The Plan Sponsor’s Ability to Evaluate Conflicts of Interest

By Fred Reish and Joe Faucher

When making decisions about their retirement plans, plan sponsors have a duty to understand and evaluate conflicts of interest that could impact the plan. In some cases, plan sponsors are prohibited from entering into transactions that involve conflicts of interest.

Those conflicts fall into two broad categories. The first is where the plan sponsor has a conflict. The second is where a service provider has a conflict of interest.

On the former, a plan sponsor must put the interest of the participants ahead of its own when making decisions about retirement plans. For example, if a bank told a plan sponsor that it would get a lower interest rate on its corporate loans, or a larger extension of credit if the administration of the plan was placed with the bank, the plan sponsor would have a conflict in making that decision. That is because, from a corporate perspective, it would be in the plan sponsor’s benefit to get the better loan. However, from a retirement plan perspective, it may or may not be in the best interest of the participants. But, in this case, the plan sponsor cannot avoid the conflict simply based on the quality of the bank’s 401(k) services. That is because ERISA strictly prohibits the plan sponsor from gaining any advantage from its use of plan assets. Even if the arrangement is favorable to the employees, it is strictly prohibited by ERISA.

Some conflicts are not prohibited by law, but even then, a plan sponsor must evaluate the conflict and act in the best interest of the participants.

If you are interested in knowing more about this subject, take a look at our White Paper on conflicts of interest for plan sponsors. It is located at www.reish.com/publications/pdf/whitepprmar09.pdf.

The balance of this article is about the second type of conflicts – those involving service providers.

So that you fully appreciate the legal responsibility, let’s look at what the DOL says:

With regard to the prudent selection of service providers generally, the Department has indicated that a fiduciary should engage in an objective process that is designed to elicit information necessary to assess the provider’s qualifications, quality of services offered and reasonableness of fees charged for the service. The process also must avoid self dealing, conflicts of interest or other improper influence.

That is a difficult job because, while the provider knows about its conflicts, a plan sponsor may not. So, the starting point is for the plan sponsor to ask the provider to describe, in writing, all materials conflicts of interest that could impact the plan and/or the participants. That will be easier for some providers, but harder for others. For example, registered investment advisers, or RIAs, are required to provide plan sponsors with a Form ADV Part II, or a similar brochure, which discloses conflicts of interest, but other advisors may not have similar disclosure documents.

What are material conflicts of interest? Typically, but not always, a material conflict involves money. For example, is your adviser receiving money from one of the providers or from the investments? If so, that creates a conflict where the adviser may favor the provider or the investment over the plan and the participants. It doesn’t mean that the adviser will make biased decisions (and, in our experience, most do not), but it does mean that there is the potential for a biased decision.

What should you do if a service provider refuses to give you a written description of his material conflicts? The first alternative is to refuse to work with the service provider. Viewed from a legal perspective, the provider is refusing to support you in the fulfillment of your fiduciary responsibilities. You have to ask, is the benefit of working with this particular provider so great that you are willing to take on additional responsibility, and potential risk, in fulfilling your fiduciary duties?

Last year, there was a proposed Department of Labor regulation which would have required service providers to disclose their material conflicts before entering into an agreement with a plan. Unfortunately, that regulation was held up by the prior Administration. However, the DOL is reworking that regulation as we write this article.

However, for the time being, if your provider refuses to give you the information (but you want to continue to work with that provider), you have a fiduciary duty to investigate in order to determine whether there are any conflicts. Among other things, that means that you need to carefully read all of the materials that the provider gives you—and you should probably have your ERISA attorney review those materials and advise you on potential conflicts as well.

Note: Once the 408(b)(2) regulation is effective, it will require most service providers to disclose their material conflicts of interest.

© 2009 Reish & Reicher, A Professional Corporation. All rights reserved. The REPORT TO PLAN SPONSORS is published as a general informational source. Articles are general in nature and are not intended to constitute legal advice in any particular matter. Transmission of this report does not create an attorney-client relationship. Reish & Reicher does not warrant and is not responsible for errors or omissions in the content of this report.

Learn more about R&R related practice areas:
Employee Benefits