Fidelity Investments reveals 'all-time high' 401(k) plan sponsor discontent, thanks to DOL monkey wrench that creates 'race to bottom,' key expert adds

The DOL rule may finally be turning the 401(k) industry upside down -- with help from market conditions -- based on the head-spinning results of the latest Fidelity Investments plan sponsor survey.

The survey revealed that competition among plan advisors and recordkeepers "is reaching an all-time high." It puts nearly $5 trillion of defined contribution assets in play or near to it.

Some 47% of plan sponsors are considering a new advisor, up from 34% last year, and 48% are considering a change of recordkeepers, the Fidelity survey found.

Louis Harvey, president of Dalbar Inc., a Boston market research company, says Department of Labor (DOL) rules emphasizing low fees have caused many 401(k) lawsuits and may be one of the reasons driving change. See: The DOL's Trump-era reprieve from rollover fiduciary rigor is over with aspects of remedy that might 'scare the daylights' out of defense lawyers

“The DOL has done virtually no enforcement, but it is their regulatory disclosures 408(b)(2) and 404(a)(5) that have enabled the excessive fee lawsuits. So, yes, you could say the DOL is at the root of the problem," Harvey says by email. 

"The rules caused fee disclosure so the plaintiffs had the information to file lawsuits. 408(b)(2) required fee disclosures to plan sponsors and 404(a)(5) required fee disclosures to participants. Before they went into effect, it was extremely difficult to obtain the information needed to sue." he said.

He adds that the myopic focus on cutting fees is causing a "race to the bottom."

Litigation frenzy

The Trump administration released an exemption-happy rule, which emphasized lower fees over quality service. The rule was approved and adopted in December 2020, though plan sponsors' takeaway remained roughly the same as the 2017 version.  See: The DOL's Trump-era reprieve from rollover fiduciary rigor is over with aspects of remedy that might 'scare the daylights' out of defense lawyers

An explosion of litigation over 401(k) plan fees followed. Plaintiff's lawyers filed more than 170 class actions leading to tens of millions of dollars in settlements, according to a Bloomberg Law analysis.

The suits are essentially based on "cookie cutter" allegations that employers are mismanaging retirement plans by offering expensive investments and failing to curb administrative fees. 

“For more than five years, plan sponsors have been surrendering to allegations that record keepers are undifferentiated except for fees. Eventually, plan sponsors are beginning to believe this falsehood and therefore actively seek lower cost replacements,” Harvey says.

“The unfortunate aspect is this trend creates a ‘race to the bottom,’ which hurts only the participants since recordkeepers are forced to degrade their service to remain viable,” he says. 

The U.S. Supreme Court gave litigators a more precise running lane in January by reviving a lawsuit by Northwestern University employees challenging the school’s retirement plan fees and investment lineup.

Employees argued that a plan has to do more than offer an array of investment options -- some good, some not so good. Retirement plans must offer only the most prudent fund options at the lowest cost. 

Not surprisingly, 51% of plan sponsors say they want more advisor expertise in many areas, notably proactive suggestions for improving plan performance, according to the Fidelity survey. 

Dynamic shift

Poor service is extra degrading during the perfect storm of inflation and bad markets waking plan sponsors to broader 401(k) service issues, says Aaron Schumm, CEO of Vestwell, a startup digital recordkeeper.

Vestwell has about $25 billion in assets with 25,000 employers as clients and 1 million participants. 

“The shift in market dynamics starts to create greater scrutiny on 401(k) plan structures, bringing into question aspects that would've taken a backseat from consideration before," Schumm says. 

When these shifts happen, Schumm says a small firm like his reaps the rewards. “All of these factors, amongst others, work to our favor at Vestwell.” 

Fidelity's survey of 1,285 plan sponsors with at least 25 participants and $3 million in plan assets, found that the high concerns focus on the way 401(k) fiduciaries choose to invest.

Some 93% of those surveyed said they plan to make changes to their investment menu lineup and 88% want a change in plan design.

The Fido survey particularly indicts recordkeepers and advisors for poor employee communications and education.  Recordkeepers were also cited for being ineffective in dealing with service issues, during the 2020 pandemic, according to the study. 

Advisor impact

Oddly, the study showed that 76% of plans were satisfied with their advisors -- the highest level in five years  -- even though 47% of employers said they are looking for a new advisor and recordkeeper.

Scott Smith, an analyst at Cerulli Associates in Boston, attributed the anomaly to plan sponsors who are likely content, but not necessarily impressed, by the advisors they are working with.

"This signals an increase in the baseline competency levels for advisors in the space. It's no longer good enough to get a plan established and working smoothly.

"The advisors need to be able to show how they are impacting the biggest areas of interest for sponsors: employee communications, investment lineup, and service issues.”

Liz Pathe, head of defined contribution investment-only sales at Fidelity Institutional, agreed, saying plan sponsors want experts. 

“Plan sponsors are continuously seeking more expertise from their plan advisors year-over-year to help them in a more diversified capacity and are not afraid to look elsewhere if a competing advisor offers a better experience," she said in a statement.

Cerulli analyst Shawn O' Brien says only about 19% of plan sponsors are actively seeking a new recordkeeper, according to Cerulli data. 

Net benefits

“The biggest surprise is the severe effect litigation has already had on plan sponsors,” Harvey says.

“On the other hand, plan sponsors are also awakening to two factors that compromise the participant retirement security.

"First is the need for support at and after retirement, and the second is the massive loss of returns due to pointless asset allocation.

The 60/40 asset allocation is applicable to less than 5% of participants but is routinely used for more than 95% of cases.”

In keeping with that observation,  93% of sponsors said they plan to make changes in their investment lineups.

Expanding sustainable environmental, social and governance funds, increasing other investments and managed account options drew about equal support.

Harvey is sure Fidelity sees the study signifying greener pastures more than red flags.

“As for the effect on Fidelity, there is a net benefit for them," he says. "Being among the top recordkeepers in the business, they are most likely to win far more business than they lose when changes take place.”