With fees for defined contribution (DC) record keepers declining, there’s a greater push to use a record keeper’s proprietary funds, especially target date funds (TDFs) and stable value. Is that a problem for fiduciary plan sponsors and advisors?
At the heart of the DOL rule is making parties that have influence over which investments are selected a fiduciary, changing their role from determining if an investment is suitable to looking out for a client’s best interest. Fiduciaries are paid a fee on overall assets whereas brokers are paid commissions which may vary. Revenue sharing for record keepers is like commissions for brokers – some funds, especially record keeper’s proprietary funds, pay more to the record keeper. Research shows that only 13.7% of poorly performing funds managed by record keepers are replaced compared to 25% for other funds yet 67% of all DC plans use at least one of their record keeper’s prop funds.
It’s no coincidences that the three largest TDF providers (Vanguard, Fidelity and T Rowe Price) are also record keepers.
A recent NY Times article (subscription required) highlights the problem. Comparing identical funds from the same fund families that performed poorly, those distributed by brokers associated with the company lost significantly fewer assets than those sold by independent advisors. Though the funds may have been “suitable” they probably would not have passed the best interest test under the DOL’s new fiduciary rule.
DC record keepers claim that they are not fiduciaries – the choice of which funds to select are up to the plan sponsor who might be guided by a fiduciary advisor. And there’s nothing wrong with the record keeper offering a discount for their services if their proprietary funds are selected.
Here’s the problem. Many plan sponsors select the TDF or stable value fund offered by the record keeper without the proper due diligence. In addition, it’s hard to determine how much revenue sharing the record keeper might be receiving from prop funds through intercompany transfers which means plan sponsors will not know how much they are paying for services which is a core fiduciary responsibility. Even worse, smaller DC plans are not offered a choice of TDF or stable value funds.
In the DOL’s FAQ Part II on their new fiduciary rule, if a record keeper suggests an investment line-up to a new client, which is common practice, that does not suggest all funds that meet the plans IPS (investment policy statement), then that record keeper will be a fiduciary.
Whether the DOL rule is delayed or even scuttled, it is a new world out there. Plan sponsors and their advisors have to be more careful especially which it pertains to a record keeper’s prop funds.
