Who gets how much money to run defined contribution retirement plans is often as clear as mud. That’s troubling because plan sponsors are responsible for informing their employees about the costs of building their nest eggs. The lack of transparency concerns employee advocates and, increasingly, government overseers, who worry that the murkiness may conceal high fees and make it difficult for plan sponsors to comparison-shop among providers.
Through the bull market of the 1990s, no one paid much attention to fees, which were overshadowed by hearty investment returns. But when the bear market started in 2000, plan sponsors and their participants gave them closer scrutiny.
Now regulators are also taking an interest. The Department of Labor has three initiatives under way, the result of several years’ study. And last November, Congress asked the Government Accountability Office, its investigative arm, to examine the transparency of fees charged in retirement accounts. The first part of the GAO’s report is due by the end of this year.
“Many service providers flatly refuse to disclose their fees,” says Kevin Wiggins, an ERISA attorney with West Virginia law firm Steptoe & Johnson. He doesn’t think that providers are trying to hide anything. Rather, he says, “they simply are not willing to bend over backward to explain their fee structure.”
Some plan sponsors and their advisers snipe that as the markets have rebounded and defined contribution assets have grown in recent years, providers have made windfall returns without lowering their fees.
“The growth rate of assets means that the revenues generated by plans grow at a far faster clip than the costs of running the plans,” contends Matthew Gnabasik, whose Chicago-based Blue Prairie Group is one of several consulting firms that have counseled plan sponsors to challenge and reduce their fees.
Throughout the industry, fees are levied and divvied up in complicated ways, and the lack of transparency doesn’t just put plan sponsors at a disadvantage. It can also make it more difficult for providers to compete.
“There is no standard fee disclosure form,” grouses Laurie Nordquist, business director of Wells Fargo & Co.’s Institutional Trust Services unit, which administers approximately $30 billion in defined-contribution-plan assets. Nordquist acknowledges that her shop is “not the lowest-cost vendor,” but she contends that Wells’s fees would appear more competitive if its rivals disclosed theirs more fully. She’s taking the tack of disclosing Wells’s fees directly to plan sponsors in the hope that her clients, both current and prospective, will demand the same of her competitors.
Wells Fargo distributes its retirement plan services directly, unlike many providers that rely on the sales networks of brokers, who in turn act as fee collectors. Wells bills for a combination of charges: direct flat fees to the plan sponsor; fees that are levied per participant and charged either to the plan sponsor or to the participant; and, most typical, asset-based fees that are charged to participants’ individual accounts and, in most cases, deducted directly from their balances. Most providers — and any that use brokers — only charge asset-based fees that are deducted directly from the participants’ balances and are thus obscured.
Asset-based fees are routinely spelled out in the prospectuses of mutual funds. But for the retirement share classes, the dense boilerplate language can seem impenetrable and vague, while indicating a wide range of fees.
There are reasons aplenty for the range. The cost of administering retirement plans can be a shifting target, rising and falling as participants sign up for more loans, pay them off or demand other services. Meantime, the revenues generated from asset-based fees can increase steadily as accounts swell with regular contributions and investment returns.
“We try to do an annual fee review with our clients for precisely that reason,” notes Wells Fargo’s Nordquist. “We frequently end up lowering our fees or adding services. Or we might move participants from paper-based loan transactions to electronic ones that are much cheaper.”
The Department of Labor’s first regulatory initiative will require plan sponsors to tease out the fees that are shrouded in the expense ratios of investment funds and report them in their annual filing, known as the 5500 form. The DoL will issue the first proposal in the initiative this month.
“Our target date for the notice of proposed rule making for the change to the 5500 form is August 2006,” notes Louis Campagna, head of the regulatory division of the DoL’s pension unit. “Of course, that’s followed by the standard period of comments and then the rewriting of the rule to reflect those comments.”
The second initiative by the DoL — to clarify that plan sponsors are responsible for making sure that fees are reasonable — is expected to be announced by year-end. And a third initiative, requiring plan sponsors to explain their plan’s fees to participants, is on the horizon. “Of the three changes, this last will have the biggest impact,” says Wells Fargo’s Nordquist.
How much of an effect these changes will have on providers is an open question. DoL has limited regulatory authority over plan sponsors; it can only require them to demand that mutual funds provide fee information.
Still, consultant Gnabasik and other industry observers think that plan sponsors’ increasing demands for transparency could drive down prices (it’s harder to overcharge once everything’s spelled out clearly), spur more competition among providers on services and lead to more consolidation among managers as margins tighten. “I’m interested in using information to draw down the costs of plans,” asserts Gnabasik.
Plan sponsors have not had much interest in holding down fees as long as those fees have been paid out of participants’ account balances. As the lines of responsibility are sharpened, however, the plaintiffs’ bar will be more likely to hold sponsors’ feet to the fire to make sure fees are reasonable and clearly disclosed.
The fees that are deducted from participants’ accounts cover costs incurred by the investment manager, the recordkeeper or administrator, the trustee, the custodian and the subtransfer agent. Providers take either a fully integrated approach, in which the asset manager offers the investments and most administrative services, or they depend on unbundled arrangements in which the plan provider is paid out of (or joins in) the investment manager’s fees, either through so-called revenue-sharing agreements or 12b-1 fees.
The managers of investment firms that also offer administrative services (including Fidelity Investments, T. Rowe Price Group and Vanguard Group) have typically been reluctant to disclose their intracompany payments that show the relative profitability of business units. Unbundled arrangements do not require full disclosure of payments that have been only vaguely described in prospectuses.
In either case, costs are frequently difficult to ascertain. The expenses of running a defined contribution plan change as the number of participants increases (diminishing per participant but at a variable rate, depending on the level of services demanded) and as average account balances increase. This changing landscape frequently results in ongoing negotiations among all the service providers, making it even more important to first make those fees crystal-clear to plan sponsors and then to maintain that clarity.
Congress is also setting its sights on retirement plan fees. Last November, California Democrat George Miller, the ranking minority member of the House Education and Workforce Committee, which oversees labor laws, wrote to the GAO asking for a full-scale investigation of fees: who pays them, how well they are disclosed and what can be done to improve the disclosure. In his letter Miller pointed out that both average and median 401(k) balances — $45,000 and $15,000, respectively — fall woefully short of the $1 million that would provide adequate retirement income. Miller is looking for legislative remedies to help boost those savings, with a heavy emphasis on fee disclosure.
Notes Michael Barry, president of Plan Advisory Services, which consults with plan sponsors, “The issue of 401(k) fees could take off if the House Republicans pick it up or if the Democrats take back the House this fall or if there’s some major publicity similar to the mutual fund scandals.”
