Publication - 12/1/2004

Trading Places

Plan Sponsor

As recently stated by the DOL, plan fiduciaries have a responsibility to know whether their plans have invested with mutual funds implicated in the trading scandals, must understand the consequences of those activities, and take reasonable steps to prevent harm to their participants.

Similarly, it seems clear that fiduciaries need to consider qualitative issues (such as the fund management's support of the objectives of long-term shareholders) in prudently selecting and monitoring the investment options. As the fund complexes impose trading restrictions, including redemption fees, fiduciaries need to evaluate those restrictions and determine whether they are suitable and appropriate for their plans and their participants. If not, then plan sponsors should consider removing the fund and replacing it with a more suitable alternative, either another mutual fund or other vehicles such as collective trusts or separate accounts.

Similarly, if the fiduciaries determine that the restrictions impose by their recordkeepers are unsuitable (e.g., because they failed to address the trading abuses or because they are overly burdensome), the fiduciary should consider replacing the recordkeeper with another provider.

In evaluating trading restrictions, the issues are somewhat different depending on factors such as the size of the plan and the recordkeeper's use of an omnibus account (which usually combines the fund holdings of a large number of plans). For example, the plan of a very large employer may have a direct relationship with the mutual funds included in the plan. As a result, if the plan includes 15 mutual funds, it is possible that the participants will be subject to 15 separate sets of trading restrictions (which are imposed by the terms of the fund prospectuses). As a practical matter, it probably will be impossible for participants to cope with that level of complexity. In addition, it will be difficult for the fiduciaries to develop and distribute appropriate communication materials explaining 15 separate sets of trading restrictions. As a result the fiduciaries may be compelled to eliminate the funds with the most uncommon or rigid trading restrictions and to include only funds with similar trading restrictions so that participants end up with one set of rules. Similar issues exist for plans that use recordkeepers that have separate accounts with mutual funds for each plan they serve.

For the most part, smaller plans use investment platforms where restrictions will, at least for the moment, be imposed at the recordkeeper level because the recordkeeper uses omnibus accounts that combine all of the participant transactions for all of the plans it serves. In most cases, the computer systems of those providers are not set up to implement the trading restrictions and redemption fees mandated by mutual fund prospectuses. As a result, these plans likely will be facing one set of restrictions--imposed by the recordkeepers (rather than the fund)--for all of the investment options. However, the SEC is considering whether--and, if so, how--to allow redemption fees to be charged for short-term trades in 401(k) plans. In addition, some of the mutual fund complexes are proposing to impose their retail trading restrictions on 401(k) plans. At some point, it is likely that the recordkeepers will be forced to modify their systems to impose prospectus restrictions. At that time, the plans served by "omnibus" recordkeepers also will have to deal with the possibility of multiple sets of restrictions (by that time, the mutual fund industry will have developed a single set of standards).

In both cases, plan fiduciaries will need to understand and evaluate the restrictions, to compare the restrictions of their current investments and providers with those in the market, and to make a decision in the best interest of their plan and participants.