Some retirement plan record keepers resort to aggressive sales tactics with proprietary products

Firms with both record-keeping and asset management units will often discount record-keeping services if a 401(k) uses their proprietary funds

Mar 27, 2016 @ 12:01 am

By Greg Iacurci

Throughout 2014, financial adviser Barbara Delaney repeatedly made the case for using a lower-cost target-date-fund share class on behalf of her client, an employer sponsoring a 401(k) plan.

The plan's record keeper, however, which also happened to be the target-date-fund provider for this particular client, continually balked at the proposal. That is, until it found out the client planned to switch plan providers.

That revelation led the incumbent to acquiesce to the lower TDF share class, as well as offer a $60,000 refund to the plan (reflecting the aggregate cost of having used the more expensive funds for a year) if the plan sponsor retained the current business relationship.

Although this sort of behavior is increasingly rare nowadays, according to Ms. Delaney, principal at Stone Street Advisor Group and a 401(k) specialist, the anecdote speaks to the aggressive sales tactics some record keepers resort to when their proprietary investment products are involved, and the lucrative nature of managing those pots of money.

“The record-keeping business doesn't make money, generally. Asset management does,” said Jason Chepenik, managing partner at Chepenik Financial. “Record keeping for many of these vendors is only a means to an end — to get access to participants to manage money.”

Financial services firms with both record-keeping and asset management units often will discount their record-keeping services if a 401(k) plan uses their proprietary funds, typically a target date or stable value fund, advisers say.


A standard discount is generally 5 basis points, Mr. Chepenik said. That may not sound like much at face value, but it represents a 20% reduction on an asset-based record-keeping fee of 25 basis points, he explained.

Discounts could extend further, though. For example, Jamie Greenleaf, principal at retirement plan advisory firm Cafaro Greenleaf, had a 401(k) client with a record-keeping expense of approximately 27 to 30 basis points. But the plan provider was willing to drop that to five to six basis points if the plan used its TDFs and re-enrolled plan participants into the funds.

“That's a huge difference,” Ms. Greenleaf said. “It just tells you what they're making on the asset management side of the house.”

One provider was even willing to offer its record-keeping services for free to one of Ms. Delaney's clients, an $80 million 401(k) plan, if the plan used both the provider's TDF suite and stable value fund. Absent that, record-keeping costs were 10 basis points.

Joe Ready, the director of Wells Fargo Institutional Retirement and Trust, calls this commonly used discounting “relationship pricing,” which honors the broader relationship between the vendor and client, not unlike sales practices in industries outside the retirement market.

Discounts can vary depending on the amount of assets projected to go into proprietary funds, such as if the TDFs are the plan's default investment and if participants are re-enrolled into the funds, with each provision typically providing a steeper level of reduction.

“You might say it smells like a conflict of interest a little bit,” said Robert E. Pike, president at Stratford Advisors.

A spokesperson for the Labor Department, which regulates retirement accounts, didn't return a request for comment on the TDF sales practice. However, in 2013, the DOL issued TDF guidance for plan fiduciaries suggesting they consider options other than the vendor's proprietary funds.


Many advisers say it isn't inherently wrong to take advantage of discounting, as long as it doesn't run afoul of solid fiduciary management and due diligence.

“It almost feels like you're getting bribed to use the target date,” said Fred Barstein, founder and chief executive of The Retirement Advisor University Inc. “It intuitively feels wrong, but I don't think it is.”

The discounting practice occurs most frequently with TDFs, advisers say, which is not surprising given they've become a juggernaut in the defined-contribution world in the decade following passage of the Pension Protection Act of 2006.

Assets in target-date mutual funds grew to $763.4 billion by the end of 2015, up from $116 billion in 2006, according to Morningstar Inc.

One reason for this surge is the legal protection the PPA gave plan sponsors using TDFs (as well as target-risk funds and managed accounts) as their default investment. TDFs became the clear winner in the legislative aftermath — 74% of plans that designate a qualified default investment use TDFs, according to the Plan Sponsor Council of America. Cerulli Associates, a research firm, projects TDFs will capture nearly 90% of new contributions to 401(k) plans by the end of the decade.

“TDFs are a really lucrative business because you're supposed to let money sit there for 40 years. So you know you get your management fee every single year,” said Paul McGowan, general manager of payroll and benefits at Mitsui & Co. (U.S.A.) Inc., which sponsors two 401(k) plans with an aggregate $90 million.

Further, the TDFs of record-keeping firms such as Vanguard Group, Fidelity Investments and T. Rowe Price — the three largest target-date mutual fund providers, respectively, controlling an aggregate 70.6% of the market — provide an extra benefit on the asset management side of the house because the TDFs' underlying mutual funds are almost entirely proprietary as well.

Spokespeople for the three firms declined comment.

Jim O'Shaughnessy, a managing partner at Sheridan Road Financial, said there have been times when he's taken on new 401(k) clients, and it seems as if their past investment decisions were made with an eye on price reduction.

“I think there are definitely times where we feel like the decision-making process was led by how compensation was structured,” Mr. O'Shaughnessy said.

“It's totally understandable why some businesses would want to use this [discounting] method to lower their fees. But there's a trade-off,” said Grant Easterbrook, cofounder of 401(k) startup Dream Forward Financial. “Sometimes these funds aren't in the best interest of participants that use them.”

The discounting practice has been less prevalent over the last few years, and the discounting less aggressive, due in part to the proliferation of open-architecture record-keeping platforms, the growing pool of TDF providers from which to choose and an enhanced understanding of fiduciary best practices, according to advisers.

Retirement plan advisers recommend going through separate due diligence exercises for plan record keepers and target-date providers. If the record keeper's TDFs end up being the most optimal for plan participants and a discount is offered for using them, it's an added bonus, they say.


They also ask record keepers to submit a fee quote independent of proprietary investments during the bid process to create a level playing field among all vendors.

“[Fiduciary] decisions can get more and more challenging if there's not transparency around how pricing shakes out,” said Shelby George, senior vice president of advisor services at asset management firm Manning & Napier.

Some record keepers bake the assumption of proprietary fund use into their pricing, which could create the perception during a bid process that their services are less expensive than they really are, advisers say.

Sean Deviney, head of the retirement plan department at Provenance Wealth Advisors, tries to avoid such a circumstance unless a particular investment is “the absolute best option,” because record-keeping expense would suddenly increase if the plan were to switch TDFs.

“I don't want to put myself in a position of increasing the cost of the plan,” he said.

Discounting tends to be more prominent in the small-plan 401(k) market, where sponsors are often less attuned to their fiduciary responsibilities, advisers say. In addition, plans with a small asset base are generally less profitable for record-keeping firms, and proprietary investments help support their service to the plan.

“Record keeping is expensive to do,” Mr. Easterbrook said. “If you're looking at a small- [or] midsized plan, one way to make up for the cost is to direct them toward the TDFs and collect the TDF fees.”

Ultimately, record keepers provide a valuable service to 401(k) plans, and offering an incentive to use their products isn't an evil practice.

“Good plan sponsors and good plan professionals, we're in business together, and I want my record keeper to be profitable so they can maintain a high level of service,” Mr. Chepenik said.

He added a word of caution for advisers, though: Some vendors have good proprietary TDFs while others don't.


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