Trends and developments in the 401(k) market often migrate over to 403(b) plans. Examples include automatic enrollment, which is increasingly popular with plan sponsors, and litigation against plan fiduciaries, which is less popular). Sometimes trends can run the other way, from 403(b) to 401(k) plans.
An existing practice in the 403(b) space that is migrating into the 401(k) world is awareness and concern over record keepers' use of their privileged access to plan participants and participants' data to support the cross-selling of nonplan products and services.
Two recently proposed settlement agreements in ERISA fiduciary lawsuits — those involving the Vanderbilt University and Johns Hopkins University 403(b) plans — specifically stated that plan fiduciaries issue requests for proposal for record-keeping services. These RFPs must request that service providers agree not to solicit plan participants for the purpose of cross-selling nonplan products and services (including individual retirement accounts, nonplan managed accounts, insurance, banking and wealth management services).
These proposed settlements provide new visibility to an open secret in the 401(k) world: Many 401(k) record keepers, especially those with large retail businesses, use their role as record keeper as a platform for cross-selling to plan participants.
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Serving as the 401(k) record keeper places these providers in a unique position to promote their products and services to participants. After all, the employer has selected the provider to give participants information about retirement planning and investing — and this selection can be viewed by participants as an implicit endorsement of the record keeper's nonplan products and services.
In the authors' experience, we have witnessed numerous instances when plan participants perceived these services offered by a plan record keeper as being a part of the employer-sponsored retirement program, as having been endorsed by the plan sponsor or both. Record keepers are more than glad to capitalize on this implicit endorsement to cross-sell.
Now that plan sponsors (and advisers) have been alerted to the fact that these cross-sales create some potential fiduciary risk, what can be done? Here are some key starting points for advisers:
• Analyze the record keeper's business model to assess the potential for a conflict of interest that would lead to the promotion of nonplan products and services. Does the record keeper have significant individual products, such as IRAs or annuities? If so, greater scrutiny of the record keeper's policies and practices is appropriate.
• Analyze the record keeper's compensation model (often available on the Securities and Exchange Commission Form ADV-Part 2A). Are employees incented to sell nonplan products? Commissions and other similar incentives are a warning sign — record-keeper representatives will follow these incentives.
• Review the record keeper's contractual provisions. Will the record keeper agree that it will not cross-sell? Similarly, will the record keeper agree that it will not share data (even with its own affiliates) unless such sharing is necessary to perform the contracted record-keeping services?
• Will the record keeper disclose information on the nonplan services and products sold to plan participants? Record keepers track key metrics, such as the amount of nontaxable distributions "captured" by the record keeper's proprietary products. Record keepers may seek to avoid sharing this information, but the Department of Labor's regulations on indirect compensation (29 CFR Section 2550.408b-2) offer plan fiduciaries some leverage in assessing whether a record keeper is draining large account balances out of the plan upon the occurrence of a distributable event.
Record keepers are feeling the pressure to reduce fees charged to plan participants. However, these providers have a readily available pathway to alternative revenue streams: nonplan-related products and services.
While a provider may charge relatively low, competitive institutional pricing to administer a plan, nonplan products can yield significantly higher fees.
In light of evolving record-keeper practices, we need to remember that ERISA's fiduciary standard requires that fiduciary prudence must evolve with the market. After all, ERISA requires that a plan fiduciary act "with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use."
Monitoring record-keeper cross-selling activities may prove to be the next fiduciary frontier for advisers.
Daniel Alexander and Allen Steinberg are respectively the founder and chief legal officer of RetireAware.