Saturday, March 29, 2008

The Letter of the Law

An early “win” for plan sponsors (perhaps more accurately, a win for a plan sponsor) was Hecker v. Deere & Co.

That’s the case where, last June, U.S. District Judge John Shabaz tossed “with prejudice and costs” allegations that the plan had incurred excessive fees and had violated its fiduciary obligations by not disclosing revenue-sharing relationships to participants (see “Fighting Words”). It was, many experts said at the time (including this writer), a correct decision, but bad law, with Shabaz too broadly (IMHO) applying the shield of ERISA 404c to excuse an entire series of fiduciary responsibilities not encompassed by that statute.

Not surprisingly, that decision has been appealed—and this time, the Department of Labor has offered its opinion as a “friend of the court” (see “DoL: ERISA Fiduciaries Could Have Disclosure Mandate Not Specified in Law”). And perhaps not surprisingly, the DoL also seems to think that Judge Shabaz missed the boat on a number of his conclusions.

404(c) "Immunity"

First and foremost, the DoL stated that “the statutory safe harbor in section 404(c) does not immunize the Plans' fiduciaries to the extent they acted imprudently in offering investment options with excessive fees”—and also that “section 404(c) does not give fiduciaries a defense to liability for their own imprudence in the selection or monitoring of investment options available under the plan.” Further, that “[a]ll of the fiduciary provisions of ERISA remain applicable to both the initial designation of investment alternatives and investment managers and the ongoing determination that such alternatives and managers remain suitable and prudent investment alternatives for the plan.” None of those statements are particularly controversial, IMHO, though they may surprise some that have seen 404(c) as some kind of magic talisman to ward off all fiduciary evils.

In fact, in its amicus brief, the DoL noted that “[i]f, as alleged, the defendants violated their fiduciary duties by selecting investment options with excessive fees, section 404(c) provides no defense to their fiduciary misconduct,” and made no bones about where it stood on Judge Shabaz’ ruling: “The district court thus erred in holding that ERISA section 404(c) immunizes fiduciaries from liability for any resulting losses as the basis for dismissing plaintiffs' claim for excessive fees.”

However, the DoL also noted that fiduciaries are forbidden from “misleading plan participants about their plan”—and said that that duty, “in certain circumstances, require[s] fiduciaries to disclose information that participants need to know to exercise rights under the plan or protect their interests in the plan.”

And while the DoL did note that there might be an obligation to disclose information to participants beyond that outlined in the so-called “black letter of the law,” that did not equate to an absolute obligation to disclose everything, much less the particulars of revenue-sharing relationships. The DoL noted, “This is not to say, however, that the Secretary agrees with plaintiffs' more sweeping suggestions that the fiduciaries of participant-directed plans must always, or even usually, disclose revenue sharing arrangements as a matter of general fiduciary principles. Indeed, we are skeptical that, absent any misrepresentations, ERISA's duties of prudence and loyalty would have required disclosure to plan participants of revenue sharing among Fidelity affiliates.”

At this juncture, we still don’t know if the fees charged in this case (or the dozen or so that alleged similar transgressions against a variety of employers by the Schlichter, Bogard & Denton law firm) were unreasonable or not, or if the alleged breaches of fiduciary duty are founded on anything of substance.

What we do have, thanks at least in part to the DoL’s brief, is a clear restatement of what the law actually requires. And that’s a step toward better law, as well as a better decision.

- Nevin E. Adams, JD

The DoL brief is here.

Saturday, March 22, 2008

Safety “Net”

Over the past several weeks, I’ve gotten a lot of calls from reporters across the country looking to understand more about what appears to be a recent uptick in the volume of loan and hardship withdrawals from 401(k) plans. By most accounts, those volumes are up—in some cases, perhaps, up by a factor of two—from a year ago.

The natural assumption is that some combination of the subprime crisis, the struggling investment markets, and/or just general economic stress is forcing participants to tap into their 401(k)s. Of course, pretty much year-in and year-out, somewhere between 10% and 12% of participants have loans outstanding (though a huge database maintained by the Employee Benefit Research Institute (EBRI) indicates that the percentage with loans outstanding has been in the high teens for a number of years, certainly among larger plans). Still, there is clearly movement afoot.

The question, of course, is what should be done about it? If savings rates and accumulated balances are already inadequate to ensure retirement security, it’s hard to imagine a scenario under which depleting them—even if only for a short time—doesn’t make a bad situation worse, IMHO.

Moreover, when people “borrow money from themselves,” as the 401(k) loan process is often characterized, they quickly find out that they are really borrowing money from the plan, collateralized by their balance. That not only means that the 401(k) loan must be repaid on a regular basis (the plan fiduciary has an obligation to oversee these just like any other asset of the plan)—it also means that, while the participant may have satisfied one obligation, they have just picked up another.

The Loan Benefit

There are, of course, reasons to take advantage of the loan benefit, for that is surely what it is. There’s the interest rate, of course—generally prime +1%. Interest that, even if it has to be funded by the participant, does at least eventually wind up in their own account, rather than some credit card company’s. Plan loans are usually relatively easy—and the ability to simply tap into money that you have set aside is certainly more appealing to one’s sense of self-reliance than prostrating oneself before some loan official.

This industry has long and consistently embraced the notion that loans were something of a necessary evil in these programs. After all, if we didn’t give participants a way to tap into those funds in an emergency, they’d be much less inclined to save—or so runs the common wisdom. Odds are, if you’ve had the opportunity to explain these loan features to reluctant savers, you’ve perhaps thrown in the notion that “you can get to the money in an emergency.”

All in all, most participants appear to have treated that option responsibly. Over the past 20 years, the number of participants with loans outstanding has remained relatively constant, and while there are certainly cases of individual abuse, the combination of plan limits, processing fees, and sheer inertia has evidently served to keep this genie in the bottle. There are, however, clear signs of a shift here—a shift likely to accelerate along with the uptick in mainstream media coverage of the issue.

This doesn’t have to be a bad thing, of course. And while there is reason for concern if this simply becomes just one more way of fueling (no pun intended) our nation’s apparently insatiable desire for “stuff,” there’s little point in having a retirement savings account if you and your family get thrown out of your home 20 years before then.

However, unsettling economic periods are not restricted to the here and now, and as important as the safety net afforded by these programs can be in the short-term, it is a net that must be repaired and restored at some point. It’s one thing to borrow from yourself, after all—and something else altogether when you simply rob Peter to pay Paul.

- Nevin E. Adams, JD

Saturday, March 15, 2008

Marshal Law

When a co-worker forwarded to me an e-mail about Eliot Spitzer’s alleged tie with a prostitution ring last week, I thought it was a joke.

It was no joke, of course—though, in incredibly short order, it became something of a circus (one can only hope that with Spitzer’s resignation, we’ll be spared the tiresome details about the personal life of the prostitute(s) whose services he engaged).

Spitzer was touted as a crusader by some—but like the crusaders of old, his motives and actions surely weren’t always pure. And though he reportedly embraced the image of a sheriff, he more accurately brought to mind Henry Fonda’s gunslinger marshal Clay Blaisdell in “Warlock” who, hired to rid the town of terrorizing bandits, soon became an even more ominous threat to the peace and well-being of the citizenry.

Spitzer made a lot of enemies during his career—IMHO, not so much because of what he did, but how he chose to do it. He was, of course, challenging large and powerful interests, but he frequently seemed all too willing to resort to the equivalent of extortion to impose his will on the targets of his investigations.

He may or may not have had the interests of his New York constituency at heart—he may well have merely viewed it as part of a political calculus designed to take him to Albany, and perhaps beyond. However, for the very most part, he wrested acquiescence and money, not guilty verdicts, from his targets. And, mind you, much, if not most, of the financial benefits have wound up in the Empire State’s coffers, not the pockets of those actually injured.

Still, whatever lies ahead for Mr. Spitzer, he has unquestionably left his mark on this industry. Because of his efforts, a number of illegal—and many highly questionable—practices were brought to light, and a new, sharper focus was brought to bear on the fees paid by the investing public, including 401(k) plan participants. I can still remember reading—with much the same incredulity that accompanied the early reporting of Spitzer’s prostitution ties—the arrangements that fund complexes had made to facilitate late trading, the pre-communication about trading movements with hedge funds, and the written agreements that violated both the spirit and letter of these same funds’ commitment to shareholders (see “IMHO: Wrong-Headed”). And let’s not forget that certain other regulatory bodies, given the opportunity to step in, did not (see “IMHO: Between the Devil and the Deep Blue Sea”).

Ultimately, of course, what got most of those firms in trouble was the hypocrisy of saying they did one thing while they did something else altogether. That, and a certain hubris about the application of the law. These are maladies often visited upon those grown too rich and too powerful.

It’s more than mildly ironic that they now appear to have contributed to the downfall of a man who also grew rich - and perhaps too powerful - at the expense of others.

- Nevin E. Adams, JD

Saturday, March 08, 2008

Utility "Bills"

While it’s been a relatively mild winter here (and it’s not over yet), it’s been cold enough—and our house old enough—that opening the various utility bills has been akin to a monthly exercise in economic roulette. Not that we don’t know what the rates are (though that doesn’t mean they’re reasonable, IMHO), and not that, with some effort, we couldn’t find the appropriate meters and, at least in theory, undertake the calculations that would allow us to know what we have to pay before that envelope arrives. Still, those fees (more accurately, fee rates) are disclosed, and in theory, I am able to monitor them.

The reality, of course, is something different. The placements that make it convenient for the entities that deliver fuel and power to my home make it somewhat less than convenient for me to get to them on a regular basis (particularly during the winter months). Not that it would matter in any event—when it comes to utility preferences, my choices as a homeowner are relatively limited. My only viable recourse—and one that I entertain at least briefly following the receipt of each month’s bill—is simply to consume less of what I am being charged for. Sweaters for everyone!

Retirement savings plan participants are not dissimilarly positioned, IMHO. In theory most—despite the angst of lawmakers—are already in possession of information that would allow them to figure out what they are paying for their retirement accounts, although not always in a place, or explained in a manner, that makes the task easy (1). Additionally, when it comes to retirement savings plans, most of us are “stuck” with the plan chosen by our employer.

It’s not quite a utility monopoly, of course—I don’t have to save for retirement, and I certainly am not limited to doing so within the confines of a workplace retirement plan (of course, I don’t have to heat my house, either, but you take my point). It is, of course, the only practical way to avail myself of the “free money” of the company match (if available), and for most, it’s a significantly more convenient option than setting up a payroll deduction for a savings account (particularly for those lacking the discipline to deposit money regularly). For most, then, if there is an issue with what they are being charged for those services (and many don’t have an issue because they don’t know how much they are paying), the only viable recourse is, like with my home utilities, to consume less of what they are being charged for.

Tell “Tail”

That, of course, is the concern expressed by those defending the status quo on participant fee disclosure; that if we tell people how much they are paying, they will stop participating in these programs. That would be an unfortunate and, I think, unintended consequence, since by most measures, most folks already aren’t saving “enough.”

As a consumer, I’m not happy about the high cost of my utility bills. There are limits to how many layers one can put on, or how low you can set the thermostat at night and still be able to sleep. But seeing that cost every month does at least provide the opportunity to consider alternatives, including a greater involvement with the powers that oversee such matters. Similarly, seeing the cost of my retirement plan spelled out as a number separate and apart from the investment returns in which it is currently imbedded isn’t a panacea. Some may well decide that they don’t want to pay that much, or use that cost as a rationalization for not saving at all.

But it also might provide a reason for participants (and plan sponsors) to consider some more-cost-effective alternatives (such as index funds or lower-expense share classes), it might engender a more proactive dialogue about curtailing some of these unnecessary “bells and whistles” that add cost but little value to these programs—and it might even foster greater participant attention to these critical savings vehicles. But even if it doesn’t—and even if the disclosure costs participation in the short-term—no one is well-served by a system that people think is “free.”

We don’t know how participants will react if those disclosures were more explicit(2). But every time I hear someone caution against doing so, one of two thoughts comes to mind: first, that they haven’t got a clue how little attention participants actually pay to these accounts and the accompanying disclosures; and second, that “they” have something to hide.

- Nevin E. Adams, JD

(1)Ironically, most of the regulatory focus to date has been on the types of accounts where prospectus disclosures are available, but almost none on the part of the industry reliant on annuity investments, where, by most accounts, fees are higher and disclosures nearly non-existent – but that’s a topic for another column.

(2)Anecdotally, there are a growing number of programs out there that offer that level of fee disclosure – and I have never heard that it has actually created an issue with participation rate declines of any real consequence.