Fiduciary Liability Unclear When Selecting and Monitoring Default Retirement Investments By: Blaine AikinAIFA®, CFA, CFP®

The DOL can justifiably claim credit for its role in the success auto enrollment and qualified default options have had in boosting worker retirement savings. These measures were enacted following the passing of the Pension Protection Act of 2006. Nonetheless, a recent Government Accountability Office study suggests widespread uncertainty over potential fiduciary liability when selecting and monitoring default investments.

Prior to the Pension Protection Act, studies showed two major problems with defined contribution plans:  1) many workers simply failed to enroll; and 2) when they did enroll, they failed to properly diversify.  At the time, an estimated one-third of eligible workers failed to take advantage of these important savings plans.  For the ones who did enroll but failed to select investment options, plan sponsors often placed them into cash or low-risk stable value funds to avoid fiduciary liability in the event of a market correction.

When implementing the Pension Protection Act, the DOL created the safe harbor that allows plan sponsors to automatically enroll employees who do not take action and identified the three types of investments (known as Qualified Default Investment Alternatives) that sponsors can select to qualify the plan for that protection:  a balanced fund, a target-date series, or managed accounts.

Like other safe harbors under the Employee Retirement Income Security Act, the QDIA safe harbor does not absolve plan sponsors of their basic fiduciary duties.  Among other things, plan fiduciaries must prudently select and monitor QDIAs on an ongoing basis.

The GAO report, which was released in August, examined which default investments plan sponsors select, and why; how they monitor these investments; and what challenges they face in adopting a QDIA.  The report reveals that eight years after the rule’s adoption, numerous questions remain, particularly in regard to fiduciary liability. 

The report, requested by Sen. Elizabeth Warren, D-Mass., first reviews the safe harbor regulation, current DOL guidance, and three industry studies conducted annually between 2009 and 2013. The agency, which is the independent auditing arm of Congress, also interviewed 96 stakeholders conversant with various aspects of 401(k) plans, undertook a content analysis of literature on plan QDIAs, and analyzed responses to an online questionnaire from 227 plan sponsors.

The results suggest that plan sponsors appreciate the ability to offer asset diversification as a default option, but recognize the imperfect fit at the individual participant level.  For example, one sponsor noted that the investment mix for a middle-aged participant will differ depending on which type of QDIA offered, whether a balanced fund, off-the-shelf TDF, a customized TDF for the plan (based on various factors such as salary growth and contribution rates), or a managed account tailored to each individual participant’s demographics (age, gender, salary account balance, other assets).

Some were also confused by DOL regulatory guidance heavily emphasizing age as a major determinant but then made an exception for balanced funds, which maintain static weightings of stocks and bonds.  With regard to the latter, the QDIA regulation indicated sponsors should consider the “participant population as a whole.”  The age determinant – which advisers associate with investment time horizon – raised other questions from more than half of the respondents in the questionnaire.  Some were unsure whether worker demographics applied to potential and existing participants together, or only to those in the plan itself, or simply to those who defaulted through auto enrollment.  Most preferred TDFs over the other options since various target dates allowed more flexibility matching employees to funds.

Others were unsure of what factors to consider in monitoring the QDIA.  According to the report, DOL officials said a change in investment fees, strategies, or the investment team might be factors to consider in replacing one QDIA with another.  Sponsors had widely different views on monitoring, though.  One exchanged their existing QDIA for a publicly traded TDF due to greater transparency, while another switched to a TDF due to their popularity in the marketplace.  Another sponsor, concerned about generating new fiduciary liability, decided against replacing its QDIA even though it thought another one would have been an improvement.  

Benchmarking was considered to be impractical for those who had selected managed accounts.  Others rightly viewed benchmarking investment performance of same-year TDFs as challenging given widely varying glide paths.

The consensus view expressed in the report is that sponsors are not convinced that all QDIAs are created equal. Despite the DOL indicating that all qualified options are protected, plan sponsors still want guidance on making decisions in the best interests of their participants and assurances that they continue to be shielded from fiduciary liability for QDIA decisions. The lack of clarity on these and other issues prompted the GAO to recommend that the DOL assist fiduciaries through clearer guidance or regulations. 

The DOL, which reviewed the draft before its release, generally concurred with the GAO’s findings.  The agency added that it will consider a Request for Information from the public or a research project of its own in determining whether additional guidance was needed. 

This article was originally published by InvestmentNews. Copyright © 2015 fi360, Inc. Used with permission.  

Blaine F. Aikin

Blaine Aikin is the Chief Executive Officer of fi360 and a recognized thought-leader in the field of financial advice and fiduciary responsibility. At the helm of fi360 since 2007, he has directed the rise to prominence of the company’s professional development capabilities, investment management platform...

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