Despite the Best Efforts of the Government ...

Despite the best efforts of the federal government and of governmental agencies, most Americans in the workforce today really have no idea how they are going to retire or if they are going to be able to retire. Disclosures are much more comprehensive than they were in earlier years. Opportunities for tax-favored savings have grown. Plan designs that truly encourage savings have become common.

So, where did things go wrong?

To consider this, let's look at a brief history of retirement plans -- very brief in this case.

In the beginning (Genesis in this case is known as ERISA), most American workers who were fortunate enough to have company-provided retirement plans were in defined benefit plans. In fact, Section 401(k) had not yet been added to the Internal Revenue Code. So, while some industries tended to favor thrift plans (after-tax savings plans that often also provided for an employer match), university systems and certain other tax-exempt organizations tended to have 403(b)s, and professional corporations often had money purchase and profit sharing combinations, lots of workers had DB plans as their backbones.

And, the workforce model fit with DB plans. Likely, the company that you worked for at age 30 would be the one you would retire from. As a retention device, there were lots of goodies that came with staying with that company until at least age (usually) 55. Another wonderful device known as subsidized early retirement, sometimes combined with early retirement windows, allowed companies to manage their workforces without the need for layoffs. In DB plans, there is no such thing as leakage if you stay with the same company.

So, a worker really didn't have to know all that much. What they did know is that when they retired, they would have a combination of their pension and their Social Security and that between them, that felt like enough to live on.

As the Old Testament evolved, so did the landscape change. Gradually, DB plans were replaced by 401(k) plans until we were faced with the New (world) Testament where the bulk of American workers were no longer accruing defined benefits. And, in a 401(k) plan, as we all know, it's really difficult for a participant to figure out exactly what he can buy for the rest of his life with an account balance.

And then there were disclosures.

Now, we get disclosures about the level of fees being charged against our accounts in a plan. I'm in this business. I can't read them. While the wording is not bad, those disclosures are so boring that even if I try, I am unlikely to make it through the first paragraph.

And, there are proposals that will require my employer (through a TPA) to tell me just what my 401(k) may grow to and how much per year that will be worth in my retirement. But, those all use assumptions.

I can understand those assumptions. If you are reading this, it's likely that you can as well. But, how about the poor participant who doesn't know if 6% annual investment return is reasonable? How about the poor participant who doesn't know whether retiring two years later is worth very much in terms of leading to a more comfortable retirement?

Savings plans are a good supplement, but with the current level of communications, to me, they are not the answer. Computer-based models might help, but even then, they would be dependent upon the assumptions underlying the modeling. If plan sponsors choose them, those assumptions might be reasonable in the aggregate, but very rarely for any given individual. If participants choose them, then they need more education than they can ever expect to get on those selections.

From where I sit, there is no easy answer.

Perhaps it's time to return to Genesis. When plans were funded responsibly, costs were controllable and participants who retired under a DB system with some amount of voluntary savings are generally doing pretty well in retirement.

But, will you?

Academic Study Inflames 401(k) Community

Ian Ayres, a Professor of Law at Yale University recently inflamed the 401(k) community by sending roughly 6,000 letters to plan sponsors telling them, in essence, that the fees associated with their investment lineups are too high. They appear to use as a benchmark a family of index funds provided by Vanguard and the fees at which those funds could be available. Additionally, Mr. Ayres is doing working with Quinn Curtis, Associate Professor of Law at the University of Virginia School of Law. Messrs Ayres and Curtis have posted a draft of the paper they intend to publish on the topic. If you were to do an internet search on Ayres/Curtis papers, you would probably find it, but since the authors ask that the paper not be specifically cited, I will leave that to the reader (more hints to come).

Three attorneys at Drinker, Biddle & Reath LLP (Fred Reish, Bruce Ashton, and Joshua Waldbeser) have written a critical analysis directed to the 401(k) community as well as an accompanying "cover memo." If you choose to read them carefully, you might find a way to access the draft paper (Ayres/Curtis).

Essentially, Ayres [and Curtis] has concluded that most participant "losses" in 401(k) plans (losses are cumulative investment returns that are less than optimal) are what they call "menu excess fee losses." While it's not 100% clear to me, I think that they are comparing the cost of a plan's investment menu to the cost of an arguably (or not) comparable Vanguard menu.

FULL DISCLOSURE: I personally have no strong bias for or against Vanguard as compared to their competitors. I have at various times had money invested in Vanguard funds. I know people who work for Vanguard as well as many of their competitors.

There are many factors that the Ayres/Curtis work fails to consider. Reish et al discuss what I would consider to be the large majority of them. I could opine on my own, but for the moment, I will take a different tact.

Suppose you were buying a car. All cars will, at least for a while, provide a capable driver with transportation from one place to another. Some cars are less expensive than others. Should you always purchase the least expensive car that meets your minimum standards? Most readers, I believe, would say no.

Let's return to the real topic at hand. Often times, for a plan sponsor to negotiate the best recordkeeping fee arrangement for plan participants (remember that those fees may be charged back to participants in an ERISA plan), the sponsor must agree to include some of the recordkeeper's proprietary funds in their investment menu. Done properly, the sponsor will have worked with experts internally or externally who have evaluated each of those funds to ensure to their satisfaction that the funds are appropriate for a participant-directed ERISA plan. Presumably, funds that either have poor track records, lack of manager stability, or other red flags that would cause them to be suspect will either not be chosen, or at least placed on a watch list.

As Reish et al point out, most plan committees do strive to fulfill their fiduciary duties. One could surmise this to be the case from the number of lawsuits that have been filed alleging that they are not fulfilling those duties as compared to the number that have not been thrown out by the courts.

Further, the study gathered much of its data from Forms 5500 for the 2009 plan years. Schedule C to Form 5500 is the place where plan sponsors disclose certain fees paid from plan assets. To what extent can a researcher gather this data to determine menu excess fee losses? Do the authors know what Vanguard would be charging the same plan sponsor? Do they know how much the sponsor was paying to the investment firms for each fund? What happens where a plan uses multiple funds from the same vendor and those fees are all listed together? Suppose some of those funds use asset classes not available through Vanguard.

In the limited cases where plan sponsors have been judged to not be fulfilling their fiduciary obligations, I have been critical of them. Personally, however, if I were to perform a study of this sort, I believe that many commentators would tell me that I was fishing for opportunities to serve as an expert for plaintiffs bar. Perhaps Ayres and Curtis are simply performing a service to the 401(k) community. My own feeling though is that they and other academics will always be well-served to seek out the opinions of people who actually work in the field rather than relying entirely on raw data. Perhaps they have, but I have not found evidence.

If Messrs Ayres and Curtis happen to read this, I would be more than happy to allow them to respond to this post. And, to the extent that any of my assertions are incorrect, I will correct them.

What Do You Think of Those Retirement Plan Fee Disclosures You've Received

Ah, ERISA 408(b)(2). Those horrible fee disclosures. If you're a plan sponsor, you've gotten a bunch by now. What are you doing with them?

If you're like a lot of other plan sponsors, you have newly found information. You have a better idea of how much you are really paying for various services. So will everyone else.

That means that you are in the beginning of a time where you can find out just how high or low those fees are. Are you paying a lot for a high-priced firm? Are you getting the level of service that justifies those high fees? If the answer is yes and you are happy with that equation, that's great.

Suppose the answer is no. Suppose you haven't changed firms despite mediocre service and now you find out that you are paying top dollar for that mediocre service. Perhaps you haven't changed providers for a while because it's just a hassle and a little bit of fee savings just wasn't worth it. Now you learn that there are a lot of savings to be had.

Consider why you are paying so much. Perhaps you've been with the same firm for years and years and they've just been raising your fees over time ... because they could. Perhaps you are with a firm that has a lot of overhead which helps their best people to provide better service, but you're not getting that level of excellence. It might be that you are not quite in their market sweet spot and while they tell you how much they value your business, they have assigned a 2nd or 3rd tier team. You're still paying for the best they have, but you're not getting the best they have.

Does any of this resonate with you? You're not sure? You can find out now. Or, to the extent that you don't have all the data you need, you can certainly find out soon. If when you do, you're not happy, rest assured that there are plenty of firms out there that would love to work with you and charge you a reasonable level of fees.

Think about it. You have a fiduciary responsibility under ERISA.

401(k) Fee Case Decided on its Merits -- Plaintiffs Prevail !!

We knew that it was coming. Sooner or later, a 401(k) excessive fee case was going to be decided by a court of law on its merits rather than being settled before a court could rule. If you like, you can download a pdf of the decision in Tussey v ABB, Inc. here. This case may not be over, though. The ruling was made in the District Court for the Western Division of Missouri, Central Division. Missouri lies in the 8th Circuit, not one of the ones bemoaned by the legal profession for its entirely odd decisions.

So, what happened?

ABB, a company with significant US operations, but a Swiss parent, has maintained two 401(k) plans (union and non-union) in the United States. ABB and its 401(k) plans were fairly long-term recordkeeping clients of Fidelity. However, Fidelity was not only the recordkeeper, but also a 3(21) investment advisor. The plans offered primarily Fidelity investment options. Over time, Fidelity became not only the TPA for the 401(k) plans, but also for ABB's pension plan, its health care plans and its payroll services.

The judge in the case was Nanette Laughrey, a 1995 Clinton appointee. The Wikipedia article on her describes her as "a stern judge." Judge :Laughrey's decision is thick. It reads a full 81 pages and is not complimentary of the actions taken by defendants. In fact, in my reading, the only thing that I could find for which she did not berate defendants was that they did, in fact, have an investment policy statement (IPS). Whether this worked in their favor or against them is not clear.

On to the case itself. The Court gave significant weight to the testimony of an expert witness on fee issues. The expert analyzed the fees that the plans paid over a 6-year period. On average, according to testimony, those fees ranged from approximately $65 per participant to $180 per participant per year. The same expert found that a reasonable fee would have been in the range of $44 to $70. Paramount in the expert's comparison was that of the ABB plans to the Texa$aver Plan, a non-ERISA governmental plan. At the beginning of 2000, ABB's 401(k) plan assets were approximately $1.4 billion while the Texa$aver Plan had somewhere north of $1 billion.

It gets worse. ABB did the right thing, but made the right thing bad by ignoring its own process. In 2005, whether it was a serious fee check or merely to check a box on its IPS, ABB hired Mercer to review its fees. Mercer found three problems: 1) the fees that ABB was paying to Fidelity were excessive, 2) the fees paid by the plan were subsidizing other non-plan services that Fidelity was providing to ABB, and 3) when plan assets increased, ABB paid higher fees under a basis point arrangement, but when plan assets decreased, Fidelity charged additional hard dollars to make up the difference; in other words, Fidelity was collecting increased dollars for the same amount of services.

The words of the Court could be particularly troubling to ABB. While the opinion is relatively scathing from beginning to end, here are some of the most troubling issues cited:

• The IPS stated, "[a]t all times ... rebates will be used to offset or reduce [emphasis added] the cost of providing administrative services to plan participants." In failing to due this, ABB violated its own IPS and breached its fiduciary duty.
• In some cases, the plans used Fidelity share classes that were not the least expensive available to them. This was expressly in violation of language in the IPS saying that they would choose the share class with the lowest expenses. This, the Court found, violated their duty of fiduciary prudence.
• While the Court did not find revenue sharing, per se, to be problematic, it noted that ABB allowed Fidelity to take revenue sharing as a means of covering recordkeeping costs, but that it did not offset or reduce administrative costs, in direct violation of ABB's IPS. 
• In 2000, ABB removed the Vanguard Wellington Fund (a balanced fund) for poor performance. It replaced the Wellington Fund with Fidelity Freedom Funds (target date funds or TDFs). Again, their own IPS worked against them. It required a review of a 3-5 year performance (if that period existed) and if there were 5 years of underperformance, a fund went on the Watch List. After 6 more months, it could be removed. The Wellington Fund had a 70-year track record. That track record was exceptional. Additionally, over the 3-5 year monitoring period, it beat its Morningstar benchmark by more than 400 basis points.

To this, the Court noted "suspicions" about the "conflicted relationship" between ABB and Fidelity. The Court supposed that the relationship "infected far more than the specific instances" that plaintiffs had raised as fiduciary breaches. 

The Court found the following damages:

• $13.4 million in lost fees for failure to properly monitor recordkeeping costs
• $21.8 million in the mapping from the Wellington Fund to the Fidelity Freedom Funds
• $1.7 million against Fidelity for improperly retaining the float on plan benefits

Remember, the 408(b)(2) fee disclosure regulations will finally take force this summer. Data such as this will be much more transparent. Plaintiffs bar will be monitoring.

If I were an ERISA plan sponsor that was paying fees from an ERISA trust, I would do all of the following post haste:

• Ensure that an Investment Policy Statement is in place
• Ensure that the IPS is being followed
• Consider whether any fees that are asset-based rather than service-based satisfy the fiduciary duty of prudence
• Confirm that the IPS policies and procedures for monitoring of funds and replacing funds are being followed
• Benchmark your fees

DOL Finalizes Fee Disclosure Regulations.

It's been nearly two weeks since the Department of Labor (DOL) finalized its regulations under
Section 408(b)(2) of ERISA. For those of you who are more words people than numbers people, those are the fee disclosure regulations that require service providers (vendors) to inform plan fiduciaries just how and how much those vendors are getting paid for their services.

It's been interesting hearing some of the observations to the finalizing of this regulation. One experienced retirement practitioner noted to me that this regulation was the result of a recent law change. Hmm, ERISA, recent, Gerald Ford signed it into law and he died in 2006. He last signed a piece of federal legislation in 1977, not exactly recent in the benefits industry. Another experienced benefits practitioner remarked that these regulations were the result of a new government agency established under the Obama Administration. Well, for those of you who are not fans of our current president, there are many things that you could probably choose to blame him for, but I can assure you that President Obama did not create the Department of Labor.

On to the actual guidance ... I'm going to assume that if you are reading this that you have at least some knowledge of the history of this regulation. If not, you can certainly look in this blog under the label "Fees" or in thousands of other places on the internet. Or, you can read my take here or here.

Effective Date


The effective date is now July 1, 2012, postponed from April 1, 2012. Since an earlier DOL pronouncement synced the timing of the effective date of this regulation with the participant-level disclosures under ERISA Section 404(a)(5), the initial disclosures for calendar-year plans under those regulations will be due on or before August 30, 2012.

Electronic Delivery


The body of the regulation is silent. However, nerdy people like me who read a lot of regulations from the DOL and IRS know that in recent years, the preamble to regulations is often (read that as almost always) far more useful and informative than the regulation itself. The preamble, in this case, tells us that there is nothing in the regulation that would limit the ability of service providers to furnish fee disclosures electronically including making that information available on a website so long as participants are notified how they may access those disclosures. [Tell me, why doesn't the government do what a normal person would do and specify in the regulation what vendors can do to fulfill their requirements?] In any event, the regulation indicates the DOL's expectation that 50% of disclosures will be provided electronically. I expect that the DOL's margin of error in making that statement is not more than 50%.

The Disclosure Goesintas


For the uninformed, goesintas is an old term (I think it comes from 298th century BCE (we used to call that BC) Aramaic) for what goes in to something. The analogue for the really curious is the comesoutas. For the most part, this has not changed from earlier proposals. However, at some point in the future, the DOL may require service providers to give fiduciaries a guide to understanding the disclosures. For the time being, there is a sample guide in an appendix to the regulation. And, there is a placeholder in the regulations for such a guide.

For the curious, the sample has two columns. The first column lists services [to be] provided. The second column shows where in the service agreement (if you don't have a service agreement, you can't use this) that service can be found or where information related to investment fees and expenses can be found online.

Enhancing the Technical Details


Service providers will be required to provide to plan fiduciaries sufficient information to assess the reasonableness of both direct and indirect compensation. While the interim regulation required the service provider to at least estimate the amount of indirect compensation it expects to receive, the services for which that compensation is to be received, and from whom that compensation is to be received, the final regulations require that the relationship between the service provider and the payer be disclosed. So, for example, under the final regulations, the service provider might identify a payer as a subcontractor, an affiliate, or a subsidiary.

Certain investment products are often referred to as look through investments. In 401(k) plans, for example, perhaps the most common of these are collective investment trusts (CITs). Under the interim rule, the disclosures were required to contain:

1. compensation charged directly for acquisitions, sales, transfers, or withdrawals
2. annual operating expenses or expense ratio unless the product's return is fixed
3. ongoing expenses

Under the final regulations, a designated investment product (DIA) need not disclose numbers 2 and 3. Instead, it must disclose total annual operating expenses which in turn must be disclosed to participants under the disclosure regulations that apply to them.

What Brokers and Recordkeepers Have to Tell Fiduciaries

The change from the interim rules appears to be fairly subtle in this regard. For most organizations, I think it will be. Under the interim rules, recordkeepers with DIAs on their platforms were required to provide certain DIA information on their platforms. They could satisfy that requirement by passing through information from the issuer, typically a prospectus, but the materials had to be regulated by a governmental agency. The new rules change the government oversight. No longer do the materials need to be regulated, but instead, the issuer of the pass-through materials needs to be regulated. Further, the issuer may not be affiliated with the recordkeeper in order to use the pass-through rule, but the regulations indicate that the requirement can be met by replicating materials.

... time out for a rant ... what is the significance of copying and pasting as compared to just passing through? I don't think I am overly stupid, but this seems like burden for the sake of burden.

... now we return to our regularly scheduled programming ...

Information Requests

The interim rules required service providers to respond to requests (for Form 5500, for example) for additional information from fiduciaries within 30 days. The final regulation changes that to "reasonably in advance" of the governmental filing deadline.

Corrections

In keeping with the interim rule, the final rule says that corrections to disclosures must be provided within 30 days. The final rule, however, adds that such corrections must include errors and omissions, not just corrections.

Cost

Where there is an explicit fee agreement (e.g., contract) in place, this information must be disclosed. Where there is not, the final regulation specifies that reasonable estimates must be made and that any assumptions used to make those assumptions must be disclosed. Further, the final rule indicates that ranges may be used as a reasonable method of disclosure of compensation. However, the final rule states that where more precise information is available, it is to be disclosed.

So, that's about it. The remainder is generally unchanged. Since this is a final rule, and we haven't heard people screaming yet, it looks like disclosures will begin being provided by mid-year. That's not bad. ERISA was signed into law on September 2, 1974 (Labor Day). We get required disclosures in less than 38 years.

Fee Disclosures Under 408(b)(2) Postponed Once Again

I have to say that government agencies have a tendency to be consistent. Effective dates initially published in regulations are considered aggressive by plan sponsors. And, then they get postponed, and often postponed again and again and again. So goes the progress of these regulations. If you are not familiar, you can find my initial take on them here.

For those who have not been following this particular regulation, these disclosures are the ones that will be provided by fiduciaries (plan sponsors) to plan participants, generally in defined contribution plans. They will now be effective not earlier than April 1, 2012.

I view this as good news in that worthless inevitability is being postponed.

Why worthless? Go back and read my initial take. I consider myself a fairly savvy reader of information about 401(k) investment options, and these disclosures will have little if any value to me other than curing insomnia that I might have at the moment. Fortunately, there are generally electronic disclosure options available to plan sponsors, so the decline in tree population will not be significant.

Fee Disclosure Rules Get Postponed Effective Date

On Wednesday, the Employee Benefits Security Security Administration (EBSA) of the Department of Labor (DOL) published a proposed rule (it's really kind of silly that this has to be a proposed rule as nobody is going to object to an extension) to delay the effective date of the 408(b)(2) (fiduciary-level fee disclosure) and 404(a)(5) (participant-level fee disclosure) regulations. For those who are not sure, those sections are parts of ERISA, not the Internal Revenue Code.

Under the proposal, calendar year plans will have until April 30, 2012 to issue their initial disclosures. The first quarterly disclosures of fees deducted will be due not later than May 15, 2012 for calendar year plans.

We shall see if there is further extension later in the year. It would not surprise me.

DOL Proposes Sponsor to Participant Disclosure Regulations

Here's an article http://tinyurl.com/2eubs8w that I wrote on the new regulations that the DOL wrote on ERISA Section 404(a). As I said in the article:

Probably the key takeaway is that sponsors (and their service providers) will have a lot of work to do to bring their plan disclosures into compliance with this new rule. Establishment of websites for non-public funds, developing and formatting participant communications, making sure that necessary information is captured, and the redesign of systems to accomplish all of this, will for many sponsors and service providers involve significant expenditure of management time and expense. The larger issue to consider may be how much of the cost associated with these changes will be passed along to plan sponsors and/or participants by those service providers.

No good checklists currently exist to assist sponsors in ensuring that each requirement is covered. Additionally, in some cases, service providers may not be willing or able to assist plan sponsors in complying with requirements. Perhaps this will be an appropriate time for sponsors to use outside experts who can do this effectively rather than having someone struggle to learn the rules once and rarely, if ever,apply them again.

The compliance burden aside, the information actually provided to participants may or may not be helpful. The DOL has done a lot of work – including focus group testing – to come up with a disclosure scheme that will improve participant choices. Whether, in practice, the new rules have their intended effect only time and experience will tell.

401(k) Fee Disclosures

The DOL has undertaken a 3-part project on 401(k) fee disclosures with focus on:

• Provider fees disclosed on Form 5500 Schedule C
• Provider-to-Sponsor fee disclosure
• Sponsor-to-Participant Fee Disclosure

I was featured in an Employee Benefit News podcast this month on the topic: "5 Minutes With".

Listen here if you dare: http://ebn.benefitnews.com/pdfs/FMW1110_KK.JohnLowell.mp3