The Markets December 22, 2006

DoL QDIA Proposal Prompts 98 Comment Letters

The Department of Labor’s (DoL) September proposal governing qualified default investment alternatives (QDIAs) evoked applause from the retirement industry, but that approval was soon followed by a flood of suggestions on ironing out the kinks before a final proposal is inked.
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In some of the 98 letters – posted online at the DoL Web site – about the proposal, correspondents asked the agency to:

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  • reconsider the requirement that participants get a notice 30 days before the first investment in a default alternative, because it limits plans that offer automatic enrollment upon hire;

  • offer greater clarification on 401(k) plan investment fees and to map out a plan to more closely monitor those fees;

  • add stable value funds to the list of permitted QDIAs;

  • make sure that redemption fees or other transfer restrictions applied to a QDIA at the fund level are not considered financial penalties.

The DoL proposal included a safe harbor rule that would give retirement plan sponsors some protections for the default investment options they chose (See DOL Unwraps New Default Investment Guidelines).

Lawmaker Letter

One of the comment letters came from four Democratic members of Congress, including the two incoming chairs of the House and Senate pension committees and the panels’ respective ranking Democrats. The lawmakers asked the DoL to address the effects of inflation of the rate of return, saying that the primary way “by which investments can preserve or increase capital is by earning returns that equal or exceed the rate of inflation,” and to make more clear that the goal of generating “adequate retirement savings” requires putting aside adequate savings and does not necessarily mean relying only on the unrealistic investment returns.

In the wake of 401(k) fee disclosure suits and the Government Accountability Office’s plea to Congress to consider mandating those disclosures (See GAO Urges Congress to Consider 401(k) Plan Fee Disclosure), the letter from the legislators urges the department to more closely monitor fees and offer detailed guidance on how to compare, understand and document all fees and expenses. The letter requested that the agency make clear that employers, plan administrators and fiduciaries may not receive payments for offering certain investment options (See Plan Sponsor Sues Principal over 401(k) Fund Revenue Sharing).

The legislators also asked the DoL to require plan sponsors provide an explanation that failure to select an option will result in a default election and to set out a process on what participants can do to exercise their right to select an option.

The Congress members signing the letter were Representatives George Miller of California and Robert Andrews of New Jersey as well as Senators Edward Kennedy of Massachusetts and Barbara Mikulski of Maryland. Kennedy and Miller are set to chair the committees in their respective chambers handling pension issues – the Senate Health, Education, Labor and Pensions Committee and the House Committee on Education and the Workforce.

Major Players Weigh In

The DoL also received comment letters from:

  • Fidelity Investments contended that the department’s disclosure requirement that says material received by a plan relating to a participant’s or beneficiary’s investment in a QDIA be passed to participants or beneficiaries who have been defaulted into the QDIA is too burdensome. Fidelity also asked that the final regulations provide fiduciary relief when a plan transfers participants from existing investment options to a QDIA, whether or not a participant provided instructions with respect to the original investments.

  • Hewitt Associates asked that the department apply safe harbor protections to previously defaulted amounts that are subsequently moved from either a prior default investment that was not a QDIA into a QDIA, or a QDIA to an alternative QDIA. The firm also asks that the department eliminate the requirement that a QDIA can only be managed by either an investment company registered under the Investment Company Act of 1940 or an investment manager as defined by the Employment Retirement Income Security Act (ERISA). The group also requested that the final regulation clarify that the annual default investment notice requirement does not apply to one-time default investment events.

  • The American Society of Pension Professionals & Actuaries (ASPPA) asked that a principal preservation investment be added to the list of QDIAs for a period of 120 days or less, to allow plans enough time to process participants’ requests to return their deferrals. The group also asked that the final regulation permit plan sponsors to provide notices to participants in a current default fund that will be a QDIA informing them that their accounts would remain in the current investment unless they make a different election and that participants be able to transfer their plan assets out of the QDIA within a certain time period for plans that do not provide more frequent investment election changes.

  • Profit-Sharing/401(k) Council of America asked the department to shorten the 30-day notice requirement before investing a plan participant’s assets in a default investment alternative. The group also asked that a mutual fund and pooled fund redemption fee, as well as other fees routinely applied to an investment when offered as a normal, non-default investment, not be considered a penalty. The council also suggested that the rule limits the ability of plan sponsors to manage qualified default alternatives and that these investment alternatives should be able to hold employer securities in separately managed accounts.

  • The Committee on Investment of Employee Benefit Assets (CIEBA) said that the department’s requirement about who can manage a QDIA could limit plan sponsors’ ability to offer cost effective and well-diversified options tailored to a particular plan. The group also suggested the department shorten the 30-period required for giving a participant notice of default investment.

  • Fred Reish, a prominent ERISA attorney with the law firm Reish Luftman Reicher & Cohen, said that the final regulation needs greater clarification that the third party that determines the asset allocations of a plan qualifies as an investment manager under ERISA. He also suggested a change that even though that third party is a fiduciary investment manager for the purposes of the QDIA, the independent party does not, because of that activity, become a fiduciary for the purpose of selecting or monitoring the investment options in the plan.

  • Stable Value Investment Association called the DoL’s definition of a QDIA too narrow and asked that it include stable value funds as a stand-alone default investment option, because plan fiduciaries may want “more conservative default investments.”

  • DALBAR, Inc. called the age-based default investment options “inappropriate for an employee after retirement,” saying that “employees relying on the default will find that their retirement portfolio is very poorly structured to replace a paycheck for the rest of their lives.” The firm also asked the agency to clarify the responsibility of the fiduciary adviser, particularly if an adviser to a plan gets the same protection as the plan sponsor.

The DoL default investment safe harbor would apply to all defined contribution plans that give participants a decision in the investments of their assets, including 401(k), 403(b), and 457 plans. However the rule only applies to plan scenarios where a plan participant’s assets are invested in permitted qualified default investment alternatives (QDIAs), which include: lifecycle funds, balanced funds and managed accounts.

Compliance December 22, 2006

So, You Think You Have Problems?

You may think things are crazy this time of year in your office – and they may well seem that way. Advisers are human, after all, and advisory firms composed of human advisers. We’re all subject to human foibles. But a recent NASD settlement reminds us all of just how out of control things can get.
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The $5 million settlement with USAllianz Securities was reached for what was described by NASD as “widespread supervisory and record-keeping violations.’ Supervisory violations are, unfortunately, not all that unusual in such matters, and record-keeping violations also seem rather innocuous, though they can have rather ominous implications (these days, as in this case, it generally comes down to email management).

Still, a settlement that, as this one did, also bars a firm from opening any new offices for 30 days – and from hiring any new registered representatives for seven days, seems a bit out of the norm. That USAllianz was also “ordered to retain an independent consultant to verify that it has fully implemented recommended modifications and additions to its supervisory system and procedures’ seemed to emphasize just how little faith NASD had in the ability to implement the mandated changes, despite the $5 million fine.

Making a List

In its announcement of the agreement, NASD said that “…for almost five years, USAllianz failed to establish and maintain a reasonable supervisory system and written procedures designed to oversee the firm’s registered representatives and their activities.’ It then went on to enumerate those deficiencies, including:

  • “Supervising principals who, in some instances, did not know which registered representatives they were responsible for supervising and in other instances registered representatives could not identify their supervising principals, both resulting in supervisory lapses.’
  • “Supervisors who were not qualified to carry out their supervisory responsibilities because they lacked experience, education and training; and, in other instances, supervisory principals inappropriately delegating their day-to-day supervisory responsibilities to other, less experienced principals, often without notifying the firm.’
  • “Inadequate staffing resources dedicated to compliance given the size and location of the firm’s sales force.’
  • “An internal office inspection program that failed to provide adequate oversight, training and guidance, leading to substantial failures to properly identify deficiencies.’
Specifically, NASD found that from April 2001 through March 2006, USAllianz did not have an adequate system in place to ensure that principals with supervisory responsibilities knew which registered representatives they were responsible for supervising. NASD noted that some representatives could not identify their supervising principal – and that, as a result, for certain representatives, activities commonly associated with daily supervision (such as trade blotter and correspondence review) did not take place.

Supervisory, Compliance Shortfalls Cited

NASD says that “many’ supervisors were not qualified to carry out their supervisory responsibilities because of a lack of experience, education and training – and that some delegated those responsibilities to individuals that were even less qualified.

NASD also took issue with the size of USAllianz’s compliance department, noting that for “much of 2001 and 2002, it had just two compliance officers for a large field sales force that were working in numerous offices scattered throughout the United States.’ NASD also took issue with the firm’s internal office inspection program, noting that it “failed to provide adequate oversight, training and guidance,’ and “did not provide inspectors with any objective standards for finding deficiencies or potential rule violations,’ – the latter led to “numerous instances where deficiencies were not appropriately identified.’ The settlement announcement noted as an example a situation where “an inspector could determine that an entire office was fully compliant in an area simply because a single registered representative did not exhibit any deficiencies in that area.’

NASD also said that USAllianz failed to offer an adequate training program for inspectors and did not ensure that they had an appropriate level of experience before conducting inspections. Finally, prior to March 2005, NASD says that “USAllianz did not have any system in place to capture, preserve and maintain e-mail communications.’

Now, as is frequently the case in such matters, in settling with NASD, USAllianz neither admitted nor denied the findings. They did, however, consent to NASD’s findings.

The NASD news release is online here

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