Compliance March 13, 2020

SEC Adopts Rule to Simplify Variable Annuity Disclosures

The action, in part, addresses the concern plan sponsors had about the ability to understand—and to communicate to participants—these complex products.

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The U.S. Securities and Exchange Commission (SEC) has adopted a new rule and related regulatory amendments to simplify and streamline disclosures for investors about variable annuities and variable life insurance contracts.

SEC Chairman Jay Clayton says the changes permit the use of “a concise, reader-friendly prospectus designed to improve investors’ understanding of the contracts’ features, fees and risks.” He says the new framework’s use of “layered disclosure and technology” will provide investors with a roadmap so they can more easily access the information they need to make an informed investment decision.

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“With today’s technology and the benefits of layered disclosure, investors should not have to work through hundreds of pages of disclosure to understand these products’ risks, fees and features in order to make informed investment decisions,” Clayton says in a statement published alongside the final rule.

Under this framework, detailed information about a variable annuity or variable life insurance contract must still be made available online, and an investor can choose to have that information delivered in paper or electronic format at no charge.

Clayton says the framework builds on the commission’s experience with a similar layered disclosure approach developed for mutual funds. To implement the improved disclosure framework, the commission adopted amendments to the registration forms and related rules for variable annuity and variable life insurance contracts. Variable annuities and variable life insurance contracts may begin using the modernized layered disclosure approach as early as July 1.

Technically, the SEC has introduced a new Rule 498A under the Securities Act, which permits the use of two distinct types of contract summary prospectuses. These are an “initial summary prospectus” covering variable contracts currently offered to new investors and an “updating summary prospectus” for existing investors.

According to an SEC fact sheet, the initial summary prospectus must include the following features: a table summarizing certain key information about the contract’s fees, risks and other important considerations; an overview of the contract; and more detailed disclosures relating to fees, purchases, withdrawals and other contract benefits. The updating summary prospectus, in turn, must include a brief description of certain changes to the contract that occurred during the previous year, as well as the key information table from the initial summary prospectus.

The SEC’s action is timely considering the Setting Every Community Up for Retirement Enhancement (SECURE) Act has established a fiduciary safe harbor for annuity provider selection for retirement plan sponsors. The safe harbor addresses one concern plan sponsors have had about offering annuities within defined contribution (DC) plans, and some think it will open the door for more plan sponsors to do so. Another concern plan sponsors had is the ability to understand—and to communicate to participants—these complex products.

The initial financial services industry reaction to the SEC’s action seems to be positive. For example, the Insured Retirement Institute (IRI) shared supportive comments upon the SEC’s announcement.

“This is a major leap forward in the ability to provide consumers with information they need to make educated investment decisions about financial products that can be essential to ensure a secure and dignified retirement,” says Jason Berkowitz, IRI chief legal and regulatory affairs officer. “We are carefully scrutinizing the final rule with our members to fully understand its ramifications and to ensure that it allows for a more rational disclosure of important consumer information versus today’s required book-length paper versions delivered by U.S. mail. We are deeply appreciative of the commission’s thoughtful and inclusive process in this rulemaking.”

Compliance March 13, 2020

Salesforce Accused of Fiduciary Imprudence in New ERISA Lawsuit

Case documents show Salesforce has actually changed some of the practices that are criticized in the complaint, but the plaintiffs argue that these changes were made too late.

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The latest Employee Retirement Income Security Act (ERISA) lawsuit filed in federal court is targeting Salesforce for a number of alleged fiduciary breaches in the operation of its defined contribution (DC) retirement plan.

The complaint was filed in the U.S. District Court for the Northern District of California and seeks class action status on behalf of a sizable group of retirement plan participants and beneficiaries. Named as defendants are Salesforce itself, along with its board of directors and its investment advisory committee.

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According to the complaint, the Salesforce plan had more than $2 billion in assets at the end of 2018. The complaint, echoing numerous other excessive fee lawsuits filed under ERISA, states that the size of the plan gives it substantial bargaining power to negotiate lower fees for both investment products and for recordkeeping services.

“Defendants, however, did not try to reduce the plan’s expenses or exercise appropriate judgement to scrutinize each investment option that was offered in the plan to ensure it was prudent,” the complaint alleges.

Salesforce is accused of failing to take advantage of the lowest cost share class available for many of the mutual funds offered in its retirement. The defendants are further accused of failing to consider the use of collective investment trusts, comingled accounts or separate accounts as alternatives to mutual fund offerings, despite potentially lower fees.

Notably, case documents show Salesforce has actually changed some of the practices that are criticized in the complaint. But the plaintiffs argue that these changes were made too late and that the plan fiduciaries should be held financially liable for not making these “prudent” decisions earlier.

“It appears that in 2019, five years into the class period, wholesale changes were made to the plan wherein certain plan investment options, some of which are the subject of this lawsuit, were converted to [lower cost] shares,” the decision states. “These changes were far too little and too late as the damage suffered by plan participants to that point had already been baked in. There is no reason not to have implemented these changes by the start of the class period, when the majority of lower-cost shares were available.”

Important context for understanding these allegations comes from the fact that large employers across the United States are fighting practically identical claims, with mixed success. So far the federal courts have promulgated a complex and even contradictory mix of decisions, some of them seeming to favor plaintiffs and others defendants.

In this particular case, much of the text of the complaint is dedicated to a basic recitation of the fiduciary duties under ERISA, to the fact that passive investments can cost less than active investments, and to establishing that collective investment trusts and other investing vehicles available to large retirement plans can cost less than mutual funds. Only after spelling out this general information does the complaint claim the Salesforce fiduciaries failed to prudently and loyally monitor their plans expenses.

“The funds in the plan stayed relatively unchanged from 2013 until 2019,” the complaint states. “Taking 2018 as an example year, almost half of the plan’s core investments (including all but one of the target-date funds[TDFs]) were much more expensive than comparable investments found in similarly-sized plans (plans having over a billion dollars in assets).  The expense ratios for these funds were in some cases up to 135% (in the case of the Fidelity Contra Class K) above the median expense ratios in the same category. … At all times during the class period, defendants knew or should have known of the existence of cheaper share classes and therefore also should have immediately identified the prudence of transferring the plan’s funds into these alternative investments.”

The full text of the complaint is available here. Salesforce has not yet responded to a request for comment.

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