401(K) Plans:

Certain Investment Options and Practices That May Restrict Withdrawals Not Widely Understood

GAO-11-291: Published: Mar 10, 2011. Publicly Released: Mar 16, 2011.

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401(k) plan sponsors are responsible for offering an array of appropriate investment options, and participants are responsible for directing their investments among those options. While participants expect to be able to switch investment options or withdraw money from their accounts, during the recent economic downturn, some 401(k) plan sponsors and participants found that they were restricted from doing so. GAO was asked to (1) identify some of the specific investments and practices that prevented plan sponsors and participants from accessing their 401(k) plan assets and (2) determine any changes the Department of Labor (Labor) could make to assist sponsors in understanding the challenges posed by the investments and practices that restricted withdrawals. To do this, GAO reviewed relevant federal laws and regulations and consulted with experts, federal officials, service providers, and plan sponsors.

Between 2007 and 2010, some 401(k) plan sponsors and participants were restricted from withdrawing their plan assets from certain 401(k) investment options, including real estate, money market, and stable value investment options, as well as other investment options that lent securities (the practice of lending plan assets to third parties in exchange for cash as collateral that a fund reinvests). In most cases, the withdrawal restrictions were caused by losses and illiquidity in the investment options' underlying portfolios and sometimes contract constraints placed on plan sponsors by the investment options. For stable value funds, and also for those investment options that lent securities, the withdrawal restrictions and their causes highlight the risks that participants face when allocating their 401(k) plan assets to these investment options--and, that losses are borne by plan participants. In addition, participants often do not understand or may receive insufficient disclosures of the risks posed by these investments. Further, plan sponsors may be unaware or receive insufficient disclosures of the risks and challenges involved with those investment options and practices. Labor can take a variety of steps to help plan sponsors who offer stable value funds and investment options that lend securities. Many of these steps can draw upon the changes that the Securities and Exchange Commission and others have already made, or will make, regarding these investment options and recent suggestions from plan sponsors, industry service providers, and other key stakeholders. Specifically, Labor could identify and take action to address those stable value contract constraints that may hinder plan sponsors from performing their fiduciary responsibilities and provide better disclosures to plan sponsors about certain investment options to help sponsors make decisions on behalf of participants. Similarly, revising Labor's prohibited transaction exemption for securities lending to restrict those securities lending arrangements that may pose unreasonable financial terms upon plans and providing more guidance, in general, about such transactions can also help plan sponsors and participants understand the risks that cash collateral reinvestment can pose to plan assets in investment options that lend securities and how to mitigate them.

Status Legend:

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  • Review Pending-GAO has not yet assessed implementation status.
  • Open-Actions to satisfy the intent of the recommendation have not been taken or are being planned, or actions that partially satisfy the intent of the recommendation have been taken.
  • Closed-implemented-Actions that satisfy the intent of the recommendation have been taken.
  • Closed-not implemented-While the intent of the recommendation has not been satisfied, time or circumstances have rendered the recommendation invalid.
    • Review Pending
    • Open
    • Closed - implemented
    • Closed - not implemented

    Recommendations for Executive Action

    Recommendation: The recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act includes requirements that will affect deliberations about stable value funds and requires that the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC), in consultation with the Department of Labor (Labor) and the Department of the Treasury (Treasury), conduct a study of stable value funds. To ensure additional protection for plan participants, appropriate information for plan sponsors, and to better inform the study required by the Dodd-Frank Act, as it conducts its consultative analysis to assist the SEC and CFTC, Labor should also analyze stable value funds specifically in a 401(k) investment context to identify those situations or conditions that prevented plan sponsors from withdrawing from stable value funds, such as contract restrictions, and take appropriate regulatory steps to assist plan sponsors in fulfilling their fiduciary responsibilities.

    Agency Affected: Department of Labor

    Status: Open

    Comments: The Department of Labor will consider whether further action would be appropriate after consulting with the SEC and the CFTC upon completion of their study as mandated by the Dodd-Frank Wall Street Reform and the Consumer Protection Act.

    Recommendation: The recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act includes requirements that will affect deliberations about stable value funds and requires that the SEC and the CFTC, in consultation with Labor and Treasury, conduct a study of stable value funds. To ensure additional protection for plan participants, appropriate information for plan sponsors, and to better inform the study required by the Dodd-Frank Act, Labor should amend its regulation on plan sponsor disclosure to participants to include a specific requirement for plan sponsors to provide information to participants that discloses the risks of investing in stable value funds.

    Agency Affected: Department of Labor

    Status: Open

    Comments: The Department of Labor (DOL) disagrees with this recommendation. Without further study and review, the agency reported that it is not prepared to conclude that the regulations governing the disclosure of investment-related information to participants and beneficiaries must be amended to specifically address table value funds. DOL believes the current regulation specifically requires that information pertaining to investment risks, as well as investment strategies, be available to plan participants with respect to all investment alternatives offered under a participant-directed individual account plan, including stable value funds. Given the complexity of the issues involving stable value funds, GAO encourages DOL to initiate the study, review what it deems necessary, and amend its disclosure regulations as appropriate.

    Recommendation: The recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act includes requirements that will affect deliberations about stable value funds and requires that the SEC and the CFTC, in consultation with Labor and Treasury, conduct a study of stable value funds. To ensure additional protection for plan participants, appropriate information for plan sponsors, and to better inform the study required by the Dodd-Frank Act, Labor should provide guidance to plan sponsors on the risks, structure, and dynamics of stable value funds, consistent with the recommendations proposed by the Employee Retirement Income Security Act of 1974 (ERISA) Advisory Council regarding the disclosure of information about stable value funds.

    Agency Affected: Department of Labor

    Status: Open

    Comments: The Department of Labor reported that it is not prepared at this time to commit to providing the recommended guidance. However, the agency will pursue further consideration of the recommendation prepared by the ERSIA Advisory Council regarding stable value funds. GAO believes that the guidance should be issued in a prudent but expeditious manner. Given that the ERISA Advisory Council report on stable value funds was posted in April 2010, without additional guidance or assistance, plan sponsors may remain unaware of the risks and challenges associated with this investment option. Furthermore, because Labor will be consulting with SEC and CFTC with regard to their study of stable value funds, Labor has a unique opportunity to assist participants in their understanding of the restrictions, limitations, and risks of investing in such funds. This effort would provide a great opportunity for DOL to assist plan sponsors and participants in building retirement security.

    Recommendation: Given the current practice of securities lending with cash collateral reinvestment, its role in 401(k) plan investments, and our findings that plans and plan participants can bear a disproportionate amount of any loss associated with the practice, Labor should take action to help plan sponsors of 401(k) plans and plan participants understand the role, risk, and benefits of securities lending with cash collateral reinvestment in relation to 401(k) plan investments. ERISA requires that the fees paid to plan service providers be reasonable with respect to the services performed and Labor, in its implementation of prohibited transaction exemption (PTE) 2006-16, its prohibited transaction class exemption for securities lending, specifically requires that compensation received by the parties involved in the securities lending transaction should be reasonable. According to Labor, PTE 2006-16 does not cover cash collateral reinvestment. Therefore, Labor should review the practice of securities lending with cash collateral reinvestment, to provide guidance to plan sponsors as to what would be reasonable levels of fees and reasonable distributions of returns when 401(k) plan assets are utilized in this practice.

    Agency Affected: Department of Labor

    Status: Open

    Comments: The Department of Labor (DOL) disagrees with this recommendation. DOL notes that a plan sponsor's decision to offer any investment option, which may engage in securities lending, is a decision that must be made in accordance with the fiduciary responsibility provisions of ERISA, based on all relevant facts and circumstances. Because each decision is made based on a number of variables, DOL believes it would not be possible for the agency to provide specific guidance on reasonable levels of fees and reasonable distributions of returns in connection with any particular securities lending cash collateral reinvestment. GAO recognizes the complexity of these transactions and the diligence that should be taken in developing such guidance. Nevertheless, key participants in securities lending transactions are already moving in the direction of providing additional guidance to plan sponsors. For example, some securities lending agents have already begun to make changes to their securities lending programs in response to plan sponsors who have requested more disclosure about securities lending and cash collateral pools and have also requested that their securities lending programs take on less risk. In addition, securities lending agents are beginning to standardize guidelines for cash collateral pool investments, changes which they think would provide participants with some protection from losses. These industry driven developments clearly suggest that not only is such guidance possible, but that it is in the best interest of plan sponsors for Labor to provide some assistance on this issue.

    Recommendation: Given the current practice of securities lending with cash collateral reinvestment, its role in 401(k) plan investments, and our findings that plans and plan participants can bear a disproportionate amount of any loss associated with the practice, Labor should take action to help plan sponsors of 401(k) plans and plan participants understand the role, risk, and benefits of securities lending with cash collateral reinvestment in relation to 401(k) plan investments. ERISA requires that the fees paid to plan service providers be reasonable with respect to the services performed and Labor, in its implementation of PTE 2006-16, its prohibited transaction class exemption for securities lending, specifically requires that compensation received by the parties involved in the securities lending transaction should be reasonable. According to Labor, PTE 2006-16 does not cover cash collateral reinvestment. Therefore, Labor should revise PTE 2006-16 to include the practice of cash collateral reinvestment by requiring that plan sponsors who enter into securities lending arrangements utilizing cash collateral reinvestment on behalf of 401(k) plan participants not do so unless they ensure the reasonableness of the distributions of expected returns associated with this arrangement.

    Agency Affected: Department of Labor

    Status: Open

    Comments: The Department of Labor (DOL) noted that section II(g) of the exemption currently requires that all fees and other consideration received by the plan in connection with the loan of securities are reasonable. It is not feasible to require additionally that plan sponsors ensure a certain level of expected return on any particular investment. Market forces and the chocie of investments will affect the return to the plan. However, DOL will consider whether to amend PTE 2006-16 to require the securities lending agreement described therein to provide enhanced disclosures to plan fiduciaries. It is not GAO's intent that rates of return should be ensured in such transactions, but that the reasonableness of the distributions of expected returns be ensured. However, under ERISA, DOL is already responsible for enforcing the requirements that plan sponsors ensure that the fees paid with plan assets are reasonable and for necessary services. Applying the same standard to the parameters of transactions involving securities lending with cash collateral can help reduce the risk of loss to plan participants. Securities lenders are already implementing changes that could redefine the potential of loss and return to plan participants from these transactions. Action by DOL can help to ensure that it will not only be sophisticated plan sponsors who are likely to get the disclosures they need, while other plans sponsors continue to be unaware of what they need to ask for and understand regarding securities lending with cash collateral reinvestment.

    Recommendation: Given the current practice of securities lending with cash collateral reinvestment, its role in 401(k) plan investments, and our findings that plans and plan participants can bear a disproportionate amount of any loss associated with the practice, Labor should take action to help plan sponsors of 401(k) plans and plan participants understand the role, risk, and benefits of securities lending with cash collateral reinvestment in relation to 401(k) plan investments. ERISA requires that the fees paid to plan service providers be reasonable with respect to the services performed and Labor, in its implementation of PTE 2006-16, its prohibited transaction class exemption for securities lending, specifically requires that compensation received by the parties involved in the securities lending transaction should be reasonable. According to Labor, PTE 2006-16 does not cover cash collateral reinvestment. Therefore, Labor should amend its regulation on plan sponsor disclosure to participants to include provisions specific to (1) the practice of cash collateral reinvestment utilized by fund providers' securities lending programs and (2) disclosing the potential for withdrawal restrictions.

    Agency Affected: Department of Labor

    Status: Open

    Comments: The Department of Labor (DOL) disagrees with this recommendation. Without further study and review, DOL believes it is not prepared to conclude that the regulations governing the disclosure of investment-related information to participants and beneficiaries must be amended to specifically address securities lending-related issues. GAO strongly encourages DOL to initiate the study and review what it deems necessary, and, to amend its disclosure regulations as appropriate. Securities lending with cash collateral reinvestment arrangements can be very complex transactions. Labor's participant disclosure regulations do not explicitly require plan sponsors to disclose information on the risks of securities lending with cash collateral reinvestment or withdrawal restrictions that can result from securities lending. GAO acknowledges that the current participant disclosure regulations require that information pertaining to investment risks and investment strategies be available to plan participants. However, these regulations require only disclosure of investment options, and not all practices utilized by those investment options - of which securities lending is one practice - and it is unclear how much or to what extent securities lending fees and risks will be discussed in these disclosures. Furthermore, DOL only requires that information be made available to plan participants, not disclosed, which would require plan participants to know what information they need to avail themselves of in order to understand the fees and risks of securities lending. Without better disclosures on securities lending with cash collateral, participants may continue to be unaware of the practice of cash collateral reinvestment and the risks it poses, as well as the potential for withdrawal restrictions resulting from such practices.

    Recommendation: Given the current practice of securities lending with cash collateral reinvestment, its role in 401(k) plan investments, and our findings that plans and plan participants can bear a disproportionate amount of any loss associated with the practice, Labor should take action to help plan sponsors of 401(k) plans and plan participants understand the role, risk, and benefits of securities lending with cash collateral reinvestment in relation to 401(k) plan investments. ERISA requires that the fees paid to plan service providers be reasonable with respect to the services performed and Labor, in its implementation of PTE 2006-16, its prohibited transaction class exemption for securities lending, specifically requires that compensation received by the parties involved in the securities lending transaction should be reasonable. According to Labor, PTE 2006-16 does not cover cash collateral reinvestment. Therefore, Labor should provide plan sponsors with guidance alerting them to the risks of engaging in securities lending with cash collateral reinvestment and the types of information they should seek from their service providers about these investments.

    Agency Affected: Department of Labor

    Status: Open

    Comments: The Department of Labor will consider this recommendation in light of its experience with security lending practices.

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