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+
+ - ARE HIDDEN 401(K) FEES UNDERMINING RETIREMENT SECURITY?
+
+[House Hearing, 110 Congress]
+[From the U.S. Government Publishing Office]
+
+
+
+
+ ARE HIDDEN 401(K) FEES
+ UNDERMINING RETIREMENT SECURITY?
+=======================================================================
+
+
+
+ HEARING
+
+ before the
+
+ COMMITTEE ON
+ EDUCATION AND LABOR
+
+ U.S. House of Representatives
+
+ ONE HUNDRED TENTH CONGRESS
+
+ FIRST SESSION
+
+ __________
+
+ HEARING HELD IN WASHINGTON, DC, MARCH 6, 2007
+
+ __________
+
+ Serial No. 110-7
+
+ __________
+
+ Printed for the use of the Committee on Education and Labor
+
+
+ Available on the Internet:
+ http://www.gpoaccess.gov/congress/house/education/index.html
+
+
+
+
+ U.S. GOVERNMENT PRINTING OFFICE
+33-655 PDF WASHINGTON : 2007
+---------------------------------------------------------------------
+For sale by the Superintendent of Documents, U.S. Government
+Printing Office Internet: bookstore.gpo.gov Phone: toll free (866)
+512-1800; DC area (202) 512-1800 Fax: (202)512-2250 Mail: Stop SSOP,
+Washington, DC 20402-0001
+
+
+
+ COMMITTEE ON EDUCATION AND LABOR
+
+ GEORGE MILLER, California, Chairman
+
+Dale E. Kildee, Michigan, Vice Howard P. ``Buck'' McKeon,
+ Chairman California,
+Donald M. Payne, New Jersey Ranking Minority Member
+Robert E. Andrews, New Jersey Thomas E. Petri, Wisconsin
+Robert C. ``Bobby'' Scott, Virginia Peter Hoekstra, Michigan
+Lynn C. Woolsey, California Michael N. Castle, Delaware
+Ruben Hinojosa, Texas Mark E. Souder, Indiana
+Carolyn McCarthy, New York Vernon J. Ehlers, Michigan
+John F. Tierney, Massachusetts Judy Biggert, Illinois
+Dennis J. Kucinich, Ohio Todd Russell Platts, Pennsylvania
+David Wu, Oregon Ric Keller, Florida
+Rush D. Holt, New Jersey Joe Wilson, South Carolina
+Susan A. Davis, California John Kline, Minnesota
+Danny K. Davis, Illinois Bob Inglis, South Carolina
+Raul M. Grijalva, Arizona Cathy McMorris Rodgers, Washington
+Timothy H. Bishop, New York Kenny Marchant, Texas
+Linda T. Sanchez, California Tom Price, Georgia
+John P. Sarbanes, Maryland Luis G. Fortuno, Puerto Rico
+Joe Sestak, Pennsylvania Charles W. Boustany, Jr.,
+David Loebsack, Iowa Louisiana
+Mazie Hirono, Hawaii Virginia Foxx, North Carolina
+Jason Altmire, Pennsylvania John R. ``Randy'' Kuhl, Jr., New
+John A. Yarmuth, Kentucky York
+Phil Hare, Illinois Rob Bishop, Utah
+Yvette D. Clarke, New York David Davis, Tennessee
+Joe Courtney, Connecticut Timothy Walberg, Michigan
+Carol Shea-Porter, New Hampshire
+
+ Mark Zuckerman, Staff Director
+ Vic Klatt, Minority Staff Director
+
+
+ C O N T E N T S
+
+ ----------
+ Page
+
+Hearing held on March 6, 2007.................................... 1
+Statement of Members:
+ Altmire, Hon. Jason, a Representative in Congress from the
+ State of Pennsylvania, prepared statement of............... 60
+ Hare, Hon. Phil, a Representative in Congress from the State
+ of Illinois, prepared statement of......................... 60
+ McKeon, Hon. Howard P. ``Buck,'' Senior Republican Member,
+ Committee on Education and Labor........................... 4
+ Prepared statement of.................................... 5
+ Miller, Hon. George, Chairman, Committee on Education and
+ Labor...................................................... 1
+
+Statement of Witnesses:
+ Bovbjerg, Barbara D., Director, Health, Education, Human
+ Services Division, Government Accountability Office........ 7
+ Internet link to GAO-prepared testimony, ``Private
+ Pensions: Increased Reliance on 401(k) Plans Calls for
+ Better Information on Fees''........................... 9
+ Butler, Stephen J., president and founder, Pension Dynamics
+ Corp....................................................... 28
+ Prepared statement of.................................... 30
+ Chambers, Robert, Esq., partner, Helms, Mulliss & Wicker,
+ PLLC; chairman, American Benefits Council.................. 22
+ Prepared statement of.................................... 24
+ Hutcheson, Matthew, pension consultant, independent pension
+ fiduciary.................................................. 9
+ Prepared statement of.................................... 10
+
+
+ ARE HIDDEN 401(K) FEES
+ UNDERMINING RETIREMENT SECURITY?
+
+ ----------
+
+
+ Tuesday, March 6, 2007
+
+ U.S. House of Representatives
+
+ Committee on Education and Labor
+
+ Washington, DC
+
+ ----------
+
+ The committee met, pursuant to call, at 11:02 a.m., in room
+2175, Rayburn House Office Building, Hon. George Miller
+[chairman of the committee] presiding.
+ Present: Representatives Miller, Kildee, Payne, Andrews,
+Woolsey, McCarthy, Tierney, Wu, Davis of California, Sestak,
+Yarmuth, Hare, Courtney, Shea-Porter, McKeon, Petri, Ehlers,
+Kline, Marchant, Fortuno, Boustany, Davis of Tennessee, and
+Walberg.
+ Staff present: Aaron Albright, Press Secretary; Tylease
+Alli, Hearing Clerk; Jody Calemine, Labor Policy Deputy
+Director; Sarah Dyson, Administrative Assistant, Oversight;
+Carlos Fenwick, Policy Advisor for Subcommittee on Health,
+Employment, Labor and Pensions; Michael Gaffin, Staff
+Assistant, Labor; Jeffrey Hancuff, Staff Assistant, Labor; Ryan
+Holden, Senior Investigator, Oversight; Brian Kennedy, General
+Counsel; Thomas Kiley, Communications Director; Ann-Frances
+Lambert, Administrative Assistant to Director of Education
+Policy; Danielle Lee, Press/Outreach Assistant; Joe Novotny,
+Chief Clerk; Megan O'Reilly, Labor Policy Advisor; Rachel
+Racusen, Deputy Communications Director; Michele Varnhagen,
+Labor Policy Director; Michael Zola, Chief Investigative
+Counsel, Oversight; Mark Zuckerman, Staff Director; Robert
+Borden, General Counsel; Steve Forde, Communications Director;
+Ed Gilroy, Director of Workforce Policy; Rob Gregg, Legislative
+Assistant; Jessica Gross, Deputy Press Secretary; Taylor
+Hansen, Legislative Assistant; Victor Klatt, Staff Director;
+Lindsey Mask, Director of Outreach; Jim Paretti, Workforce
+Policy Counsel; Molly McLaughlin Salmi, Deputy Director of
+Workforce Policy; and Linda Stevens, Chief Clerk/Assistant to
+the General Counsel.
+ Chairman Miller [presiding]. The Committee on Education and
+Labor will come to order for the purposes of conducting a
+hearing of whether or not hidden 401(k) fees are undermining
+workers' retirement security.
+ This is, again, one of a series of hearings where we are
+looking at the middle class and what we can do to strengthen
+and to cultivate the middle class.
+ And I think that this is a very important hearing, because
+it does deal with the ability of millions of middle-class
+workers, whether or not they will have the ability to put
+together a plan for retirement security and for the maintenance
+of a standard of living that allows them to provide for
+themselves and their families.
+ If you earn your income from a paycheck, the chances are
+that one of the things you are concerned with is trying to put
+enough money away for the golden years. If you use a 401(k) or
+a similar plan to help you save some of that money for
+retirement, then you ought to have all of the information you
+need to make a well-informed decision about what plans and
+investment options will give you the best deal.
+ That is the purpose of this hearing: to examine the growing
+role of 401(k)-style plans are playing in helping people pay
+for their retirement and find out if hidden fees are eating
+into workers' retirement savings account balances without them
+even knowing it.
+ During much of the 20th century, two types of retirement
+plans--Social Security and traditional employment-based pension
+plans--helped to lift older Americans out of poverty and
+allowed American workers to maintain a decent standard of
+living when their working lives were over.
+ But now today, many of those traditional pensions, defined
+benefit plans, are no longer being created. New plans are being
+created or greater reliance is being placed on 401(k) plans,
+and clearly Social Security is now the sole source of
+retirement income for over half of the retirees and the primary
+source of income for two-thirds of all retirees.
+ Luckily, I would say, we have fended off the attacks on the
+program from people who wanted to privatize it, turning it into
+a gamble for retirees, instead of a sure thing. So we now have
+Social Security and 401(k)s.
+ The rub is that 401(k)s were never intended to be the
+primary source of retirement income, either. Today, the average
+balance among private-sector workers is just $28,000, and that
+is a pool of workers that struggle at the end of every month to
+be able to continue to invest in their retirement savings and
+in their ultimate retirement.
+ This morning, we will hear testimony about services that
+are being provided and the fees are being charged. Some of
+these fees are reasonable and necessary, but today we will also
+hear about a dizzying array of terminology, revenue-sharing,
+and wrap fees, finders' fees, shelf space, surrender charges,
+soft dollars, 12(b)(1) fees.
+ We have to ask whether or not all of these fees are
+necessary, and we have to examine whether they are undermining
+the workers retirement security. That is because even a
+seemingly small difference in the fees that workers pay can
+have an enormous difference in the overall size of their 401(k)
+balance.
+ As we will hear later today, a 1 percentage point
+difference in fees can reduce retirement benefits by nearly 20
+percent. So you have a situation where people are struggling to
+put this money away every month, and making the sacrifices that
+go along with that, and yet we see just that 1 percentage
+difference.
+ As a way of an example, if you take one person
+participating in the Thrift Savings Plan, where people who are
+making the same contribution over a 30-year period of time, and
+the other is going into an asset-based fees program, what you
+see here is that at the end of that time, the amount available
+is $175,000, if you had an asset-based fees or 3 percent, and
+$279,000, as you have in the Thrift Savings Plan.
+ Three hundred basis points is not unusual, I am told, but
+as we will hear that from the experts, it creates dramatic
+difference in what people can expect to draw on and how long
+they will expect these funds to last. And so this kind of
+difference insists that we pay attention to this matter.
+ Over the years, I have participated in a number of
+conferences on savings plans, on getting America to save more.
+How do we encourage savers to do this? With tax deductions, and
+tax credits, and all the rest of it, and those are all very,
+very important.
+ But if, in fact, what we see is, after workers with very
+limited resources make the very difficult decision to save
+their money,, the question is, what is the stewardship of that
+money?
+ We understand the laws of the fiduciary relationship and
+the responsibilities of trust to those individuals. But the
+fact of the matter is, it does not appear that that is always
+being honored.
+ The other thing here is that sometimes when people, delve
+into this subject, it is very complicated, as you will start to
+hear when the witnesses start to speak about it. Most of these
+explanations are not written in plain English. Most of these
+explanations are not presented in a matter in which
+participants can understand them.
+ If you go through this information packet for these fees, I
+am sure that either your head will be on your chest, your eyes
+will be glazed over, and you simply will not be able to
+decipher the information that you need as the saver.
+ Now, people will argue that this is for the plans, that the
+plans can look at this and make these determinations. The
+language is complicated; the language in many cases is
+unintelligible; the choices are unknown to the participant at
+many levels.
+ And so what we have is a situation where people work very
+hard, make the decision we want them to make, to set aside
+money for their retirement, and what they find out is there is
+a lot of people who are putting their hands into that money in
+the names of fees, commissions, all of the terms that I used
+before.
+ And what happens at the end of the year, what happens at
+the end of 10 years and 20 years and 30 years is that a
+remarkable amount of the assets that could have been available
+for retirement have leaked out of that fund to the benefit of
+others.
+ We will remember through the course of this hearing and of
+future hearings, the only source for all of the fees and the
+commissions is the hard-earned retirement dollars that these
+people have set aside and that their employers have contributed
+to, in some cases. All of the fees, all of the commissions are
+derived from that source of money.
+ And that is what makes, I believe, this hearing so
+critical, on what we might do, what we should consider, in
+terms of further disclosure, and further transparency, and
+certainly to make it more understandable for middle-class
+families, as they consider the choices that they have to build
+that retirement nest egg, using the 401(k) plan.
+ So I look forward to hearing the witnesses.
+ And at this time, I would like to recognize Mr. McKeon, the
+senior Republican on the committee, and then I will--hope
+springs----
+ [Laughter.]
+ I don't want you to characterize the hope I have. It is
+truly mine. But at that time, then I will introduce the
+witnesses.
+ Mr. McKeon?
+ Mr. McKeon. Thank you, Mr. Chairman. And thanks for the
+reprieve.
+ As you know, this committee is no stranger to the issue of
+retirement security. And in fact, I would say we have proven
+ourselves the House's leader on this important issue.
+ In the long term, I believe the pension legislation we
+enacted last year will prove to be one of the most meaningful
+reforms of the 109th Congress. And the fact that we were able
+to do it in a bipartisan way, with 76 Democrats supporting the
+bill, and in an election year, no less, demonstrated what a
+bottom-line issue this is to workers, retirees and taxpayers.
+ We should not forget that those pension reforms were set in
+motion right there in this committee room. And though we did
+not have universal agreement at the end of the process or even
+as little as a comprehensive alternative plan from the other
+side of the aisle, we did produce what has become the most
+fundamental overhaul of the private pension system in more than
+a generation.
+ Indeed, the ground work for today's hearing and those that
+may follow has clearly and concretely been laid by our previous
+work. The issue before us is one that has become increasingly
+important, because defined contribution plans are clearly the
+future of our retirement security system.
+ In fact, in addition to the new safeguards we put in place
+last year to bolster the traditional defined benefits system, I
+believe two of the most important aspects of our pension reform
+bill focused on 401(k) plans.
+ First, we established new auto-enrollment procedures to
+increase the number of 401(k) participants. And, secondly, we
+fixed a flaw in outdated pension law that barred workers from
+receiving high-quality, independent investment advice as an
+employee benefit.
+ Years from now, I believe we will look back upon these
+reforms as a starting point or a turning point, placing more
+power than even before in the hands of workers, as they make
+decisions about their retirement.
+ This morning, as we look at potentially tweaking 401(k)
+rules, I will say what I said during the pension reform debate
+from the last Congress: Our first principle must be to do no
+harm. The pension bill we passed last year took years to get
+ready for the president's signature, and for good reason. We
+did not want to do anything that would force employers out of
+this voluntary system, nor did we want to take any action that
+would have discouraged retirement savings or investment,
+unintended consequences that we fought vigorously to avoid.
+ This should be guiding philosophy once again this time
+around. For example, if we are considering whether to place
+additional requirements upon plan sponsors on top of those we
+already established a year ago, we must do so with great
+caution, as the financial futures of millions of workers and
+retirees depend upon it.
+ At the outset of this hearing process, I also believe that
+it is vital to understand the delicate balance that exists
+within our retirement security system. For instance, workers do
+have a responsibility to make certain decisions involving their
+savings. Likewise, I believe we all must recognize that the
+topic of today's hearings, the 401(k) fees, are one of many
+factors, such as the historical performance and investment risk
+for each plan option, which plan participants do have
+responsibility to consider when investing in a 401(k) plan.
+ Now, do we want to or expect workers to be completely on
+their own? Of course not. No one believes that. But at the same
+time, we must resist the urge to simply overload workers with
+information. That little prospectus that you held up a while
+ago, one of the reasons that that is so thick and cumbersome is
+regulations and laws that we have passed here.
+ We must not mandate the distribution of out-of-context
+information that may lead participants to poor investment
+choices. A quick fix like that may help some of us feel good
+about ourselves, but it would do great harm to workers and
+retirees, which as I said is what we must seek to avoid.
+ Mr. Chairman, I believe our time together today will serve
+to start the process of deliberately and thoughtfully examining
+whether changes to federal law are necessary to provide greater
+information to plan participants. I enter it with an open mind,
+just as I am sure you and all of our colleagues do.
+ I appreciate our witnesses taking the time to be with us
+today, and I look forward to their testimony.
+ Thank you.
+ [The prepared statement of Mr. McKeon follows:]
+
+Prepared Statement of Hon. Howard P. ``Buck'' McKeon, Senior Republican
+ Member, Committee on Education and Labor
+
+ Chairman Miller, as you know, this Committee is no stranger to the
+issue of retirement security, and in fact, I'd say we have proven
+ourselves the House's leader on this important issue. In the long-term,
+I believe the pension legislation we enacted last year will prove to be
+the most meaningful reforms of the 109th Congress. And the fact that we
+were able to do it in a bipartisan way--with 76 Democrats supporting
+the bill, and in an election year, no less--demonstrated what a bottom
+line issue this is to workers, retirees, and taxpayers.
+ We should not forget that those pension reforms were set in motion
+right here, in this Committee room, and though we did not have
+universal agreement at the end of the process--or even as little as a
+comprehensive alternative plan from the other side of the aisle--we did
+produce what has become the most fundamental overhaul of the private
+pension system in more than a generation. Indeed, the groundwork for
+today's hearing and those that may follow has clearly and concretely
+been laid by our previous work.
+ The issue before us is one that has become increasingly important
+because defined contribution plans are clearly the future of our
+retirement security system. In fact, in addition to the new safeguards
+we put in place last year to bolster the traditional defined benefit
+system, I believe two of the most important aspects of our pension
+reform bill focused on 401(k) plans.
+ First, we established new auto-enrollment procedures to increase
+the number of 401(k) participants, and secondly, we fixed a flaw in
+outdated pension law that barred workers from receiving high-quality,
+independent investment advice as an employee benefit. Years from now, I
+believe we will look back upon these reforms as a turning point,
+placing more power than ever before into the hands of workers as they
+make decisions about their retirement.
+ This morning, as we look at potentially tweaking 401(k) rules, I
+will say what I said during the pension reform debate from the last
+Congress: our first principle must be to do no harm. The pension bill
+we passed last year took years to get ready for the President's
+signature, and for good reason. We did not want to do anything that
+would force employers out of this voluntary system, nor did we want to
+take any action that would have discouraged retirement savings or
+investment--unintended consequences that we fought vigorously to avoid.
+ This should be our guiding philosophy once again this time around.
+For example, if we are considering whether to place additional
+requirements upon plan sponsors--on top of those we already established
+a year ago--we must do so with great caution, as the financial futures
+of millions of workers and retirees depend upon it.
+ At the outset of this hearing process, I also believe that it is
+vital to understand the delicate balance that exists within our
+retirement security system. For instance, workers do have a
+responsibility to make certain decisions involving their savings.
+Likewise, I believe we all must recognize that the topic of today's
+hearing--401(k) fees--are one of many factors, such as the historical
+performance and investment risk for each plan option, which plan
+participants do have the responsibility to consider when investing in a
+401(k) plan.
+ Now, do we want to--or expect--workers to be completely on their
+own? Of course not; no one believes that. But at the same time, we must
+resist the urge to simply overload workers with information--or worse,
+to mandate the distribution of out-of-context information that may lead
+participants to make poor investment choices. A quick fix like that may
+help some of us feel good about ourselves, but it would do great harm
+to workers and retirees, which--as I said--is what we must seek to
+avoid.
+ Mr. Chairman, I believe our time together today will serve to start
+the process of deliberately and thoughtfully examining whether changes
+to federal law are necessary to provide greater information to plan
+participants. I enter it with an open mind, just as I am sure you and
+all of our colleagues do. I appreciate our witnesses taking the time to
+be with us today, and I look forward to their testimony.
+ ______
+
+ Chairman Miller. Thank you.
+ Our panel this morning is a distinguished panel with a long
+history in this subject.
+ And first witness will be Barbara D. Bovbjerg, who is the
+director of education, workforce and income security issues at
+the U.S. Government Accountability Office. At the GAO, she
+oversees evaluative studies on age and retirement income policy
+issues, including Social Security, private pension programs,
+and the operation and managements at the Social Security
+Administration, the Pension Benefit Guaranty Corporation, the
+Employee Benefits Security Administration of the Department of
+Labor.
+ Matthew D. Hutcheson is an independent pension fiduciary.
+He is the author of a text, ``Retirement Plan Compliance and
+Reporting,'' at Texas Tech University's International
+Foundation for Retirement Education. He is also a member of the
+Board of Standards at the American Academy of Financial
+Management. His clients include the plans of Fortune 100, 500
+and 1,000 companies, mid-and small-size companies, government
+and legal and accounting firms.
+ Mr. Robert Chambers is a partner in the Employer Services
+Practice Group, of the Charlotte-based law firm of Helms,
+Mulliss & Wicker. And his practice emphasizes executive
+compensation and employee benefit law. Mr. Chambers is a member
+of the taxation, business and law, and employment law sections
+of the American Bar Association and serves on several
+committees within those sections. He is the chairman of the
+American Benefits Council, an employee-benefit lobbying firm in
+Washington, whose members either employ or administer plans for
+more than 100 Americans, and a 1971 graduate of Princeton
+University.
+ Mr. Stephen J. Butler is the founder and president of the
+Pension Dynamics Corporation retirement plan administration
+firm in Pleasant Hill, California. In April 1997, Money
+magazine published Mr. Butler's article entitled, ``Beware:
+Retirement Plan Rip-offs.'' Mr. Butler has also written two
+books on 401(k) plans, the most recent being one titled
+``401(k) Today,'' published in 1999. For the past 7 years, he
+has been a weekly columnist covering retirement-related
+financial interests and has been quoted extensively in Fortune
+and Money, the Wall Street Journal, New York Times and numerous
+other publications.
+ So, Ms. Bovbjerg, we will begin with you.
+ And you know the rules here, but for the other witnesses,
+the green light will be on for 5 minutes, then it will turn to
+orange, which we will ask you to start summing in, and then
+red, if you can wrap your remarks so that we will have time for
+questions.
+ Thank you.
+
+STATEMENT OF BARBARA D. BOVBJERG, DIRECTOR, HEALTH, EDUCATION,
+ HUMAN SERVICES DIVISION, GOVERNMENT ACCOUNTABILITY OFFICE
+
+ Ms. Bovbjerg. Thank you, Mr. Chairman, Mr. McKeon, members
+of the committee.
+ I am pleased to be here today to speak about 401(k) plans.
+And in these plans, participating workers are responsible for
+choosing how much of their earnings to contribute, how to
+invest these contributions, and how to manage the resultant
+accumulation in retirement.
+ Today, I would like to describe trends in the use of
+401(k)s and summarize our recent report about fees associated
+with these plans. Fees are one of the aspects of 401(k)s that
+workers should know about and understand in order to ensure
+adequate income from the plan when they retire.
+ First, the trends. 401(k)s are defined contribution, D.C.,
+plans, meaning that benefits are based on contributions to
+accounts and investment returns that accrue. Historically,
+pension benefits were provided through defined benefit, D.B.,
+plans, which provide a fixed level of monthly retirement income
+for life, based on salary, service and age of retirement.
+ Since 1985, the number of D.C. plans and participants has
+risen dramatically, while the number of D.B. plans and workers
+covered by them has fallen. Today, there are about 700,000 D.C.
+plans, covering 55 million workers, and D.C. plans now hold the
+majority of pension fund assets.
+ 401(k) plans are an important part of this gross. Although
+they were once relatively rare, today they predominate among
+D.C.-type plans. In 1985, they were only about 7 percent of all
+D.C. plans, but now account for almost 95 percent. In 20 years,
+the number of participants in these plans has grown from 7
+million to 47 million workers, and assets held by these plans
+rose from $270 billion to about $2.5 trillion.
+ 401(k) plans are popular with many workers, in that they
+are portable, which D.B.'s are generally not, and they are
+easier to understand than typical D.B. plans. Yet 401(k)s also
+place responsibilities on workers that D.B. plans do not.
+ The majority of 401(k) plans are participant-directed.
+Because so much rides of workers' decisions with regard to
+their 401(k) saving, it is crucial that workers have
+information to help them make wise choices.
+ There are many factors that a worker should take into
+account, one being the fees associated with the plan. So let me
+turn now to issues regarding fees.
+ Fees are important factors in 401(k)s because, in general,
+the higher the fee, the less savings will accumulate in the
+course of a working lifetime. Although various fees pertain to
+401(k)s, investment fees account for the largest portion of the
+total. These pay for services including selecting the plan's
+portfolio of securities and managing the fund.
+ Plan record-keeping fees are the next largest. These are
+usually charged by the service provider to set up and maintain
+the plan. Whether and how participants or plan sponsors pay
+these fees varies by the type of fee and the size of the plan.
+ Investment fees are usually charged at the 6 percentage of
+assets and netted from investment return, while record-keeping
+fees may be charged as a percentage of assets, or as flat fees.
+These fees are increasingly being paid by participants, rather
+than by sponsors. ERISA requires that sponsors disclose a range
+of information about plans, but only limited information about
+fees.
+ Although plan sponsors may voluntarily provide information
+on fees, participants may not have a clear picture of all the
+fees they pay, because even the information that is provided
+may be offered in a piecemeal fashion, through plan
+descriptions, fund prospectuses, and fund profiles.
+ Not only do participants not necessarily know what they are
+paying in fees overall, they have no simple way to compare fees
+among investment options within their plan. The Department of
+Labor has authority under ERISA to oversee 401(k) fees and fee
+arrangements among plan service providers, but it lacks
+information sufficient to provide effective oversight.
+ Labor must ensure that fees are paid with plan assets, are
+reasonable, and that sponsors report information known about
+business arrangements involving service providers. But it is
+difficult for Labor to monitor fees that are netted out of
+returns and are not required to be reporter. Further, fee
+arrangements between service providers are sometimes hidden
+from the sponsor and can mask a conflict of interest that could
+affect the plan.
+ Labor has initiatives under way to improve the disclosure
+of fee information to participants, as well as in required
+reporting to Labor itself, and to spell out what information
+sponsors need to obtain from service providers.
+ In conclusion, 401(k) have emerged as the primary type of
+pension plans for American workers, yet requirements for
+reporting information workers should have to manage these types
+of plans has not fully caught up to the need. Fee information,
+in particular, needs to be more widely available, more
+comprehensive, and more clearly presented.
+ GAO has recommended that measures be taken by both Labor
+and the Congress to help make this information more accessible
+and, in so doing, help protect workers' retirement savings.
+ This concludes my statement, Mr. Chairman. I welcome any
+questions and hope that my full statement will be included in
+the record.
+ [The Internet link to GAO-prepared testimony, ``Private
+Pensions: Increased Reliance on 401(k) Plans Calls for Better
+Information on Fees'' follows:]
+
+ http://www.gao.gov/new.items/d07530t.pdf
+ ------
+
+ Chairman Miller. Thank you.
+ For all the witnesses, your statement, all your written
+material will be put in the record in its entirety.
+ Mr. Hutcheson?
+
+STATEMENT OF MATTHEW HUTCHESON, PENSION CONSULTANT, INDEPENDENT
+ PENSION FIDUCIARY
+
+ Mr. Hutcheson. Chairman Miller, Congressman McKeon and
+members of the committee, from personal experience and research
+as an independent fiduciary, I believe the retirement income of
+America's workforce has been unnecessarily reduced due to
+confusion caused by blending fiduciary and non-fiduciary
+practices.
+ Many billions more should be available for health care and
+prescription drugs, home repairs, and basic living necessities.
+Instead, these sums line the pockets of others.
+ Conventional 401(k) plans now cost around 3 percent of plan
+assets per year to manage. Some are even as high as 5 percent.
+In my experience, that is 1.5 to 3.5 percent more than is
+reasonably necessary.
+ To put this into perspective, just 1 percent in excess
+costs to plan participants, having $2.5 trillion in 401(k) plan
+assets, represents a wealth transfer of $25 billion to others
+each and every year. A large portion of the costs of
+conventional 401(k) plans relate to services that have little
+or nothing to do with building and protecting the retirement
+income security and, hence, are excessive.
+ Take an average participant with a $30,000 account balance,
+contributing $150 per pay period. If this person earns an
+average of 8 percent over a 25-year time period, he or she will
+have accumulated over $500,000. However, add an additional 1
+percent in annual fees, and the account balance drops nearly
+$85,000. Add 1 percent more, and the account balance drops
+$150,000.
+ This translates into approximately $540 per month in
+retirement income loss. This loss can be prevented, and it
+begins by enlightening plan sponsors about the realities of
+401(k) plan economics. When we buy bread, we know exactly how
+much it costs: One dollar buys one dollar's worth of bread.
+However, when it comes to 401(k) plans, the sticker price is
+advertised at 50 cents, yet the actual cost may be closer to
+three dollars.
+ Fiduciaries simply cannot make good decisions when the
+costs of services are undisclosed. There are at least seven
+types of hidden fees or costs borne by plan participants. These
+range from brokerage fees, shared between the broker and an
+investment fund, to record-keeping subsidies between a mutual
+fund a third-party administrator.
+ Contrary to fiduciary principles, some of the fees borne by
+participants are for services they do not receive. It is costly
+and unnecessary to offer a wider variety of investment
+alternatives than is absolutely necessary to construct a
+prudent, low-cost portfolio.
+ The more fund choice is offered, the more mistakes
+participants make. Employees tinker with the investment within
+their accounts, incurring hidden trading costs that reduce
+their returns.
+ The current 401(k) environment encourages mistakes, for no
+good or necessary reason. The brokerage and investment fund
+industries understand and count on participants making
+imprudent investment decisions. They rely on fiduciary
+ignorance to generate revenue. This is a substantial and hidden
+cost about which participants are almost universally unaware.
+ An efficient, low-cost, market-tracking portfolio could
+easily and fairly be put in place for all participants. To my
+astonishment, the industry persists in the assertion that,
+without higher fees, they cannot deliver the desired services.
+ This is the heart of the matter: It is the services or plan
+options that are excessive, and those services or options are
+not always necessary for protecting participants' retirement
+income. Because 401(k) participants own stocks and bonds,
+constituting $2.5 trillion, it is essential that plans be
+managed by individuals who understand and uphold the standards
+of fiduciary care and loyalty.
+ In conclusion, it is incumbent upon us to be absolutely
+certain there are no unnecessary obstacles, whether intentional
+or unintentional, to the long-term success of our private
+retirement system. American workers deserve proper protections
+for the hard-earned savings they have set aside in their 401(k)
+plans, but these protections have been largely denied in the
+current state of the industry.
+ I believe in implementing simple solutions. Change will
+require exposing and confronting powerful economic interests
+that support the current system. It is daunting to tackle this
+vital issue, affecting millions now and in generations to come.
+Despite the forces arrayed against change, America's workers
+deserve better than they have received to date from the
+providers of 401(k) services.
+ Thank you.
+ [The statement of Mr. Hutcheson follows:]
+
+ Prepared Statement of Matthew Hutcheson, Pension Consultant,
+ Independent Pension Fiduciary
+
+Introduction
+ Very few matters of social importance are more complex than the one
+before you today. This particular issue is not only about uncovering
+obscure dollars unscrupulously extracted from the account balances of
+America's workforce, but it is also about correcting the culture that
+has permitted the problem to thrive in the first place. This written
+testimony will explain what the culture is, why it exists, how it has
+evolved over time, how it violates basic economic principles, the
+integrity of rules of fiduciary prudence, the exclusive benefit rule
+under ERISA, and other common sense practices that are critical for
+delivery of expected results from employer defined contribution
+retirement plans.
+The American Worker Is Hurt by What He Can't See
+ ``If we make a few rough calculations, the importance of the topic
+will be very clear. The SEC estimates in Concept Release 33-8349, that
+1% of the average mutual fund's investment return disappears each year
+due to brokerage expense, execution costs, and transaction spreads.
+Other industry sources indicate that an additional .50% slips away via
+``revenue sharing payments.'' The impact on the average American is
+profound.
+ ``Consider two thirty year old workers who each invest $3,000
+annually into their 401(k) programs. American #1's 401(k) program is
+run according to stringent fiduciary principles and earns 7.5%
+annually. However, American #2's 401(k) is operated by conflicted,
+sales driven entities and only earns 6% annually after the
+aforementioned return erosion. The table below details the results.
+
+
+
+----------------------------------------------------------------------------------------------------------------
+ American #1--
+ Year Fiduciary 401(k) American #2--Hidden
+ Earning 7.5% Fee 401(k) Earning 6%
+----------------------------------------------------------------------------------------------------------------
+10................................................................ $45,624 $41,915
+20................................................................ $139,658 $116,978
+30................................................................ $333,463 $251,405
+40................................................................ $732,902 $492,143
+47................................................................ $1,244,260 $766,694
+----------------------------------------------------------------------------------------------------------------
+
+ ``Even though both employees contributed the same amount and took
+the same investment risk, American #2 must work an additional seven
+years to make up for the lack of fiduciary oversight in his 401(k)
+plan.''\1\
+ The difference in hidden fees costs American worker #2 nearly
+$500,000 during the illustrated period of time. This issue is about
+real people, real money, and the quality of their lives later in life.
+Consider the impact on American worker #2's ability to pay for health
+care, prescription drugs, home repairs or even groceries. If actuarial
+tables hold true, today's retiree may need to be prepared to live a
+quarter century longer than his grandparents did.
+Background
+A ``401(k)'' is a Qualified Retirement Plan
+ Qualified retirement plan assets pursuant to Internal Revenue Code
+(``IRC'') section 401(a) are held in trust pursuant to IRC Sec. 501(a )
+exclusively for the future benefits of participants and beneficiaries.
+There are three types of ``qualified'' plans.
+ Stock bonus
+ Pension, and
+ Profit sharing
+ A 401(k) plan, as we call it, is actually a profit sharing plan (in
+most cases) \2\ that has a feature allowing employees to take wages and
+bonuses in cash, or defer them into the profit sharing plan, and hence
+are often referred to as ``employee deferrals.'' However, those
+employee deferrals are technically ``employer'' contributions made
+pursuant to a ``cash or deferred election.'' Deposits of all employer
+contributions, including employee deferrals, plus investment earnings
+of ``401(k)'' plans are subject to the same rules of trust
+administration, governance, and fiduciary prudence which apply to stock
+bonus and traditional pension plans.
+ERISA--Employee Retirement Income Security
+ The purpose of a retirement plan, including 401(k) plans, is to
+provide future income for retired American workers. Those who are
+charged with the management of a qualified retirement plan must do so
+with an eye single to this purpose and none other. Such an individual
+is a ``fiduciary.''
+Rules of Fiduciary Prudence
+ As it relates to the issue at hand, the following fiduciary axioms
+have consistently held true:
+ Fiduciary based decisions secure future retirement income.
+ Non-fiduciary based decisions diminish future retirement
+income.
+ Hidden and excessive fees exist because both types of
+decisions (fiduciary based and non-fiduciary based) exist
+simultaneously within 401(k) and other similar plans, complicating and
+obscuring a fiduciary's ability to understand his duties and to
+properly discharge them.
+ This written testimony will focus solely on 401(k) and similar plan
+assets held in trust, pursuant to IRC Sec. 501(a). Therefore, rules of
+Fiduciary Prudence are a fundamental component of this discussion
+because trusts are governed and managed by fiduciaries. True prudent
+practices should deliver optimal results. Poor or partial fiduciary
+practices will deliver sub-optimal or even poor results.
+ Fiduciary principles and ideals are not obscure, nor are they
+difficult to learn and understand. In fact, modern rules of fiduciary
+prudence have existed for nearly two hundred years. However, in the
+United States, the primary way fiduciary responsibilities are taught to
+sponsors of retirement plans is through the financial industry. Since
+an important element of fiduciary governance is monitoring those who
+provide services to a retirement plan, strangely enough, we have
+accepted a system where those being monitored are teaching those who
+are doing the monitoring, and doing so according to their philosophies
+and standards, with a particular objective in mind.
+ The current 401(k) culture essentially couples the ``fox teaching
+the rooster how to guard the hen house'' with a perceived governmental
+``get out of jail free card'' (i.e. DOL regulation 404(c)). The effect
+of adopting these two ``cultural'' elements has, over time, caused
+401(k) plans to be governed through the commingling of fiduciary and
+non-fiduciary practices and philosophies.
+ Therefore, resolving the issue of hidden, obscure, and excessive
+fees is wholly dependent on bifurcating fiduciary elements and
+practices from the non-fiduciary ones within the 401(k) industry. Then,
+logic will reveal that any fees paid for non-fiduciary services and
+practices are unnecessary, and hence excessive. Furthermore, these are
+the fees that are hidden because they simply cannot be justified when
+viewed through the lens of true fiduciary prudence. In short, if
+fiduciaries eliminate non-fiduciary practices in their 401(k) plans,
+they will immediately eliminate hidden and excessive fees. To argue
+otherwise would suggest that 401(k) plans are only ``partially''
+subject to fiduciary prudence, and hence are only a ``partially''
+qualified plan.
+ Conceptually, it is as simple as that--but in practice, it is far
+more difficult.
+Complexity
+ The hidden fee problem in 401(k) and similar plans is actually a
+mysterious Gordian Knot consisting of trust law, tax law, public
+policy, doctrines of fiduciary prudence, financial principle, economic
+principle, and perhaps the lack of discipline to defer control and
+gratification until actual retirement. It is difficult to see the ends
+of the rope, and very few know how to unravel it. In addition, many who
+might discern how to unravel it have strong incentives not to do so.
+ It is widely accepted that 401(k) and similar arrangements are the
+way most Americans will invest for retirement. Therefore, it is
+incumbent upon us all to be absolutely certain there are no unnecessary
+obstacles (whether intentional or unintentional) to its long-term
+success. As it stands today, there is an imbalance between prudent
+practices aimed at efficiently securing the retirement income of
+America's workforce, and non-fiduciary services created for business
+purposes between competing service providers in the private sector.
+Obstacles to a Clear Understanding
+ Conflicting Governmental messages that confuse
+qualification rules under IRC Sec. 401(a) with rules of fiduciary
+prudence and process as defined by Department of Labor regulation, case
+law, and other regulatory pronouncements.
+ ``Exemptions'' given to non-fiduciary firms or individuals
+to receive compensation from trust assets without being legally held to
+a fiduciary standard of conduct. In other words, non-fiduciary
+involvement in 401(k) plans has created a non-fiduciary operating
+environment.
+ ERISA has imposed a federal fiduciary duty and
+responsibility on business executives and board directors who serve as
+``ERISA Fiduciaries'' requiring them to act exclusively in the best
+interest of plan participants and beneficiaries. A growing chorus of
+benefit industry gurus believes that such executives and directors had
+a pre-existing fiduciary duty and responsibility to the owners of the
+business. Query: Has ERISA unintentionally imposed an incurable
+conflict of interest? That is, can any person faithfully serve the best
+interest of two conflicting masters? Plan participants may believe they
+are out of harm's way and protected, as fiduciary oversight is mandated
+by ERISA, but increasingly these fiduciaries appear to be like a
+sightless watchdog that doesn't bark.
+ Fiduciary ignorance, fear, uncertainty, and doubt, which
+leads to non-fiduciary decisions and practices.
+Identifying non-fiduciary practices, and their associated costs
+ Decisions and/or functions that are clearly fiduciary in nature
+include proactively monitoring costs, selecting a proper number of
+efficient investments necessary to construct an appropriate portfolio,
+and operating the plan in exact accordance to its purpose--which is to
+deliver retirement income to its beneficiaries.
+ Decisions and/or functions that are clearly imprudent include
+purchasing high cost funds when their identical match is available at
+perhaps less than half the cost, or turning a blind eye to obvious
+mishandling of trust assets by non-fiduciaries (i.e. the participants)
+and, at the same time, claiming for themselves protection from
+fiduciary liability under 404(c).
+Fiduciary/Non-fiduciary/``The Gray Area'' (Subject to discernment)
+ There are other decisions and/or functions that fall into a gray
+area. Such decisions or functions might be prudent, or they might not
+be.
+ The significance of this explanation is that some fees are
+obviously necessary and prudent. Some fees are hidden and imprudent and
+pay for excessive or unnecessary services. Finally, there are fees that
+could be improper in some plans, and acceptable in others, and it takes
+an experienced, discerning eye to recognize the differences.
+Excessive is as excessive does
+ The following examples show the interplay between various
+imprudent, hidden, and excessive fees as influenced by the 401(k)
+culture described above.
+ Even at this time, a blatant non-fiduciary based feeding frenzy is
+taking place at the expense of American workers' 401(k) plans.
+ ``The mutual fund industry is now the world's largest skimming
+operation--a $7 trillion (now $12 trillion) trough from which fund
+managers, brokers, and other insiders are steadily siphoning off an
+excessive slice of the nation's household, college, and retirement
+savings.'' \3\ ($12 trillion update added)
+ Most experts agree that trust fiduciary laws are nominally default
+rules,\4\ and hence should be simple to adhere to and operate under.
+However, managing 401(k) plans is anything but simple. It's a jumbled
+mess because non-fiduciary investment sales people have infiltrated,
+and now control what was intended to be a purely fiduciary function.
+ It would be simple to obtain optimal results. Then why isn't it
+happening?
+ For example, the S&P 500 Index consistently outperformed 98% of
+mutual fund managers over the past three years, 97% over the past 10
+years ending October 2004, and 94% over the past 30 years.\5\
+ Recent studies reveal (and many more continue to substantiate),
+that a passive 60% stock, 40% bond portfolio outperformed 90% of the
+nation's largest corporate pension plan portfolios, ``run by the
+world's best and brightest investment minds.'' \6\ The average return
+on actively managed equity mutual funds over the past 35 years trails
+the S&P by 87 basis points per year, and 105 basis points on broader
+indexes. ``Over long periods, this difference in return amounted to
+substantial differences in wealth.'' \7\ This is an unnecessary waste
+of participant's hard earned money. ``This is why most academic and
+many professional advisors recommend that the best investment strategy
+is to match the market's performance. You can do this by putting your
+money in a fund that holds all stocks in proportion to their market
+value. Since these index funds do no research and little trading, the
+costs of holding their portfolios are extremely small, some ranging as
+low as 0.10 percent a year.'' \8\
+ Then why do literally hundreds of thousands of 401(k) plan
+fiduciaries do just the opposite? It's because they are ``guided'' to
+particular decisions by non-fiduciaries (i.e. brokers, registered
+representatives, insurance agents, etc.) in pursuit of compensation
+which very frequently is in the form of hidden and excessive fees.
+Making Sense of It All
+ Following are some of the usual hidden costs found in 401(k) plans.
+Hidden Costs #1--Undisclosed Trading Costs
+ The assets held in account for the benefit of participants and
+beneficiaries do not belong to them. These assets are owned by an
+``entity,'' which is the trust. The participants are entitled to future
+benefits from the trust. This is an important concept in trust
+governance. In other words, if the investments belonged to the
+participants right now, there would be no need for fiduciaries.
+Therefore, the fiduciaries are charged with making decisions for the
+future benefit of others, based on what they deem appropriate for the
+participants and beneficiaries, in a similar way a member of the House
+of Representatives makes decisions for their constituents. The decision
+is based upon what they judge to be in their constituents' best
+interests.
+ ``The new prudent investor rule directs the trustee to invest based
+on risk and return objectives reasonably suited to the trust.'' \9\
+ A major flaw in the 401(k) system, therefore, is allowing non-
+fiduciaries (in this instance, plan participants themselves) to control
+trust assets by choosing without skill from a large array of investment
+choices, carefully presented in such a way as to generate additional
+brokerage (trading) commissions by encouraging ``active'' trading
+within participant accounts. In other words, emotional reactions of
+participants who lack investment expertise trigger undisciplined and
+imprudent investment decisions in the trust, when a simple 60/40
+portfolio described above is well within the reach of every single
+participant. The brokerage and mutual fund industries not only fully
+understand that participants are making imprudent investment decisions,
+but are counting on participant ignorance to generate revenue. This is
+a substantial and hidden cost that participants are almost universally
+unaware, and have no concept of how it is reducing the future
+retirement income they would otherwise receive. The average actively
+traded mutual fund experiences approximately 80% turnover per year,
+meaning that 80% of the underlying stocks and/or bonds are sold each
+year. It is estimated that for every 1% in turnover, there is 1% in
+added brokerage commission cost. Hence, the average mutual fund has an
+added cost of .8% (otherwise known as 80 ``basis points.'') This is the
+first hidden and unnecessary cost.
+ It becomes easier to understand why so many 401(k) plans primarily
+offer (1) actively traded mutual funds, and (2) more funds than are
+necessary to construct a prudent, low cost portfolio. It also
+demonstrates rampant ignorance that exists in the fiduciary ranks--in
+plans large and small.
+ ``TheStreet.com profiled a fund last year that had a 5 star rating,
+a 1% expense ratio, and 800 bps in brokerage expense.''\10\
+ Reducing net returns through unnecessary and excessive brokerage
+expenses is a non-fiduciary and imprudent practice that runs counter to
+the principles set forth in ERISA, which is to secure the retirement of
+American workers. Consider the chaos that would result if Congress gave
+each citizen 15 laws to choose from. Individually, we might pick and
+choose those we deem appropriate for us and, in turn, adhere only to
+the particular laws we chose. The principle of fiduciary prudence is
+that fiduciaries make decisions for all individuals to whom they are
+responsible based upon what is in their best interest, whether they
+like it or not. As unpopular as this concept is, we must not equivocate
+on protecting participants and beneficiaries from their own ignorance,
+just as each of you protect your constituents from their ignorance on
+various matters.
+ The current 401(k) culture has eroded the principles of true
+fiduciary governance through the begging, pleading, lobbying, or
+through other ways and means, we have drifted from ``protect and
+nurture their needs'' to ``give them what they want--in fact, let's
+give them even more than what they think they want.''
+Hidden Costs #2--SEC Rule 28(e) ``Soft Dollar'' Revenue Sharing
+ Hidden Cost #2 is symbiotic with Hidden Cost #1 above, and it
+violates fundamental fiduciary rules and significantly hurts
+participants. 28(e) Soft Dollars are generated by active trading within
+mutual funds and similar investment vehicles. Allowing ``Soft Dollars''
+to go ``un-captured'' and credited back to the 401(k) trust is not a
+fiduciary practice, and the historical problems caused by soft dollars
+are self evident.
+ Shortly after the creation of the IRA, but before the creation of
+the 401(k) as we know it, a change occurred within the brokerage and
+mutual fund industry. As part of the Securities Acts Amendments of May
+1975 (SAA '75), fixed commission rates on the purchase and sale of
+securities through brokerage firms were eliminated. The significance of
+the elimination of fixed commission rates would prove to be one of
+several core issues of debate regarding fees in retirement plans. This
+would ultimately allow brokerage firms to charge excess commissions,
+thereby creating ``at play'' revenue that actually belonged to the
+participants, which is commonly referred to as ``soft dollar'' revenue
+or ``SEC Rule 28(e)'' revenue. With hundreds of billions of securities
+trades each year, the revenue made available by SAA '75 would forever
+change the mutual fund and retirement plan industry. These soft
+dollars, coupled with the urgent need to compete in the 401(k) industry
+and the creation of the 12(b)-1 in 1980 created the ``perfect fee
+storm,'' which until now has existed with little or no notice by
+Federal regulators, plan sponsors, participants, or the general public.
+ As a result of the Securities Acts Amendments of 1975, Section
+28(e) was added to the Securities Exchange Act of 1934. With fixed
+commission rates no longer the law, Section 28(e) created a safe harbor
+for brokerage firms who exercise no investment discretion as defined
+under Section 3(a)(35) of the 1934 Act to be able to charge a mutual
+fund a commission that was more than what it costs to actually execute,
+clear, and settle a securities transaction without violating the law or
+fiduciary duties. This excess commission could be used to purchase
+additional services from the brokerage firm in the form of presumably
+valuable investment research. In order to receive protection under the
+safe harbor, the mutual fund must act in good faith to ensure the
+excess commission was ``reasonable in relation to the value of
+brokerage and research services provided by the broker-dealer.'' Since
+a passive indexing approach requires no research and also consistently
+outperforms 90% of actively managed approaches that do require
+research, then what is the value of the research? The 10% that do
+outperform an indexing approach are temporarily fortuitous.\11\ If you
+follow the money, modern investment research exists so 28(e)
+commissions can be captured, not to provide consistent market returns
+to participants.
+ Actively traded funds inherently have higher trading costs. In
+other words, every time a mutual fund manager buys and/or sells the
+underlying securities within the fund, the participants' return is
+decreased by the cost of those trades. Part of the reason for this lies
+in the fact that ``excess'' commissions are being charged for non-
+fiduciary purposes.
+ SEC rule 28(e) encourages turnover and the cost of trading because
+mutual fund managers receive revenue from the brokerage firms for
+clearing the Funds' securities trades. This explains why the
+intelligent approach so widely accepted by the world's most astute
+investing minds is thrown out the window in 401(k) plans. Brokerage and
+Mutual Fund companies work together to generate excess revenue at the
+expense of participants, because they believe they can indiscriminately
+do so, not because it is prudent, intelligent, or advisable.
+ Prior to ERISA, mutual funds used any ``excess'' commission on a
+securities transaction to buy additional goods or services from their
+chosen brokerage firm. For example, if a trade costs 3.5 cents per
+share (trade execution, clearance and settlement), and the brokerage
+fixed commission was 5 cents per share, the excess 1.5 cents could
+either be used to purchase additional goods or services from the broker
+that directly benefited the account holder, or be credited back to
+their rightful owners, the account holders. Excess brokerage
+commissions (28(e) soft dollars) were handled the same way for IRAs and
+qualified plans.
+ After ERISA, the practice of using such soft dollars in IRAs would
+remain the same, but with respect to participants and beneficiaries
+within a qualified 401(k) plan subject to rules of fiduciary prudence,
+a conflict clearly exists with ERISA sections 403(c)(1), 404(a)(1),
+406(a)(1)(D), 406(b)(1) and 406(b)(3).
+ ERISA 403(c)(1) states that the assets of a plan ``shall
+never inure to the benefit of any employer and shall be held for the
+exclusive purposes of providing benefits to participants in the plan
+and their beneficiaries and defraying reasonable expenses of
+administering the plan.'' Significance: Using soft dollars for purposes
+other than for the exclusive purpose of providing benefits to
+participants and beneficiaries and paying operational costs of the plan
+itself is a fiduciary breach.
+ ERISA 404(a)(1) states that a fiduciary must act prudently
+and solely in the interest of the participants and beneficiaries
+Significance: Using soft dollars to buy loyalty of brokerage firms,
+consultants or other parties-in-interest to the plan is a fiduciary
+breach.
+ ERISA 406(a)(1)(D) states that a fiduciary shall not
+transfer to, or use by or for the benefit of a party-in-interest, any
+assets of an ERISA governed plan. Significance: Use of soft dollars
+could effectively be a transfer to a party-in interest, thereby
+creating a fiduciary breach.
+ Due to the lack of oversight of 28(e) Soft Dollar Revenue in
+qualified retirement plans, the Securities and Exchange Commission was
+compelled to address the issue before the Congressional Subcommittee on
+Capital Markets, Insurance and Government Sponsored Enterprises,
+Committee on Financial Services. This occurred on June 18, 2003,
+shortly after H.R. 2420, the ``Mutual Funds Integrity and Fee
+Transparency Act of 2003'' was presented to the House of
+Representatives by Chairman Baker, Ranking Member Kanjorski and other
+members of the Subcommittee. According to the testimony of Paul F.
+Roye, Director, Division of Investment Management of the SEC, the
+Mutual Funds Integrity and Fee Transparency Act would:
+ Provide investors with disclosures about ``estimated''
+operating expenses incurred by shareholders, soft dollar arrangements,
+portfolio transaction costs, sales load break points, directed
+brokerage and revenue sharing arrangements.
+ Provide investors with disclosure of information on how
+fund portfolio managers are compensated.
+ Require fund advisers to submit annual reports to fund
+directors on directed brokerage and soft dollar arrangements, as well
+as on revenue sharing.
+ Recognize fiduciary responsibility and obligations of fund
+directors to supervise these activities and assure that they are in the
+best interest of the fund and its shareholders.
+ Require the SEC to conduct a study of soft dollar
+arrangements to assess conflicts of interest raised by these
+arrangements, and examine whether the statutory safe harbor in Section
+28(e) of the Securities Exchange Act of 1934 should be reconsidered or
+modified.
+ While it is commendable that the SEC has decided to act on this
+issue, 17 years earlier the U.S. Department of Labor issued ERISA
+Technical Release 86-1 notifying the public of this very issue. The
+nature of ETR 86-1 was to ``reflect the views of the Pension and
+Welfare Benefits Administration (PWBA) with regard to `soft dollar' and
+directed commission arrangements pursuant to its responsibility to
+administer and enforce the provisions of Title I of the Employee
+Retirement Income Security Act of 1974 (ERISA).''
+ An excerpt from ETR 86-1 states:
+ ``It has come to the attention of PWBA that ERISA fiduciaries may
+be involved in several types of `soft-dollar' and directed commission
+arrangements which do not qualify for the `safe harbor' provided by
+Section 28(e) of the 1934 Act. In some instances, investment managers
+direct a portion of a plan's securities trades through specific broker-
+dealers, who then apply a percentage of the brokerage commissions to
+pay for travel, hotel rooms and other goods and services for such
+investment managers which do not qualify as research with the meaning
+of Section 28(e). In other instances, plan sponsors who do not exercise
+investment discretion with respect to a plan direct the plan's
+securities trades to one or more broker-dealers in return for research,
+performance evaluation, and other administrative services or discounted
+commissions. The Commission (SEC) has indicated that the safe harbor of
+Section 28(e) is not available for directed brokerage transactions.''
+ Subsequent SEC investigations have shown that illegal ``28(e)''
+revenues have been used by ``non-fiduciary'' consultants to make
+certain services available to mutual funds.
+ Among them:
+ Conferences and other similar group meetings where the
+consultant invites both the ``client'' (i.e. a 401(k) plan sponsor/
+trustees) and representatives of the mutual funds who want to sell
+their funds to the client of the consultant. In other words, the mutual
+fund pays the consultant a significant amount of money to be invited to
+meetings where the consultant's clients will be in attendance.
+ Sales and marketing support to the mutual fund's staff.
+ ``Objective looking'' performance reports that paint the
+mutual fund in the best light, and facilitate the sale of that fund to
+clients of the consultant.
+ Other ``image enhancement'' or ``sales facilitation''
+services.
+ Loyalty of consultant or brokerage firm.
+ 28(e) revenue practices hurt plan participants and their
+beneficiaries, and violate ERISA Sections 403(c)(1), 404(a)(1) and
+406(a)(1)(D). Illegal 28(e) soft dollars are the most difficult fee to
+uncover.
+Hidden Costs #3--Sub-Transfer Agent Revenue Sharing
+ The following is a rather lengthy, but important illustration of
+the widespread practice of subsidized record keeping services through
+excess mutual fund management fees.
+ Envision a meeting among three individuals. An employer with 75
+employees, wanting to design a brand new plan for their employees; a
+Registered Investment Representative; and a Record Keeper commonly
+referred to as a ``Third Party Administrator.'' After the meeting, the
+employer requests formal proposals from the Investment Representative
+and the Record Keeper. They leave the employer's office and agree to
+work together to design a plan that works for all parties. The
+Registered Representative and the Record Keeper collaborate and develop
+two proposals for the employer to consider.
+ The first proposal recommends 6 mutual funds, 4 of which are
+actively traded mutual funds. As a portion/component of the Funds'
+Management Fees, the 4 actively traded mutual funds pay a .5% ``finders
+fee'' of each new dollar invested to the Registered Representative plus
+a .5% trail commission--referred to as a 12(b)-1 commission. (A more
+detailed discussion of 12(b)-1 commission will be forthcoming later in
+this testimony). The Record Keeper proposes a $4,000 base fee per year,
+plus $60 per participant per year, paid by the employer.
+ When the employer does the math, he discovers that if each of his
+75 employees contributed $100 per semi-monthly pay period, the
+Investment Representative would earn $100 x .5% x 75 x 24 = $900 the
+first year, and every year thereafter, plus an additional .5% on the
+accumulating balance. This $900 doesn't seem like much, especially when
+compared to the record keeping fee $8,500 ($4,000 base fee plus $4,500
+(75 participants x $60)).
+
+ SUMMARY OF PROPOSAL A
+----------------------------------------------------------------------------------------------------------------
+ Cost item Investment Record keeping
+----------------------------------------------------------------------------------------------------------------
+Finders Fees...................................................... $900 per year N/A
+Ongoing Commissions............................................... $900 and growing N/A
+Base Fees......................................................... N/A $4,000
+Per Head Charges.................................................. N/A $4,500
+----------------------------------------------------------------------------------------------------------------
+
+ The employer looks at the record keeping fees, squirms a little,
+and quietly questions whether the record keeper's services are really
+worth $8,500 per year. Then he requests Proposal B. Having experienced
+that reaction before, the Investment Representative and the Record
+Keeper are prepared to present something more palatable.
+ The second proposal consists of 12 mutual funds, 9 of which are
+actively traded. To the employer's delight, proposal B seems much
+better. The Investment Representative's compensation remains the same,
+but the Record Keeping fee is cut by 70%! The base fee is reduced to
+$800 per year, and the per-head charge is reduced to $25.
+
+ SUMMARY OF PROPOSAL B
+----------------------------------------------------------------------------------------------------------------
+ Cost item Investment Record keeping
+----------------------------------------------------------------------------------------------------------------
+Finders Fees...................................................... $900 per year N/A
+Ongoing Commissions............................................... $900 and growing N/A
+Base Fees......................................................... N/A $800
+Per Head Charges.................................................. N/A $1,875
+----------------------------------------------------------------------------------------------------------------
+
+ This proposal seemed like the best of both worlds. Twice as many
+mutual fund options for one-third the cost! The employer thinks
+participants will love it, and of course he loves it, too. It doesn't
+occur to the employer that he should question the economics, or whether
+there are fiduciary implications to going with one proposal vs.
+another. It seems like a no-brainer, so the decision is made to go with
+Proposal B.
+ Fast forward 10 years and the employer now has 150 employees, and
+$4 million dollars in the plan. As far as the employer is concerned,
+the economics are still the same as the first day the plan was adopted.
+However, there was an element the employer didn't understand. Remember
+the reaction to the $8,500 fee for record keeping fees? The employer
+wasn't certain if that was a fair fee for services rendered. Maybe it
+was fair, and if that was the case, the employer might have reduced or
+cut-back on various optional ``elements'' of the plan to arrive at a
+fee that seemed appropriate, all services considered.
+ The $2,675 in fees associated with Proposal B seemed about right.
+With the growth of the company and the plan, the fact that plan costs
+also increased went without saying. Looking back at the original
+``deal'', the employer computes the fees and costs as he thinks it
+stands today. All things remain the same except for 150 participants
+instead of 75, and there are $4 million dollars in assets.
+
+ SUMMARY OF COSTS 10 YEARS LATER--PROPOSAL B
+ [The ``believed-to-be'' costs]
+----------------------------------------------------------------------------------------------------------------
+ Cost item Investment Record keeping
+----------------------------------------------------------------------------------------------------------------
+Finders Fees...................................................... $1,800 per year N/A
+Ongoing Commissions............................................... $20,000 growing N/A
+Base Fees......................................................... N/A $800
+Per Head Charges.................................................. N/A $3,750
+----------------------------------------------------------------------------------------------------------------
+
+ Paying the record keeper for such an extensive array of services
+rendered might even be perceived as being a little low. The employer
+intuitively knows the record keeper is worth more than $4,550, but is
+uncertain ``how much more.'' If the record keeper needed more money,
+they would certainly ask for it, and if they don't request more they
+must be satisfied. The employer also notices the Investment
+Representative is now being paid over $20,000--and given all of the
+enrollment and investment education meetings--along with all of the
+reports, trustee meetings, and general education given to the
+fiduciaries, it might seem ``about right.''
+ Luckily for the employer and the participants, the employers' niece
+happened to be a student of fiduciary prudence and retirement plan
+economics and something seemed ``fishy'' to her.
+ After looking into the economics of ``Proposal B'' today, the
+employer's niece reluctantly brought the bad news. Something has gone
+terribly wrong, and the employer is stunned beyond words. Here's how
+the true economics look:
+
+ TRUE ECONOMICS
+----------------------------------------------------------------------------------------------------------------
+ Cost item Investment Record keeping
+----------------------------------------------------------------------------------------------------------------
+Finders Fees...................................................... $1,800 per year N/A
+Ongoing Commissions............................................... $20,000 growing N/A
+Base Fees......................................................... N/A $800
+Per Head Charges.................................................. N/A $30,150
+----------------------------------------------------------------------------------------------------------------
+
+ How could the record keeper be making more money than the
+Investment Representative? Ten thousand dollars more * * * and growing!
+ Remember the ``collaboration'' the Investment Representative and
+Record Keeper originally entered into? Proposal B involved the payment
+of Sub-Transfer Agent fees (Revenue Sharing from the Mutual Funds). The
+increase in funds was not an added benefit to the employer or employees
+as initially believed. Rather, it was a carefully calculated design
+element to capture a particular type of revenue sharing based upon two
+things: (1) The number of funds offered multiplied by (2) the number of
+participants with assets in those funds.
+ Assume in this case 8 of the 9 actively traded mutual funds are
+being utilized by participants. Also assume that the mutual funds each
+pay $22 per participant per year. The true economics are therefore 150
+participants x $22 Sub-Transfer Agent Revenue Sharing x 8 Funds =
+$26,400. When the existing ``per head'' fee paid by the employer
+($3,750) and the base fee ($800) are added to the Revenue Sharing
+number, the new total is $26,400 + $3,750 + $800 = $30,950.
+ The employer is angry for four reasons. First, he feels deceived
+because he didn't understand the true economics of the plan. Second, he
+feels his ability was impeded to prudently judge whether the services
+rendered were worth what the Record Keeper received in actual
+compensation. Third, he understands now that the ``extra'' funds had
+nothing to do with helping participants build a better portfolio. It
+had everything to do with multiplying the potential revenue sharing--
+and that has not helped the participants at all. Fourth, the
+realization that the employer has allowed assets to be improperly spent
+on services with skewed economics might place him squarely in the cross
+hairs of an effective litigator.
+ Such is the nature of hundreds of thousands of 401(k) and similar
+retirement plans across the United States even as you read this.
+What is a Sub-Transfer Agent? (and Sub Transfer Agent Revenue Sharing?)
+ A transfer agent is usually a bank or trust company (or the mutual
+fund itself) that executes, clears and settles a security buy or sell
+order, and maintains shareholder records (i.e. accounts for ``title''
+of the ownership of the shares). When certain functions of the transfer
+agent are sub-contracted to a third party, that third party becomes a
+``sub-transfer agent.'' Within the context of this paper, a sub-
+transfer agent would be one of the following entities:
+ 1. A third party administrator.
+ 2. A bank or trust company performing recordkeeping services.
+ 3. Some other entity tracking the number of shares held for the
+benefit of a specific participant within an individual account plan.
+ Payment to these parties for this sub-contracted service has come
+to be known as ``Sub-Transfer Agent fees.'' Sub-Transfer agent fees
+exist solely to support the participant directed account culture in
+actively managed mutual funds.
+ Sub-transfer agent fees are generally paid as a flat dollar, per-
+participant, per fund. For example, many funds will pay a third party
+administrator $10 per participant, per fund. Other funds will pay a
+percentage of assets--such as 5 to 10 basis points. However, some funds
+pay up to $22 per participant, per fund or 35 basis points. The
+problems with sub- transfer agent fees is not how much is being paid to
+the service provider. Rather, the problem is being unaware who is
+receiving the payments, and whether or not the payments fairly
+represent the value of the service being rendered. The Department of
+Labor has made it very clear that a plan sponsor must understand the
+value and associated compensation of each individual servicing company,
+thereby making the cost of the parts more important than the cost of
+the whole.
+ An estimated 100 million shareholder accounts, or approximately 40
+percent of all mutual funds, are in sub accounts at financial or record
+keeping intermediaries at this writing. Approximately $2 billion
+dollars per year is paid to third parties for sub-accounting services.
+There are potential costly and ERISA-violating problems inherent in
+omnibus accounts with underlying participant directed sub-accounts
+which are beyond the scope of this testimony.
+Hidden Costs #4--Non-Fiduciary Compensation (12(b)-1 commissions)
+ There are two types of 12(b)-1 fees:
+ 1. Sales commission 12(b)-1--paid to a registered representative
+for selling mutual funds for an individual or within a plan.
+ 2. Servicing 12(b)-1--paid to a person or entity who services an
+account after the sale.
+ SEC Rule 12(b)-1 was enacted in 1980. It is partially responsible
+for the proliferation of mutual funds in individual account plans.
+Again, referring to the mutual fund relationship with the distribution
+medium (sales force) of the brokerage firm, it creates a conflict of
+interest between the brokerage firm and the mutual fund, thereby
+rendering each unable to devote their loyalties to the plan
+participants. It permits mutual funds to increase their internal fund
+expense ratio by up to 1% in aggregate.
+ The combination of these two commissions may not exceed 1%. For
+example, the sales 12(b)-1 could be 50 basis points (.5%) and the
+service 12(b)-1 could also be 50 basis points.
+ It is common to refer to both sales and servicing revenue as
+``12(b)-1'' fees, not differentiating between the two. More than half
+of all mutual funds have a 12(b)-1 feature. These commissions are
+disclosed in the prospectus, but very few plan sponsors understand
+their significance to the plan, the participants, and the trustees.
+ The 12(b)-1 commissions are a concern because non-fiduciary sales
+people carefully place products with high 12(b)-1 commissions within
+401(k) plans without the full understanding of the plan sponsor or
+trustees. Conversely, a Fiduciary Investment Advisor would be obligated
+to disclose fees in writing, invoice the plan sponsor or plan for those
+stated fees, and credit any 12(b)-1 fees back to the trust. This clear
+difference in behavior and reporting shows the crisis that exists in
+the industry. Plan sponsors don't know there is a difference; mutual
+funds are simply mutual funds to them.
+ Another seldom considered 12(b)-1 issue is that of unfair subsidy
+disparity. Fee subsidy disparity is often referred to by the fiduciary
+community as the ``Hidden Tax'' paid by participants with larger than
+average account balances because 12(b)-1 commissions pay for non-
+fiduciary services.
+Illustration
+ Let's compare two hypothetical plans, Plan ``A'' and Plan ``B.''
+Let's say each has $50 million in assets, both have identical mutual
+funds and service providers, each paying 3% (1.50% in trading costs,
+and 1.50% in fund management fees). Further, assume that 40% of the
+fund management fee pays for revenue sharing arrangements (brokers,
+record keepers, insurance agents, and others), and 60% is kept by the
+fund manager. Let's also say that Plan ``A'' has 500 employees and Plan
+``B'' has 2,500 employees.
+ Are costs consistent for all employees as a percentage of their
+account balances? Yes, of course. But what are the real economics? Take
+a look at the following example of a comparison between two
+hypothetical plans:
+
+
+
+----------------------------------------------------------------------------------------------------------------
+ Fee/Cost element Plan A Plan B
+----------------------------------------------------------------------------------------------------------------
+Gross fund fees and commissions......................... $1,500,000 ($50,000,000 x $1,500,000 ($50,000,000 x
+ 3%) 3%)
+Revenue sharing......................................... $300,000 (1.50% x 40% x $300,000 (1.50% x 40% x
+ $50,000,000) $50,000,000)
+Revenue Sharing borne by each participant............... $300,000 500 $300,000 2500
+ participants = $600 per participants = $120 per
+ participant participant
+----------------------------------------------------------------------------------------------------------------
+
+ In this example, the participants of Plan ``A'' are subsidizing the
+overhead of Plan ``B.''
+Hidden Costs #5--Variable Annuity Wrap Fees
+ A Variable Annuity is an investment contract between a plan and an
+insurance company where (normally) a series of ongoing deposits are
+made to accumulate resources sufficient to pay a future benefit.
+Variable Annuities can be sold by insurance agents who have little or
+no formal investment or fiduciary training. Variable Annuities are
+separate vehicles that invest in mutual funds--they are not mutual
+funds in and of themselves.
+ Variable annuities offer a variety of investment options that are
+typically mutual funds investing in stocks, bonds and cash. Gains on
+variable annuities are tax deferred whether held in a qualified trust
+or not, and there are costs associated with this ``built-in'' tax
+deferral. The fee associated with obtaining this tax-deferred benefit
+is an insurance component. Therefore, one must ask whether or not
+putting a variable annuity in an ERISA-governed vehicle is necessary,
+or even wise. In other words, you could buy a lower cost mutual fund
+using the inherent benefits of a 401(k) and still get the deferral of
+tax. Paying the insurance company for the tax deferral may not be
+prudent. Variable annuities generally have higher expenses than
+comparable mutual funds, and these fees are assessed in such a way that
+each component service is ``wrapped up'' into one aggregate fee.
+Accordingly, this aggregate fee is called a ``wrap'' fee. The wrap fee
+hides individual component fees and services, which are:
+ Investment Management: Management fees of the mutual fund
+that is contained within the variable annuity. (Note that trading costs
+are in addition to the investment management component, and are
+extremely difficult to discover in variable annuity contracts.)
+ Surrender Charges: If withdrawals are made from a variable
+annuity within a certain period of time after units are purchased
+within the annuity, the insurance company will assess a surrender
+charge. The charge is used to reimburse the insurance company for the
+commission payments they paid to a broker or insurance agent upfront.
+The surrender charge usually starts out higher, and decreases over the
+length of the surrender period.
+ Mortality and Expense risk charge: This charge is equal to
+a percentage of the account value, typically 1.25% per year over the
+investment management fees--but could be more or less depending on who
+is purchasing the annuity.
+ Administrative Fees: The insurer may deduct charges to
+cover record-keeping and other administrative expenses. It is common to
+see fees of $25 or $30 per year, or a percentage of each participant's
+account value, typically in the range of an additional .15% per year.
+ Fees and Charges for Other Features: Stepped up death
+benefit, a guaranteed minimum income benefit, long-term care insurance
+etc. These fees are stated in the annuity contract, and are actuarially
+computed based on age, health, etc., and hence differ from participant
+to participant.
+ Bonus Credits: Some insurance companies offer bonus
+credits, which is a credit back to the account of percentage of each
+purchase--e.g. 3% of each deposit. These types of accounts often have
+higher expenses, and the expenses can be larger than the credit. Bonus
+credits are generally ``purchased'' with higher surrender charges,
+longer surrender periods, higher mortality and expense risk charges.
+Hidden Costs #6--Administrative ``Pass Throughs''
+ An unfortunate and yet almost universally common in 401(k) plans is
+an expense borne by all participants for unnecessary services demanded
+by a vocal minority. A fiduciary is obligated to protect and treat all
+participants equally. It is a violation of ERISA's exclusive benefit
+rule that millions of participants unknowingly pay for the
+undisciplined urges of others to immediately wrest benefit from their
+retirement plans. Three examples are:
+ Easy loans taken against a participant's vested balance
+ Open brokerage options
+ Investment ``advice'' services
+ While some may argue that these plan features are available to all
+participants equally, we must not confuse matters of coverage and non-
+discrimination in benefits rights and features (pursuant to IRC
+Sec. 401(a)(4)) with fiduciary prudence. Plan assets should not be used
+to pay for services that all Participants do not collectively receive
+or benefit from plan assets. In hundreds of thousands of companies
+across the U.S. there are assertive individuals, who are the vocal
+minority, that want various bells and whistles in their 401(k), and the
+unsuspecting end up having to pay for it. This subtle violation of the
+exclusive benefit rule is rampant and costly. Plans with optional
+benefits that increase the overall cost of plan operation should be
+paid for by the individual users or by the plan sponsor, not by the
+plan. These amounts vary from plan-to-plan, but they can be
+substantial, especially if the fees are ``translated'' into an asset
+based charge that goes un-examined year after year.
+Hidden Costs #7--Non-Fiduciary Mish-Mash
+ To wrap up this discussion, it's important to highlight a few
+remaining hidden costs. The following is not an all-inclusive list,
+because there are dozens of variations to each of these items, and even
+a few other costs that are highly complex and difficult to explain.
+These are beyond the scope of this hearing, but might be examined as
+part of a subsequent hearing. Some of the remaining fees and costs
+employers of all sizes are struggling to grasp are:
+ Share class variances based upon plan size. (i.e. high
+load share classes in large plans. Common share classes include A, B,
+C, R, etc.) \12\
+ Shadow Index Funds. These are basically funds that closely
+track passive indexes, but have ``actively managed'' prices. In other
+words, they are overly priced index funds, some overpriced by 200% to
+300%.
+ Suspected Inter-Fund pricing discrimination. (Evidence
+that this practice is now coming to light, but this is so new that
+independent fiduciaries are still trying to grasp the full nature and
+extent of this particular issue.) \13\ This is where a mutual fund cuts
+``deals'' with preferred investors, and increases fees to non-preferred
+clients so that the total fee balances out to what is disclosed in the
+prospectus. For example, a prospectus of a two hundred million dollar
+fund might state that the fund management fee is 1% of assets. The fund
+manager then ``discriminates'' against clients 2--6 by cutting a deal
+with preferred Client 1 that reduces their fee by half.
+
+
+
+------------------------------------------------------------------------
+ Actual
+ Assets fee
+------------------------------------------------------------------------
+Client 1................................... $100,000,000 .50%
+Client 2................................... 20,000,000 1.10%
+Client 3................................... 20,000,000 1.10%
+Client 4................................... 20,000,000 1.10%
+Client 5................................... 20,000,000 1.10%
+Client 6................................... 20,000,000 1.10%
+ ----------------------------
+ Total................................ $200,000,000 1.00%
+------------------------------------------------------------------------
+
+ Clients 2 through 6 are paying for the backroom ``deal'' between
+the fund manager and client 1, and will experience lower returns at the
+same time, a clear example of investment return and cost
+discrimination. Also, other suspected violations of fiduciary prudence
+are coming to light where the ``deal'' isn't with a preferred client,
+but with the Investment Representative. This has even more serious
+implications when proven to be true.
+ Expert fiduciaries are still trying to get their arms around this
+issue. It's such a startling revelation that independent fiduciaries
+don't want to believe it, and hence are trying to find other reasonable
+explanations for their findings, hoping it simply isn't so. However,
+the economics of 401(k) plans are so defiant, entrenched, and arrogant,
+that it might very well be happening more often than one would like to
+think. Like Andrew Fastow, the former CFO of the complex ENRON
+``special purpose entities,'' maybe the industry thought no one would
+ever figure it out.
+ There is more that can and should be shared with legislators about
+other activities in the final markets that adversely affect
+participants and beneficiaries. I hope this testimony provides
+sufficient background to assist in grasping the issues at hand and
+comprehending the necessity of diligently considering possible
+solutions.
+Possible Solutions
+ Require full disclosure of all financial service provider
+costs and expenses. Create stiff monetary sanctions for any person,
+entity, or institution to withhold information from named fiduciaries
+for any qualified plan. This would require full transparency of all
+service provider activities and costs. It would enable fiduciaries to
+better understand the basis for their decisions regarding plan
+operations and investments. With improved understanding, the retirement
+income security of millions of Americans would be enhanced.
+ Require fiduciaries to itemize any and all fees and
+expenses extracted from plan assets at any level, including trading
+commissions, spreads, management fees, soft dollar arrangements,
+finders fees, transfer agent fees, and other expenses, and to disclose
+those directly to participants on the Summary Annual Report. This will
+demonstrate to participants that fiduciaries are aware of the costs the
+plan is bearing, and that they are taking responsibility for those
+costs.
+ Hold all individuals or companies who are paid from plan
+assets to a fiduciary standard. This includes brokers, insurance
+agents, record keepers, actuaries, and others. Those individuals or
+professionals unwilling to assume fiduciary responsibility could
+negotiate payments directly from plan sponsors.
+ Require all mutual funds held in a qualified trust (within
+the meaning of Internal Revenue Code section 501(a)) to be ``revenue
+sharing free'' which would include barring 28(e) soft dollars, 12(b)-1
+marketing or servicing commissions, and sub transfer agent fees. This
+would force the industry to price services based upon what
+knowledgeable fiduciaries determine to be reasonable and appropriate
+and are willing to bear.
+ Eliminate Department of Labor Regulation 404(c). Plan
+sponsors and service providers have hidden behind this regulatory
+allowance as a perceived shield from fiduciary liability while ignoring
+the plight of workers who desperately need guidance and oversight for
+their investments. Rule 404(c) is non-fiduciary at its core, and it
+encourages other decisions that are not in the interests of securing
+the retirement incomes of American workers.
+Conclusion
+ Thank you for the invitation to testify before this committee. It
+is my earnest belief that the workers of America deserve proper
+protections for the hard earned savings they have set aside in their
+401(k) plans--protections which they are denied in the current state of
+the industry. I also believe that the problems with the industry can be
+solved rather simply, though it will require confronting powerful
+economic interests that support the current system. But America's
+workers deserve better than they have received to date from the
+providers of financial services. Finally, thank you for beginning the
+daunting task of tackling this very important and relevant social issue
+that will affect millions in the coming decade. I look forward to
+elaborating on this written testimony in more detail during the
+question and answer period.
+ endnotes
+ \1\ Randy Cloud, founder of CNMLLC. Accredited Investment Fiduciary
+Auditor and a member of the Revere Coalition, a non-profit fiduciary
+advocacy group of independent investment fiduciaries.
+ \2\ Stock bonus plans may also have a 401(k) feature.
+ \3\ Statement by Senate Governmental Affairs Subcommittee on
+Financial Management, The Budget, and International Security. November
+3, 2003, Senator Peter G. Fitzgerald (R- IL)
+ \4\ http://papers.ssrn.com/abstract--id=868761
+ \5\ http://www.ifa.com/Book/Book--pdf/overview.pdf--``Step 5''
+ \6\ Dimensional Fund Advisors, Basic 60/40 Balanced Strategy vs.
+Company Plans 1987-2003. FutureMetrics, 2004.
+ \7\ http://finance.yahoo.com/expert/article/futureinvest/6953--
+``The Truth About Money Management''
+ \8\ Ibid--``The Birth of Indexing''
+ \9\ http://papers.ssrn.com/abstract--id=868761 page 2
+ \10\ ``Fee Forensics, The impact of brokerage expense and trade
+execution in mutual fund portfolios.'' 2005 Annual Conference of the
+Center for Fiduciary Studies. Santa Fe, New Mexico.
+ \11\ http://www.efficientfrontier.com/ef/997/tough.htm
+ \12\ http://www.nasd.com/InvestorInformation/InvestorAlerts/
+MutualFunds/UnderstandingMutualFundClasses/NASDW--006022
+ \13\ The following is a startling quote from an actual Independent
+Fiduciary fee review: ``We find it noteworthy that the funds in the
+Plan are paying out more than half of the revenue they receive for
+`investment management'. In fact, one fund (fund name deleted) is
+paying out 150% of the revenue that it discloses by prospectus. Several
+other funds (mostly name deleted / name deleted funds) pay out more
+than 70% of their receipts. Obviously, this indicates that they may be
+making up their lost revenues in some other manner. We spot checked the
+SAIs of a couple of the Plan's funds and found hidden expenses in
+excess of .50% for transaction expenses. Some portion of this money
+goes back to the manager in one form or another (research services,
+commission rebates, etc.). We estimate that the true investment and
+recordkeeping cost of the plan is significantly greater than the .94%
+that is revealed by the basic plan expense ratios.''
+ ______
+
+ Chairman Miller. Mr. Chambers?
+
+ STATEMENT OF ROBERT CHAMBERS, ESQ., PARTNER, HELMS, MULLISS &
+ WICKER, PLLC; CHAIRMAN, AMERICAN BENEFITS COUNCIL
+
+ Mr. Chambers. Good morning, Chairman Miller, Ranking Member
+McKeon, members of the committee. My name is Robert Chambers,
+and I am a partner in the Charlotte, North Carolina-based, law
+firm of Helms, Mulliss & Wicker. As was noted earlier, I am
+also the chairman of board of the American Benefits Council, on
+whose behalf I am testifying today.
+ The council very much appreciates the opportunity to
+present testimony with respect to 401(k) plan fees. Our goal,
+like yours, is that the 401(k) system remains fair and
+equitable, that it functions in a transparent manner, and that
+it provide meaningful benefits at a fair price.
+ Our members have been successful in obtaining fee
+information and using it to sponsor less expensive and more
+efficient 401(k) programs, and yet, at the same time, we think
+that there is room for improvement through more universal
+disclosure of both fee and other information to both
+fiduciaries and to plan participants.
+ There are three pieces to the fee disclosure puzzle that we
+will be discussing today: one, disclosure by service providers
+to employers and other fiduciaries; two, disclosure by those
+fiduciaries to participants; and, three, disclosure by the
+fiduciaries to the government.
+ Now, this comports with the GAO's recommendations in its
+2006 report, as has previously been mentioned, and with the
+three-part project that the Department of Labor is currently
+pursuing. Admittedly, we have some concerns with some of the
+details in the department's proposals, but we absolutely agree
+with their general approach.
+ Now, I would like to take the rest of my time to raise five
+points that we think, at the council, bear consideration this
+morning.
+ First, the 401(k) plan system in the United States is
+voluntary. It depends on the willingness of employers to offer
+plans and the willingness of employees to use them. Whatever
+fee disclosure reform efforts evolve, they must not undermine
+these basic building blocks.
+ If a new regiment is overly complicated, overly costly,
+some employers will drop their plans. Others will comply and
+pass the costs onto participants, either in the form of plan
+expenses, or perhaps reduced employer contributions.
+ Further, and perhaps most important, many employees will be
+confused by the overemphasis on fees. Compared to equally
+valuable investment consideration, such as diversification,
+actual investment performance, and risk factors, and they will
+either make unbalanced investment decisions or, even worse, a
+decision not to participate at all.
+ Investment education is based on balance, and neither
+Congress, the Department of Labor, nor plan fiduciaries should
+counteract that concept through a disproportionate focus on
+plan fees.
+ Second, every new feature that is added to a 401(k) plan
+adds new costs. There are mandatory bells and whistles, such as
+the benefit statement rules that are new, and permissive bells
+and whistles, such as automatic enrollment. But they are all
+bells and whistles; they have all been adopted by Congress; and
+they all cost money to administer.
+ Additional fee disclosure will also result in additional
+cost. Therefore, we must carefully measure the value of what
+may be gained against the cost of the annual disclosure. Let's
+make sure that our efforts to reduce costs do not, in the end,
+actually reduce savings.
+ Third, in our system of commerce, it is the quality and
+features of a product or service that permit one manufacturer
+or service provider to charge more than a competitor. Some cars
+cost more than others, as do computers, and, unfortunately, my
+plumber.
+ Similarly, 401(k) plan fees should not be evaluated
+independently from the product or service that is provided.
+Every participant would be willing to pay higher fees if the
+total net return on the investment were increased. Enhanced
+disclosure will enable participants to determine whether the
+quality of the product or the quality of the provider warrants
+it cost. The two are inextricably tied to one another.
+ Fourth, we acknowledge that fee levels differ among differ
+plans, just like cable TV service. Some people want only basic
+service; some employers want to provide only a basic 401(k)
+plan. But other folks want hundreds of channels, providing,
+they expect, an even wider spectrum of entertainment. And many
+employers want to provide a similarly broad span of retirement
+plan features for their participants.
+ More bells and whistles, more costs. Enhanced disclosure
+will help participants to make decisions among the choices
+presented.
+ It is also true that many smaller employers pay higher
+401(k) plan fees. This is usually attributable to fewer lives
+over which to amortize fixed costs. We believe that increased
+disclosure will exert downward pressure on fee levels in the
+marketplace.
+ Fifth, and finally, some maintain that revenue-sharing is
+wrong and should be prohibited. People with this view, we
+think, misunderstand how the 401(k) system works. They also
+probably think that Toyota manufactures cars. It does not. It
+assembles cars.
+ No one expects Toyota to manufacture all of the glass, all
+of the seats, all of the computer components for its vehicles.
+They subcontract. And revenue-sharing in the 401(k) context is
+simply a way of paying for subcontracting.
+ One service provider delegates a function to another, who
+is able to perform the function more efficiently and at less
+cost. Revenue-sharing reduces the overall cost of the plan for
+both employers and employees.
+ So, in conclusion, we are very supportive of enhanced
+disclosure of plan fees, but fee disclosure must be addressed
+in a way that does not overemphasize fees relative to other
+factors in the investment decisionmaking process, nor should it
+undermine confidence in the retirement system, or create new
+costs that, in turn, could decrease retirement benefits.
+ I would be happy to answer any questions that you may have.
+ [The statement of Mr. Chambers follows:]
+
+Prepared Statement of Robert Chambers, Esq., Partner, Helms, Mulliss &
+ Wicker, PLLC; Chairman, American Benefits Council
+
+ My name is Robert G. Chambers and I am a partner in the Charlotte,
+North Carolina law firm of Helms Mulliss & Wicker. I have advised
+clients with respect to 401(k) plan issues since 401(k) was added to
+the Internal Revenue Code in 1978. In that regard, my clients have
+included both major employers that sponsor 401(k) plans as well as
+national financial institutions that provide services to 401(k) plans.
+ I am also chair of the board of the American Benefits Council
+(``Council'') on whose behalf I am testifying today. The Council's
+members are primarily major U.S. employers that provide employee
+benefits to active and retired workers and that do business in most if
+not all states. The Council's membership also includes organizations
+that provide services to employers of all sizes regarding their
+employee benefit programs. Collectively, the Council's members either
+directly sponsor or provide services to retirement and health benefit
+plans covering more than 100 million Americans.
+ The Council very much appreciates the opportunity to present
+testimony with respect to 401(k) plan fees. With the decline of the
+defined benefit plan system, 401(k) plans have become the primary
+retirement plan for millions of Americans. Accordingly, it is more
+important than ever for all of us to take appropriate steps to ensure
+that 401(k) plans provide those Americans with retirement security. In
+that regard, our goal is an effective and fair 401(k) system that
+functions in a transparent manner and provides meaningful benefits at a
+fair price in terms of fees.
+We Support Enhanced Disclosure And Reporting Requirements
+ With respect to 401(k) plan fees, we believe that this Committee
+would be pleased by what our member companies are doing. Our members--
+both plan sponsors and service providers--report to us that plan
+fiduciaries are taking extensive steps to ensure that fee levels are
+fair and reasonable for their participants. Plan fiduciaries are asking
+hard questions regarding the various plan services and fees, and the
+fiduciaries are obtaining answers that give them the tools to negotiate
+effectively for lower fees and to provide meaningful information to
+participants. In the case of small plans with less bargaining power,
+plan fiduciaries are using additional fee information to shop more
+effectively for service providers.
+ Are there exceptions to this rosy picture? Of course there are. No
+system functions perfectly. So we need to strive to make the system
+even better. How can we achieve those improvements? The answer is
+conceptually simple: through even more universal disclosure of
+meaningful information. We need to ensure that all plan fiduciaries and
+service providers follow the practices we are hearing about from our
+members. Those practices include disclosure to plan fiduciaries of
+direct and indirect fees that service providers receive from the plan
+or from unrelated third parties. Those practices also include clear,
+meaningful disclosure to participants.
+ In this regard, we commend the Department of Labor and the
+Government Accountability Office (``GAO''). The Department of Labor has
+been working on a three-part project to enhance transparency that is
+conceptually the same as the enhanced regime we are recommending. This
+three-part approach is very similar to the recommendations made by GAO.
+One part would require the type of disclosure by service providers to
+plan fiduciaries that I refer to above. A second part would require
+clear, meaningful disclosure to participants. And a third part would
+require plans to report fee information to the Department. We have
+concerns regarding certain specific points with respect to the
+Department's proposals, but conceptually we are in agreement with the
+general approach. We look forward to a constructive dialogue with the
+Department as its proposals move forward.
+ As described in its letter to GAO regarding plan fees, the
+Department of Labor has already taken a number of steps to improve
+awareness and understanding with respect to plan fees. The Department
+makes available on its website important materials designed to help
+participants and plan fiduciaries understand plan fees. These materials
+include ``A Look at 401(k) Plan Fees for Employees'', which is designed
+to assist participants in selecting investment options. For employers
+and other plan fiduciaries, the Department makes available
+``Understanding Retirement Plan Fees and Expenses'', ``Tips for
+Selecting and Monitoring Service Providers for Your Employee Benefit
+Plan'', and ``Selecting and Monitoring Pension Consultants--Tips for
+Plan Fiduciaries''. In addition, the Department makes available a model
+form--called the ``401(k) Plan Fee Disclosure Form''--that is designed
+to facilitate the disclosure of plan fees by service providers to plan
+fiduciaries and the comparison of these fees. Finally, the Department
+has been conducting educational programs across the country that are
+designed to educate plan fiduciaries about their duties.
+ In short, we believe that the Department of Labor and GAO are
+making, and have been making, important contributions to improving the
+401(k) plan system. In this regard, we are also proud of our own
+efforts to improve fee disclosure, which include working in a
+constructive manner with the Department to help it improve disclosure
+and transparency. For example, recently, a group of associations
+submitted to the Department of Labor an extensive list of fee and
+expense data elements that plan sponsors can use to discuss fees
+effectively with their service providers. (The associations were the
+American Benefits Council, the Investment Company Institute, the
+American Council of Life Insurers, the American Bankers Association,
+and the Securities Industry Association (now the Securities Industry
+and Financial Markets Association).) We view disclosure enhancement as
+a critical part of our mission to strengthen the 401(k) plan system and
+we are committed to continuing to offer our help to this Committee,
+other Committees, and the agencies.
+Addressing Concerns And Questions
+ So far, I have been talking about positive things that can be done
+to improve the 401(k) plan system. Now I would like to touch on
+concerns that I know are shared by this Committee and answer some
+questions that have been raised.
+We Must Not Undermine The Voluntary System
+ The success of the 401(k) plan system is dependent on many things,
+including very notably the willingness of employers to offer these
+plans and the willingness of employees to participate in the plans. It
+is critical that any reform efforts not inadvertently undermine these
+key building blocks of our system. Clear, meaningful disclosure is
+needed; overly complicated and burdensome disclosures would only push
+employers and service providers away from the 401(k) plan system. In
+particular, burdensome rules would be yet another powerful disincentive
+for small employers to maintain plans. Overly complicated disclosure
+would also confuse rather than inform participants; participants need
+clear meaningful information that is relevant to their decision-making.
+ In addition, employee confidence is critical to their participation
+in the system. If the huge number of employees participating in well-
+run efficient 401(k) plans hear only about the 401(k) plan problems and
+do not hear about the strengths of the system, their confidence will be
+eroded, their participation will decline, and their retirement security
+will be undermined.
+We Must Not Inadvertently Increase Fees In The Effort To Reduce Them
+ Every new requirement imposed on the 401(k) plan system has a cost.
+And generally it is participants who bear that cost. So it would be
+unfortunate and counterproductive if a plethora of new complicated
+rules are added in an effort to reduce costs, but the expense of
+administering those new rules actually ends up adding to those costs.
+The Department of Labor has explicitly raised this exact concern. In
+its letter to GAO regarding the GAO plan fee report, the Department
+noted that its own fee disclosure project must be designed ``without
+imposing undue compliance costs, given that any such costs are likely
+to be charged against the individual accounts of participants and
+affect their retirement savings.''
+ In this regard, it is important to recognize a key point noted in
+the GAO report. In the course of numerous plan fee investigations
+conducted by the Department of Labor in the late 1990's, no ERISA
+violations were found with respect to 401(k) plan fees. Moreover, the
+Department of Labor receives enforcement referrals from various
+entities, such as federal and state agencies. The GAO report notes that
+``only one of the referrals that the [Department of Labor] has closed
+over the past 5 years was directly related to fees'' (emphasis added).
+In the context of these facts, imposing burdensome new rules and costs
+to be borne by participants would be even less justified.
+Fees Can Only Be Evaluated In The Context Of The Services They Pay For
+ Another critical point to bear in mind is that we must not examine
+fee amounts out of context. Any specific fee can only be effectively
+evaluated in the context of the quality of the service or product that
+is being paid for. For example, some actively managed investment
+options may logically have higher than average expenses, but it is the
+net performance of the option that is critical to retirement plan
+sponsors and participants, not the fee component in isolation. We must
+avoid studying fees in a vacuum. Fees are very important, but they are
+only one component of performance; with respect to investments, other
+key components include minimization of risk, diversification, relative
+peer group performance, quality of the investment organization, and, of
+course, investment return. Our objective should be excellent
+performance and service at a fair price.
+ Another example of this point is that increased fees generally
+reflect increased services. In the past several decades, there has been
+enormous progress in the development of services and products available
+to defined contribution plans (``DC plans'') such as 401(k) plans. For
+example, many years ago, plan assets generally were valued once per
+quarter--or even once per year--so that employees' accounts were
+generally not valued at the current market value. Participants
+generally were not permitted to invest their assets in accordance with
+their own objectives; the plan fiduciary generally invested all plan
+assets together. Today, 401(k) plans generally value plan investments
+on a daily basis, and permit participants to make investment exchanges
+frequently (often on a daily basis) to achieve their own objectives.
+Other new services include, for example, internet access and voice
+response systems, on-line distribution and loan modeling, on-line
+calculators for comparing deferral options, and investment advice and/
+or education services.
+ In addition, the legal environment for DC plans used to be simpler,
+with far fewer legal requirements and design options. New legal
+requirements or options can require significant systems enhancements.
+For example, system modifications were needed to address catch-up
+contributions, automatic rollovers of distributions between $1,000 and
+$5,000, Roth 401(k) options, redemption fees and required holding
+periods with respect to plan investment options, employer stock
+diversification requirements, default investment notices, automatic
+enrollment, and new benefit statement rules. Today, 401(k) plans have
+become the dominant retirement vehicle for millions of American
+workers. With this change has come the need to help participants
+adequately plan for their retirement. Service providers have responded
+by developing investment advice offerings, retirement planning and
+education, programs to increase employee participation in plans, and
+plan distribution options that address a participant's risk of
+outliving his or her retirement savings.
+ Naturally, the new services and products and the needed systems
+modifications have a cost. In this regard, we also want to emphasize
+that the disclosure rules need to be flexible enough to take into
+account the ever evolving 401(k) plan service market. For example, the
+rules need to be consistent with the current trend toward reducing the
+size of the plan investment menu as well as the trend toward offering a
+brokerage account option.
+ On a related point, we see enhanced plan fee disclosure as another
+important step with respect to participant education. And we look
+forward to working with this Committee on further participant education
+initiatives.
+Why Do Fee Levels Differ So Much Among Different Plans?
+ Different workforces need different services. Accordingly, the
+401(k) plan market has attracted a number of different service
+providers that have developed numerous service options for plans, often
+with different fee structures and different services available for
+separate fees. This structure avoids forcing plans to pay for services
+that they do not want or use, and increases the options available to
+plan sponsors wishing to find providers and services that meet their
+and their employees' unique needs.
+ Concerns have been raised about the higher level of fees for
+smaller plans. Many plan fees vary only slightly (if at all) based on
+the number of participants in the plan. Accordingly, on a per-
+participant basis, plan costs can be much higher for small plans than
+for large plans. On a similar point, many costs do not vary with the
+size of a participant's account, so plans with small accounts will
+often pay much higher fees--on a percentage of assets basis--than plans
+with large accounts. These effects are most often a function of the
+nature of the services rendered: for example, plans must meet the same
+regulatory requirements without regard to whether a plan has 100
+participants or 100,000 participants, and without regard to whether the
+average account size is $5,000 or $50,000.
+Who Pays DC Plan Fees?
+ By law, the employer must pay certain fees, such as the cost of
+designing a plan. But there are a wide range of fees that are permitted
+to be paid by the plan and its participants, such as fees for
+investments (which generally constitute the vast majority of a plan's
+total fees), recordkeeping, trustee services, participant
+communications, investment advice or education, plan loans, compliance
+testing, and plan audits. Many employers voluntarily pay for certain
+expenses that could be charged to the plan and its participants, such
+as recordkeeping, administrative, auditing, and certain legal expenses.
+On the other hand, investment expenses, such as expenses of a
+particular mutual fund or other investment option, are generally borne
+by the participant whose account is invested in the fund.
+Why Does One Service Provider Sometimes Receive Fees From Another
+ Service Provider? Is This ``Revenue Sharing''? Is This A
+ Problem Area?
+ Some maintain that ``revenue sharing'' is wrong and should be
+prohibited. That view reflects a misunderstanding of how the 401(k)
+plan system works. Let me explain.
+ It is not uncommon, for example, for mutual funds or other
+investment options to pay other plan service providers for services
+needed by the funds. For example, assume that participants of a plan
+invest some of their assets in Mutual Fund A. If these were retail
+investors in Mutual Fund A, Fund A would need to: maintain separate
+accounts for each investor; provide a means for investors to interact
+with Fund A (e.g., internet access, voice response systems, telephone
+service representatives); make certain that investors receive
+statements, investment confirmations, and any statutory notices; and
+prepare the appropriate tax reporting for any distributions. When a
+participant invests in Fund A through a retirement plan, the plan's
+recordkeeper generally assumes these responsibilities and bears the
+cost of performing them. It is not uncommon for Fund A to pay the
+plan's recordkeeper for performing the services that the fund would
+otherwise have to perform in the retail environment.
+ Such ``inter-service provider'' fees arise because different
+service providers cooperate in providing a total service package to a
+plan. ``Revenue sharing'' is the term often used to described these
+types of inter-service provider fees. In fact, fund companies typically
+designate a portion of their overall expense ratio as ``shareholder
+servicing fees'', and it is this expense stream that is typically used
+to pay other providers.
+ There is nothing inherently problematic regarding inter-service
+provider fees and the current-law prohibited transaction rules preclude
+inter-service provider arrangements that would create conflicts of
+interest. For example, assume that a plan pays Mutual Fund A $100 for
+investment services and the plan pays unrelated Service Provider B $50
+for recordkeeping services. Assume further that Mutual Fund A pays
+Service Provider B $10 to provide shareholder services so that A
+receives $90 net and B receives a total of $60. Assume further that B
+discloses the receipt of the extra $10 to the plan fiduciary so that
+the plan fiduciary can evaluate the fee and the relationship between
+Mutual Fund A and Service Provider B. If $100 is a fair price for
+investment services, why does it matter whether A performs shareholder
+servicing itself or subcontracts with Service Provider B to perform
+those services? In other words, if Mutual Fund A performed the services
+itself, the cost to the plan would be the same $150, but A would keep
+the full $100, instead of paying $10 of its $100 fee to B. And if $50
+is a fair price for recordkeeping services provided to the plan, why
+does it matter if B receives an additional $10 for services rendered to
+A? This example illustrates how an efficient subcontracting
+relationship works among service providers.
+ We are not suggesting that disclosure of the inter-service provider
+fees is not important. On the contrary, as discussed previously, we are
+very supportive of such disclosure. But the existence of these
+arrangements is not indicative of an inherent problem or a sign that
+401(k) participants are paying excessive fees. If fully disclosed,
+these subcontracting arrangements can, on the contrary, be quite
+efficient and the current-law prohibited transaction rules are already
+in place to preclude conflicts of interest.
+Are Plan Fees Too High?
+ Competition among investment options and service providers is
+intense, which exerts downward pressure on fee levels. For example, as
+noted above, investment expenses are generally the largest plan
+expense. These expenses are reviewed in the context of reviewing the
+performance of investment options. Plans routinely review such
+performance: a 2006 survey by the Profit Sharing/401(k) Council of
+America indicates that 62% of plans review plan investments at least
+quarterly and substantially all plans conduct such a review at least
+annually.
+ In fact, plan investment fees are much lower than fees outside the
+context of plans. For example, a 2006 study by the Investment Company
+Institute found that in 2005 the average asset-weighted expense ratio
+for 401(k) plans investing in stock mutual funds was .76%, compared to
+a .91% average for all stock mutual funds.
+Conclusion
+ We are very supportive of enhanced disclosure of plan fees. But fee
+disclosure must be addressed in a way that does not undermine
+participant confidence in the retirement system and does not create new
+costs that have the counterproductive effect of increasing fees borne
+by participants. We are committed to working with the government to
+make improvements in the fee disclosure area, including reporting to
+the Department of Labor. We believe that the best approach to the fee
+issue is through simple, clear disclosures that enable plan sponsors
+and participants to understand and compare fees in the context of the
+services and benefits being offered under the plan.
+ ______
+
+ Chairman Miller. Thank you.
+ Mr. Butler?
+
+STATEMENT OF STEPHEN J. BUTLER, PRESIDENT AND FOUNDER, PENSION
+ DYNAMICS CORP.
+
+ Mr. Butler. Chairman Miller, Congressman McKeon and members
+of the committee, my name is Steve Butler. I am the founder and
+president of the Pension Administration Firm in Pleasant Hill,
+California.
+ My company is one of the largest independent administration
+firms in Northern California, and we have operated well over a
+thousand retirement plans over the past 30 years.
+ I have written two books on the subject. The first was
+``The Decisionmaker's Guide to 401(k) Plans.'' The second was
+entitled ``401(k) Today.'' Both books identified hidden costs
+and offered a formula for making an effective comparison
+between the total costs of different vendors and vendor
+combinations.
+ This led to some national publicity focused on what we
+called the Butler Index. This is an index of total costs,
+employee and employer, on a same plan, which was then the
+subject of a New York Times article. The article compared about
+a dozen major vendors in the 401(k) industry, and the results
+were shocking. Money magazine then wrote a feature article
+based on the Butler Index.
+ A persistent lack of disclosure leads many plan
+decisionmakers to purchase 401(k) plans that careful analysis
+of costs would show to be a poor value for participants.
+ A number of academic and industry studies show that just an
+extra 1 percent of assets charged to a plan will reduce
+retirement account balances by roughly 20 percent over a 30-
+year period. This means that someone retiring will have 80
+percent of what they otherwise would have had, if fees had been
+reasonable and competitive.
+ The need for full disclosure of 401(k) fees should be as
+obvious as the reasons for any consumer protection laws.
+Throughout the history of these plans, a subset of the
+financial services industry has advertised free 401(k) bundle
+services to sponsoring employers, while the actual costs were
+billed to plan participants. And if costs were disclosed at
+all, a breakdown of these costs has not been offered to those
+participants.
+ In many cases, they were not disclosed to or fully
+understood by the company decisionmakers. To date, the
+Department of Labor has still not required bundled 401(k)
+vendors to fully disclose all the real fees associated with
+these plans.
+ Today, American workers have what I estimate to be $3
+trillion in 401(k) plans. To pay for the record-keeping and
+money management services, they are paying somewhere between 1
+percent and 2 percent, $30 billion to $60 billion a year. And,
+of course, that will only increase.
+ Charges for these basic functions can differ by as much as
+600 percent for essentially the same range of services from
+different providers. This says that, while some plan
+participants are receiving good value, others are being grossly
+overcharged.
+ By comparison in the automobile industry, there is the
+manufacturer suggested retail price, commonly known as the
+sticker price, a legal requirement that the price be emblazoned
+on the window of every car sold in this country, with the
+component costs of each option listed separately.
+ There is nothing that should stand in the way of an
+equivalent, simple, and elegant solution to a problem that is
+otherwise costing American retirement savers as much as 20
+percent of their ultimate retirement nest egg.
+ The approach of the Butler Index was to identify and
+breakdown all costs of either a bundled plan or combination of
+vendors. It was not rocket science. Anyone smart enough to
+operate a 401(k) plan today is smart enough to be able to go
+one step further, to identify and disclose the fees it is
+charging and what those fees are for.
+ Anyone asking for an exemption from these disclosure
+requirements because they say it can't be done is insulting our
+intelligence. Are they really trying to say that they have no
+way of determining the extent to which they are making a profit
+on a 401(k) plan client?
+ Any 401(k) is better than no 401(k), even if it an
+expensive one. However, company owners and managers owe it to
+themselves and their employees to make informed decisions about
+the plans they purchase on behalf of their fellow employees. In
+fact, the failure of corporate plan sponsors to have adequate
+disclosure of 401(k) fees and a breakdown of what those fees
+are for has been the subject of recent class-action lawsuits
+brought by participants, alleging that the plan sponsors
+breached their fiduciary duties under ERISA.
+ Full disclosure of 401(k) plan fees to corporate plan
+sponsors and participants will allow for cost comparisons. Give
+the number of players in the 401(k) marketplace, this will
+create competition, ultimately leading to reduced costs, to the
+benefit of participants.
+ In the absence of full disclosure, we see the equivalent of
+the fog of war. The battle for extremely valuable retirement
+plan money is so intense that the industry cannot resist any
+steps that enhance the perceived value of their product. The
+simplest of these enhancements has been to bury the total cost
+and fees charged to participants and then fail to disclose
+them.
+ As I see it, this is the problem that needs to be addressed
+with disclosure legislation and/or appropriately crafted
+Department of Labor regulations.
+ Thank you.
+ [The statement of Mr. Butler follows:]
+
+ Prepared Statement of Stephen J. Butler, President and Founder,
+ Pension Dynamics Corp.
+
+A Brief History
+ The 401(k) phenomenon is an accident in legislative history that
+has changed the face of America's retirement system. Voluntary pre-tax
+contributions from employees have generated substantial financial
+resources that provide a comfortable retirement for many. Considering
+the average American employee, early projections indicated that these
+plans would generate roughly five times the asset value at retirement
+than would have been received from the continuation of what was then a
+combination of qualified profit sharing, money purchase and defined
+benefit plans. Current statistics for the average employee who has been
+a participant for at least twenty years (and who is in their early
+60's) support this original projection. The $3 trillion now accumulated
+in 401(k) plans offers a testimonial to their success.
+ The fact that pension laws have evolved to provide what amount to
+``portable'' pension plans is critical in a country where the average
+employee changes jobs every seven years. The Bureau of Labor Statistics
+recently determined that the average employee born between 1957 and
+1964 has had 10.5 different jobs between ages 18 and 40. Twenty-one
+percent of this group have had 15 jobs. Only fifteen percent have had
+fewer than four jobs. Those with college degrees had no better
+statistics regarding job stability than those without degrees.
+ To the extent that the traditional retirement plan system (that
+which preceded the 401(k) era) failed to meet expectations, its failure
+was largely attributable to the practical reality of employee turnover.
+Traditional pension benefits were designed to create a form of ``golden
+handcuffs'' with vesting schedules that rewarded only those employees
+who remained with a company long enough to become vested in their
+retirement benefits. In the early '70's, this could have required as
+much as ten years of service. A direct quote from President Reagan at
+the time was that he wanted to create ``portable pension programs.''
+Over 70% of working Americans work for companies having less than 100
+employees. A large percentage of these employees work for companies
+with less than 25 employees. In the past, small, relatively unstable
+companies rarely offered traditional retirement plans when employer
+contributions were the only source of funds. Today, many offer some
+variation of a 401(k) plan or the small-company equivalent in the form
+of SIMPLE 401(k)'s.
+ The complicated laws requiring 401(k) plans to pass non-
+discrimination tests has compelled company owners and highly-
+compensated managers to spend time and money promoting plans to all
+rank and file employees. Without substantial contribution percentages
+from these non-highly compensated people, the managers were limited to
+contribution amounts below the legal maximums. This has prompted
+management to do everything in their power to promote the plans.
+Matching contributions, company discretionary contributions, employee
+meetings, individual financial advice and careful selection of
+investments are all a part of this promotional effort leading to the
+success of these plans.
+Cost to Participants in General
+ The costs to 401(k) participants struggling to save for retirement
+is a detriment that has marred what would otherwise have been the
+unqualified success of the 401(k) phenomenon. Excessive fees, just over
+the past twenty years, have reduced participant account balances by an
+average of 15%. On a projected basis, excessive fees charged to
+participants will have reduced retirement ``nest-eggs'' by 20%
+according to a wide variety of organizations conducting research on the
+subject.
+Understanding the Fundamentals of 401(k) Costs
+ Fees taken from plan assets to pay for administration and/or money
+management are paid with funds that could otherwise be earning and
+compounding on a tax-deferred basis. The ``Magic of Compound Interest''
+works against employees to dramatically magnify the loss of these
+missing dollars. The business term for this condition is ``opportunity
+cost''--the calculated cost in dollars of a lost opportunity.
+ Example:
+ The best illustration of the cost of excessive fees is to project a
+flow of 401(k) contributions over time at percentage returns that
+reflect the difference of 1% (a typical amount of an ``excessive
+fee.'') Choosing $10,000 as an employee contribution amount is
+reasonable considering that we are looking well into the future. The
+median income today is $71,000 and the average contribution amount is
+6-7%. In many cases, both members of a married couple are contributing,
+so $10,000 per year is not unreasonable. The returns for the American
+stock market have averaged 10% per year over a long historical period.
+
+ THE OPPORTUNITY COST OF A 1% EXCESS COST--$10,000 ANNUAL CONTRIBUTION
+----------------------------------------------------------------------------------------------------------------
+ Account value Account value Account value
+ Percentage annual return 10 years 20 years 30 years
+----------------------------------------------------------------------------------------------------------------
+10%............................................................. 171,178 641,491 1,925,836
+9%.............................................................. 162,568 566,549 1,570,441
+Cost of 1% fee.................................................. 8,610 74,942 355,395
+----------------------------------------------------------------------------------------------------------------
+
+ For the 20-year period through the 1980's and 1990's, the stock
+market averaged a 16% rate of return. Looking at what might be higher
+underlying rates of return going forward, the opportunity cost of the
+missing 1% is much higher. By 2000, many employees in expensive plans
+who had been participating for twenty years effectively paid the
+following amounts in opportunity costs as a result of high fees during
+that 20-year period.
+
+ THE OPPORTUNITY COST OF A 1% EXCESS COST--$10,000 ANNUAL CONTRIBUTION
+----------------------------------------------------------------------------------------------------------------
+ Account value Account value Account value
+ Percentage annual return 10 years 20 years 30 years
+----------------------------------------------------------------------------------------------------------------
+15%............................................................. 232,057 1,279,641 6,008,782
+14%............................................................. 215,656 1,079,734 4,541,874
+Cost of 1% fee.................................................. 16,401 199,907 1,466,908
+----------------------------------------------------------------------------------------------------------------
+
+ After twenty years, this illustrates the actual cost for what might
+have been a single employee contributing $10,000 a year (or two people
+contributing $5,000 each) in the twenty years ending in 2000. Multiply
+these single-participant detrimental effects times the $3 trillion now
+in 401(k) plans and we can understand why the fee issue is critical.
+ Stop and recall for a moment the ``Rule of 72'' which states that
+money earning 7.2% doubles every ten years, and money earning 10%
+doubles every 7.2 years. Today's $3 trillion can be reasonably expected
+to double twice to $12 trillion in the next 14 years, thanks to
+reasonable investment returns and annual contributions. Excessive,
+undisclosed fees scheduled to cost participants as much as $2 trillion
+dollars is the problem we are here to try to correct.
+Where the Abuse Begins
+ The greatest abuses are seen in the small-company environment where
+the average company owner is not a mutual fund or retirement plan
+expert. Large companies, by comparison, have reasonably sophisticated
+decision-makers. Xerox, for example, operated its own mutual funds and
+charged participants just 3/100ths of one percent per year.
+Participants in many small-company plans can be paying as much as 3
+full percentage points--exactly 100 times more for the same level of
+services.
+ Technically, all fees charged to participants are disclosed today
+to plan sponsor decision-makers, but not all fees are disclosed to
+participants. In the insurance industry, for example, the practice of
+non-disclosure was justified by the rationale that ``fees didn't
+matter--net investment results were all that participants needed to
+see.'' This was an actual quote from the marketing Vice President of a
+major insurance company when interviewed by MONEY magazine in 1998.
+ Fees charged to participants may be stated in the investment
+materials, but they remain effectively hidden on an ongoing basis
+because participants never receive a bill and never see a separate line
+item outlining what their costs, in dollars, have been.
+ According to FORBES magazine, the mutual fund industry is the
+world's most profitable as it earns a consistent 30% pre-tax profit.
+Investors are not fee sensitive because they are focused on returns.
+Generally this means ``chasing last year's best performing mutual
+funds.''
+ In today's seamless electronic financial services arena, the hard-
+dollar cost of administering a mutual fund with at least $50,000 is 6/
+100ths of one percent per year--approximately $30. Virtually all 401(k)
+plans are administered in pooled accounts where the investor is the
+plan itself--not the individual employee. As a result, virtually all
+401(k) accounts, on a fund-by-fund basis, meet this $50,000 benchmark,
+meaning that the profit on the account is anything beyond the 6/100ths
+being charged. If the average mutual fund charge in a 401(k) investment
+is 1 full percentage point per year, the profit on those accounts might
+be as high as 94%.
+ In all discussions regarding fees, we have to take as a given that
+no single mutual fund or fund family can show that that they have
+consistently earned a higher rate of return (to justify higher fees)
+for any sustained length of time. The money management industry is a
+``zero sum game'' in which all players revert to the norm at some
+point. Moreover, even when we can review past performance, there is no
+way to know prospectively whose performance might compensate for an
+excessive fee going forward. Over longer periods of time, a difference
+in performance among funds of the same type can be largely attributed
+to the difference in their costs to investors.
+How 401(k) Plans are Structured
+ Most 401(k) money is maintained today in a ``daily-valued''
+electronic environment managed by the mutual fund or insurance
+companies themselves or the transfer agent industry that services the
+mutual fund industry. Plan participants can dial up their account
+information on an 800 voice-response number, but by far the most
+popular access is through the Internet. The raw cost of providing this
+seamless, electronic recordkeeping function is approximately $50 per
+year per participant. This is referred to as the ``recordkeeping fee.''
+It is the cost of maintaining the accounting of the participant's
+account.
+ Apart from the money management, there is the cost of complying
+with the layers of retirement plan regulations dictated by ERISA. This
+work is concentrated immediately after the end of every year when the
+discrimination testing must be completed. Later in the year, the
+government reporting form (Form 5500) for the plan must be completed
+and submitted. It is essentially a balance sheet and income statement
+for the plan. The cost of this compliance testing and administration is
+typically about $35-$60 per participant with a base company fee of
+$1,000- $1,500.
+An Illustration of Fees in a Typical Plan
+ We can use an example a plan with 50 participants and $3,000,000 in
+assets. This is typical of an engineering or professional firm that has
+had a plan for twenty years.
+ The record keeping and compliance cost for these 50 employees
+should be roughly $130 per employee. If the true cost of money
+management is only 6/100ths of a percent, the money management cost for
+$3,000,000 would be $1,800. The total cost of the plan would be $7,800.
+By comparison, a typical vendor in the industry today would be charging
+an average of $36,500 for this plan. Some have scheduled fees that
+would amount to as much as $60,000 or 2% of assets.
+ While a plan sponsor (the company) might be happy to pay for the
+administration cost, it will never pay total fees of this magnitude.
+Asset-based money management fees will always be charged to
+participants where they will be largely ignored. After all, no
+participant ever receives a bill or writes a check for these costs.
+They are automatically deducted from what would have been earnings--or
+from principal in years when earnings may be negative.
+Techniques that Obscure the Magnitude of Fees
+ Having established that hidden excessive costs are a guaranteed
+detriment to optimizing savings results over time, it is generally easy
+to identify them when we know where to look. Some of the more difficult
+hidden costs, however, are those that are buried in the process and
+that will never show up in any stated cost to participants.
+Non-disclosure at Participant Level in ``Bundled Plans''
+ In the 401(k) marketplace, participants are told the annual expense
+ratios of the mutual funds offered by the plan, but administrative fees
+charged to their accounts are typically disclosed only in an annuity
+contract signed by the plan sponsor. This percentage amount is referred
+to as the ``wrap fee'' and it is typically one or two percent in a
+small company environment. The insurance industry is not legislated by
+federal laws, so the normal disclosure requirements demanded of the
+fund industry do not apply to insurance companies legislated only by
+state governments. In the mutual fund industry, the cost of
+administration, if presented as being ``free,'' is usually imbedded in
+the expense ratios of the funds. Comparable funds, if not priced to
+support administration, could generally be found that would be less
+expensive for participants.
+ These plans that combine investment products with administration
+all provided by one company are referred to as ``bundled'' plans, and
+the providers of such plans are suggesting that ``bundled'' plans be
+exempt from any disclosure requirement to come out of these hearings.
+With what I estimate to be 70% of all 401(k) plans provided in this
+``bundled'' format, making them exempt would emasculate any new
+disclosure requirements.
+Mutual Fund Industry--Proprietary Fund Requirement
+ In the mutual fund industry, the fees to participants are disclosed
+because they are the normal annual expense ratios of the funds. They
+are spelled out in the prospectus of each fund and today are
+universally summarized in the employee promotional literature. The
+mutual fund industry does not add a wrap fee. Instead, a company such
+as Fidelity will insist that at least half of the funds selected for
+the plan include their own proprietary funds. Remembering that the
+profit from a 401(k) account can be as much as 94% to the fund family,
+the insistence that at least half of the funds come from the fund
+family's proprietary list ensures that the plan will be profitable. A
+refinement of this technique is to require that the so-called ``core
+funds'' will be proprietary. These are the large-company or balanced
+funds that traditionally attract as much as 70% of the money in the
+plan. So, while the fund requirement based on the number of funds may
+only be half of the offerings, the percentage of employee money in
+those funds can easily be 70% or more.
+ The balance of the funds offered in the plan may come from other
+fund companies as part of an effort to create a ``veneer of
+objectivity'' for marketing reasons. These other fund families will
+typically be limited to just those funds that charge enough to pay the
+primary fund family 25/100ths of one percent and possibly some
+additional funds to buy ``shelf space'' on the ``platform'' offered by
+the primary fund family selling and administering the plan.
+ What does this practice cost the participant? No single fund family
+offers superior funds across the entire spectrum of the industry.
+Common sense would tell us that selecting from a vast universe of
+choices will generate better fund selection than a limited universe
+from just a single fund family. Here, we are selecting funds for the
+convenience and pricing demands of the vendor--not with the sole
+purpose of improving the outcome for the participant. Knowing that this
+is the case explains why major mutual fund companies in the 401(k)
+industry refuse to be construed as fiduciaries of the plan. Selling
+their own funds would be a prohibited transaction and would violate the
+requirement that fiduciaries make decisions based upon the ``sole
+interests of participants.''
+ In the sample plan above, (50 employees and $3,000,000) most
+vendors today would offer to do the administration and record keeping
+at no cost to the plan sponsor. A quick review of the arithmetic would
+explain why. Those administrative costs would have been about $7,000
+and the plan is charging participants $30,000.
+Barring the Exit--Back-end Charges for Plan Sponsors who Want to Leave
+ The most egregious examples of excessive fees today are found in
+plans that are using share classes or annuity products that pay
+commissions up front and then have high ongoing fees to participants to
+offset, over time, the commission that was paid up-front. If a plan
+sponsor chooses to leave one of these plans there will be a
+``contingent deferred sales charge'' otherwise known as a ``back-end
+load.'' Eventually, the load grades down and disappears after five to
+seven years, but in the meantime, the plan sponsor can not leave
+without subjecting participants to an exit charge that can be as high
+as 5% of their assets. Moreover, the law specifically bars a plan
+sponsor from paying that cost as a company expense, because plan
+contributions can only be made as a percent of compensation--never as a
+percent of assets. These are the plans that can be charging
+participants as much as 3% per year. Once introduced, they are locked
+in by exit charges for at least five years.
+ The insurance industry and the subset of the mutual fund industry
+selling through the NASD brokerage industry are selling these 401(k)
+packages with back-end loads. The pure no-load sub-set of the fund
+industry does not offer this format. The back-end-load phenomenon
+occurs only in an environment where a mutual fund sales person or
+insurance agent requires a sales commission that has to be charged to
+the plan.
+Funds as a ``Feeding Trough'' for the Brokerage Industry
+ As yet another example of a hidden fee, FORBES magazine published
+an article entitled, `` What's the Matter With Brokers' Funds?'' The
+fact that these funds generate relatively poor performance is well-
+established, and the reasons have to do with two facts. The article
+stated that ``* * * the whole psyche of a brokerage firm is built
+around selling, not buying * * * Analysts at wire houses get ahead by
+helping underwriters, not by being skeptical.'' This is essentially
+saying that the brokerage-sponsored funds are used as a resource for
+investing in the kind of companies that the firm was underwriting. High
+turnover of assets in the funds also generated trading fees for the
+brokerage firm. I was once told by a Prudential-Bache retirement plan
+representative offering a ``free'' plan to a plan sponsor that ``once
+we have the assets, we don't have to worry about making money.'' The
+FORBES article went on to say, ``Another problem is that broker-
+sponsored funds tend to have steep expense ratios.''
+How an Expensive Plan Can Be Marketed
+ Thanks to the benefit of hindsight, a classic marketing ploy
+involves a presentation of funds from a new vendor candidate that have
+substantially out-performed the incumbent selection of the existing
+vendor. The current vendor, of course, is saddled with a selection of
+funds that were chosen three years previously in most cases. There are
+the problems of logistics and inertia that stand in the way of making
+changes in plans unless performance has fallen off a cliff. Of course,
+in this environment, a new set of fund choices will always look
+substantially better. The average plan sponsor rarely thinks to ask for
+examples of what the proposed new vendor's investment selections might
+be for a plan that they have operated for three years. There would
+typically be no improvement shown by this comparison.
+ This is symptomatic of how the consultants and marketing personnel
+in the industry can appear to be offering improvement when, in fact,
+they are simply rearranging the deck chairs and adding to the level of
+hidden fees in many cases. Representations of superior performance are
+a major tool used to take the focus away from participant fees.
+Misinformed Decision-making on the part of Plan Sponsors
+ Section 404(c) is a U.S. Department of Labor regulation
+establishing requirements for plan sponsors that reduces their
+liability for making poor decisions with regard to the plan. Employees
+must be able to change investments and receive statements at least
+quarterly. They must be offered three basic fund types including a
+money market or guaranteed fixed income option. Finally, the plan must
+have a written investment policy statement, and employees should be
+provided with investment education (the latter being undefined and
+unspecified.)
+ Ironically, Section 404( c ) proved to be a solution looking for a
+problem which then created a far more serious disadvantage for the
+employee participant. Since 1980 or the earliest days of the 401(k)
+phenomenon, virtually all plans offered quarterly statements and
+investment changes and a selection of different investment types.
+Remember that senior executives were major beneficiaries of these plans
+and they were inclined to want investment quality and flexibility.
+Virtually all plans operated under what was essentially an investment
+policy statement because decision-makers wanted decent investment
+choices for themselves.
+ The financial services community seized on Section 404( c ) as the
+reason for hiring them to monitor the plan and therefore reduce
+liability. In fact, there was no practical liability for reasons having
+to do with 404( c ). At industry conferences, lawyers were quick to
+point out that there were no lawsuits anywhere in the country brought
+by employees or groups of employees offered a selection of name-brand
+mutual funds and a rudimentary investment education and plan
+promotional effort.
+ The law of unintended consequences quickly created a ``create the
+need'' opportunity for the financial services community. An army of
+qualified and experienced ``advisors'' fanned out across the 401(k)
+Plan Sponsor community and talked about the potential liability of not
+using professional help and advice with regard to operating the plan.
+What this universe of advisors did not point out was that a.) there was
+no practical legal problem stemming from the way plans were typically
+being operated, and b.) the cost of this advisory service was going to
+be, at a minimum, one half percent to one full percentage point charged
+to plan participants--a cost that guaranteed a loss of up to 20% of
+retirement assets for each participant.
+ Meanwhile, there have been some lawsuits successfully filed against
+plan sponsors. The first that I am aware of was against First Union
+Bank settled for $25 million in behalf of the bank's employees. The
+bank was operating a collection of mutual funds, (Evergreen Funds which
+they owned at the time) and these funds were charging bank employees
+substantially more than 401(k) investments the bank was selling to its
+bank customers.
+ In the same vein, the recent class action suits against Fortune 500
+companies such as Caterpillar, Boeing, Kraft and International Paper
+are all centered on fees--not a lack of reporting, investment choice or
+investment education.
+Avoiding Compliance Responsibility
+ While the financial services industry has seized upon Section 404 (
+c ) and the scare tactics it can foster, they have deliberately avoided
+responsibility for most of the other IRS and Labor Department
+Regulations that they should be upholding when representing themselves
+as providing 401(k) administrative services. A typical service contract
+will have hold harmless language such as ``the design and ongoing
+operation of your retirement plan needs to be reviewed by your tax and
+legal advisors.'' The ``bundled provider'' contract of one of the
+nation's largest mutual fund companies says the company will perform
+the 401(k) test and coverage test, but all other tests are the
+responsibility of the plan sponsor. In effect, the financial services
+industry is saying that they will do the work, but they are not
+offering a guarantee that it will be done correctly or completely. A
+plan failing an audit can cost the plan sponsor a substantial amount of
+money in legal fees and corrective measures. In an indirect way, this
+misrepresentation could be construed to be a hidden fee. The average
+plan sponsor assumes that the major financial institution handling
+their plan has taken responsibility for its compliance with all
+government regulations. In my experience, however, the immediate
+response when compliance problems arise is the voice on the phone
+saying, ``read your contract.''
+The Search for a Solution
+ To identify a solution, a process would involve working back from a
+perfect, if admittedly impractical, model.
+ Ideally, the best 401(k) plan would be one that charged nothing to
+the plan. All fees, even those associated with managing the mutual
+fund, would be charged to the company and paid with tax-deductible
+corporate dollars. A typical employee would be better off electing to
+have his or her taxable salary reduced slightly to help defray all or a
+portion of these costs. This would be far better than having the same
+costs deducted from plan assets that could be compounding on a tax-
+deferred basis.
+ Here's an actual example of that positive arithmetic. Over 800
+dentists use a money management firm to manage retirement assets at
+their respective practices. The firm charges 1% of assets and routinely
+levies this charge against plan assets. In one actual case, I pointed
+out to a dentist that the firm was free to bill his practice for what,
+in this case was $15,000 per year on $1.5 million of assets. The net
+cost to the dentist billed directly, considering his 50% marginal state
+and federal tax bracket was $7,500. Instead, the dentist was paying
+that year's $15,000 with money in his plan that in 7.2 years (at a 10%
+annual return) would have doubled to $30,000. In 14.4 years, it would
+have doubled again to $60,000--in 22 years, $120,000 etc. Obviously,
+the dentist asked to be billed directly and then started wondering if
+1% might be little high for mediocre investment management that failed
+to beat basic benchmarks. The financial services industry will always
+opt to bill the plan directly because they do not want fees to become
+an issue. The arrangement outlined above had persisted for over twenty
+years. The billing format had a projected cost for the dentist and his
+employees of well over one million dollars of opportunity cost--a cost
+that was reduced to a fraction of that amount in future years with the
+stroke of a pen.
+ Xerox charged just 3/100ths of one percent to its employees.
+Vanguard, on large amounts of money, can charge as little as 6/100ths
+of a percent and still make a profit. DFA is yet another mutual fund
+company renowned for its Vanguard-equivalent low fees. These
+organizations offer mute testimony to the fact that it doesn't have to
+cost what most of the industry charges to invest pools of money. An
+oligopolistic situation exists thanks to buyers who are unaware of the
+impact of fees. With few exceptions, nobody in the financial services
+industry wants to see this condition change.
+The Solution
+ A simple but impractical solution would be to bar any organization
+that manages money from actually selling and administering 401(k)
+plans. The industry selling plans would be barred from receiving any
+revenue-sharing from the money management (mutual fund) industry. This
+would end the hidden fee elements seen in the brokerage industry and
+mutual fund industry where the sale of 401(k) plans is an engine for
+selling proprietary funds and generating trading commissions. There are
+3,500 third party administrators across the country today who are
+independent of major financial institutions and that perform
+recordkeeping services and compliance work for retirement plans. Some
+of these companies, such as Hewitt Associates and Milliman and Roberts,
+are substantial and equipped to handle the nation's largest plans.
+Without this separation between product producers and 401(k)
+administration and sales, it is difficult to see how some of the more
+subtle examples of hidden costs can be avoided. Considering the
+foothold that mutual fund companies have in the industry, however, it
+is difficult to envision this as a practical solution. The horse is out
+of the barn.
+ The next option would be to have a national standard fee disclosure
+form required of any 401(k) presentation and require that it be renewed
+to reflect any change in investment mix. This standard would require
+that the cost in dollars and compound earnings over ten and twenty year
+time periods would be based upon the average fee charged to
+participants, assuming an even mix of investments across the entire
+spectrum of fund offerings. This would be stated on the front page of
+the 401(k) presentation and as part of the Summary Plan Description. In
+other words, a 401(k) vendor would have to show what the average
+opportunity cost would amount to over ten and twenty years based upon
+the average fee charged to a $10,000 per year contribution. It would be
+reasonable to assume a 10% rate of return as the starting point or
+gross return on investments assuming no fee. Fees would then be
+subtracted from this percentage amount, and the compound results would
+be illustrated. Using an average contribution of $10,000 per year would
+be simple (and inspirational.)
+ This comparison would illustrate the dramatic difference in costs
+over time between different vendors. It would offer a reality check for
+the average decision-maker who might otherwise have chosen a hidden-
+cost but expensive plan for his or her company. It is critical to
+require that the comparison use an example in dollars as I have
+suggested. To just require a stated percentage cost is too abstract.
+Even investment professionals have a hard time grasping the magnitude
+of opportunity cost presented by just a fraction of a percent in excess
+costs.
+The Outcome and Benefit to Those Saving for Retirement
+ Saving fees increases retirement benefits, in the aggregate, by as
+much as 15%-20%. How can this not be important enough to enact
+disclosure standards demanded of every company in the industry?
+Decision-makers may still purchase expensive plans for their employees,
+but not without hearing from the ``self-styled mutual fund experts''
+that manage to find a voice in every company. An army of retirement
+savers have now deposited $3 trillion in their 401(k) plans. They are
+rapidly becoming a nation of reasonably sophisticated investors. For
+the most part, they know how to diversify investments, and they have
+lived through the volatility of stock market performance. This is a
+clear case where the glass is half full. The financial services
+industry can be commended for getting us this far. Going forward,
+however, we can improve results by insisting on an educational tool
+(comprehensive cost disclosure) that the industry acting on its own is
+inclined to avoid.
+ ______
+
+ Chairman Miller. Thank you very much to all of you for your
+testimony.
+ Mrs. Bovbjerg, toward the end of your testimony, you said
+that one of the problems was that many of the fees are hidden
+from sponsors and might mask conflicts of interest. Could you
+elaborate?
+ Ms. Bovbjerg. What we are talking about there is when a
+sponsor may contract with a pension consultant or a service
+provider, who then has, unknown to the sponsor, a business
+relationship with, say, a fund manager, and then recommends to
+the sponsor, ``You should use this, you should go with this
+fund manager.''
+ Chairman Miller. And that may be without regard to
+performance or cost?
+ Ms. Bovbjerg. It may not be in the best interest of the
+plan.
+ Chairman Miller. You also said that the Department of Labor
+did not have resources to adequately--fill in the--to do what?
+I didn't catch the last part of your testimony there.
+ Ms. Bovbjerg. Well, the Department of Labor doesn't get the
+information that they would need to enforce fee
+responsibilities. They don't get a total fee reported to them
+in the Form 5500, the primary way that they get information
+from plan sponsors. We think that they should make that more
+clear, that they need all of the fees in one place.
+ Chairman Miller. You think that should be corrected?
+ Ms. Bovbjerg. We have recommended that to them, and they
+are pursuing several initiatives in the area.
+ Chairman Miller. What is the status of that, do you know,
+since this report?
+ Ms. Bovbjerg. Of our recommendation?
+ Chairman Miller. Yes.
+ Ms. Bovbjerg. They are considering it.
+ Chairman Miller. Yes?
+ Ms. Bovbjerg. They haven't done anything yet, but they are
+considering it.
+ Chairman Miller. Okay, thank you.
+ The example that you just pointed out, a few months, there
+was a story in one of the business journals talking about this
+arrangement, where money was between sponsor and a fund. And it
+was one of the worst-performing funds and had been one of the
+worst-performing funds for multiple years, like among the
+worst, and yet they kept paying out money to get, you know,
+recommendations of deposits of funds in that fund.
+ So is that what you are talking about, that kind of
+conflict of interest? I am not necessarily saying of that
+magnitude, because this was----
+ Ms. Bovbjerg. Well, we are talking about some of the things
+that came up in the SEC report a couple of years ago. They
+looked at 24 pension consultants and found that about half of
+them had undisclosed relationships with other types of service
+providers.
+ Now, that is not to say that there was necessarily a
+conflict or that it harmed the pension fund, but it was not
+disclosed, and they felt that was problematic.
+ Chairman Miller. Mr. Hutcheson, in your testimony, you
+suggest that that is not that unusual.
+ Mr. Hutcheson. No, sir, that is very common. That is a very
+common practice. In some cases, the term ``directed
+brokerage,'' which is now a banned practice with mutual funds,
+an explanation of that is where a fund manager would speak with
+a brokerage firm and say, ``I will bring all of the trades of
+the underlying securities of our mutual fund to you if you will
+then recommend my fund to your sales force.''
+ And what would happen is, is the sales force would get a
+recommendation for a particular fund, and they would go out and
+sell it to plan sponsors.
+ Chairman Miller. That is a now banned practice, you are
+saying?
+ Mr. Hutcheson. In mutual funds, it is.
+ Chairman Miller. In mutual funds.
+ Mr. Hutcheson. There are some other types of investment
+pools, where it is not a banned practice, but the egregious
+problems happened in mutual funds, and now that is a banned
+practice.
+ Chairman Miller. Thank you.
+ Mr. Chambers, you suggested that people think that Toyota
+builds cars, but they assemble them. But at the end of the day,
+they are buying a car which can be--is rated over time. People
+say that this is what it costs to drive this car for this year,
+this is the maintenance, this is the miles per gallon, and all
+the rest of it.
+ They can find out information and make a decision between
+that Toyota and the Chevrolet Impala, if they want. They can
+make that decision. My concern is here is that people are being
+asked to make decisions or decisions are made for them, and the
+assumption is that that is better or that is different.
+ Because what we see is that, you know, day in and day out,
+it is very hard for fund managers to beat the S&P index, right?
+ Mr. Chambers. If you would elaborate on a particular fund--
+--
+ Chairman Miller [continuing]. Mr. Hutcheson's testimony, I
+think it was--it is obviously used many times by index funds.
+But, for example, the S&P 500 index consistently outperformed
+98 percent of the fund managers over 3 years, 97 percent over
+10 years, and 94 percent over the past 30 years.
+ Recent studies reveal--and many more continue to
+substantiate--that the passive 60 percent stock, 40 percent
+bond portfolio outperformed 90 percent of the largest corporate
+pension plan portfolios, ``run by the world's best and
+brightest investment minds.''
+ Mr. Chambers. And the source for that, sir?
+ Chairman Miller. It is in Mr. Hutcheson's testimony, but we
+see this remark all of the time at the end of the year or the
+quarter, where they match and compare actively managed funds
+against index funds and other such funds. And it is very hard
+for those managers to beat those index over any period of time.
+ Mr. Chambers. Well, I think, in given periods, you are
+absolutely right.
+ Chairman Miller. Well, 10 years.
+ Mr. Chambers. But I also think--and if I may, I also
+think----
+ Chairman Miller. Thirty years is a pretty good given
+period, since that is the time most people work.
+ Mr. Chambers. Possibly. It depends upon which fund it is,
+of course. I can tell you, for example, that the funds----
+ Chairman Miller. Well, it beats 94 percent of the active
+funds, so you can pick the other 6 percent of the funds, and I
+hope I could find them.
+ Mr. Chambers. Well, I can tell you, sir, that, for example,
+in our retirement plan, at our law firm, we get this
+information every quarter. And over 5 years, which is a
+measurement--our law firm has not been in existence for 30
+years, so we don't have that information.
+ But over the last 5 years, we have outperformed--if you
+take all of the funds that we make available, about 10 funds,
+we have outperformed the appropriate market index for each one
+of those funds an average of 3.05 percent over 5 years.
+ Do I think that--and if you take a look at the peer
+performance reviews of the investment managers who we retained
+and the funds that we retain, they are not necessarily in the
+top 5 percent or 10 percent of their peer group every year. I
+think it depends upon the way that you are looking at the
+statistics.
+ I don't know that I necessarily agree with Mr. Hutcheson's
+statistics, not knowing what his basis is.
+ Chairman Miller. I would say that Mr. Hutcheson is one of
+among many--and I am not vouching for his statistic, I am just
+saying that this is a comparison that is made in every economic
+journal at the end of every quarter and the end of every year,
+when they put in a special section on mutual funds, and they
+compare how it is done.
+ Mr. Butler, I don't know if you want to chime in on this,
+but----
+ Mr. Butler. Well, I would just refer to the Stanford
+professors about 30 years ago who threw darts at the Wall
+Street Journal and proved that a randomly selected group of
+stocks would beat 85 percent of all efforts to manage money
+over any rolling 10-year period of time.
+ It led to five different Nobel Prizes for research coming
+out of that original dart-throwing exercise. So I think it is
+pretty well-established that, at the end of the day, low fees
+are the primary determinant factor for investment results that
+are optimal.
+ Chairman Miller. If I might, I would just like to take one
+minute of the committee's time here. The question here, I
+think, is the transparency and information available and the
+value of that. And, you know, you have what we get in our TSP,
+the Thrift Savings Plan, in a relatively simple form at the
+very bottom, it has cost to participant. And it is fixed basis
+points across all of the funds, except for the L funds, and
+those are variable funds, so, as of this date, that was not
+available to them.
+ You have the vanguard approach, which is, again, a one-
+page, very simply laid out cost to this. And this is to the
+plan, not to the participant. This is to the plan. And then you
+have what, I believe, that ING reached an agreement with
+Attorney General Spitzer on this, where you have to charge--one
+is the end-year balance without fees, end-of-year balance after
+the fees.
+ So I don't know whether these are the right things to do or
+not, but the point is, there does appear that there can be a
+simplification of explanations, both to plans and to the
+participants, in those plans. And that is the quest of this
+committee, to see whether or not some of these might make
+sense, in terms of helping the participants and the plans make
+these decisions.
+ And with that, I will yield to Mr. McKeon.
+ Mr. McKeon. Thank you, Mr. Chairman.
+ Ms. Bovbjerg, in the colloquy that you had with the
+chairman, you talked about the Department of Labor has received
+input, and you don't know where they are in the process of
+coming out with regulations or proposals?
+ Ms. Bovbjerg. Well, they have three initiatives in process
+right now. And I believe that they told us that the regs would
+be forthcoming later this year. They have been collecting a lot
+of comments on those initiatives.
+ Our recommendation to them was a little different than
+those initiatives. We would have recommended that they require
+sponsors to provide a total of the fees associated with the
+plan by type, in the Form 5500, and they have not taken action
+on that yet, but they also hadn't said they wouldn't. They are
+considering it.
+ Mr. McKeon. How much do you think could be done by the
+Department of Labor, versus what we should try to do in
+legislation?
+ Ms. Bovbjerg. Well, some things, for example, with regard
+to the 5500, can be done by regulations in the Department of
+Labor. Other things, you are so right, have to be done through
+statute.
+ We had recommended in our recent report on fees a couple of
+things that Congress might consider. Both would require
+amendments to ERISA. One was to require service providers to
+provide information on their financial relationships to
+sponsors. And the other--and that would be an explicit
+requirement. Now it is not a requirement. Some sponsors know;
+some sponsors don't.
+ And another would be to require sponsors to provide
+participants information on fees that would allow them to make
+comparisons across funds.
+ Mr. McKeon. It sounds to me like all of you are in
+agreement that something should be done for disclosure
+simplification.
+ Ms. Bovbjerg. I think we are.
+ Mr. McKeon. Well, that is what I heard in the testimony.
+The concern I have is one that I addressed in my opening
+statement, is unintended consequences. And how do you simplify
+without making it much more complicated?
+ It seems like every time we try to simplify--not our
+committee, but the Ways and Means, when they try to simplify
+the tax code, pages upon pages are added to the tax code. And
+that is a concern I have.
+ The prospectus that the chairman showed--well, they are all
+familiar with them, as we are. They are very complicated. I
+have bought stocks for my life, and I am sorry to admit that I
+usually don't read every word in those things. And it would be
+nice to have a little summary or something to go with them, but
+a lot of that is a result of laws that have been passed or
+regulations.
+ So I am really sympathetic to the need to simplify. I am
+just concerned of, once we start trying to simplify, what we
+end up with at the end of the road. You know, if we sat down
+with these four people in a room--a few of us--we could
+probably work something out that would be good and be
+profitable. And I am concerned as we move forward that we just
+don't make things worse at the end of the day.
+ So, Mr. Chairman, what I would like to ask all of them and
+others, as we go through this process, to keep involved. And if
+you will watch where we are skewing things one way or another,
+please try to bring it back. I don't know if you are planning
+on moving forward with legislation on this, but that would be
+my big concern, is that we----
+ Chairman Miller. I am thinking about it now.
+ Ms. Bovbjerg. Could I chime in for a minute? I perceive
+that part of it is the concern about not overburdening
+sponsors, and another part is the concern about plain English,
+which is something that we at GAO worry about across a lot of
+different programs, and something that the Social Security
+Administration has to worry about, with the benefit statements
+they send out to a much wider ranger of Americans than people
+who actually have pensions.
+ It is something that I think any disclosure of initiatives
+that we as a government take in this area, we might consider
+some language about plain English, making it accessible.
+ Mr. McKeon. Like the things that the chairman just showed,
+I think were good, simple. The problem is, we pass laws, the
+president signs the law, regulators write what they think that
+we meant when we passed the law. And by the time it all gets
+done, plain English is totally gone.
+ And, I mean, we did that--when we go to the doctor's now,
+we all have to sign a new form. And I am a little chagrined
+every time I go in the doctor's office and have to sign that,
+because it was federal legislation that required that. And it
+just gets put somewhere in a file, nobody ever reads it, nobody
+ever does anything with it, but it just was a result of some
+legislation.
+ So I would be happy to join with you, if you think that is
+an approach----
+ Chairman Miller. I appreciate the comments. I hadn't smoked
+out what we would do yet. I would like to think about it. But
+when I read much of this testimony, it along with the GAO and
+its make a fairly compelling case that inaction is probably not
+an option for the committee.
+ And I appreciate your concerns and your willingness to work
+on this and to, certainly, use these witnesses as resources.
+ And we always know that, when the law leaves here, it is
+clearly written, so it is not open to ambiguous interpretation.
+But we know we can start with a clear statement of purpose.
+ Mr. Kildee?
+ Mr. Kildee. I will be brief. I think we have a vote on the
+floor.
+ But, Mr. Butler, what do you think it would take to get the
+401(k) industry to move towards a simple, one-page fee
+disclosure that captures all the fees?
+ Mr. Butler. Well, I think it would be very simple. First of
+all, you have to appreciate that the entire industry today
+operates in a seamless, electronic environment. So those of us
+who are actually keeping track of this money--I won't make it
+too absurdly simple, but I would almost say that, with a few
+keystrokes, we can determine what the actual costs are and
+report them very effectively.
+ I see it being a de minimis additional effort and probably
+not something that would increase costs in any way.
+ Mr. Kildee. You think it is not rocket science to do?
+ Mr. Butler. It is not rocket science.
+ Mr. Hutcheson. Could I, Congressman Kildee? I agree. I
+believe that the solution is very simple. I believe in letting
+the markets work and letting competition drive prices. And I do
+not believe that this would impair, or impede, or discourage
+employers from maintaining plans. I believe that it would
+greatly increase confidence in letting that competition go,
+unencumbered and unimpeded.
+ And I just wanted to share and elaborate on something.
+William Sharpe, who won the Nobel Prize in Economics, said that
+the market generally is supposed to be efficient. And when you
+start actively managing investments, whether at the mutual fund
+level, or at the plan level, or at the sub-plan level, the
+participants level, the fees start to be added, and there is a
+direct correlation, an exact correlation between the returns of
+what the participants receive and the costs.
+ So active-managed funds and index funds are the same before
+costs. You add costs and fees, and there becomes the disparity.
+ And what happens is, is that when a participant receives
+their participant statement, they show that their funds and
+their plan are meeting the benchmarks or matching this index or
+that index, but that is for the fund. That is for the fund
+itself.
+ Those statements do not show what that particular
+participant's return was. And that has to be corrected,
+because, with all due respect, a good-manned firm may have
+great performing funds at the fund level, but once you start
+adding in various costs, the actual participant returns are
+very different. And that is an important clarification that I
+wanted to make.
+ But coming back to this, I believe strongly that it is
+simple. If we strip out all the ambiguity, all the obscurity,
+and let the market work based on fully transparent, fully
+disclosed information, the fees will go down. There will be
+good competition. There will be confidence in the system.
+ Plan sponsors will appreciate it. I don't see plan sponsors
+bailing out of this. I see them embracing this. And it is in
+the best interest of American business to shore up the economic
+security of its workforce, because 20 years from now, we have
+got a big pool of baby boomers who are going to be retired who
+won't have enough money to meaningfully participate in the
+economy.
+ And a lot of businesses are going to wonder why they are
+struggling. It is because a whole segment of the economy was
+removed because they didn't have enough money. There is no
+money to spend.
+ And so it behooves plan sponsors to deal with this. It is
+in everybody's interests.
+ Mr. Kildee. And they are going to be in the 401(k)-type
+rather than the defined benefit-type, so we have a large number
+of people who will be affected by this then.
+ Mr. Hutcheson. That is correct.
+ Mr. Kildee. Ms. Bovbjerg, can we learn anything from the
+Thrift Savings Plan that we have in the federal government that
+can help us in the 401(k)s?
+ Ms. Bovbjerg. The Thrift Savings Plan discloses information
+in a clear way, as Chairman Miller was showing. I think it is
+important to remember that the Thrift Savings Plan is somewhat
+different from 401(k)s, in that their administrative costs are
+exceedingly low compared to other forms of--you know, other
+types of plans, that some of that has to do with the way that
+that plan is administered throughout the government.
+ It also has to do with--they have been very effective in
+keeping their costs low, I have to acknowledge that. I just
+think it is difficult to make that comparison, because you are
+dealing with a less diverse group of people. We are dealing
+with federal employees. They can all read; they all speak
+English. You know, it is quite different than a much broader
+type of plan coverage.
+ Mr. Kildee. Thank you very much.
+ Thank you, Mr. Chairman.
+ Mr. Boustany. Thank you, Mr. Chairman.
+ We would all agree that disclosure and transparency are
+very good things. Mr. Chambers, is there a danger in
+oversimplifying, when providing information to participants,
+that could lead to poor choices? Could you elaborate on that
+and what sort of problems that that might create?
+ Mr. Chambers. Surely, thank you.
+ Despite some of the comments that have been made earlier
+today about fees being the most important--and, perhaps--I am
+not suggesting anyone has said the only important, but the most
+important factor here--a large number, certainly in my
+experience, the predominant number of financial advisers have
+indicated that there are many different things that should be
+put into focus as you are making an investment decision.
+Clearly, fees are one of them.
+ The gentleman to my right, Mr. Hutcheson, I think just
+mentioned the fact that, you know, you look at total return.
+That is generally going to be net of some fees, perhaps all
+fees, depending upon what is being paid out of the funds.
+ Risk is an issue. Diversification is an issue. There are
+many, many issues that need to go into an investment decision.
+Perhaps that is why Mr. McKeon is no longer investing in
+stocks, because of all of the different things that you have to
+consider when you are making an investment decision.
+ So I think that the big problem with oversimplification
+here is an overemphasis on fees. Yes, they are important. Yes,
+they should generally be disclosed. But they can--just looking
+at that and that alone can lead to some very bad investment
+decisions.
+ Mr. Boustany. I thank you for that answer.
+ Ms. Bovbjerg, in looking at ERISA, Section 404, could you
+basically state what it requires and what was its intended
+purpose? And in the view of GAO, is it really meeting that
+purpose?
+ Ms. Bovbjerg. I don't know if I can do all that right here
+and now. I can talk a little about 404(c), which is
+particularly relevant----
+ Mr. Boustany. 404(c) is particular, yes.
+ Ms. Bovbjerg [continuing]. To this topic, that plans that
+fall under 404(c) are essentially seeking freedom from
+liability for investment choices that the participants make. In
+return, they have to disclose certain things beyond what other
+plans would have to do.
+ We had a little trouble trying to figure out what
+proportion 401(k)s sell under 404(c). We thought it was 50
+percent to 60 percent, somewhere in there. Those are the plans
+that the Labor Department is thinking about focusing new fee
+reporting requirements on.
+ Now, the way we see some of the fee reporting, it is all
+over. It is effective in some plans, but not uniformly.
+Participants have to ask for certain things; they have to know
+to ask for certain things; they have to pull information from
+several different sources.
+ You know, and 404(c) plans, it is easier to get that
+information, no question about it. But is it complete? It is
+just not clear to us that it is.
+ Mr. Boustany. I thank you.
+ I yield back.
+ Chairman Miller. Mr. Yarmouth?
+ Mr. Yarmuth. Thank you, Mr. Chairman.
+ I only have one question, and I think I know the question,
+but it seems like there is nothing to prohibit any of the
+providers from disclosing their fee structure. And my question
+is--and anyone can address is--why is unreasonable that this
+wouldn't become a huge competitive advantage, in what is
+apparently a pretty competitive field, 700,000 plans out there?
+ Why couldn't we allow--just allow the markets, the
+providers to use that as their advantage? The lowest fee
+structure, if they advertised it, would give them a competitive
+advantage.
+ Mr. Hutcheson. If I might, thank you for that question.
+ The reason--and I will try not to be too complicated here,
+or complex, rather--401(k) are today governed partially in a
+fiduciary environment, as they were originally intended and
+contemplated, and partially in a non-fiduciary environment.
+They are exemptions that exist that permit non-fiduciary
+investment firms and others to participate in 401(k) plans,
+where otherwise they might have been prohibited from doing so,
+had the exemption not been given.
+ And so this intermingling or blending of non-fiduciary and
+fiduciary philosophies is the root cause of this. And if you
+bifurcate the two, fiduciary standards of care demand
+transparency and open competition based on equal information
+between the buyer and the seller.
+ It is the non-fiduciary component of 401(k) plans that is
+obscuring this, partially due to that exemption or to
+exemptions. And when I say ``that exemption,'' I am referring
+to the Merrill exemption that permits them to participate in
+401(k) plans and receive various forms of compensation without
+being held to a fiduciary standard.
+ And if we help everybody to a fiduciary standard, this
+might self-correct.
+ Mr. Yarmuth. Can I just ask for clarification? Do I
+understand you correctly that what you are saying is that
+different providers have different obligations under these
+plans, and therefore the fees wouldn't be apples to apples?
+ Mr. Hutcheson. Exactly. You can take two physicians'
+offices. Both of them have 20 employees. One of them has
+service providers that acknowledge their fiduciary status and
+behave as such. The other physician's office has the exact same
+mutual funds, or funds, but yet their service providers are
+hiding behind an exemption that protects them from fiduciary
+responsibility.
+ And, therefore, they are not held to the same standards of
+disclosure, and that has to be eradicated from the 401(k)
+system. I believe that it will self-correct if that happens.
+ Mr. Chambers. My experience is that, although certainly
+there are some folks who will perform a service as a fiduciary
+and others who will perform the same service as a non-
+fiduciary, is that I don't see any less disclosure of fees in
+one situation, as opposed to the other.
+ And, clearly, plan sponsors, if they wish to off-load
+fiduciary status onto someone rather than retaining it
+themselves, they certainly have the capacity and the
+marketplace to do that. As Mr. Hutcheson just pointed out,
+there are organizations out there who will accept this role.
+ There are other organizations, though, that say, ``I will
+do it in a different fashion,'' and that is the marketplace.
+There is a decision. I don't believe that in under any
+circumstances do you need to homogenize that, do you need to
+invariably go out and find someone who is willing to serve as a
+fiduciary to perform the function to the exclusion of someone
+who is not, particularly for purposes of this hearing, if both
+of them are charging relatively the same fee or, even if they
+are not, if they are disclosing it.
+ Mr. Hutcheson. If I may just clarify, because 401(k) plans
+are a fiduciary animal, they are subject to trust laws. And
+trust laws have fiduciaries. And fiduciaries must be able to
+discharge their duties unimpeded. They must not have obscured
+information or they must not have information withheld.
+ Let me give you a specific example. I was asked by the
+chairman of an organization to come in and explain how their
+investment providers are managing their fee for free. Well,
+clearly, that can't be the case, but that is what the chairman
+was told. And we are talking about $100 million plan.
+ And I categorically and summarily disagree absolutely. The
+fiduciaries simply didn't know what the pay or cost structure
+was of the plan. None only does ERISA demand that fiduciaries
+know, but if fiduciaries don't really understand whose getting
+paid, then they can't discharge their duties.
+ And they are withholding information, because they are not
+held to a fiduciary standard. And I believe strongly that they
+should be.
+ Mr. Butler. If I may, as a further answer----
+ Mr. Yarmuth. I think I am glad I asked this question.
+ Mr. Butler. Pardon me?
+ Mr. Yarmuth. I think I am glad I asked this question.
+ Mr. Butler. Well, what I would like to do is just elaborate
+and talk about money for a minute, as opposed to fiduciaries.
+Mr. Chambers, in his written testimony, presented an elegant,
+perfect example of how fees are charged.
+ He used as an example $150 for the total cost of operating
+a plan for, say, a participant; $50 of that cost would be for
+the actual administration of the plan, $100 would be for the
+money management portion.
+ And then he pointed out that, on the $100 of the money
+management portion, which is going to the mutual fund, they are
+going to give up or pay $10 of it back to the company doing the
+administration. So the administration company is actually
+getting $60, and the mutual fund company is getting a net of
+$90.
+ In the real world, you can expand that to a real situation.
+Let's say that we have a $10 million plan. It has 150
+employees, probably an engineering firm, a law firm, company
+that has been around for at least 15 to 20 years. And so now,
+instead of $150, we have actually 1.5 percent, which would be
+pretty typical, $150,000 is what is now being paid, one way or
+the other, to administer this plan of $10 million.
+ We have got $100,000 going to the mutual fund. They are
+giving up $10,000 of it and paying it to the record-keeper.
+Somebody understanding that there is that breakdown of cost
+could now start shopping for the record-keeping services. And
+on this particular plan, they would be able to get those
+services for something in the neighborhood of roughly $10,000 a
+year. They don't need to pay $50,000.
+ The $10,000 for the record-keeping is really for the
+seamless electronic environment that allows people to dial up
+their account on the Internet, and that is a basic commodity in
+the industry today.
+ So now you have a plan sponsor who has an opportunity
+possibly to save his participants about $40,000. And at this
+point, he is now looking at the other component of the plan,
+which is the mutual fund company that is charging $90,000. And
+a person confronted with that information is going to say to
+himself, ``Maybe I can get this money managed for something
+closer to $40,000, instead of $90,000,'' and he could.
+ So now he is just saved his participants, including
+himself, because he has his own account to think about, he
+saved himself and his participants about 1 full percentage
+point per year. The magic of compound interest works against us
+when we start taking fees or paying fees out of money that
+could otherwise be compounding, tax-deferred.
+ It is counterintuitive. In this particular example, let's
+say we have saved about--we have increased our returns by about
+10 percent, let's say. So you ask yourself, ``Well, why is that
+leading to 20 percent more money downstream?'' And the answer
+to that is, because that additional 1 percent compounded adds
+up to 20 percent of the total account balance.
+ He has essentially saved his participants 20 percent of
+what they otherwise would have spent, and effectively he has
+increased everybody's retirement nest egg by 25 percent. And
+that is what this is really all about; that is why these
+hearings are so important.
+ Chairman Miller. The gentleman's time has expired.
+ Mr. Kline?
+ Thank you for the question.
+ Mr. Kline. Well, I am going to let us continue down that
+line. It looked like Mr. Chambers wanted to have something to
+say. I would like you to do that, and then I would like to
+address my question.
+ Mr. Chambers. Thank you, sir.
+ The point that I was going to make is, that that is exactly
+the problem that I have highlighted. Mathematically, that makes
+great sense. But should the employer or whoever it is who is
+making the decision on who is going to be investing plan assets
+or whose products will be available, who is going to be
+administering the plan, that they should do that, either solely
+on the basis of fees or largely on the basis of fees?
+ There was no indication here about what the relative
+performance of the two record-keeper. Does the record-keeper,
+does the new program permit all the bells and whistles that the
+employer and the employees want? That costs money. Does the
+investment adviser, who is being selected, because, in fact,
+they charge fewer dollars, you know, per thousand, what is
+their relative rate of return over a long period of time?
+ All of this needs to be put into the perspective of a lot
+of different people making decisions on the basis of a lot of
+different points.
+ Thank you.
+ Mr. Kline. Thank you. I knew you were chomping at the bit
+there, so to speak.
+ I don't know, Mr. Chairman, do the witnesses have this----
+ Chairman Miller. I don't know, but we will get it to them.
+ Mr. Kline. Okay.
+ Chairman Miller. Yes, it was shown up. Maybe it can be put
+back up on the plasma screen.
+ Mr. Kline. It seems to me like there is some agreement here
+in the committee--and maybe throughout the room--that
+transparency and visibility into these funds is a useful thing.
+ But I am concerned that we sometimes do confuse the famous
+apples and oranges, and I am just trying to understand. I
+think, Ms. Bovbjerg, you were talking about this issue earlier,
+not confusing or not trying too hard to compare the Thrift
+Savings Plan with some other 401(k)s.
+ And this, clearly, is doing exactly that. It is comparing
+the Thrift Savings Plan with some--I don't know if that is a
+real fund, but it shows a significant difference, when you
+compare the TSP with this notional 401(k). It looks like those
+are dollars per individual.
+ What I would like you to do is go back where you were a
+couple of questioners ago and talk about why it is that the
+Thrift Savings Plan comes in at asset-based fees of 0.6 percent
+and why it is not. We are a little apples and oranges here when
+we try to compare other 401(k)s. Could you do that for us, kind
+of pick up where you were? Thank you.
+ Ms. Bovbjerg. Absolutely.
+ I think I would also like to say that this is a graph that
+is similar in spirit to one that was in our report on fees that
+looks at what, if your fees were 1 percent higher over a 20-
+year period, what would that mean? It would be about a 17
+percent loss of income, assets.
+ The Thrift Savings Plan uses administrators across the
+federal government to help people sign up to make changes. The
+Department of Education has them; the GAO has them; Congress
+has them.
+ Mr. Kline. And these are public employees rather than----
+ Ms. Bovbjerg. These are public employees, and they are--
+Congress pays for its office. GAO pays for its personnel office
+that has these people in the Department of Education, so----
+ Mr. Kline. Thus reducing the costs?
+ Ms. Bovbjerg. Yes. So the six basis points is not really
+what the administrative cost is of the Thrift Savings Plan, but
+that is not to take away from the fact that Thrift Savings Plan
+is very efficiently run. So the administrative costs are still
+pretty low.
+ Mr. Kline. Okay, thank you.
+ Yes, Mr. Hutcheson?
+ Mr. Hutcheson. The underlying investments in the Thrift
+Savings Plan are what we call index funds generally. They are
+passive funds. You are getting the broad market.
+ In the private sector, funds very similar to what is in the
+Thrift Savings Plan are available to employers. They might be
+slightly more expensive, because it is a price based on the
+assets in the plan. But what we are seeing here is a perfect
+example of what Professor Sharpe, who won the Nobel Prize in
+Economics, and also many other people have said.
+ If you track the broad market as closely as possible, you
+will get market returns, and you really, over the long haul,
+can't do better than that.
+ Mr. Kline. Sure, I understand. You are proposing that we
+use the index funds. But what I was trying to get at is that
+there is--in the fee world, which we are trying to get
+visibility in the fees--what is now shown here, was what Ms.
+Bovbjerg pointed out--that because the taxpayers are paying, in
+some part, for the administration of this, because we have
+public employees who are doing part of this work, the Thrift
+Savings Plan is not the best apple-to-apple comparison and what
+fees are.
+ Thank you, Mr. Chairman. I yield back.
+ Chairman Miller. Thank you.
+ Mr. Wu?
+ Mr. Wu. Thank you, Mr. Chairman.
+ First, I want to ask the panel--and, Bob, you in
+particular--do we have pretty much uniformity of agreement that
+disclosure of the various fees is non-objectionable, as long,
+as you said, Bob, that it does not drown out other valuable
+information, that disclosure of brokerage fees, 12b-1 fees, and
+so on and so forth, that all of those disclosures are
+appropriate.
+ Mr. Chambers. Well, I generally agree, but I think that
+where the rubber hits the road is going to be in terms of what
+fees needed to be disclosed and how we slice and dice the fees
+that are out there.
+ And to go back to one of the points that the chairman made
+earlier, and when he was alluding to my Toyota example, when
+you go to buy a car, there is not fee disclosure on how much
+Toyota paid for the glass, and there is not fee disclosure on
+how much Toyota paid for the computer components. There is an
+overall fee.
+ And I agree: There are ways to assess whether that
+particular automobile is better than another automobile,
+through miles per gallon, you know, performance, which is what
+we are talking about here.
+ So I think that the council's concern--well, the overall
+concept is, yes, we are very favorably behind the idea of full
+and fair disclosure of fees. But I do think that where we are
+going to run into issues is, exactly how are we going to be
+slicing and dicing that? Because I don't know that it is
+necessarily essential for a plan participant--to mix the two
+metaphors now--that a plan participant needs to know how much
+the glass costs in the car.
+ And I can see, for example, that, if you have a large
+financial institution which has been empowered through
+contract, you know, to perform services for a plan, and if, for
+example, that financial institution decides that it is going to
+take one of the functions that it is contractually bound to
+perform, and to hand it off to one of its affiliate companies,
+you know, say it has a captive trust company, for example, I
+don't know that that necessarily is something that needs to be
+disclosed. That is internal proprietary information.
+ But by and large, overall fees, yes, we are very much in
+favor of that.
+ Mr. Wu. Yes. And because of the limitations of time, let me
+just say that, in contrast to, say, a Toyota, because of the
+difficulty of predicting future market performance, because the
+market is basically different from being able to calculate the
+speed or safety of a car, some of the rear-view mirror things,
+if you will, like fees, take on a disproportionately important
+role, I would like to be--I would be very interested in hearing
+from all the panelists what disclosures you all feel are
+important and the best display format for that, so that it is
+most useful for investors.
+ And I would like to ask that question and get that set of
+answers over time in writing, because I would like to turn to
+Mr. Hutcheson for a second. And I am not sure that this came
+out, Matt, in your oral testimony, but in going through your
+written testimony last night, there was a recurring theme of
+non-fiduciary functions and fiduciary functions and having
+those mixed together, and a core problem of mixing those non-
+fiduciary and fiduciary functions together.
+ But as I read the materials, one of the non-fiduciary
+functions was actually the investment decisions of the plan's
+beneficiary. And I would like to take me through this a little
+bit. It is one of the--where you are going with this, if we
+take it all the way out with a fiduciary plan, is that we
+ultimately get the plan beneficiary off the loop, in terms of
+decisionmaking about investment vehicles.
+ Mr. Hutcheson. That is right. I personally believe--and
+just to clarify before I answer the question--that no person
+can time the market. I just don't believe it. I think there is
+empirical research that shows that there is only a few points
+in time each year where the market really takes a big leap
+forward, and you have to be in the market at that point in
+time.
+ And so placing decisions in people who have no financial or
+economic or investing experience, and not only just placing
+investment decisions, but we are talking about trust assets
+subject to fiduciary prudence.
+ So 404(c) says that a participant will not be deemed a
+fiduciary to the extent that they are directing these trust
+assets, and that is kind of a conflict in fundamental fiduciary
+prudence and trust oversight, as we have been accustomed to,
+many, many years, decades before 404(c) was enacted.
+ And very short, I believe that participants play with their
+accounts based on recommendations of friends, what they see in
+the news. They have the ability to make changes. 404(c) says
+that you have to be able to change your allocations quarterly
+or more frequently, as the market dictates. Why would they want
+to be changing their accounts based on what happens yesterday?
+ That is not prudent. It makes no economic sense. It is not
+based on good, sound investment research or theory. It in
+itself, I believe, is bad public policy. And it, in my opinion,
+goes contrary to fundamental laws of fiduciary prudence.
+ Mr. Chambers. May I add one point, please, to that? And
+that is--well, actually two points.
+ One is, I don't think that that is a correct statement of
+trust law, number one. It is difficult for someone to be a
+trustee for himself or herself. And, therefore, you are not a
+fiduciary, which involves acting on behalf on someone else. So
+I don't think that that is a correct statement.
+ Number two, you need to take a look at the program, I
+think, that Mr. Hutcheson is proposing. Now, you know, one of
+the comments or one of the things that we talk about is the
+series of movies that were out a number of years ago, you know,
+``Back to the Future.''
+ Well, I think that what he is suggesting is the opposite,
+which is ``Forward to the Past.'' There is, if you take a look
+at what he is suggesting--which is a very viable program for
+employers who are so inclined. I am not trying to say that it
+is a bad program at all. I don't think that it is particularly
+viable in the view of most employers with whom I work.
+ It is essentially the creation of a television set that
+only gets one channel, and it is a channel that, whoever it is
+that is putting that set together, is developing. One set of
+investments, you know, no loans, no this, no that.
+ Why would an employee want to make a decision to change an
+investment because of what happened yesterday? There may be
+something else in his or her life that dictates that. It also
+may be that they no longer have confidence in the investments
+that they previously made.
+ Chairman Miller. The gentleman's time is expired. Thank
+you.
+ Mr. Wu. Thank you, Mr. Chairman.
+ Chairman Miller. Mr. Andrews?
+ Mr. Andrews. Thank you, Mr. Chairman.
+ I very much appreciate the witnesses, and I appreciate this
+hearing. I view this hearing as a continuation of work that
+this committee has done on a bipartisan basis over the last
+number of years, reflecting a number of points of consensus.
+ The first point of consensus is that it is a reality that
+individuals are managing their own investment decisions, and I
+think there is a consensus that we should not impede that
+individual choice or individual freedom.
+ In the wake of the Enron scandal a few years ago, there
+were some discussions of putting legal limitations on choices
+people could make in their own 401(k) plans. I, frankly,
+opposed those suggestions, and I am glad they are not the law.
+ The second point of consensus is that people should--we
+should facilitate people getting sound investment advice. Now,
+there is still significant disagreement over what that means.
+There was a compromised reach in the act of 2006. We will
+evaluate the efficacy of that compromise and continue the
+discussion, but I think it is obviously true that sound
+investment advice is better than no investment advice or,
+frankly, a lot better than investment advice from an
+incompetent source who doesn't know what he or she is talking
+about.
+ The third point of consensus is that we should maximize
+transparency so that people making these individual choices
+have the widest array of facts in front of them so they can
+make the best choices, which leads us to today's discussion,
+which is, what should the form and nature of that transparency
+include?
+ I will confess to you, I come to this discussion as an
+agnostic. I am very interested in what you think as to how we
+can answer that question. But in my simple agnosticism, I would
+make the following proposition.
+ We talk about people buying cars? I think the best example
+is someone selling their house. It is the single most important
+economic decision most Americans make. And when most Americans
+sell their home, they ask one question. They ask two questions,
+really: How much am I going to get for the house? What is the
+sale price going to be? And how much of the sale price am I
+going to get to keep?
+ I actually practiced real estate law before I did this and
+represented hundreds of homebuyers, and they would ask the
+realtor how much they were going to get for the home, how much
+the contract was going to be for. And they would ask me, as
+their attorney, how much they were going to get to keep.
+ And we have disclosure laws, RESPA, in the real estate
+context that tells someone how much of the proceeds they have
+to pay to someone else, the real estate commission and other
+fees, and how much they get to keep.
+ I think that is the basis on which we should build this
+disclosure. I think we should build it on the proposition--if
+my 401(k) were invested, and I got to keep everything, every
+dollar earned on that investment decision, how much would that
+be? And then how much are we going to get in a net return,
+after whatever fees, or contracts, or considerations are paid?
+ Does anybody disagree with that as a conceptual framework
+for approaching this problem?
+ Okay. Now, I think there is a second category of this
+disclosure we also have to think about. And I am not sure
+whether the present law covers this or not, and that is the
+situation where, to use the analogy, the sale price of my house
+is too low because the realtor was conflicted in some way, that
+the realtor sold the house to her sister-in-law rather than to
+the highest bidder.
+ Does anyone think that the present ERISA statute does not
+prohibit that situation? Does anybody think that the present
+statute doesn't prohibit the situation where the person making
+some plan decisions is depriving me of the highest price or the
+best investment?
+ Mr. Butler. If I may, I think there are all kinds of
+opportunities for that to happen right now, under the current
+situation. Forbes magazine talked about the extent to which the
+brokerage industry's own mutual funds do very poorly as
+investments, comparatively speaking.
+ And the reason for that is because the brokerage industry's
+source of revenue, to a large extent, has to do with trading
+commissions. So the mutual funds that they operate, in many
+cases, are feeding troughs for their trading operation. And
+that is an example that I see in the industry, along the lines
+of what you were just talking about.
+ Mr. Andrews. Okay. Because my time--do you agree with that
+conclusion of Mr. Butler or not?
+ Mr. Butler. Yes, I do. I would say that----
+ Mr. Andrews. No, I know you agree. I asked Mr. Chambers if
+he agrees with you.
+ Mr. Chambers. I don't always agree with myself, so I need
+to deal with that.
+ Mr. Andrews. Okay.
+ Mr. Chambers. Before I respond to that, to respond to your
+comment or your question, I am concerned with your using the
+word ``best'' in conjunction with what ERISA requires, as
+opposed to what is reasonable, which is, in fact, what the
+statutory standard is.
+ Mr. Andrews. Of course, it doesn't require what is
+reasonable. It requires what is in the best interests of the
+participant party.
+ Mr. Chambers. Best interest, yes, but not necessarily the
+best result.
+ Mr. Andrews. Okay. You would agree, that is not synonymous
+with reasonable, though. If you make a reasonable choice that
+is not in the fiduciary interest of your----
+ Mr. Chambers. No, but somebody has to act reasonably. And
+one of the ways that they have to act reasonably is within the
+best interests of the participants and the beneficiaries.
+ I think that, if everyone had to go around chasing the best
+investment results, or if everyone had to go around chasing the
+lowest conceivable method of administrative fees, I think that
+this would be a very different world.
+ Mr. Andrews. Of course, that is not what I asked, though. I
+asked whether you thought that the statute prohibits someone
+making a conflicted or self-interested decision in the
+investment context.
+ Mr. Chambers. I think that, yes, the statute does currently
+prohibit that.
+ Mr. Andrews. Effectively?
+ Mr. Chambers. Pardon me?
+ Mr. Andrews. Effectively? Do you think there is any
+loopholes in that?
+ Mr. Chambers. Are there loopholes? I don't know that I
+would call this a loophole, but remember that, for example,
+employers have issue--every employer that sponsors a plan
+invariably has issues about its role as the settlor of the
+plan, the sponsor of the plan, versus its role as a fiduciary
+of the plan. And that is something that is inherent in
+sponsorships.
+ So I don't know that you would call that a loophole, but
+certainly that is something that everyone has to be concerned
+about.
+ Mr. Andrews. My time is expired. I would just ask if Mr.
+Hutcheson wanted to respond.
+ Chairman Miller. Mr. McKeon wanted to tag on----
+ Mr. Andrews. Sure, Mr. Chairman, I would yield.
+ Mr. McKeon. Will the gentleman yield?
+ In your example, if the realtor brings an offer to me to
+sell my house, I can accept or reject it. So I don't see where
+that really plays a role, a comparable role.
+ The first part, where you talked about just final net
+return, it sounds great to me. I don't know where----
+ Mr. Andrews. Yes, if the gentleman would yield, here is the
+analogy of the realtor bringing an offer. Someone has to make a
+decision which options to give the plan participant. You could
+limit----
+ Mr. McKeon. But it all washes out with the net return.
+ Mr. Andrews. It washes out----
+ Chairman Miller. I will take your answer off the air.
+ Mr. Andrews. Thank you.
+ Chairman Miller. Mr. Sarbanes?
+ Mr. Sarbanes. Thank you, Mr. Chairman, and thank you for
+holding the hearing.
+ I have a brief question. In my view, when it comes to
+information, there are two ways you can hide the ball. You can
+not disclose enough information, or you can disclose so much
+that it becomes impossible for the consumer of the information
+to sift through it and understand it. You see that happen in
+many, many different arenas.
+ So, Mr. Butler, I wanted to ask you to address this,
+because it is not just about more disclosure. It is about
+better disclosure. And I feel as though I get plenty of
+information on a lot of things that represent ``full
+disclosure'' that I can't make heads or tails of. And this is
+another arena were that would be the case.
+ So it is about how you package it. And your index,
+obviously, attempts to do that. But if you could just speak to
+the pitfalls of too much disclosure or how we package or
+present the information in a way that is really constructive
+for the consumer.
+ Mr. Butler. I would love to address that.
+ First of all, the need to know, from a decisionmaking
+standpoint, really centers on the company management people who
+are basically charged with deciding what kind of plan and which
+vendors they are going to use. That is why my first book was
+called ``The Decisionmaker's Guide to 401(k) Plans.''
+ The participants really then wind up being the
+beneficiaries of hopefully some informed decisionmaking. When
+you are looking at the component costs of one of these plans--
+and the example that I was using earlier--what is important is
+for these decisionmakers to be able to basically understand
+each component cost so that they can effectively decide whether
+or not they want to be part of a package deal or not.
+ And the example that I used, we presupposed that we had
+mutual funds and then a separate company, let's say, as a
+record-keeper. But, in fact, in about 70 percent of all 401(k)
+plans, it is all in the same building. It is the mutual fund
+that also has three floors of record-keepers keeping track of
+the money and doing the compliance-related issues.
+ And so the important thing is for this bundled provider to
+be able to present to the decisionmakers, their clients, what
+the component costs are so that the decisionmakers can decide
+whether or not they want to be part of a package deal. Or can
+they create a much better opportunity for their participants by
+breaking things up and shopping for better opportunities?
+ It is like, when you buy a car, you might decide that you
+don't want the manufacturer's Bose stereo because you can get a
+much better deal buying a stereo independently.
+ Mr. Sarbanes. Do you think that the ``decisionmakers'' can
+be as susceptible to getting too much information, as
+beneficiaries can, or because they are better versed and this
+is their responsibility, to make these decisions, that they are
+sort of protected against that?
+ Mr. Butler. My experience, in the smaller company
+environment--and, bear in mind, 70 percent of all Americans
+work for companies that have less than 100 employees--my
+experience is that decisionmakers in that environment tend to
+be the company owners, who are by definition successful
+businesspeople, many are self-styled investment experts
+themselves, or mutual fund experts.
+ Also, the CFO or controller will also be part of that de
+facto decisionmaking committee. And these people are very, very
+sophisticated. They make the right decisions if given the right
+information.
+ Mr. Sarbanes. Thank you.
+ Mr. Chambers. May I comment?
+ Mr. Sarbanes. Sure.
+ Mr. Chambers. I guess I agree with most of what Mr. Butler
+just said. The one issue that I have is, that I am not sure
+that it is appropriate or essential to get a bundled provider
+to explain what the cost allocation is or the expense
+allocation is, if it is not making those services available
+independent of one another.
+ In other words, the way--and I just went through this with
+a client--that is a small employer, about 100, 150 employees,
+and they wanted to look at new record-keeping investment
+systems. And they went to some programs that were bundled, and
+we found out what the total costs were from that. And then they
+went to other programs which were not bundled, and we found out
+what the total costs were there.
+ I don't know that it would be essential to receive
+information from the bundled program, for example, about how
+much it was allocating to provide record-keeping, as opposed to
+some other component, if that is not available from that same
+organization. I don't know that that is information that is
+going to help you to make a meaningful decision.
+ Mr. Sarbanes. Well, I hear that, and I worry--it is a fair
+point, although it could also be the beginning of a slide, kind
+of slippery slope, in terms of what comparative information is
+available.
+ I yield back. Thanks.
+ Ms. Shea-Porter. Thank you, Mr. Chairman.
+ I can remember when the fees for banking and mortgages were
+so absolutely confusing, and there has been some streamlining.
+And probably my son, who is 17, is the only one who still pays
+10 percent monthly on his balance at a bank, and we are going
+to straighten that out.
+ But the reason I brought that up was because it is
+difficult for people who are not knowledgeable to understand.
+And it is pretty clear on the bank statements to me now, you
+know, what the fees will be. And I will be teaching my 17-year-
+old shortly the same thing.
+ But when you try to compare different plans, I think there
+is an obligation--this actually is to Ms. Bovbjerg--an
+obligation to be as explicit as possible. And I think it is
+possible to be simple, as well, when you are explaining the
+fees.
+ And I listened to my colleague talk about the costs of the
+TSP, for example, and I wanted to ask you to address that. He
+said that federal employees were picking up some of the cost of
+the administration. Do you have any idea how much the federal
+employees are actually picking up? And is it possible to
+compare those two plans?
+ I am fortunate enough to be in the TSP, and it is clear,
+and the administrative fees are lower. So could you address
+that, please?
+ Ms. Bovbjerg. And you have touched on one of the reasons
+that makes it so difficult to compare the Thrift Savings Plan
+to other types of retirement saving vehicles.
+ When I brought up the thing about the Thrift Savings Plan,
+I did want to say that, you know, this graph is essentially
+showing the math between two things. And the math is correct,
+but it is the implication that six basis points is sort of
+normal I was a little concerned about.
+ The Thrift Savings Plan has certain levels of expenses.
+And, in fact, we will be reporting on these costs for
+Congressman Davis in a couple of months. But the Thrift Savings
+Plan does take its--gets revenue from not only, you know, from
+not having to do things, but also from the money that is what I
+would call ``left on the table,'' you know, the federal
+government matches and puts in 1 percent.
+ And for people who come to the federal government, the
+people who leave before they invest, can only take their money,
+and they leave the federal money on the table. That also nets
+the administrative costs for the TSP. That is one of the
+reasons why they look so low.
+ I would like to say that, in terms of reporting to
+individuals, it is critical that it be simple, that it be
+clear, it be all in one place, and that people don't have to go
+ask for it, because they will never find it. Only a certain
+percentage of people will know to do that.
+ But it is hard. It is hard for the Social Security
+Administration to produce a benefits statement that 270 million
+Americans can understand. And they put a lot of effort into it.
+So I don't want to discount what I know are the concerns about,
+how do you really make something that people will find
+accessible? It is not easy, but it is important.
+ Ms. Shea-Porter. Right, but it is doable, that is what you
+are saying.
+ Ms. Bovbjerg. It is doable.
+ Ms. Shea-Porter. Right, and still leave a healthy profit
+for those who are the administrators.
+ Ms. Bovbjerg. I can't say what it would cost, different
+kinds of sponsors. And, certainly, I know that the Department
+of Labor is weighing, you know, sponsor burden against the
+outcome and trying to figure out how they can best achieve some
+sort of optimal result.
+ Ms. Shea-Porter. Okay, thank you.
+ Chairman Miller. Thank you very much.
+ And thank you for all of your testimony.
+ A couple of things here. One is, I guess the question I
+would ask--and I appreciate Mr. Andrews raising the point, if
+you had a net-net-net figure, would that tell you what you
+really need to know as a consumer, or would these other
+packages of information be more informative, or what have you?
+And that is obviously to be discussed further.
+ But the real question for me is, again, a lot of people--
+you know, you can have $100 million plan, and a lot of people
+are struggling to put in $6,000, $7,000 into this plan. And
+they don't have a lot of room for risk and fees and the rest of
+this.
+ And the question that I would raise is, are we sure that we
+are getting the value added for that? And is there a reasonable
+reason why somebody made a decision to go in that direction? Or
+was it a conflicted decision? Or was it a decision that really
+didn't meet that reasonableness when you consider who is in the
+plan?
+ You know, the Miller family doesn't have a lot of margin of
+error for mistakes. My employer apparently does, because we
+have got $1 trillion debt he is running around with. But, you
+know, the sponsor of this plan, the owner of the business, and
+maybe the officers, depending on the size of it, they may have
+a lot of income. People working for them may have reasonable
+income or good income. But good income today doesn't give you a
+lot of room for risk.
+ So, you know, the question is, how does that factor in? And
+I guess the disappointment I see is that you have a lot of
+people dipping into other people's money. You know, I didn't
+put the money into the 401(k) plan so a lot of strangers could
+come in and start dipping into this, under manufactured titles,
+for fees of questionable services, whether I need them or not
+need them.
+ Now, I am an individual, and so then we have to go to the
+plan, we have to go to the sponsors, and I think that is the
+central question for me, that this really is about other
+people's monies. And I think that, also, you are in an
+atmosphere where people have determined--maybe it is the advent
+of the Internet--but if you can charge a real small fee a
+billion times, you can become a really rich company. And people
+say, ``Oh, that fee doesn't matter.''
+ Well, as we have seen, every one of you have given us a
+comparison chart of what it would mean--let's just use the 1
+percent differential. That is a lot of money to a middle-class
+working American, at the end of the time, when they think they
+are going to retirement, and what are they going to be able to
+extract if they don't want to eat up the principal of that nest
+egg?
+ Those are big differences. One of you said that the
+difference was the--between the 1 percent and 1.5 percent, 1.5
+percent differential, the person who was on the bad end of that
+bargain would have to work an additional 7 years. I mean, these
+are big consequences to workers and to families.
+ And I guess my concern--I mean, one of the things discussed
+with the members of the committee and with others, is the
+question really, are they getting value added here?
+ You know, I have listened to I don't know how many
+financial shows over 20 years, where one side is saying, ``This
+should be the position for most American investors, an index
+fund. It is safe, it is low cost, and the rest of that.''
+ And the other people say, ``Oh, no, you can go out there,
+and you can beat the market,'' and there is a lot of reasons
+why people say that, because they are out there trying to beat
+the market, and they need clients to do so. And that may be
+good for some people, but it may not be good for this plan that
+is becoming a larger and larger percentage of people's
+retirement.
+ This isn't their mad money; this is their retirement. By
+default, this has become one of the two remaining legs on the
+retirement stool in this.
+ You know, we have been talking about a comparison of the
+thrift plan, but I think IBM and Xerox are even more efficient
+in these 401(k) plans than the thrift. Does anybody have any
+knowledge of that, that they--one of you had it in your
+statement, I am sorry.
+ Mr. Butler. My understanding is that Xerox charges .03
+percent to their employees. They probably have some other
+costs, but they are paying those costs as a tax-deductible
+corporate business expense, instead of having participants pay
+it with money that would otherwise be compounding tax-free.
+ Chairman Miller. That is because of a separate decision
+they made, how they would allocate the costs. So that is a
+benefit, I guess, that you would argue they feel strongly
+enough financially to be able to shift.
+ Mr. Butler. Exactly. And there is no way that Xerox would
+then be paying 100 basis points as a corporate business
+expense. They have just figured out what the fixed cost is for
+each participant in the plan, and it is probably about $50 a
+year to keep track of the money, per person.
+ Chairman Miller [continuing]. Xerox is not a small
+business, with, you know, 100, 150 employees. So there is some
+bargaining----
+ Mr. Chambers. I think you need to look at it as an employer
+contribution to the plan. And Xerox could ask the employees to
+pay whatever the amount is and be providing a larger employer
+contribution in the form of a match or, perhaps, in a profit-
+sharing contribution. And the employees would be in the same
+position.
+ So I think that you are correct, but there is another way
+to do it, which is the way that a lot of employers are doing
+it.
+ Mr. Hutcheson. Chairman Miller, I don't think that anybody
+is suggesting radical open-heart surgery. I think what we are
+suggesting is, is asking that plans be governed by prudent
+fiduciaries in possession of full and correct information. Once
+they are in possession of all the information, if they want
+bells and whistles, and the fiduciaries certainly have the
+discretion to purchase them on behalf of the participants and
+beneficiaries to whom they serve.
+ Without full information, the fiduciaries are impeded. And
+if we have a seller and a fully informed buyer, the free market
+system will take care of this. But as it is today, the
+purchasers of retirement services do not understand, not even
+the Department of Labor fully understands what the nature of
+the economics are or is.
+ And, thus, we have a situation. That is what needs to be
+remedies. We need to empower the fiduciaries with correct, full
+information, and let knowledgeable fiduciaries and the
+knowledgeable deliverers of services negotiate on equal
+standing.
+ Mr. Chambers. I don't disagree with that at all. I think we
+need to maintain confidence in this system. I think we need to
+improve confidence in this system.
+ And I think that, again, all of us on the panel agree that
+there needs to be another methodology of providing this
+information to all three of the constituencies that we have
+been discussing, participants, and the fiduciaries, and the
+government, in order to pursue this. I don't disagree with that
+at all.
+ But I think it is important to make sure, as I have
+mentioned before, that the cost of doing this is not going to
+overwhelm the benefit that comes from it, that, in fact, we
+wind up not diminishing end-of-the-road retirement benefits,
+simply because we have overemphasized fees, compared to all of
+the other important considerations that go into the
+administration of these plans and the investment of their
+assets.
+ Chairman Miller. Should the plan sponsor know whether or
+not there is conflicting financial arrangements for the
+placement of those funds?
+ Mr. Chambers. I think that the plan sponsor needs to
+understand what the relationships are. And I think, then, that
+the plan sponsor needs to make a decision as to whether there
+is a conflict there, whether the conflict is----
+ Chairman Miller. So they should have the information? You
+would agree that they should have the information?
+ Mr. Chambers. I think that they need to have information
+relating to what the role of each service provider is. And then
+they can decide whether or not there is a conflict.
+ One of the issues that are out there is that you may have a
+service provider that has a relationship at this end of the
+spectrum with a financial organization, and you have entirely
+independent people working at that plan level. So the question
+is, is there a conflict?
+ There may be a conflict in an entirely unrelated area. Does
+the administrator or the plan sponsor need to know that? I
+think it would be very helpful, but I am not sure that in every
+situation you are going to be able to provide that information.
+ Ms. Bovbjerg. Which is why recommended the Congress amend
+ERISA to explicitly require service providers to provide that
+information to plan sponsors.
+ Chairman Miller. If ``A'' is placing their funds with
+``B,'' and ``B'' is getting money from ``C,'' that in itself is
+an important piece of information.
+ Mr. Chambers. Right. How about if a bank is a lender to a
+particular organization, you know, is a primary lender or is
+involved--that is why I am saying----
+ Chairman Miller. Well, with all due respect, you know,
+those questions are answered every day in the courtrooms of
+this country, because among the biggest players in this field,
+they are suing one another over exactly those relationships.
+ We just saw a whole series of arrangements in the mutual
+fund industry, 3, 4, 5 years ago, where all kinds of privileges
+were extended based upon other arrangements. People were
+allowed to trade after 4 o'clock. People were allowed to not
+mark to market. People were allowed to go over until the next
+day.
+ You know, and they were based upon loans and placements of
+funds. I mean, that goes on in the financial services industry
+every day. Big clients get privileges, and connected people get
+privileges. So this goes on all the time.
+ The question is, you know, my little firm, and I am trying
+to take care of my employees, should I know whether the person
+I am working with has these financial relationships? I will
+then make a decision about whether I think that is impacting or
+not impacting, or it may come back to me a year later when I
+see what happens. I may say, ``Whoa, whoa, let's go back and
+see what that relationship was.''
+ Mr. Chambers. I believe, sir, that if you are limiting this
+primarily to the retirement plan context, I think, then, that
+it would be possible to come up with a reasonable way of
+creating disclosure that is beneficial.
+ But as I was mentioning, I think it is very difficult--if I
+decide that I want to go to a bank to serve as the trustee of
+my retirement plan, and it turns out that that bank is the
+primary lender to an organization that is providing retirement
+services to me, all right, is that a conflict? And how is it
+that somebody is supposed to be disclosing that too me?
+ Chairman Miller. That may or may not be. Again, when people
+look back over transactions, very often they all of a sudden
+recognize a conflict that they didn't recognize at the time. So
+the information is important.
+ It has been very important to the SEC. It has been very
+important to states' attorneys generals and to others, because
+patterns do develop. We just saw a pattern develop of inside
+trading. There, the enforcement officers recognized it for the
+investment firm, and then they decided they would cut
+themselves in on it. You know, we just went through the arrest
+here this last week.
+ So the information is important, not only at the time you
+can make your judgment, whether you think that is right or
+wrong; it may be important down the road, if a pattern develops
+or these people have relationships. You know, it may not be
+about your fund, but it may be about all of the investors that
+come there and the fund they go to.
+ You may be part of a larger piece of action. That is all I
+am saying. So I just am asking whether or not that arrangement,
+in and of itself, should be a piece of information that is
+available. I am not determining whether it is a conflict or not
+a conflict, simply whether that disclosure is important.
+ And most of these things that concern me about little
+people, it is because I see the big guys fighting it out. You
+know, they are battling over their pension plans, very large
+corporations, because somebody decided they were going to dip
+their hand into other people's money, with an insignificant
+fee, and they could drain it off.
+ I mean, that is sort of the nature of financial abuse in
+the financial services industry. People come up with these
+schemes sort of, you know, every full moon.
+ Any other questions?
+ [Additional statements for the record follow:]
+ [The prepared statement of Mr. Altmire follows:]
+
+Prepared Statement of Hon. Jason Altmire, a Representative in Congress
+ From the State of Pennsylvania
+
+ Thank you, Mr. Chairman, for holding this important hearing on
+``Hidden 401(k) Fees,'' and for your continued leadership on issues of
+great importance to America's working families.
+ I would like to extend a warm welcome to today's witnesses. I thank
+all of you for taking the time to be here and look forward to hearing
+from you.
+ In recent years, 401 (k) plans have emerged as the most common way
+for Americans to save for their retirement. Currently, nearly 50
+million employees are enrolled in 401(k) plans as compared to
+approximately 20 million employees who are enrolled in traditional
+pension plans. With the rise of the number of employees using 401 (k)
+plans to prepare for their retirement, we must work to ensure that
+their plans operate as efficiently as possible.
+ Many have raised concerns about the operation of 401(k) plans. The
+most common complaint is that administrative and management fees for
+401 (k) plans are not clearly defined and delineated. Many of these
+fees nickel and dime the retirement savings of employees who may not
+even be aware of their existence. I share these concerns and believe
+that these fees should be properly disclosed, rather than simply
+deducted from the account balances of employees.
+ I also believe that we should do more to encourage employees to
+invest in 401 (k) plans and properly prepare for their retirement.
+While there is no doubt that it is increasingly difficult for workers
+to plan for a secure retirement, there is much that can be done to make
+this security more attainable. I look forward to hearing our witness'
+ideas on this issue.
+ ______
+
+ [The prepared statement of Mr. Hare follows:]
+
+Prepared Statement of Hon. Phil Hare, a Representative in Congress From
+ the State of Illinois
+
+ Since the beginning of the 110th Congress, the Education and Labor
+Committee has been investigating what has been termed the ``middle
+class squeeze,'' referring to the challenges the majority of Americans
+face in acquiring financial stability, affording high healthcare costs,
+saving for college and building retirement security, despite having
+jobs with strong wages. I am happy to see today we are reviewing the
+issue of retirement and the roadblocks involved in pension and
+retirement plans that make it difficult for the middle class to build
+retirement security.
+ There is no doubt that we all support employer-sponsored retirement
+plans and would like to help facilitate the expansion of those plans by
+providing the support and assistance employers need. However, I will
+not support efforts that do this on the backs of hard-working
+employees. The discussion about hidden fees in 401(k) plans, which the
+majority of American workers have, is extremely upsetting to me. Full
+disclosure of these fees is critical so that employees have full
+knowledge about their investments and the ability to compare plans to
+choose the best one for them.
+Questions for the Panel
+ Mr. Chambers: Would requiring the disclosure of these fees
+discourage employers from offering retirement plans because of
+increased administrative costs? What do your clients need from the
+federal government in order to provide reasonable retirement options
+for their employees?
+ Ms. Bovbjerg: We as Members of Congress are privileged in
+that we have the best retirement plan in the world--the Thrift Savings
+Plan (TSP). The government will match employee contributions to this
+plan up to 5%. We also have the choice among many investment options.
+What can we do as legislators either through better disclosure
+reporting or financial offsets to expand TSP-type plans to all sectors
+of the American workforce?
+ Mr. Hutcheson: How did this ``culture'' come to be that
+has allowed unscrupulous extractions from the bank accounts of
+hardworking Americans? How do we reestablish the integrity of our
+retirement structure? Can disclosure or elimination of hidden fees do
+it alone? And, what options do employees have once they know about the
+hidden fees they are paying?
+ ______
+
+ Chairman Miller. Well, thank you very much. I think your
+testimony and your comments and your responses to the members
+of the committee have been very helpful for this initial
+hearing. And we would hope that you would agree with Mr.
+McKeon, that you would continue to serve as a source of
+information to us, as we continue this discussion.
+ Thank you. The committee will stand adjourned. Thank you.
+ [Whereupon, at 12:55 p.m., the committee was adjourned.]
+
+
+
+