Message from the Firm

By Fred Reish

The Winds of Change Are Blowing

The expectations for plan sponsor responsibility are increasing. In the past, plan sponsors and fiduciaries were generally expected to review the investment and operating expenses of 401(k) plans to make sure that they were reasonable. Now, fiduciaries, such as plan committee members, are expected to understand and evaluate the revenue sharing and other payments being made by mutual funds, and their managers and affiliates, to a plan's providers and advisers. (I am using the term "revenue sharing" loosely to mean any payments made, directly or indirectly, by or through the plan's investments.) Fiduciaries who do not know the amounts of revenue sharing being paid from the investments in their plans are taking a chance of breaching their fiduciary duties. That is an unnecessary and unwarranted risk in today's environment.

Some fiduciaries are paying attention to revenue sharing and are negotiating a reduction in those amounts. Typically, the reduction takes the form of either a restoration of some of that money to the plan or of the payment of other plan expenses, or both. When the money is restored to the plan, it must be allocated to the participants by the end of each year. I have attached a copy of a report on that subject prepared by Stephanie Bennett and myself.

The fiduciary responsibility for participant investing is also increasing. I believe that is primarily a function of the popularity of target maturity, or aged-based, funds, as well as of the fiduciary safe harbor given to qualified default investment alternatives (or QDIAs). From a legal perspective, any plan sponsor who is not using a QDIA as a default (for participants who don't give investment instructions) simply doesn't understand the legal protection given to those investments.

In addition to using target maturity funds, lifestyle funds, and managed accounts as default investments, every plan should include at least one of those categories of investments in its regular line-up. ERISA's investment principles are based on generally accepted investment theories, including modern portfolio theory. In effect, that means that ERISA contemplates that participants' accounts will be invested like well-designed portfolios. To the extent that plan sponsors, or their participants, don't understand those concepts, a plan is taking unnecessary risk. The best way to abate that risk is to offer professionally designed or managed portfolios, such as those mentioned above, to the participants.

Finally, automatic enrollment is being embraced much more rapidly than I had thought it would be. I thought that it would take a few years to take hold. Based on early data, it seems to be happening very quickly. For example, Hewitt Associates believes that over half of the largest plans will be automatically enrolling by the end of this year. Other providers are also reporting significant increases in the use of automatic enrollment.

On average, automatic enrollment produces participation rates of around 90%, which is about a third higher than non-automatically enrolled plans. As the concept takes hold, it will change the perspective on the appropriate level of participation, and employers will be expected to do more to increase the levels of participation.

The effect of these changes will be to impose additional responsibility on plan sponsors to educate themselves on expenses, revenue sharing, QDIAs, automatic enrollment, and so on. However, in my opinion, the changes will inure to the benefit of employers . . . because they will increase both the quantity and quality of employee participation in 401(k) plans. As a result, attentive and concerned employers will enhance the retirement plan experience of their employees and will, I believe, build a stronger bond with those employees.

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