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401k Fiduciary Liability in a Multi-Vendor Environment

October 15
00:03 2013

According to DOL publication Meeting Your Fiduciary Responsibilities, “Hiring a service provider in and of itself is a fiduciary function.” The significance of this statement becomes dreadfully apparent when, later on in that same missive, the 63921_5985_street_vendor_stock_xchng_royalty_free_300DOL states, “With these fiduciary responsibilities, there is also potential liability. Fiduciaries who do not follow the basic standards of conduct may be personally liable to restore any losses to the plan, or to restore any profits made through improper use of the plan’s assets resulting from their actions.” For all the dire warnings, though, the DOL does add, “However, fiduciaries can limit their liability in certain situations.”

When it’s all said and done, the single most important issue for the 401k plan sponsor (i.e., the entity with the fiduciary responsibility for hiring service providers) involves the flow of money. Within that realm, there are three significant liability risks. The first concerns delays in processing. The second deals with – er – self-dealing transactions. Any half-way decent monitoring system can detect delays relatively quickly. The advent of the 401k Fiduciary Disclosure Rule makes it easier, but by no means fool-proof, to identify self-dealing transactions. We’ll address the third in a moment.

Readers might also be interested in reading: “5 Fiduciary Facts the DOL Wants Every 401k Plan Sponsor to Know

A 401k plan sponsor can hire any number of service providers (see “408(b)(2) Compliance and the Service Provider List,”, March 6, 2013). For the purposes of this article, though, we’ll focus on the following service providers:

  1. Payroll Processor
  2. Custodian
  3. Third Party Administrator (TPA)/Recordkeeper
  4. Investment Sales/Adviser

In all cases, if the plan is paying fees to these providers, we immediately recognize 401k plan sponsors face the very strict fiduciary liability of Rule 408(b)(2) – the 401k Fee Disclosure Rule. In every case, the plan sponsor must obtain the appropriate fee disclosure. If no such disclosure is obtained, the plan sponsors must fire the service provider within 90 days. This represents the third money flow liability.

Readers can discoverer more here: “New 408(b)(2) “Guide”: Not Necessarily What 401k Plan Sponsors Hoped For

Now, let’s take at look at each service provider function.

Payroll Processor: This often overlooked provider is the most likely source for delays in processing. Rick Unser, Vice President, ERISA Risk Management Consultant, Lockton Retirement Services, Los Angeles, California, says, “The decision on when employee salary contributions are transmitted to your custodian is a fiduciary act. Contributions that are deemed to be late are considered a prohibited transaction. This is not only reportable on your Form 5500 filing, but will likely result in lost earnings restorative payments to the plan and could open you up to a Department of Labor investigation. To manage fiduciary liability, plan sponsors should implement a defined and repeatable process for transmitting employee salary contributions in a timely fashion.

Custodian: While many few the custodian’s role as similar to the payroll processor – i.e., merely that of an intermediary for the money – this ignores the reality of today’s 401k custodians. Several popular custodians only work with specific mutual fund platforms and receive revenue sharing from mutual funds on that platform. This may represent a prohibited self-dealing transaction. This may sound minor, but, as we’ll see in a moment, funds that pay revenue sharing or 12b-1 fees have a distinct disadvantage compared to those that don’t.

Third Party Administrator (TPA)/Recordkeeper: Here we speak primarily of the recordkeeping function. A TPA that doesn’t offer recordkeeping may or may not be involved in the money flow. Peter Macaluso, Vice President at FM International Services (NY), Ltd. located in Melville, New York says TPAs “will usually assist in plan design and comment on the pros and cons of other service providers. It is possible to hire some TPAs as [a] 3(16) [fiduciary], but that is rife with conflicts of interest.” In the purest sense, only the recordkeeping role plays a part in the money flow process. “Whether it is using forfeiture to cover employee deferrals, causing participants to incur lost earnings when forfeiture is being used, taking away dividends from distributed accounts, calculating earnings as dividends and not allocating them properly, or charging fees that are not disclosed, these issues could get any plan sponsor in a whole lot of hot water,” says Macaluso. He’s also concerned that “this is usually covered up by most recordkeepers” and advises, “The only thing I can say is vet your recordkeeper well.”

Investment Sales/Adviser: These relationships present the greatest challenges when it comes to fiduciary liability. “First and foremost,” says Unser, “plan sponsors need to identify if they are working with a ‘sales person,’ a broker or a registered investment adviser. As sales person, as the name implies, is just there to sell product. While they may be able to define fiduciary, they are not going to share any fiduciary responsibility. A broker may be able to help a plan sponsor differentiate between different vendors or investment options, however their recommendations must only be deemed to be ‘suitable’ and do not carry any fiduciary weight. A registered investment adviser (‘RIA’) is obligated to provide advice to plan sponsors. That advice, if followed, does share in fiduciary liability with the plan sponsor. If a plan sponsor is looking for ways to mitigate risk around their plan investments, the first step is to align themselves with an investment professional whose advice will bring fiduciary accountability.” It is precisely this multitude of possible venders that introduces confusion regarding forms of payments. For example, salesmen and brokers have no restrictions regarding getting transaction fees normally considered prohibited self-dealing fees. This is because these commissions represent the standard manner of payment. Fiduciaries, on the other hand, usually cannot engage in prohibited self-dealing transactions. From a plan sponsors point, this may not matter – because of their own fiduciary responsibility. Studies have repeatedly shown funds which do not have 12b-1 fees or engage in revenue sharing tend to outperform those that are “broker-sold” (i.e., those offering 12b-1 fees and revenue sharing) by as much as 3.6% per year.

Readers might want to read: “Study: SEC Fiduciary Delay Costing Retirement Investors $1 Billion per Month

Bundled-Service Providers: Up until now we’ve focused on separate independent service providers. Many plans, either for reasons of cost or convenience, use one single vendor – a bundled-service provider – for all delegated duties. This represents an all-too common situation for smaller 401k plans and presents a major potential liability for the plan fiduciary. Macaluso says, “By having independent parties working on a plan together there is a built in check from party to the next. With a bundled service provider there is almost no checks and balances and if one service fails the other will not recommend a change.” (See “Should 401k Plan Sponsors Sell Their Souls for One-Stop-Shopping?, December 6, 2011.)

There are many liability traps when comes to hiring service providers for 401k plans. Oftentimes, a well-documented system can help mitigate that liability, but there are many demons that can tempt plan sponsors to take a seemingly common sense short-cut that can end up costing more in the end. We’ll close with Unser’s advice. He says, “Your fiduciary duty is to develop an informed prudent process for making decisions that are in the best interest of your plan participants. Whether you have one service provider or multiple, your obligation remains the same and what is convenient for you as a plan sponsor will always take a back seat to what is in the best interest of participants.”

Interested in learning more about this and other important topics confronting 401k fiduciaries? Explore Mr. Carosa’s book 401(k) Fiduciary Solutions and discover how to solve those hidden traps that often pop up in 401k plans.

About Author

Christopher Carosa, CTFA

Christopher Carosa, CTFA

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