Jon Chambers

A couple of other quick points on the Morningstar averages: 1) The averages are weighted by fund, not by dollars invested, so very small funds (which tend to have higher expense ratios than larger funds) are given the same weight as larger funds with lower expense ratios. This inflates the averages. 2) Multi-class funds (i.e., funds with A shares, B shares, C shares, etc.) are counted as independent funds for purposes of calculating the averages. Since loaded funds are more likely than no-load funds to have multiple share classes, and since the 12b-1 fees in loaded funds tend to increase the expense ratio, the share class factor tends to inflate Morningstar's calculated averages. The Principia database listed above can be easily used to calculate averages for more realistic peer groups. For example, you could use Principia to calculate the average for no-load large value funds with assets greater than $500 million, for institutional small growth funds, or for indexed large blend funds. This type of service is regularly provided by the plan's investment consultant (we definitely do this for our plan clients).

Did you see what Security Trust was doing? It's clearly "broke". There are changes coming, and the status quo will not be acceptable. Unfortunately, everyone needs to change procedures when someone breaks the rules. PJB--while I agree that intentional market timing is pretty much fruitless (unless its an arbitrage opportunity), the problem with the hard close, is that it will force cross-fund family traders out of the market for a day while they are trading. If the trades are large, and happen to occur on a good day for the market, opportunity losses could be significant. This is likely to create ill-will among participants.

Many after-tax contributory programs (particularly with governmental employers) are referred to as 401(a) plans (to distinguish them from 403(b)s and 457s). So one possible distinction is that 401(k) contributions are pre-tax, and 401(a) contributions are after-tax. Note that this is not necessarily the case--many 401(a) plans have no employee contributions, just pre-tax employer contributions, and, as previously noted, 401(k) plans are a special type of 401(a) plan.

Hi Pete. I have a slightly different read on the ABN/AMRO letter. The DOL indicates that ABN/AMRO is permitted to retain 12b-1 fees because they are NOT acting as an investment advisor. The fact pattern is ok solely b/c the Client Plan independently selects the ABN/AMRO fund(s). If ABN/AMRO were acting as an investment advisor, and recommended a fund that paid a 12b-1, it would be a PT, regardless of whether the fund were proprietary or not. See below: "You represent that when a Client Plan engages AATSC to provide bundled services, a Client Plan fiduciary, independent of AATSC or its affiliates, will select the Client Plan’s investment options. We note, however, that if, with respect to a particular Client Plan, AATSC provides ‘investment advice’ within the meaning of regulation 29 CFR 2510.3-21©, AATSC would engage in a violation of section 406(b)(1) of ERISA in causing the Client Plan to invest in a Proprietary Fund (or any mutual fund that pays a fee to AATSC or its affiliates)."

How about pre-1990 offered J&S option, post doesn't? There are probably many other possible reasons relating to distribution options, or other reasons.

As I re-read the thread, I realize we have diverged significantly from the original question. Additionally, we have responded to follow-on questions based on our individual biases and experience. For example, I work with larger plans that almost always engage institutional trustees. So I thought it might make sense to go back to the original question, and summarize consensus of opinion, and where opinions differ. 1) Who can provide investment advice to individual participants? jmckean indicates that only a registered investment advisor (RIA) can provide investment advice, citing SEC guidelines. ERISA 3(38) indicates that banks and qualified insurance companies also qualify. My opinion is that there is a bit of a turf war going on here, with SEC trying to assert authority it may not have. In any event, it is clear that a traditional broker cannot provide investment advice. This is because the broker's compensation derives from his or her recommendations. Brokers providing advice create prohibited transactions (PTs), because their fiduciary activities (providing investment advice) generate variable and unrelated compensation (commissions) payable specifically to them. 2) Can fees for investment advice be paid from participant accounts? Posters seem to agree that fees can be paid, provided that the advisor is qualified under ERISA. AlanM notes a concern that fees paid may create a tax issue if the fee is not otherwise deductible. 3) Does the plan sponsor (or other fiduciary) have a duty to monitor the investment advisor? We seem to be split on this issue. Most posters agree that where the plan sponsor plays no role in selecting the advisor, there is no residual duty to monitor the advisor. jmckean and KJ seem concerned that where the sponsor facilitates payment of fees, they play a role in administration that may infer the need to monitor. jmckean also expresses concerns that only the plan sponsor can appoint investment managers (IMs), hence the plan sponsor has a duty to monitor. My opinion on this topic is that the plan sponsor's duties relating to the IMs may depend on the plan document and plan structure. I'll cite as an example plans using Charles Schwab Trust Company (CSTC) as trustee. CSTC supports many plans offering individual brokerage accounts. Their prototype document provides that participants can engage IMs, and that IMs can receive fee payments from participant accounts. CSTC even has a structured program for referring participants with brokerage accounts to qualified IMs. In this type of structure, I don't believe that the plan sponsor has any duty to monitor the IM. The sponsor plays no role in engaging or paying the IM. So I don't think the sponsor has a duty to monitor. But there are also scenarios where the sponsor must play a more active role, and I can see how this could conceivably introduce a duty to monitor. 4) Can 404© protection be maintained where the participant works with an IM and a broker, not an "identified plan fiduciary obligated to comply with the participant's investment instructions"? We are also split on this issue. It's my opinion that this is a form over substance issue. It's easy to come up with other examples of how fiduciaries delegate ministerial functions. For example, a payroll officer that calculates and wires salary deferrals to the trust is not a fiduciary if they are simply following established procedures--they have no discretion, and are simply performing an administrative function for the real fiduciary. I'd argue that the broker or fund company executing a trade is performing a similar administrative function on behalf of the plan's identified fiduciary. When we work with plans offering individual brokerage accounts, we typically help the fiduciary identify transactions that the broker is always authorized to execute, transactions that the broker is never authorized to execute, and transactions that require discretion--i.e., the broker must contact the fiduciary prior to executing. A simple mutual fund purchase might be always approved, purchase of collectibles might be never approved, and purchase of options might require fiduciary approval. I believe that in these circumstances, the sponsor retains 404© protection (assuming they had it to begin with). I also believe the sponsor has a fiduciary duty to monitor the broker. For example, the sponsor might want to place some test trades to see if the broker follows the established procedures. 5) Do brokers/advisors/insurance agents in practice accept written designation as fiduciary? Brokers and insurance agents definitionally can't act in a fiduciary capacity for the PT reasons discussed above. While our firm normally works at the plan level, we are occasionally engaged by individual participants, and we accept written designation as a fiduciary, because it's what we do as an RIA, and because we believe that it's required under ERISA if we want to get paid. That being said, our agreement is with the individual participant, and as several other posters have noted, it is not clear whether the individual participant has the authority to make us a fiduciary. In conversations with other RIA firms, I believe their procedures with respect to advising individual participants are reasonably similar to ours. I hope this summary overview helps. My apologies if I misstated anyone's position--if I did, it was an honest mistake.

I'm in full agreement with this position. My point on monitoring is that appointing fiduciaries have a duty to monitor the IMs/funds/service providers etc. that they DID select. I don't believe recordkeepers have a fiduciary duty to monitor. I do believe Plan Administrators have a fiduciary duty to monitor, presuming they are the appointing fiduciary. What monitoring standards are appropriate is an entirely different topic. ERISA merely requires procedural prudence, what constitutes procedural prudence is a facts and circumstances determination. Our firm has developed monitoring protocols we believe are appropriate for our clients' plans, I'm sure other advisors have similar and equally prudent monitoring protocols. Just because something is difficult, doesn't mean you shouldn't do it. Discrimination testing and cross-testing is difficult, but important. Similarly, monitoring investment performance is difficult, but important.

mjb: So we are supposed to take the position that the IRS should disqualify plans b/c they claim to be 404© compliant, but don't follow the 404© regs, so aren't administered in accordance with their terms, but we should disregard DOL regs and pronouncements regarding fiduciary duties to monitor b/c we believe that the DOL position is unsupported by case law. Can I generalize here? We should follow IRS regs and disregard DOL regs? (only kidding) My main point is why not monitor? It may do some good, and by monitoring, a plan sponsor can mount a reasonable defense against breach of fiduciary claims that the sponsor should have monitored, but didn't. A plan sponsor that doesn't monitor may still win the litigation, but I believe it's better to avoid the litigation in the first place. KJohnson: You note: "Under the terms of the plan, the participant or beneficary has a reasonable opportunity to give investment instructions (in writing or otherwise, with an opportunity to obtain wirtten cofirmation of such instructions) to an identified plan fiduciary who is obligated to comply with those instructions...", and observe that this looks more like a definitive duty than a delegable function. A colleague, Stuart Hack, who has done significant consulting on 404© compliance suggests the approach I briefly outlined. Stuart develops 404© compliance manuals that identify a "Participant Investment Directions Administrator" (generally the Plan Administrator) that has a fiduciary duty to transmit and confirm participant instructions to plan's investment provider. Stuart's structure then has the Plan Administrator delegate this function to the plan's recordkeeper (as we all know, ERISA permits fiduciaries to delegate tasks. Most of us agree that fiduciaries maintain a residual duty to monitor the results of the delegation). Would Stuart's proposed approach withstand a legal challenge? I don't know. Does it appear to be a reasonable attempt to comply with a complex regulation? In my opinion, it does.

With respect to Gordy and KJohnson's most recent posts, the 404© requirement that plans have a designated fiduciary responsible for ensuring that valid participant investment directions are in fact executed can be satisfied within the brokerage (SDBA) structure, without making the broker a fiduciary. The "designated fiduciary" is typically the Plan Administrator. The PA reviews the broker's transaction processing structure to determine whether the broker can reasonably be expected to execute transactions as directed by the participant. The PA has the ability to act on behalf of the participant in circumstances where the broker has not followed the participant's (otherwise valid) direction. Some commentators allege that without the designated fiduciary, 404© protection is not available. Without opining on this issue, I suggest that plan's intending to avail themselves of 404© protection should list a designated fiduciary, and that in an SDBA structure, the designated fiduciary should review the broker's transaction process. I agree with KJohnson that this requirement argues for limiting the number of brokerage firms that the plan works with.

Thought you all might be interested in the following summary of a recent press release: "June 11, 2003 (PLANSPONSOR.com) – Plan sponsors in defined contribution plans at MetLife now have available a new participant service to automatically rebalance the investor’s portfolio annually. According to a news release, MetLife Resources is offering the service through a partnership with asset allocation provider ProManage, Inc. ProManage will assume fiduciary responsibility for the advice, the announcement said. ProManage aims its service at participants who do not want to do their own investing, don't have the time, or would rather have a professional do it for them. Armed with participant data provided by MetLife, ProManage reallocates the employee’s plan assets for them without their having to do anything. Only those participants in the ProManage PROgram pay for the service - and each ProManage participant can choose to opt out of the ProManage PROgram at any time, according to the announcement." This is a hybrid scenario of what has been discussed in the thread. The plan sponsor has partial responsibility for selecting an IM to provide asset allocation advice (ProManage). However, the participant decides whether or not to engage ProManage's services, and only those participants choosing the service pay for it. While the release is silent on the topic, I believe fees can be paid from the account. On a couple of other topics in the thread, the advisor does not have to be an RIA, but must be a QPAM (check ERISA for the QPAM definition). I acknowledge that in practice, most QPAMs will be RIAs, particularly in this area. mbozek asked for case cites relating to the fiduciary duty to monitor. Frankly, as a non-attorney, I don't spend a lot of time on cases. I'll note that the DOL has frequently asserted that fiduciaries have a duty to monitor (e.g., the following quote from "A Look at 401(k) Plan Fees", "Employers are held to a high standard of care and diligence...Among other things, this means that employers must:... Monitor investment alternatives and service providers once selected to see that they continue to be appropriate choices." I know from prior postings, mbozek has taken the position that unless there is a current case cite, there is no relevant legal authority. I take the position that the DOL's opinion also matters, since the DOL can audit, sue, and otherwise make life miserable for an employer. Similarly, cites are only available on cases that get litigated. We see plenty of cases that get settled without the court making any judgment. Plaintiffs attorneys will regularly use regulations and other DOL pronouncements as source material for their complaint. Whether or not they would win in court is perhaps less important than whether they can create a colorable claim that pressures the defendant into a settlement. We recommend that clients manage their plans in a "squeaky clean" manner, such that they will have a perceived impenetrable defense against possible claims of breach of fiduciary duty.

Good question KJohnson. While I can't speak to all the specifics, I'm aware of plans that offer on-line investment advice through programs such as Financial Engines, Morningstar or mPower (recently acquired by Morningstar). In certain configurations, I understand that employees pay the fee for these services from their individual accounts. However, Financial Engines, Morningstar or mPower are not "Investment Managers" in the traditional sense, since although they will make recommendations based on the employee's inputs, it is up to the employee to implement the recommendation. Is this the type of arrangement you were thinking about? Perhaps someone from one of the referenced on-line investment advice firms could comment on how this works in practice.

I guess the open question is how you know whether an ID or SS# is fake or not. I had a client once who employed migrant workers. They would show up year by year with new IDs and SS#s. Client wanted to know whether the same person with a different ID was one participant or two (BTW, this was way pre-Patriot Act, with much less sensitivity to fake IDs). We advised that they should accept the participant's representation regarding ID, unless they knew IDs were fake. Following this logic, we established new accounts and new participant records when participants presented new ID. I guess this begs another question--could the same person take a distribution as a former participant under their old ID, while continuing to accrue benefits as an active participant under their new ID. Luckily, we were never asked this question.

Well put GBurns!

Wow. This thread really took off since last I checked in. In my early post, I was presuming that the advisor was a QPAM (Qualified Professional Asset Manager, probably an RIA), hired by the plan administrator under Section 402©(3) of ERISA. This addresses KJohnson's question. In this case, the plan administrator hires the advisor, and clearly has the duty to monitor such appointment. This is the structure we generally work under. The second type of arrangement, where the advisor is engaged by the participant raises various issues, although we see this relatively often also. I've seen these situations quite frequently where Schwab acts as custodian for the SDBA, and also with Fidelity SDBAs. The advisor probably should still be a QPAM. While I haven't researched the issue of whether or not the plan administrator has a duty to monitor the advisor, it would seem that the 404© protections afforded in an SDBA structure should extend to the advisor (presuming the plan otherwise qualifies for 404© protection. alanm raises a good point about the taxability of fees paid out of the plan. I have to say this is outside my area of expertise, so I will refrain from commenting on it. The other point made by various individuals, that the plan must provide for payment of fees, is clearly also on point.

Assuming the fees are otherwise permissible, yes, they can be deducted directly from the account. This is a relatively common practice.

Note that McHenry couches its opinion in the following terms: "Based on our conversations with regulators on related topics..." This leads me to believe that guidance is verbal rather than published. You could call Ward Harris directly and ask him what his source was (800) 638-8121. On your second point (TPAs keeping excess revenue share), this would appear to contradict the assumptions underlying the Frost opinion that you reviewed, however, I hear DOL may be moving away from Frost. In any event, Frost dealt with a specific case, and while indicative of DOL's thinking, doesn't constitute law.

Is your plan level advice fee-only or commission based? If commission based, you have a legit PT concern. If not, you may be ok to give separate advice to participants, provided your contracts are set up properly, and provided you are advising on plan assets, not managing plan assets. We are also an RIA, and have several clients that have adopted the type of structure I think you are describing, and our agreements were blessed by our counsel. But make sure you check with qualified counsel rather than relying on my post, b/c this is very technical stuff.

Here's an opinion on the topic from a McHenry Consulting white paper: "Did your firm, its affiliates or associates, provide plan clients with GUST amendments and assist with adoption strategy at no charge? Do you use plan assets as a criterion for determining which plans are charged for this service?Based on our conversations with regulators on related topics, and firms interviewed on this specific issue, there are several things to look at if you answered 'yes' to either question: The Department of Labor considers revenue generated by investments to be a plan asset. Some plan amendment activities are settlor expenses, and cannot be paid for out of plan assets. Directing plan assets to pay a settlor expense may be deemed a fiduciary act. Use of plan assets to the benefit of the settlor may violate exclusive use rules. What to do? McHenry believes the 'no free lunch' principle may apply. Where a settlor function is performed, there should be a corresponding expense and payment trail. Plan service providers that do not charge for settlor services, or charge only selected clients for certain settlor services based upon the amount of plan assets, may eventually be put at risk if the DoL audits and asks to 'look under the covers'. " here's a link to the whole paper: http://www.mchenryconsulting.com/research/...lert6_20_02.asp They also have a thorough report on revenue sharing here: http://www.plantools.com/pdfs/RevenueShari...Report_9_01.pdf

Here's what PSCA reports on the issue: 6. SARBANES-OXLEY SECTIONS 404 AND 906 MAY REQUIRE PLAN ACTION Public Law 107-204, the Sarbanes-Oxley Act, contains two provisions that appear to require action by plans that file form 11-K's for annual reports of employee stock purchase, savings, and similar plans pursuant to section 15(d) of the Securities Exchange Act of 1934. Section 404 of Sarbanes-Oxley mandates the SEC to issue rules requiring each annual report required by section 13(a) or 15(d) to contain an internal control report which states the responsibility of management for establishing an adequate internal control structure and procedures for financial reporting; and to contain an assessment, as of the end of the most recent fiscal year of the issuer, of the effectiveness of the internal control structure and procedures of the issuer for financial reporting. Section 906 appears to require that all 11-Ks filings include a written certification by the CEO, CFO, or an equivalent thereof. ERISA plans are due to file their 11-K's by June 28.

The problem you face is that there are different types of revenue sharing, and different interpretations of what is legal. Generally, if the revenue sharing is structured as a commission (e.g., a 12b-1 fee), if the revenue sharing is rebated to participants, you have probably violated NASD rules prohibiting the rebating of commissions. Illegal? Perhaps, but not necessarily. If the revenue sharing is from the fund's OER, it's probably not a problem. There are lots of arrangements out there. I've even seen revenue sharing rebated to the plan sponsor, ostensibly to offset their staff costs for plan administration. I've also seen commentators argue that "free" plan amendments are illegal, b/c they are settlor functions paid for (at least indirectly) with revenue sharing, which should be considered to be a plan asset, and plan assets can't legally be used to pay settlor costs. Due to the complexity of determining the revenue sharing source, different ways to apply the revenue sharing, and different ways to account for the sharing, it's very hard to make blanket statements about what is or isn't "legal". I generally suggest that sponsors that want to rebate revenue sharing to participants would be better served by selecting low cost funds that don't offer revenue sharing.

To answer your questions directly, no, and no--at least not any "duty" specified in the Code or regs. I'd suggest you have a problem with your IPS. Any criterion that states funds must continually be in the top 50% of their category WILL be violated at some point in time. In my opinion, this criteria should simply trigger a committee review, but not formal probation or replacement. We write a lot of IPS, and believe that such a mechanical criterion is contrary to the goals of most plans. There is no duty to share the results of the evaluation. Generally, these discussions are not relevant to most rank and file participants, and we recommend that minutes/reports etc. be kept private. Finally, if the fund has been placed on a watch list, you might want to communicate that fact--it shows good faith, and if the fund is replaced, participants received more notice.

In their booklet on 401(k) fees for employees, the Department of Labor advises that employers have a duty to: 1) Establish a prudent process for selecting investment alternatives and service providers 2) Ensure that fees paid to service providers are reasonable in light of the level and quality of services provided 3) Select investment alternatives that are prudent and adequately diversified 4) Monitor investment alternatives and service providers once selected to see that they continue to be appropriate choices This fourth item is what you are probably looking for.

Plans offering employer stock have a natural defense--they were following the terms of the plan, that provide for investement in employer stock. No such defense is available to the plan that offers stock that is NOT employer stock--the fact pattern here. Additionally, Employer stock is exempt from the diversification rules under ERISA, but not from the prudence rules. Hence, you see prudent fiduciary conduct that changes the terms under which employer stock is offered when there is a substantive question regarding the prudence of retaining employer stock as an investment option, such as United Airlines' decision to retain an independent fiduciary for employer stock held through its retirement plans (the independent fiduciary decided to sell), or Federal Mogul's decision to discontinue matching with employer stock when asbestos litigation threatened bankruptcy. Employer stock doesn't get a free pass from fiduciary concerns. Stock that is not employer stock, that is offered as a designated investment alternative, comes perilously close to a per se violation of ERISA's fiduciary rules.

The DOL's position on this issue is clear. The following quote is from their booklet "A look at 401(k) fees... for employees". Note the third bullet point: "Employers are held to a high standard of care and diligence and must discharge their duties solely in the interest of the plan participants and their beneficiaries. Among other things, this means that employers must: Establish a prudent process for selecting investment alternatives and service providers Ensure that fees paid to service providers and other expenses of the plan are reasonable in light of the level and quality of services provided Select investment alternatives that are prudent and adequately diversified Monitor investment alternatives and service providers once selected to see that they continue to be appropriate choices" I don't see how any single stock could be "prudent and adequately diversified".

ERISA generally precludes investments in individual account plans that could create a loss larger than the participant's account balance--such as naked options and excessive leverage. For this reason, most SDBA providers do not permit margin purchases or naked options. Some SDBA providers do not permit ANY options, but this is a business decision, not a regulatory requirement. I agree with mbozek that covered calls are perfectly permissible.