GAO urges more stable-value protections

The Government Accountability Office is calling for new regulations to safeguard DC plan participants against risk in stable value funds.

During the 2008-2009 credit crisis, participants in some defined contribution plans — most notably Lehman Brothers Holdings Inc. and Mervyn's LLC — faced withdrawal restrictions in their stable value investments, a recently released GAO report noted. But the report was inconclusive as to the extent of the problem.

Some in the stable value and 401(k) industries say the risks cited in the GAO report are exaggerated and that withdrawal restrictions were few, driven by once-in-a-generation market conditions.

The GAO report "401(k) Plans: Certain Investment Options Practices That May Restrict Withdrawals Not Widely Understood" notes that some participants in 401(k) plans were prohibited from withdrawing money from their stable value funds because of “employer-initiated events” such as bankruptcies, mergers and changing stable value providers. These events invalidated wrap contracts used to insure the funds against volatile interest rates, temporarily preventing participants from retrieving their money.

Following the bankruptcy of Mervyn's in July 2009, for example, participants in the company's 401(k) plan were unable to withdraw money from the stable value option because the wrap contract stipulated that withdrawals could be restricted in the case of a company bankruptcy.

The same thing happened at Lehman after it filed bankruptcy in September 2008.The report also cited another case — involving the merger of two companies and subsequent integration of their DC plans — where participants were restricted from making withdrawals from the stable value funds for nearly two years, although the merger of the two firms took only four and a half months. The companies were not identified.

The GAO report also noted that “even if the wrap contract remains valid ... new participants and participants who remain in the fund could be at risk for losses because the rate of return going forward will be adjusted downward by the wrap contract provider to reflect the market losses that were temporarily covered by the wrap provider.” That occurs if participants withdraw more money than a fund's liquidity reserves can handle when the fund is at less than book value.

The GAO report recommends that the Department of Labor analyze stable value funds to identify situations that prevented plan executives from withdrawing from the funds; amend its regulation on participant disclosure to require plan executives to provide information to participants about the risks of stable value funds; and provide guidance to plan executives about the risks of the funds.

In addition to the GAO report, Sen. Herb Kohl, D-Wis., chairman of the Senate Special Committee on Aging, has launched a committee investigation into stable value funds, but it is uncertain when the findings will be complete.

Gina Mitchell, president of the Stable Value Investment Association, Washington, said in a telephone interview that the withdrawal restrictions were “one-off events” that were limited primarily to Lehman and Mervyn's. “If you read the report it sounds like there are major problems with stable value, and that just isn't so.” Ms. Mitchell said.

She said the Mervyn's and Lehman withdrawal restrictions were “outliers” and “99.9% of stable value funds did not have the issues that were raised in this report for participants.”

She noted that while the Lehman plan's stable value portfolio had a negative return in December 2008 (-1.7%), the fund had a positive return (2%) for the full year.

“I don't think other investments can say that,” she said.

David Wray, president of the Profit Sharing/401(k) Council of America, Chicago, said “the stable value system probably was the best-performing asset program in the country” during the credit crisis.

“Virtually all participants” in stable value funds did not take a hit on their principal and were paid returns as provided by their contracts, Mr. Wray said in a telephone interview.

Plus, stable value was buoyed by participants moving money to stable value from equities during the crisis, providing a positive cash flow that helped stabilize the funds.

“It allowed for the system to make timely distributions at full face value, and also to gradually work off the more risky parts of their portfolios,” Mr. Wray said.

He advised against the GAO recommendation to require disclosure to participants about risks associated with stable value funds.

“If you overwhelm (participants) with things they don't understand, it's going to impact whether they participate in the plan,” he said. “I certainly wouldn't want to add another notice. We're already swamped with notices.”

Withdrawal restrictions might not be an issue with some stable value providers because of changes in the industry.

Peter Marchese, director of investment analytics of consultant Blue Prairie Group, Chicago, said in a telephone interview that many of the large stable value funds that Blue Prairie tracks now have higher cash balances and allocations to U.S. Treasuries and U.S. agency bonds than previously, which could prevent the need to enforce withdrawal restrictions.

“Those are the most liquid bonds in the bond market and can be sold at a moment's notice to meet large participant withdrawals,” he said.

Charles Jeszeck, the GAO's acting director of education, work force and income security and co-author of the report, said plan executives and participants should have more information about the risks of stable value funds and wrap contracts.

“We're saying you're responsible for your own retirement and the (plan executive) has to live up to their fiduciary duties; we want to give them the tools to do that,” he said.

Mr. Jeszeck said the GAO found it difficult in its investigation to determine the extent of problem with withdrawal restrictions associated with stable value funds. He said the forthcoming report by the Senate Aging Committee on stable value funds is expected to have better data to determine the extent of the problem.

That report is expected to be released sometime this month, he said.

Meanwhile, the DOL, in its response to the GAO recommendations, said it will consider whether further action on the review of stable value funds is necessary, noting that the Securities and Exchange Commission and the Commodities Futures Trading Commission also are reviewing the funds as mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act.