Empower and Vanguard Penalized for Undisclosed Conflicts

On August 29, the Securities and Exchange Commission issued orders against units of Empower and Vanguard for inadequate and misleading disclosure regarding the firms’ conflicts of interest in promoting their managed account products. 

This blog will describe the practices identified by the SEC, focusing on the Empower order, which highlighted Empower’s actions in servicing plans sponsored by governmental entities. Please note—although this blog describes the SEC order targeting Empower’s specific activities in this one market (governmental plans), in our experience, these practices are not unique to Empower or to governmental plans. In other words, the practices described in the Empower order highlight the kinds of practices that undermine a broad range of employer-sponsored defined contribution plans. More importantly,  the SEC orders provide a roadmap for monitoring plan providers. 

Empower Retirement Plan Advisors  

Empower is one of the nation’s largest recordkeepers and is a major provider in the governmental plans market. Empower employed “Retirement Plan Advisors” to service these government plans. Retirement Plan Advisors were, among other things, responsible for:

• Providing one-on-one education to plan participants, 
• Providing personalized retirement advice on investing, savings strategies, and distributions, and
• Discussing and, at times, advising plan participants about enrolling their in-plan retirement accounts in Empower’s fee-based managed account service.  

In other words, Retirement Plan Advisors were trusted resources for plan participants. However, participants did not know how Empower’s compensation practices would affect the words and actions of these trusted resources. 

Prior to the beginning of each year, Retirement Plan Advisors received their yearly performance goals from Empower; achievement of these goals affected their annual bonus and merit increases. Certain Retirement Plan Advisors received an annual performance goal that included the amount of assets they enrolled in the managed account service (their “Managed Account AUM goal”). Although the specific weighting varied, the weight of attaining their Managed Account AUM goal ranged from 25% to 35% of Retirement Plan Advisors’ annual performance goal, and attainment of the performance goal could mean a bonus equal to 20% of salary. In other words, as noted by the SEC, “[t]his compensation structure incentivized Retirement Plan Advisors to enroll Plan Participants in the Managed Account service”.   

Retirement Readiness Reviews

One of the primary responsibilities of the Retirement Plan Advisors was to conduct “Retirement Readiness Reviews” with plan participants. As a part of these reviews, the Retirement Plan Advisors utilized a “Retirement Readiness Review” tool that compared their projected retirement income (based on current investments) with the projected retirement income of they made asset allocation/investment changes. At the conclusion of the Retirement Readiness Review, the Retirement Plan Advisor was responsible for advising and educating the Plan Participant about the various ways they could implement the recommended investment strategy/asset allocation generated during the review, which included: (1) self-managing their retirement account, (2) investing in a target date fund or using the self-service online advice tool, or (3) enrolling in Empower’s Managed Account service, which charged a quarterly advisory fee.

The SEC described how the Retirement Plan Advisors heavily skewed their advice toward the use of the managed account, without adequately disclosing the Advisor’s financial interest in participants’ use of the managed accounts. As noted by the SEC:

During Retirement Readiness Reviews, certain Retirement Plan Advisors routinely spent a significant amount of time discussing the benefits of the Managed Account service while only focusing on the drawbacks of self-managing or investing in a target date fund. In other instances, certain Retirement Plan Advisors discussed only the Managed Account service with Plan Participants and did not explain that alternative options existed. And in some instances, Retirement Plan Advisors explicitly recommended the Managed Account service as the best option for Plan Participants to achieve their desired retirement income goals

…

[D]uring Retirement Readiness Reviews, certain Retirement Plan Advisors made statements to Plan Participants concerning compensation that were rendered misleading because the Retirement Plan Advisors did not disclose that they had a financial incentive to enroll the Plan Participant in the Managed Account service. For example, throughout the Retirement Readiness Reviews, certain Retirement Plan Advisors routinely told Plan Participants they were salaried or noncommissioned, acting in a fiduciary capacity, and that they were acting in the Plan Participant’s best interest. In more egregious cases, Retirement Plan Advisors even told Plan Participants that their enrollment in the Managed Account service would not affect the Retirement Plan Advisor’s compensation and that no conflict of interest existed. These statements assured Plan Participants that Retirement Plan Advisors were providing disinterested advice that was in the Plan Participants’ best interest when Retirement Plan Advisors advised Plan Participants to enroll in the Managed Account service. Plan Participants were not told that certain Retirement Plan Advisors were financially incentivized to enroll Plan Participants in the service, and neither Empower Advisory nor Empower Financial Services provided Plan Participants with full and fair disclosure of such conflicts of interest.

Other Disclosure Failures

The SEC order also cited a number of disclosures by Empower that were inadequate because they did not fully inform participants of the true nature of the conflict presented by Empower’s compensation structure. Examples of inadequate or misleading disclosure included the following:

• Statements such as “employees will have an opportunity to earn bonus compensation” and “representatives may be indirectly compensated through bonus compensation, in addition to their salary, for communication, education and/or assisting participants to enroll in [Empower Advisory’s] Services” were inadequate because they understated the fact that representatives were directly incentivized to enroll participants in the managed accounts.
• Statements that described advisors’ incentive compensation in generalities, such as [incentive compensation is based on the achievement of individual performance goals that consider factors unrelated to an account holder’s adoption of investment products or services offered through Empower, “ failed to inform participants of “the full nature” of the advisors’ conflicts of interest.
• The representation that advisors’ performance goals considered “factors unrelated to an account holder’s adoption of . . . services offered through Empower” was misleading. Such representation failed to disclose to participants that, for certain Retirement Plan Advisors, the amount of assets a Retirement Plan Advisor enrolled in the Managed Account service was a direct factor in calculating their compensation. As noted by the SEC, Empower’s “references to an ‘asset goal’ and ‘retained or accumulated assets’ also did not fairly apprise Plan Participants of the existence of a Managed Account AUM Goal or the impact of that goal on Retirement Plan Advisor compensation.”
• The SEC also determined that the Reg BI (best interest) disclosure and Form CRS (client relationship summary) issued by Empower’s broker/dealer unit were similarly deficient. As stated by the SEC:

Empower Financial Services’ disclosure that it “may consider” a Retirement Plan Advisor’s success in “gathering, retaining and consolidating client assets” when determining the Retirement Plan Advisor’s variable bonus was misleading for two reasons. First, the use of “may consider” was misleading because Empower Financial Services did take into consideration a Retirement Plan Advisor’s performance on the Managed Account AUM Goal when calculating a bonus and merit raise. Second, the references to gathering client assets and asset goals did not fully and fairly inform Plan Participants of the Managed Account AUM Goal or the conflict of interest resulting from the impact that goal had on Retirement Plan Advisors’ compensation.

Comment: The deficiencies identified by the SEC in Empower’s disclosures should not come as a surprise. In our experience, it is not uncommon for providers to minimize the impact of incentive programs by use of “may” rather than “shall”  and to direct attention away from specific programs by referring to a variety of (other) factors in determining compensation incentives. The real question is whether other entities that use similar indirect approaches to describing incentive payments will voluntarily change their descriptions to avoid the fate of Empower or just continue current practices and accept that any SEC penalties are simply a cost of doing business. 

Empower Remedies

The SEC imposed an array of penalties and required remedial acts on Empower. These included payment of almost $6 million (consisting of both payments to affected participants and fines to the SEC) and a range of structural changes (such as overhauling compliance procedures). 

Interestingly, the remedies also included the removal of the Managed Account AUM Goal from all Retirement Plan Advisor goals and “the implementation of an algorithmic decision tool to assist Plan Participants in assessing the value of the Managed Account service offering.” Although details on this algorithmic tool were not disclosed, this could offer participants a more objective mechanism for weighing the different ways to achieve any asset reallocation indicated in the Retirement Readiness Review (such as in comparing the effect of using the managed account to using target date funds).

Vanguard

The SEC action against Vanguard was based on Vanguard’s general practices in promoting managed accounts to retail clients (rather than Empower’s actions, which were specific to the governmental plan market). As with Empower, Vanguard (i) utilized managed account sales in determining advisors’ annual bonuses and merit compensation increases and (ii) downplayed that link in a range of communications to consumers. For example, Vanguard’s Form CRS disclosure stated that:

“Our advisors … are salaried employees who do not earn commissions or additional compensation based on the products they recommend or the amount of assets they service.”   

Yet, the SEC noted, Vanguard advisors were eligible to receive additional compensation based in part on the number of clients they successfully enrolled and kept in the managed program. 

Vanguard’s penalty was solely monetary–$19.5 million. It appears that other remedies were not imposed because Vanguard did take some additional steps while negotiating with the SEC, such as correcting its disclosure documents and hiring a consultant to review its approach to disclosure and conflict of interest identification.

Conclusion

The effort to get plan providers to deemphasize sales incentives within their compensation structures, and ensure that any remaining sales incentives are adequately disclosed, can be compared to a never-ending game of whack-a-mole, with providers constantly tweaking sales incentives—and their obfuscatory descriptions of those incentives in required disclosure documents. And, whether or not they like it, this is a game that plan sponsors must continue to play.