401(k) Plans – Compliance Solutions: Hiring and Monitoring Third-Party Service Providers

From: Staffing

401(k) Plans – Compliance Solutions: Hiring and Monitoring Third-Party Service Providers

401(k) Plans – Compliance Solutions: Hiring and Monitoring Third-Party Service Providers

Due to the complexity of compliance and potential costs of failure to be compliant, employers often hire outside professionals (third-party service providers) to augment their use of internal administrative committees and their human resources department. These outside experts are engaged to consult or manage some or all of a plan’s day-to-day operations. Inside the employing organization there may be one or more official(s) with discretion over the plan, called the plan’s fiduciaries.

Plan fiduciaries exercise discretion and control over implementing the plan according to the business decisions made by an employer. Fiduciaries can include a trustee, investment advisors, persons exercising discretion in administering the plan, members of a plan’s administrative committee (if applicable), and any committee officials (if applicable).

Plan fiduciaries are subject to standards of conduct and specified responsibilities, and must:

  • Act solely in the interest of plan participants and beneficiaries with the exclusive purpose of providing benefits to them.
  • Carry out all duties prudently.
  • Follow the plan documents (unless they are inconsistent with ERISA).
  • Diversify plan investments.
  • Pay only reasonable plan expenses and refrain from prohibited transactions.

Many of the actions required to operate a 401(k) plan involve fiduciary acts or decisions, including the process of hiring and/or retaining an outside service provider to perform fiduciary functions. Therefore, it is important for employers to document their selection process and continually monitor the services provided.

Hiring Service Providers

Pre-Hiring Process

When an employer hires a service provider to perform fiduciary functions for the plan, the service provider is in a position of trust with respect to plan participants and beneficiaries. Fiduciaries are required to carry out activities through a prudent process; thus, employers are challenged with ensuring the process of hiring a fiduciary is done with care.

Employers are encouraged to develop an objective process to use during the hiring process. This will ensure the employer considers relevant and important criteria when evaluating potential service providers. Before interviewing potential service providers, employers should understand the following:

  • The types of fees and expenses involved and a review of those charges as they pertain to investments under consideration and expected services.
  • The specific services that should be contracted (i.e., legal, trustee/custodian, accounting, investment management, investment education, or advice recordkeeping).
  • The types and frequency of:
    • Reports related to services provided;
    • Communications to participants;
    • Meetings for participants; and
    • Participant investment transfers.
  • The amount of responsibility the service provider is expected to have, including the types of services required to be included in the plan, any customized or added services that will be provided, and other optional features (such as loans, Internet trading, or phone transfers).

Hiring Process

Due diligence in selecting a service provider and executing a service contract is required. The service contract itself must be “reasonable.” Therefore, employers must obtain certain information from potential service providers. Specifically, for a contract to be reasonable, the employer must ensure the service provider has disclosed the following information pursuant to 29 CFR § 2550.408b-2:

  • A description of the services that will be provided.
  • The service provider’s, or their affiliate’s or subcontractor’s, intent to provide services directly to the plan as a fiduciary or registered investment advisor.
  • All compensation (direct and indirect), including compensation paid in connection with terminating the contract they will receive under the service agreement.
  • Whether recordkeeping services are provided to the plan.
  • Where applicable, certain investment disclosures.

Ensuring the contract is reasonable also highlights to the employer whether there are any conflicts of interest that could impact the service provider’s performance.

Employers should consider the following when hiring a service provider:

  • General information about the firm and its history, including any business affiliations, financial status, experience with 401(k) plans, and assets under its control.
  • The firm’s business practices, including how plan assets will be invested if the firm will be managing plan investments or how the firm handles participant investment directions.
  • Information about the staff/service providers at the firm and affiliates, including the identity, experience level, and qualifications of staff assigned to the employer’s account and whether any of the firm’s affiliates will be involved with the account.
  • The firm’s business history, including any recent or past litigation or enforcement actions against the firm and any performance record.
  • Whether the firm has fiduciary liability insurance.

Monitoring Service Providers

In addition to making diligent decisions when hiring service providers, employers must continually monitor service provider performance. Employers should:

  • Evaluate notices received from service providers regarding potential changes to compensation or any other information provided when they were initially or subsequently evaluated by the employer, such as at renewal.
  • Review performance, including following up on any participant complaints.
  • Read any reports generated by the service provider.
  • Audit fees charged by the service provider.
  • Inquire about the service provider’s policies and practices related to trading, investment turnover, and proxy voting, among others.
  • Evaluate the frequency of information received and ensure that frequency allows the employer to adequately monitor investment returns and service provider performance in order to make necessary changes.