan participants. These types of transactions are allowable with increased reporting requirements.
Retirement plans are set up with the best of intentions, allowing employees to prepare for retirement and potentially share in profits if employer contributions are made. But these plans can have real unintended consequences for the plan sponsors.
Investment-savvy participants are becoming the norm in the workplace and market gyrations can potentially motivate these participants to attempt to recoup losses caused by inadequate investment offerings. Having a system in place that minimally documents the above processes can help, but utilizing the resources available by the Labor Department or consulting an attorney specialized in these areas are options as well.
Ryan Snyder, CPA, is a manager at Mengel, Metzger, Barr & Co. LLP. He can be reached at Rsnyder@mmb-co.com.