SEC Issues RISK ALERT on Target-Date Funds

Procedures for Monitoring Were Absent!

Sponsors of the 401(k) funds don’t disclose their use of underlying in-house investments.

The Securities and Exchange Commission, the agency’s Office of Compliance Inspections and Examinations risk alert said some TDFs provided “incomplete and potentially misleading disclosures” around conflicts of interest, such as those that could arise from “the use of affiliated funds and affiliated investment advisers.”

This is problematic for many reasons, but companies of all sizes and business owners as fiduciaries have an obligation to their employees to receive suggestions, changes and recommendations from their investment advisors so they can avoid problems.

Such a fund structure — in which a TDF provider uses its in-house investment funds as the underlying building blocks for its TDFs — is common among the largest target-date providers.

According to Sway Research, which studies asset management distribution in retirement plans said at the end of last year, 95% of target-date assets were held in TDFs that used only proprietary funds.  Not good. Also, TDFs have roughly $1.8 trillion in mutual funds and collective investment trust funds.  It’s unlikely an asset manager is the best choice across all of the asset classes in a target-date fund.

The bottom line is this, as investors direct money to TDFs sponsored by companies like Vanguard, Fidelity and T. Rowe Price, they are directing money to those companies’ other mutual funds, such as large-cap stock or bond funds, as well.  Are those the best of the best funds for employees?

This is a main reason why companies like Fidelity, Lockheed Martin, Anthem and Brown University have been sued by their employees and former employees for using mainly or all proprietary funds in the 401(k)s, excessive or unreasonable fees, and lacking diversification options.  Not to mention the lack of education to employees which I wrote about here “The #1 401(k) Problem.”

It’s not that 401(k) plans must offer the lowest-cost investment choices, but they must be reasonable or subject to periodic review.  This includes the expenses charged by mutual funds – the primary type of investment vehicle in 401(k) plans – and any program fees for recordkeeping, shareholder communication and other administrative tasks.

Under ERISA, employer-sponsored retirement plans have a fiduciary responsibility for selecting and monitoring appropriate investments, as well as removing investments that no longer fit criteria established in an investment policy statement, the plan’s blueprint.

Scott Krase, President of CrossPoint Wealth, said he still sees poor performing proprietary funds inside 401(k) plans. But too much employer stock and other potentially unsuitable investments have become less common, he added.  “Companies hire us because of our independent business model and program details.  We provide a careful, prudent process as anInvestment Manager responsible for selecting, managing, monitoring and benchmarking the investment offerings within a 401(k) plan and have full discretion to make investment decisions.”

In the agency’s findings, which was an analysis of more than 30 Target-Date Funds, the SEC thinks some asset managers are not doing their job and are inadequately disclosing this conflict to retirement investors.

According to consulting firm Cerulli Associates, the funds have quickly grown to be the most popular investment option for 401(k) participants. The funds currently capture around 58% of 401(k) contributions; that’s set to increase to more than 80% in 2023.

Employees should speak to their company to better understand this Risk Alert. Also, if an investor rolled over their 401(k) into an IRA and kept their same positions the same they need to review their Target-Date Fund holdings as well.

Finally, the SEC states, many TDFs also had “incomplete or missing procedures” around monitoring asset allocations; overseeing the implementation of changes to glide-path asset allocations; overseeing advertisements, which may have been inconsistent with fund prospectuses; and monitoring whether disclosures around glide-path deviations were accurate.  That’s also not good for companies, business owners and especially employees.

It’s important to have a qualified second opinion of your current 401(k), 403(b) and 457 plans from an outside Investment Manager, not a family member, so you can avoid having many pitfalls like we have discussed in this educational article.

Thank you for reading and sharing.

Until Next Time…