The 408(b)(2) fee disclosure regulation requires 401(k) service providers to fully disclose in an understandable manner their fees and any potential conflicts of interest that may affect their performance. This regulation, issued by the Department of Labor last year, was Congress' recognition of the well-documented fact that Wall Street can be counted on to put its own profit goals and interests ahead of those of its clients.
This new regulation raises several challenging questions that sponsors and fiduciaries must answer:
- Does a competitive fee necessarily provide good value?
- How should value be defined?
- Did many of the providers' conflicts of interest go unaddressed because ignoring them enabled sponsors and fiduciaries to conceal their own conflicts of interest with participants?
Given the current economic malaise and the likelihood that 401(k) litigation will increase in volume and sophistication, sponsors and fiduciaries should realize that it is in their best interest to not only seriously address these questions, but also to document the steps they are taking to resolve them. If they don't do this, their non-compliance with the 408(b)(2) regulation will turn them into “sitting ducks” for clever and knowledgeable plaintiffs' litigators.
Judging something by price alone is seldom wise. Items with similar prices and intended for the same purpose often differ dramatically in quality and performance.
Thus, sponsors and fiduciaries should specify the value propositions they expect each of their vendors to deliver, explain how those value propositions will help participants achieve retirement security, spell out the processes they will use to evaluate whether or not each vendor fulfilled its contractual obligations, and document that they turned their words into actions.
The Encarta Dictionary defines value as “the worth, importance or usefulness of something to someone.” Value, then, is in the eyes of the beholder. For example, sponsors and record keepers maintain that Internet-based educational tools empower participants to help themselves. Participants apparently don't share that view since few of them have identified their retirement goals and calculated the cost to fund them. In fact, the 13th Annual Transamerica Retirement Survey found that 47% of the respondents guessed what their retirement needs would be. In all, 3,609 full- and part-time workers were polled.
Further, studies made by the large record keepers have found that the average contribution rates are way too low to enable most participants to accumulate an adequate retirement nest egg. Perhaps studies like these underlie the observation of Howard Silverblatt, senior index analyst for S&P Dow Jones Indices, who said: “The American dream of a golden retirement for baby boomers is quickly dissipating.”
Why, then, do sponsors and record keepers tout the virtues of these ignored tools? Perhaps it is an effort to conceal conflicts of interest between themselves as well as with their participants. As psychologist Dan Ariely has observed: “(Conflicts of interest) can deeply color the person's perception, and thereby end up leading even the most upstanding citizens astray, and this happens often.”
Understanding a sponsor's overall human resource goals is essential to determining whether conflicts of interest exist. The Deloitte/ISCEBS 2012 Top Five Total Rewards Priorities Survey found that helping employees achieve a comfortable and secure retirement was not one of the top five corporate priorities either for 2012 or the next three years.
The top two corporate priorities for 2012 were “the cost of providing health-care benefits to active employees” and “the willingness or ability of employees to pay for benefit plan coverage and to manage their own reward budget. ... Concerns about a shortage of qualified talent have emerged as the most significant challenge facing organizations over the next three years.”
In direct contrast to their employer's priorities, the same survey found that 83% of the respondents rank the ability to afford their own retirement and post-retirement health care as their No. 1 concern. Tying for third place among the respondents' worries were employment security and their 401(k) plan's investment performance.
Deloitte's 2011 Annual 401(k) Benchmarking Survey seems to contradict the Total Rewards Priorities Survey. The retirement readiness of active participants was considered very important or quite important by 72% of the retirement committees surveyed.
Towers Watson's 2011 U.S. Retirement Plan Governance Survey found that good 401(k) governance doesn't exist for many large plans. Only 44% of defined contribution fiduciaries — almost all of which oversee 401(k) plans — “measure the effectiveness of their decisions ... on a regular basis using specific metrics. ... (39%) do not use any metrics to measure the effectiveness of their decision making” and in 17% of the plans, “some metrics are monitored and reviewed on an ad hoc basis.”
In addition, Deloitte's benchmarking survey also found that only 20% of the plan sponsors have ever assessed their participants' projected retirement income replacement ratios. Despite most of them not having done quantitative analyses, 85% of the plan sponsors felt that most of their employees would not be prepared for retirement. This is a tacit admission that their participant communication efforts have failed to engage participants in their own retirement planning.
The sponsors' contradictory behavior generates three obvious questions:
- How believable is it that participants' retirement readiness is important to sponsors if their retirement committees don't measure it? After all, you measure what you value, and you value what you measure.
- Without assessing their participants' retirement readiness, can fiduciaries and sponsors objectively assess to what extent their providers' products and services are providing significant value to their participants? Presumably getting participants to use the 401(k) plan more effectively — to enhance their retirement readiness — is the best, and the most meaningful, measure of value.
- Without quantifying changes in their participants' retirement readiness, can fiduciaries evaluate whether their decisions are helping, hurting, or having no effect on their participants' chances of fulfilling their retirement goals?
Target-date funds illustrate the importance of this last question. In 2008, the 2010 target-date funds imploded and blame was attributed to the design of the glide path: to or through (and how far through) retirement and the rate at which the amount allocated to stocks decreased over time.
401(k) fiduciaries and sponsors did not seriously question this explanation as evidenced by the increasing popularity of these funds. After all, Congress and the DOL endorsed these Noble Prize-winning ideas, and modern portfolio theory is widely used by large investment managers, including those who sell TDFs.
It was also assumed that even if TDFs aren't perfect, participants are surely better off with professional investment management than being left to their own “dart throwing.” In addition, participants achieve peace of mind, knowing they are in a professional's care. Participant peace of mind leads to better appreciation of the sponsor's 401(k) plan.
Unfortunately, the use of MPT is being seriously challenged by highly regarded “quants” like Columbia University's Emanuel Derman, Massachusetts Institute of Technology's Andrew Lo and Nassim Nicholas Taleb, author of “Fooled by Randomness” and “The Black Swan: The Impact of the Highly Improbable.” Sponsors of endowments and defined benefit pension plans are rethinking the traditional approaches to managing portfolio risk, including the role of diversification in risk mitigation.
To make matters worse, Nobel laureate Daniel Kahneman calls professional investment management an illusion of skill and validity. A question, then, that fiduciaries now answer is: Are target-date funds giving participants their money's worth or are they just a placebo?
Given the disconnect between corporate priorities and 401(k) participants' goals, it shouldn't surprise anyone that sponsors have not been asking their record keepers to provide assessments of their participants' retirement readiness. Likewise, since fiduciaries are the employees of the sponsor, they, as rational actors, have no desire to raise issues that their bosses did not want to hear.
The behavior of both sponsors and fiduciaries can be explained by the author Upton Sinclair: “It is difficult to get a man to understand something when his salary depends on him not understanding it.” Fortunately for participants, the 408(b)(2) regulation has brought about a new day for them.
Richard D. Glass is president of Investment Horizons Inc., Pittsburgh.
