Current Regulatory, Judicial and Legislative Environment

By Kartik Jambulapati

MAY 31, 2017

Department of Labor Delays Fiduciary Rule

The Department of Labor announced in April that it is delaying the effective date of the fiduciary rule by 60 days. The DOL explained this decision as a response to the request from President Trump to review whether the new rule would limit Americans from receiving retirement information and investment advice.

Starting June 9 (instead of April 10), advisers will have to comply with rules requiring them to make investment recommendations in the best interests of their customers, charge reasonable compensation for their services and refrain from making misleading statements. On January 1, 2018, all of the conditions, including written disclosures, are scheduled to become fully applicable. In the meantime, the DOL will examine the fiduciary rule and decide whether or not to make further changes.

Aon Hewitt Sued Over Fee Scheme

In January 2017, Aon Hewitt Financial Advisors LLC was accused of entering into a fee-sharing agreement with an online investment adviser, Financial Engines Inc. The lawsuit stated that Aon Hewitt entered into a fee arrangement with Financial Engines that led to unreasonable and excessive fees for the participants of Caterpillar Inc.’s 401(k) plan. Before 2014, Aon Hewitt had a direct agreement with Financial Engines to provide investment advice to participants in Caterpillar’s retirement plan. The fee for those services was significantly higher because Financial Engines paid a significant percentage of the fees they charged to Aon Hewitt.

Aon Hewitt was receiving about 25% of the advice fee paid by participants and between 20 and 25% of the managed account fee paid to Financial Engines. This resulted in millions of dollars in losses for the participants in Caterpillar Inc.’s 401(k) plan. This is the fourth lawsuit to target the fee arrangement for services provided through a recordkeeper; the other recordkeepers who have been sued under similar complaints include Fidelity, Voya and Xerox HR Solutions.

Self-Dealing Lawsuit Filed Against Charles Schwab

A lawsuit has been filed against Charles Schwab Corporation and its plan fiduciaries, claiming that plan fiduciaries acted imprudently in the decision to include Schwab’s proprietary investment products as investment options in the plan and to promote their own services to the plan. The complaint alleged that Schwab charged significant fees while making profits at the expense of the plan participants, and made no effort to investigate whether these products were prudent for the plan. The fees were noted to be excessive and unreasonable while vastly exceeding the costs of administering the plan. At the end of 2015, there were more than $500 million in plan assets invested in Schwab-affiliated funds. The assets were broken down into seven Schwab mutual funds, 10 Schwab target date funds (TDFs), a Schwab stable value fund, a Schwab money market fund and a Schwab savings account.

BlackRock Accused in 401(k) Excessive Fee Case

An employee of BlackRock has filed a lawsuit against the firm, claiming the use of proprietary funds in its 401(k) plan caused plan participants to pay excessive fees. Plan fiduciaries are accused of selecting and retaining high-cost and poor-performing investment options. The complaint states that almost all of the fund options offered to BlackRock employees and participants are funds affiliated with BlackRock. The plan has approximately $1.56 billion in assets and is of sufficient size to leverage access to lower-cost investment products and services. The complaint noted that the fees charged by BlackRock for their proprietary funds were much higher than the fees charged by other mutual fund companies with similar investment strategies.

Furthermore, the complaint alleges that the BlackRock LifePath Funds in the plan underperformed relative to target date benchmarks and alternative TDFs with similar investment strategies. Based on the $509 million the plan invested in the BlackRock LifePath Funds, employees lost tens of millions of dollars in retirement assets due to excessive fund layering. The plaintiffs are seeking relief equal to all investment advisory fees paid to BlackRock from plan assets and any losses to their retirement accounts from the fiduciary breaches and prohibited transactions.

Tax Reform

In April 2017, President Trump announced his plans for a tax reform bill, which cuts individual tax rates in the top bracket from 39.6% to 35%, and cuts the highest tax rate for all businesses from 35% to 15%. The proposal for lower individual income tax rates would cut the number of tax brackets from seven to three, consisting of rates of 10%, 25%, and 35% respectively. The White House has yet to finalize the levels of income that would apply to each of the three proposed brackets.

With the corporate tax cut, owners and shareholders of pass-through businesses are likely to benefit the most.  Because owners in a pass-through business report their profits on their personal tax returns, a reduction of the pass-through entity tax to 15% would represent a huge opportunity for these owners to report more of this money as business income and less as compensation, which would be subject to higher individual rates. Along with the proposals to reduce individual and corporate tax rates, President Trump has also called for a one-time tax on profits earned overseas by U.S. corporations, along with a switch to a territorial tax system that would require all U.S. companies to pay taxes on profits, even if those profits are accumulated outside the United States.

Department of Labor Focuses Audits on Timely Payments to Participants

Due to the significant number of large plans with potentially unpaid pension benefits, the Department of Labor has started inspecting retirement plans to determine whether plan sponsors have paid vested benefits in a timely manner to retirement-eligible participants. Plan qualification provisions require that retirement benefits be paid to participants and former participants by a specific date. Failure to issue a required minimum distribution may result in plan disqualification by the IRS and a possible 50% excise tax on the participant or beneficiary.

DOL officials have stated that the value of unpaid pension benefits was about $500 million for six plans they recently audited. Many of these investigations have been focused on plan procedures to find participants who may have moved, inform retirement-eligible participants that a benefit is payable and make required minimum distributions. The DOL discovered that some retirement plan sponsors do not have procedures in place to confirm the timely payment of retirement benefits to participants.

Legal Framework for Open MEP in Progress

In March 2017, bipartisan legislation was presented in the House and the Senate to make it easier for small businesses to offer retirement plans through an open multiple employer plan (MEP). The bill proposes the Department of Labor and the Treasury Department allow employers and sole proprietors participating in retirement plans administered in the same way to file a single Form 5500.

Under current law, each plan is required to file a separate Form 5500 to fulfill reporting requirements under ERISA. Bill sponsors stated that self-employed individuals and small business owners are most likely to establish a retirement savings plan that would benefit from and meet the requirements of an open MEP. The proposed legislation should eliminate duplicative reporting by plan administrators and will reduce costs for small businesses that offer retirement plans.

IRS Proposes Changes to Allow Forfeitures to Fund QNEC and QMAC

The IRS has proposed amendments to regulations that would allow plan sponsors to use forfeitures in their 401(k) plans to make qualified matching contributions (QMACs) and qualified nonelective contributions (QNECs). Current regulations require that a QMAC or a QNEC satisfy the nonforfeitability and distribution requirements at the time the contribution is made. Forfeitures are defined as employer contributions that are subject to a vesting requirement when made and then forfeited when participants terminate their employment before sustaining the vesting requirement.

Generally, plans with vesting requirements permit the employer to use forfeitures to reduce future employer contributions and plan costs. However, current regulations effectively exclude using forfeitures to make QMACs or QNECs.The proposed amendments in the regulations would require the nonforfeitability and distribution requirements to apply when the contributions are allocated to participants’ accounts.