Collective Bargaining for DC Vendors Has Risks for Plan Sponsor and Plan Participants

Some plan sponsors in the pubic sector have added vendors to their IRC Section 457 or other plans as a result of collective bargaining with one or more public employee unions.  This can be a risky decision that is fraught with potential problems for both the employer and employees.

While at first this may seem an easy benefit to provide that is not costly to the public employer, it is a practice that may have financial consequences for the plan sponsor in the long run:

1.    Fiduciary responsibility trumps collective bargaining

A number of rulings and lawsuits have made it clear that the plan sponsor must act  “in the best interests of plan participants and beneficiaries.”  Most recently, the 8th U.S. Circuit Court of Appeals affirmed the position of the Department of Labor that the plan sponsor must prudently monitor fees paid to plan providers.  Failure to do so can result in financial liability for the employer.[1]

Adding another vendor simply because it was a condition of collective bargaining does not relieve the plan sponsor of its duties to monitor fees and other plan features in the best interests of plan participants.  Many union-sponsored arrangements are “bundled” arrangements over which the plan sponsor has no control in the area of fees, investments or features.  Yet, while the plan sponsor cannot control these elements, it remains the plan fiduciary.  In other words, you have all the risk but someone else is making all the decisions. 

2.    Adding a program that failed an independent review

In many situations, another vendor was added as an available option even though that program failed to pass an independent public bid evaluation process.  This not only applies to union-sponsored programs, but situations where a local broker or financial adviser proposed a program that failed to pass muster in a formal bid review process, yet was added later due to political or collective bargaining pressure.  This is never an acceptable action for a prudent plan fiduciary.

3.    Increased risk of liability for failure to disclose available options

 How would you respond if this situation unfolded at your city, county or special district?

A plan sponsor selected a vendor for their plan following a competitive bidding process.  A consultant was involved, along with a review committee.  The result of the process was to select a vendor that ranked highest according to the criteria of the public bid.  The plan sponsor entered into a contract with that vendor.

Shortly after the bid process, a union bargained for their endorsed program to be added as a secondary option for employees.  The employer, in a collective bargaining process agreed.  The union program had been submitted for consideration in the original process to select a single vendor, but it scored poorly compared to other bidders and was not selected for general employees.

Nonetheless, the plan sponsor added the second vendor as a result of negotiations with one of the unions.  The union routinely signed up new union employees in its endorsed program. About a year later, a union employee who automatically joined the union endorsed program discovered that another program was also available, when his spouse took a job with the same employer.  As a general employee, she was enrolled in the program that was created as a result of the public bid process.  Both employees were confused as to why they were enrolled in separate programs.  The general employee spouse worked in finance, so she prepared a comparison of her program and the program her husband was enrolled in.  Both spouses were surprised at the high fees and poorer performing investment options in the union sponsored program.  They were also surprised to learn that the union was receiving a share of the fee revenue from the endorsed program.  That fact was not disclosed to participants at enrollment.

The union employee then claimed that he was never made aware of the alternative plan when he joined the public entity.  He alleges that the employer was negligent in failing to inform him that he was eligible for another less expensive plan.  He also alleges that the employer failed to inform him that the endorsed plan had been independently reviewed, but did not score well and was therefore excluded from consideration for general employees.

This is a nightmare situation for any public plan sponsor.  In this instance, the plan sponsor exercised due diligence in selecting one vendor for all employees, but did not do so in signing a contract for another segment of employees. Furthermore, the employee automatically enrolled in the union plan allegedly had no knowledge that he could have joined the other plan.

So, the question is:

  • Is this simply a disclosure issue for the plan sponsor, or;
  • Would this be viewed as the plan sponsor turning their back on their obligation to be certain that all of their offerings were “in the best interests of plan participants and their beneficiaries?”

If the plan sponsor could be held liable for their decision (as indicated in Tussey v. ABB) then the financial ramifications of this situation could be severe.

4.    The role of a third party sponsor

 Public employee unions play an important role for their members and constituents, so the issues raised in this article are not negative towards unions or other third party sponsors of programs. To the contrary, third party oversight can be helpful, particularly for smaller public employers who cannot afford an independent consultant and/or who don’t have the expertise to conduct a full market review or public bid.

One major area of concern on third party sponsored programs is how independent the sponsor is from the vendor they have selected.  I took a look at the four largest union and third party affinity sponsored programs used in the public sector.  Of the four, one had conducted a public review with an independent consultant in the past five years, and openly discussed the findings of that review with participating entities.  It was not clear from publicly available information what public reviews or bids were undertaken recently by the other three sponsoring organizations.  Only one of the four had information about a public market review on their web site.  There was no mention of independent reviews on the other sites.  Interestingly, only one of the four had actually changed vendors in the past several years.  One appears to have had the same vendor for over 30 years.

These findings don’t imply anything bad or improper with endorsed programs.  However, any prudent plan sponsor should require some evidence of a formal independent review on a regular basis if they are asked to sign a contract as a result of collective bargaining, and not due to an independent market review.

5.    The union as fiduciary      

In at least one instance, an employer who agreed to add a program through collective bargaining did so but refused to sign the contract with the union endorsed company. They required that the union sign the contract and assume the fiduciary liabilities that go with it. This option poses an interesting legal question.  While a fiduciary can delegate all or some of their obligations to a discretionary trustee, you would need the opinion of your own legal counsel to determine whether or not your circumstances permit you to delegate fiduciary responsibility to a third party, and if so, who that third party can be.  For example, even if you are able to delegate fiduciary responsibility to a third party, what due diligence must you perform to be certain you are delegating fiduciary responsibility to an entity that is financially sound and is qualified to act in that role?  These are all questions for your legal counsel, but the delegation issue is in interesting concept when the employer agrees to add a vendor negotiated through collective bargaining and not through a formal bid process or market review.

6.    How many programs are enough?

Finally, once an employer begins adding program options through collective bargaining, and not through a formal review process, it opens a floodgate for other employee groups to add their own endorsed program.  There are many situations where a city or county has multiple vendors, most of whom were added through collective bargaining or because one particular group (management, unions or both) had a preferred vendor. These multiple-vendor programs can be very confusing to employees, and begs the question about who benefits from this –employees or the sponsoring organizations?  It would be hard to demonstrate that you carried out your fiduciary duties in a responsible manner when all you did was add whatever programs you were asked to make available.  At the end of the day, the plan sponsor is the fiduciary and has the liability that comes with it.

“Balkanization” of your plan is not a good solution

The term “balkanize” means to “ divide into small, quarrelsome, ineffectual states” as was the case with the break up of the Balkan states in Europe. Chopping up your defined contribution plan to accommodate various groups with financial interests in their own products or endorsement fees is not a prudent way to manage a pension program.  A plan fiduciary should design your defined contribution plan “in the best interests of plan participants and their beneficiaries” and not for the benefit of other parties.

Unions and other employee and employer organizations can play an important role in public pension policy, and in the products, services and features a defined contribution plan should offer employees.  These groups can play a valuable role as part of an overall review committee or board that selects a vendor to manage the plan for the benefit of all employees.  This process is used by most  larger plan sponsors and it works well to use combined purchasing power and collective talent to develop a program with low fees and attractive features available to all employees.

Chopping you plan up into small pieces, each one chosen through collective bargaining or political pressure, and not by independent review and evaluation, is not a “best practice” for a plan fiduciary.  It entails risks for the plan sponsor and can hardly be viewed as being in the “best interests” of the employee.

Gregory Seller Consulting, LLC

All rights reserved.  May not be reprinted in whole or in part without written permission. Provided for information only and is not legal or investment advice.  Plan sponsors should seek their own legal counsel on the impact of court rulings on their fiduciary liability.



[1] Tussey v. ABB