March 11, 2010
Dr. Susan Mangiero, CEO of Investment Governance, Inc., interviews Mr. Ed Lynch and Ms. Lynne McAuley to get their thoughts about 401(k) fee economics and communication with plan participants. Mr. Edward M. Lynch, Jr., AIFA is Managing Director of investment advisory firm, 401(k) Advisors Group. In 2009, Mr. Lynch was voted by his peers as one of the 40 "Most Influential Retirement Plan Advisors" in the United States. Ms. Lynn McAuley is an associate with Fiduciary Plan Governance LLC. From 1990 to 2004, Ms. McAuley served as an auditor for the United States Department of Labor’s Employee Benefits and Security Administration (EBSA) in the Boston Regional Office. During her tenure, she investigated over 200 qualified retirement plans and welfare plans. To access their respective full bios, click here and here.
Susan: Welcome Ed and Lynne. It's a great pleasure to have you both join us today to talk about 401(k) fees. It's such an important topic for many investment committee members and participants alike. Let's start with a basic question. What are the fees that apply to 401(k) investment choices?
Ed: Thanks, Susan. As you know, this is something I've been working on for years and, now with Lynne working with me, we're trying to help clarify the issues around fees as much as possible. Basically, when considering 401(k)-related fees, you begin with the obvious. Hard dollar fees are any that are billed to the plan, the plan sponsor or the plan participants. Typical examples are auditor fees, third-party administration, record keeping, advisory services…pretty much anything that you see as a separate charge.
Lynne: These hard dollar fees are billed directly to the plan sponsor. What has been confusing is that the investment charges are the highest fees but they are not directly billed in a lot of instances.
Susan: Can you help to quantify? Which of these fees are higher?
Ed: Sure. The first thing to keep in mind is that in the world of 401(k) plans, nothing is free. I distinguish between billable or hard dollar fees, which are often lower than the direct charges such as investment management fees. In the case of the latter, these are not broken out in a way that is clear and readily understandable.
Susan: But who pays for which fee?
Ed: Unless someone, like the plan sponsor, is actually writing a check, the plan and therefore the participants, are paying all fees.
Lynne: Susan, in terms of who pays for what fee, it depends on the situation. It can be the plan sponsor or the plan itself. If it is the plan itself, ERISA allows for whatever is stated in the plan document and what has been contractually negotiated. Often, the plan document allows the plan sponsor fiduciary a lot of discretion. Also, the various contracts with the service providers include language that has the fee as a percentage of assets or as a cost per participant or a flat fee for a particular service. Fees and expenses can be vaguely described in either the plan and/or in the various contracts. Given a choice, many plan sponsors will opt to have the participants pay the fee. That, in and of itself, is not the problem. It is that the various fees are often netted out of the participants’ investment return and seldom clearly presented.
Ed: As far as which fees are higher, it's generally the investment expense, or more correctly, the internal fund expenses since not all internal expenses are actually part of investment management fees, again the highest single expense. I have seen situations, such as those in which index and institutional class mutual funds or collective trusts are used, in which a vendor or advisory fee is higher than the internal fund expenses. The key is to understand what the plan and the participants are getting for whatever fees they’re paying.
Susan: Where does someone go to get information about what fees apply to a particular 401(k) plan?
Ed: The prospectus for each fund will have fund expense information but that's just the beginning. If you are a plan sponsor and are trying to understand what fees are impacting your plan, I'd suggest you go to your third party administrator, your record keeper and your broker or advisor with a request to provide you with details about all of the fees they know anything about. Get the information in writing and ask for a written assurance that they have included all the fees they know about, not just those they charge. Then, once you have that information, you need to understand what they mean. For that, you might be wise to hire an independent expert.
Lynne: Like Ed said, there are various sources for fee information. Check out the prospectus and other related documents for each various fund included as a 401(k) plan choice. Within each prospectus, review the different ratios provided.
Susan: Are you saying then that each plan participant must carefully review the prospectus for each 401(k) choice?
Ed: Well, that would be prudent but not necessarily the most efficient way to tackle the problem. In my view, it is a fiduciary’s responsibility to make that information readily available.
Lynne: This information is not in the Summary Plan Description and participants have to go on a treasure hunt with each fund. Even then nothing is obvious.
Susan: So it makes sense then that some participants are frustrated because they don't feel that they are receiving full information.
Ed: For participants, as Lynne indicates, getting a clear, complete picture of fees is hard. I'd say almost impossible and, therefore, it's up to the plan fiduciaries to be clear about fees and to communicate clearly to their participants.
Lynne: Yes, and this is an issue that was not even on the radar screen until a few years ago.
Susan: Lynne, you were a U.S. Department of Labor investigator. What has changed to make people more aware of the need to be fee-literate?
Lynne: When times were good, no one paid attention to the fees. In 2004, the U.S. Department of Labor ("DOL") started studying this issue and realized that no one really knew what was involved since the terminology was confusing and not standardized.
Ed: You're telling me! I've been talking and writing about this for almost 15 years...for most of the first 10, it often seemed like no one was listening.
Susan: Congress is busy at work on fee disclosure legislation. Is a new law the solution or will that create its own set of problems?
Lynne: Congress, the Obama Administration and the courts are all weighing in on solutions. The solutions will be incremental. As each problem is addressed, new problems will crop up. Each step is followed by confusion and then more discussions. But the regulatory fixes appear to be attempting to deal with the approach on a piecemeal basis and then make corrections as new problems emerge.
Ed: I don't have a great deal of faith that Congress is going to come up with something really meaningful. The vested interests, including lobbyists, are just too powerful. I think we'll end up with something unclear, ambiguous and, ultimately, toothless. I do, however, think the DOL, as the recent disclosure proposal indicates, is going to create something worthwhile...for a time. I do, though, have some faith in the marketplace, by which I mean that there is a growing awareness that fees need to be understood so fiduciaries are, and better be, asking for detailed information. Another factor, which may come across as somewhat self-serving, is the growing presence and influence of independent experts and fiduciaries.
Susan: Hmm - It seems like legislation is coming but it's unclear as to the form it will take. What should a fiduciary do now? Where does a fiduciary start? What are the first 5 things a fiduciary, analyst and/or board member should do?
Ed: First, ask for the information on fees and revenue arrangements as I mentioned above.
Lynne: Fiduciaries should take various steps. They should ask vendors to explain how they chose funds that are included in their fund line-up or platform. They should gather data on fund expenses and compare the expenses. By expenses, they should look within the prospectus at administration costs, investment management costs and distribution costs.
Lynne: They should review this information and compare it to information in Morningstar, Lipper, Thompson and Standard and Poor’s.
Ed: I have a three step formula for fee investigations: Find Them. Control Them. Apportion Them. Once you've asked about, and received, what your vendors/service providers warrant are all the fees and revenue arrangements they know about, you can cross check the information by going to the sources Lynne suggests or by hiring an expert to either do the analysis or assist you in doing it.
Lynne: The sponsors should ask what services are provided for these expenses. Be specific and keep asking for simplification if you get a lot of jargon. Ask about services that are provided for the 12b-1 fees, sub-TA (transfer agent) fees and shareholder services.
Ed: The key in this step is to understand not only what the fees are but how they can be modified. Some can. Some can't. You need always ask who is being paid what by whom for what service.
Susan: There are a lot of services being provided for a fee. How does bundling work and is that a solution or does it introduce its own set of problems?
Ed: Let's back up and identify all the providers of services to a 401(k) plan. Call it the "401(k) Ecosystem." Here's what's swimming in your estuary. Who holds the money? A custodian. Who accounts for the money? Both a trustee and a record keeper. Who makes sure your documents are in order and filed properly? The third-party administrator or, possibly, the trustee. Who invests the money? An investment company (mutual fund), a collective trust or some other kind of vehicle. Who reviews a plan's internal controls? A plan auditor. Who handles legal and regulatory compliance? ERISA counsel, sometimes the third party administrator. Have I missed anything?
Lynne: It is just like shopping for a computer system or a car. Bundling offers convenience but some of the services offered are unnecessary and would not be picked normally if the costs were unbundled. Fees are only part of the equation. Remember, while fees are important, fiduciaries are not required to go with the lowest costs under ERISA but to ask questions and be diligent in gathering information.
Susan: Is there a one size fits all solution? If not, how does a 401(k) plan decision-maker know that the right course of action is being taken with respect to service providers and, by extension, the fees they charge?
Ed: There is no single solution, not even for plans with similar characteristics.
Susan: What are the variables?
Ed: Company culture, staffing, sophistication of the participant population, how a company communicates with its employees. In other words, it isn't a "product purchase" decision. A 401(k) is part of an overall benefits package. Your demographics, your ability to pay or pass on expenses, how you value your employees...all these come into play.
Susan: Who are the exemplars in the industry in terms of transparency? If you are not comfortable mentioning names, perhaps you can describe what they do that is considered "best practices."
Lynne: If it is a bundled approach, some providers also show what the components of the bundling include. That is a best practice.
Ed: In my view, the best in the business readily disclose all fees clearly. They identify revenue sharing. They break out their required revenue for services. They don't restrict fund/investment access in anyway.
Susan: This topic is so critical for 401(k) and 403(b) decision-makers. We will be setting up another meeting about fees. You have both been hugely helpful. Many thanks.
Ed: Looking forward to exploring this further! Thanks, Susan.
Lynne: Yes, thank you.