November 10, 2004

Report of the Working Group on Fee And Related Disclosures To Participants

Introduction

The working group on fee and related disclosures to participants(1) framed the issue for study as follows:

Description

This working group is going to study fee and related disclosures to participants in defined contribution plans that relate to investment decisions and retirement savings. The scope of the study will encompass both plans that are intended to meet the ERISA(2) §404(c) requirements and those that are not intended to meet those requirements. Existing disclosure requirements within the scope of this study will be examined. The goal is to assess the adequacy and usefulness of the current requirements and whether changing the disclosure requirements could help participants to more effectively manage their retirement savings. Among the hoped for results are a determination of whether:

1. Present fee disclosures to participants adequately inform participants to enable them to make rational investment decisions;
2. The present division between required disclosures and disclosures upon request in the §404(c) regulations is appropriate; and
3. New disclosure methods could be utilized to make compliance less costly and enhance utility for participants.

Questions

1. What information is typically available for participants to know and understand the fees and expenses paid in their defined contribution accounts?
2. What information must be disclosed to participants relating to fees and expenses associated with their defined contribution accounts in plans subject to ERISA §404(c) and in plans not subject to ERISA §404(c)?
3. What is among the information presently required to be disclosed under plans subject to ERISA §404(c) and in plans not subject to ERISA §404(c) that should not have to be disclosed?
4. What additional information should be subject to required disclosure for both plans subject to ERISA §404(c) and in plans not subject to ERISA §404(c)?
5. What information is available upon request by participants relating to fees and expenses associated with their defined contribution accounts in plans subject to ERISA §404(c) and in plans not subject to ERISA §404(c)?
6. Should any of the information that is available on request be subject to required disclosure?
7. Is information readily available, and presented in a context that is understandable by a typical plan participant?
8. Do disclosures relating to fees and expenses associated with defined contribution accounts typically use electronic means of communication? If these means are not typically utilized, should they be utilized more often?
9. Typically, investment returns and account balances are presented on both a consolidated and individual account basis for a participant. Is it possible for fees and expenses to be presented on a consolidated or aggregate basis also, or is it up to the participant to calculate and aggregate this information in order to determine the total fees and expenses to which his/her account is subject?
10. Is it possible to develop a prototype format for presenting usable fee and expense information in a cost efficient manner?

The description and questions were given to all of the witnesses in advance of their testimony. The witnesses were all told that the questions were merely a starting point to generate thought and discussion of the issue being studied. The questions were not intended to limit the parameters of their testimony.

The working group solicited testimony of witnesses from a variety different backgrounds. The witnesses and the dates of their testimony are as follows:

August 5, 2004

• Louis Campagna, Chief, Division of Fiduciary Interpretations, Office of Regulations and Interpretations, US Department of Labor, Washington D.C.
• Mercer Bullard, President and Founder Fund Democracy, Inc. and Assistant Professor of Law, University of Mississippi
• Russell K. Ivinjack, Principal, Ennis Knupp & Associates, Inc.

September 21, 2004

• Edward Ferrigno, Vice President, Profit Sharing/401k Council of America
• Dennis Simmons, Principal and Senior Counsel and Stephen P. Utkus, Principal, both of the Vanguard Group
• Elizabeth Krentzman, General Counsel, Investment Company Institute
• Bruce Ashton, President, ASPA and partner of Reish, Luftman, Reicher & Cohen
• Norman P. Stein, Professor of Law, University of Alabama
• John Kimpel, Senior Vice President and Deputy General Counsel, Fidelity Investments

Presently Required Investment Expense Disclosures

ERISA contains numerous statutory and regulatory disclosures. Disclosure requirements aimed at identifying investment expenses are relatively few.

Russell Ivinjack identified general disclosure requirements applicable to ERISA defined contribution plans that can involve some identification of plan investment expenses. Most such plans are required to distribute to participants a summary annual report that identifies total expenses and benefit payments for the plan year. Additionally, a summary plan description of the plan's rules is required and some description of expenses might be included in that document.

Louis Campagna's testimony listed the materials that must be disclosed and the materials disclosed on request under the ERISA §404(c) regulations. The testimony of Russell Ivinjack and his handout material also described these disclosures.

ERISA §404(c) and the regulations interpreting that provision allow plan fiduciaries to avoid liability for participant investment decisions if specified requirements are met.(3) These requirements include a mandatory expense disclosure and an expense disclosure that must be made upon request.

The required or automatic disclosure in this regard is a description of transaction fees and expenses that affect the value of the participant's account. Examples of these expenses are commissions, sales loads, deferred sales charges and redemption or exchange fees. Expense information can also be extracted from the investment option prospectus that must be distributed to the participant after the initial investment. This requirement only applies to investment options subject to the Securities Act of 1933.

There are two kinds of investment expense information available on request. The first is the annual operating expenses that reduce the rate of return of the investment options. The participant may also request to see these expenses as a percentage of average net assets. Examples of these expenses include investment management fees, administrative fees and transactions costs. The second is information about the value of shares or units in the investment options, as well as the past and current investment performance determined net of expenses.

John Kimple also testified that ERISA §105 requires that participants be given a statement of their accrued benefits upon demand. He said that this requires that the account balance of a participant in a defined contribution plan be provided net of all expenses that reduce the account and that all such fees be identified on any account statement.

Range Of Available Investment Expense Disclosures

The working group heard a variety of testimony about the wealth of information available to plan participants about plan investment options. Much of this material goes beyond what is legally required to distribute to participants. A common problem concerned the format in which much of this information may be presented. Some formats, like a prospectus, are not user friendly. Additionally, many witnesses noted that the available information is so dispersed that it takes a determined participant to corral it all.(4)

Examples of the available information (which include some items produced pursuant to legal requirements) are 5500 annual reports; summary annual reports (SARs); prospectus for plan investments subject to regulation under the Securities Act of 1933; summary plan descriptions; fund fact sheets; information on investment option expenses available through the Employee Benefits Security Administration (EBSA) web page on the Department of Labor's (DOL's) web site;(5) and recordkeeper web sites.

Consensus Recommendation

Scope Of Plans Subject To Consensus Recommendation - The consensus is for additional disclosure of fees in defined contribution plans that seek the protections of ERISA §404(c). This makes sense because plan sponsors use §404(c) for protection against fiduciary liability for participant investment choices, although the plan sponsor still retains the fiduciary obligation to monitor the funds available for investment decisions by the participants. Testimony from Louis Campagna, an attorney with the DOL is consistent with this conclusion. He testified that ERISA §404(c) “offers a defense for liability for plan sponsors and other plan fiduciaries if there is an informed choice and control by the participant with respect to the investment choices available to them under the plan.” He also testified that plans not intended to meet the 404(c) requirements operate under the working assumption that the fiduciary decided to be the party liable for investment choices, “[s]o the same type of control issues won't be present in those types of plans.”

This does not minimize the need for disclosure and the availability of information for participants in defined contribution plans not subject to §404(c). The sponsors of those plans, however, do not have any special protection from investment choices that may be allowed to participants. Therefore, the level of participant disclosure may not be as acutely needed as it is in the context of §404(c) plans. Nonetheless, we do not purport to address the general fiduciary duties of sponsors under such plans as those duties may relate to participant disclosures. That topic is beyond the scope of this investigation.

Considerations In Arriving At The Consensus - The working group heard testimony that information on investment option expenses is important to the health and vitality of plan participants' retirement accumulations. Testimony from Professor Mercer Bullard and from Stephen Utkus indicated that while future investment returns are unpredictable and beyond a participant's control, investment expenses are known.

The working group agrees that disclosure to participants of factual information on investment option expenses is, in the abstract, beneficial. Nonetheless, there are practical constraints on the degree, quantity and cost of disclosures. A balance must be struck between the desire for complete disclosure and the utility of additional disclosure.

Additionally, a balance must be struck between what can reasonably be expected of small plan sponsors and the potential capabilities of larger plan sponsors. The working group wants to avoid a rule that is so burdensome that it discourages the adoption and maintenance of defined contribution plans. Section 401k plans in particular have become popular and convenient investment vehicles for the US workforce. Disclosure rules should not be so onerous that they impede this popular and useful savings vehicle. Finally, the fee disclosure rules should be user friendly. The disclosures must be in an easy to read format that provides pertinent information for the investment decision. The disclosures must be easy to read and understand.(6) They must also be presented in a context of other investment information typically utilized by investors to make investment decisions. One item of information cannot be presented in a vacuum and fees must be presented with other information about the investment option.

Finally, the fee disclosure rules should be user friendly. The disclosures must be in an easy to read format that provides pertinent information for the investment decision.

Recommendation - The working group recognizes that providing actual fee information for a particular participant's account over a stated period of time is not justified at this time by the cost of providing that information. Given the current state of technology and recordkeeping practices, it is a complex and costly procedure to sum the total costs to a particular participant's account because of investment changes over time.(7)

Nonetheless, the working group saw examples of investment statements showing the expense of each investment option expressed as a ratio for each fund in which a participant was invested as of the date of the statement. The working group believes that this is pertinent information that is helpful in making the investment decision. This information can also be presented in an understandable format.

One example was in materials distributed in connection with Russell Ivinjack's testimony. It consisted of a table having the following information going across the page: fund name, fund type, objective/strategy, risk level and expense ratio. Another example was in materials distributed by Dennis Simmons and Stephen Utkus who were from the Vanguard Group. The sample all-in fee report and the sample fund fact sheet are attached as exhibits to this report. The sample all-in fee report is substantially similar to the DOL Fee Disclosure Form.

The consensus of the working group results in only minor suggestions for regulatory improvement. The weakness of the present §404(c) regulatory framework is in the manner the fee information is made available. The working group recommends a remedy to this without suggesting drastic changes to the information that must be provided. The working group, however, recognizes that different considerations apply to open platform (also known as open brokerage) options in plans subject to §404(c). Therefore, the recommendations of the working group do not apply to such investment options.(8)

The consensus recommendation is as follows:

1. The profile prospectus of each investment option should be delivered to each employee upon eligibility to participate.(9) The profile prospectus is a summary prospectus allowed under Securities and Exchange Act Rule 498 (see Form N-1A). It has vital investment information that includes investment expense information. It is logical to require some modicum of information on the investment options before a participant is asked to invest his or her money. Some investment fund options are not subject to regulation by the SEC. For those options, the DOL should require a disclosure with information substantially similar to the information on the profile prospectus.(10) Providing this information prior to the initial investment decision should eliminate the need to automatically provide a full prospectus or other information concerning the particular investment options elected immediately after the investment options are elected. A participant would still be able to request such materials.
2. An educational requirement would be a corollary to the recommendation in item 1. Participants must be given materials (like a glossary) that explain the meaning of the terms used in the profile prospectus (or other like document) coincident with the delivery of the profile prospectus. This explanation would include a description of an expense ratio and what it means to have the investment expenses of an investment option expressed as a ratio. Included in this would be a mathematical example demonstrating the calculation necessary to approximately determine the expenses that apply to a particular participant's account investments as of a particular date. Account and investment recordkeepers should be encouraged to develop internet web sites where participants can research information about plan investment options and review information about their own investment choices. Additionally, these recordkeepers should be encouraged to develop web-based tools for participants to calculate alternative investment scenarios that incorporate assumptions about investment expenses as well as rates of return. Nonetheless, it is not intended that the suggestions in this paragraph be made into requirements.
3. To the extent that an annual statement is provided by the recordkeeper, the statement must provide the expenses of each investment option expressed as a ratio along with other information provided about the investment options.(11) There must also be an identification of the investment expenses that are paid entirely or in part by the plan sponsor. The investment expenses do not include other expenses for general plan maintenance paid by the plan sponsor, including, but not limited to, legal expenses, consulting expenses and accounting expenses. If such investment expenses were paid in part by the plan sponsor the portion so paid would be identified. Any new requirement implemented under this item 3 should have a delayed effective date as applied to small and medium sized plans, based on the number of participants. New requirements like those described in this item could be more costly to implement for such plans than for large plans. Defining what a small to medium size plan is for these purposes should err on the high side. Perhaps plans covering fewer than 500 participants would come within this classification. Delaying the application would likely allow service providers time to design necessary systems to provide the contemplated disclosures in a cost effective manner for such sponsors.
4. The DOL should provide a sample model disclosure format that is available on its web site. This would be a helpful addition to existing tools already provided on its web site for understanding expenses both from the perspective of a participant and a plan sponsor.

Click here for a Summary of Testimony received by the working group.

Exhibits From Vanguard

Footnotes

1. Hereinafter referred to as the working group.
2. Meaning the Employee Retirement Income Security Act of 1974.
3. Meeting these requirements does not eliminate the plan fiduciary's responsibility to prudently choose and monitor investment options made available to plan participants.
4. John Kimple was a contrarian on this point. He testified: We therefore, interpret this requirement [ERISA §105] to require the identification of any such fee on the participant's statements. Therefore, by looking at the expense ratios for a plan's investment options as disclosed in the mutual fund prospectus or the 404(c) required fund description for investments other than mutual funds, together with additional fees, if any, assessed against the participant's account as disclosed in the participant's statement, the participant should be able to readily calculate the aggregate fees that reduce the value of his or her account. As a consequence, the expense ratios for mutual fund and non-mutual fund investments and any administrative expenses that reduce the value of the participant's account balance are all currently disclosed to participants in sufficient detail to allow participants to evaluate the costs they pay against the services they receive.
5. John Kimpel and others in their testimony spoke favorably about these existing resources on the DOL web site – A Look at 401k Plan Fees for Employees, A Look at 401k Plan Fees for Employers and a fee worksheet.
6. In his testimony, Professor Stein emphasized the need for easily understandable materials because many participants lack sophistication regarding investments. He also noted that while he believed that the DOL should work with the SEC to develop appropriate rules for disclosures, he believed the DOL was the agency that should prescribe the format because the DOL has more experience designing materials for employees and plan participants.
7. For example, Russell Ivinjack testified as follows: “It would be too complex to go on a day-by-day basis, calculate their balances as the market changes, as contributions go in, to accurately calculate what their exact calculation would be for that full year.”
8. For example, Bruce Ashton testified that “it would be unfeasible for a plan sponsor to disclose to the plan participant many of the costs sustained through open brokerage windows . . .”
9. Advisory Opinion 2003-11A allowed a profile prospectus to be used as a prospectus when it is the most recent prospectus in the possession of the plan to satisfy the §404(c) regulatory requirement regarding the delivery of a prospectus. The Department of Labor has already seen the utility of the profile prospectus. Professor Bullard spoke favorably of the DOL position in his testimony by saying “ERISA has actually moved ahead of the SEC in this area by allowing the profiles . . . to serve in place of the prospectus.” His criticism was that the DOL does not require the delivery of the profile before the investment decision. The working group's recommendation partially addresses this concern.
10. Elizabeth Krentzman's testimony noted a gap between the information that may be available for mutual fund options that are subject to SEC regulation and investment options that are not. She said that “[w]ithout equivalent information, plan sponsors may not be able to make meaningful fee comparisons among investment products.” The working group believes that this observation applies equally to plan participants, as does Ms. Krentzman as demonstrated in her second recommendation to the DOL regarding participant disclosures.
11. This is consistent with Edward Ferrigno's testimony where he recommended the changes in investment costs be provided automatically on an annual basis for plans subject to ERISA §404(c). Dennis Simmons also recommended that this information be provided on an annual basis.

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