W. Scott Simon
Any discussion about the regulatory effort (i.e., proposed rule §2550.404a-5 set forth by the Department of Labor) or the legislative effort (i.e., HR 3185) to disclose fees associated with qualified retirement plans such as 401(k) plans must begin with citation to the relevant portion of section 404(a)(1)(A) of the Employee Retirement Income Security Act (ERISA): “[A] fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and for the exclusive purpose of: (i) providing benefits to participants and their beneficiaries; and (ii) defraying reasonable expenses of administering the plan.”
This essential duty of plan sponsor fiduciaries requires them (among other things) to identify and understand plan expenses that are paid to plan service providers so that they can determine whether they’re reasonable in light of the level and quality of services offered by the providers. This is basic ERISA law and cannot be in dispute.
Only after a sponsor determines through a conscious, prudent process that the expenses associated with the investment options offered in a retirement plan are reasonable can the sponsor then make such options available to plan participants. The sequence here is important: The plan sponsor must make a determination of the reasonableness of costs before it can be in a position to disclose such costs intelligently to participants in the plan it sponsors.
In promulgating its proposed rule §2550.404a-5, the Department of Labor has failed to require that plan service providers, such as mutual fund families, insurance companies, and other large financial-services firms, make complete and understandable cost disclosures to plan sponsors in a uniform format. This failure means that plan sponsors will continue to have a weak grasp of the total economic impact that the costs in their plans have on the account balances of plan participants. If plan sponsors have a weak grasp of this, plan participants have little chance to get the cogent information they need to make intelligent decisions with respect to their plan accounts.
Certain plan providers with a keen self interest in obfuscating the disclosure of costs associated with retirement plans have had a direct hand in guiding the Department of Labor by the nose toward promulgation of its proposed rule, now commonly known as the “anti- participant rule.” Part of this “guidance” has included focusing the Department of Labor on the supposed confusion and added costs of making expense disclosures to plan participants. Such commotion has never been anything other than a red herring. In fact, complete and cogent disclosure of costs by plan providers to plan sponsors in a uniform format would allow plan sponsors to make complete and cogent disclosure of costs to plan participants in a uniform format.
By the way, the bleating by plan service providers about the “added” costs they would incur by having to make cost disclosures to plan participants is pure baloney. In fact, plan record- keepers have this data readily available because it has already been compiled. Are we to believe that service providers don’t know, to the penny, what their costs are and therefore what their profits are?
Another wonderful byproduct of the “anti-participant rule” is that costs associated with retirement plans will otherwise remain unnecessarily high because of their obfuscation. The Department of Labor just doesn’t seem to understand this. Buried in the 31-page manifesto issued by the Department of Labor in the July 23, 2008, Federal Register titled “Fiduciary Requirements for Disclosure in Participant-Directed Individual Account Plans; Proposed Rule,” is this passage:
“In developing proposed regulation [408(b)(2)], the [Department of Labor] considered why the market alone does not provide transparent fee disclosure to participants comparable to that prescribed by this regulation .. The lack of transparent fee disclosure in this market suggests to the [Department of Labor] that individuals may underestimate the impact that fees and expenses can have on their account balances, and thus undervalue transparent fee disclosure. The [Department of Labor] believes that this causes individuals to make uninformed investment decisions that result in inferior outcomes to those that would result from making investment decisions based on full information. If employees undervalue disclosure, plan sponsors might underprovide it. Sub-optimal levels of disclosure translate into inefficiencies in participants choices of investment products and services.”
What’s disturbing about this series of illogically sequenced sentences (as indicated, some were omitted to make this mish-mash less nonsensical) is that the initial question posed– why the market alone does not provide transparent fee disclosure to participants–is never answered. The focus, instead, is on plan participants that “underestimate the impact that . expenses can have on their account balances,” thereby causing them to “undervalue transparent fee disclosure,” which in turn causes them to “make uninformed investment decisions that result in inferior outcomes.”
The next-to-last sentence of this meandering passage is a real corker: “If employees undervalue disclosure, plan sponsors might underprovide it.” The Department of Labor has it exactly backward here. Instead, it should read: Plan sponsors underprovide disclosure so naturally participants undervalue disclosure–or worse, they don’t value it at all since they have no idea about the costs of plan investment options. Added to this, of course, should be the obvious notion that sponsors underprovide disclosure to participants because they are not provided with complete and cogent disclosure of costs by plan providers.
The only sentence in this passage that makes any sense is the last one: “Sub-optimal levels of disclosure translate into inefficiencies in participants’ choices of investment products and services.” Yeah, no kidding. But the Department of Labor merely scratches it head here and doesn’t even attempt to answer either its initial question (why doesn’t the market provide transparent fee disclosure to plan participants) or this one. In fact, the root answer to both is the same: plan service providers have no duty under ERISA to disclose to plan sponsors the costs associated with the investment options in retirement plans, despite the GAO’s repeated urging that the Congress amend ERISA to fix the “disconnect” that I’ve described previously in this column. The Department of Labor could have done something to help correct that disconnect, but it punted and failed to do so.
Because the Department of Labor’s “anti-participant rule” fails to require plan sponsors to make meaningful cost disclosures to plan participants, participants are still left in the dark about the harmful total economic impact on their account balances made by the Rube Goldberg-like business models followed by many plan providers.
Another aspect of the “anti-participant rule” is that it’s being touted as a major “reform” when in fact it’s really the opposite: a decided setback for meaningful cost disclosure. Those with a self interest in keeping plan sponsors (not to mention plan participants) in the dark about costs so that they can continue their system of extracting excess compensation from participant accounts get to strut about and assume the mantle of “reformer.” Talk about a Bizarro universe in which plan participants (and plan sponsors) continue to be harmed and plan service providers continue to thrive at their expense. This is the very antithesis of ERISA and its “sole interest” and “exclusive purpose” rules which are concerned with no one else other than plan participants (and their beneficiaries).
All this could have been avoided, of course, by having the Department of Labor focus first on the duties that plan sponsors are charged with under ERISA and making it mandatory for plan providers to provide full and complete cost disclosures to plan sponsors in a uniform format. That’s really the only way for sponsors to understand costs effectively in order to meet their reasonableness duty so that they can then disclose such costs meaningfully to their participants. Disclosure in this context must mean that all relevant information is conveyed and that it’s understandable to the average person.
Alas, this nonsense wasn’t avoided for a number of reasons. One is that the plan sponsors that comprise the membership of certain interest groups whose representatives testified before the House education and labor committee and the Department of Labor don’t want to have the costs associated with the plans they sponsor to be disclosed clearly to their employees. Clear and complete disclosure would reveal, in many cases, how much these companies are passing on such costs to their participants.
It’s easy to understand why such companies would not want to have the hidden–and therefore high costs–associated with the plans they sponsor disclosed to their participants. But the answer to that is not to perpetuate this game which, by the way, is played even by many of the Fortune 500 companies that continue to pack their retirement plans with retail- priced investment options.
The answer, rather, for any plan sponsor is to demand that plan service providers provide them with full and complete disclosure of the costs associated with the investment options offered in their plan while also insisting that such options be institutionally priced (i.e., low cost) and diversified broadly. It is possible–even in the face of the Department of Labor’s “anti-participant rule”–to avoid the high costs and poor diversification inherent in the investment products offered by far too many of the current crop of plan providers.
Another reason why the nonsense of the “anti-participant rule” will become final is that certain interest groups whose representatives testified before the House education and labor committee and the Department of Labor comprise not only plan sponsor employers but also mutual fund companies, insurance companies, and other large financial-services firms. The interest groups whose memberships are dominated by these large firms mirror the views of such firms rather than those of plan participants and the employers that owe fiduciary duties to them in their retirement plans. That explains why these groups are motivated to oppose any proposed regulations or legislation that would harm the interests of their members, such as full and complete disclosure of costs to plan sponsors and plan participants–even if such proposals would be beneficial to sponsors and participants.
Where does all this leave plan participants? Answer: the “anti-participant rule” leaves plan participants out in the cold with no entity–especially not the Department of Labor–having an interest in championing their interests. This is directly contrary to the sole interest and exclusive purpose rules of ERISA section 404(a)(1)(A).
Given the reality of the “anti-participant rule,” it would behoove the Congress to pass H.R. 3185 in 2009. Then after its passage by the Senate, either the reform candidate–John McCain–or the change candidate–Barack Obama–should sign it into law.
W. Scott Simon is an expert on the Uniform Prudent Investor Act, Restatement (Third) of Trusts and Title I of ERISA. He provides services as a consultant and expert witness on fiduciary investment issues in depositions, arbitrations and trials as well as in written opinions. Simon is the author of two books including The Prudent Investor Act: A Guide to Understanding. He is a member of the State Bar of California, a Certified Financial Planner® and an Accredited Investment Fiduciary Analyst™. The author’s views expressed in this article do not necessarily reflect the views of Morningstar.