Retirement Plan Advisors Advantage

Mutual fund company TPAs and the myth of free 401(k) administration. Why there is a cost to plan sponsors for using mutual fund companies as a third party administrator.

In England, many of the top pubs are owned by British breweries because watering holes are an effective means of beer distribution. Pepsico (owners of Pepsi) used to own Yum brands (KFC, Taco Bell, Pizza Hut, etc.) for that very same reason.

The 401(k) industry is dominated by mutual funds, so it should come a

s no shock that many mutual funds companies offer services as a third party administrator (TPA) because it's an effective means of distributing their mutual funds. Mutual funds distribution is extremely important for mutual funds companies because their bread and butter are the funds' asset management fees and more assets under management equal more revenue for the mutual fund company.

While many mutual funds companies only offer TPA services for larger plans, they are a few mutual funds companies that have been rather aggressive in offering TPA services to small and medium size plans. While mutual fund companies do offer an attractive alternative as part of a one stop shop, plan sponsors are under misimpression that the mutual fund companies' TPA services are free.

As stated in a previous article about 401(k) administration, there is no such thing as a free lunch or free 401(k) administration. Mutual fund companies make their money as a TPA through those very same mutual fund management fees that I had discussed earlier. Many of the same companies that offer TPA services are the very same mutual funds companies that offer revenue sharing or sub TA fees to TPAs for plans that use their funds. So by keeping plans under their roof, these mutual funds companies can keep their revenue sharing/ sub-TA fees to themselves. These mutual fund companies also guarantee the fees they make, by requiring that a percentage of a plan's assets (up to 100%) be invested into their own proprietary mutual funds. I recently came across a 401(k) plan with T. Rowe Price as a TPA that offered 12 mutual funds to participants for directed investment and all 12 funds were T. Rowe Price. T. Rowe Price is an excellent fund company, but I find it hard to believe that out of 8,000+ mutual funds, only T. Rowe Price funds made the grade.

For plan sponsors and trustees who serve as fiduciaries under ERISA, it is a question of the prudence rule and whether it is prudent to offer investments into a specific mutual fund company, only because that mutual fund company is the TPA. While some mutual fund companies have sterling reputations, there are a still a number of mutual fund companies who have been tainted by the late trading scandals of the last decade, as well as poor performance and high fees. All plan sponsors that utilize a mutual fund company as a TPA should understand that there is a cost involved with their plan's administration, as well as being advised as to the standing of the mutual fund company within the entire mutual fund industry to make sure it doesn't become the next Steadman fund family.

Plan sponsors should consult with their 401(k) financial advisor to determine whether a mutual fund company as a TPA is the right fit for them. Mutual fund companies may be an attractive option for some, but plan that offer what is known as out of the box provisions may not be a good fit, as well as a plan sponsor that wants unbundled options in the selection of mutual funds.

The Dark Side of Fee Disclosure Regulations. Why plan sponsors and fiduciaries have to be more vigilant when it comes to their service providers and fee disclosures.

With the new Department of Labor regulations regarding fee disclosure for 401(k) and other retirement plans to take effect in 2011, many believe that this will be the end all of any discussions regarding hidden 401(k) fees. Fee disclosure regulations will require service providers to disclose fees, there is always a chance that some service providers think that they are above the law and won't comply.

As stated before, I know one third party administration firm (TPA) currently under Department of Labor (DOL) that changed their practice of pocketing revenue sharing fees into a new fee called an asset based fee for custodial platform administration service that they offset revenue sharing against. Yes, a TPA went through the trouble of inventing a fake fee so they can claim they fully disclose revenue sharing.

What if this TPA tries some chicanery when the new regulations come out? If a TPA or any other service provider fails to meet the disclosure requirements, the contract or arrangement will not be "reasonable" and fees paid to that service provider will be considered a prohibited transaction. Prohibited transaction penalties of 15 percent of the fees involved will apply and compound annually until the disclosure is corrected or the contract is terminated. The service provider will be responsible to pay this penalty. Also, to correct this prohibited transaction, the fees involved should be paid back to the plan sponsor.

However, the contract or arrangement will not be considered unreasonable if the TPA, acting in good faith, makes an error or omission in disclosing information as long as the covered service provider discloses the correct information no later than 30 days after the error or omission is discovered.

The problem with the regulations that very few people talk about is that if the covered TPA fails to disclose the required information under this final rule, the responsible plan fiduciary (the plan sponsor or the trustee) will have violated their fiduciary duty because they caused the plan to engage in a prohibited transaction by hiring the covered service provider. For protection from this violation, a fiduciary has to file for a prohibited transaction exemption with the DOL. This exemption is available if:

1) The fiduciary did not know that the covered service provider failed to make the required disclosures and reasonably believed that the information disclosed met the requirements.

2) On discovery that the covered service provider failed to adequately disclose, the fiduciary requests in writing that the provider disclose the required information.

3) On failure of the service provider to provide the required information, the fiduciary notifies the DOL no later than 30 days following the date that the covered service provider's refusal to furnish the required information or 90 days after the fiduciary's written request.

4) The fiduciary provides the DOL with certain information, including the names of parties, contact information, plan numbers, service descriptions, description of information the covered service provider failed to provide, dates of importance and a statement as to whether the service provider continues services for the plan.

If the fiduciary does not file for a prohibited transaction exemption, plan fiduciaries may be held liable (including personal liability) for any losses incurred by the plan and the DOL may impose on the plan fiduciary an additional 20% penalty on any amount recovered in connection with the breach by the fiduciary of any of its fiduciary duties under ERISA.
liable for losses incurred by the plan.

Plan fiduciaries should also be aware that compliance with the Fee Disclosure Regulations does not negate ongoing fiduciary obligations with respect to hiring, retaining and monitoring service providers. The Fee Disclosure Regulation requirements are independent of the general fiduciary obligations set forth in ERISA, including the duties of loyalty and prudence which obligate plan fiduciaries to obtain sufficient information to make informed decisions in retaining and monitoring service providers.

So while plan sponsor and plan fiduciaries believe that the new DOL regulations will make their job easier, I think it makes their jobs harder because they will have to be more vigilant that their plan service providers adhere to the new fee disclosure. Otherwise, some plan fiduciaries may be personally liable for plan losses with unscrupulous plan providers. That is why the use on an independent ERISA attorney will be needed now, more than ever.

Many 401(k) Plans are Museums For Former Top Funds Some financial advisors load on former top funds, which are now clunkers.

When I was 19 years old, I bought my first mutual fund. Since that time was the winter of 1992, I plucked down $2,100 on a mutual fund that was one of the best performing mutual funds in 1991, the Kaufmann Fund. The Kaufmann Fund had returns of 79% in 1991 and I thought I could expect such typical returns in the future (even with their annual expense ratio of 265 basis points, who looked at expense ratios back then?). Clearly as a neophyte investor, I didn't understand that running after funds with huge returns was a mistake. The sad story is that many 401(k) financial advisors make the same mistake I did back then, the problem is that they get paid for this error.

The good folks at Brightscope unveiled a list of the top 401(k) mutual funds in the m

arketplace by distribution. Looking at the list, it will certainly give you an idea of what the top mutual funds were, 5-10 years ago.

American Growth Funds of America, Fidelity Contrafund, and Pimco Total Return were some of the top distributed funds. Unfortunately, some of the funds on the list have seen better days.
Too often, there is a herd mentality where some financial advisors run after the hot mutual funds of today and once those funds get too big to manage, their returns start to stall. We saw this with former stars like Fidelity Magellan, many of the Janus Funds, and Federated Kauffman (good luck for Federated buying that).

It is a sad story that many 401(k) plans have become museums to the former top funds of yesterday. This is the case where the Plan has no advisor or an advisor who never bothers to sit down with the plan sponsor and review the returns of the funds versus the investment policy statement (if they actually have one).

My great grandmother often said that you shouldn't run after the carriage if it won't pick you up. When it comes to selecting mutual funds for a 401(k) plan, you shouldn't run after the carriage if it picks everyone else up.

2 Simple Rules on Telling the Difference between The Good, The Bad, and The Ugly TPAs
The differences between the good and bad TPA is easy to detect.

Telling the difference between a good third party administration firm (TPA) and a bad one are pretty simple, so here are just two simple rules.

To understand the professionalism of a TPA firm, look at the background of you're the administrator who handles your Plan at the TPA. Look at their background or experience. The good TPAs will employ administrators with a deep background in retirement plans with accreditation from The American Society of Pension Professionals & Actuaries (ASPPA). The bad TPAs hire administrators with limited experience, limited training, and rarely any accreditation from ASPPA.

When it comes to plan errors, my experience with TPAs can be easily summed up. The best TPAs make mistakes rarely and when they do, they take the blame and correct it. The worst TPAs constantly make errors and blame everybody else, but themselves for these errors.

Jump on to The 401(k) Blue Comet or get hit. How the Edison case is the future of 401(k) litigation.

Three years ago, I left my job as an attorney for a third party administration firm ( TPA) that was also a registered investment advisor (RIA) because I thought fee disclosure was the future and the way we practiced business was part of the past. I knew that the times of excessive fees, improper share classes for larger plans, and hiding revenue sharing were going to end and three years later, I was right. I only wish I could have predicted the housing market implosion, credit crunch, and recession so I could have made a few bucks by shorting the market. Plus I could have invented Twitter if I foresaw the magnitude of tweets.

I saw the Blue Comet of the future of the 401(k) business and I decided to jump off the track to avoid being hit and hitched a ride.

A few months back, I was talking about the Edison case in California blue comet

where in Federal court, 401(k) participants won a huge case when the Judge made a ruling that without any malice on their part, Edison violated the ERISA prudence rule because it never sought to purchase institutional share classes when they were available for a plan of that size. I thought that case was going to be the future of litigation and just another headache for Plan sponsors to worry about.
Of course, the case has far reaching results. Apparently the Department of Labor read the decision and is currently arguing that the Unisys case in Pennsylvania that was thrown out should be reinstated because of the Edison argument. Apparently, Unisys was using retail shares in their Fidelity plan when retail class shares when less expensive, institutional classes were available. Slowly, but surely, the Edison case will increase the size of its effect as the decision will spread to Federal courts around the country.

Which reminds me of my old home, currently under Department of Labor investigation for many of the problems I was leery of. Their biggest client was a plan close to $75 million on the Fidelity platform. A review of their funds indicate some expensive share classes when the Plan was moved from Fidelity's 279 platform to the Fidelity 251 platform. Perhaps, the Edison case will be a wakeup call for them. Otherwise, the Blue Comet may hit them.
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The Rosenbaum Law Firm Advisors Advantage, October 2010

Vol. 1, No. 5

The Rosenbaum Law Firm P.C.
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Garden City, New York 11530
516-594-1557