(updated with correction)
Some in the embattled securities lending industry, hoping to retain retirement plan clients, have responded to plan executives by cutting the length of investments, increasing awareness about securities lending in retirement plans and providing better splits on fees.
But a recently released GAO report is calling on plan executives and the Department of Labor to increase scrutiny and disclosure of securities lending practices.
The Government Accountability Office, in a report released March 16, called on the Department of Labor to provide guidance to 401(k) plan sponsors about the potential risks and benefits of securities lending and the reasonableness of fees and returns. It also asked that plans be required to ensure expected returns are reasonable before entering into securities lending arrangements.
Labor Department officials rejected the recommendations.
The GAO report acknowledged that some in the securities lending industry already are making changes. But the GAO noted that without more explicit and accessible information on securities lending with cash collateral pools — where index funds aim to earn greater returns on the stocks they hold by lending out securities and investing the cash collateral they receive — participants are “unknowingly bearing a greater risk of loss than they are currently aware of and, more importantly, have no control over.”
“These changes have come as a result of securities lending agents who have recently reported that some plan sponsors that they service have not only requested more disclosure about securities lending and cash collateral pools, but have also requested that their securities-lending programs take on less risk,” the GAO report states.
Ross Bremen, partner at NEPC LLC, Cambridge, Mass., said in a telephone interview that many defined contribution plan executives are looking to avoid securities lending.
Plan executives “understand it and don't want to deal with the complexity or don't understand it and don't want to have to get up the curve on complexity.”
He said most index providers now offer non-securities-lending versions of their index funds, unlike in the past where such options existed for some, but not all, index funds.
Mr. Bremen said that when companies offer index products, the option provider asks plan executives “whether they want lending or non-lending.”
Virgilio A. “Bo” Abesamis III, executive vice president and head of master trust, securities lending and global custody at consultant Callan Associates Inc., San Francisco, said there's a “heightened awareness and sensitivity” from plan sponsors, consultants and securities lending agents about disclosure and risk.
“If the client doesn't raise (the topic of securities lending), then we will,” he said. “We're glad the industry is migrating toward this type of mindset,” where clients understand securities lending.
But while executives at larger 401(k) plans and their consultants are increasingly aware of details concerning securities lending, “there are small to midsized 401(k) plans that may not be as savvy as larger ones that are in tune,” Mr. Abesamis said.
The GAO report noted executives at 17 of 74 plans surveyed for the report said their plans' service providers do not disclose securities lending activities; 20 others weren't sure if the information had been disclosed.
Charles Jeszeck, the GAO's acting director of education, work force and income security, told the Senate Special Committee on Aging on March 16 that most participants and some plan executives were unaware their 401(k) plans are involved in securities lending.
“That was a disturbing finding,” he said.
Also, Mr. Jeszeck said, while plan participants and securities lending agents both benefit from gains, participants bear the full brunt of losses when they occur. This creates an incentive for securities lending agents to partake in riskier investments because they don't have any stake in the losses but could reap more gains from the riskier investments.
Allison Klausner, assistant general counsel-benefits, Honeywell International, Inc., Morristown, N.J., told the committee that securities lending activity in Honeywell's retirement plans is disclosed to plan participants.
She warned that prohibiting securities lending in DC plans could hurt participants' retirement savings. “The takeaway is that, depending upon fact and circumstances, offering defined contribution plan participants the opportunity to invest in securities lending can be a prudent decision,” Ms. Klausner said.
Anthony Nazzaro, principal of A.A. Nazzaro Associates, a securities lending agent in Yardley, Pa., told the committee that shortening the duration of investments to reduce risk and exposure is the single most important change that's needed.
NEPC's Mr. Bremen said many managers who engage in securities lending have “tightened their process significantly and are investing a lot of collateral in overnight securities.”
“Broadly, the securities lending folks have looked to mitigate risk on a going-forward basis,” Mr. Bremen said. “We have seen a period of risk reduction, shorter duration and higher-quality securities.”
Mr. Nazzaro also recommended that DC plans place a cap on how much of their securities may be put out on loan.
In a separate report March 16, the Senate panel cited a survey of 30 large 401(k) plans that showed a huge range of securities lending by DC plans. In 2010, the survey said, plans loaned anywhere between 0.04% and 97% of their assets.