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The theater of the absurd


Chutzpah is nerve, shameless audacity. The best example of chutzpah is someone who kills their parents and asks the court for leniency because they’re an orphan.


I’ve been in this business of ours for the past 20 plus years and I’m still shocked by some of the things that go on.  The store I’m about to tell you is true and you’ll think I made it up.


There is a 401(k) plan with an ERISA §3(38) Fiduciary and an ERISA §3(16) administrator. Eventually, the 3(16) administrator and the third party administrator are fired. In addition, the advisor on the plan leaves for another firm, so his new firm is the new §3(38), fiduciary. The advisor discovers (at least he claims) that his old firm, the old §3(38) fiduciary was paid 40 basis points per quarter instead of 40 basis points annually.


Instead of demanding that his old firm hand over the excess payments they received, he conspired with them to what I think was a hustle/shakedown of the ERISA §3(16) administrator. They demanded that the §3(16) administrator, pony up half of the excess payments of $13,500, which means that the old §3(38) fiduciary would still keep $13,500 of the excess. The §3(16) administrator wasn’t born yesterday and suggested that the easiest solution was for the previous §3(38) fiduciary to hand over the entire excess payments because they were fiduciaries at the time and breached their duty by keeping a payments from the plan that they weren’t entitled to, since it was quadruple what they contracted for and disclosed to the plan sponsor. The §3(16) administrator was flabbergasted by this hustle, especially when the third party administrator (TPA) had paid them an excess fee, which they turned over when the TPA discovered it. The other funny part is when the advisor said that the fiduciary liability policy for the old §3(38) fiduciary wouldn’t cover the loss. Of course, they wouldn’t since the previous §3(38) was holding on to the excess. It was rather suspicious that the advisor would cover for their previous employer, but the §3(16) administrator had a hunch that the advisor had made money from that excess payment.


A few months pass and the §3(16) administrator is contacted by the plan sponsor. The plan sponsor sends a letter, demanding the same hustle, suggesting that the previous §3(38) hands over half of the error and that the §3(16) administrator hands over half. The §3(16) administrator quickly replied that they wouldn’t accept the proposal. The administrator pointed out that the previous §3(38) fiduciary breached their duty and committed a prohibited transaction by keeping a fee they weren’t entitled to. The proposal proffered still meant that the previous §3(38) fiduciary would still pocket $13,500 they weren’t entitled to. In addition, the current advisor was breaching his fiduciary duty by protecting his previous employer. The plan sponsor would also be breaching their fiduciary duty by allowing the previous §3(38) fiduciary keep a $13,500 payment that was in excess of the contracted amount and in excess of the fee disclosures, which would be a prohibited transaction.  The §3(16) administrator demanded that the previous §3(38) fiduciary return the excess payment or the prohibited transaction would be reported to the Department of Labor.


The previous §3(38) fiduciary blinked and agreed to fork over the entire $27,000 payment. In addition, they tipped their hand and confirmed that the previous advisor would have to fork over payments he received for that excess payment.


The story is amazing because it is surprising that a registered advisory firm a registered advisor would think that it was OK to pocket a fee that was in excess of the contracted and disclosed amount. They took such a gamble to try to shake down the ERISA §3(16) administrator and convinced the plan sponsor to agree to a prohibited transaction. A fiduciary has a duty to do right by the plan instead of using plan assets for their own benefit. Like the Twilight Zone, the 401(k) business can be the theater of the absurd.

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