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May 13, 2004
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Thank you, Steve [Saxon] for that kind introduction. I’m pleased to be
here today at SPARK’s National Conference. I also want to commend you,
Steve, and your colleagues for the key role the SPARK Institute has played
in protecting the interests of plan participants and beneficiaries. Your
efforts have been critical to the education of key players on the Hill and
in the Administration on the impact of current events upon the retirement
services industry. Your message is timely and cautionary: Policy makers must
respond wisely and responsibly.
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I also commend the Institute for the excellent job it does keeping your
members “in the know.” This conference is just one example of that.
Another is your 2004 Marketplace Update. The Update included an extremely
upbeat assessment of the pension and 401(k) market.
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I was pleased to see that, based on your most recent data, after three
difficult years, total assets in retirement plans -- including DB, DC, and
IRAs -- rose 20 percent last year to nearly 12 trillion. And total funds in
DC vehicles climbed 22 percent to $3.9 trillion in 2003. This is good news
indeed for Americans seeking a secure retirement.
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Today, I ‘d like to address some of the issues that are roiling the mutual
fund industry, such as late trading, market timing, pay to play conflicts,
and issues surrounding the level and appropriateness of fees. I also want to
touch on the President’s efforts to preserve and strengthen the choices of
participants and beneficiaries through the recently enacted pension funding
legislation and his 401(k) reform plan.
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Your challenges are great -- the market place is demanding, ERISA is
complicated, and there is a constant drumbeat of publicity about wrongdoing.
But your presence here today is a sign of your efforts to make the right
decisions on behalf of your clients and the participants and beneficiaries
for whom they are responsible.
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My goal today is to provide some insight into the Department’s role and to
offer you a better understanding of the implications of ERISA. Ideally, this
will make your professional lives, if not easier, at least a little bit more
manageable.
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I know the allegations of wrongdoing in the mutual fund industry – and the
legislative and regulatory response they have set off – are of interest to
you.
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Clearly, problems in mutual funds and collective trusts are problems for
retirement plans – problems that we at the Labor Department must address.
Investor trust and confidence have been shaken but there is an opportunity
to restore it. To do so, the government must respond with strong but
sensible regulation. And plan fiduciaries and service providers are
understandably concerned about how they should react to the current turmoil
in the retirement services industry.
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While the SEC focuses on securities fraud cases, DOL’s role is to enforce
the provisions of ERISA regarding the mishandling of retirement plan assets.
The Department acts through the Employee Benefits Security Administration,
or EBSA. EBSA doesn’t have direct authority over mutual funds because,
under ERISA, the assets of a mutual fund are not “plan assets.” However,
affiliates of the mutual fund may act as fiduciaries to retirement plans,
bringing them under our jurisdiction. And, ERISA-covered pension plans, and
the workers and retirees who participate in them, are significant investors
in mutual funds.
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In addition, common and collective trusts sponsored by banks and other
institutions do not have the same statutory exception in ERISA. They do hold
plan assets and thus are directly subject to ERISA’s fiduciary rules.
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Anyone who exercises discretionary authority or control over the management
of a plan or its assets, or gives investment advice for a fee, is a
fiduciary under ERISA and must act prudently and solely in the interests of
the plan’s participants and for the exclusive purpose of providing
promised benefits. Plan sponsors, brokers, investment managers, and advisors
are all potentially subject to ERISA’s fiduciary rules if they meet this
test.
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What is the practical implication of being a fiduciary under ERISA? Simply
put, plan fiduciaries must act thoughtfully and undertake a process to
determine what, if any, action they should take to protect plan
participants.
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On February 18, the Department issued guidance to assist fiduciaries in
determining whether plan investments in mutual funds and other pooled
investment vehicles are, or continue to be, appropriate for their plan. The
guidance also addressed steps that plan fiduciaries might take to limit the
potential for market timing in their plans. For those who may not have had a
chance to read it, I’d like to take a moment to summarize several of the
key points from this guidance. (And, I’d suggest you take the time to
review it in its entirety when you get home.)
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As significant investors in mutual funds and collective trusts, plan
fiduciaries, understandably, are concerned about the impact of reported late
trading and market-timing abuses on their plans and the steps that should be
taken to protect the interests of their plans’ participants and
beneficiaries.
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Although investors generally could not anticipate the late trading and
market-timing problems identified by Federal and state regulators, plan
fiduciaries nonetheless are now faced with the difficult task of assessing
the impact of these problems on their plans’ investments and on investment
options made available to the plans’ participants and beneficiaries.
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As fiduciaries conduct their review, it is important that they remember that
ERISA requires that they discharge their duties prudently. The exercise of
prudence in this context requires a careful, deliberative process.
Fiduciaries, in deciding whether to make any changes in mutual fund
investments or investment options, must make decisions that are as well
informed as possible under the circumstances.
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In cases where specific funds have been identified as under investigation by
government agencies, fiduciaries should consider the nature of the alleged
abuses, the potential economic impact of those abuses on the plan’s
investments, the steps taken by the fund to limit the potential for such
abuses in the future, and any remedial action taken or contemplated to make
investors whole. To the extent that such information has not been provided
or is not otherwise available, a plan fiduciary should consider contacting
the fund directly in an effort to obtain specific information. Fiduciaries
of plans invested in such funds may ultimately have to decide whether to
participate in lawsuits or settlements. In doing so, they will need to weigh
the costs to the plan against the likelihood and amount of potential
recoveries.
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Of course, the appropriate course of action will depend on the particular
facts and circumstances relating to a plan’s investment in a fund. Plan
fiduciaries should follow prudent plan procedures relating to investment
decisions and document their decisions. The guiding principle for
fiduciaries should be to ensure that appropriate efforts are being made to
act reasonably, prudently and solely in the interests of participants and
beneficiaries. Through our discussions with employer groups and other
members of the employee benefits community, we believe that most fiduciaries
are taking these issues seriously and are considering the available
information in attempting to fulfill their fiduciary duties.
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In an effort to address these concerns, plan sponsors and fiduciaries have
raised questions as to the steps that can be taken to address market timing
by plan participants. In particular, questions have been asked as to whether
a plan’s offering of mutual fund or other similar investments that impose
reasonable redemption fees on sales of their shares – or whether
reasonable plan or mutual fund limits on the number of times a participant
can move in and out of a particular investment within a particular period
– would affect the 404( c ) safe harbor that protects plan sponsors from
liability for the investment decisions of individuals in
participant-directed plans. The guidance makes clear that both these
approaches would not, in and of themselves, violate the safe harbor,
provided that any such restrictions are clearly disclosed to the plan’s
participants and beneficiaries.
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The allegations and the response by regulators of all stripes and the
plaintiff’s bar have changed your world. And changes are already being
made! According to SPARK’s 2004 Marketplace Update, employers have begun
reviewing their plans and considering making changes. The Update reports
that 23,000 retirement plans -- which represent $142 billion in assets --
intend to conduct a search for new 401(k) providers. While impressive, my
guess is that this understates what is going on. Everywhere I go people tell
me they are focusing on this fiduciary responsibility more closely than ever
before. And, let me reiterate – the appropriate course of action will
depend on the particular facts and circumstances relating to a plan’s
investment in a fund.
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As you know, in December of last year, the SEC issued a proposed rule to
combat illegal late trading, which has come to be known as the “Hard 4
Close” proposal. Under the proposed rule, all mutual fund orders would
have to be received by fund companies by Market Close (generally, 4 p.m.
eastern time).
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Most of the retirement services industry, including the SPARK Institute, is
strongly opposed to the “Hard 4 Close.” You were one of the first to
raise concerns and have strenuously argued that the SEC’s proposal will
create enormous disadvantages for participants investing through retirement
plans. Under a “Hard 4 Close” approach, intermediaries, such as third
party administrators, will be forced to cut-off trading in mutual funds much
earlier than 4 p.m. in order to process trades and ensure that they are
delivered to fund companies by 4 p.m.
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Retirement plan participants will see even earlier cut-off times because of
the additional administrative and regulatory obligations around retirement
plan transactions. Unlike individual investors, participants in 401(k) plans
will not be able to do a round-trip trade in a day, and may have to trade at
the next day’s price. And, some retirement plan administrators also argue
that the Hard 4 proposal unfairly favors large institutions that offer
proprietary funds.
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SPARK points out that, although they are generally long-term investors, plan
participants are in fact vulnerable to short term price volatility. And, I
recognize SPARK’s concern that a change to a Hard 4 close would require
comprehensive and expensive modifications to most plan recordkeeping and
trade processing systems.
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In response to the SEC’s request, the SPARK Institute and others have
advanced various alternatives they argue would provide certainty that
illegal late trading will be detected without disadvantaging the retirement
plan investor. Under the SPARK Solution, which is very similar to the “Smart
4” option you may have heard me talk about before, trades must be received
by 4 p.m. at the fund company unless intermediaries are certified by the SEC
to have an electronic audit trail, executive certification, and other key
protections in place.
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This alternative has been shared with the SEC and is similar, although more
fleshed out, to proposals being considered in Congress. We share the SEC’s
interest in developing a rule that will protect all investors from fraud and
market-timing while recognizing legitimate concerns raised by the unique
aspects of retirement plan administration, such as trade processing and
recordkeeping.
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I know that SPARK is now working with AICPA to develop a statement of
position (SOP) that includes a proposal for an outside auditor authorized to
perform financial examinations on a real-time basis. I understand from Steve
that the SEC has expressed a great deal of interest in this creative
proposal that would further safeguard against abuse.
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EBSA is currently conducting its own review of practices by mutual funds and
other pooled investment vehicles, such as bank collective trusts, as well as
service providers and so-called “intermediaries” to such funds, to
determine whether there have been any violations of ERISA. We are examining
a sample of mutual fund and other financial institutions to see whether
activities such as market timing or illegal late trading may have harmed
retirement plan beneficiaries.
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Under ERISA, a mutual fund affiliate or other retirement plan fiduciary that
engages in or facilitates market timing or late trading, causing losses to
an ERISA covered plan, is liable to restore losses to the plan. We are
focusing primarily on investment companies and banks that offer 401(k)
services to plans rather than on plan sponsors. We are also looking for
improper compensation arrangements between mutual funds and brokers who are
fiduciaries and whether financial institutions’ own retirement plans have
been involved in market timing or late trading.
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I should note that this review is exploratory and not the result of specific
evidence that investment professionals serving as fiduciaries have engaged
in improper or illegal activity. We don’t know yet if there are
significant problems here but we take our obligation to investigate
seriously and will take appropriate action if we discover abuses.
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As Steve predicted at your conference a year ago, another ERISA fiduciary
concern currently in the news is the issue of fees. Under ERISA, fiduciaries
have a legal obligation to ensure that fees and expenses paid by its
retirement plan are reasonable, and to prudently select and monitor the
investment options that it makes available under its plan. This duty is
ongoing, so the fiduciary must monitor to determine that particular service
providers and investment options continue to be appropriate choices.
Performance is only one element in this analysis. Another is the
reasonableness of the fees charged to the plan.
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Additionally, an investment provider sometimes may offer financial
incentives such as 12b-1 fees or revenue sharing arrangements to plan
service providers such as brokers or consultants for including and
recommending that vehicle on the provider’s “platform” or making that
vehicle available as an investment option to its clients. This is sometimes
referred to as a “pay-to-play arrangement”. Finally, “soft dollar”
and directed brokerage arrangements are under increasing scrutiny, and there
are proposals to change or even abolish them.
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Plan fiduciaries have a duty under ERISA to act prudently and in the
interests of plans and participants when evaluating all service
arrangements, including bundled fee arrangements, soft dollar and directed
brokerage arrangements, to ensure that the aggregate fees paid by their
plans are reasonable in light of the quality and level of services provided.
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There are a variety of direct and indirect fees that may be charged when
plans invest in a mutual fund or other collective investment vehicles. Many
plan service providers offer “bundled fee” arrangements where a number
of different services, including record keeping, are packaged together and
the plan is charged a single fee.
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If a plan fiduciary does not have sufficient information to compare service
providers and make an informed decision, he or she should request all
relevant information from the service provider. The Department posts on its
Website a series of educational pamphlets on ERISA fiduciary
responsibilities, including fees, and a very useful tool developed by ABA,
ACLI, and ICI designed to provide employers with detailed information from
financial service providers comparing the services offered and fees charged.
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“Pay to play” and soft-dollar arrangements present particularly
difficult issues for plan sponsors and fiduciaries because of the inherent
conflicts of interest involved. With regard to “pay to play,” if the
financial service provider receiving these payments is itself a plan
fiduciary, the transaction violates ERISA’s prohibited transaction rules
because the service provider is using its fiduciary authority to increase
its compensation. This is illegal self-dealing.
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Even if the financial service provider is not a fiduciary, it must still
provide the plan sponsor or other designated official sufficient information
so that they can fulfill their fiduciary obligations.
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For “soft dollars,” the plan fiduciary should know and approve its
investment manager’s arrangement. The fiduciary should determine whether
research and services being purchased with the plan’s brokerage are worth
the higher trading costs and that the broker has provided the best execution
of the trades. It is up to the fiduciary to make this determination.
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Disclosure is equally important for plan participants when they direct their
own investments. Under ERISA, to the extent a participant or beneficiary
exercises free and independent control over the assets in his or her
individual account, fiduciaries of the plan are not liable for any losses
resulting from the participant’s investment decisions. Without
information, however, participants cannot exercise control. And, without
participant control, fiduciaries cannot escape liability.
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For this reason, DOL regulations require that certain information be
furnished to plan participants and beneficiaries. Among the information
required to be provided to the participant is a description of any
transaction fees and expenses paid in connection with purchases or sales of
interests in investment alternatives, such as commissions, sales loads,
deferred sales charges, redemption or exchange fees. Also, the participant
must be provided directly or upon request with a description of the annual
operating expenses of each designated investment alternative which reduces
the rate of return of the alternative, such as investment management fees,
administrative fees and transaction costs, and copies of any prospectuses,
financial statements and reports, and of any other materials relating to
investment alternatives available under the plan.
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In spite of asset gains from the recent bull market, the
PBGC estimates pension underfunding increased to a record $400 billion by
December 2003. As the SPARK 2004 Marketplace Update notes, “as long as the
economic and demographic factors driving liabilities upward persist,
underfunding is likely to remain an issue for pension plan sponsors.”
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Let me assure you that this Administration is committed
to ensuring that defined benefit plans continue to be a viable option for
employers and workers. But to accomplish this, we must address the level of
underfunding in the defined benefit system as a whole and work to preserve
the integrity of the PBGC, which protects the pensions of approximately 44
million workers and retirees participating in over 31,000 private sector
defined benefit plans.
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Our reform efforts focus on policies that encourage
employers to make benefit promises they can afford and to fund the benefit
promises they make. As you know, on April 10, 2004, President Bush signed
into law H.R. 3108, the Pension Funding Equity Act. Among its provisions, it
replaced the 30 Year Treasury-based interest rate used in calculating
pension funding with a rate based on corporate bonds for the next two plan
years (2004 and 2005). The law also established several new notice
requirements and DRC funding relief.
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On the issue of long-term reform, the Administration
continues to work on crafting a solution that will get pension plans better
funded without increasing the risk of corporate bankruptcies. Our goal is to
simplify, improve the transparency, and reduce the volatility of the funding
rules while targeting those firms that pose the greatest threat to their
workers and retirees and the PBGC. This is a tall order but we are closing
in on it.
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In the meantime, corporate sponsors are responding to
increased contribution requirements by changing their asset mix to more
closely match liabilities and, in some cases, freezing plans or considering
termination. We must work together to develop a sensible set of rules that
allow defined benefit plans to thrive without putting workers, retirees, and
taxpayers at risk.
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With respect to defined contribution plans, the President
has proposed five reforms, two of which – addressing black out periods –
became law in the Sarbanes-Oxley-bill. The remaining three reforms -
allowing employees to divest company matching stock after three years,
requiring quarterly benefit statements, and increasing access to
professional investment advice – were passed by the House and are pending
in the Senate. I commend SPARK for the key role you played in helping to
develop and support Chairman Boehner’s investment advice proposal.
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In closing, let me just say that perhaps a silver lining
to the unfortunate spate of alleged fiduciary breaches and mutual fund
disclosures is a renewed emphasis on good corporate governance and good plan
governance. I hope that the issues raised with respect to corporate fraud
and mutual fund practices have focused plan fiduciaries – both plan
sponsors and their fiduciary advisors – on the important role they play in
protecting plan participants and has provided a necessary wake up call for
people to take their fiduciary responsibilities seriously. In the long run,
a renewed focus on fiduciary responsibility will benefit us all.
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The mutual fund practices that have been uncovered are
potentially harmful to plan participants and have broken a bond of trust
with the investing public. To the extent that they are illegal, the
responsible parties must be prosecuted to the fullest extent and ordered to
make restitution.
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But, we would have learned the wrong lesson if small
investors were to flee from mutual funds and collective investments – to
abandon the diversification and stability offered by these funds in favor of
shifting their retirement savings into individual stocks, or worse, out of
the market completely. Mutual funds and collective trusts have truly
democratized investing; confidence in these vehicles must be restored and
strengthened.
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The challenge before the Administration, the Congress,
and the industry is to implement the necessary changes in regulation and
business practices, and then work together to reassure the investor that the
problems have been corrected and their retirement savings are safe.
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I’d be happy to take a few questions on these issues or
others that I may not have addressed. Thank you.
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