There is concern some fees received by providers in 401(k) alliances from mutual funds may be an ERISA prohibited transaction.
The Department of Labor has issued a series of advisory opinions with respect to alliances - the arrangements involving record keeper, trustee and investment management that banks, consulting firms and mutual funds put together for 401(k) plans. These arrangements permit a 401(k) plan to offer as investment options mutual funds and other investment funds from different, unrelated companies. Typically, the alliance provider (e.g., a bank or consultant) is the record keeper and receives from an alliance mutual fund, for instance, 10 basis points on any assets invested in the fund.
There is concern that receipt of this money by alliance providers from mutual funds might be a prohibited transaction under the Employee Retirement Income Security Act. The Department of Labor has also raised the possibility that an alliance provider's deletion of funds from its fund menu may be a fiduciary act.
Several people have requested opinions from the Department of Labor with respect to alliance arrangements, including Frost Bank, Aetna and the American Bankers Association. These rulings are important because they clarify that a directed trustee will not be found to violate ERISA's anti-kickback rule and indicate that DOL will take a practical, flexible approach in determining whether adequate information has been made available about alliance pricing arrangements and whether an alliance provider's control over the fund menu makes it a fiduciary.
Each request is a little different. Frost Bank acts as a trustee for the plans in its alliance network and, in some cases, advises the employer on which funds to select from the fund menu. Thus, it clearly is a fiduciary. In its fee arrangements, Frost offsets dollar-for-dollar any fees it receives from mutual funds against trustee and record-keeping fees the plan owes to Frost or third parties. Where the mutual fund fees exceed the amount of trust and record-keeping fees owed by the plan, the excess is paid to the plan.
Aetna does not act as trustee and does not advise employers on fund selection. Thus, it does not have the fiduciary powers Frost has. Aetna does not provide for a dollar-for-dollar offset, or for that matter any explicit offset, of fees received from mutual funds against fees owed by the plan.
The American Bankers Association filed its opinion letter request to clarify the application of the DOL's position to a directed bank trustee that does not make a dollar-for-dollar offset of fees received from the mutual fund.
No ERISA prohibited "kickback"
Let's get technical for a second. Where a trustee is directed - that is, where it does not use any fiduciary discretion with respect to a transaction - it has long been the DOL's position that, even if the fiduciary benefits from the transaction, there is no ERISA-prohibited self-dealing.
For instance, if Frost Bank were directed by an employer to invest plan assets in a Frost fund, and Frost got a fee for managing that fund, there would be no ERISA violation because Frost did not use its own discretion to cause the plan to engage in the transaction. The employer caused the plan to engage in the transaction.
That's the rule for self-dealing. Until now, however, DOL has not extended that rule to ERISA's anti-kickback provision - the provision of ERISA that prohibits a fiduciary from causing the plan to engage in a transaction with respect to which the fiduciary receives a fee from a third party.
With the Frost Bank advisory opinion just published, it did extend that rule to kickbacks. It holds that, where a trustee receives a fee from an unrelated mutual fund with respect to a plan investment in that fund, there is no prohibited transaction so long as the trustee did not use its fiduciary power to cause the plan to make the investment, i.e., so long as it was acting as a directed trustee.
As noted, however, Frost does not always act solely as a directed trustee. Where the trustee is advising the employer on which funds to select, it may be using its fiduciary authority to cause the plan to enter into the transaction, and the receipt of a fee from the mutual fund would ordinarily be prohibited.
Under Frost Bank's arrangement, however, all fees received from mutual funds are offset against fees owed by the plan. In these circumstances, the DOL found no prohibited kickback.
Whether a fiduciary
Unlike Frost, Aetna does not advise employers on which funds to include in a plan's line-up and does not act as trustee. So, is Aetna a fiduciary? In its advisory opinion, DOL noted this was an inherently factual question. With respect to an alliance provider, the answer would depend on whether the employer in fact has control over what funds are offered under its plan.
DOL stated that: "(A) person would not be (a fiduciary) solely as a result of deleting or substituting a fund from a program of investment options and services . . . provided that the appropriate plan fiduciary in fact makes the decision to accept or reject the change. In this regard, the fiduciary must be provided advance notice of the change . . . and afforded a reasonable period of time . . . to decide whether to accept or reject the change and, in the event of rejection, secure a new service provider."
In Aetna's arrangement, if Aetna decides to delete a fund from the available list of funds, it sends a notice 60 days in advance to the employer. If the employer rejects the proposal to delete the fund, the employer has 60 more days to find another service provider. Aetna indicated these rules are flexible and it would, for instance, allow an employer more time to find a new record keeper where that was necessary. DOL found that Aetna's approach provided adequate notice and that, therefore, Aetna was not a fiduciary merely because of its ability to delete or substitute funds.
Employer review of fee arrangements
The other issue presented by these letters, and perhaps the most important, is the degree to which an alliance provider must disclose to an employer the amount of fees it received from its mutual fund "allies."
In the Frost and Aetna letters, DOL said the employer (or another independent fiduciary) must: "assure that the compensation paid directly or indirectly by the plan to the (alliance provider) is reasonable, taking into account the . . . services provided to the plan as well as any other fees or compensation received by (the alliance provider) in connection with the investment of plan assets . . . it is the view of the Department that the responsible plan fiduciaries must obtain sufficient information regarding any fees or other compensation that (the alliance provider) receives with respect to the plan's investments in each mutual fund to make an informed decision whether (the alliance provider's) compensation for services is no more than reasonable."
It may be argued that, because Frost offsets any fees it receives from mutual funds on a dollar-for-dollar basis against fees owed by the plan, there is no need for an independent fiduciary review of those arrangements. For Frost, the proper question is, is the direct fee arrangement between Frost and the plan reasonable?
Aetna, however, does not provide for an offset. In its request for an advisory opinion, Aetna stated that it would provide existing and prospective customers a statement disclosing that it receives, or may receive, fees from many, but not all, of the mutual funds in its alliance. The statement will enumerate the services Aetna provides to the mutual funds and the rate of fees paid and will identify a toll-free phone number that customers may call to get detailed information concerning which funds pay fees and an estimate of how much Aetna receives or has received during a particular time period. While DOL did not comment explicitly on the adequacy of these disclosures, it did not identify them as a presenting a problem.
The DOL's response to the American Bankers Association request simply confirms that the analysis in the Frost and Aetna letters applies to directed bank trustees as well. Thus, a directed trustee will not be a fiduciary with respect to the receipt of fees from a mutual fund where it does not exercise any discretion on the allocation of assets to that fund.
When DOL first indicated that it was going to issue a response to Frost's request for advice there was a concern that it would: (1) suggest that the only allowed fee arrangement between an alliance provider and its mutual fund "allies" was one that provided for a dollar-for-dollar offset of mutual fund fees against fees paid by the plan, (2) hold that an alliance provider that has the ability to delete a mutual fund from the alliance fund menu was a fiduciary and/or (3) come up with a rigid set of rules as to what information about mutual fund fees an alliance provider must give to an independent fiduciary (e.g., the employer) and how much notice it must give before it deletes a fund from its fund line-up.
Instead, DOL has provided flexible and practical rules, allowing an arrangement with no direct offset, allowing the deletion of funds where the employer receives adequate notice (loosely defined) and imposing no explicit fee disclosure requirement.