401(K) Plans:

Certain Investment Options and Practices That May Restrict Withdrawals Not Widely Understood

GAO-11-291: Published: Mar 10, 2011. Publicly Released: Mar 16, 2011.

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401(k) plan sponsors are responsible for offering an array of appropriate investment options, and participants are responsible for directing their investments among those options. While participants expect to be able to switch investment options or withdraw money from their accounts, during the recent economic downturn, some 401(k) plan sponsors and participants found that they were restricted from doing so. GAO was asked to (1) identify some of the specific investments and practices that prevented plan sponsors and participants from accessing their 401(k) plan assets and (2) determine any changes the Department of Labor (Labor) could make to assist sponsors in understanding the challenges posed by the investments and practices that restricted withdrawals. To do this, GAO reviewed relevant federal laws and regulations and consulted with experts, federal officials, service providers, and plan sponsors.

Between 2007 and 2010, some 401(k) plan sponsors and participants were restricted from withdrawing their plan assets from certain 401(k) investment options, including real estate, money market, and stable value investment options, as well as other investment options that lent securities (the practice of lending plan assets to third parties in exchange for cash as collateral that a fund reinvests). In most cases, the withdrawal restrictions were caused by losses and illiquidity in the investment options' underlying portfolios and sometimes contract constraints placed on plan sponsors by the investment options. For stable value funds, and also for those investment options that lent securities, the withdrawal restrictions and their causes highlight the risks that participants face when allocating their 401(k) plan assets to these investment options--and, that losses are borne by plan participants. In addition, participants often do not understand or may receive insufficient disclosures of the risks posed by these investments. Further, plan sponsors may be unaware or receive insufficient disclosures of the risks and challenges involved with those investment options and practices. Labor can take a variety of steps to help plan sponsors who offer stable value funds and investment options that lend securities. Many of these steps can draw upon the changes that the Securities and Exchange Commission and others have already made, or will make, regarding these investment options and recent suggestions from plan sponsors, industry service providers, and other key stakeholders. Specifically, Labor could identify and take action to address those stable value contract constraints that may hinder plan sponsors from performing their fiduciary responsibilities and provide better disclosures to plan sponsors about certain investment options to help sponsors make decisions on behalf of participants. Similarly, revising Labor's prohibited transaction exemption for securities lending to restrict those securities lending arrangements that may pose unreasonable financial terms upon plans and providing more guidance, in general, about such transactions can also help plan sponsors and participants understand the risks that cash collateral reinvestment can pose to plan assets in investment options that lend securities and how to mitigate them.

Recommendations for Executive Action

  1. Status: Closed - Not Implemented

    Comments: According to the Department of Labor, because the SEC and CFTC have not completed their study as mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act, it is premature for the Department to assess whether further action is currently warranted. This determination will be made after the Department has the opportunity to examine the formal findings made by the SEC and CFTC. This study was to have been completed by October 2011.

    Recommendation: The recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act includes requirements that will affect deliberations about stable value funds and requires that the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC), in consultation with the Department of Labor (Labor) and the Department of the Treasury (Treasury), conduct a study of stable value funds. To ensure additional protection for plan participants, appropriate information for plan sponsors, and to better inform the study required by the Dodd-Frank Act, as it conducts its consultative analysis to assist the SEC and CFTC, Labor should also analyze stable value funds specifically in a 401(k) investment context to identify those situations or conditions that prevented plan sponsors from withdrawing from stable value funds, such as contract restrictions, and take appropriate regulatory steps to assist plan sponsors in fulfilling their fiduciary responsibilities.

    Agency Affected: Department of Labor

  2. Status: Closed - Not Implemented

    Comments: The Department of Labor has informed GAO that it has no current plans to amend its disclosure regulations. The Department states that its regulation governing disclosure of investment related information to participants and beneficiaries already specifically requires that information relating to investment risks, as well as investment strategies, be available to plan participants with respect to all designated investment alternatives offered under a participant-directed individual account plan, including designated stable value funds.

    Recommendation: The recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act includes requirements that will affect deliberations about stable value funds and requires that the SEC and the CFTC, in consultation with Labor and Treasury, conduct a study of stable value funds. To ensure additional protection for plan participants, appropriate information for plan sponsors, and to better inform the study required by the Dodd-Frank Act, Labor should amend its regulation on plan sponsor disclosure to participants to include a specific requirement for plan sponsors to provide information to participants that discloses the risks of investing in stable value funds.

    Agency Affected: Department of Labor

  3. Status: Closed - Not Implemented

    Comments: The Department of Labor does not believe it would be an appropriate allocation of its limited resources to substitute, at this time, consideration of this recommendation in place of work on other regulatory and guidance priorities. Consideration of this recommendation would also benefit from the information and conclusions in the joint SEC/CFTC study of stable value funds which DOL asserts is not complete. DOL states that this decision will be revisited during the next regulatory cycle, taking into account agency priorities and available resources.

    Recommendation: The recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act includes requirements that will affect deliberations about stable value funds and requires that the SEC and the CFTC, in consultation with Labor and Treasury, conduct a study of stable value funds. To ensure additional protection for plan participants, appropriate information for plan sponsors, and to better inform the study required by the Dodd-Frank Act, Labor should provide guidance to plan sponsors on the risks, structure, and dynamics of stable value funds, consistent with the recommendations proposed by the Employee Retirement Income Security Act of 1974 (ERISA) Advisory Council regarding the disclosure of information about stable value funds.

    Agency Affected: Department of Labor

  4. Status: Closed - Not Implemented

    Comments: The Department of Labor continues to disagree with this recommendation and has no current plans to provide specific guidance on reasonable levels of fees and reasonable distributions of returns in connection with any particular securities lending cash collateral reinvestment arrangement. The Department, however, is considering requiring plans to report information on securities lending transactions as part of its regulatory project on modernizing the Form 5500 Annual Return/Report of Employee Benefit Plans.

    Recommendation: Given the current practice of securities lending with cash collateral reinvestment, its role in 401(k) plan investments, and our findings that plans and plan participants can bear a disproportionate amount of any loss associated with the practice, Labor should take action to help plan sponsors of 401(k) plans and plan participants understand the role, risk, and benefits of securities lending with cash collateral reinvestment in relation to 401(k) plan investments. ERISA requires that the fees paid to plan service providers be reasonable with respect to the services performed and Labor, in its implementation of prohibited transaction exemption (PTE) 2006-16, its prohibited transaction class exemption for securities lending, specifically requires that compensation received by the parties involved in the securities lending transaction should be reasonable. According to Labor, PTE 2006-16 does not cover cash collateral reinvestment. Therefore, Labor should review the practice of securities lending with cash collateral reinvestment, to provide guidance to plan sponsors as to what would be reasonable levels of fees and reasonable distributions of returns when 401(k) plan assets are utilized in this practice.

    Agency Affected: Department of Labor

  5. Status: Closed - Not Implemented

    Comments: The Department of Labor reports that it has carefully considered GAO's recommendation and currently believes that no further amendment of PTE 2006-16 is required in light of a fiduciary's ongoing duty to assess the prudence, including the risk and return elements, of plan investments.

    Recommendation: Given the current practice of securities lending with cash collateral reinvestment, its role in 401(k) plan investments, and our findings that plans and plan participants can bear a disproportionate amount of any loss associated with the practice, Labor should take action to help plan sponsors of 401(k) plans and plan participants understand the role, risk, and benefits of securities lending with cash collateral reinvestment in relation to 401(k) plan investments. ERISA requires that the fees paid to plan service providers be reasonable with respect to the services performed and Labor, in its implementation of PTE 2006-16, its prohibited transaction class exemption for securities lending, specifically requires that compensation received by the parties involved in the securities lending transaction should be reasonable. According to Labor, PTE 2006-16 does not cover cash collateral reinvestment. Therefore, Labor should revise PTE 2006-16 to include the practice of cash collateral reinvestment by requiring that plan sponsors who enter into securities lending arrangements utilizing cash collateral reinvestment on behalf of 401(k) plan participants not do so unless they ensure the reasonableness of the distributions of expected returns associated with this arrangement.

    Agency Affected: Department of Labor

  6. Status: Closed - Not Implemented

    Comments: The Department of Labor continues to disagree with this recommendation and has no current plans to amend its disclosure regulations to address securities lending issues related to investment funds available as investment options in participant-directed individual account plans. The Department, however, is considering requiring plans to report information on securities lending transactions as part of its regulatory project on modernizing the Form 5500 Annual Return/Report of Employee Benefit Plans.

    Recommendation: Given the current practice of securities lending with cash collateral reinvestment, its role in 401(k) plan investments, and our findings that plans and plan participants can bear a disproportionate amount of any loss associated with the practice, Labor should take action to help plan sponsors of 401(k) plans and plan participants understand the role, risk, and benefits of securities lending with cash collateral reinvestment in relation to 401(k) plan investments. ERISA requires that the fees paid to plan service providers be reasonable with respect to the services performed and Labor, in its implementation of PTE 2006-16, its prohibited transaction class exemption for securities lending, specifically requires that compensation received by the parties involved in the securities lending transaction should be reasonable. According to Labor, PTE 2006-16 does not cover cash collateral reinvestment. Therefore, Labor should amend its regulation on plan sponsor disclosure to participants to include provisions specific to (1) the practice of cash collateral reinvestment utilized by fund providers' securities lending programs and (2) disclosing the potential for withdrawal restrictions.

    Agency Affected: Department of Labor

  7. Status: Closed - Not Implemented

    Comments: The Department of Labor does not believe it would be an appropriate allocation of its limited resources to substitute consideration of this recommendation in place of work on other regulatory and guidance priorities. The Department states that its decision will be revisited during the next regulatory cycle, taking into account agency priorities and available resources.

    Recommendation: Given the current practice of securities lending with cash collateral reinvestment, its role in 401(k) plan investments, and our findings that plans and plan participants can bear a disproportionate amount of any loss associated with the practice, Labor should take action to help plan sponsors of 401(k) plans and plan participants understand the role, risk, and benefits of securities lending with cash collateral reinvestment in relation to 401(k) plan investments. ERISA requires that the fees paid to plan service providers be reasonable with respect to the services performed and Labor, in its implementation of PTE 2006-16, its prohibited transaction class exemption for securities lending, specifically requires that compensation received by the parties involved in the securities lending transaction should be reasonable. According to Labor, PTE 2006-16 does not cover cash collateral reinvestment. Therefore, Labor should provide plan sponsors with guidance alerting them to the risks of engaging in securities lending with cash collateral reinvestment and the types of information they should seek from their service providers about these investments.

    Agency Affected: Department of Labor

 

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