That raises the fiduciary issue of how to balance the value of the service with its cost, as well as how to select an investment manager to offer to the participants. This article discusses those, and other, issues and offers ideas for plan sponsors about how to manage their fiduciary responsibility when providing this benefit to their participants. (This article uses “plan sponsors” to refer to the fiduciaries of participant-directed plans, such as 401(k) and 403(b) plans. That role is often served by a plan committee or a responsible corporate officer.)

The value of individually managed accounts is fairly obvious, particularly for older participants with larger account balances. For example, one 55-year-old may plan on retiring at age 60, while another 55-year-old may plan on retiring at age 70. Even though their investment needs are markedly different, most plans would present their 2030 target date fund as being appropriate for both. Individually managed accounts can take into account those differences, if the participant provides information about his or her retirement timing, and an investment manager can take into account a participant’s risk tolerance and other considerations, such as income, account balances, and even outside assets.

In most cases, the starting point for customization is through information provided by the recordkeeper. That could include, for example, age, income, and account balance. The next step is to allow the participant to provide additional information about their preferences (e.g., conservative or aggressive investment strategies), goals (such as anticipated retirement age and standard of living in retirement), needs and other circumstances (e.g., whether they are married or have assets outside the plan). The more information obtained by the adviser, the more individualized the investment strategy can be. And, as a general statement, the more individualized the strategy, the more value to the service, which can justify a higher fee for the advisory service.

 

Legal Principals

Selection and Monitoring of Designated Investment Managers

Plan sponsors can select investment managers to offer to their participants. That is clear in ERISA; in fact, there is a name for that…a Designated Investment Manager.

But, when a plan sponsor selects any service provider to a plan, it must prudently select and monitor the provider. As explained by the Department of Labor (DOL) in Field Assistance Bulletin (FAB) 2007-01:

With regard to the prudent selection of service providers generally, the Department has indicated that a fiduciary should engage in an objective process that is designed to elicit information necessary to assess the provider’s qualifications, quality of services offered and reasonableness of fees charged for the service….In applying these standards to the selection of investment advisers for plan participants, we anticipate that the process utilized by the responsible fiduciary will take into account the experience and qualifications of the investment adviser, including the adviser’s registration in accordance with applicable federal and/or state securities law, the willingness of the adviser to assume fiduciary status and responsibility under ERISA with respect to the advice provided to participants, and the extent to which advice to be furnished to participants and beneficiaries will be based upon generally accepted investment theories.

As the bolded language explains, plan sponsors should ask the investment advisers for information about their:

• Experience and qualifications in managing investments for retirement.
  
• The adviser’s registration under applicable state or federal securities laws.
  
• The willingness of the adviser to serve as an ERISA fiduciary investment manager for participants’ accounts.
  
• Whether the adviser will base its advice on generally accepted investment theories.

In addition to those questions, a plan sponsor should evaluate the cost that the adviser will charge for the service and determine whether it is reasonable. An adviser can help with this by providing the plan sponsor with information about the charges of other advisers for similar services. Also, that information may be available from a plan’s recordkeeper.

Assuming that the answers to those questions are favorable, a plan sponsor could prudently select an adviser to serve as a plan’s Designated Investment Manager. But the fiduciary job is not done—the investment manager must be monitored at reasonable intervals. As a practical matter, most plans monitor their advisers on an annual basis. Here’s what the DOL said in the FAB about the monitoring process:

In monitoring investment advisers, we anticipate that fiduciaries will periodically review, among other things, the extent to which there have been any changes in the information that served as the basis for the initial selection of the investment adviser, including whether the adviser continues to meet applicable federal and state securities law requirements, and whether the advice being furnished to participants and beneficiaries was based upon generally accepted investment theories. Fiduciaries also should take into account whether the investment advice provider is complying with the contractual provisions of the engagement; utilization of the investment advice services by the participants in relation to the cost of the services to the plan; and participant comments and complaints about the quality of the furnished advice. With regard to comments and complaints, we note that to the extent that a complaint or complaints raise questions concerning the quality of advice being provided to participants, a fiduciary may have to review the specific advice at issue with the investment adviser.

In other words, plan sponsors need to repeat the initial selection process, but with updated information, and also need to determine if adviser is performing properly in accordance with its agreement, and if the participants have complaints about the quality of the advice. In performing this job, plan sponsors should consider information about the investment management services and investment performance relative to the stated objectives (e.g., volatility and benchmark performance). For example, the accounts of more aggressive investors (perhaps, but not necessarily, younger participants) should ordinarily be more volatile than the accounts of older, but perhaps more conservative, participants. If that is not the case, it doesn’t necessarily mean that there is a problem, but to be safe, plan sponsors should ask for and receive credible explanations from the advisers.

While that involves some additional work, it also has a benefit for plan sponsors in their roles as fiduciaries. In that regard, the DOL explained in the FAB:

Thus, it is the view of the Department that a plan sponsor or other fiduciary that prudently selects and monitors an investment advice provider will not be liable for the advice furnished by such provider to the plan’s participants and beneficiaries, . . .

This is consistent with ERISA, which provides fiduciary protections for the investment services of investment managers, so long as plan sponsors prudently select and monitor the investment managers. (This is sometimes referred to as a 3(38) “safe harbor.”)

In sum, in exchange for the effort involved in prudently selecting and monitoring the adviser (which a plan sponsor may be doing in any event, if the adviser is also engaged to advise on the plan’s investment lineup), plan sponsors will be able to provide a valuable service to their participants and will be protected from potential liability for claims of bad advice.

As a technical note, when a plan offers a Designated Investment Manager, DOL regulations require that the participants be given that information as a part of the plan’s 404a-5 disclosures.

Selection of Advisers by Participants

On the other hand, when a participant selects an investment manager (as opposed to one being designated by the plan), a plan sponsor does not have a duty to monitor that adviser. As explained in the DOL’s Interpretive Bulletin 96-1:

The Department also notes that a plan sponsor or fiduciary would have no fiduciary responsibility…with respect to the actions of a third party selected by a participant or beneficiary to provide education or investment advice where the plan sponsor or fiduciary neither selects nor endorses the educator or advisor, nor otherwise makes arrangements with the educator or advisor to provide such services.

At first blush, this may seem less burdensome. However, as a practical matter, it’s unlikely that most participants are in a position to select an investment adviser or, if they are, the fees would probably be higher than those that a plan could arrange for. In other words, it probably isn’t a realistic option for a plan sponsor who is interested in providing high quality, reasonably priced investment management services to all of its participants, regardless of their income level or account balance.

 

Concluding Thoughts

As 401(k) plans mature, and particularly as older participants accumulate larger account balances, there is an emerging need for individualized investment services. Target date funds provide age-based investment strategies for participants, but they assume that all participants in a particular age range have identical needs. That may be somewhat true of younger participants, most of whom probably have small account balances and only vague thoughts about retirement, but the need for individualization increases as participants age and their account balances grow. The “one-size-fits-all” approach of target date funds doesn’t accommodate the needs of participants as their circumstances become more individualized.

Fortunately, the retirement industry and the fiduciary rules contemplate that retirement plans can hire advisers as investment managers for individual participant accounts. Recordkeeper technology allows the efficient management of accounts at attractive prices, and plan sponsors can reasonably engage in the processes required to select and monitor participant investment managers. The needs of the retirement world have evolved over time, and to respond to those needs, new services have been created. It is up to plan sponsors to implement those new solutions for the benefit of their participants.