Conflict of Interest Case Studies

In the industry, we see conflicts of interest coming from two sources: employers managing 401(k) plans, and service providers working on behalf of those employers. In either case, conflicts of interest arrive when an employer or service provider has an incentive to put its own interests in front of the needs of the employees the retirement plan serves. Review the following quick case studies for examples of what different conflicts of interest can look like in the context of different plans.

Conflict #1: Banking Arrangements

Type of conflict of interest
Employer

The Scenario
A local financial services firm provides wealth management solutions to both a small business owner and the business’s 401(k) plan.

The Potential Conflict
There’s nothing inherently wrong with this scenario, but there is a potential for conflict. If, for example, the bank required the business to hire it for some of its 401(k) plan services to receive a discount on other services provided to the business, then the business has the incentive to make a decision to benefit itself, and not the employees. As a fiduciary, if the business chooses a plan service provider based on a separate benefit to the business, that is a prohibited conflict of interest.

The Solution
The business must follow bank’s standard fee schedule and get no special discount. The plan services cannot be tied to the business services. As always, the business should thoroughly document its prudent process in choosing to use the bank as its 401(k) provider.

Conflict #2: Personal Provider Relationships

Type of conflict of interest
Employer

The Scenario
A small business owner chooses a 401(k) service provider that employs his nephew as a financial advisor on the account.

The Potential Conflict
Because a nephew is involved, the seriousness of the conflict depends on whether the relationship would affect the owner’s judgment. If so, it is a prohibited conflict. If not, it can proceed, although the owner should thoroughly document the prudent process used to choose the 401(k) provider.

If the scenario involved a parent, grandparent, spouse, child, or grandchild, the arrangement would be completely prohibited. Siblings and nieces are treated as described above with respect to the nephew.

The Solution
The nephew would have to waive the right to receive any fee associated with the account. Another option would be for the business owner to document that the relationship with the nephew is so insignificant that it would not impact the owner’s judgment, but that is an admittedly strange memo to write because it declares your nephew is unimportant.

Conflict #3: Proprietary Funds

Type of conflict of interest
Service Provider

The Scenario
A 401(k) service provider strongly recommends that a small business offer it’s proprietary funds through the business’s 401(k) plan, and the funds pay a fee to the 401(k) service provider.

The Potential Conflict
The fee paid to the service provider is generally prohibited because the service provider stands to make an additional profit from the use of the funds in the plan. The conflict is that the provider has an incentive to offer more expensive funds, when there may be lower cost funds of equal quality available elsewhere.

The Solution
It’s very common for service providers to offer proprietary funds, and there’s nothing wrong with them doing so. In order to avoid a potential conflict of interest, the service provider would have to do one of the following:

  1. Qualify for a regulatory exemption, such as the Best Interest Contract Exemption, which permits fiduciaries to receive compensation despite the conflict, subject to certain conditions.
     
  2. Charge no fee at the fund level. This is what Fisher does. We charge a single asset-based fee at the plan level. Another way to accomplish this would be to reimburse or offset the fund level fees against other plan fees.

Conflict #4: Revenue Sharing

Type of conflict of interest
Service Provider

The Scenario
A financial advisor helps an employer select a non-fiduciary recordkeeper and recommends the funds available to the plan. The funds share revenue with the recordkeeper and financial advisor. The recordkeeper is not an affiliate of the financial advisor.

The Potential Conflict
The fee paid to the financial advisor is generally prohibited because the financial advisor stands to make an additional profit from the use of the funds in the plan. This extra profit is a motivator for the financial advisor to choose a fund, rather than what is best for the employees.

The recordkeeper can receive the shared revenue so long as it is not a fiduciary to plan and is not affiliated with the financial advisor.

The Solution
In order to avoid a prohibited conflict, the financial advisor would have to do one of the following:

  1. Not make any recommendation about the funds available through the plan.
     
  2. Qualify for a regulatory exemption, such as the Best Interest Contract Exemption, which permits fiduciaries to receive compensation despite the conflict, subject to certain conditions.
     
  3. Charge no fee at the fund level.

Conflict #5: Ancillary Product Sales

Type of conflict of interest
Service Provider

The Scenario
A financial advisor gives advice to a 401(k) plan and also sells other investment products to employees participating in the plan.

The Potential Conflict
Sometimes, there’s more money to be made for a financial advisor in selling ancillary investment products and services to individual participants than there is in advising a 401(k) plan. A financial advisor might make 0.02% of a $1,000,000 401(k) plan in fees, worth $2,000 per year. But they might also sell a $100,000 annuity to an individual employee in that plan, with a 5% fee that equals $5,000 in additional revenue. Is this financial advisor selling these products to employees in a plan because they’re a good solution for those employees, or is the financial advisor simply seeking to make additional profit, using the 401(k) plan as a foot in the door?

The Solution
In order to avoid a prohibited conflict, the financial advisor would have to do one of the following:

  1. Not give any advice to the plan.
     
  2. Receive no fee in connection with the products or services provided to the individual employees.
     
  3. Qualify for a regulatory exemption, such as the Best Interest Contract Exemption, which permits fiduciaries to receive compensation despite the conflict, subject to certain conditions.

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Fisher Investments 401(k) Solutions is dedicated to helping small and mid-size businesses deliver successful ‭retirement plan services. Our success is defined by each business achieving its custom 401(k) plan goals and by ‭empowering employees with the dedicated support and resources necessary to achieve a dignified retirement. Our ‭solutions are built on the core principles of providing employers and employees ready access to dedicated 401(k) ‭specialists, flexible investment options, and fee transparency.

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