401(K) Plans:

Improved Regulation Could Better Protect Participants from Conflicts of Interest

GAO-11-119: Published: Jan 28, 2011. Publicly Released: Feb 28, 2011.

Additional Materials:

Contact:

Charles A. Jeszeck
(202) 512-7036
contact@gao.gov

 

Office of Public Affairs
(202) 512-4800
youngc1@gao.gov

Recent volatility in financial markets highlights the need for prudent investment decisions if 401(k) plans are to provide an adequate source of retirement income. While plan sponsors and participants may receive help in assessing their investment choices, concerns have been raised about the impartiality of the advice provided. GAO was asked to describe circumstances where service providers may have conflicts of interest in providing assistance related to the selection of investment options for (1) plan sponsors and (2) plan participants, and (3) steps the Department of Labor (Labor) has taken to address conflicts of interest related to the selection of investment options.

The sponsors of 401(k) plans face conflicts of interest from service providers assisting in the selection of investment options because of third-party payments and other business arrangements. For example, providers who help sponsors to establish and maintain their plans may receive third-party payments from investment fund companies. The payments, sometimes called revenue sharing, create a conflict of interest because the provider may receive greater compensation from certain funds. Moreover, providers are reported to commonly structure their relationships with sponsors in a manner that avoids being subject to fiduciary standards under the Employee Retirement Income Security Act (ERISA). According to several industry experts, many sponsors, particularly of smaller plans, do not understand whether or not providers to the plan are fiduciaries, nor are they aware that the provider's compensation may vary based on the investment options selected. Such conflicts could lead to higher costs for the plan, which are typically borne by participants. In certain situations, participants face conflicts of interest from providers that have a financial interest when providing investment assistance. For example, although investment education is defined as generalized investment information, providers may highlight their own funds as examples of investments available within asset classes even though they may have a financial interest in the funds. According to industry experts, participants perceive education as investment advice. Thus, participants may not understand that the provider is not a fiduciary adviser required to act solely in participants' best interests. Also, several industry experts expressed concerns that providers stand to gain higher profits from marketing investment products outside of plans to participants, a practice known as cross-selling. For example, if participants use their plan provider for Individual Retirement Account rollovers, they may not understand, because of insufficient disclosures, that fees are often higher for products offered outside the plan and that the provider may not be serving as a fiduciary adviser. Consequently, participants may choose funds that do not meet their needs and pay higher fees, which reduce their retirement savings. While Labor has taken steps to address the potential for conflicted investment advice provided to sponsors and participants, more can be done to ensure they receive impartial advice. In fiscal year 2007, the Employee Benefits Security Administration (EBSA) began a national enforcement project that focuses on the receipt of improper or undisclosed compensation by certain providers, but its enforcement efforts are constrained to fiduciary providers and limited by EBSA's approach for generating cases. In addition, EBSA issued regulations to revise the definition of an ERISA fiduciary and require enhanced disclosure of providers' compensation and fiduciary status. These regulations, as currently specified, would help EBSA and sponsors detect and deter conflicted investment advice. However, the regulations do not require that certain disclosures be made in consistent or summary formats, which may leave sponsors with information that is not sufficient or comparable. GAO recommends that Labor amend pending regulations to require that service providers disclose compensation and fiduciary status in a consistent, summary format and revise current standards, which permit a service provider to highlight investment options in which it has a financial interest. GAO also recommends that the Department of the Treasury amend proposed regulations to require disclosure that investment products outside a plan typically have higher fees than products available within a plan. Overall, Labor and Treasury generally agreed to consider our recommendations as they evaluate comments received on pending regulations.

Recommendations for Executive Action

  1. Status: Closed - Implemented

    Comments: In April 2015, after multiple rounds of public comments, Labor re-proposed a rule to mitigate the effects of conflicted investment advice on participants in retirement savings programs. In a statement on July 13, 2015, President Obama affirmed the importance of this re-proposed regulation and stated they will push for finalization. The rule addresses this recommendation by requiring service providers who make investment recommendations to formally acknowledge fiduciary status and provide impartial advice. It also addresses written disclosures by requiring that either an adviser operates without a conflict of interest (and no compensation that varies based on investment choices) or the adviser signs a written contract disclosing any conflicts of interest and adopting policies to mitigate those conflicts so that all advice is made in the best interest of the recipient. It will no longer be permissible for an adviser to provide conflicted advice simply by disclosing it. Labor held public hearings on this rule in August 2015 and expects it to soon be issued in FY2016.

    Recommendation: To better ensure that plan sponsors and participants can rely on impartial information in making investment decisions, the Secretary of Labor should direct the Assistant Secretary for EBSA to amend and finalize proposed regulations to change the definition of a fiduciary for purposes of investment advice. Specifically, the Secretary should amend the proposed regulations to require that service providers' written disclosures specifying that they are not undertaking to provide impartial investment advice be provided to the plan sponsor in a consistent and prominent manner.

    Agency Affected: Department of Labor

  2. Status: Closed - Implemented

    Comments: The Department of Labor (DOL) took significant steps to begin addressing this recommendation. DOL published a proposed amendment to the 408(b)(2) disclosure regulation that may require covered service providers to supply plan fiduciaries with a guide or similar tool to assist fiduciaries in quickly locating the required disclosures on March 12, 2014. The comment period closed on June 10, 2014. DOL is working with a contractor to recruit focus group participants and plans to conduct eight focus group sessions with approximately 70 to 100 responsible plan fiduciaries (RPFs), primarily focusing on RPFs to small pension plans (those with less than 100 participants). DOL intends to use the information collected from focus groups to evaluate whether, and how, a guide, summary, or similar tool would help fiduciaries understand the disclosures. Results will be used to inform and support DOL's notice of final rulemaking for the guide requirement. GAO supports Labor's effort to conduct outreach with plan fiduciaries, such as focus groups, to determine how best to revise the proposed amendment to the 408(b)(2) regulation in order to provide information on service provider compensation in a consistent and summary format. The Department of Labor implemented this recommendation in its proposed revision to the definition of a fiduciary. In April 2015, Labor re-proposed its rule that redefines an ERISA fiduciary with regards to advice. The rule includes a model disclosure form for service providers to use to clearly and consistently communicate the compensation they receive, both on a transactional and ongoing basis. The disclosure includes information on compensation both to the advisor and to the firm as well as identifying charges to the investor. In addition, the new Best Interest Contract exemption, which is a key part of the new definition of fiduciary, includes a requirement that the written contract disclose fiduciary status. The proposed rule has undergone intense scrutiny and consideration and is expected to be issued as a final rule in FY2016.

    Recommendation: To better ensure that plan sponsors and participants can rely on impartial information in making investment decisions, the Secretary of Labor should direct the Assistant Secretary for EBSA to amend and finalize interim final regulations regarding disclosure of service providers' direct and indirect compensation from plan investments and fiduciary status to require that the information be provided in a consistent and summary format.

    Agency Affected: Department of Labor

  3. Status: Closed - Implemented

    Comments: The Department of Labor (DOL) is continuing to review if, and to what extent, the Interpretative Bulletin should be modified. DOL also said it will re-consider the provisions currently in Interpretative Bulletin 96-1 (29 CFR section 2509.96-1) that seek to limit the potential for abuse where specific investment options are used to populate an investment education tool. In April 2015, DOL re-proposed the conflict of interest rule to replace the interpretive bulletin on investment education. Specifically, paragraph (b)(6) would supersede IB-96-1. The changes reflect considerable evaluation and revision of policy contained in IB-96-1. The proposed rule is a departure from IB-96-1 because of a new condition of investment education that, as recommended by GAO, "the information and materials not include advice or recommendations as to specific investment products" and alternatives available under the plan. This rule clarifies that presenting or highlighting materials which identify specific investment options, proprietary or not, is advice and thus may trigger fiduciary status. Labor held public hearings on this rule in August 2015 and expects it will soon be issued in FY2016.

    Recommendation: To better ensure that plan sponsors and participants can rely on impartial information in making investment decisions, the Secretary of Labor should direct the Assistant Secretary for EBSA to evaluate and revise Labor's interpretive bulletin on investment education, which is important in helping participants and beneficiaries make investment decisions. Specifically, in light of current practices, the Secretary should revise current standards, which permit a service provider to highlight certain investment alternatives, such as proprietary funds, which may result in greater revenue to the service provider, in educational materials. Labor could consider a variety of steps to address this potential conflict of interest, such as requiring service providers to disclose that they may have a financial interest in the options highlighted or prohibiting them from using proprietary funds as examples.

    Agency Affected: Department of Labor

  4. Status: Closed - Implemented

    Comments: In April 2015, after multiple rounds of public comments, Labor re-proposed a rule to mitigate the effects of conflicted investment advice on participants in retirement savings programs. In a statement on July 13, 2015, President Obama affirmed the importance of this re-proposed regulation and stated they will push for finalization. This rule addresses our recommendation by clarifying that anyone providing advice that is individualized or specifically directed to a participant pertaining to a decision to take a distribution from the plan, to rollover from a plan to an IRA, or where to invest the money after it is distributed from the plan, is a fiduciary. As a fiduciary, the adviser must provide impartial advice in their clients' best interest. Advisers operating under the new Best Interest Contract exemption are required, as a part of that written contract, to disclose to clients any financial interests that they may have in the outcomes of their investment transactions and to identify themselves as an ERISA fiduciary. Labor held public hearings on this rule in August 2015 and expected it to soon be issued in FY2016.

    Recommendation: To better ensure that plan sponsors and participants can rely on impartial information in making investment decisions, the Secretary of Labor should direct the Assistant Secretary for EBSA to require that service providers, when assisting participants with the purchase of investment products offered outside of their plan, disclose in a consistent and prominent manner, either before or at the point of sale, any financial interests they may have in the outcomes of such transactions and inform participants as to whether their assistance is subject to ERISA fiduciary standards.

    Agency Affected: Department of Labor

  5. Status: Closed - Implemented

    Comments: In consultation with Treasury, in April 2015, after multiple rounds of public comments, Labor re-proposed a rule to mitigate the effects of conflicted investment advice on participants in retirement savings programs. In a statement on July 13, 2015, President Obama affirmed the importance of this re-proposed regulation and stated they will push for finalization. The rule addressed this recommendation by clarifying that service providers who give advice to participants regarding rollovers of plan assets into IRAs are acting as a fiduciary. As a fiduciary, the provider must provide impartial advice in their clients best interest. Labor held public hearings on this rule in August 2015 and the rule is expected to be issued in FY2016.

    Recommendation: To better ensure that plan participants have sufficient information when deciding whether to move plan funds into investment alternatives outside their plan, the Secretary of the Treasury should amend the applicable requirements of its proposed disclosure rule to specifically require that service providers, when recommending the purchase of investment products outside retirement plans, inform plan participants that fees applicable outside their plans may be higher than fees applicable within their plans.

    Agency Affected: Department of the Treasury

 

Explore the full database of GAO's Open Recommendations »

Jan 27, 2016

Dec 30, 2015

Nov 3, 2015

Sep 4, 2015

Jul 30, 2015

Jul 27, 2015

Jun 25, 2015

Jun 11, 2015

May 22, 2015

May 5, 2015

Looking for more? Browse all our products here