Compliance Consult | PLANADVISER September/October 2016

The Last 10 Years

A look back at the decade's milestones

By David Kaleda | September/October 2016

PAJF16_Article-Image-Comp-Con-_David-Kaleda-Portrait_Tim-Bower.jpgArt by Tim BowerAs this issue celebrates the 10th anniversary of PLANADVISER, I thought it would be interesting to highlight some of the developments and milestones we have seen in the retirement plan industry since that first issue went to print.

The rise of target-date funds (TDFs) as the predominant investment vehicle in participant-directed 401(k) plans is remarkable. According to the Investment Company Institute (ICI), at the end of 2014, TDFs accounted for 18% of 401(k) plan assets, a sharp rise from only 5% at the end of 2006. The increase in the popularity of the funds is in large part due to Congress’s enactment of the Pension Protection Act of 2006 (PPA), which created a fiduciary safe harbor for default investments of participant account balances.

The Department of Labor (DOL)’s implementing regulation—known as the “qualified default investment alternative,” or “QDIA,” regulation—made it clear that the department favored TDFs and similar investment vehicles over investments that protect principal. As a result, the last 10 years have seen an evolution in products and services such as lifecycle funds, collective investment trusts (CITs) and managed accounts.

The last decade has also seen a rise in class action lawsuits under the Employee Retirement Income Security Act (ERISA), which have left widespread implications, especially for 401(k) plan sponsors. Of particular note are lawsuits focusing on the inclusion of employer stock as an investment option under a participant-directed 401(k) plan—what are now known as “stock drop” suits.

In the past, stock drop cases had been largely unsuccessful due to the application by most courts of a presumption of prudence, which generally protects the inclusion of employer stock in all but exceptional cases, such as those involving fraud or other criminality—e.g., Enron and Worldcom. However, in a landmark decision, the Supreme Court eliminated the presumption of prudence in Fifth Third Bancorp v. Dudenhoeffer, and, as a result, fiduciaries and their advisers must now balance additional considerations in deciding whether to include employer stock in their plans. To make matters even more challenging, at the same time that plan sponsors are adjusting to a post-Dudenhoeffer world, litigation continues to hit court dockets with novel claims and theories regarding employer stock.

The last decade has also witnessed a pandemic of fee litigation. Such cases generally target plan fiduciaries with allegations that the company’s plan, or plans, pays improper or excessive fees to service providers. In response, plan fiduciaries, with the help of their advisers, have taken steps to gain a better understanding of direct and indirect plan fees. As a result, plan fiduciaries have generally become better equipped to negotiate lower fees with service providers. And, on a technical level, plan fiduciaries have a much better understanding of the difference between a retail class share and an institutional class share, how to use an ERISA budget account, and what 12b-1, shareholder servicing and sub-transfer-agent fees are.

In more recent years, the use of technology as a means to provide investment advice or to help advisers provide advice has grown substantially. The use of the phrase “financial technology” or “fintech” has now become part of the industry vernacular. Additionally, fiduciaries are looking to “robo-advisers” to provide investment advice to plan participants and individual retirement account (IRA) owners.

Of course, as with innovations anywhere, technology in the retirement industry brings both new opportunities and challenges. In particular, regulators, including the Securities and Exchange Commission (SEC), Financial Industry Regulatory Authority (FINRA) and the DOL must now grapple with the challenge of applying their rules and regulations to advisory services that are increasingly provided by a computer or an app. Similarly, traditional “brick and mortar” advisers will need to consider how to adapt, and perhaps even compete, with the new technology shaping the industry.

Lastly, the DOL has been particularly influential in areas such as fee disclosure. As a result of new regulations, lengthy disclosures of fees have become a regular feature of the industry. Moreover, notwithstanding all of the dramatic changes over the past 10 years, the release of the agency’s final fiduciary rule in April reshaped the industry in a way unseen since the passage of ERISA itself. With its redefinition of “investment advice” and introduction of the Best Interest Contract (BIC) exemption, the DOL has ventured into regulation of the retail advisory business in a completely unprecedented manner.

Clearly, it has been a revolutionary 10 years for our industry. With the continually evolving landscape, it will be interesting to see where we are 10 years from now.

David Kaleda is a principal in the Fiduciary Responsibility practice group at the Groom Law Group in Washington, D.C. He has an extensive background in the financial services sector. His range of experience includes handling fiduciary matters affecting investment managers, advisers, broker/dealers, insurers, banks and service providers. He served on the DOL’s ERISA Advisory Council from 2012 through 2014.