Many reasons cited for shift from proprietary products
More defined contribution plans are moving to an open-architecture investment lineup strategy, seeking greater flexibility and less reliance on proprietary products offered by their record keepers.
Consultants and ERISA attorneys say the strategic shift has many causes — a quest for greater diversification, tougher negotiating over fees and services, federal fee transparency regulations and fiduciary breach lawsuits.
This phenomenon goes by many names — open vs. closed architecture, bundled vs. unbundled plans or proprietary vs. non-proprietary products. But the theme is the same: reducing exposure to a single or dominant source of investment options.
Unbundling “offers a clear articulation of fees,” which is the primary reason Willis Towers Watson PLC recommends it, said Robyn Credico, the Arlington, Va.-based defined contribution practice leader.
Sixty-three percent of Willis Towers Watson DC plan clients had unbundled arrangements last year, up from 52% in 2014, according to an internal survey of 105 clients.
The company defines a bundled arrangement as investments that are wholly or primarily those of a plan's record keeper. In bundled plans, administrative fees are typically paid via revenue sharing. Willis Towers Watson has been preaching the unbundled sermon for many years, “but it didn't really resonate with clients until we saw all of those lawsuits,” said Ms. Credico, referring to excessive-fee lawsuits filed against plans in the previous decade.
Clients also became more responsive to unbundling after the Department of Labor enacted fee-transparency rules for record keepers and sponsors in 2012, she said.
Annual surveys by Callan Associates Inc. show a rising interest among DC executives for a fully unbundled plan design — 44% last year, reflecting a steady annual increase from 29.9% in 2011. “Fully unbundled” means the record keeper and trustee are independent and none of the investments is managed by the record keeper.
Last year, 14.2% of plans in the survey had fully bundled strategies. The rate has vacillated in recent years, reaching a high of 22.7% in 2011. “Fully bundled” means the record keeper and trustee are the same, and all investments are managed by the record keeper.
Partially bundled plans accounted for 39% of last year's Callan survey, but the number has bounced around from year to year - with a high of 54.1% in 2012. In these plans, the record keeper and trustee are the same, but some investments aren't managed by the record keeper.
“It's very rare” for a Callan client to be fully bundled, said Lori Lucas, the Chicago-based executive vice president and defined contribution practice leader, adding that a majority of respondents in Callan's surveys aren't clients. “We always talk to sponsors about separating record keeping and investments.”
Consultants and ERISA attorneys say there's nothing automatically troublesome about DC plans using proprietary products from record keepers or, in the case of financial service company DC plans, from parent companies. They also emphasized that using a fully open-architecture lineup doesn't insulate plans from ERISA fiduciary breach suits.
“Nothing makes you bulletproof,” said Andrew Oringer, a New York-based partner at Dechert LLP, who represents plan sponsors and financial firms. DC plan executives wishing to add or keep proprietary products “need to ramp up their procedures,” such as documenting deliberations and the process for choosing such options, he said.
DC plans should use standard best practices with proprietary investments, Ms. Credico said. These practices include a fee benchmarking study every three years and, for larger plans, a quarterly review of investments and expenses.
One set of DC plans that appear more willing to accept record keepers' proprietary investment products are 403(b) plans, especially those in large universities. Ms. Credico said her firm's 403(b) plan clients have been the least receptive to open architecture. “We have been trying to talk to them for awhile,” she said.
But the recent spate of lawsuits against 403(b) plans run by large universities should get their attention, she said. In these cases, participants have alleged, among other things, that the plans rely too heavily on record keepers' products. (Pensions & Investments Aug. 22). In recent comments to Pensions & Investments, university representatives disputed the allegations and vowed to defend their plan practices.
Reliance on record keepers' products was one criticism in a January report by Aon Hewitt, describing how 403(b) plans waste money. “A growing number” of plans are moving to open architecture, the report said, because “no single investment manager has been identified that can offer compelling proprietary investment options across all asset classes.”
Proprietary investments also have been the target of a series of ERISA lawsuits in the last 12 months against DC plans of financial services firms. Participants have alleged that these plans hold too many of the parent companies' investment products, arguing that the plans could have found better-performing and/or less-expensive options elsewhere.
Among the defendants are DC plans and executives from American Century Cos. Inc., Kansas City, Mo.; Morgan Stanley (MS), New York; M&T Bank Corp., Buffalo, N.Y.; Putnam Investments, Boston; Allianz Asset Management of America; and Franklin Resources Inc., San Mateo, Calif.
“We continue to believe that the lawsuit filed by the two former employees is without merit and we are mounting a vigorous defense,” Chris Doyle, an American Century spokesman, wrote in an email. “We recently filed a motion for summary judgment to dismiss the case.” Other companies' representatives declined to comment or didn't respond to requests for comment.
Proprietary-product lawsuits against financial firms' DC plans aren't new, said Jeremy Blumenfeld, a Philadelphia-based partner at Morgan Lewis & Bockius LLP, acknowledging the recent increase in lawsuits. “Litigation risk alone should not govern behavior,” said Mr. Blumenfeld, who represents sponsors in ERISA cases and who declined to comment on specific lawsuits.
Plan executives wishing to retain proprietary funds can take steps to reduce litigation risk, including documenting decision-making for investment choices, he said. “Do something on the fee side to mitigate litigation risk,” such as making sure fees charged to a financial firm's DC plan are the same as the fees that the firm charges to other DC plans, he added.
The most dramatic action would be dropping proprietary funds. “Even eliminating proprietary funds does not eliminate the litigation risks,” Mr. Blumenfeld said. “You still face the same risks and challenges of any other company with non-proprietary funds in its plan.” n
This article originally appeared in the October 3, 2016 print issue as, "More plans embrace open architecture".