Regulators focusing on alternatives, proprietary funds

PALM BEACH, Fla. – Alternative and proprietary funds in 401(k) plans are increasingly drawing regulatory scrutiny, one of the nation’s leading employee-benefits lawyers said Tuesday.

“If you’re dealing with alternatives, you can expect the DOL to focus on this,” Steve Saxon, the chairman of Groom Law Group in Washington, D.C., said in a presentation at the 2013 Society of Professional Asset-Managers and Record Keepers meeting.

Alternative investments are gaining some traction within defined contribution plans, a trend that is expected to continue for the next several years. Critics, however, warn that fee levels can be higher for alternative investments, and many alternatives have more complex incentive fee structures.

In a session that focused on the major regulatory issues affecting 401(k)s, Saxon also said that the biggest litigation risk at the moment was the use of proprietary funds. “That’s definitely going to be on their radar screens. They view it as an inherent conflict of interest,” he said of regulators.

Mutual fund families, despite serving as retirement plan fiduciaries and hosting “open architecture” plans, nevertheless favor their own fund offerings, according to research published earlier this year. The researchers found that even poorly performing funds are more likely to appear on 401(k) menus if they are affiliated with the plan trustee.

Over the past few years, there have been at least 30 lawsuits against 401(k) plans alleging such conflicts, along with charges that fees were too high.

Suggesting that these are “turbulent and dangerous times in Washington,” Saxon said the retirement industry has a number of regulatory issues to watch for.

Among the more pressing ones: fiduciary regulations and those related to guaranteed income illustrations.  

On the closely watched fiduciary regulations, now expected to be issued late this year, Saxon said one of the more urgent questions is whether merely making a sales presentation puts an advisor into a fiduciary role. 

Saxon said there’s no doubt the DOL is intent on broadening the scope of who’s considered a fiduciary. But he relayed a conversation with a regulator who told him not to make too many assumptions about what will end up in the regulation, indicating that the DOL has been careful to listen to industry concerns. “I took that as a positive sign,” he said.

Still, to one degree or another, the redrawn rule will no doubt affect brokers, RIAs and even record-keepers, he said.

In other comments, Saxon said the DOL today has a well-trained investigative staff that works hard in pursuing plan sponsors and providers that in some way or another breach their fiduciary responsibilities. “They know more about how plans operate than ever before and ask better questions. And they’re focusing on areas where they get the biggest bang for the buck,” Saxon said.

“The investigations last longer and are harder to resolve,” he said.

Along those lines, Saxon said the DOL, in its goal of making “participants whole,” has investigations under way in “multiple regions” across the country focusing simply on the human errors made in the millions of transactions in 401(k) plans. 

Regarding regulatory efforts at developing new lifetime income illustrations, Saxon expressed surprise that the issue has become so controversial.

The DOL is trying to “do the right thing” in tackling the issue, he said, in hopes of helping people better understand what their retirement income might look like.

The problem, however, may be in a requirement to produce more illustrations with too many projections that will leave most participants confused, Saxon said.  

His hope, he said, is that the DOL will remember the adage to “keep it simple, stupid.”

Read more coverage from the 2013 Society of Professional Asset-Managers and Record Keepers:

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