State Retirement Arrangements for Small Business Employees

After posting "Public-Private Retirement Plans and Possible Fiduciary Gaps," a senior legal expert kindly informed me that Connecticut's legislation draws extensively from U.S. federal pension law. (ERISA does not directly apply to most government plans and the U.S. Department of Labor has proposed a safe harbor that would exempt states from being tagged as ERISA fiduciaries.) Interestingly, a word search for "fiduciary" in the Public Act No. 16-29 document comes up empty. Specifically, as laid out in Section 6, entitled "Board Duty To Act With Prudence And In Interest of Participants," the Connecticut Retirement Security Authority board of directors are to act with the "care, skill, prudence and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of like character and with like aims" and solely "in the interests of the program's participants and beneficiaries."

Regarding legal redress, my understanding is that individuals who allow their employers to deduct three percent of their taxable wages to be placed in an "age-appropriate target date fund" or similarly allowed investment will not have the right to sue individual members of the Connecticut Retirement Security Authority Board nor will they have the right to sue the State of Connecticut. They will have to rely on authorized directors and the Attorney General to properly oversee selected service providers and take corrective action to improve things going forward. However, even if participants can demonstrate economic harm, they would not be able to recover past damages.

Programs offered by other states vary. One would have to research dozens of legal documents to compare and contrast governance, investment opportunities and conflict of interest avoidance mechanisms. Interested parties can visit the Pension Rights Center's State-based retirement plans for the private sector or the AARP's State Retirement Savings Resource Center. I am not sure how often these websites are updated.

I remain skeptical and am not alone. Michael Barry, president of the Plan Advisory Services Group, explains his reservations in "Are State Plans the Answer?" (Plan Sponsor, November 2015). Paul Schott Stevens, president and CEO of the Investment Company Institute, gives a thumbs up to private initiatives such as expanding multiple employer plans or MEPs to include smaller companies. Another way forward would be to simplify 401(k) plan regulations to encourage employers to better help their workforce save for retirement. See "State-Run Retirement? Better to Go Private" (Wall Street Journal, February 7, 2016).

My lack of enthusiasm for these state-run programs has more to do with philosophy and a desire to encourage economic growth. Here is some food for thought.

  • Small businesses around the world are drowning in a sea of regulations. According to an article in Small Business Trends, there is an inverse relationship between company formations and the number of pages in the Federal Register. These "little engines that could" create jobs are not leaving the train station, discouraged by too many rules.
  • As any free market economist can handily demonstrate, unintended consequences often occur, resulting in added expense and unwelcome behavior. Instead of spending X hours per month on growing sales and profit, a small business owner that is obliged to complete paperwork may now forego hiring new employees or cut back on existing perks.
  • Some of the states that are setting up retirement programs for private company workers have a poor track record as evidenced by underfunded pension plans for municipal staff.
  • Unless one is convinced that small company employees are unable or unlikely to set up an IRA on their own, these state-involved arrangements are not needed. CNBC reports that "Employees participating in auto enrollment tend to contribute less than people who sign up for 401(k) plans on their own, often because their employers set a low default contribution level."
  • It's not clear to me that individuals will have a better level of consumer protection by being part of a state-run program versus setting up an IRA account directly with a reputable financial institution. So far, no one has convinced me to the contrary.

I'm all for encouraging individuals to save for the long-term but I seriously wonder why government has to be involved with every decision someone makes. Hopefully I will be proven wrong and these state programs for private company employees will succeed.

Note: I welcome insightful essays and commentaries on this and other relevant pension governance topics. If you would like to be a guest contributor, please email contact@fiduciaryleadership.com with your idea or write-up.

Public-Private Retirement Plans and Possible Fiduciary Gaps

Hot off the press, a study from Pew Charitable Trusts ("Pew") examines retirement benefit planning by geography. Key takeaways from "A Look at Access to Employer-Based Retirement Plans in the Nation's Metropolitan Areas" and a summary by Pew's Director of Retirement Savings, John Scott, include the following:

  • At least four out of ten full-time employees work for private companies that do not offer a retirement plan;
  • Where one works can influence whether an individual has access to an employer-provided retirement plan;
  • Data shows that access is lowest in Florida, Texas and California; 
  • Access is typically lower for employees of small companies;
  • Workers who earn more than $100,000 per year generally have greater access to an employer-sponsored plan than individuals who earn less than $25,000; and
  • Underserved employees (in terms of access to a company-provided retirement plan) are clustered in large cities.

These insights validate what many know. Millions of people worldwide are not saving enough by far for retirement. One response (not surprisingly) is for government involvement to encourage individuals to save more. On November 16, 2015, the U.S. Department of Labor ("DOL") announced its proposed regulation to enable states to facilitate retirement plans for uncovered private sector employees without being subject to the Employee Retirement Income Security Act ("ERISA"). Read "State Savings Programs for Non-Government Employees" for details.

As the result of this suggested safe harbor (as I don't believe the DOL regulation has been passed yet), lots of states are jumping on the retirement bandwagon. Besides the State of Washington, California and Illinois require or encourage mostly smaller employers to offer a plan or engage in getting their employees to join a state network.

Not everyone is shouting with glee. According to "Initiatives for private-sector retirement moving to states" by Hazel Bradford (Pensions & Investments, January 25, 2016), certain financial service organizations fear increased compliance costs due to a patchwork approach across fifty states. Another concern is whether participants in newly formed state programs will be adequately protected. Even if a state private-public program is run by those who have sufficient experience and knowledge, will they be held to a fiduciary standard? If not, why not? If so, how will the fiduciary standard compare with ERISA norms if ERISA does not apply? In my discussions with several persons involved in this area, they too share the concern about a fiduciary gap.

Consider the case of Connecticut. After threatening to veto the bill to create the Connecticut Retirement Security Board in mid May 2016, the Nutmeg State's governor signed the act on May 27 with operations planned to commence in 2018. According to the original text for sHB 5591, if an employee does not "affirmatively opt in" then a "qualified" employer must enroll each employee and deduct three percent of taxable wages "up to normal IRS limits." An employee can opt out by indicating a contribution level of zero. The chairperson and other directors of the Connecticut Retirement Security Board will be selected by the governor in concert with the General Assembly. The board members must "act with care and solely in the interests of the program participants" with power given to the attorney general to "investigate violations of this requirement and to seek injunctive relief regarding violations." Board members are to have "protection from individual liability."

I will defer to attorneys to hash the legal niceties about individual state endeavors to assist private company employees. From a governance perspective, I belief strongly that private company employers, plan participants and taxpayers must have answers to critical questions such as those listed below:

  • How will board members be protected? If they are to be covered by some kind of liability insurance policy, who will pay the premiums and determine the adequacy of coverage? Will taxpayers be asked to pay anything if something goes awry and the insurance policy is insufficient?
  • Who will monitor the performance of board members to assess possible conflicts of interest?
  • Will board members be term limited?
  • Will board members be compensated and who will pay their compensation?
  • In the event of a major snafu, do participants have any redress? If so, to whom and on what basis? Litigation? Mediation? Arbitration? Other?
  • When would board members act as fiduciaries? Will their actions be evaluated on the basis of state trust law? If so, how does the state trust law compare to ERISA fiduciary duties? Weaker? Stronger? Same?
  • Would individuals have stronger protection if they transact directly with a financial service company and open up an IRA on their own?

In the aftermath of the passage of the U.S. Department of Labor Fiduciary Rule (acknowledging several legal challenges just filed), the concept of fiduciary duty is foremost on the minds of numerous industry executives and policymakers. Will public-private retirement plans receive the same scrutiny or is there a fiduciary gap? If the latter, who is on the hook in case of a problem?

The DOL Fiduciary Rule, Seller's Exception and Independent Fiduciaries

How does a service provider determine whether it is making a recommendation to "independent fiduciaries of plans and IRAs with financial expertise?" This is a key question that could determine whether an organization or individual is tagged as an ERISA fiduciary and subject to added liability as a result.

According to "Chart Illustrating Changes From Department of Labor's 2015 Conflict Of Interest Proposal To Final," one of several modifications includes the following: "Providing an expanded seller's exception for recommendations to independent fiduciaries of plans and IRAs with financial expertise and plan fiduciaries with at least $50 million in assets under management is not fiduciary advice."

As always with legal issues, I defer to knowledgeable attorneys to parse this language. However, given an implementation deadline, compliance professionals of firms that sell to ERISA plans and IRA owners no doubt want to clarify definitions and concepts such as "independence" and "financial expertise."

One attorney with whom I spoke suggested the intent is to lower the chance of a conflict such as when a fiduciary receives compensation for a vendor or product he helped put in place. Another attorney put forth the notion that fiduciaries of a "larger" plan (in this case, a trust with assets above $50 million) could be seen as more "sophisticated" and "informed." I'm not convinced that the ambiguity of the final language can be dispatched without addressing a series of questions, some of which are listed below.

  • Is a consulting firm that seeks an exception and wants to sell its delegated investment management or Outsourced Chief Investment Officer ("OCIO") services thereby prohibited from pitching any of its own proprietary products and using them if it wins a contract?
  • When a C-level executive such as a Chief Financial Officer sits on a plan investment committee, who will assess whether her decisions are made solely in the interest of plan participants and not to plump up a bonus tied to a particular decision or outcome?
  • Can a seller avoid fiduciary classification if the client is a plan or IRA with assets less than $50 million but managed by knowledgeable fiduciaries?
  • Might a seller fail to procure an exception if it is later shown that a plan or IRA with more than $50 million in assets is "large" but managed by fiduciaries who do not possess financial expertise?
  • How do sellers intend to determine whether "financial expertise" exists and can they do so without insulting potential buyers?
  • How will existing "know your customer" guidelines change to accommodate the notion of "financial expertise?"
  • How do regulators intend to determine whether "financial expertise" exists?
  • If there are multiple fiduciaries and some possess "financial expertise" but others do not, is the seller at risk for losing the exception or not obtaining it in the first place unless it can verify that all in-house fiduciaries are competent?
  • If a plan fiduciary or IRA owner or manager changes, does the seller need to assess "financial expertise" for the replacements? Does the U.S. Department of Labor need to do likewise? 
  • On what basis is the $50 million determined? At a point in time or as a rolling average? Are assets to be based on market value or book value or something else? Will regulators review Form 5500 numbers to determine if the $50 million test has been met?

If anyone knows of an article or webinar that addresses these issues, please kindly email contact@fiduciaryleadership.com. I would like to share resources about "independence" and "financial expertise" with readers of Pension Risk Matters.

Note: Interested persons can click to download "Pension risk, governance and CFO liability" by Dr. Susan Mangiero (Journal of Corporate Treasury Management). The phone number listed on the article is not current. 

Fiduciary Rule: Instant Gratification or Panic

If you haven't viewed Tim Urban's TED Talk about procrastination, I urge you to do so when you have a short break. He spins a tale of prioritization woe by referencing different parts of our brain. There is the Instant Gratification Monkey who tries to lure the Rational Decision-Maker from productive endeavors. This playful little fella holds sway until deadlines force the appearance of the Panic Monster. Someone then responds by pulling an all-nighter or two until the next crisis. As this illustrator and Wait But Why blog site co-founder explains, it's not an enjoyable way to manage tasks and seldom generates good results. It is far better to prepare in advance and schedule "must do items" accordingly.

Occasionally, planning ahead is difficult. Other times, it is easy. As Mr. Urban illustrates during his fifteen minute "eat your peas" presentation, there are signposts that indicate when acceleration is required. In his case, it was the appearance of his photo and bio in a TED Talks program that gave a date certain he could not ignore. For investment professionals who anticipate the eventual passage of the U.S. Department of Labor Conflict of Interest Proposed Rule into law, it is clear that significant change is afoot. Even if the exact final language or timing is unknown today, fiduciaries (now and later) may not want to sit back and wait.

Already there is talk of increased delegation to organizations that are willing to serve as either an ERISA 3(21) or 3(38) fiduciary, acknowledging that nothing eliminates risk completely. As Pension Resource Institute CEO Jason Roberts opines in an Investment News interview, "...while these offerings can limit fiduciary responsibility for advisers at the plan level, advisers could still be exposed at the participant level."

Others advance the idea that the so-called fiduciary rule will catalyze creative problem-solving, especially in the technology area, and that smart money is on first movers. See "Fiduciary Rule May Spur Product Innovation" by Andrew Welsch (Financial Planning, March 16, 2016). If you missed my earlier posts on this topic, see "Retirement FinTech Gets Another Suitor - Goldman Sachs" and "Financial Technology and the Fiduciary Rule."

Whatever path is decided on will require a minimum amount of time for contracting and setting up operations. Starting late could be costly for everyone involved. Lest you figure out a way to be able to succumb to the Instant Gratification Monkey (unlikely in the case of regulations and rules that require sufficient compliance), now is a good time for procrastinators to address priorities. Expending time right away may not be fun but is nonetheless necessary.

Investment Management and Stress

The fact that some people thrive on stress could be a plus if you want to work in the financial services industry. According to "The most (and least) stressful jobs in banking and finance" (efinancialcareers.com, December 31, 2015), careers that were ranked as most stressful to least stressful are as follows:

  • Investment banker;
  • Trader;
  • Risk management and compliance;
  • Wealth management/private banker;
  • Institutional sales;
  • Management consulting;
  • Private equity;
  • Equity research;
  • Fund manager; and
  • Accounting.

Interviews with recruiters and employees mentioned long hours and a lack of control over issues that create problems and demand solutions. Respondents who work in the risk management and compliance areas talked about their frustration when they call out areas in need of improvement but then "nothing is done." 

Other professionals, such as those who work in wealth management, talked about competition as being a source of stress. Making money only occurs after an advisor expends considerable effort to build a big client base but then more time is needed to prevent an aggressive peer from taking assets away.

Besides job-specific concerns, industry changes can be a source of worry if they are expected to radically transform the way business is conducted. Consider the rise of financial technology ("FinTech") or what Inc. Magazine referred to as "One of the Most Promising Industries of 2015." According to a recent Wall Street Journal article entitled "Can Robo Advisers Replace Human Financial Advisors?", assets managed without human intervention grew from $3.7 billion to $8 billion between July 2014 and July 2015. Although critics counter that robots cannot offer individualized advice about specialties such as estate planning, a reliance on automation, if substantial, will result in winners and losers.

Regulatory changes can raise stress levels too, especially if one has little latitude to adapt to a new rule at the individual level. The U.S. Department of Labor's proposed fiduciary rule is already showing up in the form of strategic corporate decisions that are moving people from one place to another. This week's announcement about a sale of MetLife's U.S. advisor unit to the Massachusetts Mutual Life Insurance Co. comes on the heels of the American International Group's decision to sell its broker-dealer unit rather than potentially incur added compliance costs. See "MetLife exits brokerage business as DOL rule looms" (Investment News, February 29, 2016).

Although not specifically mentioned in articles about stressful jobs, ERISA retirement plan fiduciaries are surely aware of their personal and professional liability exposure. Add the complexities of new legislation and economic challenges such as negative interest rates and it's not a stretch to understand why some fiduciaries might need to take a few deep breaths to relax. No doubt their public pension colleagues may need a zen moment as well.

Fiduciary Frenemies

As senior ERISA litigation attorney Steve Rosenberg points out in a recent blog post, a service provider with a wayward institutional client could end up in a lose-lose situation. Ignore questionable or illegal conduct and co-fiduciary liability might lead to allegations of breach and a costly fallout for the advisor. Inform authorities and one is likely to lose that client and accompanying revenue.

Referencing a Plan Adviser article entitled "Do Retirement Plan Advisers Have a Duty to 'Rat?'," Attorney Rosenberg describes this dilemma as a real problem. I concur and offer that the growth in outsourcing arrangements could be a catalyst for further friction unless all parties understand how work is to be allocated and are equally committed to a high standard of care. With over $1.2 trillion categorized as "outsourced assets," there is a lot at stake.

In 2014, the ERISA Advisory Council had an entire forum on the topic of outsourcing of employee benefit plan services. On the topic of duties, law professor Colleen E. Medill testified that "... the courts have not provided much guidance on whether one fiduciary has the right to sue another fiduciary for equitable relief under ERISA.  She noted that this issue will be of increased importance as more employers and other named fiduciaries look to outsource fiduciary functions.  Likely, in a co-fiduciary situation, one fiduciary is more culpable than the other.  Thus, while both fiduciaries are jointly and severally liable under ERISA, the less culpable fiduciary may wish to sue the other fiduciary for damages in a contribution or similar action."

Based on my experience as an expert witness, service provider disputes can arise for a number of reasons, including, but not limited to, what I call an expectations gap wherein some task is left undone because it has not been formally assigned. In other situations, a conflict may exist that makes it hard for a third party to act independently on behalf of its institutional client. Of course, an investment committee member(s) may likewise have a conflict that impedes the advisor's ability to do what he or she is supposed to do. A pay-to-play kickback that involves a trustee with authority to hire an advisor is one example.

As I've written about many times, vetting and overseeing service providers by an investment committee is critical. As Attorney Rosenberg reminds his Boston ERISA Law blog readers, knowing one's customer is likewise important. After all, some lawsuits are brought by plan participants against both internal and outsourced fiduciaries. It is not unreasonable to conclude that working with a governance-focused client and vice versa redounds to the advantage of both buyer and seller.

U.S. Department of Labor Hearings About Conflict of Interest and Fiduciary Role

Though it may seem arcane to those outside of the financial services industry, the current debate about who serves as a fiduciary, compensation and duties is a big deal. Depending on what you read and with whom you speak, millions of retirees could be materially impacted. In the spirit that what happens next is newsworthy, you may want to tuck the hearing URL away and check back often. As the four days of public hearings proceed, the U.S. Department of Labor is expected to publish a transcript of what witnesses say. Besides a chance to know what professionals from a wide variety of backgrounds aver (both pro and con), interested parties can download nearly 2,600 comment letters. Click here to access the Public Hearing Agenda for the period from August 10, 2015 through August 13, 2015. Click here to download and read the following: (a) requests to present during public hearings (b) comment letters and (c) petitions.

ERISA Litigation Predicted To Rise

I have just returned from Chicago where I spent two days listening to transaction attorneys, litigators and insurance company executives talk about trends in ERISA enforcement and legal disputes. Sponsored by the American Conference Institute, this assembly about ERISA litigation included sessions on class actions, Employer Stock Ownership Plan ("ESOP") problem areas, the role of economic experts in litigation, challenges to the church plan exemption, questions about excessive fees, de-risking, stock drop defense strategies, health care reform, how much ERISA fiduciary liability insurance to purchase and much more.

I took a lot of notes and intend to write about implications for plan sponsors and their service providers through an economic and governance lens.

It may be coincidental but certainly not trivial that the United States Department of Labor released its fiduciary proposed rule about conflicts of interest on the second day of this important ERISA litigation convening, i.e. on April 14, 2015. The thinking is that the adoption of a more rigorous rule could open the door wide to a multitude of further disputes and heightened examinations. Click here to access the language of the proposed rule and supporting documents.

It sounds like many will be even busier in the coming months.

ERISA Whistle Blowers

In the aftermath of the November 17, 2014 Strafford CLE webinar entitled ERISA Plan Investment Committee Governance, I asked several attorneys for their thoughts about whistle blower protection.

Attorney Stephen P. Wilkes, Of Counsel to The Wagner Law Group, took time out of a busy schedule to share his thoughts about a hypothetical scenario. He wrote the following:

Person X, a corporate officer, is a member of the Investment Committee for the corporate retirement plan ("Plan"). Person X determines that a specific course of action is in the best interest of the Plan (e.g. remove employer securities as an investment option or replace Bank Y with Bank Z as trustee). However, the Chief Financial Officer ("CFO") of this made-up company inappropriately steers the decision to one that serves the corporate interest and not the Plan interest (e.g. maintain employer securities as an investment option or continue to use Bank Y as trustee because it is providing corporate finance services to the company at below-market prices).What is Person X to do? He or she has a duty to serve the company and its shareholders, yet as an ERISA fiduciary, is there is a duty owed in this instance to the Plan and its participants? Person X complains to the U.S. Department of Labor ("DOL"). Five months later, Person X is terminated from employment by the CFO for "performance issues."

There is an inherent conflict of interest when corporate officers serve in an ERISA fiduciary capacity. The DOL and the U.S. Supreme Court have each determined that one can wear dual hats (sometimes an ERISA fiduciary, other times not an ERISA fiduciary),

In this hypothetical situation, Person X is clearly wearing the ERISA fiduciary hat when engaged in Plan Investment Committee work and owes the corresponding duty at that time to the Plan and its participants and beneficiaries.

The very purpose of the whistleblower statutes (such as ERISA Section 510 or Sarbanes-Oxley Section 1514A) is to root out problems and protect the reporting individual (the "whistleblower") from retaliation in this sort of scenario.The legal mechanism is in place to protect whistleblowers.There are some legal distinctions yet to be fully resolved about whether or not a particular retaliation is unlawful or not. They turn on whether an employee "has given information or has testified or is about to testify in any inquiry or proceeding." In other words, there are some open legal issues about whether unsolicited grievances are protected (as compared to whistle-blowing about ERISA violations during an active or ongoing investigation).

The question as to whether the presence of senior management who serve alongside mid-level or junior-level employees at the ERISA fiduciary table creates a "chilling" effect is a good one. Though the answer ultimately turns on the compliance culture of each company, potential problems can be mitigated well in advance with solid corporate governance and ERISA fiduciary training, as well as having appropriate policies and procedures in place with regard to risk management.

On behalf of the readers of Pension Risk Matters, thank you Attorney Wilkes.Your insights are much appreciated.