The Moment of Truth
A great deal of attention has been paid to plan participants’ reaction to the 404(a)(5) fee disclosure that took effect August 30, 2012—but what about sponsors’ feedback to the corollary 408(b)(2) rule that became effective July 1, 2012?
While it appears that participants have had little—if any—response to the disclosures, sponsors do not have that luxury. Sponsors’ fiduciary duty to assess fee reasonableness—and the fact that the disclosures are not presented in a consistent format—is prompting many to turn to financial advisers for help to understand and benchmark their fees, industry insiders say. In some cases, advisers are helping plan sponsors to negotiate slightly lower fees or issue requests for proposals (RFPs).
Of course, advisers also are covered service providers and are being required to disclose their fees. This is causing some plan sponsors to question their advisers as well as their service providers, leading to both a challenge and an opportunity for advisers. With prospects, advisers can help review a competing advisory fee disclosure, as well as recordkeeping and other service provider fees. With current clients, however, in addition to reviewing the disclosures from their recordkeepers or other service providers, advisers must be prepared to review their own fees, too.
The fee disclosure rule is a “daunting sea change in the fiduciary role, responsibilities and risk management of plan sponsors,” says Ronald Hagan, executive vice president with Roland | Criss, a fiduciary consultancy in Arlington, Texas. “The increase in responsibility requires dramatically more of the plan sponsor—more time, analysis, diligence and accountability.”
“The time it takes—and the attention to detail it takes—is more than sponsors can handle,” says Michael Sanders, principal of the retirement practice at Cammack LaRhette Consulting in New York, a consultancy to 403(b) plans at large hospitals, universities, museums and endowments. “Based on the need to make sense of, understand and benchmark the fee disclosures, we have seen a strong uptick in our clients utilizing advisers. A lot of people on the retirement committees do not understand 12b-1 fees, revenue sharing and ERISA [Employee Retirement Income Security Act] budget accounts.”
In fact, Cammack LaRhette’s annual survey of 200 403(b) sponsors found that, in 2010, 33% worked with a retirement plan adviser. In 2012, that percentage nearly doubled, to 63%. Among all defined contribution (DC) plans, 55.2% worked with a retirement plan adviser in 2008, and, by 2012, this number increased to 66.4%, according to the 2012 PLANSPONSOR DC Survey.
Looking for Guidance
“The fee disclosure rule is a huge opportunity for advisers,” agrees Ilene H. Ferenczy, managing partner of Ferenczy & Paul LLP, an ERISA attorney in Atlanta. “It’s a wonderful opportunity for advisers to help their clients understand their fees, as well as the value that they themselves are providing.”
Advisers who can demonstrate proficiency in 408(b)(2) due diligence and benchmarking will have a distinct competitive advantage and may be able to win business from advisers without this expertise, says Fred Reish, chairman of the Financial Services ERISA practice at Drinker Biddle & Reath LLP in Los Angeles.
Indeed, recent polls show that sponsors are eager for advisers to help them parse through the new fee information. According to a survey of 200 plan sponsors that Oppenheimer Funds conducted in September 2012, only 20% said they were confident about what to do with the disclosure information received, and a mere 9% said they knew what steps to take if they did not receive adequate disclosures.
Sponsors at small businesses appear to be even less prepared, according to a ShareBuilder 401k survey of small business owners with 100 employees or less. Only 60% recalled receiving fee disclosures, and 83% of these individuals said they had questions about what steps to take. Another 68% said they were unprepared to answer employee questions about fees.
A good number of sponsors apparently view fee disclosure as a win. More than one-third of sponsors told Oppenheimer they believe that fee disclosure is a positive change, and nearly as many said it would make their lives easier. The top benefits cited were: helping them fulfill their fiduciary responsibilities; improving provider transparency; helping them better understand fees relative to services; and making educated decisions about providers.
The Biggest Challenge
The biggest challenge of the fee disclosure rule for sponsors is that it does not require disclosures to be given in any particular format, Reish says: “Compensation may be described or estimated as a monetary amount, percentage of assets or a per capita charge.” Or, if the compensation cannot reasonably be expressed as a dollar amount or a percentage, he says, the only guidance from the Department of Labor (DOL) is that the disclosure “contain sufficient information to permit evaluation of the reasonableness of the compensation.”
“By and large, the information is not coming in a comprehensible format,” Reish says.
Additionally, retirement plan fees in and of themselves are “quite complex,” Reish continues. “For example, 12b-1 fees are paid from the expense ratios of mutual funds, often to the plan’s broker/dealer [B/D] or plan provider, and the compensation of recordkeepers is even more complex because it can involve 12b-1 fees, sub-transfer agency fees and proprietary investments.”
Adding to this complexity is the opaqueness of the methodologies of plan providers with bundled services as opposed to open architecture services, says Sean P. Riley, vice president at Eldridge Investment Advisers, an LPL affiliate in Manchester, New Hampshire. “Bundled providers are less transparent,” he says. “Information is laid out in ranges and is difficult to understand. Open architecture is much clearer. I’ve seen fee disclosures from bundled providers that are 15 to 30 pages long, whereas disclosures from open architecture providers typically run three to five pages.”
Furthermore, the structure of many bundled platforms will not allow a plan to convert indirect commission compensation into direct payment in an ERISA budget account, Riley says.
Their Own Justification
Just as the financial adviser community has worked to discourage individual investors from considering fees only when making investment selections, it is also making efforts to help plan sponsors fully understand not just the fees but the true value of their retirement plan providers’ and advisers’ services.
Reish recommends that, as advisers reveal their fees to sponsors, they should aim to stand out from the competition by pointing out both their investment management and risk-mitigation services, as well as their fiduciary, plan-level and participant-level services. Then, they should go a step farther and underscore the results they deliver—such as higher participation and contribution rates, fund performance and retirement preparedness analysis.
“Most plan sponsors really like their advisers and are not looking to replace them as a result of 408(b)(2),” says Michele Suriano, president of Castle Rock Investment Company in Castle Rock, Colorado. However, the regulation might prompt some plan sponsors to seek advisers who can act as fiduciaries and, therefore, bear some of the responsibility for complying with the new law, she says.
For the small plan sponsors who neglect to work with an adviser to analyze the fee disclosures, Suriano fears they run the risk of failing audits in the years ahead. “I have heard of several plan sponsors receiving the disclosures, not reviewing them and just filing them away,” she says. “Those most at risk are those who do not have a financial adviser helping them. The fee disclosure rule is absolutely an opportunity for advisers, but we are in the first wave in what is going to be a slow movement of educating the smaller plan sponsors.”
In Complete Context
Prudent 408(b)(2) analysis starts with benchmarking a plan against an appropriate peer group—and should not just consider fees but also the design of a plan and participant success measures, Reish advises. Plan sponsors are turning to plan advisers to obtain third-party benchmarking data and to apply their ERISA expertise in assessing it, he says.
In a white paper titled “Retirement Plan Value: More Than a Number,” Principal Financial Group tells plan sponsors that the assessment of whether a fee they are paying is reasonable “is far more than a number. Recognize that a number, by itself, doesn’t tell the whole story. Reasonable doesn’t always mean the lowest cost, as the lowest cost option may not be the most effective at meeting the needs of your plan.” In fact, if a sponsor selects the least expensive option without considering the scope and the quality of other choices, that could be considered a fiduciary breach, the paper states.
Principal Financial advises: “It’s necessary to know what that number pays for. There is not one consistent fee structure or disclosure format to follow. It’s up to the plan fiduciary to understand all the fee components—both direct and indirect—for the plan and decide how the fees will be paid.”
Fees can vary, the white paper says, depending on: investment offerings; participant education and/or advice; plan design; advisory fees; recordkeeping fees; custodial services; and CPA or attorney fees.
Lower Fees
In 2012, as a direct result of the fee disclosure rule, several recordkeepers began to reduce recordkeeping fees, according to a report from investment consulting firm NEPC of Cambridge, Massachusetts, titled “Defined Contribution Plan Fees Hit a Record Low.” Last year, the annual median total plan cost for plan sponsors was 55 basis points, or 55 cents for every $100 in fund assets, down from 58 basis points in 2011, NEPC says.
“The steep drop in recordkeeping fees in 2012 [was] likely fueled by new rules aimed at making fees more transparent and [by] well-publicized litigation,” NEPC writes. “We expect the trend towards lower expense ratios to continue in the near term [due to] the attention paid to these costs and the diligent efforts of plan sponsors and their advisers to better understand and monitor these payments.”
The consultancy warns advisers and sponsors that some of the bundled recordkeepers that reduced their fees are attempting to replace that lost revenue by raising investment management fees. “To this end, plan sponsors should press recordkeepers for a reduction in total fees and not settle for a mere rebalancing of the different fee categories,” NEPC states.
Retirement plan vendors would rather lower their fees than lose a client, Sanders says. “They do not want to lose business, so they are doing whatever it takes to make the client happy. If it’s a $1 billion plan, you might see fees going down significantly, by 30%, 35% or even more. Those are the kind of reductions we are seeing,” he says.
Reish adds: “I know for a fact that the new fee disclosure rule has caused some providers to review their books of business to see what their pricing looks like.” In some cases, particularly for plans that have grown and that can offer economies of scale, Reish says, “[service providers] have re-priced more competitively. It seems that most [of them], including advisers, have decided that if they are going to be evaluated, they want to benchmark in a way that is, at the least, reasonable.”