"Might" Makes Right?

Last week the Government Accountability Office (GAO) published a 67-page report titled “Conflicts of Interest Involving High Risk or Terminated Plans Pose Enforcement Challenges.” In announcing the results of that report, Congressmen George Miller (D-California) and Ed Markey (D-Massachusetts), who had commissioned the report, issued a press release claiming that “Undisclosed Conflicts Reduce Pension Plan Returns,” and that “Workers Likely Bear Brunt of Lower Returns in the Form of Reduced Pension Benefits.”

The gist of that report: “[P]ension plan consultants assisting significant numbers of pension plan sponsors may have conflicts of interest, as a result of their affiliations or business arrangements with other firms that could affect the advice they provide to these sponsors.”

However, let me draw your attention to two words in that long sentence: “may” and “could.”

That’s right, after drilling down into the specific firms identified in a Securities and Exchange Commission (SEC) report two years ago (see “IMHO: Disclose Sure?”), the GAO determined only that pension consultants might have a conflict of interest that could affect the advice they provide to plan sponsors. Or, one is tempted to add, they might not.

The SEC report (see “Staff Report Concerning Examinations of Select Pension Consultants”) continues to be dredged up and referenced in media reports as suggesting that “more than half” the pension consultants examined by the SEC had potential conflicts of interest. What is frequently overlooked in that comment is that we’re talking about 13 of 24 firms (the SEC said that 1,742 firms under its oversight provided pension consulting services) – and even then, the SEC’s report said only that the “duality” in the customer base “may create a conflict of interest.”

Still, the most recent report notes that those 13 consulting firms had over $4.5 trillion in assets under advisement and, further, that a sampling of defined benefit plans “associated with” those firms had total assets of $183.5 billion. By any measure, that’s a lot of potential influence.

Performance Standards?

Now, if the report had left it there, it would have been just another expenditure of taxpayer dollars directed toward a fairly obvious result (though the GAO reports are generally very well-researched and informative in describing the historical and legislative background of the issues they cover). However, the GAO report went further – claiming to have found a difference in annual returns between the DB plans who used consultants with those potential conflicts, and those who did not – a 1.3% difference in annual returns, to be specific.

While I commend the GAO for taking the time and effort to see if a difference in result could be quantified, I have to say that I found their conclusion to be something of an extrapolation based on an assumption, founded on a premise – and thus undeserving of its appearance in the report. The GAO itself acknowledged the limitations of their analysis, noting that, “because many factors can affect returns, and data and modeling limitations limit the ability to generalize and interpret the results, this finding, while suggestive, should not be considered as proof of causality between consultants and lower rates of return.” (1) Indeed, consultants offer many types of guidance to pension plans, guidance that is not always solely oriented toward providing the very highest rates of return.

The GAO, again to its credit, acknowledged that the Department of Labor’s Employee Benefits Security Administration (EBSA) “noted a number of concerns about our statistical analysis and in particular our econometric analysis that suggests a negative association between consultants with undisclosed conflicts of interest and rates of return on assets. EBSA expressed important cautions that should be considered when interpreting our results, including some data limitations and our use of an estimate for our investment returns variable.”

Additionally, while the GAO claimed to have found a return differential between plans that were associated with the potentially conflicted consultants and those that relied on other firms, they “did not find significant differences in returns for those plans that had associations with both types of consultants.”

So - there are questions about the assumptions employed, the data itself, proof of the existence of a real conflict of interest that might have resulted in tainted guidance, doubt that the result measured – absolute performance results – would be appropriate under the circumstances - oh, and no apparent difference in the performance results of DB plans that worked with potentially conflicted AND ostensibly unconflicted firms.

As for the impact of all this on retiree benefits and pension funding, the GAO said that EBSA “emphasized the view that it is primarily the failure of plan sponsors to adequately fund pension plans causing plan underfunding problems rather than poor investment advice from self-interested service providers.”

Ultimately, IMHO, we’re left with more questions than answers – loose allegations predicated on tenuous assumptions – and the certainty only that consulting conflicts of interest may exist and could, if present, result in a difference in performance results. That, and a few hyperbolic headlines that, IMHO, cast a broad net of overly generalized assumptions.

If, indeed, there are real conflicts of interest, it’s time we identified them and ended the practice(s), once and for all. No ifs, ands, or “mights” about it.


- Nevin E. Adams, JD


(1) Among the caveats in the report about the assumptions employed were: the use of a “potentially unrepresentative sample of pension consultants to identify the pension plans included in our investigation that therefore limits the ability to generalize the results. A few pension consultants that had significant conflicts of interest that impacted their activity could very well drive the observed negative relationship. Further, the imbalance between the large number of plans associated exclusively with conflicted consultants and the small number of those that were not raise additional statistical issues and limits the ability to generalize the results. Lastly, given the short time period analyzed, it could be possible that some plans’ returns were abnormally low due to their investment strategies, and would have higher returns had the time period analyzed been lengthened.”

Fighting Words

“[T]he complaint is a rambling 38 page collection long on legal argument, public policy rhetoric and repetition, but vague in its allegations of facts which might be relevant to the claims alleged.”

With all the tact of a law professor dressing down a first-year student, U.S. District Judge John Shabaz of the U.S. District Court for the Western District of Wisconsin last week dismissed one of the so-called 401(k) revenue-sharing lawsuits brought by the St. Louis-based law firm of Schlichter, Bogard & Denton – and did so in just 18 pages. And he did so “with prejudice and costs.”

It was the second such case to be dismissed. In an even more succinct dismissal in February (two-pages), U.S. District Judge John Darrah said that the 401(k) participants in the Exelon Corp. plan failed to make a "link between the administrative fees they were charged and their market-based losses" (see Court Tosses 401(k) Participants’ Request for Investment Losses Relief).

Not that there weren’t elements of plan structure that might raise eyebrows in some quarters in the most recent case—the agreement between the plan sponsor (Deere & Co.) and the provider (Fidelity) to limit the fund menu to funds managed by Fidelity, for one thing (23 of the 26 funds on the menu were Fidelity’s). And then there is the judge’s matter of fact assertion that “Defendant Deere could have negotiated lower fees with Fidelity Research, or could have selected different funds from different providers with lower rates but has made no effort to do so.” One could readily imagine those exact words being uttered as a stark condemnation of a fiduciary that had failed to live up to its duty—but this court recounted it as a statement of fact, nothing more (and, for the record, there’s no fiduciary bar to doing what Deere did, so long as their motivations were solely in the best interests of plan participants/beneficiaries, and the fees and services so obtained were reasonable). Besides, the plan did offer access to a brokerage window. If participants wanted something beyond a Fidelity offering, they could tap into some 2,500 other alternatives.

Reasonable Doubts?

Furthermore, IMHO, Judge Shabaz was too willing to conclude that, since Deere participants were paying the same for their mutual investments as other investors, the fees must be reasonable. On the surface, the fees weren’t obscene—fees ranged from .07% for the Spartan Fund to 1.01% for the Diversified International Fund, according to the ruling. Still, it’s one thing to conclude that those fees were reasonable; quite another, IMHO, to assume that they are reasonable simply because others (and retail investors, to boot) are willing to pay them.

Still, Shabaz was clear in refuting the notion that the plan had any obligation to delve into the specifics of any revenue-sharing arrangement (“recent proposals to amend the regulations…to require revenue-sharing disclosures in annual reports make it apparent that present regulations do not require it”), and clearer still in rebuffing the notion that there was an obligation to share those details with plan participants (“Nothing in the statute or regulation directly requires such a disclosure”). Additionally, Shabaz concluded that the fee disclosures included in the Summary Plan Descriptions (SPDs) and prospectuses were sufficient for participants to make informed investment decisions—or at least that requiring more would “require judicial expansion of the detailed disclosure regime crafted by Congress and the Department of Labor pursuant to its statutory authority.”

While he acknowledged that some of the issues raised were undergoing reconsideration (1), when all was said and done, he found no merit in the claims, concluding in effect that it appeared “beyond a reasonable doubt that the plaintiffs can prove no set of facts in support of the claim which would entitle the plaintiffs to relief.”

One should be cautious in drawing too many conclusions from this result, of course. In the same way that lawsuits contain only one side of the situation, dismissals all too often shuttle aside potentially triable issues, not because the issues aren’t there, but because plaintiff’s counsel didn’t make an effective presentation. Still, on the issue of revenue-sharing disclosures, I think Shabaz got it right.

When the cases were first filed I, perhaps like many of you, was no doubt surprised that these kinds of allegations were applied to some of the largest 401(k) plans in the nation—plans that, by any reasonable assessment, probably had the staff and plan-size “clout” to get such matters “right.” Of course, they also had the size that makes for “deep pockets” and public brand(s) that typically eschew the kind of publicity that accompanies a lawsuit and facilitates a quiet settlement.

This time, however, it seems that they have a willingness to fight back.

- Nevin E. Adams, JD

(1) “A review of the report confirms that the revenue sharing issue raised by plaintiffs’ complaint is a matter of policy concern within the Department of Labor. It also unequivocally confirms that present regulations do not require disclosure of the information.”

Caveat Emptor

A couple of weeks ago my better half told me that she thought it was time that we traded in two of our aging vehicles – one a car that is too small for our family, the other a van that now seems too big for all but cross-country trips – for something in the middle. I was amenable to the idea – until she mentioned that she didn’t think we needed to buy a new vehicle as a replacement.

If you have ever in your life purchased a “pre-owned” anything, you’ll appreciate the dangers inherent in the principle of caveat emptor, literally “let the buyer beware.” That’s why, to this day, the notion of purchasing a used car practically causes me to break out in cold sweats. Not that lemons don’t roll off the new car lots every day – but there, at least, it seems that your odds are better – if not in terms of product, at least of obtaining satisfaction if something doesn’t work out.

Buying a used car is, of course, as much art as science – particularly if you aren’t mechanically inclined. That’s why it has become fairly common to enlist the support of a trusted mechanic to assess the reliability of a potential vehicle purchase. Of course that works only if you actually HAVE a trusted mechanic to rely on. In my experience, the only way – outside of a personal relationship - for a mechanic to have earned that trust is for you to have spent a lot of time at the garage (which, of course, may be why you are looking for a different vehicle in the first place).

Plan sponsors are increasingly looking for guidance on what constitutes reasonable, and – spurred by the flurry of recent 401(k) plan lawsuits, and the increasing level of scrutiny applied by regulators and lawmakers – have, logically, tended to be dominated by a focus on fees.

It’s hard to argue with the “clarity” of that focus, but what do you think would be the result if my used car purchase used cost as the only criteria? All things being equal, cost may be a perfectly adequate point of differentiation, but all things are seldom “equal”. When it comes to used cars, common sense dictates that a vehicle in better condition could well be worth more than an identical make and model that has been handled roughly. And we all know of “cheap” car purchases that have more than made up for that initial price differential in terms of subsequent trips to the repair shop.

Things are even more complicated with retirement plans, where plan design flaws are often obscured, and where subtle restrictions and operational limitations don’t appear until well after that finals presentation. Fortunately, ERISA doesn’t require “cheapest.” However, it does call for plan fiduciaries to make decisions that are solely in the best interests of plan participants and beneficiaries, to ensure that those decisions culminate in the selection of services (and fees for those services) that are “reasonable” – and to do so with the insights and perspective of an expert in such matters, or to enlist the support of those who are.

Failing that – “caveat emptor’.

Nevin E. Adams, JD

Moving Targets

In nearly 30 years working with employer-sponsored retirement plans, I am hard-pressed to call to mind a product innovation that has been adopted with as much vigor as the current generation of target-date funds. In PLANSPONSOR’s 2006 Defined Contribution Survey, more than three in four of the nearly 5,000 responding plans had a risk- or target-date-based option on their menu – compared with “just” 54% in the prior year’s survey.

There’s being on the menu, of course, and there’s being chosen from that menu. Still, in the 2006 survey, roughly 25% of participant balances, on average, were already invested in such options – and, on the median, 15% - and this well ahead of the Department of Labor’s tacit enhancement of these vehicles as the default investment vehicle of choice. All in all, it would appear that participants have more access to such choices and are beginning to wake to the simplicity of an investment choice that requires referencing little more than a birth certificate (many still make the case that a single investment allocation approach cannot possibly be suitable for each and every participant who plans to retire in the year 2040).

Moreover, the investment management industry has responded to the opportunity with enthusiasm. One need consider only the number of new offerings introduced in 2007 alone to appreciate just how much more choice is available than was the case the last time I penned a column on the topic (see “Style Conscious,” PLANSPONSOR, September 2005). That’s a very positive development for the most part – after all, a lack of choice was, in the very recent past, a cautionary note of consideration for plan fiduciaries. Additionally, as the choices have expanded, competition (not to mention a renewed emphasis on fee transparency) seems certain to provide a pricing discipline that surely must be applied by fiduciaries, certainly in a “just pick one” fund alternative.

Philosophical Differences

Our free market also has served to bring to the fore a dazzling array of differences in basic asset allocation philosophy. There are compelling arguments being made for allocations that are heavily laden with equities at retirement, while others embrace a more “traditional” fixed-income bent, and still others seek to mirror the allocations in evidence among large defined benefit programs (which themselves are undergoing some fairly radical shifts). These competing notions – and seemingly everything in between – are still often “cloaked,” certainly in the case of target-date offerings, behind names that are frustratingly similar. All claim to be focused on helping the investor achieve retirement security, while minimizing risk – that of running out of money too soon, or of not having enough to run out of in the first place. They can’t ALL be right, surely.

On the other hand, in the midst of all this burgeoning interest, it also has been interesting to watch some of the industry’s more revered asset allocation fund pioneers reinvent and/or rejigger their strategies, their glide paths, the logic that underpins their asset allocation philosophy.

It’s impossible at this point to say who is “right,” of course (perhaps even harder to say that a single investment allocation approach is suitable for each and every participant who plans to retire in the year 2040). Still, IMHO, the industry’s willingness to continue to contemplate and embrace change in these glide paths bodes well, I think, for the intellectual rigor that surely must attend their emergence as a ubiquitous presence on defined contribution plan menus.

What that also means, of course, is that plan fiduciaries will be similarly challenged to keep pace.

- Nevin A. Adams, JD

Life Lines

A couple of weeks ago, I stumbled across a paper published by the National Bureau of Economic Research titled “New Estimates of the Future Path of 401(K) Assets.” In this particular case, “new” appeared to relate to the paper, not the future path of 401(k) assets. Bottom line: 401(k) assets are going to keep growing, and at a better rate over the next couple of decades than they have the past 20 years (there was also a brief article on this paper in the New York Times last week, which you also may have seen syndicated locally). In fact, the paper notes enthusiastically, “We conclude that the increase in the pension assets of future retirees will be much greater than the assets of current retirees.”

This is good news, of course, since such programs seem destined to represent the primary retirement savings in the decades to come. We need them to grow, and we need them to grow faster than they have heretofore, certainly based on the average and, more significantly, median account balances reported from various sources.

Projections of the future are, inevitably, based on understandings and extrapolations of the past, and this paper is no exception. The paper’s authors remind us that 401(k)s are a relatively recent “invention,” with contributions to them beginning only in 1982. Thus, the argument goes, the balances in today’s retiree accounts have not had as long to accumulate as will those who retire 40 years hence. Moreover, they compare data from 1984 with that in 2003 that illustrates a large increase both in the number of workers eligible for a 401(k), and in those actually choosing to participate. In essence, today’s retiree balances have suffered from both a late, and a slow, start relative to the retirees of the future. And, since the retirees of 40 years hence will have had “full” access to the benefits of saving (and investing) via a 401(k) for their entire working lives, they will wind up with more—significantly more—In the way of savings accumulations than their parents.

None of this is particularly controversial logic, though it seems to me that it ignores another reality—that defined contribution savings programs existed well before the advent of 401(k)s. As a mid-range Boomer, I was saving in my employer’s “thrift incentive plan” for the “free money” from a match just as soon as they would let me (waiting a year to be eligible was normal in those days). My savings weren’t pre-tax then, of course (1979)—but the earnings and company match were.

Now, it is entirely possible that the advantages of pre-tax savings drew the attention of workers in the 1980s who had not previously taken advantage of various “thrift” plan alternatives—programs that were (including stock bonus and profit-sharing), in large part, subsumed (in name, anyway) into the newer 401(k). It is equally possible that the nation’s economic resurgence in the 1980s led employers to offer 401(k)s that had not previously offered a defined contribution plan, or that the tightening labor market of the 1990s compelled employers to offer new programs as a competitive advantage. Furthermore, there seems little doubt that the decline in coverage and availability of traditional pensions, and the widespread media coverage of same, has more recently led some to contribute to their own retirement security in amounts they might not otherwise.

Still, while we certainly have more ways to save today, ways that are generally “better” and more “convenient” (don’t even have to fill out an enrollment form these days) than they were 20 years ago, the savings rates I hear reported for younger workers today strike me as remarkably consistent with those of the past. IMHO, choosing to save for retirement, or for any purpose, is—and always has been—about balancing current economic realities with long-term goals. Generally speaking, the former looms larger the younger—and poorer—you are.

There’s little question that the 401(k) has attained a certain ubiquity (though it’s worth remembering that most American workers aren’t covered by a workplace retirement plan). But we shouldn’t assume that just because more workers have an earlier ability to participate in a 401(k) plan—and for their entire working lives—that they will do so. We—and they—can’t afford to.

- Nevin E. Adams, J.D.

The research paper is online at http://papers.nber.org/papers/w13083.pdf