DOL, SEC expected to give some long-awaited guidance
After a year of relative calm, the defined contribution industry faces a series of potentially sweeping regulations expected from the Labor Department and, to a lesser extent, the SEC in 2014.
“It will be a very busy year,” said Larry Goldbrum, Washington-based general counsel for the SPARK Institute Inc. “There will be a significant amount of regulatory activity.”
Mr. Goldbrum's list includes anticipated Department of Labor regulations on the definition of, and responsibilities of, a fiduciary; proposed rules on safe-harbor protection for DC plans offering annuities embedded in their plans; a required illustration by sponsors to participants about spending their retirement assets; and the Securities and Exchange Commission's final rule on money-market funds.
According to a DOL regulatory calendar, the department expects to issue in January a follow-up rule on a 2012 regulation governing fee disclosure to sponsors from providers and a final rule on target-date fund disclosure in March. The SEC's final rule on the marketing and advertising of target-date funds is expected in October.
In August, the DOL is scheduled to issue a proposed rule telling DC plans how to illustrate lifetime earnings streams to participants — the same month it will offer a proposed rule on defining a fiduciary.
In October, the DOL expects to issue more comprehensive proposed regulations on safe-harbor protection sponsors that offer annuities embedded in 401(k) plans. The SEC is scheduled to publish its new money-market fund regulations in October, too.
In another big issue affecting DC plans, the Supreme Court will hold oral arguments in the spring on a case that could determine the future of stock-drop lawsuits against DC plans that offer company stock as part of their investment menus. The court will make a decision before its term ends in June.
In December, the court accepted the case — Fifth Third Bancorp et al. vs. Dudenhoeffer et al. — to settle a dispute among federal appellate circuits. Although most appellate courts have adopted a tougher standard for reviewing stock-drop lawsuits, the 6th Circuit, headquartered in Cincinnati, has endorsed a less restrictive standard.
A decision favoring the softer standard “could make sponsors reconsider company stock,” said Lori Lucas, the Chicago-based executive vice president and defined contribution practice leader for Callan Associates Inc.
“The outcome could certainly lead to additional stock-drop cases — or kill most of the cases,” added Ross Bremen, a partner with the Boston-based investment consulting firm NEPC LLC.
For some key issues, 2014 will be the year of the do-over.
The Labor Department offered a proposed regulation on defining a fiduciary in October 2010, but the retirement industry's reaction was so fierce - and congressional pressure so strong — that Phyllis Borzi, assistant secretary of labor and head of the Employee Benefits Security Administration, withdrew the proposal. She said the DOL would try again (Pensions & Investments, Sept. 19, 2011).
SPARK's Mr. Goldbrum said the fiduciary definition could have a significant impact for the DC industry, even though much of it is expected to address conflicts of interests relating to the role of advisers, their compensation and rollovers to individual retirement accounts. “There will be enough impact for everyone,” he predicted.
According to the DOL's regulatory calendar, the proposed rule “would reduce harmful conflicts of interest” by amending the definition of a fiduciary in the Employee Retirement Income Security Act.
Addressing another matter that triggered an angry outburst from the DC industry in 2012, the Labor Department has decided to revisit the fiduciary duties of sponsors that offer self-directed brokerage accounts.
The percentage of participants using these accounts — and the percentage of plans' assets devoted to the accounts — is usually in low single digits. However, DC plans often offer these accounts to mollify the few participants who want choices beyond the qualified default investment alternatives and core funds that make up plans' investment menus.
In May 2012, the Labor Department issued a guidance document on regulations governing fee disclosure between sponsors and participants. But tucked into this field assistance bulletin were several comments about self-directed brokerage accounts that industry members argued would add costs, create confusion and increase fiduciary responsibilities. The guidance document, they complained, was a back-door attempt at regulation.
By July 2012, the Labor Department removed what industry participants said were the most onerous comments in the guidance document. However, Ms. Borzi said the department would examine this issue again (P&I, July 31, 2012).
The department's first step is to issue a request for information in April. The request will “explore whether, and to what extent, regulatory guidance on fiduciary and regulatory safeguards for such arrangements are appropriate,” according to the DOL regulatory calendar.
Lifetime income options embedded in DC plans haven't caught on, especially with the largest DC plans. One of the biggest reasons, cited by plan executives and DC consultants, is the desire for more fiduciary protection through regulation.
Sponsors that have adopted these lifetime income options, such as annuities embedded in 401(k) plans, say they believe existing DOL safe-harbor rules offer protection, but most sponsors want more. The DOL's regulatory calendar said the department will propose amendments to its 2008 rules, which will concentrate primarily “on the condition in the safe harbor relating to the ability of the annuity provider to make all future payments under the annuity contract.”
Although a safe harbor might solve one piece of the lifetime income puzzle, consultant Sue Walton said sponsors and participants still must overcome their concerns about the complexity of products, the transparency of fees and the portability of products if a participant changes jobs or if a sponsor changes record keepers. “This market isn't ready yet,” said Ms. Walton, a director at Towers Watson Investment Services, Chicago.
The other lifetime income issue coming due will be the DOL's proposed regulations on how sponsors should best illustrate how accrued benefits can be converted into an estimated lifetime stream. Last May, the DOL issued an advance notice of proposed regulation — an indication of what is being considered but not a formal proposed regulation. This notice set off a sharp debate, especially over whether the DOL should mandate a specific approach for sponsors to explain lifetime income streams. “I think it would be a mistake to try to mandate one way to do something,” said Thomas Kmak, the Kansas City, Mo.-based CEO and co-founder of consulting firm Fiduciary Benchmarks Inc.
The issuance in 2014 by DOL and SEC of target-date fund regulations will come at a time when DC consultants expect changes for this increasingly popular qualified default investment alternative.
In a survey to be released Jan. 7, Callan Associates is reporting that more than one-third of sponsors will make changes in their target-date funds, with the most frequent being finding another fund or fund manager and shifting to an all-passive approach or to a mixture of active and passive funds, said Ms. Lucas.
Half of the sponsors interviewed for the 2013 survey made changes that included reducing fees, choosing lower-fee classes or switching to a collective investment trust strategy, Ms. Lucas said. Callan conducts an annual survey with about 100 DC plan executives; there were 107 for the 2014 survey.
According to the DOL, its regulation, first proposed in November 2010, “will provide more specificity to fiduciaries” concerning what information must be disclosed to participants about target-date funds or other QDIAs. According to the SEC, its new rule, first proposed in June 2010, will provide investors with “enhanced information” about advertising materials issued by target-date fund firms.
More pressure on fees
DC consultants say plan executives will continue to exert pressure on providers to reduce fees and increase transparency. “I expect there will be more opportunities (for sponsors) to move away from revenue sharing when they exist,” said Mr. Bremen of NEPC.
“Sponsors are paying more attention to fees whether it's due to the Department of Labor (regulations) or lawsuits,” said Robyn Credico, the Arlington, Va.-based defined contribution practice leader for Towers Watson & Co. “That will continue as part of routine governance. Even if the lawsuits stop, they will continue to monitor fees.”
The DOL is scheduled to issue final regulations this month outlining “a guide or similar investments” that record keepers should provide to sponsors, said the DOL regulatory calendar. This guide “may assist fiduciaries, especially fiduciaries in small to medium-sized plans” to better understand “potentially complex” disclosure documents.
DC consultants said plan executives will continue to wrestle with offering fixed-income investments as interest rates remain low. “The big change in 2013 was the interest rate environment because we are seeing losses in bond funds for the first time in years,” said Donald Stone, managing partner and CIO at Plan Sponsor Advisors, Chicago.
Mr. Stone predicted plans might shift to more active management of fixed-income funds. Bond index funds tend to have longer durations and a high concentration in government securities, he said, while actively managed funds can respond more quickly to duration risk and government bond risk. He also predicted greater interest among plans in multiasset funds that include such investments as bank loans, high-yield bonds and emerging market debt.
This article originally appeared in the January 6, 2014 print issue as, "Action out of Washington to keep things hopping".