There is a major marketing opportunity for good consulting firms and investment managers to gain business in a market dominated by few providers. That is the 457 deferred compensation plan market. These public employee saving plans generally lack efficiency, transparency and professional oversight. They are dominated by a few third-party administrators that commonly bundle their own investment products with those of other managers. And the plans often offer investment choices in the form of variable annuities, adding an extra layer of fees, as well as a redundant tax advantage.
"This is a new area where we're seeing "bad practices that needs to be reformed," commented Richard C. Ferlauto, director-pension and benefit investment policy, American Federation of State, County and Municipal Employees, Washington, said when asked to comment.
Just as times have changed since 457 plans were created, so has knowledge about investment management of employer-sponsored plans. Some plan sponsors have improved plans accordingly, to the benefit of participants. But other sponsors haven't, to the detriment of participants, often costing them in underperformance and higher fees.
The assets of 457 plans totaled $56 billion in 2005, up from $52 billion in 2003, according to the National Association of Government Defined Contribution Administrators. The total size of the market is hard to determine, because the NAGDCA survey doesn't capture all of its membership, especially among the some 120 local government sponsors that belong to the association, said Ralph D. Marsh, NAGDCA president. Nationwide Life Insurance Co. alone has as clients 8,000 public deferred compensation plans, whose combined assets total $40 billion, according to Karah Brody, Nationwide spokeswoman.
Meanwhile, 457 plans have come under greater scrutiny as they have grown.
A major focus of the scrutiny is revenue sharing, a practice of mutual funds or other investment managers paying third-party administrators part of the fee.
Nationwide was sued last month on behalf of the $50 million Sheriff's Office of Orange County Section 457(b) Deferred Compensation Plan in Orlando, Fla., seeking restitution of revenue-sharing payments paid to Nationwide from mutual funds and other investment advisers (Pensions & Investments, Nov. 27).
The suit, filed in U.S. District Court in Columbus, Ohio, where Nationwide is based, seeks certification as a class action on behalf of participants in other 457 plans that use Nationwide,
"Nationwide is breaching its fiduciary duty to 457 plans by taking kickbacks from mutual funds," said Roger L. Mandel, attorney with Stanley, Mandel & Iola LLP, Dallas, which represents the plaintiff in the suit. The revenue sharing "was not provided for in the variable annuity contracts, nor was it disclosed by Nationwide."
In response, Erica Lewis, Nationwide spokeswoman, said in the story that revenue sharing "is a well-known and accepted practice in the industry. These payments describe the practice of fund companies entering into lawful business agreements, where fund companies are paying for administrative services they would normally provide. The overall effect is to lower plan cost to participants."
The court will have to decide the issue. But there is no denying concern about potential abuses in 457 plans. "We think relationships with investors have been abused," Mr. Ferlauto said. "We're concerned many 457 plans are invested in annuities that have high fees and don't make any sense for tax-sheltered plans." AFSCME recommends sponsors examine 457 contracts for excessive fee payments and appropriate types of investments by their advisers.
AFSCME, which has served its members — and shareholders in general — so well in tackling corporate governance reform, ought to apply the same type of effort on behalf of 457 participants.
State and local government legislators ought to examine the plans to ensure they have an accountable board overseeing them, perhaps adding them to the responsibilities of existing defined benefit plans. Often 457 plans aren't run as rigorously as public pension plans and people overseeing 457 plans lack experience with and knowledge of investment management issues; Plus, annuity products restrict transfer of investments, making it difficult for participants to switch to other investment vehicles.
As 457 plans come more into the spotlight, the neglect of much of that market will end, benefiting participants.