Trust “Company”

I saw an interesting event headline the other day. It said simply, “Trust is an economic stimulus package.”

A short, and somewhat simplistic, assessment to be sure. And yet, IMHO, one that may well lie at the heart of our current economic turmoil; trust – or perhaps more accurately, the lack thereof.

Trust was surely at issue when the financial system ground to a halt last fall, with investors anxiously pulling back funds from institutions that were similarly concerned about the financial integrity of those to which they had extended credit. In response, the federal government first tried to broker deals between troubled firms and what turned out to be soon-to-be-troubled firms…and then decided to sit on the sidelines when the second “opportunity” emerged, leaving everyone to wonder if the government would step in or not – and if so, how (and how much)? Under stress (if not duress), the first big bailout was pressed through – but the articulated plan for its dispersal was abruptly set aside – and before you know it, $350 billion of our money seems to have vanished with no more apparent impact than a cupful of water poured onto a raging inferno.

Since then, we’ve had a change in administrations, and while some surely remain hopeful, trust remains elusive. Nor, IMHO, has there been much, if any, effort to nurture a restoration of trust. Let’s face it, the choices some of firms have made regarding compensation packages and activities (including their mode of transportation to Congressional hearings) in this environment do demonstrate an incredible disregard for the sensitivities of the times (in their defense, some legitimate business activities are being caricatured as abuses, and not every dollar spent by these firms came from the taxpayer’s pockets; however, the resonance of those criticisms is indicative of the climate of mistrust). Many of those same members of Congress that evidence such outrage about those activities turn around and, with a straight face, claim that they’ll “stimulate” the economy by chumming in projects to an “emergency” package that are surely every bit as wasteful and inappropriate for the times as the corporate activities they publicly disparage. And then they have the temerity to tell the nation that the package contains no “earmarks.”(1)

Advisers know first hand how important trust is in cultivating relationships, both at the plan sponsor and participant levels. Unfortunately, trust is one of those things that can be wiped out in an instant – and once damaged, even under the best of circumstances, can take years to restore. Those entrusted with other people’s money have perhaps a unique obligation, for when they violate that trust, that impact can be felt beyond that one individual, but even to the system(s) they represent. For example, clients of Bernie Madoff – or clients of firms that were clients of Bernie Madoff – will surely, for a time anyway, be less trusting of their advisers – and who can blame them? When might participants – most of whom seem, for the moment, anyway, to be willing to stick with their current investment plans – decide that they can’t afford to keep throwing good money into a market that continues to erode, not reward, their hard-earned savings? How much of their patience with that result is a function of the trust they have invested in you?

I think we can all accept the notion that these are extraordinary times, and that even the so-called experts aren’t exactly sure what will “work,” or how much of what will work will be required. I think we can even accept some misguided attempts to do the right things – even if they turn out to be the wrong things – so long as they are well-reasoned, well-intentioned, and well-articulated (or at least explainable).

What we really can’t tolerate - while we’re trying so hard to pull together – are the kinds of attitudes and behaviors that keep pulling us apart.

- Nevin E. Adams, JD


(1)One man’s definition of “pork” is another’s “much needed expenditure of government funds” (and always has been), and the definition of “earmark” remains more art than science. For some, the Congressional definition of an “earmark” wouldn’t include specific projects that are included in legislation that is voted on (as opposed to specific projects that are added on AFTER legislation is adopted) – and that is apparently the definition being applied when we’re told that the bills being signed in recent days are bereft of earmarks. It’s not a wholly illegitimate position – but, IMHO, one that is at least “nuanced.”

Note that the Congressional Research Service defines earmarks as "Provisions associated with legislation (appropriations or general legislation) that specify certain congressional spending priorities or in revenue bills that apply to a very limited number of individuals or entities. Earmarks may appear in either the legislative text or report language (committee reports accompanying reported bills and joint explanatory statement accompanying a conference report)." Personally, I think that is consistent with the way in which most Americans would see the term accurately applied. Feel free to disagree.

Anything's Possible

I’ve spent most of my life, certainly my adult life, confident that Americans, certainly in large part, are reasonable and rational. I have not, unfortunately, always been as sure of certain subsets of the population, notably politicians.

On numerous occasions during the political season just past, as one outrageous claim after another was laid at the feet of one candidate or another (and sometimes both), I heard (and was heard to utter) “rebuttals” of a sort—“They’d NEVER do that,” for example, or at least, “They’d never get away with that.” Granted, sometimes I’d say those words—and yet wonder if, this time, “they” actually might. One’s position on such things is inevitably interwoven with one’s comfort with the idea, of course. “Anything’s possible” can be both an anthem of positive change and an ominous portent of doom.

Those were the kinds of reactions that last fall’s hearings on the impact of the markets on retirement engendered, certainly in terms of the reactions to comments made at those hearings, particularly those held by the House Education and Labor Committee. Hearings that included the perspectives of some who clearly see the 401(k) as a failure—and who seemed willing, if not anxious, to trade it in for a better model. Indeed, the notion that we’d not only impose a new Social Security-like tax on workers and employers to build a new solution—and fertilize it with the carcass of the 401(k) (or at least the carcass of the tax support for the 401(k))—drew a lot of (IMHO) well-deserved comment and criticism, including mine (see “IMHO: The Pit and the Pendulum”). In fact, “The Plot to Kill the 401(k)” was the December cover story of PLANSPONSOR.

Best, Worst Case

Despite those ominous portents, the Washington insiders I have discussed this with over the intervening months—nearly to a person—dismiss the notion. At worst, they view this as a bridge too far, even for the commanding majorities in Congress. At best, they simply don’t think this is what Congressman George Miller (D-California), Chairman of the House Education and Labor Committee, has in mind or would support.

That said, that same committee is getting ready to start up another wave of hearings (see “They’re Baaack….Hearings on Retirement Security, 401(k) Resurface” )—and, much as I would like to console my fears with those Washington-insider voices, I can’t quite get there.

Don’t get me wrong. When, in announcing the hearings, the Committee Web site speaks to “a series of hearings to explore the shortcomings of our nation’s retirement system and look at solutions,” I couldn’t be more supportive. By nearly any measure, many Americans aren’t saving enough on their own, most don’t have the support of a pension, and whatever fiscal integrity Social Security still enjoyed has surely been sacrificed in an era where the federal government claims to be providing tax “cuts” to workers who aren’t paying any kind of federal tax beyond that earmarked for Social Security (FICA). Nor, though I am an ardent supporter of the 401(k) system, do I see it as sufficient in every case to do the job (see “IMHO: ‘Broken’ Record”).

I keep thinking that maybe I’m being too sensitive—that I’m too willing to impugn the motives of folks who are genuinely trying to do something that I have long advocated needs doing: figuring out a solution to the “problem” of ensuring retirement security (see “IMHO: ‘Focus’ Group”). And yet, when I also read in the Ed/Labor Committee’s announcement that the “first hearing will examine how the current economic crisis has highlighted existing weaknesses in the 401(k) retirement savings system,” I can’t help but feel that at least some of this is about excoriating a valuable part of the solution, rather than crafting a more complete one.

Those reservations notwithstanding, I’m going to try to watch these hearings with an open mind—and I hope you will as well (to their credit, the Ed/Labor Committee has been very good about broadcasting these hearings on the Internet and archiving them for later viewing). For we surely need some alternatives not yet on the table—and, IMHO, we need to be attentive to preserving and enhancing the ones we currently do have.

Because, after all… anything’s possible.

—Nevin E. Adams, JD

“Winning” Ways?

We got another verdict on those infamous revenue-sharing lawsuits last week. Not a verdict in the sense of a Perry Mason trial, perhaps - but we did have two sides presenting their case to a judge who, once again, basically felt that the plaintiffs didn’t make their case.

Personally, I find this entire class of revenue-sharing lawsuits abhorrent. Not that I don’t think there are some real issues to be had with regard to how some plans are being charged, and how some of those revenue-sharing arrangements are perhaps being abused. Rather, I resent them because, in large part, I think the cases brought to date—at least as I understand the facts—are probably not where the real problems lie. They do, however, represent huge piles of money—and if you’re a contingent-fee lawyer, that is (to borrow Willie Sutton’s famous phrase) “where the money is.”

Consequently, back in 2007, when U.S. District Judge John Shabaz of the U.S. District Court for the Western District of Wisconsin tossed—and, IMHO, “trashed”—the case brought against Deere & Co., it felt like a vindication of sorts—at least until I studied the rationale Judge Shabaz relied on. Good decision, bad law, IMHO (see “IMHO: Fighting Words”). But hey, it beats a bad decision, right?

In the intervening months, the plaintiffs appealed Judge Shabaz’s verdict, of course, and other experts—notably the Department of Labor—also weighed in (see “IMHO: The Letter of the Law”) and managed to express the application of the law in a manner consistent with what my nearly three decades of experience in the field had taught me to believe.

However, my reading of last week’s decision by Judge Diane P. Wood of the 7th U.S. Circuit Court of Appeals (see “Appellate Court Backs Deere Case Dismissal”), suggests that we’re still making the “right” decision—but for the wrong reasons, IMHO.

Decision Tree

For example, based on my reading of the case, if I were advising a plan sponsor on how to stay out of court (or at least on how to win once dragged there), based on the 7th Circuit’s ruling in Deere:

I would advocate giving participants LOTS of fund choices1—via a brokerage window if possible—and I would make sure that there were at least some low-cost fund choices available via that window 2.

I wouldn’t concern myself at all with whether the core menu was comprised strictly of a single provider’s offerings3, nor would I concern myself overly much with the fees paid by the plan/participants—so long as those fees were paid via mutual fund expense ratios that are the same as those paid by investors in the retail market.4

I would be comfortable telling participants with a straight face that the employer was paying all the administrative fees of the plan—even if those fees were all really being paid via the aforementioned mutual fund expense ratios5(nor would I be ashamed to admit that I thought that there were no administrative fees—because then, even if I was paying nothing, well, at least I couldn’t be accused of distorting the facts).6

Oh, and as for the protections of 404(c)—I would just make sure that participants are given the opportunity to transfer their balances between all those investment options and given prospectuses about those options that include details on the expense ratios of those choices.7, 8 Better yet, you won’t even have to worry about being prudent in the selection of fund options for the plan, because, according to the recent ruling, that safe harbor extends to that decision9—as well as pretty much any issue a participant might raise regarding their retirement account investments.

None of this, of course, is how I actually see the law, or the obligations of plan fiduciaries to uphold their responsibilities. On any given day, it might be good enough to persuade a sympathetic jurist—or to overpower impotent plaintiff arguments.

But, IMHO, winning for the wrong reasons doesn’t necessarily mean you’re right.

--Nevin E. Adams, JD


1“[E]ven if, as plaintiffs urge, there is a fiduciary duty on the part of a company offering a plan to furnish an acceptable array of investment vehicles, no rational trier of fact could find, on the basis of the facts alleged in this Complaint, that Deere failed to satisfy that duty.”

2“The 2,500 mutual funds available through BrokerageLink had fees ranging from .07% to 1%. Any allegation that these options did not provide the participants with a reasonable opportunity to accomplish the three goals outlined in the regulation, or control the risk of loss from fees, is implausible….”

3 “[M]any prudent investors limit themselves to funds offered by one company and diversify within the available investment options….We see nothing in the statute that requires plan fiduciaries to include any particular mix of investment vehicles in their plan.…We therefore
question whether Deere’s decision to restrict the direct investment choices in its Plans to Fidelity
Research funds is even a decision within Deere’s fiduciary responsibilities.”

4 “As the district court pointed out, there was a wide range of expense ratios among the twenty Fidelity mutual funds and the 2,500 other funds available through BrokerageLink….Importantly, all of these funds were also offered to investors in the general public, and so the expense ratios necessarily were set against the backdrop of market competition…It is untenable to suggest that all of the more than 2500 publicly available investment options had excessive expense ratios.”

5 “The fact that there were no additional fees borne by Deere is immaterial. While Deere may not have been behaving admirably by creating the impression that it was generously subsidizing its employees’ investments by paying something to Fidelity Trust when it was doing no such thing, the Complaint does not allege any particular dollar amount that was fraudulently stated.”

6 “The Complaint does not allege that the representation in the SPD supplement—that Deere paid the administration expenses for the Plans—was an intentional misrepresentation. To the contrary, plaintiffs have since submitted evidence with their Rule 59(e) motion showing that Deere believed that Fidelity Trust’s services were free.”

7 “[T]o the extent participants incurred excessive expenses, those losses were the result of participants exercising control over their investments within the meaning of the safe harbor provision.”

8 “If particular participants lost money or did not earn as much as they would have liked, that disappointing outcome was attributable to their individual choices. Given the numerous investment options, varied in type and fee, neither Deere nor Fidelity (assuming for the
sake of argument that it somehow had fiduciary duties in this respect) can be held responsible for those choices.”

9 “Plaintiffs would like us to decide whether the safe harbor applies to the selection of investment options for a plan, but in the end we conclude that this abstract question need not be resolved to decide this case. Even if § 1104(c) does not always shield a fiduciary from an imprudent selection of funds under every circumstance that can be imagined, it does protect a fiduciary that satisfies the criteria of § 1104(c) and includes a sufficient range of options so that the participants have control over the risk of loss….”

"Spreading" the Wealth

In one of the more memorable sound bytes of the Presidential campaign just past, candidate Obama tried to explain the rationale underpinning his economic philosophy as a belief that we should “spread the wealth.”

Of course, it remains to be seen just how much wealth will be spread, and to whom (and from whom) – but, like it or not – there are also certain redistributive principles at work in our retirement plans. And while I think it’s fair to say that no new ground was broken, a recent paper, “The Structure of 401(k) Fees,”,published by the Center for Retirement Research (CRR) at Boston College, highlighted the potential inequities that current fee structures may be imposing on plan participants (see “Disclosure not the Only Issue with 401(k) Plan Fees”).

Setting aside for a moment whether the fees charged are fair, the paper highlighted a fact that, while obvious, is not always intuitive: When asset-based fees are the order of the day, as they surely still are for most retirement plans, participants with larger balances pay more.

The rationale behind asset-based fees has long been a sense that larger accounts benefit more from the services associated with those fees, notably investment management. And, certainly, there is an appealing simplicity and efficiency to a process that simply takes from each investor a fixed and identical percentage of their account balance.

Still, the CRR paper offers an example with a plan where the costs amount to 0.8% of assets, costs that include marketing and administrative costs of $100 per year for each participant, as well as investment management expenses, which range from $200 a year for a participant with a balance of $20,000 to $400 a year for a participant with a balance of $80,000. In the example, the plan’s 0.8% expense ratio means that a participant with a balance of $80,000 would pay a fee of $640, even though this participant would account for only $500 of the plan’s costs – while a participant with a balance of $20,000 would pay a fee of $160 while accounting for $300 of the plan’s costs.

Twice, Told

Indeed, the CRR paper notes that “participants with twice the balances of others are not likely to entail twice the management cost, although they pay twice the management fee. Thus, a constant expense ratio is a deceptively simple method of pricing, which, by decoupling fees from costs, reduces the return credited to higher balance accounts while boosting that on lower balance accounts.”

This type of discrepancy is often acknowledged but discounted because we tend to see it as a positive thing that the participant with a larger balance – who is generally assumed to be an executive – effectively subsidizes the individual with the smaller account balance, who is generally assumed to have a smaller income. Certainly this is true in some cases – and surely discrepancies in pay can, and do, account for disparities in account balance.

Still, what is frequently overlooked is that there are some – perhaps many - $80,000 account balances that belong to workers who simply have been saving longer, or perhaps just more diligently, than those with those $20,000 balances.

Moreover, how much of the imbedded costs of “running” retail mutual funds are effectively being spread to and across retirement plan balances “proportionately,” muted only (in some cases) by a “better” class of shares? How much of the costs we don’t see – the trading costs in the funds, for example, which can be significant – are generated by retail investors with relatively modest balances…but spread across to the accumulated “wealth” of retirement plan investors?

It’s one thing to truly spread wealth – and another altogether to simply take it.

- Nevin E. Adams, JD