ABA Webinar Notes: Investment & Service Provider Contracts, Continued

Yesterday I had the pleasure of speaking on an American Bar Association webinar sponsored by the Joint Committee on Employee Benefits. Webinars are always difficult -- there's so much information to get through that valuable nuggets often get left out. Here are the last minute deletions:

Alternative Investment Contracts: Multiple signors and fees

Many agreements for alternative investments don't support multiple signors/trustees or a retirement plan committee. I ran into this in a self-directed brokerage account situation where the agreement was asking for the personal information of the plan trustee (in this case there were several trustees) for the account registration. Besides the confusion on how to register the investment and who needed to sign, this presents several problems including the discomfort the committee had on making a judgement call on whether to allow this employee to include this investment in their self-directed brokerage account, as well as the problems that will inevitably occur when a plan trustee registered on the investment rotates off the committee or leaves the company altogether.

Another consideration for using alternative investments is whether all the sales fees and compensation to the advisor/broker have been properly disclosed in order to determine if the fees are reasonable. In some cases, the compensation can be as high as 5% to the broker. This means the committee must be educated on what the norms are for the particular investment in question.

Fixed Account Investment Contracts: Watch for inflexibility

Service providers frequently offer guaranteed interest or fixed interest accounts. Yesterday I covered that the fees for these are not transparent, however, most service providers can provide an estimate of what the revenue received is. When looking at the weighted average fees for the plan for determining fee reasonableness, be careful not to overlook including the revenue received from these types of accounts -- most often the averages are calculated assuming the fees for these accounts at zero. 

Be sure to look for any constraints on liquidity and transfers within the investment contract. One service provider I work with has a rule that no more than 20% of the total balance can be transferred out of the investment in one year. This could prove problematic if there are managed accounts that need to be rebalanced, the committee desires to replace that investment, or the plan moves service providers. In our case, we needed a place to park settlement money transferring into the plan before we could determine how it should be invested. We had to rethink our decision due to the transfer constraints.

How do you monitor a computer fiduciary?

While investment quantitative and qualitative statistics can be measured and parsed as good or bad by a computer algorithm, it can't make a judgement call on whether the investment makes sense for your employee base or pension, deserves an exception and for what reason, and it certainly won't provide perspective on how a particular investment strategy is playing out under current market conditions. Computers also won't make proactive suggestions as the market and investment trends change. How will you monitor that algorithm over time? Algorithms are only as good as the programming that went into them, and many will argue that Black Monday in 1987 was helped along by pension insurance algorithms all triggering sell orders at the same time. Finally, it's a bit difficult to negotiate with computers on fees or types of services being provided! 

These may not be the Droids you are looking for.

Fee Negotiations: Historical perspective

Zero revenue share funds + a record keeping/administration fee + investment advisory fees are picking up speed.

We mentioned yesterday that there are still a number of investment managers that don't provide zero revenue share funds. The full story is this: By the early 1990s, 401ks were provided by Fortune 100 companies only. Pre-1990s, A and B shares were all that were available and sold in the retail market. Revenue sharing payments in 401k plans became standard because the costs related to individual shareholders and transfer agency fees were being performed by the record keepers instead of the fund company. Institutional shares were around, but only for trades over $1 million. Keep in mind that a non-institutional trade of $1 million in the 1990s was a BIG deal because it didn't happen very often, unlike today's environment where large DC plans and $1 million or more trade tickets are the norm. The availability of R shares came about until the early 2000s out of the need for use in DC plans. Depending on how the fund accounting was/is structured at the investment management firm, there may not be enough in assets in the fund to support a myriad of share classes, all held as separate trusts, and still have advantageous expense ratios on each for investors. 

All this to say that ERISA budget accounts paired with crediting back the unused revenue sharing fees to participants are still a viable way to allow participants to get the lowest expense ratios (often the A share at NAV with revenue sharing credited back). For your service provider contracts where returning revenue sharing payments is involved, watch for how those fees are returned and at what intervals. Some record keepers will credit them back daily, others monthly or quarterly. 

Another angle to consider is there is often more negotiation power involved with plan service providers when registered funds are not involved because the fees aren't mandated by a mutual fund prospectus. Collective Investment Trusts or separately managed accounts can often be a way to reduce overall investment fees, provided that the plan sponsor understands the difference in using them over registered mutual funds. Here it is imperative that the trustees get good education.

Last on this subject, it's important to remember that record keeping systems are large and somewhat old. Making what seems like a simple change to the programming takes an inordinate amount of time and resources, and many of the record keeping companies have put constraints on size and circumstance for crediting back revenue sharing fees. Check for this in your service provider contracts.

Investment Advisor Contracts: Best practices

As stated on the webinar yesterday, there is evidence to support that the vast majority of financial advisors working with retirement plans are merely accommodating them as part of their wealth management practice. Additionally, many firms place compliance restraints on their registered representatives or investment advisors to keep them from taking certain risks or liability associated with plans. It is easier for larger organizations to paint hard and fast lines to make sure everyone stays in bounds to reduce risk. Keep a running tally or reach out to other attorneys to get feedback on what working with certain firms are like, particularly if they do not have a reputation as being retirement plan specialists.  Your advisor RFP should include questions along these lines to help your clients weed out those that will be ill-equipped to handle your client's particular situation.

On the flip side, in order to make sure an advisor doesn't end up with a multitude of unique snowflake clients, many times advisors will choose to standardize their processes or service offerings among clients. Keep this in mind for your RFP and ask references questions on what the service experience is like or how particular services are delivered.

If you were on the webinar, thanks very much for joining us!