Securities Lending can destroy your 401k…

securities lendingSecurities Lending and Your 401k…

Securities lending in 2008 exceeded $2 trillion, and played a key role in the financial crisis.  Yet, few investors understand the harm security lending will cause to their 401k when the next crisis happens.  Insurance companies are required by law to keep 401k investments separate from their general account, and as such, cannot not legally engage in such practices.  During the last crisis, Principal Financial did not engage in securities.  The reality is that they stole billions of dollars from 401k accounts, and fraudulently failed to report millions of dollars in participant’s contributions to the Department of Labor.

There is enough evidence to support the fact that Principal engaged in money laundering, reporting the missing funds as “unrealized losses” in their Annual Reports.  These activities occurred during the months leading up to the crisis, and continued during and after the crisis was over.  

Principal sold investments from the PUSPSA to securities investors through Commercial Mortgage Backed Securities in which Principal was the lender.  Principal represented the original 401k investors, then defaulted on a loan Principal assumed on behalf of those same investors, a mortgage payable to themselves (Principal).  The security was then foreclosed by the CMBS Trustee through a service provider, who paid off the loan with proceeds received through the auction, including accrued interest and liens, back to Principal.  The property was then purchased at auction at a fraction of the original cost to the 401k separate account, believed to be an affiliate of Principal.  Once again, the only losers were invisible 401k investors like yourselves.

Securities lending is big business today.  The Plan Provider working on your behalf to provide an allocation of funds will profit handsomely when he also lends your investment to a third party.  Principal added another twist to their fraudulent activities by providing equity loans to developers, using investor’s contributions to do so.  If Principal was an equity partner in the investment, they would use 401k accounts to guarantee loans to developers, typically through Bank of America and Wells Fargo Bank lending services.  These activities generated huge profits for Principal at the expense of their 401k clientele.  It also removed any risk factor for the developer and Principal as co-developer, since again, the invisible 401k investor would lose if the planned development went into default.  The PUSPSA, for example, would purchase  the defaulted loan and accrued interest, all unpaid liens against the property, and under the Loan Purchase Agreement,  Principal Real Estate Investors would take ownership under a successor and assigns agreement.

The borrowers in a securities lending agreement are usually hedge funds, and the securities are sold as a short sale, where the borrower believes he will repurchase the securities at a lower price to make a profit.  The so-called “lender” in a security lending transaction is typically representing a client as a fiduciary, with the expectation their client will lose money in the transaction.  If the regulators allow that same lender to sell their client proprietary products owned by the lender, that fact will compound the problem, since that so-called fiduciary not only has sold an owned fund to an investor, he has also, as lender, forfeited shareholder value by loaning it to a third party.

When, not if, the next financial crisis occurs, the typical 401k investor and employer must be aware of this potential hazard, and the employer, as a fiduciary, must be sure his plan provider does not sell investment products to third parties in a short sale.  If you, the employer/fiduciary, fails to provide safeguards for your employees to prevent this from happening, you will be personally liable for your employees losses.

If your 401k plan provider is Principal Life Insurance Company, you can be assured that your 401k plan assets are likely being sold to third parties under a lending protocol.  The level of profit is too great for Principal to ignore this opportunity to make money.  Based upon recent judgments, Principal is not considered a fiduciary under ERISA and cannot be held liable for losses.  In addition, if you believe you have protection under a Trustee Agreement you purchased from Principal for Wilshire to be a trustee for you 401k plan, you should read the fine print in that securities lendingagreement.   While Wilshire will provide ERISA 3(21) and 3(38) services as a trustee, the language in the agreement controls their responsibilities.  Historically, Principal sponsored trustee services have excluded separate accounts as they involve an insurance company annuity, and under such Principal owns all plan assets.  Fiduciary responsibility in this case cannot be assigned.

Future uncertainties hold challenges for the 401k industry, challenges that can be met only with stricter enforcement of existing laws and regulations.  Recently, President Trump has vowed to loosen the regulations for Wall street companies, and also severely punish the wrongdoers when those individuals violate existing rules and regulations.  He can start with the Principal Financial Group of Companies.

 

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Author: Dennis Myhre

Mr. Myhre can be contacted at..... dmyhre@fiduciaryfactor.com