Managed Account Services
As 401(k) plan sponsors explore ways to provide participants with more services and better outcomes, adviser managed account services are increasingly gaining attention. These are customized investment management services for participant plan accounts. This article focuses on managed account services that a plan sponsor designates as an available investment service for participants. Here are some key points that advisers should keep in mind.
ERISA Considerations
In providing investment management services for a participant’s account, the adviser is a fiduciary under the Employee Retirement Income Security Act and an ERISA Section 3(38) investment manager with respect to the account assets; he also must provide an ERISA 408(b)(2) disclosure to the plan sponsor.
As a fiduciary, the adviser must adhere to the duties of prudence and loyalty in managing the participant account assets. This means he should undertake a diligent process to obtain information about the participant—such as the person’s investment objectives, risk tolerance and financial needs—and then use that information to develop and implement an investment strategy that aligns with those variables.
It is a good best practice for the adviser to document the process supporting the investment decisions. He should also ensure that the compensation for the managed account service is reasonable relative to the services provided.
Besides these ERISA considerations, advisers should be aware of the Securities and Exchange Commission’s guidance on reverse churning and should therefore actively manage the participant accounts. At least one lawsuit has already been filed alleging reverse churning violations.
The Services
The principal service offered in a managed account is customized discretionary portfolio management. There is a growing trend to offer additional valuable services—e.g., projections on retirement readiness, savings rate guidance, Social Security retirement benefit guidance, and retirement distribution planning. These additional services should be considered in evaluating the reasonableness of the adviser’s compensation.
Plan Design
There are two ways for a managed account service to be offered in a 401(k) retirement plan—opt-in and opt-out. With an opt-in plan design, the managed account service is available for all participants to elect. With an opt-out plan design, managed accounts are the plan’s qualified default investment alternative, meaning that participants who fail to make an election are defaulted into a managed account. The participant may then opt out and elect other plan investments.
The opt-out plan design may be structured as a “dynamic” QDIA—i.e., a QDIA that uses a target-date fund as the initial default until a specified age, such as 45 or 50, and then the plan transitions the QDIA from the TDF to a managed account. Incidentally, a plan may offer both opt-in and opt-out services, with one being for participants to actively choose and the other being the default.
QDIA Status
To qualify as a QDIA, the managed account program must:
- Be managed consistently with generally accepted investment theories—e.g., model portfolio theory;
- Use the plan’s designated investment alternatives, meaning that, if investments outside the plan line-up are used, the managed accounts will fail to qualify as the QDIA, though it may qualify under another QDIA category—e.g., a target-date or balanced-model portfolio managed by a 3(38) investment manager;
- Allocate among equity and fixed-income investments;
- Be based upon the participant’s age, target retirement date or life expectancy; and
- Be diversified to minimize the risk of large losses, with the objective of becoming more conservative with the holder’s increasing age.
In addition, the plan must provide participants with notices about the QDIA.
Conclusion
There are more considerations—e.g., disclosures and the prohibited transaction rules, which are discussed in the briefs below. Managed account solutions provide advisers with an opportunity to help participants improve investment outcomes and promote retirement readiness.
More on Adviser Managed Accounts
Prohibited Transactions
Advisers who intend to offer managed account services for plan sponsors to provide as an available investment service for participants should be aware of the self-dealing prohibited transaction rule under the Employee Retirement Income Security Act and the Internal Revenue Code. This rule says a fiduciary may not use her fiduciary authority to cause herself to receive additional compensation from a client’s plan. This means a fiduciary adviser may not use her authority to recommend herself to the plan as a participant-level investment manager and receive an additional fee.
This prohibited transaction issue can be managed in a few ways:
Rely on Prohibited Transaction Exemption 2020-02. PTE 2020-02 is an exemption from the prohibited transaction rules for conflicts of interest arising from nondiscretionary fiduciary recommendations. Here, the fiduciary adviser’s recommendation to hire herself as a participant-level investment manager is nondiscretionary because the plan sponsor will make the final decision as to whether to engage her. In order to secure the protection provided by the PTE, a number of conditions must be satisfied, including adherence to: a best interest standard, disclosure obligations, policies and procedures to ensure compliance, and an annual retrospective review of compliance.
Have no fiduciary status at the time of the recommendation. If the adviser is not an ERISA fiduciary to the plan or the participant and simply engages in a “hire me” discussion touting her services, this is not self-dealing. In fact, the sponsor may hire the adviser to provide an array of services.
Do not charge a managed account fee. If the adviser is a fiduciary to the plan receiving a plan-level advisory fee, she may recommend her managed account service as long as she charges no additional fee for that service. In that case, there would be no self-dealing.
Disclosure Considerations
An adviser designated by a plan sponsor to provide a managed account service must provide a 408(b)(2) disclosure to the sponsor describing the service, compensation and adviser’s status in advance of the engagement.
While there is no Department of Labor-specific guidance that the adviser provide a similar disclosure to the participants, doing so is a best practice so they understand how their account will be managed and the risks involved. Further, it is a best practice to provide participants with the adviser’s Form ADV, Part 2, or similar brochure.
Where similar portfolio management services such as model portfolios are provided to participants, Rule 3a-4 of the Investment Company Act of 1940 provides a safe harbor from the definition of an investment company such as a mutual fund.
In effect, the rule requires that each participant receive individualized investment treatment. For instance, the adviser must contact the individual at least annually to determine whether there have been changes to his investment objectives. Where participant accounts are managed based on a number of participant-specific factors, they will not closely resemble one another, which is helpful in avoiding the need for Rule 3a-4.
Advisers who offer managed account services should develop disclosures with these considerations in mind.
Joan Neri is counsel for Faegre Drinker’s financial services ERISA practice in Florham Park, New Jersey. Fred Reish is chairman of the financial services ERISA practice at Faegre Drinker in Los Angeles.