Hazard Prevention

Art by Dalbert B. Vilarino

Over the last few years, 403(b) plan sponsors have discovered that they have more fiduciary responsibility than they realized, says Elizabeth Kaido, vice president of sales for BPAS in Utica, New York.

“Plan sponsors are asking advisers to help them establish plan governance practices—maintaining and reviewing plan documents, keeping meeting minutes of decisions, and reasons for those decisions, and setting participant communication and education guidelines,” she says.

Responses in two recent years to the PLANSPONSOR Defined Contribution (DC) Survey bear out that many sponsors work with, and follow the guidance of, an adviser. For Employee Retirement Income Security Act (ERISA)-governed 403(b) plans, the percentage that used the services of a plan adviser or institutional investment consultant in 2016 was 59.2%. In 2019, 73.8% of 403(b) plans overall—ERISA and non-ERISA—used a plan adviser or investment consultant.

Overall, last year, 84.8% of 403(b) plans said they had an investment committee, and 76.2% indicated they had an investment policy statement (IPS).

But while governance practices have improved, 403(b) sponsors face a new threat: participant lawsuits. David Levine, a principal with Groom Law Group, Chartered, in Washington, D.C., says this litigation started with institutions of higher learning, but now all types of tax-exempt entities face being sued. “Many have adviser help, but that doesn’t stop plaintiffs from second-guessing decisions,” he says.

The lawsuits, filed on behalf of participants, allege excessive investment and plan administration fees, unnecessary expense due to 403(b) plans’ multiple recordkeeper model, and the confusing number of investment options the plans frequently offer. A large percentage of suits are being filed by litigators that have targeted 401(k) plans and repeat many of those claims. However, 403(b)s are different from 401(k)s, Levine says, and it is important for advisers to recognize this. It is often impossible to shape a 403(b) like a 401(k), so advisers should not try to fit them into that mold.

Until ERISA was passed in 1974, 403(b) plan participants were restricted to offering annuities, Kaido points out. These were set up individually by participants, in order to give them more choice, she says. Since ERISA allowed for 403(b) plan assets to be invested in custodial accounts—e.g., mutual funds—sponsors began adding more providers to their plan.

Plan sponsors and their advisers should re-evaluate the prudence of maintaining a multiple recordkeeper/provider construct once their plan offers mutual funds, Kaido says. “Providers have open-architecture platforms by which any mutual fund can be accessed from one provider. Unlike 401(k) plan sponsors, many 403(b) sponsors have not aggregated assets, to use buying power to lower fees.” The size of plans, in terms of the amount of assets they hold, and, hence, their ability to bargain for lower fees, has been cited in many of the suits filed against 403(b) plan sponsors.

Streamlining a 403(b) plan’s investment menu—as the suits seem to imply is best practice—is not so easy, though. Levine notes that the annuities held in 403(b)s are individual contracts between the participants and providers—the plan sponsor may not move the assets in those annuities without the participant’s consent. Convincing participants to switch to another investment, and then doing so, is complex and requires a number of steps. Advisers should realize that assets may not be moved all at once or the participant will incur large surrender charges. Often, contracts are set up such that participants may move only increments of assets, spaced out over a specified time, without being charged.

“Advisers should recognize that the differences in fund lineups for nonprofits and for-profits are sometimes for good reasons,” Levine says. “They require different discussions.”

For example, to do what is best for participants, and to try to avoid litigation, sponsors could improve their governance practices for evaluating annuity fees. Donna Kramer, regional sales director at BPAS in New York City, says, with annuities, it can be hard to ascertain what the fees are and who is being paid what; mutual funds have more transparency, and funds without revenue sharing are available.

A benefit to plan sponsors of offering annuities is that revenue sharing and other fee components can cover the plan’s costs; however, there is little transparency as to what fees—e.g., surrender charges—could affect the participants. “Advisers can help shine a light on whether products being offered include compensation for recordkeeping or administration and whether the cost to participants moving out of the products is transparent,” Kaido says. That criteria can be the basis for whether to keep offering the product.

With 401(k) plans, recordkeeper, adviser and investment fees are typically separate, she adds, noting that in many 403(b) plans, fees are still “mashed together” in investment costs. Also, fee levelization is not as common in 403(b) plans as in 401(k) plans.

“Advisers should benchmark plan fees on an annual basis. It’s a relatively simple exercise to make sure the plan’s expenses are in line with the services plan participants are receiving,” Kaido says. “Advisers should issue a request for proposals [RFP] every three to five years, depending on the plan size and service structure. Review all applicable providers, investment option performance and expenses.”

Kramer says advisers should encourage 403(b) plan sponsors to develop an IPS and establish a committee to review the plan and investments on an ongoing basis. “Committees typically do reviews quarterly. Advisers should give [client] committees reports on changes to investments, such as a fund manager change, as well as a fund performance review and an overall market review—especially important in volatile times like now,” she says.

Kaido says having documented processes is important; there should be processes and policies in place that include the different roles and responsibilities for managing the plan and for decisionmaking; there should be documentation to back up decisions.

“It’s important to have a record. If you’re doing all this work and not documenting it or you can’t produce documentation, that can really get you in trouble,” Kramer says. In a lawsuit alleging imprudence in the management of two New York University 403(b) plans, the court sided with the university, in large part because of the evidence that proved its adviser offered regular updates and reports, and that showed the committee made decisions based on adequate investigation and independent assessment.

Regarding the IPS, Levine says many sponsors like to use a generic IPS, which he does not recommend. He leans toward a short, broad-based IPS lacking much detail to allow for flexibility. And he says advisers should think carefully about how the IPS relates to 403(b)s’ unique structure.

When it comes to the lawsuits, he says, advisers and sponsors can learn from them, “but just because a lawsuit says a, b and c, doesn’t mean it’s right.” Again, advisers need to keep in mind that some of the low-cost investment vehicles available to 401(k) plans are not available to 403(b)s—for example, collective investment trusts (CITs).

The lawsuits against 403(b) plan sponsors suggest the one-recordkeeper model of 401(k) plans is the optimal model, but Levine says there is no wrong or right answer. “Among 403(b) plan sponsors, some say one recordkeeper is the best idea; some say they like to offer participants choices. It’s a great example of how the 403(b) world is different,” he says. They may also say, “‘We like annuities that Provider X offers but mutual funds that Provider Y offers,’” so telling a client it needs just one is not a slam-dunk, he says.

His advice to advisers of 403(b) plans is to first understand the culture of the client, the history of its investing and why that history is where it is before trying to implement a cookie-cutter solution.