Thursday, August 8, 2013

Professor Ayers’ Letter: A Legitimate Cause for Concern for Retirement Plan Sponsors; Why Business Owners Should Support The DOL’s Rule-Making Efforts


1. Fees and costs matters. Plan sponsors should thoroughly investigate the fees and costs of the mutual funds or other investment products they provide to plan participants in the retirement plan.

2. Professor Ayers' warning to plan sponsors should not be ignored. While any study has its limitations, the reality is that many (if not most) plan sponsors today are at risk of potential liability due to excessive fees and costs associated with the investments in their plan. In this regard, Professor Ayers' letter constitutes - in large part - a legitimate warning to plan sponsors to take their fiduciary obligations seriously.

3. The DOL (EBSA) is moving forward with its fiduciary rule-making. I expect the re-proposed rule to be submitted to OMB in September. Expect a determination by OMB as to whether the rule will be released by year-end or early next year. But a monumental effort by Wall Street and insurance companies seeks to ensure that the re-proposed rule never sees the light of day.


5. In the interim - until all "retirement plan consultants" are held to ERISA's strict fiduciary standard, plan sponsors remain at risk. The courts are increasingly approving class action claims against plan sponsors on the basis of excessive fees within the mutual funds contained in the plan. In addition, ALL revenue-sharing payments are likely to be highly scrutinized by the courts.

6. In my view, plan sponsors (who are fiduciaries) SHOULD NOT ever RELY upon a non-fiduciary retirement plan consultant. If the plan sponsor is currently served by a non-fiduciary consultant, the plan sponsor should IMMEDIATELY seek a fiduciary advisor to provide a second opinion.

7.  Tough questions should be asked by plan sponsors of all of their "advisors" - and the answers should be received in writing.

Introduction: The Adverse Effect On Plan Participants Of Excessive Fees And Costs In The Investment Choices They Are Provided

Unknown to most plan sponsors, many "retirement plan consultants" charge excessive fees (in my view) for advice that is often conflicted (and results to additional compensation for the retirement plan consultant). Rarely is this advice truly “expert” – for often little due diligence has been undertaken with respect to the funds recommended for the 401(k) or other plan. The result is often high-expense mutual funds and other investment choices provided to plan participants.

As is well known in the investment industry, substantial academic evidence supports the conclusion that, on average, the fees and costs of a mutual fund possess a direct inverse correlation to the likely long-term returns of mutual funds, when compared to mutual funds with similar investment strategies. Executives of broker-dealers and insurance companies may deny their knowledge of this simple truth, but we don’t have to believe that they are so ignorant.

In essence, investing in mutual funds is not (as many unknowledgeable plan sponsors might believe) bound by the principle that “you get what you pay for”; sadly, when higher fees and costs are incurred returns to the investor are nearly always lower, over the long term.

I like to explain it to clients in this fashion. Suppose you owned a horse entered in a horse race. In most horse races all jockeys possess the same weight; this is done by adding weight to some horses to bring the burden all horses possess to the same level.

But suppose your horse has been given an extra 25 pounds more to carry than the other horses. Does this mean that the horse cannot win the race? Not necessarily; it is possible that a strong (or lucky) horse can win the race. But … the longer the race, the more the impact of that extra weight. This makes it extraordinarily difficult for the horse with the extra weight (or the fund with the higher fees and costs) to prevail over the long term.

Professor Ayers’ Letter and the Responses Thereto.

In July 2013 Professor Ian Ayers sent a letter to some 6,000 retirement plan sponsors warning them, based upon his study (as documented in the white paper authored by Curtis Quinn and Ian Ayers, which can be found at, that they may be subject to potential liability due to providing investment options with excessive fees.

In discussing Professor Ayers' letter to plan sponsors and his study with several of my investment adviser colleagues recently, there was general agreement that the letter and study from Professor Ayers are significant in that it alerts many plan sponsors to potential liability. It puts these plan sponsors “on notice” that the plan sponsor (usually a small business owner) is ultimately responsible for the decisions made with regard to investment offerings under the plan, and that they should scrutinize the quality of the “advice” they receive carefully.

While the analysis of Prof. Ayers has limitations, as ERISA expert and attorney Fred Reish (with two colleagues from Dinker Biddle) points out (in an open letter found at Of course, any study has limitations; data sources are never perfect, and are often never as current as one would like. And the level of services provided to a plan sponsor or the complexity of the plan may vary (although in my view they don’t vary all that much, to justify substantially higher fees, in most cases).

Professor Ayers’ letter should not be viewed as a definitive conclusion that fiduciary duties have been breached by any particular plan sponsors. However, plan sponsors should not be calmed by such an assurance. As noted by Fred Reish et. al. in the concluding paragraph of their open letter, “plan sponsors do have a fiduciary duty to prudently monitor plan and investment expenses. If they have not compared their costs to market data in the last two or three years, they should do that now … particularly in light of last year’s 408(b)(2) disclosures.”

I hope that, in the end, Professor Ayers’ letters and white paper, and the substantial response from the industry thereto and the debate triggered, may ultimately bring forth a good result. I would hope that a wave of plan sponsors question the validity of the current “advice” they receive.

Hopefully many plan sponsors will now look for advice they can rely upon from fiduciary advisors, rather than the advice received from non-fiduciary consultants (who dominate the provision of investment counsel in much of the defined contribution market). Moreover, plan sponsors should carefully review the results of benchmarking of fund fees and expenses, and should ensure that the fees and costs of the funds on their platform are in line with, or lower, than the benchmark averages.

The end result, if plan sponsors adequately heed Professor Ayers' warning, will be the replacement of expensive mutual funds with much lower-fee mutual funds, in defined contribution plans. Taken in aggregate, the savings to plan participants could be billions, or tens of billions of dollars, each and every year. This would greatly aid the retirement security of our fellow Americans.

Business Owners Large And Small Are At Risk – And Should Support The Fiduciary Standard For All Providers Of Investment Advice To Retirement Plan Sponsors

The burden on plan sponsors – business owners attuned to running their own businesses but rarely possessing a sophisticated knowledge of investments – is quite high. ERISA demands that fiduciaries act with the type of “care, skill, prudence, and diligence under the circumstances” not of a lay person, but of one experienced and knowledgeable with these matters. 29 U.S.C.
§ 1104(a)(1)(B).

The real tragedy for plan sponsors occurs when private litigation arises against plan sponsors [including class action litigation by plan participants, just made easier in the 7th Circuit today (Aug. 7, 2013)]. Alternatively, and largely in response to complaints by plan participants, a DOL audit can result in an enforcement action and/or restitution to plan participants. In such instances, the plan sponsor (a small business owner, typically, although larger business owners also are at risk) is held to account.

Yet – and here is the rub - the plan sponsor has great difficulty holding the "retirement plan consultant" to account, given the low standard of conduct applicable to measure the potential liability of a non-fiduciary consultant. The plan sponsor is the victim of poor (and non-fiduciary) advice.

(NOTE: There exists a disagreement in the courts over the circumstances in which a "retirement plan consultant" becomes a fiduciary, applying the current DOL definition of "fiduciary" and certain language under the ERISA statute. The DOL's re-proposed rule, if it is re-proposed and finalized, would likely negate the courts' attempts to address this issue.)

Indeed, usually the plan sponsor (business owner) has substantial monies invested in retirement plan, and suffers personally from the poor investment choices contained therein. But, in the end, the plan sponsor is often the one "on the hook" - and the "retirement plan consultant" is "off the hook" by not being considered a fiduciary to the plan.

It should be noted that such cases are not rare. The courts have recently been far more receptive to “excessive fee” cases arising under ERISA against plan sponsors. Recent court decisions, including those of Abbott v. Lockheed Martin Corporation (7th Circuit, August 7, 2013), Tussey v. A.B.B., Inc. (W.D. Missouri, March 31, 2012), and Tibble v. Edison Int’l (March 21, 2013), which cases may each be regarded as a “watershed moment for fiduciaries to understand their duties regarding the requirement to prudently select funds, even ‘conservative’ funds, such as SVFs” in the opinion of Thomas E. Clark, Jr., J.D., LL.M., CCO/Director of Fiduciary Oversight of Fiduciary Risk Assessment LLC (FRA) and PlanTools, LLC (

Of course, plan sponsors routinely in fact rely upon the advice provided by the non-fiduciary "retirement plan consultant."

 This was evident in the Tibble v. Edison Int’l case (currently undergoing re-hearing at the appeals court level), in which the U.S. Court of Appeals for the 9th Circuit stated: “Since at least 1999, Edison has contracted with Hewitt Financial Services (‘HFS’) for investment consulting advice. It argued below, and re-urges here, that it reasonably depended on HFS for advice about which mutual fund share classes should be selected for the Plan … HFS frequently engages with the Investment Committee staff at Edison to help design and manage the Plan menu. It applies the investment staff’s criteria: (1) fund stability/management, (2) diversification, (3) performance relative to benchmarks, (4) expense ratio relative to the peer group, and (5) the accessibility of public information on the fund. HFS then approaches the Committee with options and discusses their respective merit with its members. And to keep Edison abreast of developments, it provides the Committee with monthly, quarterly, and annual investment reports … the district court found that Edison failed to satisfy [the requirement of] reasonable reliance. We agree. Just as fiduciaries cannot blindly rely on counsel … a firm in Edison’s position cannot reflexively and uncritically adopt investment recommendations.”

From the decision, it is unclear if, at the time, Hewitt Financial Services, LLC was a fiduciary to the plan sponsor, Edison. This matters a great deal. If Hewitt Financial Services, LLC was not a fiduciary at the time to the plan sponsor, Edison, recovery by the plan sponsor for the poor advice provided by this “consultant” would be doubtful. The low (suitability and other) rules of conduct governing the actions of Hewitt Financial Services, LLC (currently a broker-dealer, but not currently registered (as per the 8/7/2013 SEC web site) as a registered investment advice) simply would not support a likely claim by the plan sponsor against a non-fiduciary consultant.

The unfairness of all of this - the lack of an adequate remedy for the plan sponsor who relies upon the "retirement plan consultant" - is a valid reason the DOL is seeking to move forward with its new "Definition of Fiduciary" rule – to correct the inequity that a plan sponsor (also a victim, in many instances) is held to liability in excessive fee (and other forms of) cases, yet the plan sponsor can seldom hold the (non-fiduciary) retirement plan “consultant” to account for the advice provided.

Plan sponsors should not be placed in this untenable position.

 The DOL’s proposed rule would correct this problem, by ensuring that all providers of investment advice to plan sponsors are fiduciaries under the law and can be held accountable as such.

Moreover, both large and small businesses should support the DOL's rule-making efforts. 

Only businesses associated with the sell-side broker-dealer and insurance company communities would find support of the DOL's rule-making efforts objectionable. Indeed, in one of the great deceptions of our time, currently in Washington, D.C. the lobbyists are rolling out "small businesses" who would be "hurt" by the imposition of fiduciary standards upon retirement plan consultants. Who are most of these "small businesses" being paraded in front of Congress and the OMB? The non-fiduciary retirement plan consultants, themselves! The ones whose fees are nearly often excessive, and whose conflict-ridden advice places all other business owners at risk!

Should Plan Sponsors Ever Rely Upon a Non-Fiduciary Consultant? – No.

If, as is nearly always the case, the plan sponsor is not able to properly discern the fees and costs of mutual fund products (or at least properly estimate them), the plan sponsor should obtain advice.

But, in such circumstances, can a plan sponsor turn to a non-fiduciary “retirement plan consultant” for advice? While I am not ready to say that plan sponsors cannot, per se, rely upon non-fiduciary retirement plan consultants, I believe plan sponsors put themselves at great risk if they choose to do so.

In essence, a fiduciary – the plan sponsor – can only fulfill its obligations properly (and with a high degree of confidence) if the plan sponsor in the selection of an investment consultant considers the consultant’s qualifications. And, if the investment consultant is not bound to act as a fiduciary to the plan sponsor, the plan sponsor has no business relying upon the advice provided by such a consultant. Accordingly, prudent plan sponsors will choose to work ONLY with retirement plan consultants who are fiduciaries, and who acknowledge such fiduciary obligations in writing.

Of course, some plan sponsors might feel (as they are often very successful business people) that they can evaluate the offerings of any retirement plan consultant themselves. But do they really possess that knowledge? It’s not just knowledge of mutual fund share classes; it is also the knowledge of the fees and costs of mutual funds which are not included in the annual expense ratio. These include fees and costs relating to transactions within the mutual fund, including brokerage commissions (including but not limited to insidious soft dollar payments), bid-ask spreads and principal mark-ups and mark-downs, market impact, and opportunity costs for delayed or cancelled trades. Opportunity costs due to the presence of cash within a fund also exist. Securities lending revenue may also exist, which may enhance a fund’s returns, but often inappropriate (in my view) sharing of securities lending revenue occurs with the investment adviser.

Moreover, even those fees which are part of the annual expense ratio should be assessed carefully. As I have written before, 12b-1 fees of any kind should be highly suspect (regardless of whether they are utilized to offset fees of service providers to the plan). The recent Tibble v. Edison Int’l decision contains an express warning to plan sponsors that 12b-1 fees are likely to be heavily scrutinized, for their adverse impact upon plan participants, in future cases.

What Questions Should Plan Sponsors Be Asking?

In the interim, all plan sponsors should be asking very tough questions of their "retirement plan consultants" or "advisors" - and seeking the answers in writing. The questions posed might be similar to those I have previously suggested that individual investors should ask. See “How to Choose a Financial/Investment Advisor – A Checklist for Consumers” – located at

Even then, some “fiduciary advisors” seek to “disclaim” or have client “waive” their fiduciary obligations. And such fiduciary advisors (incorrectly, in my view) believe that they can operate however they please, as long as they disclose the existence of conflicts of interest. “Aunt Bea” found this out – too late – as shown in the article found at

Plan Sponsors - Be Careful Out There!

In conclusion, it’s a minefield of potential liability for plan sponsors.

Some relief, in the form of a new definition of “fiduciary” offered by the U.S. Department of Labor, may be coming. But the rule-making process will likely take a year or more (if the rule gets enacted at all, given the huge opposition to the rule from Wall Street and the insurance companies).

In the interim, plan sponsors should, in my view, only engage those “retirement plan consultants” who are willing to accept full fiduciary status, in writing. Such consultants should not receive any other material compensation, from any third party (no 12b-1 fees, no payment for shelf space, no soft dollar compensation, and no gifts or trips). In other words, no revenue sharing payments should be permitted. Tough questions should be asked, and the answers obtained in writing.


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