The Department of Labor's proposed rules on fee disclosure will help plan sponsor fiduciaries make better decisions on investment-related services, and give them increased knowledge of the true costs of those services.
Greater transparency in fees has long been needed, and the proposed rules — now out for public comment until Aug. 30, and likely to become effective July 16, 2011 — are a welcome step. The new rules should, for example, enable plan fiduciaries to identify when participants in 401(k) plans are being charged unreasonable fees on the funds in which they invest. They should also make conflicts of interest easier to identify.
The regulation spelling out the rules applies to defined benefit and defined contribution retirement plans. It would apply to any service provider that expects to receive at least $1,000 in compensation for services and that provides certain fiduciary or registered investment services; record keeping or brokerage services to 401(k) or similar plans; and certain other services for which indirect compensation is received.
Among other items, the regulation requires service providers to supply to plan sponsors a written description of the services to be provided and all direct and indirect compensation to be received by the provider, its affiliates or subcontractors.
Service providers must also disclose if they are providing record-keeping services and the compensation attributable to services, even when no explicit charge is identified as part of the service contract.
The protracted effort to propose the new rules, going on since 2007, is an indication of how ineffective the DOL has been in overseeing 401(k) plans.
It got off on the wrong regulatory foot when 401(k) plans were created. From the start, the DOL should have required investment providers to be fiduciaries, and it should have required that mutual funds offer only institutional funds to 401(k) plans.
But the DOL permitted mutual funds to avoid being fiduciaries in 401(k) plans (to do otherwise might have required an amendment to the Employee Retirement Income Security Act), and to offer retail-priced funds.
The new regulation begins to address at least some of the issues — costs in DC plans and conflicts of interest in both defined benefit and defined contribution plans, and should lead to improved performance.
With participants assuming all the investment risk, sponsors have a fiduciary duty to focus on keeping costs low, reducing that impact on overall returns.
New evidence from Morningstar Inc. indicates the impact of fees on performance: Lower-fee funds outperform high-fee funds. “If there is anything in the whole world of mutual funds that you can take to the bank, it's that expense ratios help you make a better decision,” wrote Russel Kinnel, director of fund research, in the report. “In every single time period and data point tested (for the report), low-cost funds beat high-cost funds.
“Expense ratios are strong predictors of performance. In every asset class over every time period (analyzed in the report), the cheapest quintile produced higher total returns than the most expensive quintile.”
A Government Accountability Office 2007 study of defined benefit plans, “Conflicts of Interest Involving High Risk of Terminated Plans Pose Enforcement Challenge,” found that undisclosed fees mask potential conflicts of interest and harm performance.
Pension funds in which conflicts weren't disclosed had annual returns 120 to 130 basis points lower between 2000 and 2004 than those funds that used consultants that were transparent about conflicts, the GAO study found.
The DOL's proposed rule will shed light on the investment providers and their services in hopes of enabling better decisions. But the DOL now should tackle the larger issue of fiduciary duty and institutional-quality portfolios to make 401(k) plans an appropriate retirement vehicle on which most employees will likely have to depend.