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This report was produced by the Advisory Council on Employee Welfare and
Pension Benefit Plans, which was created by ERISA to provide advice to the
Secretary of Labor. The contents of this report do not necessarily
represent the position of the Department of Labor.
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November 10, 2004
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The working group on fee and related disclosures to participants(1) framed the issue for study as
follows:
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Description
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This working group is going to study fee and related
disclosures to participants in defined contribution plans that relate to
investment decisions and retirement savings. The scope of the study will
encompass both plans that are intended to meet the ERISA(2)
§404(c)
requirements and those that are not intended to meet those requirements.
Existing disclosure requirements within the scope of this study will be
examined. The goal is to assess the adequacy and usefulness of the current
requirements and whether changing the disclosure requirements could help
participants to more effectively manage their retirement savings. Among the
hoped for results are a determination of whether:
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Present fee disclosures to
participants adequately inform participants to enable them to make
rational investment decisions;
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The present division between required
disclosures and disclosures upon request in the §404(c) regulations is
appropriate; and
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New disclosure methods could be
utilized to make compliance less costly and enhance utility for
participants.
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Questions
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What information is typically
available for participants to know and understand the fees and expenses
paid in their defined contribution accounts?
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What information must be disclosed to
participants relating to fees and expenses associated with their defined
contribution accounts in plans subject to ERISA §404(c) and in plans
not subject to ERISA §404(c)?
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What is among the information
presently required to be disclosed under plans subject to ERISA §404(c)
and in plans not subject to ERISA §404(c) that should not have to be
disclosed?
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What additional information should be
subject to required disclosure for both plans subject to ERISA §404(c)
and in plans not subject to ERISA §404(c)?
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What information is available upon
request by participants relating to fees and expenses associated with
their defined contribution accounts in plans subject to ERISA §404(c)
and in plans not subject to ERISA §404(c)?
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Should any of the information that is
available on request be subject to required disclosure?
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Is information readily available, and
presented in a context that is understandable by a typical plan
participant?
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Do disclosures relating to fees and
expenses associated with defined contribution accounts typically use
electronic means of communication? If these means are not typically
utilized, should they be utilized more often?
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Typically, investment returns and
account balances are presented on both a consolidated and individual
account basis for a participant. Is it possible for fees and expenses to
be presented on a consolidated or aggregate basis also, or is it up to
the participant to calculate and aggregate this information in order to
determine the total fees and expenses to which his/her account is
subject?
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Is it possible to develop a prototype
format for presenting usable fee and expense information in a cost
efficient manner?
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The description and questions were given to all of the
witnesses in advance of their testimony. The witnesses were all told that
the questions were merely a starting point to generate thought and
discussion of the issue being studied. The questions were not intended to
limit the parameters of their testimony.
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The working group solicited testimony of witnesses from a
variety different backgrounds. The witnesses and the dates of their
testimony are as follows:
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August 5, 2004
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Louis Campagna, Chief, Division of
Fiduciary Interpretations, Office of Regulations and Interpretations, US
Department of Labor, Washington D.C.
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Mercer Bullard, President and Founder
Fund Democracy, Inc. and Assistant Professor of Law, University of
Mississippi
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Russell K. Ivinjack, Principal, Ennis
Knupp & Associates, Inc.
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September 21, 2004
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Edward Ferrigno, Vice President,
Profit Sharing/401k Council of America
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Dennis Simmons, Principal and Senior
Counsel and Stephen P. Utkus, Principal, both of the Vanguard Group
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Elizabeth Krentzman, General Counsel,
Investment Company Institute
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Bruce Ashton, President, ASPA and
partner of Reish, Luftman, Reicher & Cohen
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Norman P. Stein, Professor of Law,
University of Alabama
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John Kimpel, Senior Vice President and
Deputy General Counsel, Fidelity Investments
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ERISA contains numerous statutory and regulatory disclosures. Disclosure
requirements aimed at identifying investment expenses are relatively few.
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Russell Ivinjack identified general disclosure requirements applicable to
ERISA defined contribution plans that can involve some identification of
plan investment expenses. Most such plans are required to distribute to
participants a summary annual report that identifies total expenses and
benefit payments for the plan year. Additionally, a summary plan description
of the plan’s rules is required and some description of expenses might be
included in that document.
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Louis Campagna’s testimony listed the materials that must be disclosed and
the materials disclosed on request under the ERISA §404(c) regulations. The
testimony of Russell Ivinjack and his handout material also described these
disclosures.
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ERISA §404(c) and the regulations interpreting that provision allow plan
fiduciaries to avoid liability for participant investment decisions if
specified requirements are met.(3)
These requirements include a mandatory
expense disclosure and an expense disclosure that must be made upon request.
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The required or automatic disclosure in this regard is a description of
transaction fees and expenses that affect the value of the participant’s
account. Examples of these expenses are commissions, sales loads, deferred
sales charges and redemption or exchange fees. Expense information can also
be extracted from the investment option prospectus that must be distributed
to the participant after the initial investment. This requirement only
applies to investment options subject to the Securities Act of 1933.
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There are two kinds of investment expense information available on request.
The first is the annual operating expenses that reduce the rate of return of
the investment options. The participant may also request to see these
expenses as a percentage of average net assets. Examples of these expenses
include investment management fees, administrative fees and transactions
costs. The second is information about the value of shares or units in the
investment options, as well as the past and current investment performance
determined net of expenses.
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John Kimple also testified that ERISA §105 requires that participants be
given a statement of their accrued benefits upon demand. He said that this
requires that the account balance of a participant in a defined contribution
plan be provided net of all expenses that reduce the account and that all
such fees be identified on any account statement.
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The working group heard a variety of testimony about the
wealth of information available to plan participants about plan investment
options. Much of this material goes beyond what is legally required to
distribute to participants. A common problem concerned the format in which
much of this information may be presented. Some formats, like a prospectus,
are not user friendly. Additionally, many witnesses noted that the available
information is so dispersed that it takes a determined participant to corral
it all.(4)
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Examples of the available information (which include some
items produced pursuant to legal requirements) are 5500 annual reports;
summary annual reports (SARs); prospectus for plan investments subject to
regulation under the Securities Act of 1933; summary plan descriptions; fund
fact sheets; information on investment option expenses available through the
Employee Benefits Security Administration (EBSA) web page on the Department
of Labor’s (DOL’s) web site;(5) and recordkeeper web sites.
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Scope Of Plans Subject To Consensus Recommendation - The consensus is for additional disclosure of fees in
defined contribution plans that seek the protections of ERISA §404(c). This
makes sense because plan sponsors use §404(c) for protection against
fiduciary liability for participant investment choices, although the plan
sponsor still retains the fiduciary obligation to monitor the funds
available for investment decisions by the participants. Testimony from Louis
Campagna, an attorney with the DOL is consistent with this conclusion. He
testified that ERISA §404(c) “offers a defense for liability for plan
sponsors and other plan fiduciaries if there is an informed choice and
control by the participant with respect to the investment choices available
to them under the plan.” He also testified that plans not intended to meet
the 404(c) requirements operate under the working assumption that the
fiduciary decided to be the party liable for investment choices, “[s]o the
same type of control issues won't be present in those types of plans.”
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This does not minimize the need for disclosure and the
availability of information for participants in defined contribution plans
not subject to §404(c). The sponsors of those plans, however, do not have
any special protection from investment choices that may be allowed to
participants. Therefore, the level of participant disclosure may not be as
acutely needed as it is in the context of §404(c) plans. Nonetheless, we do
not purport to address the general fiduciary duties of sponsors under such
plans as those duties may relate to participant disclosures. That topic is
beyond the scope of this investigation.
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Considerations In Arriving At The Consensus - The working group heard testimony that information on
investment option expenses is important to the health and vitality of plan
participants’ retirement accumulations. Testimony from Professor Mercer
Bullard and from Stephen Utkus indicated that while future investment
returns are unpredictable and beyond a participant’s control, investment
expenses are known.
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The working group agrees that disclosure to participants
of factual information on investment option expenses is, in the abstract,
beneficial. Nonetheless, there are practical constraints on the degree,
quantity and cost of disclosures. A balance must be struck between the
desire for complete disclosure and the utility of additional disclosure.
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Additionally, a balance must be struck between what can
reasonably be expected of small plan sponsors and the potential capabilities
of larger plan sponsors. The working group wants to avoid a rule that is so
burdensome that it discourages the adoption and maintenance of defined
contribution plans. Section 401(k) plans in particular have become popular
and convenient investment vehicles for the US workforce. Disclosure rules
should not be so onerous that they impede this popular and useful savings
vehicle.Finally, the fee disclosure rules should be user friendly. The
disclosures must be in an easy to read format that provides pertinent
information for the investment decision. The disclosures must be easy to
read and understand.(6)
They must also be presented in a context of other
investment information typically utilized by investors to make investment
decisions. One item of information cannot be presented in a vacuum and fees
must be presented with other information about the investment option.
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Finally, the fee disclosure rules should be user friendly. The disclosures must be in an easy to read format that provides pertinent information for the investment decision.
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Recommendation - The working group recognizes that providing actual fee
information for a particular participant’s account over a stated period of
time is not justified at this time by the cost of providing that
information. Given the current state of technology and recordkeeping
practices, it is a complex and costly procedure to sum the total costs to a
particular participant’s account because of investment changes over time.(7)
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Nonetheless, the working group saw examples of investment
statements showing the expense of each investment option expressed as a
ratio for each fund in which a participant was invested as of the date of
the statement. The working group believes that this is pertinent information
that is helpful in making the investment decision. This information can also
be presented in an understandable format.
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One example was in materials distributed in connection
with Russell Ivinjack’s testimony. It consisted of a table having the
following information going across the page: fund name, fund type,
objective/strategy, risk level and expense ratio. Another example was in
materials distributed by Dennis Simmons and Stephen Utkus who were from the
Vanguard Group. The sample all-in fee report and the sample fund fact sheet
are attached as exhibits to this report. The sample all-in fee report is
substantially similar to the DOL Fee Disclosure Form.
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The consensus of the working group results in only minor
suggestions for regulatory improvement. The weakness of the present §404(c)
regulatory framework is in the manner the fee information is made available.
The working group recommends a remedy to this without suggesting drastic
changes to the information that must be provided. The working group,
however, recognizes that different considerations apply to open platform
(also known as open brokerage) options in plans subject to §404(c).
Therefore, the recommendations of the working group do not apply to such
investment options.(8)
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The consensus recommendation is as follows:
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The profile prospectus of each investment option should
be delivered to each employee upon eligibility to participate.(9)
The profile
prospectus is a summary prospectus allowed under Securities and Exchange Act
Rule 498 (see Form N-1A). It has vital investment information that includes
investment expense information. It is logical to require some modicum of
information on the investment options before a participant is asked to
invest his or her money. Some investment fund options are not subject to
regulation by the SEC. For those options, the DOL should require a
disclosure with information substantially similar to the information on the
profile prospectus.(10)
Providing this information prior to the initial
investment decision should eliminate the need to automatically provide a
full prospectus or other information concerning the particular investment
options elected immediately after the investment options are elected. A
participant would still be able to request such materials.
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An educational requirement would be a corollary to the
recommendation in item 1. Participants must be given materials (like a
glossary) that explain the meaning of the terms used in the profile
prospectus (or other like document) coincident with the delivery of the
profile prospectus. This explanation would include a description of an
expense ratio and what it means to have the investment expenses of an
investment option expressed as a ratio. Included in this would be a
mathematical example demonstrating the calculation necessary to
approximately determine the expenses that apply to a particular participant’s
account investments as of a particular date.
Account and investment recordkeepers should be encouraged
to develop internet web sites where participants can research information
about plan investment options and review information about their own
investment choices. Additionally, these recordkeepers should be encouraged
to develop web-based tools for participants to calculate alternative
investment scenarios that incorporate assumptions about investment expenses
as well as rates of return. Nonetheless, it is not intended that the
suggestions in this paragraph be made into requirements.
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To the extent that an annual statement is provided by the
recordkeeper, the statement must provide the expenses of each investment
option expressed as a ratio along with other information provided about the
investment options.(11)
There must also be an identification of the investment
expenses that are paid entirely or in part by the plan sponsor. The
investment expenses do not include other expenses for general plan
maintenance paid by the plan sponsor, including, but not limited to, legal
expenses, consulting expenses and accounting expenses. If such investment
expenses were paid in part by the plan sponsor the portion so paid would be
identified.
Any new requirement implemented under this item 3 should
have a delayed effective date as applied to small and medium sized plans,
based on the number of participants. New requirements like those described
in this item could be more costly to implement for such plans than for large
plans. Defining what a small to medium size plan is for these purposes
should err on the high side. Perhaps plans covering fewer than 500
participants would come within this classification. Delaying the application
would likely allow service providers time to design necessary systems to
provide the contemplated disclosures in a cost effective manner for such
sponsors.
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The DOL should provide a sample model disclosure format
that is available on its web site. This would be a helpful addition to
existing tools already provided on its web site for understanding expenses
both from the perspective of a participant and a plan sponsor.
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Summary of Testimony of Louis Campagna
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Section 404(c) is the starting point for ERISA fee and related disclosure
requirements for defined contribution plans. To come within the protections
of 404 (c), participants must have investment control and must have
information sufficient to enable them to make informed investment decisions.
To accomplish this goal, there are information disclosure requirements. Some
are automatic and some are upon request (or the plan sponsor can go ahead
and provide some or all of the materials that are available upon request).
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Automatic disclosure includes information fundamental to all participants.
The requirements are intended to be flexible enough to respond to different
plan designs and numbers of participants. The requirements should not be a
burden. Automatic disclosure requirements include: with respect to
investments, description of investment alternatives and their investment
objectives, risk-return characteristics, the nature of assets,
identification of fund managers, how to give investment instructions and any
limits on those (e.g., transfer restrictions); with respect to fees and
related items, fees, commissions, sales loads and deferred sales charges,
exchange fees, and redemption fees must be disclosed (generally transaction
related fees). The disclosures can be part of a prospectus; they needn’t
be in a separate document. The prospectus can be given either immediately
before or immediately after the first investment in a plan investment
alternative. In September, 2003, the DOL issued an Advisory Opinion ruling
that a mutual fund profile prospectus, as defined by the SEC, could be used
instead of a prospectus. A profile is a summary of the prospectus –
shorter, clearer, simple and easier to understand. He said that the profile
prospectus was “designed for participants and it should be helpful in this
regard with respect to disclosure information to the participants.”
Nonetheless, if the full prospectus was the most recent prospectus available
to the plan then that still had to be used to satisfy the requirement.
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Plans that charge brokerage fees, or charge for loans or other investment
instructions, must provide periodic information regarding these fees.
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On request information includes for each investment alternative the latest
information on annual operating expenses that reduce the rate of return
(e.g., management fees), the average amount, information on past and current
performance net of expenses on a reasonable and consistent basis, and the
value of shares. Only information and documents the plan already has need to
be provided, and the plan can limit the number of times and frequency of
such requests.
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For non-404(c) plans, only general disclosures are required – SPD, summary
annual reports. Communications need not mirror 404(c) communications.
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In choosing the funds menu, the plan fiduciary needs to examine the fees,
which must be at a reasonable level given the services and their quality. In
the 1997 Advisory Opinion (the “Frost Opinion”), it was stated that
compensation to a service provider needs to be reasonable taking into
account services provided as well as other compensation the service provider
receives such as from asset fees.
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In 2002, the “Electronic Communication Regulation” addressed getting
information to plan participants via electronic means and provides a safe
harbor to use electronic media where participants have electronic access at
work or beyond. In 2004, the DOL updated its booklet on fees of which to be
aware. Also, there is a worksheet on the DOL web site for 401(k) plans to use
for comparison shopping for mutual funds.
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During questioning, Mr. Campagna noted the plan fiduciary can make someone
else the agent for the delivery of information. Investment fees are not
required to be displayed in any particular way to facilitate comparison
among investment choices, other than as a percentage of assets. The
comparison of fees among potential vendors is part of the plan fiduciary’s
role in choosing the investment menu. He also noted that there is no
requirement to vary the communication to adapt to the literacy level of
participants.
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Summary of Testimony of Mercer Bullard
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Professor Bullard testified that ERISA was never set up
as an investment statute. This committee is in a good position to consider
the basis for government intervention in this area and the economics of
government intervention. He believes there is a role for government
intervention in this area.
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Excessive fees are one area where government intervention
can be justified. The SEC has the authority to bring cases on excessive fees
but never has done so. Nor does Professor Bullard believe the DOL has ever
brought such a case.
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Another justification for government intervention is that
investors are not very efficient at finding and using the information they
need. Required fee disclosure would promote competition. The mutual fund
industry is a good example of the effectiveness of competition – the fee
table is the reason for this. Fees have dropped in recent years and
Professor Bullard attributes the drop to disclosure. In the end, this
disclosure enhances personal freedom.
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Therefore, this working group should ask the following
specific questions that neither Congress nor the SEC asks.
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How are 401(k) participants’
investments performing?
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Do they pay more in fees than other
investors pay?
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Professor Bullard speculates that participants do pay
higher fees than other investors because fees are less transparent in
qualified plans. He also believes that 401(k) participants’ investments
perform better than the investments of individuals outside of 401(k) plans.
He attributes this to the fact that 401(k) investors trade less often than
other investors partially because their objectives are long-term and
partially because of inertia.
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Mutual funds are required to disclose their fees in a fee
table in the prospectus. It is important that fees be disclosed as a
percentage of assets.
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The mutual fund fee table divides the costs of investing
into two categories: shareholder fees and operating expenses.
Shareholder fees are based on the shareholder’s particular account. These
include distribution fees such as front-end and back-end sales charges,
which are paid to the fund’s underwriter and the shareholder’s broker,
and redemption fees, which are paid to the fund to compensate the fund
primarily for the cost of buying and selling portfolio securities and
typically apply only to short-term holdings. There also are other
shareholder fees.
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The term ‘operating expenses’ is somewhat of a
misnomer, as some of these fees are actually used not for operating the
fund, but for distributing its shares. As already stated, operating expenses
include 12b-1 fees, which are used primarily to compensate the shareholder’s
broker for distribution services. Part of the management fee also may be
used to compensate brokers for distribution services. Operating expenses are
also arguably mislabeled because they do not include portfolio transaction
costs.
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Professor Bullard believes that ERISA regulation is ahead
of the SEC by permitting the fund profile to be the required disclosure
document. But, the profile should be required to be provided prior to making
the investment decision. Nor are updates of information such as the
prospectus required in ERISA as it must be under the securities laws. This
means that decisions may be being made on stale information.
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Professor Bullard believes there are problems with the
fee tables. Those issues include:
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Lack of disclosure on how much brokers
are being paid. Professor Bullard believes that legislation will be
passed that will be important. Outside the qualified plan context, there
are efforts by Congress and the SEC to ensure that the complex fee
payments will be disclosed – and there are efforts to bring mutual
fund disclosures up-to-date to be more equivalent to disclosures in
other areas. Note: these are “push” documents. The key is to force
disclosure to people who would not otherwise seek this information.
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In 2003 the SEC declined to require
disclosure on mutual fund quarterly statements. Professor Bullard
expects this will be revised and may become a requirement. The primary
argument by the industry is that this would be very expensive but one
company has decided to do it voluntarily. Professor Bullard believes
this disclosure would be very useful because it would reach people who
read nothing except their account statements.
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The SEC has never supported
comparative fee disclosure. Professor Bullard believes this would
promote competition.
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The expense ratio does not include
portfolio transactions costs. Consumer groups would like this statistic
to be more comprehensive especially in costs related to the fund’s
trading decisions. This is being considered by the SEC and it is likely
that there will be some increased disclosure here.
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Professor Bullard maintained that the ERISA statute does
not require disclosure of information. Instead, there is just the 404(c) “carrot
and stick” that requires some disclosure to get fiduciary protection for
the plan and its fiduciaries. Professor Bullard believes the existing
disclosure requirements under 404(c) are not very effective. And, he
believes the exchange of fiduciary protection for disclosure to be very
unusual from the perspective of securities regulation. Although he did
acknowledge that the reason for this may be that the plan is the actual
customer and not the participant.
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Making information available on request is a good thing
but that is not where it is important to protect investors as consumers. The
key is to ensure that people who are less engaged in the process pay less
for their retirement investments.
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Q: How have you been estimating costs on turnover?
A: Numerous academics have been doing this using a
variety of techniques. It is somewhat subjective and that is one of the
objections made by the investment community. The primary objection Professor
Bullard has to the current reporting is that information on this would
change the behavior of a number of funds. There is a separate question as to
which regulators should intervene. There is an obligation to determine how
the government can efficiently regulate. He believes the DOL has a stronger
obligation to look at regulatory intervention because of the tax-favored
nature of qualified plans, etc.
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Q: On point of sale requirements, who is the buyer?
Who should be required to get POS disclosures?
A: In the 401(k) context, the profile should be provided
prior to the investment decision. The problem for plans is different for
plans because of the goal of plans to participate. If the disclosure
decreases participation, then no disclosure would be preferable. Disclosure
should be tested. In this context the “before” and “after”
distinction is less important.
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Q: We are moving into a more passive situation with
401(k) plans where employees make fewer investment decisions and stay in
plans after employment termination. How should that affect disclosure?
A: In such a situation, there is a good argument for no
disclosure at all. There are wonderful ideas for automatic investment in
life-cycle funds, etc. but disclosure does not have a role to play. You do
have to regulate the plan provider.
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Q: How much volatility is there in fees and expenses
within a particular fund?
A: Very little. The largest expense is the management fee
and changes to the management contract must be approved by the shareholders.
Some changes are created by voluntary and temporary fee waivers. Across
funds there is a significant range in expense ratios.
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Q: Is it fair to say that the information participants
need exists and takes a form similar to the fee table?
A: Yes. The information could be improved by providing
comparative information but there is a need to consider the costs of
disclosure.
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Q: But, what if the plan has many options? The fee
table might become overwhelming.
A: True but Professor Bullard doesn’t believe that it
makes sense to have more than 10 or 20 mutual funds in the plan. It would
not be feasible to provide comparative fee information for open platform
plans.
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Q: So, should options be limited?
A: Yes, at some point increasing the number of investment
options becomes counterproductive.
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Q: In the example of comparing employer plan costs,
since the costs rely primarily on what the employee chooses for investments,
is that a helpful comparison?
A: No, that is true. But, a 401(k) is an investment
option and it may make sense to compare the ability to invest in 401(k)
plans with other tax-favored investment vehicles.
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Q: The testimony has concentrated on mutual fund
disclosures. To what extent would the disclosures apply to other investment
products?
A: Yes the disclosure obligations we have discussed could
apply to other investment products, but it would require war with the
investment community. There is far less disclosure in other investment
vehicles and it surprises Professor Bullard that employers would use those
vehicles. Optimally employers would require all investment vehicles make
equivalent disclosure.
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Q: Another witness testified about the broad variety
of fees that exist and expressed concerns with how much money some vendors
make. What is your view on this?
A: From an economist’s view, profit is irrelevant.
Instead what matters is the quality that is provided. Courts can’t
determine when profits are “too high” and the ability to profit is at
the heart of capitalism. Professor Bullard believes that disclosure of sub
factors of fees, if disclosed at all, should be disclosed in a comparative
way such as in a pie chart.
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Q: John Templeton’s argument was that his strategies
were so successful because high fund fees deterred investors from taking
short term views and moving money quickly. Is there a conflict of interest
in banks and do bank customers choose bank services to protect other
benefits?
A: There is not a great deal of conflict in this area.
This is not necessarily the type of conflict that raises to the level of
required disclosure.
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Q: Have you looked at the fees associated with the
employer stock holdings?
A: I’m not aware of this. Council discussion indicated
that there are no management fees permitted. On the fee issue employer stock
is very efficient.
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Q: Can you reconcile the lack of concern with profits
vs. interest in how much money is going into a broker’s pocket?
A: Those are separate matters. The need is to understand
what the incentives are for the broker to push one fund over another. The
best example is the revenue sharing payments that used to be made to
brokers. This allegedly may affect a broker’s recommendations.
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Q: Are there studies indicating that 401(k) plan
participants would make a decision based on fees vs. returns?
A: Not aware of studies within the 401(k) context but
there are studies indicating that investors do sometimes make decisions
based on fees. Council discussion among members indicated that in plans most
decisions are made on returns. Professor Bullard stated that costs are a
better predictor of returns than past returns. As a general matter plan
participants are better at choosing investments than other mutual fund
investors.
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Q: Follow up re: statement that lower costs correlate
with higher returns.
A: That is true in large cap funds. In response to a
question about small cap and international funds, Professor Bullard
indicated that it becomes less true in those funds.
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Q: Follow-up question to why plan participants do
better than other mutual fund investors.
A: That occurs because plan participants trade less. In
part that is due to inertia.
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Q: Re: POS document, what should it look like?
A: It should be a one pager and the focus is likely to be
core information on fees.
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Summary of Testimony of Russell Ivinjack
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Mr. Ivinjack discussed his background and that of his
firm. Turning to his presentation materials, he discussed the importance of
fee disclosure. He indicated that currently there is a good level of fee
disclosure in defined contribution plans, but that the information presented
is not useful to either plan sponsors or participants. Neither employees nor
employers know the true costs they pay each year.
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Mr. Ivinjack discussed the amount of information
available to participants – SPD’s, fund fact sheets, prospectuses, etc.,
and indicates that it is possibly too much information. He then proceeded to
review the costs that are currently required to be disclosed by Section
404(c). He discussed that the requirements for non-404(c) plans are not as
stringent. He indicated that the disclosures for plans that are not 404(c)
plans present fees on an aggregate basis, and not broken out in terms of
explicit costs.
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He recommended that some context should be provided with
the fee disclosure. For instance, fees relative to an industry average or
peer average would be helpful. However, creating a peer or industry average
presents some problems of its own. If you use all relevant information out
there to create a universe, it may not be relevant. He indicated that
information presented by asset category would be most helpful. For example,
equity index fund costs should be compared to other index fund costs, not to
active management.
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Mr. Ivinjack indicated that each participant should be
told explicitly what their costs are on an annual basis in terms of dollars
as well as on a percentage basis. Mr. Ivinjack indicated, as other witnesses
had, that providing a snapshot point in time annual cost estimate was
adequate. Mr. Ivinjack indicated that the industry can do a much better job
of helping participants understand what the costs are and how that weighs
into their investment decisions.
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Summary of Testimony of Edward Ferrigno
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Ed Ferrigno spoke on behalf of the PSCA. Mr. Ferrigno
indicated that although participants need to be aware of the fees paid
through their plan investments, ERISA’s fiduciary requirement that any
fees paid with plan assets be reasonable reduces the risk of improper fees
being imposed on participants.
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Mr. Ferrigno stated that PSCA supports improving the information that is
provided in a mutual fund’s prospectus by mandating that additional
expenses which are reported in the fund’s Statement of Additional
Information (SAI) be included in the prospectus. Brokerage fees, which are
usually not included in the expense ratio in the prospectus but are reported
in the SAI, should be included in the prospectus and the fund profile.
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The DOL should determine whether the prospectus information provided on
mutual funds is provided for other types of investments and, if not, the
regulations should be changed to achieve this.
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Mr. Ferrigno stated that the PSCA supports revising 404(c) to require
disclosure of changes in investment costs annually. However, Mr. Ferrigno
cautioned that mandatory fee disclosure could produce unintended results. An
unsophisticated investor could be improperly influenced by relative plan
fees if that investor does not understand what drives fee levels. He
addressed the cost-benefit issues that should accompany any discussion of
enhanced fee disclosure. Mr. Ferrigno also addressed fees not connected with
investment decisions such as trustee fees, recordkeeping fees, etc.
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He stated that PCSA is intrigued by the concept of analyzing and reporting
at the account level on fees not related to investment decisions. He stated
this should be further investigated.
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Summary of Testimony of Dennis Simmons and Stephen Utkus
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The Vanguard Group is the world’s second largest mutual
fund family, and the nation’s second largest provider of investments and
recordkeeping services. Vanguard administers more than $215 billion of
defined contribution plan assets on behalf of more than 3200 plan sponsors
and more than 2.5 million plan participants.
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Vanguard was represented by Dennis Simmons and Stephen P.
Utkus. Mr. Simmons is Senior Counsel in Vanguard’s ERISA Legal Department
and manages Vanguard’s Plan Consulting Group. Mr. Utkus is the director of
Vanguard’s Center for Retirement Research.
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Mr. Utkus testified that retirement plan costs have a
critical influence on retirement savings plan participants. Lower plan costs
lead to higher retirement accumulations and greater security for plan
participants. While plan sponsors and participants cannot control investment
returns or performance, they have some control over the costs they pay for
participating in capital markets through plan investments. Any steps taken
to encourage price competition and reduce fees and expenses charged against
retirement plan accounts directly contribute to the long-term retirement
security of American workers.
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Mr. Utkus provided an illustration of how costs affect
retirement plan savings over a working career. In his illustration, a
participant in a low-cost retirement plan (30 bp annually) would save
$132,000 more over the participant’s working lifetime than a participant
in a medium-cost plan (100 bp annually), and $182,000 more than a
participant in a high-cost plan (130 bp annually).
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Because plan sponsors set the aggregate level of fees and
expenses charged to the plan as a whole and to plan participants, plan
sponsors must take the initiative to obtain competing bids for services and
to negotiate the fees and expenses charged against participants’ plan
accounts. To assist plan sponsors, a public policy goal should be to
encourage greater price transparency and greater price competition at plan
sponsor level.
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Plan participants must understand the costs associated
with each available plan investment options and assess those costs in
relation to other factors and characteristics of the options that are
important to investment decision making. To assist plan participants, a
public policy goal should be to insure that plan participants have full
access to information on the costs of investment options available to them.
This disclosure should be simple to understand and provided in a uniform
manner for all investment options.
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Costs incurred by defined contribution retirement plans
are either flat fees for participant accounts, commonly but not universally
paid by employer, or asset-based fees usually charged against the investment
return of individual participant accounts. Mr. Utkus indicated that there
has been a shift in the last decade away from flat fees to all asset-based
fees, which are less visible to both plan sponsors and plan participants.
This is a harmful development for plan participants because, according to
research cited by Mr. Utkus, investors will go to great lengths to avoid
visible flat fees, but can be oblivious to amount of indirect investment
management fees charged against investment performance. Therefore, enhancing
participants’ and sponsors’ understanding of indirect charges should be
a top priority for enhancing cost disclosures for sponsors and participants.
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Mr. Simmons presented Vanguard’s recommendations for
improving fee and expense disclosures to both plan sponsors and plan
participants. The first recommendation for disclosures to plan sponsors is
that service providers should provide plan sponsors with an all-in fee
expense ratio (as illustrated by an example provided by Vanguard). The
all-in fee expense ratio is a more comprehensive cost measure, and thus is a
more helpful and useful measure. The all-in fee expense ratio includes the
investment related expense ratio for each plan investment plus direct
administrative and recordkeeping charges paid by the plan. The Department of
Labor should encourage plan sponsors to use the all-in fee expense ratio
because:
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It is a simple and effective way to
obtain measure of total cost of plan;
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Evaluating all plan fees is a
fiduciary best practice; and
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It enables the plan sponsor to monitor
trends with respect to total fees paid by plan, which encourages greater
price competition and more cost efficiency.
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Vanguard’s second recommendation for disclosures to
plan sponsors is that the Department should require each investment provider
to deliver to the plan sponsor the investment-related expense ratio for each
investment offered in the plan. The investment-related expense ratio for an
investment includes all fees and expenses taken directly from investment
returns, which reduces plan participant’s return.
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The third Vanguard recommendation for plan sponsor
disclosures is that the investment-related expense ratio for each investment
option should be accompanied by a comparative benchmark, so plan sponsors
can compare the expense ratio of each investment option against an
appropriate industry benchmark.
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With respect to disclosures to plan participants,
Vanguard’s first recommendation is that the Department should require,
under ERISA Section 404(c), that disclosures to plan participants must
include investment-related expenses that indirectly impact a plan
participant’s retirement savings. This disclosure should be in the form of
an expense ratio for each investment option, and should be required to be
provided annually. Presently, the plan sponsor is only required to provide
this information upon request.
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Vanguard’s second recommendation for disclosures to
plan participants is that the Department should require investment expense
ratios disclosed to participants to be accompanied by appropriate
comparative benchmark for other investments in similar asset class.
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Mr. Simmons testified that the third recommendation for
plan participant disclosures is that fund fact sheets should be used as the
main format through which to communicate to plan participants costs and other
aspects of investment options, because the fact sheets are concise, easy to
read summaries of vital investment information.
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Vanguard’s final recommendation for plan participant
disclosures is that the Department should continue to permit and encourage
the use of web sites and other electronic media for delivery of ERISA
disclosures.
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In response to questions from the Working Group, Mr.
Simmons and Mr. Utkus stated that developing the appropriate comparative
benchmarks to be disclosed to plan sponsors and plan participants should not
be a difficult or expensive task for investment providers, because in
general the required information is already available and only needs to be
compiled. They did acknowledge that the comparative benchmarks may be more
helpful to plan sponsors than plan participants, because the plan
participants do not have any control over the investment options offered in
the plan. However, the benchmark provides context to both the plan sponsor
and the plan participants, even if the benchmark is more valuable to
sponsor. They noted that the benchmark may be more valuable to a plan
participant if the plan’s options include multiple options from same
investment class. It was also noted that the benchmark may be more valuable
to a plan participant if the investment-related expenses are expressed as a
dollar value instead of a percentage of assets.
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Mr. Simmons and Mr. Utkus conceded that the Department
may not technically have the authority to require investment providers to
make disclosures to plan sponsors. However, if the Department encourages or
requires plan sponsors to obtain these disclosures, providers will begin
providing the information.
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With respect to the contents of disclosures to plan
participants, it was noted that wrap fees need to be disclosed in addition
to the investment-related expense ratio. However, unless these fees are
stated separately or included in the expense ratio without additional
explanation, the benchmark comparison may be affected. Plan participants
need to know the bottom line of the total fees and expenses charged against
their plan accounts as well as the components of that bottom line.
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Mr. Simmons and Mr. Utkus agreed that it would be
difficult and expensive to tell a plan participant the actual fees that were
netted against the participant’s individual investment return for a
specific period of time. However, it should be simple and inexpensive to
provide estimated fees based on a snapshot of the participant’s account.
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It was noted that plans of different sizes may have
different total expense ratios or investment fees for the same investment
option. This can also complicate the disclosure of an appropriate benchmark.
However, if investment providers are required to provide benchmarks, those
providers will develop the appropriate benchmarks, which will make
appropriate benchmarks available to small plans.
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Summary of Testimony of Elizabeth Krentzman
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Ms. Krentzman indicated that the Investment Company Institute strongly
supported the disclosure of detailed fee information for all plan
alternatives during the DOL hearings on plan fees and expenses, and the
Institute continues to strongly support meaningful disclosure, both to plan
sponsors and to plan participants.
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The marketplace is highly competitive with respect to
fees and expenses. Many fiduciaries choose bundled fee arrangements which
provide a package of administrative, custodial and investment services. In
bundled arrangements, plan providers may receive compensation from the
mutual fund itself through 12b-1 fees, or through revenue sharing where the
fund advisor compensates the service provider from its profits.
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The Institute recommends disclosure to the plan sponsor
of the fees and expenses of all investment options. The Institute also
recommends that the Department require that plan sponsors receive from
prospective service providers information concerning the provider’s
potential receipt of compensation, including revenue sharing. A third
recommendation was for the Department to assemble a task force to assist the
Department in developing a disclosure regime for compensation arrangements.
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Regarding fee disclosures to plan participants, the
Institute recommends that plan participants be provided, upon request, an
investment summary for each investment offered under the plan. The summary
would include fee disclosure via a fee table. A second recommendation is
that participants in 404(c) plans be provided with disclosure comparable to
that provided in a mutual fund profile for all investment options provided
under the plan. The Institute also recommends that electronic reporting
through hyperlinks and e-mail would enhance exposure to participants while
reducing costs for plans and participants.
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Summary of Testimony of Bruce Ashton
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Mr. Ashton indicated that by year-end 2003, an estimated
42 million workers in the U.S. participated in 401(k) plans, holding assets
of $1.9 trillion. Given the significant amount of money in defined
contribution plans, the level of fees incurred by participants is a major
factor in determining whether a participant will ever achieve retirement
security. To illustrate the impact of fees, Mr. Ashton indicated that over a
25 year period, a participant account that bears expenses of 0.5% would
accumulate 28% more retirement income than a similar plan bearing expenses
of 1.5%.
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Mr. Ashton pointed out that fees and expenses are an
inherent and necessary part of the operation of a plan, and that the per
participant cost of operating a plan covering 100,000 participants is less
than the cost of operating a 20 life plan. ASPA believes that full
disclosure of all plan fees and expenses charges against a participant’s
individual account in a defined contribution plan should be provided to each
participant. Mr. Ashton then discussed the various types of fees charged to
participant accounts – third party administration, commissions, wrap fees,
12b-1 fees, recordkeeping, compliance, loan processing and withdrawals.
Costs may be charges as a percent of total plan assets, or as a fixed amount
per participant.
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The current rules relating to the disclosure of plan
related fees and expenses only go so far in disclosing to the plan
participant what he or she is really paying out. ASPA believes that plan
participants should receive full and complete disclosure of all fees and
expenses paid out of plan assets that can be reasonably identified. Further,
this disclosure should be provided in a meaningful and understandable
format. To minimize administrative burdens, the disclosure could be
distributed in conjunction with the plan participants regular year-end
statement. Although specific disclosure of the amount actually charged to a
participant’s account may be preferable, the burden of providing this
individualized information is significant, and providing such information
could have a chilling effect on the creation and maintenance of such plans.
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Mr. Ashton also presented an ASPA recommendation regarding section 404(c)
disclosure, and requested guidance on certain applications of 404(c).
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Summary of Testimony of Norman Stein
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Professor Stein opened his testimony by framing the three
sections of his testimony. The first focuses on the disclosure of fees
charged to participants by vendors providing investment products and
services to the plan. The second focuses on the fiduciary’s responsibility
to choose investment products with competitive fees and to regularly monitor
those products. The items monitored include investment related fees,
non-investment related fees and investment returns. The third section covers
other items including non-investment related fees charged against
participant account balances.
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Professor Stein next told a personal story. In 1987, he
was a visiting professor at the University of Texas. While there, he was
able to contribute to a 403(b) annuity. An insurance salesman from a
prominent company sold him an investment product for this and Professor
Stein contributed $1,000 to it.There was no discussion of fees, but there
was a fee of $30 per year. That fee sometimes exceeded the investment
return. He did not know why he did not ask about fees for this product. He
speculated that he might have thought that his employer would not permit an
investment product to be sold that could be disadvantageous.
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The point of the story was how important the disclosure
of fees can be. Nonetheless, Professor Stein also said that he believes that
many participants lack the investment savvy for fee disclosure to be of much
utility for them.
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Clear and understandable disclosure of fees is still
important. Uniformity of presentation is necessary so that participants have
the same information about all investment options. The disclosure must also
provide examples of how fees affect the rate of return and of how fees can
make it more expensive to move in and out of investment options. He also
points out the DOL does not have expertise in the area of investments. The
SEC does, however, have expertise in this area. Therefore, the DOL should
consult with the SEC when designing rules for these kinds of disclosures.
Nevertheless, the DOL has more expertise in designing the format of such a
disclosure than the SEC, so the DOL should prescribe the format.
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Disclosure will not be enough for all participants.
Participants who lack investment sophistication rely on plan fiduciaries’
judgement to choose investment options with competitive fee structures. This
includes the obligation to monitor the options once chosen.
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Professor Stein acknowledged the challenges of small plan
sponsors with limited resources. Therefore, he urged the DOL to provide
useful tools to help these sponsors by providing appropriate benchmarks
against which they can judge fees.
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Professor Stein also criticized an administration
proposal to exempt certain otherwise conflicted parties from giving
investment advice from the prohibited transaction rules. He questioned the
wisdom of this.
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Professor Stein also criticized DOL Field Assistance
Bulletin 2000-3. That Field Assistance Bulletin (FAB) gave plan fiduciaries
more flexibility to allocate expenses against accounts on either a pro rata
or per capita basis. In particular, he is concerned that pro rata
allocations of non-investment expenses will inhibit the ability of lower
income participants to build retirement savings. Additionally, the FAB would
allow a participant’s QDRO expenses to be allocated against his or her
account. This hits small accounts more significantly than large accounts and
is a reversal of the prior position of the DOL. Nonetheless, if fees are
charged to accounts in ways permitted by this FAB, participants should
receive explicit disclosure with illustrations in the summary plan
description.
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In response to a question, Professor Stein opined that a
balance between cost and benefit of investment expense disclosures could be
struck with an initial disclosure of the expenses with that disclosure
repeated annually. Also in response to a question, he again stated his
opinion that some participants are not capable of making good investment
decisions by themselves.
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Professor Stein elaborated on his objection to being able
to charge QDRO expenses to specific accounts. He opined that such expenses
should be paid by the sponsor as part of the costs associated with the
privilege of sponsoring a plan.
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Summary of Testimony of John Kimpel
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Mr. Kimpel commented that much had been written lately about how 401(k) and
other plan participants are being “ripped off” by the high fees mutual
funds and other providers charge for their services, and that some
commentators suggested that participants do not know what fees they are
paying. The legal standard embedded in ERISA is for the fees to be “reasonable”.
Mr. Kimpel then offered four questions to illustrate the issue:
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Are plan participants (and sponsors) aware of what fees
they are paying?
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What 401(k) plan fees are participants paying?
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What 401(k) plan services are participants receiving?
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Are the 401(k) plan fees a reasonable price to pay for
the services that participants are receiving?
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Mr. Kimpel then discussed the results of an independent study of 401(k) fees
and expenses commissioned in 1997 by the DOL as a result of earlier public
hearings on the issue of 401(k) fees. The DOL responded to the study by
developing a pamphlet for participants, “A Look at 401(k) Plan Fees for
Employees”, and another entitled “A Look at 401(k) Plan Fees for
Employers”. Mr. Kimpel then discussed the SEC rules on fee disclosure for
mutual funds. Mr. Kimpel indicates that participants should be able to look
at available information and calculate the aggregate fees that reduce the
value of his or her account. Mr. Kimpel indicates that the answer to the
first question is that fees are fully disclosed, readily ascertainable, and
easily calculable by any participant who desires to do so.
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The second question asks what plan fees are participants paying. Mr. Kimpel
walked through an approximation of the average fee paid based on an average
account balance, allocated to different investment options as a typical
account would be allocated, and including average recordkeeping and other
administrative fees paid by participants. The approximate fees worked out to
be $320 per year for an average account balance of $55,000, or approximately
0.58% (58 basis points).
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Mr. Kimpel then discussed the services which the participant receives for
this expense, including asset management, administrative services, daily
valuation, transfer agent services, payroll and contribution processing, and
educational services, among others. Mr. Kimpel then discussed the
reasonableness of these fees, comparing the annual expense ($320) to other
expenses in everyday life, such as the cost of a newspaper ($380 per year),
a daily cup of coffee ($350), taking the family to a football game ($320)
etc.
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Mr. Kimpel then indicates that the median participant age at Fidelity is 44
years, and the median compensation is $53,000 per year. The average
participant contributes 7% of pre-tax compensation, and the average
effective employer match adds an additional 3%. This average participant
should have over $720,000 at a retirement age of 65. Mr. Kimpel then present
additional calculations for the average account balance and median
compensation for 44 year olds. Mr. Kimpel concluded his presentation by
asking whether anyone can argue that 58 basis points is an unreasonable fee
given the menu of investment and other services provided to the typical
401(k) participant.
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Exhibits From Vanguard
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Transcripts for the Council's full meetings and working group sessions are available at a cost through the Department of Labor's contracted court reporting service, which is Neal R. Gross and Co., Inc. 1323 Rhode Island Avenue, NW, Washington, DC 20005-3701 at 202.234.4433 or www.nealgross.com.
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The members of the working group on fee and related
disclosures to participants were:
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C. Mark Bongard, Chairperson
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John J. Szczur, Vice Chairperson
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Charles J. Clark
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Lynn L. Franzoi
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Neil Gladstein
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Sherrie E. Grabot
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Timothy W. Knopp
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Mary Maguire
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Dana M. Muir
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Thomas Nyhan
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Antoinette Pilzner
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Judy Weiss
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David L. Wray, ex officio
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R. Todd Gardenhire, ex officio
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Hereinafter referred to as the working
group.
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Meaning the Employee Retirement Income
Security Act of 1974.
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Meeting these requirements does not
eliminate the plan fiduciary’s responsibility to prudently choose and
monitor investment options made available to plan participants.
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John Kimple was a contrarian on this
point. He testified:
We therefore, interpret this requirement [ERISA §105] to require the
identification of any such fee on the participant's statements.
Therefore, by looking at the expense ratios for a plan's investment
options as disclosed in the mutual fund prospectus or the 404(c)
required fund description for investments other than mutual funds,
together with additional fees, if any, assessed against the
participant's account as disclosed in the participant's statement, the
participant should be able to readily calculate the aggregate fees that
reduce the value of his or her account. As a consequence, the expense
ratios for mutual fund and non-mutual fund investments and any
administrative expenses that reduce the value of the participant's
account balance are all currently disclosed to participants in
sufficient detail to allow participants to evaluate the costs they pay
against the services they receive.
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John Kimpel and others in their
testimony spoke favorably about these existing resources on the DOL web
site – A Look at 401(k) Plan Fees for Employees, A Look at 401(k) Plan
Fees for Employers and a fee worksheet.
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In his testimony, Professor Stein
emphasized the need for easily understandable materials because many
participants lack sophistication regarding investments. He also noted
that while he believed that the DOL should work with the SEC to develop
appropriate rules for disclosures, he believed the DOL was the agency
that should prescribe the format because the DOL has more experience
designing materials for employees and plan participants.
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For example, Russell Ivinjack
testified as follows: “It would be too complex to go on a day-by-day
basis, calculate their balances as the market changes, as contributions
go in, to accurately calculate what their exact calculation would be for
that full year.”
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For example, Bruce Ashton testified
that “it would be unfeasible for a plan sponsor to disclose to the
plan participant many of the costs sustained through open brokerage
windows . . .”
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Advisory Opinion 2003-11A allowed a
profile prospectus to be used as a prospectus when it is the most recent
prospectus in the possession of the plan to satisfy the §404(c)
regulatory requirement regarding the delivery of a prospectus. The
Department of Labor has already seen the utility of the profile
prospectus. Professor Bullard spoke favorably of the DOL position in his
testimony by saying “ERISA has actually moved ahead of the SEC in this
area by allowing the profiles . . . to serve in place of the
prospectus.” His criticism was that the DOL does not require the
delivery of the profile before the investment decision. The working
group’s recommendation partially addresses this concern.
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Elizabeth Krentzman’s testimony
noted a gap between the information that may be available for mutual
fund options that are subject to SEC regulation and investment options
that are not. She said that “[w]ithout equivalent information, plan
sponsors may not be able to make meaningful fee comparisons among
investment products.” The working group believes that this observation
applies equally to plan participants, as does Ms. Krentzman as
demonstrated in her second recommendation to the DOL regarding
participant disclosures.
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This is consistent with Edward
Ferrigno’s testimony where he recommended the changes in investment
costs be provided automatically on an annual basis for plans subject to
ERISA §404(c). Dennis Simmons also recommended that this information be
provided on an annual basis.
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