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Statement of Elizabeth Krentzman
General Counsel
Investment Company Institute

on Disclosure to Plan Sponsors and Participants

Before the
ERISA Advisory Council
Working Groups on Disclosure

September 21, 2004

Good morning. I am Elizabeth Krentzman, General Counsel of the Investment Company Institute,1 the national association of the mutual fund industry. It is my pleasure to be here today before the ERISA Advisory Council to support additional disclosure to plan sponsors and participants.

The subject of this week’s hearings is extremely important for everyone involved in the defined contribution plan market. For many American workers, their single largest financial asset is their investment in a participant-directed defined contribution plan. For the mutual fund industry, improved disclosure helps enhance the retirement security of our investors.

The mutual fund industry serves the long-term savings needs of over 86 million Americans. Mutual funds are the investment vehicle of choice for defined contribution plans — holding nearly half of all defined contribution plan assets and nearly half of all 401(k) plan assets.2 Mutual fund firms and their affiliates also serve as plan recordkeepers and provide other services for many defined contribution plans. Clearly, American workers have entrusted their retirement savings to the mutual fund industry. The fund industry is committed to retaining this trust by, among other things, providing well-managed and diversified investment products that meet the needs of all of our investors.

The Institute has long been a strong proponent of the Department’s efforts to enhance ERISA’s disclosure standards. The Institute, for example, strongly supported the disclosure of detailed fee information for all plan investment alternatives during the Department’s 1997 hearings on plan fees and expenses. The Institute also was instrumental in the development of the Model 401(k) Plan Fee Disclosure Form; this disclosure form has been available to plan sponsors on the Department of Labor’s website since 2000.

Our support for initiatives that ensure meaningful disclosure to investors remains as strong as ever. As the former SEC official who spearheaded the SEC’s efforts to improve mutual fund disclosure, including the development of the mutual fund “profile” disclosure document, I would add that I have a very strong and long-standing personal commitment to clear and effective disclosure to all investors.

Table of Contents

I. Summary of Recommendations

Recommendations for Disclosure to Plan Sponsors

Recommendations for Disclosure to Plan Participants

II. Overview of the Mutual Fund Industry’s Perspective and Role

The Shift to Defined Contribution Plans

The Role of Plan Fiduciaries

The Role of Mutual Funds and Their Affiliates

Plan Fees and Expenses

III. Disclosure of Plan Fees and Expenses to Plan Sponsors

Mutual Funds Currently Provide Extensive Fee Disclosure

Service Provider Disclosure of Receipt of Compensation Should Be Required

IV. Disclosure of Investment and Fee Information to Plan Participants

Current Disclosures Provided to Participants

Enhanced Disclosure Concerning Plan Investment Options Is Needed

V. Conclusion

I. Summary of Recommendations
My testimony today addresses the topics of both Working Groups — disclosure to plan sponsors and disclosure to plan participants. The Institute strongly supports clear, meaningful, and effective disclosure in both areas. Disclosure to plan sponsors should enable them to meet their stringent duties as ERISA fiduciaries. Disclosure to defined contribution plan participants should provide them with descriptions of all plan investment alternatives in a consistent manner that helps them make informed decisions. Based on these principles, we recommend the following:

Recommendations for Disclosure to Plan Sponsors

  • The Department should require that plan sponsors obtain complete information about the fees and expenses of each investment option before they decide to include the option under their plans. Complete, easily accessible and standardized information about the cost of investing in a mutual fund is disclosed already — in the detailed fee and expense information included at the beginning of each fund’s prospectus. Similar information should be provided for all types of investment options.
  • The Department should require that plan sponsors receive from prospective service providers information concerning the providers’ potential receipt of compensation, including “revenue sharing,” in connection with their services to the plan. This information should be received during the selection process.
  • The Institute proposes to take a leading role in organizing a Task Force of plan sponsors, service providers and investment product representatives. The Task Force would assist the Department in developing a disclosure regime for compensation arrangements in this dynamic and competitive marketplace.

Recommendations for Disclosure to Plan Participants

  • The Department should require that participants be provided, upon request, with a clear and concise summary of each investment option offered under a defined contribution plan. The recommended “investment summary” would highlight each investment option’s key characteristics to assist participants in making informed investment decisions.
  • The Department should require that participants in section 404(c) plans be provided with disclosure comparable to that provided in a mutual fund profile for all pooled investments offered under their plans.
  • The Department should strongly encourage and facilitate the use of electronic media to provide disclosures under ERISA.

II. Overview of the Mutual Fund Industry’s Perspective and Role
The Shift to Defined Contribution Plans
The growth of defined contribution plans, such as the 401(k) plan, is one of the most significant developments in the retirement area since ERISA was enacted 30 years ago.3 In 1974, employers maintained relatively few defined contribution plans and, significantly, 401(k) plans did not exist. Consequently, defined benefit plans were largely the model upon which ERISA was crafted. The Institute strongly supports efforts to ensure that ERISA fully accommodates defined contribution plans, so that ERISA serves fully all plan participants.

The marketplace for defined contribution plan service providers is highly competitive. In the Institute members’ experience, plan fiduciaries examine each element of competing firms’ contract proposals before selecting plan service providers and investments; fees and expenses are closely scrutinized.

The Role of Plan Fiduciaries
In General
The fiduciaries of 401(k) and other defined contribution plans have substantial responsibilities concerning these plans, even when investments are self-directed and the employee’s ultimate benefit is tied to his or her account balance. Fiduciaries, among other things, are responsible for selecting and monitoring the investment options that are available to their employees, as well as the service providers involved in the administration of the plan.

ERISA requires that plan fiduciaries perform their duties prudently. In addition, fiduciaries must act solely in the interests of the plan participants and beneficiaries. In this regard, fiduciaries must act for the exclusive purpose of providing benefits to participants and beneficiaries, and defraying the reasonable expenses of administering the plan.4 Plan fiduciaries must also provide plan participants with information about their plan.5

Responsibilities with Respect to Fees
Plan fiduciaries have an obligation to ensure that the costs relating to the plan and its investments are reasonable.6 In analyzing the reasonableness of a particular fee arrangement, plan fiduciaries must consider all expenses involved in the operation and administration of the plan; these expenses include those associated with particular investment options and those incurred in connection with administering the plan. The overall reasonableness of a particular fee arrangement also depends on the plan’s features and the services provided by each service provider. For example, certain plan features, such as plan loans, may increase the cost of plan administration. In addition, while fiduciaries typically obtain recordkeeping services from plan service providers, they also may obtain other important services from them, such as preparation of prototype plan documents, participant communications, and Form 5500 annual reports.

The Role of Mutual Funds and Their Affiliates
The mutual fund industry provides many products and services to the defined contribution plan market. Mutual funds serve as investment options under defined contribution plans; as noted above, about half of all defined contribution plan assets are invested in mutual funds. Many mutual fund organizations also provide services, such as plan recordkeeping and administration, to retirement plans.

Plan Fees and Expenses
Each of the services performed by a plan service provider typically involves a cost that may or may not be separately stated. Generally, specific provisions of the plan document state whether the plan sponsor/employer will pay the expenses of the plan or whether the expenses will be paid from plan assets. The plan sponsor makes this decision in establishing the plan.

Although plan fiduciaries can contract separately with different service providers, many fiduciaries chose to enter into “bundled” arrangements, which provide a comprehensive package of administrative, custodial, and investment services. A bundled arrangement may be offered by one financial institution or by a “strategic alliance” in which several vendors contractually agree to offer comprehensive 401(k) plan services. According to a recent survey of over 1,000 retirement plans, almost 80% utilized a bundled provider.7

Bundled arrangements — whether they involve mutual funds or other pooled investment vehicles offered as plan investment options — typically do not entail separate charges to the plan for recordkeeping or other administrative services. In bundled arrangements with mutual funds as investment options, plan service providers generally receive compensation from two sources. First, fees may be paid by the mutual fund through “sub-transfer agent fees,” 12b-1 fees, or other administrative fees; these fees compensate the service provider for the services it provides to the fund. Under the second type of arrangement, typically referred to as “revenue sharing,” the fund’s adviser (or a related entity) compensates the service provider from its legitimate profits for services provided.

The Department of Labor examined these compensation arrangements in the mid-1990s to determine whether they raised prohibited transaction issues under ERISA. In the Frost and Aetna advisory opinions,8 the Department provided guidance as to how these arrangements must be structured so that the payment of fees to the service provider do not raise prohibited transaction concerns. Both of the Department of Labor’s letters noted that, in order to satisfy their duties under ERISA, plan fiduciaries must obtain “sufficient information” regarding fees and expenses when entering into an arrangement with a service provider.

Plan fiduciaries often approach their obligations to evaluate plan fees and expenses by analyzing and comparing various arrangements through the use of detailed requests for proposal (“RFPs”), sometimes with the assistance of plan consultants. In addition, the Institute, along with the American Council of Life Insurers and the American Bankers Association, developed a model form for fee disclosure in 2000 that is currently available to plan fiduciaries on the Department of Labor’s website.9 This model disclosure form allows plan fiduciaries to compare the costs of and services provided by various parties to arrangements in a consistent format. A similar worksheet has been developed by the Profit Sharing/401(k) Council of America.

The defined contribution marketplace is evolving at a sufficiently fast pace that the ongoing effectiveness of the disclosure regime should be reviewed periodically. Recent efforts to strengthen the disclosures provided in the defined contribution plan market have been significant. Nevertheless, for the reasons discussed below, ERISA’s disclosure regime does not fully address the needs in today’s sophisticated retirement plan marketplace. The remainder of my testimony discusses our recommendations for improved disclosure, first with respect to disclosure to plan sponsors, and then with respect to disclosure to plan participants.

III. Disclosure of Plan Fees and Expenses to Plan Sponsors
Overview
The Advisory Council’s Working Group on Plan Fees & Reporting on Form 5500 states in its materials that one of its primary goals is to determine whether plan sponsors adequately understand the total fees and expenses they are paying. As part of its review, the Working Group has focused on the Form 5500; this Form requires the annual reporting by plan administrators of information concerning, among other things, the income and expenses of the plan during that year. ERISA plans must file this Form with the Department and the IRS, as well as make it available to plan participants and beneficiaries.

We do not believe that the Form 5500 would be the most effective vehicle for enhanced disclosure of such fees and expenses because it is not prepared until after the end of the plan year. Thus, the information about expenses need not be assembled until well after the plan has engaged its service providers and incurred the related fees and expenses. We submit that the effort to enhance the fee and expense information available to plan sponsors would be served best by requiring disclosure at the time plan sponsors are choosing their service providers and investments. The enhanced disclosure would better enable plan sponsors, acting as fiduciaries, to select service providers and investments in a prudent manner.

Mutual Funds Currently Provide Extensive Fee Disclosure
Plan sponsors currently receive extensive disclosure about the fees paid by mutual fund investment options in a readily identifiable, consistent format. Mutual funds are required by SEC rules to include at the beginning of the fund prospectus a standardized fee table that provides a breakdown of the fund’s investment management fee, distribution fee (via the fund’s 12b-1 plan), and other expenses.10 Thus, in the current mutual fund prospectuses, plan sponsors already have access to:

  • the percentage of a fund’s assets paid to compensate the fund’s investment adviser for investment management services,
  • the percentage of a fund’s assets paid to compensate brokers and other parties for distribution and shareholder servicing, and  
  • the percentage of a fund’s assets paid for various administrative expenses, such as transfer agent, legal, and accounting services.

In addition, the fee table presents a quantitative example of the impact of these fees on a hypothetical $10,000 investment.

Only mutual fund options are subject to these prospectus requirements. Thus, the fee and expense information that plan sponsors receive may not be equivalent for competing investment options. Without equivalent information, plan sponsors may not be able to make meaningful fee comparisons among investment options. Accordingly, plan sponsors should be required to obtain comparable disclosure from all investment products.

Service Provider Disclosure of Receipt of Compensation Should Be Required
As noted above, a potential plan service provider may receive compensation from other service providers or related entities in connection with its services to the plan. We believe that information concerning this type of compensation would be valuable to the plan sponsor in assessing the reasonableness of any arrangement with the service provider. Specifically, we recommend that the plan sponsor be required to obtain additional disclosure from potential service providers during the selection process concerning any compensation, including revenue sharing, that the service providers may receive for their services to the plan. This information would allow plan sponsors to examine the direct and indirect costs of the services provided in accordance with their fiduciary duties. Of all the parties to the arrangement, the recipient is the only party with knowledge of each potential source of its compensation; the recipient, therefore, is the only party that can provide comprehensive information about such conflicts to the plan sponsor.11 The recipient of the compensation also typically will have direct contact and interaction with the plan sponsor; the recipient, therefore, typically should have little difficulty providing this information to the plan sponsor.

We also propose to take a leading role in organizing a Task Force, similar to the group that created the Model 401(k) Plan Disclosure Form, to assist the Department in developing a model format for compensation disclosure. Our past experience with the Model 401(k) Plan Disclosure Form suggests that such an approach will result in a useful tool for plan sponsors. In this context, a Task Force representing various interests is needed because of the rapid changes in this dynamic and competitive marketplace and the variety of the compensation arrangements, service providers and investment products.

The Institute would support changes to the Model 401(k) Plan Disclosure Form or the creation of an alternative format for this disclosure. We particularly support electronic preparation and delivery of this information in order to facilitate comparative analysis by the plan sponsor.

IV. Disclosure of Investment and Fee Information to Plan Participants
Equally important to proper plan sponsor-level disclosure is clear and effective disclosure to participants in defined contribution plans. Participants in these plans are responsible for selecting their investments. It is therefore critical that they are properly informed about their plan’s investment alternatives.

Current Disclosures Provided to Participants
ERISA contains a number of specific disclosure requirements designed to provide plan information to participants and beneficiaries. The Summary Plan Description (“SPD”) must describe the type of plan sponsored by the employer, identify the responsible fiduciaries, and explain the eligibility, vesting and benefit accrual features of the plan.12 These disclosures do not focus on the investment options provided in participant-directed defined contribution plans.

Plans that seek to meet the requirements of ERISA section 404(c) are required to provide greater investment disclosure to participants. Among other things, the section 404(c) regulations require that a description of the investment alternatives available under the plan, including a general description of the investments’ characteristics, be provided to participants. To the extent that a plan sponsor meets this disclosure and other enumerated requirements, they are relieved from liability for participants’ investment decisions.

Additional section 404(c) disclosure requirements apply only to mutual funds and other investments subject to the Securities Act of 1933. Specifically, the most recent fund prospectus provided to the section 404(c) plan must be delivered to participants immediately prior to or after the participant’s initial investment. As discussed above, fund prospectuses must include a fee table that provides detailed, standardized information about a fund’s investment management, distribution, and other expenses; a quantitative example of the impact of these fees on a hypothetical $10,000 investment also must be provided. The Department in a 2003 advisory opinion clarified this section 404(c) requirement by providing that the delivery of a mutual fund “profile” (that provides key information about a fund, including the fund’s fee table) satisfies the prospectus-delivery standards of section 404(c).13

Apart from ERISA’s specific disclosure standards, many mutual fund organizations and other plan service providers voluntarily provide investment-related information to participants. For example, many fund companies prepare and deliver to participants “fact sheets” on funds offered under a plan. These documents, which typically consist of one or two pages, summarize the key features of the fund, such as the fund’s investment objective, expense ratio, the risks, and the investment adviser to the fund.

Enhanced Disclosure Concerning Plan Investment Options Is Needed
Although the information included in the SPD and other ERISA-mandated documents provides important disclosures to plan participants, these documents are generally not tailored to the needs of participants in defined contribution plans. In addition — and significantly — while section 404(c) and the underlying regulations have gone far to establish disclosure standards for participant-directed plans, not all defined contribution plans seek to meet the requirements of section 404(c) and the disclosure that is required is not uniform.

To meet the needs of all participants in participant-directed defined contribution plans, ERISA’s disclosure regime should provide greater investment-specific disclosure to participants responsible for directing their own investments. The disclosure requirements that we recommend will assist plan participants in comparing plan investment alternatives and making informed choices to meet their retirement goals.

An Investment Summary Should Be Made Available
The Department should require that participants be provided, upon request, with an “investment summary” for each investment option offered under a defined contribution plan. This summary would highlight the investment option’s key characteristics in an easy-to-read format. The mutual fund profile, and the fact sheets that many fund companies voluntarily provide today, would serve as useful models.

We recommend that the summary include information about four key features of an investment option — the investment product’s:

  • investment objective,
  • principal risks,
  • fee/expense ratio (e.g., in a fee table), and
  • investment adviser.

This information should be presented in a consistent manner. Consistency would enable participants to better understand their plan investment alternatives, compare the investment alternatives and fees associated with each investment option, and ultimately make more informed, prudent decisions about their retirement assets.

Beyond the key elements of the investment product, flexibility should be provided on other aspects of the summary. Plan sponsors — working with their investment product providers — should be permitted to determine the appropriate format and any additional content, given the particular needs of the workforce covered by the plan.

By providing investment summaries to requesting participants (in electronic or paper form), individuals seeking investment product information would have ready access to it. Updates to each summary also should be provided upon request. In addition, the SPD and/or other general plan disclosure documents should refer to the summaries’ availability.

Comparable Disclosure Should be Provided for All Pooled Investment Options In Section 404(c) Plans
Under current law, participants invested in non-mutual fund pooled investments offered by a section 404(c) plan are not required to receive fee and expense information comparable to that provided for mutual fund investment options. For non-mutual fund products, only a “description” of the investment alternatives and transaction-related fees (such as commissions, sales loads) must be delivered to participants.

The section 404(c) regulations should be amended to require that participants receive comparable fee and investment-related information for all pooled investments offered on a plan menu. The regulations also should clarify that the disclosure provided by the mutual fund profile meets the section 404(c) prospectus delivery requirement. Our recommendations would ensure that all participants in a section 404(c) plan receive consistent disclosure of relevant investment-specific information, notwithstanding the type of pooled investment offered under their plan.

Electronic Disclosure Should Be Strongly Encouraged
Electronic media should be fully utilized and encouraged in providing disclosures under ERISA. Given advances in technology and the accessibility of information via the internet, the Council should evaluate and strongly encourage the effective use of electronic media with regard to its disclosure initiatives. The Department’s 2002 regulations on electronic media moved a substantial step forward in this area by, for example, clarifying the types of disclosure that may be provided electronically.14

Most mutual fund firms provide investment product information, including fund prospectuses, on their websites. Plan information also is often updated on the plan sponsor and/or service provider’s website — thereby providing availability in “real time.” Electronic references to such information through “hyperlinks” in e-mail communications provide an easy and accessible method for delivering all types of plan or investment-related documents.

Efforts to improve disclosure under ERISA — including our recommendations — should leverage these technologies to enhance disclosure to participants, while reducing costs for plans and their participants. We therefore strongly encourage the Council to be mindful of such considerations with regard to any disclosure proposal it develops.

V. Conclusion
The Institute applauds the work of the two Working Groups, the ERISA Advisory Council, and the Department of Labor on these important matters. Given the importance and the timeliness of the Council’s inquiries, we urge the Council to consider and adopt our recommendations. We would be pleased to assist the Council and the Department in efforts to advance disclosure initiatives — including taking a leading role in organizing a Task Force to develop model disclosures — that would strengthen the retirement security of working Americans.

ENDNOTES

1 The Investment Company Institute is the national association of the American investment company industry. Its membership includes 8,600 open-end investment companies ("mutual funds"), 630 closed-end investment companies, 135 exchange-traded funds and 5 sponsors of unit investment trusts. Its mutual fund members manage assets of about $7.351 trillion. These assets account for more than 95% of assets of all U.S. mutual funds. Individual owners represented by ICI member firms number 86.6 million as of mid 2003, representing 50.6 million households.

2 As of year-end 2003, mutual funds held $1.4 trillion of the $2.9 trillion of defined contribution plan assets and $922 billion of the $1.9 trillion of 401(k) plan assets. Mutual Funds and the U.S. Retirement Market in 2003, Fundamentals, Vol. 13, No. 2, Investment Company Institute (June 2004).

3 Apart from establishing a comprehensive legal framework for employer-sponsored pension plans, ERISA created the individual retirement account (IRA). As of year-end 2003, mutual funds held about $1.3 trillion in IRA assets, constituting about 43% of all IRA assets. Mutual Funds and the U.S. Retirement Market in 2003, Fundamentals, Vol. 13, No. 2, Investment Company Institute (June 2004).

4 ERISA section 404(a)(1).

5 See, e.g., ERISA section 102 (requiring the delivery of a summary plan description).

6 See, e.g., ERISA section 404(a)(1)(A); Department of Labor Advisory Opinion 97-16A.

7 46th Annual Survey of Profit Sharing and 401(k) Plans, Profit Sharing/401(k) Council of America (PSCA), p. 33 (2003).

8 Department of Labor Advisory Opinion 97-15A; Department of Labor Advisory Opinion 97-16A.

9 The model form also is available on the Institute’s website.

10 Item 3 of Form N-1A (SEC Registration Statement Form).

11 The Institute since 1997 has supported increased disclosures by broker-dealers at the point of sale in order to alert investors to potential conflicts of interest. In particular, we support pending NASD and SEC proposals that would require disclosure of revenue sharing arrangements on the part of broker-dealers at the “point of sale.” See Institute Letter to Jonathan G. Katz, Secretary, Securities and Exchange Commission, dated April 12, 2004, and Institute Letter to Barbara Z. Sweeney, NASD, dated October 17, 2003.

12 ERISA section 102; 29 C.F.R. section 2520.102.

13 Department of Labor Advisory Opinion 2003-11A.

14 67 Fed. Reg. 17264 (April 9, 2002).