A Professor Puts the Scare in Plan Sponsors
That's a nice 401(k) plan you've got there...it'd be a shame if something happened to it.
Ian Ayres of Yale University has the 401(k) marketplace fuming.
Using data provided to him by a firm that collects information on 401(k) plans, Brightscope, Professor Ayres has calculated the fees paid to plan providers by 46,875 (!) companies. The professor sorted the companies by the assets of their funds into various size buckets and then ranked the companies in each bucket from top to bottom according to how much they paid.
Soon, he says, he will name names. Apparently, he has mailed letters to several thousand plan sponsors that have above-average costs in his study, warning them that he will publish this data in spring 2014. Now might be a good time for those companies to clean up their acts, he suggests:
"Using data from the form 5500 your company filed with the Dept. of Labor in 2009 and BrightScope Inc. I have identified your plan as a potential high-cost plan. We recommend that you improve your plan menu offerings, including adding lower fee options, both at the plan and fund level, and consider eliminating high-fee funds that do not meaningfully contribute to investor diversification."
Or else? Ayres doesn't have a history of filing lawsuits, but the tone rings ominously for 401(k) plan sponsors, who have faced 30 lawsuits for having overly high fees over the past several years. (That Ayres is on Yale's legal faculty as well as its business faculty can't be comforting, either.) Between Ayres' data and the publicity that his list will create, the stage seems to be set for additional legal woes. Plan sponsors are not happy about this, to put it mildly.
The early criticism has been that Ayres' data set is old (2009) and that one can't evaluate the quality of a 401(k) plan solely by its costs. It doesn't sound as if the critics have a winning hand. Plan features tend not to change much from year to year, and while it's true that different 401(k) plans have different levels of service, it's also a side issue. The point of the professor's exercise is to sort from cheapest to priciest. Unless somebody claims otherwise, we'll assume that he has done so accurately.
This is the third major salvo fired at the 401(k) industry over the past 14 months. In May 2012, the think tank Demos released The Retirement Savings Drain: The Hidden & Excessive Costs of 401(k)s. You needn't read further than the paper's title to know that the industry received a damned good whacking. This April brought PBS FrontLine's equally scathing The Retirement Gamble. Now we have the professor's letters.
There will be more salvos before next year is up. Whether the fund industry and plan sponsors wish to acknowledge it, when they shifted the responsibility for managing retirement risk from corporations (via defined-benefit plans) to employees (via 401(k) and other defined-contribution plans), they inevitably brought attention with them. There wasn't much scrutiny in the early years of 401(k)s, but now that the 401(k) plan has become a national standard, the watchers have arrived: politicians, the media, policy makers, and, yes, lawyers.
Many 401(k) plans will need to change. As I've stated elsewhere, leading providers and plan sponsors have largely anticipated outsiders' criticisms and have improved their 401(k) offerings by shifting to lower-cost fund options (including index funds and greater use of target-date funds), automated default and investment programs, and--prompted by the Department of Labor, to be sure--better disclosure. For most Americans, today's 401(k) plan is a lot better than the plans of 10 or 15 years ago. However, not everyone has yet received the message. For those 401(k) plan sponsors, and their providers, Professor Ayres' list is an unpleasant surprise.
It's understandable that the 401(k) marketplace dislikes the letter's implicit threat. However, such annoyances are part of the deal. The 401(k) plan has given fund companies nearly $3 trillion in incremental assets--$15 billion in annual revenues, assuming an average fund expense ratio of 0.50%. It has permitted corporations to shed the burden of guaranteeing pensions. Those benefits for fund companies and plan sponsors don't come for nothing. They come with a spotlight. Get used to the glare, people. It will only get brighter.
John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.