401(k) Fiduciaries

February 13, 2019

One of the least understood areas about 401(k) plans relates to the various fiduciary requirements for the plan.  Every 401(k) plan has fiduciaries, as required by ERISA (the law governing retirement plans).   There are different types of fiduciaries involved with 401(k) plans…which leads to common questions:

            What exactly are fiduciaries, and what do they have to do? 

In the simplest terms, fiduciaries are financial specialists who are working on your behalf, not their own.  Fiduciaries are required to make decisions that are in their clients’ best interest, not their own.  Registered investment advisors are fiduciaries by law.  Brokers are not.  Yet, both provide financial advice or may be considered “financial advisors.”  This does not mean all brokers are bad; it simply means they are not required to always keep their clients’ interest ahead of theirs.  The difference is most commonly seen (and felt in the pocketbook) in the sale of products.  A broker, a non-fiduciary, could sell a high fee product to a customer and take the high fee commission that comes with the product, knowing there is an identical cheaper alternative available that would benefit the client.  A registered investment advisor may not take such action.  Not all brokers are unscrupulous used car salesmen, but the law permits it, and investors and clients should be aware of the possibility.

The Department of Labor lists the general responsibilities of 401(k) fiduciaries as:

  • Acting solely in the interest of plan participants and their beneficiaries with the exclusive purpose of providing benefits to them;
  • Carrying out their duties prudently;
  • Following the plan documents unless such plan documents violate ERISA;
  • Diversifying plan investments; and
  • Paying only reasonable plan expenses.

If fiduciaries fail in the above duties, they can be fined by the Department of Labor and become subject to potential liability from the plan beneficiaries (e.g. the company’s employees).  One of the fastest growing litigation fields in the United States is class action lawsuits against plan fiduciaries for violating the above duties.  In 2018 alone, companies paid out almost $100 million in settling ERISA 401(k) fiduciary lawsuits.  Large companies such as Transamerica and FedEx have been sued, as well as companies with less than five employees.

There are several different types of 401(k) fiduciaries, including Section 3(16) fiduciaries, Section 3(21) fiduciaries, and Section 3(38) fiduciaries.   The roles of each type are summarized in the following Department of Labor table:

During the Obama administration, the Federal Government attempted to pass what was known as the “Fiduciary Rule.”  This rule would have required all 401(k) providers, brokers, and companies to be fiduciaries.  The industry fought this tooth and nail and eventually succeeded in killing the rule. 

That means a broker selling an employer 401(k) plan might not be looking out for the employees’ or the employer’s best financial interests.  They might try to sell branded plans, with higher commissions and costs, and funds/investment options that are inferior and which may cost more.  This does not mean all brokers are out to fleece people for high commissions – just that they are permitted to and do not have to disclose that they are doing so.  The easiest way to avoid this is to request that whoever you are dealing with confirms, in writing, that they are acting as a fiduciary.

Most broker sold plans establish the employer with the liabilities and responsibilities that a Section 3(38) fiduciary typically has. Therefore, if the employees get angry that the plan lineup is not diverse enough or has too many expenses, the employer gets sued and has the liability…even though the employer trusted the broker to sell the company the right product and to set it up properly. Note, even if the employer transfers these liabilities to a 3(38) advisor, the employer is still responsible for prudently selecting the investment advisor.

Litigation continues to grow in this area, particularly attacking the fees index tracking funds which exists in 401(k) lineups.  For instance, a registered investment advisor, operating as a fiduciary, may put the ETF SPY, Charles Schwab’s S&P 500 Fund, or Vanguard’s equivalent Fund, all of which charge under 0.10% (less than ten basis points).  This is in contrast to placing a S&P 500 Fund from Guggenheim that has an S&P 500 fund charging over 2% (over 20 times as much) and well-known institutions such as DWS, Invesco, JPMorgan, Principal, and Wells Fargo, whose equivalent funds all charge over 1.0% (over 10 times as much).  Employees who object to these fees might have a claim against the Section 3(38) fiduciary of the 401(k) plan.  If that’s the employer, significant liability could be attached.

However, a registered investment advisor is a fiduciary by law and can, by contract, assume the employer’s 3(38) fiduciary duties.  In this circumstance, an employer can be assured that the plan investment choices have been thoughtfully prepared for their employees to optimize cost, expenses, and efficiencies.  And, if for some reason, there is a lawsuit over the plan lineup or its expenses, the employer is indemnified from the claim, as it is the plan’s 3(38) fiduciary who is responsible for the plan’s lineup.  An employer cannot remove all of its fiduciary liabilities, but it can ensure that the Section 3(38) responsibilities are not falling on an employee or owner of the company.

We always advise our clients to specifically ask any 401(k) plan sales representative to confirm, in writing, that he/she is acting as a fiduciary.  Without that statement in writing, the employer should look elsewhere for a provider.  Ideally the employer can offload the Section 3(38) responsibilities as well.

Beware the dual role advisor though…that is an advisor who is both a registered investment advisor and a broker.  The law permits such people to claim to be a fiduciary (through their registered investment license), and then “switch hats” to act as a broker and sell inferior, but higher commissioned products.  There is no requirement of a dually registered financial advisor (broker and registered investment advisor) to tell clients which hat is being worn (broker earning commissions or registered investment advisor acting as a fiduciary).  The only real safeguard against this is to confirm, in writing, that the financial advisor/broker will be, at all times, acting as your fiduciary.  Any client may always request this of their financial advisors.  Run if they refuse.

Do not let any of this prevent you from dealing with a dual role advisor (registered investment advisor and broker) or just a broker.  Brokers sometimes have access to products that might fit a client’s needs, wants, and financial situation exactly.  Some of the better financial advisors out there likely have dual registrations.  Always be aware that you might be dealing with someone that is not required to be acting in your best interests and request, in writing, that your financial advisor is acting as a fiduciary.  This applies whether it’s a 401(k) advisor or one acting with an individual.

One other area in which there exists significant litigation relates to the requirement of having a fidelity bond.  As an employer, particularly if you are one who cannot delegate Section 3(38) responsibilities, you are required by law to carry a fidelity bond.  According to the Department of Labor, “fidelity bonding is usually necessary for the plan administrator and those officers and employees of the plan or plan sponsor (employer, joint board, or employee organization).  Most employers are completely unaware of this fact, and many non-fiduciary brokers selling 401(k) plans do not inform the employer of the bonding requirements. 

Note that fidelity bonds and 401(k) insurance are not the same thing.  Insurance may protect against mistakes and sometimes negligence.  This typically falls under E&O policy coverage (errors and omissions insurance).

Should a dispute arise regarding a 401 (k) plan, and the employer has failed to maintain a fidelity bond, if the plan has a loss due to fraud, dishonesty, theft, or a criminal act, then the employer becomes liable and the named employee who is the administrator (normally the head of the company) becomes personally liable for those losses.  This means if a rogue secretary, a transfer agent, or anyone else steals from the plan, the head of the company could end up paying out of his or her own personal pocket for any investment losses.

A proper ERISA bond must meet certain requirements:

  1. The bond must have a minimum payout equal to at least 10% of the plan’s assets.  However, the payout cannot be less than $1,000 or more than $10,000;
  2. The bond cannot have a deductible;
  3. The bond must be in the name of the retirement plan;
  4. The bond amount must be fixed annually, for each fiduciary, depending on the plan asset total;
  5. The bond must be placed with a Department of Treasury-approved surety or reinsurer, and the plan fiduciaries cannot have any control or interest in the surety or reinsurer; and
  6. The bond must cover ERISA regulation criminal losses.

ERISA bonds are normally specifically marketed as such, making them easier to find.  They also tend not to be that expensive.  Yet the Department of Labor estimates that over half of employer sponsored 401(k) plans are missing the required bond.   

When reviewing your current 401(k) plan, always determine who the fiduciary to the plan will be.  Ask questions.  Request bonding information.  Be direct.  Registered investment advisors will promote the fact they are fiduciaries.  Unscrupulous brokers will become evasive, while the ethical ones will tell you they are not required to be fiduciaries and promote their other benefits.  Some will even agree to act as fiduciaries, even though they are not legally required to do so.  You should always get fiduciary status confirmed in writing.

401(k) plans are one of the best retirement vehicles available to most employees in the United States.  Yet many employers do not realize the quantity of choices available in the marketplace regarding the 401(k) plans they offer their employees.  If you would like your plan reviewed, email or contact us at any time.  We do such reviews free of charge and only need your 403(b) expense statement to begin an analysis. 

Christopher Welsh is a licensed investment advisor and president of Lorintine Capital, LP. He provides investment advice to clients all over the United States and around the world. Christopher has been in financial services since 2008 and is a CERTIFIED FINANCIAL PLANNER™. Working with a CFP® professional represents the highest standard of financial planning advice. Christopher has a J.D. from the SMU Dedman School of Law, a Bachelor of Science in Computer Science, and a Bachelor of Science in Economics. Christopher is a regular contributor to the Steady Options Anchor Strategy and the Lorintine Capital Blog.

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