The Night of the Living Dead Retirement Plan Participants

W. Scott Simon


ERISA section 404(a)(1)(A) states that “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.”

The foregoing, one of the most basic fiduciary duties of plan sponsors under ERISA,
requires them to identify and understand plan expenses so that they can determine
whether they’re reasonable. As the U.S. Department of Labor notes, plan sponsors
must “ensure that fees paid to service providers and other expenses of the plan are
reasonable in light of the level and quality of services provided.” (See “A Look at 401
(k) Plan Fees,” Aug. 3, 2007.) This duty obviously requires some degree of specificity
in matching fees paid to service providers and other expenses of the plan to the
products and services they are supposed to pay for. In addition, ERISA section 404(a)
(1)(D) requires, as a matter of retirement plan qualification, that a plan be operated in
accordance with the terms of its plan documents (but only, of course, to the extent
that such terms don’t conflict with ERISA). If products and services provided and
charged to a plan are not required by the terms of the plan or are otherwise
unreasonable in cost, then the plan can be disqualified, resulting in taxation of plan

The Great Disconnect in the ERISA Statutory Scheme

A highly disturbing fact is that many plan sponsors fail to discharge their ERISA section
404(a)(1)(A) duties because they don’t know about–much less understand–the total
economic impact that the hodgepodge of both “visible” costs (e.g., the annual expense
ratio of mutual funds) and “invisible” costs (e.g., the bid-ask spreads of mutual funds)
can have on the account balances of the participants in the plans provided to them by
the sponsors. This failure is caused by a gaping “disconnect” in the ERISA statutory
scheme: non-fiduciary plan providers have no duty to disclose the total economic
impact that these costs can have on plan participants to fiduciary plan sponsors who,
as noted, have the duty to identify and understand such costs with some specificity.

This great disconnect creates a crazy situation which is akin to allowing plan provider
inmates to run the asylum even though plan sponsor wardens clearly have that
responsibility–not to mention personal liability for any failures to meet that
responsibility. The disconnect of allowing non-fiduciary inmates to control fiduciary
wardens creates two immediate problems, both of which could have long-term
consequences for American society.

The first problem is that many plan participants (and their beneficiaries) have way too
much money needlessly deducted from their retirement plan accounts which, as sure
as the morning follows the evening, will net them far less money for retirement. The
end result of that could well be millions of retired participants with plan balances in the
five figures and decades of life expectancy ahead of them wandering America like the
zombies in “The Night of the Living Dead.” Do we, as a nation, really want to keep
allowing the kind of public policy that could lead to such a spectacle?

The second problem is that many plan sponsors are placed in needless legal jeopardy
because they cannot carry out one of their basic ERISA fiduciaries, which is to conduct
a meaningful analysis of the total economic impact that visible and invisible costs have
on the account balances of the participants in the plans they sponsor. This impact is
often unnecessarily far too great in cases where plan providers present plan sponsors
with plans riddled with high and hidden costs. Under the current system, many plan
sponsors are, in effect, unwittingly held hostage by, and are therefore at the mercy of,
those that provide products and services to the plans they sponsor. Some of these
providers, primarily insurance companies and mutual fund companies, show up over
and over alongside plan sponsors as codefendants in lawsuits involving accusations of
retirement plans associated with high and hidden costs. That fact surely isn’t going to
change in the foreseeable future.

Current Attempts to Bridge the Disconnect

H.R. 3185, now winding its way through the House of Representatives, is a legislative
attempt to correct the great disconnect in the ERISA statutory scheme that I have
described. The Department of Labor, in its regulatory attempt to bridge this
disconnect, held a “Hearing on Reasonable Contracts or Arrangements Under Section
408(b)(2) – Fee Disclosure” on March 31 and April 1.

The title of that hearing literally demands that plan providers provide plan sponsors
with a full and fair disclosure of fees; after all, that’s the only way sponsors can
determine whether the contracts or arrangements they have with plan providers are
reasonable. If plan sponsors cannot make that determination, then they have not
prudently discharged their duties to plan participants and their beneficiaries, and that
failure can harm them. Basic ERISA law outright forbids such outcomes.

The Dark Side Likes the Disconnect Just Fine

There are, of course, many groups that have little interest in seeing H.R. 3185 become
law or in having the Department of Labor enact any meaningful regulations. These
groups, comprised of many insurance companies, mutual fund companies and others
benefit directly from keeping plan sponsors in the dark about the total economic
impact that the plans they provide to sponsors have on plan participant account
balances. Depending on the outcome of this tremendous legislative and regulatory
fight, hundreds of billions of dollars will end up either in the pockets of these groups or
in the account balances of plan participants.

The head of one such group typifies how they regard plan participants and their ability
to understand the myriad of costs inherent in their plans: “We don’t want to give
[participants in retirement plans] information [about the total economic impact of
visible and invisible costs] that they can’t explain how all these fee
structures work to them I think is really beyond the [retirement plan]
system.” (Remember what the insurance company vice president cited in this column
last July said: “I’m afraid the revenue-sharing would just confuse people.” Is it
possible that these two are reading from the same talking points? Nah.)

Plan participants may miss the subtlety of this person’s point so he provides a helpful
analogy to keep it simple for these country bumpkins, uh, plan participants: “It’s like a
person who buys a car. They want to know what the price of the car is. They don’t
want to know what the price of the engine is, what the price of the front door handle
is. What they want to know is what’s the total cost.”

This person has analogized the total cost of purchasing a car to the total costs borne
by participants in retirement plans such as 401(k) plans. This analogy, which appears
to be somewhat imprecise (why of course we don’t want to know the cost of each
component of a car but we certainly want to know the car’s “sticker” price), is often
tossed out to the media by those that have no interest in letting the unwashed (e.g.,
dumb plan participants) know about the total economic impact that the plans they
provide to plan sponsors have on the account balances of the unwashed. Many of the
components that comprise this impact are filched from the pockets of the unwashed
(e.g., real flesh-and-blood plan participants) in the dark of night.

Perhaps a more precise analogy would be: what we need to know are the cost
components involved in financing a car (akin to invisible investment costs) plus the
sticker price of the car (akin to visible investment costs)–not the cost of each
component of the car–so that we can know the total cost of the car (invisible and
visible investment costs) and therefore know whether to purchase it. So, yes, I’m in
agreement with this person when he says: “What they want to know is what’s the total

The big problem with all this, of course, is that many insurance companies, mutual
fund companies and others follow business models that profit from the scandalous
obfuscation of the cost components of retirement plans so there’s simply no way to
know “what’s the total cost” unless, of course, an intrepid plan sponsor hires, say, a
moonlighting FBI forensic accountant to ferret them out. Those following these models
actively promote such obfuscation, despite their lame (there’s really no other word for
it) denials.

Bridging the Disconnect With a Simple Yet Comprehensive Cost Matrix

Matt Hutcheson, a well-known independent fiduciary, testified last month at the
Department of Labor hearing, noted previously. He proposed, among other things, that
plan providers provide plan sponsors with a simple yet comprehensive gross-to-net
cost matrix which standardizes disclosure across all kinds of investment products. This
matrix shows gross returns and then net returns with the difference being costs, which
can then be broken down into visible (e.g., an annual expense ratio) and invisible
(e.g., bid-ask spreads) costs. The cost matrix also benchmarks against performance.

Two vitally important goals are accomplished through use of this matrix. Not only can
the total costs of a plan be measured accurately (based on readily available data
already compiled by plan record-keepers; those trying to spook legislators and
regulators by whining about the need to build “costly” and “burdensome” new data-gathering
and generating systems should therefore be ignored), but any opportunity
costs that might have been lost can also be known. This is a simple and very effective
solution to bridging the disconnect–which, of course, is why those with an interest in
preserving that disconnect don’t like it.

With this kind of cost matrix in place, those entities such as a well-known life
insurance company profiled earlier this year in the media would be forced to
acknowledge that the total economic impact on plan participants in a plan they service
is about three times what they claimed initially, once both visible and invisible costs
are taken into account. (For those who want to see this as well as a whole lot of
people who have no idea how much they’re paying for their retirement plans, tune in
to Bloomberg TV on May 8)

There are, of course, those that say invisible costs such as bid-ask spreads and market
impact costs are not hidden at all because their impact is netted out and reflected in
the performance of a fund. That kind of assertion is valid only if gross returns are
known so that they can be compared to net returns for analysis in a proper context.
Hutcheson’s cost matrix does this nicely and will reveal the presence of cost-efficient
or cost-inefficient (and those in between) retirement programs.

This approach is much more sensible than eye-balling a net return and having no idea
how cost-efficiently it was arrived at. Hutcheson’s cost matrix also has the advantage
of keeping retirement plan decision-makers focused on costs, which can be controlled,
rather than eye-balling returns which are uncontrollable since they’re nothing more
than random variables subject to uncertainty (indeed, nobody on this Earth can know-
-fer sure, fer sure–what the price of a particular asset class, mutual fund or individual
stock will be one year or one month from now, much less one week from now).

A plan provider focused on the extraordinary importance of the total economic impact
that visible and invisible costs can have on the account balances of plan participants
brings far, far greater value to both plan participants and plan sponsors than many,
many of those that comprise the current crop of providers. This kind of provider can
make available to a plan sponsor (and, in turn, to plan participants) a high quality,
institutional level retirement plan that features sophisticated, broadly diversified model
portfolios with a total economic impact on participants of 1% or less (and a slightly
higher impact for plans with $10 million or less) per year. The all-too-common
alternatives provided by the dark side are low quality, retail level retirement plans
featuring an unhealthy smorgasbord of poorly diversified investment option leftovers
with a total economic impact on participants of 3%-4% (or even 5%) per year. That
seemingly small 2%-3% (or even 4%) annual differential–which demonstrates to us
yet again that investing is a game of inches, not of yards–can mean a very
comfortable retirement or one spent wandering around like a zombie in some bad

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.

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