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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 2004 Advisory Council on Employee Welfare and Pension Benefit Plans (“Advisory
Council”) created a Working Group to study retirement plan investment
management fees and expenses as they are currently reported on Form 5500. The
Working Group was charged with studying whether plan sponsors adequately
understand the total fees and expenses they are paying and whether those fees
are reported on the Form 5500 in a manner consistent with the Department of
Labor's reporting objectives. In particular, the Working Group was interested in
determining whether the Form 5500's fee reporting requirements (along with the
accompanying Schedules) meet the Department of Labor's objectives with regard to
the data that is collected. The Working Group was also interested in determining
whether plan sponsors currently receive adequate data from the service providers
in order to both understand and report the fees. Finally, the Working Group
studied whether new reporting methods should be adopted in order to increase the
plan sponsor’s understanding of overall plan fees and to improve reporting.
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The first task of the Working Group on Plan Fees and Reporting on Form 5500 (“Working
Group”) was to determine what fees and expenses are currently reported by plan
sponsors on Form 5500 and to determine whether there are other fees and expenses
that should be reported, but currently are not. In general, each plan document
has specific provisions stating whether the plan sponsor/employer will pay the
expenses, or whether the expenses will be paid from plan assets. The plan
settlor makes the decision as to how the expenses will be treated when
establishing the plan.
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In the circumstance where the plan is required to underwrite its expenses and
the fiduciaries contract separately with different service providers that are
billed explicitly, it is clear that the billed or explicit charges of the plan
provider paid from plan assets are reportable on the Form 5500. However, with
the evolution of 401(k) and 403(b) plans using mutual funds as a popular
investment option,(1) the investment management fees and expenses of the mutual
fund are netted from the mutual fund's performance and are not reported to the
plan sponsors; as a result, these expenses are not reported on the Form 5500.
Additionally, many plan fiduciaries enter into bundled arrangements with plan
service providers for record keeping or other administrative services which
typically do not entail explicit charges to the plan. Rather, in a bundled
arrangement plan service providers such as record keepers and trustees often are
compensated for their services to the plan from the underlying mutual fund
investment through either (1) "sub-transfer agent fees," 12(b)(1) fees, or other
administrative fees, or (2) through "revenue sharing" arrangements whereby the
mutual fund's advisor compensates the provider directly from its profits for the
services provided. In either case, the fees and expenses are not paid from "plan
assets", but rather from a portion of the mutual funds operating expense which
is shared with the plan’s service provider. These fees also are not reported
on the Form 5500.
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The Working Group received oral and written testimony at a series of public
hearings. The Working Group also received and discussed research and material
from public sources that related to the topic of study.
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At the hearing on August 4, 2004, Donald Stone, President of Plan Sponsor
Advisors, Inc., reviewed the type of revenue sharing arrangements engaged
between plan providers at mutual fund companies and reviewed various surveys of
plan sponsors which demonstrated that many plan sponsors are largely unaware of
the various revenue sharing arrangements between the vendors and mutual fund
companies. The Working Group also heard testimony from John J. Canary, Chief of
the Division of Covered Reporting and Disclosure in the Employee Benefit
Security Administration Office of Regulations and Interpretations, concerning
the current requirements regarding the reporting of fee and expense information
as part of the Form 5500 annual report. Additionally, Mr. Canary briefly
commented upon the need to employ rule-making if the Department of Labor decided
to amend the Form 5500. Additionally, the Working Group heard from Scott Albert,
Chief of the Division of Reporting Compliance Office of the Chief Accountant of
the Department of Labor, regarding reporting compliance with Form 5500.
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At a hearing on September 21, 2004, the Advisory Council received testimony
from Elizabeth Krentzman, General Counsel of the Investment Company Institute,
who testified that plan sponsors need to receive information from prospective
service providers concerning the provider's receipt of compensation, including
"revenue sharing" in connection with their services to the plan, but that Form
5500 was not an appropriate vehicle for reporting that information. The Working
Group also heard testimony from two representatives of The Vanguard Group, Inc.,
Mr. Dennis Simmons and Mr. Stephen P. Utkus, who testified in favor of
encouraging transparency in fee arrangements between retirement plan providers
and that greater transparency will foster sharper competition in the marketplace
which will contribute to lower overall costs for retirement plans.
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On September 23, 2004, the Working Group heard testimony from Lawrence R.
Johnson, CPA, of Lawrence Johnson and Associates, concerning the specific fee
information that is currently required on the Form 5500 as well as need to
improve disclosure of all fees including investment management fees, 12(b)(1)
fees, revenue sharing, commissions, “pay to play” arrangements, sales
charges, administrative fees, trustees fees, etc. Later that day, Mr. Mark Davis
of Mark A. Davis Consulting testified that there exists a significant difference
in the disclosure patterns concerning revenue sharing in the different sectors
of the market; the larger and more sophisticated plans tending to require candid
and clear disclosures, with mid-size and smaller plans receiving significantly
less disclosure. Mr. Lawrence R. Johnson of Lawrence Johnson and Associates
testified that 70% to 80% of all 401(k) costs are represented in the internal
expense ratios of the mutual fund but are not reported on the Form 5500. Mr.
Michael Olah of Schwab Corporate Services testified that Schedules A and C of
Form 5500 are an attempt at identifying fees and expenses paid from a plan to a
service provider directly out of plan assets (i.e., "hard dollar" payments).
However fees intrinsic to specific investment products (i.e., investment
management fees and administrative expenses) are not discloseable on Form 5500
because they are not paid with "plan assets". While transparency in fees is
important, Schwab does not believe the Form 5500 is appropriate for this task
because it is filed too late to be of help to the plan fiduciary in selecting a
provider or investment option. Instead, Mr. Olah recommended that existing
Department of Labor worksheets be employed. The Working Group also heard from
Mr. Edward Ferrigno, Vice President of Profit Sharing / 401k Council of America,
who testified that the Form 5500, as currently structured is not useful to
government policy makers, plan sponsors, and plan participants, because it does
not begin to capture the expenses of many retirement plans. Additionally, Ms.
Laura Gough, Chair of the Securities Industry Association Retirement and Savings
Committee, testified that the Form 5500 is not an appropriate vehicle for the
disclosure of embedded fees to plan sponsors and further described the
difficulty in accurately accounting for investment management fees and expenses
incurred at the mutual fund level at the retirement plan level. Finally, the
Working Group heard testimony from Mr. Thomas M. Kinzler, of the MassMutual
Financial Group, who recommended that fee and expense information be reported
and monitored on a periodic basis and include explicit as well as imbedded fees
and expenses.
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Executive Summary
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Currently the Form 5500 fee reporting requirements do not meet the Department
of Labor's objectives with regard to the data collected. There are numerous
pooled investment vehicles in which the fees are intrinsic to the underlying
investment and are not reported to (or known by) the plan sponsor nor reported
on Form 5500. Additionally, fees paid to plan service providers such as record
keepers and trustees out of these asset-based fees, in the form of revenue
sharing, sub-transfer agency fees, 12(b)(1) fees or the like are not reported on
Form 5500 or the accompanying Schedules. While some more sophisticated plan
sponsors are cognizant of the overall fees, both explicit and embedded, as well
as the revenue sharing arrangements between various providers, many plan
sponsors simply do not understand the total fees paid to service providers, nor
the revenue streams between them. The fiduciary responsibility provisions of
ERISA require that plan sponsors know the amount of fees paid in relationship to
the services provided and to understand the revenue sharing arrangements between
plan providers. Therefore, the Department of Labor should consider amending the
Form 5500 and the accompanying Schedules and, through its rule-making authority,
solicit the input from the industry as to the appropriate methodology for
capturing that information. In particular, the Department of Labor may wish to
consider use of a proxy in order to estimate total fees in light of the
significant difficulties of capturing exact information at the plan level. The
Department of Labor may also wish to modify its existing worksheet for plan
sponsors in order to provide a tool to help plan sponsors understand the true
nature of the non-explicit fees and revenue sharing arrangements among the plan’s
providers prior to choosing the provider or an investment option.
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Relevant General Fiduciary Requirements
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ERISA imposes certain obligations on plans and their fiduciaries. For
example, a plan fiduciary must discharge its duties solely in the interest of
the plan and its participants and beneficiaries for the exclusive purpose of
providing plan benefits and defray reasonable plan expenses.
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A fiduciary must also act with the care, skill, prudence and due diligence
under the circumstances then prevailing that a reasonably prudent person acting
in a like capacity (and familiar with such matters) would use in the conduct of
an enterprise of like character and with like aims. The highlighted terms
distinguish ERISA's prudence rule, often described as the "prudent man
standard," from the traditional common law "good faith" standards. The prudent
man standard means, among other things, that the level of care imposed upon a
fiduciary may vary with the complexity of the plan involved.
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What is clear however, is that the Department of Labor has consistently held
that under Section 404(a)(1) of ERISA, the responsible plan fiduciaries must act
prudently and solely in the interest of plan participants and beneficiaries both
in deciding whether to enter into or to continue a particular arrangement with a
plan service provider and in determining which investment options to utilize or
to make available to plan participants. This is true even for fiduciaries of
plans where investments are self-directed by the participant and the ultimate
benefit is tied to his or her account balance, as is the case with many 401(k)
and 403(b) plans. In such cases the fiduciary is responsible for selecting and
monitoring the investment options that are available to the participants, as
well as the service providers to the plan. In this regard, the responsible plan
fiduciary must insure that the compensation paid directly or indirectly by the
plan to the service provider is reasonable, taking into account the services
being provided to the plan as well as other fees or compensation received by the
provider in connection with the investment of plan assets. The Department has
repeatedly emphasized its view that the responsible plan fiduciary must obtain
sufficient information regarding any fees or other compensation that the service
providers receive with respect to the plan's investments and to make an informed
decision as to whether or not the service provider's compensation for services
is no more than reasonable. See, Department of Labor Advisory Opinion 97-15A and
Department of Labor Advisory Opinion 97-16A.
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Findings
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Initially, when ERISA was passed in 1974, the pension world was a very
different place than it is today. In an environment populated by defined benefit
plans, fees and expenses of the retirement plans were explicit and were paid by
the plan sponsor or, alternatively by the plan from plan assets. Additionally,
according to generally accepted accounting principles ("GAAP"), these fees and
expenses paid by the plan were reported in the expense section of the retirement
plan's Income and Expense Statement so that actual fees paid by the plan matched
the fees reported both in the plan's audit report and the Form 5500.
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The emergence of defined contribution plans in the 1980s, in particular
401(k) and 403(b) plans, with the heavy reliance on pooled investment vehicles
such as mutual fund investments, has caused a dramatic change in the way fees
are charged. In particular, the pricing methodology has evolved from the
explicit charges billed to and paid by the plan (or by the plan sponsor) into an
asset-based fee model. Under such an arrangement the investment management fees
and expenses of the mutual fund are netted out of its performance on a daily
basis in arriving at the mutual fund's net asset value (NAV) and as such, those
fees and expenses are intrinsic to the investment and not easily identifiable by
the plan sponsor. Likewise other pooled investment vehicles have migrated to the
asset-based fee model and suffer from the same reporting deficiencies. To
further complicate matters, many plan sponsors have moved to "bundled"
arrangements with plan providers whereby other costs of administration such as
record keeping or trustee fees are offset, in whole or in part, by revenue
sharing arrangements with the mutual funds and other investment vehicles with
asset-based fee structures. In many cases the plan sponsor’s decision to
choose one particular investment vehicle or another is driven by its desire to
reduce or eliminate its costs through the revenue sharing devices inherent in
such bundled arrangements. Indeed, the testimony established that explicit
charges in many plans have been substantially reduced or nearly completely
eliminated and the majority of costs associated with administering many
retirement plans are now embedded in the form of asset-based fees and borne by
the plan participants.
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One problem that has emerged is, that as a result of this evolution in how
fees are collected, the Form 5500 as currently structured is outdated and simply
no longer reflects the way fee structures work in the industry. As noted, many
explicit fees have all but disappeared and many very large plans have little or
no explicit fees whatsoever. Because the asset-based fees are netted from the
investment funds performance (and as such not paid with "plan assets"), the
actual costs of operating the plan are reflected only indirectly in the
retirement plan's income statement.(2)
Thus the current Form 5500 does not
provide plan sponsors, participants, or governmental regulators adequate
information to understand true cost of the plan. While the evidence suggests
that some of the larger and more sophisticated plan sponsors do in fact
understand the totality of fees and expenses, the vast majority of plan sponsors
have not calculated and do not know the actual cost of running the plan.(3)
This "out of sight, out of mind," mentality of some plan sponsors is particularly
dangerous in asset-based fee arrangement because as the account balances grow,
so do the fees regardless of whether additional services are provided. Yet one
of Department of Labor objectives in requiring the Form 5500 is to ensure that
plan fiduciaries monitor the operations of the plan, including costs. This is
consistent with the overarching fiduciary responsibility provisions of ERISA
which require plan fiduciaries to review and monitor fees for reasonableness on
a periodic basis.
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The Advisory Council respectfully suggests the present reporting requirements
are inconsistent with the stated goals of ERISA, which was to provide full and
fair disclosure with respect to the fees and costs associated with a retirement
plan. A great number of Form 5500's filed by defined contribution plans are of
little use to government policy makers, government enforcement personnel, plan
sponsors and participants or other interested persons in terms of understanding
the cost of the plan. The Advisory Council believes that by capturing indirect
fee and expense data on Form 5500, plan fiduciaries will be forced to calculate
and therefore fully appreciate the true costs of the plan. Additionally by
requiring the reporting of cost information on Form 5500 which is a publicly
available document, a data bank will emerge which will undoubtedly be used as a
tool by competing providers to drive down overall plan costs. Finally,
governmental policy makers and enforcement personnel will have access to more
meaningful information regarding plan fees and costs.
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However, capturing accurate fee information is a complicated task and in some
respects not feasible in light of the current state of the art in record
keeping. First, it is unclear to the Working Group as to whether accurate data
can be captured concerning exact revenue sharing payments between the mutual
fund and plan service providers at the individual plan level. If the information
can be accurately gathered at a reasonable cost, it should be reported on
Schedules A and C. If the information can not be accurately and economically
captured, it should be estimated and reported. However, the task is even more
complicated when it comes to investment management fees and expenses of the
mutual fund which are calculated and subtracted on a daily basis to arrive at
NAV. The testimony from a wide variety of witnesses suggested that, as a result
of the way the mutual fund industry record keeping is currently configured, the
industry is unable to account for mutual fund investment management fees and
expenses at the plan level. The Advisory Council is also concerned that the
costs associated with requiring an informational system overhaul that would
allow the differing record keeping platforms of the mutual fund industry and
record keeping industry to coordinate information exchange (if feasible) would
be excessive and outweigh the benefit of exactitude. However, the Advisory
Council does believe a proxy could and should be developed which would fairly
approximate the fees and expenses of the plan by taking a snapshot of plans
holdings at a given point in time and extrapolating from the mutual funds known
operating expense ratio.
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The shift to asset-based fees coupled with the proliferation of revenue
sharing devices between mutual funds and plan service providers has also made it
very difficult for plan sponsors to fully understand the fees that are paid
indirectly to various service providers such as record keepers, trustees, etc.
The evidence before the Working Group established that there exists an asymmetry
of information which impedes plan sponsors from knowing how much the plan
provider is paid outside of the explicit or billed fees. A study by Grant
Thornton that was provided to the Committee and which included a broad survey of
plan sponsors, indicated that 81% of the plan sponsors did not know what the
vendors were receiving for sub-transfer agency fees, 69% did not know what the
vendor received in 12(b)(1) fees, and 80% of the plan sponsors did not know what
the vendor was receiving in placement fees, (i.e., marketing fees, finders fees,
etc.). Although a vast majority of 401(k) plans utilize these bundled
arrangements,(4) the evidence shows that the flow of money in such arrangements
is often not disclosed and is accomplished by a variety of revenue sharing
devices, that are to say the least, confusing. The lack of transparency in this
area has led to an inefficient market where it is extremely difficult for the
plan sponsor to determine either the absolute level of fees, or the flow of
fees, i.e., who is getting paid what. The latter point is particularly important
for a plan fiduciary selecting various investment options; the testimony
indicated that certain vendors have steered plan sponsors to mutual funds which
pay a high revenue share and de-emphasize funds with little or no revenue share.
Alternatively, providers have recommended a particular class of a mutual fund,
where a different class (with a lower revenue share) might be more appropriate.
Thus we think it is critical that plan sponsors obtain full and complete
information concerning all revenue sharing arrangements for each individual
investment option, along with alternatives, in order to serve as a check upon
the service provider's self-interest in promoting one investment option over
another. We believe such a requirement would be consistent with the Department
of Labor's repeated admonitions that it is part of the plan sponsors’
fiduciary responsibility to ensure that they fully appreciate the amount of
fees, both direct and indirect, that are being paid to the providers.
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Unfortunately the Form 5500 is not the best vehicle to promote such practices
as the Form is filed well after the plan sponsor has already engaged the
provider and selected the investment options. While Form 5500 would be helpful
in monitoring performance, we believe plan sponsors need a tool to help them
understand the revenue sharing arrangement at the point of sale.
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As earlier noted, ERISA places substantial responsibilities on plan
fiduciaries charged in overseeing the administration and investments of pension
plans to understand the total amount of fees paid to a service provider to ensure reasonableness
and also to understand the revenue sharing arrangements between various
providers. However, many plan sponsors simply do not have sufficient experience
or an appropriate source of information concerning industry practice to deal
with and understand revenue sharing arrangements. Therefore, the Advisory
Council has concluded that educational information would be very useful for all
plan sponsors and other fiduciaries, and would be particularly beneficial to
fiduciaries of small and medium size pension plans. The Advisory Council notes
that as a result of hearings in 1997 and an independent study commissioned by
the Department of Labor on 401(k) fees and expenses, the Department developed a
pamphlet for plan sponsors, "A Look At 401(k) Plan Fees for Employers" which was
later replaced with a brochure entitled Understanding Retirement Plan Fees
and Expenses which is available on the Department of Labor's web site. While
these pamphlets advise plan sponsors in general terms of the fiduciary
responsibilities in determining that 401(k) plan fees are "reasonable," the
Department of Labor web site includes a detailed worksheet that enables plan
sponsors to evaluate and compare fees of potential 401(k) vendors. The witnesses
testified that the worksheet is widely used by plan sponsors in selecting
service providers. While this form is an excellent tool to analyze explicit
fees, it does not attempt to capture the revenue sharing streams that are
prevalent in the industry today. The Advisory Council respectfully recommends
that the Department of Labor update this worksheet in order to provide tools for
fiduciaries to understand the revenue sharing and total fees received by the
service provider for each investment option under consideration prior to its
selection.
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The Advisory Council concludes that the Department of Labor should initiate
rule-making in order to modify the Form 5500 and the accompanying schedules so
that total fees incurred either directly or indirectly by the plan can be
reported or estimated. Additionally, the Advisory Council believes that all fees
paid to plan providers either directly or indirectly through revenue sharing
devices should be reported or estimated. As a result of the significant
accounting (and audit) difficulties that might arise through the use of
estimation techniques, the Department of Labor may wish to consider developing a
new schedule which includes a uniform proxy formula designed to capture the
information.
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The Department of Labor should amend its worksheet for plan sponsors of
401(k) plans in order to provide a tool which will help them fully appreciate
the true nature and magnitude of non-explicit fees as well as revenue sharing
arrangements. Moreover the Department of Labor should advise plan sponsors that
good fiduciary conduct requires the use of the worksheet (or some similar tool)
before selecting the service provider or the investment options for the plan.
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The Advisory Council makes the following recommendations in an effort to
further educate plan sponsors and fiduciaries:
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Plan sponsors should avoid entering transactions with vendors who refuse
to disclose the amount and sources of all fees and compensation received in
connection with plan.
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Plan sponsors should require plan providers to provide a detailed written
analysis of all fees and compensation (whether directly or indirectly) to be
received for its services to the plan prior to retention.
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Plan sponsors should obtain all information on fees and expenses as well
as revenue sharing arrangements with each investment option. Plan sponsors
should also determine the availability of other mutual funds or share classes
within a mutual fund with lower revenue sharing arrangements prior to selecting
an investment option.
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Plan sponsors should require vendors to provide annual written statements
with respect to all compensation, both direct and indirect, received by the
provider in connection its services to the plan.
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Plan sponsors need to be aware that with asset-based fees, fees can grow
just as the size of the asset pool grows, regardless of whether any additional
services are provided by the vendor, and as a result, asset-based fees should be
monitored periodically.
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Plan sponsors should calculate the total plan costs annually.
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Summary of Testimony of Donald Stone
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Don is President of Plan Sponsor Advisors, a Chicago-based retirement
consulting firm. He began his testimony stating that he felt neither plan
sponsors nor participants have a good grasp of the fees they are paying in their
defined contribution plans, and the 5500 as currently designed does not provide
adequate information. Mr. Stone outlined three key issues: 1) an asymmetry of
information, given vendors do not provide plan sponsors with adequate
information on the fees or revenues received from the plan, 2) a significant
shift in the past decade with regard to how fees are charged causing higher
fees, and 3) due to the lack of information, plan sponsors are unable to discern
the “reasonableness” of fees.
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Mr. Stone explained that plan sponsors do appear to understand the explicit
fees charged for plan services, but they do not understand revenue sharing
arrangements. They are much more unclear about wrap fees, 12(b)(1) fees,
sub-transfer agent fees, in many cases, not really being sure what some of those
items actually are. He supported this with data from a survey conducted by Grant
Thornton and Plan Sponsor Advisors. He noted that given plan sponsors do not
understand the economics of the business, they do not know what questions to ask
of their vendors. Without adequate information, plan sponsors are unable to 1)
compute the vendor’s total revenue generated from the plan, and 2) compare
fees in the marketplace to determine reasonableness.
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Mr. Stone outlined the types of fees and sources of revenue. Over a decade
ago, all fees were “hard dollar” costs, or explicitly defined fees. With the
growth in the use of mutual funds and other investment vehicles, many fees and
sources of revenue for vendors have become “soft dollar” or embedded in the
investment vehicles. He proposed that the shift to asset-based fees has caused
1) an increase in fees, 2) larger accounts within plans to subsidize smaller
accounts, and 3) larger plans, or more profitable plans, within a vendor’s
book of business to subsidize smaller plans, or less profitable plans. Without
the appropriate information, plan sponsors will pay more for administrative
services than is reasonable just because the participants have high account
balances. He cited examples where plans using “soft dollars” or asset-based
fees to pay for services were frequently paying significantly more than those
who paid for plan fees explicitly or capped the asset based fees.
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Mr. Stone explained that the current design of the 5500 is antiquated due to
industry changes and does not provide information on the “soft dollar” fees
in plans, which are now a substantial component of plan fees. In fact in many
plans, no fees would be disclosed on the 5500. The reporting on the 5500 for
broker fees is included for insurance products, but not for other investment
products such as mutual funds and stable value funds. He recommends increased
fee transparency on the 5500 and education for plan sponsors. The two key
changes to the 5500 would be 1) require all investment fees to be disclosed, and
2) require all compensation to brokers and advisors to be disclosed.
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Summary of Testimony of Joe Canary and Scott Albert
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The DOL testified before the Working Group to provide background information
regarding the Form 5500 annual reporting requirements generally. Under Part 1 of
Title I of ERISA, administrators of pension and welfare benefit plans are
required to file reports annually concerning, among other things, the financial
condition, investments, and operations of the employee benefit plan that they
administer. The DOL stated that the Form 5500 series is a primary source of
information concerning the operation, funding, assets, and investments of
pension and other employee benefit plans. In addition to being an important
disclosure document for plan participants and beneficiaries, it is a compliance
and research tool for the department and a source of information and data for
use by other federal agencies, Congress, and the private sector in assessing
employee benefit plan issues and related tacks in economic policy issues.
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The DOL described the 5500 as a “packaging list.” The Form 5500 collects
information, basic identifying information, about the plan, the plan
administrator, the plan sponsor, the types of benefits provided, the number of
participants covered, the form of funding, trust, insurance, general assets, and
a list of the separate schedules that are attached. The DOL articulated the
types of schedules, the purpose of the schedule and the agency for whom the
schedule is applicable. Overall the instructions are subject to user
interpretation and are not explicit in regards to the treatment of all fees.
Banks and insurance companies are subject to different reporting requirements,
so fees appear to be generally disclosed. With mutual funds, fees are not
necessarily disclosed or if they are, they are in the gains and losses line
item.
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The DOL stated that the entire reporting scheme -- and that includes the
audit and the Form 5500 -- is that it promotes a discipline whereby plan
administrators would actually focus, at least once a year, on their operations
of their plans, on the assets, on their performance, and ensure that plan assets
have been properly accounted for. In addition, the DOL provides booklets and
instructions with tips for selecting and monitoring service providers for
employee benefit plan, meeting your fiduciary responsibilities and on
understanding retirement plan fees and expenses. There is also a more technical
guide called the Troubleshooter's Guide to Filing the Form 5500.
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The DOL indicated that the Form 5500 for the Department of Labor is a
creature of regulation. And to adjust the Form would require a public notice and
comment process and an adjustment to the regulations.
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Summary of Testimony of Mark Davis
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Mark Davis is President of Davis Consulting. Mr. Davis began his testimony
stating that the majority of fiduciaries do not understand what they and/or
their participants are truly paying and very few vendors take meaningful steps
to help in the process. He proposed that fiduciaries need to be able to judge
the reasonableness of all fees to which participants and plans are exposed.
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Mr. Davis articulated a couple of key issues with the current reporting.
First, commissions paid to NASD registered brokers are not disclosed to
sponsors in any widely used or meaningful way. Plans are typical “sold”
investments that pay distributors more in order to reduce the “hard dollar”
fees charged to the plan sponsor. In many cases, a provider may be a
broker/advisor who increases the fees the plan pays without increasing the
benefit to the plan. Second, revenue sharing to other providers, such as
recordkeepering and custody service providers is not always disclosed. A
plan sponsor who does not have this information, can end up paying more than
a reasonable fee for service without even being aware. For example, with a
mutual fund that does not revenue share with the plan recordkeeper, the
participant may be “paying twice” for shareholder recordkeeping
services. Third, reporting is quite different based upon type of product and
interpretation. Some insurance product fee information is disclosed on
Schedule A, while some is not. Fees paid by the plan to fee-based advisors
must be disclosed on Schedule C, while fees paid by the plan to commissioned
brokers and advisors may not be disclosed.
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Mr. Davis proposed that given many participants now bear the responsibility
of paying the fees, plan fiduciaries should be required to be even more vigilant
with regards to the reasonableness requirement. He proposed that all fees for
services should be reported and all revenues paid to all providers, both direct
and indirect, should be reported. He proposed disclosure along with education
will enable plan fiduciaries to determine reasonableness of fees.
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Summary of Testimony of Larry Johnson
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Larry Johnson is President and Founder of Lawrence Johnson & Associates.
He began his testimony by stating that 1) plan sponsors don’t understand the
fees they pay, 2) fees and expenses are not adequately reported on the Form
5500, and 3) the DOL’s reporting objectives are not currently being met with
the existing Form 5500. He stated that if the employer or plan sponsor pays
fees, those are not reported on the Form 5500. Overall, he said, the 5500 today
collects expenses such as actuarial costs, record keeping costs that are charged
to the plan and investment advisory fees charged to the plan explicitly. But the
internal expense ratios or charges of mutual funds will not be disclosed on the
5500, which represent a significant portion of the plan fees. He quoted from a
recent Hewitt study that anywhere from 70 to 80% of plan expenses are now
indirect and not subject to reporting.
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Mr. Johnson stated that over a decade ago, all plan fees were paid
explicitly. So plan sponsors understood what fees were paid for what services.
Typically, the fee was transaction based. Given the evolution to a system
whereby more of the fees are paid indirectly through investment products, fees
are now paid for based on account size even though the cost of the transaction
is not impacted by account size. Reporting has not kept pace with the change in
the system.
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Mr. Johnson indicated that for plans whose fees and expenses are paid through
revenue sharing, 12b-1s, finders' fees, sub-transfer agency fees and other
non-disclosed arrangements or any other plan that utilizes mutual funds, the
fees are not currently disclosed on the Form 5500, if at all to plan sponsors.
He would propose that all fees and revenue sharing with providers be disclosed
to plan sponsors.
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Mr. Johnson argued that these fees would be easily available on recordkeeping
platforms given the recent changes made in recordkeeping platforms to handle the
fund redemption rules. Given this new programming now enables recordkeeping
systems to track the holding period during the year for each participant of each
mutual fund, the corresponding expense ration paid could also be tracked. He did
not believe the changes to the system would be considered onerous at this point.
He further stated the clarity and accuracy of fee transparency outweighed the
expected cost of system changes.
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Summary of Testimony of Michael Olah
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Michael Olah is the Field Vice President of Schwab Corporate Services. Mr.
Olah began by stating “the issue here is not whether service providers are
gouging retirement plans and ultimately plan participants by charging exorbitant
fees. Nor is it even the difficulty of plan sponsors to perform meaningful fee
comparisons. While there may be some plans that are overcharged and that clearly
needs to be dealt with, the real issue should be centered around what
information is needed by plan fiduciaries to do their jobs and do them well and
when and where that information should be provided.”
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He contended that the form 5500 could not contain the appropriate information
to fulfill this goal. He stated, “This is all about the basics of fiduciary
responsibility being proactive about fees not yet incurred rather than reactive
in evaluating fees already paid.”
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He discussed what he believes ERISA requires. He provided the two obligations
imposed on fiduciaries that relate to the disclosure of fees are the exclusive
benefit rule and the prudent expert standard. “Under the exclusive benefit
rule, plan fiduciaries must operate the plan for the exclusive purpose of
providing benefits for the plan participants and offsetting only those fees that
are reasonable. This is the only provision of ERISA that even mentions fees and
it conditions the use of plan assets for payment only of those fees that are
reasonable.” He said only those fees that are paid from plan assets are
subject to the exclusive benefit rule but the total of all fees would be subject
to the prudent expert standard. He stated plan sponsors should be provided 1)
information on both direct fees paid as well as “intrinsic” or indirect fees
(which reduce investment earnings), 2) an understanding of sources of revenue
received by service providers in administering plans, and 3) costs of services
provided. He argued that details do not need to be provided with regard to
revenue sharing arrangements or the costs of services be detailed or “unbundled.”
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Mr. Olah continued to say that “plan sponsors have been making fee
reasonableness determinations knowing only half the picture, the hard dollar
half, completely unaware of the existence and magnitude of the revenue sharing
half. By disclosing to plan sponsors the revenue received by the service
provider from all sources the plan sponsor can make a determination of the
reasonableness of the service providers' fees in total.”
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From a reporting perspective, Mr. Olah disagreed with others. He stated that
the 5500 was not the appropriate place to report the information given the form
is provided after the fact and would not provide plan fiduciaries with the
information in advance to ensure an appropriate initial decision. He was a
proponent of the DOL’s fee worksheet and suggested adding an additional tool
that would provide a line item list for the revenue side of the equation for
plan sponsors. Although he did not know what percentage of plan sponsors
currently use the DOL’s fee worksheet, he did state that most of Schwab’s
RFP’s currently include the worksheet.
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Mr. Olah concluded his statements by saying, “Fees should be disclosed.
Fees should be disclosed in advance of decision making and on an ongoing basis
to enable monitoring and fees should be presented in an easy to understand, easy
to compare format that allows fiduciaries to do their job and be good
fiduciaries.” He later stated that he thought the 5500 was a good tool to
provide for the ongoing monitoring of fees and revenue arrangements.
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With regard to reporting the fees from a mutual fund, Mr. Olah proposed a
snapshot approach. Rather than provide actual reporting of the fees as suggested
by Mr. Johnson, he stated that the easier method would be to take a total in
each mutual fund either on a period-end date and multiply it by the expense
ratio or revenue share basis points to determine the asset-based fees or revenue
share component.
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Summary of Testimony of Ed Ferrigno
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Ed Ferrigno is Vice President of Washington Affairs for the Profit-Sharing
401(k) Council of America. Mr. Ferrigno started by stating that “Form 5500
reporting no longer explicitly lists all of the expenses paid from retirement
plan assets. This is especially true for defined contribution plans. As a
result, Form 5500 fee-related information is not useful to government
policy-makers, plan sponsors, plan participants and others with an interest in
this information.”
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Mr. Ferrigno agreed with previous testimony that the industry has evolved
from paying fees directly to paying indirectly through investment management
asset-based fees. The result, he says, is “that a substantial portion of the
expenses paid from retirement plan assets are no longer explicitly reported on
the Form 5500 makes fiduciary oversight of plans more difficult and has reduced
the transparency critical to fiduciary decision-making.” He further proposed
that transparency of fees paid indirectly on the 5500 would decrease doubts
about the credibility of the defined contribution system.
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Mr. Ferrigno stated that PSCA recommends the playing field be level for all
service providers by ensuring that the most beneficial aspects of Schedules A
and C are applied to all providers. Additionally, the DOL should advocate
extending the requirement to provide plan administrators with the information
needed to file the Form 5500 in a timely manner pursuant to ERISA Section
103(a)(2) to other service providers.
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PSCA also suggested the use of an expanded DOL fee worksheet to include fee
arrangements designed by a joint industry-government group. PSCA proposed
enhanced reporting coupled with increase plan fiduciary education by the DOL
will enable plan sponsors to understand the fee and revenue structures and
thereby make better decisions.
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Summary of Testimony of Laura Gough
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Laura Gough is Managing Director of R.W. Baird and 2004 chair of the
Securities Industry Association's Retirement and Savings Committee. Ms. Gough
began by stating, “With defined contribution plans becoming a key part of
American retirement security, SIA and its member firms want to ensure that all
disclosure provided to plan sponsors and plan participants is transparent and
informative.”
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She noted that with the increased presence of mutual funds in defined
contribution plans, the majority of fees are now asset-based. Those fees, she
proposed, are currently provided to plan sponsors since they are “built-in” to
the fund’s net asset value daily. She cited the following ways plan sponsors
can get at fee information: 1) net performance figures compared against
benchmarks, 2) proposals submitted by various vendors, 3) prospectus and
disclosure booklets, 4) annual and semi-annual reports from the investment
vehicles, and 5) through the use of the DOL’s fee worksheet. But she stated
additional reporting is necessary.
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Ms. Gough said, “SIA strongly supports efforts to enhance transparency of
revenue sharing and differential compensation. At a minimum, such enhanced
disclosure should embody the following elements: (1) a clear simple presentation
of the expenses reimbursed pursuant to revenue sharing agreements, (2)
identification of funds or fund families with which revenue sharing arrangements
exist, and (3) the funds or fund families with respect to which higher
percentage rates of compensation are paid to associated persons such as
proprietary funds or for sales of different classes of shares.”
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She indicated, “SIA does not believe that the 5500 form is an appropriate
vehicle for disclosure improvements to plan sponsors and would encourage the
working group to consider other options. The 5500 would have to be substantially
revised. Since it is intended to serve a regulatory purpose, it's probably not
the best starting point to educate plan sponsors because it is so after the
fact.” Additionally she stated mandating a form would be challenging given the
significant difference amongst plans. The suggestion was for increased
disclosure and open-book accounting being provided by the industry combined with
plan sponsor education from the DOL would be the appropriate response.
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Summary of Testimony of Thomas Kinzler
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Mr. Tom Kinzler is Vice President and Associate General Counsel of Mass
Mutual. Mr. Kinzler started by proposing a simplified and consistent approach to
the disclosure of fees to plan participants and plan sponsors in an effort to
restore confidence in the retirement system. He recommended that fees be
disclosed both at the point of sale and on a regular periodic basis to plan
fiduciaries and participants. He further recommended that all financial
institutions make such disclosures in a uniform manner that is easily understood
and subject to comparison by plan sponsors.
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The first suggestion was for a point-of-sale disclosure plan sponsors,
requiring the disclosure of all plan expenses on a single, all-in disclosure
form. This was stated to be of highest importance to enhance competition in the
marketplace. He outlined PTE 77-9 requirements for insurance companies at point
of sale to obtain three items in writing from the independent fiduciary. First,
is an acknowledgment of receipt of the sales commission paid by the insurance
company to the agent, broker, or consultant in connection with the purchase.
Second is a description of any charges, fee discounts, penalties or adjustments,
which may be imposed under the contract. Third is any affiliation the broker,
agent, or consultant has with the insurance company. He proposed that
fiduciaries receive a single, full, and fair disclosure at the point of sale –
in the form of the PTE 77-9 commission disclosure form or a different disclosure
made pursuant to another class exemption for all service providers.
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Mr. Kinzler suggested that the disclosure should contain five items:
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Detailed information about all distribution-related costs including
identification of recipients and amounts of sales commissions, finders fees and
12(b)(1) distribution fees;
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Identification of sources and amounts of revenue sharing payments;
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Estimated costs of administering and record-keeping the participants'
accounts and plan including mutual fund management and administration fees,
12(b)(1) service fees, shareholder servicing fees, sub-transfer agency fees, any
start up or conversion-related charges, any service provider termination
expenses, and any separately imposed charges for participants, loans, or checks,
et cetera;
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Conflicts on interest that may arise in connection with transactions
involving the service provider and plan sponsor and an agreed upon disclosure
methodology should a conflict arise;
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Financial ratings of the financial institution and the unallocated capital
or surplus of the financial institution.
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For ongoing monitoring, Mr. Kinzler recommended amending Form 5500 Schedule A
with a new disclosure schedule that will include all fee information from all
financial institutions, administrators, and record keepers. This would include
both explicit as well as embedded fees. Currently, he said, there is an uneven
playing field since the insurance industry reports information not required of
other investment companies.
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He further recommended “that administrative expense information currently
found on Schedule H for large plan financials and service provider information
found on Schedule C also be reported on the new disclosure schedule so that a
plan sponsor will go to one place for a comprehensive list of plan expenses.”
In addition the Harris Trust disclosure provided by insurance companies annually
could also be incorporated into the new proposed disclosure.
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Mr. Kinzler raised the issue of timing also. Given the filing of the 5500 can
occur up to 120 days after the close of the plan year, the fee disclosure would
occur too late to be of any real value. He proposed a 90 day limit to speed the
filing and information flow.
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Overall, the insurance industry is held to a different standard than other
providers, such as mutual fund companies. Mr. Kinzler argues the playing field
should be leveled to create a more efficient market.
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Meeting of August 4, 2004
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Meeting of September 23, 2004
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Agenda
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Official Transcript
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Statement by Mark Davis, Davis Consulting
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Statement by Lawrence Johnson, Lawrence Johnson & Associates
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Statement by Michael Olah, Vice President, Schwab Corporate Services
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Statement by Edward Ferrigno, Vice President, Profit Sharing Council of
America
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Statement by Laura Gough, Managing Director, Corporate & Executive
Services and Retirement Plans, RW Baird
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Statement by Thomas Kinzler, Vice President and Associate General Counsel,
Mass Mutual Financial Group
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Hewitt Associates, Trends and Experience in 401(k) Plans, 2003
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Transcripts for the Council's full meetings and working group sessions are availabe 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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While a majority of the testimony
before the Working Group addressed the asset based fee model of the
mutual fund industry, it is apparent that plan sponsors invest in a wide
variety of pooled investment vehicles where fees and expenses are paid
directly from the underlying investment vehicle rather than from trust
fund assets, and are not reported on Form 5500. The findings and
recommendations of the Advisory Committee are not limited to the mutual
fund industry but rather apply to any pooled investment vehicle where
fees are intrinsic to the underlying investment and not explicitly
billed or paid by the plan.
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Indeed any effort to report the
indirect or asset-based fees on the current Form 5500 would result in a
conflict with the plan's audit report which based on current GAAP
standards would be limited to fees, commissions and expenses explicitly
charged to, and paid by the plan. Moreover, as will be discussed later
in this report, it would be nearly impossible to accurately report and
calculate the precise amounts of asset-based fees.
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According to a recent Hewitt Survey of
Fortune 500 401(k) plans only 33% of plan sponsors even attempted to
calculate the cost of maintaining the plan. 2003 Trends and Experience
in 401(k) Plans, Hewitt Associates, LLC, pg. 79.
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According to a recent survey of over
1,000 retirement plans almost 80% utilized a bundle provider. 46th
Annual Survey of Profit Sharing and 401k Plans, Profit Sharing /401k
Council of America, (PSCA) Pg. 33 (2003).
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