Disclosure: A Fox’s Guide to the Henhouse


Plan fiduciaries rely on disclosure to protect participants from plan providers whose economic interests conflict with the best interests of participants. This reliance is misplaced.

One of the great challenges facing regulators –including the DOL and the SEC– and fiduciaries of both ERISA and non-ERISA plans is how to deal with plan providers who have dual loyalties.

These providers have been retained to provide services to a plan (such as recordkeeping or plan investments) and, for the most part, want to do a good job for the plan. On the other hand, these very same providers may also view the plan (and plan assets and participants) as a means to an end–as a way to generate revenue that is more profitable than income received from the (fee sensitive) retirement plan market and that avoids the challenges of winning new business in the (very competitive) retail markets.
Conflicted providers represent a significant challenge–and risk–to plan fiduciaries. These providers leverage the “implicit endorsement” of the plan sponsor and capitalize on participant confusion over the role of the financial “advisors” who work for these providers.
The most common response is to rely in legal notices and disclosures to “address” concerns over conflicted providers. However, this reliance on legal notices and disclosures needs more careful examination.

Proscription or Disclosure?

In thinking about this issue, let’s start with regulators.

  • The DOL appears to have taken a two-pronged approach, of both proscribing certain behaviors and using disclosure to curb other behaviors. The (now invalidated) regulations expanding the definition of the term “fiduciary” would have imposed a higher standard of conduct on many plan providers by requiring them to act as fiduciaries; fiduciaries are required to act for the “exclusive benefit” of a plan and participants–so categorizing more providers as fiduciaries would (effectively) have limited their ability to take advantage of their relationship with a plan as a springboard to greater riches.

    With the DOL’s acquiescence in the court decision to invalidate this expansion of the definition of “fiduciary” the DOL’s primary tool for addressing the risks posed by conflicted providers is disclosure. And, indeed, the DOL has also issued fee disclosure requirements, intended to help plan fiduciaries identify indirect compensation received by providers and offer plans some protection from nondisclosed conflicts.

    These fee disclosure requirements have been in place since 2012 and experience indicates that the fee disclosure requirements are limited in scope–and effectiveness. Many categories of conflict are not subject to disclosure because the fee disclosure rules are focused solely on direct and “indirect” compensation to the provider received “in connection to providing services to the plan.”

    As a result, current DOL authority offers little help for fiduciaries dealing with plan providers who can manage to avoid the substantial restrictions that accompany status as a plan “fiduciary” and who can mask their revenue streams to avoid fee disclosure.

  • Plan fiduciaries can also look to the SEC in considering the dilemma posed by conflicted providers. After all, these conflicted providers typically sell financial products governed by federal securities laws. Here too, the primary resource offered by the SEC to concerned plan fiduciaries is…more disclosure.

  • The SEC, most recently in proposed regulations governing broker behavior, leans (heavily) on the side of disclosure. The proposed regulation BI issued by the SEC in 2018 would require that brokers “establish, maintain, and enforce written policies and procedures reasonably designed to identify, and disclose, or eliminate, all material conflicts of interest” covered by the proposed regulation. Also, the proposed regulation would require that, as a part of making a recommendation, a broker “reasonably disclose … the material facts relating to the scope and terms of the relationship with the retail customer and all material conflicts of interest associated with the recommendation.’’

    In effect, the SEC has concluded that all conflicts can be addressed by disclosure alone–under the regulation as proposed, the requirement to eliminate the risk of conflict can be met through disclosure, not true elimination.

  • Plan fiduciaries, in turn, take their lead from regulators. If the DOL and SEC rely on disclosure to protect against conflicted providers, then fiduciaries are unlikely to go much beyond obtaining and sharing the disclosures provided by providers.

    Can Disclosure Ever Do the Job?

    The SEC’s proposed regulation has definitely gotten the attention of the industry and the public, drawing thousands of comments. One significant criticism of the proposed regulation comes down to a simple point: disclosure is not an adequate substitute to holding providers to a higher standard of conduct. In effect, disclosure is simply not to an adequate tool to protect against the risks posed by conflicted providers. As was noted in comments submitted to the Consumer Federation of America, the new regulation’s focus on disclosure “does not create an unambiguous obligation for brokers to do what is best for their customers,” “does not prevent brokers from placing their own interests ahead of customers’ interests in most circumstances” and, would allow brokerage firms to “remain free to engage in common industry practices that encourage and reward conduct that is harmful to their customers”.

    In considering the SEC’s reliance on disclosure to protect plan participants (and other investors), we also note the comment submitted by a group of eleven former senior SEC economists, stating “we are aware of no evidence that disclosures enable retail customers to understand the implications for their own welfare”. https://www.sec.gov/comments/s7-07-18/s70718-4895197-177769.pdf

    In effect, there are fundamental questions about the ability to rely on disclosure to protect participants from providers with significantly conflicted economic incentives.

    (We do note that in recent comments, the chair of the SEC has stated that in some instances disclosure is not enough to mitigate a conflict and certain conflicts will need to be eliminated when the final regulations are issued. https://www.investmentnews.com/article/20190326/FREE/190329946/clayton-says-disclosure-sufficiently-mitigates-some-conflicts-under At this point it is not clear which circumstances will require actual elimination. However, even after these comments, we anticipate that the SEC’s reliance on conflict disclosure–rather than conflict elimination–will be the core of the SEC’s final regulations.)

    A Fox’s Guide to the Henhouse

    Questions about the efficacy of disclosure are even more significant when one considers the source of the disclosure– the conflicted service provider. Think about it: a service provider who has economic interests that might conflict with the best interests of a plan participant is responsible for preparing the disclosure…that explains the service provider’s conflict. The incentive–and the opportunity– to obfuscate is enormous.

    Over the years we have reviewed numerous provider disclosures. In order to limit the effectiveness of the disclosure providers may describe compensation practices (to the extent such description is required) and may even note the existence of a conflict between the interests of the provider and the plan participant. However, provider disclosures appear to go out of their way to avoid detailing the scope and magnitude of these conflicts. In effect, provider disclosure may look like a series of dots on a page–with no information on how to connect those dots.

    This contradiction — of a service provider having responsibility to describe their economic conflicts — overshadows all other questions about the effectiveness of these disclosures. In effect, we really don’t know whether disclosure can adequately protect plan participants and other investors from conflicts. But, we are pretty sure that disclosures will never be sufficient as long as these same providers are the ones responsible for preparing the disclosures.