November 10, 2004

Summary of Testimony Received by the Working Group on Plan Fees and Reporting on Form 5500

Don is President of Plan Sponsor Advisors, a Chicago-based retirement consulting firm. He began his testimony stating that he felt neither plan sponsors nor participants have a good grasp of the fees they are paying in their defined contribution plans, and the 5500 as currently designed does not provide adequate information. Mr. Stone outlined three key issues: 1) an asymmetry of information, given vendors do not provide plan sponsors with adequate information on the fees or revenues received from the plan, 2) a significant shift in the past decade with regard to how fees are charged causing higher fees, and 3) due to the lack of information, plan sponsors are unable to discern the “reasonableness” of fees.

Mr. Stone explained that plan sponsors do appear to understand the explicit fees charged for plan services, but they do not understand revenue sharing arrangements. They are much more unclear about wrap fees, 12(b)(1) fees, sub-transfer agent fees, in many cases, not really being sure what some of those items actually are. He supported this with data from a survey conducted by Grant Thornton and Plan Sponsor Advisors. He noted that given plan sponsors do not understand the economics of the business, they do not know what questions to ask of their vendors. Without adequate information, plan sponsors are unable to 1) compute the vendor’s total revenue generated from the plan, and 2) compare fees in the marketplace to determine reasonableness.

Mr. Stone outlined the types of fees and sources of revenue. Over a decade ago, all fees were “hard dollar” costs, or explicitly defined fees. With the growth in the use of mutual funds and other investment vehicles, many fees and sources of revenue for vendors have become “soft dollar” or embedded in the investment vehicles. He proposed that the shift to asset-based fees has caused 1) an increase in fees, 2) larger accounts within plans to subsidize smaller accounts, and 3) larger plans, or more profitable plans, within a vendor’s book of business to subsidize smaller plans, or less profitable plans. Without the appropriate information, plan sponsors will pay more for administrative services than is reasonable just because the participants have high account balances. He cited examples where plans using “soft dollars” or asset-based fees to pay for services were frequently paying significantly more than those who paid for plan fees explicitly or capped the asset based fees.

Mr. Stone explained that the current design of the 5500 is antiquated due to industry changes and does not provide information on the “soft dollar” fees in plans, which are now a substantial component of plan fees. In fact in many plans, no fees would be disclosed on the 5500. The reporting on the 5500 for broker fees is included for insurance products, but not for other investment products such as mutual funds and stable value funds. He recommends increased fee transparency on the 5500 and education for plan sponsors. The two key changes to the 5500 would be 1) require all investment fees to be disclosed, and 2) require all compensation to brokers and advisors to be disclosed.

Summary of Testimony of Joe Canary and Scott Albert

The DOL testified before the Working Group to provide background information regarding the Form 5500 annual reporting requirements generally. Under Part 1 of Title I of ERISA, administrators of pension and welfare benefit plans are required to file reports annually concerning, among other things, the financial condition, investments, and operations of the employee benefit plan that they administer. The DOL stated that the Form 5500 series is a primary source of information concerning the operation, funding, assets, and investments of pension and other employee benefit plans. In addition to being an important disclosure document for plan participants and beneficiaries, it is a compliance and research tool for the department and a source of information and data for use by other federal agencies, Congress, and the private sector in assessing employee benefit plan issues and related tacks in economic policy issues.

The DOL described the 5500 as a “packaging list.” The Form 5500 collects information, basic identifying information, about the plan, the plan administrator, the plan sponsor, the types of benefits provided, the number of participants covered, the form of funding, trust, insurance, general assets, and a list of the separate schedules that are attached. The DOL articulated the types of schedules, the purpose of the schedule and the agency for whom the schedule is applicable. Overall the instructions are subject to user interpretation and are not explicit in regards to the treatment of all fees. Banks and insurance companies are subject to different reporting requirements, so fees appear to be generally disclosed. With mutual funds, fees are not necessarily disclosed or if they are, they are in the gains and losses line item.

The DOL stated that the entire reporting scheme -- and that includes the audit and the Form 5500 -- is that it promotes a discipline whereby plan administrators would actually focus, at least once a year, on their operations of their plans, on the assets, on their performance, and ensure that plan assets have been properly accounted for. In addition, the DOL provides booklets and instructions with tips for selecting and monitoring service providers for employee benefit plan, meeting your fiduciary responsibilities and on understanding retirement plan fees and expenses. There is also a more technical guide called the Troubleshooter's Guide to Filing the Form 5500.

The DOL indicated that the Form 5500 for the Department of Labor is a creature of regulation. And to adjust the Form would require a public notice and comment process and an adjustment to the regulations.

Summary of Testimony of Mark Davis

Mark Davis is President of Davis Consulting. Mr. Davis began his testimony stating that the majority of fiduciaries do not understand what they and/or their participants are truly paying and very few vendors take meaningful steps to help in the process. He proposed that fiduciaries need to be able to judge the reasonableness of all fees to which participants and plans are exposed.

Mr. Davis articulated a couple of key issues with the current reporting. First, commissions paid to NASD registered brokers are not disclosed to sponsors in any widely used or meaningful way. Plans are typical “sold” investments that pay distributors more in order to reduce the “hard dollar” fees charged to the plan sponsor. In many cases, a provider may be a broker/advisor who increases the fees the plan pays without increasing the benefit to the plan. Second, revenue sharing to other providers, such as recordkeepering and custody service providers is not always disclosed. A plan sponsor who does not have this information, can end up paying more than a reasonable fee for service without even being aware. For example, with a mutual fund that does not revenue share with the plan recordkeeper, the participant may be “paying twice” for shareholder recordkeeping services. Third, reporting is quite different based upon type of product and interpretation. Some insurance product fee information is disclosed on Schedule A, while some is not. Fees paid by the plan to fee-based advisors must be disclosed on Schedule C, while fees paid by the plan to commissioned brokers and advisors may not be disclosed.

Mr. Davis proposed that given many participants now bear the responsibility of paying the fees, plan fiduciaries should be required to be even more vigilant with regards to the reasonableness requirement. He proposed that all fees for services should be reported and all revenues paid to all providers, both direct and indirect, should be reported. He proposed disclosure along with education will enable plan fiduciaries to determine reasonableness of fees.

Summary of Testimony of Larry Johnson

Larry Johnson is President and Founder of Lawrence Johnson & Associates. He began his testimony by stating that 1) plan sponsors don’t understand the fees they pay, 2) fees and expenses are not adequately reported on the Form 5500, and 3) the DOL’s reporting objectives are not currently being met with the existing Form 5500. He stated that if the employer or plan sponsor pays fees, those are not reported on the Form 5500. Overall, he said, the 5500 today collects expenses such as actuarial costs, record keeping costs that are charged to the plan and investment advisory fees charged to the plan explicitly. But the internal expense ratios or charges of mutual funds will not be disclosed on the 5500, which represent a significant portion of the plan fees. He quoted from a recent Hewitt study that anywhere from 70 to 80% of plan expenses are now indirect and not subject to reporting.

Mr. Johnson stated that over a decade ago, all plan fees were paid explicitly. So plan sponsors understood what fees were paid for what services. Typically, the fee was transaction based. Given the evolution to a system whereby more of the fees are paid indirectly through investment products, fees are now paid for based on account size even though the cost of the transaction is not impacted by account size. Reporting has not kept pace with the change in the system.

Mr. Johnson indicated that for plans whose fees and expenses are paid through revenue sharing, 12b-1s, finders' fees, sub-transfer agency fees and other non-disclosed arrangements or any other plan that utilizes mutual funds, the fees are not currently disclosed on the Form 5500, if at all to plan sponsors. He would propose that all fees and revenue sharing with providers be disclosed to plan sponsors.

Mr. Johnson argued that these fees would be easily available on recordkeeping platforms given the recent changes made in recordkeeping platforms to handle the fund redemption rules. Given this new programming now enables recordkeeping systems to track the holding period during the year for each participant of each mutual fund, the corresponding expense ration paid could also be tracked. He did not believe the changes to the system would be considered onerous at this point. He further stated the clarity and accuracy of fee transparency outweighed the expected cost of system changes.

Summary of Testimony of Michael Olah

Michael Olah is the Field Vice President of Schwab Corporate Services. Mr. Olah began by stating “the issue here is not whether service providers are gouging retirement plans and ultimately plan participants by charging exorbitant fees. Nor is it even the difficulty of plan sponsors to perform meaningful fee comparisons. While there may be some plans that are overcharged and that clearly needs to be dealt with, the real issue should be centered around what information is needed by plan fiduciaries to do their jobs and do them well and when and where that information should be provided.”

He contended that the form 5500 could not contain the appropriate information to fulfill this goal. He stated, “This is all about the basics of fiduciary responsibility being proactive about fees not yet incurred rather than reactive in evaluating fees already paid.”

He discussed what he believes ERISA requires. He provided the two obligations imposed on fiduciaries that relate to the disclosure of fees are the exclusive benefit rule and the prudent expert standard. “Under the exclusive benefit rule, plan fiduciaries must operate the plan for the exclusive purpose of providing benefits for the plan participants and offsetting only those fees that are reasonable. This is the only provision of ERISA that even mentions fees and it conditions the use of plan assets for payment only of those fees that are reasonable.” He said only those fees that are paid from plan assets are subject to the exclusive benefit rule but the total of all fees would be subject to the prudent expert standard. He stated plan sponsors should be provided 1) information on both direct fees paid as well as “intrinsic” or indirect fees (which reduce investment earnings), 2) an understanding of sources of revenue received by service providers in administering plans, and 3) costs of services provided. He argued that details do not need to be provided with regard to revenue sharing arrangements or the costs of services be detailed or “unbundled.”

Mr. Olah continued to say that “plan sponsors have been making fee reasonableness determinations knowing only half the picture, the hard dollar half, completely unaware of the existence and magnitude of the revenue sharing half. By disclosing to plan sponsors the revenue received by the service provider from all sources the plan sponsor can make a determination of the reasonableness of the service providers' fees in total.”

From a reporting perspective, Mr. Olah disagreed with others. He stated that the 5500 was not the appropriate place to report the information given the form is provided after the fact and would not provide plan fiduciaries with the information in advance to ensure an appropriate initial decision. He was a proponent of the DOL’s fee worksheet and suggested adding an additional tool that would provide a line item list for the revenue side of the equation for plan sponsors. Although he did not know what percentage of plan sponsors currently use the DOL’s fee worksheet, he did state that most of Schwab’s RFP’s currently include the worksheet.

Mr. Olah concluded his statements by saying, “Fees should be disclosed. Fees should be disclosed in advance of decision making and on an ongoing basis to enable monitoring and fees should be presented in an easy to understand, easy to compare format that allows fiduciaries to do their job and be good fiduciaries.” He later stated that he thought the 5500 was a good tool to provide for the ongoing monitoring of fees and revenue arrangements.

With regard to reporting the fees from a mutual fund, Mr. Olah proposed a snapshot approach. Rather than provide actual reporting of the fees as suggested by Mr. Johnson, he stated that the easier method would be to take a total in each mutual fund either on a period-end date and multiply it by the expense ratio or revenue share basis points to determine the asset-based fees or revenue share component.

Summary of Testimony of Ed Ferrigno

Ed Ferrigno is Vice President of Washington Affairs for the Profit-Sharing 401(k) Council of America. Mr. Ferrigno started by stating that “Form 5500 reporting no longer explicitly lists all of the expenses paid from retirement plan assets. This is especially true for defined contribution plans. As a result, Form 5500 fee-related information is not useful to government policy-makers, plan sponsors, plan participants and others with an interest in this information.”

Mr. Ferrigno agreed with previous testimony that the industry has evolved from paying fees directly to paying indirectly through investment management asset-based fees. The result, he says, is “that a substantial portion of the expenses paid from retirement plan assets are no longer explicitly reported on the Form 5500 makes fiduciary oversight of plans more difficult and has reduced the transparency critical to fiduciary decision-making.” He further proposed that transparency of fees paid indirectly on the 5500 would decrease doubts about the credibility of the defined contribution system.

Mr. Ferrigno stated that PSCA recommends the playing field be level for all service providers by ensuring that the most beneficial aspects of Schedules A and C are applied to all providers. Additionally, the DOL should advocate extending the requirement to provide plan administrators with the information needed to file the Form 5500 in a timely manner pursuant to ERISA Section 103(a)(2) to other service providers.

PSCA also suggested the use of an expanded DOL fee worksheet to include fee arrangements designed by a joint industry-government group. PSCA proposed enhanced reporting coupled with increase plan fiduciary education by the DOL will enable plan sponsors to understand the fee and revenue structures and thereby make better decisions.

Summary of Testimony of Laura Gough

Laura Gough is Managing Director of R.W. Baird and 2004 chair of the Securities Industry Association's Retirement and Savings Committee. Ms. Gough began by stating, “With defined contribution plans becoming a key part of American retirement security, SIA and its member firms want to ensure that all disclosure provided to plan sponsors and plan participants is transparent and informative.”

She noted that with the increased presence of mutual funds in defined contribution plans, the majority of fees are now asset-based. Those fees, she proposed, are currently provided to plan sponsors since they are “built-in” to the fund’s net asset value daily. She cited the following ways plan sponsors can get at fee information: 1) net performance figures compared against benchmarks, 2) proposals submitted by various vendors, 3) prospectus and disclosure booklets, 4) annual and semi-annual reports from the investment vehicles, and 5) through the use of the DOL’s fee worksheet. But she stated additional reporting is necessary.

Ms. Gough said, “SIA strongly supports efforts to enhance transparency of revenue sharing and differential compensation. At a minimum, such enhanced disclosure should embody the following elements: (1) a clear simple presentation of the expenses reimbursed pursuant to revenue sharing agreements, (2) identification of funds or fund families with which revenue sharing arrangements exist, and (3) the funds or fund families with respect to which higher percentage rates of compensation are paid to associated persons such as proprietary funds or for sales of different classes of shares.”

She indicated, “SIA does not believe that the 5500 form is an appropriate vehicle for disclosure improvements to plan sponsors and would encourage the working group to consider other options. The 5500 would have to be substantially revised. Since it is intended to serve a regulatory purpose, it's probably not the best starting point to educate plan sponsors because it is so after the fact.” Additionally she stated mandating a form would be challenging given the significant difference amongst plans. The suggestion was for increased disclosure and open-book accounting being provided by the industry combined with plan sponsor education from the DOL would be the appropriate response.

Summary of Testimony of Thomas Kinzler

Mr. Tom Kinzler is Vice President and Associate General Counsel of Mass Mutual. Mr. Kinzler started by proposing a simplified and consistent approach to the disclosure of fees to plan participants and plan sponsors in an effort to restore confidence in the retirement system. He recommended that fees be disclosed both at the point of sale and on a regular periodic basis to plan fiduciaries and participants. He further recommended that all financial institutions make such disclosures in a uniform manner that is easily understood and subject to comparison by plan sponsors.

The first suggestion was for a point-of-sale disclosure plan sponsors, requiring the disclosure of all plan expenses on a single, all-in disclosure form. This was stated to be of highest importance to enhance competition in the marketplace. He outlined PTE 77-9 requirements for insurance companies at point of sale to obtain three items in writing from the independent fiduciary. First, is an acknowledgment of receipt of the sales commission paid by the insurance company to the agent, broker, or consultant in connection with the purchase. Second is a description of any charges, fee discounts, penalties or adjustments, which may be imposed under the contract. Third is any affiliation the broker, agent, or consultant has with the insurance company. He proposed that fiduciaries receive a single, full, and fair disclosure at the point of sale – in the form of the PTE 77-9 commission disclosure form or a different disclosure made pursuant to another class exemption for all service providers.

Mr. Kinzler suggested that the disclosure should contain five items:

1. Detailed information about all distribution-related costs including identification of recipients and amounts of sales commissions, finders fees and 12(b)(1) distribution fees;
2. Identification of sources and amounts of revenue sharing payments;
3. Estimated costs of administering and record-keeping the participants' accounts and plan including mutual fund management and administration fees, 12(b)(1) service fees, shareholder servicing fees, sub-transfer agency fees, any start up or conversion-related charges, any service provider termination expenses, and any separately imposed charges for participants, loans, or checks, et cetera;
4. Conflicts on interest that may arise in connection with transactions involving the service provider and plan sponsor and an agreed upon disclosure methodology should a conflict arise;
5. Financial ratings of the financial institution and the unallocated capital or surplus of the financial institution.

For ongoing monitoring, Mr. Kinzler recommended amending Form 5500 Schedule A with a new disclosure schedule that will include all fee information from all financial institutions, administrators, and record keepers. This would include both explicit as well as embedded fees. Currently, he said, there is an uneven playing field since the insurance industry reports information not required of other investment companies.

He further recommended “that administrative expense information currently found on Schedule H for large plan financials and service provider information found on Schedule C also be reported on the new disclosure schedule so that a plan sponsor will go to one place for a comprehensive list of plan expenses.” In addition the Harris Trust disclosure provided by insurance companies annually could also be incorporated into the new proposed disclosure.

Mr. Kinzler raised the issue of timing also. Given the filing of the 5500 can occur up to 120 days after the close of the plan year, the fee disclosure would occur too late to be of any real value. He proposed a 90 day limit to speed the filing and information flow.

Overall, the insurance industry is held to a different standard than other providers, such as mutual fund companies. Mr. Kinzler argues the playing field should be leveled to create a more efficient market.

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