One challenge in advising plans is choosing a "reasonable' agreement among service providers
Advising companies that sponsor a 401(k) plan has become a more popular business model, and though it is a model that can offer benefits and opportunities different from those of a typical advisory business, there are also distinct responsibilities and challenges that must be met.
One of the major roles of a 401(k) plan financial adviser is vendor selection.
The Employee Retirement Income Security Act of 1974 requires plan sponsors to enter into “reasonable” agreements with vendors. As simple and subjective as that may sound, fulfilling this reasonableness obligation entails thorough and well-documented due diligence in the selection of service providers to the plan.
A modified form of ERISA's exclusive-purpose rule serves as a mission statement for service pro-vider selection: Vendors are to be selected based upon their ability to deliver desired benefits for participants and beneficiaries after careful and objective consideration of the costs and capabilities of competing service providers.
FOUR STEPS
That mission statement gives structure to a four-step selection process: (1) define the services (benefits) to be delivered, (2) identify providers capable of delivering the desired services, (3) evaluate the abilities of competing vendors to deliver the services at a fair and reasonable cost, and (4) engage and monitor the top-ranked service provider.
The first step is the most important.
Service provider selections are unlikely to be successful if desired services aren't well-defined and appropriately prioritized according to the benefits that they provide to participants. Without prioritization of services, competing vendors can't be compared properly.
Meeting income needs in retirement is far and away the most important benefit for plan participants, and investment management is clearly the most critical service to address that benefit directly. For this reason, manager selection criteria should attach a high priority to a vendor's ability to offer or support asset classes that promote effective diversification and a strong menu of investment options.
Reliable legal, accounting, trustee/ custodial and record-keeping services are unquestionably necessary, but in these areas, it is most important to set baseline expectations for these services. Variations in capabilities across providers of these services that exceed baseline standards should be considered.
However, the responsible plan fiduciary must evaluate the costs of extra services in terms of possible benefits for participants in order to prioritize them properly.
In the second step, potential service providers can be identified by conducting an informal process of soliciting information from vendors about their capabilities, reviewing published literature about vendors and asking other plan sponsors or respected sources about potential service providers. This pre-qualification process should result in a short list of three to 10 firms likely to be the most capable of delivering the desired services at a competitive price.
The focus of the third step is issuance of a formal request for proposals to the pre-qualified service providers.
The RFP specifies required and preferred services. Each competitor is expected to address the specified services in the proposal and is permitted to note additional capabilities.
DISCLOSURES
Under ERISA 408(b)(2) regulations, which took effect last July and di-rectly address service provider disclosures, plan sponsors must obtain and consider certain information from providers for a service agreement to be deemed reasonable.
Specifically, for each service to be provided, vendors must identify the direct and indirect compensation arrangements involved and indicate whether the vendor intends to act in a fiduciary capacity. Services that are to be delivered by affiliates or contractors must be described, along with compensation arrangements among the parties and potential conflicts of interest.
In addition, the RFP should inquire about the service provider's financial status, insurance coverage, staff turnover, regulatory history, complaint records and experience in serving similar plans. Additionally, the vendor's processes for transitioning business from an existing service provider should be examined.
References from comparable 401(k) plan clients should be required and checked.
RFP submissions should be compared on their ability to deliver desired benefits at a reasonable cost. As a best practice, a scoring system often is used to weigh the relative importance of the services that were prioritized in the first phase and quantitatively compare the capabilities of each service provider.
In the fourth and final step, the responsible plan fiduciary formally engages the selected service pro-vider and puts a performance-monitoring process in place. As part of the contracting process, the service delivery model should be checked against the plan document, the investment policy statement and other governing documents to make sure they are aligned.
DOCUMENT EVERYTHING
At this point, the responsible plan fiduciary should ensure that the entire selection process has been carefully documented. This documentation demonstrates fulfillment of the reasonableness obligation.
To refer to this as the “final” step is something of a misnomer because plan fiduciaries have a continuing obligation to monitor service providers. Vendor relationships should be reviewed periodically as both the plan's service needs and competitive marketplace evolve.
The Labor Department has stated an assumption that “plans normally conduct RFPs from service providers at least once every three to five years.”
This has become an established best practice, though not a hard-and-fast fiduciary obligation.
Selecting service providers is one of the most critical responsibilities of a responsible 401(k) plan fiduciary. An agreement established by a plan fiduciary with a service pro-vider that has not been carefully vetted is inherently unreasonable.
Blaine F. Aikin is chief executive of fi360 Inc.
