Litigation, Regulation, and Tax Reform – Oh My!

It’s been a busy year, a crazy summer – and we’ve still got a presidential election to go.

It has been years since things actually slowed down in the summer (at least in the way we all seem to remember it), but this summer has been busier than any I can remember. Not only has everybody been making preparations for the implementation of the Labor Department’s fiduciary regulation (and it’s affecting different business models very differently), we’ve had the looming prospects of litigation regarding the legality of the regulation itself, and the authority of the Labor Department to undertake it.

The challenges to that regulation share certain critical aspects, and yet each has its own unique flavor – and let’s not forget that they are filed in three different federal venues (four, counting the one filed just last week). Could one prevail in convincing a federal judge to grant a preliminary injunction to stop the rule’s implementation? Could such a ruling actually serve to maintain the status quo until after the presidential election? Could that presidential election result in new leadership at the Labor Department? If so, might a new president decide to halt implementation, and set a new course for that regulation? It seems unlikely now, but that’s pretty much what happened in 2008 with the then-pending advice regulation from the Labor Department.

Oh, and what about the series of excess litigation lawsuits taking on some of the nation’s largest (and we’re talking multi-billion dollar) university retirement plans? A decade ago, the law firm of Schlichter, Bogard & Denton galvanized the retirement industry’s attention with about a dozen such lawsuits filed against similarly mammoth 401(k) plans.

Things have changed since then, of course. Sure, revenue sharing is still an issue, as is the disclosure of such transactions to participants. But there is a greater sophistication in the current wave of allegations – it’s not just the use of retail versus institutional shares, but the failure to consider investment vehicles like collective investment trusts and separate accounts, the choice of active management funds with an S&P 500 benchmark instead of an S&P 500 index option itself, the choice of a poor-yielding money market fund instead of a stable value option – and in some cases, the choice of what is alleged to be a high-priced stable value choice rather than a relatively straightforward money market fund.

Since the beginning of the year, the cases brought against 401(k) plans – and this has found its way into the 403(b) litigation – have challenged not only the methodology for recordkeeping fees (dismissing asset-based revenue-sharing in favor of per-participant approaches), but attempted to set markers as to what that reasonable per-participant charge should be. Needless to say, millions of dollars are at stake – and one suspects we’re not near the end of even this litigation cycle.

And then there’s the prospects for tax reform. Sure, we may have been lulled into complacency by the gridlock in Congress that calls to mind a Friday afternoon traffic jam on the Beltway. But the major party candidates are already talking about changes to tax rates, and the rates they plan to cut – and in some cases plan to raise – could, if enacted, have a ripple effect on the current tax structures for retirement plans. Could the current 401(k) deferral be rejected in favor of a Roth-only approach? Might the contribution limits and benefit levels be frozen in place – or even reduced? Tax reform means different things to different people – and can impact different people in very different ways. And make no mistake, those kinds of changes are being contemplated as you read this. Could something actually happen?

In the midst of all this change and potential disruption lies opportunity for advisors. There will be plan fiduciaries looking for guidance, and plan sponsors more open to plan design changes than they may have been otherwise. It’s likely that firms (and advisors) that had previously been committed to the retirement business will rethink that commitment, and advisors who merely dabbled in this space may well decide it has simply become too rife with potential litigation to continue their dalliance.

That said, if the field is winnowed, the firms – and advisors – who remain will doubtless be made of sterner stuff. Those who survive and who hope to prosper will likely have to step up their game to compete effectively in this new, and more challenging arena.

- Nevin E. Adams, JD

Somebody’s Got To Pay

Much has been made in recent weeks over the so-called Ponzi scheme foisted on the investing public by Bernie Madoff. The classic elements are all there: the promise of future returns that are, in reality, fueled by new investors lured by the promise of future returns that are…well, you know. Of course, the perpetrators of these schemes manage along the way to siphon off their cut from the flow of funds. Human beings fall prey to such schemes all the time, and for a variety of reasons: gullibility, greed, and sometimes a simple willingness to trust the wrong people. Madoff, whose role in worsening the current economic crisis is still surely underappreciated, managed to play on those tendencies better and for longer than most.

We’ve already seen some $350 billion worth of government bailout absorbed by the system like so much water into a thirsty sponge. And, since that didn’t work, the answer apparently is to double down—and then some. Which, IMHO, calls to mind a comment candidate Obama made during the campaign about the definition of insanity….(1)

Now, in fairness, the new spending isn’t being sent in the same direction as the last bailout (or whatever euphemism you’re most comfortable using). Of course, as far as I can tell, that first package (which by most accounts was strongly influenced, if not architected, by the new Secretary of the Treasury) didn’t wind up going in the direction(s) we were told it would—and while we were told that the government needed discretion to administer the funds where it best saw fit, most Americans probably didn’t think that meant it would wind up funding big corporate takeovers and massive golden parachutes. Ultimately—let’s face it—the bill was really about helping financial institutions stay in business, and, once that money was in hand, many proceeded to do just that.

On the other hand, if that first package was ill-approved in haste, the second wave approved by the U.S. House last week was, in almost every respect, IMHO, a slap in the face of American taxpayers. You don’t have to have (or win) the argument about whether infrastructure spending is truly stimulative to the economy or just a necessary investment to realize that much of what the members of Congress (at least the ones who voted for this monstrosity) apparently want us to pay for is—their reelection.

Something’s “Fishy”

What seems to be lost in the furor over needing to DO something—and we’re all surely anxious for things to get better—is that the federal government doesn’t have its own bank account. And for all the talk of the burden we’re leaving our grandchildren, there is a fiscal reality coming, and probably sooner than that. We all know this at some level—just as we all knew that that housing bubble was going to burst eventually, that those paper business plans couldn’t possibly justify that kind of market valuation for technology start-ups, and that there had to be something fishy about how Enron was reporting its revenues.

In sum, we all know this is wrong, if not criminally stupid. Maybe we’re not quite sure what to do, and perhaps we’ve been hopeful that wiser minds than ours can figure something out. However, if this is the best they can do—well, then, IMHO, it’s time to take away their ATM card—which, lest we forget, is wired to OUR bank accounts.

Now, in this, as in life generally, it’s relatively easy to sit on the sidelines and criticize those who don’t have that option. This is the time, even if you’ve never felt the urge before, to weigh in with those making decisions that will affect your job, your investments, your retirement….

Before it’s too late….because, sooner or later, somebody has to pay.

—Nevin E. Adams, JD

(1) He quoted Albert Einstein who noted that doing the same thing over and over again and expecting a different result was the definition of insanity.

Unbelieve Able

As my wife and I drove to pick up our eldest for the Thanksgiving break, I saw something I never thought I would see again: $1.95/gallon gasoline (even more incredible, that was while I was still in the borders of Connecticut, which imposes some of the highest gasoline taxes in the nation).

Indeed, what with the election, the introductions of the new Administration’s team, the bailout/rescue of the week, and the continued jitters of the world markets, the reality that gasoline costs about half what it did in July has gone almost unreported. Still, I heard a report last week that suggests the net impact of that drop in price has put about $500 billion back in American pockets—now THAT’S a “stimulus package” we can believe in!

Still, what I find interesting about that dramatic turnaround in oil prices is that it happened so rapidly that the explanations of why it ran up so quickly are still ringing in my ears. I remember all too well the pundits laying the price hikes off on the growth in the emerging industrial economies of China and India, the impact of hurricanes on production in the gulf, concern about turmoil in the Middle East, the perceived vulnerability of the shipping lanes....Others, of course, cited the fact that we hadn’t built a new refinery in more than a decade, and that we refuse to consider drilling in areas that wouldn’t seem to pose a threat to man nor beast. But what I remember most vividly was how consistently the so-called experts denied that “mere” speculation could account for these kinds of increases.

Yeah, right.

IMHO, one of the most frustrating things about the current economic crisis is that nobody seems to know what is causing it and, thus, no one can offer a credible idea of how long it will last or what can (or should) be done to hasten its end, much less what the “rest of us” are supposed to do in the “interim.”

While financial pundits are, these days, prone to trace cyclical “corrections” to the bursting of “bubbles”—housing, tech—the resulting declines are generally not that sudden, nor are they, generally speaking, wholly unanticipated. Rather, they are the result of pressures on our financial system like the geological pressures that often result in earthquakes or the eruption of volcanoes. And, like those geophysical manifestations, there are often precursors to the actual “big event,” as well as significant after effects (nor do you have to be a financial genius to see them—how many times did you look at the soaring prices of homes in your neighborhood and think “this can’t go on?”). The problems at Freddie Mac and Fannie Mae that ostensibly triggered the most recent crisis were so blatantly obvious that even Congress felt compelled to hold hearings on the subject (and back in 2006, no less!).

At the outset of the current crisis, I was encouraged to see the federal government step forward to help and facilitate some—but not every—institution that appeared to be struggling. In hindsight, that may not have been as well-reasoned as one might want to believe, but at least there was the appearance of selective and intelligent, if not appropriate, involvement.

We want to believe that the so-called experts know what they’re doing. But with every passing day, it seems more and more obvious that they don’t. Little wonder, then, that the American electorate is increasingly disinclined to simply hand over a blank check. Little wonder also that some of the market’s “natural” remedies have apparently been staved off by people waiting to see how much the government would do—knowing full well that an outgoing Administration desperate for its legacy, and an incoming Administration anxious to prove itself would be more than somewhat inclined to do more than might otherwise be the case.

Retirement plan investors are consistently and, IMHO, prudently told to “stay the course” in times of turmoil; reminded that, even when change seems appropriate, even essential, to be careful about overreacting. It’s an approach that advisers, in large part, applaud and support.

Maybe it’s time the folks in Washington took a bit of THAT advice to heart.

- Nevin E. Adams, JD

Thank Full

Thanksgiving has been called a “uniquely American” holiday, and while that is perhaps something of an overstatement, it is unquestionably a special holiday, and one on which it seems a reflection on all we have to be thankful for is fitting.

Here’s my list for 2007:

First, I’m thankful for the voluntary nature of the defined contribution solutions in the Pension Protection Act—that plan sponsors were given guidelines and protections for adhering to specific safe harbor approaches, but were not forced to adopt those or prohibited from pursuing their own approaches to things like automatic enrollment (albeit without the regulatory protections). I’m thankful for the Department of Labor’s ongoing willingness—and enthusiasm—for soliciting and incorporating feedback on their regulations from those of us who have to work with them every day.

I’m thankful that, despite the mass coverage of defined benefit plan freezes—and the new restrictions imposed on these programs by the PPA and the accounting profession—so many employers remain committed to the concept. I’m thankful—as are, no doubt, the workers that count on those programs—that so many employers have been willing (and, I suppose in some cases, forced) to make the contributions to at least narrow, if not eliminate, their funding gaps.

I’m thankful for an extra year to gear up for 409A, the thoughtful and deliberative approach by the Department of Labor on the final qualified default investment alternatives (QDIA), and the availability (if somewhat later than one might have hoped) of a sample notice for automatic enrollment plans. I’m glad that 403(b) plan participants can look forward to some of the structural efficiencies and fiduciary oversight that have long been part of the 401(k) market—and thankful that plan sponsors were given some extra time to prepare for that fairly significant change.

I’m thankful that so many entities are concerned about how much we are paying for our 401(k)s—and only a little bit worried that so much of that well-placed concern will serve to make things worse.

Much as there is to be thankful for, there are some things still to look forward to. For instance, I’ll be thankful when:

• Those in Washington appear to worry as much about encouraging employers to set up workplace retirement plans as they do about scrutinizing and punishing those who have;
• Plan sponsors simply decide to eliminate company stock as a participant investment option—if only to deny the plaintiffs’ bar so many easy targets.

Still, all in all, I’m thankful to be able to play a small part in helping provide for the retirement security of others—and grateful that so many gifted professionals have committed themselves to being part of the solution to these issues.

Most of all, I’m thankful for the unconditional love and patience of my family, the camaraderie of dear friends and colleagues over the years, the opportunity to write and share these thoughts—and for the ongoing support and appreciation of readers like you.

Why Knots?

We spend a fair amount of time worrying about the relatively small percentage of workers who choose not to participate—at all, fully, or effectively—in their workplace savings plan. Well that we should, because for a myriad of reasons, they are letting a great opportunity pass them by.

However, the real crisis, IMHO, is not about the minority that we hope to stir to action with devices like automatic enrollment, tailored communications, and personal advice. Rather, the real crisis is the majority of American workers who lack even the opportunity to participate in a workplace retirement plan. Certainly, those people are on politicians’ minds, as evidenced by last week’s proposal by Senator Hillary Clinton that purports to provide "universal access to a generous 401(k) for all Americans.” Now, you can argue whether tax credits for the middle- and lower-income workers targeted will be enough to motivate them to take action, and you can certainly take issue with the price tag (and if we know nothing else about politicians of all stripes, it is that those cost projections are always “optimistic”)—but it’s hard to take issue with the need to expand the opportunity to save for retirement to everyone.

And yet, in the interests of laudable goals like “transparency,” “fairness,” and “accountability,” we have nonetheless managed to regulate private-sector retiree health care nearly out of existence, to relegate the support of private-sector defined benefit plans to the sidelines—and we are well on the way to doing the same in the public sector. In fairly short order, our once-vaunted three-legged stool now totters on the financial viability of Social Security and the ability and willingness of individual American workers to make the proper preparations.

It has its imperfections, but it’s clear that the employer-sponsored system works. We may fret about 75% participation rates, but left to their own devices—without the financial support, structure, and education of the employer-sponsored system—individual savings rates are appallingly low. We may well worry about the lack of revenue-sharing transparency and “excessive” fees paid by 401(k) plan participants, but have you taken a look lately at what you would pay for to open a retail IRA that offers a fraction of the services in your 401(k)?

As effective as that employer-sponsored system has been—as essential an element as it surely is in ensuring the retirement security of millions—we continue to undermine the willingness of employers to carry the burden. Somewhere along the way, we seem to have lost sight of the fact that these programs are voluntary, in every sense of the word. They cost money, they take time, they are subjected to an ongoing barrage of change—and, of course, there’s the ever-present threat of litigation.

Yet, we seem to expect employers to continue to support these programs, an expectation that, IMHO, borders on arrogance in view of the burdens imposed. Sure, they attract and, perhaps, allow us to retain good workers—and certainly there are modest tax incentives. But in a time when companies are driven to focus on their “core competencies,” surely we must find some more-meaningful ways to encourage those who have made the commitment to stay the course—and some compelling financial rationale for employers that have resisted the pull to join in.

We all know well why we need the employer-sponsored system. What is less obvious each day—is why a rational employer would be willing to take on the headaches currently imposed by that system.

- Nevin E. Adams, JD