There is a novel recordkeeping and plan investment arrangement for governmental 457(b) plans that could create a number of problems for the plan’s sponsor, fiduciaries and participants. There may be a significant number of these arrangements them throughout California.

According to a financial adviser who sets up these arrangements, a “co-provider” arrangement is one where you have a single governmental 457(b) plan that is evidenced by a single plan document, with more than one plan recordkeeper and at least one plan investment consultant. You might ask: “How would a plan end up with more than one recordkeeper?” Here’s how:

• Many of the 457(b) plans maintained by California cities and special districts are established with large insurance company providers that encourage the investment of plan assets through some type of annuity contract. Most of these contracts, which provide certain guaranteed rates of return, contain restrictions on the ability of the plan sponsor to move the assets of the plan to another provider – another recordkeeper.
• All administrative service agreements, or recordkeeping agreements, that relate to these plans contemplate a single provider will assist the employer in tracking all accounts, investments, vesting, contribution limits, participant loans, etc. under the plan.
• Most newly hired financial consultants, when faced with this situation, would simply arrange to set up a new and separate 457(b) plan – one that competes with the existing arrangement. We recently learned of a situation where the new adviser instead found another recordkeeper willing to recordkeep just a portion of an existing plan. It set up a new investment menu with the new recordkeeper and “invited” participants in the existing plan to invest their deferrals and their existing accounts in the new “co-provider” arrangement without informing the original provider. This siphoned away or redirected monies into the new arrangement from the old, not unlike “borrowing” your neighbor’s electricity without telling them.

While we can appreciate the objective of offering different, perhaps better, plan investments to employees, we have serious concerns about how these co-provider arrangements may be set up and operated:

• Here, the new financial consultant and new recordkeeper did not properly analyze the terms of the plan’s annuity contract with the incumbent provider. As a result, the new arrangement appears to breach the terms of the existing investment arrangement and jeopardized participants’ abilities to earn higher-than-market guaranteed rates of return under the older arrangement.
• The chances of compliance violations (i.e., excessive deferrals, hardships, loans, etc.) were dramatically increased by having two recordkeepers not communicating with one another. The new recordkeeper was only “looking at its part of the elephant.” However, the original recordkeeper thought it was still responsible for the entire plan, even though it did not have all of the plan’s assets on its books.
• Neither of the recordkeepers were in a position to track all of the plan-level, participant-level limits and restrictions. This responsibility fell back on the employer. Unfortunately, this new burden was not properly explained to the agency when the new arrangement was being proposed.
• Understandably, the new financial consultant started with only a small portion of the plan – which grew significantly over the years. It priced its services accordingly and charged a significant number of basis points. That might have been okay initially, except for the fact that the assets under its control have since tripled and it has not adjusted its rate of compensation. It may be charging three times too much.

The moral of the story: Beware of unusual arrangements that seem expedient and designed to get around established arrangements and providers. Some work, but some are not well thought out.