ABSTRACT PSNTs are attracting more attention. Could this focus increase regulatory oversight or spur rulemaking that transforms the industry? Possible, but not the most likely scenario. In the absence of visible, widespread, and disruptive violations, motivation to come after a relatively small sector of the financial services world, particularly one that does not pose systemic risk, is limited. PSNTs already operate in a highly regulated environment. Regulatory entities govern investments, banking, nonprofit status, fundraising, activities of the PSNT administrator, and disability and related benefits. Many financial products have emerged from bits and pieces of the tax code and other legislation, 401(k) plans, for example. And while the resulting products might have started as unintended consequences, when the products work for consumers and business and create tax revenue, we have not seen them targeted by transformational regulation. Governance and compliance can and should be managed proactively as the PSNT industry matures. Tools used successfully by other industries use that can be applied here include Codes of Ethics, industry-wide Governance committees, specific initiatives that anticipate regulators’ concerns, and open channels of communication with regulatory entities.
There is a view that more regulation is coming, inevitably, to the Pooled Special Needs Trust (PSNT) industry. This scenario envisions that regulation can be accelerated, by bad apples and by attracting attention, or decelerated by adherence to best practices. The quiet part of the thought is that perhaps there was not full awareness of what was legislated into existence back in ‘93, and once the scope and evolution of the PSNT industry is fully known, regulators will desire to constrain it.
Possible? Sure. But we don’t see it unfolding that way. Here’s why.
Evolution v. Revolution
Regulators jump in to stop behavior to which they object. They do that by creating rules and by punishing violations with tools like litigation and fines. They lean reactive.
In the moment, no widespread, intentional violation of regulations or rules by the PSNT industry that is harming vulnerable people or ringing alarm bells has surfaced. Contrast that, for example (as I write this) to the disconnect in the financial markets with so called “meme” stocks, and “free” brokerage accounts. Outsize gains and losses and the potential for consumer misdirection are the kinds of things that grab the regulators’ attention and create urgency, and for good reason.
There is certainly indication of growth and opportunity for PSNTs. However, in the moment, the industry is nascent, and is dwarfed by nearly all sectors of the financial services industry. (According to the Investment Company Institute’s (ICI) published statistics at publication, assets in retirement accounts exceed $33 trillion, much of which is invested in mutual funds ($24 trillion) and ETFs (more than $5 trillion). The PSNT industry does not in the moment affect nearly the number of investors or beneficiaries that would attract widespread regulation or enforcement in the absence of a catalyst.
The vast majority of PSNT providers do excellent work, are well-governed, and appropriately resourced. PSNTs don’t create systemic risk or have the ability to influence capital markets. Trusts are taxable, which the government generally views as a plus.
While is there no single set of regulations applying to PSNTs, per se, there is indeed substantial oversight of many aspects of PSNT operations by entities with regulatory authority, among them:
- Securities Exchange Commission (SEC), which regulates investment advice and management, including communication regarding investments
- State Attorney’s General, also known to jump in on investment-related consumer complaints and issues
- Bank regulators, including the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC) and others, govern bank operations including trusts
- IRS, controls tax status of the nonprofit trust administrator
- States establish audit and fundraising registration requirements
- Social Security Administration (SSA) rules govern eligibility for means-tested benefits, and direct how the PSNTs must be organized so beneficiaries qualify for these benefits
PSNTs are Unique, but Not Alone
Defined contribution (DC) plans – 401(k)s, for most people – were, like PSNTS, brought into existence by tax legislation, back in 1978. The legislation stipulates, among other things, that investment returns and capital gains in investor accounts are not taxable until withdrawal. These deferred taxes became an eye-catching target as plans grew but concerns about the IRS going after them have not materialized. More recently, there is discussion about new rules for Donor Advised Funds (also nonprofits, and which also offer tax benefits to donors) as the donations TO them outstrip distributions FROM them.
The evolution of defined contribution plans over time is instructive for PSNTs. Now, multiple regulators address components of the business. The SEC focuses on the investments, the IRS sets annual contribution limits, and the Department of Labor (DOL) focuses on employer fiduciary responsibility. No single entity governs the entire industry.
Today DC plans have a bit of work keeping track and staying in front of the regulation and rules and ensuring compliance. That’s where we see this going for PSNTs as the industry matures.
Proactive management of a maturing industry, including its regulatory framework, suggests a number of specific activities, all expanding on a foundation of best practices. For example:
- Creation and Adoption of an industry Code of Ethics
- Specific PSNT industry initiatives that reflect regulators’ identified agendas
- For example, the SEC cares very much about fee disclosure to consumers for financial products. An initiative that defines an industry-standard format for disclosure of PSNT fees would sync with their worldview.
- Dialogue with regulators to help them understand the world of PSNTs and those served by them, and to clarify regulations that already exist, where clarification is helpful
- IRS private letter rulings, for example
- Creation of an industry Governance / Compliance / Advocacy committee to track and interpret applicable and anticipated regulations
The government entity most engaged with PSNTs now is Medicaid, fighting battles over beneficiary resources in the Circuit courts. (While stressful for non-lawyers, litigation is a form of engagement, and thankfully not the only one.) The PSNT industry is doing a great job of avoiding being a soft target in the short-term, even as the tide turns inexorably against penalty-free transfers to PSNTs for the 65 and older cohort.
Regulators face headline risk in launching an offensive on financial products that serve people with disabilities, particularly in the context of the Biden-Harris administration’s vocal support for the disability community. A certain former Secretary of Education experienced that when she went after the Special Olympics, even with a sympathetic administration in charge.
Regulation is a factor in every industry. Regulation paved the way for PSNTs, so it is reasonable to foresee additional rules as the industry grows and the world around it changes.
Individual enterprises running amok can, yes, open the door to industry scrutiny, which bears fruit for regulators when violations are widespread.
Now is the time to be proactive on both governance and ethics by creating and reinforcing durable structures and processes for industry governance, including engaging with independent industry analysis. This solid foundation will maximize industry credibility, voice, vote, and sustainability.