[Senate Hearing 108-716]
[From the U.S. Government Publishing Office]

                                                        S. Hrg. 108-716

                         BROKER SALES PRACTICES



                               before the


                                 of the

                              COMMITTEE ON
                          GOVERNMENTAL AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED EIGHTH CONGRESS

                             SECOND SESSION


                           SEPTEMBER 30, 2004


      Printed for the use of the Committee on Governmental Affairs

97-046                      WASHINGTON : 2004
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov  Phone: toll free (866) 512-1800; (202) 512�091800  
Fax: (202) 512�092250 Mail: Stop SSOP, Washington, DC 20402�090001


                   SUSAN M. COLLINS, Maine, Chairman
TED STEVENS, Alaska                  JOSEPH I. LIEBERMAN, Connecticut
GEORGE V. VOINOVICH, Ohio            CARL LEVIN, Michigan
NORM COLEMAN, Minnesota              DANIEL K. AKAKA, Hawaii
ARLEN SPECTER, Pennsylvania          RICHARD J. DURBIN, Illinois
ROBERT F. BENNETT, Utah              THOMAS R. CARPER, Delaware
PETER G. FITZGERALD, Illinois        MARK DAYTON, Minnesota
JOHN E. SUNUNU, New Hampshire        FRANK LAUTENBERG, New Jersey
RICHARD C. SHELBY, Alabama           MARK PRYOR, Arkansas

           Michael D. Bopp, Staff Director and Chief Counsel
      Joyce A. Rechtschaffen, Minority Staff Director and Counsel
                      Amy B. Newhouse, Chief Clerk



                PETER G. FITZGERALD, Illinois, Chairman
TED STEVENS, Alaska                  DANIEL K. AKAKA, Hawaii
GEORGE V. VOINOVICH, Ohio            CARL LEVIN, Michigan
ARLEN SPECTER, Pennsylvania          THOMAS R. CARPER, Delaware
ROBERT F. BENNETT, Utah              MARK DAYTON, Minnesota
JOHN E. SUNUNU, New Hampshire        FRANK LAUTENBERG, New Jersey
RICHARD C. SHELBY, Alabama           MARK PRYOR, Arkansas

                   Michael J. Russell, Staff Director
              Richard J. Kessler, Minority Staff Director
            Nanci E. Langley, Minority Deputy Staff Director
                       Tara E. Baird, Chief Clerk

                            C O N T E N T S

Opening statements:
    Senator Fitzgerald...........................................     1
    Senator Lautenberg...........................................     5
    Senator Pryor................................................    18
Prepared statement:
    Senator Akaka................................................    49

                      Thursday, September 30, 2004

Steven T. Miller, Commissioner, Tax Exempt and Government 
  Entities Division, Internal Revenue Service....................     7
Mary L. Schapiro, Vice Chairman and President, Regulatory Policy 
  and Oversight, NASD............................................     9
Ernesto A. Lanza, Senior Associate General Counsel, Municipal 
  Securities Rulemaking Board....................................    11
Hon. Michael A. Ablowich, Treasurer, State of New Hampshire, on 
  behalf of the National Association of State Treasurers.........    23
Jacqueline T. Williams, Executive Director, College Advantage 
  Savings Plan, Ohio Tuition Trust Authority, on behalf of the 
  College Savings Plan Network...................................    25
Martin M. Noven, Deputy Chief of Staff, on behalf of Judy Baar 
  Topinka, State Treasurer, State of Illinois....................    27
Richard O. Davis, Deputy Executive Director for Finance and 
  Administration, Utah Higher Education Assistance Authority.....    29
Daniel McNeela, CFA, Senior Analyst, Morningstar, Inc............    30
Mercer E. Bullard, President and Founder, Fund Democracy, Inc....    32

                     Alphabetical List of Witnesses

Ablowich, Hon. Michael A.:
    Testimony....................................................    23
    Prepared statement...........................................    90
Bullard, Mercer E.:
    Testimony....................................................    32
    Prepared statement...........................................   123
Davis, Richard O.:
    Testimony....................................................    29
    Prepared statement...........................................   112
Lanza, Ernesto A.:
    Testimony....................................................    11
    Prepared statement...........................................    65
McNeela, Daniel:
    Testimony....................................................    30
    Prepared statement...........................................   114
Miller, Steven T.:
    Testimony....................................................     7
    Prepared statement...........................................    51
Noven, Martin M.:
    Testimony....................................................    27
    Prepared statement...........................................   107
Schapiro, Mary L.:
    Testimony....................................................     9
    Prepared statement...........................................    56
Williams, Jacqueline T.:
    Testimony....................................................    25
    Prepared statement...........................................   103


The chart entitled ``Value of a $10,000 investment after 10 
  years''........................................................   164
The chart entitled ``Value of a $10,000 investment after 18 
  years''........................................................   165
The chart entitled ``Growth in Section 529 Plans 1996-2004''.....   166
The ``529 Plan Information'' chart from the Morningstar website..   167
Barbara Hafer, Treasurer, Commonwealth of Pennsylvania, prepared 
  statement with an attachment...................................   170
Tim Berry, Indiana State Treasurer and NAST President, National 
  Association of State Treasurers................................   180
Questions and Responses to Senator Lautenberg from Mr. Miller, 
  Mr. Lanza, Ms. Schapiro, Mr. McNeela, and Mr. Bullard..........   186

                         BROKER SALES PRACTICES


                      THURSDAY, SEPTEMBER 30, 2004

                                     U.S. Senate,  
                  Subcommittee on Financial Management,    
                  the Budget, and International Security,  
                  of the Committee on Governmental Affairs,
                                                    Washington, DC.
    The Subcommittee met, pursuant to notice, at 10:30 a.m., in 
room SD-342, Dirksen Senate Office Building, Hon. Peter G. 
Fitzgerald, Chairman of the Subcommittee, presiding.
    Present: Senators Fitzgerald, Lautenberg, Carper, and 


    Senator Fitzgerald. This hearing will come to order. I 
would like to begin by welcoming all of our witnesses who are 
present today, and by thanking them for taking time out of 
their schedules to be here.
    Today, we are conducting an oversight hearing on Section 
529 College Savings Plans, State-sponsored investments that are 
designed to encourage families to save money for their 
children's college education. Section 529 refers to the 
Internal Revenue Code section that authorizes and confers 
special tax treatment on these entities, and it shouldn't be 
confused with IRS Section 527, which confers special tax 
treatment on those political groups that are now so 
controversial in the current Presidential campaign.
    Section 529 College Savings Plans are instrumentalities of 
the various State Governments. The States usually organize the 
plans as trusts which, in turn, typically invest the plan 
assets in mutual funds managed by third party asset managers.
    Today's hearing will build on two previous hearings in 
which this Subcommittee examined mutual fund management and 
governance, mutual fund fees, and the adequacy of fee 
    Because they typically invest their assets in mutual funds, 
all of the same problems that are prevalent with mutual funds--
high fees, inadequate disclosure, and questionable brokerage 
sales practices--are also prevalent with Section 529 College 
Savings Plans. But as problematic as ordinary mutual funds may 
be, many Section 529 plans are even more problematic. That is 
because the State Governments which run Section 529 plans are 
exempt from most of the Federal securities laws, including the 
Investment Company Act of 1940. Indeed, the Securities and 
Exchange Commission does not have jurisdiction over the State 
Governments which run the college savings plans.
    Section 529 plans are also more problematic than ordinary 
mutual funds, at least in my judgment, because they carry an 
extra layer of fees. With an ordinary mutual fund investment, 
the consumer may pay a fee to a broker who steers him or her 
into a mutual fund and then pay ongoing management fees to the 
fund manager. With a Section 529 plan, the consumer may not 
only have to pay a brokerage fee and ongoing fees to the fund 
manager, but in addition will almost certainly have to pay one-
time and ongoing fees to the State Government that sets up the 
    In other words, with Section 529 plans, the State 
Governments interpose themselves as additional middlemen and 
take additional fees from investors. State fees associated with 
Section 529 plans can include enrollment fees, application 
fees, account maintenance fees, program management fees, 
administrative fees, and asset-based fees.
    As our earlier hearings pointed out, fees charged to mutual 
fund investors when they are stated as a percentage of the 
assets sound de minimis and trivial, but small differences in 
fees add up to very large differences in investment returns 
over time. Just as investors are free to experience the miracle 
of compounding returns, so, too, they are free to experience 
the tyranny of compounding costs.
    We had a chart in an earlier hearing that showed one 
percentage point of fees over 40 years of investing will cut 
someone's retirement nest egg by 45 percent, and that math has 
all been worked out and it actually is true. You have to 
recognize that those fees compound over time, and each year 
there is money that is not in your account that you are no 
longer earning a return on.
    Given the additional fees that college savings plans charge 
over and above ordinary mutual funds, it is probably safe to 
say that no one would invest in Section 529 plans if they 
weren't tax advantaged. In fact, the tax advantages are 
probably the only reason to invest in Section 529 plans.
    It is, then, a fair question whether the additional fees 
which States charge to Section 529 plan investors carry any 
benefit. I am going to be asking questions about that today. 
Clearly, Congress could devise a means of authorizing Section 
529 plans that would eliminate the dead weight fees that the 
State Governments charge. State bureaucrats might not like it, 
but the millions of American families which have Section 529 
accounts would be a lot better off. There are now about 6.8 
million Section 529 accounts holding about $54 billion in total 
assets as of the middle of this year.
    Few things in life are more important to parents than the 
education of their children, and few things in life are more 
expensive than a college education. Over the last 10 years, the 
cost of attending college has increased a whopping 40 percent. 
According to the College Board, the average cost of a 4-year 
post-secondary education is currently $42,544 for State 
universities and $107,416 for private colleges and 
universities. The price tag for higher education is expected to 
continue rising, likely outstripping any gains in average 
household earnings.
    The hearing we are holding today will address a number of 
the vexing issues and concerns which analysts and commentators 
have raised regarding Section 529 plans. We hope to make saving 
for college easier for average American families.
    Even before the hearing begins, though, I have several 
suggestions for how we might do that. First, Section 529 plans 
have a complex cost structure which makes it difficult for 
investors to compare and select plans in an informed manner. At 
a minimum, Congress ought to simplify and improve fee 
disclosures so that families can more easily compare Section 
529 plans on an apples-to-apples basis.
    Second, in some cases, high fees and commissions are 
charged not only by the broker and the State, but also some 
mutual funds, in fact, charge a higher fee to Section 529 plan 
participants than they do to regular mutual fund investors in 
the same fund. Some analysts have questioned whether these high 
fees offset the tax advantages of investing in a Section 529 
college savings account, and as we have heard before, small 
differences in fees can result in enormous differences in 
returns over time.
    This chart was actually prepared from a hypothetical 
example that the Securities and Exchange Commission included in 
a memorandum prepared by SEC staff who are studying Section 529 
plans for Chairman Donaldson and delivered to House Banking 
Committee Chairman Oxley.\1\ This shows that actually under 
certain circumstances, you may be better off investing in a 
fully taxable but low-cost, low-fee ordinary mutual fund than 
you would be investing in a tax-advantaged college savings plan 
that charges very high fees.
    \1\ The chart entitled ``Value of a $10,000 investment after 10 
years,'' appears in the Appendix on page 164.
    Theoretically, you may be brought into a Section 529 plan 
by a broker, and thus pay a 5\1/2\ percent sales load for Class 
A shares, and then have to pay 2 percentage points in aggregate 
annual fees. Assuming an 8 percent annual return, then after 10 
years, you would be worse off than if you had gone into a fully 
taxable fund that only charged 50 basis points or \1/2\ of 1 
percentage point in annual fees and had no load. Even if you 
paid a 10 percent capital gains tax at the end when you took 
the money out, you would have $1,625 more on an original 
$10,000 investment. Again, that example came from the 
Securities and Exchange Commission.
    Another chart, if you could put chart 2 up,\2\ this is a 
comparison of a low-cost Section 529 plan with a high-cost 
Section 529 plan. The Rhode Island J.P. Morgan Higher Education 
Plan is a very high-cost plan. It has a 4.75 percent sales 
load, 135 basis points, or 1.35 percentage point annual expense 
ratio, and a $25 annual fee. If you invest $10,000 in that 
Rhode Island fund for 18 years, you will have $7,700 less than 
if you invest in the Utah Educational Savings Plan Trust. Utah 
has a Vanguard fund underlying it. Vanguard only charges 10 
basis points for their management fee. The State of Utah, 
however, as you can see, interposes an additional 17 basis 
points in fees, bringing the total expense ratio up to 27.5 
basis points, but that is still way better than being in the 
Rhode Island fund, in which you pay a $25 annual fee. After 18 
years, you will have $7,700 more in the Utah fund. You will 
have $37,000 as opposed to $29,000 for your kid's education.
    \2\ The chart entitled ``Value of a $10,000 investment after 18 
years,'' appears in the Appendix on page 165.
    So the bottom line is that in a high-cost college savings 
plan, the brokers and fund managers, together with a new actor, 
the State Governments which set up the plans, in effect can 
swallow up the tax benefits, leaving the uninformed consumer 
worse off than if he or she had invested in a fully taxable but 
low-cost mutual fund.
    Now, according to Morningstar, the five worst plans are 
offered by the States of Wisconsin, Arizona, Wyoming, and Ohio. 
That is only four States--oh, Arizona has two of the five 
worst. OK. [Laughter.]
    The five best are offered by Utah, which we just saw, 
Nevada, Virginia, Michigan, and Alaska. Now, some of those may 
have changed, I understand, since some of these reports have 
come out. Possibly some of the worst States have improved their 
plans, and they can certainly set that record straight.
    Quite simply, in my judgment, Congress should act to make 
sure that investors and not State bureaucrats, brokers, or fund 
managers capture the tax benefits from Section 529 plans. Right 
now, there are too many middlemen, including State bureaucrats, 
that are feeding at the Section 529 college savings trough.
    Third, several areas of disclosure warrant increased 
scrutiny of Section 529 plans. These disclosure issues include 
the level of disclosure required, the type of information 
disclosed, and the manner in which the information is 
presented. Under the Investment Company Act, ordinary mutual 
funds have to provide annual and semi-annual disclosure 
discussing the fund's performance, listing its holdings, and 
providing the fund's financial statements. Unfortunately, 
Federal securities laws do not require Section 529 plans to 
make even these limited disclosures. Congress should, in my 
judgment, at a minimum, at least provide the minimal 
disclosures that are now provided by regular mutual funds.
    Fourth, while Federal tax advantages are standard for all 
Section 529 College Savings Plans, State tax treatment varies 
from State to State, sometimes holding residents captive to a 
given State's home State plan. Congress, in my judgment, should 
encourage States to compete amongst themselves and discourage 
protectionist measures which lock State residents into 
substandard State funds. Congress could easily make these 
    The growth in the college savings plan industry has no 
doubt resulted in growing pains. While Section 529 plans were 
created under the Federal tax code for use under State law, no 
comprehensive regulatory regime was created to oversee this new 
financial product. Although lacking in enforcement powers, the 
industry's trade group, the College Savings Plan Network, 
issued voluntary disclosure principles in May 2004 to help 
enhance uniformity of fee disclosure across the industry. This 
morning, we will hear from the College Savings Plan Network 
about their progress in this effort.
    In addition, several agencies are also examining Section 
529 plans. They are subject to anti-fraud rules and broker 
dealer sales practices. Earlier this year, Securities and 
Exchange Commission Chairman William Donaldson announced the 
creation of the Chairman's Task Force on College Savings Plans 
to study the fee disclosure issue in the sale of Section 529 
plans. The SEC is expected to report its findings before the 
end of this year.
    Additionally, the NASD, whom we will also hear from this 
morning, has been investigating alleged misconduct by 
securities firms in the sales of Section 529 plans. Mary 
Schapiro is here, chomping at the bit, waiting to go.
    Our other witnesses will address statutory and regulatory 
guidelines for Section 529 plans and those who sell them, 
discuss investor and consumer concerns regarding these State 
plans, and make recommendations for change. We will also hear 
from two witnesses, one from my home State of Illinois and the 
other from the State of Utah, who will discuss their State's 
Section 529 plans.
    Again, I want to thank our witnesses for being here today. 
Before I introduce them, I would like to turn to Senator 
Lautenberg, who has graced us with his presence this morning, 
and welcome him to make an opening statement.


    Senator Lautenberg. Thanks very much, Mr. Chairman. I 
assume that the audience here noted that neither of the weaker 
plans was from New Jersey or from the State of Illinois, and 
the Chairman wasn't sure that I was going to be here, so that 
the truth is obvious.
    Mr. Chairman and all of our guests here today, this is an 
important hearing. The economy is in the doldrums. Real family 
incomes are declining while costs for tuition continue to rise 
and that makes college more and more unaffordable for many 
Americans. And yet post-secondary education has never been more 
important for people entering the workforce. According to the 
Department of Labor, college graduates earn nearly twice as 
much as workers who have only a high school diploma.
    Because of these circumstances, the Section 529 College 
Savings Plans are crucial. But the problems that are there need 
attention, as we will see today, and those problems can and 
must be fixed.
    The problems that we need to address include the following: 
First, because Section 529 plans are run by States, they are 
only loosely regulated by the Securities and Exchange 
Commission. Section 529 plans are not subject to most of the 
securities laws, and as a result, we are seeing problems that 
parallel the ones in recent mutual fund scandals.
    Also, too many layers of investment management are 
involved, as we have heard from our Chairman. As a result, 
investors are paying such high fees that in some instances, 
those fees actually cancel the benefits that these tax savings 
plans have.
    We need to look at ways that Section 529 plans are 
regulated and administered to make them more investor and 
beneficiary friendly. Section 529 plans are complex. Tax rules 
vary from State to State. Many of the plans do not have 
understandable or meaningful disclosures.
    Mr. Chairman, I know firsthand how important a college 
education is and I know how it can be out of reach for the 
ordinary person. When I returned from Europe at the end of 
World War II, the only way I could afford to go to Columbia 
University--which was a dream of mine--was on the GI Bill, and 
I want to improve Section 529 plans because I want to make sure 
that everyone who wants to go to college and is willing to do 
the work can go to college. An educated person is an 
incomparable asset for our country, far more valuable than some 
of our natural resources. No matter how precious the other 
assets are, we have got to focus on this one. We have got to do 
whatever we can to seed, grow, and harvest an educated society 
and we intend to do that.
    Mr. Chairman, I commend you for holding this hearing and I 
want to apologize because I have another function to go to. I 
would ask that the record be kept open so that any questions 
for our distinguished guests can be submitted in writing.
    Senator Fitzgerald. Absolutely, and thank you for being 
here. I have to say, even though you are a member of the other 
party, I think that we are probably better off--small investors 
certainly are better off--now that you have returned to the 
Senate after a brief retirement.
    Senator Lautenberg. That is very kind.
    Senator Fitzgerald. I am retiring now on January 2, so you 
may have to pick up----
    Senator Lautenberg. Think about it a couple of years and 
see how you feel.
    Senator Fitzgerald. You may have to pick up a couple of 
these issues, and you might be able to eliminate some of these 
fees after I am gone.
    Senator Lautenberg. You have an advantage, Mr. Chairman, 
having come from a business background. I really believe that.
    Senator Fitzgerald. Yes.
    Senator Lautenberg. This is not to discourage or dissent 
with any opinions about our attorneys and other professionals. 
We have doctors and lawyers. We almost have an Indian Chief, 
and he is about to retire, unfortunately. But the fact of the 
matter is that a business background, Mr. Chairman, I think is 
invaluable. So we may as well gloat while we can and thank all 
of you.
    Senator Fitzgerald. Well, thank you. I just want to add 
that since we did those hearings on the high fees before, 
several mutual funds have announced they are lowering their 
fees. Fidelity has lowered them down to 10 basis points on 
their index funds. So even though we didn't pass legislation 
yet, I think the focus on those high fees has helped. Thank you 
very much, Senator Lautenberg.
    I would like to now introduce our witnesses. Our first 
witness is Steven T. Miller, who serves as Commissioner of the 
Tax Exempt and Government Entities Division of the Internal 
Revenue Service. Mr. Miller's division oversees the 
administration of tax laws relating to employee plans, tax-
exempt organizations, and government entities. Before joining 
his current division in June 2004, Mr. Miller served as the 
Director of Exempt Organizations within the IRS.
    We would also like to welcome back our second witness, Mary 
L. Schapiro. She appeared first before this Subcommittee in 
November 2003 on the mutual fund trading practices and abuses. 
Ms. Schapiro currently serves as Vice Chairman and President of 
Regulatory Policy and Oversight at NASD. Prior to assuming her 
duties at NASD, Ms. Schapiro was appointed the Chairman of the 
Commodity Futures Trading Commission in 1994 by President 
Clinton. Before that position, she served as a Commissioner of 
the Securities and Exchange Commission from 1988 to 1993, when 
she was appointed Acting Chairman of the SEC. So she has been 
Commissioner and Acting Chairman of the SEC and Chairman of the 
Commodity Futures Trading Commission--a very impressive 
    I would also like to welcome Ernesto A. Lanza, who is the 
Senior Associate General Counsel of the Municipal Securities 
Rulemaking Board, the MSRB. The MSRB is a self-regulatory 
organization established by Congress to develop rules 
regulating securities firms and banks involved in underwriting, 
trading, and selling municipal securities. Mr. Lanza joined 
MSRB in 1997 after practicing law as a public finance attorney.
    I would like to thank all of you for being here. In the 
interest of time, it is usually best if you can just introduce 
your written statements into the record and we will make them a 
part of the permanent record of the Committee. We ask, as best 
as possible, if you could summarize your remarks within 5 
minutes. I won't be too tough on that, but in order to keep the 
hearing going, we would like to stick to that 5 minutes.
    Mr. Miller, I thank you for being here and you may proceed.


    Mr. Miller. Thank you, Mr. Chairman, for the opportunity, 
and I would ask that my written testimony be entered into the 
    \1\ The prepared statement of Mr. Miller appears in the Appendix on 
page 51.
    Thank you for inviting us today. My division, as you 
mentioned, is responsible for ensuring that Section 529 
programs meet the exemption requirements under the Code. I will 
divide my remarks into two parts, first, a general overview of 
the tax rules, and second, how the Service interacts with 
Section 529 programs.
    As  you  mentioned,  Section  529  of  the  Internal  
Revenue  Code exempts qualified tuition programs provided they 
meet certain requirements. The first requirement is that the 
program has to be established and maintained by a State, an 
agency or instrumentality of the State, or by one or more post-
secondary institutions. Thus, the plan either needs to be a 
State-run program or a program established or maintained by 
private colleges or universities.
    Second, the operation of the program is limited to one of 
two designs. State programs may be either pre-paid or a savings 
program. Those programs established by eligible private 
colleges and universities may offer only the pre-paid design. 
Under pre-paid design, the person purchases actually credits or 
certificates for qualified education expenses. Under a savings 
plan maintained by a State, a person contributes to an account 
that is established for the purpose of meeting a designated 
beneficiary's education expenses. The balance in the account 
can go up or down depending on what the investment does over 
    When we talk about qualified higher education expenses 
defined in Section 529, we are talking about tuition, fees, 
supplies and equipment required for either enrollment or 
attendance at an eligible educational institution. Certain room 
and board expenses are also included in that.
    The third requirement is that the individual must be 
designated at the time that you make the contribution to the 
    Other requirements include the fact that only cash can be 
contributed to these plans, and that there is a separate 
accounting with respect to each beneficiary in the plan. With 
respect to college and university programs, those programs must 
employ a trust instrument, and an interest in the program may 
not be used as security for a loan.
    The Code has one final requirement that I will mention. The 
ability to select and change investments in a program is 
limited under Section 529. Contributors and beneficiaries may 
not direct the investment of earnings or contributions. That 
does not mean, however, that a program violates the requirement 
if selection is permitted among various broad-based investment 
strategies that are designed exclusively for the program.
    Turning to rules relating to contributions under Section 
529, there is a limitation on the amount that can be 
contributed. Those amounts are limited to amounts that are 
necessary to provide for a beneficiary's qualified expenses. 
There is no statutory dollar limitation, but proposed rules in 
the area indicate that 5 years' worth of expenses can be funded 
through one of these accounts.
    Contributions are not deductible for Federal income tax 
purposes, and as you mentioned, whether a State deduction is 
available quickly depends on the State law.
    Let me move to tax rules on distributions quickly. 
Distributions are not taxed if they are used to pay qualified 
expenses. The earnings component might be subject to income tax 
if it is not used for those expenses and will be subject to a 
10 percent additional tax, as well, in many instances.
    There are also special estate and gift tax rules that we 
briefly discuss in the written testimony.
    That is a quick outline of some of the tax rules. Let me 
talk very quickly about how the IRS administers the section.
    State programs are not required to come to us for a ruling 
that they are a Section 529 plan. In contrast, private colleges 
and university plans must come in to the IRS to be approved as 
a Section 529 plan. Coming in, they will request a private 
letter ruling. I think it is important to note that Section 529 
doesn't require plans to follow a prototype, so that all plans 
that come in are different and there are discussions with our 
staff concerning whether they meet the requirements before we 
can confirm status.
    In terms of reporting, a program generally has no 
requirement to file a tax or information return regarding its 
operations with the IRS. This is consistent with our treatment 
of other State Governmental entities. If there is unrelated 
business income tax due, then we do require a Form 990-T. In 
terms of reporting to the participants, a program is required 
to provide an annual account statement showing the total 
account balance, the contributions to the account, earnings, 
and any distributions. A plan is also required to issue a Form 
1099-Q for each designated beneficiary who has actually 
received a distribution, and also where there is a transfer 
between plans, a 1099-Q will occur, as well.
    I see my time has run out and so has my testimony, Mr. 
Chairman, so I am willing to take any questions. Thank you.
    Senator Fitzgerald. Thank you, Mr. Miller. Ms. Schapiro.

                       SECURITIES DEALERS

    Ms. Schapiro. Thank you very much, Mr. Chairman. It is a 
pleasure to be back before this Committee. We are very grateful 
to have this opportunity to talk about Section 529 College 
Savings Plans. We also have a longer statement that we would 
like to submit, with your permission, for the record.
    \1\ The prepared statement of Ms. Schapiro appears in the Appendix 
on page 56.
    NASD is the world's largest private sector regulator of 
financial services. We regulate every broker dealer in the 
United States, about 5,200 of them, that do business with the 
public. Last year, we brought more than 1,400 enforcement 
actions and barred or suspended more than 850 individuals from 
the securities industry, and I am sorry to say these are both 
record numbers.
    Our interest in scrutinizing Section 529 sales stems in 
part from their having become hugely popular. Every State 
offers at least one Section 529 plan and there are now about 80 
available. Our investor protection duty compels us to examine 
sales practices of all investment products and most 
particularly those that generate a high level of investor 
    This morning, I would like to briefly cover three topics. 
First is our investigative efforts regarding Section 529 plans. 
The second is the need for standardized disclosure among plans. 
And finally, our efforts to help educate investors about them.
    By way of background, Mr. Chairman, NASD does not regulate 
the State issuers of Section 529 plans nor do we directly 
regulate mutual funds that are offered as investment choices in 
Section 529 plans. As you pointed out, Congress has authorized 
the MSRB to regulate sales of Section 529 plans. We enforce the 
MSRB's rules.
    In 2003, we began hearing allegations of inappropriate 
recommendations of brokers selling Section 529 plans. We 
undertook a review of six firms, chosen based on the number of 
customer complaints and the sales volumes of particular plans. 
We wanted to learn about the suitability of the recommendations 
investors were getting and about the procedures firms had for 
ensuring the efficacy of those recommendations. Since last 
year, we have expanded our review to include 12 additional 
firms in order to have a more comprehensive and representative 
sample of the firms we regulate.
    We were surprised to discover that in some cases, more than 
95 percent of the dollar value of Section 529's sold came from 
sales to customers who are not residents of the States in whose 
plans they invested. Selling an investor an out-of-state plan 
is not necessarily a problem. It may be that the underlying 
investment companies offered by the in-state plan could provide 
inferior portfolio management or a relatively limited array of 
investment choices. As you point out, the fees associated with 
the in-state plan could be very high. And, of course, some 
States don't provide a tax deduction or other benefit. 
Consequently, another State's plan might be a perfectly 
suitable recommendation.
    But since half the States offer State tax deductions for 
residents investing in their plans, and some are quite 
significant, the fact that out-of-state sales exceeded 95 
percent in some cases led us to wonder if broker dealers were 
doing suitability analyses before making recommendations and 
whether they were giving their customers all the information 
they needed before deciding which plan to buy, in-state or out-
    Our sales practice investigations have also included 
reviews of advertising and marketing materials. In a number of 
cases, we have required firms to significantly revise 
advertising to be more balanced, to disclose risks as well as 
potential rewards, and to disclose more prominently the fees 
and tax implications of Section 529 investing. And finally, we 
are reviewing suitability, breakpoint, and supervisory issues, 
as well.
    Most importantly, however, retail investors have been ill 
served by the lack of uniform disclosure among Section 529 
plans. Such disclosure would allow easy comparison in making 
investment choices. The lack of transparency concerning fees 
and expenses, disparate State tax policies and rates, share 
classes, and other features of Section 529 plans have led to 
significant investor confusion. We strongly support a uniform 
disclosure regime for Section 529 plans.
    With this lack of uniformity in mind, NASD has increased 
its effort to educate investors about Section 529's. We have 
two tools on our website to help investors in this area. Our 
booklet, ``Smart Saving for College,'' details all of the 
features of Section 529 College Savings Plans as well as other 
college savings vehicles, including Coverdell Education Savings 
Accounts, prepaid tuition plans, custodial accounts, and even 
U.S. Savings Bonds.
    We also offer an online Section 529 expense analyzer which 
can calculate for investors how fees and expenses affect their 
returns. The analyzer explains the many different Section 529 
plan fees and provide guidance on where to find them in the 
Section 529 disclosure documents. It also provides prompts that 
help investors to make the best possible comparison between 
    We recently issued an investor alert, advising investors to 
be aware of certain facts, including that contribution limits 
and State tax treatment vary from State to State, that 
investment options vary broadly, from high-risk stock funds in 
some plans to more conservative short-term bond funds in 
others, and that there are wide disparities among fees and 
expenses from plan to plan.
    More positively, I would note, as you did, that several 
States have been working to make their Section 529 plans 
clearer and more attractive to investors by lowering enrollment 
and management fees and expanding investment options.
    In closing, Mr. Chairman, NASD is committed to protecting 
investors by ensuring that they have all the information they 
need to make informed investment choices and that the brokers 
they work with adhere to just and equitable principles of 
dealing. We will, as appropriate, continue to broaden both our 
educational and regulatory and investigative efforts with 
regard to Section 529 College Savings Plans.
    Thank you again, and I am happy to answer any questions 
that you might have.
    Senator Fitzgerald. Thank you, Ms. Schapiro. Mr. Lanza.


    Mr. Lanza. Yes. Thank you, Mr. Chairman, Members of the 
Subcommittee. My name is Ernesto Lanza, Senior Associate 
General Counsel of the Municipal Securities Rulemaking Board. I 
appreciate this opportunity to testify today. I ask that our 
written statement be admitted into the record. Thank you.
    \1\ The prepared statement of Mr. Lanza appears in the Appendix on 
page 65.
    The MSRB is a self-regulatory organization established by 
Congress to write rules covering the municipal securities 
activities of brokers. Because shares in Section 529 plans are 
municipal securities, our rules apply to brokers in this 
    Congress sought to protect investors in municipal 
securities through MSRB regulation of broker activities while 
exempting State and local governments from Federal securities 
laws. MSRB rules, therefore, must recognize that unregulated 
State and local governments may act in their best judgment in 
widely divergent ways. Further, we are prohibited by statute 
from using broker regulation to indirectly require issuers to 
produce disclosure materials for customers. In contrast, 
Congress provided for interlocking mutual fund regulation 
covering all parties so that mutual fund broker rules fit hand-
in-glove with issuer rules.
    Within this statutory landscape, the MSRB has adopted a 
comprehensive set of broker rules in the Section 529 plan 
market. Our primary customer protection measures which 
establish standards of fair practice and professionalism 
require that brokers deal fairly with all persons and not 
engage in any deceptive, dishonest, or unfair practice.
    When a broker recommends that a customer invest in a 
specific Section 529 plan, the broker needs to first conclude 
that this investment is suitable for the customer. The broker 
can't steer customers toward a particular share class just to 
increase his commissions, and the broker can't steer customers 
away from available break-point discounts. Brokerage firms 
can't conduct sales contests or use incentives that may cause 
individual brokers to act unfairly toward customers. These 
marketing rules will soon be strengthened by a pending proposal 
banning most forms of non-cash sales incentives.
    Unlike in the mutual fund market, the MSRB is legally 
prohibited from setting broker fees. However, our fair 
commission rule should effectively keep Section 529 broker 
charges at a level consistent with if not lower than broker 
charges for the comparable investment in the mutual fund 
    Full and timely disclosure is central to investor 
protection and to the health of the Section 529 plan market. We 
require brokers to disclose to their customers at the point of 
sale the material facts about that investment. Also, a broker 
that markets an out-of-state Section 529 plan must let the 
customer know that he or she may lose out on a State tax break 
by not investing in-state. Then, by no later than settlement, 
the broker must deliver the Section 529 plan's program 
disclosure document to the customer.
    On Section 529 plan advertisements, we provided extensive 
guidance on a number of specific items of disclosure and we are 
moving towards comprehensive standards that will greatly 
improve the quality and comparability of performance data in 
    Because of the political environment in which State and 
local governments operate, the MSRB also has unique conflict of 
interest rules. These rules, G-37, dealing with political 
contributions, and G-38, on outside consultants, apply equally 
to the Section 529 plan market.
    The MSRB strongly encourages vigorous enforcement of these 
rules by the SEC, NASD, and the bank regulators. These are the 
agencies that enforce our rules. It is worth noting, however, 
that our broker rules do not apply when State personnel market 
their own Section 529 plans directly to investors.
    Now, turning to the other topics for this hearing, the MSRB 
has long been an advocate for the best possible disclosure 
practices in the Section 529 plan market. The needs of 
investors dictate that disclosure be based on six basic 
characteristics: Comprehensiveness, understandability, 
comparability, universality, accessibility, and timeliness.
    The MSRB applauds the College Savings Plan Network's first 
steps at addressing the need for such disclosure through its 
draft voluntary disclosure principles. Meaningful success in 
this area will require the ongoing commitments of the issuer 
    In cases where Section 529 program costs exceed those of 
comparable mutual fund investments, this can often be 
attributed to the extra layering involved in plan structures, 
either from fund of funds structures with expenses incurred at 
two levels, or from costs incurred for State agency public 
policy initiatives for in-state or lower-income residents, such 
as subsidized fees, matching grants, or scholarships. In our 
view, these activities are within the purview of the States. We 
strongly believe, however, that all material program expenses 
must be fully disclosed to investors.
    Finally, on variation of State tax treatment, we have been 
at the forefront of ensuring that brokers inform their 
customers of the possible loss of State tax benefit for out-of-
state investments. The MSRB believes that any State tax benefit 
is one of many appropriately weighted factors that can 
influence a customer's investment decision but should not 
necessarily always be the controlling factor.
    The MSRB takes no position on States providing or 
withholding State tax benefits based on their own public policy 
determinations. We believe that comprehensive and easily 
accessible centralized disclosure of State tax treatment would 
enhance the market and provide investors with the tools needed 
to make meaningful investment choices.
    Thank you for inviting me to testify this morning. I will 
be happy to take questions.
    Senator Fitzgerald. Thank you. I thank all of you very 
much. I appreciate your being here.
    We have been joined by Senator Pryor from Arkansas. Senator 
Pryor is welcome to make an opening statement if he wishes to, 
or ask questions.
    Senator Pryor. I really don't have an opening statement. I 
was just down on the floor a few moments ago doing the 
intelligence issue, which I know most of the Committee Members 
are very interested in that because that has come to our 
Committee, so I don't have any opening statement, but you go 
ahead and ask questions.
    Senator Fitzgerald. Well, thank you.
    I wanted to start with Ms. Schapiro and ask you about the 
NASD's investigations. You began your investigations of the 
sales of Section 529 College Savings Plans because you heard of 
numerous customer complaints, as I understand it. What types of 
complaints were you getting, and is it the complaints that were 
to such an extent that it caused you to begin the 
    Ms. Schapiro. Thank you, Mr. Chairman. We received several 
customer complaints. They related largely to investor confusion 
about State tax deductibility issues, quite honestly, but also 
about some of the fees that are associated with investing in 
Section 529 plans.
    What really spurred our interest in this area, though, as I 
said, is the tremendous growth in assets invested in Section 
529 plans and whether when a product becomes very popular very 
quickly, broker dealers have in place adequate supervisory and 
compliance procedures to ensure that the product is being sold 
    Senator Fitzgerald. Now, did you get people complaining 
that after they were in the plan for a while, they realized 
that they weren't getting a tax benefit because maybe they had 
invested in an out-of-state plan?
    Ms. Schapiro. Yes, that kind of question, and a number of 
the complaints were not received by us directly but were 
reported on in the press as well as received at some of the 
brokerage firms where investors had sent complaints.
    Senator Fitzgerald. So then you follow up on them. Now, 
during NASD's investigation of 20 securities firms, it was 
discovered that 18 firms had made sales of out-of-state Section 
529 plans which accounted for 84 percent or more of total sales 
and the other two firms had percentages of 69 percent and 37 
percent. These figures are pretty astounding.
    What criteria are you using to evaluate any possible 
violations of MSRB rules? Mr. Lanza has testified that the MSRB 
rules require the brokers to explain the possible loss of tax 
benefits by going out of State. Is that what you are looking 
for, to see if the brokers explained to consumers that they 
might lose tax benefits?
    Ms. Schapiro. Yes. We want to ensure that they fully 
explain to investors--first of all, that they did the 
suitability analysis, that they determined that the Section 529 
plan, if they recommended a particular one, was, in fact, 
suitable for investors, including the underlying investments of 
that Section 529 plan, a stock fund versus a bond fund, for 
example. And then secondarily, whether they explained the 
presence of a State tax benefit that might exist for the 
investor who chose to buy their home State's plan if, in fact, 
there was one. About half the States don't give any State tax 
deduction for the contributions, but about half do.
    So we also focused our second round of inquiries on firms 
that were selling particularly to residents of States where 
there was an in-state tax benefit to see if they were doing a 
better job of disclosing that information.
    Senator Fitzgerald. Have you had any settlements yet with 
brokerage firms?
    Ms. Schapiro. No. We are still in the information gathering 
part of this investigation. We are looking at their sales 
literature to understand whether they are accurately and 
adequately disclosing risks. We look at the training materials 
to see whether firms are adequately training brokers to make 
all the explanations and disclosures that they need to make. We 
are looking at the offering memoranda, the dealer agreements 
between the plans and the dealers, as well as customer 
complaints, and then the transaction data, which allowed us to 
come up with the chart that is in the written testimony that 
demonstrates the very high percentage of out-of-state sales.\1\
    \1\ The chart entitled ``Growth in Section 529 Plans 1996-2004,'' 
appears in the Appendix on page 166.
    Senator Fitzgerald. Would you have any recommendations at 
this point based on what you found so far?
    Ms. Schapiro. Well, I would say that we strongly recommend 
that there be uniform disclosure of fees, expenses and tax 
issues with respect to Section 529 plans. It strikes us as 
incongruous that there is very detailed, specific and formatted 
disclosure for mutual funds, but investors who are basically 
investing in mutual funds but do so through the Section 529 
program are not getting anywhere near that kind of uniformity 
of disclosure. Without uniform disclosure, you don't have 
comparability and you put investors----
    Senator Fitzgerald. It is not just that there is not 
uniform disclosure, there really doesn't have to be any 
disclosure. There is no mandate that they disclose the fee, 
really, is there?
    Ms. Schapiro. We cannot require, nor can the MSRB require 
the issuers, the States, to disclose particular information.
    Senator Fitzgerald. Congress could, though.
    Ms. Schapiro. Yes, that is right.
    Senator Fitzgerald. Congress has said that the States are 
exempt from our securities regulations except for maybe in a 
couple areas, but they are certainly exempt from the Investment 
Company Act, which imposes certain requirements such as having 
a semi-annual statement that mutual funds have to give. I 
thought those disclosures were inadequate, and I wanted to beef 
them up. But, in fact, in the case of Section 529 College 
Savings Plans, the States don't even have to give those minimal 
disclosures that mutual funds give.
    Mr. Miller, you mentioned in your testimony, you went 
through the IRS requirements and you said there is no 
requirement that the fees be disclosed. Is that correct?
    Mr. Miller. There is a requirement to give an annual 
account statement that shows contributions, earnings, and any 
distributions, but I am unaware of anything that would indicate 
    Senator Fitzgerald. And Congress dictated that law, right? 
I mean, we drafted that law and you are just enforcing that.
    Mr. Miller. I believe so. We have rules out in terms of----
    I think we probably could go beyond that, Mr. Chairman.
    Senator Fitzgerald. Well, could the IRS go beyond the rules 
that are out there and require a disclosure of the fees?
    Mr. Miller. The disclosure on the fees--I think the answer 
probably is yes. The problem, Mr. Chairman, is it would be too 
late in the plan by that point because the account balance 
information is once you are in the plan. There is no 
requirement under the code for disclosure prior to entry into 
the plan. So the timing would sort of miss, I believe.
    Senator Fitzgerald. OK, but could you draft a rule pursuant 
to Section 529 that required, say, from now on, that every plan 
participant would receive an annual or at least semi-annual 
statement that included the fee, not just an account statement 
that tells you how much money you have at the end of the year, 
but showed you the fee? Could the IRS----
    Mr. Miller. I would have to check on that, but I believe 
the answer is that we could.
    Senator Fitzgerald. I would encourage you to look at that. 
We don't have to wait around for Congress to get to revising 
the statute. If you have that authority, take that up with 
people because we are dealing with a vehicle that was supposed 
to encourage people to save for college, and there are tax 
advantages here, but it looks like high fees are gobbling up a 
lot of the tax benefits. The SEC isn't a player here. There is 
no one to regulate these programs except possibly the IRS. I 
know it is not your usual area, but you are the only ones who 
potentially have any authority. So I would encourage you to 
take that up with the Commissioner.
    Mr. Lanza, would you have any recommendations you would 
want to add here? I know that the MSRB has proposed an 
extensive set of draft amendments to its advertising rules that 
would improve the quality and comparability of performance 
data. If adopted, these rules would only apply to broker 
dealers. Since the rules would not apply to the States which 
also sell the plans directly, how can we ensure consistent 
dissemination of information?
    Mr. Lanza. Right. I should start off by saying that we, in 
fact, are a broker dealer organization and therefore our 
mission is to regulate broker dealers, and so we typically have 
not opined as to what it is that issuers should or should not 
be required to do. We clearly have stated that disclosure is 
fundamental to----
    Senator Fitzgerald. Could you require the broker dealers to 
disclose what the State plans----
    Mr. Lanza. Well, we do require at the time of trade that 
broker dealers provide disclosure to the customer of all 
material information about the program so that if there is a 
material fee, expense or cost, that is covered by our 
disclosure obligation. But again, it only applies to broker-
sold plans. It would not apply to non-broker-sold plans.
    Senator Fitzgerald. Right. So if somebody buys it directly 
from the State, there is nothing you can do about it.
    Mr. Lanza. That is correct.
    Senator Fitzgerald. So they are likely to get more 
information if they go through a broker. However, they are also 
likely to pay a load.
    Mr. Lanza. There is a trade-off, but certainly the States 
are making an effort, it seems, to try to create uniform 
disclosure and we are hopeful that effort will work.
    Senator Fitzgerald. Would any of you have any 
recommendations for Congress on what we might be able--I mean, 
there is nothing any of you can really do about this because 
you don't have any powers over the State Governments that are 
administering these plans. Does it make sense to you that we 
have this additional layer of fees interposed by State 
Governments? Why couldn't Congress just design Section 529 
plans that would allow you to go directly to Fidelity or 
Vanguard or any one of the mutual fund companies and open a 
Section 529 plan and not pay a fee to a State Government? Do 
any of you want to venture forth on that?
    Ms. Schapiro. I probably shouldn't, but I will. That is 
something that clearly should be considered and an option that 
the Congress ought to consider very carefully. There is a 
tremendous amount of confusion because of the different way the 
plans are administered and the different, particularly tax 
issues associated with the contributions at the State level. 
But I also think that if we could have very clear, very concise 
disclosure for investors about fees and expenses on one page, 
so that they could not only see what happens with their in-
state plan, but compare across plans within their State and 
across all the States and then make an informed investment 
decision, that would be a tremendous step forward. The 
comparability from our perspective, whether it is mutual funds 
you are talking about, variable annuity sales, or Section 529 
plan sales, it is absolutely critical for investors to be 
informed of choices.
    Senator Fitzgerald. Do any of you see any reason why 
college savings plans need to be run by State Governments? Is 
there something I am missing here? All I see is an additional 
layer of fees. Do any of you see any benefit to having the 
State Governments be involved? I suppose the one benefit is the 
tax benefit. If they are not running them, they are probably 
not going to give you a State tax benefit, right?
    Mr. Lanza. I would let the States speak for themselves, but 
it is a policy question between the Federal and State 
Government as to where things should lie. Some States provide 
certain benefits that they believe are beneficial to their 
residents and others may not. Again, it is a policy decision, 
at least from the MSRB's view, between the States and the 
Federal Government.
    Senator Fitzgerald. Well, the Federal Government could 
simply make them all tax-exempt, Federal and State tax-exempt, 
and that would be the end of it, and you could go and just buy 
them directly online and not pay an additional layer of fees. 
Am I missing something here? Can you think of a benefit that 
having an additional middleman, in addition to the brokers and 
in addition to the fund managers, having the State Governments 
get in there and get their paws on a fee? Can you articulate a 
benefit we get by setting it up this way?
    Mr. Miller. The only thing I would mention, Mr. Chairman, 
is that the history of these plans is that they grew out of the 
States, and so in the 1980's and 1990's, that is how these 
things were created out of State plans, and when the Congress 
acted in 1996, that is what was in front of it at that time----
    Senator Fitzgerald. Were there any State plans prior to 
1996, or was it in 1996 the State Treasurers Association came 
to Washington----
    Mr. Miller. No. There were, in fact, plans in the 1980's 
and 1990's that States had set up and their tax treatment was a 
point of discussion and contention, to some extent. That was 
clarified in 1996. So that gives some background as to why we 
are where we are today.
    Senator Fitzgerald. So it was just clarified in 1996. It 
arguably may have been--they may have been tax advantaged 
before 1996?
    Mr. Miller. There would be a court case that indicated that 
that was the case. We lose a court case against Michigan's 
Education Trust.
    Senator Fitzgerald. Oh, I see. OK. So in 1996, we made the 
internal build-up in the accounts tax advantaged by Federal 
statute, and then in 2001----
    Mr. Miller. Distribution side.
    Senator Fitzgerald [continuing]. We made distributions from 
the plan, and then the funds have really grown since that time, 
is that correct? Making the distributions tax-exempt when used 
for educational purposes, that has caused additional quick 
    Mr. Miller. We are not tracking that at the Service. 
Inferentially, that would seem right, but I would look to other 
people to answer that question.
    Ms. Schapiro. I would agree with Mr. Lanza. It is really a 
question of where the authority ought to lie, with the Federal 
Government or the State Governments. I will say that it would 
provide a tremendous simplification for the brokerage industry 
to have some uniformity here with respect to the tax treatment 
across all the States and would help with sales practice 
issues, quite honestly.
    Senator Fitzgerald. It is really tough for the brokers, 
too. They may make a mistake, because you have to know the tax 
laws in all 50 States, then, in order to be able to fully 
educate your customers, right?
    Ms. Schapiro. MSRB rules don't require them to specifically 
analyze the different tax treatments of every State. They do 
have to give general disclosures--such as ``there may be an in-
state tax benefit versus going out of State.'' But nonetheless, 
good brokers really do want to be able to explain what the 
impact on the value of an investment is of a tax benefit at the 
State level as well as the impact of expenses----
    Senator Fitzgerald. So the broker's only obligation is to 
say to the customer, if you go out of State, you might lose a 
tax benefit. I don't know, but you will have to look this up. 
He doesn't have to tell you, I am recommending this plan and--
    Mr. Lanza. That is a baseline obligation. If you are 
marketing an out-of-state plan, the duty is to let the 
customers know that they may be missing out on an in-state 
    Senator Fitzgerald. That is a pretty minimal requirement. I 
would think a lot of brokers are going to want to know a lot 
more than that. Say if you are a broker in my State of Illinois 
and somebody is going to go out of State, you are going to want 
to know what happens to your Illinois customers as far as their 
taxes are concerned. So maybe from the standpoint of your 
rules, they don't have a duty of going further, but I would 
think a lot of diligent brokers out there would be forced to 
study the tax laws very carefully here. That seems to me it 
imposes an additional enormous obligation on them.
    Ms. Schapiro. I think that is absolutely right. Brokers 
really do want to be able to give that information to their 
customers. In addition, brokerage firms are working very hard 
to increase the number of States plans that they sell so that 
they can have within their menu of investment options one that 
is an in-state plan for as many of their customers as they can. 
That creates a lot of administrative burden on the firms.
    Senator Fitzgerald. Thank you all for your testimony. I 
appreciate it.
    Senator Pryor, do you have any questions you would like to 


    Senator Pryor. Let me just say, Mr. Chairman, I think you 
have done a great job of quizzing the panel and defining some 
very important issues here. I think I share your concerns about 
the confusing nature and some of the details of this policy 
that we have on the books today.
    I would say this, and I think everybody pretty much in the 
room and probably in the Congress would agree that I think as a 
matter of national policy, it is a good thing for us to get 
more people to go to college. I think that we should find ways 
here in the Congress, whether it is through our tax code or 
whatever, but we need to find ways--if it is creative, so be 
it--but find ways to incentivize people to go to college.
    I think, really, if you look at the Section 529's, that is 
probably the original intent of this, is to allow investors, 
allow people to look at their options and have this as a viable 
option for them to really give them a tax incentive, an 
advantage, if you will, in sending their children to college. 
So that concept is totally acceptable to me. In fact, I think 
it is something that we need to keep on the books.
    But at the same time, some of the ways this program is 
implemented, whether it was intentional or unintentional, I 
don't know and we can't speak for all of that, but I do think 
it is time for us to revisit this. Mr. Chairman, I appreciate 
your leadership on this because I think you have really laid 
out the issues and helped us define the issues so that we can 
proceed on this and hopefully have some positive restructuring 
of the Section 529 program.
    So let me just make a couple observations, but really ask a 
few questions, and that is in looking at the Section 529 
savings plans, I think it is confusing. As I understand it, 
there are at least, or about, six possible fees that could 
apply, and depending on what you are doing and what your 
circumstances are, you may get one or a combination of those 
fees. My impression is that there is just not a very good 
system in place to disclose all of this to the investor. Is 
that fair? Ms. Schapiro, I don't want to pick on you, but is 
that a fair statement?
    Ms. Schapiro. That is a fair statement.
    Senator Pryor. I guess my first question is, why don't we 
just adopt--I know you all can't do it, but why doesn't 
Congress just adopt a uniform fee, just a flat or very easy to 
understand formula, just a uniform fee that would apply to 
this? Do you all see any problem with just a uniform fee in 
some way? Does that create a problem?
    Mr. Lanza. It would be a different approach than currently 
exists elsewhere in the marketplace, but I see no legal 
    Senator Pryor. All right. Well, let us talk about that. 
What currently exists in the marketplace today?
    Mr. Lanza. Typically, for example, the MSRB--and again, our 
jurisdiction is limited to broker dealers--we are statutorily 
prohibited from setting fees. The Congress's determination at 
the time that we were created, and I believe it also applies in 
general to the NASD, was that market forces should be left to 
operate. So we certainly don't have any kind of mandate to 
create any kind of fixed fees.
    Senator Pryor. OK. I see these as a little bit different, 
like the Chairman said, because the State has a role in this, 
but anyway, that is good.
    Ms. Schapiro. There actually is, under NASD rules with 
respect to mutual funds, an 8.5 percent cap on sales charges in 
funds where there are no 12b-1 fees or services assessed. 
Otherwise, it is a 6.25 percent cap. But generally, fee caps 
and limits and the dictation of fees has not been done by the 
government or by the Congress but rather set in the 
marketplace. Critical to the marketplace functioning with 
respect to the competition among fees is disclosure that 
investors can understand so that they can make informed choices 
about whether they want to pay particular fees or not----
    Senator Pryor. Right.
    Ms. Schapiro [continuing]. And so that they can understand 
what the impact of multiple levels of fees are on their 
investment's return over time.
    Senator Pryor. Right. As I understand, the SEC has mandated 
the so-called ``plain English'' rule so that investors, when 
they read materials, etc., most investors, at least, can 
understand it or at least come closer to understanding it than 
if it is just filled with legalese. I think the National 
Association of State Treasurers and the College Savings Plan 
Network have come up with what may be considered their version 
of this. It is kind of voluntary disclosure principles, 
guidelines, etc.
    These are voluntary disclosure principle guidelines. Do you 
know how many are complying with these voluntary disclosures? 
Do we have a sense of what everybody is doing out there?
    Mr. Lanza. I don't have a figure. I understand that some 
States have begun to implement it. Others are, I believe, 
waiting for the SEC Chairman's task force report. But again, I 
am not the person to speak to that.
    Senator Pryor. I guess what is puzzling to me about this 
is, and maybe it is because of my Attorney General background 
where we did a lot of consumer protection work, but it is just 
puzzling to me where the States would not want their consumers 
to have full knowledge and a clear understanding of what they 
are getting themselves into. I am puzzled by that. I know that 
you can't speak for them or speak to that.
    Let me ask you just one last question. Is it your opinion 
that the States and the investment community are doing enough 
to allow parents and students to make intelligent investment 
decisions, or do you think that we need to review and revise 
what we have on the books today?
    Mr. Lanza. Clearly, we believe disclosure can be improved. 
I mentioned the six characteristics that we think disclosure 
needs to bring in, which is that it be understandable, 
comprehensive, comparable, universal, accessible, and timely. 
All the information that anyone needs needs to be available in 
a timely manner and in a simple manner and in a way that they 
can compare one State versus the other.
    Again, we are hopeful that the CSPN disclosure principles 
will get them there. It is not an easy process. It will take a 
lot of work and real vigilance.
    I will mention that MSRB also regulates broker dealers in 
the municipal bond area, which has clearly had a longer 
history, and over time, disclosure practices have improved in 
that market, as well, even though there is no mandatory set of 
requirements for disclosure. So certainly it is possible. I 
just can't predict where it will go.
    Ms. Schapiro. I think improving disclosure is key, too. We 
have developed a one-page disclosure document that would lay 
out for investors what fees they pay to buy and own a Section 
529 plan and then, out of those fees and expenses that they 
pay, what is paid to the brokerage firm and to the broker for 
selling that plan. I don't know if it is perfect, but it is 
that kind of point-of-sale, simple, one-page disclosure that 
allows for comparability across different plans that I think 
would be the greatest service we could provide investors in 
this area.
    Mr. Miller. That is not really a tax issue for our side of 
    Senator Pryor. Thank you very much, Mr. Chairman.
    Senator Fitzgerald. Senator Carper from Delaware has joined 
us. You are free to ask any questions or we can bring up the 
second panel.
    Senator Carper. Let me just ask a question of each of the 
witnesses, if I could. Thank you for being here. I apologize 
for not being here to hear your testimony, but I would just ask 
that you briefly give me a take-away or two, what you would 
have us take away from this hearing.
    Steve Miller, you are about the third Steve Miller we have 
had testify in this Congress.
    Mr. Miller. There are a lot of us.
    Senator Carper. I always ask the same thing, like what have 
you been doing since your recording career sort of leveled 
off---- [Laughter.]
    But you still look young. You look great.
    Mr. Miller. Thank you. [Laughter.]
    What we testified on, Senator, were the basic requirements 
for exemption for a qualified tuition program under Section 
529. There is nothing explicit in that that really deals with 
the disclosure area to prospective customers, and I think that 
is a take-away.
    Senator Carper. All right, thanks. Ms. Schapiro.
    Ms. Schapiro. I sound a bit like a broken record, but I 
would say that the key take-away from our perspective would be 
the need for uniform disclosure concerning fees, expenses, tax 
treatment, and all the other unique features of Section 529 
plans that go well beyond the underlying mutual fund 
investment, things like the rollover options and designation of 
beneficiaries and so forth.
    Senator Carper. Thank you. Mr. Lanza.
    Mr. Lanza. I spoke to the broker dealer obligations to 
customers and I think, as Ms. Schapiro said, we believe 
disclosure really is the key in this marketplace because it is 
complex and there are lots of features and the best thing for 
investors as well as the broker dealers who market to investors 
is to be able to understand the marketplace and understand all 
the key features. So we urge the issuer community to really 
work on quality, comparable, timely, and comprehensive 
    Senator Carper. I don't know if any of you have children of 
your own, but some of you may, but if you are giving advice to 
people who have children, about to have children, someday have 
children, what they might want to keep in mind as they prepare 
for their children's education as it relates to the Section 
529's. What would you have them keep in mind?
    Ms. Schapiro. I do have children. I have two daughters, 
both of whom have Section 529 plans. I also serve on the board 
of a college, and so I see from that perspective what 
tremendous burdens are placed on families who are trying to pay 
for a particular private school education, but even today, 
public school education. My advice would be to start saving day 
one. The day the child is born, open a Section 529 plan. Look 
for one with the lowest possible fees and expenses, with a good 
reputation on the part of the mutual fund complex that 
underlies the Section 529 plan, and make regular contributions 
to it, watching the investment very carefully, of course, so 
that if there are issues that arise over time, you can make the 
appropriate changes.
    Senator Carper. Good. Thank you. What college?
    Ms. Schapiro. Franklin and Marshall in Lancaster, 
    Senator Carper. We know where that is in Delaware.
    Ms. Schapiro. That is right. [Laughter.]
    Senator Carper. Gentlemen.
    Mr. Miller. I think that the most likely take-away on that 
is that you really do need to do your homework because the 
plans are very different, and that is really what we would 
suggest, as well.
    Senator Carper. All right.
    Mr. Lanza. I don't think anyone in their right mind would 
want to take financial advice from me, but we have college 
savings plans as well for our children. We think they are very 
helpful. We were very careful in our selection, making sure 
they met with our----
    Senator Carper. What did you consider when you were making 
those selections?
    Mr. Lanza. Well, it is a matter of personal choice. I tend 
to go for the low-cost indexed type of funds. Others have other 
views towards the mutual fund industry in general. Some like 
more actively managed. In my case, it is more of an index fund, 
so I went in that direction.
    Senator Carper. All right.
    Mr. Lanza. But it is a matter of what your personal 
investing style is.
    Senator Carper. How old are your children?
    Mr. Lanza. One is 11. The other one is six.
    Senator Carper. Ms. Schapiro.
    Ms. Schapiro. Eight and ten.
    Senator Carper. Eight and ten, all right. Mr. Miller.
    Mr. Miller. Five years old.
    Senator Carper. Five years old, OK. Fourteen and sixteen, 
and we have a plan for each of our boys, too. Thank you very 
    Senator Fitzgerald. Thank you to this panel of witnesses. I 
did want to tell Senator Pryor there definitely are huge 
variations in fees. I am going to have my staff try and get you 
something that has been worked up by Morningstar. We are going 
to hear from a Morningstar witness. You might want to take a 
look at the fees they charge in Arkansas, too. I won't state 
those publicly, but you might want to take that up with your 
Treasurer back home.
    All of you, you have been great. We appreciate your time. 
Thank you so much for coming here.
    Now, I would like to welcome our witnesses for panel two. 
Our first witness on this panel is the Hon. Michael A. 
Ablowich, who is the Treasurer for the State of New Hampshire. 
Treasurer Ablowich began his 2-year term in January 2003 and is 
responsible for cash management and investment of more than 
$300 million daily, banking relationships, debt management, and 
trust fund management. Treasurer Ablowich also is statutorily 
appointed to a number of State committees, including the New 
Hampshire Municipal Bond Bank and the New Hampshire College 
Tuition Savings Plan Advisory Commission.
    Our second witness is Jacqueline T. Williams, who serves as 
the Executive Director of the Ohio Tuition Trust Authority. The 
Ohio General Assembly created the Tuition Trust Authority in 
1989 to promote savings for higher education. Prior to her 
current role, Ms. Williams held leadership roles as Chief 
Administrative Officer for the Ohio Bureau of Workers' 
Compensation and the Director of Consumer Services for the Ohio 
Consumers Council.
    Our third witness is from my home State of Illinois. Martin 
M. Noven serves as Deputy Chief of Staff to Illinois State 
Treasurer Judy Baar Topinka. Mr. Noven joined the Treasurer's 
Office in 1993 and his responsibilities include supervision of 
all legal, legislative, and policy matters, including program 
creation and new initiatives. Mr. Noven is responsible for the 
implementation and supervision of Bright Start, the college 
savings program established by Treasurer Topinka.
    Our next witness is Richard O. Davis. Mr. Davis is the 
Deputy Executive Director for Finance and Administration for 
the Utah Higher Education Assistance Authority. The Authority 
is a subsidiary organization of the Utah State Board of Regents 
that oversees the operation of the State's student loan 
secondary market activities, guarantor operations, and the Utah 
Educational Savings Plan trust.
    Our fifth witness is Dan McNeela, who is a senior analyst 
at Morningstar, an independent investment research firm. Mr. 
McNeela has researched mutual funds for Morningstar since 
October of 2000 and is the firm's lead editorial analyst 
covering Section 529 College Savings Plans.
    Our final witness is Mercer Bullard, whom we welcome back 
before this Subcommittee. Mr. Bullard also testified at our 
mutual fund hearings in November 2003. Mr. Bullard is the 
founder of Fund Democracy, a nonprofit membership organization 
that serves as an advocate and information source for mutual 
fund shareholders and their advisors. Mr. Bullard also is an 
assistant professor of law at the University of Mississippi, 
where he teaches in the areas of securities and banking 
regulation, corporate finance, and contracts. I know one of my 
staff members was keeping abreast of the conference you held on 
mutual fund ownership down in Mississippi, and you have been a 
great advocate for investors. We thank you for being here.
    To the best of your ability, please try to summarize your 
remarks within 5 minutes. We will take your full written 
statements for the record, and we will make them part of the 
record. Thank you all for being here.
    I would like to begin with Treasurer Ablowich from New 
Hampshire. I went to Dartmouth College in Hanover, New 
Hampshire, so I have some connection to your State. Welcome.


    Mr. Ablowich. Thank you very much, Mr. Chairman and Members 
of the Subcommittee. My name is Michael Ablowich. I am the 
Treasurer of the State of New Hampshire and trustee of both the 
UNIQUE College Investing Plan and the Fidelity Advisor Section 
529 Plan, both of which are sponsored by our State. I would 
like to have my written testimony entered into the record of 
this Subcommittee, please, Mr. Chairman.
    \1\ The prepared statement of Mr. Ablowich appears in the Appendix 
on page 90.
    Senator Fitzgerald. Without objection.
    Mr. Ablowich. I am also a member of New Hampshire's College 
Tuition Savings Plan Advisory Commission and a member of the 
College Savings Plan Network, which is an affiliate of the 
National Association of State Treasurers. CSPN coordinates 
State college savings efforts by harnessing the collective 
resources of States to improve industry practices and develop 
self-regulating policies.
    It is my sincere pleasure to be here today to speak with 
you about Section 529 College Savings Plans, the State of New 
Hampshire's perspective, and philosophy regarding these plans 
and how States are making them successful.
    The States have been working with Congress for over a 
decade to increase access to college by helping families 
overcome one of the greatest barriers to college, the ever-
increasing cost of higher education for their children.
    New Hampshire's story is really no different in this case. 
We began our Section 529 plans in 1998 and since then, 
residents in New Hampshire and other States have responded to 
these plans with excitement and enthusiasm. More than $3.3 
billion has been invested in more than 330,000 accounts in our 
two programs combined. That high level of response is even more 
amazing when you consider that we started these plans a couple 
years before one of the most challenging financial markets in 
    Investors clearly understand the need for higher education 
and the principle of saving early and regularly in a tax 
advantaged account. Of course, while periodic investing 
strategies do not guarantee a profit or protect against loss in 
a declining market, investing in a Federal income tax-free 
vehicle like a Section 529 plan may be one of the simplest and 
best ways for families to start saving for college.
    Our Section 529 plan is built on the foundation of putting 
investors and beneficiaries first. We make every program 
decision with the interests of our investors in the forefront, 
and while we maintain an outstanding relationship with our 
private sector partner, our first priority is always to our 
investors, the plan participants. That is why New Hampshire 
currently has two Section 529 plans to choose from, each 
offering investors a different method of deciding on which 
investment options are best for them.
    The UNIQUE College Investing Plan is sold directly to 
investors and the Fidelity Advisor Section 529 Plan is marketed 
to investors through intermediaries, like financial planners or 
brokers. Both plans give investors a wide range of college 
savings options to satisfy their college savings goals. Our 
retail UNIQUE plan is designed with smaller investors in mind, 
but these investors, they can get started with as little as $50 
and $50 monthly contributions, or for a one-time contribution 
of $1,000. It is our goal to offer solid investment choices to 
attract a wide range of investors with varying risk tolerances 
and investment philosophies.
    Everyone talks about the amount of money saved in Section 
529 plans, and it is substantial, but I believe the more 
important statistic is the number of accounts. I really don't 
care whether people are saving $50 or $50,000 as long as they 
save. I am also not concerned whether they save in one of our 
two Section 529 plans or in another plan or, frankly, in their 
name in a traditional bank savings account or some other 
method. The important thing is that parents are making plans 
for one of the most important investments in their lives, their 
children's education.
    In New Hampshire, we have worked to develop college savings 
awareness to ensure that every resident, regardless of income, 
understands and has easy access to the Section 529 plan and 
other college financing options. We have also made this 
decision simpler for our residents by allowing them to receive 
favorable State tax interest and dividends tax treatment 
regardless of the plan they participate in.
    The States have a legitimate vested interest in making 
college more affordable and accessible to their citizens. In 
New Hampshire, the Treasurer's Office is responsible for our 
Section 529 plans, as is the case in most States. We have been 
entrusted with looking after the hard-earned dollars of 
families who are saving for their children and grandchildren's 
    Our Advisory Commission meets regularly to review plan 
operations, the performance of securities markets, and 
performance in each of the portfolios and investment options 
available to our investors. We have worked hard to ensure that 
our Section 529 plans, whether bought directly or through 
financial advisors, offer competitive fees that are fully 
disclosed to all investors.
    We also spend much time reviewing the performance of each 
portfolio to ensure that investors are earning competitive 
returns net of fees compared to the appropriate benchmarks. 
This allows me and our commission to exercise full and 
effective control over the program as well as oversee our 
private sector program manager. Every significant decision made 
regarding the plan, whether investment-related or 
administrative, is analyzed and approved by the commission. The 
roles of the Treasurer and the Advisory Commission and the 
terms of the contract with Fidelity Investments, our plan 
administrator, have been approved consistent with the process 
used for all State contracts.
    After listening to the customer concerns regarding 
disclosure and transparency, the National Association of State 
Treasurers and the College Savings Plan Network have undertaken 
an effort to create voluntary disclosure principles. These 
principles were adopted in draft form with input from our 
private sector partners this May at the Network's annual 
meeting. The National Association of State Treasurers has also 
adopted the principles at its annual conference earlier this 
    The goal of the principles is to provide a framework for 
disclosure so that investors can easily understand his or her 
own State's plans compared to other Section 529 plans on an 
apples-to-apples basis.
    Senator Fitzgerald. You have got to wind it up.
    Mr. Ablowich. Can I have 2 more minutes, Mr. Chairman?
    Senator Fitzgerald. We will give you time in the question 
and answer segment. We have got to give everyone an 
opportunity. We want to stay to that 5 minutes, so please watch 
these lights. We will come back to you.
    Mr. Ablowich. Thank you, Mr. Chairman.
    Senator Fitzgerald. Thank you very much, Treasurer. Ms. 


    Ms. Williams. Thank you, Mr. Chairman and Subcommittee 
Members. I am Jackie Williams, Executive Director of the Ohio 
Tuition Trust Authority and I appreciate the opportunity to 
share one State's perspective on Section 529 plans and 
hopefully clear up some misperceptions and highlight the 
enormous value these plans provide to America's families.
    \1\ The prepared statement of Ms. Williams appears in the Appendix 
on page 103.
    Our agency is an independent State agency governed by an 
11-member board comprised of business, education, and elected 
leaders in our State. In 1989, Ohio was one of the first States 
in the country to offer a Section 529 qualified tuition 
program. The General Assembly created the plan to make higher 
education more affordable and accessible for all Ohio citizens. 
Since inception, our State provided tax-exempt earnings to 
encourage early savers. Only 11 States have fewer college 
graduates than Ohio, and a recent report by our governor 
indicates that our economic future depends on increasing 
participation in higher education.
    The Tuition Trust first offered a unit-based prepaid plan 
designed to keep pace with tuition inflation at Ohio's public 
universities. The plan enjoyed wide acceptance and market 
success. Long before I became an employee of the plan, I 
financed the education of my two sons through the guaranteed 
    In 1994, the Ohio General Assembly and Ohio voters approved 
a constitutional amendment putting the State's full faith and 
credit backing behind the plan if it could not meet future 
    In 1996, Ohio's plan fell under guidelines established by 
Congress establishing qualified State tuition programs and 
adding Section 529 to the Internal Revenue Code. These changes 
have encouraged more States to offer college savings plans and 
expanded their ability to offer new investment choices and tax 
incentives. Legislation to take advantage of the Federal 
changes was approved unanimously by the Ohio General Assembly 
in 1999, and this also created new investment options and added 
a $2,000 annual State tax deduction on contributions.
    Launched in the Fall of 2000, College Advantage included 
the original prepaid plan and the new actively managed 
investments. We were one of the first States to offer both a 
director-sold and an advisor-sold program. We found that many 
savers wanted investment advice from financial professionals 
and were willing to pay to receive it and that there were also 
do-it-yourself investors who wanted to make their own 
investment decisions and wanted a broad range of low-cost 
options. With product enhancements and improved distribution, 
we have over 266,000 beneficiaries in Ohio alone.
    The Federal Tax Act of 2001 permitted a tax exemption on 
earnings on funds when they were used for qualified higher 
education expenses. When that law took effect in June 2001, 
there were a million-and-a-half U.S. children with Section 529 
accounts valued at $9.5 billion. Three years later, Section 529 
plans have become the preferred college savings vehicle, with 
6.8 million accounts valued at over $54 billion. Unfortunately, 
unless extended by Congress, the Federal law will expire after 
December 2010.
    For 15 years, our organization has worked very hard to 
educate people to determine what kinds of products and features 
to offer, how best to inform and educate, and how to distribute 
products to a broad cross-section of the public. Each 
investment manager is selected through a rigorous competitive 
process subject to State procurement laws.
    We currently work with two investment firms, Putnam 
Investments, which provides actively managed investment 
products, and the Vanguard Group, which provides passively 
managed index funds. Recently, we selected an Ohio bank to 
develop a Section 529 banking product. Our goal is to make 
investment vehicles available to savers at every level of 
income, education, and investment experience.
    We encourage families to save through flexible contribution 
methods, such as electronic funds transfer, payroll deduction, 
and online investing. Participants pay no application or 
service fees. Ohio residents pay no annual account fees. And 
account fees are waived for non-residents who are participating 
in systematic investing. A College Advantage account can be 
opened for as little as $15.
    And while expense ratios vary by investment, our direct-
sold plan offers some of the industry's lowest fees and our 
advisor-sold fees are about average for advisor-sold actively 
managed funds. Obviously, enhancing disclosure of fees and 
performance is a very high priority of ours and we fully 
support CSPN's direction on this.
    Earlier this year, we took a leadership position and 
disclosed all of our fees on a single page in our opening 
statement. I would just like to say that there are a number of 
organizations that rate Section 529 programs, and I think in 
many cases they have done a disservice to the people who read 
their reviews and have not shed light on these plans. Frankly, 
much of their information has a very long shelf life, and these 
plans are dynamic ones which can change the day after these 
articles are written. For example, the Rhode Island J.P. Morgan 
fund no longer exists. So clearly, it is in the best interests 
of States, as well, to make sure that our information is out 
there and that the organizations reporting on them are using 
accurate, timely information. Thank you very much.
    Senator Fitzgerald. Thank you, Ms. Williams. Mr. Noven, 


    Mr. Noven. Thank you. Good morning, Chairman Fitzgerald and 
Members of the Subcommittee. I would like to enter my written 
comments into the record, as well.
    \1\ The prepared statement of Mr. Noven appears in the Appendix on 
page 107.
    Senator Fitzgerald. Without objection.
    Mr. Noven. Thank you. We appreciate the opportunity to 
present this testimony. I personally appreciate your inviting 
me to testify on behalf of Treasurer Topinka. She feels very 
strongly about a number of the issues that you are discussing 
and appreciates the opportunity to share her views on the 
    When these State Section 529 programs were set up, they 
were set up so that there would be someone looking out for the 
interests of consumers. They were set up by States so they 
would have a product to offer their investors in-state and 
their consumers in-state that would be protected by someone who 
was looking out for their interests so they could feel 
comfortable that they weren't paying high fees, that they 
weren't getting false information.
    In that spirit, Treasurer Topinka created the Bright Start 
College Savings Program. It wasn't an easy program to start. 
Legislatively, we had a difficult time getting authority. We 
were actually forced by the banking industry to include some 
unique provisions in our law that made it more difficult to 
have a successful program. For example, all contributions and 
applications have to go through Illinois banks to participate 
in the Illinois plan, and banks even have the option, although 
very few actually--it is a negligible amount have actually 
taken advantage of it--to have some deposits on hand as part of 
the investments that are in the participants' portfolio.
    So we worked very hard to get a plan together. We were glad 
that despite the fact that we had a hard time getting people to 
respond to the RFP and some of the responses that we did get 
had inflated fees because of our unique requirements, we were 
able to negotiate a contract with Smith Barney that gave us one 
of the lowest-cost programs in the Nation. It gave a tremendous 
amount of control to the Treasurer to protect consumers. And 
also, with their affiliation with Citibank, they were able to 
comply with our enabling legislation.
    We are extremely pleased with the success of the Bright 
Start program. We have more than 100,000 accounts that have 
been opened. Our performance places us among the top in the 
Nation. We have done all of this without engaging in the 
problems that you have mentioned: The high fees and 
commissions, the questionable sales practices, the inadequate 
disclosure. We feel very strongly that all of these are 
important things that we need to consider. We applaud the 
efforts of the Federal regulatory agencies that are looking at 
some of these issues. We think it is important.
    When the largest programs in the Nation, the ones that are 
growing the fastest and being sold most aggressively and have 
the most consumer assets, are the ones that are least consumer-
friendly and are the ones that charge consumers the highest 
fees so they have the least amount of assets to grow, like you 
mentioned on the charts that you have, we have got a real 
problem here and we are glad that it is being looked at.
    We have been fighting that battle in Illinois, as well, 
where two dollars is being invested out of State in these high-
priced broker-sold plans for every dollar that is being 
invested in-state. The performance of these plans has not been 
better than Bright Start. The broker fees are higher in these 
plans. These citizens are paying higher fees and not getting 
the tax benefits in Illinois. That has caused some concern in 
Illinois, and instead of the brokerage community dealing with 
this conflict by changing their selling practices, they have 
come after us with a fleet of lobbyists in Springfield, trying 
to force us to extend those benefits to encourage Illinoisans 
to go to plans that are not in their best interests as a 
consumer. Those are the concerns we have.
    We have tried to extend our State tax benefits to any other 
State plan that will agree to adequate disclosure and the 
industry killed the bill. We tried to extend it to any plans 
that had reasonable sales charges. The industry killed that 
bill. We offered--it was a legislative proposal, it didn't get 
to the bill form--if other States would treat Illinois 
residents as well as they treated their own and not charge 
extra fees and commissions to help pad their State treasury, 
extend the tax benefits to them, and the industry rejected that 
    So we have been working very hard on this issue. On a 
state-by-state level, we fear that States are competing with 
each other for assets as opposed to looking out for consumers, 
as was the original intention of this bill. We very much 
welcome the chance to address these issues.
    Senator Fitzgerald. Thank you very much, Mr. Noven. Mr. 


    Mr. Davis. Thank you, Mr. Chairman. Mr. Chairman, Members 
of the Subcommittee, my name is Richard Davis, Deputy Executive 
Director for Finance and Administration for the Utah Higher 
Education Assistance Authority, which is a subsidiary board of 
the Utah State Board of Regents. We manage the Utah Section 529 
plan as part of our role to provide financial and informational 
assistance to Utah residents.
    \1\ The prepared statement of Mr. Davis appears in the Appendix on 
page 112.
    The Utah plan was set up in 1996 as a State agency and is 
governed by a 17-member Board of Directors comprised of members 
from both private and the public sector. In response to the 
burden of increasing costs of education, the Board of Directors 
was charged with creating a safe, simple, and low-cost college 
savings program. The Board made a conscientious decision to 
create a plan that charges the lowest fees possible. To 
maintain these lower costs, the Board has chosen to offer its 
plan, manage it internally, and market it directly to 
investors. For example, a Utah account with a balance of 
$10,000 will pay, on average, between $50 and $60 of fees per 
year, depending on the investment options.
    A Utah savings account may be established with no 
enrollment fees and an initial deposit as low as $25 per 
family. Once this account has been created, there are no 
deposit requirements and the account holder may choose a 
payment schedule that meets their specific needs.
    We have ten investment options utilizing nine Vanguard 
mutual funds and the Utah Public Treasurer's Investment Fund, 
which mirrors the attributes of a money market account. We have 
four static investment options where the allocation of funds 
remains the same throughout the entire time the account is open 
and five different age-based options, all of which provide 
portfolios that change the allocation of funds to become more 
conservative as the beneficiary approaches college enrollment.
    Residents of Utah also benefit from a State tax deduction 
of up to $1,470 currently, or $2,940 on a joint return.
    As a confirmation of the value of this decision to offer a 
low-cost college savings plan, Utah has been consistently rated 
by various investment research organizations and financial 
magazines and other third parties as among the top five Section 
529 plans in the Nation. Although we only market within the 
State of Utah, 80 percent of our participants are non-Utah 
residents, out of State.
    We recently began a new pilot program which provides 
matching funds for low-income families in Utah. We provide a 
matching incentive of up to $300 per year for 4 years for 
families with incomes up to 200 percent of the Federal poverty 
    As a member of the College Savings Plan Network, Utah 
supports the effort to create a voluntary disclosure system 
among the various plans. We are currently working towards 
developing and refining our own offering materials to meet the 
objectives of the disclosure principles and plan to provide 
materials that will help consumers make more informed and 
objective comparisons of fees and expenses.
    Mr. Chairman, Section 529 plans in general and Utah in 
particular have proven to be very successful among families as 
they plan for their children's education. Congress set out to 
create a simple and easy-to-understand process to assist 
participants save money for college. We believe this goal is 
being accomplished every day through the continued growth in 
these plans.
    Thank you, Mr. Chairman and Members of the Subcommittee. I 
appreciate the opportunity to speak here and would be pleased 
to address any questions.
    Senator Fitzgerald. Mr. Davis, thank you very much. Mr. 

                        MORNINGSTAR, INC

    Mr. McNeela. Thank you. I ask for my written testimony to 
be entered into the record.
    \1\ The prepared statement of Mr. McNeela appears in the Appendix 
on page 114.
    Senator Fitzgerald. Without objection.
    Mr. McNeela. Thank you for the opportunity to appear before 
this distinguished Subcommittee. My name is Dan McNeela. I am a 
senior analyst with Morningstar, Inc. My testimony focuses on 
the shortcomings of Section 529 plans and the steps that can be 
taken to ensure that the generous Federal tax breaks are not 
    Some of our greatest concerns relate to the host of costs 
investors pay to participate in a Section 529 plan. Investors 
face enrollment fees, account maintenance fees, administrative 
fees, management fees, and in many cases, broker fees. Some of 
those costs are dollar-based while others vary depending on the 
amount of assets an investor has in the plan. Most Section 
529's exacerbate this problem by burying this important cost 
information in the back of a 100-page-long program disclosure 
document. At its worst, the complexity of the cost structure 
and the reluctance to make this information easily accessible 
and understandable amount to deceit on the part of Section 529 
    When all the costs are added together, too many Section 529 
plans appear to be prohibitively expensive. One reason these 
plans cost so much is that several groups have lined up to 
collect fees. With States, fund companies, brokers, third-party 
administrators all putting their fingers in the pie, it is no 
wonder that investors can end up with a knuckle sandwich.
    With several plans having investment options whose costs 
approach or exceed 2 percent of assets, investors' ability to 
capture needed investment gains is significantly impaired. 
States offering Section 529 plans need to provide more 
disclosure on how fees are used and how investment managers are 
chosen. Only by opening up these decisions to public scrutiny 
can citizens feel comfortable that the plans are being operated 
for their benefit.
    The final area in need of improved disclosure is 
performance evaluation. To grasp how well a plan is performing, 
investors need to see the performance of relevant benchmarks 
alongside the plan's returns. If this is done properly, plans 
saddled with poorly performing funds and high cost structures 
will have few places to hide. As a supplement to those numbers, 
plans should provide investors with a written commentary 
explaining why the investment options did better or worse than 
their benchmarks.
    This distinguished Subcommittee must decide what, if 
anything, must be done on a Federal level to assure that 
Section 529 plans reach their full potential. Toward that end, 
I submit the following recommendations.
    First, bring uniformity to standards for disclosure and 
transparency by appointing the SEC to set the regulatory 
environment. With the SEC in charge, all plans will be required 
to comply with the same set of rules. That measure will 
increase investor confidence, make comparisons between plans 
easier, and allow for alignment with rules and protections 
already being enforced as they relate to mutual funds.
    Second, ensure that the Section 529 marketplace is 
competitive by granting the Federal tax break only to plans 
that promote fair competition through the adoption of the 
following standards. First would be State tax laws on 
contributions and withdrawals should be applied uniformly to 
all Section 529 plans with no special status afforded to a 
State's own plan. Twenty-six States offer a deduction or tax 
credit on contributions, but typically that benefit is not 
bestowed on those who find an out-of-state plan more 
compelling. Four States grant tax-free withdrawals for citizens 
who opt for the home State plan, but require beneficiaries to 
pay State tax on qualified withdrawals from out-of-state plans, 
and Illinois and Mississippi residents who choose an out-of-
state plan give up both benefits.
    Also, we think it is important to require uniform access to 
Section 529 plans. Some States have seen fit to create two 
distinct plans, one geared to in-state residents while the 
other is for out-of-state residents. This two-tiered system can 
impact the range and quality of the underlying investment 
    Third, we would require uniform fee schedules regardless of 
residency. In addition to restricting access, some States have 
created a special low-cost share class that is available only 
to its residents. Out-of-state investors can't buy the lower-
cost shares and usually must pay a sales load and higher 
ongoing expenses to access the plan. Certain plans also waive 
annual maintenance fees only for in-state residents.
    States protect themselves from competing plans and favor 
their residents over out-of-state investors because they have 
little motivation to act otherwise. Only the Federal Government 
is in position to set appropriate ground rules that will 
promote fair competition and ensure freedom of choice for 
investors. By ensuring a competitive marketplace, the Federal 
Government will guarantee that tax benefits has bestowed upon 
Section 529 plans are not squandered.
    I thank you for your time and I will take any questions.
    Senator Fitzgerald. That was excellent. Thank you very 
much. Mr. Bullard.

                         DEMOCRACY, INC

    Mr. Bullard. Thank you, Chairman Fitzgerald and members of 
the Subcommittee, again for inviting me to appear today. It is 
an honor and a privilege to speak on this very important issue 
and I would like my written testimony to be added to the 
    \1\ The prepared statement of Mr. Bullard appears in the Appendix 
on page 123.
    Senator Fitzgerald. Without objection.
    Mr. Bullard. Today, I am going to deal with the four issues 
that were listed in the title of this hearing: High fees, fee 
disclosure, questionable sales practices, and disparate State 
tax benefits.
    High fees and fee disclosure are actually closely related. 
Seventy years of Federal securities regulation have taught us 
that effective fee disclosure can promote price competition and 
mitigate high fees.
    There is no coincidence that since the adoption of the 
mutual fund expense ratio and fee table, for example, mutual 
fund assets have increased substantially as investors have been 
drawn to the product's transparency and accessibility. Mutual 
fund fee disclosure rules have led investors to migrate to 
lower-cost funds, and these rules, these mandatory rules, have 
thereby created wealth by reducing costs. Effective fee 
disclosure rules have provided Americans with more money to 
finance their children's education and their retirement.
    Effective fee disclosure did not come about voluntarily. It 
came about only as a result of SEC rulemaking. Low-cost 
providers have a strong incentive to provide fee transparency, 
but high-cost providers have an equally strong incentive to 
obscure their fees. Effective fee disclosure should be 
standardized, transparent, understandable, and comprehensive, 
but most of all, it must be mandatory. Only when the high fees 
charged by high-cost providers are required to be disclosed 
will the markets be able to operate efficiently to bring down 
    Sponsors of Section 529 plans have flatly rejected this 
model for fee disclosure. Fees for many Section 529 plans are 
extremely obscure. Section 529 plan sponsors argue that fee 
disclosure should be voluntary and left to the markets. The 
disclosure principles, for example, proposed by the College 
Savings Plan Network strongly emphasize that ``the guidelines 
are not intended to suggest that alternative disclosure 
practices may not be acceptable or a comprehensive list of 
disclosure matters that must be addressed in connection with 
Section 529 plans in order to fulfill their responsibility of 
State issuers to their account owners.''
    As long as obscure fee disclosure is an acceptable 
alternative to transparent fee disclosure Section 529 plan fee 
disclosure will not promote price competition and thereby 
reduce fees. Section 529 plan sponsors that charge high fees 
have a strong disincentive to provide standardized disclosure 
that will only put them at a disadvantage to their low-cost 
competitive. It is essential that Section 529 plan fee 
disclosure be mandatory.
    Congress should also consider addressing high fees by 
limiting certain fees. Mutual fund sales charges are already 
subject to NASD rules that limit the amount of sales charges 
that can be imposed. Section 529 plans should be subject to the 
same limits.
    Limiting sales charges would also reduce high fees while 
addressing another issue, the issue of questionable sales 
practices. By bringing sales charges in Section 529 plans into 
line with mutual fund sales charges, the extra incentive to 
push inappropriate Section 529 plans over mutual funds would be 
removed. But this step is not enough. Brokers will still have 
economic incentives to sell inferior Section 529 plans that pay 
higher sales compensation, as indicated by Mary Schapiro's 
testimony earlier this morning. Brokers may receive higher 
compensation for selling one Section 529 plan than another 
plan, even though the services provided to the broker's client 
are the same. The situation exists because we allow investment 
products to pay brokers to push the product, the functional 
equivalent of a bribe.
    What is even more troubling is that such differential 
compensation is not required to be disclosed to the investors. 
Investors should be made aware of the dollar amount of brokers' 
incentives to recommend one product over another, whether or 
not it is in the best interests of the client. In addition, 
Congress should begin to unravel the regulatory structure that 
effectively requires that sales compensation depend on which 
product the broker sells rather than the quality of the 
services the broker provides.
    The last issue, disparate State tax treatment, arises from 
States granting State tax benefits with respect to 
contributions to in-state plans while denying these benefits 
for contributions to out-of-state plans. This is not 
surprising, as Congress has essentially authorized the States 
to engage in the business of developing and selling financial 
products and it should be expected that they, like any other 
enterprise, will seek to gain advantages over their 
competitors, such as by limiting State tax benefits to their 
own investment products. This practice distorts market 
incentives, however, as it may cause an investor to choose an 
inferior State Section 529 plan that offers a State tax break 
over a superior out-of-state plan that does not. Congress 
should consider requiring that States afford equal tax 
treatment on all Section 529 plans.
    This disparate State tax treatment issue is really a part 
of a broader problem with Section 529 plans. Governments are 
good at funding public projects, and providing tax breaks for 
their citizens' education fits squarely within that role. 
Developing, managing, and marketing financial services products 
is not something that we should expect governments to do as 
well as markets. Congress should expect issues like a disparate 
State tax treatment issue to arise and become increasingly 
    By asking State Governments to invest in the infrastructure 
needed to support Section 529 plans, Congress created a vested 
governmental interest in their continued growth, regardless of 
whether the markets continue to believe that Section 529 plans 
provide an efficient way to save for education. This was 
illustrated during a recent House subcommittee meeting in June 
where a State Representative noted that lifetime savings 
accounts would threaten the viability of Section 529 plans. 
Congress needs to be especially vigilant in protecting against 
the distortions in the financial services marketplace that 
governmental sponsorship of private enterprise invariably 
    Thank you again for the opportunity to appear here today. I 
would be happy to take questions.
    Senator Fitzgerald. Thank you.
    We are going to have some good basis for questions between 
this side of the panel and that side of the panel based on all 
that testimony.
    I want to start out asking Mr. McNeela and Mr. Bullard, you 
both basically seem to go in the same direction I went in my 
opening statement where I was questioning what benefit we get 
by allowing the States to run these plans and just charge an 
extra fee. Is there any benefit that you can see to having the 
States run these plans? Why can't people go to a mutual fund 
provider and open a Section 529 plan and cut out this 
additional layer of fees?
    Mr. Bullard. That is precisely what Congress decided to do 
with 403(b)s, 401(k), IRAs, Roth IRAs, and Coverdell accounts. 
The entire list of accounts that have been created for tax-
deferred purposes have done that and done it very well. There 
is absolutely no reason why States should be in the business of 
creating and developing and marketing these products, thereby 
essentially putting them in competition with industry.
    Senator Fitzgerald. And do all the States charge an 
additional fee for their services? Mr. McNeela, would you know? 
Are there any States that don't charge an additional fee?
    Mr. McNeela. I am not aware of any States that don't charge 
fees. I know Utah does have a money market option that they 
provide at no cost to investors, but outside of that, I am not 
aware of any other State that doesn't charge fees.
    Senator Fitzgerald. If I could refer to this chart that I 
put up earlier \1\ and I showed how much better somebody would 
do if they were in the Utah plan as opposed to the Rhode Island 
plan, which Ms. Williams pointed out no longer exists, and that 
is a good thing, but Utah, as I understand it, you are ranked 
as one of the best year in and year out by Morningstar. Mr. 
McNeela will confirm that Utah has one of the best plans. They 
use Vanguard as your underlying fund provider.
    \1\ The chart entitled ``Value of a $10,000 investment after 18 
years,'' appears in the Appendix on page 165.
    My understanding, your total expense ratio is 27.5 basis 
points. Only 10 basis points of that is Vanguard, am I correct, 
and another 17 basis points is charged by the State of Utah? Is 
that correct, Mr. Davis?
    Mr. Davis. Mr. Chairman, the Vanguard fees can range, 
depending on the option selected, up to 42 basis points. That 
is the highest.
    Senator Fitzgerald. So you are not just allowing people to 
invest in index funds? Vanguard's index funds are very low. You 
have some that have expense ratios as high as 43 basis points 
at Vanguard?
    Mr. Davis. Yes, sir.
    Senator Fitzgerald. Are they not index funds?
    Mr. Davis. They are index funds, but not just----
    Senator Fitzgerald. International index?
    Mr. Davis. Yes.
    Senator Fitzgerald. OK. But is it true that you impose an 
additional cost on--the State of Utah charges an additional fee 
on top of whatever Vanguard charges, right?
    Mr. Davis. That is correct.
    Senator Fitzgerald. And how much is that?
    Mr. Davis. That is $5 per $1,000 of account, up to $25 max.
    Mr. McNeela. But I believe there is also an administrative 
fee that is added on, and largely those expenses are to pay for 
customer service calls, administration of the plan in terms of 
servicing and sending out the account statements, unless I am 
missing something, because the Vanguard would just be providing 
the investment management expertise of the index funds and 
administering the accounts would be the responsibility of Utah 
and there would be costs associated with that.
    Mr. Davis. That comes out of the $25.
    Mr. Bullard. Chairman, just to add to the issue of the 
extra layer of fees, that layer of fees will exist no matter 
what economic or regulatory structure is used because the way 
these work is just like 403(b)s, 401(k)s, and all those other 
types of investments. All the investments are pooled by some 
kind of intermediary who keeps track of the accounts. What 
actually goes into the mutual fund is one large account. So 
there will inevitably be those costs. And in 401(k)s, employers 
typically pick them up----
    Senator Fitzgerald. Wait a second----
    Mr. Bullard [continuing]. IRAs, you pay an account fee.
    Senator Fitzgerald. OK----
    Mr. Bullard. So there is a parallel in all of the privately 
offered similar----
    Senator Fitzgerald. Well, 401(k)s, yes, but I know some of 
them have expense ratios, total expense ratios as low as 10 
basis points, for example. But what would prevent someone from 
going to--if Congress authorized individuals to open Section 
529 plans directly at mutual fund complexes, what would prevent 
somebody from going into, say, a Vanguard and getting an index 
fund-based account that had a total expense ratio of 17 or 18 
basis points?
    Mr. Bullard. And that is exactly what would happen, but 
there will be people who live in a market channel where they 
are going to use an intermediary for whatever investment they 
make and----
    Senator Fitzgerald. They might----
    Mr. Bullard [continuing]. They will get high-cost Section 
529 plans----
    Senator Fitzgerald. There will be some who go, but now, 
with the current set-up, you have consumers paying brokerage 
commissions, loads. You have them paying management fees to the 
fund complexes. And then you have them paying a fee to the 
State Governments. I am just trying to figure out what benefit 
the State Governments bring for their additional fees. Now I 
will let the Treasurer defend this.
    Ms. Williams. Mr. Chairman.
    Senator Fitzgerald. Yes.
    Ms. Williams. Can I just make one statement? First of all, 
if an individual were to go to a mutual fund company and 
attempt to open a mutual fund, there is no mutual fund that I 
am aware of that you could get into for a $15 minimum. Mutual 
fund companies typically have very high minimums in order to 
come into many of those funds, and I think the States look at 
it from the perspective that we are trying to make these 
programs available to residents of every income level and that 
is why we establish very low points of entry for people who 
come into these plans. So I think that many people who are now 
able to have very small Section 529 accounts would never be 
able to go into a mutual fund because they simply do not have 
the initial investment amount that would allow them the 
opportunity to get into the fund.
    One thing I would like to correct that Mr. McNeela 
mentioned, you do not have to be an Ohio resident to 
participate in our low-cost options, and I would be happy to 
provide him with a copy of our offering statement.
    Senator Fitzgerald. Mr. Noven.
    Mr. Noven. I do think there is an importance in having 
someone that is overseeing what is being done in this area for 
people who are saving for college that is actually looking out 
for the consumer. In the State of Illinois, we have been able 
to add value in a number of ways. One, we have been able to get 
institutional share classes for investors that they wouldn't 
get on the street. For 99 basis points in Illinois, that is an 
all-in fee. There is no account maintenance fees or set-up fees 
or annual fees, or any other types of additional----
    Senator Fitzgerald. Of that 99 basis points, how much is 
paid to Smith Barney and how much does the State of Illinois 
    Mr. Noven. Smith Barney provides us 5 basis points to 
administer the program. We have a unique statute that the 
Treasurer drafted intentionally that any monies that we bring 
in with the 5 basis points that is above what is needed to 
actually pay for the expenses of administering the Bright Start 
program, anything extra, in excess of that, is refunded as a 
dividend to participants or will reduce the fee of the program. 
So it is not a money-maker for the State of Illinois.
    Senator Fitzgerald. So is your net fee lower than the 99 
basis points?
    Mr. Noven. It will be in the future unless we issue 
dividends. One way or the other, now that we have had a 
successful program----
    Senator Fitzgerald. OK, but of that 99 basis points, how 
much--is Smith Barney keeping all but 5 basis points of that?
    Mr. Noven. Well, out of the 94 basis points that are 
remaining, all the internal fund management fees are paid out 
of that. A broker commission is paid out of that, so it is not 
charged to consumers if a financial advisor sells the product 
    Senator Fitzgerald. It is not possible for a consumer to 
pay a load----
    Mr. Noven. No.
    Senator Fitzgerald [continuing]. Going in----
    Mr. Noven. No. Smith Barney pays the load out of their fee 
because we didn't want consumers that use financial advisors to 
be treated less well than----
    Senator Fitzgerald. Are all the Smith Barney funds that you 
allow Bright Start participants, are they all index funds?
    Mr. Noven. No, they are actively managed funds. We actually 
have some non-Smith Barney funds. We have a lot of control to 
switch funds and make sure that consumers have funds that are 
performing and are doing well. We recently put in--actually, 
now it is probably a year and a half ago--we substituted an MFS 
fund that on the street would cost a consumer 180 basis points 
just in the fund management fees, not talking about a sales 
load or any other added fees, if they bought it on the street. 
They can get that as part of the 99 basis points through our 
program. So we have been able to negotiate some benefits for--
    Senator Fitzgerald. Why would you allow--I mean, 88 percent 
of mutual funds, actively managed mutual funds, underperform 
the market, and they underperform the market almost by the 
exact amount of their fees. The markets returned, on average, a 
little bit under 12 percent over the last 20 years, and the 
average mutual funds returned about 2 percentage points, which 
is exactly their fees. I mean, why would you even encourage 
residents to go into an actively managed fund if they are just 
going to pay higher fees?
    Mr. Noven. There certainly is the age-old debate as to 
whether you are wiser to invest in an actively managed product 
or an indexed product. I think everyone would agree, if you are 
not looking out for your investments, if you are not an 
informed consumer, if you don't have a State entity looking out 
for you and making sure those funds are performing with enough 
extra benefit to justify the fees, then you would be better off 
to invest in index funds. We are not a passive investor as the 
State Treasurer of Illinois----
    Senator Fitzgerald. If I invested in a Bright Start index 
fund, will I pay less than the 99 basis points?
    Mr. Noven. Well, we don't have an index fund that is 
currently offered, although we are looking at----
    Senator Fitzgerald. There are no index funds that are 
    Mr. Noven. In Bright Start? No, there aren't. We are 
looking to expand our offerings. I don't want to go down that 
road, but the Treasurer is----
    Senator Fitzgerald. Fidelity's index funds charge 10 basis 
points now. They have lowered their fees to 10 basis points.
    Mr. Noven. We have had a fortunate run, Senator, but we are 
lucky to have outperformed the index, our benchmarks and 
outperformed what an index fund would have done. Of course, you 
never know how it is going to look over time, but so far, we 
have been successful and we are committed to trying to give the 
best investment product we can to consumers.
    Senator Fitzgerald. Mr. Ablowich.
    Mr. Ablowich. I guess, Mr. Chairman, one of the comments I 
would make is with regards to active management. While I think 
that your chart is an accurate mathematical calculation of the 
value of fees net of expenses and a return, I think one of the 
other things that we would emphasize in our plan is that we use 
100 percent actively managed funds. We also use, which a lot of 
plans do, so-called age-based portfolios, so that when you 
first start out investing for your child--and I have a 10\1/2\-
year-old son that I participate in our plan for. When I opened 
the account for him when he was younger, it is much more--it is 
more heavily weighted in equities and over time it shifts more 
towards fixed income and cash.
    So in your example, let us assume you have a constant 8 
percent compounded annual return. But what we think customers 
are concerned about is not necessarily seeing a straight line 
up at 8 percent, but as the markets go up and down, capture the 
up side, but also, when your child is ready to go to college, 
make sure those dollars are there. You may not be willing to 
accept the volatility when your child is a junior in high 
school or a senior in high school when you are waiting to pay 
tuition perhaps in 1\1/2\ or 2 years from now.
    Senator Fitzgerald. Your New Hampshire Fidelity Advisor, 
the sheet that I have, suggests that it has a maximum expense 
ratio of 130 basis points. Is that right?
    Mr. Ablowich. That would be for the advisor-sold product, 
that is right, Mr. Chairman. Again, two products, one advisor-
sold, broker-sold plan. There are some people who like working 
with a broker. The broker will give them that personal advice 
with regards to the unique plan, or assuming a Fidelity 
    Senator Fitzgerald. That includes Fidelity's fee and 
whatever you take?
    Mr. Ablowich. Correct.
    Senator Fitzgerald. How much do you retain of that 130 
basis points?
    Mr. Ablowich. In the 130 basis points you are looking at 
there, I am assuming that includes not only the underlying fee 
on all the mutual funds, but also 30 basis points that is split 
between the State and Fidelity investments, and there is 
probably in that number, as well, a trail for the broker that 
sold the advisor-sold product. Which is standard mutual fund 
    Senator Fitzgerald Our Federal mutual fund, the Thrift 
Savings Plan, would any of you care to guess what we pay in 
expense ratios----
    Mr. Bullard. I was in it, and it ranges between about 5 and 
8 basis points.
    Senator Fitzgerald. Yes. It is going to be like 5 basis 
points for our total expense ratio. It is all index funds. We 
are lower than any of the private sector index funds out there 
but you get much lower expenses by going into low-cost index 
funds. I am just having trouble understanding, other than the 
tax advantages of having a Section 529 plan, it seems to me if 
the fees are so high in so many of these, so much higher than 
just index funds that anybody can go to, why would anybody be 
in the Section 529 plans but for the tax advantages?
    Mr. Ablowich. I think one of the issues to consider, Mr. 
Chairman, is the issue of the active management and an age-
based portfolio, that you can't have that security over time. 
You may be willing to take more risk at the beginning, but for 
some investors, they are not willing to sit down every year and 
constantly review their portfolio to make sure they have the 
right amount of risk given the investment horizon that they are 
looking for.
    So part of that cost, we believe, also goes to help an 
active management so that over time, you become more 
conservative, and again, limit that risk at the end of the 
period when they are ready to pay for tuition.
    Mr. Bullard. Those lifestyle funds are also available in 
the private marketplace. There is nothing unique about Section 
529 plans that provides you can only get them there. In fact, 
if Section 529 plans were run like IRAs, you would have exactly 
the same funds being offered privately.
    Mr. McNeela. Right. And Utah, primarily using index funds, 
has age-based options, as well, that get more conservative as 
the child moves up to college age. So the bulk of that asset 
allocation decision can be handled easily in the framework of 
an index fund. The only potential for active management to 
surpass that is if they made a market call saying that the 
stock market was highly valued and pulled below to a low level 
of stocks relative to bonds to kind of mitigate some 
volatility. But it is questionable about how much benefit there 
is to that effort.
    Mr. Bullard. If I could just put a face on Mr. Noven's 
point about protecting the residents of Illinois from high-
priced products, Mississippi has a $20,000 deduction for 
contributions to its plan, but this year, I plan on investing 
in the Utah plan because I would give back all of that tax 
deduction in a matter of years because Mississippi's products 
are more expensive. I wonder how Mr. Noven explains to his 
constituents why those who choose lower-cost investments--and 
that would be easy to do at 99 basis points--why they are 
deprived of the Illinois State tax benefit if they go outside 
to get a better product than what Illinois is providing, not to 
mention the fact that Mary Schapiro's testimony shows that your 
argument is simply failing. We have got 95 percent of these 
brokers, whether or not the State tax benefit is available 
somewhere else, going somewhere else.
    So the plan isn't working. It deprives people of choice. 
And it ends up--and it has ended up for me costing me more 
money because I won't be able to use the Mississippi State tax 
    Senator Fitzgerald. If I can defend Mr. Noven, that may not 
be his responsibility. That is probably our State legislature 
that enacted the tax laws that penalize you if you go out of 
State, is that correct?
    Mr. Noven. What we did in Illinois is we sought to get the 
tax benefits to our residents when 35 States offered tax 
benefits to their own residents and it was primarily a state-
by-state program. We sought to give those same benefits to our 
residents that other States got in their home States.
    What we have recently tried to do is promote legislation 
that would give the tax deduction to plans that were low-cost 
plans. We don't think that the State should, as a government, 
provide a tax incentive for people to make bad financial 
decisions by going to the fastest-growing, highest-cost 
programs in the Nation.
    The industry hired lobbyists to kill the bill that would 
have extended these benefits to other low-cost programs because 
they don't want the other low-cost programs to get traction. It 
is truly a consumer issue.
    We agree with you. I agree with what these folks are 
saying, other than 99 basis points being high because that is 
an all-in fee. That is not one of five different fees that is 
being charged. And if you look relative to other programs, it 
is one of the lowest cost in the Nation.
    Senator Fitzgerald. Do you agree with Mr. Bullard's comment 
earlier that Congress should act to limit the States' abilities 
to offer the tax benefits only to their own benefits?
    Ms. Williams. Mr. Chairman, can I just say that, coming 
from a State where we do offer a tax deduction, we feel that it 
is the State's exclusive prerogative to decide whether they are 
going to offer a tax deduction and to whom to offer it. 
Frankly, very few States would be willing to extend a tax 
benefit to plans over which they exercise no fiduciary 
    The other thing is that States lose tax revenues by 
providing deductions.
    Senator Fitzgerald. We require you to give tax benefits for 
401(k)s, don't we?
    Ms. Williams. Well, that, I don't know. I can't address the 
401(k). I do know that with a Section 529 plan, in Ohio, you 
can only get the State tax deduction on contributions if you 
participate in our plan. However, on withdrawal of the funds, 
the withdrawals are State tax-free and the State allows that 
consideration for any plan.
    So I think the key is for States to provide effective 
product offerings so that they can be competitive, but I think 
that States are going to----
    Senator Fitzgerald. But they are enacting protectionist 
legislation protecting----
    Ms. Williams. Well, we certainly aren't----
    Senator Fitzgerald [continuing]. Their own State's program 
from competition.
    Ms. Williams. We certainly aren't, and I think that if 
these programs, particularly in a time of difficult State 
budgets, if our State were required to extend State tax 
benefits to any plan operating in the country, what would end 
up happening is that the State would withdraw the tax deduction 
for all plans, which I really think is what some in the 
industry want. If they can't provide a competitive product and 
be competitive without the State tax benefit, then perhaps they 
shouldn't offer a plan. But I think that the State has the 
prerogative to offer a State tax deduction only for their own 
plan if they want.
    Senator Fitzgerald. Mr. Bullard.
    Mr. Bullard. So what you are telling Ohio residents is, we 
will give you a State benefit. We really want you to be able to 
afford college. But we will only give you the State tax benefit 
if you buy my product.
    Ms. Williams. That is exactly what we are telling Ohio 
residents, but we have told any Ohio resident that there are a 
wide variety of options available and we ask that they be very 
well educated. It is in our benefit as a State in the final 
analysis if every single child in our State has a Section 529 
plan, whether it is ours or another State's, because that means 
that there are resources available for that child to attend 
college, and hopefully they will stay in our State and 
contribute to the economy in our State. So we try to be 
competitive by offering a very wide variety of product 
offerings, and by the way, we do happen to have a tax 
    Senator Fitzgerald. Mr. Noven, when you mentioned you would 
like the money to be invested in-state, with Illinois, you 
appointed Smith Barney as your agent as trustee and they are 
not based in Illinois. They are part of Citibank and they are 
based in New York. So the money isn't invested in Illinois, is 
    Mr. Noven. Yes, but I don't believe I made that statement. 
If I did, I didn't mean to state that. Also, to the previous 
question, if Congress----
    Senator Fitzgerald. There is no real benefit when a lot of 
the States say, we want to keep this invested in-state. The 
money is really not invested in-state unless you are in New 
York or Massachusetts or maybe California or Philadelphia, 
where Vanguard is. In most States, it is not an issue. The 
money is not going to be invested in-state even if the plan is 
sponsored by a State.
    Mr. Noven. We are not talking about those assets actually 
being invested physically in-state. There are two things about 
having assets in Bright Start that are important to Illinois 
consumers. One, we believe it is a tested program. We are 
looking out for consumers and they are not being charged 
excessive commissions and fees. They are getting adequate 
disclosure. The Treasurer is not seeking to get any assets of 
any individuals in the State if they would do better in their 
home State because of tax benefits. We are running a consumer-
friendly program that we feel good about, so we feel good about 
having our consumers in it.
    Also, there are economies of scale when it comes to college 
savings programs. We have 100,000 Illinois families that are 
invested in Bright Start and if Bright Start is raided by out-
of-state programs that are entering into this broker bidding 
war to get brokers to ``sell mine, sell mine,'' then Illinois 
residents are hurt, and 100,000 Illinois families will be hurt 
because our program will not be able to be viable unless we 
compete by paying brokers high fees, and we don't want to enter 
into that bidding war. We want to have a nice even playing 
field. We would welcome Congress taking control of some of 
these issues.
    Senator Fitzgerald. How do consumers in Illinois benefit 
from having to go through the State of Illinois to invest in a 
college savings plan? And I would ask you that and also Ms. 
Williams. I mean, why do we need to have the State Governments 
involved in college savings programs at all?
    Mr. Noven. If Illinois----
    Senator Fitzgerald. Shouldn't you just be able to go online 
on Vanguard and open your own college savings account and just 
pay Vanguard's fee and not a fee to the States?
    Mr. Noven. If Illinois consumers went directly to buy all 
the funds that are part of Bright Start currently, they would 
pay higher fees overall than if we hadn't put this program 
together, we wouldn't have negotiated institutional share 
classes that were lower using the economies of scale. We are 
bringing a billion dollars to a vendor. We are able to use, in 
the same way that we do with our Illinois Funds Investment 
Program in Illinois that I am sure you are familiar with----
    Senator Fitzgerald. States haven't negotiated low fees. 
Some of them have negotiated awful fees.
    Mr. Noven. Right.
    Senator Fitzgerald. The Rhode Island J.P. Morgan Higher 
Education Fund, 4.75 percent sales load, 135 basis points 
annual expense ratio, annual fees. You get clobbered in some of 
    Mr. Noven. We agree, and those are the programs that we are 
unwilling to provide our tax benefits to and give consumers an 
incentive to join, because those are the types of programs that 
are not a good deal for Illinois consumers.
    Senator Fitzgerald. But will you provide your tax benefit--
    Mr. Noven. To Utah? Absolutely. We tried to. We tried 
multiple pieces of legislation that would have given the tax 
benefit to people who invest in Utah. It is a wonderful 
program. It has got good fees. People should----
    Senator Fitzgerald. The legislature defeated it?
    Mr. Noven. Yes. Well, the brokerage industry defeated it 
because they want to sell that plan over there that is on your 
chart and they don't want to----
    Senator Fitzgerald. Has anybody seen patterns of the 
brokerage industry coming in trying to--Mr. Bullard, would 
    Mr. Bullard. I mean, that is exactly what I would expect 
them to do. But, in fact, whether or not you provide your in-
state tax benefit to those out-of-state plans, the brokers are 
going to sell the out-of-state product and so that theory is 
not succeeding. All you are really accomplishing is the people 
in Illinois who want to buy a better plan, that is, the Utah 
plan, are unable to do that and get the same State tax benefit 
that those who invest in your high-cost plan, your 99 basis 
point plan, get.
    Mr. Noven. Some day, I would like to sit down with you and 
talk about fees and show you what our fees are so we can all 
talk from the same----
    Mr. Bullard. The best thing that a State----
    Mr. Noven [continuing]. But I would like to say, as a 
fiduciary, as State Treasurer, we feel an obligation not to 
provide a financial incentive to make it easier for brokers to 
put people in a plan that is not in their best interest and I 
think the Treasury has an obligation to do that as a policy 
    Mr. Ablowich. Mr. Chairman, one thought I had for you is 
that when we are talking about broker-sold programs in the 
Section 529 area, the pricing is really not that much different 
than broker pricing for any other mutual fund product. I know 
that your Subcommittee has worked, discussed this issue of the 
mutual fund industry and fees and governance and oversight and 
transparency. The National Association of State Treasurers and 
CSPN has a long history of supporting thoughtful efforts in 
this area.
    To the extent that those efforts are successful and costs 
come down and transparencies improve, all of those benefits are 
ultimately passed on, as well, to Section 529 investors, as 
well. I think that is important to mention, because this 
pricing that you are talking about exists today not just in 
Section 529, but in retirement plans and so on.
    The other thing I would offer is that we heard from the 
NASD that they are investigating and gathering information 
about questionable broker practices. At this point, we don't 
have any specific instances of where brokers are making 
unsuitable, or not taking into account the suitability of 
investors. But to the extent that there are those documented 
cases, I welcome--and I know all of my colleagues do--getting 
that information so that we can work with our plan 
    And then also when I go back to Concord, I can walk 
upstairs to see our State Securities Regulator and ask him or 
her, is this something that we should be--what are you doing in 
this area? Here is something you should be aware of, as well, 
because those State Securities Regulators are typically on the 
front line of working with those individual investors. So that 
is another important point I wanted to bring up for your 
    Ms. Williams. Mr. Chairman, can I just say that I think one 
of the things that the States do, long before the savings plans 
were offered, we worked to offer a prepaid plan. We have a 
full-service organization. We have marketing representatives 
who live in various regions of our State who work with very 
small organizations. Increasingly over the years, we have 
decreased the average age of enrollment in our plan to 5 years 
of age. We work with over 2,000 employers in our State to offer 
payroll deduction because we believe that small investors 
should have access to these investments, as well.
    Unfortunately, with the high minimum entry in most of these 
mutual funds, the average consumer would never have the 
opportunity to participate in these mutual funds were it not 
for the fact that we allow them to get in with as little as 
$15. That has been the fact since we first started our savings 
program and we are going to continue to require that people be 
able to get in with as little as $15 and can save as little as 
$15 a month if they want to do it in a systematic way. They 
could not do that if they were enrolling directly with a mutual 
fund company.
    Senator Fitzgerald. What about the disclosures, or the lack 
of disclosures, in the Section 529 area? We have had repeated 
testimony that the State Governments as trustees of these plans 
are exempt from the Investment Company Act of 1940 and don't 
even have to make the minimal disclosures that ordinary mutual 
funds have to make. How do the Treasurers feel about that, Mr. 
    Mr. Noven. Go ahead, Mr. Ablowich.
    Mr. Ablowich. I think that the disclosure principles we put 
together are certainly a very important first step. They are 
not going to be perfect. That is why we have asked the NASD--
well, we haven't asked the NASD--the Securities and Exchange 
Commission and the MSRB to comment on what was prepared to get 
their feedback. Even before we received their feedback, around 
30 States have already started adopting these principles and 
incorporating them into their disclosure documents.
    Senator Fitzgerald. Do these principles require a dollars 
and cents disclosure, or are all the expenses stated in 
percentage terms?
    Mr. Ablowich. They are used in dollars and cents 
disclosure, Mr. Chairman.
    Senator Fitzgerald. They are? OK. That is good. Mr. 
    Mr. Bullard. They provide for dollar disclosure of dollar 
fees. They do not require a dollar disclosure of individualized 
costs and expenses that you are paying. They include an example 
that is similar to the mutual fund example on a hypothetical 
investment, but not individualized cost disclosure.
    Senator Fitzgerald. Mr. Noven, did you have something to--
    Mr. Noven. I was going to say, we support the work that the 
College Savings Plan Network is doing on these disclosure 
requirements but we think they need to be mandatory. We think 
they need to go further. The Treasurer feels especially strong 
about disclosing the fact that there may be tax benefits that a 
resident may be giving up, so that people know that. We have 
that notification in our glossy brochure, not on page 85 of a 
program disclosure statement. We feel very strongly about 
disclosure. We think it is a great first step. We should go 
even further.
    Senator Fitzgerald. I would like to let Mr. McNeela have a 
chance to talk for a second.
    Mr. McNeela. Just from my perspective, it is hard for 
investors to have confidence that they are getting all the 
information they need when the disclosure requirements are 
voluntary and the fund company or the plans can choose to 
follow some of the requirements that are recommended but ignore 
others at their discretion. It makes very little sense to me to 
allow that situation to exist.
    Senator Fitzgerald. You have prepared a chart that is 
available on the Morningstar website,\1\ apparently, that 
discloses the fees for Section 529 plans, and you have the 
program manager's fees on the left and then the expense ratio 
on the right. Are the program manager fees the fees paid to the 
State Governments? Do they include the expense ratio charged by 
the underlying fund manager?
    \1\ The ``529 Plan Information'' chart from the Morningstar website 
appears in the Appendix on page 167.
    Mr. McNeela. The program manager fees typically do not 
include underlying fund fees, but they can include broker 
compensation in the form of 12b-1 fees.
    Senator Fitzgerald. OK. Where it says the Alaska John 
Hancock Fund charges a maximum program manager fee of 165 basis 
points, is that in addition to the maximum expense ratio of 130 
basis points?
    Mr. McNeela. Yes, it is.
    Senator Fitzgerald. It is? So we are up to, like, 3 
percentage points in total fees on that fund?
    Mr. McNeela. It is not always appropriate to add maximums 
and maximums together because sometimes they will give you a 
discount on one or the other, but yes, that sounds possible 
that total expenses could be well in excess of 2 percent if a B 
or C Class share was sold which had large 12b-1 fees, 
administrative fees, and underlying fund fees, as well.
    Senator Fitzgerald. Now, on the Illinois Bright Start plan, 
they list a program administration fee at 99 basis points, but 
then they say an additional 65 basis points is paid in 
    Mr. Noven. That is incorrect. That is an error in the 
    Mr. McNeela. And that was my qualification--I am sorry, if 
I could just talk to that for one minute--where Illinois has a 
flat fee of 99 basis points regardless of----
    Senator Fitzgerald. And that includes the expense ratio----
    Mr. McNeela. But they also make an effort to break out the 
costs for underlying fund fees and administrative fees and 
those vary depending on the investment options, but the total 
always comes out to 99 basis points.
    Senator Fitzgerald. So even if you invest in a lower-cost 
fund, you will still pay 99 basis points?
    Mr. Noven. You are paying 99 basis points to invest in a 
fund that is usually 180 basis points on the street, but you 
are also paying 99 basis points to invest in a fund that may be 
65 basis points on the street because there are the extra 
administrative fees that are charged by the vendor to comply 
with the IRS regulations.
    Senator Fitzgerald. But it is always 99 basis points and no 
other charges?
    Mr. Noven. Right, and we thought that was the best way to 
disclose fees to consumers, to not have a $30 account 
maintenance fee that is paid every year. If you have a small 
balance, that is a huge percentage. So all those other little 
expenses that consumers may not be aware of that they are going 
to get socked with going forward----
    Senator Fitzgerald. Now, you disclose the 99 basis points. 
Do you disclose it in dollars and cents? Do you explain the 
impact of the fees paid by consumers over time? Do you show 
them how much their savings erode over 18 years of investing by 
paying those fees?
    Mr. Noven. We certainly incorporate that into the 
discussion, and we are very interested in----
    Senator Fitzgerald. And if I am in Bright Start, do I get 
an annual account statement?
    Mr. Noven. And monthly statements and regular reporting.
    Senator Fitzgerald. And monthly statements?
    Mr. Noven. Yes. And we will be glad to give you copies of 
what we do. We are very proud of the way we do it and how we 
disclose information. We would be glad to share it with you.
    Senator Fitzgerald. That would be very expensive to send 
monthly statements.
    Mr. Noven. We have a vendor that is required to do that.
    Senator Fitzgerald. Solomon Smith Barney is required to do 
that, but that adds to their whole--they probably charge you 
    Mr. Noven. Well, we believe we negotiated a good contract.
    Senator Fitzgerald. All right. Ms. Williams.
    Ms. Williams. I would just say that I think that a lot of 
States have made a lot of progress in this matter. In fact, we 
do have one page in our document that shows what all the 
program fees and expenses are.
    I appreciate Morningstar and other organizations who are 
looking at these matters, but I guess my concern is how 
frequently is the data updated to reflect changes in State 
programs? I know that in June, Mr. McNeela and I had a 
conversation regarding where they get their information in 
order to be able to display it and how often it is updated. So 
I think it is a good thing and I think that will put pressure 
on States to make sure their information is accurate. I just 
want to make sure that the information is reflected accurately 
and is up to date.
    It is in the best interest of the State to make sure that 
they adhere to these disclosure guidelines and, in fact, that 
they go beyond the voluntary disclosure guidelines, because 
clearly, as it becomes easier to compare plans, their plans are 
going to suffer by comparison if they have made it very 
difficult for people to be able to find the information they 
need to make a valid comparison.
    So my only request would be that information is timely and 
up to date and accurate, because many times, articles have been 
written, comparisons have been made, and information is simply 
not accurate, and that has accrued to the detriment not only of 
the State programs, but also consumers who are trying to make 
valid comparisons and who often find themselves paralyzed into 
doing nothing regarding savings. All the while, college 
expenses continue to escalate.
    Senator Fitzgerald. You don't want to ever offer a bad plan 
because it will stay with you forever, hang out there on the 
Internet and people will see it, even if you have withdrawn a 
bad plan.
    Ms. Williams. That is right.
    Senator Fitzgerald. So maybe the lesson is never to offer a 
bad plan. But listen, all of you have been terrific. I posed 
some tough questions--Mr. Davis, do you have something to add 
    Mr. Davis. One comment, Mr. Chairman. As I sat here between 
crossfire on my left and right, I thought about your question, 
what do States add, and I think it is important for you to know 
that there are a fair number of middle- and low-income people 
in our State who have not been served and are not currently 
served by the free market of the Smith Barneys and the 
Fidelities of our Nation who are now saving. We are working on 
that and we are seeing a tremendous support of that. The fact 
that we have put together a fairly decent program cost-wise 
which has drawn a fair number of out-of-state investors, we are 
seeing much more progress in the State, which the intent of the 
Board was to accomplish. And so that is where our success comes 
    Senator Fitzgerald. Do all of your States competitively bid 
out your asset management?
    Ms. Williams. We certainly do, yes.
    Mr. Noven. Yes.
    Mr. Ablowich. Yes. For the record, yes.
    Mr. Davis. We manage internally.
    Senator Fitzgerald. You manage--well, you have Vanguard, 
though. How did you select Vanguard?
    Mr. Davis. The State Treasurer has dealt with them, among 
    Senator Fitzgerald. Is there a bidding process or a request 
for proposal or how did they do that?
    Mr. Davis. We piggybacked on the State Treasurer's contract 
initially and have stayed there.
    Senator Fitzgerald. OK. In Illinois, I understand you are 
about to rebid?
    Mr. Noven. We are bidding an advisor-sold plan. We are 
concerned that consumers that work through financial advisors 
are not being offered a low-cost, low-commission, quality 
program that would suit their needs. We are concerned that most 
of the brokerage commissions that are being paid--everyone has 
risen up to the 5.75 percent, all trying to jockey for 
    Senator Fitzgerald. What percentage of your participants 
pay a brokerage commission?
    Mr. Noven. Well, none of our participants pay a brokerage 
    Senator Fitzgerald. They can't.
    Mr. Noven. They cannot. Smith Barney absorbs that.
    Senator Fitzgerald. OK.
    Mr. Noven. But a lot of folks that go to brokers that do 
not want to sell the Smith Barney product, they do want to have 
a product to sell consumers in Illinois, their consumers that 
work with them, and if we could find a consumer-friendly 
advisor-sold plan, we think we would be providing a real 
service to Illinois consumers. So we are looking at that, as 
    Senator Fitzgerald. So most people are still going to their 
brokers to figure out where to get one of these, and they don't 
realize that their broker is going to get paid a fee out of 
their savings in order to steer them into a plan.
    Mr. Noven. A very large fee, right.
    Senator Fitzgerald. Yes, but now, will that change as the 
SEC is now going to require a statement at a point of sale?
    Mr. Bullard. As currently proposed, it wouldn't include any 
reference to the State tax advantages. But it is simply 
unrealistic to think that a broker is going to give up any 
compensation at all in order to recommend an Illinois product. 
I mean, it is just not going to happen and it is not realistic 
to think that has any kind of deterrent effect.
    Mr. Noven. We actually have a lot of selling agreements 
with a lot of folks and there are--while I share his skepticism 
about brokers, there are a lot of brokers who are doing the 
right thing, using a low-cost college savings program as a way 
to build trust with the client and make money off of other 
products. We actually think that is the right way to go. We are 
not going to be competing with the most expensive plans in the 
Nation because they will follow the money, but there are a core 
group of brokers that we believe will do the right thing----
    Senator Fitzgerald. Vanguard is the second largest mutual 
fund in the country. It has done that largely by having the 
lowest cost. When John Bogle was the Chairman, the company 
never advertised. It is much younger than Fidelity, which goes 
back to the 1940's. Bogle founded Vanguard in the 1970's, and 
it grew to the second largest just on word of mouth, because of 
having the lowest fees.
    So if your fund is really a good deal and it is going to 
get high rankings from Morningstar, consumers will figure that 
out, won't they? Even without brokers and without paying loads, 
you will have money migrate to your fund.
    Mr. Noven. If consumers would figure it out on their own--I 
think brokers talk them out of that when they go into their 
office frequently. If consumers would figure it out on their 
own, the largest programs in the Nation right now would not be 
the ones that charge consumers the most money. We don't think 
the system is working, which is why we are excited about----
    Senator Fitzgerald. What is the largest right now in the 
    Mr. Noven. I think Virginia is the largest one. I think 
they have got something like 7----
    Senator Fitzgerald. But that is a pretty good plan, at 
least according to Morningstar, isn't it?
    Mr. McNeela. It is a broker-sold plan, but it is a quality 
plan with terrific investment choices and flexibility.
    Senator Fitzgerald. Who is the underlying manager?
    Mr. McNeela. The American Funds.
    Senator Fitzgerald. OK. And Nevada also has a top plan, 
doesn't it?
    Mr. McNeela. Right. Nevada primarily uses Vanguard, at 
least for one of their plans.
    Mr. Bullard. Mr. Noven's point really just tells us that 
most people buy through intermediaries, so logically, the plans 
that use intermediaries are going to be the largest.
    Senator Fitzgerald. OK.
    Ms. Williams. Mr. Chairman, about half of our State 
residents have purchased directly from our agency and the other 
half have used financial intermediaries.
    Senator Fitzgerald. Maybe we should just cap what kind of a 
load or commission can be paid to the brokers.
    Mr. Bullard. Well, the first step would be to apply 
expressly to brokers of Section 529 plans the NASD limits----
    Senator Fitzgerald. Which are?
    Mr. Bullard [continuing]. Which MSRB cannot legally do.
    Senator Fitzgerald. Right. So there is no limit now.
    Mr. Bullard. Well, the MSRB can impose a fair and 
reasonableness standard, but they can't expressly state that we 
always consider that to be the NASD limit. So there are going 
to be cases where----
    Senator Fitzgerald. If a fee is paid, if a load is paid to 
a broker, say a 6 percent load, is that disclosed to a Section 
529 purchaser?
    Mr. Bullard. Not in dollars, but, of course, that is also 
true for mutual funds and the SEC proposal will, one way or 
another, address that in both contexts.
    Senator Fitzgerald. And require a dollar----
    Mr. Bullard. Both for Section 529 plans and for mutual 
    Senator Fitzgerald. OK. But right now, there is technically 
no limit on the load?
    Mr. Bullard. Technically, no limit other than the MSRB's 
fair and reasonable standard.
    Senator Fitzgerald. Unbelievable.
    Mr. Noven. We tried that in Illinois. We tried to provide a 
tax benefit to any State that would agree to charge a load that 
was under a certain cap. It was a 4 percent cap, and we thought 
that was a reasonable amount of compensation for a financial 
intermediary. That is what brought all the brokers out of the 
woodwork and that is why there is a fleet of lobbyists working 
on the issue in Illinois. You should see how full our 
conference room was after we tried that in Springfield. It is a 
hard issue to tackle.
    Senator Fitzgerald. OK. All right. Well, thank you all. You 
have been great----
    Mr. Bullard. Chairman, if I could just take a second----
    Senator Fitzgerald. Yes.
    Mr. Bullard. I don't know if I will be back here by the end 
of the year, but I wanted to thank you for your leadership on 
financial services issues, especially over the last 12 months 
or so, and hope that you will continue the battle--either 
rejoin the Illinois Senate race or continue the battle outside 
of your tenure here in the Senate.
    Senator Fitzgerald. I am hoping somebody takes up the issue 
after I am gone, and my last day is January 2, but I certainly 
appreciate the help you supplied, Mr. Bullard. You were a great 
witness a year ago at this time, and I do think our hearings on 
high fees led to some of the fund complexes lowering their 
fees, as we have seen. That will, over time, result in a lot 
more money for savers.
    I want to thank all the witnesses today. I would like to 
mention that Senator Akaka, the Subcommittee's Ranking 
Democratic Member, wanted to be here but was unable to attend. 
He will submit a statement for the record.
    [The prepared statement of Senator Akaka follows:]

    Thank you, Senator Fitzgerald for your continued leadership in 
helping Americans understand more fully the opportunities and risks 
available to them as investors. As a father and grandfather, I know the 
considerable burden facing young people and their families when it 
comes to financing college educations. As a former educator, I believe 
that investing in an education is one of the most important investment 
an individual can make.
    In response to rapidly escalating college tuition costs, Congress 
amended the Tax Code in 1996 to create tax-advantaged programs to help 
families save for college. These programs are called 529 plans after 
the section in the Tax Code. One of the programs is a college savings 
plan. These plans offer investors the opportunity to contribute to a 
trust fund and accrue tax-free interest if funds are withdrawn solely 
to pay for education expenses of a selected beneficiary. Qualified 529 
college savings plans are sponsored by states which may directly 
administer their plans or select companies to manage the funds.
    These state-sponsored savings plans offer families and individuals 
the ability to save for education expenses at any accredited public or 
private educational institution, including colleges, universities, law 
or medical schools, and most community colleges. Earnings accumulate on 
a tax-deferred basis and distributions used for qualifying education 
costs are tax-free. Non-qualifying distributions are subject to a ten 
percent federal tax penalty and possible state tax liabilities. As with 
other investment vehicles, investors pay assorted fees to cover account 
costs, and the plans provide no guarantee of a specific rate of return.
    Recently, the true costs of 529 college savings plans have 
generated substantial attention. Many individuals have questioned the 
basis of plan fees and whether these fees diminish the tax benefits of 
the plans. Moreover, because the plans are not governed by federal 
investment or securities laws, there is inconsistent oversight and lack 
of transparency associated with these plans which has further elevated 
public concern. This situation is similar to the problems the 
Subcommittee examined in the mutual fund industry.
    I firmly believe that transparency and accountability must be a 
priority of the investment industry. Brokers and investment employees 
should disclose the costs and terms of the products they sell and 
provide a potential investor with the information needed to make 
informed decisions. An accurate assessment and picture of investment 
costs and returns should remain paramount.
    Because 529 college saving plans are state-sponsored and not 
regulated under federal securities laws, the Security Exchange 
Commission (SEC) cannot require the same registration and reporting 
requirements that exist for mutual funds. However, six months ago SEC 
Chairman William Donaldson formed the Chairman's Task Force on College 
Savings Plan to examine the structure and sale of the plans, and I look 
forward to this review.
    There are questions to be asked: Should federal securities laws 
govern some aspects of 529 plans because investors now face 
inconsistent disclosure policies that may result in unforeseen fees? 
How do states select plan managers, and how are fees and costs to 
investors allocated?
    Moreover, as long as investors in a college savings plan may opt to 
purchase a plan offered by a state where he or she does not reside, 
consumers must be able to compare different state plans in order to 
make informed investment decisions. Due to the complex nature of these 
plans and the lack of meaningful disclosures, I believe there should be 
strong financial literacy and investor education programs. Such 
programs are necessary so that investors may choose the plan that best 
meets their financial situation and savings goals. Furthermore, 
promoting transparency will undoubtedly enhance the financial benefits 
of these plans and the educational opportunities they put within reach 
of plan recipients.
    I look forward to working with Senator Fitzgerald and our 
colleagues to help investors better understand 529 college savings 
plans. I also wish to thank today's witnesses for sharing with us their 
concerns and recommendations.

    Senator Fitzgerald. The record will remain open for 1 week, 
until next Thursday, October 7.
    With that, this hearing is adjourned. Thank you all very 
    [Whereupon, at 1:05 p.m., the Subcommittee was adjourned.]

                            A P P E N D I X