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 Industry
Insight from Fred Barstein
Defining a No Conflict 401(k) System
True north is
useful not because it is reachable but because it provides a
good guide.
Though no conflict in 401(k)
plans may be unattainable, describing what it might look
like can provide a useful compass to determine how close or
far the current system may be.
The Prime Players - Fiduciaries
It’s
amusing
the lengths to which some broker dealers and record keepers
go to maintain that they are not fiduciaries.
The true test is whether they
have the discretionary power to affect participant outcomes.
For example, third party
traders are clearly not fiduciaries as their job is to find
the most efficient and cheapest execution.
It’s equally clear, however,
that plan sponsors, advisors, asset allocators, most record
keepers, some TPA’s and many money managers are fiduciaries
because their decisions directly affect participant
outcomes.
Advisors select the record
keepers, investments and asset allocators and are hired to
help the sponsor ensure that fees are reasonable and that
the plan is designed for the sole benefit of the
participants.
Most record keepers, even if
they do not use proprietary funds, select the investments
available on their platform and are paid different levels of
revenue sharing.
TPA’s have significant control
over plan design and become the de facto advisor
if
there is none on the plan; money mangers have the discretion
to bake in various levels of revenue sharing and advisory
fees.
The Current System - Conflicted
Though we have made
great strides, advisors still can be paid differently
depending on the fund or type of investment suggested by
them.
With varying levels of revenue
sharing, sponsors are incented, counseled or pushed to
select investments that limit out of pocket costs.
To maximize profit, record
keepers might be tempted to push or propose investments or
asset classes that have the richest revenue sharing.
Money managers might pad
revenue sharing and advisory fees to
obtain
favorable treatment from record keepers and asset allocators
who use proprietary investments or sub-advisors get paid
more on equities than cash or fixed income.
Assuming anyone can get to the
bottom of the real cost of a plan, especially with wrap fees
and surrender charges in smaller plans and trading cost
within the funds, the whole system is rife with potential
conflict.
A Proposed Alternative
Though most
problems could be solved if sponsors were willing to pay for
the costs inherent with the plan above and beyond investment
fees, no one believes that companies in this economic
environment
will be willing to go that far.
That leaves the participants to
pay, which makes it even more important to eliminate the
potential for conflict.
Advisors, record keepers, TPA’s,
asset allocators and money majors could charge a transparent
fixed or asset based fee based on the services they provide
which could be paid by a plan’s Erisa account created out of
participant accounts on a pro rata basis.
Money mangers could use
institutional shares stripped of 12(b)(1), Sub TA or revenue
sharing fees and just be paid for their investment
management rather than subsidize the whole enterprise.
Record keepers, advisors and
TPA’s would be paid the same regardless of the investments
selected or plan design.
Asset allocators, like
advisors, should be completely independent from the money
managers and their compensation should not vary depending on
the underlying investments.
Independent advisors would be
responsible for the selection and monitoring of all service
providers reporting directly to the sponsor and paid by the
participants.
No one is suggesting that everyone in the current 401(k)
system is corrupt and that all plans are poorly designed or
conflicted. Neither
should the 401(k) system be blamed for the unprecedented
market collapse of 2008.
But by maintaining a system that not only allows for
but actually rewards conflict, what chance do participants
have of expecting all the “fiduciaries” to act in their best
interests?
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