W. Scott Simon
The U.S. Department of Labor recently requested another round of comments on its “Proposed Rule on Fiduciary Requirements for Disclosure in Participant-Directed Individual Account Plans.” Ninety-one comments were received, 49 of which were from individuals such as participants in retirement plans, owners of small companies, company CFOs, and HR people, including one comment signed by three senators and two congressmen.
The other 41 comments (one commenter submitted two comments) came from mutual fund companies, insurance companies, consultants, law firms, and special-interest groups representing insurance companies, banks, mutual fund companies, and other vendors servicing qualified retirement plans such as 401(k) plans. The fact that there were 41 entities sending the Department of Labor comments on the proposed rule but only 49 individuals–out of millions and millions of participants in qualified retirement plans–serves as a useful starting point for what advisors need to know about the process that has resulted in proposed rule §2550.404a-5, otherwise known as the “anti-participant rule.”
A few particularly illuminating comments made by individuals are instructive. One such individual noted: “Since when can someone else take money away from me in the form of investment management fees and not tell me about it? Is this America or communist Russia?” In arguing for full and complete disclosure of all costs, another commenter noted: “we should not have to dig . through multiple documents and Summary Plan Descriptions [to find such costs]. . Failure to show the information up front in clear [E]nglish tells me I’m being fleeced.”
One commenter, however, captures in one sentence the fundamental, underlying reason why a truly robust disclosure rule is much needed: “This is MY money and I should know WHO is making WHAT and HOW MUCH off my account!”
These brief comments are far more useful in defining the key issues of disclosure under discussion than the thousands of words (and 39 tables!) generated by the Department of Labor in the 31-page manifesto it issued in the July 23 Federal Register.
Many of the special-interest groups and the vendors they represent that provide products and services to qualified retirement plans are no doubt quite happy with the “anti-participant rule.” And why shouldn’t they be? That rule allows them to continue hiding their high costs (if these costs weren’t high, they wouldn’t be hidden) from plan sponsors and, in turn, plan participants.
The inescapable result of this: plan sponsors will have no better chance of understanding–much less even knowing about–the total economic impact that the costs associated with the investment options in their plans will have on participants’ account balances. This generates yet another result: plan participants will have no better chance of understanding “WHO is making WHAT and HOW MUCH off my account!”
What’s worse about the “anti-participant rule” is that plan sponsors will be suckered into thinking that since the disclosure requirements in it have now been “reformed,” they can rest assured that those providing products and services to their plans will give them the straight skinny about costs. Well, now, that’s a bit complicated. Footnote 7 in the Preamble to the Department of Labor’s 31-page manifesto reads: “.fiduciaries shall not be liable for their reasonable and good faith reliance on information furnished by their service providers with respect to those disclosures [relating to investment-related information to be provided automatically].”
On its face, Footnote 7 appears to be a sound provision: plan sponsor fiduciaries will be protected from participant lawsuits if they have a good faith reliance on the information they receive from plan providers. This provision, however, also protects plan providers that will be allowed under the “anti-participant rule” to continue using a Rube Goldberg-like information delivery system rampant in the retirement plan industry that hides high costs. This perpetuates the distribution of outright false cost information to plan sponsors and ultimately to plan participants. This is little more than classic garbage-in, garbage out.
The provision in this footnote gives plan sponsors and plan providers the best of both worlds: neither is responsible and neither is hurt. The only ones hurt by this scheme are plan participants–the only entities that must be protected by the “sole interest” and “exclusive purpose” rules of ERISA section 401(a)(1)(A). The wolves–certain providers of plan service and products–remain free to raid the plan participant chicken coop because the Department of Labor farmers that were supposed to protect the chickens were asleep on the job. (Some interest groups that represent these providers have the audacity to say that they represent the interests of plan participants as well.)
The Department of Labor’s suggested model chart offers plan participants little hope of getting a handle on determining the costs of the investment options offered by their retirement plans. The way in which costs are “disclosed” in this chart is a confusing mish-mash of percentages and dollars pertaining to different time periods that must be gleaned from a number of different documents and Web sites that may–or may not–be provided and if they are, may–or may not–have the information sought. If that weren’t bad enough, many plan participants will be left scratching their heads wondering about the retirement plan industry-speak that pervades this model chart. Those commenting on the proposed rule have made clear to the Department of Labor what it must do to avoid such head scratching: “we should not have to dig . through multiple documents and Summary Plan Descriptions [to find such costs]. . Failure to show the information up front in clear [E]nglish tells me I’m being fleeced.”
How was it possible for the Department of Labor to move forward with the “anti-participant rule” in its present form when it knows darn well that its suggested format for disclosing costs in the model chart will be wholly inadequate to the needs of plan participants? Good grief, the Department of Labor itself states in Footnote 13 of its manifesto: “This estimate of excess expense does not take into account less visible expenses such as mutual funds’ internal transaction costs (including explicit brokerage commissions and implicit trading costs), which are sometimes larger than funds’ expense ratios.” (My emphasis; this italicized text, to be more accurate, in my opinion should read “which are often larger than funds’ expense ratios.”)
What this means is that internal transaction costs that are “invisible” are often larger than mutual fund expense ratios which are “visible.” Yet the Department of Labor is not requiring plan providers to account for and disclose invisible costs at all, just visible costs–and not even all of them at that. One commenter–the American Association of Retired Persons–has set forth a much improved model chart in its comment to the Department of Labor. This gross/net chart is based on the chart format already submitted to the Department of Labor by the noted independent fiduciary Matthew Hutcheson.
But even the AARP chart fails to account for invisible costs, which, again, the Department of Labor itself understands are often larger in magnitude than visible costs. That’s why Hutcheson’s gross/net format for capturing and disclosing all costs, even the oftentimes significant invisible costs, is head and shoulders above anything else that I’ve seen submitted to the Department of Labor. There’s been fierce opposition to Hutcheson’s suggested cost disclosure format because it’s a clear and comprehensive exposure of all the costs impacting participant accounts. What these critics don’t like about this format is that it invites easy cost comparison shopping. That would promote competition among plan providers and help bring down costs. That would be wonderful for plan participants but oh so bad for certain plan providers.
Piled on the current system of nondisclosure of invisible costs is the destructive game of active investing (predominant in the investment industry) that plan providers love to play. Not destructive to plan providers, mind you; on the contrary, it’s very lucrative for them. This game is destructive, however, to the account balances of plan participants because of the generally high (and unnecessary) costs of the actively invested investment options that plan providers shovel in to, say, 401(k) plans.
Most passively invested investment options (i.e., index funds and asset-class funds) are much less expensive than actively managed investment options. Requiring plan providers to give plan sponsors (and ultimately plan participants) accurate information about the total economic impact that costs have on the account balances of plan participants will result in enhanced competition among plan service providers and result in a greater number of less costly passively invested investment options. As the Department of Labor notes in its manifesto: “Downward pressure on fees will . reflect a diminution of the market for services whose costs exceeds their benefits (such as movement from more active to more passive investment management in cases where the latter is more efficient).”
(The end of the preceding sentence, “where the latter is more efficient,” refers to a common misconception. In fact, passive investing is superior to active investing even in inefficient financial markets because the high costs of active investing in such markets usually swamp any investment skill that active managers may possess. Please read my March 2005 column for a more complete treatment of this.)
Our armed forces around the world are engaged in serious work. In sharp contrast to that fact is the specter of the Department of Labor and certain providers of products and services to retirement plans and the special interest groups which represent them acting out a charade over the last few years on the Department of Labor 408(b)(2) cost disclosure project. That game is not serious work. Sad to say, the Department of Labor–and ultimately, of course, plan participants–in my opinion simply got mugged by these providers and groups, and Exhibit A is the “anti-participant rule”.
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.