Plan sponsors ponder reaction to mutual funds

HR Magazine, Feb, 2004 by Bill Leonard

Sponsors of 401(k) plans are nervously debating their options and legal obligations in light of an extensive investigation by the New York attorney general that has implicated many of the nation's largest mutual fund families.

"Employers are only now just beginning to understand the long-term ramifications of this scandal," said Rick Meigs, president of the 401khelpcenter.com LLC, a Portland. Ore.-based retirement benefits consulting firm. "This scandal affects all employers that sponsor defined contribution retirement plans, which ultimately represents millions of workers and billions of dollars."

The allegations revolve around numerous mutual fund companies and financial services firms that allowed big institutional investors to take advantage of illegal "late-day trading" after the nation's stock markets closed at 4 p.m. Eastern time, when closing prices of stock mutual funds are calculated.

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Meigs suggests that employers, if they have not already done so, should gather information on the trading scandal and see if any investment vehicles offered in their 401(k) plans are involved. Plan sponsors should consider dropping a fund from the plan if there is any evidence of unethical business practices.

"I would say that the sponsors of the larger 401(k) plans have been right on top of this scandal from the beginning, and many have responded quickly by dropping suspect mutual funds as investment options from their plans," Meigs said. "Employers with smaller to medium-sized plans have been slower to respond. Most of those plan sponsors have chosen to do nothing so far, but they could find themselves in a world of trouble if they don't act soon."

Officials with the Employee Benefits Security Administration (EBSA), who enforce the Employee Retirement Income Security Act (ERISA), say they will watch how employers and plan sponsors respond. Under ERISA, plan sponsors or fiduciaries must make all decisions, including selection of mutual funds, solely in the interest of the plan participants and beneficiaries.

"Allegations of improper mutual fund practices where a plan is invested must be factored into the plan fiduciary's determination of the continuing appropriateness of investments," said Ann L. Combs, assistant secretary of EBSA, a Department of Labor agency, to members of the National Defined Contribution Council. "The plan fiduciary may need to contact the mutual fund's management for information regarding the trading practices and take appropriate action."

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Combs said that plan sponsors should not panic and start dropping suspect mutual funds immediately but added that EBSA expects sponsors to make a "prompt and prudent response" if the mutual funds offered in their plans are involved in any irregularities.

"A prudent response means that a plan sponsor should begin to evaluate the current mutual funds held within its plan," said Jeff Robertson, an attorney with the Portland. Ore.-based law firm of Bullivant Houser Bailey. "If the plan provides for any investments in a mutual fund company [that has] been questioned as part of the ongoing investigation, the plan sponsor should evaluate whether the plan sponsor should continue to allow such a fund as part of its retirement plan."

Even if the plan's mutual fund provider has not been targeted for investigation, it is still crucial for plan sponsors to evaluate and reconsider investment decisions, because ERISA requires plan sponsors to monitor plan investment performance and practices. Robertson suggests that plan sponsors should review the investment vehicles at least once a year, if not more often. "Quarterly reviews would be an excellent practice," he added.

To show a good-faith effort in monitoring their investment options' performance, according to attorneys with the Groom Law Group in Washington, D.C., plan sponsors should consider writing to fund managers and asking for written assurance that the fund and its employees have not participated in suspect trading activities and that the fund is not aware of any ongoing investigation of its trading practices; a copy of any public statement the fund has issued or plans to issue related to the recent allegations; and a copy of the fund's policies and practices.

"Plan fiduciaries should be sure to document the steps taken to monitor investment fund performance and the decisions made due to the evaluation of a fund," said Stephen Sax-on, an attorney with Groom. "Satisfying the fiduciary duties of ERISA requires diligent and thorough actions to monitor investments and document all decisions. Such documentation can help plan sponsors demonstrate that they have acted in the best interest of the plan and its participants."

In most cases after evaluating the investment funds, plan sponsors should find "business as usual" is the best policy and most likely will continue with the investment options currently in their plans, according to Saxon. However, many plan sponsors are reacting to the revelations of unethical business practices by reconfiguring the investment options offered in their 401(k) plans. According to the CFO Out-look, a survey of nearly 240 chief financial officers released in December by Financial Executives International (FEI) and Duke University's Fuqua School of Business, 23 percent of the respondents said their organizations already had changed the investment options offered in their 401(k) plans and another 29 percent reported that they planned to make changes this year.