In the last two columns I’ve argued (1) that we should try to keep employers in the retirement savings system to preserve the diversity and “robust-ness” of our capital markets and (2) that therefore we should do something to stop the flood of litigation against them—at a minimum, provide clearer rules for, e.g., fund menu construction.
But I do think, in the long run, we are headed for a provider-based system, primarily because in 401(k) plans, retirement saving is fundamentally participant-centered, not employer-centered. Participants make all the key decisions: how much to save, how to invest and how to pay out their savings.
I think the most likely scenario is that, to encourage small employers to adopt plans, we will develop some sort of provider-based option that imposes minimal fiduciary and compliance burdens on employers. And that, once that system begins to work efficiently, many larger employers will adopt it.
This new system could take a number of different forms—robust outsourcing, open multiple employer plans (MEPs), Australian-style superannuation funds, or all of the above. But a key issue for policymakers will be how, in such a system, to produce better outcomes for savers when there is no longer an employer-fiduciary looking out for them.
Under the current system, the employer-fiduciary acts as a check on provider’s (natural) bias towards maximizing profits at the expense of the saver. In a provider-based system, the only remaining check would be the market and competition. And there is a widespread sense that, in such a context, the information asymmetries between financial services companies and individual savers will result in lower returns for the latter—at least lower than the current employer-mediated system produces.
Exhibit 1: The Center for Retirement Research at Boston College (in Investment Returns: Defined Benefit Vs. Defined Contribution Plans (2015)) found, based on Investment Company Institute data, that over the period 2000-2012 “IRAs produced substantially lower returns than defined contribution or defined benefit plans.” The authors note that “[t]he low returns on IRAs may be due to two factors – asset allocation and fees.”
There are ways of dealing with the asset allocation issue in a provider-based system, e.g., through aggressive use of defaults. But what keeps fees down in the current employer-based system (relative to IRAs) is partly buying power and partly pressure on sponsor-fiduciaries, via regulation and litigation, to “get the best deal” for participants. That is in fact what all the 401(k) fee litigation has been about.
And in a (robust) provider-based system, there would be no employer to sue. All of these lawsuits against sponsor-fiduciaries, alleging that they included imprudently high fee funds in the plan’s fund menu, would have somehow to be brought against the provider. And there’s not really much basis under the Employee Retirement Income Security Act (ERISA) for that sort of suit—ERISA’s fiduciary rules are organized around the plan sponsor. Indeed, many of the ERISA 401(k) fee suits brought against providers have been thrown out.
Thus, as we move to a provider-based retirement system there is likely be considerable support for something like a “provider’s ERISA.” DOL’s Fiduciary Rule was, in effect, an attempt at that—an attempt to extend ERISA’s fiduciary rules to providers who were “advising” (broadly re-defined) participants and IRA owners. It failed in part because (to repeat) ERISA wasn’t designed to do that—ERISA’s fiduciary rules are focused primarily on the sponsor and the fiduciaries the sponsor appoints.
And it is in that context that the SEC’s recent proposal for new (or “clarified”) standard-of-conduct rules for brokers and investment advisers (IAs) is critical. The SEC does regulate providers—that’s one of its main jobs. And the SEC’s proposal has the potential to become one of the basic building blocks of a provider-based retirement savings system, by providing a set of rules applicable to providers (brokers and IAs and the financial services companies they represent) that will, by, e.g., changing pricing and sales practices in those industries, narrow that gap between returns on IRAs versus returns on plan accounts.
Speaking as an outsider to the process—I have no expertise in SEC rules or the SEC regulatory process—the SEC proposal itself looks like a complete mess. Most confusing: Brokers are not “fiduciaries” but are subject to conduct standards that seem to have simply been lifted from ERISA’s fiduciary rules. On the other hand, IAs are “fiduciaries,” but there is only the vaguest explanation of what that means for conduct or how the rules applicable to IAs might (in real life) differ from the rules applicable to brokers. And, in that regard, the SEC is proposing that (non-fiduciary) brokers must mitigate financial conflicts (with requirements to change broker pay practices that seem modeled on that now-void fiduciary rule best interest contract exemption). But “fiduciary” IAs are not required to mitigate conflicts, only disclose them.
Nevertheless, the SEC’s effort here is absolutely critical for retirement policy. Consider current open MEPs proposals all provide that the sponsor retains considerable fiduciary responsibility. Ultimately, that isn’t going to work in a robust provider-based system. But to get to such a system, we need more confidence that providers dealing directly with savers will be subject to enough discipline—either through the market (plus, e.g., disclosure) or through regulation (à la the SEC’s proposal)—to produce better results than the current IRA system does.
In my humble opinion.
Michael Barry is president of October Three (O3) Plan Advisory Services LLC. He has 40 years’ experience in the benefits field, in law and consulting firms, and blogs regularly http://moneyvstime.com/ about retirement plan and policy issues.
This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of Strategic Insight or its affiliates.