Saturday, March 27, 2010

Court “Case”

For all the fuss about fees, a recent friend of the court filing by the Department of Labor reminds us that it’s not just what you pay, it’s what you get for what you pay.

The amicus brief had the DoL once again weighing in on another in the series of revenue-sharing suits that have kept the industry stirred up since the first wave was filed in 2006. Once again, the DoL was expressing its sense that there were real, and triable, issues in the case, this one involving Exelon Corporation (see “Solis Asks Court to Overturn Exelon Excessive Fee Case Decision”).

The DoL had previously expressed similar concerns about a similar dismissal in the same judicial district in a case involving Deere & Co. (see “Hecker Fee Case Prompts Exelon Suit Dismissal”)—a dismissal that was affirmed by the appellate court, and that the U.S. Supreme Court has refused to reconsider.

Those concerns weren’t enough to influence the appellate court in the Hecker case, though it did result in a judicial addendum that sought to limit the broader applicability of its reasoning to cases outside the specific facts in the Hecker case (see “7th Circuit Panel Limits Ruling's 404(c) Effects”). That said, the same court rejected the plaintiff’s arguments in Loomis v. Exelon Corp. as being nearly identical to those in Hecker—and dismissed it just as summarily.

Retail Fail?

In its most recent filing, the Labor Department sought to distinguish the two cases, noting that it wasn’t just the mere allegation that a large plan was offering mutual funds with “retail level fees,” but that—since those participants weren’t receiving services beyond those of any retail customer—those fees were, at least arguably, excessive(1). In fact, the DoL’s amicus brief noted that “[b]y continually returning to the point that the panel's opinion was limited to the particular facts as alleged, Hecker clearly and deliberately left the door open for other cases like this one in which the allegations about fees are tied directly to allegations about services.”

The Labor Department also took issue with the court’s admonitions that fiduciaries had no obligation to “scour the market” for the cheapest fees. “[T]he holding that fiduciaries are not duty-bound to ‘scour the market’ to find the lowest possible fees should not be read to mean they are free to pay any fee the market bears, without making a diligent effort to assure that they are getting reasonable services for the fees comparable to what prudently managed plans of similar size and type plans also pay.”

And the DoL also said that the district court made a mistake by “ruling instead, without inquiry, that the mere existence of fee ratios comparable to those in Hecker (.03 to .96% in this case) meant that the fees must be reasonable and prudently selected....” Indeed, the DoL noted that “[n]othing in ERISA or Hecker establishes that a particular numerical range of fees is either per se prudent or per se imprudent, or authorizes the courts to fashion a simple numerical test, without regard to what the evidence actually shows after the plaintiffs have been given an opportunity to present their case at trial or on summary judgment.” While the court’s reliance on Hecker as a basis for dismissal drew most of the DoL’s focus, it also pointed out that “[i]n an ERISA case alleging excessive fees in terms very similar to the allegations at issue here, the Eighth Circuit, reversing the district court's grant of a motion to dismiss, recently recognized the presumptive inappropriateness of dismissing a prudence claim at the pleadings stage.”(2)

However, at the heart of the DoL’s stance is, as it has been before, that the plaintiffs in the Exelon case had presented a case sufficient to be entitled to their day in court—and that the court’s dismissal of those claims was too preemptory(3), (4), too willing (though not perhaps in so many words) to apply a presumption of prudence to the decisions of the fiduciaries.(5)

What we don’t know yet, of course, is how much extra in types or number of services might be required to justify the payment of retail-level fees by a retirement program (especially a large one)(6), what kind of differential in penalties a court might apply if it found a “reasonable” gap—or if the 7th Circuit will reconsider its threshold for making that case.

However, what we can reasonably infer from the amicus filing is that the Labor Department thinks it should—and that the fiduciary threshold for a plan, certainly a large plan(7), is and, IMHO, should be, more than merely paying retail-level fees for retail-level service.

—Nevin E. Adams, JD


(1) Unlike the Hecker plaintiffs, the Exelon plaintiffs make very clear that they have not received more services for the same amount of money, and therefore the fees are not appropriate for an institutional investor.”

“The participants' amended complaint distinguished it from the one in Hecker by specifically alleging that the challenged fees were too high, not just in the abstract, but in relation to the services received.”

(2) “In Braden v. Wal-Mart, 588 F.3d 585, 595 (8th Cir. 2009), the court held that the plaintiff met the pleading requirements of Twombly and Iqbal, and was not required to plead additional facts explaining precisely how the fiduciaries' conduct was unlawful.”
(see “8th Circuit Says Wal-Mart 401(k) Suit Requires Further Discussion”)

(3) “Considering the fact-intensive nature of most ERISA fiduciary-breach claims, and the near monopoly defendants often have over many of the determinative facts, the statutory scheme militates against dismissal at the pleadings stage in the ordinary fiduciary-breach case.”

(4)” It was therefore error for the district court to decide at this stage that under any plausible inference based on the facts as alleged, the defendants could not possibly have acted imprudently when they selected investment options charging retail-level fees and providing retail-level services without, according to the allegations, attempting to obtain the fees (or services) that plans of comparable size are expected to secure in the institutional-fund market.”

(5)” For the reasons stated above, the dismissal was error, not only because it was based on a misreading of Hecker, but because it misapplied the established pleading standards and gave the benefit of the doubt to the wrong party.”


(6) While the DoL’s amicus brief was technically in support of giving the plaintiffs an opportunity to plead their case, it also tipped its hand on what those findings might mean: “It (the plaintiff suit) alleges that the Plan fiduciaries breached their statutory duties by imprudently selecting Plan investment options that were unreasonably expensive for the plan's size and bargaining power and did not provide services commensurate with their high fees.

(7) Such conduct, if true, would constitute a breach of fiduciary duty under ERISA and would make the responsible fiduciaries liable for any resulting losses.”

See also “IMHO: The ‘Burden’ of Proof

Saturday, March 20, 2010

"Afford" Abilities

There are in this--or perhaps any—business certain moments of epiphany that shed light and clarity,

Moments where complexity becomes simplicity, where the shining light of comprehension illuminates what had, until that very moment, been hopelessly “confuddled”.

On the subject of retirement income, my moment of clarity came at the end of a conversation with my then soon-to-be-retiring father who was trying to sort through his options regarding his various savings programs and distribution options. At the end of what I hoped was an educational and enlightening discussion of his options and trade-offs, their upsides and potential downsides, when I was sure that I had been able to unwind and demystify the maze and presented him with a straightforward presentation of alternatives, there was this long pause—and then, he turned to me and, as politely as he could, said, “I just want to know how much money I’ll have to live on every month.”

It’s been many years since that conversation, but, IMHO, the question my Dad wanted answered is the question we all want answered—certainly the closer we get to retirement (younger savers are, of course, more likely to be asking other questions).

In recent weeks, I have been giving a lot of thought to the concept of retirement income. Aside from the relentless march of time, and the still-painful shake-up call from the markets, in recent weeks there have been a series of interesting—and surprisingly different—retirement income offerings coming to market (and some interesting innovations in the ones that have been out there). Legislation has been introduced in the Senate that would put the answer to my Dad’s question right on that 401(k) statement. Moreover, the Labor Department’s recent RFI on the topic has given a new visibility to this critical issue.

But as I wrote about a month ago (see Safety "Knot"), while I think that both plan sponsors and participants want—and are looking for—a product that can answer that question, even the most committed advocate of these programs will tell you that, while there is a LOT of interest, the take-up rate is, well, somewhat less.

There were elements of that on display in last week’s Retirement Confidence Survey (see Retirement Confidence Stabilized, but Preparations Still Lacking). Just 14% of current retirees reported that they “purchased a financial product or selected a retirement plan option that pays them guaranteed income each month for the rest of their life,” and a mere one in 10 (11%) of current workers indicated they were “very likely” to purchase a guaranteed-income product or select a guaranteed-income option from a retirement plan when they retire. In fact, a full one in five said they were “not at likely to do so.”

Even more intriguing: The RCS noted that, while workers/retirees offered a variety of reasons for their reluctance to make this purchase, the most frequently cited reason was that they didn’t feel that they could afford it (26% of workers, 24% of retirees)(1).

Now, considering how little understood these products likely are by most people, IMHO, this seemed an extraordinarily large number to be so astute about the costs.

Additionally, the report noted that workers’ stated likelihood of obtaining this type of product decreases sharply as age rises, and also decreases as assets increase. Intrigued, I followed up with Matt Greenwald (whose firm produces the report) and EBRI for some additional insights. Turns out that, among those who had accumulated less than $25,000, fully 42% say they would not purchase because they cannot afford it. But that number dropped dramatically (to 26%) among those that had saved $25,000-$99,999--and even more dramatically (to 6%) among those with financial assets of $100,000 or more (this group had other objections; generally, that they had a separate pension or preferred other options. IMHO, they probably just didn’t want to surrender the money (2). Moreover, when you dig inside what those lower income workers likely meant by “afford,” Greenwald and EBRI believe it is a combination of two factors: The first is that many people have accumulated very little and feel they cannot afford to tie up this money; the second, a lack of understanding about the products.

Now, in fairness, those with very small balances don’t really have much to spend--or annuitize, for that matter. And, if you only have $25,000 saved at retirement, well, no amount of annuitization can “save” you from that. Unfortunately, those who think they can’t afford these kinds of solutions may well be the very folks who can’t afford to be without them.

--Nevin E. Adams, JD


1 Other reasons mentioned include already having a pension, investments, or income (13 percent of workers, 15 percent of retirees), not knowing enough about the product (12 percent of workers, 3 percent of retirees), feeling they could do better managing the money themselves (10 percent of workers, 4 percent of retirees), not knowing it was an option (5 percent of workers, 9 percent of retirees), not trusting or believing in them (8 percent of workers, 2 percent of retirees), lack of interest (6 percent of workers, 4 percent of retirees), and not being offered one at work (2 percent of workers, 8 percent of retirees).

2 Those findings actually dovetailed pretty squarely with another report out last week—this one, Cogent Research’s In-Retirement Income 2010 report. That report was based on an online survey among a representative sample of 961 retirees and pre-retirees with a minimum of $100,000 in investable assets--the upper end of the spectrum. Citing the “incredibly high expectations of today’s retirees and pre-retirees,” Cogent Principal and co-founder Christy White noted, “In theory, pre-retirees love the idea of a guaranteed paycheck, but in reality they are unwilling to give up control of their principal for too long—and certainly not forever.”

Sunday, March 07, 2010

Income Tacts

I don’t know if you’ve gotten to this point in your year yet, but we’ve started doing taxes in our household.

Now, tax season’s not quite the arduous experience it once was—not since that fateful “encounter” with the AMT a couple of years back, along with a year replete with a variety of “special” events, that finally persuaded me that it was a better use of my time to enlist the services of an expert. Still, there is the process of gathering the requisite information from which that expert can do his thing (aided in no small part by the order in which my better half keeps our financial house), and it provides a good opportunity to get a 30,000 foot perspective on how we spend (and invest) our money.

This year—as in most years—I was astounded at how much of our household income is absorbed by various taxes—federal, state, local/property, and, yes, FICA (which I consider a tax—but that’s a subject for another day). Indeed, while I have an opportunity to see most of these reduce my take-home every pay day, that never has quite the same impact as seeing what it adds up to over a year’s time. After all, it’s one thing to hear people talk about tax rates and tax brackets, credits, deductions, and allowances—or even to see those interim deductions on those payroll stubs. It is another altogether to see, all in one place, how much of one’s household income is “rendered unto Caesar.” This may be a free country, after all, but that doesn’t mean it’s cheap.

For all the angst and drama about fee disclosure, most plan participants are already given a fair amount of information about the costs of their retirement plan accounts. Of course, it’s generally in tiny little numbers in tiny little print—numbers that look like pennies (fractions of pennies, actually) and are expressed not in dollars and cents, but basis points, or bps (1). That doesn’t change the fact that most participants could, if they were so inclined, figure out how much their 401(k) costs. All they would have to do is sit down with their year-end statement and the prospectuses associated with the funds they have invested in, and—setting aside for a second potential “distortions” like interfund transfers (of which there generally aren’t many), the timing of contributions deposited, and the fluctuating value of the fund over the course of the year, and ignoring the impact of things like trading costs within the fund—they could get a respectable, if not completely precise, sense of how much they are paying.

Of course, what they’d also get, if they took the time to do that, is a single figure that would show them what they paid for their 401(k) last year.

Now, like many of those government taxes, those 401(k) fees are a toll that is taken along the way. For years this industry has fretted about the difficulties of producing that single number at a participant level—and, the way those fees are currently structured, that concern is not without merit (2). Some have suggested that producing that figure would produce an unhealthy focus on fees alone, rather than the broader context of a total return; others, that the additional costs of producing that figure would be prohibitive (3), and that participants wouldn’t be able to fully appreciate the array of services they are receiving for those expenditures.

That said, as “easy” as the largely imbedded nature of retirement plan fees makes it to extract them for the investment fund community, it also renders them largely invisible to the investing public.

As a consumer, when it comes to buying things like a car, I may not care (or need to care) how much commission that car salesman gets, how much the manufacturer paid for the tires, or even how much profit the dealership makes. But, at the end of the day, I expect—and have a right to expect—to know how much I am paying for the vehicle I drive off the lot. As a taxpayer, I may not know or fully appreciate just how much of my taxes go to support what services (and I may disagree with some that I do), but, at least once a year, I’ve got an opportunity to know how much I am paying in aggregate (and, generally on a somewhat less frequent basis, I have an opportunity to do something about it).

Unfortunately, as a 401(k) investor, I’m still largely in the dark—and, IMHO, the sooner participants know how much they are paying, the better off we’ll all be.

—Nevin E. Adams, JD

1 In my experience, most “regular” people don’t know what a basis point is (many don’t quite seem to understand what a mutual fund is), and many don’t read the prospectus where such things are explained.

2 One might cynically suggest that perhaps a methodology that would be easier to communicate might be more appropriate.

3 Frankly, IMHO, some of the proposals that have been made to present this information to participants would kill a lot of trees AND shed little in the way of clarity.