Investment Consultant
Bridgebay Financial, Inc.
As fiduciaries, plan sponsors must act for the sole
benefit of their plan's participants. Decisions born of the need for corporate
convenience may lead to less-than ideal arrangements or investment options for
plan participants. Sponsors need to evaluate whether the convenience of
one-stop shopping is worth the potential fiduciary risk of foregoing open
architecture.
The conventional wisdom regarding bundled service
providers is that the convenience offered by an all-in-one solution is
particularly attractive to smaller 401k plan sponsors who might not have the
scale or staffing necessary to administer the plan in-house. These types of
companies are typically spread thin already, with many individuals wearing many
hats. Tight resources tend to push plan sponsors to make the easy choice of
working with bundled service solutions. These service providers come in several
forms. They can be a broker, a mutual fund firm, a payroll processor or an
insurance company.
Truly open architecture goes well beyond the simple
ability to add non-proprietary funds to a plan's line-up. In a open
architecture, all of the service providers are either unbundled or entirely
separate entities. The goal of open architecture is to have the flexibility to
monitor and trade out each individual component, independent of the other
services with a minimal amount of disruption to the plan. The primary service
providers to a typical DC plan include the recordkeeper, investment or fund
managers, custodian or trustee, plan investment consultant, managed account
provider, and the education/communications provider. Ideally, each of these
service providers is a separate, unaffiliated entity without any vested
interest in the actions of any of the other providers.
The key is to then take a "best-of-breed"
approach and select only the best recordkeeper, TPA, mutual funds and
investment consultant. A recent study which compiled the characteristics of an
ideal 401k plan supported this approach and demonstrated that such plans do not
use bundled providers. By managing each component individually, the sponsor
maintains the flexibility to replace any element that may suffer from poorer or
declining quality service without disturbing any of the other services. The
modular nature and the ability to use best-in-class providers are the major
strengths of open architecture.
In contrast, bundled service providers typically
rely on investment products to drive revenues, making other peripheral services
an afterthought and generally a loss leader. Ancillary services such as plan
administration and recordkeeping tend to suffer when pushing investment
products is the primary source of revenue.
Additionally, by obscuring the actual cost for each
service in the bundled fee, such providers make it difficult to accurately
benchmark total plan fees. Independent providers bring with them a built-in
check-and-balance mechanism regarding the quality and fees of other service
providers. Though many bundled providers may tout the benefits of the
"economies-of-scale" that come with their arrangements, the inherent
conflicts of interest may actually result in higher fees than a truly open architecture
solution.
In recent years we have seen numerous lawsuits
brought against plan sponsors for various breaches of fiduciary duty. In 2011
we witnessed the result of the high-profile class action suit against Walmart
for breach of duty regarding the investment choices in the 401k plan. The
plaintiffs discovered that het plan's bundled service provider had placed
high-fee funds into the plan and the broker was receiving trailing commissions
for having placed those funds in the plan.
The mere fact that it took plan participants so
long to discover the breach of fiduciary duty indicates how well high fees can
be hidden within the bundled arrangement. 2012 promises to be a year of greater
disclosure and transparency on behalf of bundled service providers. The new fee
disclosure requirements outlined under sections 408(b)(2) for provider to plan
sponsor disclosures and 404(a) of the Employee Retirement Income Security Act
(ERISA) offer to shed light on the bundled service provider. This has the
potential to reshape the bundled provider industry and reinvigorate plan
sponsors' interest in pursuing open architecture.
While a bundled solution may work for plans of a
relatively small size, the modular and best-in-class approach afforded plan
sponsors by using open architecture and the potential for lower, more
competitive fees must not be ignored.
