Magazine article The CPA Journal

Protecting 401(k) Plan Sponsors from Conflicts of Interest

Magazine article The CPA Journal

Protecting 401(k) Plan Sponsors from Conflicts of Interest

Article excerpt

Plan sponsors need impartial advice when assessing and selecting investment funds and service providers for their participant-directed 401(k) plans; however, many service providers and investment brokers might recommend investment funds and provide employee education that is not in the best interest of plan participants.

In fact, some service providers, investment advisors, and brokers are deliberately structuring their advisoiy relationships with 401 (k) plan sponsors in a way that enables them to avoid accepting responsibility for their investment fund recommendations.

Mistakenly believing that they are receiving impartial advice, plan sponsors might rely upon such nonfiduciary service providers, without realizing the potential conflicts of interest that can arise when it comes to investment selection. This presents the opportunity for CPAs to advise 401(k) plan sponsors in their investment decisions and protect them from potential conflicts.

Marketplace Conflicts

The following sections describe several situations that can arise in the plan marketplace and cause conflicts of interests. CPAs must be able to recognize these complications in order to advise plan sponsors.

Biased advice. Nonfiduciary service providers, brokers, and advisors who are already conflicted as a result of thirdparty payments and other financial arrangements might provide biased advice to plan sponsors when helping them select investment funds. Because funds pay at different rates, service providers might steer plan sponsors toward funds that increase flieir own compensation.

Nonfiduciary status. Many advisors structure their relationships with 401(k) plan sponsors to avoid fiduciary status; however, most plan sponsors mistakenly trust that their advisors are fiduciaries whose compensation does not vary based upon investment fund selection. Variable compensation of advisors causes conflicts of interest, which can lead to higher plan fees, higher fund expenses, and mediocre investment performance.

Investment education. Although investment advice is required to be in the plan sponsor's best interest, investment education might highlight a proprietary fund that is in the advisor 's best interest An advisor who has a financial stake in the outcome of a plan participant's investment decision will likely create an investment menu with mediocre performance and higher expenses.

Indirect compensation. Most plan sponsors are unaware of their fiduciary responsibility for investment fund decisions and fees paid with plan assets. Indirect compensation, payable from third parties, can create an incentive for service providers to suggest funds with higher revenue-sharing payments. Thus, service providers might highlight their own proprietary funds, and advisors might emphasize funds that pay higher revenue-sharing amounts.

Excessive compensation, utilizing revenue sharing to offset recordkeeping fees is likely to create conflicts of interest if fees and offsets are not clearly disclosed to plan sponsors. Many service providers retain all of the revenue sharing generated by a plan, even when offsets exceed plan fees; therefore, plan sponsors must closely scrutinize revenue sharing and compensation arrangements.

Up-front commission. A broker may receive a substantial up-front commission upon the transfer of plan assets to a new custodial platform. Upon conversion, the commission is not likely to be commensurate with the services rendered by the broker, leading to substantial increases in annual fund expenses, as well as in insurance company contract expenses.

Actively managed funds. Service providers might promote the use of actively managed funds that have greater expenses, as well as model portfolios with wrap fees that are supposedly designed to achieve diversification. Because these investments have higher expenses than index funds, they provide greater compensation to service providers and advisors. …

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