A case brought last year by the Securities and Exchange Commission (SEC) highlights the need for employee awareness — and vigilance — in making decisions about plan distributions. Although the claims in this specific SEC case represents some especially egregious and deceptive practices, it still provides a cautionary tale for all plan sponsors and participants.
The SEC’s complaint alleges that four brokers (doing business as “Federal Employee Benefits Counselors”) targeted federal employees who were nearing retirement and who had sizable funds invested in the federal employees’ defined contribution plan (the Thrift Savings Plan or TSP). The complaint alleges that the brokers misled TSP participants concerning significant details about recommended variable annuity investments, including the associated fees and guaranteed investment returns.
Most significantly, the brokers allegedly fostered the misleading impression that they were in some way affiliated with or approved by the federal government. In some instances, these TSP participants were led to believe that their funds would be invested in a product that was offered, vetted, or specifically selected by the TSP. According to the SEC’s complaint, the brokers sent investors written materials that obscured that the investment was a privately issued variable annuity with no connection to the TSP. According to the complaint, the brokers sold approximately 200 variable annuities with a total face value of approximately $40 million to federal employees, who used monies rolled over from their TSP accounts to fund their purchases. The brokers collectively earned approximately $1.7 million in commissions on these sales.
(It should be noted that these are allegations by the SEC and the matter has not been fully adjudicated. However, two of these individuals settled the claims brought by the SEC and, as part of the agreement, have been barred from selling securities. Additionally, these four individuals are no longer registered to sell securities.)
Some Lessons to be Learned
As noted, the conduct alleged — actively misleading participants into believing that these brokers were connected with TSP and that the annuities had been vetted by TSP — is especially egregious. Nonetheless, there are lessons here for all plan fiduciaries and sponsors:
The warning signs were there. These four brokers had prior allegations and disputes involving claims of misconduct that had been settled. And, these brokers had previously worked for major firms — including some firms in the retirement plan industry. So, any of these brokers could have been a plan representative servicing an employer-sponsored retirement plan.
The lesson for plan sponsors and fiduciaries — know who is supporting your plan and talking to your participants. Consider it a part of your investment provider/recordkeeper due diligence. The data on prior allegations and possible misconduct are readily available on the FINRA broker check site.
Participants are confused — with good reason. Part I
These four individuals allegedly created materials that were intended to mislead TSP participants. However, it is not necessary to actively create false and misleading documents in order to confuse participants. Rather, there is a vast body of research documenting how participants are misled and confused by perfectly legal marketing and disclosure documents.
For example, the SEC has acknowledged that investors are confused by the difference between brokers and investment advisers and the different obligations and standards applicable to these different groups. See the SEC’s Study on Investment Advisers and Broker-Dealers (January, 2011). And, even if investors truly understood the differences between a broker and an investment adviser, such understanding can be overwhelmed when an investor is dealing with a dually-registered adviser — someone who might act either as a broker or as an investment adviser. According to the Financial Industry Regulatory Authority (FINRA), over 80% of investment advisers are dually registered as brokers. See 2018 FINRA Industry Snapshot.
This basic confusion is exacerbated by (perfectly legal) advertising that utilizes important sounding — but meaningless — titles, such as “financial adviser” and “financial consultant.” See Public Investors Arbitration Bar Association Report Major Investor Losses Due to Conflicted Advice: Brokerage Industry Advertising Creates the Illusion of a Fiduciary Duty.
Participants are confused — with good reason. Part II
One more ingredient in this stew of participant confusion is the fact that while “plan representatives” may support an employer-sponsored retirement plan and provide information relating to plan investments — these individuals work for the bundled recordkeeper and are often compensated (directly or indirectly) for steering participants toward non-plan products and services. And, in transitioning from a discussion of plan investments and distribution options, these representatives can seamlessly slip into selling-mode for non-plan products and services.
Plan sponsors and fiduciaries who select a recordkeeper may have unwittingly provided an implicit endorsement of these representatives and the non-plan products and services offered by the recordkeeper.
The behavior identified in the SEC complaint against Federal Employee Benefits Counselors appears to be the actions of an outlier. Nonetheless, in capitalizing on participant confusion, Federal Employee Benefits Counselors seemed to have been pushing on an open door.