Mutual fund providers are expecting to make a largely smooth transition when new fee and disclosure requirement take effect for firms that sell investment products into the 401(k) and 403(b) plan markets. Three years in the making, the two sets of regulations from the Department of Labor – one covering disclosures to plan sponsors, the other to participants – aim to make the true cost of service more transparent and the fee differential between providers easier to understand.
The DoL published its interim final regulation on fee disclosure to plan fiduciaries last July. They will go into effect on July 16, affecting recordkeepers, brokers, and third-party administrators that provide services to employees that sponsor any plan that operates under ERISA, including defined benefit pensions, 401(k)s, and 403(b)s. The new participant disclosure requirements will take effect for plan years starting after October 31. That represents the culmination of a policy discussion that began soon after the dot.com crash of 2000, when slumping investment returns and mismanagement of plans at high-flying companies like Enron and WorldCom focused attention on the sometimes convoluted – and costly – inner workings of 401(k)s and 403(b)s.
More comprehensive disclosure requirements will affect an estimated 483,000 participant-directed individual-account plans covering some 72 million workers and holding close to $3 trillion in assets, according to the DoL’s latest numbers. The good news for mutual fund providers is that the disclosure regs won’t require them to supply much information that they previously had not. In fact, many of them have already begun supplying this data owing to a regulation put in place two years ago by the Securities and Exchange Commission.
That rule requires mutual funds to improve their disclosure by providing investors with a concise summary – “in plain English” – of key information they need to make knowledgeable investment decisions.
The DoL appears to have modeled its disclosure rules based on the work the SEC had already done. Most 401(k) recordkeepers, following the SEC regulation, were already supplying some basic information already, and most 401(k) sponsors were sending out regular updates on paper or maintaining a place for it on their Websites.
Facing the biggest challenge may be providers of investments that compete with mutual funds in the 401(k) market, such as collective investment trusts. They were not subject to the SEC rule change and may not have progressed as far in making their fee disclosure conform to the new standards. But many plan sponsors already require their providers – mutual funds and others – to supply information on fees and descriptions of investments so that the sponsor qualifies for the safe harbor of Section 404(c) of ERISA, which can limit their fidiciary responsibility for participants’ investment choices.
Large mutual fund providers that offer their own 401(k) administration and recordkeeping, instead of doing so through third-party administrators, may also find themselves with a longer to-do list. The DoL’s main concern with the new regs was to standardize the data provided to plan sponsors and participants and the schedule for doing so, enabling the buyers of investment products to make apples-to-apples comparisons between providers.
That means the provider has to supply the plan sponsor and the participant, every year, with an overall expense ratio – i.e., the total annual operating expenses of the investment, expressed as a percentage. It also has to itemize and explain every fee charged either directly or indirectly against a participant’s investment.
That means teasing out and explaining the various fees and expenses that are charged against participants’ accounts on a plan-wide basis, such as for recordkeeping and other administration, fees to process loans and qualified domestic relations orders, investment advice and brokerage services, front- and back-end sales loads, and redemption fees. Often with large, bundled providers, these fees were not separated out. In some cases, doing so is complicated by reciprocal arrangements between the firm and its own providers, such as for soft-dollar research.
Providers must figure out, for example, how much of the cost of the fund is offsetting recordkeeping costs they provide. The DoL reg provides some breathing room by stipulating that the plan administrator meets the standard when it “reasonably and in good faith relies on information received from or provided by a plan service provider or the issuer of a designated investment alternative.”
Advocates for 401(k) account holders have reacted favorably to the new regs as well, minimizing the potential that the DoL – or Congress – will soon revisit the question of fee disclosure. “We think the regs generally do a good job of disclosing fees and other key descriptive information to participants and putting them in a plain-English format,” says Karen Friedman, policy director at the Pension Rights Center in Washington, DC.
“The real innovation here is not any single piece of data, but the fact that the participant gets to see a total expense figure, broken down into components” that can then be compared across a group of providers, says Sandy Mackenzie of the AARP Public Policy Institute, who has studied 401(k) fees. “In the past, people were often unaware not just of the amount of fees, but were unaware they were paying them at all.”
