Advisors Face New Conflict of Interest Challenges
Advisors are accustomed to skepticism about potential conflicts of interest. Historically, the skepticism focuses on the advisor’s motives, loyalties and actions. The potential for conflict is front and center in enough client relationships to motivate the Department of Labor to spend nearly 15 years attempting to expand the definition of a fiduciary, with the end goal of mitigating the harm done by conflicts.
A trio of recent litigation developments suggests that advisors may need to broaden the lens through which they identify and observe conflicts. Advisors need to continue to look inside; as a starting point, they shouldn’t lose sight of Prohibited Transaction Exemption 2020-02, which remains applicable to investment advice even as the Trump administration has tapped the brakes on its defense of President Joe Biden’s conflicts of interest rule.
However, they will be well-served to look more closely outside, as their clients—and their revenue opportunities—may be under attack from other conflicted parties. This column isn’t about passing judgment on the litigation targets or predicting ultimate liability; it’s about helping advisors to better understand their value proposition and grow and protect their businesses
Proprietary Product Placement
A pending class action lawsuit against TIAA alleges that company fiduciaries caused plan participants to use expensive versions of underperforming proprietary funds packaged as part of proprietary variable annuities. An amended complaint filed in May added three new claims, two new named plaintiffs and one new law firm. (Note that a separate pending suit against TIAA (and Morningstar) alleges that TIAA developed an investment advice tool that would increase the flow of assets into two of its most profitable proprietary investment vehicles.)
Lessons for Advisors. Courts have begun to express an appreciation for the value provided by an independent fiduciary investment advisor. Contrast In re Quest Diagnostics ERISA Litigation, in which the court celebrated the committee’s engagement of a fiduciary advisor as an indication of a diligent process, with the absence of an independent fiduciary in place in the first TIAA suit referenced above. The first suit highlights the importance of having an advisor; the second should alert advisors to the possibility that other parties’ systems may be reverse-engineered to lead participants to a particular outcome.
MEPs and PEPs: The Value of Independence
This spring, a jury awarded plaintiffs more than $38 million in a case alleging that Pentegra fiduciaries had breached their fiduciary responsibilities in connection with a multiple-employer plan for which Pentegra served as the plan sponsor and had engaged an affiliate (Pentegra Services Inc.) to provide recordkeeping and administrative fees. The case involved allegations of self-dealing, conflicts of interest and excessive fees. We learned in July that the total settlement had ballooned to $48.5 million after the parties had settled additional claims.
Lessons for Advisors. As advisors across the country join the accelerating support for pooled employer plans, the Pentegra structure serves as a cautionary tale. Pooled plan providers, who have significant statutory fiduciary responsibility with respect to PEPs, come in many flavors. The Pentegra structure suggests that advisors may be best served to prioritize “independence” as their favorite PPP flavor.
Who Can We Trust?
“Who owns the data?” This question rings throughout the ballrooms of financial services conferences. The more important question might be: “What are they doing with the data?” A recent class action lawsuit filed against Empower targets the way Empower Retirement and its affiliates use plan participant data. In overly short terms, the suit alleges that: (i) Empower leveraged its plan recordkeeper relationship to harvest plan participant data for its economic benefit; (ii) Empower provided this data to an affiliate, Empower Advisory Group, that used the data to target participants; and (iii) the affiliate falsely portrayed the out-of-plan managed account program as a superior—and in fact, the only—recommended investment option. The suit also alleges excessive fees and the concealment of sales representatives’ conflicts of interest.
Lessons for Advisors. The alleged structure is noteworthy for advisors for three important reasons:
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Client Protection: Many advisors want to know that their clients, including plan participants, are receiving sound, non-conflicted and transparent advice. This lawsuit describes an advice structure with the opposite traits.
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Convergence: Yes, as the saying goes, two things can be true. Advisors can want their clients to receive non-conflicted advice and they can desire to be paid to manage client assets. This lawsuit describes a service provider role that creates headwinds against attempts to execute on a convergence strategy.
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Partnerships: The term “partner” may be overused in the retirement plan context. However, the principle is sound: advisors have an interest in knowing which complementary service providers are working against them.
Ultimately, it is important for participants, plan sponsors and other plan fiduciaries to know who they can trust. As these cases highlight, advisors stand to benefit from that same understanding.