The degree of responsibility and risk borne by workers in 401(k) plans  underscores the need for prudent investment decisions if these plans are  to provide an adequate source of income in retirement. While plan sponsors and participants may rely on service providers for  assistance in making investment decisions, concerns have been raised  about the independence of the advice provided in some cases. Service Providers May Have Conflicts of Interest in Providing Investment Assistance to Plan Sponsors because of Third- Party Payments and Other Business Arrangements

		Service Providers’ Business Arrangements May Create Conflicts of Interest in Investment Assistance Provided to Plan Sponsors

Several industry experts we spoke with cited third-party payments, also  known as revenue sharing, as a potential conflict of interest for service  providers involved in the fund selection process for a 401(k) plan. Many Service Providers Are Reported to Arrange Their Association with Plan Sponsors in a Manner That Avoids ERISA Fiduciary Responsibility

Although service providers that are subject to ERISA fiduciary standards  are prohibited from benefiting from the investment of plan assets, many  service providers that assist in selecting investment options are reported  to structure their relationships with plans to avoid being subject to these  standards. Consequently, plan sponsors may not be aware that service providers can  have a financial incentive to recommend certain funds that would be  prohibited if they were ERISA fiduciaries. Participants May Receive Conflicted Investment Education and Advice from Service Providers in Certain Circumstances, but Enhanced Disclosure Could Help Mitigate Such Conflicts

		Participants May Perceive Investment Education as Advice and May Be Unaware of Situations when Service Providers Have Conflicts of Interest

Participants may be unaware that service providers, when furnishing  education, may have financial interests in the investment options available  to participants. For  example, the statement is not required to explain that the service provider  is not providing advice as an ERISA fiduciary who is required to act in the  participants’ best interests, and the provider may stand to profit from  participants’ investment decisions. Consequently, without the benefit of an  enhanced disclaimer that explicitly states that the highlighted funds are  not advice and that the service provider may have a financial interest in  the funds, participants may believe that providers are giving investment  advice that is in participants’ best interests, even in situations where this  may not be the case. Participants who  confuse investment education for impartial advice may choose  investments that do not meet their needs, pay higher fees than with other  investment options, and have lower savings available for retirement. Conflicts of Interest May Arise from Compensation to Service Providers for Cross-Selling Financial Products outside of Retirement Plans to Participants

Several industry experts we spoke with said that conflicts of interest also  arise for 401(k) service providers who sell nonplan products and services,  such as IRA rollovers, to participants outside their 401(k) plan, a practice  known as cross-selling, which can considerably increase the service  provider’s compensation. Indeed, although EBSA has taken steps to address conflicted investment  advice provided to plan sponsors or other plan fiduciaries by establishing  the Consultant/Adviser Project (CAP), this effort is constrained by the  current definition of an ERISA fiduciary investment adviser in its  regulations. These efforts include (1)  revising the definition of an ERISA fiduciary, (2) requiring enhanced  disclosure of providers’ direct or indirect compensation and fiduciary  status, and (3) establishing safeguards for PPA investment advice  arrangements. If the requirements specified in these regulations are  implemented as they are currently written, they may help EBSA and plan  sponsors detect and deter conflicted investment advice, but plan sponsors  and participants still would not have sufficient and comparable  information to identify potential conflicts of interest because disclosures  are not required to be provided in a consistent and summary format. Specifically, the interim final regulations do not specify that these  disclosures be made in any particular manner or format. In addition, to better ensure that plan participants have sufficient  information when deciding whether to move plan funds into investment  alternatives outside their plan, we recommend that the Secretary of the  Treasury amend the applicable requirements of its proposed disclosure  rule to specifically require that service providers, when recommending the  purchase of investment products outside retirement plans, inform plan  participants that fees applicable outside their plans may be higher than  fees applicable within their plans. Overall, Labor generally agreed with our findings and to consider our  recommendations as it conducts a review of these issues and evaluates  public comments received on pending regulations. To describe the steps that Labor has taken to address conflicts of interest,  we reviewed documentation of Labor’s enforcement activities related to  conflicted investment advice practices.
Why GAO Did This Study

Recent volatility in financial markets highlights the need for prudent investment decisions if 401(k) plans are to provide an adequate source of retirement income. While plan sponsors and participants may receive help in assessing their investment choices, concerns have been raised about the impartiality of the advice provided. GAO was asked to describe circumstances where service providers may have conflicts of interest in providing assistance related to the selection of investment options for (1) plan sponsors and (2) plan participants, and (3) steps the Department of Labor (Labor) has taken to address conflicts of interest related to the selection of investment options.

What GAO Found

The sponsors of 401(k) plans face conflicts of interest from service providers assisting in the selection of investment options because of third-party payments and other business arrangements. For example, providers who help sponsors to establish and maintain their plans may receive third-party payments from investment fund companies. The payments, sometimes called revenue sharing, create a conflict of interest because the provider may receive greater compensation from certain funds. Moreover, providers are reported to commonly structure their relationships with sponsors in a manner that avoids being subject to fiduciary standards under the Employee Retirement Income Security Act (ERISA). According to several industry experts, many sponsors, particularly of smaller plans, do not understand whether or not providers to the plan are fiduciaries, nor are they aware that the provider's compensation may vary based on the investment options selected. Such conflicts could lead to higher costs for the plan, which are typically borne by participants. In certain situations, participants face conflicts of interest from providers that have a financial interest when providing investment assistance. For example, although investment education is defined as generalized investment information, providers may highlight their own funds as examples of investments available within asset classes even though they may have a financial interest in the funds. According to industry experts, participants perceive education as investment advice. Thus, participants may not understand that the provider is not a fiduciary adviser required to act solely in participants' best interests. Also, several industry experts expressed concerns that providers stand to gain higher profits from marketing investment products outside of plans to participants, a practice known as cross-selling. For example, if participants use their plan provider for Individual Retirement Account rollovers, they may not understand, because of insufficient disclosures, that fees are often higher for products offered outside the plan and that the provider may not be serving as a fiduciary adviser. Consequently, participants may choose funds that do not meet their needs and pay higher fees, which reduce their retirement savings. While Labor has taken steps to address the potential for conflicted investment advice provided to sponsors and participants, more can be done to ensure they receive impartial advice. In fiscal year 2007, the Employee Benefits Security Administration (EBSA) began a national enforcement project that focuses on the receipt of improper or undisclosed compensation by certain providers, but its enforcement efforts are constrained to fiduciary providers and limited by EBSA's approach for generating cases. In addition, EBSA issued regulations to revise the definition of an ERISA fiduciary and require enhanced disclosure of providers' compensation and fiduciary status. These regulations, as currently specified, would help EBSA and sponsors detect and deter conflicted investment advice. However, the regulations do not require that certain disclosures be made in consistent or summary formats, which may leave sponsors with information that is not sufficient or comparable.

What GAO Recommends

GAO recommends that Labor amend pending regulations to require that service providers disclose compensation and fiduciary status in a consistent, summary format and revise current standards, which permit a service provider to highlight investment options in which it has a financial interest. GAO also recommends that the Department of the Treasury amend proposed regulations to require disclosure that investment products outside a plan typically have higher fees than products available within a plan. Overall, Labor and Treasury generally agreed to consider our recommendations as they evaluate comments received on pending regulations.