Unintended consequences are altering the retirement system

Anyone familiar with high school physics might remember Newton’s Third Law of Motion: For every action there’s an equal and opposite reaction. Proven true in natural science, that principle also applies in human nature, economics and other social sciences. History shows this time and again. Efforts made to alter human behavior to drive a desired outcome often result in some other – usually unintended – consequences.

This principle also appears to be occurring currently in the multi-trillion-dollar defined contribution retirement plan industry. A recent report from consulting firm Cerulli Associates provides fresh data on a longstanding trend that indicates plan sponsors are frightened of being sued by their participants for the investment options in their 401(k) plans. As a result, more sponsors are offering low-fee index funds over other investment options. In addition, as Cerulli’s Jessica Sclafani has told Ignites.com1, plans are avoiding menu options like custom target date funds and retirement income products for fear that selecting those vehicles will raise a red flag.

It’s no secret that plan sponsors and the retirement industry are facing heightened legal action of late, much of it focused on the way the industry is compensated. Arguments abound on the fairness and appropriateness of these lawsuits, and I’ll not offer my own perspective on this trend.

However, it’s important to point out that these lawyer-driven suits are grounded in a particular interpretation of the Employee Retirement Income Security Act (ERISA), the law governing most private retirement plans. The spirit of ERISA was not to drive all 401(k) investors to the lowest-fee products, but rather to apply reasonableness, prudence and accountability to the workplace savings system. It’s an erroneous mutation of ERISA’s intent that because of aggressive litigation, participants in retirement plans won’t have access to investment options with the potential to outperform the market or provide them with the customization they need.

In the meantime, the financial services industry is now spending countless millions of dollars to comply with the Department of Labor’s new fiduciary rule. While speculation is rampant that the Trump administration may reconsider the rule in the coming days, there’s no telling when or if that will happen.

Enforcement of the new regulation will likely come in all shapes and sizes as the rule includes both regulatory enforcement and an opening for privately initiated class-action lawsuits (something about which the DOL has not been overly communicative).

Down the road, advisors, plan sponsors or retirement plan providers who stray from the narrow, inflexible and erroneous interpretation of fiduciary’s duty are likely to face expensive action from the plaintiff’s bar that would neither further the purposes of the rule nor serve the interests of the plan participants the rule is supposed to protect. Just as the litigation around ERISA has created unintended consequences in the administration of retirement plans, it is possible that such scrutiny could impact the ability of advisors, plan sponsors and retirement plan providers to offer advice to participants who need it.

The DOL’s fiduciary rule has its merits, but it could also be improved. We must ask: What will be the impact on small investors? How can they access the advice they need under this new regulatory regime? How will the rule be enforced? How will we choose to correct the rule if unintended consequences develop?

Most importantly, what will happen if the risks and costs of providing financial advice simply become too great?

Granted, many of these topics were raised in the multi-year run-up to the rule’s establishment last April. However, it’s reasonable to think that new questions have been raised across the financial services industry over the last nine months as firms have prepared to comply with the new rule.

These are important questions, and we’re looking forward to working across the industry and with regulators to achieve the right answers.