[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]
ARE HIDDEN 401(K) FEES
UNDERMINING RETIREMENT SECURITY?
=======================================================================
HEARING
before the
COMMITTEE ON
EDUCATION AND LABOR
U.S. House of Representatives
ONE HUNDRED TENTH CONGRESS
FIRST SESSION
__________
HEARING HELD IN WASHINGTON, DC, MARCH 6, 2007
__________
Serial No. 110-7
__________
Printed for the use of the Committee on Education and Labor
Available on the Internet:
http://www.gpoaccess.gov/congress/house/education/index.html
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COMMITTEE ON EDUCATION AND LABOR
GEORGE MILLER, California, Chairman
Dale E. Kildee, Michigan, Vice Howard P. ``Buck'' McKeon,
Chairman California,
Donald M. Payne, New Jersey Ranking Minority Member
Robert E. Andrews, New Jersey Thomas E. Petri, Wisconsin
Robert C. ``Bobby'' Scott, Virginia Peter Hoekstra, Michigan
Lynn C. Woolsey, California Michael N. Castle, Delaware
Ruben Hinojosa, Texas Mark E. Souder, Indiana
Carolyn McCarthy, New York Vernon J. Ehlers, Michigan
John F. Tierney, Massachusetts Judy Biggert, Illinois
Dennis J. Kucinich, Ohio Todd Russell Platts, Pennsylvania
David Wu, Oregon Ric Keller, Florida
Rush D. Holt, New Jersey Joe Wilson, South Carolina
Susan A. Davis, California John Kline, Minnesota
Danny K. Davis, Illinois Bob Inglis, South Carolina
Raul M. Grijalva, Arizona Cathy McMorris Rodgers, Washington
Timothy H. Bishop, New York Kenny Marchant, Texas
Linda T. Sanchez, California Tom Price, Georgia
John P. Sarbanes, Maryland Luis G. Fortuno, Puerto Rico
Joe Sestak, Pennsylvania Charles W. Boustany, Jr.,
David Loebsack, Iowa Louisiana
Mazie Hirono, Hawaii Virginia Foxx, North Carolina
Jason Altmire, Pennsylvania John R. ``Randy'' Kuhl, Jr., New
John A. Yarmuth, Kentucky York
Phil Hare, Illinois Rob Bishop, Utah
Yvette D. Clarke, New York David Davis, Tennessee
Joe Courtney, Connecticut Timothy Walberg, Michigan
Carol Shea-Porter, New Hampshire
Mark Zuckerman, Staff Director
Vic Klatt, Minority Staff Director
C O N T E N T S
----------
Page
Hearing held on March 6, 2007.................................... 1
Statement of Members:
Altmire, Hon. Jason, a Representative in Congress from the
State of Pennsylvania, prepared statement of............... 60
Hare, Hon. Phil, a Representative in Congress from the State
of Illinois, prepared statement of......................... 60
McKeon, Hon. Howard P. ``Buck,'' Senior Republican Member,
Committee on Education and Labor........................... 4
Prepared statement of.................................... 5
Miller, Hon. George, Chairman, Committee on Education and
Labor...................................................... 1
Statement of Witnesses:
Bovbjerg, Barbara D., Director, Health, Education, Human
Services Division, Government Accountability Office........ 7
Internet link to GAO-prepared testimony, ``Private
Pensions: Increased Reliance on 401(k) Plans Calls for
Better Information on Fees''........................... 9
Butler, Stephen J., president and founder, Pension Dynamics
Corp....................................................... 28
Prepared statement of.................................... 30
Chambers, Robert, Esq., partner, Helms, Mulliss & Wicker,
PLLC; chairman, American Benefits Council.................. 22
Prepared statement of.................................... 24
Hutcheson, Matthew, pension consultant, independent pension
fiduciary.................................................. 9
Prepared statement of.................................... 10
ARE HIDDEN 401(K) FEES
UNDERMINING RETIREMENT SECURITY?
----------
Tuesday, March 6, 2007
U.S. House of Representatives
Committee on Education and Labor
Washington, DC
----------
The committee met, pursuant to call, at 11:02 a.m., in room
2175, Rayburn House Office Building, Hon. George Miller
[chairman of the committee] presiding.
Present: Representatives Miller, Kildee, Payne, Andrews,
Woolsey, McCarthy, Tierney, Wu, Davis of California, Sestak,
Yarmuth, Hare, Courtney, Shea-Porter, McKeon, Petri, Ehlers,
Kline, Marchant, Fortuno, Boustany, Davis of Tennessee, and
Walberg.
Staff present: Aaron Albright, Press Secretary; Tylease
Alli, Hearing Clerk; Jody Calemine, Labor Policy Deputy
Director; Sarah Dyson, Administrative Assistant, Oversight;
Carlos Fenwick, Policy Advisor for Subcommittee on Health,
Employment, Labor and Pensions; Michael Gaffin, Staff
Assistant, Labor; Jeffrey Hancuff, Staff Assistant, Labor; Ryan
Holden, Senior Investigator, Oversight; Brian Kennedy, General
Counsel; Thomas Kiley, Communications Director; Ann-Frances
Lambert, Administrative Assistant to Director of Education
Policy; Danielle Lee, Press/Outreach Assistant; Joe Novotny,
Chief Clerk; Megan O'Reilly, Labor Policy Advisor; Rachel
Racusen, Deputy Communications Director; Michele Varnhagen,
Labor Policy Director; Michael Zola, Chief Investigative
Counsel, Oversight; Mark Zuckerman, Staff Director; Robert
Borden, General Counsel; Steve Forde, Communications Director;
Ed Gilroy, Director of Workforce Policy; Rob Gregg, Legislative
Assistant; Jessica Gross, Deputy Press Secretary; Taylor
Hansen, Legislative Assistant; Victor Klatt, Staff Director;
Lindsey Mask, Director of Outreach; Jim Paretti, Workforce
Policy Counsel; Molly McLaughlin Salmi, Deputy Director of
Workforce Policy; and Linda Stevens, Chief Clerk/Assistant to
the General Counsel.
Chairman Miller [presiding]. The Committee on Education and
Labor will come to order for the purposes of conducting a
hearing of whether or not hidden 401(k) fees are undermining
workers' retirement security.
This is, again, one of a series of hearings where we are
looking at the middle class and what we can do to strengthen
and to cultivate the middle class.
And I think that this is a very important hearing, because
it does deal with the ability of millions of middle-class
workers, whether or not they will have the ability to put
together a plan for retirement security and for the maintenance
of a standard of living that allows them to provide for
themselves and their families.
If you earn your income from a paycheck, the chances are
that one of the things you are concerned with is trying to put
enough money away for the golden years. If you use a 401(k) or
a similar plan to help you save some of that money for
retirement, then you ought to have all of the information you
need to make a well-informed decision about what plans and
investment options will give you the best deal.
That is the purpose of this hearing: to examine the growing
role of 401(k)-style plans are playing in helping people pay
for their retirement and find out if hidden fees are eating
into workers' retirement savings account balances without them
even knowing it.
During much of the 20th century, two types of retirement
plans--Social Security and traditional employment-based pension
plans--helped to lift older Americans out of poverty and
allowed American workers to maintain a decent standard of
living when their working lives were over.
But now today, many of those traditional pensions, defined
benefit plans, are no longer being created. New plans are being
created or greater reliance is being placed on 401(k) plans,
and clearly Social Security is now the sole source of
retirement income for over half of the retirees and the primary
source of income for two-thirds of all retirees.
Luckily, I would say, we have fended off the attacks on the
program from people who wanted to privatize it, turning it into
a gamble for retirees, instead of a sure thing. So we now have
Social Security and 401(k)s.
The rub is that 401(k)s were never intended to be the
primary source of retirement income, either. Today, the average
balance among private-sector workers is just $28,000, and that
is a pool of workers that struggle at the end of every month to
be able to continue to invest in their retirement savings and
in their ultimate retirement.
This morning, we will hear testimony about services that
are being provided and the fees are being charged. Some of
these fees are reasonable and necessary, but today we will also
hear about a dizzying array of terminology, revenue-sharing,
and wrap fees, finders' fees, shelf space, surrender charges,
soft dollars, 12(b)(1) fees.
We have to ask whether or not all of these fees are
necessary, and we have to examine whether they are undermining
the workers retirement security. That is because even a
seemingly small difference in the fees that workers pay can
have an enormous difference in the overall size of their 401(k)
balance.
As we will hear later today, a 1 percentage point
difference in fees can reduce retirement benefits by nearly 20
percent. So you have a situation where people are struggling to
put this money away every month, and making the sacrifices that
go along with that, and yet we see just that 1 percentage
difference.
As a way of an example, if you take one person
participating in the Thrift Savings Plan, where people who are
making the same contribution over a 30-year period of time, and
the other is going into an asset-based fees program, what you
see here is that at the end of that time, the amount available
is $175,000, if you had an asset-based fees or 3 percent, and
$279,000, as you have in the Thrift Savings Plan.
Three hundred basis points is not unusual, I am told, but
as we will hear that from the experts, it creates dramatic
difference in what people can expect to draw on and how long
they will expect these funds to last. And so this kind of
difference insists that we pay attention to this matter.
Over the years, I have participated in a number of
conferences on savings plans, on getting America to save more.
How do we encourage savers to do this? With tax deductions, and
tax credits, and all the rest of it, and those are all very,
very important.
But if, in fact, what we see is, after workers with very
limited resources make the very difficult decision to save
their money,, the question is, what is the stewardship of that
money?
We understand the laws of the fiduciary relationship and
the responsibilities of trust to those individuals. But the
fact of the matter is, it does not appear that that is always
being honored.
The other thing here is that sometimes when people, delve
into this subject, it is very complicated, as you will start to
hear when the witnesses start to speak about it. Most of these
explanations are not written in plain English. Most of these
explanations are not presented in a matter in which
participants can understand them.
If you go through this information packet for these fees, I
am sure that either your head will be on your chest, your eyes
will be glazed over, and you simply will not be able to
decipher the information that you need as the saver.
Now, people will argue that this is for the plans, that the
plans can look at this and make these determinations. The
language is complicated; the language in many cases is
unintelligible; the choices are unknown to the participant at
many levels.
And so what we have is a situation where people work very
hard, make the decision we want them to make, to set aside
money for their retirement, and what they find out is there is
a lot of people who are putting their hands into that money in
the names of fees, commissions, all of the terms that I used
before.
And what happens at the end of the year, what happens at
the end of 10 years and 20 years and 30 years is that a
remarkable amount of the assets that could have been available
for retirement have leaked out of that fund to the benefit of
others.
We will remember through the course of this hearing and of
future hearings, the only source for all of the fees and the
commissions is the hard-earned retirement dollars that these
people have set aside and that their employers have contributed
to, in some cases. All of the fees, all of the commissions are
derived from that source of money.
And that is what makes, I believe, this hearing so
critical, on what we might do, what we should consider, in
terms of further disclosure, and further transparency, and
certainly to make it more understandable for middle-class
families, as they consider the choices that they have to build
that retirement nest egg, using the 401(k) plan.
So I look forward to hearing the witnesses.
And at this time, I would like to recognize Mr. McKeon, the
senior Republican on the committee, and then I will--hope
springs----
[Laughter.]
I don't want you to characterize the hope I have. It is
truly mine. But at that time, then I will introduce the
witnesses.
Mr. McKeon?
Mr. McKeon. Thank you, Mr. Chairman. And thanks for the
reprieve.
As you know, this committee is no stranger to the issue of
retirement security. And in fact, I would say we have proven
ourselves the House's leader on this important issue.
In the long term, I believe the pension legislation we
enacted last year will prove to be one of the most meaningful
reforms of the 109th Congress. And the fact that we were able
to do it in a bipartisan way, with 76 Democrats supporting the
bill, and in an election year, no less, demonstrated what a
bottom-line issue this is to workers, retirees and taxpayers.
We should not forget that those pension reforms were set in
motion right there in this committee room. And though we did
not have universal agreement at the end of the process or even
as little as a comprehensive alternative plan from the other
side of the aisle, we did produce what has become the most
fundamental overhaul of the private pension system in more than
a generation.
Indeed, the ground work for today's hearing and those that
may follow has clearly and concretely been laid by our previous
work. The issue before us is one that has become increasingly
important, because defined contribution plans are clearly the
future of our retirement security system.
In fact, in addition to the new safeguards we put in place
last year to bolster the traditional defined benefits system, I
believe two of the most important aspects of our pension reform
bill focused on 401(k) plans.
First, we established new auto-enrollment procedures to
increase the number of 401(k) participants. And, secondly, we
fixed a flaw in outdated pension law that barred workers from
receiving high-quality, independent investment advice as an
employee benefit.
Years from now, I believe we will look back upon these
reforms as a starting point or a turning point, placing more
power than even before in the hands of workers, as they make
decisions about their retirement.
This morning, as we look at potentially tweaking 401(k)
rules, I will say what I said during the pension reform debate
from the last Congress: Our first principle must be to do no
harm. The pension bill we passed last year took years to get
ready for the president's signature, and for good reason. We
did not want to do anything that would force employers out of
this voluntary system, nor did we want to take any action that
would have discouraged retirement savings or investment,
unintended consequences that we fought vigorously to avoid.
This should be guiding philosophy once again this time
around. For example, if we are considering whether to place
additional requirements upon plan sponsors on top of those we
already established a year ago, we must do so with great
caution, as the financial futures of millions of workers and
retirees depend upon it.
At the outset of this hearing process, I also believe that
it is vital to understand the delicate balance that exists
within our retirement security system. For instance, workers do
have a responsibility to make certain decisions involving their
savings. Likewise, I believe we all must recognize that the
topic of today's hearings, the 401(k) fees, are one of many
factors, such as the historical performance and investment risk
for each plan option, which plan participants do have
responsibility to consider when investing in a 401(k) plan.
Now, do we want to or expect workers to be completely on
their own? Of course not. No one believes that. But at the same
time, we must resist the urge to simply overload workers with
information. That little prospectus that you held up a while
ago, one of the reasons that that is so thick and cumbersome is
regulations and laws that we have passed here.
We must not mandate the distribution of out-of-context
information that may lead participants to poor investment
choices. A quick fix like that may help some of us feel good
about ourselves, but it would do great harm to workers and
retirees, which as I said is what we must seek to avoid.
Mr. Chairman, I believe our time together today will serve
to start the process of deliberately and thoughtfully examining
whether changes to federal law are necessary to provide greater
information to plan participants. I enter it with an open mind,
just as I am sure you and all of our colleagues do.
I appreciate our witnesses taking the time to be with us
today, and I look forward to their testimony.
Thank you.
[The prepared statement of Mr. McKeon follows:]
Prepared Statement of Hon. Howard P. ``Buck'' McKeon, Senior Republican
Member, Committee on Education and Labor
Chairman Miller, as you know, this Committee is no stranger to the
issue of retirement security, and in fact, I'd say we have proven
ourselves the House's leader on this important issue. In the long-term,
I believe the pension legislation we enacted last year will prove to be
the most meaningful reforms of the 109th Congress. And the fact that we
were able to do it in a bipartisan way--with 76 Democrats supporting
the bill, and in an election year, no less--demonstrated what a bottom
line issue this is to workers, retirees, and taxpayers.
We should not forget that those pension reforms were set in motion
right here, in this Committee room, and though we did not have
universal agreement at the end of the process--or even as little as a
comprehensive alternative plan from the other side of the aisle--we did
produce what has become the most fundamental overhaul of the private
pension system in more than a generation. Indeed, the groundwork for
today's hearing and those that may follow has clearly and concretely
been laid by our previous work.
The issue before us is one that has become increasingly important
because defined contribution plans are clearly the future of our
retirement security system. In fact, in addition to the new safeguards
we put in place last year to bolster the traditional defined benefit
system, I believe two of the most important aspects of our pension
reform bill focused on 401(k) plans.
First, we established new auto-enrollment procedures to increase
the number of 401(k) participants, and secondly, we fixed a flaw in
outdated pension law that barred workers from receiving high-quality,
independent investment advice as an employee benefit. Years from now, I
believe we will look back upon these reforms as a turning point,
placing more power than ever before into the hands of workers as they
make decisions about their retirement.
This morning, as we look at potentially tweaking 401(k) rules, I
will say what I said during the pension reform debate from the last
Congress: our first principle must be to do no harm. The pension bill
we passed last year took years to get ready for the President's
signature, and for good reason. We did not want to do anything that
would force employers out of this voluntary system, nor did we want to
take any action that would have discouraged retirement savings or
investment--unintended consequences that we fought vigorously to avoid.
This should be our guiding philosophy once again this time around.
For example, if we are considering whether to place additional
requirements upon plan sponsors--on top of those we already established
a year ago--we must do so with great caution, as the financial futures
of millions of workers and retirees depend upon it.
At the outset of this hearing process, I also believe that it is
vital to understand the delicate balance that exists within our
retirement security system. For instance, workers do have a
responsibility to make certain decisions involving their savings.
Likewise, I believe we all must recognize that the topic of today's
hearing--401(k) fees--are one of many factors, such as the historical
performance and investment risk for each plan option, which plan
participants do have the responsibility to consider when investing in a
401(k) plan.
Now, do we want to--or expect--workers to be completely on their
own? Of course not; no one believes that. But at the same time, we must
resist the urge to simply overload workers with information--or worse,
to mandate the distribution of out-of-context information that may lead
participants to make poor investment choices. A quick fix like that may
help some of us feel good about ourselves, but it would do great harm
to workers and retirees, which--as I said--is what we must seek to
avoid.
Mr. Chairman, I believe our time together today will serve to start
the process of deliberately and thoughtfully examining whether changes
to federal law are necessary to provide greater information to plan
participants. I enter it with an open mind, just as I am sure you and
all of our colleagues do. I appreciate our witnesses taking the time to
be with us today, and I look forward to their testimony.
______
Chairman Miller. Thank you.
Our panel this morning is a distinguished panel with a long
history in this subject.
And first witness will be Barbara D. Bovbjerg, who is the
director of education, workforce and income security issues at
the U.S. Government Accountability Office. At the GAO, she
oversees evaluative studies on age and retirement income policy
issues, including Social Security, private pension programs,
and the operation and managements at the Social Security
Administration, the Pension Benefit Guaranty Corporation, the
Employee Benefits Security Administration of the Department of
Labor.
Matthew D. Hutcheson is an independent pension fiduciary.
He is the author of a text, ``Retirement Plan Compliance and
Reporting,'' at Texas Tech University's International
Foundation for Retirement Education. He is also a member of the
Board of Standards at the American Academy of Financial
Management. His clients include the plans of Fortune 100, 500
and 1,000 companies, mid-and small-size companies, government
and legal and accounting firms.
Mr. Robert Chambers is a partner in the Employer Services
Practice Group, of the Charlotte-based law firm of Helms,
Mulliss & Wicker. And his practice emphasizes executive
compensation and employee benefit law. Mr. Chambers is a member
of the taxation, business and law, and employment law sections
of the American Bar Association and serves on several
committees within those sections. He is the chairman of the
American Benefits Council, an employee-benefit lobbying firm in
Washington, whose members either employ or administer plans for
more than 100 Americans, and a 1971 graduate of Princeton
University.
Mr. Stephen J. Butler is the founder and president of the
Pension Dynamics Corporation retirement plan administration
firm in Pleasant Hill, California. In April 1997, Money
magazine published Mr. Butler's article entitled, ``Beware:
Retirement Plan Rip-offs.'' Mr. Butler has also written two
books on 401(k) plans, the most recent being one titled
``401(k) Today,'' published in 1999. For the past 7 years, he
has been a weekly columnist covering retirement-related
financial interests and has been quoted extensively in Fortune
and Money, the Wall Street Journal, New York Times and numerous
other publications.
So, Ms. Bovbjerg, we will begin with you.
And you know the rules here, but for the other witnesses,
the green light will be on for 5 minutes, then it will turn to
orange, which we will ask you to start summing in, and then
red, if you can wrap your remarks so that we will have time for
questions.
Thank you.
STATEMENT OF BARBARA D. BOVBJERG, DIRECTOR, HEALTH, EDUCATION,
HUMAN SERVICES DIVISION, GOVERNMENT ACCOUNTABILITY OFFICE
Ms. Bovbjerg. Thank you, Mr. Chairman, Mr. McKeon, members
of the committee.
I am pleased to be here today to speak about 401(k) plans.
And in these plans, participating workers are responsible for
choosing how much of their earnings to contribute, how to
invest these contributions, and how to manage the resultant
accumulation in retirement.
Today, I would like to describe trends in the use of
401(k)s and summarize our recent report about fees associated
with these plans. Fees are one of the aspects of 401(k)s that
workers should know about and understand in order to ensure
adequate income from the plan when they retire.
First, the trends. 401(k)s are defined contribution, D.C.,
plans, meaning that benefits are based on contributions to
accounts and investment returns that accrue. Historically,
pension benefits were provided through defined benefit, D.B.,
plans, which provide a fixed level of monthly retirement income
for life, based on salary, service and age of retirement.
Since 1985, the number of D.C. plans and participants has
risen dramatically, while the number of D.B. plans and workers
covered by them has fallen. Today, there are about 700,000 D.C.
plans, covering 55 million workers, and D.C. plans now hold the
majority of pension fund assets.
401(k) plans are an important part of this gross. Although
they were once relatively rare, today they predominate among
D.C.-type plans. In 1985, they were only about 7 percent of all
D.C. plans, but now account for almost 95 percent. In 20 years,
the number of participants in these plans has grown from 7
million to 47 million workers, and assets held by these plans
rose from $270 billion to about $2.5 trillion.
401(k) plans are popular with many workers, in that they
are portable, which D.B.'s are generally not, and they are
easier to understand than typical D.B. plans. Yet 401(k)s also
place responsibilities on workers that D.B. plans do not.
The majority of 401(k) plans are participant-directed.
Because so much rides of workers' decisions with regard to
their 401(k) saving, it is crucial that workers have
information to help them make wise choices.
There are many factors that a worker should take into
account, one being the fees associated with the plan. So let me
turn now to issues regarding fees.
Fees are important factors in 401(k)s because, in general,
the higher the fee, the less savings will accumulate in the
course of a working lifetime. Although various fees pertain to
401(k)s, investment fees account for the largest portion of the
total. These pay for services including selecting the plan's
portfolio of securities and managing the fund.
Plan record-keeping fees are the next largest. These are
usually charged by the service provider to set up and maintain
the plan. Whether and how participants or plan sponsors pay
these fees varies by the type of fee and the size of the plan.
Investment fees are usually charged at the 6 percentage of
assets and netted from investment return, while record-keeping
fees may be charged as a percentage of assets, or as flat fees.
These fees are increasingly being paid by participants, rather
than by sponsors. ERISA requires that sponsors disclose a range
of information about plans, but only limited information about
fees.
Although plan sponsors may voluntarily provide information
on fees, participants may not have a clear picture of all the
fees they pay, because even the information that is provided
may be offered in a piecemeal fashion, through plan
descriptions, fund prospectuses, and fund profiles.
Not only do participants not necessarily know what they are
paying in fees overall, they have no simple way to compare fees
among investment options within their plan. The Department of
Labor has authority under ERISA to oversee 401(k) fees and fee
arrangements among plan service providers, but it lacks
information sufficient to provide effective oversight.
Labor must ensure that fees are paid with plan assets, are
reasonable, and that sponsors report information known about
business arrangements involving service providers. But it is
difficult for Labor to monitor fees that are netted out of
returns and are not required to be reporter. Further, fee
arrangements between service providers are sometimes hidden
from the sponsor and can mask a conflict of interest that could
affect the plan.
Labor has initiatives under way to improve the disclosure
of fee information to participants, as well as in required
reporting to Labor itself, and to spell out what information
sponsors need to obtain from service providers.
In conclusion, 401(k) have emerged as the primary type of
pension plans for American workers, yet requirements for
reporting information workers should have to manage these types
of plans has not fully caught up to the need. Fee information,
in particular, needs to be more widely available, more
comprehensive, and more clearly presented.
GAO has recommended that measures be taken by both Labor
and the Congress to help make this information more accessible
and, in so doing, help protect workers' retirement savings.
This concludes my statement, Mr. Chairman. I welcome any
questions and hope that my full statement will be included in
the record.
[The Internet link to GAO-prepared testimony, ``Private
Pensions: Increased Reliance on 401(k) Plans Calls for Better
Information on Fees'' follows:]
http://www.gao.gov/new.items/d07530t.pdf
------
Chairman Miller. Thank you.
For all the witnesses, your statement, all your written
material will be put in the record in its entirety.
Mr. Hutcheson?
STATEMENT OF MATTHEW HUTCHESON, PENSION CONSULTANT, INDEPENDENT
PENSION FIDUCIARY
Mr. Hutcheson. Chairman Miller, Congressman McKeon and
members of the committee, from personal experience and research
as an independent fiduciary, I believe the retirement income of
America's workforce has been unnecessarily reduced due to
confusion caused by blending fiduciary and non-fiduciary
practices.
Many billions more should be available for health care and
prescription drugs, home repairs, and basic living necessities.
Instead, these sums line the pockets of others.
Conventional 401(k) plans now cost around 3 percent of plan
assets per year to manage. Some are even as high as 5 percent.
In my experience, that is 1.5 to 3.5 percent more than is
reasonably necessary.
To put this into perspective, just 1 percent in excess
costs to plan participants, having $2.5 trillion in 401(k) plan
assets, represents a wealth transfer of $25 billion to others
each and every year. A large portion of the costs of
conventional 401(k) plans relate to services that have little
or nothing to do with building and protecting the retirement
income security and, hence, are excessive.
Take an average participant with a $30,000 account balance,
contributing $150 per pay period. If this person earns an
average of 8 percent over a 25-year time period, he or she will
have accumulated over $500,000. However, add an additional 1
percent in annual fees, and the account balance drops nearly
$85,000. Add 1 percent more, and the account balance drops
$150,000.
This translates into approximately $540 per month in
retirement income loss. This loss can be prevented, and it
begins by enlightening plan sponsors about the realities of
401(k) plan economics. When we buy bread, we know exactly how
much it costs: One dollar buys one dollar's worth of bread.
However, when it comes to 401(k) plans, the sticker price is
advertised at 50 cents, yet the actual cost may be closer to
three dollars.
Fiduciaries simply cannot make good decisions when the
costs of services are undisclosed. There are at least seven
types of hidden fees or costs borne by plan participants. These
range from brokerage fees, shared between the broker and an
investment fund, to record-keeping subsidies between a mutual
fund a third-party administrator.
Contrary to fiduciary principles, some of the fees borne by
participants are for services they do not receive. It is costly
and unnecessary to offer a wider variety of investment
alternatives than is absolutely necessary to construct a
prudent, low-cost portfolio.
The more fund choice is offered, the more mistakes
participants make. Employees tinker with the investment within
their accounts, incurring hidden trading costs that reduce
their returns.
The current 401(k) environment encourages mistakes, for no
good or necessary reason. The brokerage and investment fund
industries understand and count on participants making
imprudent investment decisions. They rely on fiduciary
ignorance to generate revenue. This is a substantial and hidden
cost about which participants are almost universally unaware.
An efficient, low-cost, market-tracking portfolio could
easily and fairly be put in place for all participants. To my
astonishment, the industry persists in the assertion that,
without higher fees, they cannot deliver the desired services.
This is the heart of the matter: It is the services or plan
options that are excessive, and those services or options are
not always necessary for protecting participants' retirement
income. Because 401(k) participants own stocks and bonds,
constituting $2.5 trillion, it is essential that plans be
managed by individuals who understand and uphold the standards
of fiduciary care and loyalty.
In conclusion, it is incumbent upon us to be absolutely
certain there are no unnecessary obstacles, whether intentional
or unintentional, to the long-term success of our private
retirement system. American workers deserve proper protections
for the hard-earned savings they have set aside in their 401(k)
plans, but these protections have been largely denied in the
current state of the industry.
I believe in implementing simple solutions. Change will
require exposing and confronting powerful economic interests
that support the current system. It is daunting to tackle this
vital issue, affecting millions now and in generations to come.
Despite the forces arrayed against change, America's workers
deserve better than they have received to date from the
providers of 401(k) services.
Thank you.
[The statement of Mr. Hutcheson follows:]
Prepared Statement of Matthew Hutcheson, Pension Consultant,
Independent Pension Fiduciary
Introduction
Very few matters of social importance are more complex than the one
before you today. This particular issue is not only about uncovering
obscure dollars unscrupulously extracted from the account balances of
America's workforce, but it is also about correcting the culture that
has permitted the problem to thrive in the first place. This written
testimony will explain what the culture is, why it exists, how it has
evolved over time, how it violates basic economic principles, the
integrity of rules of fiduciary prudence, the exclusive benefit rule
under ERISA, and other common sense practices that are critical for
delivery of expected results from employer defined contribution
retirement plans.
The American Worker Is Hurt by What He Can't See
``If we make a few rough calculations, the importance of the topic
will be very clear. The SEC estimates in Concept Release 33-8349, that
1% of the average mutual fund's investment return disappears each year
due to brokerage expense, execution costs, and transaction spreads.
Other industry sources indicate that an additional .50% slips away via
``revenue sharing payments.'' The impact on the average American is
profound.
``Consider two thirty year old workers who each invest $3,000
annually into their 401(k) programs. American #1's 401(k) program is
run according to stringent fiduciary principles and earns 7.5%
annually. However, American #2's 401(k) is operated by conflicted,
sales driven entities and only earns 6% annually after the
aforementioned return erosion. The table below details the results.
----------------------------------------------------------------------------------------------------------------
American #1--
Year Fiduciary 401(k) American #2--Hidden
Earning 7.5% Fee 401(k) Earning 6%
----------------------------------------------------------------------------------------------------------------
10................................................................ $45,624 $41,915
20................................................................ $139,658 $116,978
30................................................................ $333,463 $251,405
40................................................................ $732,902 $492,143
47................................................................ $1,244,260 $766,694
----------------------------------------------------------------------------------------------------------------
``Even though both employees contributed the same amount and took
the same investment risk, American #2 must work an additional seven
years to make up for the lack of fiduciary oversight in his 401(k)
plan.''\1\
The difference in hidden fees costs American worker #2 nearly
$500,000 during the illustrated period of time. This issue is about
real people, real money, and the quality of their lives later in life.
Consider the impact on American worker #2's ability to pay for health
care, prescription drugs, home repairs or even groceries. If actuarial
tables hold true, today's retiree may need to be prepared to live a
quarter century longer than his grandparents did.
Background
A ``401(k)'' is a Qualified Retirement Plan
Qualified retirement plan assets pursuant to Internal Revenue Code
(``IRC'') section 401(a) are held in trust pursuant to IRC Sec. 501(a )
exclusively for the future benefits of participants and beneficiaries.
There are three types of ``qualified'' plans.
Stock bonus
Pension, and
Profit sharing
A 401(k) plan, as we call it, is actually a profit sharing plan (in
most cases) \2\ that has a feature allowing employees to take wages and
bonuses in cash, or defer them into the profit sharing plan, and hence
are often referred to as ``employee deferrals.'' However, those
employee deferrals are technically ``employer'' contributions made
pursuant to a ``cash or deferred election.'' Deposits of all employer
contributions, including employee deferrals, plus investment earnings
of ``401(k)'' plans are subject to the same rules of trust
administration, governance, and fiduciary prudence which apply to stock
bonus and traditional pension plans.
ERISA--Employee Retirement Income Security
The purpose of a retirement plan, including 401(k) plans, is to
provide future income for retired American workers. Those who are
charged with the management of a qualified retirement plan must do so
with an eye single to this purpose and none other. Such an individual
is a ``fiduciary.''
Rules of Fiduciary Prudence
As it relates to the issue at hand, the following fiduciary axioms
have consistently held true:
Fiduciary based decisions secure future retirement income.
Non-fiduciary based decisions diminish future retirement
income.
Hidden and excessive fees exist because both types of
decisions (fiduciary based and non-fiduciary based) exist
simultaneously within 401(k) and other similar plans, complicating and
obscuring a fiduciary's ability to understand his duties and to
properly discharge them.
This written testimony will focus solely on 401(k) and similar plan
assets held in trust, pursuant to IRC Sec. 501(a). Therefore, rules of
Fiduciary Prudence are a fundamental component of this discussion
because trusts are governed and managed by fiduciaries. True prudent
practices should deliver optimal results. Poor or partial fiduciary
practices will deliver sub-optimal or even poor results.
Fiduciary principles and ideals are not obscure, nor are they
difficult to learn and understand. In fact, modern rules of fiduciary
prudence have existed for nearly two hundred years. However, in the
United States, the primary way fiduciary responsibilities are taught to
sponsors of retirement plans is through the financial industry. Since
an important element of fiduciary governance is monitoring those who
provide services to a retirement plan, strangely enough, we have
accepted a system where those being monitored are teaching those who
are doing the monitoring, and doing so according to their philosophies
and standards, with a particular objective in mind.
The current 401(k) culture essentially couples the ``fox teaching
the rooster how to guard the hen house'' with a perceived governmental
``get out of jail free card'' (i.e. DOL regulation 404(c)). The effect
of adopting these two ``cultural'' elements has, over time, caused
401(k) plans to be governed through the commingling of fiduciary and
non-fiduciary practices and philosophies.
Therefore, resolving the issue of hidden, obscure, and excessive
fees is wholly dependent on bifurcating fiduciary elements and
practices from the non-fiduciary ones within the 401(k) industry. Then,
logic will reveal that any fees paid for non-fiduciary services and
practices are unnecessary, and hence excessive. Furthermore, these are
the fees that are hidden because they simply cannot be justified when
viewed through the lens of true fiduciary prudence. In short, if
fiduciaries eliminate non-fiduciary practices in their 401(k) plans,
they will immediately eliminate hidden and excessive fees. To argue
otherwise would suggest that 401(k) plans are only ``partially''
subject to fiduciary prudence, and hence are only a ``partially''
qualified plan.
Conceptually, it is as simple as that--but in practice, it is far
more difficult.
Complexity
The hidden fee problem in 401(k) and similar plans is actually a
mysterious Gordian Knot consisting of trust law, tax law, public
policy, doctrines of fiduciary prudence, financial principle, economic
principle, and perhaps the lack of discipline to defer control and
gratification until actual retirement. It is difficult to see the ends
of the rope, and very few know how to unravel it. In addition, many who
might discern how to unravel it have strong incentives not to do so.
It is widely accepted that 401(k) and similar arrangements are the
way most Americans will invest for retirement. Therefore, it is
incumbent upon us all to be absolutely certain there are no unnecessary
obstacles (whether intentional or unintentional) to its long-term
success. As it stands today, there is an imbalance between prudent
practices aimed at efficiently securing the retirement income of
America's workforce, and non-fiduciary services created for business
purposes between competing service providers in the private sector.
Obstacles to a Clear Understanding
Conflicting Governmental messages that confuse
qualification rules under IRC Sec. 401(a) with rules of fiduciary
prudence and process as defined by Department of Labor regulation, case
law, and other regulatory pronouncements.
``Exemptions'' given to non-fiduciary firms or individuals
to receive compensation from trust assets without being legally held to
a fiduciary standard of conduct. In other words, non-fiduciary
involvement in 401(k) plans has created a non-fiduciary operating
environment.
ERISA has imposed a federal fiduciary duty and
responsibility on business executives and board directors who serve as
``ERISA Fiduciaries'' requiring them to act exclusively in the best
interest of plan participants and beneficiaries. A growing chorus of
benefit industry gurus believes that such executives and directors had
a pre-existing fiduciary duty and responsibility to the owners of the
business. Query: Has ERISA unintentionally imposed an incurable
conflict of interest? That is, can any person faithfully serve the best
interest of two conflicting masters? Plan participants may believe they
are out of harm's way and protected, as fiduciary oversight is mandated
by ERISA, but increasingly these fiduciaries appear to be like a
sightless watchdog that doesn't bark.
Fiduciary ignorance, fear, uncertainty, and doubt, which
leads to non-fiduciary decisions and practices.
Identifying non-fiduciary practices, and their associated costs
Decisions and/or functions that are clearly fiduciary in nature
include proactively monitoring costs, selecting a proper number of
efficient investments necessary to construct an appropriate portfolio,
and operating the plan in exact accordance to its purpose--which is to
deliver retirement income to its beneficiaries.
Decisions and/or functions that are clearly imprudent include
purchasing high cost funds when their identical match is available at
perhaps less than half the cost, or turning a blind eye to obvious
mishandling of trust assets by non-fiduciaries (i.e. the participants)
and, at the same time, claiming for themselves protection from
fiduciary liability under 404(c).
Fiduciary/Non-fiduciary/``The Gray Area'' (Subject to discernment)
There are other decisions and/or functions that fall into a gray
area. Such decisions or functions might be prudent, or they might not
be.
The significance of this explanation is that some fees are
obviously necessary and prudent. Some fees are hidden and imprudent and
pay for excessive or unnecessary services. Finally, there are fees that
could be improper in some plans, and acceptable in others, and it takes
an experienced, discerning eye to recognize the differences.
Excessive is as excessive does
The following examples show the interplay between various
imprudent, hidden, and excessive fees as influenced by the 401(k)
culture described above.
Even at this time, a blatant non-fiduciary based feeding frenzy is
taking place at the expense of American workers' 401(k) plans.
``The mutual fund industry is now the world's largest skimming
operation--a $7 trillion (now $12 trillion) trough from which fund
managers, brokers, and other insiders are steadily siphoning off an
excessive slice of the nation's household, college, and retirement
savings.'' \3\ ($12 trillion update added)
Most experts agree that trust fiduciary laws are nominally default
rules,\4\ and hence should be simple to adhere to and operate under.
However, managing 401(k) plans is anything but simple. It's a jumbled
mess because non-fiduciary investment sales people have infiltrated,
and now control what was intended to be a purely fiduciary function.
It would be simple to obtain optimal results. Then why isn't it
happening?
For example, the S&P 500 Index consistently outperformed 98% of
mutual fund managers over the past three years, 97% over the past 10
years ending October 2004, and 94% over the past 30 years.\5\
Recent studies reveal (and many more continue to substantiate),
that a passive 60% stock, 40% bond portfolio outperformed 90% of the
nation's largest corporate pension plan portfolios, ``run by the
world's best and brightest investment minds.'' \6\ The average return
on actively managed equity mutual funds over the past 35 years trails
the S&P by 87 basis points per year, and 105 basis points on broader
indexes. ``Over long periods, this difference in return amounted to
substantial differences in wealth.'' \7\ This is an unnecessary waste
of participant's hard earned money. ``This is why most academic and
many professional advisors recommend that the best investment strategy
is to match the market's performance. You can do this by putting your
money in a fund that holds all stocks in proportion to their market
value. Since these index funds do no research and little trading, the
costs of holding their portfolios are extremely small, some ranging as
low as 0.10 percent a year.'' \8\
Then why do literally hundreds of thousands of 401(k) plan
fiduciaries do just the opposite? It's because they are ``guided'' to
particular decisions by non-fiduciaries (i.e. brokers, registered
representatives, insurance agents, etc.) in pursuit of compensation
which very frequently is in the form of hidden and excessive fees.
Making Sense of It All
Following are some of the usual hidden costs found in 401(k) plans.
Hidden Costs #1--Undisclosed Trading Costs
The assets held in account for the benefit of participants and
beneficiaries do not belong to them. These assets are owned by an
``entity,'' which is the trust. The participants are entitled to future
benefits from the trust. This is an important concept in trust
governance. In other words, if the investments belonged to the
participants right now, there would be no need for fiduciaries.
Therefore, the fiduciaries are charged with making decisions for the
future benefit of others, based on what they deem appropriate for the
participants and beneficiaries, in a similar way a member of the House
of Representatives makes decisions for their constituents. The decision
is based upon what they judge to be in their constituents' best
interests.
``The new prudent investor rule directs the trustee to invest based
on risk and return objectives reasonably suited to the trust.'' \9\
A major flaw in the 401(k) system, therefore, is allowing non-
fiduciaries (in this instance, plan participants themselves) to control
trust assets by choosing without skill from a large array of investment
choices, carefully presented in such a way as to generate additional
brokerage (trading) commissions by encouraging ``active'' trading
within participant accounts. In other words, emotional reactions of
participants who lack investment expertise trigger undisciplined and
imprudent investment decisions in the trust, when a simple 60/40
portfolio described above is well within the reach of every single
participant. The brokerage and mutual fund industries not only fully
understand that participants are making imprudent investment decisions,
but are counting on participant ignorance to generate revenue. This is
a substantial and hidden cost that participants are almost universally
unaware, and have no concept of how it is reducing the future
retirement income they would otherwise receive. The average actively
traded mutual fund experiences approximately 80% turnover per year,
meaning that 80% of the underlying stocks and/or bonds are sold each
year. It is estimated that for every 1% in turnover, there is 1% in
added brokerage commission cost. Hence, the average mutual fund has an
added cost of .8% (otherwise known as 80 ``basis points.'') This is the
first hidden and unnecessary cost.
It becomes easier to understand why so many 401(k) plans primarily
offer (1) actively traded mutual funds, and (2) more funds than are
necessary to construct a prudent, low cost portfolio. It also
demonstrates rampant ignorance that exists in the fiduciary ranks--in
plans large and small.
``TheStreet.com profiled a fund last year that had a 5 star rating,
a 1% expense ratio, and 800 bps in brokerage expense.''\10\
Reducing net returns through unnecessary and excessive brokerage
expenses is a non-fiduciary and imprudent practice that runs counter to
the principles set forth in ERISA, which is to secure the retirement of
American workers. Consider the chaos that would result if Congress gave
each citizen 15 laws to choose from. Individually, we might pick and
choose those we deem appropriate for us and, in turn, adhere only to
the particular laws we chose. The principle of fiduciary prudence is
that fiduciaries make decisions for all individuals to whom they are
responsible based upon what is in their best interest, whether they
like it or not. As unpopular as this concept is, we must not equivocate
on protecting participants and beneficiaries from their own ignorance,
just as each of you protect your constituents from their ignorance on
various matters.
The current 401(k) culture has eroded the principles of true
fiduciary governance through the begging, pleading, lobbying, or
through other ways and means, we have drifted from ``protect and
nurture their needs'' to ``give them what they want--in fact, let's
give them even more than what they think they want.''
Hidden Costs #2--SEC Rule 28(e) ``Soft Dollar'' Revenue Sharing
Hidden Cost #2 is symbiotic with Hidden Cost #1 above, and it
violates fundamental fiduciary rules and significantly hurts
participants. 28(e) Soft Dollars are generated by active trading within
mutual funds and similar investment vehicles. Allowing ``Soft Dollars''
to go ``un-captured'' and credited back to the 401(k) trust is not a
fiduciary practice, and the historical problems caused by soft dollars
are self evident.
Shortly after the creation of the IRA, but before the creation of
the 401(k) as we know it, a change occurred within the brokerage and
mutual fund industry. As part of the Securities Acts Amendments of May
1975 (SAA '75), fixed commission rates on the purchase and sale of
securities through brokerage firms were eliminated. The significance of
the elimination of fixed commission rates would prove to be one of
several core issues of debate regarding fees in retirement plans. This
would ultimately allow brokerage firms to charge excess commissions,
thereby creating ``at play'' revenue that actually belonged to the
participants, which is commonly referred to as ``soft dollar'' revenue
or ``SEC Rule 28(e)'' revenue. With hundreds of billions of securities
trades each year, the revenue made available by SAA '75 would forever
change the mutual fund and retirement plan industry. These soft
dollars, coupled with the urgent need to compete in the 401(k) industry
and the creation of the 12(b)-1 in 1980 created the ``perfect fee
storm,'' which until now has existed with little or no notice by
Federal regulators, plan sponsors, participants, or the general public.
As a result of the Securities Acts Amendments of 1975, Section
28(e) was added to the Securities Exchange Act of 1934. With fixed
commission rates no longer the law, Section 28(e) created a safe harbor
for brokerage firms who exercise no investment discretion as defined
under Section 3(a)(35) of the 1934 Act to be able to charge a mutual
fund a commission that was more than what it costs to actually execute,
clear, and settle a securities transaction without violating the law or
fiduciary duties. This excess commission could be used to purchase
additional services from the brokerage firm in the form of presumably
valuable investment research. In order to receive protection under the
safe harbor, the mutual fund must act in good faith to ensure the
excess commission was ``reasonable in relation to the value of
brokerage and research services provided by the broker-dealer.'' Since
a passive indexing approach requires no research and also consistently
outperforms 90% of actively managed approaches that do require
research, then what is the value of the research? The 10% that do
outperform an indexing approach are temporarily fortuitous.\11\ If you
follow the money, modern investment research exists so 28(e)
commissions can be captured, not to provide consistent market returns
to participants.
Actively traded funds inherently have higher trading costs. In
other words, every time a mutual fund manager buys and/or sells the
underlying securities within the fund, the participants' return is
decreased by the cost of those trades. Part of the reason for this lies
in the fact that ``excess'' commissions are being charged for non-
fiduciary purposes.
SEC rule 28(e) encourages turnover and the cost of trading because
mutual fund managers receive revenue from the brokerage firms for
clearing the Funds' securities trades. This explains why the
intelligent approach so widely accepted by the world's most astute
investing minds is thrown out the window in 401(k) plans. Brokerage and
Mutual Fund companies work together to generate excess revenue at the
expense of participants, because they believe they can indiscriminately
do so, not because it is prudent, intelligent, or advisable.
Prior to ERISA, mutual funds used any ``excess'' commission on a
securities transaction to buy additional goods or services from their
chosen brokerage firm. For example, if a trade costs 3.5 cents per
share (trade execution, clearance and settlement), and the brokerage
fixed commission was 5 cents per share, the excess 1.5 cents could
either be used to purchase additional goods or services from the broker
that directly benefited the account holder, or be credited back to
their rightful owners, the account holders. Excess brokerage
commissions (28(e) soft dollars) were handled the same way for IRAs and
qualified plans.
After ERISA, the practice of using such soft dollars in IRAs would
remain the same, but with respect to participants and beneficiaries
within a qualified 401(k) plan subject to rules of fiduciary prudence,
a conflict clearly exists with ERISA sections 403(c)(1), 404(a)(1),
406(a)(1)(D), 406(b)(1) and 406(b)(3).
ERISA 403(c)(1) states that the assets of a plan ``shall
never inure to the benefit of any employer and shall be held for the
exclusive purposes of providing benefits to participants in the plan
and their beneficiaries and defraying reasonable expenses of
administering the plan.'' Significance: Using soft dollars for purposes
other than for the exclusive purpose of providing benefits to
participants and beneficiaries and paying operational costs of the plan
itself is a fiduciary breach.
ERISA 404(a)(1) states that a fiduciary must act prudently
and solely in the interest of the participants and beneficiaries
Significance: Using soft dollars to buy loyalty of brokerage firms,
consultants or other parties-in-interest to the plan is a fiduciary
breach.
ERISA 406(a)(1)(D) states that a fiduciary shall not
transfer to, or use by or for the benefit of a party-in-interest, any
assets of an ERISA governed plan. Significance: Use of soft dollars
could effectively be a transfer to a party-in interest, thereby
creating a fiduciary breach.
Due to the lack of oversight of 28(e) Soft Dollar Revenue in
qualified retirement plans, the Securities and Exchange Commission was
compelled to address the issue before the Congressional Subcommittee on
Capital Markets, Insurance and Government Sponsored Enterprises,
Committee on Financial Services. This occurred on June 18, 2003,
shortly after H.R. 2420, the ``Mutual Funds Integrity and Fee
Transparency Act of 2003'' was presented to the House of
Representatives by Chairman Baker, Ranking Member Kanjorski and other
members of the Subcommittee. According to the testimony of Paul F.
Roye, Director, Division of Investment Management of the SEC, the
Mutual Funds Integrity and Fee Transparency Act would:
Provide investors with disclosures about ``estimated''
operating expenses incurred by shareholders, soft dollar arrangements,
portfolio transaction costs, sales load break points, directed
brokerage and revenue sharing arrangements.
Provide investors with disclosure of information on how
fund portfolio managers are compensated.
Require fund advisers to submit annual reports to fund
directors on directed brokerage and soft dollar arrangements, as well
as on revenue sharing.
Recognize fiduciary responsibility and obligations of fund
directors to supervise these activities and assure that they are in the
best interest of the fund and its shareholders.
Require the SEC to conduct a study of soft dollar
arrangements to assess conflicts of interest raised by these
arrangements, and examine whether the statutory safe harbor in Section
28(e) of the Securities Exchange Act of 1934 should be reconsidered or
modified.
While it is commendable that the SEC has decided to act on this
issue, 17 years earlier the U.S. Department of Labor issued ERISA
Technical Release 86-1 notifying the public of this very issue. The
nature of ETR 86-1 was to ``reflect the views of the Pension and
Welfare Benefits Administration (PWBA) with regard to `soft dollar' and
directed commission arrangements pursuant to its responsibility to
administer and enforce the provisions of Title I of the Employee
Retirement Income Security Act of 1974 (ERISA).''
An excerpt from ETR 86-1 states:
``It has come to the attention of PWBA that ERISA fiduciaries may
be involved in several types of `soft-dollar' and directed commission
arrangements which do not qualify for the `safe harbor' provided by
Section 28(e) of the 1934 Act. In some instances, investment managers
direct a portion of a plan's securities trades through specific broker-
dealers, who then apply a percentage of the brokerage commissions to
pay for travel, hotel rooms and other goods and services for such
investment managers which do not qualify as research with the meaning
of Section 28(e). In other instances, plan sponsors who do not exercise
investment discretion with respect to a plan direct the plan's
securities trades to one or more broker-dealers in return for research,
performance evaluation, and other administrative services or discounted
commissions. The Commission (SEC) has indicated that the safe harbor of
Section 28(e) is not available for directed brokerage transactions.''
Subsequent SEC investigations have shown that illegal ``28(e)''
revenues have been used by ``non-fiduciary'' consultants to make
certain services available to mutual funds.
Among them:
Conferences and other similar group meetings where the
consultant invites both the ``client'' (i.e. a 401(k) plan sponsor/
trustees) and representatives of the mutual funds who want to sell
their funds to the client of the consultant. In other words, the mutual
fund pays the consultant a significant amount of money to be invited to
meetings where the consultant's clients will be in attendance.
Sales and marketing support to the mutual fund's staff.
``Objective looking'' performance reports that paint the
mutual fund in the best light, and facilitate the sale of that fund to
clients of the consultant.
Other ``image enhancement'' or ``sales facilitation''
services.
Loyalty of consultant or brokerage firm.
28(e) revenue practices hurt plan participants and their
beneficiaries, and violate ERISA Sections 403(c)(1), 404(a)(1) and
406(a)(1)(D). Illegal 28(e) soft dollars are the most difficult fee to
uncover.
Hidden Costs #3--Sub-Transfer Agent Revenue Sharing
The following is a rather lengthy, but important illustration of
the widespread practice of subsidized record keeping services through
excess mutual fund management fees.
Envision a meeting among three individuals. An employer with 75
employees, wanting to design a brand new plan for their employees; a
Registered Investment Representative; and a Record Keeper commonly
referred to as a ``Third Party Administrator.'' After the meeting, the
employer requests formal proposals from the Investment Representative
and the Record Keeper. They leave the employer's office and agree to
work together to design a plan that works for all parties. The
Registered Representative and the Record Keeper collaborate and develop
two proposals for the employer to consider.
The first proposal recommends 6 mutual funds, 4 of which are
actively traded mutual funds. As a portion/component of the Funds'
Management Fees, the 4 actively traded mutual funds pay a .5% ``finders
fee'' of each new dollar invested to the Registered Representative plus
a .5% trail commission--referred to as a 12(b)-1 commission. (A more
detailed discussion of 12(b)-1 commission will be forthcoming later in
this testimony). The Record Keeper proposes a $4,000 base fee per year,
plus $60 per participant per year, paid by the employer.
When the employer does the math, he discovers that if each of his
75 employees contributed $100 per semi-monthly pay period, the
Investment Representative would earn $100 x .5% x 75 x 24 = $900 the
first year, and every year thereafter, plus an additional .5% on the
accumulating balance. This $900 doesn't seem like much, especially when
compared to the record keeping fee $8,500 ($4,000 base fee plus $4,500
(75 participants x $60)).
SUMMARY OF PROPOSAL A
----------------------------------------------------------------------------------------------------------------
Cost item Investment Record keeping
----------------------------------------------------------------------------------------------------------------
Finders Fees...................................................... $900 per year N/A
Ongoing Commissions............................................... $900 and growing N/A
Base Fees......................................................... N/A $4,000
Per Head Charges.................................................. N/A $4,500
----------------------------------------------------------------------------------------------------------------
The employer looks at the record keeping fees, squirms a little,
and quietly questions whether the record keeper's services are really
worth $8,500 per year. Then he requests Proposal B. Having experienced
that reaction before, the Investment Representative and the Record
Keeper are prepared to present something more palatable.
The second proposal consists of 12 mutual funds, 9 of which are
actively traded. To the employer's delight, proposal B seems much
better. The Investment Representative's compensation remains the same,
but the Record Keeping fee is cut by 70%! The base fee is reduced to
$800 per year, and the per-head charge is reduced to $25.
SUMMARY OF PROPOSAL B
----------------------------------------------------------------------------------------------------------------
Cost item Investment Record keeping
----------------------------------------------------------------------------------------------------------------
Finders Fees...................................................... $900 per year N/A
Ongoing Commissions............................................... $900 and growing N/A
Base Fees......................................................... N/A $800
Per Head Charges.................................................. N/A $1,875
----------------------------------------------------------------------------------------------------------------
This proposal seemed like the best of both worlds. Twice as many
mutual fund options for one-third the cost! The employer thinks
participants will love it, and of course he loves it, too. It doesn't
occur to the employer that he should question the economics, or whether
there are fiduciary implications to going with one proposal vs.
another. It seems like a no-brainer, so the decision is made to go with
Proposal B.
Fast forward 10 years and the employer now has 150 employees, and
$4 million dollars in the plan. As far as the employer is concerned,
the economics are still the same as the first day the plan was adopted.
However, there was an element the employer didn't understand. Remember
the reaction to the $8,500 fee for record keeping fees? The employer
wasn't certain if that was a fair fee for services rendered. Maybe it
was fair, and if that was the case, the employer might have reduced or
cut-back on various optional ``elements'' of the plan to arrive at a
fee that seemed appropriate, all services considered.
The $2,675 in fees associated with Proposal B seemed about right.
With the growth of the company and the plan, the fact that plan costs
also increased went without saying. Looking back at the original
``deal'', the employer computes the fees and costs as he thinks it
stands today. All things remain the same except for 150 participants
instead of 75, and there are $4 million dollars in assets.
SUMMARY OF COSTS 10 YEARS LATER--PROPOSAL B
[The ``believed-to-be'' costs]
----------------------------------------------------------------------------------------------------------------
Cost item Investment Record keeping
----------------------------------------------------------------------------------------------------------------
Finders Fees...................................................... $1,800 per year N/A
Ongoing Commissions............................................... $20,000 growing N/A
Base Fees......................................................... N/A $800
Per Head Charges.................................................. N/A $3,750
----------------------------------------------------------------------------------------------------------------
Paying the record keeper for such an extensive array of services
rendered might even be perceived as being a little low. The employer
intuitively knows the record keeper is worth more than $4,550, but is
uncertain ``how much more.'' If the record keeper needed more money,
they would certainly ask for it, and if they don't request more they
must be satisfied. The employer also notices the Investment
Representative is now being paid over $20,000--and given all of the
enrollment and investment education meetings--along with all of the
reports, trustee meetings, and general education given to the
fiduciaries, it might seem ``about right.''
Luckily for the employer and the participants, the employers' niece
happened to be a student of fiduciary prudence and retirement plan
economics and something seemed ``fishy'' to her.
After looking into the economics of ``Proposal B'' today, the
employer's niece reluctantly brought the bad news. Something has gone
terribly wrong, and the employer is stunned beyond words. Here's how
the true economics look:
TRUE ECONOMICS
----------------------------------------------------------------------------------------------------------------
Cost item Investment Record keeping
----------------------------------------------------------------------------------------------------------------
Finders Fees...................................................... $1,800 per year N/A
Ongoing Commissions............................................... $20,000 growing N/A
Base Fees......................................................... N/A $800
Per Head Charges.................................................. N/A $30,150
----------------------------------------------------------------------------------------------------------------
How could the record keeper be making more money than the
Investment Representative? Ten thousand dollars more * * * and growing!
Remember the ``collaboration'' the Investment Representative and
Record Keeper originally entered into? Proposal B involved the payment
of Sub-Transfer Agent fees (Revenue Sharing from the Mutual Funds). The
increase in funds was not an added benefit to the employer or employees
as initially believed. Rather, it was a carefully calculated design
element to capture a particular type of revenue sharing based upon two
things: (1) The number of funds offered multiplied by (2) the number of
participants with assets in those funds.
Assume in this case 8 of the 9 actively traded mutual funds are
being utilized by participants. Also assume that the mutual funds each
pay $22 per participant per year. The true economics are therefore 150
participants x $22 Sub-Transfer Agent Revenue Sharing x 8 Funds =
$26,400. When the existing ``per head'' fee paid by the employer
($3,750) and the base fee ($800) are added to the Revenue Sharing
number, the new total is $26,400 + $3,750 + $800 = $30,950.
The employer is angry for four reasons. First, he feels deceived
because he didn't understand the true economics of the plan. Second, he
feels his ability was impeded to prudently judge whether the services
rendered were worth what the Record Keeper received in actual
compensation. Third, he understands now that the ``extra'' funds had
nothing to do with helping participants build a better portfolio. It
had everything to do with multiplying the potential revenue sharing--
and that has not helped the participants at all. Fourth, the
realization that the employer has allowed assets to be improperly spent
on services with skewed economics might place him squarely in the cross
hairs of an effective litigator.
Such is the nature of hundreds of thousands of 401(k) and similar
retirement plans across the United States even as you read this.
What is a Sub-Transfer Agent? (and Sub Transfer Agent Revenue Sharing?)
A transfer agent is usually a bank or trust company (or the mutual
fund itself) that executes, clears and settles a security buy or sell
order, and maintains shareholder records (i.e. accounts for ``title''
of the ownership of the shares). When certain functions of the transfer
agent are sub-contracted to a third party, that third party becomes a
``sub-transfer agent.'' Within the context of this paper, a sub-
transfer agent would be one of the following entities:
1. A third party administrator.
2. A bank or trust company performing recordkeeping services.
3. Some other entity tracking the number of shares held for the
benefit of a specific participant within an individual account plan.
Payment to these parties for this sub-contracted service has come
to be known as ``Sub-Transfer Agent fees.'' Sub-Transfer agent fees
exist solely to support the participant directed account culture in
actively managed mutual funds.
Sub-transfer agent fees are generally paid as a flat dollar, per-
participant, per fund. For example, many funds will pay a third party
administrator $10 per participant, per fund. Other funds will pay a
percentage of assets--such as 5 to 10 basis points. However, some funds
pay up to $22 per participant, per fund or 35 basis points. The
problems with sub- transfer agent fees is not how much is being paid to
the service provider. Rather, the problem is being unaware who is
receiving the payments, and whether or not the payments fairly
represent the value of the service being rendered. The Department of
Labor has made it very clear that a plan sponsor must understand the
value and associated compensation of each individual servicing company,
thereby making the cost of the parts more important than the cost of
the whole.
An estimated 100 million shareholder accounts, or approximately 40
percent of all mutual funds, are in sub accounts at financial or record
keeping intermediaries at this writing. Approximately $2 billion
dollars per year is paid to third parties for sub-accounting services.
There are potential costly and ERISA-violating problems inherent in
omnibus accounts with underlying participant directed sub-accounts
which are beyond the scope of this testimony.
Hidden Costs #4--Non-Fiduciary Compensation (12(b)-1 commissions)
There are two types of 12(b)-1 fees:
1. Sales commission 12(b)-1--paid to a registered representative
for selling mutual funds for an individual or within a plan.
2. Servicing 12(b)-1--paid to a person or entity who services an
account after the sale.
SEC Rule 12(b)-1 was enacted in 1980. It is partially responsible
for the proliferation of mutual funds in individual account plans.
Again, referring to the mutual fund relationship with the distribution
medium (sales force) of the brokerage firm, it creates a conflict of
interest between the brokerage firm and the mutual fund, thereby
rendering each unable to devote their loyalties to the plan
participants. It permits mutual funds to increase their internal fund
expense ratio by up to 1% in aggregate.
The combination of these two commissions may not exceed 1%. For
example, the sales 12(b)-1 could be 50 basis points (.5%) and the
service 12(b)-1 could also be 50 basis points.
It is common to refer to both sales and servicing revenue as
``12(b)-1'' fees, not differentiating between the two. More than half
of all mutual funds have a 12(b)-1 feature. These commissions are
disclosed in the prospectus, but very few plan sponsors understand
their significance to the plan, the participants, and the trustees.
The 12(b)-1 commissions are a concern because non-fiduciary sales
people carefully place products with high 12(b)-1 commissions within
401(k) plans without the full understanding of the plan sponsor or
trustees. Conversely, a Fiduciary Investment Advisor would be obligated
to disclose fees in writing, invoice the plan sponsor or plan for those
stated fees, and credit any 12(b)-1 fees back to the trust. This clear
difference in behavior and reporting shows the crisis that exists in
the industry. Plan sponsors don't know there is a difference; mutual
funds are simply mutual funds to them.
Another seldom considered 12(b)-1 issue is that of unfair subsidy
disparity. Fee subsidy disparity is often referred to by the fiduciary
community as the ``Hidden Tax'' paid by participants with larger than
average account balances because 12(b)-1 commissions pay for non-
fiduciary services.
Illustration
Let's compare two hypothetical plans, Plan ``A'' and Plan ``B.''
Let's say each has $50 million in assets, both have identical mutual
funds and service providers, each paying 3% (1.50% in trading costs,
and 1.50% in fund management fees). Further, assume that 40% of the
fund management fee pays for revenue sharing arrangements (brokers,
record keepers, insurance agents, and others), and 60% is kept by the
fund manager. Let's also say that Plan ``A'' has 500 employees and Plan
``B'' has 2,500 employees.
Are costs consistent for all employees as a percentage of their
account balances? Yes, of course. But what are the real economics? Take
a look at the following example of a comparison between two
hypothetical plans:
----------------------------------------------------------------------------------------------------------------
Fee/Cost element Plan A Plan B
----------------------------------------------------------------------------------------------------------------
Gross fund fees and commissions......................... $1,500,000 ($50,000,000 x $1,500,000 ($50,000,000 x
3%) 3%)
Revenue sharing......................................... $300,000 (1.50% x 40% x $300,000 (1.50% x 40% x
$50,000,000) $50,000,000)
Revenue Sharing borne by each participant............... $300,000 500 $300,000 2500
participants = $600 per participants = $120 per
participant participant
----------------------------------------------------------------------------------------------------------------
In this example, the participants of Plan ``A'' are subsidizing the
overhead of Plan ``B.''
Hidden Costs #5--Variable Annuity Wrap Fees
A Variable Annuity is an investment contract between a plan and an
insurance company where (normally) a series of ongoing deposits are
made to accumulate resources sufficient to pay a future benefit.
Variable Annuities can be sold by insurance agents who have little or
no formal investment or fiduciary training. Variable Annuities are
separate vehicles that invest in mutual funds--they are not mutual
funds in and of themselves.
Variable annuities offer a variety of investment options that are
typically mutual funds investing in stocks, bonds and cash. Gains on
variable annuities are tax deferred whether held in a qualified trust
or not, and there are costs associated with this ``built-in'' tax
deferral. The fee associated with obtaining this tax-deferred benefit
is an insurance component. Therefore, one must ask whether or not
putting a variable annuity in an ERISA-governed vehicle is necessary,
or even wise. In other words, you could buy a lower cost mutual fund
using the inherent benefits of a 401(k) and still get the deferral of
tax. Paying the insurance company for the tax deferral may not be
prudent. Variable annuities generally have higher expenses than
comparable mutual funds, and these fees are assessed in such a way that
each component service is ``wrapped up'' into one aggregate fee.
Accordingly, this aggregate fee is called a ``wrap'' fee. The wrap fee
hides individual component fees and services, which are:
Investment Management: Management fees of the mutual fund
that is contained within the variable annuity. (Note that trading costs
are in addition to the investment management component, and are
extremely difficult to discover in variable annuity contracts.)
Surrender Charges: If withdrawals are made from a variable
annuity within a certain period of time after units are purchased
within the annuity, the insurance company will assess a surrender
charge. The charge is used to reimburse the insurance company for the
commission payments they paid to a broker or insurance agent upfront.
The surrender charge usually starts out higher, and decreases over the
length of the surrender period.
Mortality and Expense risk charge: This charge is equal to
a percentage of the account value, typically 1.25% per year over the
investment management fees--but could be more or less depending on who
is purchasing the annuity.
Administrative Fees: The insurer may deduct charges to
cover record-keeping and other administrative expenses. It is common to
see fees of $25 or $30 per year, or a percentage of each participant's
account value, typically in the range of an additional .15% per year.
Fees and Charges for Other Features: Stepped up death
benefit, a guaranteed minimum income benefit, long-term care insurance
etc. These fees are stated in the annuity contract, and are actuarially
computed based on age, health, etc., and hence differ from participant
to participant.
Bonus Credits: Some insurance companies offer bonus
credits, which is a credit back to the account of percentage of each
purchase--e.g. 3% of each deposit. These types of accounts often have
higher expenses, and the expenses can be larger than the credit. Bonus
credits are generally ``purchased'' with higher surrender charges,
longer surrender periods, higher mortality and expense risk charges.
Hidden Costs #6--Administrative ``Pass Throughs''
An unfortunate and yet almost universally common in 401(k) plans is
an expense borne by all participants for unnecessary services demanded
by a vocal minority. A fiduciary is obligated to protect and treat all
participants equally. It is a violation of ERISA's exclusive benefit
rule that millions of participants unknowingly pay for the
undisciplined urges of others to immediately wrest benefit from their
retirement plans. Three examples are:
Easy loans taken against a participant's vested balance
Open brokerage options
Investment ``advice'' services
While some may argue that these plan features are available to all
participants equally, we must not confuse matters of coverage and non-
discrimination in benefits rights and features (pursuant to IRC
Sec. 401(a)(4)) with fiduciary prudence. Plan assets should not be used
to pay for services that all Participants do not collectively receive
or benefit from plan assets. In hundreds of thousands of companies
across the U.S. there are assertive individuals, who are the vocal
minority, that want various bells and whistles in their 401(k), and the
unsuspecting end up having to pay for it. This subtle violation of the
exclusive benefit rule is rampant and costly. Plans with optional
benefits that increase the overall cost of plan operation should be
paid for by the individual users or by the plan sponsor, not by the
plan. These amounts vary from plan-to-plan, but they can be
substantial, especially if the fees are ``translated'' into an asset
based charge that goes un-examined year after year.
Hidden Costs #7--Non-Fiduciary Mish-Mash
To wrap up this discussion, it's important to highlight a few
remaining hidden costs. The following is not an all-inclusive list,
because there are dozens of variations to each of these items, and even
a few other costs that are highly complex and difficult to explain.
These are beyond the scope of this hearing, but might be examined as
part of a subsequent hearing. Some of the remaining fees and costs
employers of all sizes are struggling to grasp are:
Share class variances based upon plan size. (i.e. high
load share classes in large plans. Common share classes include A, B,
C, R, etc.) \12\
Shadow Index Funds. These are basically funds that closely
track passive indexes, but have ``actively managed'' prices. In other
words, they are overly priced index funds, some overpriced by 200% to
300%.
Suspected Inter-Fund pricing discrimination. (Evidence
that this practice is now coming to light, but this is so new that
independent fiduciaries are still trying to grasp the full nature and
extent of this particular issue.) \13\ This is where a mutual fund cuts
``deals'' with preferred investors, and increases fees to non-preferred
clients so that the total fee balances out to what is disclosed in the
prospectus. For example, a prospectus of a two hundred million dollar
fund might state that the fund management fee is 1% of assets. The fund
manager then ``discriminates'' against clients 2--6 by cutting a deal
with preferred Client 1 that reduces their fee by half.
------------------------------------------------------------------------
Actual
Assets fee
------------------------------------------------------------------------
Client 1................................... $100,000,000 .50%
Client 2................................... 20,000,000 1.10%
Client 3................................... 20,000,000 1.10%
Client 4................................... 20,000,000 1.10%
Client 5................................... 20,000,000 1.10%
Client 6................................... 20,000,000 1.10%
----------------------------
Total................................ $200,000,000 1.00%
------------------------------------------------------------------------
Clients 2 through 6 are paying for the backroom ``deal'' between
the fund manager and client 1, and will experience lower returns at the
same time, a clear example of investment return and cost
discrimination. Also, other suspected violations of fiduciary prudence
are coming to light where the ``deal'' isn't with a preferred client,
but with the Investment Representative. This has even more serious
implications when proven to be true.
Expert fiduciaries are still trying to get their arms around this
issue. It's such a startling revelation that independent fiduciaries
don't want to believe it, and hence are trying to find other reasonable
explanations for their findings, hoping it simply isn't so. However,
the economics of 401(k) plans are so defiant, entrenched, and arrogant,
that it might very well be happening more often than one would like to
think. Like Andrew Fastow, the former CFO of the complex ENRON
``special purpose entities,'' maybe the industry thought no one would
ever figure it out.
There is more that can and should be shared with legislators about
other activities in the final markets that adversely affect
participants and beneficiaries. I hope this testimony provides
sufficient background to assist in grasping the issues at hand and
comprehending the necessity of diligently considering possible
solutions.
Possible Solutions
Require full disclosure of all financial service provider
costs and expenses. Create stiff monetary sanctions for any person,
entity, or institution to withhold information from named fiduciaries
for any qualified plan. This would require full transparency of all
service provider activities and costs. It would enable fiduciaries to
better understand the basis for their decisions regarding plan
operations and investments. With improved understanding, the retirement
income security of millions of Americans would be enhanced.
Require fiduciaries to itemize any and all fees and
expenses extracted from plan assets at any level, including trading
commissions, spreads, management fees, soft dollar arrangements,
finders fees, transfer agent fees, and other expenses, and to disclose
those directly to participants on the Summary Annual Report. This will
demonstrate to participants that fiduciaries are aware of the costs the
plan is bearing, and that they are taking responsibility for those
costs.
Hold all individuals or companies who are paid from plan
assets to a fiduciary standard. This includes brokers, insurance
agents, record keepers, actuaries, and others. Those individuals or
professionals unwilling to assume fiduciary responsibility could
negotiate payments directly from plan sponsors.
Require all mutual funds held in a qualified trust (within
the meaning of Internal Revenue Code section 501(a)) to be ``revenue
sharing free'' which would include barring 28(e) soft dollars, 12(b)-1
marketing or servicing commissions, and sub transfer agent fees. This
would force the industry to price services based upon what
knowledgeable fiduciaries determine to be reasonable and appropriate
and are willing to bear.
Eliminate Department of Labor Regulation 404(c). Plan
sponsors and service providers have hidden behind this regulatory
allowance as a perceived shield from fiduciary liability while ignoring
the plight of workers who desperately need guidance and oversight for
their investments. Rule 404(c) is non-fiduciary at its core, and it
encourages other decisions that are not in the interests of securing
the retirement incomes of American workers.
Conclusion
Thank you for the invitation to testify before this committee. It
is my earnest belief that the workers of America deserve proper
protections for the hard earned savings they have set aside in their
401(k) plans--protections which they are denied in the current state of
the industry. I also believe that the problems with the industry can be
solved rather simply, though it will require confronting powerful
economic interests that support the current system. But America's
workers deserve better than they have received to date from the
providers of financial services. Finally, thank you for beginning the
daunting task of tackling this very important and relevant social issue
that will affect millions in the coming decade. I look forward to
elaborating on this written testimony in more detail during the
question and answer period.
endnotes
\1\ Randy Cloud, founder of CNMLLC. Accredited Investment Fiduciary
Auditor and a member of the Revere Coalition, a non-profit fiduciary
advocacy group of independent investment fiduciaries.
\2\ Stock bonus plans may also have a 401(k) feature.
\3\ Statement by Senate Governmental Affairs Subcommittee on
Financial Management, The Budget, and International Security. November
3, 2003, Senator Peter G. Fitzgerald (R- IL)
\4\ http://papers.ssrn.com/abstract--id=868761
\5\ http://www.ifa.com/Book/Book--pdf/overview.pdf--``Step 5''
\6\ Dimensional Fund Advisors, Basic 60/40 Balanced Strategy vs.
Company Plans 1987-2003. FutureMetrics, 2004.
\7\ http://finance.yahoo.com/expert/article/futureinvest/6953--
``The Truth About Money Management''
\8\ Ibid--``The Birth of Indexing''
\9\ http://papers.ssrn.com/abstract--id=868761 page 2
\10\ ``Fee Forensics, The impact of brokerage expense and trade
execution in mutual fund portfolios.'' 2005 Annual Conference of the
Center for Fiduciary Studies. Santa Fe, New Mexico.
\11\ http://www.efficientfrontier.com/ef/997/tough.htm
\12\ http://www.nasd.com/InvestorInformation/InvestorAlerts/
MutualFunds/UnderstandingMutualFundClasses/NASDW--006022
\13\ The following is a startling quote from an actual Independent
Fiduciary fee review: ``We find it noteworthy that the funds in the
Plan are paying out more than half of the revenue they receive for
`investment management'. In fact, one fund (fund name deleted) is
paying out 150% of the revenue that it discloses by prospectus. Several
other funds (mostly name deleted / name deleted funds) pay out more
than 70% of their receipts. Obviously, this indicates that they may be
making up their lost revenues in some other manner. We spot checked the
SAIs of a couple of the Plan's funds and found hidden expenses in
excess of .50% for transaction expenses. Some portion of this money
goes back to the manager in one form or another (research services,
commission rebates, etc.). We estimate that the true investment and
recordkeeping cost of the plan is significantly greater than the .94%
that is revealed by the basic plan expense ratios.''
______
Chairman Miller. Mr. Chambers?
STATEMENT OF ROBERT CHAMBERS, ESQ., PARTNER, HELMS, MULLISS &
WICKER, PLLC; CHAIRMAN, AMERICAN BENEFITS COUNCIL
Mr. Chambers. Good morning, Chairman Miller, Ranking Member
McKeon, members of the committee. My name is Robert Chambers,
and I am a partner in the Charlotte, North Carolina-based, law
firm of Helms, Mulliss & Wicker. As was noted earlier, I am
also the chairman of board of the American Benefits Council, on
whose behalf I am testifying today.
The council very much appreciates the opportunity to
present testimony with respect to 401(k) plan fees. Our goal,
like yours, is that the 401(k) system remains fair and
equitable, that it functions in a transparent manner, and that
it provide meaningful benefits at a fair price.
Our members have been successful in obtaining fee
information and using it to sponsor less expensive and more
efficient 401(k) programs, and yet, at the same time, we think
that there is room for improvement through more universal
disclosure of both fee and other information to both
fiduciaries and to plan participants.
There are three pieces to the fee disclosure puzzle that we
will be discussing today: one, disclosure by service providers
to employers and other fiduciaries; two, disclosure by those
fiduciaries to participants; and, three, disclosure by the
fiduciaries to the government.
Now, this comports with the GAO's recommendations in its
2006 report, as has previously been mentioned, and with the
three-part project that the Department of Labor is currently
pursuing. Admittedly, we have some concerns with some of the
details in the department's proposals, but we absolutely agree
with their general approach.
Now, I would like to take the rest of my time to raise five
points that we think, at the council, bear consideration this
morning.
First, the 401(k) plan system in the United States is
voluntary. It depends on the willingness of employers to offer
plans and the willingness of employees to use them. Whatever
fee disclosure reform efforts evolve, they must not undermine
these basic building blocks.
If a new regiment is overly complicated, overly costly,
some employers will drop their plans. Others will comply and
pass the costs onto participants, either in the form of plan
expenses, or perhaps reduced employer contributions.
Further, and perhaps most important, many employees will be
confused by the overemphasis on fees. Compared to equally
valuable investment consideration, such as diversification,
actual investment performance, and risk factors, and they will
either make unbalanced investment decisions or, even worse, a
decision not to participate at all.
Investment education is based on balance, and neither
Congress, the Department of Labor, nor plan fiduciaries should
counteract that concept through a disproportionate focus on
plan fees.
Second, every new feature that is added to a 401(k) plan
adds new costs. There are mandatory bells and whistles, such as
the benefit statement rules that are new, and permissive bells
and whistles, such as automatic enrollment. But they are all
bells and whistles; they have all been adopted by Congress; and
they all cost money to administer.
Additional fee disclosure will also result in additional
cost. Therefore, we must carefully measure the value of what
may be gained against the cost of the annual disclosure. Let's
make sure that our efforts to reduce costs do not, in the end,
actually reduce savings.
Third, in our system of commerce, it is the quality and
features of a product or service that permit one manufacturer
or service provider to charge more than a competitor. Some cars
cost more than others, as do computers, and, unfortunately, my
plumber.
Similarly, 401(k) plan fees should not be evaluated
independently from the product or service that is provided.
Every participant would be willing to pay higher fees if the
total net return on the investment were increased. Enhanced
disclosure will enable participants to determine whether the
quality of the product or the quality of the provider warrants
it cost. The two are inextricably tied to one another.
Fourth, we acknowledge that fee levels differ among differ
plans, just like cable TV service. Some people want only basic
service; some employers want to provide only a basic 401(k)
plan. But other folks want hundreds of channels, providing,
they expect, an even wider spectrum of entertainment. And many
employers want to provide a similarly broad span of retirement
plan features for their participants.
More bells and whistles, more costs. Enhanced disclosure
will help participants to make decisions among the choices
presented.
It is also true that many smaller employers pay higher
401(k) plan fees. This is usually attributable to fewer lives
over which to amortize fixed costs. We believe that increased
disclosure will exert downward pressure on fee levels in the
marketplace.
Fifth, and finally, some maintain that revenue-sharing is
wrong and should be prohibited. People with this view, we
think, misunderstand how the 401(k) system works. They also
probably think that Toyota manufactures cars. It does not. It
assembles cars.
No one expects Toyota to manufacture all of the glass, all
of the seats, all of the computer components for its vehicles.
They subcontract. And revenue-sharing in the 401(k) context is
simply a way of paying for subcontracting.
One service provider delegates a function to another, who
is able to perform the function more efficiently and at less
cost. Revenue-sharing reduces the overall cost of the plan for
both employers and employees.
So, in conclusion, we are very supportive of enhanced
disclosure of plan fees, but fee disclosure must be addressed
in a way that does not overemphasize fees relative to other
factors in the investment decisionmaking process, nor should it
undermine confidence in the retirement system, or create new
costs that, in turn, could decrease retirement benefits.
I would be happy to answer any questions that you may have.
[The statement of Mr. Chambers follows:]
Prepared Statement of Robert Chambers, Esq., Partner, Helms, Mulliss &
Wicker, PLLC; Chairman, American Benefits Council
My name is Robert G. Chambers and I am a partner in the Charlotte,
North Carolina law firm of Helms Mulliss & Wicker. I have advised
clients with respect to 401(k) plan issues since 401(k) was added to
the Internal Revenue Code in 1978. In that regard, my clients have
included both major employers that sponsor 401(k) plans as well as
national financial institutions that provide services to 401(k) plans.
I am also chair of the board of the American Benefits Council
(``Council'') on whose behalf I am testifying today. The Council's
members are primarily major U.S. employers that provide employee
benefits to active and retired workers and that do business in most if
not all states. The Council's membership also includes organizations
that provide services to employers of all sizes regarding their
employee benefit programs. Collectively, the Council's members either
directly sponsor or provide services to retirement and health benefit
plans covering more than 100 million Americans.
The Council very much appreciates the opportunity to present
testimony with respect to 401(k) plan fees. With the decline of the
defined benefit plan system, 401(k) plans have become the primary
retirement plan for millions of Americans. Accordingly, it is more
important than ever for all of us to take appropriate steps to ensure
that 401(k) plans provide those Americans with retirement security. In
that regard, our goal is an effective and fair 401(k) system that
functions in a transparent manner and provides meaningful benefits at a
fair price in terms of fees.
We Support Enhanced Disclosure And Reporting Requirements
With respect to 401(k) plan fees, we believe that this Committee
would be pleased by what our member companies are doing. Our members--
both plan sponsors and service providers--report to us that plan
fiduciaries are taking extensive steps to ensure that fee levels are
fair and reasonable for their participants. Plan fiduciaries are asking
hard questions regarding the various plan services and fees, and the
fiduciaries are obtaining answers that give them the tools to negotiate
effectively for lower fees and to provide meaningful information to
participants. In the case of small plans with less bargaining power,
plan fiduciaries are using additional fee information to shop more
effectively for service providers.
Are there exceptions to this rosy picture? Of course there are. No
system functions perfectly. So we need to strive to make the system
even better. How can we achieve those improvements? The answer is
conceptually simple: through even more universal disclosure of
meaningful information. We need to ensure that all plan fiduciaries and
service providers follow the practices we are hearing about from our
members. Those practices include disclosure to plan fiduciaries of
direct and indirect fees that service providers receive from the plan
or from unrelated third parties. Those practices also include clear,
meaningful disclosure to participants.
In this regard, we commend the Department of Labor and the
Government Accountability Office (``GAO''). The Department of Labor has
been working on a three-part project to enhance transparency that is
conceptually the same as the enhanced regime we are recommending. This
three-part approach is very similar to the recommendations made by GAO.
One part would require the type of disclosure by service providers to
plan fiduciaries that I refer to above. A second part would require
clear, meaningful disclosure to participants. And a third part would
require plans to report fee information to the Department. We have
concerns regarding certain specific points with respect to the
Department's proposals, but conceptually we are in agreement with the
general approach. We look forward to a constructive dialogue with the
Department as its proposals move forward.
As described in its letter to GAO regarding plan fees, the
Department of Labor has already taken a number of steps to improve
awareness and understanding with respect to plan fees. The Department
makes available on its website important materials designed to help
participants and plan fiduciaries understand plan fees. These materials
include ``A Look at 401(k) Plan Fees for Employees'', which is designed
to assist participants in selecting investment options. For employers
and other plan fiduciaries, the Department makes available
``Understanding Retirement Plan Fees and Expenses'', ``Tips for
Selecting and Monitoring Service Providers for Your Employee Benefit
Plan'', and ``Selecting and Monitoring Pension Consultants--Tips for
Plan Fiduciaries''. In addition, the Department makes available a model
form--called the ``401(k) Plan Fee Disclosure Form''--that is designed
to facilitate the disclosure of plan fees by service providers to plan
fiduciaries and the comparison of these fees. Finally, the Department
has been conducting educational programs across the country that are
designed to educate plan fiduciaries about their duties.
In short, we believe that the Department of Labor and GAO are
making, and have been making, important contributions to improving the
401(k) plan system. In this regard, we are also proud of our own
efforts to improve fee disclosure, which include working in a
constructive manner with the Department to help it improve disclosure
and transparency. For example, recently, a group of associations
submitted to the Department of Labor an extensive list of fee and
expense data elements that plan sponsors can use to discuss fees
effectively with their service providers. (The associations were the
American Benefits Council, the Investment Company Institute, the
American Council of Life Insurers, the American Bankers Association,
and the Securities Industry Association (now the Securities Industry
and Financial Markets Association).) We view disclosure enhancement as
a critical part of our mission to strengthen the 401(k) plan system and
we are committed to continuing to offer our help to this Committee,
other Committees, and the agencies.
Addressing Concerns And Questions
So far, I have been talking about positive things that can be done
to improve the 401(k) plan system. Now I would like to touch on
concerns that I know are shared by this Committee and answer some
questions that have been raised.
We Must Not Undermine The Voluntary System
The success of the 401(k) plan system is dependent on many things,
including very notably the willingness of employers to offer these
plans and the willingness of employees to participate in the plans. It
is critical that any reform efforts not inadvertently undermine these
key building blocks of our system. Clear, meaningful disclosure is
needed; overly complicated and burdensome disclosures would only push
employers and service providers away from the 401(k) plan system. In
particular, burdensome rules would be yet another powerful disincentive
for small employers to maintain plans. Overly complicated disclosure
would also confuse rather than inform participants; participants need
clear meaningful information that is relevant to their decision-making.
In addition, employee confidence is critical to their participation
in the system. If the huge number of employees participating in well-
run efficient 401(k) plans hear only about the 401(k) plan problems and
do not hear about the strengths of the system, their confidence will be
eroded, their participation will decline, and their retirement security
will be undermined.
We Must Not Inadvertently Increase Fees In The Effort To Reduce Them
Every new requirement imposed on the 401(k) plan system has a cost.
And generally it is participants who bear that cost. So it would be
unfortunate and counterproductive if a plethora of new complicated
rules are added in an effort to reduce costs, but the expense of
administering those new rules actually ends up adding to those costs.
The Department of Labor has explicitly raised this exact concern. In
its letter to GAO regarding the GAO plan fee report, the Department
noted that its own fee disclosure project must be designed ``without
imposing undue compliance costs, given that any such costs are likely
to be charged against the individual accounts of participants and
affect their retirement savings.''
In this regard, it is important to recognize a key point noted in
the GAO report. In the course of numerous plan fee investigations
conducted by the Department of Labor in the late 1990's, no ERISA
violations were found with respect to 401(k) plan fees. Moreover, the
Department of Labor receives enforcement referrals from various
entities, such as federal and state agencies. The GAO report notes that
``only one of the referrals that the [Department of Labor] has closed
over the past 5 years was directly related to fees'' (emphasis added).
In the context of these facts, imposing burdensome new rules and costs
to be borne by participants would be even less justified.
Fees Can Only Be Evaluated In The Context Of The Services They Pay For
Another critical point to bear in mind is that we must not examine
fee amounts out of context. Any specific fee can only be effectively
evaluated in the context of the quality of the service or product that
is being paid for. For example, some actively managed investment
options may logically have higher than average expenses, but it is the
net performance of the option that is critical to retirement plan
sponsors and participants, not the fee component in isolation. We must
avoid studying fees in a vacuum. Fees are very important, but they are
only one component of performance; with respect to investments, other
key components include minimization of risk, diversification, relative
peer group performance, quality of the investment organization, and, of
course, investment return. Our objective should be excellent
performance and service at a fair price.
Another example of this point is that increased fees generally
reflect increased services. In the past several decades, there has been
enormous progress in the development of services and products available
to defined contribution plans (``DC plans'') such as 401(k) plans. For
example, many years ago, plan assets generally were valued once per
quarter--or even once per year--so that employees' accounts were
generally not valued at the current market value. Participants
generally were not permitted to invest their assets in accordance with
their own objectives; the plan fiduciary generally invested all plan
assets together. Today, 401(k) plans generally value plan investments
on a daily basis, and permit participants to make investment exchanges
frequently (often on a daily basis) to achieve their own objectives.
Other new services include, for example, internet access and voice
response systems, on-line distribution and loan modeling, on-line
calculators for comparing deferral options, and investment advice and/
or education services.
In addition, the legal environment for DC plans used to be simpler,
with far fewer legal requirements and design options. New legal
requirements or options can require significant systems enhancements.
For example, system modifications were needed to address catch-up
contributions, automatic rollovers of distributions between $1,000 and
$5,000, Roth 401(k) options, redemption fees and required holding
periods with respect to plan investment options, employer stock
diversification requirements, default investment notices, automatic
enrollment, and new benefit statement rules. Today, 401(k) plans have
become the dominant retirement vehicle for millions of American
workers. With this change has come the need to help participants
adequately plan for their retirement. Service providers have responded
by developing investment advice offerings, retirement planning and
education, programs to increase employee participation in plans, and
plan distribution options that address a participant's risk of
outliving his or her retirement savings.
Naturally, the new services and products and the needed systems
modifications have a cost. In this regard, we also want to emphasize
that the disclosure rules need to be flexible enough to take into
account the ever evolving 401(k) plan service market. For example, the
rules need to be consistent with the current trend toward reducing the
size of the plan investment menu as well as the trend toward offering a
brokerage account option.
On a related point, we see enhanced plan fee disclosure as another
important step with respect to participant education. And we look
forward to working with this Committee on further participant education
initiatives.
Why Do Fee Levels Differ So Much Among Different Plans?
Different workforces need different services. Accordingly, the
401(k) plan market has attracted a number of different service
providers that have developed numerous service options for plans, often
with different fee structures and different services available for
separate fees. This structure avoids forcing plans to pay for services
that they do not want or use, and increases the options available to
plan sponsors wishing to find providers and services that meet their
and their employees' unique needs.
Concerns have been raised about the higher level of fees for
smaller plans. Many plan fees vary only slightly (if at all) based on
the number of participants in the plan. Accordingly, on a per-
participant basis, plan costs can be much higher for small plans than
for large plans. On a similar point, many costs do not vary with the
size of a participant's account, so plans with small accounts will
often pay much higher fees--on a percentage of assets basis--than plans
with large accounts. These effects are most often a function of the
nature of the services rendered: for example, plans must meet the same
regulatory requirements without regard to whether a plan has 100
participants or 100,000 participants, and without regard to whether the
average account size is $5,000 or $50,000.
Who Pays DC Plan Fees?
By law, the employer must pay certain fees, such as the cost of
designing a plan. But there are a wide range of fees that are permitted
to be paid by the plan and its participants, such as fees for
investments (which generally constitute the vast majority of a plan's
total fees), recordkeeping, trustee services, participant
communications, investment advice or education, plan loans, compliance
testing, and plan audits. Many employers voluntarily pay for certain
expenses that could be charged to the plan and its participants, such
as recordkeeping, administrative, auditing, and certain legal expenses.
On the other hand, investment expenses, such as expenses of a
particular mutual fund or other investment option, are generally borne
by the participant whose account is invested in the fund.
Why Does One Service Provider Sometimes Receive Fees From Another
Service Provider? Is This ``Revenue Sharing''? Is This A
Problem Area?
Some maintain that ``revenue sharing'' is wrong and should be
prohibited. That view reflects a misunderstanding of how the 401(k)
plan system works. Let me explain.
It is not uncommon, for example, for mutual funds or other
investment options to pay other plan service providers for services
needed by the funds. For example, assume that participants of a plan
invest some of their assets in Mutual Fund A. If these were retail
investors in Mutual Fund A, Fund A would need to: maintain separate
accounts for each investor; provide a means for investors to interact
with Fund A (e.g., internet access, voice response systems, telephone
service representatives); make certain that investors receive
statements, investment confirmations, and any statutory notices; and
prepare the appropriate tax reporting for any distributions. When a
participant invests in Fund A through a retirement plan, the plan's
recordkeeper generally assumes these responsibilities and bears the
cost of performing them. It is not uncommon for Fund A to pay the
plan's recordkeeper for performing the services that the fund would
otherwise have to perform in the retail environment.
Such ``inter-service provider'' fees arise because different
service providers cooperate in providing a total service package to a
plan. ``Revenue sharing'' is the term often used to described these
types of inter-service provider fees. In fact, fund companies typically
designate a portion of their overall expense ratio as ``shareholder
servicing fees'', and it is this expense stream that is typically used
to pay other providers.
There is nothing inherently problematic regarding inter-service
provider fees and the current-law prohibited transaction rules preclude
inter-service provider arrangements that would create conflicts of
interest. For example, assume that a plan pays Mutual Fund A $100 for
investment services and the plan pays unrelated Service Provider B $50
for recordkeeping services. Assume further that Mutual Fund A pays
Service Provider B $10 to provide shareholder services so that A
receives $90 net and B receives a total of $60. Assume further that B
discloses the receipt of the extra $10 to the plan fiduciary so that
the plan fiduciary can evaluate the fee and the relationship between
Mutual Fund A and Service Provider B. If $100 is a fair price for
investment services, why does it matter whether A performs shareholder
servicing itself or subcontracts with Service Provider B to perform
those services? In other words, if Mutual Fund A performed the services
itself, the cost to the plan would be the same $150, but A would keep
the full $100, instead of paying $10 of its $100 fee to B. And if $50
is a fair price for recordkeeping services provided to the plan, why
does it matter if B receives an additional $10 for services rendered to
A? This example illustrates how an efficient subcontracting
relationship works among service providers.
We are not suggesting that disclosure of the inter-service provider
fees is not important. On the contrary, as discussed previously, we are
very supportive of such disclosure. But the existence of these
arrangements is not indicative of an inherent problem or a sign that
401(k) participants are paying excessive fees. If fully disclosed,
these subcontracting arrangements can, on the contrary, be quite
efficient and the current-law prohibited transaction rules are already
in place to preclude conflicts of interest.
Are Plan Fees Too High?
Competition among investment options and service providers is
intense, which exerts downward pressure on fee levels. For example, as
noted above, investment expenses are generally the largest plan
expense. These expenses are reviewed in the context of reviewing the
performance of investment options. Plans routinely review such
performance: a 2006 survey by the Profit Sharing/401(k) Council of
America indicates that 62% of plans review plan investments at least
quarterly and substantially all plans conduct such a review at least
annually.
In fact, plan investment fees are much lower than fees outside the
context of plans. For example, a 2006 study by the Investment Company
Institute found that in 2005 the average asset-weighted expense ratio
for 401(k) plans investing in stock mutual funds was .76%, compared to
a .91% average for all stock mutual funds.
Conclusion
We are very supportive of enhanced disclosure of plan fees. But fee
disclosure must be addressed in a way that does not undermine
participant confidence in the retirement system and does not create new
costs that have the counterproductive effect of increasing fees borne
by participants. We are committed to working with the government to
make improvements in the fee disclosure area, including reporting to
the Department of Labor. We believe that the best approach to the fee
issue is through simple, clear disclosures that enable plan sponsors
and participants to understand and compare fees in the context of the
services and benefits being offered under the plan.
______
Chairman Miller. Thank you.
Mr. Butler?
STATEMENT OF STEPHEN J. BUTLER, PRESIDENT AND FOUNDER, PENSION
DYNAMICS CORP.
Mr. Butler. Chairman Miller, Congressman McKeon and members
of the committee, my name is Steve Butler. I am the founder and
president of the Pension Administration Firm in Pleasant Hill,
California.
My company is one of the largest independent administration
firms in Northern California, and we have operated well over a
thousand retirement plans over the past 30 years.
I have written two books on the subject. The first was
``The Decisionmaker's Guide to 401(k) Plans.'' The second was
entitled ``401(k) Today.'' Both books identified hidden costs
and offered a formula for making an effective comparison
between the total costs of different vendors and vendor
combinations.
This led to some national publicity focused on what we
called the Butler Index. This is an index of total costs,
employee and employer, on a same plan, which was then the
subject of a New York Times article. The article compared about
a dozen major vendors in the 401(k) industry, and the results
were shocking. Money magazine then wrote a feature article
based on the Butler Index.
A persistent lack of disclosure leads many plan
decisionmakers to purchase 401(k) plans that careful analysis
of costs would show to be a poor value for participants.
A number of academic and industry studies show that just an
extra 1 percent of assets charged to a plan will reduce
retirement account balances by roughly 20 percent over a 30-
year period. This means that someone retiring will have 80
percent of what they otherwise would have had, if fees had been
reasonable and competitive.
The need for full disclosure of 401(k) fees should be as
obvious as the reasons for any consumer protection laws.
Throughout the history of these plans, a subset of the
financial services industry has advertised free 401(k) bundle
services to sponsoring employers, while the actual costs were
billed to plan participants. And if costs were disclosed at
all, a breakdown of these costs has not been offered to those
participants.
In many cases, they were not disclosed to or fully
understood by the company decisionmakers. To date, the
Department of Labor has still not required bundled 401(k)
vendors to fully disclose all the real fees associated with
these plans.
Today, American workers have what I estimate to be $3
trillion in 401(k) plans. To pay for the record-keeping and
money management services, they are paying somewhere between 1
percent and 2 percent, $30 billion to $60 billion a year. And,
of course, that will only increase.
Charges for these basic functions can differ by as much as
600 percent for essentially the same range of services from
different providers. This says that, while some plan
participants are receiving good value, others are being grossly
overcharged.
By comparison in the automobile industry, there is the
manufacturer suggested retail price, commonly known as the
sticker price, a legal requirement that the price be emblazoned
on the window of every car sold in this country, with the
component costs of each option listed separately.
There is nothing that should stand in the way of an
equivalent, simple, and elegant solution to a problem that is
otherwise costing American retirement savers as much as 20
percent of their ultimate retirement nest egg.
The approach of the Butler Index was to identify and
breakdown all costs of either a bundled plan or combination of
vendors. It was not rocket science. Anyone smart enough to
operate a 401(k) plan today is smart enough to be able to go
one step further, to identify and disclose the fees it is
charging and what those fees are for.
Anyone asking for an exemption from these disclosure
requirements because they say it can't be done is insulting our
intelligence. Are they really trying to say that they have no
way of determining the extent to which they are making a profit
on a 401(k) plan client?
Any 401(k) is better than no 401(k), even if it an
expensive one. However, company owners and managers owe it to
themselves and their employees to make informed decisions about
the plans they purchase on behalf of their fellow employees. In
fact, the failure of corporate plan sponsors to have adequate
disclosure of 401(k) fees and a breakdown of what those fees
are for has been the subject of recent class-action lawsuits
brought by participants, alleging that the plan sponsors
breached their fiduciary duties under ERISA.
Full disclosure of 401(k) plan fees to corporate plan
sponsors and participants will allow for cost comparisons. Give
the number of players in the 401(k) marketplace, this will
create competition, ultimately leading to reduced costs, to the
benefit of participants.
In the absence of full disclosure, we see the equivalent of
the fog of war. The battle for extremely valuable retirement
plan money is so intense that the industry cannot resist any
steps that enhance the perceived value of their product. The
simplest of these enhancements has been to bury the total cost
and fees charged to participants and then fail to disclose
them.
As I see it, this is the problem that needs to be addressed
with disclosure legislation and/or appropriately crafted
Department of Labor regulations.
Thank you.
[The statement of Mr. Butler follows:]
Prepared Statement of Stephen J. Butler, President and Founder,
Pension Dynamics Corp.
A Brief History
The 401(k) phenomenon is an accident in legislative history that
has changed the face of America's retirement system. Voluntary pre-tax
contributions from employees have generated substantial financial
resources that provide a comfortable retirement for many. Considering
the average American employee, early projections indicated that these
plans would generate roughly five times the asset value at retirement
than would have been received from the continuation of what was then a
combination of qualified profit sharing, money purchase and defined
benefit plans. Current statistics for the average employee who has been
a participant for at least twenty years (and who is in their early
60's) support this original projection. The $3 trillion now accumulated
in 401(k) plans offers a testimonial to their success.
The fact that pension laws have evolved to provide what amount to
``portable'' pension plans is critical in a country where the average
employee changes jobs every seven years. The Bureau of Labor Statistics
recently determined that the average employee born between 1957 and
1964 has had 10.5 different jobs between ages 18 and 40. Twenty-one
percent of this group have had 15 jobs. Only fifteen percent have had
fewer than four jobs. Those with college degrees had no better
statistics regarding job stability than those without degrees.
To the extent that the traditional retirement plan system (that
which preceded the 401(k) era) failed to meet expectations, its failure
was largely attributable to the practical reality of employee turnover.
Traditional pension benefits were designed to create a form of ``golden
handcuffs'' with vesting schedules that rewarded only those employees
who remained with a company long enough to become vested in their
retirement benefits. In the early '70's, this could have required as
much as ten years of service. A direct quote from President Reagan at
the time was that he wanted to create ``portable pension programs.''
Over 70% of working Americans work for companies having less than 100
employees. A large percentage of these employees work for companies
with less than 25 employees. In the past, small, relatively unstable
companies rarely offered traditional retirement plans when employer
contributions were the only source of funds. Today, many offer some
variation of a 401(k) plan or the small-company equivalent in the form
of SIMPLE 401(k)'s.
The complicated laws requiring 401(k) plans to pass non-
discrimination tests has compelled company owners and highly-
compensated managers to spend time and money promoting plans to all
rank and file employees. Without substantial contribution percentages
from these non-highly compensated people, the managers were limited to
contribution amounts below the legal maximums. This has prompted
management to do everything in their power to promote the plans.
Matching contributions, company discretionary contributions, employee
meetings, individual financial advice and careful selection of
investments are all a part of this promotional effort leading to the
success of these plans.
Cost to Participants in General
The costs to 401(k) participants struggling to save for retirement
is a detriment that has marred what would otherwise have been the
unqualified success of the 401(k) phenomenon. Excessive fees, just over
the past twenty years, have reduced participant account balances by an
average of 15%. On a projected basis, excessive fees charged to
participants will have reduced retirement ``nest-eggs'' by 20%
according to a wide variety of organizations conducting research on the
subject.
Understanding the Fundamentals of 401(k) Costs
Fees taken from plan assets to pay for administration and/or money
management are paid with funds that could otherwise be earning and
compounding on a tax-deferred basis. The ``Magic of Compound Interest''
works against employees to dramatically magnify the loss of these
missing dollars. The business term for this condition is ``opportunity
cost''--the calculated cost in dollars of a lost opportunity.
Example:
The best illustration of the cost of excessive fees is to project a
flow of 401(k) contributions over time at percentage returns that
reflect the difference of 1% (a typical amount of an ``excessive
fee.'') Choosing $10,000 as an employee contribution amount is
reasonable considering that we are looking well into the future. The
median income today is $71,000 and the average contribution amount is
6-7%. In many cases, both members of a married couple are contributing,
so $10,000 per year is not unreasonable. The returns for the American
stock market have averaged 10% per year over a long historical period.
THE OPPORTUNITY COST OF A 1% EXCESS COST--$10,000 ANNUAL CONTRIBUTION
----------------------------------------------------------------------------------------------------------------
Account value Account value Account value
Percentage annual return 10 years 20 years 30 years
----------------------------------------------------------------------------------------------------------------
10%............................................................. 171,178 641,491 1,925,836
9%.............................................................. 162,568 566,549 1,570,441
Cost of 1% fee.................................................. 8,610 74,942 355,395
----------------------------------------------------------------------------------------------------------------
For the 20-year period through the 1980's and 1990's, the stock
market averaged a 16% rate of return. Looking at what might be higher
underlying rates of return going forward, the opportunity cost of the
missing 1% is much higher. By 2000, many employees in expensive plans
who had been participating for twenty years effectively paid the
following amounts in opportunity costs as a result of high fees during
that 20-year period.
THE OPPORTUNITY COST OF A 1% EXCESS COST--$10,000 ANNUAL CONTRIBUTION
----------------------------------------------------------------------------------------------------------------
Account value Account value Account value
Percentage annual return 10 years 20 years 30 years
----------------------------------------------------------------------------------------------------------------
15%............................................................. 232,057 1,279,641 6,008,782
14%............................................................. 215,656 1,079,734 4,541,874
Cost of 1% fee.................................................. 16,401 199,907 1,466,908
----------------------------------------------------------------------------------------------------------------
After twenty years, this illustrates the actual cost for what might
have been a single employee contributing $10,000 a year (or two people
contributing $5,000 each) in the twenty years ending in 2000. Multiply
these single-participant detrimental effects times the $3 trillion now
in 401(k) plans and we can understand why the fee issue is critical.
Stop and recall for a moment the ``Rule of 72'' which states that
money earning 7.2% doubles every ten years, and money earning 10%
doubles every 7.2 years. Today's $3 trillion can be reasonably expected
to double twice to $12 trillion in the next 14 years, thanks to
reasonable investment returns and annual contributions. Excessive,
undisclosed fees scheduled to cost participants as much as $2 trillion
dollars is the problem we are here to try to correct.
Where the Abuse Begins
The greatest abuses are seen in the small-company environment where
the average company owner is not a mutual fund or retirement plan
expert. Large companies, by comparison, have reasonably sophisticated
decision-makers. Xerox, for example, operated its own mutual funds and
charged participants just 3/100ths of one percent per year.
Participants in many small-company plans can be paying as much as 3
full percentage points--exactly 100 times more for the same level of
services.
Technically, all fees charged to participants are disclosed today
to plan sponsor decision-makers, but not all fees are disclosed to
participants. In the insurance industry, for example, the practice of
non-disclosure was justified by the rationale that ``fees didn't
matter--net investment results were all that participants needed to
see.'' This was an actual quote from the marketing Vice President of a
major insurance company when interviewed by MONEY magazine in 1998.
Fees charged to participants may be stated in the investment
materials, but they remain effectively hidden on an ongoing basis
because participants never receive a bill and never see a separate line
item outlining what their costs, in dollars, have been.
According to FORBES magazine, the mutual fund industry is the
world's most profitable as it earns a consistent 30% pre-tax profit.
Investors are not fee sensitive because they are focused on returns.
Generally this means ``chasing last year's best performing mutual
funds.''
In today's seamless electronic financial services arena, the hard-
dollar cost of administering a mutual fund with at least $50,000 is 6/
100ths of one percent per year--approximately $30. Virtually all 401(k)
plans are administered in pooled accounts where the investor is the
plan itself--not the individual employee. As a result, virtually all
401(k) accounts, on a fund-by-fund basis, meet this $50,000 benchmark,
meaning that the profit on the account is anything beyond the 6/100ths
being charged. If the average mutual fund charge in a 401(k) investment
is 1 full percentage point per year, the profit on those accounts might
be as high as 94%.
In all discussions regarding fees, we have to take as a given that
no single mutual fund or fund family can show that that they have
consistently earned a higher rate of return (to justify higher fees)
for any sustained length of time. The money management industry is a
``zero sum game'' in which all players revert to the norm at some
point. Moreover, even when we can review past performance, there is no
way to know prospectively whose performance might compensate for an
excessive fee going forward. Over longer periods of time, a difference
in performance among funds of the same type can be largely attributed
to the difference in their costs to investors.
How 401(k) Plans are Structured
Most 401(k) money is maintained today in a ``daily-valued''
electronic environment managed by the mutual fund or insurance
companies themselves or the transfer agent industry that services the
mutual fund industry. Plan participants can dial up their account
information on an 800 voice-response number, but by far the most
popular access is through the Internet. The raw cost of providing this
seamless, electronic recordkeeping function is approximately $50 per
year per participant. This is referred to as the ``recordkeeping fee.''
It is the cost of maintaining the accounting of the participant's
account.
Apart from the money management, there is the cost of complying
with the layers of retirement plan regulations dictated by ERISA. This
work is concentrated immediately after the end of every year when the
discrimination testing must be completed. Later in the year, the
government reporting form (Form 5500) for the plan must be completed
and submitted. It is essentially a balance sheet and income statement
for the plan. The cost of this compliance testing and administration is
typically about $35-$60 per participant with a base company fee of
$1,000- $1,500.
An Illustration of Fees in a Typical Plan
We can use an example a plan with 50 participants and $3,000,000 in
assets. This is typical of an engineering or professional firm that has
had a plan for twenty years.
The record keeping and compliance cost for these 50 employees
should be roughly $130 per employee. If the true cost of money
management is only 6/100ths of a percent, the money management cost for
$3,000,000 would be $1,800. The total cost of the plan would be $7,800.
By comparison, a typical vendor in the industry today would be charging
an average of $36,500 for this plan. Some have scheduled fees that
would amount to as much as $60,000 or 2% of assets.
While a plan sponsor (the company) might be happy to pay for the
administration cost, it will never pay total fees of this magnitude.
Asset-based money management fees will always be charged to
participants where they will be largely ignored. After all, no
participant ever receives a bill or writes a check for these costs.
They are automatically deducted from what would have been earnings--or
from principal in years when earnings may be negative.
Techniques that Obscure the Magnitude of Fees
Having established that hidden excessive costs are a guaranteed
detriment to optimizing savings results over time, it is generally easy
to identify them when we know where to look. Some of the more difficult
hidden costs, however, are those that are buried in the process and
that will never show up in any stated cost to participants.
Non-disclosure at Participant Level in ``Bundled Plans''
In the 401(k) marketplace, participants are told the annual expense
ratios of the mutual funds offered by the plan, but administrative fees
charged to their accounts are typically disclosed only in an annuity
contract signed by the plan sponsor. This percentage amount is referred
to as the ``wrap fee'' and it is typically one or two percent in a
small company environment. The insurance industry is not legislated by
federal laws, so the normal disclosure requirements demanded of the
fund industry do not apply to insurance companies legislated only by
state governments. In the mutual fund industry, the cost of
administration, if presented as being ``free,'' is usually imbedded in
the expense ratios of the funds. Comparable funds, if not priced to
support administration, could generally be found that would be less
expensive for participants.
These plans that combine investment products with administration
all provided by one company are referred to as ``bundled'' plans, and
the providers of such plans are suggesting that ``bundled'' plans be
exempt from any disclosure requirement to come out of these hearings.
With what I estimate to be 70% of all 401(k) plans provided in this
``bundled'' format, making them exempt would emasculate any new
disclosure requirements.
Mutual Fund Industry--Proprietary Fund Requirement
In the mutual fund industry, the fees to participants are disclosed
because they are the normal annual expense ratios of the funds. They
are spelled out in the prospectus of each fund and today are
universally summarized in the employee promotional literature. The
mutual fund industry does not add a wrap fee. Instead, a company such
as Fidelity will insist that at least half of the funds selected for
the plan include their own proprietary funds. Remembering that the
profit from a 401(k) account can be as much as 94% to the fund family,
the insistence that at least half of the funds come from the fund
family's proprietary list ensures that the plan will be profitable. A
refinement of this technique is to require that the so-called ``core
funds'' will be proprietary. These are the large-company or balanced
funds that traditionally attract as much as 70% of the money in the
plan. So, while the fund requirement based on the number of funds may
only be half of the offerings, the percentage of employee money in
those funds can easily be 70% or more.
The balance of the funds offered in the plan may come from other
fund companies as part of an effort to create a ``veneer of
objectivity'' for marketing reasons. These other fund families will
typically be limited to just those funds that charge enough to pay the
primary fund family 25/100ths of one percent and possibly some
additional funds to buy ``shelf space'' on the ``platform'' offered by
the primary fund family selling and administering the plan.
What does this practice cost the participant? No single fund family
offers superior funds across the entire spectrum of the industry.
Common sense would tell us that selecting from a vast universe of
choices will generate better fund selection than a limited universe
from just a single fund family. Here, we are selecting funds for the
convenience and pricing demands of the vendor--not with the sole
purpose of improving the outcome for the participant. Knowing that this
is the case explains why major mutual fund companies in the 401(k)
industry refuse to be construed as fiduciaries of the plan. Selling
their own funds would be a prohibited transaction and would violate the
requirement that fiduciaries make decisions based upon the ``sole
interests of participants.''
In the sample plan above, (50 employees and $3,000,000) most
vendors today would offer to do the administration and record keeping
at no cost to the plan sponsor. A quick review of the arithmetic would
explain why. Those administrative costs would have been about $7,000
and the plan is charging participants $30,000.
Barring the Exit--Back-end Charges for Plan Sponsors who Want to Leave
The most egregious examples of excessive fees today are found in
plans that are using share classes or annuity products that pay
commissions up front and then have high ongoing fees to participants to
offset, over time, the commission that was paid up-front. If a plan
sponsor chooses to leave one of these plans there will be a
``contingent deferred sales charge'' otherwise known as a ``back-end
load.'' Eventually, the load grades down and disappears after five to
seven years, but in the meantime, the plan sponsor can not leave
without subjecting participants to an exit charge that can be as high
as 5% of their assets. Moreover, the law specifically bars a plan
sponsor from paying that cost as a company expense, because plan
contributions can only be made as a percent of compensation--never as a
percent of assets. These are the plans that can be charging
participants as much as 3% per year. Once introduced, they are locked
in by exit charges for at least five years.
The insurance industry and the subset of the mutual fund industry
selling through the NASD brokerage industry are selling these 401(k)
packages with back-end loads. The pure no-load sub-set of the fund
industry does not offer this format. The back-end-load phenomenon
occurs only in an environment where a mutual fund sales person or
insurance agent requires a sales commission that has to be charged to
the plan.
Funds as a ``Feeding Trough'' for the Brokerage Industry
As yet another example of a hidden fee, FORBES magazine published
an article entitled, `` What's the Matter With Brokers' Funds?'' The
fact that these funds generate relatively poor performance is well-
established, and the reasons have to do with two facts. The article
stated that ``* * * the whole psyche of a brokerage firm is built
around selling, not buying * * * Analysts at wire houses get ahead by
helping underwriters, not by being skeptical.'' This is essentially
saying that the brokerage-sponsored funds are used as a resource for
investing in the kind of companies that the firm was underwriting. High
turnover of assets in the funds also generated trading fees for the
brokerage firm. I was once told by a Prudential-Bache retirement plan
representative offering a ``free'' plan to a plan sponsor that ``once
we have the assets, we don't have to worry about making money.'' The
FORBES article went on to say, ``Another problem is that broker-
sponsored funds tend to have steep expense ratios.''
How an Expensive Plan Can Be Marketed
Thanks to the benefit of hindsight, a classic marketing ploy
involves a presentation of funds from a new vendor candidate that have
substantially out-performed the incumbent selection of the existing
vendor. The current vendor, of course, is saddled with a selection of
funds that were chosen three years previously in most cases. There are
the problems of logistics and inertia that stand in the way of making
changes in plans unless performance has fallen off a cliff. Of course,
in this environment, a new set of fund choices will always look
substantially better. The average plan sponsor rarely thinks to ask for
examples of what the proposed new vendor's investment selections might
be for a plan that they have operated for three years. There would
typically be no improvement shown by this comparison.
This is symptomatic of how the consultants and marketing personnel
in the industry can appear to be offering improvement when, in fact,
they are simply rearranging the deck chairs and adding to the level of
hidden fees in many cases. Representations of superior performance are
a major tool used to take the focus away from participant fees.
Misinformed Decision-making on the part of Plan Sponsors
Section 404(c) is a U.S. Department of Labor regulation
establishing requirements for plan sponsors that reduces their
liability for making poor decisions with regard to the plan. Employees
must be able to change investments and receive statements at least
quarterly. They must be offered three basic fund types including a
money market or guaranteed fixed income option. Finally, the plan must
have a written investment policy statement, and employees should be
provided with investment education (the latter being undefined and
unspecified.)
Ironically, Section 404( c ) proved to be a solution looking for a
problem which then created a far more serious disadvantage for the
employee participant. Since 1980 or the earliest days of the 401(k)
phenomenon, virtually all plans offered quarterly statements and
investment changes and a selection of different investment types.
Remember that senior executives were major beneficiaries of these plans
and they were inclined to want investment quality and flexibility.
Virtually all plans operated under what was essentially an investment
policy statement because decision-makers wanted decent investment
choices for themselves.
The financial services community seized on Section 404( c ) as the
reason for hiring them to monitor the plan and therefore reduce
liability. In fact, there was no practical liability for reasons having
to do with 404( c ). At industry conferences, lawyers were quick to
point out that there were no lawsuits anywhere in the country brought
by employees or groups of employees offered a selection of name-brand
mutual funds and a rudimentary investment education and plan
promotional effort.
The law of unintended consequences quickly created a ``create the
need'' opportunity for the financial services community. An army of
qualified and experienced ``advisors'' fanned out across the 401(k)
Plan Sponsor community and talked about the potential liability of not
using professional help and advice with regard to operating the plan.
What this universe of advisors did not point out was that a.) there was
no practical legal problem stemming from the way plans were typically
being operated, and b.) the cost of this advisory service was going to
be, at a minimum, one half percent to one full percentage point charged
to plan participants--a cost that guaranteed a loss of up to 20% of
retirement assets for each participant.
Meanwhile, there have been some lawsuits successfully filed against
plan sponsors. The first that I am aware of was against First Union
Bank settled for $25 million in behalf of the bank's employees. The
bank was operating a collection of mutual funds, (Evergreen Funds which
they owned at the time) and these funds were charging bank employees
substantially more than 401(k) investments the bank was selling to its
bank customers.
In the same vein, the recent class action suits against Fortune 500
companies such as Caterpillar, Boeing, Kraft and International Paper
are all centered on fees--not a lack of reporting, investment choice or
investment education.
Avoiding Compliance Responsibility
While the financial services industry has seized upon Section 404 (
c ) and the scare tactics it can foster, they have deliberately avoided
responsibility for most of the other IRS and Labor Department
Regulations that they should be upholding when representing themselves
as providing 401(k) administrative services. A typical service contract
will have hold harmless language such as ``the design and ongoing
operation of your retirement plan needs to be reviewed by your tax and
legal advisors.'' The ``bundled provider'' contract of one of the
nation's largest mutual fund companies says the company will perform
the 401(k) test and coverage test, but all other tests are the
responsibility of the plan sponsor. In effect, the financial services
industry is saying that they will do the work, but they are not
offering a guarantee that it will be done correctly or completely. A
plan failing an audit can cost the plan sponsor a substantial amount of
money in legal fees and corrective measures. In an indirect way, this
misrepresentation could be construed to be a hidden fee. The average
plan sponsor assumes that the major financial institution handling
their plan has taken responsibility for its compliance with all
government regulations. In my experience, however, the immediate
response when compliance problems arise is the voice on the phone
saying, ``read your contract.''
The Search for a Solution
To identify a solution, a process would involve working back from a
perfect, if admittedly impractical, model.
Ideally, the best 401(k) plan would be one that charged nothing to
the plan. All fees, even those associated with managing the mutual
fund, would be charged to the company and paid with tax-deductible
corporate dollars. A typical employee would be better off electing to
have his or her taxable salary reduced slightly to help defray all or a
portion of these costs. This would be far better than having the same
costs deducted from plan assets that could be compounding on a tax-
deferred basis.
Here's an actual example of that positive arithmetic. Over 800
dentists use a money management firm to manage retirement assets at
their respective practices. The firm charges 1% of assets and routinely
levies this charge against plan assets. In one actual case, I pointed
out to a dentist that the firm was free to bill his practice for what,
in this case was $15,000 per year on $1.5 million of assets. The net
cost to the dentist billed directly, considering his 50% marginal state
and federal tax bracket was $7,500. Instead, the dentist was paying
that year's $15,000 with money in his plan that in 7.2 years (at a 10%
annual return) would have doubled to $30,000. In 14.4 years, it would
have doubled again to $60,000--in 22 years, $120,000 etc. Obviously,
the dentist asked to be billed directly and then started wondering if
1% might be little high for mediocre investment management that failed
to beat basic benchmarks. The financial services industry will always
opt to bill the plan directly because they do not want fees to become
an issue. The arrangement outlined above had persisted for over twenty
years. The billing format had a projected cost for the dentist and his
employees of well over one million dollars of opportunity cost--a cost
that was reduced to a fraction of that amount in future years with the
stroke of a pen.
Xerox charged just 3/100ths of one percent to its employees.
Vanguard, on large amounts of money, can charge as little as 6/100ths
of a percent and still make a profit. DFA is yet another mutual fund
company renowned for its Vanguard-equivalent low fees. These
organizations offer mute testimony to the fact that it doesn't have to
cost what most of the industry charges to invest pools of money. An
oligopolistic situation exists thanks to buyers who are unaware of the
impact of fees. With few exceptions, nobody in the financial services
industry wants to see this condition change.
The Solution
A simple but impractical solution would be to bar any organization
that manages money from actually selling and administering 401(k)
plans. The industry selling plans would be barred from receiving any
revenue-sharing from the money management (mutual fund) industry. This
would end the hidden fee elements seen in the brokerage industry and
mutual fund industry where the sale of 401(k) plans is an engine for
selling proprietary funds and generating trading commissions. There are
3,500 third party administrators across the country today who are
independent of major financial institutions and that perform
recordkeeping services and compliance work for retirement plans. Some
of these companies, such as Hewitt Associates and Milliman and Roberts,
are substantial and equipped to handle the nation's largest plans.
Without this separation between product producers and 401(k)
administration and sales, it is difficult to see how some of the more
subtle examples of hidden costs can be avoided. Considering the
foothold that mutual fund companies have in the industry, however, it
is difficult to envision this as a practical solution. The horse is out
of the barn.
The next option would be to have a national standard fee disclosure
form required of any 401(k) presentation and require that it be renewed
to reflect any change in investment mix. This standard would require
that the cost in dollars and compound earnings over ten and twenty year
time periods would be based upon the average fee charged to
participants, assuming an even mix of investments across the entire
spectrum of fund offerings. This would be stated on the front page of
the 401(k) presentation and as part of the Summary Plan Description. In
other words, a 401(k) vendor would have to show what the average
opportunity cost would amount to over ten and twenty years based upon
the average fee charged to a $10,000 per year contribution. It would be
reasonable to assume a 10% rate of return as the starting point or
gross return on investments assuming no fee. Fees would then be
subtracted from this percentage amount, and the compound results would
be illustrated. Using an average contribution of $10,000 per year would
be simple (and inspirational.)
This comparison would illustrate the dramatic difference in costs
over time between different vendors. It would offer a reality check for
the average decision-maker who might otherwise have chosen a hidden-
cost but expensive plan for his or her company. It is critical to
require that the comparison use an example in dollars as I have
suggested. To just require a stated percentage cost is too abstract.
Even investment professionals have a hard time grasping the magnitude
of opportunity cost presented by just a fraction of a percent in excess
costs.
The Outcome and Benefit to Those Saving for Retirement
Saving fees increases retirement benefits, in the aggregate, by as
much as 15%-20%. How can this not be important enough to enact
disclosure standards demanded of every company in the industry?
Decision-makers may still purchase expensive plans for their employees,
but not without hearing from the ``self-styled mutual fund experts''
that manage to find a voice in every company. An army of retirement
savers have now deposited $3 trillion in their 401(k) plans. They are
rapidly becoming a nation of reasonably sophisticated investors. For
the most part, they know how to diversify investments, and they have
lived through the volatility of stock market performance. This is a
clear case where the glass is half full. The financial services
industry can be commended for getting us this far. Going forward,
however, we can improve results by insisting on an educational tool
(comprehensive cost disclosure) that the industry acting on its own is
inclined to avoid.
______
Chairman Miller. Thank you very much to all of you for your
testimony.
Mrs. Bovbjerg, toward the end of your testimony, you said
that one of the problems was that many of the fees are hidden
from sponsors and might mask conflicts of interest. Could you
elaborate?
Ms. Bovbjerg. What we are talking about there is when a
sponsor may contract with a pension consultant or a service
provider, who then has, unknown to the sponsor, a business
relationship with, say, a fund manager, and then recommends to
the sponsor, ``You should use this, you should go with this
fund manager.''
Chairman Miller. And that may be without regard to
performance or cost?
Ms. Bovbjerg. It may not be in the best interest of the
plan.
Chairman Miller. You also said that the Department of Labor
did not have resources to adequately--fill in the--to do what?
I didn't catch the last part of your testimony there.
Ms. Bovbjerg. Well, the Department of Labor doesn't get the
information that they would need to enforce fee
responsibilities. They don't get a total fee reported to them
in the Form 5500, the primary way that they get information
from plan sponsors. We think that they should make that more
clear, that they need all of the fees in one place.
Chairman Miller. You think that should be corrected?
Ms. Bovbjerg. We have recommended that to them, and they
are pursuing several initiatives in the area.
Chairman Miller. What is the status of that, do you know,
since this report?
Ms. Bovbjerg. Of our recommendation?
Chairman Miller. Yes.
Ms. Bovbjerg. They are considering it.
Chairman Miller. Yes?
Ms. Bovbjerg. They haven't done anything yet, but they are
considering it.
Chairman Miller. Okay, thank you.
The example that you just pointed out, a few months, there
was a story in one of the business journals talking about this
arrangement, where money was between sponsor and a fund. And it
was one of the worst-performing funds and had been one of the
worst-performing funds for multiple years, like among the
worst, and yet they kept paying out money to get, you know,
recommendations of deposits of funds in that fund.
So is that what you are talking about, that kind of
conflict of interest? I am not necessarily saying of that
magnitude, because this was----
Ms. Bovbjerg. Well, we are talking about some of the things
that came up in the SEC report a couple of years ago. They
looked at 24 pension consultants and found that about half of
them had undisclosed relationships with other types of service
providers.
Now, that is not to say that there was necessarily a
conflict or that it harmed the pension fund, but it was not
disclosed, and they felt that was problematic.
Chairman Miller. Mr. Hutcheson, in your testimony, you
suggest that that is not that unusual.
Mr. Hutcheson. No, sir, that is very common. That is a very
common practice. In some cases, the term ``directed
brokerage,'' which is now a banned practice with mutual funds,
an explanation of that is where a fund manager would speak with
a brokerage firm and say, ``I will bring all of the trades of
the underlying securities of our mutual fund to you if you will
then recommend my fund to your sales force.''
And what would happen is, is the sales force would get a
recommendation for a particular fund, and they would go out and
sell it to plan sponsors.
Chairman Miller. That is a now banned practice, you are
saying?
Mr. Hutcheson. In mutual funds, it is.
Chairman Miller. In mutual funds.
Mr. Hutcheson. There are some other types of investment
pools, where it is not a banned practice, but the egregious
problems happened in mutual funds, and now that is a banned
practice.
Chairman Miller. Thank you.
Mr. Chambers, you suggested that people think that Toyota
builds cars, but they assemble them. But at the end of the day,
they are buying a car which can be--is rated over time. People
say that this is what it costs to drive this car for this year,
this is the maintenance, this is the miles per gallon, and all
the rest of it.
They can find out information and make a decision between
that Toyota and the Chevrolet Impala, if they want. They can
make that decision. My concern is here is that people are being
asked to make decisions or decisions are made for them, and the
assumption is that that is better or that is different.
Because what we see is that, you know, day in and day out,
it is very hard for fund managers to beat the S&P index, right?
Mr. Chambers. If you would elaborate on a particular fund--
--
Chairman Miller [continuing]. Mr. Hutcheson's testimony, I
think it was--it is obviously used many times by index funds.
But, for example, the S&P 500 index consistently outperformed
98 percent of the fund managers over 3 years, 97 percent over
10 years, and 94 percent over the past 30 years.
Recent studies reveal--and many more continue to
substantiate--that the passive 60 percent stock, 40 percent
bond portfolio outperformed 90 percent of the largest corporate
pension plan portfolios, ``run by the world's best and
brightest investment minds.''
Mr. Chambers. And the source for that, sir?
Chairman Miller. It is in Mr. Hutcheson's testimony, but we
see this remark all of the time at the end of the year or the
quarter, where they match and compare actively managed funds
against index funds and other such funds. And it is very hard
for those managers to beat those index over any period of time.
Mr. Chambers. Well, I think, in given periods, you are
absolutely right.
Chairman Miller. Well, 10 years.
Mr. Chambers. But I also think--and if I may, I also
think----
Chairman Miller. Thirty years is a pretty good given
period, since that is the time most people work.
Mr. Chambers. Possibly. It depends upon which fund it is,
of course. I can tell you, for example, that the funds----
Chairman Miller. Well, it beats 94 percent of the active
funds, so you can pick the other 6 percent of the funds, and I
hope I could find them.
Mr. Chambers. Well, I can tell you, sir, that, for example,
in our retirement plan, at our law firm, we get this
information every quarter. And over 5 years, which is a
measurement--our law firm has not been in existence for 30
years, so we don't have that information.
But over the last 5 years, we have outperformed--if you
take all of the funds that we make available, about 10 funds,
we have outperformed the appropriate market index for each one
of those funds an average of 3.05 percent over 5 years.
Do I think that--and if you take a look at the peer
performance reviews of the investment managers who we retained
and the funds that we retain, they are not necessarily in the
top 5 percent or 10 percent of their peer group every year. I
think it depends upon the way that you are looking at the
statistics.
I don't know that I necessarily agree with Mr. Hutcheson's
statistics, not knowing what his basis is.
Chairman Miller. I would say that Mr. Hutcheson is one of
among many--and I am not vouching for his statistic, I am just
saying that this is a comparison that is made in every economic
journal at the end of every quarter and the end of every year,
when they put in a special section on mutual funds, and they
compare how it is done.
Mr. Butler, I don't know if you want to chime in on this,
but----
Mr. Butler. Well, I would just refer to the Stanford
professors about 30 years ago who threw darts at the Wall
Street Journal and proved that a randomly selected group of
stocks would beat 85 percent of all efforts to manage money
over any rolling 10-year period of time.
It led to five different Nobel Prizes for research coming
out of that original dart-throwing exercise. So I think it is
pretty well-established that, at the end of the day, low fees
are the primary determinant factor for investment results that
are optimal.
Chairman Miller. If I might, I would just like to take one
minute of the committee's time here. The question here, I
think, is the transparency and information available and the
value of that. And, you know, you have what we get in our TSP,
the Thrift Savings Plan, in a relatively simple form at the
very bottom, it has cost to participant. And it is fixed basis
points across all of the funds, except for the L funds, and
those are variable funds, so, as of this date, that was not
available to them.
You have the vanguard approach, which is, again, a one-
page, very simply laid out cost to this. And this is to the
plan, not to the participant. This is to the plan. And then you
have what, I believe, that ING reached an agreement with
Attorney General Spitzer on this, where you have to charge--one
is the end-year balance without fees, end-of-year balance after
the fees.
So I don't know whether these are the right things to do or
not, but the point is, there does appear that there can be a
simplification of explanations, both to plans and to the
participants, in those plans. And that is the quest of this
committee, to see whether or not some of these might make
sense, in terms of helping the participants and the plans make
these decisions.
And with that, I will yield to Mr. McKeon.
Mr. McKeon. Thank you, Mr. Chairman.
Ms. Bovbjerg, in the colloquy that you had with the
chairman, you talked about the Department of Labor has received
input, and you don't know where they are in the process of
coming out with regulations or proposals?
Ms. Bovbjerg. Well, they have three initiatives in process
right now. And I believe that they told us that the regs would
be forthcoming later this year. They have been collecting a lot
of comments on those initiatives.
Our recommendation to them was a little different than
those initiatives. We would have recommended that they require
sponsors to provide a total of the fees associated with the
plan by type, in the Form 5500, and they have not taken action
on that yet, but they also hadn't said they wouldn't. They are
considering it.
Mr. McKeon. How much do you think could be done by the
Department of Labor, versus what we should try to do in
legislation?
Ms. Bovbjerg. Well, some things, for example, with regard
to the 5500, can be done by regulations in the Department of
Labor. Other things, you are so right, have to be done through
statute.
We had recommended in our recent report on fees a couple of
things that Congress might consider. Both would require
amendments to ERISA. One was to require service providers to
provide information on their financial relationships to
sponsors. And the other--and that would be an explicit
requirement. Now it is not a requirement. Some sponsors know;
some sponsors don't.
And another would be to require sponsors to provide
participants information on fees that would allow them to make
comparisons across funds.
Mr. McKeon. It sounds to me like all of you are in
agreement that something should be done for disclosure
simplification.
Ms. Bovbjerg. I think we are.
Mr. McKeon. Well, that is what I heard in the testimony.
The concern I have is one that I addressed in my opening
statement, is unintended consequences. And how do you simplify
without making it much more complicated?
It seems like every time we try to simplify--not our
committee, but the Ways and Means, when they try to simplify
the tax code, pages upon pages are added to the tax code. And
that is a concern I have.
The prospectus that the chairman showed--well, they are all
familiar with them, as we are. They are very complicated. I
have bought stocks for my life, and I am sorry to admit that I
usually don't read every word in those things. And it would be
nice to have a little summary or something to go with them, but
a lot of that is a result of laws that have been passed or
regulations.
So I am really sympathetic to the need to simplify. I am
just concerned of, once we start trying to simplify, what we
end up with at the end of the road. You know, if we sat down
with these four people in a room--a few of us--we could
probably work something out that would be good and be
profitable. And I am concerned as we move forward that we just
don't make things worse at the end of the day.
So, Mr. Chairman, what I would like to ask all of them and
others, as we go through this process, to keep involved. And if
you will watch where we are skewing things one way or another,
please try to bring it back. I don't know if you are planning
on moving forward with legislation on this, but that would be
my big concern, is that we----
Chairman Miller. I am thinking about it now.
Ms. Bovbjerg. Could I chime in for a minute? I perceive
that part of it is the concern about not overburdening
sponsors, and another part is the concern about plain English,
which is something that we at GAO worry about across a lot of
different programs, and something that the Social Security
Administration has to worry about, with the benefit statements
they send out to a much wider ranger of Americans than people
who actually have pensions.
It is something that I think any disclosure of initiatives
that we as a government take in this area, we might consider
some language about plain English, making it accessible.
Mr. McKeon. Like the things that the chairman just showed,
I think were good, simple. The problem is, we pass laws, the
president signs the law, regulators write what they think that
we meant when we passed the law. And by the time it all gets
done, plain English is totally gone.
And, I mean, we did that--when we go to the doctor's now,
we all have to sign a new form. And I am a little chagrined
every time I go in the doctor's office and have to sign that,
because it was federal legislation that required that. And it
just gets put somewhere in a file, nobody ever reads it, nobody
ever does anything with it, but it just was a result of some
legislation.
So I would be happy to join with you, if you think that is
an approach----
Chairman Miller. I appreciate the comments. I hadn't smoked
out what we would do yet. I would like to think about it. But
when I read much of this testimony, it along with the GAO and
its make a fairly compelling case that inaction is probably not
an option for the committee.
And I appreciate your concerns and your willingness to work
on this and to, certainly, use these witnesses as resources.
And we always know that, when the law leaves here, it is
clearly written, so it is not open to ambiguous interpretation.
But we know we can start with a clear statement of purpose.
Mr. Kildee?
Mr. Kildee. I will be brief. I think we have a vote on the
floor.
But, Mr. Butler, what do you think it would take to get the
401(k) industry to move towards a simple, one-page fee
disclosure that captures all the fees?
Mr. Butler. Well, I think it would be very simple. First of
all, you have to appreciate that the entire industry today
operates in a seamless, electronic environment. So those of us
who are actually keeping track of this money--I won't make it
too absurdly simple, but I would almost say that, with a few
keystrokes, we can determine what the actual costs are and
report them very effectively.
I see it being a de minimis additional effort and probably
not something that would increase costs in any way.
Mr. Kildee. You think it is not rocket science to do?
Mr. Butler. It is not rocket science.
Mr. Hutcheson. Could I, Congressman Kildee? I agree. I
believe that the solution is very simple. I believe in letting
the markets work and letting competition drive prices. And I do
not believe that this would impair, or impede, or discourage
employers from maintaining plans. I believe that it would
greatly increase confidence in letting that competition go,
unencumbered and unimpeded.
And I just wanted to share and elaborate on something.
William Sharpe, who won the Nobel Prize in Economics, said that
the market generally is supposed to be efficient. And when you
start actively managing investments, whether at the mutual fund
level, or at the plan level, or at the sub-plan level, the
participants level, the fees start to be added, and there is a
direct correlation, an exact correlation between the returns of
what the participants receive and the costs.
So active-managed funds and index funds are the same before
costs. You add costs and fees, and there becomes the disparity.
And what happens is, is that when a participant receives
their participant statement, they show that their funds and
their plan are meeting the benchmarks or matching this index or
that index, but that is for the fund. That is for the fund
itself.
Those statements do not show what that particular
participant's return was. And that has to be corrected,
because, with all due respect, a good-manned firm may have
great performing funds at the fund level, but once you start
adding in various costs, the actual participant returns are
very different. And that is an important clarification that I
wanted to make.
But coming back to this, I believe strongly that it is
simple. If we strip out all the ambiguity, all the obscurity,
and let the market work based on fully transparent, fully
disclosed information, the fees will go down. There will be
good competition. There will be confidence in the system.
Plan sponsors will appreciate it. I don't see plan sponsors
bailing out of this. I see them embracing this. And it is in
the best interest of American business to shore up the economic
security of its workforce, because 20 years from now, we have
got a big pool of baby boomers who are going to be retired who
won't have enough money to meaningfully participate in the
economy.
And a lot of businesses are going to wonder why they are
struggling. It is because a whole segment of the economy was
removed because they didn't have enough money. There is no
money to spend.
And so it behooves plan sponsors to deal with this. It is
in everybody's interests.
Mr. Kildee. And they are going to be in the 401(k)-type
rather than the defined benefit-type, so we have a large number
of people who will be affected by this then.
Mr. Hutcheson. That is correct.
Mr. Kildee. Ms. Bovbjerg, can we learn anything from the
Thrift Savings Plan that we have in the federal government that
can help us in the 401(k)s?
Ms. Bovbjerg. The Thrift Savings Plan discloses information
in a clear way, as Chairman Miller was showing. I think it is
important to remember that the Thrift Savings Plan is somewhat
different from 401(k)s, in that their administrative costs are
exceedingly low compared to other forms of--you know, other
types of plans, that some of that has to do with the way that
that plan is administered throughout the government.
It also has to do with--they have been very effective in
keeping their costs low, I have to acknowledge that. I just
think it is difficult to make that comparison, because you are
dealing with a less diverse group of people. We are dealing
with federal employees. They can all read; they all speak
English. You know, it is quite different than a much broader
type of plan coverage.
Mr. Kildee. Thank you very much.
Thank you, Mr. Chairman.
Mr. Boustany. Thank you, Mr. Chairman.
We would all agree that disclosure and transparency are
very good things. Mr. Chambers, is there a danger in
oversimplifying, when providing information to participants,
that could lead to poor choices? Could you elaborate on that
and what sort of problems that that might create?
Mr. Chambers. Surely, thank you.
Despite some of the comments that have been made earlier
today about fees being the most important--and, perhaps--I am
not suggesting anyone has said the only important, but the most
important factor here--a large number, certainly in my
experience, the predominant number of financial advisers have
indicated that there are many different things that should be
put into focus as you are making an investment decision.
Clearly, fees are one of them.
The gentleman to my right, Mr. Hutcheson, I think just
mentioned the fact that, you know, you look at total return.
That is generally going to be net of some fees, perhaps all
fees, depending upon what is being paid out of the funds.
Risk is an issue. Diversification is an issue. There are
many, many issues that need to go into an investment decision.
Perhaps that is why Mr. McKeon is no longer investing in
stocks, because of all of the different things that you have to
consider when you are making an investment decision.
So I think that the big problem with oversimplification
here is an overemphasis on fees. Yes, they are important. Yes,
they should generally be disclosed. But they can--just looking
at that and that alone can lead to some very bad investment
decisions.
Mr. Boustany. I thank you for that answer.
Ms. Bovbjerg, in looking at ERISA, Section 404, could you
basically state what it requires and what was its intended
purpose? And in the view of GAO, is it really meeting that
purpose?
Ms. Bovbjerg. I don't know if I can do all that right here
and now. I can talk a little about 404(c), which is
particularly relevant----
Mr. Boustany. 404(c) is particular, yes.
Ms. Bovbjerg [continuing]. To this topic, that plans that
fall under 404(c) are essentially seeking freedom from
liability for investment choices that the participants make. In
return, they have to disclose certain things beyond what other
plans would have to do.
We had a little trouble trying to figure out what
proportion 401(k)s sell under 404(c). We thought it was 50
percent to 60 percent, somewhere in there. Those are the plans
that the Labor Department is thinking about focusing new fee
reporting requirements on.
Now, the way we see some of the fee reporting, it is all
over. It is effective in some plans, but not uniformly.
Participants have to ask for certain things; they have to know
to ask for certain things; they have to pull information from
several different sources.
You know, and 404(c) plans, it is easier to get that
information, no question about it. But is it complete? It is
just not clear to us that it is.
Mr. Boustany. I thank you.
I yield back.
Chairman Miller. Mr. Yarmouth?
Mr. Yarmuth. Thank you, Mr. Chairman.
I only have one question, and I think I know the question,
but it seems like there is nothing to prohibit any of the
providers from disclosing their fee structure. And my question
is--and anyone can address is--why is unreasonable that this
wouldn't become a huge competitive advantage, in what is
apparently a pretty competitive field, 700,000 plans out there?
Why couldn't we allow--just allow the markets, the
providers to use that as their advantage? The lowest fee
structure, if they advertised it, would give them a competitive
advantage.
Mr. Hutcheson. If I might, thank you for that question.
The reason--and I will try not to be too complicated here,
or complex, rather--401(k) are today governed partially in a
fiduciary environment, as they were originally intended and
contemplated, and partially in a non-fiduciary environment.
They are exemptions that exist that permit non-fiduciary
investment firms and others to participate in 401(k) plans,
where otherwise they might have been prohibited from doing so,
had the exemption not been given.
And so this intermingling or blending of non-fiduciary and
fiduciary philosophies is the root cause of this. And if you
bifurcate the two, fiduciary standards of care demand
transparency and open competition based on equal information
between the buyer and the seller.
It is the non-fiduciary component of 401(k) plans that is
obscuring this, partially due to that exemption or to
exemptions. And when I say ``that exemption,'' I am referring
to the Merrill exemption that permits them to participate in
401(k) plans and receive various forms of compensation without
being held to a fiduciary standard.
And if we help everybody to a fiduciary standard, this
might self-correct.
Mr. Yarmuth. Can I just ask for clarification? Do I
understand you correctly that what you are saying is that
different providers have different obligations under these
plans, and therefore the fees wouldn't be apples to apples?
Mr. Hutcheson. Exactly. You can take two physicians'
offices. Both of them have 20 employees. One of them has
service providers that acknowledge their fiduciary status and
behave as such. The other physician's office has the exact same
mutual funds, or funds, but yet their service providers are
hiding behind an exemption that protects them from fiduciary
responsibility.
And, therefore, they are not held to the same standards of
disclosure, and that has to be eradicated from the 401(k)
system. I believe that it will self-correct if that happens.
Mr. Chambers. My experience is that, although certainly
there are some folks who will perform a service as a fiduciary
and others who will perform the same service as a non-
fiduciary, is that I don't see any less disclosure of fees in
one situation, as opposed to the other.
And, clearly, plan sponsors, if they wish to off-load
fiduciary status onto someone rather than retaining it
themselves, they certainly have the capacity and the
marketplace to do that. As Mr. Hutcheson just pointed out,
there are organizations out there who will accept this role.
There are other organizations, though, that say, ``I will
do it in a different fashion,'' and that is the marketplace.
There is a decision. I don't believe that in under any
circumstances do you need to homogenize that, do you need to
invariably go out and find someone who is willing to serve as a
fiduciary to perform the function to the exclusion of someone
who is not, particularly for purposes of this hearing, if both
of them are charging relatively the same fee or, even if they
are not, if they are disclosing it.
Mr. Hutcheson. If I may just clarify, because 401(k) plans
are a fiduciary animal, they are subject to trust laws. And
trust laws have fiduciaries. And fiduciaries must be able to
discharge their duties unimpeded. They must not have obscured
information or they must not have information withheld.
Let me give you a specific example. I was asked by the
chairman of an organization to come in and explain how their
investment providers are managing their fee for free. Well,
clearly, that can't be the case, but that is what the chairman
was told. And we are talking about $100 million plan.
And I categorically and summarily disagree absolutely. The
fiduciaries simply didn't know what the pay or cost structure
was of the plan. None only does ERISA demand that fiduciaries
know, but if fiduciaries don't really understand whose getting
paid, then they can't discharge their duties.
And they are withholding information, because they are not
held to a fiduciary standard. And I believe strongly that they
should be.
Mr. Butler. If I may, as a further answer----
Mr. Yarmuth. I think I am glad I asked this question.
Mr. Butler. Pardon me?
Mr. Yarmuth. I think I am glad I asked this question.
Mr. Butler. Well, what I would like to do is just elaborate
and talk about money for a minute, as opposed to fiduciaries.
Mr. Chambers, in his written testimony, presented an elegant,
perfect example of how fees are charged.
He used as an example $150 for the total cost of operating
a plan for, say, a participant; $50 of that cost would be for
the actual administration of the plan, $100 would be for the
money management portion.
And then he pointed out that, on the $100 of the money
management portion, which is going to the mutual fund, they are
going to give up or pay $10 of it back to the company doing the
administration. So the administration company is actually
getting $60, and the mutual fund company is getting a net of
$90.
In the real world, you can expand that to a real situation.
Let's say that we have a $10 million plan. It has 150
employees, probably an engineering firm, a law firm, company
that has been around for at least 15 to 20 years. And so now,
instead of $150, we have actually 1.5 percent, which would be
pretty typical, $150,000 is what is now being paid, one way or
the other, to administer this plan of $10 million.
We have got $100,000 going to the mutual fund. They are
giving up $10,000 of it and paying it to the record-keeper.
Somebody understanding that there is that breakdown of cost
could now start shopping for the record-keeping services. And
on this particular plan, they would be able to get those
services for something in the neighborhood of roughly $10,000 a
year. They don't need to pay $50,000.
The $10,000 for the record-keeping is really for the
seamless electronic environment that allows people to dial up
their account on the Internet, and that is a basic commodity in
the industry today.
So now you have a plan sponsor who has an opportunity
possibly to save his participants about $40,000. And at this
point, he is now looking at the other component of the plan,
which is the mutual fund company that is charging $90,000. And
a person confronted with that information is going to say to
himself, ``Maybe I can get this money managed for something
closer to $40,000, instead of $90,000,'' and he could.
So now he is just saved his participants, including
himself, because he has his own account to think about, he
saved himself and his participants about 1 full percentage
point per year. The magic of compound interest works against us
when we start taking fees or paying fees out of money that
could otherwise be compounding, tax-deferred.
It is counterintuitive. In this particular example, let's
say we have saved about--we have increased our returns by about
10 percent, let's say. So you ask yourself, ``Well, why is that
leading to 20 percent more money downstream?'' And the answer
to that is, because that additional 1 percent compounded adds
up to 20 percent of the total account balance.
He has essentially saved his participants 20 percent of
what they otherwise would have spent, and effectively he has
increased everybody's retirement nest egg by 25 percent. And
that is what this is really all about; that is why these
hearings are so important.
Chairman Miller. The gentleman's time has expired.
Mr. Kline?
Thank you for the question.
Mr. Kline. Well, I am going to let us continue down that
line. It looked like Mr. Chambers wanted to have something to
say. I would like you to do that, and then I would like to
address my question.
Mr. Chambers. Thank you, sir.
The point that I was going to make is, that that is exactly
the problem that I have highlighted. Mathematically, that makes
great sense. But should the employer or whoever it is who is
making the decision on who is going to be investing plan assets
or whose products will be available, who is going to be
administering the plan, that they should do that, either solely
on the basis of fees or largely on the basis of fees?
There was no indication here about what the relative
performance of the two record-keeper. Does the record-keeper,
does the new program permit all the bells and whistles that the
employer and the employees want? That costs money. Does the
investment adviser, who is being selected, because, in fact,
they charge fewer dollars, you know, per thousand, what is
their relative rate of return over a long period of time?
All of this needs to be put into the perspective of a lot
of different people making decisions on the basis of a lot of
different points.
Thank you.
Mr. Kline. Thank you. I knew you were chomping at the bit
there, so to speak.
I don't know, Mr. Chairman, do the witnesses have this----
Chairman Miller. I don't know, but we will get it to them.
Mr. Kline. Okay.
Chairman Miller. Yes, it was shown up. Maybe it can be put
back up on the plasma screen.
Mr. Kline. It seems to me like there is some agreement here
in the committee--and maybe throughout the room--that
transparency and visibility into these funds is a useful thing.
But I am concerned that we sometimes do confuse the famous
apples and oranges, and I am just trying to understand. I
think, Ms. Bovbjerg, you were talking about this issue earlier,
not confusing or not trying too hard to compare the Thrift
Savings Plan with some other 401(k)s.
And this, clearly, is doing exactly that. It is comparing
the Thrift Savings Plan with some--I don't know if that is a
real fund, but it shows a significant difference, when you
compare the TSP with this notional 401(k). It looks like those
are dollars per individual.
What I would like you to do is go back where you were a
couple of questioners ago and talk about why it is that the
Thrift Savings Plan comes in at asset-based fees of 0.6 percent
and why it is not. We are a little apples and oranges here when
we try to compare other 401(k)s. Could you do that for us, kind
of pick up where you were? Thank you.
Ms. Bovbjerg. Absolutely.
I think I would also like to say that this is a graph that
is similar in spirit to one that was in our report on fees that
looks at what, if your fees were 1 percent higher over a 20-
year period, what would that mean? It would be about a 17
percent loss of income, assets.
The Thrift Savings Plan uses administrators across the
federal government to help people sign up to make changes. The
Department of Education has them; the GAO has them; Congress
has them.
Mr. Kline. And these are public employees rather than----
Ms. Bovbjerg. These are public employees, and they are--
Congress pays for its office. GAO pays for its personnel office
that has these people in the Department of Education, so----
Mr. Kline. Thus reducing the costs?
Ms. Bovbjerg. Yes. So the six basis points is not really
what the administrative cost is of the Thrift Savings Plan, but
that is not to take away from the fact that Thrift Savings Plan
is very efficiently run. So the administrative costs are still
pretty low.
Mr. Kline. Okay, thank you.
Yes, Mr. Hutcheson?
Mr. Hutcheson. The underlying investments in the Thrift
Savings Plan are what we call index funds generally. They are
passive funds. You are getting the broad market.
In the private sector, funds very similar to what is in the
Thrift Savings Plan are available to employers. They might be
slightly more expensive, because it is a price based on the
assets in the plan. But what we are seeing here is a perfect
example of what Professor Sharpe, who won the Nobel Prize in
Economics, and also many other people have said.
If you track the broad market as closely as possible, you
will get market returns, and you really, over the long haul,
can't do better than that.
Mr. Kline. Sure, I understand. You are proposing that we
use the index funds. But what I was trying to get at is that
there is--in the fee world, which we are trying to get
visibility in the fees--what is now shown here, was what Ms.
Bovbjerg pointed out--that because the taxpayers are paying, in
some part, for the administration of this, because we have
public employees who are doing part of this work, the Thrift
Savings Plan is not the best apple-to-apple comparison and what
fees are.
Thank you, Mr. Chairman. I yield back.
Chairman Miller. Thank you.
Mr. Wu?
Mr. Wu. Thank you, Mr. Chairman.
First, I want to ask the panel--and, Bob, you in
particular--do we have pretty much uniformity of agreement that
disclosure of the various fees is non-objectionable, as long,
as you said, Bob, that it does not drown out other valuable
information, that disclosure of brokerage fees, 12b-1 fees, and
so on and so forth, that all of those disclosures are
appropriate.
Mr. Chambers. Well, I generally agree, but I think that
where the rubber hits the road is going to be in terms of what
fees needed to be disclosed and how we slice and dice the fees
that are out there.
And to go back to one of the points that the chairman made
earlier, and when he was alluding to my Toyota example, when
you go to buy a car, there is not fee disclosure on how much
Toyota paid for the glass, and there is not fee disclosure on
how much Toyota paid for the computer components. There is an
overall fee.
And I agree: There are ways to assess whether that
particular automobile is better than another automobile,
through miles per gallon, you know, performance, which is what
we are talking about here.
So I think that the council's concern--well, the overall
concept is, yes, we are very favorably behind the idea of full
and fair disclosure of fees. But I do think that where we are
going to run into issues is, exactly how are we going to be
slicing and dicing that? Because I don't know that it is
necessarily essential for a plan participant--to mix the two
metaphors now--that a plan participant needs to know how much
the glass costs in the car.
And I can see, for example, that, if you have a large
financial institution which has been empowered through
contract, you know, to perform services for a plan, and if, for
example, that financial institution decides that it is going to
take one of the functions that it is contractually bound to
perform, and to hand it off to one of its affiliate companies,
you know, say it has a captive trust company, for example, I
don't know that that necessarily is something that needs to be
disclosed. That is internal proprietary information.
But by and large, overall fees, yes, we are very much in
favor of that.
Mr. Wu. Yes. And because of the limitations of time, let me
just say that, in contrast to, say, a Toyota, because of the
difficulty of predicting future market performance, because the
market is basically different from being able to calculate the
speed or safety of a car, some of the rear-view mirror things,
if you will, like fees, take on a disproportionately important
role, I would like to be--I would be very interested in hearing
from all the panelists what disclosures you all feel are
important and the best display format for that, so that it is
most useful for investors.
And I would like to ask that question and get that set of
answers over time in writing, because I would like to turn to
Mr. Hutcheson for a second. And I am not sure that this came
out, Matt, in your oral testimony, but in going through your
written testimony last night, there was a recurring theme of
non-fiduciary functions and fiduciary functions and having
those mixed together, and a core problem of mixing those non-
fiduciary and fiduciary functions together.
But as I read the materials, one of the non-fiduciary
functions was actually the investment decisions of the plan's
beneficiary. And I would like to take me through this a little
bit. It is one of the--where you are going with this, if we
take it all the way out with a fiduciary plan, is that we
ultimately get the plan beneficiary off the loop, in terms of
decisionmaking about investment vehicles.
Mr. Hutcheson. That is right. I personally believe--and
just to clarify before I answer the question--that no person
can time the market. I just don't believe it. I think there is
empirical research that shows that there is only a few points
in time each year where the market really takes a big leap
forward, and you have to be in the market at that point in
time.
And so placing decisions in people who have no financial or
economic or investing experience, and not only just placing
investment decisions, but we are talking about trust assets
subject to fiduciary prudence.
So 404(c) says that a participant will not be deemed a
fiduciary to the extent that they are directing these trust
assets, and that is kind of a conflict in fundamental fiduciary
prudence and trust oversight, as we have been accustomed to,
many, many years, decades before 404(c) was enacted.
And very short, I believe that participants play with their
accounts based on recommendations of friends, what they see in
the news. They have the ability to make changes. 404(c) says
that you have to be able to change your allocations quarterly
or more frequently, as the market dictates. Why would they want
to be changing their accounts based on what happens yesterday?
That is not prudent. It makes no economic sense. It is not
based on good, sound investment research or theory. It in
itself, I believe, is bad public policy. And it, in my opinion,
goes contrary to fundamental laws of fiduciary prudence.
Mr. Chambers. May I add one point, please, to that? And
that is--well, actually two points.
One is, I don't think that that is a correct statement of
trust law, number one. It is difficult for someone to be a
trustee for himself or herself. And, therefore, you are not a
fiduciary, which involves acting on behalf on someone else. So
I don't think that that is a correct statement.
Number two, you need to take a look at the program, I
think, that Mr. Hutcheson is proposing. Now, you know, one of
the comments or one of the things that we talk about is the
series of movies that were out a number of years ago, you know,
``Back to the Future.''
Well, I think that what he is suggesting is the opposite,
which is ``Forward to the Past.'' There is, if you take a look
at what he is suggesting--which is a very viable program for
employers who are so inclined. I am not trying to say that it
is a bad program at all. I don't think that it is particularly
viable in the view of most employers with whom I work.
It is essentially the creation of a television set that
only gets one channel, and it is a channel that, whoever it is
that is putting that set together, is developing. One set of
investments, you know, no loans, no this, no that.
Why would an employee want to make a decision to change an
investment because of what happened yesterday? There may be
something else in his or her life that dictates that. It also
may be that they no longer have confidence in the investments
that they previously made.
Chairman Miller. The gentleman's time is expired. Thank
you.
Mr. Wu. Thank you, Mr. Chairman.
Chairman Miller. Mr. Andrews?
Mr. Andrews. Thank you, Mr. Chairman.
I very much appreciate the witnesses, and I appreciate this
hearing. I view this hearing as a continuation of work that
this committee has done on a bipartisan basis over the last
number of years, reflecting a number of points of consensus.
The first point of consensus is that it is a reality that
individuals are managing their own investment decisions, and I
think there is a consensus that we should not impede that
individual choice or individual freedom.
In the wake of the Enron scandal a few years ago, there
were some discussions of putting legal limitations on choices
people could make in their own 401(k) plans. I, frankly,
opposed those suggestions, and I am glad they are not the law.
The second point of consensus is that people should--we
should facilitate people getting sound investment advice. Now,
there is still significant disagreement over what that means.
There was a compromised reach in the act of 2006. We will
evaluate the efficacy of that compromise and continue the
discussion, but I think it is obviously true that sound
investment advice is better than no investment advice or,
frankly, a lot better than investment advice from an
incompetent source who doesn't know what he or she is talking
about.
The third point of consensus is that we should maximize
transparency so that people making these individual choices
have the widest array of facts in front of them so they can
make the best choices, which leads us to today's discussion,
which is, what should the form and nature of that transparency
include?
I will confess to you, I come to this discussion as an
agnostic. I am very interested in what you think as to how we
can answer that question. But in my simple agnosticism, I would
make the following proposition.
We talk about people buying cars? I think the best example
is someone selling their house. It is the single most important
economic decision most Americans make. And when most Americans
sell their home, they ask one question. They ask two questions,
really: How much am I going to get for the house? What is the
sale price going to be? And how much of the sale price am I
going to get to keep?
I actually practiced real estate law before I did this and
represented hundreds of homebuyers, and they would ask the
realtor how much they were going to get for the home, how much
the contract was going to be for. And they would ask me, as
their attorney, how much they were going to get to keep.
And we have disclosure laws, RESPA, in the real estate
context that tells someone how much of the proceeds they have
to pay to someone else, the real estate commission and other
fees, and how much they get to keep.
I think that is the basis on which we should build this
disclosure. I think we should build it on the proposition--if
my 401(k) were invested, and I got to keep everything, every
dollar earned on that investment decision, how much would that
be? And then how much are we going to get in a net return,
after whatever fees, or contracts, or considerations are paid?
Does anybody disagree with that as a conceptual framework
for approaching this problem?
Okay. Now, I think there is a second category of this
disclosure we also have to think about. And I am not sure
whether the present law covers this or not, and that is the
situation where, to use the analogy, the sale price of my house
is too low because the realtor was conflicted in some way, that
the realtor sold the house to her sister-in-law rather than to
the highest bidder.
Does anyone think that the present ERISA statute does not
prohibit that situation? Does anybody think that the present
statute doesn't prohibit the situation where the person making
some plan decisions is depriving me of the highest price or the
best investment?
Mr. Butler. If I may, I think there are all kinds of
opportunities for that to happen right now, under the current
situation. Forbes magazine talked about the extent to which the
brokerage industry's own mutual funds do very poorly as
investments, comparatively speaking.
And the reason for that is because the brokerage industry's
source of revenue, to a large extent, has to do with trading
commissions. So the mutual funds that they operate, in many
cases, are feeding troughs for their trading operation. And
that is an example that I see in the industry, along the lines
of what you were just talking about.
Mr. Andrews. Okay. Because my time--do you agree with that
conclusion of Mr. Butler or not?
Mr. Butler. Yes, I do. I would say that----
Mr. Andrews. No, I know you agree. I asked Mr. Chambers if
he agrees with you.
Mr. Chambers. I don't always agree with myself, so I need
to deal with that.
Mr. Andrews. Okay.
Mr. Chambers. Before I respond to that, to respond to your
comment or your question, I am concerned with your using the
word ``best'' in conjunction with what ERISA requires, as
opposed to what is reasonable, which is, in fact, what the
statutory standard is.
Mr. Andrews. Of course, it doesn't require what is
reasonable. It requires what is in the best interests of the
participant party.
Mr. Chambers. Best interest, yes, but not necessarily the
best result.
Mr. Andrews. Okay. You would agree, that is not synonymous
with reasonable, though. If you make a reasonable choice that
is not in the fiduciary interest of your----
Mr. Chambers. No, but somebody has to act reasonably. And
one of the ways that they have to act reasonably is within the
best interests of the participants and the beneficiaries.
I think that, if everyone had to go around chasing the best
investment results, or if everyone had to go around chasing the
lowest conceivable method of administrative fees, I think that
this would be a very different world.
Mr. Andrews. Of course, that is not what I asked, though. I
asked whether you thought that the statute prohibits someone
making a conflicted or self-interested decision in the
investment context.
Mr. Chambers. I think that, yes, the statute does currently
prohibit that.
Mr. Andrews. Effectively?
Mr. Chambers. Pardon me?
Mr. Andrews. Effectively? Do you think there is any
loopholes in that?
Mr. Chambers. Are there loopholes? I don't know that I
would call this a loophole, but remember that, for example,
employers have issue--every employer that sponsors a plan
invariably has issues about its role as the settlor of the
plan, the sponsor of the plan, versus its role as a fiduciary
of the plan. And that is something that is inherent in
sponsorships.
So I don't know that you would call that a loophole, but
certainly that is something that everyone has to be concerned
about.
Mr. Andrews. My time is expired. I would just ask if Mr.
Hutcheson wanted to respond.
Chairman Miller. Mr. McKeon wanted to tag on----
Mr. Andrews. Sure, Mr. Chairman, I would yield.
Mr. McKeon. Will the gentleman yield?
In your example, if the realtor brings an offer to me to
sell my house, I can accept or reject it. So I don't see where
that really plays a role, a comparable role.
The first part, where you talked about just final net
return, it sounds great to me. I don't know where----
Mr. Andrews. Yes, if the gentleman would yield, here is the
analogy of the realtor bringing an offer. Someone has to make a
decision which options to give the plan participant. You could
limit----
Mr. McKeon. But it all washes out with the net return.
Mr. Andrews. It washes out----
Chairman Miller. I will take your answer off the air.
Mr. Andrews. Thank you.
Chairman Miller. Mr. Sarbanes?
Mr. Sarbanes. Thank you, Mr. Chairman, and thank you for
holding the hearing.
I have a brief question. In my view, when it comes to
information, there are two ways you can hide the ball. You can
not disclose enough information, or you can disclose so much
that it becomes impossible for the consumer of the information
to sift through it and understand it. You see that happen in
many, many different arenas.
So, Mr. Butler, I wanted to ask you to address this,
because it is not just about more disclosure. It is about
better disclosure. And I feel as though I get plenty of
information on a lot of things that represent ``full
disclosure'' that I can't make heads or tails of. And this is
another arena were that would be the case.
So it is about how you package it. And your index,
obviously, attempts to do that. But if you could just speak to
the pitfalls of too much disclosure or how we package or
present the information in a way that is really constructive
for the consumer.
Mr. Butler. I would love to address that.
First of all, the need to know, from a decisionmaking
standpoint, really centers on the company management people who
are basically charged with deciding what kind of plan and which
vendors they are going to use. That is why my first book was
called ``The Decisionmaker's Guide to 401(k) Plans.''
The participants really then wind up being the
beneficiaries of hopefully some informed decisionmaking. When
you are looking at the component costs of one of these plans--
and the example that I was using earlier--what is important is
for these decisionmakers to be able to basically understand
each component cost so that they can effectively decide whether
or not they want to be part of a package deal or not.
And the example that I used, we presupposed that we had
mutual funds and then a separate company, let's say, as a
record-keeper. But, in fact, in about 70 percent of all 401(k)
plans, it is all in the same building. It is the mutual fund
that also has three floors of record-keepers keeping track of
the money and doing the compliance-related issues.
And so the important thing is for this bundled provider to
be able to present to the decisionmakers, their clients, what
the component costs are so that the decisionmakers can decide
whether or not they want to be part of a package deal. Or can
they create a much better opportunity for their participants by
breaking things up and shopping for better opportunities?
It is like, when you buy a car, you might decide that you
don't want the manufacturer's Bose stereo because you can get a
much better deal buying a stereo independently.
Mr. Sarbanes. Do you think that the ``decisionmakers'' can
be as susceptible to getting too much information, as
beneficiaries can, or because they are better versed and this
is their responsibility, to make these decisions, that they are
sort of protected against that?
Mr. Butler. My experience, in the smaller company
environment--and, bear in mind, 70 percent of all Americans
work for companies that have less than 100 employees--my
experience is that decisionmakers in that environment tend to
be the company owners, who are by definition successful
businesspeople, many are self-styled investment experts
themselves, or mutual fund experts.
Also, the CFO or controller will also be part of that de
facto decisionmaking committee. And these people are very, very
sophisticated. They make the right decisions if given the right
information.
Mr. Sarbanes. Thank you.
Mr. Chambers. May I comment?
Mr. Sarbanes. Sure.
Mr. Chambers. I guess I agree with most of what Mr. Butler
just said. The one issue that I have is, that I am not sure
that it is appropriate or essential to get a bundled provider
to explain what the cost allocation is or the expense
allocation is, if it is not making those services available
independent of one another.
In other words, the way--and I just went through this with
a client--that is a small employer, about 100, 150 employees,
and they wanted to look at new record-keeping investment
systems. And they went to some programs that were bundled, and
we found out what the total costs were from that. And then they
went to other programs which were not bundled, and we found out
what the total costs were there.
I don't know that it would be essential to receive
information from the bundled program, for example, about how
much it was allocating to provide record-keeping, as opposed to
some other component, if that is not available from that same
organization. I don't know that that is information that is
going to help you to make a meaningful decision.
Mr. Sarbanes. Well, I hear that, and I worry--it is a fair
point, although it could also be the beginning of a slide, kind
of slippery slope, in terms of what comparative information is
available.
I yield back. Thanks.
Ms. Shea-Porter. Thank you, Mr. Chairman.
I can remember when the fees for banking and mortgages were
so absolutely confusing, and there has been some streamlining.
And probably my son, who is 17, is the only one who still pays
10 percent monthly on his balance at a bank, and we are going
to straighten that out.
But the reason I brought that up was because it is
difficult for people who are not knowledgeable to understand.
And it is pretty clear on the bank statements to me now, you
know, what the fees will be. And I will be teaching my 17-year-
old shortly the same thing.
But when you try to compare different plans, I think there
is an obligation--this actually is to Ms. Bovbjerg--an
obligation to be as explicit as possible. And I think it is
possible to be simple, as well, when you are explaining the
fees.
And I listened to my colleague talk about the costs of the
TSP, for example, and I wanted to ask you to address that. He
said that federal employees were picking up some of the cost of
the administration. Do you have any idea how much the federal
employees are actually picking up? And is it possible to
compare those two plans?
I am fortunate enough to be in the TSP, and it is clear,
and the administrative fees are lower. So could you address
that, please?
Ms. Bovbjerg. And you have touched on one of the reasons
that makes it so difficult to compare the Thrift Savings Plan
to other types of retirement saving vehicles.
When I brought up the thing about the Thrift Savings Plan,
I did want to say that, you know, this graph is essentially
showing the math between two things. And the math is correct,
but it is the implication that six basis points is sort of
normal I was a little concerned about.
The Thrift Savings Plan has certain levels of expenses.
And, in fact, we will be reporting on these costs for
Congressman Davis in a couple of months. But the Thrift Savings
Plan does take its--gets revenue from not only, you know, from
not having to do things, but also from the money that is what I
would call ``left on the table,'' you know, the federal
government matches and puts in 1 percent.
And for people who come to the federal government, the
people who leave before they invest, can only take their money,
and they leave the federal money on the table. That also nets
the administrative costs for the TSP. That is one of the
reasons why they look so low.
I would like to say that, in terms of reporting to
individuals, it is critical that it be simple, that it be
clear, it be all in one place, and that people don't have to go
ask for it, because they will never find it. Only a certain
percentage of people will know to do that.
But it is hard. It is hard for the Social Security
Administration to produce a benefits statement that 270 million
Americans can understand. And they put a lot of effort into it.
So I don't want to discount what I know are the concerns about,
how do you really make something that people will find
accessible? It is not easy, but it is important.
Ms. Shea-Porter. Right, but it is doable, that is what you
are saying.
Ms. Bovbjerg. It is doable.
Ms. Shea-Porter. Right, and still leave a healthy profit
for those who are the administrators.
Ms. Bovbjerg. I can't say what it would cost, different
kinds of sponsors. And, certainly, I know that the Department
of Labor is weighing, you know, sponsor burden against the
outcome and trying to figure out how they can best achieve some
sort of optimal result.
Ms. Shea-Porter. Okay, thank you.
Chairman Miller. Thank you very much.
And thank you for all of your testimony.
A couple of things here. One is, I guess the question I
would ask--and I appreciate Mr. Andrews raising the point, if
you had a net-net-net figure, would that tell you what you
really need to know as a consumer, or would these other
packages of information be more informative, or what have you?
And that is obviously to be discussed further.
But the real question for me is, again, a lot of people--
you know, you can have $100 million plan, and a lot of people
are struggling to put in $6,000, $7,000 into this plan. And
they don't have a lot of room for risk and fees and the rest of
this.
And the question that I would raise is, are we sure that we
are getting the value added for that? And is there a reasonable
reason why somebody made a decision to go in that direction? Or
was it a conflicted decision? Or was it a decision that really
didn't meet that reasonableness when you consider who is in the
plan?
You know, the Miller family doesn't have a lot of margin of
error for mistakes. My employer apparently does, because we
have got $1 trillion debt he is running around with. But, you
know, the sponsor of this plan, the owner of the business, and
maybe the officers, depending on the size of it, they may have
a lot of income. People working for them may have reasonable
income or good income. But good income today doesn't give you a
lot of room for risk.
So, you know, the question is, how does that factor in? And
I guess the disappointment I see is that you have a lot of
people dipping into other people's money. You know, I didn't
put the money into the 401(k) plan so a lot of strangers could
come in and start dipping into this, under manufactured titles,
for fees of questionable services, whether I need them or not
need them.
Now, I am an individual, and so then we have to go to the
plan, we have to go to the sponsors, and I think that is the
central question for me, that this really is about other
people's monies. And I think that, also, you are in an
atmosphere where people have determined--maybe it is the advent
of the Internet--but if you can charge a real small fee a
billion times, you can become a really rich company. And people
say, ``Oh, that fee doesn't matter.''
Well, as we have seen, every one of you have given us a
comparison chart of what it would mean--let's just use the 1
percent differential. That is a lot of money to a middle-class
working American, at the end of the time, when they think they
are going to retirement, and what are they going to be able to
extract if they don't want to eat up the principal of that nest
egg?
Those are big differences. One of you said that the
difference was the--between the 1 percent and 1.5 percent, 1.5
percent differential, the person who was on the bad end of that
bargain would have to work an additional 7 years. I mean, these
are big consequences to workers and to families.
And I guess my concern--I mean, one of the things discussed
with the members of the committee and with others, is the
question really, are they getting value added here?
You know, I have listened to I don't know how many
financial shows over 20 years, where one side is saying, ``This
should be the position for most American investors, an index
fund. It is safe, it is low cost, and the rest of that.''
And the other people say, ``Oh, no, you can go out there,
and you can beat the market,'' and there is a lot of reasons
why people say that, because they are out there trying to beat
the market, and they need clients to do so. And that may be
good for some people, but it may not be good for this plan that
is becoming a larger and larger percentage of people's
retirement.
This isn't their mad money; this is their retirement. By
default, this has become one of the two remaining legs on the
retirement stool in this.
You know, we have been talking about a comparison of the
thrift plan, but I think IBM and Xerox are even more efficient
in these 401(k) plans than the thrift. Does anybody have any
knowledge of that, that they--one of you had it in your
statement, I am sorry.
Mr. Butler. My understanding is that Xerox charges .03
percent to their employees. They probably have some other
costs, but they are paying those costs as a tax-deductible
corporate business expense, instead of having participants pay
it with money that would otherwise be compounding tax-free.
Chairman Miller. That is because of a separate decision
they made, how they would allocate the costs. So that is a
benefit, I guess, that you would argue they feel strongly
enough financially to be able to shift.
Mr. Butler. Exactly. And there is no way that Xerox would
then be paying 100 basis points as a corporate business
expense. They have just figured out what the fixed cost is for
each participant in the plan, and it is probably about $50 a
year to keep track of the money, per person.
Chairman Miller [continuing]. Xerox is not a small
business, with, you know, 100, 150 employees. So there is some
bargaining----
Mr. Chambers. I think you need to look at it as an employer
contribution to the plan. And Xerox could ask the employees to
pay whatever the amount is and be providing a larger employer
contribution in the form of a match or, perhaps, in a profit-
sharing contribution. And the employees would be in the same
position.
So I think that you are correct, but there is another way
to do it, which is the way that a lot of employers are doing
it.
Mr. Hutcheson. Chairman Miller, I don't think that anybody
is suggesting radical open-heart surgery. I think what we are
suggesting is, is asking that plans be governed by prudent
fiduciaries in possession of full and correct information. Once
they are in possession of all the information, if they want
bells and whistles, and the fiduciaries certainly have the
discretion to purchase them on behalf of the participants and
beneficiaries to whom they serve.
Without full information, the fiduciaries are impeded. And
if we have a seller and a fully informed buyer, the free market
system will take care of this. But as it is today, the
purchasers of retirement services do not understand, not even
the Department of Labor fully understands what the nature of
the economics are or is.
And, thus, we have a situation. That is what needs to be
remedies. We need to empower the fiduciaries with correct, full
information, and let knowledgeable fiduciaries and the
knowledgeable deliverers of services negotiate on equal
standing.
Mr. Chambers. I don't disagree with that at all. I think we
need to maintain confidence in this system. I think we need to
improve confidence in this system.
And I think that, again, all of us on the panel agree that
there needs to be another methodology of providing this
information to all three of the constituencies that we have
been discussing, participants, and the fiduciaries, and the
government, in order to pursue this. I don't disagree with that
at all.
But I think it is important to make sure, as I have
mentioned before, that the cost of doing this is not going to
overwhelm the benefit that comes from it, that, in fact, we
wind up not diminishing end-of-the-road retirement benefits,
simply because we have overemphasized fees, compared to all of
the other important considerations that go into the
administration of these plans and the investment of their
assets.
Chairman Miller. Should the plan sponsor know whether or
not there is conflicting financial arrangements for the
placement of those funds?
Mr. Chambers. I think that the plan sponsor needs to
understand what the relationships are. And I think, then, that
the plan sponsor needs to make a decision as to whether there
is a conflict there, whether the conflict is----
Chairman Miller. So they should have the information? You
would agree that they should have the information?
Mr. Chambers. I think that they need to have information
relating to what the role of each service provider is. And then
they can decide whether or not there is a conflict.
One of the issues that are out there is that you may have a
service provider that has a relationship at this end of the
spectrum with a financial organization, and you have entirely
independent people working at that plan level. So the question
is, is there a conflict?
There may be a conflict in an entirely unrelated area. Does
the administrator or the plan sponsor need to know that? I
think it would be very helpful, but I am not sure that in every
situation you are going to be able to provide that information.
Ms. Bovbjerg. Which is why recommended the Congress amend
ERISA to explicitly require service providers to provide that
information to plan sponsors.
Chairman Miller. If ``A'' is placing their funds with
``B,'' and ``B'' is getting money from ``C,'' that in itself is
an important piece of information.
Mr. Chambers. Right. How about if a bank is a lender to a
particular organization, you know, is a primary lender or is
involved--that is why I am saying----
Chairman Miller. Well, with all due respect, you know,
those questions are answered every day in the courtrooms of
this country, because among the biggest players in this field,
they are suing one another over exactly those relationships.
We just saw a whole series of arrangements in the mutual
fund industry, 3, 4, 5 years ago, where all kinds of privileges
were extended based upon other arrangements. People were
allowed to trade after 4 o'clock. People were allowed to not
mark to market. People were allowed to go over until the next
day.
You know, and they were based upon loans and placements of
funds. I mean, that goes on in the financial services industry
every day. Big clients get privileges, and connected people get
privileges. So this goes on all the time.
The question is, you know, my little firm, and I am trying
to take care of my employees, should I know whether the person
I am working with has these financial relationships? I will
then make a decision about whether I think that is impacting or
not impacting, or it may come back to me a year later when I
see what happens. I may say, ``Whoa, whoa, let's go back and
see what that relationship was.''
Mr. Chambers. I believe, sir, that if you are limiting this
primarily to the retirement plan context, I think, then, that
it would be possible to come up with a reasonable way of
creating disclosure that is beneficial.
But as I was mentioning, I think it is very difficult--if I
decide that I want to go to a bank to serve as the trustee of
my retirement plan, and it turns out that that bank is the
primary lender to an organization that is providing retirement
services to me, all right, is that a conflict? And how is it
that somebody is supposed to be disclosing that too me?
Chairman Miller. That may or may not be. Again, when people
look back over transactions, very often they all of a sudden
recognize a conflict that they didn't recognize at the time. So
the information is important.
It has been very important to the SEC. It has been very
important to states' attorneys generals and to others, because
patterns do develop. We just saw a pattern develop of inside
trading. There, the enforcement officers recognized it for the
investment firm, and then they decided they would cut
themselves in on it. You know, we just went through the arrest
here this last week.
So the information is important, not only at the time you
can make your judgment, whether you think that is right or
wrong; it may be important down the road, if a pattern develops
or these people have relationships. You know, it may not be
about your fund, but it may be about all of the investors that
come there and the fund they go to.
You may be part of a larger piece of action. That is all I
am saying. So I just am asking whether or not that arrangement,
in and of itself, should be a piece of information that is
available. I am not determining whether it is a conflict or not
a conflict, simply whether that disclosure is important.
And most of these things that concern me about little
people, it is because I see the big guys fighting it out. You
know, they are battling over their pension plans, very large
corporations, because somebody decided they were going to dip
their hand into other people's money, with an insignificant
fee, and they could drain it off.
I mean, that is sort of the nature of financial abuse in
the financial services industry. People come up with these
schemes sort of, you know, every full moon.
Any other questions?
[Additional statements for the record follow:]
[The prepared statement of Mr. Altmire follows:]
Prepared Statement of Hon. Jason Altmire, a Representative in Congress
From the State of Pennsylvania
Thank you, Mr. Chairman, for holding this important hearing on
``Hidden 401(k) Fees,'' and for your continued leadership on issues of
great importance to America's working families.
I would like to extend a warm welcome to today's witnesses. I thank
all of you for taking the time to be here and look forward to hearing
from you.
In recent years, 401 (k) plans have emerged as the most common way
for Americans to save for their retirement. Currently, nearly 50
million employees are enrolled in 401(k) plans as compared to
approximately 20 million employees who are enrolled in traditional
pension plans. With the rise of the number of employees using 401 (k)
plans to prepare for their retirement, we must work to ensure that
their plans operate as efficiently as possible.
Many have raised concerns about the operation of 401(k) plans. The
most common complaint is that administrative and management fees for
401 (k) plans are not clearly defined and delineated. Many of these
fees nickel and dime the retirement savings of employees who may not
even be aware of their existence. I share these concerns and believe
that these fees should be properly disclosed, rather than simply
deducted from the account balances of employees.
I also believe that we should do more to encourage employees to
invest in 401 (k) plans and properly prepare for their retirement.
While there is no doubt that it is increasingly difficult for workers
to plan for a secure retirement, there is much that can be done to make
this security more attainable. I look forward to hearing our witness'
ideas on this issue.
______
[The prepared statement of Mr. Hare follows:]
Prepared Statement of Hon. Phil Hare, a Representative in Congress From
the State of Illinois
Since the beginning of the 110th Congress, the Education and Labor
Committee has been investigating what has been termed the ``middle
class squeeze,'' referring to the challenges the majority of Americans
face in acquiring financial stability, affording high healthcare costs,
saving for college and building retirement security, despite having
jobs with strong wages. I am happy to see today we are reviewing the
issue of retirement and the roadblocks involved in pension and
retirement plans that make it difficult for the middle class to build
retirement security.
There is no doubt that we all support employer-sponsored retirement
plans and would like to help facilitate the expansion of those plans by
providing the support and assistance employers need. However, I will
not support efforts that do this on the backs of hard-working
employees. The discussion about hidden fees in 401(k) plans, which the
majority of American workers have, is extremely upsetting to me. Full
disclosure of these fees is critical so that employees have full
knowledge about their investments and the ability to compare plans to
choose the best one for them.
Questions for the Panel
Mr. Chambers: Would requiring the disclosure of these fees
discourage employers from offering retirement plans because of
increased administrative costs? What do your clients need from the
federal government in order to provide reasonable retirement options
for their employees?
Ms. Bovbjerg: We as Members of Congress are privileged in
that we have the best retirement plan in the world--the Thrift Savings
Plan (TSP). The government will match employee contributions to this
plan up to 5%. We also have the choice among many investment options.
What can we do as legislators either through better disclosure
reporting or financial offsets to expand TSP-type plans to all sectors
of the American workforce?
Mr. Hutcheson: How did this ``culture'' come to be that
has allowed unscrupulous extractions from the bank accounts of
hardworking Americans? How do we reestablish the integrity of our
retirement structure? Can disclosure or elimination of hidden fees do
it alone? And, what options do employees have once they know about the
hidden fees they are paying?
______
Chairman Miller. Well, thank you very much. I think your
testimony and your comments and your responses to the members
of the committee have been very helpful for this initial
hearing. And we would hope that you would agree with Mr.
McKeon, that you would continue to serve as a source of
information to us, as we continue this discussion.
Thank you. The committee will stand adjourned. Thank you.
[Whereupon, at 12:55 p.m., the committee was adjourned.]