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An Alternative to a Bundled Retirement Plan

A solution where different entities provide different plan services to a plan has the double-barreled virtues of looking like a bundled plan, without actually being a bundled plan.

W. Scott Simon, 07/09/2012

W. Scott Simon is a principal at Prudent Investor Advisors, a registered investment advisory firm. He also provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. Simon is the recipient of the 2012 Tamar Frankel Fiduciary of the Year Award. 

In my last two columns, I wrote about the case of Tussey v. ABB, Inc. which was decided on March 31 in Missouri by federal district court judge Nanette Laughrey. In May's column, I discussed the case in terms of the complex, inefficient, and unnecessarily expensive Rube Goldberg-like contraption that is revenue-sharing. In June's column, I discussed Tussey in terms of a bundled retirement plan and how that helps disguise where money is flowing from, where money is flowing to, and in what amounts. Without knowing such things, no plan sponsor can determine whether a plan's costs are reasonable in relation to the services for which they're expended within the meaning of section 404(a) of the Employee Retirement Income Security Act (ERISA).

Tussey demonstrates in spades how the revenue-sharing bundled retirement plan model helps keep otherwise presumably competent employees at plan sponsors who are in charge of running 401(k) plans from reaching their full intelligence quotient. The consequences of their ill-informed decision-making contribute directly to a less secure and comfortable retirement lifestyle for plan participants (and their beneficiaries).

Such employees--whether serving in fiduciary or non-fiduciary capacities in their retirement plan--should be ever mindful that they can have an impact for good or ill on real flesh-and-blood people. Because many of these employees are in lower and middle management--and therefore not privy to the special retirement goodies often available to upper management--it would seem that much of their own retirement wealth accrues primarily in their company's 401(k) plan. One would think that, if nothing else, the self interest of these employees would motivate them to influence a company's decision-makers to establish a retirement plan with reasonably low costs and well-diversified investment options that would more efficiently build their own wealth.

Each of the 401(k) plans present in the troika of cases of Tibble v. Edison International, Braden v. Wal-Mart, and Tussey holds more than $1 billion in assets; they are not mom-and-pop plans. These companies have the means to devote significant monetary resources and personnel to their 401(k) plans. Yet despite that, they cannot seem to comprehend the harmful consequences of revenue-sharing or even understand that their plans need not submit to the inflexibilities of a bundled offering. (So just what were those 28 persons--all named defendants--on the retirement plans committee at Wal-Mart in Braden v. Wal-Mart doing all day?)

Take a moment to think about it: Isn't it remarkable that giant providers of bundled retirement plans such as Fidelity ordinarily choose not to take onto their own shoulders the legal responsibility (and liability) for selecting, monitoring, and replacing their plans' investment options carried by their plan sponsor clients? In fact, they choose normally not to assume any legally meaningful fiduciary responsibility at all. Even in cases where sponsors have the option of off-loading their selecting/monitoring/replacing duties and decide not to exercise that option, presumably they would still wish to offer plan participants reasonably low-cost (and well-diversified) plan investment options. And yet, as shown in June's column, providers of bundled plans are indifferent to offering such investment options to participants because they have no incentive to do so. In fact, they are motivated to do just the opposite: offer investment options bloated with the added costs of revenue-sharing for the non-proprietary funds (and internal credits for their proprietary funds) on their record-keeping platform.

What's more, even giant providers of bundled plans won't be there to take care of plan sponsors if the sponsors get into legal trouble with plan participants, the DOL, or the IRS. These providers ordinarily are not sued, and even when they are, they rarely incur any serious liability. So any plan sponsor contemplating (or already) using such a giant can take little comfort from any perceived legal advantage offered by such "bigness."

The 'Unbundled Bundled' Solution
The alternative to the contraption of revenue-sharing that a bundled retirement plan provider such as Fidelity offers to its plan sponsor client ABB, Inc. in Tussey (or Hewitt offers to its client Edison in Tibble, or Merrill Lynch offers to its client Wal-Mart in Braden) is the so-called "unbundled bundled solution" (a term I first saw in a 2007 white paper, but which may have been coined even earlier). This solution, where different entities provide different plan services to a plan, has the double-barreled virtues of looking like a bundled plan, without actually being a bundled plan. I know that this solution works very well because our firm, Prudent Investor Advisors, seamlessly provides it to all our plan sponsor clients.

There are four entities involved in servicing a 401(k) plan: an investment advisor, a record-keeper, a custodial trustee, and a mutual fund company (or companies). In a bundled offering, the same entity (e.g., Merrill Lynch, Fidelity, or Vanguard) provides all plan services.

In an unbundled bundled solution, different entities provide different services. Our firm--which is a registered investment advisor that's an investment manager pursuant to ERISA section 3(38) and is therefore a fiduciary with discretionary authority over a plan's assets within the meaning of ERISA section 3(21)(A)(i)--recruits and assembles the other separate servicing entities with the approval of (and ongoing monitoring by) the plan sponsor. This approach offers the convenience of integrating an unbundled suite of services on a trading platform that, from a plan sponsor's viewpoint, looks for all intents and purposes like a bundled plan.

But the real advantage of such an approach is that it clearly separates out services such as record-keeping, participant communications, and reporting and disclosures from one another, and then ties each of them directly to the costs (including profit) for which they're expended. When, for example, a fund with no revenue-sharing in an unbundled bundled solution replaces a revenue-sharing laden fund in a bundled offering, something truly remarkable happens: The true cost of revenue-sharing (including a record-keeper's excessive-because-it's-hidden profit) is unlocked from the expense ratios of funds. As the costs of record-keeping and investment options are exposed to the sunlight of market competition, they're driven down. This solution is much better than a plan sponsor guessing (or not even knowing) about the true costs of record-keeping and other services offered in a bundled offering. It's also much better than having a court attempt to guess after the fact a plan sponsor's understanding of revenue-sharing.

The unbundled bundled solution also gives a plan sponsor the ability to swap out a part of the service provider team, should it become unsuitable, and swap in a new one. This avoids the problem of having to keep the rotten apple that spoils the whole barrelful since changing an entire servicing team can often be quite disruptive to companies.

The unbundled bundled solution described here is good for plan sponsors because it allows them to off-load significant fiduciary responsibility and liability onto the shoulders of a decision-making fiduciary with real discretionary authority (and therefore liability) for plan assets. It's also good for plan participants because that discretionary fiduciary will provide them with a prudent menu of reasonably low-cost and broadly and deeply diversified investment options. In addition, this solution provides for an ERISA section 3(38) investment manager to be in full fiduciary alignment with a plan sponsor that legally provides a more level playing field between them, thereby helping to ensure that a plan is run in the sole interest and for the exclusive benefit of plan participants (and their beneficiaries).

W. Scott Simon is an expert on the Uniform Prudent Investor Act and the Restatement 3rd of Trusts (Prudent Investor Rule). He is the author of two books, one of which, The Prudent Investor Act: A Guide to Understandingis the definitive work on modern prudent fiduciary investing.

Simon provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. He is a member of the State Bar of California, a Certified Financial Planner, and an Accredited Investment Fiduciary Analyst. Simon's certification as an AIFA qualifies him to conduct independent fiduciary reviews for those concerned about their responsibilities investing the assets of endowments and foundations, ERISA retirement plans, private family trusts, public employee retirement plans as well as high net worth individuals.

For more information about Simon, please visitPrudent Investor Advisors, or you can e-mail him at wssimon@prudentllc.com

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar.

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