From Potomac Fund Management, this is the Conquer Risk Podcast. Join us as we discuss the business of running an RIA firm and the practice of investment management. And now, our hosts. Welcome to the Conquer Risk Podcast.
My name is Minish Kada, as always, well not as always, but I'm here this week with my business partner Jeff Goodnow. For those of you who know us, you know that we do a lot of work for advisors in the 4-3-B space. And so this week we wanted to talk about something that has come up earlier in this year, and that is the lawsuit surrounding the fiduciary responsibility of plans in the 4-3-B space. And so I want to take a step back and maybe start with how this all came about.
And you and I have spoken about this over the years, many times. You know, in 2009, regulations came down that forced 4-3-B plans to have record-keeping requirements similar to that of a 4-1-K, discrimination testing, anti-discrimination testing, making sure that you keep track of contributions with thralls and not to, you know, have an account outside of a plan. And so, since then, you know, the plan providers, the fidelities and the crafts of the world, you know, it was easy for them to make changes to their plan documents because, well, you know, they managed 4-1-Ks across the country. But the actual plan administrators, the schools, hospitals, universities, they were clueless.
They didn't know what to do. They didn't know how to adjust to this new sort of paradigm of them being a fiduciary being responsible. And so they, I think in hindsight, probably made some mistakes that we'll touch on. And so from 2009 to about 2016, as these regulations took place, the plan for fiduciaries or the plan administrators just didn't keep pace.
And in 2016, a bunch of lawsuits were starting to be filed for major universities across the country. This isn't, you know, small nonprofit plans, these are major plans. And so why don't you sort of touch on maybe some of the reasons these lawsuits came about? Why were the plan participants so upset with their administrators?
Yeah, well, it's, look, there's sort of a never-ending feud, I think, in some cases. You know, you had the great recession, and obviously people were upset about that. But, you know, coming, stemming from that as one of the basis, you know, a real common one is, is the investment choices, right? People complained in various forms about investment choices, whether that be it was too limited, or there's, say, sometimes too many, they can't understand.
I mean, it was kind of all over the place. So, you know, really, there's, you know, investment choices is one of the big ones that we still see some lawsuits about. Obviously, excessive fees is another. And look, that's a rabbit hole.
We're not going to go, like, super deep on. But that can be everything from just not being aware, right, the plan administrator, not being aware of what the fees are, and that there may be other solutions that are better in fees, offer a similar solution, to the actual products. I mean, you know, it could be everything from, again, whether it's just a mutual fund product or it's a variable annuity product, are there restrictions, are there guarantees, are there, you know, all kinds of limitations like that, surrender charges. You just have to, as an administrator, you have to be aware.
And I think that was one of the big problems coming out of that time period, the great recession, and for several years after, is that it just wasn't an awareness, right? You have to remember, these aren't experts in the financial field. And that's what I was going to say. Like, to their credit, you have an HR person at a university who goes out there and vets these different firms to add to their, you know, 4-3-B plan.
And they're not aware of revenue sharing in 12-1, and they get approached. And the providers say, look, you can have this for free. You know, we do everything for you. Here's a hundred funds.
It's all free. They don't know that on the back, no one does anything for free. So in the back end, where's that money coming from? You know, where's the revenue sharing coming from?
And they were ignorant to it all and just signed up. And so I think some of the blame is, you know, maybe on the providers, you know, that maybe disclose more of where these fees are coming from. But my point is, he planned administrators, in this case, you know, the university's colleges, the HR folks, I just, they didn't understand how to keep up with the regulation changes or how to adjust. Right.
Well, and I'll add, I mean, even, you know, not that American funds is a bad company, but just as an example, I went out, it's been a few years since I looked at their Compunial R shares. And just to take two minutes and look, and maybe we'll throw that in show notes, at their, their table of the different R share iterations, what advisor compensation is, what record keeping costs are, all that stuff. I mean, it's like hieroglyphics, if you're not paying attention, you know, there's just so many different iterations. And the understanding of what compensation is actually there in proper share classes is one of the things that has caused lawsuits in the past.
And again, it's not that American funds is bad. It's just, it's just an example that they offer like 20 different iterations. Yeah, I don't think it's, I totally agree. I don't think it's the admissions fault completely.
I mean, listen, I've done nothing but pick neutral funds for 17 years. And I pop in there and look at Pimco has like 25 share classes and everything. I still don't know half the time what share class I'm supposed to do. You know, we have to die now.
It's all institutional share classes. But before that, they had one for retirement, A shares, all these, I mean, it's hard to keep up with what the hell they're releasing. Well, and the fact that it's not consistent, right? It's not that there's, I mean, yeah, A share is an A share pretty much across the board, right?
What about these new R shares and C shares? Exactly. I mean, an institutional isn't even an eye share necessarily. And God forbid, I share becomes a brand name for BlackRock.
I mean, really, personally, I think that was pretty smart, you know. I share, I share exactly the Kleenex of the financial industry. All right, so let's see this. So what, so these lawsuits all started in 2016, right?
Yale, Duke, John Hopkins, a bunch of top places, Vanderbilt. And then in 2019, earlier this year, they seem to have hit a wall. And because the last, I think five or six were all dismissed. I think some of the earlier ones had some settlements, but recently, they were all dismissed.
The most recent was Georgetown earlier this year. And the judge basically just dismissed all the complaints. And so let's kind of talk. What are some of the reasons why these things got dismissed?
Well, you know, one of the things I think is interesting is the plan providers have pretty much been considered not fiduciaries. I mean, that to me is a big one. And to clarify, let's because plan providers, in this case, is the fidelity and crafts and vanguards of the world, right? Right, which is interesting if you think about it, because they're the ones creating the products.
And yet what it's really saying is that they have no responsibility for the products that they create, right? It's like, I mean, you know, it's, yeah, I almost went down a rabbit hole. I'm not going to go down. So, but anyway, that's really the point of that particular issue is that the product providers are not fiduciaries.
So what that really means is it goes to the plan administrator, right? To be the decision maker in most of this, right? They have to decide and therefore they have to understand what it is that they are choosing for the plan participants to invest. So what you're saying, I guess, is before, or, you know, part of this lawsuit was that everyone was pointing the fingers.
So the participants really have to plan administrators. The plan administrators saying, hey, you know, we're not, it's fidelity and craft and the plan providers that are doing this. We don't have anything to do with it. Yeah, exactly.
It's sort of like the plan administrators. I think for the most part for years, it said, you know, look, they're not going to offer anything to us that isn't valid. Yeah, why would you assume that a for-profit company is going to always be looking out in your best interest? Well, now we know, right?
If they're not considered fiduciaries, they don't have to. And again, it's not to throw anybody into the bus. It's just, this is the way the law is looking at it. So.
Okay. And then so one of the things that Potomac has utilized for years that we both agree has really solved the lawsuit problems is the brokerage window. Right. And just a quick explanation on that.
The reason that we think it's solved is that the plan administrators can now pick a limited handful of funds, right? They can go out and say, all right, these are the 10 best funds from large cat, mid cat, mid cat, small cat, real estate, whatever the asset classes they decide on. And then there's this thing called brokerage window where the client can then choose to open themselves up to a brokerage account with 3,500 funds, but they are on their own and they sign off that they agree that they are using this brokerage window to go find whatever funds they like. Is that right?
Yeah. And this is, this is where I think, right? Everything, you know, can sometimes have a cycle and you get a period where, you know, there was a relative with each vendor, there was maybe a relatively limited amount of choices, but then over time, you know, those always expand, right? And well, wait, there's not, and part of this is our market, the volume of products that are available.
I mean, think about it. Could you, you know, could you get an ETF on water rights? Well, no, not always until a few years ago. So, you know, is there a mutual fund for gold is in the portfolio?
Is there a mutual fund for other precious metals? And I'm picking on those because they're a little bit more unique, but the plans had these expanding lists and there's a point at which they realize that there's a responsibility to monitor those lists. And is it the best gold fund or the best international fund or whatever? Well, that, that point was the lawsuit.
Right. Exactly. And so, so I think this is where you and I agree that the decision to create something like a brokerage link and different vendors have different iterations of this, you know, some sort of a self-directed, which is a more common, commonly used term brokerage link is specific to Fidelity, but the ability to have one of the investment choices, be this open door to go into a much broader pool for those that want to have more freedom in their investment choices and then it shifts and then it shifts the liability right to the client and rightfully so for them to decide what they want. Right.
But that what that really does is enable the the plan administrator to have a much more narrowly focused list. And that's okay. Right. And therefore their job and their responsibility becomes much smaller because they're not having to try and monitor a hundred funds.
They may be have like, you know, okay, so here's some target eight funds for the really simple here's some a few passive active or index or whatever. Right. It's just a handful of selections. But oh, by the way, if you really want more and you want to take that on your shoulders here, you can go use brokerage link and that that's open up for us exactly.
The other added benefit at that point is that on that brokerage like account, you can then hire a financial advisor if you want additional services around managing money, asset allocation and even financial planning, depending on the advisor you choose. So it really it not only opens the client up to a lot more choice, but it also allows them to hire a professional and they don't have to. That's a great thing about it. You know, and this is where I love where free market works.
Listen, there's 10 funds, probably a couple of target dates. If that's what you want, knock yourself out. If you want a brokerage window, it opens it up and it allows you to then hire a professional if you value the service of a professional. And that's entirely up to you.
And so the point being to bring this back around is that I think this is totally solved any future lawsuits because the plaintiff industries are going to add this and we've seen it, right? You've seen it and I know you have an example of where, you know, the states have taken control and are sort of forcing this where, you know, we want to have that brokerage window reduce the liability on the plaintiff administrators and allow more control for the client. Yeah. And so as an example, so there's two things.
One, so 2017 Fidelity actually won a big lawsuit where and that was part of the gig we've been discussing, right, where they're not a fiduciary. And in fact, to go even farther, the fact that what the determination was is everything was dismissed is that brokerage link is just another investment choice. The difference between it and the other choices that the participants have is that it does open up this broader pool. And once they go in that door, that's on them.
But you know, there are states in this process, when you think overall all these lawsuits and so forth, Ohio, I'll keep it short, Ohio has made the determination, they spent about two years working with an outside consultant to take all of their four years and two year colleges and really sort of clean house, for lack of better phrase, right? They're narrowing down the list of vendors available so that they have better control, less likely to get sued, right? There's going to still going to be multiple vendors, but it gives the participants a much more focused list of places to choose. And in this particular example, Fidelity will be one of them.
And so their brokerage link is one of the choices within. And there, so yeah, back to your point, right? Well, let me contrast that. Let me contrast that with.
Sure. Last time I checked, California has 267 vendors. So just to contrast that in terms of proving your point there. Yeah, well, I mean, it really, it streamlines everything.
But the great part for clients, right? That's what we're all here to do is to help clients. The great piece of this out of this whole process is that now there's a great piece of revenue in which to be able to hire a personal financial advisor who can then work with them to do any number of things, but includes hiring outside manager who can physically manage the account. And that's just not an option in most of the traditional 403b plans.
Yeah, and it's just allowing freedom and allowing the client to decide what's best for them versus someone else deciding to do that. Exactly. Okay. So yeah, hopefully this does solve future lawsuits.
You know, we'll see how it plays out. But anything else you got on this topic? Yeah, no, I think we're good on this. I guess it's a parting note.
I will say there was a, and I can put this link in the show notes, you know, that some of the ERISA notification is all about risk management. So just keep that in mind as you have the opportunity to help clients, right? Their options are available and should be available from the plan standpoint to be able to help clients mitigate risk. So, yeah, just a food for thought.
So recommendations, what do you got? So I was a vegan for about two and a half weeks. Well, that's two and a half weeks more than me, bro. And I don't know what to say.
Like I didn't have some out of body experience. I wasn't like, you know, feeling tremendously different from when I didn't. So I don't know. Fuck it.
I'm done with it. So my recommendation this week is for Arctic Char. Have you ever had Arctic? I've had a fish guy, right?
You just barely scratched a surface. Hey, for the record, I got down here to the Gulf and the first two nights, I had Mahi Mahi and. Oh, what the heck is up? Well, now I can't even remember.
I had two different kinds of fish in two days. So for me, that's pretty impressive. Well, here's the thing. I'm a fish knob.
I think the majority of Americans are unbelievably horrible at deciding what is considered fish. Tilapia. I wouldn't even use this chum and it's on everyone's menu. The salmon they're producing these days is horrendous.
I'm not getting into it. But the point is Arctic Char, it's like a salmon and a trout made a beautiful baby. And it's delicious. And so my recommendation is it's usually at Whole Foods or Fishmonger.
They're not going to have it probably at your local grocery store. But if you can find it, give it a try. I think it's wonderful. It's interesting.
I haven't even seen that on the menu. I don't remember seeing that. They're barely going to serve at a restaurant. But if you can get to a fishmonger or even a Whole Foods, it's similarly priced a salmon.
It's a freshwater fish and a saltwater fish. Long story. But the point is Arctic Char is delicious and everyone should try it. So it's an anti-discriminatory fish.
That's what you're saying. Yeah, exactly. All right. Well, I have to carry over from last week.
You love my recommendation so much. Don't do it. You love it so much. All right.
And then I'm going to stop going down this road because we've got a different recommendation for our next podcast. But wait, wait, wait. For those people who don't watch the video and just listen to the podcast, Jeff is a 50-year-old white guy. Go ahead.
Yeah, amen. So my podcast recommendation this week is the movie that's a few years old now, but straight out of Compton. I mean, look, I love it. I love it.
It's got some of the same people and issues that were in my last recommendation. You know, hey, just got to have some fun, man. It's a good movie. Good music.
What can I say? That's my recommendation every week from here on out. Did you see my tweet about your Disney Plus? Yeah, I don't care.
I'll spend $50 a month for Disney Plus. Yeah. Well, with three kids. I won't be able to buy any lattes and I won't be able to retire and blah, blah, blah.
Yeah. No, it's all good. All right. Hey, man.
We appreciate it. Everybody like, subscribe, enjoy our podcast. We certainly would love to hear from you on the Connect Us page with Potomacfund.com. And on that note, I guess we're out.
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