Shoppers often must confront the hidden costs of convenience. Sometimes it means paying a little extra for that convenience. Sometimes it’s accepting a little lesser quality for that convenience.
All 401(k) plan sponsors must act as fiduciaries for the sole benefit of their plan’s participants. When they make a decision based on personal or corporate convenience, 401(k) plan sponsors need to ask themselves if it’s worth it to sell their souls for one-stop shopping.
Many believe, and not without some merit, bundled service providers offer a convenience particularly compelling to the smaller 401(k) plan sponsor. These plans often are associated with companies too thin on personnel to assign one specifically to the 401(k) plan. As a result, the plan sponsor – usually the company owner or its president – simply decides to make the easy choice and selects an “all-in-one” service provider. This can be a broker, a mutual fund firm, an insurance company or even a payroll processor, for example.
While we can’t indict all such service providers, we will mention that a recent study compiling the characteristics of the ideal 401(k) plan concluded such plans don't use bundled service providers. Instead, they adopt a “best-of-breed” approach, cherry-picking only the best recordkeepers, TPAs, mutual funds and fiduciary consultants. In this way, if one vendor suffers from poorer quality service, it’s simply a matter of replacing that one vendor and leaving all others in place.
Contrast this to bundled service providers. They generally rely on (commonly overpriced) investment products to drive revenues, leaving ancillary services as nothing more than loss leaders. And when’s the last time you associated the attribute “highest quality” with the term “loss leader”? It’s not surprising to find plan administration to suffer when recordkeeping is consigned to the ash heap of loss leader-dom.
But the story doesn’t end with lower quality. The reality is, without independent service providers, bundled service providers offer not built-in “check-and-balance” regarding the quality and fees of other service providers. This means, ironically given they’re frequently pitched as “low-cost” beneficiaries of economies-of-scale, bundled service providers’ inherent conflicts-of-interest can and frequently do lead to higher fees.
Just this past week we saw a settlement in the much-watched class action suit against Walmart for breach of fiduciary duty regarding its 401(k) investments. When the plaintiffs discovered Merrill Lynch – the bundled service provider of the plan – placed certain high fee funds in the firm’s 401(k) plan, they added the broker as a defendant alleging the broker received “kick-backs” for placing funds in Walmart’s plan. How significant was this breach? Although details of the settlement are sketchy, reports indicate Merrill Lynch paid $10 million 0f the total settlement of $13.5 million dollars.
That it took the plaintiffs so long to discover the true fees of their own plan shows how well hidden those costs can be in a bundled arrangement. Soon, however, there will be no place to hide. Beginning April 2012, all 401(k) plans will need to disclose all these fees to participants. If 2011 featured the “Arab Spring,” then 2012 will no doubt will become known as the “401(k) Spring.”
It will be a whole new world for bundled service providers, 401(k) plan sponsors and 401(k) investors. There’s a potential for a seismic shift in the nature and delivery of 401(k) services, with much more emphasis on the source of fees and the pinpointing of clear conflicts of interest. Plan participants will ask awkward questions to plan sponsors, who in turn will direct (perhaps angry) questions at their bundled service providers.
And somewhere, deep in the bowels of trial attorney data bases, searches that once scoured 5500 filings for evidence of company stock in 401(k) plans (a much litigated phenomenon) will now begin searching 5500 filings for brand names financial service providers famous for offering bundled service packages to plan sponsors.
The clock to April 2012 is ticking.