GuidePost - Vol. 3, Issue 4 2007

The GRABot BAG
by Sherrie E. Grabot, CEO

June 2007
Clearing the air on fee transparency

Most people in this business ultimately make their living from the fees charged for managing assets, providing services, or brokering deals related to 401(k) investing. The consumer pays most of these costs, more or less willingly and knowingly. Simple enough, right? But depending on the amounts involved, and on your point of view, those fees can range from practically a public service to highway robbery. And like most things in life, appearances matter greatly. As fees become a hot-button issue, how they’re disclosed is almost as important as what they add up to.

Big changes in disclosure rules in the name of fee transparency are in the works at the Department of Labor. Because I was privileged to sit on the DOL’s ERISA Advisory Board for a few years, it would not be appropriate for me to comment on the substance of any potential changes, assuming I knew about them. Or as fans of The Sopranos might put it, “if told you, I’d have to kill you.” However, the public knowledge about this topic is still plenty interesting – and worth thinking about.

Beyond “buyer beware:” making sense of fee disclosure
The issue of appropriate fees has always been with us. In recent years, however, it’s increasingly clear that “K” plans have become the backbone of Americans’ retirement strategies. Fees are now no longer simply a question of business practices and “buyer beware,” but have become a matter of public policy. And following the change of leadership in Congress, they’re even something of a hot topic.

The question was raised most recently in November, 2006 by a GAO report, which strongly recommended that the fees charged by investment managers, service providers, and brokers should be made easier for the 401(k) participant to understand. It pointed out that fee disclosure is patchy and confusing today not just for consumers, but for the Department of Labor as well, which significantly hinders the DOL’s job of overseeing the 401(k) business.

The next development involved hearings this March before the House Education and Labor Committee. Testimony focused on how much of an impact seemingly small fees can have on retirement savings. As one independent fiduciary estimated during the hearings, a 1% difference in fees applied to $2.5 trillion of 401(k) assets adds up to “a wealth transfer of $25 billion to others – each and every year” from the nation’s retirement savings piggybank. To put it another way, the GAO calculated that an extra 1% in fees over 20 years would reduce a participant’s account balance by 17% at retirement.

How much is too much?
Of course, to anyone in the business a change in fees of 1% is rather unrealistic – it represents roughly the total management fees charged by many investment funds. But there’s also no question that smaller fee amounts still have an impact measured in the billions. And while there is much debate over what grand total of management fees, brokerage commissions and other costs can be considered “fair,” fees in the 401(k) arena may actually have gone down in recent years. Meanwhile service fees are practically an epidemic in other financial service sectors, from student loans to mortgages.

This last point has not been missed by the Congress, which looks to make consumer financial fees a significant priority across the board. Meanwhile the DOL has taken note of the debate’s high profile by issuing a request for information on the subject as the Department prepares to publish some sort of new fee guidelines.

Other people’s money
What those will be is still anyone’s guess. According to a recent article in Human Resource Executive, experts such as Mercer HR Consulting urges plan sponsors not to wait, but to be proactive about the changes. They should be working to understand the total fee picture better and communicate it more effectively to participants. Above all, they should make sure the retirement plans they provide offer fair value to participants based on a complete and comparative knowledge of the fees involved. As one analyst put it, “the most important thing for plan sponsors to recognize is that they are spending someone else’s money.”

Should this really be a surprising idea in an industry whose entire purpose is taking care of other people’s money? To my mind, transparency is a concept everyone should be able to agree on. Consumers and their various advocates are informed and empowered; plan sponsors improve their decision-making power; free-marketers get a more economically efficient market; and even providers get a level playing field on which to demonstrate their performance and service qualities.

I, for one, am not worried. Technological efficiencies, economies of scale, and fundamental changes in the world of investment have far outpaced the disclosure rules on the books. After all, nobody should have to pay more for a few simple index funds than for a full-scale, automated advice and managed account solution. The fact that it’s still possible to do so means that the system is not working in the best interest of the participant. And while that interest is driving the regulatory bandwagon for fee transparency, ultimately it’s in everyone’s interest to jump on.

~~ Sherrie