[Senate Hearing 110-999]
[From the U.S. Government Publishing Office]
S. Hrg. 110-999
401(K) FEE DISCLOSURE: HELPING WORKERS SAVE FOR RETIREMENT
=======================================================================
HEARING
OF THE
COMMITTEE ON HEALTH, EDUCATION,
LABOR, AND PENSIONS
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
SECOND SESSION
ON
EXAMINING 401(K) PLAN FEE DISCLOSURE, FOCUSING ON HELPING WORKERS SAVE
FOR RETIREMENT
__________
SEPTEMBER 17, 2008
__________
Printed for the use of the Committee on Health, Education, Labor, and
Pensions
Available via the World Wide Web: http://www.gpoaccess.gov/congress/
senate
----------
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Washington, DC 20402-0001
COMMITTEE ON HEALTH, EDUCATION, LABOR, AND PENSIONS
EDWARD M. KENNEDY, Massachusetts, Chairman
CHRISTOPHER J. DODD, Connecticut MICHAEL B. ENZI, Wyoming
TOM HARKIN, Iowa JUDD GREGG, New Hampshire
BARBARA A. MIKULSKI, Maryland LAMAR ALEXANDER, Tennessee
JEFF BINGAMAN, New Mexico RICHARD BURR, North Carolina
PATTY MURRAY, Washington JOHNNY ISAKSON, Georgia
JACK REED, Rhode Island LISA MURKOWSKI, Alaska
HILLARY RODHAM CLINTON, New York ORRIN G. HATCH, Utah
BARACK OBAMA, Illinois PAT ROBERTS, Kansas
BERNARD SANDERS (I), Vermont WAYNE ALLARD, Colorado
SHERROD BROWN, Ohio TOM COBURN, M.D., Oklahoma
J. Michael Myers, Staff Director and Chief Counsel
Ilyse Schuman, Minority Staff Director and Chief Counsel
(ii)
C O N T E N T S
__________
STATEMENTS
WEDNESDAY, SEPTEMBER 17, 2008
Page
Harkin, Hon. Tom, a U.S. Senator from the State of Iowa, opening
statement...................................................... 1
Enzi, Hon. Michael B., a U.S. Senator from the State of Wyoming,
opening statement.............................................. 3
Campbell, Bradford P., Assistant Secretary, Department of Labor,
Employee Benefits Security Administration, Washington, DC...... 7
Prepared statement........................................... 10
Lacy, Olena Berg, Director and Senior Advisor for Financial
Engines, Testifying on Behalf of the Pension Rights Center,
Washington, DC................................................. 21
Prepared statement........................................... 22
Benna, R. Theodore, Founder, the 401(k) Association, Jersey
Shore, PA...................................................... 28
Prepared statement........................................... 29
Hunt, Paul, President, Millennium Advisory Services, Testifying
on Behalf of the U.S. Chamber of Commerce, Glen Allen, VA...... 30
Prepared statement........................................... 32
ADDITIONAL MATERIAL
Statements, articles, publications, letters, etc.:
Wall Street Journal, article................................. 4
American Benefits Council (ABC).............................. 43
American Council of Life Insurers (ACLI)..................... 44
American Society of Pension Professionals & Actuaries (ASPPA)
and the Council of Independent 401(k) Recordkeepers (CIKR). 45
Investment Company Institute (ICI)........................... 67
AARP......................................................... 85
(iii)
401(K) FEE DISCLOSURE: HELPING WORKERS SAVE FOR RETIREMENT
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WEDNESDAY, SEPTEMBER 17, 2008
U.S. Senate,
Committee on Health, Education, Labor, and Pensions,
Washington, DC.
The committee met, pursuant to notice, at 10:04 a.m. in
Room SD-430, Dirksen Senate Office Building, Hon. Tom Harkin
presiding.
Present: Senators Harkin and Enzi.
Opening Statement of Senator Harkin
Senator Harkin. Good morning, everyone. The U.S. Senate
Committee on Health, Education, Labor, and Pensions will come
to order.
Though he is not here today, I would like to thank Chairman
Kennedy, as well as our subcommittee chair Senator Mikulski and
our Ranking Member Senator Enzi, for giving me this opportunity
to hold a hearing on my legislation, S. 2473, the Defined
Contribution Fee Disclosure Act.
To paraphrase Mark Twain, the reports of this bill's death
have been greatly exaggerated. It is a fairly simple piece of
legislation, even though there is 25 pages to it. That is
simple around this place. All this legislation says is that
people need enough information to make an informed decision on
one of the most critical financial decisions they will ever
make in their entire lifetimes.
Given this week's tumult in the stock market, this
legislation is designed to address what might seem to be at
first glance a small issue, but, in fact, it has a dramatic
impact on the retirement security of millions of Americans who
have 401(k) plans. Not many people realize this, but ERISA does
not require plan sponsors to provide participants with
information on the level of fees that participants are charged
by the various plans that they have to choose between.
While everyone is seeing a big dip in their nest egg for
the short term during each tumble that the stock market takes,
those losses are temporary, I hope, and recoverable. Erosion
from high fees, however, is quiet. It is long-term, insidious,
and you don't recoup it. It cuts benefits by a huge amount over
a long period of time.
The number of people participating in defined contribution
plans grows every year, and unfortunately, these plans are a
bigger part of their nest egg as more and more employers freeze
or terminate defined benefit plans. One of the key things in
moving from defined benefits to defined contributions is making
sure that people have all of the information they need to help
them decide which plan serves them the best.
Recently, AARP conducted a survey in which it asked
individuals with 401(k) plans if they even knew what they paid
each year in fees. Only 17 percent of the people asked said
that they knew what their fee levels were. Well, again, it is
not just an academic problem. It could be disastrous for a lot
of people when they reach retirement.
One person shared with me a story that highlights what is
at stake. She noticed one day that her 401(k) wasn't actually
earning anything at all. After some examination, she found that
the agent who set up the plan for the company received a fee of
2 percent annually for the first 5 years, reduced to 2.25
percent after that, which was paid by the employees and not the
company. The investment firm charged a fee of 1.25 percent,
which they said was standard for companies under $1 million.
Last year, she was paying 3.25 percent in fees and earning
less than 4 percent from her money market fund. She didn't have
a clue about the fees until she inquired after she realized she
wasn't making any money on her fund.
So, again, if you look back at the AARP survey, of the 17
percent who said they knew what their fees were--of the 17
percent who said they knew what their fees were, 33 percent
said they weren't being charged anything at all. Of course,
they were charged something, but one out of three thought they
weren't even being charged anything.
Some companies tell people they aren't being charged fees.
Well, some companies may pay the fees, but that is not really
much of the norm when they pick it up. A few may do that.
The Government Accountability Office recently estimated
that a 45-year-old with $20,000 in 401(k) would have $70,550 at
age 65 for his retirement, assuming he was getting a 6.5
percent return and only paying 0.5 percent in fees. But that
figure decreases dramatically if the fees are increased by just
a single percentage point to 1.5 percent. At that figure, the
same individual investing the same amount of money would have
only $58,400 for his retirement, or $12,000 less.
Consider this case. If a 35-year-old invested $20,000 in a
plan over 30 years, paying 0.5 percent in fees, that individual
would have $132,287 for retirement. But if you increased the
fees just by 1 percent up to 1.5 percent, the amount available
for retirement is only $99,679. That is a 25 percent reduction
in the account balance at retirement.
A lot of times people say, ``Well, I pay a fee of 0.5
percent or 1 percent or 1.25 percent, it doesn't seem like
much. It just doesn't seem to amount to a lot.'' But when you
add it up over a 25-, 30-year period of time, you can see that
it can be, as I pointed out here, a reduction of 25 percent in
their total amount.
Again, what has happened is over this period of time, I
have gotten more and more information from people who have
awakened to the fact that they have been paying into their
401(k)s for a long time, and they have been paying high fees.
Then they found someone else who has not been paying very high
fees at all. These things are getting matched up, and they are
saying why am I not having the same kind of retirement nest egg
as someone else simply because I am paying higher fees?
So the information gap, that to let both the participants
and the sponsors, both, have as much knowledge as is needed so
they can make informed decisions is what my bill is all about.
To provide with easily understandable information about the
fees they are paying. Provide it before they pick which plans
they want to invest in and, again, regularly on their quarterly
statements.
It would also require companies to disclose more
information to the plan sponsors. Right now, if you provide a
401(k), you have a fiduciary responsibility. Well, in carrying
out that fiduciary responsibility, you better have a good
knowledge of what is involved and what those fees are.
Sometimes there are hidden fees that aren't even disclosed to
the plan sponsors.
Sometimes those sponsors also aren't told about business
arrangements between service providers to steer participants
into investment options in which they have a stake. Again, I
think that is a classic case of a conflict of interest. So,
again, the bill would require all the plan providers to
disclose all fees and relationships between service providers
to the people selecting the plan that the company will
ultimately offer.
Again, the bottom line is that people need to be investing
more and more confidently in the 401(k)s that they are being
offered, especially in a world where defined benefit plans are
being slashed. And for many people their only source of real
retirement income, aside from Social Security, is 401(k)s.
So, again, I see the bill as a win for companies who want
to provide their workers with secure retirements. It is a win,
I think, for the 401(k) providers. Again, many of them have
been providing really reasonable fees all along, none of this
hidden stuff. But then there is always someone out there trying
to game the system, trying to get a little leg up, trying to
get a little bit ahead, and doing it.
So, again, I think it is a win for those responsible
providers that have been providing good 401(k) plans with
reasonable fees, and I think it is a win for all of the
Americans who now are investing in their 401(k) plans.
And before I introduce our witnesses, I would recognize our
distinguished Ranking Member, Senator Enzi.
Opening Statement of Senator Enzi
Senator Enzi. Well, thank you, Mr. Chairman. I want to
congratulate you on the work that you have done on this issue
and for holding this hearing. It is a very important hearing
and a very timely hearing.
Our crowd isn't as big as it is sometimes for hearings. I
think that is because we are going to be talking about numbers.
[Laughter.]
As the only accountant in the Senate, though, this is one
of my favorite kind of hearings.
Senator Harkin. You know about this stuff.
Senator Enzi. Yes, I actually filled out several of the
Form 5500s that we will talk about, and I have looked at the
chart there and find it fascinating that the fund that is
giving the biggest return also has the lowest operating
expense.
Senator Harkin. Say that again, Mike.
Senator Enzi. The fund that is giving the biggest return on
that chart has the lowest operating expense.
Senator Harkin. Interesting.
Senator Enzi. That is kind of an anomaly, but I am trying
to figure out how you get people to actually take a look at the
numbers, even if we provide the numbers. How do you get them to
look at the numbers? How do you get them to understand the
numbers?
I think part of that is due to our education system. I
don't think we run them by enough charts like this that they
can understand what they are or even the importance of
investing in 401(k)s. So we are holding this hearing at a very
opportune time. What is occurring in our capital markets holds
key lessons for individuals who are investing their retirement
savings for their golden years. We should diversify our
investments, and we should not take on too much risk. Those are
the two principal foundations of investing.
Unfortunately, our financial institutions seem to have
forgotten those rules. We can't afford to do the same with
retirement savings. The Department of Labor tells us that there
are nearly $2.3 trillion in 401(k)s and related accounts
invested in capital markets, and we have to invest these moneys
prudently.
Now, with respect to the fees paid on these accounts, over
the years we have been told by experts that fees matter, and
the smallest increase in fees can cost thousands of dollars
over a 20- to 30-year period. However, we have also been told
that we cannot just pay attention to fees. We also need to make
the right financial investments based on our families' needs
for the future.
Last week, a major news publication printed an article in
which the reporter sought to find out how much she was paying
in 401(k) fees and whether those fees were in line with the
fees paid by others for similar investments. I request
unanimous consent to have the article included in the record.
Senator Harkin. Without objection.
[The information referred to follows:]
[Wall Street Journal--September 10, 2008]
(By Karen Blumenthal)
how much does your 401(k) cost you?
Page D1--You may not realize it, but you could be paying thousands
of dollars a year in fees on your 401(k) retirement account, hidden
expenses that affect how your savings will grow. The government is now
trying to expose those charges so you can make better investment
decisions.
Under regulations proposed by the Department of Labor, 401(k) plans
every year will have to disclose each investment's annual expense
ratio--the percentage that goes to management and other costs--along
with more detailed performance data. In addition, any administrative or
other fees deducted from your account will have to be spelled out. New
regulations may go into effect as soon as Jan. 1.
The fees and other costs we pay are hard to find because they're
taken out before we see investment results. But they are significant
because they nibble into our returns now, and, over decades, they can
take a huge bite out of our future savings tally. Perhaps more
important, expense ratios--even more than an investment's past
performance--turn out to be a strong indicator of how a mutual fund
will fare down the road.
``In almost every study we've run, expenses show up as a very
significant predictor of future performance,'' says Christine Benz,
director of personal finance at Morningstar Inc., the investment
research firm. In other words, over time, funds with lower fees are
likely to outperform those with higher fees in the same category. By
contrast, says Ms. Benz, ``our data indicates that past performance is
a weak indicator'' of future results.
But even with more information, understanding and making sense of
investment expenses can be a mind-bender. To get a handle on them, I
decided to dig into my own 401(k) account to see what I was paying and
what I could do about it. The plan is a typical one, and the exercise
turned out to be revealing--and somewhat painful.
Finding the details. Many plans, but not all, provide performance
data on the various mutual funds and other investment options they
offer, though they may not detail the 1-, 3- and 5-year data and
equivalent benchmark performance that the Labor Department will likely
require. Yet plans don't currently have to detail the administrative
fees or the expenses built into investment choices, and finding those
can be tedious and time-consuming.
My plan is managed by Fidelity Investments, which provides lots of
information on a fairly user-friendly Web site. It was easy to find the
expense-ratio link for the Spartan International Index fund, for
instance. But once there, the numbers were confounding: There were
three separate expense ratios--0.2 percent as of April, 0.1 percent
after reductions as of February and 0.1 percent after a cap on expenses
in 2005. It took conversations with three people at Fidelity to confirm
that the expenses are capped at $10 for every $10,000 invested. Finding
the fund's prospectus--which contained details on the expenses--
required a few extra clicks.
My funds don't come with any ``loads,'' the sales charges assessed
when you buy or sell a fund. Neither do they assess so-called 12b-1
sales and marketing fees. But your funds might. Some of mine do assess
penalties for short-term trading, but I'm way too lazy to move into and
out of funds frequently.
To find out who pays my 401(k) plan's administrative expenses--
those outside of individual funds--I needed to locate something called
the Summary Plan Description. That required a call to my employer's
benefits department to get a copy. I learned on page 87 that the
company picks up the modest legal and accounting fees, and the rest of
the expenses appear to be paid from what Fidelity already charges.
That's good news: Some plans actually charge participants for all or
part of the administrative cost.
How cheap is it? Knowing that the Fidelity Growth fund charges $94
in expenses for every $10,000 invested still didn't tell me if those
expenses were reasonable. Fred Reish, a Los Angeles lawyer specializing
in employee benefits, cautions against looking at the average expense
ratios for, say, large growth funds, since those averages include high-
cost retail funds that wouldn't normally be in a 401(k). Instead, he
suggests a better comparison would be the funds with the lowest
expenses in their category.
At the Morningstar.com1 site, I put in the fund's ticker symbol
(FDGRX) and clicked on a little ``i'' next to the expenses number. That
showed me the fund's expenses were well below the category average of
$137 per $10,000 invested, but still fell into the second quartile. In
other words, this fund was more department store than Target, cost-
wise.
Michael Callahan, of pension consultant Pentec Inc., says he would
consider expensive any U.S. stock fund with an expense ratio over 1.5
percent, or an international fund with a ratio of 2 percent or more.
Using another free Morningstar tool called Xray, I entered all my
stock funds and found that my average expense ratio was 0.36 percent,
or $36 per $10,000 invested, mostly because I lean toward index funds
and Fidelity's are among the cheapest.
I was feeling pretty smug--but there was a catch. I couldn't find
the expense ratio for one of my favorite investments, a company-
sponsored ``guaranteed investment contract'' fund, which functions as
sort of a low-volatility intermediate bond fund. The new Labor
Department rules will require disclosure of expense ratios for these
types of funds, as well as for collective trusts, which operate like
mutual funds but aren't subject to regulation.
Gina Mitchell, president of the Stable Value Investment
Association, a trade group, says the typical guaranteed-investment-
contract fund has an expense ratio that ranges from about 0.4 percent
to about 0.8 percent, depending on whether administrative fees are
included. The higher end of the range is more than the bond-fund
offerings in my plan charge. If it applies to my account, it would
raise my average overall cost to about half a percentage point, or
around $2,500 a year in expenses on a $500,000 portfolio.
Figuring out your overall cost is especially important if you are
deciding whether to keep your 401(k) with a former employer. Hewitt
Associates compared the expenses of a typical 401(k) and the retail
costs of an individual retirement account, and found that a 35-year-old
saver who chose the IRA could end up with 9 percent to 18 percent less
in her retirement account at age 70 than if she stayed in the original
plan. If your plan charges high expenses, you may also want to consider
how much of your income you want to invest in it, beyond capturing the
full employer match.
What to do now. Even with differences in costs among funds, don't
invest based on expenses alone. They should only be a factor, along
with your asset mix, the fund's ranking among its peers and its long-
term performance.
Consider my international stock funds: Spartan International Index
and Fidelity Diversified International, a managed fund with 10 times
the expenses--$102 per $10,000. Even with much-higher costs, the
managed fund has outperformed the index fund over 3, 5 and 10 years.
Over the long run, the cheaper index fund may ultimately do better.
But in the meantime, I appreciate the managed fund's outstanding
performance. My solution: Divide my international piece between the
two. I will also now watch the managed fund more diligently. The higher
costs underscore why we need to expect more from actively managed funds
and avoid them if they don't routinely offer superior results or
diversification.
You can find out more about the proposed disclosure changes at the
Labor Department's Employee Benefits Security Administration site
(www.dol.gov/ebsa\2\). Comments are due this week; you can e-mail yours
to [email protected]\3\, with the subject line ``Participant fee disclosure
project.''
Email: [email protected]\4\
Senator Enzi. The good news is that she was able to find
the information. The bad news is that it was an exhausting
journey because she had to seek out computer programs and
expert advice that were not given to her employer.
She found that her index fund fees were smaller than the
industry norm. However, her international fund fees were a bit
higher. After careful analysis, she decided to keep her
international fund investment because it would deliver higher
returns over the long-term.
We can make 401(k) fees as transparent as we like, but if
we don't provide the tools for employees and individuals on how
to interpret and compare the information, then the information
is useless. Last week, Apple Computer's Steve Jobs had a major
press conference on his new innovations. One of his new ideas
was something called Genius software.
This Genius software would enable a person to pick one song
from his or her library of music, and then the software would
put together a song list. If we are able to have Genius
software for music, why can't we have Genius software for
retirement savings? If we gave the iPod generation Genius
software for their retirement savings, then we can be sure that
our youngest generation is set for their golden years as they
are set for their music today.
People, of course, are a little worried about how much
people might learn about them. But a lot of them have the
little grocery store discount things. That helps them to make
sure that the right things are on the shelf at the right time
and they know what people are going to buy.
We watch the ads for eHarmony. That is picking a future
mate by a computer software program. I am not sure why we don't
have the same thing for stocks. You know, put in goals, wind up
with a list. It might have something to do with the liability
question, though.
But recently, Chairman Chris Cox of the Securities and
Exchange Commission embarked on an initiative to require
companies to use Extensive Business Reporting Language, XBRL,
for companies and mutual funds to tag the data in their
financial disclosures. The concept is based on a very similar
concept used by Steve Jobs. But instead of tagging song titles,
the SEC wants to tag financial earnings, fees, and asset
holdings.
With this type of innovation for retirement savings, I
envision that computer models could easily produce useful,
meaningful, transparent disclosures based upon each employee's
and their family's needs.
Mr. Chairman, I do want to thank you for working with us to
invite two small business persons to testify. Under the Pension
Protection Act, we made great strides in reducing the hurdles
for companies to establish auto-enrollment 401(k) plans.
However, we still lag behind in the number of small businesses
offering retirement benefit plans.
According to recent data by the Congressional Research
Service, only 26 percent of employers with fewer than 25
employees have retirement plans. This compares to 65 percent of
all large companies that have pension plans.
Anything that we do with respect to 401(k) fee disclosure
and investor education should not place disproportionate
burdens on small entities, nor should it saddle them with
additional liability. And we already do provide some exclusions
for small businesses, but we don't have the education programs
to get them involved in providing it for their employees.
I believe that everyone in the room today shares the same
goal of providing better 401 fee disclosure. However, we should
now be looking down the road and harness technology to make
that information more useful and meaningful to working
families. They are the only ones who can make the necessary
choices to address their own needs.
I thank you for holding this important hearing today.
Senator Harkin. Thank you very much, Senator Enzi. Thanks
for all your help in developing this and moving this hearing
along. Hopefully, we will get something done here.
We have two panels, and we have a short morning here. We
have to be out of there by shortly after 11 o'clock. Our first
panel would be Assistant Secretary Bradford Campbell,
Department of Labor, in charge of the Employee Benefits
Security Administration, Washington, DC.
Mr. Secretary, we have your statement in its entirety.
Again, I would ask you if you could just summarize it in 5 to 7
minutes, then we could have an interchange before we bring up
our second panel.
So welcome to the committee, Mr. Campbell, and please
proceed.
STATEMENT OF BRADFORD P. CAMPBELL, ASSISTANT SECRETARY,
DEPARTMENT OF LABOR, EMPLOYEE BENEFITS SECURITY ADMINISTRATION,
WASHINGTON, DC
Mr. Campbell. Well, thank you, Mr. Chairman, Senator Enzi
and other members of the committee.
I want to thank you for the opportunity to come here today
to testify about the Department of Labor's significant progress
in promulgating regulations that we have developed to address
these very issues of fee and expense and conflict of interest
information in 401(k) and other employee benefit plans. These
regulations are a top priority for the Department of Labor.
As you noted, over the past 20 years, the retirement
universe has changed, and there are significant changes
affecting both workers and plan fiduciaries who are making
decisions about their plans. More workers now control the
investment of the retirement assets in participant-directed
individual account plans, such as 401(k) plans, and they need
better tools to make informed decisions.
Plan fiduciaries, who are charged by law with paying only
reasonable fees for necessary services, have found their jobs
more difficult as both the number and types of fees proliferate
and the relationships between financial service providers have
become more complex.
These trends caused the Department to conclude that despite
the success we have been having in our enforcement efforts and
our education and outreach efforts to participants and
fiduciaries, a new regulatory framework was necessary to better
protect the interests of America's workers, retirees, and their
families. That is why we began several years ago initiating a
series of three major regulations, each addressing a different
aspect of this problem.
The first regulation addresses the needs of participants
for concise, useful, comparative information about their plan's
investment options. The second regulation addresses the needs
of plan fiduciaries, who require more comprehensive disclosures
by service providers to enable them to carry out their duties
under the law. And the third regulation addresses disclosures
made by the plan to the public and the Government in the annual
Form 5500, which is filed with the Labor Department by these
plans.
It is essential to understand, I believe, that the
disclosure needs of each of these groups is different, and that
is exactly why we structured this in three separate
regulations, which are each targeted to those different needs.
Participants are choosing their investments from among a
defined universe of options that are in their plan. And to do
this, they need concise summary information that allows them to
compare those options in meaningful ways that take into account
the fees that they are paying, the historical rates of return,
the nature of the investment, and the other relevant factors
that one considers in making a long-term retirement investment
decision.
Our proposed regulation will, for the very first time,
ensure that all 65 million Americans in these plans have the
basic information that they need to make these decisions and
that they can actually use to compare across investment
products. So instead of throwing up their hands and throwing
out 12 of 14 or however many prospectuses might be passed
through the participant that are unread, by and large, workers
will be able to use the model disclosure form, which we have a
sample of here for you to review, that would help them find
this basic information they need in a very useful format.
Now there is widespread agreement in the comments that we
have received throughout this process--from workers, from
consumer groups, from plan sponsors, employers--that a 50-page
written document in legalese isn't helpful to workers. It just
costs more money to prepare. And that is exactly what our
proposals are intended to avoid to provide workers with useful
information.
Plan fiduciaries have a different duty than workers in
making these choices, and it requires a different and more
comprehensive disclosure. Fiduciaries are trying to decide if
the services the plan is receiving are necessary and if the
prices that are being charged for those services are
reasonable, that is taking into account the needs of the plan
as a whole.
These fiduciaries need to know whether the services that
are being provided are going to be influenced by compensation
arrangements between the service providers and third parties,
whether the direct charges that the plan is paying to the
service provider are properly reflecting any payments that the
service provider is receiving from a third party such as
revenue sharing or other arrangements, what services they will
be receiving and information of that nature that they need to
assess all of the factors involved.
Our final regulation in this area will ensure that
fiduciaries get this information before they are entering into
these arrangements so that they can carry out their obligations
to the workers.
I do want to note that we are nearing the end of what has
been a multiyear process. It is a comprehensive public
regulatory process. The final regulation that provided the
disclosures to the Government and the public in the Form 5500
was promulgated last year.
Last year, we also proposed the regulation requiring
disclosures from service providers to plans, and we held 2 days
of administrative hearings to further augment the record on
these issues that were raised this spring. We will be issuing a
final regulation in the next several months.
This summer, we proposed the participant disclosure
regulation, and the comment period on that recently closed. We
are in the process of evaluating those comments, and we will
promulgate a final regulation this year.
I do want to commend the committee for its interest in
enhanced fee and expense disclosure. I think it is a very
important area that we should all be looking at.
But, I do want to note that the Department has the
authority under current law to undertake these regulatory
initiatives, and we have been exercising it to ensure that
workers are protected from exactly the concerns that have been
raised in the congressional hearings that have been held on
this topic. And I think that our very deliberative and open
process of rulemaking has been very conducive to addressing
some of the fairly complex technical issues that have been
presented.
In conclusion, Mr. Chairman and Senator Enzi and the
committee, I want to thank you for the opportunity to come here
and for your interest in this important issue because it is
crucial to ensuring that Americans have adequate retirement
savings and adequate retirement income.
I am committed to ensuring that our regulatory projects are
completed in a timely manner, and I appreciate the opportunity
to address those and would be happy to answer any questions you
have.
[The prepared statement of Mr. Campbell follows:]
Prepared Statement of Bradford P. Campbell
introductory remarks
Good morning Chairman Harkin, Ranking Member Enzi, and members of
the committee. Thank you for inviting me to discuss plan fees, the
Department of Labor's role in overseeing plan fees, and proposals to
increase transparency and disclosure of plan fee and expense
information. I am Bradford Campbell, the Assistant Secretary of Labor
for the Employee Benefits Security Administration (EBSA). I am proud to
be here today representing the Department of Labor and EBSA. Our
mission is to protect the security of retirement, health and other
employee benefits for America's workers, retirees and their families,
and to support the growth of our private benefits system.
Ensuring the security of retirement benefits is a core mission of
EBSA, and one of this Administration's highest priorities. Excessive
fees can undermine retirement security by reducing the accumulation of
assets. It is therefore critical that plan participants, directing the
investment of their contributions, and plan fiduciaries, charged with
the responsibility of prudently selecting service providers and paying
only reasonable fees and expenses, have the information they need to
make appropriate decisions.
That is why the Department began a series of regulatory initiatives
to expand disclosure requirements in three distinct areas:
1. Disclosures by plans to participants to assist in making
investment decisions;
2. Disclosures by service providers to plan fiduciaries to assist
in assessing the reasonableness of provider compensation and potential
conflicts of interest; and
3. More efficient, expanded fee and compensation disclosures to the
government and the public through a substantially revised,
electronically filed Form 5500 Annual Report.
Each of these projects addresses different disclosure needs, and
our regulations are tailored to ensure that appropriate disclosures are
made in a cost-effective manner. For example, participants are unlikely
to find useful extensive disclosure documents written in ``legalese''--
instead, it appears from comments we received thus far that
participants want concise and readily understandable comparative
information about plan costs and their investment options. By contrast,
plan fiduciaries want detailed disclosures in order to properly carry
out their duties under the law, enabling them to understand the nature
of the services being provided, all fees and expenses received for the
services, any conflicts of interest on the part of the service
provider, and any indirect compensation providers may receive in
connection with the plan's business.
We have made significant progress on these projects. On November
16, 2007, we issued a final regulation requiring additional public
disclosure of fee and expense information on the Form 5500. On December
13, 2007, we published a proposed regulation requiring specific and
comprehensive disclosures to plan fiduciaries by service providers, and
held 2 days of administrative hearings on the proposed regulation on
March 31 and April 1, 2008, and we plan to complete a final regulation
this year. On July 23, 2008, we published a proposed rule requiring
plans to disclose fee and expense, investment return and other
essential information to plan participants. This proposal was informed
by public comments on participant disclosures we received following a
Request for Information published on April 25, 2007. The public comment
period on the proposed regulation recently closed, and we are
evaluating the comments received from consumer groups, plan sponsors,
service providers and others as we work to finalize the proposal.
The Employee Retirement Income Security Act of 1974 (ERISA)
provides the Secretary of Labor with broad regulatory authority,
enabling the Department to pursue these comprehensive disclosure
initiatives without need for a statutory amendment. The regulatory
process currently underway ensures that all voices and points of view
will be heard and provides an effective means of resolving the many
complex and technical issues presented. I hope that as Congress
considers this issue, it recognizes the Department's existing statutory
authority and takes no action that could disrupt our current efforts to
provide these important disclosures to workers. My testimony today will
discuss in more detail the Department's activities related to plan
fees. Also, I will describe the Department's regulatory and enforcement
initiatives focused on improving the transparency of fee and expense
information for both plan fiduciaries and participants.
background
EBSA is responsible for administering and enforcing the fiduciary,
reporting, and disclosure provisions of Title I of ERISA. EBSA oversees
approximately 679,000 private pension plans, including 387,000
participant-directed individual account plans such as 401(k) plans, and
millions of private health and welfare plans that are subject to
ERISA.\1\ Participant-directed individual account plans under our
jurisdiction hold over $2.2 trillion in assets and cover more than 65
million participants. Since 401(k)-type plans began to proliferate in
the early 1980s, the number of employees investing through these types
of plans has grown dramatically. Assets held in these plans are, in
real terms, more than 13 times greater than the amount held in 1984 and
have increased by 22.5 percent since 2000. EBSA employs a
comprehensive, integrated approach encompassing programs for
enforcement, compliance assistance, interpretive guidance, legislation,
and research to protect and advance the retirement security of our
Nation's workers and retirees.
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\1\ Based on 2005 filings of the Form 5500.
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Title I of ERISA establishes standards of fiduciary conduct for
persons who are responsible for the administration and management of
benefit plans. It also establishes standards for the reporting of plan-
related financial and benefit information to the Department, the IRS
and the Pension Benefit Guaranty Corporation (PBGC), and the disclosure
of essential plan-related information to participants and
beneficiaries.
the fiduciary's role
ERISA requires plan fiduciaries to discharge their duties solely in
the interest of plan participants and beneficiaries, and for the
exclusive purpose of providing benefits and defraying reasonable
expenses of plan administration. In discharging their duties,
fiduciaries must act prudently and in accordance with the documents
governing the plan. If a fiduciary's conduct fails to meet ERISA's
standards, the fiduciary is personally liable for plan losses
attributable to such failure.
ERISA protects participants and beneficiaries, as well as plan
sponsors, by holding plan fiduciaries accountable for prudently
selecting plan investments and service providers. In carrying out this
responsibility, plan fiduciaries must take into account relevant
information relating to the plan, the investments available under the
plan, and the service provider, and are specifically obligated to
consider fees and expenses.
ERISA prohibits the payment of fees to service providers unless the
services are necessary and provided pursuant to a reasonable contract,
and the plan pays no more than reasonable compensation. Thus, plan
fiduciaries must ensure that fees paid to service providers and other
expenses of the plan are reasonable in light of the level and quality
of services provided. Plan fiduciaries must also be able to assess
whether revenue sharing or other indirect compensation arrangements
create conflicts of interest on the part of the service provider that
might affect the quality of the services to be performed. These
responsibilities are ongoing. After initially selecting service
providers and investments for their plans, fiduciaries are required to
monitor plan fees and expenses to determine whether they continue to be
reasonable and whether there are conflicts of interest.
ebsa's compliance assistance activities
EBSA assists plan fiduciaries and others in understanding their
obligations under ERISA, including the importance of understanding
service provider fees and relationships, by providing interpretive
guidance \2\ and making related materials available on its Web site.
One such publication developed by EBSA is Understanding Retirement Plan
Fees and Expenses, which provides general information about plan fees
and expenses. In conjunction with the Securities and Exchange
Commission, we also developed a fact sheet, ``Selecting and Monitoring
Pension Consultants--Tips for Plan Fiduciaries.'' This fact sheet
contains a set of questions to assist plan fiduciaries in evaluating
the objectivity of pension consultant recommendations.
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\2\ See, e.g., Field Assistance Bulletin 2002-3 (November 5, 2002)
and Advisory Opinions 2003-9A (June 25, 2003), 97-16A (May 22, 1997),
and 97-15A (May 22, 1997).
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EBSA also has made available on its Web site a model ``401(k) Plan
Fee Disclosure Form'' to assist fiduciaries of individual account
pension plans when analyzing and comparing the costs associated with
selecting service providers and investment products. This form is the
product of a coordinated effort of the American Bankers Association,
Investment Company Institute, and the American Council of Life
Insurers.
To help educate plan sponsors and fiduciaries about their
obligations under ERISA, EBSA conducts numerous educational and
outreach activities. Our campaign, ``Getting It Right--Know Your
Fiduciary Responsibilities,'' includes nationwide educational seminars
to help plan sponsors understand the law. The program focuses on
fiduciary obligations, especially related to the importance of
selecting plan service providers and the role of fee and compensation
considerations in that selection process. EBSA has conducted 26
fiduciary education programs since May 2004 in different cities
throughout the United States. EBSA also has conducted 58 health
benefits education seminars, covering nearly every State, since 2001.
Beginning in February 2005, these seminars added a focus on fiduciary
responsibilities. EBSA will continue to provide seminars in additional
locations under each program.
disclosures to participants under current law
ERISA currently provides for a number of disclosures aimed at
providing participants and beneficiaries information about their plans'
investments. For example, information is provided to participants
through summary plan descriptions and summary annual reports. Under the
Pension Protection Act of 2006, plan administrators are required to
automatically furnish pension benefit statements to plan participants
and beneficiaries. The Department issued Field Assistance Bulletins in
December 2006 and in October 2007 to provide initial guidance on
complying with the new statutory requirements. Statements must be
furnished at least once each quarter, in the case of individual account
plans that permit participants to direct their investments, and at
least once each year, in the case of individual account plans that do
not permit participants to direct their investments. Other disclosures,
such as copies of the plan documents, are available to participants on
request.
Additional disclosures may be required by the Department's rules
concerning whether a participant has ``exercised control'' over his or
her account. ERISA section 404(c) provides that plan fiduciaries are
not liable for investment losses which result from the participant's
exercise of control. A number of conditions must be satisfied,
including that specified information concerning plan investments must
be provided to plan participants. Information fundamental to
participants' investment decisions must be furnished automatically.
Additional information must be provided on request.
ebsa participant education and outreach activities
EBSA is committed to assisting plan participants and beneficiaries
in understanding the importance of plan fees and expenses and the
effect of those fees and expenses on retirement savings. EBSA has
developed educational brochures and materials available for
distribution and through our Web site. EBSA's brochure entitled A Look
at 401(k) Plan Fees for Employees is targeted to participants and
beneficiaries of 401(k) plans who are responsible for directing their
own investments. The brochure answers frequently asked questions about
fees and highlights the most common fees, and is designed to encourage
participants to make informed investment decisions and to consider fees
as a factor in decisionmaking. Last fiscal year, EBSA distributed over
5,400 copies of this brochure, and over 46,000 visitors viewed the
brochure on our Web site.
More general information is provided in the publications, What You
Should Know about Your Retirement Plan and Taking the Mystery out of
Retirement Planning. In the same period, EBSA distributed over 86,000
copies of these two brochures, and almost 102,000 visitors viewed these
materials on our Web site. EBSA's Study of 401(k) Plan Fees and
Expenses, which describes differences in fee structures faced by plan
sponsors when they purchase services from outside providers, is also
available.
regulatory initiatives
EBSA has completed one initiative and currently is finalizing two
others to improve the transparency of fee and expense information to
participants, plan sponsors and fiduciaries. We began these
initiatives, in part, to address concerns that participants are not
receiving information in a format useful to them in making investment
decisions, and that plan fiduciaries are having difficulty getting
needed fee and compensation arrangement information from service
providers to fully satisfy their fiduciary duties. The needs of
participants and plan fiduciaries are changing as the financial
services industry evolves, offering an increasingly complex array of
products and services.
Disclosures to Participants
On April 25, 2007, the Department published a Request for
Information, inviting suggestions from plan participants, sponsors,
service providers, consumer advocates and others for improving the
current disclosures applicable to participant-directed individual
account plans. In response to this request, the Department received
more than 100 comment letters from a variety of interested parties.
Drawing on these comments, the Department developed a proposed rule
that will, upon adoption, require fiduciaries of all participant-
directed individual account plans--not just plans electing to comply
with section 404(c)--to furnish to the plan's participants and
beneficiaries important plan and investment-related information. This
proposed regulation, published in the July 23, 2008 Federal Register,
will ensure that all participants who are responsible for making
investment decisions under their plan receive understandable
information about their plan and the investments offered thereunder,
including information about the fees and expenses that directly affect
their retirement savings.
A major challenge in developing the proposal was determining
precisely what information plans should be required to disclose to
participants. Many commenting on the Request for Information encouraged
the Department to keep in mind that, while appropriate disclosures are
helpful, simply mandating the disclosure of page after page of legal
jargon is actually contrary to the interests of participants, as the
quantity of information may be overwhelming to participants and the
benefits may not justify the cost, which are likely to be charged
against the accounts of participants. Our proposal adopts a disclosure
framework that favors quality over quantity, providing plan
participants with concise, useful information in a format that
facilitates comparative judgments between plans' investment options.
Specifically, the proposal would require that participants be
furnished, upon enrollment and at specified intervals thereafter, two
general categories of information--``plan-related information'' and
``investment-related information.''
Plan-related information primarily encompasses administrative
expenses of the plan, such as legal and accounting fees, and expenses
related to the actions of a specific participant, such as a loan
processing fee. In addition to requiring descriptions of what and how
these fees and expenses are assessed, to be furnished upon enrollment
and at least annually thereafter, the proposal requires that the
amounts actually charged against a participant's account for such
expenses be disclosed quarterly, noting that this quarterly disclosure
requirement could be satisfied by including the required information on
the participant's quarterly benefit statement.
With respect to investment-related information, the proposal
provides for the disclosure of specific information regarding each
designated investment option and that such information be disclosed in
a form that facilitates comparisons of investments. The proposal also
includes a model comparative disclosure form. The specific investment-
related information required to be disclosed under the proposal
includes:
The name of each investment option, type or category of
the investment (e.g., money market fund, balanced fund, etc.), and
whether the investment is actively or passively managed.
Information about the performance of each investment over
1-, 5-, and 10-year periods.
Benchmarks against which each investment may be compared
in terms of performance.
Fee and expense information with respect to each
investment--specifically, the total operating expenses, and any
shareholder-type fees that might be charged directly against the
participant's investment.
In addition, a Web site address is required to be provided with
respect to each designated investment option for those participants who
want additional information about their investment choices. The Web
site would, at a minimum, make available information concerning the
principal investment strategies, attendant risks, investments
comprising the portfolio, portfolio turnover, etc.--similar to the
information that would be contained in more detailed prospectuses.
The comment period on the proposal closed on September 8. Although
we have not yet finished reviewing all of the comment letters, let me
just say that we are pleased to see that so many stakeholders under
ERISA support simple and short communications between plans and
participants as the most helpful and meaningful.
Disclosures to Plan Fiduciaries
On December 13, 2007, EBSA issued a proposed regulation amending
its current regulation under ERISA section 408(b)(2) to clarify the
information fiduciaries must receive and service providers must
disclose for purposes of determining whether a contract or arrangement
is ``reasonable,'' as required by ERISA's statutory exemption for
service arrangements. Our intent is to ensure that service providers
entering into or renewing contracts with plans disclose to plan
fiduciaries comprehensive and accurate information concerning the
providers' receipt of direct and indirect compensation or fees and the
potential for conflicts of interest that may affect the provider's
performance of services. The information provided must be sufficient
for fiduciaries to make informed decisions about the services that will
be provided, the costs of those services, and potential conflicts of
interest based on fees or compensation. The Department believes that
such disclosures are critical to ensuring that contracts and
arrangements are ``reasonable'' within the meaning of the statute.
Public comments on the proposed regulation are currently under review
and we are working on developing a final regulation.
Disclosures to the Public
On November 16, 2007, EBSA promulgated a final regulation revising
the Form 5500 Annual Report filed with the Department to complement the
information obtained by plan fiduciaries as part of the service
provider selection or renewal process. The Form 5500 is a joint report
for the Department of Labor, Internal Revenue Service and PBGC that
includes information about the plan's operation, funding, assets, and
investments. The Department collects information on service provider
fees through the Form 5500 Schedule C.
Consistent with recommendations of the ERISA Advisory Council
Working Group, the Department published a final regulation amending the
Form 5500, including changes that expand the service provider
information required to be reported on the Schedule C. The changes more
specifically define the information that must be reported concerning
the ``indirect'' compensation service providers received from parties
other than the plan or plan sponsor, including revenue sharing
arrangements among service providers to plans. The changes to the
Schedule C were designed to assist plan fiduciaries in monitoring the
reasonableness of compensation service providers receive for services
and potential conflicts of interest that might affect the quality of
those services.
We intend that the changes to the Schedule C will work in tandem
with our 408(b)(2) initiative. The amendment to our 408(b)(2)
regulation will provide up front disclosures to plan fiduciaries, and
the Schedule C revisions will reinforce the plan fiduciary's obligation
to understand and monitor these fee disclosures. The Schedule C remains
a requirement for plans with 100 or more participants, which is
consistent with long-standing congressional direction to simplify
reporting requirements for small plans.
ebsa's enforcement efforts
EBSA has devoted enforcement resources to this area, seeking to
detect, correct and deter violations such as excessive fees and
expenses, and failure by fiduciaries to monitor on-going fee structure
arrangements. From fiscal year 1999 through August 2008, we closed 674
401(k) investigations involving these issues, with monetary results of
over $131 million.
In carrying out its enforcement responsibilities, EBSA conducts
civil and criminal investigations to determine whether the provisions
of ERISA or other Federal laws related to employee benefit plans have
been violated. EBSA regularly works in coordination with other Federal
and State enforcement agencies, including the Department's Office of
the Inspector General, the Internal Revenue Service, the Department of
Justice (including the Federal Bureau of Investigation), the Securities
and Exchange Commission, the PBGC, the Federal banking agencies, State
insurance commissioners, and State attorneys general.
EBSA is continuing to focus enforcement efforts on compensation
arrangements between pension plan sponsors and service providers hired
to assist in the investment of plan assets. EBSA's Consultant/Adviser
Project (CAP), created in October 2006, addresses conflicts of interest
and the receipt of indirect, undisclosed compensation by pension
consultants and other investment advisers. Our investigations seek to
determine whether the receipt of such compensation violates ERISA
because the adviser or consultant used its status with respect to a
benefit plan to generate additional fees for itself or its affiliates.
The primary focus of CAP is on the potential civil and criminal
violations arising from the receipt of indirect, undisclosed
compensation. A related objective is to determine whether plan sponsors
and fiduciaries understand the compensation and fee arrangements they
enter into in order to prudently select, retain, and monitor pension
consultants and investment advisers. CAP will also seek to identify
potential criminal violations, such as kickbacks or fraud.
concerns regarding legislative proposals
While I am pleased that the Department's regulatory initiatives and
the legislative proposals introduced in Congress share the common goal
of providing increased transparency of fee and expense information, I
am concerned that legislative action could disrupt the Department's
ongoing efforts to provide these important disclosures. Proposed
legislation may not achieve the primary goal of participant
disclosures--providing workers with useful and concise information--by
mandating very detailed and costly disclosure documents. Excessively
detailed disclosures are likely to be ignored by participants even as
those participants bear the potentially significant cost of their
preparation and distribution. Participants are most likely to benefit
from concise disclosures that allow them to meaningfully compare the
investment options in their plans. The Department has received many
comments highlighting the importance of brevity and relevance in
disclosures to participants. The regulatory process is well-suited to
resolving the many technical issues arising as we seek to strike the
proper balance in providing participants with cost-effective, concise,
meaningful information.
I am also concerned by proposals suggesting that specific
investment options should be mandated. Requiring specific investment
options would limit the ability of employers and workers together to
design plans that best serve their mutual needs in a changing
marketplace.
conclusion
Mr. Chairman and members of the committee, thank you for the
opportunity to testify before you today. The Department is committed to
ensuring that plans and participants pay fair, competitive and
transparent prices for services that benefit them--and to combating
instances where fees are excessive or hidden. We are moving as quickly
as possible consistent with the requirements of the regulatory process
to complete our disclosure initiatives, and we believe they will
improve the retirement security of America's workers, retirees and
their families. I will be pleased to answer any questions you may have.
Senator Harkin. Thank you very much, Mr. Secretary, and I
appreciate that.
Getting to this model comparative chart that you came up
with, the AARP conducted a survey last month comparing
participant reaction to your model disclosure form to one that
they came up with and said in a letter to you, which they
obviously sent to me, that, ``Roughly a third or fewer
respondents agree that DOL's model disclosure form is easy to
read--30 percent; is easy to understand--25 percent; has a
clear purpose--33 percent; has terms that are clearly defined--
24 percent; and explains how to get additional information--35
percent.''
``In contrast, at least 7 in 10 respondents who viewed
AARP's form agree that AARP's model disclosure form is easy to
read--77 percent; easy to understand--72 percent; has a clear
purpose--78 percent; has terms that are clearly defined--70
percent; and explains how to get additional information--75
percent.''
I am asking how would you respond to this? Is it possible
that DOL would amend the model disclosure to incorporate some
of AARP's suggestions?
Mr. Campbell. Actually, my staff and I met with the AARP
earlier this week to discuss exactly the issues that they
raised in their comment, and I would say that that is the
benefit of the notice and comment rulemaking process in that we
get the expertise across the spectrum of workers and advocates
and others to help us inform what the final regulation will
look like.
I do think there are a couple of important differences in
what we proposed with the AARP's form that go to the fact that
their form had a slightly different purpose. It was a
retrospective analysis of what an individual paid in the
options they were already in, whereas our model disclosure is
intended to provide a prospective view of the entirety of the
options in the plan so that participants can select among them.
I think the other big difference between the two dealt with
the disclosure of historical rates of return and, just as
importantly, benchmarks to compare those rates to. I think that
was something the survey also revealed was very valuable to
participants. So, again, we certainly appreciate those
comments, and we will be happy to consider them as we go
through the process.
Senator Harkin. I hope so. Again, I look at this model
comparative chart, and say, I will tell you what I should
invest in. I should get into that fund there, the Russell 1,000
there, maybe. Or the D, the Fund Midcap ETF 15 percent, 13
percent, 12 percent compared with those bonds down there that
are 3.8 percent and 4 percent. That is where I want to go.
The average person looks at that, and they say, ``Wait,
well, of course, why be dumb? I want to put that in there. I
get the biggest rate of return right there, 15, 13, and 12
percent average rate. Wow, boy, that is where I would want to
go.'' I mean, that is just the average person, I would think,
would look at that. I mean, what else would they need to know
other than that?
Mr. Campbell. Well, I think that that goes to exactly the
point that Senator Enzi made about the importance of education
and ensuring that participants can understand the relative
merits of these, and that is an issue that we were trying to
address in this model disclosure so that workers would have in
one place the information they need to make those judgments.
I think the point that the Senator is making goes to issues
of diversification, and should you put all your eggs into one
basket? I think those are the sorts of issues that, for
example, the PPA addressed in the quarterly benefits statement
requiring basic education information and diversification
materials.
Senator Harkin. I think Senator Enzi is on to something
here on software. My older daughter said to me one time, not
too long ago, ``You still using that credit card of yours?'' I
said, ``Yes, I have been using it for years.'' She said, ``Oh,
that is not good. You should get a better card, get better
deals.'' And I said, ``Well, I never thought about it.''
There is a site you can go to. I don't recall the name of
it. So I went online, and got on that site. They have a form
that you fill out. You tell about who you are and what you do,
and how much money you earn, and family information, and they
come up with a program of what might be the best credit card
for you.
It seems to me, as was said, if they can do this with iPods
and music, why can't we come up with a software program when an
individual would sit down and plug in a lot of information as
to family size, their age, their health, other savings they may
have, other resources they might have, job history, perhaps
even looking ahead--how many different kinds of jobs--what is
their income level and what is their prospectus. You plug in
information like that.
Now some of that is sort of by guess and by golly, but
people can have a pretty good idea of what they are going to be
doing and how much money they are going to be making and what
their situations are at that point in time. You plug that in,
and back comes a program that says, you know, with all that
information you have given us, here is probably what you ought
to be thinking about investing in.
Why can't we come up with a software program like that?
Mr. Campbell. Well, fortunately, the Pension Protection Act
has finally removed some barriers that prevented exactly those
kinds of software programs from being more widely available in
plans. Actually, the department just in the last month issued a
proposed regulation to implement those provisions. So we are
working quite diligently to do exactly that because I think
those are very wise decisions that Congress made and an
excellent suggestion.
Senator Harkin. Will that be part of your final rule, to
come up with that kind of software program? Could the
Department of Labor, EBSA, come up with a model software
program?
Mr. Campbell. The regulation I had mentioned in my opening
statement is what is addressing this in investment advice. The
Pension Protection Act does not specify that the Labor
Department create the model. It does require the Labor
Department to determine the qualifications of a person eligible
to certify the independence of such a model created by another.
I think the intent in Congress was to ensure that we
weren't fixing in law and in regulation a static model that
doesn't reflect changes that occur, which I think was a wise
decision. Our proposed regulation will implement those
provisions, and once finalized, that regulation will enable
this computer model advice to be available to participants.
So I am very excited about that regulation as well, and I
would be happy to discuss it.
Senator Harkin. I am just trying to think who is going to
come up with this model software program.
Mr. Campbell. Typically.
Senator Harkin. You would want someone divorced from the
business. You would want some independent group or some
independent agent to do that, I would think.
Mr. Campbell. That certainly occurs currently. Also in the
PPA, the requirements would allow various proprietary models to
be developed. But they have to be certified that they are
unbiased and independent, that the advice they produce is
independent.
Senator Harkin. Yes.
Mr. Campbell. The provisions in the PPA were very wise, and
I think our regulation accurately is implementing them. Our
proposed regulation would accurately implement them.
Senator Harkin. I still wonder who is going to come up with
the software. It costs money to do something like that, and you
wouldn't get any return on it. I mean, this is just information
unless someone came up with it and it was just widely adopted
by all of the plans. I suppose they could pay a fee to use the
software or something. I don't know----
Mr. Campbell. The intent of the provision in the PPA that
makes it more widely available is that by removing some of the
barriers in law, it allows service providers to offer the
investment advice along with other offerings, which previously
was quite difficult to do and, thus, makes it a more common
feature in plans.
Senator Harkin. One last question. Do you know how much you
pay into TSP, what your fees are in TSP?
Mr. Campbell. Generally, the fees in the TSP are quite low.
They range between 1, 2, 3 basis points. Unfortunately, that is
not quite an apples-to-apples comparison with the private
sector. For one thing, the Federal agencies absorb a great deal
of the payroll and other costs that are associated with private
sector plans, which factor into the fees that are paid by those
plans. So it is not quite apples-to-apples.
Of course, also the TSP is very large. So it does have
economies of scale that aren't available to smaller businesses.
Senator Harkin. There is a lot of difference between 3 or 4
or 5 basis points and 100 basis points or 200 basis points that
are out there. It raises also the question of pooling. You
might have small entities out there, but why can't they be
pooled?
Mr. Campbell. One of the strengths of our private benefit
system has always been its flexibility. It allows the workers
and the employees in a given employment situation to come up
with benefits that best suit them and their unique
circumstances.
One of the questions, I think, in a pooling arrangement
would be to what extent is that strength diminished by
Government-imposed regulations or one-size-fits-all products. I
think that has been a concern that I would have in looking at
that.
But I think one of the biggest significant impacts of the
regulations we have proposed is that by making this a more
transparent marketplace, by ensuring that fiduciaries see
revenue-sharing arrangements and know exactly what the service
provider is getting, that it puts the fiduciaries in the
position of being able to accurately and more--to have the
information they need to actually negotiate with service
providers and understand what is being paid, which protects
participants.
In turn, with participants having fee information, it
provides feedback the other way to the plan fiduciaries,
because the workers now have the tools they need to ask
questions of their own plans. And I think there is important
feedback that will be provided by these regulations that will
have a downward effect on prices.
Senator Harkin. When do you expect the final rules to be
out?
Mr. Campbell. We expect to issue the final fiduciary
disclosure regulation in the next several months and the
participant fee disclosure regulation by the end of the year.
Senator Harkin. I hope you are seriously taking into
account the information from AARP and looking at what they have
come up with, too.
Mr. Campbell. We will very seriously consider all the
comments we have received. We are big believers in the notice
and comment process at EBSA because it has been very valuable
to us in all of our regulations to get that expert input.
Senator Harkin. Thank you very much, Mr. Secretary.
Senator Enzi.
Senator Enzi. Thank you.
I am going to go to a little bit more basic question to
start off because there are many families and individuals that
are watching the capital markets right now, and they are
worried about the safety of their retirement investments
altogether. Are our workers' 401(k) accounts safe? And what
should workers be doing to invest for the long-term retirement
security, any advice for people at this point in time?
Mr. Campbell. Certainly. I would say our 401(k)s and other
long-term savings vehicles are very safe. They are designed to
be that way.
The assets in your 401(k), the assets in your traditional
pension plan, these are separate and held separately in trust
from the assets of the company. So even if your employer goes
bankrupt, your retirement is separate from the employer and,
therefore, safe from the problems they may have.
Traditional pension plans have an insurance factor from the
Federal Government. The SEC, through a variety of mechanisms,
has guarantees up to $500,000 for securities that are held by
brokers and so forth. So there are a variety of protections in
place that make retirement savings vehicles very secure.
I would urge people not to react precipitously. You are
investing for the long-term. You should continue to make your
regular contributions every payroll period and not be spooked
into making radical adjustments but think about what is the
best way to get to your ultimate retirement goal.
Personally, for my own account in the Thrift Savings Plan,
I am continuing to invest in the C Fund on the grounds that I
am dollar cost averaging. And hopefully, when things come back
up, I will own more shares that I purchased at a lower price.
But hopefully, time will prove me right about that.
Senator Enzi. We have been working on the financial
literacy thing for a long time with all of the agencies, and it
is something that people have to concentrate on. There aren't a
lot of sources out there.
You mentioned the Pension Protection Act several times, and
I greatly appreciate all of the time and effort that you and
your employees have extended to bring that law to life. One
important part of the law was to reduce the hoops that
companies had to jump through in order to provide automatic
enrollment in 401(k) plans, and the initial numbers from the
Employees Benefit Research Institute shows this is really
making a difference and is helping get more employees enrolled
to save for their retirement.
However, as you heard in my opening remarks, only a quarter
of the small businesses are offering 401(k) type plans for
their employees. As a former small business owner, I know it is
difficult to offer benefits. What are the messages that you
have received from small businesses in the comments and letters
and your outreach efforts?
In addition, how did that influence the disclosure
requirements that you put in the regulatory proposal?
Mr. Campbell. Well, the regulation, particularly in
disclosures by service providers to plan fiduciaries, really is
primarily a boon for small- and mid-sized companies because
these are the fiduciaries that have traditionally had the most
difficult time getting the information they really needed
because they didn't have the negotiating clout that, for
example, a 200,000-person firm would have in negotiating with
those same vendors.
By requiring this information to be provided to all
fiduciaries, we are ensuring that fiduciaries know what
revenue-sharing arrangements are occurring, really know whether
there is a conflict that they should be concerned about when
one fund is recommended over another, and I think will very
much help small businesses and mid-sized businesses in offering
plans and offering them on good terms in fulfilling their
fiduciary duties to offer very reasonable prices to their
workers.
Investment advice I think is also important. Under the PPA
provisions, that can now be a service that is more widely
available as part of a package of services that a provider
would provide, for example, a small business, which typically
goes to a single provider for most of the services connected
with their plans. That can be valuable to their workers, but
also to the small business owners in terms of their own plan.
So there is an incentive there.
We also, of course, offer a great deal of education and
outreach, working with small business owners to make sure they
are aware of their fiduciary responsibilities under the law. I
have received many positive comments about the sessions that we
have held and the materials that we produce, which are intended
to be understandable and useful, and that is something we work
on regularly.
Senator Enzi. Several times you have used the words
``fiduciary responsibility.'' To the small businessman, that
translates into ``liability and lawsuit.'' What are you doing
to counter that, to give them some confidence that if they go
with a 401(k) plan, they are not just asking for more lawsuits?
Mr. Campbell. Right. Well, I think the Pension Protection
Act was important in helping clarify some of those roles,
particularly, as you said, in automatic enrollment. The
Department of Labor issued a regulation regarding what sorts of
investments are appropriate to be used and that would not carry
with them undue liability for workers to be automatically
enrolled in, but that would also provide workers with the type
of long-term retirement savings returns that are appropriate.
That's in the best interests of workers and also the plan
sponsors.
In our educational efforts, we make sure that fiduciaries
are aware of where the common pitfalls are. The best way to not
have a problem is to avoid making a mistake in the first place.
And if we can use our experience in the violations that we have
seen on our enforcement side to inform our educational side, we
can steer plans clear of the common pitfalls, and that is to
the benefit of everyone in the system.
Senator Enzi. Well, that is why I am hoping that we will
have some more technology involved in this. And when the
technology is approved, those using it won't be held
responsible so that they can encourage their employees to use
that relatively lawsuit free.
Mr. Campbell. I think that is important. The independent
certification in the computer model is ensuring that those who
then use it can rely on it to be unbiased.
Senator Enzi. Thank you. I have used my time.
Senator Harkin. Thank you, Senator.
Secretary Campbell, thank you very much.
Mr. Campbell. Thank you, sir.
Senator Harkin. Good job. Our second panel, Olena Berg
Lacy, Director and Senior Advisor for Financial Engines,
testifying on behalf of the Pension Rights Center; R. Theodore
Benna, Founder of the 401(k) Association, Jersey Shore, PA;
Paul Hunt, President, Millennium Advisory Services, testifying
on behalf of the U.S. Chamber of Commerce.
We have everyone here, and again, all your statements will
be made a part of the record in their entirety. I am going to
ask if you could each sum it up maybe in 5 minutes, I would
sure appreciate that. We will start, again, with Olena Berg
Lacy from the Pension Rights Center.
Ms. Lacy, welcome to the committee.
STATEMENT OF OLENA BERG LACY, DIRECTOR AND SENIOR ADVISOR FOR
FINANCIAL ENGINES, TESTIFYING ON BEHALF OF THE PENSION RIGHTS
CENTER, WASHINGTON, DC
Ms. Lacy. Thank you, Mr. Chairman, Senator Enzi, and other
members of the committee.
I appreciate you inviting me here this morning to talk
about this very important issue of 401(k) fee disclosure. My
name is Olena Berg Lacy, and I was the head of the Employee
Benefits Security Administration during the Clinton
administration. So I have some familiarity with these issues.
I am also a member of the board of directors of the Pension
Rights Center, and as you mentioned, I am representing them
here today.
I am going to address the issue of fee disclosure from the
perspective of participants. Now while I was at the EBSA 10
years ago, we held hearings on fees and produced a report as a
result of those hearings. So I recently went back to look at
that report to see what had happened in the interim, and not
much actually had until the department undertook its regulatory
efforts.
The only thing that has really changed is that there is
substantially more assets in plans that are subject to these
fees. Fees are important because, as you have already pointed
out, millions of people depend on the 401(k) as the primary
supplement that they will have to Social Security in their
retirement, and fees greatly affect the level of assets people
are able to accumulate.
They are also important because of the magnitude of dollars
involved. If you look at all defined contribution plans, there
are somewhere around $3 trillion held in these types of plans.
And if you made a rough assumption that they were collectively
managed for 100 basis points, or 1 percent, that means there is
somewhere around $30 billion a year going into fees and out of
retirement savings accounts.
Disclosure of these fees is a critically important consumer
issue. And that disclosure, as you have pointed out, has to
occur at two levels. It has to occur at the plan sponsor level,
so the plan sponsor is able to make the decisions that they
need to, to ensure that they have complied with their fiduciary
duty to make appropriate choices for their plan participants.
There needs to be disclosure to participants that is clear and
concise and easy to understand.
Let us start with disclosure to plan sponsors. Large
employers probably have the resources to shop around among
service providers, get the information they need, and do the
analysis to get the best deals for their plans. But many
smaller plan sponsors don't have the ability to do this. They
may not know the options that are available to them or even how
to evaluate those options.
And fees do vary substantially for very similar investment
products. So it is important that they have this information.
Currently, there is no explicit legal obligation for service
providers to give them that information.
As Secretary Campbell has just discussed, the EBSA
undertook a regulatory project to provide that kind of
information to plan sponsors, the information that they will
need to make prudent decisions. I could spend a lot of time
commending all the good things that they have done, but since
my time is limited, I would like to focus on the areas where
they might not have gone far enough.
One failure, I believe, in the proposed regulation is that
the DOL is not requiring that service providers unbundle their
fees or separately report different kinds of fees. I think
without this unbundling it is going to be difficult for smaller
plan sponsors to make comparisons among different offerings.
The DOL report 10 years ago pointed out that there are 80
different ways these fees can be displayed, and also
aggregating fees can disguise potential conflicts of interest,
and I go into that in my written testimony in greater detail. I
believe we need congressional action that goes beyond the DOL
proposal.
As I mentioned earlier, the second level of fee disclosure
is from sponsors to participants. If participants can determine
that the fees they are paying are excessive, they often have
the ability to influence the plan design by making their
desires and wishes known to their employer. They need clear
disclosure as well, and they need to know what they are paying
for and how to select wisely among the options that are offered
to them.
The DOL, again, has proposed regulations to address this
disclosure. And again, I applaud their efforts but believe, as
in the case of plan sponsors, they could have gone a bit
further. I think the same disaggregation needs to occur at the
participant level, perhaps not in the same detail as plan
sponsors will need, but some separation of fees into the basic
categories of services.
Now there are other issues with the proposed regulations as
well. Senator Harkin, in your question, I think you got to the
heart of it. The chart has both fees and performance, and I
believe performance data was put in probably because the
department heard from a lot of people, that if you just give
participants fee data, they will go for the lowest. They need
to know performance as well.
That performance chart has no mention of risk. And I think
it is a far greater harm if people go to the riskiest funds
because they appear to provide the most return than it is if
people go to the lowest fee.
I will be happy to answer any questions that you have and
quickly point out that with another hat, I sit on the board of
directors of a company that provides exactly the software you
have been talking about, and I would be happy to brief you on
that at any time.
[The prepared statement of Ms. Lacy follows:]
Prepared Statement of Olena Berg Lacy
Thank you, Mr. Chairman and members of the committee, for inviting
me here to speak to you about the important issue of fee disclosure to
401(k) plans and their participants. My name is Olena Berg Lacy and I
was head of the Department of Labor's Employee Benefits Security
Administration (EBSA) during the Clinton administration. I am also a
member of the board of directors of the Pension Rights Center, which I
am representing today. The Center is a nonprofit consumer organization
that has been working since 1976 to promote and protect the retirement
security of American workers and their families. I would like to
address the fee issue from the perspective of what level of disclosure
is in the best interests of plan participants.
While I was with EBSA, we held hearings on 401(k) fees in November
1997 and issued a report in April 1998. I recently went back to review
that report and see what had changed since. I am sorry to say that not
a lot has changed in the intervening decade--except that substantially
more assets are in plans that are subject to these fees.
Of course, the major development that has occurred in the last
decade is the increase in the shift from defined benefit plans to
defined contribution plans so that increasingly a DC plan--a 401(k), a
457, or a 403(b)--will be the only or the primary supplement to Social
Security for millions of workers.
Fees are important. We cannot predict future returns on
investments, but fees are a certainty. They can make a substantial
difference in a retirement account balance. The Government
Accountability Office has pointed out that a 1 percent increase in fees
on an account achieving a 7 percent rate of return annually will reduce
retirement savings by 17 percent over 20 years. The impact of fees is
greater still on smaller account balances or over a longer period of
years.
Fees are also important because of the magnitude of dollars
involved. More than $3 trillion is invested in these plans. If you
assume that collectively, they are operated for just 100 basis points
(1 percent), that amounts to more than $30 billion per year taken from
retirement saving accounts in fees. The significance of this loss of
retirement income is greatly magnified when markets are in turmoil and
participants are incurring losses in their accounts.
For fee disclosure to truly benefit plan participants, it must
occur at two levels: disclosures from service providers to plan
sponsors on fees assessed to the plan, and from plan sponsors to plan
participants on the fees participants are paying. Disclosure to
sponsors at the plan level is critically important to participants
because it is the sponsor who makes the determination of what services
to provide and what investment alternatives to include in the plan. The
sponsor has a fiduciary duty to ensure that these decisions are made
prudently and for the sole and exclusive benefit of the participants.
You might expect that in order to fulfill this duty, plan sponsors
would simply ``shop'' among service providers to find the best deal for
their plans. In the large plan market, this is largely the case. But as
the DOL report pointed out in 1998, the market is not efficient in
allowing small- and medium-sized plan sponsors to be aware of what is
available to them. They have difficulty in getting the information they
need to make informed decisions. Because fees vary substantially for
very similar investment products and services, it is critical that such
information be provided but there is no explicit legal obligation for
service providers to do so. In the absence of such a requirement,
sponsors are on their own to sort out fee information. As the DOL study
pointed out, there are more than 80 ways fees could be displayed. This
is because there are different types of fees: asset-based, per
participant fees, and itemized fixed charges. There are also different
categories of fees, such as administrative costs, communications,
investment management and sales charges. Many of these categories have
subcategories.
Given the lack of information available and the confusing array of
ways in which it is presented, it is reasonable to ask if some plan
sponsors are selecting investment and service options with excessive
fees. While there is not a lot of data, a 2007 study might be
indicative. IMC, a consulting firm, examined the offerings of thousands
of plans of all sizes and different categories of investment offerings.
Based on their findings and extrapolating what they found to the entire
market, they estimated that as many as 5.5 million of more than 55
million participants may be paying some unreasonable fees, and the
assets subject to these fees total almost $300 billion. If you add in
plans paying some high fees, 26 percent of total assets may be subject
to high or excessive fees. In small plans with under $5 million in
assets, almost 50 percent may be paying some high or excessive fees.
In general, large-plan sponsors have the ability to issue RFPs to
numerous service providers and to demand that information be provided
in a consistent format so that comparisons may be easily made. They
have the sophistication to evaluate the information they receive.
Small-plan sponsors probably do not. In fact, the DOL report noted that
surveys showed that cost was not a primary consideration for them and
that, in fact, many select as their 401(k) provider financial
institutions that provide them with other financial services. Yet these
sponsors have the same fiduciary duty to make these decisions for the
sole and exclusive benefit of plan participants.
To level the playing field, it is important that explicit
disclosure requirements exist for the information that service
providers must provide plan sponsors and that there be uniformity in
the format so that comparisons are easy to make. The EBSA undertook a
regulatory project earlier this year to effect such requirements and
should be commended for undertaking this important effort. Its proposal
provides much-needed information to plan sponsors to allow them to make
reasonable decisions. Unfortunately, the proposed regulations do not go
far enough.
Most importantly, the DOL failed to require that expenses be
unbundled.\1\ Without separation of fees for the different categories
of investment management, plan administration, and participant
services, it will be difficult, if not impossible for small- and
medium-sized plan sponsors to make comparisons among different
offerings. And as they monitor the reasonableness of the fees they pay,
without unbundling, they will be unable to determine if investment
managers and other service providers are reaping windfalls when the
growth in assets subject to an all-in management fee exceeds the
incremental costs of providing administrative and other services.
---------------------------------------------------------------------------
\1\ 401(k) plan fees and expenses generally fall into three
categories: plan administration fees, individual service fees, and
investment fees. Some employers may provide for or negotiate these
services separately and the expenses charged by each provider
(recordkeeper, investment manager, etc.) are charged separately. This
is referred to as an ``unbundled'' arrangement. In the case of
unbundled arrangements, the proposed regulations require that the
dollar amount of plan administration fees be disclosed to participants
in quarterly benefit statements. Other plans may have some or all of
the services offered by one provider for a single fee and that provider
will then pay out of its fee any other service providers it may have
contracted with to provide services. This is a ``bundled'' arrangement.
The proposed regulations do not require disclosure of plan
administration fees in bundled arrangements.
---------------------------------------------------------------------------
Aggregating fees can also disguise potential conflicts of interest.
For example, assume there is a plan with 15 different investment
offerings, but the record-keeper is getting 65 percent of its revenue
from just one or two of those offerings--and those are proprietary
offerings. If the funds under-perform, the record-keeper may well
resist removing them from the investment line-up because of the
difficulty in replacing that lost fee revenue.
Also, if regulations or legislation were to allow aggregate-level
disclosure, we would be concerned that plan sponsors might assume that
their duty to examine fees extended no further than what was required
to be revealed to them. In reality, ERISA requires that they ferret out
such conflicts of interest. And they need sufficient information to do
so.
It is vital that we get this right and there is a need for
congressional action to go beyond the DOL proposal.
As I mentioned earlier, the second level of disclosure is from plan
sponsors to plan participants on the fees they are paying. In
discussions about this issue, I have noticed that even those who
support better disclosure to plan sponsors are less willing to concede
that greater disclosure to participants is also needed. I respectfully
disagree. Plan participants also have important decisions to make that
such disclosures would support. The first critical decision is whether
to participate in the plan in the first place. Most participants to not
contribute anywhere near the maximum annual limit and many do not
contribute enough to maximize the company match. Many lower-wage
workers do not even contribute beyond the IRA limit and may well be
better off with an IRA if the costs of operating the 401(k) plan exceed
the value of the company match.
Furthermore, participants often have the ability to influence plan
design and investment offerings by making their desires known to their
employer. So they need to understand what they are paying for. The DOL
study posed it this way: ``If participants knew how much optional
features of their plans cost, would they demand so many?'' An Internet
study showed that 85 percent of 1,000 respondents voted for greater
investment returns versus more services from their plans.
Again, in addition to plan features, participants may influence
which investment options are offered. And certainly they need fee
comparisons to select among those options.
The DOL has also undertaken a regulatory effort to address
disclosure to plan participants and recently issued proposed
regulations. By requiring a single, tabular description of fees to
participants, the department's proposal will significantly improve the
transparency of fees. However, as with the DOL's approach to service
provider disclosure to plan sponsors, these regulations fall short.
Indeed, one can assume that if the plan sponsor disclosures are
inadequate, they will not be conveyed to participants in a way that is
meaningful and can be easily understood. The information should be
unbundled at the participant, as well as the sponsor level. While
participants may not need the same level of disaggregation of fees that
plan sponsors should have, at the very least, fees for the different
categories of services should be separately disclosed.
For disclosure to participants to be helpful, it needs to be clear,
concise, and readily accessible. Financial terminology needs to be
explained in simple terms. The regulation as proposed does not require
sufficient explanation of either fees or investment choices. While too
much information may overwhelm participants, too little will not
support reasonable decisionmaking. And the information must be
presented using terms that most participants will understand. Effective
disclosure also requires easy access to the information. Electronic
means of disclosure will not be appropriate for participants without
access to computers or knowledge of how to use them.
There are other issues with the proposed regulations, as well. They
require the provision of summary investment performance information.
This requirement is undoubtedly in response to the concern expressed by
many industry observers that the provision of fee information only
might lead some financially unsophisticated participants to opt for the
lowest fee funds without regard to performance. Unfortunately, the
summary performance information could result in a similar problem with
this group of participants: that they opt for the highest performing
funds without regard to risk. We submit that this is a far greater
danger and, if it cannot be averted, the fee information should stand
alone.
Finally, in some respects, the proposed regulations weaken
currently required disclosures. (Please see the attached letter from
the Pension Rights Center to the DOL commenting on the regulations for
more detail). So as with disclosure to plan sponsors, there is a need
for Congress to step in.
I mentioned at the beginning of my remarks that not much has
changed in the last decade. But there is some new evidence that just
your interest in this issue is making a difference. A recent article in
Investment News reported on a survey that showed that 30 percent of
plan sponsors cited costs and fees as their reason for switching plan
providers. This marks a significant change from the last survey in
2005, when only 18 percent changed for this reason. The article
mentioned that discussions in Congress, as well as the recent DOL
activity, has brought the issue of fees to the forefront. We believe
that without further congressional action, this momentum could fade. So
we thank you for holding this hearing and for your interest in this
issue of paramount importance to the retirement well-being of millions
of American workers.
Pension Rights Center,
Washington, DC 20036,
September 8, 2008.
Office of Regulations and Interpretations,
Employee Benefits Security Administration,
Attn: Participant Fee Disclosure Project, Room N-5655,
U.S. Department of Labor,
200 Constitution Avenue, NW,
Washington, DC 20210.
Re: Comments on Proposed Regulations on Fiduciary Requirements for
Disclosure in Participant-Directed Individual Account Plans
We are submitting comments on the Department of Labor's proposed
regulations for fiduciary requirements for disclosure in Participant-
Directed Individual Account Plans. The Pension Rights Center is a
nonprofit consumer organization that has been working since 1976 to
promote and protect the retirement security of American workers and
their families.
As the Department of Labor noted in its preamble to the proposed
regulations, and as the Department of Labor's Advisory Council on
Employee Welfare and Employee Retirement Plans noted in a 1998 report
on fees in defined contribution plans, high fees can have a substantial
negative effect on an employee's retirement savings in a defined
contribution plan. And the evidence is strong that in many defined
contribution plans, particularly 401(k) plans sponsored by small and
medium sized firms, fees exceed reasonable levels.
The proposed regulations create a new regulatory regime for
disclosing fees and investment performance information to participants.
While we think that the proposal springs from good intentions and
incorporates some sound ideas, it is, in many respects, problematic.
The regulations will not ensure that adequate information is provided
to participants to help them make intelligent decisions on how to
invest plan assets, or, indeed, whether to participate in the plan at
all. Moreover, the regulations provide some information that may
mislead the typical investor, resulting in some investors making
poorer, rather than wiser, decisions. In addition, the regulations fall
short on providing participants with sufficient information to evaluate
the performance of the fiduciaries responsible for selecting investment
alternatives and negotiating fees with third parties.
Our specific concerns include the following:
1. The regulations should require that fees be unbundled. The
regulations' most significant short-coming is that they do not require
that fees for broad categories of services be separately stated, but
rather allow fees to be bundled.\1\
---------------------------------------------------------------------------
\1\ 401(k) plan fees and expenses generally fall into three
categories: plan administration fees, individual service fees, and
investment fees. Some employers may provide for or negotiate these
services separately and the expenses charged by each provider (record
keeper, investment manager, etc.) are charged separately. This is
referred to as an ``unbundled'' arrangement. In the case of unbundled
arrangements, the proposed regulations require that the dollar amount
of plan administration fees be disclosed to participants in quarterly
benefit statements. Other plans may have some or all of the services
offered by one provider for a single fee and that provider will then
pay out of its fee any other service providers it may have contracted
with to provide services. This is a ``bundled'' arrangement. The
proposed regulations do not require disclosure of plan administration
fees in bundled arrangements.
---------------------------------------------------------------------------
Particularized information about the nature and size of fees is
critical to responsible investing. When fees are bundled, however,
participants are denied this information. Fee unbundling is critical to
providing participants with the information they need to choose among
investment alternatives (and decide whether to participate in the
plan). Moreover, with bundled fees, a plan record keeper may be able to
overburden non-proprietary funds with excess fees, making its
proprietary funds more attractive. Bundled fees may thus result in
participants who invest in certain investment alternatives subsidizing
the recordkeeping and other fees of participants who invest in other
alternatives.\2\
---------------------------------------------------------------------------
\2\ It should also be noted that unbundled fees would permit fee
disclosures to include benchmarks for different types of fees.
---------------------------------------------------------------------------
Bundled fees also mask the cost of particular services, some of
which might not be used by most participants. If the costs of such
services were more transparent, participants might ask the plan sponsor
to drop the services or charge the costs of the services directly to
the participants who use them. Finally, when administrative services
are bundled with investment fees, it becomes more likely that vendors
of investment vehicles will reap windfalls when asset growth exceeds
the incremental additional costs of providing administrative services.
We are aware that to provide this information it will be necessary
for investment vendors who currently bundle fees (or who receive
revenue sharing or similar payments from other parties) to modify their
current business practices. But such transitional costs for vendors do
not seem too large a price for the vendors' ability to participate in
one of the largest investment markets in the world, and it is
reasonable to require that market participants play by rules that
maximize transparency. We also know that there are technical issues
involved in requiring that fees be separately stated, but we believe
that the Department of Labor should be able to draw on the considerable
investment expertise of other Federal agencies and the private markets
to create a workable regulatory regime in which fees for broad
categories of services are separately stated.
It is also worth observing that some observers have suggested that
the proposed regulations, by requiring greater transparency when fees
are not bundled, will result in more plans contracting with vendors who
bundle fees. This would further undercut efforts to improve
transparency.
2. Plans in Which Participants Do Not Have Investment Choice. The
proposed regulations require disclosure to participants in plans where
employees allocate their accounts among several investment
alternatives, but do not apply to plans where the investments are
professionally managed for the participants as a unitary group. But
participants in the latter plans also have a need to know the
investment and administrative fees for which they are paying, to assist
them in their planning for retirement and to evaluate fiduciary
performance. The regulations should extend fee disclosures to
participants in such plans.
3. Description of Investment Information. The proposed regulation
requires the provision of summary investment performance information.
This requirement is undoubtedly in response to the concern expressed by
many observers that the provision of fee information only might lead
some unsophisticated participants to opt for the lowest fee funds
without regard to performance. Unfortunately, the summary performance
information could result in another problem with this group of
participants: they may opt for the highest performing funds without
regard to risk. We submit that this is a far greater danger and if it
cannot be averted, the fee information should stand alone. In fact, the
required disclosure fails to provide even summary descriptions of each
alternative or notation of the level of risk associated with each
investment.
While we agree that furnishing participants with excessive
information can be counterproductive, this does not mean that the
optimal level of disclosure is the least disclosure. We do not see how
participants who are unwilling or technologically ill-equipped to
search Web sites for information on each of their investment
alternatives are served with the scant summary information required by
the regulations. Indeed, the regulations, seem to adopt a name, rank,
serial number approach to disclosure: they require written disclosure
for each investment alternative of only the following: (1) category of
investment, (2) form of management (passive or active); and (3)
historical performance data (with a market benchmark). This is
insufficient and may result in some investors selecting the investment
with the highest historical return--without regard to risk or the value
of portfolio diversification--since this is what the disclosure
statement appears to isolate as the key determinant of the value of an
investment. We note that the Federal Thrift Savings Plan provides
understandable summary paragraphs for each investment alternative and
might be a starting model for better disclosure than the proposed
regulations would require.
We also recommend that if performance data is included in the final
regulations, the regulations specify that investment return be reported
net of fees.\3\ In addition, there should be a requirement that key
terms such as expense ratio, basis points, large-cap fund, operating
expenses, active management and passive management, etc., be clearly
defined.
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\3\ The definition of ``average annual total return'' refers to
Securities and Exchange Commission Form N-IA, which requires that
investment performance be disclosed net of fees, but since some plan
fiduciaries may not be familiar with the SEC requirements, the fact
that investment return must be shown net of fees should be made
explicit in the final regulations.
---------------------------------------------------------------------------
4. The Regulations Should Not Reduce Investment Disclosure. The
regulations currently in effect under ERISA Sec. 404(c) require that a
prospectus be provided to participants for each investment alternative
offered by the plan. The proposed regulations, which would replace
these rules, do not require provision of prospectuses. Instead, they
merely require plans to provide information on how to access
prospectuses on the Internet. Many participants are more likely to read
a prospectus if they are provided with a hard copy than if they must
access the Internet. We urge that the new regulations focus on
improving disclosure rather than weakening it.
5. Expenses Charged to Individuals. The regulations require that
expenses charged directly to individual participants be disclosed. We
think it probable that some participants will not understand the
significance of some of these charges. We thus believe the regulations
should provide information to help individuals understand the nature of
the charges and the impact they can have on return. As an example, we
note in the sample disclosure chart in the regulations, that one
investment imposes a $20 annual service fee on accounts with less than
$10,000. The average return for this fund over the previous 5-year
period was .22 percent and 8.9 percent for the previous year. If a
participant had invested $1,000 in this account and the fund returned
on average 2 percent annually over the next 5 years, the account
balance would not have grown at all during this period. And if the
returns during this period were initially lower than 2 percent, the
return would have been negative over those 5 years, notwithstanding the
2 percent average rate of return. We do not think this will be apparent
to many participants. In addition, we are skeptical that all
participants are aware of how, for example, a ``4.25 percent deferred
sales charge against amounts invested or redeemed,'' might affect their
investments.
6. Correlation of fee disclosure and investment disclosure. The
typical participant reading the Model Comparative Chart would not know
whether the ``average annual total return'' for a fund on Part I
reflected the fees separately stated on Part II (both annual operating
fees and shareholder and shareholder-type fees).
7. Timing and Method of Disclosure. The proposed regulations permit
general fee and investment disclosure to be made in a plan's summary
plan description and require that modifications to the general
disclosures be made by the 30th day following the adoption of a
material change. While providing information in the summary plan
description is useful, we believe that providing a stand-alone
disclosure to participants when they first commence plan participation,
and annually thereafter, would better serve participants and put only a
mild additional burden on plan sponsors. We also believe that material
changes in fee and investment information should be reported to
participants before, rather than after, they are adopted.
Finally, we want to note that promulgation of a regulation on fee
disclosure requires two conceptually distinct inquiries: first, what
information does a participant require about fees to make informed
investment decisions; and second, how the information can be made
intelligible to participants. The latter inquiry can be most
effectively answered through testing various alternatives with actual
participants. We urge the Department to undertake such a study.
Respectfully submitted,
Norman P. Stein,
Policy Advisor.
Jane T. Smith,
Policy Associate.
Senator Harkin. All right. We will come back to that.
Next, we will turn to R. Theodore Benna, founder of the
401(k) Association, who I am told is the parent of 401(k)s.
Mr. Benna, welcome. I often wondered who dreamed this whole
thing up.
STATEMENT OF R. THEODORE BENNA, FOUNDER, THE 401(K)
ASSOCIATION, JERSEY SHORE, PA
Mr. Benna. Thank you. Well, it's a pleasure to be here, Mr.
Chairman and Congressman Enzi.
I appreciate the opportunity and want to comment just
briefly on the fees, but more importantly, I think, about other
issues that tie into it, which you were both addressing, and
that is participants making wiser investment decisions and
burden of liability placed on employers.
Definitely greater disclosure is required to plan sponsors
and participants. This is a very high-level frustration for
both of those audiences. So action clearly is needed.
On the other side, being involved in the administration of
small plans for small businesses, I have to warn you that it is
not easy to obtain the information that you are asking to be
disclosed. It is extremely difficult to find the information
due to the many layers of fees that exist.
On the investment side, the fact that funds that are
offered in these plans can be--there are many different share
classes that are involved. There is no easy way to go out
there, gain the fee information and the investment return
information, and provide it.
My best estimate in terms of having to do that in our
little business is it probably would result in having to
increase fees to our clients by 5 to 10 percent to be able to
pull that information together. Certainly one of the things
that would be very helpful to the industry would be some
centralized place because everybody who has a plan and is
servicing them would have to disclose fees. Right now, there
isn't one easy place where you can go to and find performance
information and fee information for all share classes that are
readily available that I know of.
That is my comment on fees. I want to comment on your
concern about participant investments. It is probably about 7
years ago now, when we were coming up to the 25th anniversary
of the first 401(k) savings plan, that I was focusing on the
fact that we have a lot to learn from the experience we have
gained. One of the things that frustrated me was the fact that
despite millions of dollars thrown at education, it hadn't
really changed the bar.
I helped, as Olena did, launch the investment advice
business with computer-driven models and had the hope that that
was going to help overcome this hurdle of participants making
better investment performance. After a couple of years'
experience watching that model, I concluded that it wasn't
doing any more than what education did to change the way
participants were investing.
At that time, Money magazine ran an article. The title of
the story was ``Fixing 401(k).'' I had a quote in that, which
was a one-liner, which was, ``The father of 401(k) said if he
were starting over from scratch today, he would blow up
existing investment structures.'' That got a little concern in
the investment community, I might add.
What I was talking about were two things that you are both
obviously focusing on. That is getting participants to
understand and to make easier decisions, and the question I was
asking is why should employers be liable, have a gun held to
their head being fearful of being sued when they are helping
their employees save for retirement? It doesn't make sense.
At that time, I started talking here and visited some
different people and promoted the idea of a fiduciary safe
harbor that would protect businesses who chose to structure
their plans in a certain way from liability exposure. The
investment structure I was talking about at that time, frankly,
was replacing these big menus that we throw out at participants
and expect them to be able to understand and make informed
investment decisions about and to use vehicles that are already
in place that provide proper allocations, automatically re-
balance, and automatically reduce risk as participants grow
older.
Those investment vehicles are commonly known as target
maturity funds. Seven years ago, there was only one mutual fund
company that offered those funds. Today, every player in the
field must offer them due to the demand and the awareness that
these funds are achieving a lot of the things that you are
looking to accomplish.
PPA included a provision in it that reduces fiduciary
liability potentially for employers who utilize funds of this
type, and that was put in primarily for default investment
purposes. However, that application potentially has much
broader potential for employers who use that kind of structure
and the benefits of QDIA to help their participants get better
investment results without having to make all these complex
decisions and also substantially reduce employer liability for
the employers.
Thank you.
[The prepared statement of Mr. Benna follows:]
Prepared Statement of R. Theodore Benna
I am commonly referred to as the father of 401(k) because I
designed and installed the first plan that used a matching employer
contribution and employee pre-tax contributions. I am semi-retired, but
I am still active and have been in the retirement plan business for 49
years,
I am here as an advocate for participants and employers and as a
co-owner and officer of a small company that administers plans for
small employers.
Substantial progress has been made to disclose fees during the past
10 years due to governmental attention and market pressure. Most
employers receive fee information today but many participants either
don't or it is available but hard to find.
There is lots of room for improvement.
As a 401(k) advocate, I support the adoption of the Department of
Labor proposed regulations but with a delayed effective date. As an
officer of a company that administers plans, I am concerned about the
time and cost related to complying with these regulations.
A major problem is the fact that there isn't any place where the
data is readily available for all mutual funds that may be offered in a
401(k) plan. A community effort to gather this information will be
useful.
The effective date is unworkable.
A determination needs to be made regarding who will be responsible
for providing the necessary information. Greater disclosure is badly
needed but it is questionable how much of an impact greater disclosure
will have.
Senator Harkin. Thank you very much, Mr. Benna.
And now we will turn to Paul Hunt, President of the
Millennium Advisory Services on behalf of the U.S. Chamber of
Commerce.
Mr. Hunt.
STATEMENT OF PAUL HUNT, PRESIDENT, MILLENNIUM ADVISORY
SERVICES, TESTIFYING ON BEHALF OF THE U.S. CHAMBER OF COMMERCE,
GLEN ALLEN, VA
Mr. Hunt. Thank you, Senator Harkin. I appreciate being
here today, and I want to thank both of you, Senator Enzi and
Senator Harkin, for the opportunity to discuss the
appropriateness of retirement plan fees.
I am Paul Hunt. I am president of Millennium Advisory
Services. We are an SEC-registered investment advisory firm. I
am also president of Millennium Capital Management, and we do
traditional investment business through our broker/dealer
relationship with Triad Advisors out of Atlanta, GA.
I am pleased to testify today on behalf of the U.S. Chamber
of Commerce, where I am a member, and I am also a member on
their Corporate Leadership Advisory Council.
As you know, the Chamber is the world's largest federation,
representing more than 3 million businesses and organizations
of every size, sector, and region. Over 96 percent of the
Chamber members are small businesses with fewer than 100
employees. So I am a very good representative of the Chamber
today because we are a small business.
Also being a small business, we are in the investment
world. As investment advisors--we are investment advisors on
several retirement plans, and employees of Millennium Capital,
through Triad Advisors and are registered reps on several
retirement plans. We are also a small business that sponsors
our own retirement plan.
I believe it is critically important to discuss the impact
of potential legislation on the small business sponsor. For
that reason, I appreciate this opportunity to discuss fee
disclosure and the potential impact that it may have for small
businesses.
While there have been several bills introduced in Congress
on fee disclosure and several sets of regulations issued by the
Department of Labor, my comments today will focus on general
principles and concerns of small business plan sponsors rather
than on specific provisions in any one piece of legislation. I
would like to highlight the following areas.
Plan fee disclosure can be helpful to small business plan
sponsors in the appropriate context. Onerous administrative and
cost burdens will negatively affect small business plan
sponsorship. Liability concerns are an important consideration
for small business owners. And the ability to buy bundled
services should be preserved.
First, it is important to state that plan fee disclosure
can be very helpful to small businesses. Being in the
investment business, we are true believers of transparency, and
I applaud what you gentlemen are doing. We believe that
transparency is a very, very important factor in the retirement
plan world.
Clarification of fee disclosure requirements can be very
helpful to small business plan sponsors to ensure that they are
aware of the services that they are receiving and the prices
they are paying. At the same time, it is critical that the
significance of plan fees be put in the appropriate context.
Some plan sponsors may begin to feel that they need to
choose the least expensive investment option in order to avoid
litigation claims. However, the lowest fees are not a guarantee
of the best performance. Moreover, plan sponsors may desire
services or features that are not included in the lowest fees.
Therefore, it is necessary for plan sponsors to also consider
expenses in the greater context of investment performance and
features.
As you are aware, small business owners are very sensitive
to administrative and cost increases. Due to their size and
resources, small business owners often feel these burdens
sooner and more deeply than their larger counterparts. Unlike a
large company that may have a dedicated human resource or
benefits professional, or even an entire department, this
function in a small business may be one of several other duties
of an employee, more likely the owner.
Therefore, small business owners will be less likely to
establish a retirement plan if there are going to be
significant administrative burdens that they do not have the
resources to cover. The threat of litigation is a serious
concern for small business plan sponsors.
While the publicity garnered by congressional hearings,
lawsuits, and newspaper articles has highlighted the importance
of plan fees, it has also created for some a negative
impression of plan fees and plan sponsors. A small business
owner who does not have the resources to hire an outside
consultant may become wary of offering an individual account
plan at all for the fear of a potential lawsuit. Therefore, it
is critical to proceed cautiously and thoroughly, consider all
implications associated with any changes or requirements.
I am going to make a side comment on that. In my opinion, I
think that it is very dangerous because of litigation. I think
it is almost a catch-22 for the small business owner. The
threat of being sued over not having the lowest expense fees,
and then the other side of the coin is, as you know, markets
are very cyclical. Different investments perform different in
different times, and choosing the lowest cost fee does not
provide for protection against cyclicality.
Therefore, I think that the small business owner is also
afraid of litigation for not having better performing funds in
there and a wider choice. So I think that is something you have
to be very careful of.
Finally, we request that Congress let the market determine
the services and products available to sponsors. There is a
need for support for both bundled and unbundled services. The
choice of which service model to use should be made by the
consumer, in this case the plan sponsor, based on its needs and
resources.
For both administrative and cost concerns, there are
employers that may prefer to use bundled services for their
retirement plans. In terms of administration, it is one-stop
shopping. Furthermore, the pricing of bundled services may be
more attractive to some plan sponsors.
Again, for a small business sponsor who is trying to
maximize resources, this is an important consideration.
Congress should consider the need to increase plan sponsorship
in the small business market if it considers any changes to
bundled fee arrangements.
In conclusion, the concerns of small business plan sponsors
need additional consideration. Unreasonable administrative
requirements, additional liabilities and potential cost
increases could drive small businesses away from the private
retirement system. At a time when small business retirement
plans are beginning to experience success, we should encourage
these efforts by creating requirements that fully consider the
concerns and possible consequences to small business plan
sponsors.
I appreciate the opportunity to address our concerns, and I
am open for any questions you may have.
[The prepared statement of Mr. Hunt follows:]
Prepared Statement of Paul Hunt, U.S. Chamber of Commerce
summary
The U.S. Chamber of Commerce is the world's largest business
federation, representing more than 3 million businesses and
organizations of every size, sector, and region.
More than 96 percent of the Chamber's members are small businesses
with 100 or fewer employees, 70 percent of which have 10 or fewer
employees. Yet, virtually all of the Nation's largest companies are
also active members. We are particularly cognizant of the problems of
smaller businesses, as well as issues facing the business community at
large.
Besides representing a cross-section of the American business
community in terms of number of employees, the Chamber represents a
wide management spectrum by type of business and location. Each major
classification of American business--manufacturing, retailing,
services, construction, wholesaling, and finance--is represented. Also,
the Chamber has substantial membership in all 50 states.
The Chamber's international reach is substantial as well. It
believes that global interdependence provides an opportunity, not a
threat. In addition to the U.S. Chamber of Commerce's 105 American
Chambers of Commerce abroad, an increasing number of members are
engaged in the export and import of both goods and services and have
ongoing investment activities. The Chamber favors strengthened
international competitiveness and opposes artificial U.S. and foreign
barriers to international business.
Positions on national issues are developed by a cross-section of
Chamber members serving on committees, subcommittees, and task forces.
More than 1,000 business people participate in this process.
______
Thank you, Chairman Kennedy, Ranking Member Enzi, Senator Harkin
and members of the committee for the opportunity to appear before you
today to discuss the appropriateness of retirement plan fees. My name
is Paul Hunt, President of Millennium Advisory Services, Inc., which is
an SEC-registered investment advisory firm. I am also President of
Millennium Capital Management of Virginia, Inc., which does traditional
investment business through our broker/dealer relationship with Triad
Advisors, Inc. I am pleased to be able to testify today on behalf of
the U.S. Chamber of Commerce where I am a member of its Small Business
Council and the Corporate Leadership Advisory Council. The Chamber is
the world's largest business federation, representing more than 3
million businesses and organizations of every size, sector, and region.
More than 96 percent of the Chamber members are small businesses with
fewer than 100 employees.
Millennium Advisory Services is an investment advisor for several
retirement plan clients, and employees of Millennium Capital Management
are registered representatives on several other retirement plans. We
are also a small business that sponsors our own retirement plan.
As a provider of services to small business plan sponsors, I
believe that it is critically important to consider the impact of any
potential legislation on the small business plan sponsor. For that
reason, I appreciate the opportunity to discuss the issue of plan fee
disclosure and the potential impact on small business plan sponsors.
introduction
According to the U.S. Small Business Administration, small
businesses (less than 500 employees) represent 99.9 percent of the
total firms and more than half of the workforce in the United
States.\1\ Clearly, ensuring adequate retirement security for all
Americans means encouraging small businesses to participate in the
private retirement system. Small businesses, in general, face
significant hurdles and may view retirement plans as yet another
potential obstacle and therefore, choose not to establish them. Thus,
there have been tremendous efforts to provide incentives and encourage
small business owners to establish and maintain retirement plans.\2\
Consequently, it is important to give special consideration to
potential burdens that new legislation may impose on small businesses.
---------------------------------------------------------------------------
\1\ U.S. Small Business Administration Office of Advocacy estimates
based on data from the U.S. Dept. of Commerce, Bureau of the Census,
and U.S. Dept. of Labor, Employment and Training Administration.
\2\ Under the Economic Growth and Tax Relief Reconciliation Act of
2001 (``EGTRRA'') that was made permanent by the Pension Protection Act
of 2006 (``PPA'') small businesses may claim a tax credit for
establishing a retirement plan equal to 50 percent of qualifying costs
up to $500 per year for the first 3 years. In addition, the PPA
instituted a number of additional positive reforms including the
creation of the Roth 401(k), simplification of a number of complex
administrative requirements, and the creation of the DB(k) for small
businesses.
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Despite the obstacles, and due to various incentives, small
businesses are having success in the retirement plan arena. Small
businesses with less than 100 employees cover more than 19 million
American workers.\3\ Most of these small business employees enjoy
generous annual retirement plan contributions from their employers,
often in the range of 3 to 10 percent of compensation. Thus, the small
business qualified retirement plan system is successful in delivering
meaningful retirement benefits for its employees and all efforts should
be made to encourage its continued success.
---------------------------------------------------------------------------
\3\ Patrick J. Purcell, Congressional Research Service (CRS) Report
for Congress, Social Security Individual Accounts and Employer-
Sponsored Pensions, February 3, 2005, Table 2. Employee Characteristics
by Employer Retirement Plan Sponsorship, 2003 at CRS-5.
---------------------------------------------------------------------------
My comments today focus on the concerns of small business plan
sponsors as they relate to additional fee disclosure requirements.
While there have been several bills introduced in Congress on fee
disclosure and several sets of regulations issued by the Department of
Labor, our comments today focus on general principles and concerns
rather than focusing on specific provisions in any one piece of
legislation or regulation. Clarification of fee disclosure requirements
can be very helpful to small business plan sponsors to ensure that they
are aware of the services that they are receiving and the prices that
they are paying. In order to ensure that plan fee legislation helps
small businesses, we ask Congress to consider our following concerns.
small business plan concerns
Costs Considerations are Important to Small Business Plan Sponsors.
Of course, small business owners--like all business owners--are
concerned about costs. The costs of maintaining a retirement plan may
be a greater consideration for a small business owner, because once a
small business decides to establish a retirement plan it is often
subject to higher administrative fees than larger companies. A report
by the Small Business Administration found that the administrative
costs for large companies (over 500 employees) averaged $30 to $50 per
participant while the administrative costs for mid-size companies (500
to 199 employees) were slightly higher at $50 to $60 per participant.
For the smallest companies, however, (200 and fewer employees), the
average administrative costs jumped to over $400 per participant.\4\
One reason for the higher cost is that there is a minimum
administrative cost to establishing and maintaining a retirement plan
and small companies have fewer employees to spread the costs over;
therefore, the costs per participant can become significantly
higher.\5\ Thus, it is critical to keep this distinction in mind when
discussing the appropriateness of plan fees.
---------------------------------------------------------------------------
\4\ Joel Popkin and Company, Small Business Administration, Office
of Advocacy, Cost of Employee Benefits in Small and Large Businesses 38
(2005).
\5\ Id.
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Moreover, small business plan sponsors have a personal stake in the
cost and operation of the plan since they are also generally plan
participants. At the start, small business owners typically solicit
multiple bids for the contract and ask the potential service providers
questions about the plan before signing up for services. Once the plan
is established, the small business owner, who is generally also a plan
participant, has a vested interest in keeping fees down for both the
plan and the participants.
Anticipated Liabilities May Drive Small Business Owners Away from
Plan Sponsorship. We should not underestimate the small business
owner's concern over additional liabilities (even if they are only
perceived). Over the past year, plan fees have been the subject of
congressional hearings, lawsuits, and newspaper articles. While this
publicity has highlighted the importance of plan fees, it has also
created a negative impression of plan fees and plan sponsors. Thus,
there is a heightened scrutiny of plan fees. A small business owner who
does not have the resources to hire an outside analyst may become wary
of offering an individual account plan at all. In addition, some small
business owners may have a difficult time obtaining fee information
from their service providers in a format that they can easily digest
and provide for their participants. The ERISA Advisory Council warned
that ``a balance must be struck between what can reasonably be expected
of small plan sponsors and the potential capabilities of larger plan
sponsors.'' \6\ For example, statements that imply that there is an
``average'' amount for plan fees can be misleading to participants in
small business plans for the reasons mentioned above and lead to
additional liability for the plan sponsors. Therefore, it is critical
to proceed cautiously and thoroughly consider all implications
associated with any future changes or requirements.
---------------------------------------------------------------------------
\6\ Advisory Council on Employee Welfare and Pension Benefit Plans,
ERISA Advisory Council, Report of the Working Group on Fee and Related
Disclosures to Participants 5 (2004).
---------------------------------------------------------------------------
Onerous Administrative Burdens Will Negatively Impact Small
Business Plan Sponsorship. Small business owners are very sensitive to
administrative and costs increases. Due to their size and resources,
small business owners often feel these burdens sooner and more deeply
than their larger counterparts. Small business owners generally have
fewer resources and, therefore, have greater concerns about taking on
additional administrative responsibilities. Unlike a large company that
may have a dedicated human resources or benefits professional or even
an entire department--this function in a small business may be one of
several other duties of an employee or, more likely, the owner.
Therefore, small business owners will be less likely to establish a
retirement plan, if there are going to be significant administrative
burdens that they do not have the resources to cover.
Bundled Service Arrangements are Advantageous to some Small
Businesses. For both administrative and costs concerns, there are
employers that may prefer to use bundled services for their retirement
plans. In terms of administration, it is one-stop shopping. Rather than
dealing with several different service providers, the plan sponsor can
deal with only one or two; thereby, maximizing the allocation of his or
her resources by minimizing administration responsibilities.
Furthermore, the pricing of bundled services may be more attractive to
some plan sponsors. Again, for a small business plan sponsor who is
trying to maximize resources this is an important consideration.
Congress should consider the need to increase plan sponsorship in the
small business market if it considers any changes to bundled fee
arrangements.
Moreover, as an entrepreneur and member of the Chamber, I believe
that services and products should be determined by the market and not
by Congress. There is a need and support for both bundled and unbundled
services. The choice of which service model to use should be made by
the consumer--in this case the plan sponsor--based on its needs and
resources. We sincerely urge Congress not to mandate one type of
service arrangement over another.
Bundled Service Arrangements are Consistent with Fiduciary
Obligations. The fiduciary of the trust (normally the employer) must
operate the trust for the exclusive purpose of providing benefits to
participants and their beneficiaries and defraying reasonable expenses
of administering the plan.\7\ In other words, the fiduciary has a duty
under the Employee Retirement Income Security Act of 1974 to ensure
that any expenses of operating the plan, to the extent they are paid
with plan assets, are reasonable. We do not believe that bundled
services in any way impede the plan sponsor's ability to carry out its
fiduciary duties. On the contrary, as long as the plan sponsor receives
information that includes all of the services provided and the total
costs, he or she should be able to compare this to information from
other bundled providers as well as unbundled providers and determine
whether the fees, taken in totality, are reasonable for the services
being provided. As long as the plan sponsor is fully informed of the
services being provided, it can compare and evaluate whether the
overall fees are reasonable without having to analyze fees on an
itemized basis.
---------------------------------------------------------------------------
\7\ ERISA section 404(a)(1).
---------------------------------------------------------------------------
general principles on plan fee disclosure
For this hearing, we were asked to specifically highlight the
concerns of small business plan sponsors. Of course, the issue of plan
fee disclosure concerns Chamber members of all sizes; therefore, it is
important to share the Chamber's general principles on plan fee
disclosure. Over the past year, the Chamber has testified before the
House of Representatives and submitted several sets of comments to the
Employee Benefits Security Administration (EBSA).\8\ The Chamber's
comments reflected not only concerns about new rules on plan fee
disclosures, but also formed the principles with which the Chamber
views any forthcoming reforms to plan fee disclosures. These principles
are outlined below.
---------------------------------------------------------------------------
\8\ On September 8, 2008, the Chamber submitted comments to the
Department of Labor on the proposed rule on Fiduciary Requirements for
Disclosure in Participant-Directed Individual Account Plans. On March
31, 2008, the Chamber testified before the Department of Labor on the
disclosure of fees between service providers and plan sponsors. On
February 11, 2008, the Chamber submitted joint comments with the ERISA
Industry Committee, the College and University Professional Association
for Human Resources, the National Association of Manufacturers, the
Profit Sharing/401(k) Council of America and the Society for Human
Resource Management to the Department of Labor on the proposed
regulations issued under ERISA section 408(b)(2). On October 30, 2007
Harold Jackson, President and CEO of Buffalo Supply, Inc. testified on
behalf of the Chamber before the House Ways and Means Committee on the
appropriateness of plan fees from the perspective of the small business
plan sponsor. On October 4, 2007 the Chamber presented a joint witness
in a hearing before the House Education and Labor Committee on the
401(k) Fair Disclosure for Retirement Security Act of 2007 (H.R. 3185).
On July 24, 2007, the Chamber submitted comments to the DOL in response
to their request for information on Fee and Expense Disclosures to
Participant Account Plans.
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The Importance of Plan Fees Should be Considered in the Appropriate
Context. Over the past year, plan fees have received a lot of
publicity. While highlighting the importance of fees in the investment
context, this publicity has also possibly had the negative effect of
implying that plan fees are the only factor to consider when making
investment decisions. This could be detrimental to both participants
and plan sponsors.
Participants making investment decisions should not rely solely on
the fees associated with the investment option. While the fees are an
important part of the consideration, there are several other factors
that may be considered, such as historical performance and investment
risk. In its testimony before Congress, the Government Accountability
Office (GAO) also recognized the importance of a variety of factors
when making investment decisions, even noting that ``higher fees can
also arise if an investment option has additional features.'' \9\
---------------------------------------------------------------------------
\9\ United States Government Accountability Office, Private
Pensions: Changes Needed to Provide 401(k) Plan Participants and the
Department of Labor Better Information on Fees 19 (2006).
---------------------------------------------------------------------------
Similarly, plan sponsors may begin to feel that they need to choose
the least expensive investment option in order to avoid litigation
claims. However, the lowest fees are not a guarantee of the best
performance. Moreover, plan sponsors may desire services or features
that are not included in the lowest fees. Therefore, it is necessary
for plan sponsors to also consider expenses in the greater context of
investment performance and features.
Fee Disclosures to Participants Should be Useful and Easy to
Understand. As you are aware, plan participants already receive many
notices from the plan. While some participants may read and digest
these notices, most participants bypass the information without
receiving any benefit from it. For this reason, we believe that fee
information provided to participants should be stated as clearly as
possible. In addition, the Chamber recommends that this information be
combined with other notices already required to be sent to the
participant.
The Chamber also suggests that information on fees should be
limited to the amounts that are paid by the participant. There is
general agreement that analyzing plan fees between providers, plans,
and participants is complicated. Each individual plan sponsor
determines how much of the fees they will pay and how much participants
will pay. As mentioned above, plan sponsors consider a number of
factors in addition to expenses when choosing a service provider. If
the plan sponsor chooses to pay those additional costs and it does not
impact the participants' accounts, then this information is not
relevant to the participants and may create unnecessary confusion.
Disclosure Requirements Should Not be Unduly Burdensome. Plan
sponsors are subject to numerous statutory and regulatory requirements
and must constantly balance costs against the benefits of maintaining
the retirement plan. Consequently, it is important to minimize the
burdens on plan sponsors. In its 2004 report, the ERISA Advisory
Council noted this concern:
The working group wants to avoid a rule that is so burdensome
that it discourages the adoption and maintenance of defined
contribution plans. Section 401(k) plans in particular have
become popular and convenient investment vehicles for the U.S.
workforce. Disclosure rules should not be so onerous that they
impede this popular and useful savings vehicle.\10\
---------------------------------------------------------------------------
\10\ Advisory Council on Employee Welfare and Pension Benefit
Plans, ERISA Advisory Council, Report of the Working Group on Fee and
Related Disclosures to Participants 5 (2004).
The Chamber very much agrees with this statement and urges this to
be kept in mind as the process moves forward.
The Chamber does not have a specific proposal for the disclosure
format, but has several general recommendations. We recommend that
disclosure information be as efficient in length as possible to keep
participants from being overwhelmed with information. If possible, we
also recommend that fee information be included as part of other notice
requirements to minimize the amount of notices that are being created
and sent. For example, including fee information with the participant
benefit statement or the summary annual report should be considered.
Finally, we recommend that plan sponsors be given flexibility in the
method of distribution of the notice (electronic, paper, intranet,
etc.) and in design of the notice. Because plans and investment options
vary significantly, it could be a tremendous burden on some plan
sponsors to have to comply with rigid criteria.
Small Business Plan Sponsors May Require Additional Consideration.
For all of the reasons mentioned above, we believe that it is critical
to consider the additional burdens and obstacles that may be placed on
small business plan sponsors when considering possible legislation.
conclusion
As more workers become dependent on individual account plans for
retirement, it becomes increasingly important to provide participants
with information that will allow them to make well-informed decisions.
Given the complicated nature of plan fees, it is not a simple task to
discern which information and what format will prove most meaningful to
participants--rather, it will take input and dialogue from many
different parties and experts.
In particular, the concerns of small business plan sponsors need
additional consideration. Unreasonable administrative requirements,
additional liabilities, and potential costs increases could drive small
businesses away from the private retirement system. At a time when
small business retirement plans are beginning to experience success, we
should encourage these efforts by creating requirements that fully
consider the concerns and possible consequences to small business plan
sponsors. We appreciate the opportunity to express our concerns and
look forward to future conversations with you and other interested
parties.
Senator Harkin. Thank you very much, Mr. Hunt.
First, the issue has come up--I have listened carefully and
read the testimony--the question about fiduciary
responsibilities here. Starting with you, Ms. Lacy. There are
fiduciary liability responsibilities in ERISA. Why are they
important? It seems to me that better disclosure would make it
easier for businesses to fulfill that fiduciary responsibility.
Ms. Lacy. I entirely agree with you, Senator. We can argue
whether or not the fiduciary duty should exist as it does, but
the reality is it does. The small plan sponsor has the same
obligation as the largest plan sponsor to meet that requirement
that you act for the sole and exclusive benefit of your plan
participants and the decisions that you make are prudent and
reasonable. That duty exists.
So, it seems to me that the kinds of disclosures that are
being proposed by the department and in legislation can only
assist smaller plan sponsors in making sure that the
information they are going to need has been provided to them.
It puts the duty on the service providers to hand them the
information.
As you well know, ERISA is more about process than if
ultimately it turns out you made the right decision. No one is
going to know what happens in the future with investments. So
your requirement under the law is to be prudent about how you
went about making your process. So the other advantage of these
disclosures is they will create that kind of paper trail.
Senator Harkin. Now you are not suggesting in any way that
we look at removing this fiduciary responsibility, are you?
Ms. Lacy. No, I am not. I am saying it exists, and let us
help people meet it better.
Senator Harkin. Now, Mr. Benna, you mentioned something I
wrote down here. What was that term you used, oh, ``fiduciary
safe harbor.'' In other words, what I took from what you said
was that maybe somehow we ought to look at removing this
fiduciary responsibility for small businesses and providing
some kind of a safe harbor. What does that mean?
Mr. Benna. Well, the goal that you are talking about here
is participants doing a better job of investing their money.
And education, giving them all these choices and providing
sufficient information for them to go out and make decisions on
their own hasn't worked real well, and it is not going to.
Disclosure is necessary. I fully support the disclosure
efforts you are talking about, but the framework I am talking
about in terms of reducing employer liability is already there
in the Pension Protection Act. You already passed it in
Congress.
You included in PPA a thing called ``qualified default
investment option,'' which, when employers choose to utilize
that provision as it was enacted in PPA and following the
guidelines of the regulations of Department of Labor, they get
fiduciary relief, greater fiduciary relief than they get under
Section 404(c) of ERISA.
It is already there. I am just--the only thing I am
suggesting that would be helpful to everybody in this field--
participants, employers inclusive--is to make it clear that
that protection that is there in PPA through the QDIA is
applicable when a plan utilizes that structure for the
operation of its entire plan rather than just default for
participants who do not pick investments when they are
enrolled.
I have used this provision. I mean, you want to talk about
changing participant behavior. I have taken plans that operate
the way we are talking here, and I have blown them up and I
have moved all the participants into these type of funds where
that is where their money is invested automatically. Then they
have to choose if they want to go out and go back and run it
the way they have been doing, by having to worry about knowing
enough about all these different funds and their track records,
etc.
So the framework is already there.
Senator Harkin. Ms. Lacy, do you have any thoughts on that?
Ms. Lacy. I believe the relief may be a bit more limited
than Mr. Benna is describing. Although there are safe harbors
if you default people into certain types of investments--
lifecycle funds, managed accounts, balanced funds--a plan
sponsor still has the fiduciary obligation to make a prudent
selection of that fund, to monitor it and the costs and all of
those things.
So the safe harbor in this kind of investment is all right,
but you still have all your same obligations for putting people
into them appropriately.
Mr. Benna. May I come back on it? I agree with that. But
one big burden that they do not have, which they now have under
404(c), is providing sufficient information for participants to
make informed investment decisions, and that has proved to be
unworkable. I mean, the reality of trying to turn 50 to 60
million amateurs into professional investors by providing
enough information and education, you commented DOL's efforts
on that model notice are admirable.
But, yes, I agree with you the average participant is going
to look at it and say, ``Hey, I want this.'' Why in the world
wouldn't they take the fund with a 15 percent return? I mean,
it is mission impossible continuing to play that game.
Senator Harkin. Don't you think there could be decent
software that could be developed?
Mr. Benna. Well, it exists. It is there. But the problem is
what has happened and the reason I concluded that it is not
doing the job is that those who need help the most don't
utilize it. The ones that tend to utilize it are the ones that
are already interested and have investment savvy. They will go
out and they will go access that and utilize it to fine-tuning
what they are doing.
The bulk of participants who are clueless about what they
are doing and how they are running won't take the time, don't
have the interest, and still they have to apply it, and they
may or may not apply it properly.
So, yes, it is a useful tool. Definitely the efforts to
expand and make that available should be encouraged, but still
it is not the ultimate answer.
Senator Harkin. Thank you.
Mr. Hunt, I listened to you talk about the role of
bundling. Nothing in our bill would prevent bundling. It just
requires that you disclose the elements of the bundling.
Mr. Hunt. Right, and I think that is fine. But there is a
danger in that some of the larger providers will use certain
things as loss leaders to attract the retirement plan assets.
They may show administrative costs at very small amounts and
tack it on somewhere else. I just think there is a little
danger in there.
Senator Harkin. But if everything was lined up and we knew
every exact fee that was being charged in the bundle, then both
the sponsor would have a better idea and, hopefully, the
participant, too.
Mr. Hunt. If we can do that--and there is also a danger in
some of these companies that have proprietary funds. I think
even just fee disclosure, there may still be some ways to have
other fees in there that really are not going to be known to
some degree. If it is a proprietary fund, there is trading
issues. There is a lot that goes into a lot of this stuff.
Senator Harkin. My time is running out.
Senator Enzi.
Senator Enzi. Thank you, Mr. Chairman.
I do want to thank all our witnesses on this second panel.
It has been very educational, very diverse panel, representing
a cross-section of consumers, small business, and financial
expert opinions. I do have several technical questions that I
will just give to you for a response rather than putting
everybody to sleep in the audience. I have done that before.
Some of the accounting questions don't work very well, but
I will address my first question to Mr. Benna and Mr. Hunt.
While automatic enrollment under the Pension Protection Act has
begun to get more workers saving in their retirement, we are
still lagging on getting small businesses to offer retirement
benefits. What should we be doing to facilitate small
businesses to offer these 401(k) plans?
Mr. Benna.
Mr. Benna. Well, first, they have to want to do it. Reality
is that there are many small businesses that don't have an
interest in offering a retirement plan for a variety of
reasons.
You have to, in my opinion, segregate the small business--I
hate to sound negative in terms of referring to ``mom and pop''
operation. But if we go out around the Capitol here and do a
10-, 20-minute tour, there are many small businesses that are
mom and pop type operations that, for a variety of reasons,
aren't likely to offer retirement plan, in my opinion and
experience, pretty much regardless of what you do, other than
if you picked up all the cost and somebody else paid for it for
them.
That will continue to persist as a problem, in my opinion.
I don't see it going away. I think there have been laudable
efforts made with plans like the SIMPLE plan. It is
unfortunate, in my opinion, that that program hasn't received
more wide support than it has.
I know, Senator, in answering that question, one of the
things--I get small business people who come to me frequently,
and they will say, ``I want to start a 401(k) plan.'' And the
first question I ask them is, ``Well, really? Are you sure? Let
us talk about what is involved, and maybe a SIMPLE or a SEPP or
other type of plan might be a better option for you rather than
a 401(k).''
Continuing to get information out, as some of the
government agencies have and others, showing that there are
other programs out there for small business, and potentially,
they should be getting more attention than what they are.
Coming back to this liability issue for small employers,
that is a concern. If more effort were made to clarify the
facts about the Pension Protection Act, such as, structuring
your plan in a certain way for small business greatly reduces
their liability exposure by going with that structure. I think
that would help if the Department of Labor were to take the
lead on that and clarify in their regulations that that has
broader application than just for default investment
opportunities.
Senator Enzi. Thank you.
Mr. Hunt.
Mr. Hunt. A couple of points. I think litigation is an
issue, but that is not what we really hear is the issue from
the small business owners that we work with. We work with a
number of small business owners on their personal side, and
oftentimes, we will recommend that they have a retirement plan.
I will give you an example. We have a small business owner
that owns a countertop company, has 10 employees. He could put
a large chunk of money away for himself and his employees. Tax
laws would benefit him. His comment to us was, ``My guys would
rather have an extra 20 bucks a week in their paycheck.'' And
that is the mentality that a lot of these small businesses are
dealing with.
Education, I am not sure--for that type of business, I am
not sure that education is going to be the factor. For the
professional businesses, absolutely.
I think the other big issue is cost in the 401(k) world. I
can't quote exactly what the numbers are, but I think the large
company may run $20 to $30 or $40 per participant, mid-sized
company $50 to $60 per participant, and a small business, the
average individual--the fee per individual in that plan runs
over $400. I know in my own business, we have 7 employees, and
my estimated administrative cost for this year are $3,800. We
pay all that for our employees. But that is a big chunk of
money for a lot of small businesses, and that deters them from
the 401(k) world.
As Mr. Benna said, the option of a SIMPLE IRA may be a
better option. But in that situation, now people want to
maximize their retirement plan benefits, they can't put away as
much as they could in a 401(k). So there is a lot of issues
here that--and a lot of it is education.
Like the comment you had on financial literacy because we
have actually launched something called the Millennium
Financial Literacy Series to be able to provide that type of
education, a lifecycle type education, because everybody in a
company is at a different stage in their lifecycle, and where
does it fit in for you?
We are trying to take that by the horns and develop those
types of programs for clients. I think that, as time goes on,
more businesses in my business world will begin to do those
types of things, too.
That is where I think maybe the fee transparency is a help
because it is going to make people in my business need to be
more competitive. From our standpoint, education and financial
literacy is one of the things that helps us become more
competitive.
Senator Enzi. Thank you.
Ms. Lacy, I want to thank you for your comment about the
chart needing to have something about risk factor. That should
be really predominant on our minds these last few weeks. There
are some investments that have high returns, but it is because
they are high risk.
On the fee structure, I am really conflicted about whether
disclosing every single fee and cost would be beneficial,
especially when we can't get individuals to read their
disclosure statements, and those are fairly complicated.
In addition, if we force the disclosure of every single fee
and cost, I assume that someone is going to have to pay for it,
and that most likely will be the employee either through higher
fees or through reduced services. Shouldn't there be a
balancing of competing interests?
Ms. Lacy. Senator, I absolutely agree with you that there
has to be a balancing of the need for more information and
costs that may result from that. And I can tell you there is no
group that is more interested in keeping fees low for
participants than the Pension Rights Center.
You have to effect that balance, and I think there are
important differences in the level of information that
participants need versus plan sponsors. I like the department's
approach in saying you try and come up with something pretty
simple that is disclosed to everyone, and then you allow people
access through the Web, or however they get their information,
to more details to the extent that they want to--there are
individuals who do want to get down in the weeds. So you make
sure the information is available for them.
At the plan sponsor level, there is definitely a need for a
higher level of disclosure, not down to every fee or every cost
certainly, but enough of the information that allows them to
make prudent choices. I mentioned earlier that when you have an
all-in fee, you can miss conflicts of interest in that that
might be revealed with more information.
Particularly important, even if you said that with one fee
you could make a prudent choice initially, my concern is there
is a problem with monitoring over time. And by that, I mean let
us say that a small plan sponsor looked at a number of
different funds and made a choice that was an all-in fee of 50
basis points and 2 or 3 years down the line looked again and
said, ``I am still paying 50 basis points. That seems pretty
reasonable to me after a few years.''
Well, in reality, what has happened is participants are
putting in more money, even if you don't have more
participants, and that is compounding, we hope, in markets
other than this one. And those assets are growing.
So that same 50 basis points is producing a lot more
revenue, but a lot of the services, particularly administrative
services, may not have changed much at all. Still doing the
same reports, all the things that were done before. So you may
have created over time opportunities for profits that didn't
exist at the onset.
Senator Enzi. Thank you.
I have run out of time. So I won't----
Senator Harkin. Ask that last question. I am going to----
Senator Enzi. Well, I was going to get Mr. Benna and Mr.
Hunt's opinion on that as well----
Senator Harkin. Go ahead and ask.
Senator Enzi [continuing]. On being conflicted on
disclosing every single fee.
Mr. Benna.
Mr. Benna. I think the regs, as proposed by Department of
Labor, are a good starting point, the level that they require
disclosure. Clearly, there are a lot of other areas of fees and
transactions that take place that would not be covered by that.
But those become even more difficult and costly to uncover, and
I am not sure what value would be added to that.
I think the proposed regs disclose the vast majority of
fees and are much, much better, obviously, than where we are
currently.
Senator Enzi. Thank you.
Mr. Hunt.
Mr. Hunt. I think the disclosure of fees is a very good
thing. As I mentioned before, there may be some difficulty from
some of the plan providers in actually knowing where these fees
are, exactly what they are disclosing because, I mean, you are
an accountant. You know numbers can be jiggled here and there,
and my fear is that low-cost providers may get the upper hand
when they may not actually be the best choices.
We are actually working in several markets right now where
we are seeing that. I am not going to talk names or particulars
on that. But we are seeing that, and I think it is going to
give us a competitive edge to--I don't know if ``expose'' is
the right word. But to be able to go in and evaluate things and
be able to provide the plan fiduciaries with the right
information that maybe they are not really getting all the
information.
Senator Enzi. I want to thank all of you, and I will submit
some questions, if you would be so kind just to answer them.
Thank you.
Senator Harkin. Thank you very much, Senator Enzi, and I
thank all of you for great testimony and for the written
testimony, but also the verbal testimony.
I ask consent that the record be held open for submissions
for 10 days from both AARP and ASPPA and for their statements
to be included in the record. They have submitted testimony.
[The information referred to may be found in Additional
Material.]
Senator Harkin. Thank you very much. I look forward to your
continued advice and input as we move ahead on this this fall
and probably again in the next year.
Thank you all very, very much. I appreciate it.
The committee will stand adjourned, subject to call of the
Chair.
[Additional material follows.]
ADDITIONAL MATERIAL
Prepared Statement of the American Benefits Council
The American Benefits Council (the Council) welcomes the continued
dialogue regarding disclosure of fees with respect to section 401(k)
plans. The role of section 401(k) plans in providing retirement
security has grown tremendously over the last 25 years and is
continuing to grow. In that light, legislative and regulatory actions
with respect to such plans similarly take on an increased importance.
Applicable legislation and regulations should ensure that these plans
function in such a way as to help participants achieve retirement
security. The Council supports fee transparency as a critical means of
assisting participants in this regard. In the same time, we all must
bear in mind that unnecessary burdens and costs imposed on these plans
will reduce participants' benefits, thus undermining the very purpose
of the plans. In addition, our voluntary retirement plan system depends
on the willingness of employers to maintain plans; excessive burdens on
employers will undercut their commitment to a system that millions of
Americans rely on for their retirement security.
The Council is a public policy organization representing
principally Fortune 500 companies and other organizations that assist
employers of all sizes in providing benefits to employees.
Collectively, the Council's members either sponsor directly or provide
services to retirement and health plans that cover more than 100
million Americans.
The Defined Contribution Fee Disclosure Act of 2007 (S. 2473), as
introduced by Senators Harkin and Kohl, reflects a constructive
dialogue with a broad range of parties in the retirement plan
community. We commend Senators Harkin and Kohl for their openness to
such a dialogue and for including many provisions that would improve
fee transparency without undue burdens. We do, however, have certain
concerns with respect to the bill and look forward to further
discussion on a number of issues, including the following:
Coordination with Department of Labor fee initiatives. The
Department of Labor is near completion of its plan fee disclosure
initiative. One of the three regulations, focused on reporting to the
government from the plan sponsor, has been completed and our members
are working towards compliance. The second of three, focused on
disclosure from the service provider to the plan sponsor, has been sent
in final form from the Department of Labor and is currently at OMB for
clearance. The Department of Labor publicly stated at this committee's
hearing that it is their goal to have this published as a final
regulation in the ``next several months.'' The last of the expected
regulations, participant fee disclosure, has been proposed and the
Department of Labor has stated that it is their goal to have it
published as final by year's end. In its deliberation regarding these
regulations, the Department of Labor received over 92 comments from
representatives of the employee benefits, participant, and service
provider communities. We believe this regulatory approach will best
balance input the Department of Labor received from various interested
parties. We understand that Congress may review the regulations and
conduct oversight of the implementation.
Liability protections. In recent years, there has been
significant growth in lawsuits with respect to defined contribution
plans, giving rise to increased costs and the potential to stunt the
continued growth of defined contribution plans. The bill creates
additional potential liabilities even for companies diligently trying
to comply with all applicable rules. It is important that safe harbors
be added to the bill so that plan fiduciaries and service providers
acting reasonably and in good faith are not subjected to such potential
liabilities.
Unbundling. Although the bill reflects great strides with
respect to the ``unbundling'' issue, more work needs to be done. Where
services are offered only on a bundled basis, disclosure of costs on an
unbundled basis provides information with no commercial significance.
The expenses incurred in generating such disclosures thus do not
generate information that is commercially usable, which is unfortunate
since participants ultimately bear those expenses.
Also, to the extent that bundled charges become, in fact,
unbundled, many more charges will be applied on a per-participant
basis, rather than based on account size. This would result in a
dramatic shift of costs from higher income, high-account balance
employees to lower income, low-account balance employees.
Effective date. It is extremely important that plan
fiduciaries and service providers have sufficient time to modify their
data collection, administrative, and communication systems in order to
comply with the new disclosure requirements. We commend Senators Harkin
and Kohl in this regard; their bill provides that its provisions will
not take effect until at least a year after the Department issues final
regulations implementing the provisions. We have some thoughts as to
how to make the Harkin/Kohl effective date rule work even better, but
we deeply appreciate the Senators' recognition of the critical
transition issue.
We look forward to working on these and other issues as the
legislative process moves forward. We share a common goal with this
committee and with Senators Harkin and Kohl: a vibrant and transparent
defined contribution plan system that delivers meaningful retirement
security at a fair price and without unnecessary costs and liabilities.
Prepared Statement of the American Council of Life Insurers (ACLI)
The American Council of Life Insurers (ACLI) has been an active
participant in the dialogue regarding disclosure of fees with respect
to section 401(k) plans. The role of section 401(k) plans in providing
retirement security has grown tremendously over the last 25 years and
is continuing to grow. In that light, Federal actions with respect to
such plans similarly take on an increased importance and should ensure
that these plans function in such a way as to help participants achieve
retirement security. The ACLI supports fee transparency as a critical
means of assisting participants in this regard. At the same time, we
all must bear in mind that unnecessary burdens and costs imposed on
these plans will reduce participants' benefits, thus undermining the
very purpose of the plans. In addition, our voluntary retirement plan
system depends on the willingness of employers to maintain plans;
excessive burdens on employers will undercut their commitment to a
system that millions of Americans rely on for their retirement
security.
The ACLI represents 373 member companies accounting for 93 percent
of the life insurance industry's total assets in the United States.
Life insurers are among the country's leaders in providing retirement
security to American workers, providing a wide variety of group
annuities and other products, both to achieve competitive returns while
retirement savings are accumulating and to provide guaranteed income
past retirement.
The ACLI would like to recognize Senators Harkin and Kohl for their
interest in this issue by introducing S. 2473, The Defined Contribution
Fee Disclosure Act of 2007. We would also like to recognize the efforts
of the Department of Labor (Department) on its plan fee initiatives to
increase transparency. The Department is near completion of its plan
fee disclosure initiative. One of the three regulations focused on
revisions to the Form 5500 report plan sponsors must file with the
government. The Department's revisions include substantial changes to
the plan fee reporting required on Schedule C. The changes to Schedule
C are effective for the 2009 reporting year and will dramatically
expand and modify the information that is required to be reported about
plan service arrangements.
The second of three, focused on disclosure of service fees by
service providers to the plan sponsors, has been sent in final form
from the Department to the Office of Management and Budget for
clearance. The proposed regulation sets forth new requirements for
determining the reasonableness of compensation paid for services to
employee benefit plans under ERISA. Failure to conform to the rules in
the proposed regulation would result in a prohibited transaction. The
Department publicly stated at this committee's hearing that it is their
goal to have this published as a final regulation in the ``next several
months.''
The last of the expected regulations address new requirements for
the disclosure of plan investment and fee information to participants
and beneficiaries of individual account plans subject to ERISA. Failure
to conform to the rules in the proposed regulation would result in a
breach of the fiduciary's duty to the participants and beneficiaries.
This regulation has been proposed and the Department has stated that it
is their goal to have it published as final by year's end. In its
deliberation regarding these regulations, the Department received over
90 comment letters from representatives of the employee benefits,
participant, and service provider communities. We understand that
Congress may review the regulations and conduct oversight of the
implementation.
We share a common goal with this committee: a vibrant and
transparent defined contribution plan system that delivers meaningful
retirement security at a fair price and without unnecessary costs and
liabilities. We look forward to achieving greater transparency for
participants and plan sponsors as our members work to comply with the
final regulations.
Prepared Statement of the American Society of Pension Professionals &
Actuaries (ASPPA) and the Council of Independent 401(k) Recordkeepers
(CIKR)
The American Society of Pension Professionals & Actuaries (ASPPA)
and the Council of Independent 401(k) Recordkeepers appreciates the
opportunity to submit our comments for the record to the U.S. Senate
Committee on Health, Education, Labor, and Pensions (HELP) on the very
important issue of 401(k) fee disclosure.
ASPPA is a national organization of more than 6,000 retirement plan
professionals who provide consulting and administrative services for
qualified retirement plans covering millions of American workers. ASPPA
members are retirement professionals of all disciplines, including
consultants, administrators, actuaries, accountants and attorneys.
ASPPA's large and broad-based membership gives ASPPA unusual insight
into current practical problems with ERISA and qualified retirement
plans, with a particular focus on the issues faced by small to medium-
sized employers. ASPPA's membership is diverse, but united by a common
dedication to the private retirement plan system.
CIKR is a national organization of 401(k) plan service providers.
CIKR members are unique in that they are primarily in the business of
providing retirement plan services as compared to larger financial
services companies that primarily are in the business of selling
investments and investment products. As a consequence, the independent
members of CIKR, many of whom are small businesses, make available to
plan sponsors and participants a wide variety of investment
alternatives from various financial services companies without bias or
inherent conflicts of interest. By focusing their businesses on
efficient retirement plan operations and innovative plan sponsor and
participant services, CIKR members are a significant and important
segment of the retirement plan service provider marketplace.
Collectively, the members of CIKR provide services to approximately
70,000 plans covering three million participants holding in excess of
$130 billion in assets.
background
ASPPA and CIKR strongly support the Senate HELP Committee's
interest in examining issues relating to 401(k) fee disclosure and the
impact of fees on a plan participant's ability to save adequately for
retirement. We are encouraged by the introduction of legislation by
Congress on this issue. In particular, on December 13, 2007, Senate
Special Committee on Aging Chairman Herb Kohl (D-WI) and Tom Harkin (D-
IA) introduced S. 2473, the ``Defined Contribution Fee Disclosure Act
of 2007,'' in addition to the two 401(k) fee disclosure bills
previously introduced in the House of Representatives in 2007:
(1) H.R. 3185, the ``Fair Disclosure for Retirement Savings
Security Act,'' sponsored by House Education and Labor Chairman George
Miller (D-MA) and passed out of the full committee on April 16, 2008;
and
(2) H.R. 3765, the ``Defined Contribution of Plan Fee Transparency
Act,'' introduced on October 4, 2007 and sponsored by House Ways and
Means Committee Subcommittee on Select Revenue Measures Chairman
Richard Neal (D-MA) and cosponsored by Rep. John Larson (D-CT).
We support all three bills' even-handed application of new
disclosure rules to all 401(k) plan service providers and encourage the
Senate HELP Committee to take the same path towards uniform disclosure
requirements. Further, we also encourage you to strike the right
balance between disclosure information appropriate for plan sponsors
versus plan participants. To demonstrate how both of these goals can be
accomplished, we have attached to these comments two sample fee
disclosure forms for your consideration--one for plan fiduciaries and
another for plan participants. Each is tailored to provide plan
fiduciaries and plan participants with the different sets of
information on fees that are needed to make informed decisions.
As you know, the Department of Labor (DOL) currently has one final
and two ongoing 401(k) fee disclosure projects: (1) A revised Form
5500, including a revised Schedule C, which is now finalized and
effective beginning on January 1, 2009; (2) a proposed ERISA
Sec. 408(b)(2) regulation, which provides sweeping changes on what
constitutes a reasonable contract or arrangement between service
providers and plan fiduciaries; and (3) a proposed ERISA Sec. 404(a)
regulation setting forth a complex set of new participant fee
disclosure requirements. The DOL has publicly announced that they plan
to have both the 408(b)(2) regulation and the participant fee
disclosure regulations finalized by the end of 2008, with effective
dates projected for sometime in 2009.
ASPPA and CIKR submitted comprehensive comment letters to the DOL
on both the 408(b)(2) and participant fee disclosure proposed
regulations.\1\ In both of these comment letters, we recommended an
extension of the proposed effective date(s) because of the significant
implementation and compliance issues/costs involved, made a number of
significant recommendations to improve each of the disclosure regimes
in order to ensure that understandable and meaningful disclosure is
provided, and stressed the need for uniform disclosure requirements--
among all types of service providers.
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\1\ We note that House Education and Labor Committee Chairman
George Miller (D-CA), Senate HELP Committee Chairman Kennedy (D-MA),
Special Aging Committee Chairman Herb Kohl (D-WI), Senate HELP
Committee Member Tom Harkin (D-IA) and House Education and Labor
Subcommittee Chairman Rob Andrews (D-NJ) also submitted joint comment
letters to the DOL on both the 408(b)(2) regulation and participant fee
disclosure regulation. These comments expressed concerns about the
DOL's approach to these disclosure initiatives and requested additional
actions be taken to protect plan participant and beneficiaries.
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ASPPA and CIKR strongly support the premise that plans and plan
participants should be provided all the information they need about
fees and expenses in their 401(k) plans--in a form that is clear,
uniform and useful--to make informed decisions about how to invest
their retirement savings plan contributions. This information is
critical to millions of Americans' ability to invest in a way that will
maximize their retirement savings so that they can achieve adequate
retirement income. We support your efforts to craft legislation that
will accomplish this goal.
plan sponsor 401(k) fee disclosure--need for uniform requirements
The 401(k) plan industry delivers investments and services to plan
sponsors and their participants using two primary business models--
commonly known as ``bundled'' and ``unbundled.'' Generally, bundled
providers are large financial services companies whose primary business
is selling investments. They ``bundle'' their proprietary investment
products with affiliate-provided plan services into a package that is
sold to plan sponsors. By contrast, ``unbundled,'' or independent,
providers are primarily in the business of offering retirement plan
services. They will couple such services with a ``universe'' of
unaffiliated, non-proprietary, investment alternatives. Generally, the
costs of the bundled and unbundled arrangements are comparable or even
slightly less in the unbundled arrangement. Under current business
practices, bundled providers disclose the cost of the investments to
the plan sponsor but do not break out the cost of the administrative
services. Unbundled providers, however, disclose both, since the costs
are paid to different providers (i.e., administrative costs paid to the
independent provider and investment management costs paid to the
managers of the unaffiliated investment alternatives).
Bundled and unbundled providers have different business models, but
for any plan sponsor choosing a plan, the selection process is exactly
the same. The plan sponsor deals with just one vendor, and one model is
just as simple as the other.
Plan sponsors must follow prudent practices and procedures when
they are evaluating service providers and investment options. This
prudent evaluation should include an ``apples to apples'' comparison of
services provided and the costs associated with those services. The
only way to determine whether a fee for a service is reasonable is to
compare it to a competitor's fee for that service.
The retirement security of employees is completely dependent upon
the business owner's choice of retirement plan service providers. If
the fees are unnecessarily high, the workers' retirement income will be
severely impacted. It is imperative that the business owner have the
best information to make the best choice.
While the DOL's proposed ERISA Sec. 408(b)(2) rules (relating to
whether a contract or arrangement is reasonable between a service
provider and plan fiduciary) would require enhanced disclosures for
service providers to 401(k) plan fiduciaries, the proposed regulation
would require only an aggregate disclosure of compensation and fees
from bundled service providers, with narrow exceptions, and would not
require a separate, uniform disclosure of the fees attributable to each
part of the bundled service arrangement. While we appreciate the DOL's
interest in addressing fee disclosure, we do not believe that any
requirement that benefits a specific business model is in the best
interests of plan sponsors and participants.
Without uniform disclosure, plan sponsors will have to choose
between a single price business model and a fully disclosed business
model that will not permit them to appropriately evaluate competing
provider's services and fees. Knowing only the total cost will not
allow plan sponsors to evaluate whether certain plan services are
sensible and reasonably priced and whether certain service providers
are being overpaid for the services they are rendering.
In addition, if the breakdown of fees is not disclosed, plan
sponsors will not be able to evaluate the reasonableness of fees as
participant account balances grow. Take a $1 million plan serviced by a
bundled provider that is only required to disclose a total fee of 125
basis points, or $12,500. If that plan grows to $2 million, the fee
doubles to $25,000, although the level of plan services and the costs
of providing such services have generally remained the same.
The bundled providers want to be exempt from adhering to uniform
disclosure rules and regulations. Simply put, they want to be able to
tell plan sponsors that they can offer retirement plan services for
free while independents are required to disclose the fees for the same
services. Of course there is no ``free lunch,'' and there is no such
thing as a free 401(k) plan. In reality, the costs of these ``free''
plan services are being shifted to participants through the investment
management fees charged on the proprietary investment alternatives, in
many cases without their knowledge.
The uniform disclosure of fees is the only way that plan sponsors
can effectively evaluate the retirement plan they will offer to their
workers. To show it can be done, attached is a sample of how a uniform,
plan sponsor disclosure would look. By breaking down plan fees into
only three simple categories--investment management, recordkeeping and
administration, and selling costs and advisory fees--we believe plan
sponsors will have the information they need to satisfy their ERISA
duties.
plan participant 401(k) fee disclosure--need for uniform
and understandable requirements
The level of detail in the information needed by 401(k) plan
participants differs considerably than from that needed by plan
fiduciaries. Plan participants need clear and complete information on
the investment choices available to them through their 401(k) plan, and
other factors that will affect their account balance. In particular,
participants who self-direct their 401(k) investments must be able to
view and understand the investment performance and fee information
charged directly to their 401(k) accounts in order to evaluate the
investments offered by the plan and decide whether they want to engage
in certain plan transactions.
The disclosure of investment fee information is particularly
important because of the significant impact these fees have on the
adequacy of the participant's retirement savings.
In this regard, studies have shown that costs related to the
investments account for between roughly 87 percent and 99 percent of
the total costs borne by participant accounts, depending on the number
of participants and amount of assets in a plan.\2\
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\2\ 2007 edition of the 401 (k) Averages Book, published by HR
Investment Consultants.
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ASPPA and CIKR urge that any new disclosure requirements to plan
participants also be uniform, regardless of whether the service
provider is bundled or unbundled. On July 23, 2008, the DOL issued
proposed regulations on participant fee disclosure that required the
annual disclosure to plan participants and beneficiaries of identifying
information, performance data, benchmarks and fee and expense
information in a comparative chart format, plus additional information
upon request. The proposed regulation further required an initial and
annual explanation of fees and expenses for plan administrative
services to plan participants and beneficiaries (disclosed on a
percentage basis) except to the extent included in investment-related
expenses.
The effect of this exception will be to highlight administrative
costs for one business model (unbundled) over another (bundled), which
would result in a disparity of treatment and confusion.
In most plans, the administrative costs of recordkeeping,
reporting, disclosure and compliance are borne, at least to some
extent, by the investments. For bundled providers, the entire
administrative cost is generally covered by investment-related fees
charged on proprietary investments. For an unbundled provider, however,
those costs are often paid through revenue sharing received from
unrelated investments, which, in many instances, is not sufficient to
offset the entire cost. Accordingly, for unbundled providers, there
would be a direct administrative charge assessed against participants'
accounts.
In effect, the DOL's requirement to disclose administrative
expenses except to the extent included in investment-related expenses
would impose an additional and burdensome disclosure requirement on
unbundled service providers, whereas there would be no such disclosure
in the case of a bundled service provider. This would be misleading to
most plan participants. In only the unbundled case would participants
see separate administrative costs charged against his or her account,
while with bundled providers, participants would be given the
impression there were no administrative costs at all as the
administrative costs would be imbedded in the investment costs.
Accordingly, as the Senate HELP Committee considers any legislation
in this area, ASPPA and CIKR recommend that the disclosure of
administrative and investment information be provided on a uniform
basis. We believe that administrative fee information provided on the
same annualized basis as investment costs would provide participants a
more complete picture of the total costs of the plan at a single time,
regardless of the business model of a service provider.
It is important to recognize that there is a cost to any
disclosure, and that cost is most often borne by the plan participants
themselves. To incur costs of disclosure of information that will not
be relevant to most participants will unnecessarily depress the
participants' ability to accumulate retirement savings within their
401(k) plans. Thus, appropriate disclosure must be cost-effective, too.
The result of mandatory disclosure should be the provision of all the
information the plan participant needs, and no more. To require
otherwise would unjustifiably, through increased costs, reduce
participants' retirement savings. Those participants who want to delve
further into the mechanics and mathematics of the fees associated with
their investment choices and other potential account fees should have
the absolute right to request additional information--it should be
readily available on a Web site, or upon participant request. This will
take care of those participants who feel they need more detailed
information.
For the committee's consideration, ASPPA and CIKR have attached a
sample fee menu to the testimony that we believe would contain, in a
clear and simple format, all the information a plan participant would
need to make informed decisions about his or her plan. It is consistent
with the recommendations ASPPA and CIKR provided to the DOL on July 20,
2007 (in response to their request for information regarding fee and
expense to disclosures in individual account plans) and on September 8,
2008 in a joint comment letter on the recent participant fee disclosure
regulations.\3\
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\3\ ASPPA and CIKR have also submitted the sample participant fee
disclosure form to the House Education and Labor Committee (October 4,
2007), the Senate Special Committee on Aging (October 24, 2007) and the
House Ways and Means Committee (November 1, 2007).
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summary
The retirement system in our country is the best in the world, and
competition has fostered innovations in investments and service
delivery. However, important changes are still needed to ensure that
the retirement system in America remains robust and effective into the
future. By enabling competition, and supporting plan sponsors through
uniform disclosure of fees and services, American workers will have a
better chance at building retirement assets and living the American
dream.
ASPPA and CIKR applaud the Senate HELP Committee's leadership in
exploring issues related to 401(k) plan fee disclosure. The committee's
consistent focus on retirement issues over the years has advanced
improvements in the employer-
sponsored pension system and led to an increased concern about the
retirement security of our Nation's workers. ASPPA looks forward to
working with Congress and the Administration on ensuring that both plan
fiduciaries and participants receive complete and consistent 401(k)
plan fee disclosures from all plan service providers.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
______
Fund Democracy Consumer Federation of America,
September 22, 2008.
Hon. Edward M. Kennedy, Chairman,
Hon. Michael B. Enzi, Ranking Member,
U.S. Senate,
Committee on Health, Education, Labor, and Pensions,
Washington, DC 20210.
Re: 401(k) Fee Disclosure
Dear Chairman Kennedy and Ranking Member Enzi: We are writing on
behalf of Fund Democracy and the Consumer Federation of America to
supplement the record of the committee's recent hearing, 401(k) Fee
Disclosure: Helping Workers Save for Retirement. We have responded
previously to the Department of Labor's request for comments on 401(k)
fee disclosure (Professor Bullard also has testified on this issue
before the Senate Aging Committee) and would like to share our views
with the committee as well. We believe that significant fee disclosure
reform for 401(k) plans can substantially reduce overall plan expenses
for beneficiaries and strengthen the foundation of Americans' financial
security in retirement.
A primary goal of 401(k) regulation should be to ensure that
Americans experience as much of the performance of the markets as
possible.\1\ Excessive investment expenses present one of the most
significant impediments to the achievement of this goal. Fees paid by
401(k) beneficiaries directly reduce their investment returns and, as a
result, their financial security in retirement. Of course, excessive
regulatory compliance costs can also reduce investment returns. For
that reason, fee disclosure reforms should be designed so that they
generate a net benefit to 401(k) participants. We believe that
transparent, standardized fee disclosure can create substantial net
benefits for 401(k) beneficiaries by raising fee awareness among
beneficiaries and increasing competition among industry participants.
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\1\ For convenience, we refer to ``401(k) regulation,'' ``401(k)
participants,'' and ``401(k) plans,'' although our comments generally
apply to all types of participant-directed plans. In addition, we use
mutual funds as examples of 401(k) investment options because they are
the most common type of investment option used in 401(k) plans.
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The most important principle for fashioning good fee disclosure is
to ensure that it is designed, not with the self-directed, fee-
sensitive investor in mind, but rather to increase awareness of fees
and their impact on investment returns among those retirement plan
beneficiaries who do not currently demonstrate fee-sensitivity. To be
effective in reaching these beneficiaries with meaningful information,
disclosures must provide them with the information they need, in a form
they can understand, and at a time when it is useful to them in making
and assessing their investment decisions. Current disclosure practice
fails all these standards. With that in mind, we believe that 401(k)
fee disclosure should satisfy the following standards:
Delivery Vehicles: Require inclusion of a fee table
(described on p. 57) in the plan summary for all investment options
available through the plan and require fee disclosures in account
statements for each investment option in which the beneficiary is
invested.
Content: Require disclosure of hypothetical fees paid on a
$1,000 investment, total expense ratios for the investment, and average
expense ratios for comparable investment vehicles, with separate
disclosure of additional (non-expense-ratio) expenses as applicable.
Fee Table: The plan summary fee table should show: expense
ratios for the investment option, total plan expenses for each
investment option; the dollar amount of expenses paid by a hypothetical
$1,000 account; and comparative expense ratios (see Exhibit A).
Additional Expenses: Require disclosure of expenses that
are not included in the plan expense ratio immediately below the fee
table in the plan summary (see Exhibit A).
Comparative Fee Information: Require disclosure in the fee
table of average industry expense ratios for: each investment option
and the plan in toto (see Exhibit A).
Format: The fee table and other disclosures should be
designed in consultation with disclosure experts to ensure that they
effectively convey the key information in a way that is both readable
and readily understandable by typical beneficiaries.
Differential Compensation: If differential compensation is
allowed for those who advise retirement plan beneficiaries, which we
recommend against, require separate disclosure of differential
compensation paid to advisers prior to the retention of an adviser, at
the time of each recommendation of an investment option in connection
with which differential compensation is received, and annually as long
as the relationship with the adviser continues.
As noted, we have previously provided the Department with general
guidance regarding 401(k) and, earlier this month, comments on the
Department's disclosure proposal. We have attached the latter comments
to this letter at Exhibit B. In short, while we congratulate the
Department on making significant progress toward an effective,
efficient disclosure model, we believe that its proposal does not
satisfy the foregoing principles in significant respects and can be
greatly improved. We hope that any legislation similarly follows the
foregoing disclosure principles.
background
The importance of 401(k) plan fees needs no detailed elaboration
here. As noted by the GAO, 401(k) plan fees ``can significantly
decrease retirement savings over time.'' \2\ For example, the GAO
estimates that paying an additional 1 percentage point in fees will
reduce an account's ending balance after 20 years by 17 percent.\3\
Mutual fund fees have a substantial impact on total 401(k) plan fees
because the bulk of 401(k) plan assets are invested in mutual funds. As
noted by the SEC, ``[t]he focus on fund fees is important because they
can have a dramatic impact on an investor's return.'' \4\ The GAO's and
SEC's observations regarding fees apply equally to other 401(k)
investment vehicles.
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\2\ Private Pensions: Increased Reliance on 401(k) Plans Calls for
Better Information on Fees, Government Accountability Office at 10
(Mar. 6, 2007).
\3\ Id.
\4\ Report of Mutual Fund Fees and Expenses, SEC Division of
Investment Management at Part IA (Dec. 2000).
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The Department recently estimated the amount by which inefficient
disclosure inflates 401(k) fees. It found a wide dispersion in 401(k)
fees that it attributes ``to market inefficiencies'' \5\ and
estimates--``conservatively''--that ``plan participants on average pay
fees that are higher than necessary by 11.3 basis points per year.''
\6\ One form of market inefficiency is the confusing way in which
401(k) fees are currently disclosed. We strongly agree with the
Department's expectation that its fee disclosure proposal will ``result
in the payment of lower fees for many participants. . . . as more fee
transparency fosters more price competition in the market.'' \7\
However, as noted above we believe that the Department needs to make
several improvements to its current proposal in order to maximize fee
reductions that can be realized through truly transparent, coherent
disclosure.
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\5\ Fiduciary Requirements for Disclosure in Participant-Directed
Individual Account Plans, Employee Benefits Security Administration,
Department of Labor 73 F.R. 43013, 43020 (July 23, 2008) (``DoL
proposal'') (citing Investment Company Institute, The Economics of
Providing 401(k) Plans: Services, Fees, and Expenses (2006)).
\6\ Id.
\7\ Id. (citing James J. Choi, David I. Laibson, and Brigitte C.
Madrian, ``Why Does the Law of One Price Fail? An Experiment on Index
Mutual Funds,'' NBER Working Paper W12261 (May 2006) (finding ``that
presenting the participants with a comparison fee chart, and not just a
prospectus, reduced the fees paid by 12 percent to 49 percent depending
on the group studied'')).
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The amount of fees charged by a 401(k) investment option within any
particular investment category is arguably the strongest predictor of
its investment performance. For example, researchers have demonstrated
the inherent unpredictability of mutual fund returns, with funds
generally being no more likely, from one quarter to the next, to repeat
top-quartile performance and to fall into the second, third or fourth
tier. To the extent that a small minority of fund managers outperform
the markets over the long-term, there is no evidence that
professionals, much less amateurs, can identify those managers a
priori. Unlike past investment performance, fees are highly predictable
and represent a certain reduction in fund's performance. Thus, within
any given asset class, fees arguably constitute the most important
factor in the evaluation of different 401(k) investment options.
fee-insensitive investors
The purpose of fee disclosure is not to provide the minimum
information necessary to enable diligent, fee-sensitive investors to
evaluate the cost of investing in their 401(k) plan, but rather to draw
the attention of all investors to the importance of fees. The purpose
of 401(k) fee disclosure reform should be to provide beneficiaries who
are not currently sufficiently sensitive to the effect of fees on the
performance of their 401(k) accounts the information they need to raise
their awareness of these important issues.\8\
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\8\ Jonathan Clements, Wall St. J. at D1 (July 18, 2007) (citing
Morningstar finding that 13 percent of stock fund assets are invested
in fund charging more than 1.5 percent annually and 24 percent of bond
fund assets are invested in funds charging more than 1 percent
annually).
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Recent research conducted by CFA and assisted by Fund Democracy
indicates that a large percentage of those who invest through workplace
retirement plans are not sensitive to fees.\9\ In a recent survey on
mutual fund purchase practices, only 51 percent of those respondents
who purchased most of their funds through a workplace retirement plan
said they considered fees even somewhat important.\10\ Furthermore,
workplace purchasers were the least fee-sensitive of the three purchase
groups identified by the survey.\11\ This likely reflects in part the
fact that workplace purchasers typically make their fund selections
from a fairly narrow menu of options. However, the relative lack of
investing experience and financial sophistication among workplace
purchasers almost certainly also play a role.\12\
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\9\ Mutual Fund Purchase Practices, an analysis of survey results
by Barbara Roper and Stephen Brobeck, Consumer Federation of America,
June 2006.
\10\ Id. Thirty percent said fees were a very important factor in
their fund selection, while 21 percent indicated fees were somewhat
important. In contrast, 70 percent indicated fund company reputation
was at least somewhat important, while 68 percent rated past
performance as at least somewhat important.
\11\ Id. The other groups were direct purchasers and those who
purchased most of their funds through a financial professional outside
a retirement plan.
\12\ Id. Just 12 percent rate themselves as very knowledgeable
about mutual funds, while nearly a third (32 percent) rate themselves
as knowing only a little. They also tend to be somewhat younger and
less educated than other mutual fund purchasers, and to have held
mutual fund investments for a shorter period of time, particularly when
compared with those who purchased most of their funds directly from a
fund company or through a discount broker or fund supermarket.
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This general lack of investing sophistication is compounded by the
fact that the financial media, financial advertisements and the
structure of disclosure requirements consistently overemphasize the
importance of past performance and underemphasize the significance of
fees. The financial media's focus on ``The Best Funds for 2007'' as
determined by their short-term investment performance sends exactly the
wrong message regarding the factors that investors should consider when
evaluating investment options. Financial advertisements focus almost
solely on past investment performance, which has little predictive
power, to the exclusion of fees, the impact of which is significant,
relatively certain and quantifiable. Fee disclosure presents fees
almost exclusively as a percentage of assets, which structurally
minimizes the true significance of fees in the overall picture of an
investor's portfolio. The effects can be seen in the fact that 68
percent of workplace purchasers in the CFA survey indicated that a
fund's past performance was at least somewhat important to their
selection, with 38 percent indicating it was very important--a far
higher percentage than considered fees to be even somewhat
important.\13\
---------------------------------------------------------------------------
\13\ Id.
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For this reason, we believe it is essential that fee disclosure be
designed to counter the misleading message that investors generally
receive regarding the relative importance of fees. To benefit fee-
insensitive investors, fee disclosure must be based on a ``push''
principle that measures the efficacy of disclosure by its success in
promoting competition and efficiency. To accomplish this, fee
disclosure for 401(k) plans should be crafted not only to make fee
information available, but also to affirmatively direct beneficiaries'
attention to fees and to do so in a way that helps them understand
those fees and the effect they have on investment returns. In short,
fee disclosure should be designed to overcome investors' predilection
for overemphasizing past investment performance and discounting fees
when making investment decisions. Investors' insensitivity to fees
represents a market failure for which fee disclosure (rather than price
regulation) offers the most cost-effective solution.
delivery vehicles
The delivery vehicles used for fee disclosure play a crucial role
in determining whether those disclosures are effective in directing
fee-insensitive investors to consider fees when making investment
decisions. Yet one of the most significant shortcomings of fee
disclosure has been the reliance on investor-unfriendly delivery
vehicles. Fees for 401(k) plan administration (i.e., plan-level fees,
as apart from fees charged by investment options) are required to be
disclosed only in Form 5500, where the fees are disclosed as a dollar
amount, in contrast with the presentation of fees as a percentage of
assets for most investment options. The Form 5500 is not required to be
provided to beneficiaries, but is delivered only upon request.
In the mutual fund context, fund expenses are described in the
prospectus and the dollar amount of expenses for a hypothetical fund
account are provided in the annual report. Employers generally provide
plan participants with the prospectus or a document that contains the
fee information in the prospectus,\14\ but they do not provide the
annual report or the hypothetical fee information, and neither fund
documents or any documents provided by employers provide fee
information about comparable investment options. Thus, basic fee
information for each investment option are not provided in the same
place as plan-level fees, no hypothetical or comparative fee
information is provided at all, and no information is provided that is
specific to a beneficiary's account. Investor-specific information is
contained only in the quarterly statement. The latter document is
generally the document that investors read, whereas fund prospectuses
and plan summaries are likely to be summarily discarded with little or
no review.
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\14\ As discussed further below, although fund expense ratios are
standardized, they sometimes are not comparable because expenses that
appear in the fund expense ratio for some funds may be excluded from
the fund expense ratio for others (e.g., transfer agency expenses may
appear either in the fund expense ratio or in plan-level expenses).
Expense ratios for non-mutual-fund investment options generally are not
even standardized.
---------------------------------------------------------------------------
Reliance on these delivery vehicles assumes that investors are
proactive and fee sensitive. The prospectus and Form 5500 require
401(k) beneficiaries to request information, calculate their total
fees, and seek out comparative data on their own to put their total
fees in context. One witness before the Department's Advisory Group
suggested that, by combining Form 5500 and prospectus fee disclosure, a
401(k) beneficiary ``should be able to readily calculate the aggregate
fees that reduce the value of his or her account.'' \15\ The witness
concluded that 401(k) fees are ``currently disclosed to participants in
sufficient detail to allow participants to evaluate the costs they pay
against the services they receive.'' \16\
---------------------------------------------------------------------------
\15\ Report of the Working Group on Fee and Related Disclosures to
Participants, Advisory Council on Employee Welfare and Pension Benefit
Plans at n.4 (2004) (Advisory Report) (quoting testimony of John
Kimpel, Sr. Vice President and Deputy General Counsel, Fidelity
Investments). Actually, the fee dollar amounts in the Form 5500 would
have to be converted to a percentage of assets and then added to the
investment option's asset-based fees.
\16\ Id.
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We disagree. Few investors, and certainly not fee-insensitive
investors, will make the effort to ``calculate'' fees in the manner
described above. As we have noted previously, they simply do not place
sufficient emphasis on fees in the first place. In addition, according
to the CFA survey, most workplace mutual fund purchasers are unlikely
to make use of the written information sources available to them. Just
over 4 in 10 (43 percent), for example, rated the prospectus as even
somewhat influential on their investment purchases, with only 19
percent rating it as very influential.
To change the behavior of fee-sensitive beneficiaries, fees must be
presented in a document beneficiaries are likely to read, they must be
presented in a standardized format, and they must be presented in a
manner that makes it easy for beneficiaries to understand how they
compare to fees charged by comparable plans and investment options. In
keeping with this approach, we urge the Department to use the delivery
vehicle most likely to be read by beneficiaries--the account
statement--for disclosure of fee and other important information.
Investors are most interested in monitoring the value and performance
of their account and, secondarily, confirming recent account activity.
The account statement therefore provides the ideal vehicle through
which to direct beneficiaries' attention to their 401(k) plans' fees.
Account statements, however, provide information after the
investment selection has been made. To provide beneficiaries with pre-
investment fee disclosures, we also urge the Department to require that
such disclosures be provided in a short document that summarizes the
plans' essential features. Such plan summaries should be required to be
presented to all employees who are eligible to participate in the plan.
Like the account statement disclosures described above, these
disclosures should also provide information that enables beneficiaries
to easily determine how those fees compare to fees for comparable plans
and investment options.
Finally, we strongly recommend that the Department encourage the
use of the Internet and electronic communications as one appropriate
delivery vehicle for fee information. The Internet and electronic
communications offer the opportunity both to enhance fee disclosure for
beneficiaries and to reduce plan expenses. For increasing numbers of
investors, the Internet and e-mail constitute their primary information
source and communication tool. According to the CFA survey, for
example, nearly all workplace investors (91 percent) have access to the
Internet, and the vast majority (87 percent) expressed a willingness to
use the Internet for at least some mutual fund purchase-related
activities.
At a minimum, all fee disclosure requirements should be required to
be made on or should be easily accessible from employer web pages.
Where delivery is required, e-mail, including especially employer
intranets, should be mandated as a delivery option investors can choose
to use. In appropriate circumstances, such as when an employee has
affirmatively decided to use either medium to obtain and receive
information, Internet posting and delivery by e-mail should be deemed
sufficient to satisfy legal delivery requirements.
form of disclosure
Disclosure of 401(k) fees should be provided in two forms. As noted
above, 401(k) fees should be disclosed on beneficiaries' account
statements, in order to ensure that they take fees into account when
evaluating their 401(k) plans, and in a plan summary document, to
ensure that beneficiaries are made aware of fees when they make their
initial investment selections.
Account Statement Disclosure. The 401(k) plan document that
investors are most likely to review is their account statement, and the
Department therefore should require that account statements include
401(k) fee disclosure. The GAO recommended, for example, that the SEC
require mutual funds to disclose in shareholders' account statements
the dollar amount of fees paid during the period covered.\17\ The SEC
decided instead to require the disclosure of the dollar amount of fees
charged on a hypothetical account in the annual report.\18\ Although
there are reasonable arguments regarding the relative costs and
benefits of disclosing fees paid on a hypothetical account and actual
fees, we believe there is no reasonable argument that fee disclosure is
materially improved by including this information in the annual report
instead of the account statement. It is simply unrealistic to believe
that fee-insensitive investors read the annual report, much less find
and study fee information that might be disclosed there. We commend the
Department for proposing to require the disclosure of fees in dollar
amounts and that this disclosure appear in quarterly statements, but we
believe that this disclosure will be misleading if it does not reflect
the total cost of investing in the plan.
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\17\ See Mutual Funds: Information on Trends in Fees and Their
Related Disclosure, Government Accountability Office (March 12, 2003).
\18\ See Shareholder Reports and Quarterly Portfolio Disclosure of
Registered Management Investment Companies, Investment Company Act Rel.
No. 26372 (Feb. 27, 2004).
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Ideally, 401(k) fee disclosure would require that the following
information appear in account statements: the fees paid on a
hypothetical $1,000 account as a dollar amount, fees paid as a
percentage of assets, and comparative fees for comparable plans and
investments. Although disclosure of actual fees paid by beneficiaries
is more likely to be understood by beneficiaries than hypothetical
fees, we recognize that, at this stage in the development of fee
disclosure for different collective investment vehicles (mutual funds
and guaranteed investment contracts), requiring disclosure of
hypothetical expenses may be the best solution. However, we believe
that any solution should move current practices toward a disclosure
system under which investors are told the dollar amount of fees they
actually have paid.
The disclosure of the dollar amount of fees is of particular value
because beneficiaries are more accustomed to thinking about expenses in
dollars rather than percentages. Fee-insensitive beneficiaries are more
likely to take notice of disclosure that looks more like a common bill
for services than a mathematical calculation. A limitation of both
dollar amount and percentage fee disclosures is that they mean little
or nothing without a comparative context in which to place them. We
therefore recommend that account statements also include comparative
expense information (as described below) for each investment option.
This information will help put the dollar amount of expenses in context
and provide a basis for beneficiaries to consider whether the fees that
they are paying are worth the price.
Standardized Fee Disclosure. Fee disclosure for 401(k) plans should
be provided in the plan summary document and standardized to facilitate
comparisons across different investment options within the 401(k) plans
and to expenses in other comparable plans. To some extent,
standardization of investment option fees already exists. For example,
mutual funds are required to use a standardized format for their
expenses ratios and other expenses. However, other investment options
use non-standardized fee disclosure, which prevents investors from
comparing the true cost of different investment options. The goal of
standardization is further frustrated by the fact that payments for
services sometimes occur at the investment option level and sometimes
at the plan level. For example, 401(k) plans that invest in a retail
class of mutual fund shares often pay lower plan expenses, because the
mutual fund rebates part of its fees to the plan administrator to cover
those expenses. If the mutual fund's fees are compared to investment
options that do not use such a rebate structure, the mutual fund's fees
will appear higher. An accurate fee comparison can be made only when
the plan's total fees are considered.
There are a number of potential solutions to the standardization
challenge. One solution would be to impose fee disclosure requirements
on non-mutual-fund investment options that are similar to those for
mutual funds. Such standardization is clearly in the best interests of
beneficiaries. However, a variety of agencies have primary
responsibility for fee disclosure for non-mutual-fund collective
investment vehicles, and it is appropriate that these agencies' rules
govern disclosure of fees charged by these investment vehicles. Until
these agencies' rules can be brought into alignment, this is probably
not a realistic approach. We encourage the committee to develop a
framework under which different agencies will work toward establishing
standardized fee disclosure for 401(k) investment options.
Another potential solution would be to require the disclosure of
401(k) fees on a functional basis. For example, fees for transfer
agency functions could be identified separately, which would permit
comparisons of these fees across different plans regardless of whether
the fees were collected by the plan administrator, or by a mutual fund
and then rebated to the plan administrator. We believe that, at this
stage, such functional fee disclosure could be administratively
burdensome and excessively costly, and would be unlikely to greatly
benefit plan beneficiaries. Fees generally are not disclosed on a
functional basis under existing legal rules for collective investment
vehicles or for 401(k) plans, and the cost of designing and
implementing new systems to provide functional disclosure might not be
justified. In any case, it is not clear that functional fee disclosure
as a general matter is a cost-effective disclosure approach, and it can
be misleading.\19\
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\19\ For example, one of the problems with mutual fund 12b-1 fees,
which purport to reflect the use of mutual fund assets for distribution
services, is that investors in funds that do not charge 12b-1 may
actually pay just as much for distribution services as investors in
12b-1 fee funds. It can be extremely difficult to define precisely the
different types of services for purposes of functional disclosure of
fees.
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We believe that the best immediate solution to the problem of
standardizing 401(k) fees is to present each fee component in the
context the plan's total fees. Toward this end, we recommend that
standardization of 401(k) fees be accomplished through the use of a fee
table (including a fee example) and a list of additional expenses as
described below.\20\
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\20\ The overall structure of this approach is similar to fee
disclosure for mutual funds, which includes an expense ratio, a list of
other expenses, and a dollar-amount fee illustration.
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Fee Table. As illustrated in Exhibit A, the fee table would include
three categories of data for each investment option. These are: the
investment option expense ratio,\21\ total plan fees (including both
the investment fees and the plan-level fees) as a percentage of assets,
and the dollar amount of fees on a hypothetical account. For each
category, a comparative expense figure would also be included. This
approach has the advantage of permitting easy comparison of different
investment options when the investment options' expense ratios are
comparable, such as for mutual funds, and when they are not. The total
expense ratio figure would not only provide a total cost figure, it
would also help address the problem of non-comparable investment fee
information. Where easily comparable fee information of the type
provided by mutual funds is not available,\22\ it would indirectly
indicate the relative cost of different investment options, because the
plan-level expenses for each option generally could be assumed to be
relatively constant. Assuming that plan-level expenses are comparable
across different investment options, to the extent that the total
expense ratio for different investment options differed, the difference
generally would be attributable to the cost of the investment options.
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\21\ The Department has specifically noted a significant failing of
the mutual fund expense ratio in its omission of portfolio transaction
costs, which can equal many multiples of a fund's other expenses. See
DoL Proposal at n.13; see also Jason Karceski, Miles Livingston and
Edward O'Neal, Portfolio Transaction Costs at U.S. Equity Mutual Funds
(2004), available at http://www.zeroalphagroup.com/news/
Execution_CostsPaper_Nov_15_2004.pdf. Although the SEC has requested
comments on ways to address this omission, it has yet to take final
action. See Request for Comments on Measures to Improve Disclosure of
Mutual Fund Transaction Costs, Investment Company Act Rel. No. 26313
(Dec. 18, 2003). We hope that the Department, the SEC and other
regulators will work together to ensure that the mutual fund expense
ratio and the expense ratio of other investment options include all of
the relative costs of investing.
\22\ As noted supra note 14, although fund expense ratios are
standardized, they sometimes are not comparable because expenses that
appear in the fund expense ratio for some funds may be excluded from
the fund expense ratio for others (e.g., transfer agency expenses may
appear either in the fund expense ratio or in plan-level expenses).
This distinction is partly responsible for the recent flurry of
excessive fee cases brought against employers in connection with their
401(k) plans.
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Additional Expenses. By making expenses charged through asset-based
fees more visible, this approach may create an incentive to shift costs
to other forms. To minimize any such cost-shifting designed to avoid
disclosure, the Department should require that additional disclosures
be provided along with the fee table listing expenses that are not
included in the expense ratio table but that may be incurred directly
or indirectly by beneficiaries. These expenses would include, for
example, purchase and redemption fees, minimum account charges, and
non-asset-based sales charges. These expenses should be presented as a
percentage of assets or a dollar amount, depending on the basis on
which they are deducted, with explanations as appropriate.
One disadvantage of the foregoing approach is that it may not fully
remove the incentive to shift expenses, in this case from the expense
ratio to the additional expenses category. For example, a 401(k)
provider could reduce the plan's expense ratio by replacing an asset-
based transfer agency fee with a flat fee for each account. This
strategy would have the effect of artificially reducing the expense
ratio, on the assumption that investors would pay less attention to the
concomitant increase in the expenses listed in the additional expenses
table. The problem of expenses being shifted out of the expense ratio
could be addressed by requiring that beneficiaries' account statements
disclose, either as a dollar amount or a percentage of assets, the
expenses incurred during the period that were not included in the
expense ratio. Where such expenses were deducted, the disclosure would
be disclosed in three parts: the expense ratio, the additional expenses
calculated as an expense ratio, and the sum of the two.
conflicts of interest and differential compensation
One of the most difficult challenges presented by fee disclosure is
the need to apprise investors of the conflicts of interests that fees
can create. Advisers to 401(k) beneficiaries are permitted, subject to
their fiduciary duty to their clients, to receive compensation from
sponsors of products that the adviser recommends (``distribution
compensation''). In limited circumstances, distribution compensation
can be higher for one product than another, which creates a conflict
between the interests of the adviser and the 401(k) beneficiary, as the
adviser has an economic incentive to recommend the product that pays
him the greatest compensation, even if it is not the best product for
the beneficiary. The cleanest and best way to deal with such conflicts,
in our view, is to eliminate them, by prohibiting all differential
compensation to advisers of 401(k) plan beneficiaries. Absent such a
ban, fee disclosure for 401(k) plans should inform beneficiaries of the
existence of any conflict of interest created by differential
compensation so that they can evaluate the objectivity and quality of
the advice provided. We note that the Department's proposal is most
deficient in this respect because it includes no provisions that
address the issue of differential compensation.
Distribution compensation generally is paid out of other fees that
already will have been disclosed to beneficiaries. This means that
disclosure of the amount of distribution compensation is not needed to
inform investors about the total cost of investing (although it would
tell them how their fees were allocated among different services).
Rather, disclosure of the existence and extent of the conflict is
needed to inform beneficiaries about advisers' financial
incentives.\23\
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\23\ See Confirmation Requirements and Point of Sale Disclosure
Requirements for Transactions in Certain Mutual Funds and Other
Securities, and Other Confirmation Requirement Amendments, and
Amendments to the Registration Form for Mutual Funds, Investment
Company Act Rel. No. 26341, at Part II (Jan. 29, 2004) (explaining
conflicts of interest necessitating requirement for point-of-sale of
distribution compensation disclosure). There is no indication that
final action on this four-year-old proposal is imminent.
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Advisers should be required to disclose prominently the extent to
which their compensation may vary based on the investment options
selected by the beneficiary. In order to qualify as ``prominent,'' the
disclosure should be in a separate document, e-mail message or web
page. The disclosure must be provided separately because otherwise it
is likely to be confused with fee disclosure that is designed to
highlight the costs of investing, rather than the economic incentives
of the adviser.\24\ The disclosure should focus on the amount of the
adviser's differential compensation in order to permit the beneficiary
to evaluate the objectivity of the adviser's recommendations.
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\24\ See Investment Advisers Act Rule 206(4)-3 (requiring
disclosure of solicitor's capacity and compensation in a separate
document).
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Moreover, differential compensation disclosure should be provided
before the beneficiary makes the decision to retain the adviser so that
the beneficiary can evaluate the adviser's services before soliciting
recommendations. After the beneficiary has retained the adviser and
received the adviser's recommendations, the opportunity to evaluate the
wisdom of retaining that adviser will have passed. In this respect, the
Department should require that, in addition to disclosure made prior to
the retention of the adviser, the adviser specifically disclose any
differential compensation received in connection with the recommended
investments at the time that the recommendation is made. Finally, the
Department should require that periodic reminders be provided to
beneficiaries as long as differential compensation payments continue.
Some may argue that disclosure of differential compensation is too
costly and complex. Advisers who choose to create the conflict of
interest that differential compensation disclosure would address should
not be allowed, however, to avoid disclosure of differential
compensation because of the complexity and disclosure costs they are
responsible for creating. If, for example, a mutual fund charged dozens
of different fees that depended on an investor's particular situation,
the fund's sponsor should not be heard to complain that the cost of fee
disclosure far exceeded its benefits. In short, the cost of fee
disclosure should be viewed not as a reason to permit conflicts of
interest to be concealed, but as a natural market constraint on
inefficient pricing practices. To the extent that investors reject
complex fee structures, such as differential compensation arrangements,
when they are fully disclosed, fee disclosure should be viewed as
having operated successfully by promoting informed investor choice,
competition and efficiency.\25\
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\25\ Although the speciousness of arguments that fee disclosure is
too costly due to its complexity is most applicable to differential
compensation arrangements, it is not limited to such arrangements. The
same analysis applies to all types of complex fee arrangements, such as
the use of different types of account and activity charges that are in
addition to a fund's expense ratio and plan expenses as disclosed in
the Form 5500.
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comparative fee information
As noted above, we believe it is critical that the disclosure of
401(k) fees be accompanied by comparative fee information. The
disclosure of fees accomplishes little when it is presented in a
vacuum, because few investors can readily assess whether the fees
charged are high or low relative to the services provided or the fees
charged by comparable investments. Mutual fund investment performance
information is required to be compared to the performance of a
comparable market index, because regulations recognize the importance
of putting performance in context, but funds are not required to do the
same for fees. Providing comparative fee information makes even more
sense than providing comparative investment performance information,
because past fees (unlike past performance) are strongly predictive of
future fees. Furthermore, fee comparisons are more valid than
performance comparisons, because fees of different 401(k) plans
generally will be more comparable than investment performance across
different investment options.
Putting fee information in context by providing comparative
information is important for a number of reasons. First, comparative
information would promote competition among investment option providers
and place downward pressure on fees. Second, comparative information
would enable beneficiaries to evaluate the costs and benefits of
investing in the 401(k) plan relative to other taxable and tax-
deferred investment options.\26\ Third, fiduciaries' interests may
conflict with benefi-
ciaries' with respect to the negotiation of 401(k) fees, since
fiduciaries may be able to lower the administrative costs paid by the
employer by shifting them onto plan beneficiaries in the form of asset-
based fees.
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\26\ In theory, comparative disclosure would enable employees to
compare employers based on the relative qualities of their 401(k)
plans. We believe that this potential benefit is secondary to the
benefits of promoting competition among investment option providers and
facilitating an informed comparison of 401(k) and non-401(k) investment
options.
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Investment Option Fees. Without the context of comparative fee
disclosure, the disclosure of an investment option's expense ratio is
of limited utility. This information conveys the fact that an
investment option and the plan are not free, but virtually all
beneficiaries already know this.\27\ Standing alone, the fees provide
little basis for evaluating whether they are reasonable in light of the
services provided. The disclosure of comparative fee information would
provide beneficiaries with a general sense of whether an investment
option is more or less expensive than its peers and increase the
likelihood that beneficiaries will think about whether above-average-
cost options are worth the price. Also, providing average cost
information for comparable investments should increase the likelihood
that beneficiaries will make appropriate cost comparisons--comparing a
bond fund's fees to average bond fund fees rather than to fees for an
actively managed stock fund, for example--rather than simply comparing
costs among various investment options with very different cost
characteristics and choosing the cheapest option.
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\27\ Although fee information may disabuse some beneficiaries of
the misimpression that their employer pays all of the costs of a 401(k)
plan, we are not aware of any evidence that a material number of
employees hold this view.
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Providing comparative fee information to beneficiaries would
promote competition among investment option providers for several
reasons. First, providing this information should help incentivize
employers, who are primarily responsible for the selection of
investment options, to choose a plan with lower investment costs.
Second, many 401(k) plans offer multiple investment options with
overlapping asset or style categories. In this context, beneficiaries'
investment decisions constitute a secondary marketplace (the plan
itself) within which investment option providers compete for assets.
This marketplace is recreated in every plan with multiple investment
options, which has the effect of combining the market power of
investment decisions by beneficiaries across many plans. Even if
fiduciaries fail to populate plans with low-cost investment options,
beneficiaries will tend to move assets to lower cost providers, if the
comparative cost of different options is prominently disclosed. Such
intra-plan dynamics will promote competition and place downward
pressure on fees.
Plan Fees. Second, even when a plan does not offer overlapping
investment options, and comparative fee information therefore does not
facilitate the comparison of different options,\28\ comparative fee
information would enable beneficiaries to make informed comparisons
between 401(k) and non-401(k) investment vehicles. The axiom that
employees should ``max out their 401(k)'' before investing elsewhere is
no longer always valid advice,\29\ because employees will sometimes be
able to experience superior long-term, after-tax investment returns in
other contexts. The proliferation of tax-deferred investment vehicles,
many of which are designed, like 401(k) plans, for retirement planning,
has provided numerous investment alternatives that offer tax advantages
that are comparable to those offered by 401(k) plans. The historically
low level of capital gains taxes relative to income taxes means that
capital gains in 401(k) plans are taxed at higher income rates when
distributed than are capital gains in taxable accounts when they are
distributed.\30\ Tax-managed funds, index funds and exchange-traded
funds employ strategies that minimize taxes, thereby substantially
minimizing their tax disadvantage relative to 401(k) plans. Thus, non-
401(k) tax-advantaged investment vehicles, lower capital gains rates,
and tax-minimizing investment vehicles mean that an employee may
sometimes be better off investing outside of a high-cost 401(k) plan.
Fee disclosure for 401(k) plans should facilitate fee comparisons with
non-401(k) investment vehicles.
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\28\ In this context, comparative fee information would allow
beneficiaries to appreciate that, for example, an international stock
fund charged higher fees than a domestic stock fund, but we believe
that the comparison among different investment categories should be
based on beneficiaries' overall investment objectives, not their
relative expenses. Comparisons of fees for investment options with
different investment objectives may mislead beneficiaries by confusing
the primary basis on which comparisons across different options should
be made, which is one of the shortcomings of the Department's current
proposal. Comparisons between actively and passively managed investment
options, however, would yield significant benefits, and the committee
certainly should consider mandating such comparisons.
\29\ In contrast, the related axiom that employees should always
``max out their 401(k) match'' (i.e., fully exploit matching employer
contributions) still holds.
\30\ To some extent, this taxable account advantage is reduced
because capital gains taxes are paid on an ongoing basis, whereas
income taxes on 401(k) capital gains are not paid until distributions
from the account are made. We encourage the committee to consider
legislation that has been proposed that would permit the deferral of
taxation of capital gain distributions by mutual funds that are re-
invested in the funds. The taxation of re-invested distributions
penalizes investors who choose to diversify their investments through
mutual funds.
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Potential Conflicts of Interest. It is important that comparative
fee information be placed in the hands of beneficiaries, as their
interests may not be aligned with those of the fiduciaries who choose
investment options for plans and negotiate administrative agreements.
Beneficiaries may have a stronger economic incentive than fiduciaries
to reduce fees, because it is often beneficiaries who pay them. In some
cases, beneficiaries' and fiduciaries' interests can conflict.
Fiduciaries may have an incentive to choose high-cost investment
options as a means of shifting expenses from the employer to the
beneficiaries. Plan fiduciaries therefore may be conflicted, because
they have an incentive to reduce plan expenses (i.e., expenses incurred
by their employer) in return for accepting higher investment option
expenses. Plan fiduciaries also may wish to be perceived as having
successfully negotiated a low-cost administrative contract, or may
simply be unaware of the trade-off between higher cost investment
options and lower cost administrative services. Although fiduciaries
generally will be more financially sophisticated than the average
beneficiary, this is not always the case. Ultimately, beneficiaries
have stronger economic incentives to uncover such tradeoffs. It takes
only a single, activist beneficiary, armed with the appropriate
information, to bring these issues to the attention of plan
fiduciaries.
Form of Comparative Fee Information. Comparative fee information
should be provided in the fee table for each investment option. The
comparative expense ratio row should show average expense ratios for
the investment option, and for total expenses, including investment and
plan-level expenses charged as a percentage of assets (see Exhibit A).
These data should be presented in a manner that ensures that they are
easily distinguishable from, and readily comparable to, the plan's
actual expense ratios. The Department should consider whether
additional comparative information should be provided, such as the
amount of the difference between each average expense ratio and the
actual expense ratio or a graphic illustration of each investment
option's expenses relative to the average. In making such decisions,
about both content and format, the Department should consult with
disclosure experts to help design disclosures that maximize
beneficiaries' ability to understand key fee information.
Employers should be permitted to use a variety of sources for
comparative data, provided that the information is provided by an
independent third party. It may be necessary, however, to establish
guidelines regarding what constitutes appropriate comparative data for
different types of investment. Employers also should be permitted to
use average plan-level expense ratios that reflect the size of the
plan, subject to appropriate guidelines.
cost issues
As to the issue of which parties should bear the cost of providing
fee information, we believe that the allocation of disclosure costs
generally should be left to the marketplace. Each of the three
principal providers of information to 401(k) beneficiaries--employers,
plan administrators and investment option sponsors--has sufficient
negotiating power to ensure that markets work efficiently to find the
optimal allocation of costs among the different parties. For example,
we recommend that beneficiaries' quarterly statements include uniform
dollar fee disclosure, which would require the calculation of the
dollar amount of fees that would have been paid by a hypothetical
$1,000 account. If the annual cost of producing that information were
$1.00 for the investment option sponsor, $1.05 for the administrator,
and $1.10 for the employer, then we would expect the cost ultimately to
be allocated to the investment option sponsor as the lowest-cost
provider. Formally ``allocating'' the cost to the administrator, for
example, would simply result in the administrator's paying the
investment option sponsor to provide the information at lower cost,
with the only economic difference being the added cost of negotiating
the transfer of this responsibility from the administrator to the
investment option sponsor.
Thus, allocating costs by rule will not change the ultimate
allocation of costs, but it can be expected to increase total costs to
the extent that the rule does not choose the most efficient information
provider. In a competitive 401(k) market, all costs ultimately will be
borne by the lowest-cost provider, because structures that allocate
costs to higher-cost providers will lose market share to more
efficient, lower-cost competitors.
Another aspect of cost allocation is the allocation of costs across
different employers. The greatest risk of implementing new fee
disclosure requirements is that they will increase the cost of 401(k)
plans for small employers to the point that they will choose not to
offer the plan at all. We urge the committee to be sensitive to these
relative cost burdens for small plans and to seek ways to minimize
them, including by identifying disclosure and other requirements that
could be modified or eliminated in order to reduce 401(k) expenses.
Finally, some have questioned the relative costs and benefits of
fee disclosure reform. As discussed at page 3 supra, we agree with the
Department that fee disclosure stands to generate billions of dollars
in savings for investors. Although we recognize that the economic
analysis of the benefits of fee disclosure reform lacks scientific
precision, the Department's findings are consistent with the widely
accepted economic principle that price transparency promotes
competition and reduces expenses. There is substantial evidence that
investors are not sufficiently price sensitive, and we believe that
enhanced price transparency, price standardization and comparative
information will provide a powerful stimulus toward lowering the
overall cost of investing by increasing price sensitivity. The steady
migration of mutual fund investors to lower-cost mutual funds is
partly, if not substantially, attributable to the high level of fee
transparency mandated by the securities laws. We believe that fee
disclosure reform will generate substantial net economic benefits to
401(k) participants.
conclusion
Investment expenses represent a significant drag on the performance
of 401(k) accounts that can be substantially mitigated through well-
designed fee disclosure requirements. Although it is possible for an
enterprising beneficiary to determine the total cost of his or her
401(k) plan's investment options and to find comparative fee
information to place those costs in context, it requires enormous
effort that only a tiny number of beneficiaries are likely to make. Fee
disclosure reform is premised on the failure of many beneficiaries to
be sufficiently sensitive to the impact of fees on their investment
returns. Fee disclosure should therefore be designed to proactively
direct fee-insensitive beneficiaries' attention to fees in order to
stimulate competitive market forces and thereby reduce beneficiaries'
expenses. We strongly encourage the committee to embrace the
opportunity that efficient, proactive 401(k) fee disclosure reform
offers as a means to enhance the retirement security of tens of
millions of Americans.
Sincerely,
Mercer Bullard,
President and Founder,
Fund Democracy, Inc.
Barbara Roper,
Director of Investor Protection,
Consumer Federation of America.
EXHIBIT A
Fee Table
------------------------------------------------------------------------
Total Illustrative
Fund Plan Annual Fee
Investment Option Expenses Expenses Paid on
[In [In $1,000
percent] percent] Balance
------------------------------------------------------------------------
Stock Fund............................ 0.80 1.00 $10.00
Industry Average...................... 0.70 0.88 $8.80
Bond Fund............................. 0.50 0.70 $7.00
Industry Average...................... 0.45 0.63 $6.30
Balanced Fund......................... 0.65 0.85 $8.50
Industry Average...................... 0.60 0.78 $7.80
------------------------------------------------------------------------
Additional Expenses: Small Account Fee--$2.50/quarter; Redemption Fee--
1.00 percent.
EXHIBIT B
Fund Democracy Consumer Federation of America,
September 8, 2008.
Office of Regulations and Interpretations,
Employee Benefits Security Administration,
Room N-5655,
Department of Labor,
200 Constitution Avenue,
Washington, DC 20210.
Re: Participant Fee Disclosure Project
Dear Ms. Halliday: We are writing on behalf of Fund Democracy and
the Consumer Federation of America in response to the Department's
request for comments on its proposed regulation on the disclosure of
fee and other information for beneficiaries of participant-directed
individual account plans (``401(k) plan participants''). Like the
Department, we believe that fee disclosure reform for 401(k) plans can
substantially reduce overall plan expenses for beneficiaries and
strengthen the foundation of Americans' financial security in
retirement.
In an earlier comment letter, we set forth the principles that
should guide the disclosure of 401(k) fees,\31\ and the Department's
proposal substantially reflects key elements of those principles. For
example, the Department proposes to require that all fees appear in a
standardized, tabular format, which will be a significant improvement
over fee disclosure for non-standardized investment options and the
disclosure of plan expenses. The Department also proposes to require
the disclosure of certain fees as a dollar amount and that this
disclosure appear in participants' quarterly account statements. We
applaud the Department for taking decisive steps to direct the
attention of fee-insensitive participants to the impact of fees in a
document that they are likely to read and in a way that is likely to
draw their attention to the fees. As a whole, the proposal makes
significant progress in increasing the transparency of 401(k) fees,
promoting greater competition in the 401(k) marketplace, and,
ultimately, helping to secure Americans' financial security in
retirement.
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\31\ See Letter from Mercer Bullard, Founder and President, Fund
Democracy, and Barbara Roper, Director of Investor Protection, Consumer
Federation of America to Office of Regulations and Interpretations,
Employee Benefits Security Administration, Department of Labor (July
24, 2007) available at http://www.funddemocracy.com/
401k%20fee%20letter%20final.pdf.
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In some respects, however, we believe that the Department's
proposal can be improved. Our principal recommendations are as follows:
Total Fee Disclosure: Investment option fees and
administrative fees should be disclosed together in order that plan
participants can evaluate the total cost of the 401(k) plan.
Revenue Sharing: Fee disclosure should avoid misleading
participants by suggesting false comparisons between investment option
fees that include administrative fees (i.e., that compensate plan
administrators through revenue sharing) and investment option fees that
do not.
Comparative Fees: Comparative fee information should be
disclosed across comparable asset classes in order to promote
competition among service providers.
Quarterly Statement Disclosure: The disclosure in the
quarterly statement of fees in dollar amounts should reflect total plan
fees paid by the participant and clearly segregate fees that are
specific to the participant.
Differential Compensation: In order to fully apprise
participants of the adviser's potential conflicts of interest, fee
disclosure should include a prominent description of any compensation
received by an adviser in connection with providing advisory services
to a participant that may vary based on the participants' decisions
with respect to the plan.
We look forward to working with the Department toward a final
proposal that will provide the 401(k) plan participants with the kind
of fee disclosure that will help them receive as much of the
performance of the market as possible and thereby achieve financial
security after their retirement.
background
As noted, we previously provided comments to the Department
regarding 401(k) fee disclosure. Rather than re-state these comments,
we incorporate them by reference in this letter. To summarize, we have
listed below the key policies that we believe 401(k) fee disclosure
should promote:
Fee Insensitive Participants: Fee disclosure should target
401(k) participants who are less likely to be sensitive to the impact
of fees on their investment returns by locating disclosure where fee
insensitive participants are likely to review it and in a format that
such participants are likely to understand.
Total Fee Disclosure: Fee disclosure should clearly
present the total cost of the plan in one place so as to facilitate
comparisons and promote sensitivity to the true impact of fees on
participants' investment returns.
Comparative Information: Fee disclosure should promote
competition by providing or at least facilitating comparisons across
products and services both at the investment option and plan levels.
Differential Compensation: If differential compensation is
allowed for those who advise 401(k) participants, then fee disclosure
should include specific information as to the amount of and trigger for
such compensation paid to advisers: (1) at or before the initiation of
the relationship with the adviser, (2) at the time of each
recommendation of an investment option in connection with which
differential compensation is received, and (3) annually as long as the
relationship with the adviser continues.
Like the Department, we believe that fees can have a significant
impact on a 401(k) participant's account balance at retirement and that
improving fee disclosure can help reduce fees. We especially appreciate
the Department's unequivocal position on the relationship between fee
disclosure and excessive fees. The Department found a wide dispersion
in 401(k) fees that it attributes ``to market inefficiencies'' \32\ and
estimates--``conservatively''--that ``plan participants on average pay
fees that are higher than necessary by 11.3 basis points per year.''
\33\ One form of market inefficiency is the confusing way in which
401(k) fees are currently disclosed. We strongly agree with the
Department's expectation that its fee disclosure proposal will ``result
in the payment of lower fees for many participants. . . . as more fee
transparency fosters more price competition in the market.'' \34\
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\32\ Text accompanying note 11 (citing Investment Company
Institute, The Economics of Providing 401(k) Plans: Services, Fees, and
Expenses (2006)).
\33\ Text accompanying note 13.
\34\ Text accompanying notes 14-15 (citing James J. Choi, David I.
Laibson, and Brigitte C. Madrian, ``Why Does the Law of One Price Fail?
An Experiment on Index Mutual Funds,'' NBER Working Paper W12261 (May
2006) (finding ``that presenting the participants with a comparison fee
chart, and not just a prospectus, reduced the fees paid by 12 percent
to 49 percent depending on the group studied'')).
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fee table
The clearest example of how fee disclosure creates market
inefficiencies is the current practice of providing investment option
fees and plan fees in separate locations, and providing plan fees in a
format that is difficult to understand or use for comparison purposes.
Plan fees currently are required to be disclosed only in Form 5500 as a
dollar amount on a plan-wide basis. Mutual fund fees (when they are the
investment option) are disclosed in a fee table in the prospectus as a
percentage of assets. Providing fee disclosure in the prospectus and
Form 5500 makes it impracticable for participants to determine the
total cost of their 401(k) plans. They cannot even compare fees of
investment options because there is no standardized set of rules that
applies across all types of investment options. Further, fees for
certain services are included in investment option fees in some cases
and in plan fees in others.
The Department's proposal to require disclosure of standardized
fees for all investment options in a single fee table represents
significant progress toward fee disclosure that will promote
competition and reduce fees paid by 401(k) participants. The proposal
will enable participants to compare the costs of different investment
options and make a more informed investment decision. This will, in
turn, promote competition among investment option providers and reduce
fees. For example, participants will be able to compare easily the cost
of an actively managed U.S. stock fund with the cost of a passively
managed U.S. stock fund (if offered) and thereby make an informed
decision as to which form of management provides a better value.
Similarly, the proposed disclosure for plan fees will constitute a
significant improvement over the Form 5500.
We are concerned, however, that the fee disclosure will be
deficient--and even misleading--in important respects. One drawback of
the proposal is that the investment option fees and plan fees would
continue to be presented separately. We appreciate that it is important
to encourage participants to compare the cost of different investment
options within a 401(k) plan, but the separate presentation of
investment option fees and plan fees effectively discourages the
comparison of 401(k) fees with fees charged by other types of
investment accounts. We recognize that, at one time, it would have been
rare for an investor to be better off investing outside of their 401(k)
plan, but changes in tax laws, the proliferation of tax-deferred
investment vehicles, and the availability of low-cost mutual funds have
created an environment in which many participants may be better off
foregoing a high-cost 401(k) plan (although probably never to the
extent of an employer matching contribution, if offered).\35\
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\35\ See Testimony of Mercer Bullard before the Senate Special
Committee on Aging at 7-8 (Oct. 24, 2007) (chart showing larger balance
after 20 years in taxable account than in 401(k) account) available at
http://www.funddemocracy.com/Senate%20Aging%20Testimony%2010.24.07.pdf.
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We believe that the Department should design fee disclosure that
facilitates not only comparisons within the plan, but also comparisons
with investment options outside of the plan. Fee disclosure for 401(k)
plans should show all of the costs of the plan in a single table that
provides a total expense ratio for each option, including
administrative expenses. Presenting the investment option fees and
administrative fee separately will make it unlikely if not
impracticable for participants to evaluate the total cost of the plan
and compare it with non-plan investment options.
Another drawback of the proposal is that it encourages comparisons
among investment options that are not truly comparable. The
Department's Model Comparative Chart shows the fees for a Large Cap,
International Stock and Mid Cap ETF option stacked one above the other
in a single column. This is a false and potentially harmful comparison.
Historically, large cap funds have been less expensive to operate than
mid cap funds, which have been less expensive to operate than
international funds. The Chart creates the impression that the
international fund is more expensive relative to the others and this
factor should count as a strike against it,\36\ even if the
international fund's fees were lower than the average for an
international fund and the fees for the other two funds were above
average relative to their peers. Thus, the investor might be inclined
to choose the most expensive funds (relative to their class) while also
failing to gain the benefit of diversification that investing in all
three asset classes would provide. Most financial planners recommend
that clients diversify their investments among different asset classes
notwithstanding that this will mean paying higher fees for certain
types of investments. The point of fee transparency is not to promote
competition among different asset classes, but among providers of
product offerings within a single asset class.
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\36\ The actual Chart does not do this because the illustrative fee
amounts are unrepresentative. The Large Cap fee is 2.45 percent and the
International fee is 0.79 percent. The Mid Cap fee is only 0.20
percent, probably because it is actually a passively managed fund (as
of the date of the Department's proposal virtually all ETFs were
passively managed).
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The appropriate fee comparison for the Large Cap fund would be fees
charged by the average Large Cap fund or the average offered by 401(k)
plans. This information would apprise participants of the cost of the
Large Cap fund offered by the plan relative to its peers and promote
competition among Large Cap funds and plan sponsors to provide lower
cost alternatives. We recognize that there is no universally accepted
standard for determining the appropriate average fee to use as the
benchmark for a particular type of fund, but it should not be difficult
to generate one. The fund management industry cannot credibly complain,
as it has in the past, that an objective classification standard would
be too difficult to implement or understand when it willingly
identifies funds as belonging in particular asset classes and other
categories for marketing purposes, a practice that certainly implies
that funds have an objective basis for doing so. Third-party
information providers such as Morningstar and Lipper also have provided
comparative fee information on funds in the same asset classes that
fund boards use to satisfy their fiduciary duty to ensure that fund
fees are reasonable. The data are available; there is no excuse for not
providing it to 401(k) participants.
As illustrated by our proposed fee table at Exhibit A to this
letter, 401(k) fee disclosure should provide participants with direct
comparisons to similar types of funds. The classifications for
different types of funds exist. It only remains for the Department to
require that plans use this information in a way that will shine a
spotlight on investment options whose fees significantly exceed a
reasonable average. It is frankly remarkable that regulators require
that the performance of a benchmark investment be disclosed with the
presentation of an investment option's investment performance, while
not requiring the same type of disclosure for fees. Studies have
consistently shown that past mutual fund investment performance has a
weak (if any) relationship to future performance, whereas fees and
their impact are, obviously, very predictable from year to year.
Requiring disclosure of benchmark fees would actually provide
participants with meaningful information with which to make investment
decisions and, we believe, have a profound impact on competition. In
contrast, the most appropriate accompaniment for 1-year investment
performance data generally would not be the performance of a benchmark,
but rather a statement that the information reveals nothing about the
relative merits of the investment.
A third drawback of the proposal is that participants, particularly
fee-insensitive participants, will be inclined to assume that the fees
that they see in one location reflect the total fees they will incur.
If they review the investment option fee disclosure, they will tend to
assume that those fees represent the total cost of the plan, and vice
versa for those who review the administrative fee disclosure. This is
not such an unreasonable assumption, for it seems counterintuitive to
provide the fees for a single 401(k) plan in two parts in two separate
locations. The Department has noted that the ``lack of transparent fee
disclosure in this market suggests . . . that individuals may
underestimate the impact that fees and expenses can have on their
account balances.'' \37\ The separate disclosure of investment option
fees and administrative fees will often cause participants to
underestimate the total cost of the plan. We believe that it is
imperative that the total fees for a 401(k) plan be presented in a
single location.
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\37\ Text accompanying note 11.
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A final drawback of the proposal is that it does not account for
the different ways in which fees are charged by different plans. Fees
for certain services may be charged at either the investment option
level or the plan level. Specifically, certain administrative fees such
as those charged for recordkeeping, accounting and legal services can
be collected by the plan's third party administrator (``TPA'') or by
the investment option. When the fee is collected by the investment
option and the services are actually provided by the TPA, the
investment option remits the fees to the TPA. This practice is commonly
referred to as ``revenue sharing.'' When the administrative fees are
charged at the investment option level, they will appear in the
investment option fee disclosure and make the investment option fees
seem higher and the plan fees lower. When they are charged at the plan
level, they will appear in the plan fee disclosure and make the plan
level fees seem higher and the investment option fees lower.
This diversity of practice has the potential to create confusion
among participants who compare the investment option fees to investment
options in other 401(k) plans or to investments in other types of tax-
deferred and taxable accounts. The Department's proposal does nothing
to resolve that confusion. When the 401(k) plan investment option fees
do not include administrative expenses that are paid to the TPA, then
the 401(k) plan investment option fee will be artificially suppressed
and seem lower, in comparison, than it actually is because the
disclosure of the 401(k) plan's administrative fees will be provided in
a separate location. If all expenses were combined in one place, as
illustrated in Exhibit A to this letter, the true total cost of the
401(k) plan option would be transparent and provide a meaningful
comparison.
quarterly statements
We also agree with the Department's decision to require the
disclosure of fees in dollars in the quarterly statement, as opposed to
disclosure only as a percentage of assets and only in plan documents.
The primary target of 401(k) fee disclosure should be participants who
are less sensitive to the impact of fees on their 401(k) accounts.
These fee-insensitive participants are less likely to review plan
documents for the purpose of evaluating fees charged to their accounts,
and they are less likely to appreciate the impact of fees expressed as
a (small) percentage of assets. These participants are more likely to
review their quarterly statements, and they are more likely to take
note of fees expressed as a dollar amount, especially when presented in
the context of the dollar value of the participant's account. To
illustrate, a 2 percent fee might seem insignificant to a less savvy
401(k) participant, but the presentation of a quarterly fee of $500 on
an account with a $100,000 balance is likely to increase the likelihood
that the participant will consider whether their fees could be reduced
by switching to another fund in the 401(k) plan or choosing a lower
cost investment in a taxable account.
We are concerned, however, that the quarterly statement disclosure
will be misleading because it will not show the participant's total
fees. As discussed above, participants will be inclined to assume that
the fees disclosed in their quarterly statement reflect all of the fees
they paid for the quarter. In fact, unless the proposal is amended, the
quarterly disclosure will not show the investment option fees and will
further understate total fees when fees for administrative services
provided by the TPA are charged at the investment option level.
Quarterly statement fee disclosure should show the participant's total
fees. As noted in our previous comment letter, this disclosure need not
necessarily show the actual dollar amount paid by the participant (we
recognize the potential expense of such disclosure), but rather could
reflect a rough estimation based on the account's beginning, ending or
average account size. The goal here is not the precision of the
disclosure, but rather the dollar format and the prominent location.
Even an estimate will provide more accurate information than the
partial information proposed to be disclosed.
Another difficulty is that the fee disclosure in the quarterly
statement will be inconsistent across different plans. As discussed
above, certain administrative services can be charged at either the
investment option level or the plan level. This means that the fees
disclosed in the quarterly statement for one participant may include
fees for these services, whereas the fees disclosed on his neighbor's
quarterly statement might not and would appear (artificially) lower.
Further confusion may be created by the mixing of participant-
specific expenses with plan administrative expenses. The Department
proposes that the ``amounts actually assessed'' for individual
expenses, such as expenses attendant to a qualified domestic relations
order, a loan to a beneficiary or investment advisory services be
disclosed, and permits such disclosure to be provided ``in a quarterly
benefit statement.'' We believe that it would be extremely confusing
for the dollar amount of administrative (or total plan expenses, as
discussed above) to be combined with the dollar amount of individual
expenses as an aggregate number. Based on the wording of paragraphs
(c)(2)(ii) and (c)(3)(ii) of rule 404a-5, we assume that the Department
does not intend to permit such combining of these expenses and suggest
that it clarify this position to avoid any doubt.
However, even if the dollar amounts for administrative (total) and
individual expenses are presented separately, as the rule seems to
require, we are concerned that participants might not appreciate the
important differences between the two types of expenses. We recommend
that the Department require that administrative (total) expenses be
presented in the quarterly statement in a way that makes it clear that
the former are plan expenses and that the latter are expenses incurred
on account of individual services provided to the beneficiary.\38\ We
believe that similar explanatory disclosure should be provided where
information about the individual expenses that might be assessed is
disclosed at the time of the beneficiary's eligibility and annually
thereafter pursuant to paragraph (c)(3)(i).
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\38\ We agree that it is not necessary or cost-effective to ``have
administrative charges broken out and listed on a service-by-service
basis.'' See Part B.2.
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conflicts of interest and differential compensation
One of the most difficult challenges presented by fee disclosure is
the need to apprise investors of the conflicts of interests that fees
can create. Advisers to 401(k) beneficiaries are permitted, subject to
their fiduciary duty to their clients, to receive compensation from
sponsors of products that the adviser recommends (``distribution
compensation''). In limited circumstances, distribution compensation
can be higher for one product than another, which creates a conflict
between the interests of the adviser and the 401(k) beneficiary, as the
adviser has an economic incentive to recommend the product that pays
him or her the greatest compensation, even if it is not the best
product for the beneficiary. The cleanest and best way to deal with
such conflicts, in our view, is to eliminate them, by prohibiting all
differential compensation to advisers of 401(k) plan beneficiaries.
Absent such a ban, fee disclosure for 401(k) plans should inform
beneficiaries of the existence of any conflict of interest created by
differential compensation so that they can evaluate the objectivity of
the advice provided.
Distribution compensation generally is paid out of other fees that
already will have been disclosed to beneficiaries. This means that
disclosure of the amount of distribution compensation is not needed to
inform investors about the total cost of investing (although it would
tell them how their fees were allocated among different services).
Rather, disclosure of the existence and extent of the conflict is
needed to inform beneficiaries about advisers' financial
incentives.\39\
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\39\ See Confirmation Requirements and Point of Sale Disclosure
Requirements for Transactions in Certain Mutual Funds and Other
Securities, and Other Confirmation Requirement Amendments, and
Amendments to the Registration Form for Mutual Funds, Investment
Company Act Rel. No. 26341, at Part II (Jan. 29, 2004) (explaining
conflicts of interest necessitating requirement for point-of-sale of
distribution compensation disclosure).
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We recommend that the Department require that advisers prominently
disclose the extent to which their compensation may vary based on the
investment options selected by the beneficiary. In order to qualify as
``prominent,'' the disclosure should be in separate document, e-mail
message or web page. The disclosure must be provided separately because
otherwise it is likely to be confused with fee disclosure that is
designed to highlight the costs of investing, rather than the economic
incentives of the adviser.\40\ The disclosure should focus on the
amount of the adviser's differential compensation in order to permit
the beneficiary to evaluate the objectivity of the adviser's
recommendations.
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\40\ See Investment Advisers Act Rule 206(4)-3 (requiring
disclosure of solicitor's capacity and compensation in a separate
document).
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Moreover, differential compensation disclosure should be provided
before the beneficiary makes the decision to retain the adviser so that
the beneficiary can evaluate the adviser's services before soliciting
recommendations. After the beneficiary has retained the adviser and
received the adviser's recommendations, the opportunity to evaluate the
wisdom of retaining that adviser will have passed. In this respect, the
Department should require that, in addition to disclosure made prior to
the retention of the adviser, the adviser specifically disclose any
differential compensation received in connection with the recommended
investments at the time that the recommendation is made. Finally, the
Department should require that periodic reminders be provided to
beneficiaries as long as differential compensation payments continue.
Some may argue that disclosure of differential compensation is too
costly and complex. Advisers who choose to create the conflict of
interest that differential compensation disclosure would address should
not be allowed, however, to avoid disclosure of differential
compensation because of the complexity and disclosure costs they are
responsible for creating. If, for example, a mutual fund charged dozens
of different fees that depended on an investor's particular situation,
the fund's sponsor should not then be heard to complain that the cost
of fee disclosure far exceeded its benefits. In short, the cost of fee
disclosure should be viewed not as a reason to permit conflicts of
interest to be concealed, but as a natural market constraint on
inefficient pricing practices. To the extent that investors reject
complex fee structures, such as differential compensation arrangements,
when they are fully disclosed, fee disclosure should be viewed as
having operated successfully by promoting informed investor choice,
competition and efficiency.\41\
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\41\ Although the speciousness of arguments that fee disclosure is
too costly due to its complexity is most applicable to differential
compensation arrangements, it is not limited to such arrangements. The
same analysis applies to all types of complex fee arrangements, such as
the use of different types of account and activity charges that are in
addition to a fund's expense ratio and plan expenses as disclosed in
the Form 5500.
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conclusion
We applaud the Department for a forward-thinking, creative and
decisive approach to the current rules for the disclosure of 401(k)
fees. With the growth of defined contribution plans and the increasing
importance of participants' individual decisionmaking role, it has
never been more critical to Americans' retirement security that 401(k)
fees be subject to the disinfecting light of full transparency and the
benefits of unencumbered market competition. The Department's proposal
takes a significant step toward truly transparent, complete disclosure
of 401(k) fees in a way that in the long term will save Americans
billions of dollars in excess fees. We hope that the Department will
capitalize on this opportunity to increase transparency and promote fee
competition by addressing the concerns that we have discussed in
developing its final proposal. Thank you for your consideration of our
comments.
Sincerely,
Mercer Bullard,
President and Founder,
Fund Democracy, Inc.
Barbara Roper,
Director of Investor Protection,
Consumer Federation of America.
______
Prepared Statement of the Investment Company Institute
The Investment Company Institute \1\ welcomes the interest of
Chairman Kennedy, Senator Harkin, Ranking Member Enzi and the committee
in enhancing disclosure in 401(k) plans and appreciates the opportunity
to provide its views in connection with the committee's September 17
hearing. The Institute has long supported effective disclosure to
participants in individual account plans and the employers who sponsor
those plans.\2\ Mutual funds currently provide the most complete
disclosure of any investment product available in 401(k) plans and the
Institute has extensively studied what information is useful to and
used by investors. We value the opportunity to offer constructive input
as the committee explores these issues and oversees regulatory efforts
at the Department of Labor (DOL).
The defined contribution system of 401(k) and similar plans has
been a huge success. As of 2007, Americans saved $4.5 trillion in
private defined contribution plans, and another $4.7 trillion in IRAs.
(Estimates suggest about half of all IRA assets originate from 401(k)
and other employer plans.) Around half of all of the assets in defined
contribution plans and IRAs are invested in mutual funds.\3\
Collaborative research between the Employee Benefit Research
Institute (EBRI) and the Institute demonstrates that participants
generally make sensible choices in allocating their investments \4\ and
that a full career with 401(k) plans produces adequate replacement
rates at retirement.\5\ Institute research also suggests that plan
participants and plan sponsors are cost conscious when selecting mutual
funds for their 401(k) plans. On an asset-weighted basis (that is,
taking into account where 401(k) participants concentrate their
assets), the average asset-weighted expense ratio for 401(k) stock
mutual fund investors was 0.74 percent, half of the simple average
stock mutual fund expense ratio in 2006 (1.50 percent).\6\
The biggest challenge in ensuring adequate retirement security for
all Americans lies in encouraging workers to contribute and encouraging
employers to offer a workplace plan. Disclosure reform should seek to
improve the 401(k) system without imposing burdens, costs and
liabilities that deter employers from offering plans. For these
reasons, we urge the committee to proceed carefully as it examines the
401(k) disclosure regime.
Initiatives to strengthen the 401(k) disclosure regime should focus
on the decisions that plan sponsors and participants must make and the
information they need to make those decisions. The purposes behind fee
disclosure to plan sponsors and participants differ. Participants have
only two decisions to make: whether to contribute to the plan (and at
what level) and how to allocate their account among the investment
options the plan sponsor has selected. Disclosure should help
participants make those decisions. Voluminous and detailed information
about plan fees could overwhelm the average participant and could
result in some employees deciding not to participate in the plan or
focusing on fees disproportionately to other important information,
such as investment objective, historical performance, and risks. On the
other hand, plan sponsors, as fiduciaries, must consider additional
factors in hiring and supervising plan service providers and selecting
plan investment options. Information to plan sponsors should be
designed to meet their needs effectively.
While we welcome congressional oversight and improved transparency,
at this point we do not see the need for congressional action in light
of the comprehensive DOL regulatory initiatives that should close the
disclosure gaps that exist under current law.
principles for reform
Disclosure to plan sponsors should provide information
that allows them to fulfill their fiduciary responsibilities.
ERISA requires that plan fiduciaries act prudently and solely in
the interest of plans and participants. Plan assets can only be used
for the exclusive purpose of providing benefits and defraying
reasonable expenses of administering plans. ERISA's prohibited
transaction rules require that a contract with a service provider be
for necessary services and provide only reasonable compensation. The
Institute has consistently supported efforts to ensure that plan
sponsors have the information they need as fiduciaries to select and
monitor service providers and review the reasonableness of plan
fees.\7\
Plan sponsors should obtain information from service providers on
the services that will be delivered, the fees that will be charged, and
whether and to what extent the service provider receives compensation
from other parties in connection with providing services to the plan.
These payments from other parties, commonly called ``revenue sharing,''
but which are really cost sharing, often are used in bundled and
unbundled service arrangements to defray the expenses of plan
administration.
We also recommend that a service provider that offers a number of
services in a package be required to identify each of the services and
total cost but not to break out separately the fee for each of the
components of the package. If the service provider does not offer the
services separately, requiring the provider to assign a price to the
component services will produce artificial prices that are not
meaningful. In today's competitive 401(k) market, bundled and unbundled
providers compete effectively for plan business. This healthy
competition has helped spur innovation in 401(k) products and services,
such as new education and advice programs and target date funds.
Forcing a 401(k) provider to quote separate prices for component
services would constitute an inappropriate decision by policymakers to
favor one business model over another. So long as plan fiduciaries can
compare the total cost of recordkeeping and investments of a bundled
provider with the total costs of recordkeeping and investments of an
unbundled provider, they have the relevant information to discharge
their fiduciary obligations.
The Institute supports requiring that a service provider disclose
to plan sponsors information about compensation it receives from other
parties in connection with providing services to the plan. This
information will allow the plan sponsor to understand the total
compensation a service provider receives under the arrangement. It also
will bring to light any potential conflicts of interest associated with
revenue sharing payments, for example, where a plan consultant receives
compensation from a plan recordkeeper.
Allocations among affiliated service providers are not revenue
sharing. When services are provided by affiliates of the service
provider, a plan sponsor should understand all the services that will
be provided and the aggregate compensation for those services. The
service provider should not be required to disclose how payments are
allocated within the organization. These allocations are not market
transactions and any pricing of these transactions will be artificial,
and, thus, of little value. Disclosure of allocations within a firm
will not inform the plan sponsor of additional compensation retained by
the firm and will not inform the plan sponsor of a potential conflict
that is not already apparent given the affiliation of the entities.
The DOL has issued proposed comprehensive disclosure regulations to
address the information plan fiduciaries need. The regulations will
require plan recordkeepers and other service providers to give
employers comprehensive information on the aggregate compensation they
receive before a contract is entered into, and on an ongoing basis
thereafter. This includes information on direct payments from 401(k)
plans to recordkeepers and payments from third parties. The disclosures
will have to include information on other potential conflicts of
interest faced by the recordkeeper. The regulations would not favor a
particular business model by requiring providers to quote component
prices for services offered as a package. Although the Institute made
suggestions to DOL to improve the effectiveness of the regulation, the
Institute supports DOL's general proposed approach.\8\
Disclosure to plan participants should be simple and
focused on key information.
Participants should receive the following key pieces of information
for each investment product offered under the plan:
Types of securities held and investment objective of
the product.
Principal risks associated with investing in the
product.
Annual fees and expenses expressed in a ratio or fee
table.
Historical performance.
Investment adviser that manages the product's
investments.
Participants also need information about the plan fees that they
pay, to the extent the fees are not included in the disclosed fees of
the investment products. Finally, participants should be informed of
any transaction fees imposed at the time of purchase (brokerage or
insurance commissions, sales charges or front loads) or at the time of
sale or redemption (redemption fees, deferred sales loads, surrender
fees, market value adjustment charges).
This list is informed by research on what information investors
actually consider before purchasing mutual fund shares.\9\ The research
also found that investors find a summary of information more helpful
than a detailed document. This basic information should be provided on
all investment options available under the plan, regardless of
type.\10\
Fees and expenses are only one piece of necessary information.
While the fees associated with a plan's investment options are an
important factor participants should consider in making investment
decisions, no participant should decide whether to contribute to a plan
or allocate his or her account based solely on fees. In many plans the
lowest fee option is a money market fund or other low-risk investment
because these funds are the least costly to manage. It is not
appropriate for most participants to invest solely in these relatively
lower return options.'' \11\
ERISA disclosure rules should encourage and facilitate electronic
delivery of investment information to participants. Plans should be
allowed to provide online disclosure for every investment option for
those employees who have reasonable access to the Internet.
DOL has also issued a proposed regulation to improve the investment
information provided to plan participants. Under the regulation,
employers will have to provide all participants in 401(k) plans with
critical and comparable information on all the investment options
available to them. DOL's proposal uses a layered approach to ensure
each participant receives key information, with more detail available
online and upon request for those participants who want it. The
proposal imposes new disclosure requirements with respect to all
investment options, not just mutual funds, which the Institute believes
is essential to an effective disclosure structure.\12\ The need for
cost-effective, simple disclosure focusing on the key information
participants need to make informed choices, and which facilitates
comparisons among investments, enjoys broad support.\13\
DOL's proposal coordinates with the SEC's proposal to improve and
streamline the information provided to mutual fund investors.\14\ With
half of defined contribution plan assets in mutual funds, the changes
to the disclosure system for plan participants should be consistent
with the summary prospectus that the SEC develops for mutual funds;
otherwise, 401(k) investors will bear the costs of mutual funds
operating under different disclosure regimes.
Congress should not mandate a 401(k) plan's investment
line-up.
One proposal that is pending in Congress (H.R. 3185) would require
a 401(k) plan to offer an index fund meeting certain requirements. The
Institute is concerned with mandating in Federal law that 401(k) plans
offer a particular type of investment option. Congress should not
substitute its judgment for investment experts and mandate investment
choices properly reserved to plan sponsors as fiduciaries. It also
should not endorse one type of investment strategy (indexing) over
another (active management). This represents a significant departure
from the basic fiduciary structure of ERISA and the Institute is
concerned about the precedent this would set.
The mutual fund industry is committed to meaningful 401(k)
disclosure, which is critical to ensuring secure retirements for the
millions of Americans that use defined contribution plans. We thank the
committee for the opportunity to submit this statement and look forward
to continued dialogue with the committee and its staff.
References
1. The Investment Company Institute is the national association of
U.S. investment companies, including mutual funds, closed-end funds,
exchange-traded funds (ETFs), and unit investment trusts (UITs). ICI
seeks to encourage adherence to high ethical standards, promote public
understanding, and otherwise advance the interests of funds, their
shareholders, directors, and advisers. Members of ICI manage total
assets of $12.14 trillion and serve almost 90 million shareholders.
2. Attached to the testimony is a Policy Statement on Retirement
Plan Disclosure adopted by the Institute Board of Governors in January
2007 that reaffirms and chronicles the Institute's long record in
support of better disclosure.
3. Brady and Holden, The U.S. Retirement Market, 2007, ICI
Fundamentals, vol. 17, no. 3 (July 2008), available at http://
www.ici.org/pdf/fm-v17n3.pdf.
4. For example, in 2006, participants in their 20s allocated 59.7
percent of their accounts to pooled equity investments and company
stock, and only 18.4 percent to GICs and other fixed-income
investments. Participants in their 60s allocated 35.6 percent to GICs
and other fixed-income investments. See Holden, VanDerhei, Alonso, and
Copeland, 401(k) Plan Asset Allocation, Account Balances, and Loan
Activity in 2006, ICI Perspective, vol. 13, no. 1, and EBRI Issue
Brief, Investment Company Institute and Employee Benefit Research
Institute, August 2007, available at http://www.ici.org/pdf/per13-
01.pdf. The 2006 EBRI/ICI database contains 53,931 401(k) plans with
$1.228 trillion in assets and 20.0 million participants.
5. See Holden and VanDerhei, Can 401(k) Accumulations Generate
Significant Income for Future Retirees? and The Influence of Automatic
Enrollment, Catch-Up, and IRA Contributions on 401(k) Accumulations at
Retirement, ICI Perspective and EBRI Issue Brief, Investment Company
Institute and Employee Benefit Research Institute, November 2002 and
July 2005, respectively, available at http://www.ici.org/pdf/per08-
03.pdf and http://www.ici.org/pdf/per11-02.pdf, respectively.
6. Holden and Hadley, The Economics of Providing 401(k) Plans:
Services, Fees, and Expenses, 2006, ICI Fundamentals, vol. 16, no. 4
(September 2007), available at http://www.ici.org/pdf/fm-v16n4.pdf.
7. See Statement of the Investment Company Institute to ERISA
Advisory Council Working Group on Fiduciary Responsibilities and
Revenue Sharing Practices (September 20, 2007), available at http://
www.ici.org/statements/tmny/07_dol_
disclose_tmny.html; Statement of the Investment Company Institute to
ERISA Advisory Council Working Groups on Disclosure (September 21,
2004), available at http://www.ici.org/statements/tmny/
04_dol_krentzman_tmny.html.
8. A copy of the Institute's comment letter is available at http://
www.ici.org/statements/cmltr/08_dol_provider_com1.html.
9. See Investment Company Institute, Understanding Investor
Preferences for Mutual Fund Information (2006), available at http://
www.ici.org/pdf/rpt_06_inv_
prefs_full.pdf.
10. Disclosure of this information is appropriate for mutual funds,
insurance separate accounts, bank collective trusts, and separately
managed accounts. The same key pieces of information are relevant and
should be disclosed for fixed-return products, where a bank or
insurance company promises to pay a stated rate of return. In
describing fees and expenses of these products, for example, the
disclosure should explain that the cost of the product is built into
the stated rate of return because the insurance company or bank covers
its expenses and profit margin by any returns it generates on the
participant's investment in excess of the fixed rate of return. In
describing principal risks of these products, the summary should
explain that the risks associated with the fixed rate of return include
the risks of interest rate changes, the long-term risk of inflation,
and the risks associated with the product provider's insolvency.
11. In 2006, the asset-weighted average total mutual fund expense
ratio for money market funds held in 401(k) plans was 0.43 percent,
compared with 0.56 percent for bond mutual funds and 0.74 percent for
stock mutual funds. See Holden and Hadley, supra note 6. In plans
offering investment in employer stock, the employer stock option fund
may be the lowest fee option because essentially no active investment
management is involved, but it also would not be appropriate for
participants to invest solely in one security. This point is made in
the Department of Labor's publication for participants, Taking the
Mystery Out of Retirement Planning, page 11, available at http://
www.dol.gov/ebsa/publications/NRTOC.html.
12. Attached is the Institute's comment letter to the Department of
Labor regarding improvements to participant disclosure.
13. This broad support is reflected in the joint recommendation by
12 trade associations to the Department of Labor in response to DOL's
request for information. See http://www.ici.org/statements/cmltr/2007/
07_dol_401k_joint_com.html.
14. See Enhanced Disclosure and New Prospectus Delivery Option for
Registered Open-End Management Investment Companies, 72 Fed. Reg. 67790
(Nov. 30, 2007). The SEC's efforts are consistent with efforts to
streamline mutual fund disclosure globally; both Canada and the
European Union have proposed to amend their relevant disclosure
documents to focus on key information. See Joint Forum of Financial
Market Regulators, Point of Sale Disclosure for Mutual Funds and
Segregated Funds (Proposed Framework 81-406, June 2007) (Canada);
Committee of European Securities Regulators, Consultation Paper on
Content and Form of Key Investor Information Disclosures for UCITS
(CESR/07-669, October 2007) (European Union).
Attachments.--Institute Policy Statement on Retirement Plan Disclosure
and Institute Comment Letter to DOL on Participant Fee Disclosure
Proposal
ICI Policy Statement--Retirement Plan Disclosure
In 2005, there were 47 million active participants in 401(k) plans,
with their retirement savings invested not only in mutual funds but
also a wide range of other investment products. As 401(k) plans assume
increasing importance for future retirees, plan sponsors must be able
to make the right choices in setting up their plans and participants
must have the information necessary to make informed investment
decisions. To that end, the Institute urges that the Department of
Labor clarify the requirements for disclosure of the fees and expenses
associated with 401(k) plans to assist plan sponsors in making
meaningful comparisons of products and service providers. Similarly, we
support action by the Department of Labor to require straightforward
descriptions of all the investment options available to participants in
self-directed plans. To achieve these important goals:
The Department of Labor should require clear disclosure to
employers that highlights the most pertinent information, including
total plan costs.
We believe required disclosure to employers should focus on the
total fees paid by the plan to a service provider (in the form of a
percentage or ratio) and how expenses are allocated between the sponsor
and participants. Required disclosure also should address the various
categories of expenses associated with a plan, including arrangements
where a service provider receives some share of its revenue from a
third party. Under ERISA, the obligation to provide this information
should rest with those parties having a direct relationship with the
employer.
In the late 1990s, the Institute, in cooperation with other
private-sector organizations, created a Model 401(k) Plan Fee
Disclosure Form, which is posted on the Department of Labor Web site.
More recently, the Institute also helped develop a list of service- and
fee-related items that plan sponsors should discuss with potential
providers. These tools serve to identify what services will be provided
for the fees charged, show all forms of expenses, and help employers
make meaningful comparisons among the products and services offered to
the plan. The tools also can be useful to the Department in crafting
regulations and other guidance.
The Department of Labor should require that participants
in all self- directed plans receive simple, straightforward
explanations about each of the investment options available to them,
including information on fees and expenses.
In making investment elections under a plan, individuals should
receive information on: investment objectives; principal risks; annual
fees (expressed in a ratio or fee table); historical performance; and
the investment adviser that manages the product's investments.
The Department should expand the current disclosure requirements to
require plan administrators to provide participants with a concise
summary of these five key pieces of information for each investment
option. One effective way to deliver this information is through e-mail
and other forms of electronic communication. Additional information,
such as how fees and expenses are allocated among service providers,
should be made available to participants (for example, posted on the
Internet).
Such disclosure requirements would fill gaps in the information
currently required to be provided to participants. The existing
disclosure regime does not cover all plans in which participants make
investment decisions for their accounts. For plans that are covered,
participants must receive full information about mutual funds, in the
form of the fund prospectus. For other products, important
information--such as operating expenses and historical performance--is
available only on request. We support revising current rules to require
a summary document for all self-directed plans that provides, for each
investment product, the type of information that investors value and
use. This information will empower participants in self-directed plans
to manage their accounts effectively.
The mutual fund industry is committed to meaningful disclosure.
Over the past 30 years, the Institute has supported efforts to improve
the quality of information provided to plans and participants and the
way in which that information is presented. Meaningful disclosure is
critical to ensuring secure retirements for millions of Americans.
Appendix.--ICI'S Record: 30 Years of Advocating Better Disclosure
The Institute has long acted both in conjunction with other
organizations and on its own to enhance the ability of employers to
make appropriate choices for their plans. The Institute also has
consistently called for effective disclosure to plan participants about
investment options. This appendix describes the Institute's efforts
over time to improve disclosure for both plan sponsors and
participants.
disclosure to participants
For more than 30 years, the Institute has provided specific
recommendations to the Department of Labor on the disclosure
participants in self-directed plans should receive about investment
options. Through letters and testimony before the Department and the
ERISA Advisory Council, we recommended regulatory measures to ensure
that participants and beneficiaries receive adequate information on
which to base their investment decisions.
In a 1976 letter to the Department, the Institute
advocated that when an individual becomes a participant, he or she
should receive complete, up-to-date information about plan investment
options, and, thereafter, regular and current information as to his or
her investments.
In 1987, the Institute recommended that under then-
proposed 404(c) regulations, participants should receive the kind of
information included in a mutual fund prospectus or Statement of
Additional Information for all investment options--not just investment
options subject to Federal securities laws. We repeated this suggestion
in 2001 to the Department and in testimony in 2004 and 2006 before the
ERISA Advisory Council.
In 1992, the Institute recommended that where a 404(c)
plan has a limited number of investment alternatives, plan fiduciaries
should be required to provide sufficient investment information about
each option up front. We urged the Department to specify the investment
information that would be deemed sufficient, including information on
fees and expenses and investment objectives.
In testimony before the Department in 1997, the Institute
asked the Department to address gaps in the disclosure regime,
especially disclosure of administrative fees charged to participant
accounts and information on annual operating expenses, which, for non-
mutual fund investment vehicles, are required to be provided only upon
request.
In 1999, the Institute urged the Department to expand the
scope of its proposed rules on electronic delivery to cover a broader
range of disclosures and recipients.
In testimony before the ERISA Advisory Council in 2004 and
2006, the Institute called for participants to receive clear and
concise summaries of each investment option, including the product's
investment objective, principal risks, fee/expense ratio (in the form
of a fee table), and information about the investment adviser. In 2006,
we added historical performance to the list. In the 2006 testimony, we
also urged that this disclosure regime should apply to all self-
directed plans--not just 404(c) plans--and that the Department update
and expand its electronic disclosure rule in light of the increasing
role of the Internet.
disclosure to plan sponsors
The Institute likewise has consistently advocated clear rules for
disclosure to plan sponsors and has developed various tools for use by
sponsors and service providers.
In 1999, the Institute published a Uniform 401(k) Plan Fee
Disclosure Form, developed jointly with the American Bankers
Association (ABA) and American Council of Life Insurance (ACLI). The
form, which the Department posted on its Web site, is designed to help
employers identify and monitor 401(k) plan fees and expenses and
compare the fees and services of different providers.
In testimony before the ERISA Advisory Council in 2004,
the Institute called for clear, meaningful, and effective disclosure to
plan sponsors. We recommended that plan sponsors be required to obtain
complete information about investment options before adding them to the
plan menu and obtain information concerning arrangements where a
service provider receives some share of its revenue from a third party.
The Institute offered to organize a task force to assist the Department
in developing a disclosure regime for these compensation arrangements.
In 2005, the Institute published a Model Disclosure
Schedule for Plan Sponsors that might be used to disclose information
on receipt by service providers of revenue from unaffiliated parties in
connection with services to a plan. The Institute began discussions
with other trade associations on developing an appropriate disclosure
regime.
In 2006, the Institute published a 401(k) plan fee and
expense reference tool, developed jointly with the ACLI, ABA,
Securities Industry Association, and American Benefits Council. The
tool is a list of fee and expense data elements that plan sponsors and
service providers may want to discuss when entering into service
arrangements. We have asked the Department to post the tool on its Web
site.
______
Investment Company Institute,
Washington, DC 20005-2148,
September 8, 2008.
Office of Regulations and Interpretations,
Employee Benefits Security Administration, Room N-5655,
U.S. Department of Labor,
200 Constitution Avenue, NW,
Washington, DC 20210.
Attn: Participant Fee Disclosure Project
Ladies and Gentlemen: The Investment Company Institute, the
national association of U.S. investment companies,\1\ strongly supports
the Department of Labor's participant fee disclosure proposal, which
will require that participants and beneficiaries in all self-directed
defined contribution plans receive basic and comparable information on
all the investment options available to them, regardless of type.
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\1\ The Investment Company Institute is the national association of
U.S. investment companies, including mutual funds, closed-end funds,
exchange-traded funds (ETFs), and unit investment trusts (UITs). ICI
seeks to encourage adherence to high ethical standards, promote public
understanding, and otherwise advance the interests of funds, their
shareholders, directors, and advisers. Members of ICI manage total
assets of $12.14 trillion and serve almost 90 million shareholders.
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Under the proposal, participants would receive, at enrollment and
annually thereafter, basic information about the plan, including plan-
level fees. They would receive a chart containing information about
each investment option designated by the plan fiduciaries, including
the type of investment, whether it is active or passive, the
investment's 1-, 5-, and 10-year return (compared against a benchmark),
and the fees associated with the investment alternative, with annual
expenses expressed as a total expense ratio. Participants would be
referred to a Web site for more information on each investment,
including the investment strategies and risks, the identity of the
investment issuer or provider, portfolio turnover, and the assets held
in the portfolio. More detailed information, like a copy of a
prospectus or similar document, would be available to participants upon
request.
We applaud the Department for seeking input prior to issuing this
proposal through its Request for Information. This process showed
dividends. The proposal focuses on the key information of use to
participants and provides for comparability and clarity. It provides
key information on fees, balanced with layered web-based disclosure on
other key information. Many features of the proposal help ensure that
the disclosure is useful to participants, the requirements are clear to
plan fiduciaries, who have the obligation to provide the disclosure,
and that the disclosure regime is cost-effective for plans and service
providers. We urge the Department to retain these features:
Avoiding a focus solely on fees. The fees associated with
a plan's investment options are an important factor participants should
consider in making investment decisions, but no participant should
decide whether to contribute to the plan or allocate his or her account
based solely on fees. The Department should retain the balance struck
in the proposal so that participants do not receive disclosure that
places undue emphasis on fees.
Disclosing investment expenses in a straightforward format
through the expense ratio. The expense ratio is a simple and widely
understood way to disclose annual operating costs of an investment fund
that can be applied to a variety of pooled products. It has been time-
tested in SEC rules for disclosing mutual fund operating costs. Use of
the total expense ratio also ensures comparability across investment
products.\2\
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\2\ We agree that fixed return products do not charge expenses in
the same way that pooled products do. While an expense ratio may not be
appropriate for GICs, certificates of deposit, and similar products
(although it is for pooled funds of bonds or GICs), we recommend that
the chart include a disclosure alerting participants that the cost of
the fixed return product is built into the stated rate of return
because the insurance company or bank covers its expenses and profit
margin by any returns it generates on the participant's investment in
excess of the stated rate of return.
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Ensuring participants understand the costs for buying and
selling the plan's designated investments prior to making a decision.
The proposal contains a requirement to disclose shareholder-type fees,
which should include fees imposed at the time of purchase (brokerage or
insurance commissions, sales charges or front-end loads) or at the time
of sale or redemption (redemption fees, deferred sales loads, surrender
fees, market value adjustment charges). It is particularly important
that participants, before making an investment decision, understand any
fees for exiting the investment within a certain period of time.
Applying disclosure across all products. This proposal
would establish baseline disclosure of key information for all
products, regardless of type. This would fill a gap in the current
404(c) regulation which requires that participants receive a prospectus
for mutual funds and other products subject to the Securities Act of
1933, but does not require delivery of key information like annual
operating expenses and historical return information for other
investment products. Closing this gap is important as investment funds
that are not subject to the 1933 Act are increasingly being marketed to
plans and participants.\3\ We recognize that current disclosure systems
do not always require that this information be developed and made
available to participants and that plans, recordkeepers, and product
providers will need to develop processes to do so. But that is exactly
the point of this proposal and why adoption is so necessary. We
strongly urge the Department to retain this feature of the proposal.
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\3\ See ``Collective Funds Gain Traction in 401(k)s,'' Wall Street
Journal, July 24, 2008, page D1.
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Allowing fees to be disclosed in the manner in which they
are charged. The proposal allows fees to be disclosed in the manner in
which they are charged, recognizing that different types of fees are
charged differently. While operating expenses of pooled funds in the
plan's menu are charged in basis points (percentage of assets), plan
level fees typically involve per capita or per transaction costs.
Coordinating participant disclosures with securities law
disclosures. Throughout the proposal the Department coordinated the
proposed requirements with similar disclosures registered investment
companies provide investors. This has the benefit of using time-tested
disclosure methodologies and avoids requiring mutual funds to recompute
information or produce entirely new calculations beyond those currently
required by the SEC. For example, the methodology for computing mutual
fund expense ratios, performance data, and benchmark information will
satisfy the rule.
Harnessing the power of web-based disclosure. The Internet
is a particularly effective and efficient means to deliver disclosure,
because of its ability to offer layers of information. The proposal
makes an important step in this direction by allowing use of a Web site
to provide layered disclosure. Below we offer recommendations on how
the Department should update its electronic disclosure rules for this
proposal.
These principles enjoy broad support, as evidenced by the letter in
response to the Department's RFI signed by 12 groups representing both
employer sponsors of defined contribution retirement plans and the
financial institutions that provide services or investments to
plans.\4\
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\4\ See Joint Letter of the Investment Company Institute, American
Benefits Council, American Council of Life Insurers, Committee on
Investment of Employee Benefit Assets, The ERISA Industry Committee,
American Bankers Association, Profit Sharing/401(k) Council of America,
Securities Industry and Financial Markets Association, National
Association of Manufacturers, U.S. Chamber of Commerce, The Financial
Services Roundtable, and Society for Human Resource Management (July
24, 2007), available at http://www.ici.org/statements/cmltr/2007/
07_dol_401k_joint_com.html.
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Our comments on specific elements of the proposal are set forth
below.
a. the department should enhance the ability of plans to use electronic
delivery and web-based disclosure
Although the proposal contemplates the use of a Web site for
layered disclosure, it otherwise simply incorporates the Department's
current electronic disclosure rules. Benefits of the layered approach
to disclosure in the proposal can best be realized if the Department
updates its electronic disclosure rules.
Use of the Internet is now virtually universal among a significant
majority of 401(k) participants. Participants under age 60 constituted
91 percent of active 401(k) participants at the end of 2006,\5\ and in
this age group, access to an Internet-enabled PC at home is generally
above 80 percent, based on Neilsen ratings (as of May 2008).\6\ The
Institute's data on mutual fund shareholders, including those who own
funds through employer plans, show broad Internet usage across all
groups. For example, 75 percent of mutual-fund owning U.S. households
with a high school education or less report having Internet access in
2006.\7\ This number is even higher--85 percent--for those with a high
school education or less who own mutual funds through a 401(k).\8\
---------------------------------------------------------------------------
\5\ See S. Holden, J. VanDerhei, L. Alonso, and C. Copeland, 401(k)
Plan Asset Allocation, Account Balances, and Loan Activity in 2006, ICI
Perspective, vol. 13, no. 1, fig. 4, and EBRI Issue Brief, no. 308,
Investment Company Institute and Employee Benefit Research Institute,
August 2007, available at http://www.ici.org/pdf/per13-01.pdf.
\6\ See Nielsen On-Line, Industry Vertical News on Internet
Penetration (May 2008), available at http://www.nielsen-netratings.com/
resources.jsp?section=btn_filter&nav=5.
\7\ See 2008 Investment Company Institute Fact Book, 48th ed.,
figure 6.12, available at http://www.icifactbook.org. Educational
attainment reported is for the sole or co-decisionmaker for savings and
investing decisions.
\8\ Data tabulated from ICI's 2006 Annual Mutual Fund Shareholder
Tracking Survey.
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The Internet is widely used for financial transactions. One
Institute member with a large recordkeeping business reported to us
that in 2007, about 75 percent of investment changes by participants
were made on-line via the plan participant Web site, compared with
about 25 percent of changes made over the phone.\9\ A 2006 Institute
study of Americans who own mutual funds (whether through employer plans
or through the retail market) found that nearly three-quarters of
shareholders who go online use the Internet to access their bank or
investment accounts, and 55 percent use the Internet to obtain
investment information.\10\
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\9\ In fact, in 2007, 84 percent of all participant contacts with
the recordkeeper were made via the participant Web site.
\10\ See 2008 Investment Company Institute Fact Book, 48th ed.,
figure 6.13, available at http://www.icifactbook.org.
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In a joint letter, the Institute and the American Benefits Council
recently recommended that the Department consider alternatives to the
affirmative consent requirement in the Department's current electronic
disclosure regulation (29 CFR Sec. 2520.104b-1(c)). We understand that
the issue of electronic delivery of information and documents required
by ERISA is the subject of a separate regulatory project. We see no
reason, however, why the Department could not include in these final
regulations rules that facilitate electronic delivery of information
required by these regulations. The Department has done so on an interim
basis for e-delivery of participant benefit statements in Field
Assistance Bulletin 2006-03 and for qualified default investment
alternatives (QDIAs). The Department should adopt a similar user-
friendly approach for this regulation.
For example, many plans enroll participants via a secure Web site.
Participants designate a contribution percentage, enter enrollment
information, and select investments at the same time. Information on
investment options is presented at the time the participant selects
investments, and the participant typically has the option to print any
of this information. It is clear that any participant who enrolls via
this process has access to the Internet because the participant is
online to enroll. The Department's rules should allow the plan to
furnish this participant with the required disclosures online.
The Department's final regulations for QDIAs allow plans to satisfy
their notice requirements using either the Department of Labor's
electronic disclosure rules or the guidance issued by the Department of
Treasury and Internal Revenue Service (26 CFR Sec. 1.401(a)-21)
relating to use of electronic media.\11\ The process of notifying
participants about a plan's QDIA typically will be intertwined with
disclosure under this new rule. The Department needs to harmonize these
rules with the QDIA electronic disclosure requirements.
---------------------------------------------------------------------------
\11\ See Preamble to Final QDIA rule, 72 Fed. Reg. 60452, 60458
(October 24, 2007). See also Field Assistance Bulletin 2008-3, Q&A-7.
---------------------------------------------------------------------------
Finally, as a technical matter, the Department should clarify that
the use of a Web site to provide the additional investment disclosure
described in paragraph (d)(1)(i)(B) of the proposal will not violate
the Department's general electronic disclosure rules, so long as a
participant can request and receive in paper the required information
that is on the Web site.\12\
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\12\ The Department should not require that all the information on
the Web site, which may include information beyond that required by the
rule, be available in paper at no charge. A requirement on the plan to
provide a paper copy should be restricted to the information required
by the regulation.
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b. comments on the presentation and content of required information
1. The Department should clarify that the Web site information
includes a description of the type of assets in the portfolio, not a
list of securities in the portfolio.
Under the proposal, participants must have access to a Web site
address that provides supplemental information on each designated
investment alternative, including ``the assets comprising the
investment's portfolio.'' We assume that the Department intended to
require information about the type of assets in the portfolio, and not
a list of every security held in the portfolio. The current 404(c)
requirement is that participants receive ``information relating to the
type and diversification of assets comprising the investment's
portfolio.'' \13\ Requiring web-based continuous disclosure of
portfolio holdings would be unnecessary and unwise.
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\13\ See 29 CFR Sec. 2550.404c-1(b)(2)(i)(B)(ii). In addition, one
of the items that must be available upon request under the proposal is
a list of assets comprising the portfolio that constitute plan assets
and the value of each such asset; this requirement is redundant if the
proposal is read to require that information be continuously available
on a Web site.
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Mutual funds are required to disclose their portfolio holdings on a
quarterly basis under SEC rules. Funds provide this information as part
of their required reports provided to shareholders twice a year,\14\
and then during the two ``off '' quarters on Form N-Q, which is filed
with SEC. The Department's proposal would of course allow participants
to obtain shareholder reports on request (see paragraph (d)(4)(ii)).
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\14\ See SEC Form N-1A, Item 22(b)(1); Rule 30e-1 under the
Investment Company Act of 1940. Many funds voluntarily disclose this
information on their Web sites on a more frequent (e.g., monthly)
basis, with a lag time designed to avoid subjecting the fund to
predatory trading practices.
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There are good reasons why the SEC does not require mutual funds to
disclose portfolio holdings continuously and contemporaneously. Besides
the administrative burden and expense of doing so, this could have an
adverse impact on funds and their shareholders, because it could
subject funds to predatory trading practices like front-running and
free riding.\15\
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\15\ If the Department intends to require disclosure of actual
portfolio holdings on the Web site, it should provide that mutual funds
should provide this information with the frequency, currentness, and
detail required by SEC rules.
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2. The Department should clarify that plans may provide additional
benchmark comparisons.
The proposal would require that participants receive, for each
investment other than fixed return products, the name and 1-, 5-, and
10-year returns of an appropriate broad-based securities market index,
for comparison purposes. The description of the required benchmark
parallels what mutual funds provide pursuant to SEC Form N-1A.
Form N-1A recognizes that a broad-based securities index may not
always provide the best comparison to a particular fund. The
instructions to Form N-1A allow mutual funds to compare their
performance not only to the required broad-based securities index, but
also to other, more narrowly based indices that reflect the market
sectors in which the fund invests or to use an additional broad-based
index or non-securities index (e.g., the Consumer Price Index), so long
as the comparison is not misleading.\16\ The Department should clarify
that these additional comparisons are allowed.
---------------------------------------------------------------------------
\16\ See SEC Form N-1A, Item 2(c)(2)(iii), Instruction 2(b); Item
22(b)(7), Instruction 6.
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3. The Department should clarify that investments with less than
the full period of performance should disclose performance from
inception date.
The Department's proposal is modeled on SEC Form N-1A, which
requires disclosure of performance over a 1-, 5-, and 10-year period,
but the Department's proposal does not address explicitly how funds
with less than a full period of performance should present their
performance. SEC rules require that funds that have been in existence
for less than a full period disclose performance for the life of the
fund. For example, a fund that has been in existence for 9 years would
disclose its 1- and 5-year performance and the performance over the 9
years since inception of the fund.
The model disclosure chart lists one of the funds (the ``B Fund'')
as ``NA'' for the 10-year performance figure, suggesting that ``NA''
should be used if the fund has been in existence for less than 10
years. We recommend that the Department clarify that plans should
disclose the performance for the life of the investment if that is less
than 1, 5, or 10 years, as applicable. This could be done by placing
the performance over the life of the fund in the column for the next
highest period, and including either an explanatory parenthetical or a
footnote.
4. If the Department retains the requirement to disclose portfolio
turnover, it should clarify that funds should calculate portfolio
turnover in accordance with Item 8 of Form N-1A.
Web site information for each designated investment alternative
under the proposal includes the portfolio turnover rate. While we would
not put fund portfolio turnover on a list of the most important pieces
of information that all investors should review,\17\ we understand that
the Department may be concerned that participants have information
about the trading costs of a fund. In that context the portfolio
turnover rate can be an indicative measure, particularly for equity
funds.
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\17\ In a survey of just over 500 households conducted in March
2008, ICI found that only 38 percent thought the section on portfolio
turnover in the proposed Summary Prospectus was ``very important, need
to keep.'' Indeed, the portfolio turnover section was ranked second
from the bottom in the list of 13 sections that respondents were asked
to prioritize, and only the name of the portfolio manager received a
lower percentage saying the information is ``very important.'' See
Investment Company Institute, Investor Views on the U.S. Securities and
Exchange Commission's Proposed Summary Prospectus (March 14, 2008),
available at http://www.ici.org/pdf/ppr_08_summary_prospectus.pdf. This
finding confirmed earlier ICI research on investor preferences about
portfolio turnover information. See Investment Company Institute,
Understanding Investor Preferences for Mutual Fund Information (2006),
available at http://www.ici.org/pdf/rpt_06_inv_prefs_full.pdf.
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The SEC has determined that the fund's turnover rate is the most
reasonable proxy for the trading costs of a mutual fund. While it is
not a perfect measure of trading costs,\18\ it is a widely-used proxy
for transaction costs, and it has the advantage of comparability. It
can be easily calculated by funds and is more easily understood by
investors than other measures.
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\18\ For example, a fund that frequently trades securities on a low
cost-per-trade basis may incur lower overall transaction costs than a
fund that trades infrequently but on a high cost-per-trade basis.
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If the Department decides to retain the requirement in the final
rule, it should apply to all investment funds--mutual funds, collective
trusts, separately managed accounts, and insurance company separate
accounts.
The Department should clarify that funds should calculate and
disclose portfolio turnover in accordance with Item 8 of Form N-1A.
This will assure comparability of disclosure across products. For
example, Form N-1A instructs mutual funds, in calculating portfolio
turnover, to exclude amounts relating to securities whose maturities or
expiration dates at the time of acquisition were 1 year or less.\19\
This is appropriate because the portfolio turnover rate is a measure of
the relationship between the adviser's investment strategies and how
frequently the portfolio turns over within a year.
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\19\ See Form N-1A, Item 8(a), Instruction 4(d)(ii).
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Similarly, Item 8 of Form N-1A exempts money market mutual funds
from the requirement to calculate and provide portfolio turnover.\20\
Since money market funds almost exclusively hold very short-term
interest-bearing securities (e.g., 60 days), and hold them to maturity,
most of the securities money market funds hold are exempt from the
calculation because they have maturities of less than 1 year. However,
because of a 1991 modification to the rules for money market funds,
these funds can now purchase a security with a remaining maturity of up
to 13 months. To avoid requiring money market funds to calculate
portfolio turnover on a small slice of their portfolios, the SEC simply
exempted all money market funds from the requirement to calculate and
provide their portfolio turnover rate.\21\ Disclosing money market fund
portfolio turnover rate could be misleading and would not provide a
comparison against the other investment options in the plan. For
example, a fund that maintains an average maturity of 60 days \22\
would have a turnover rate of about 600 percent.
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\20\ See Form N-1A, Item 8(a), Instruction 4(c).
\21\ See SEC No-Action Letter to Investment Company Institute (pub.
avail. Aug. 6, 1991). The SEC amended Form N-1A to reflect this
interpretative position 2 years later. See Securities and Exchange
Commission, Disclosure of Mutual Fund Performance and Portfolio
Managers, Final Rule, 58 Fed. Reg. 19050, 19051 n.3 (April 6, 1993).
\22\ The average maturity of taxable money market mutual funds has
been lower than 60 days in every year since 1984. See 2008 Investment
Company Fact Book, 48th ed., Table 38, available at http://
www.icifactbook.org.
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5. The Department should clarify that shareholder-type fees that
are waived for 401(k) investors should not be disclosed.
The proposal would require disclosure of ``shareholder-type'' fees
like front-end loads and redemption fees. It is very common for mutual
funds, or share classes of funds, that impose a front-end sales load or
account charges to waive the load or account fee for 401(k) and other
defined contribution investors.\23\ This would typically apply to all
participants in a plan. We read the Department's proposal to provide
that shareholder-type fees should be disclosed only if they apply to
participants, but the Department should clarify this point. The example
in the model comparative chart references a $20 annual service fee that
``[m]ay be waived in certain circumstances.'' The Department should
clarify that if a fund does not impose the fee on that plan's
participants, the waived fee should not be included.
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\23\ See B. Reid and J. Rea, Mutual Fund Distribution Channels and
Distribution Costs, ICI Perspective, vol. 9, no. 3 (July 2003),
available at http://www.ici.org/pdf/per09-03.pdf.
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In addition, the Department's proposal would require that the 1-,
5-, and 10-year performance be calculated and disclosed in the same
manner as average annual total return is calculated under Item 21 of
SEC Form N-1A. That instruction requires mutual funds to assume that
the shareholder paid the maximum sales load. The Department should
clarify that, if a fund does not impose a sales load on the plan or its
participants, the chart could omit the performance numbers that would
be required in the fund's prospectus and instead display the average
annual total return without including the sales load (assuming the
presentation is not inaccurate or misleading).
Finally, the Department should clarify that round trip or purchase
block restrictions, which do not impose a fee for exiting an
investment, but merely prohibit reinvestment in the same fund for a
short period of time to prevent market timing, are not considered
``shareholder-type fees.'' \24\
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\24\ The Department came to a similar conclusion with respect to
QDIAs.
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6. The Department should retain the requirement to disclose
quarterly only plan-level administrative fees in dollar amounts and not
impose dollar-based disclosure for investment-level fees.
Under the proposal, participants would be provided quarterly the
amount actually charged to their account for plan administrative
expenses and any fees charged for use of individual plan services
(e.g., loans). These administrative expenses exclude amounts otherwise
included in investment-related expenses (which are disclosed to
participants at enrollment and annually thereafter). The Department
should retain this feature of the proposal.
The Department should not require that plans create individualized
dollar-based disclosures for fees that are included in investment-
related expenses. This would require systems that are expensive to
design and implement and which would produce rough estimates at best.
The SEC looked at this issue in the context of disclosure of mutual
fund fees. A June 2000 General Accounting Office (now Government
Accountability Office) report on mutual fund fees suggested various
approaches to improving fee disclosure, one of which was to require
that funds calculate and disclose to each fund investor the actual
dollar amount of fund operating expenses attributable to that
investor.\25\ The SEC examined the GAO's report and concluded that the
best way to improve shareholder understanding was to require a fee
example in shareholder reports showing the expenses paid on each $1,000
invested, based both on the fund's actual operating expenses and actual
return for the period and, to allow comparisons among funds, based on
an assumed return of 5 percent per year.\26\
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\25\ See General Accounting Office, ``Mutual Fund Fees: Additional
Disclosures Could Encourage Price Competition'' (June 2000), available
at http://www.gao.gov/new.items/gg00126.pdf.
\26\ See Securities and Exchange Commission, Final Rule,
Shareholder Reports and Quarterly Portfolio Disclosure of Registered
Management Investment Companies, 69 Fed. Reg. 11244 (March 9, 2004).
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In its adopting release, the SEC cited Institute research
concluding that the aggregate costs to responding firms associated with
calculating and disclosing individualized fund expenses on quarterly
statements would be $200.4 million in initial implementation and $65
million in annual, ongoing costs.\27\ This estimate covered only the
costs for calculation and disclosure to retail investors. Providing
this type of disclosure in 401(k) plans would be even more costly
because a plan sponsor or recordkeeper must consolidate fee and account
information with respect to each investment in a participant's account,
information that derives from different sources. Current recordkeeping
systems are not designed to receive the needed information from mutual
fund companies and other financial product providers on a daily basis.
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\27\ The Institute survey was conducted in 2000, and included
responses from 39 mutual fund complexes with total net assets of $4.8
trillion (approximately 77 percent of total industry net assets as of
June 2000).
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If the Department decides to modify the proposal to require that
plans reduce asset-based investment charges into estimated dollar
amounts, the Department should follow the illustrative example that
accompanies the fee table in a mutual fund prospectus or the example in
a fund's shareholder report.\28\
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\28\ A mutual fund's prospectus provides a quantitative example
showing the dollar amount of expenses an investor would pay on a
hypothetical $10,000 investment that earns 5 percent annually over 1-,
3-, 5- and 10-year periods. This calculation number takes into account
any sales charges imposed by the fund. The fund's semi-annual and
annual reports include a table showing the expenses paid on each $1,000
invested, based both on the fund's actual operating expenses and actual
return for the most recent 6-month period and, to allow comparisons
among funds, based on an assumed return of 5 percent per year.
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7. The Department should retain flexibility of format for the
information on the Web site.
The proposal does not specify the format of the Web site
information, and we agree plans should have flexibility in how to
present this information. For example, many retirement services
providers now use fund ``fact sheets'' or post web-based versions of
fund fact sheets. These helpful tools, which are typically limited to
one or two pages, provide basic information about a plan investment's
investment objectives, risk, historical performance, and fees, in a
format that investors find useful. Innovative formats like these should
be encouraged.
In some cases it may be cost-effective for plans to provide at the
designated Web site a copy of a mutual fund's most recent prospectus,
or a short-form or summary prospectus. In addition, particularly if a
mutual fund's public Web site will be used to disclose the information,
the fund will need to ensure that information is presented in a way
that complies with all securities laws.\29\ Providing plans, service
providers, and investment providers flexibility to use fact sheets,
prospectuses or short-form or summary prospectuses (so long as the
document includes the required information) \30\ will allow plans to
provide disclosure that works best for participants.
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\29\ Along with the requirements of Form N-1A, other rules require
that information about a fund be presented in a particular way. See,
e.g., Rule 482 under the Securities Act of 1933 (17 CFR Sec. 230.482).
\30\ We believe a prospectus would include all of the information
described in paragraph (d)(i)(B). As proposed, a summary prospectus
would also include all of this information. See Enhanced Disclosure and
New Prospectus Delivery Option for Registered Open-End Management
Investment Companies, 72 Fed. Reg. 67790 (Nov. 30, 2007).
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Although the Department should provide flexibility as to format, we
urge the Department to provide guidance as to how the requirements
apply to products other than mutual funds (which already provide the
required Web site information). For example, we agree that participants
should understand the risks of investing in a fixed return product. We
recommend that the Department state that in describing the principal
risks of these products, the plan should explain, at a minimum, that
the risks associated with the fixed rate of return include the risks of
interest rate changes, the long-term risk of inflation, and the risks
associated with the product provider's insolvency.
8. The Department should address changes in the cross-references to
Form N-1A.
The proposed regulations include references, by number, to items
and instructions in the SEC's Form N-1A. The Department should clarify
that these also refer to successor items and instructions. The items
and instructions in Form N-1A are renumbered from time to time, and in
fact the SEC's current proposed changes to Form N-1A would renumber
some of them.
c. the department should revise the timing requirements to accommodate
plans with immediate eligibility
The Department's proposal would require that a host of plan and
investment information be provided on or before eligibility. A failure
to do so, under the Department's proposal, would be a breach of
fiduciary duty. The point of the requirement to disclose the required
information upon eligibility is to ensure participants have sufficient
information to make the decision whether or not to enroll in the plan
and how to allocate their contributions \31\ among the options that
plan fiduciaries have designated to be available in the plan.
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\31\ Under the proposal, the initial and annual plan-level
information must identify ``any designated investment managers,'' but
does not define the term ``designated investment manager.'' The
preamble explains that this means ``any designated investment managers
to whom participants and beneficiaries may give investment
directions.'' The Department should clarify that this plan-level
disclosure needs to identify any person designated to receive and
implement investment instructions from participants and beneficiaries
(whether or not this person is an investment manager within the meaning
of ERISA Sec. 3(38)).
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Many participant-directed defined contribution plans provide for
immediate eligibility. For these plans, the Department's rule will
require, essentially, that the disclosure be made on the first day of
work. Many employers do not provide information on benefits on the
first day of work, in part to avoid information overload with all the
other information new employees must absorb. Plans with immediate
eligibility could be vulnerable to violating the timing requirements,
if even by a few days.
Plans with immediate eligibility typically have a lag time between
the date a participant is eligible and the date of first investment,
because the first paycheck (with the first plan contribution deducted)
often does not occur on the first day of employment. We recommend that
the Department amend the requirements so that fiduciaries will be
deemed to have provided timely disclosure if it is provided on or
within a reasonable period after the date the employee becomes eligible
for the plan, but in any event on or before the date the employee makes
his or her first election to contribute to the plan or first election
to allocate his or her account to a designated investment alternative.
d. the department should extend the compliance date
While we believe participants are by and large already receiving
the information required by the proposal, at least with respect to
mutual funds, it may not be in the chart format, or at the times,
required by proposal. There is programming that will be required, and
coordination between plans, recordkeepers, and investment providers,
which our members inform us would be impossible to complete by January
1, 2009. If the Department is able to finalize and publish the rule by
the end of 2008, plans likely will be able to comply within a year,
provided the Department does not substantially increase the burdens and
disclosures of the proposal.
It is unclear whether the Department expects plans to provide the
enrollment disclosure to all existing participants on the rule's
effective date. This would be very difficult, since it would require
that the industry create disclosures that would go out to millions of
plan participants simultaneously. The Department should clarify that
plans can provide to existing participants the annual disclosure within
1 year of the regulation's effective date. Moreover, to avoid piece
meal compliance, the Department should require that plans come into
compliance for new participants, and for quarterly statements, no later
than when the plan provides its first annual update for the first plan
year beginning on or after January 1, 2009.
e. while we agree that the proposal will have significant economic
benefits, we believe they will result from lower search costs and
better asset allocation
In analyzing the rule's likely costs and benefits, the Department
states that plan participants will benefit because they will be able to
make better investment decisions with lower search costs. We agree. The
Department estimates that the benefits over a 10-year period (in
today's dollars) could be $6.9 billion to $8 billion. These estimates
seem plausible. However, we believe that these estimated benefits will
stem in significant part from participants being better equipped to
engage in knowledgeable asset allocation rather than an assumed
reduction in fees.
In the Department's analysis, benefits arise from two sources.
First, plan participants will spend less time searching for information
about their funds. This source accounts for roughly two-thirds of the
estimated benefits. The methodology on which this estimate is based
appears reasonable and could, if anything, be conservative.\32\
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\32\ For example, to estimate the benefits from plan participants
spending less time searching for information about their plans, the
Department assumes that the hourly value of plan participants' leisure
time is $31.3 per hour. This is based on an hourly wage rate of $35 for
private sector workers participating in a pension plan, which is then
reduced by 10 percent to adjust for the possibility that the
opportunity cost of leisure may be less than observed wage rates for
individuals. This 10 percent downward adjustment is based on a study by
P. Feather and W.D. Shaw, ``Estimating the Cost of Leisure Time for
Recreation Demand Models,'' Journal of Environmental Economics and
Management, 38(1), July 1999. It is possible that the Department relies
on this finding in order to be conservative, which in our view is a
sensible approach. However, the estimates in the Feather and Shaw paper
are highly uncertain, are based on a small sample of individuals living
in four States (Indiana, Nebraska, Pennsylvania, and Washington), and
costs that individuals attach to a particular kind of recreation. In
short, it is quite possible that an opportunity cost of leisure at $35
per hour for private sector workers is perfectly appropriate. If so,
the Department underestimates by 10 percent the benefits of reduced
search costs by plan participants.
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Second, the Department assumes that plan participants will benefit
from reductions in the fees that plan participants incur through their
401(k) plans. The Department bases this on its interpretation of
academic literature as suggesting that 401(k) plan participants pay
fees that are on average higher than necessary by 11.3 basis points per
year. We believe that this assumption is based on a misreading of the
literature cited, misinterpretation of the statistics presented, and
may have failed to recognize empirical difficulties in some of those
studies (see attached appendix).
We agree that better information, or information presented in a
more understandable way for all investment products offered to
participants, may result in some participants incurring lower
investment fees. For example, participants now will be able to compare
fees and expenses of all pooled investment products offered in the
plan, while previously there was no requirement that participants
receive information on annual operating expenses for products other
than registered investment companies. Participants whose plans offer
more than one investment option in a particular asset class may choose
the lower cost option. But we know of no evidence that would allow one
to conclude that 401(k) plan participants are systematically overpaying
for the investments and services they receive.
Nevertheless, as noted, we believe that the Department's estimated
benefits are plausible. Along with fee information, the proposal would
provide participants with information on the investment type (e.g.,
large cap, international equity), the risks of the investments, and the
historical return of each designated investment option. This
information will assist plan participants to make better investment
decisions. Research shows that investments with equity exposure make a
positive difference in generating retirement savings.\33\ For those
plan participants who may be too conservatively invested given their
age and risk profile, the proposed disclosure could prompt them to re-
allocate their portfolios. Previous analysis conducted by the Institute
shows that the majority of investors who have some exposure to equities
will have accumulated more retirement assets at retirement than those
with no exposure to equities.\34\
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\33\ See S. Holden and J. VanDerhei (2005) ``The Influence of
Automatic Enrollment, Catch-Up, and IRA Contributions on 401(k)
Accumulations at Retirement,'' ICI Perspective, Vol. 11, No. 2 and EBRI
Issue Brief, No. 283, Washington, DC: Investment Company Institute and
Employee Benefit Research Institute, July 2005.
\34\ See letter from Brian Reid, Chief Economist, and Elena Barone,
Assistant Counsel, Investment Company Institute, to Susan Dudley,
Administrator, Office of Information and Regulatory Affairs, Office of
Management and Budget, dated May 31, 2007. For example, a worker who
begins investing at age 30 could expect, on average, to have more than
twice the retirement assets at retirement by investing in a lifecycle
fund with exposure to equities than in a stable value fund. Lifecycle
funds performed better than stable value funds in the vast majority of
cases, even for investors who began to make contributions later in
life, when the lifecycle fund would be more conservatively invested
with less exposure to equities.
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For example, according to Morningstar, the average annual return
over the past decade for mutual funds that specialize in large blend
domestic stocks is 5.2 percent. In contrast, the average annual return
over the past decade for intermediate government bond funds is 1.3
percent. Plan participants who allocate their investments more
efficiently based on the new disclosure are likely to reap higher
returns over the long-term. Accordingly, we agree that the benefits of
the disclosure regime that the Department has proposed justify its
costs.
The mutual fund industry is committed to meaningful ERISA
disclosure. Over the past 30 years, the Institute has supported efforts
to improve the quality of information provided to plans and
participants and the way in which that information is presented. We
strongly support the Department's proposal. If you have any questions,
please contact the undersigned at 202-326-5826 or Michael Hadley at
202-326-5810.
Sincerely,
Mary S. Podesta,
Senior Counsel, Pension Regulation.
______
Attachment.--Appendix
assessing the department of labor's assumption that 401(k) plan
participants pay fees that are higher than necessary
The cost/benefit analysis in the Department of Labor's rule
proposal assumes that 401(k) plan participants ``on average pay fees
that are higher than necessary by 11.3 basis points per year.'' We know
of no evidence that would allow one to draw such a conclusion.
It is unclear how the Department reaches this 11.3 basis point
figure. The Department cites a number of academic studies and industry
studies in support of this estimate.\35\ No such estimate appears in
any of these studies and the Department provides no details on how it
arrived at the 11.3 basis point estimate. Presumably, the Department
calculated the 11.3 basis points from statistics presented in the
studies it cites. If so, this calculation likely misinterpreted the
statistics in those studies, misapplied some of those studies to 401(k)
plans, and failed to recognize empirical difficulties inherent in some
of those studies. In addition, the Department's cost/benefit study
failed to consider evidence showing that the mutual fund industry \36\
is highly competitive.
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\35\ The Department's cost/benefit analysis cites six papers in
support of its view that plan participants pay fees that are on average
too high by 11.3 basis points: Brad M. Barber, Terrance Odean and Lu
Zheng, ``Out of Sight, Out of Mind, The Effects of Expenses on Mutual
Fund Flows,'' Journal of Business, 79(6), 2095-2119, 2005; James J.
Choi, David I. Laibson, and Bridgette Madrian, ``Why Does the Law of
One Price Fail? An Experiment on Index Mutual Funds,'' NBER working
paper W12261, May 2006; Deloitte Financial Advisory Services LLP, Fees
and Revenue Sharing in Defined Contribution Plans, December 6, 2007;
Edwin J. Elton, Martin J. Gruber, and Jeffrey A. Busse, ``Are Investors
Rational? Choices Among Index Funds,'' NYU working paper, June 2002;
Sarah Holden and Michael Hadley, ``The Economics of Providing 401(k)
Plans: Services, Fees, and Expenses 2006, Fundamentals, 16(4),
September 2007; and Jason Karceski, Miles Livingston, and Edward
O'Neal, ``Portfolio Transactions Costs at U.S. Equity Mutual Funds,''
University of Florida working paper, 2004.
\36\ The Department's analysis and cited references appear to
relate almost exclusively to mutual fund fees, and as a result (and
because of the Institute's expertise), our comments also relate to
mutual fund issues. The Department's analysis is incomplete because
mutual funds represent only about half of the assets in participant-
directed plans. We believe one benefit of the proposal is that
participants will now be able to compare fees and expenses of all
pooled investments.
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While we agree that the rule the Department has proposed may result
in some participants paying less in investment-related fees (although
some may pay more if their asset allocation results in more equity
exposure), there is no basis for concluding that plan participants
systematically overpay for the investments and services they receive.
Misinterpretation of Statistics Presented in the Literature Cited
by the Department: The Department's cost/benefit analysis argues that
dispersion in 401(k) fees implies market inefficiency.\37\ As evidence,
the Department points to a study by the Institute of average costs
incurred by participants in 401(k) plans (not ``the fees that plans
pay'' as the Department suggests).\38\ Figure 9 in the cited Institute
study shows that the bulk (77 percent) of the 401(k) plan assets
invested in stock mutual funds are invested in funds with expense
ratios of less than 1 percent.\39\ The remainder (23 percent) is
invested in stock funds with expense ratios of 1 percent or more.
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\37\ There is a ``wide dispersion of fees paid in 401(k) plans. As
supported by a report of the Investment Company Institute, the fees
that plans pay vary over a wide range. According to their study, 23
percent of 401(k) stock mutual fund assets are in funds with expense
ratios of less than 50 basis points, while an equal amount are in funds
with an expense ratio of over 100 basis points. Some of this variation
could be explained by varying amounts of assets in plans and their
accompanying economies of scale. In addition, some plans might offer
more, or more expensive, plan features. The Department believes,
however, that a significant portion of the variation in plan fees is
due to market inefficiencies.'' 73 Fed. Reg. at 43020.
\38\ See Sarah Holden and Michael Hadley, ``The Economics of
Providing 401(k) Plans: Services, Fees, and Expenses, 2006,''
Fundamentals, Vol. 16, No. 4, September 2007 (hereinafter Holden and
Hadley), available at http://www.ici.org/pdf/fm-v15n7.pdf.
\39\ See Holden and Hadley, Figure 9, page 13.
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These percentages, however, say little, if anything, about market
efficiency or whether plan participants overpay or underpay for the
services they receive. The percentages are driven largely by the broad
asset allocation decisions that plan participants make, not by whether
plan participants pay too much or too little for a given type of fund.
For example, nearly half of the 23 percent of 401(k) plan assets that
are invested in stock funds with expense ratios of 1 percent or more
are invested in international equity funds. International equity funds
tend to be more costly to manage and therefore have higher expense
ratios than domestic equity funds (especially large-cap domestic equity
funds).\40\ Plan participants who choose to invest in a mix of domestic
equity and international funds will incur higher fees than participants
who invest only in domestic equity funds, but they also expect to earn
higher returns.
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\40\ As evidence, see Figure 8 in Holden and Hadley, which shows
that in 2006 the average expense ratio incurred by 401(k) plan
participants for investing in foreign stock funds was 97 basis points,
compared to 70 basis points incurred for investing in domestic stock
funds.
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Dispersion in 401(k) fees can also reflect differences in plan
services or characteristics, differences in employer subsidization of
plans, and differences in arrangements for how plan participants and
employers defray plan administrative costs. For example, as the ICI
study discusses, the costs of running a 401(k) plan generally are
shared by plan sponsors and participants and these arrangements can
vary widely. Many employers voluntarily cover some or all of plan-
related costs that plan participants would otherwise incur. Thus, an
employer's decision to pay a portion of plan costs can have a
significant effect on the 401(k) plan fees charged to plan
participants. Generally, when more plan costs are subsidized by
employers, plan participants incur lower fees.\41\
---------------------------------------------------------------------------
\41\ See, for example, Figure 4 in Holden and Hadley, which shows
that about 40 percent of plan sponsors pay some or all 401(k)
recordkeeping and administrative costs.
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Literature Cited Inapplicable to 401(k) Plans: The Department
states that a ``review of the relevant literature suggests that plan
participants, on average, pay fees that are higher than necessary by
11.3 basis points per year.'' In support, the Department references six
studies. Only two of these studies, those by the ICI and Deloitte
Financial Advisory Services LLP, relate to 401(k) plans. The ICI and
Deloitte studies provide evidence on the level of fees that plan
participants pay, not whether they overpay or underpay for services
received. To judge from these studies whether plan participants pay too
much or too little, one would have to determine the ``right'' level of
fees and services. Neither study does this, nor is it obvious how one
would go about determining such a level.
The remaining four studies consider neither 401(k) fees nor the
behavior of 401(k) plan investors. Two of the studies consider choices
made by load fund investors.\42\ A third study compares the fees
charged by load and no-load S&P 500 index funds.\43\ Since 401(k) plan
investors do not generally incur load fees, these three studies would
appear to be irrelevant. The fourth study examines brokerage fees
incurred by equity mutual funds.
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\42\ Brad M. Barber, Terrance Odean and Lu Zheng, ``Out of Sight,
Out of Mind, The Effects of Expenses on Mutual Fund Flows,'' Journal of
Business, 79(6), 2095-2119, 2005; James J. Choi, David I. Laibson, and
Bridgette Madrian, ``Why Does the Law of One Price Fail? An Experiment
on Index Mutual Funds,'' NBER working paper W12261, May 2006.
\43\ Edwin J. Elton, Martin J. Gruber, and Jeffrey A. Busse, ``Are
Investors Rational? Choices Among Index Funds,'' NYU working paper,
June 2002.
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Empirical Difficulties with the Studies Cited by the Department:
Putting aside the relevance of the studies cited by the Department,
some of these studies have empirical issues that challenge the validity
of their conclusions generally.
For example, the Department cites a study by Elton, Gruber, and
Busse (2002) on the expenses of S&P 500 funds.\44\ That study claims,
on the basis of the expense ratios of S&P 500 funds available in the
marketplace, that investors make irrational choices when selecting
mutual funds. The ICI has previously disputed that claim,\45\ showing
that: (a) S&P 500 index funds are commodities in that they have
essentially identical portfolios; (b) these funds nevertheless differ
from one another in many respects; and (c) nearly all of the dispersion
in the expense ratios of S&P 500 funds is explained by fund
characteristics (such as fund size and investors' average account
balances) rather than by market inefficiency or investor irrationality.
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\44\ Id.
\45\ See Sean Collins, Investment Company Institute, ``Are S&P 500
Index Mutual Funds Commodities,'' Perspective, Vol. 11, No. 3, August
2005.
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In addition, Elton, Gruber, and Busse (2002) claim that a ``large
amount of new cash flow goes to the poorest-performing [S&P 500 index]
funds.'' \46\ That is incorrect: over the 10-year period 1998 to 2007,
about 85 percent of the net new cash flowing to S&P 500 index funds
went to the least costly funds, those with expense ratios of 20 basis
points or less.\47\ Elton, Gruber, and Busse (2002) appear to reach
this inappropriate conclusion because they analyze flows scaled by
assets rather than dollar flows. As a result, in their study, very
small funds can have a disproportionate influence.
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\46\ Edwin J. Elton, Martin J. Gruber, and Jeffrey A. Busse, ``Are
Investors Rational? Choices Among Index Funds,'' NYU working paper,
June 2002, page 25.
\47\ Investment Company Institute, 2008 Investment Company
Factbook, 48th edition, page 65.
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In addition, the paper by Barber, Odean, and Zheng (2005) is
subject to alternative interpretations. Barber, Odean, and Zheng (2005)
claim to have found that ``[i]investors are more sensitive to salient
in-your-face fees, like front-end loads and commissions, than [fund]
operating expenses.'' One statistic that Barber, Odean, and Zheng
(2005) provide in support is that repeat buyers of front-end load funds
tend to pay lower loads on subsequent purchases than on initial
purchases, while repeat purchasers of all funds tend to pay nearly
identical expense ratios on initial and subsequent purchase. Our view
is that this says little, if anything, about whether investors are
sensitive to front-end loads and fund expense ratios. Instead, it
simply illustrates how front-end load funds are priced: front-end load
funds typically offer discounts on load fees when the cumulative dollar
value of shares purchased exceeds a given dollar amount.\48\
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\48\ Thus, for example, an investor who initially invests $25,000
and pays a front-load of 5.25 percent might expect to pay a front-load
of just 3.00 percent on a subsequent purchase of $25,000 in the same
front-end load fund.
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Another issue is that some of the studies cited by the Department
rely on samples that are representative of neither 401(k) plan
participants, nor mutual fund investors in general. One of the
studies--Barber, Odean, and Zheng (2005)--relies on a sample of load
fund investors provided by a single brokerage firm. Another study cited
by the Department--the study by Choi, Laibson, and Madrian (2006)
\49\--relies on a survey that asks a relatively small number of
individuals how they would invest in load funds, not how they do
invest. It is unclear whether the surveyed individuals are 401(k) plan
participants, whether they have any mutual fund investments, or any
investments at all.
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\49\ James J. Choi, David I. Laibson, and Bridgette Madrian, ``Why
Does the Law of One Price Fail? An Experiment on Index Mutual Funds,''
NBER working paper W12261, May 2006.
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The Mutual Fund Market is Highly Competitive: Finally, the
Department failed to cite studies indicating that the mutual fund
industry is highly competitive. The textbook definition of a
competitive industry is one in which there are many firms, none of
which has a dominant market share. Firms may freely enter or exit the
industry, and consumers are free to vote with their feet. In a
competitive industry, firms cannot overcharge and consumers do not
``overpay.''
The mutual fund industry is ``a classic, competitively structured
industry, with hundreds of competing firms offering thousands of
products, low barriers to entry . . . and low concentration.'' \50\
About 600 advisers manage mutual fund assets in the United States.
Competition has prevented any one firm from dominating the market. For
example, of the largest 25 fund complexes in 1985, only 13 remained in
this top group in 2007.\51\ Other measures also indicate that the fund
market is competitive. In 2007, for instance, the industry had a
Herfindahl index (a standard measure of industry concentration) of 440;
index numbers below 1,000 indicate that an industry is unconcentrated.
In addition, competition in the fund industry is fostered by low
barriers to entry. Indeed, the number of mutual fund advisers nearly
tripled from 1984 to 2004.\52\
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\50\ John C. Coates IV and R. Glenn Hubbard, ``Competition and
Shareholder Fees in the Mutual Fund Industry: Evidence and Implications
for Policy,'' American Enterprise Institute, working paper #127, June
2006, page i.
\51\ See Investment Company Institute, 2008 Investment Company
Factbook, 48th edition, page 21.
\52\ See Table 1 in John C. Coates IV and R. Glenn Hubbard,
``Competition and Shareholder Fees in the Mutual Fund Industry:
Evidence and Implications for Policy,'' American Enterprise Institute,
working paper #127, June 2006.
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Fund investors are mobile: they can take their investments
elsewhere if they feel a given fund's fees are too high. To be sure, in
a typical 401(k) plan, participants are limited to the menu of
investments selected by plan fiduciaries. But plan fiduciaries can and
do alter plan menus in order to replace poorly performing funds \53\
and plan participants can select from among funds in a plan's menu.
There is considerable evidence that 401(k) plan participants invest in
low cost funds. For example, although the fees of S&P 500 index funds
exhibit considerable dispersion, nearly all (more than 90 percent) of
401(k) plan assets invested in S&P 500 funds are in the least costly of
such funds (those with expense ratios of 20 basis points or less).
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\53\ See Deloitte Consulting, 401(k) Benchmarking Survey, 2008
Edition, page 22. The report finds that 95 percent of responding plan
sponsors evaluate and benchmark their plan's investments at least
annually, and that 64 percent have replaced a fund due to poor
performance in the past 2 years.
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As we state in our letter, we agree that the Department's proposed
disclosure regime will have significant benefits. But there is no basis
for concluding that plan participants systematically overpay for the
investments and services they receive in their 401(k) plans.
______
AARP,
Washington, DC 20049,
September 16, 2008.
Hon. Edward M. Kennedy,
Committee on Health, Education, Labor, and Pensions,
U.S. Senate,
Washington, DC 20510.
Hon. Michael B. Enzi,
Committee on Health, Education, Labor, and Pensions,
U.S. Senate,
Washington, DC 20510.
Dear Mr. Chairman: AARP commends you and the other members of the
committee for holding this timely hearing on the need for
comprehensive, informative and timely disclosure of fee and expense
information to defined contribution plan participants. Thank you for
providing us with this opportunity to submit this statement and the
attached reports for the record of this hearing. AARP also appreciates
the opportunity to comment on S. 2473, the Defined Contribution Fee
Disclosure Act of 2007 introduced by Senator Tom Harkin. AARP supports
the enactment of S. 2473 and urges the members of the committee to
approve this measure as soon as possible.
With 40 million members, AARP is the largest organization
representing the interests of Americans age 50 and older and their
families. About half of AARP members are working either full-time or
part-time. All workers need access to a retirement plan that
supplements Social Security's solid foundation. For those who
participate in a defined contribution plan, such as a 401(k) plan,
better and easy to understand information is essential to help them
make prudent investment decisions.
There were approximately 50 million active participants in 401(k)
plans in 2006, and overall, 401(k) plans held more than $2.7 trillion
in assets. These plans have become the dominant employer-based pension
vehicle. The participants in these plans have a need and a right to
receive timely, accurate, and informative disclosures from their 401(k)
plans to help them prepare for a financially secure retirement. The fee
information participants currently receive about their plan and
investment options is often scattered among several sources, difficult
to access, or nonexistent. Even if fee information is accessible, plan
investment and fee information is not always presented in a way that is
meaningful to participants. This must change because fees reduce the
level of assets available for retirement.
The Government Accountability Office (GAO) estimated that $20,000
left in a 401(k) account that had a 1 percentage point higher fee for
20 years would result in an over 17 percent reduction--over $10,000--in
the account balance. We estimate that over a 30-year period, the
account would be about 25 percent less. Even a difference of only half
a percentage point--50 basis points--would reduce the value of the
account by 13 percent over 30 years. In short, fees and expenses can
have a huge impact on retirement income security levels.
AARP commissioned a report in 2007 to determine the extent to which
401(k) participants were aware of fees associated with their accounts
and whether they knew how much they actually were paying in fees. The
report revealed participants' lack of knowledge about fees as well as
their desire for a better understanding of fees. In response to these
findings, the report suggested that information about plan fees be
distributed regularly and in plain English, including a chart or graph
that depicts the effect that the total annual fees and expenses can
have on a participant's account balance. I have attached a copy of this
report, 401(k) Participants' Awareness and Understanding of Fees,\54\
July 2007, for the consideration of the members of the committee.
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\54\ The report referred to may be located at http://
assets.aarp.org/rgcenter/econ/401k_fees
.pdf.
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AARP commissioned a second study in 2008 to gather information and
evaluate a model fee disclosure form developed by the Department of
Labor and an alternative disclosure form developed by AARP. I have
attached a copy of this report entitled, ``Comparison of 401(k)
Participants Understanding of Model Fee Disclosure Forms Developed by
the Department of Labor and AARP.'' \55\ The report suggests that a
disclosure form that contains participant-specific information and
actual dollar figures may improve participants' comprehension of the
form. The report also suggests modifications in the DOL form that would
make it more helpful to 401(k) plan participants. A copy of this report
was provided to the Department of Labor as part of our comments on the
Department's proposed rule on fee disclosure for participant-directed
individual account plans.
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\55\ The report referred to may be located at http://
assets.aarp.org/rgcenter/econ/fee_disclosure
.pdf.
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AARP's Public Policy Institute has just published the attached
paper entitled, ``Determining Whether 401(k) Plan Fees are Reasonable:
Are Disclosure Requirements Adequate? '' \56\ The paper explains how
excessive fees on 401(k) plans can drastically reduce the size of a
retirement nest egg and documents the unsatisfactory state of fee
disclosure and the lack of knowledge about fees among plan
participants. The paper argues convincingly for a reform of the current
regulatory framework to provide participants with the clear and basic
information necessary for them to make better-informed investment
decisions.
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\56\ The report referred to may be located at http://
assets.aarp.org/rgcenter/econ/i8_fees.pdf.
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AARP supports the enactment of S. 2473. The bill would establish a
solid framework for providing timely information about fees and
expenses to plan participants in a format that is easy for them to
understand. The bill would require plan sponsors to provide a complete
picture of investment options to participants--including risk, fees,
and historic returns, as well as certain basic information to help
investors better understand their investment options and whether those
investments will provide long term retirement security on their own or
if greater diversification is needed. The comprehensive annual benefit
statement required by S. 2473 would provide a more complete picture of
a participant's 401(k) status than available under current law. All of
the information that a participant needs would be available in a single
disclosure form, rather than requiring a participant to piece together
information from several different documents.
AARP commends you and the committee for your commitment to preserve
and enhance retirement security. We look forward to working with you
and the other members of your committee to enact legislation as soon as
possible that would require defined contribution plans to disclose
comprehensive, informative and timely information about fees and
expenses to plan participants.
If you have any questions or need additional information, please
feel free to call Cristina Martin Firvida, Director of Economic
Security in Government Relations at 202-434-6194.
Sincerely,
David P. Sloane,
Senior Vice President,
Government Relations and Advocacy.
[Whereupon, at 11:23 a.m., the hearing was adjourned.]