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- ICI Comment Letters
Statement of Elizabeth Krentzman
Investment Company Institute
on A Procedurally Prudent Investment Process
Before the ERISA Advisory Council Working Group
September 21, 2006
The Investment Company Institute,1 the national association of the mutual fund industry, is pleased to testify and submit this statement to the ERISA Advisory Council on improving the disclosure regime for self-directed plans.
As the Advisory Council is well aware, Americans increasingly will rely on defined contribution plans for retirement income. These plans have enormous potential to provide plan participants with a solid retirement.2 The challenge now is to empower participants with the tools they need to succeed. Improving the disclosure participants receive about their investment options is an important part of this effort.
Institute members have a substantial interest in these matters. Nearly one half of the $3.7 trillion in assets held in defined contribution plans at the end of 2005 were held in mutual funds.3 Mutual fund firms and their affiliates also serve as plan recordkeepers and provide other services for many defined contribution plans. In addition, the Institute is in a unique position to assist the Advisory Council in evaluating participant information needs in light of extensive research the Institute has conducted on both information investors find most useful in making investment decisions and on investor access to and use of the Internet.
We strongly urge the Department to comprehensively evaluate what investment-related information participants should receive and how they should receive it. First, we recommend that participants in all self-directed plans receive a concise summary of each investment option available under the plan. Second, the Department should update its electronic delivery rule based on Americans’ increasing access to and use of the Internet. Third, we recommend that the more detailed information about investment products required under the Department’s rules be available online or in paper copies upon request. Our recommendations are based on the Institute’s research as described below.
The Institute’s statement covers one additional matter, which arises under the Pension Protection Act. We recommend that the default and mapping provisions of the Act be coordinated to ensure that they cover the wide range of situations in which a plan does not have a participant’s investment election.
I. Improving the Content of Disclosure to Participants
The 404(c) Regulation Does Not Require Consistent Disclosure of Useful Information about All Investments
The 404(c) regulation, which provides relief for plan fiduciaries for the investment decisions of participants, is the only regulation that governs the content of investment information participants receive.4 404(c) plans must provide participants with certain information on each investment option. This includes information about the investment objective, risk and return characteristics, and investment manager for all investments under the plan. The Department imposes special requirements on mutual funds and other investments subject to the Securities Act of 1933. For these investment options, plans must provide participants with copies of prospectuses and other disclosure documents required under the Securities Act. For other investment options, additional information, such as annual operating expenses and historical performance, is required to be provided only upon request and only if that information has been provided to the plan.
This disclosure system results in significant gaps in the information participants receive about some products and can produce information overload with respect to other products. Participants receive detailed information about mutual funds.5 For other products, participants may not receive certain basic information about the product’s fees and performance.
The current disclosure system contains another potentially significant gap in that it only covers plans that seek to operate under section 404(c). It does not address the information needs of participants in self-directed plans that are not subject to 404(c).6
The Department should close these gaps. In doing so, the Department should consider what information is important to investors. The Institute has conducted extensive research on the information investors find most useful in reaching investment decisions. This research is directly relevant to the Department’s reconsideration of its disclosure regime.
In an ICI study conducted earlier this year,7 the Institute surveyed investors about the information they consider before purchasing mutual fund shares. Fund fees and expenses—which nearly three-quarters of survey participants reviewed before making an investment decision—topped the list of items of information most frequently considered. Because fees and expenses reduce an investor’s return over time, it is not surprising that investors are most likely to consider fees and expenses in making fund investment decisions. The historical performance of the fund came in a close second in importance—nearly seven in ten survey participants said they considered historical performance before making their most recent mutual fund purchase. The majority of survey participants also considered the risks associated with the fund and the types of securities in which the fund invests.8 Participants receive all of this information about mutual funds, but they do not receive all of this information about other products. In particular, fee and expense information and historical performance—the two items survey participants indicated were most important—must only be provided upon request for non-mutual fund investment options.
Significantly, the study also found that shareholders prefer a summary of mutual fund information instead of a detailed document.9 Only 34 percent of survey participants indicated that they consulted the prospectus before making their most recent purchase of fund shares.10 About half of the survey participants indicated they generally do not read or read very little of the prospectus they receive. Nearly 60 percent of recent fund investors describe mutual fund prospectuses as very or somewhat difficult to understand, and two-thirds say prospectuses provide too much information.
All Participant-Directed Plans Should Provide a Concise Summary on All Investment Options
To address information gaps in the current system and to provide participants with information they will use, we recommend that the Department require that participants in participant-directed plans receive (in electronic or hard copy form) an investment summary for each investment option offered under the plan. The summary should be required regardless of the type of investment product. The Institute has made this recommendation repeatedly, including most recently in testimony the Institute gave to the Advisory Council in 2004.11 We recommend that the summary include information regarding five key features of the investment product:
- types of securities held and/or investment objective,
- principal risks,
- annual fees and expenses expressed in a ratio or fee table,
- historical performance12 and
- investment adviser.
We recommend that this summary be provided whether or not the plan is a 404(c) plan. Basic information to make informed decisions should be provided whenever participants have the right under the plan to direct the investment of their account.
Beyond the requirement to provide the key elements outlined above in a concise document, 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 of the information and provision of any additional information, given the nature of the investment product and the needs of the workforce covered by the plan. For example, if the Securities and Exchange Commission develops a concise disclosure document for mutual funds, it may be cost-effective for mutual funds to provide this document.13
II. Leveraging the Power of Electronic Technology
In addition to addressing the content of information provided in participant-directed plans, the Department should revisit its electronic disclosure policies. Access to and use of the Internet has grown significantly since the Department first adopted these policies.
The Department Should Reconsider its Rules for Electronic Disclosure
In 2002, the Department adopted a regulation that permits disclosure of information through electronic means.14 Plan sponsors may deliver required disclosure electronically to employees who have access to the Internet or email at work and for whom accessing the Internet or email is an integral part of their duties. The plan does not have to obtain consent from these employees (although paper copies must be provided upon request). For employees for whom access to the Internet or email is not an integral part of their duties, the plan must obtain consent to use electronic delivery.
The Institute applauds the Department for the steps it took in 2002 to facilitate the use of electronic communication. Given the dramatic growth in access to and use of the Internet, it is time to revisit whether the distinction the Department drew in 2002 continues to be appropriate for investment-related information. Requiring that a participant have email access at work as an integral part of his or her duties may unnecessarily limit a plan’s option to use electronic delivery. The use of electronic delivery is a cost-effective means of providing investment-related information, which may be particularly important for small employer plans.15
As the members of the Advisory Council are likely aware, other regulators, including the SEC, are actively evaluating using electronic technologies to improve the way information is delivered and accessed by investors and other market participants.16 We are working closely with the SEC on its initiatives.17 The Department has been in the forefront in the area of electronic delivery with its 2002 regulation. We urge the Department to continue to be forward thinking in leveraging the power of electronic technology in its disclosure regime.
The Institute has conducted extensive research on access to and use of the Internet by U.S. households generally and mutual fund investors specifically.18 Our most recent study in 2005 reports that Americans’ access to the Internet has grown dramatically. Four out of five Americans today have Internet access, up from less than one-quarter of Americans in 1997.19 Among certain groups, such as those with a college education, Internet access is nearly universal, but Internet access also has grown significantly among other groups. For example, 64 percent of U.S. adults with a high school education or less report having Internet access in 2005, as compared to 10 percent in 1997. Only eight percent of people age 55 or older had Internet access in 1997—by 2005, the number grew to 64 percent. Among those with a household income below $50,000, the share with Internet access grew from 14 percent to 64 percent in the same period between 1997 and 2005.
Among Americans who own mutual funds (whether through employer plans or through the retail market), nearly 90 percent have access to the Internet. About two thirds of those with Internet access go online at least once a day. Three quarters of shareholders who go online use the Internet to access their bank or investment accounts, and nearly 60 percent use the Internet to obtain investment information.20
The Internet clearly has enormous potential as a tool of investor information and education.21 Given the prevalence of access to and use of the Internet, the Department should consider giving plan sponsors additional opportunities to deliver required disclosures electronically. At the same time, the Department should retain the requirement in its current rule that plans must provide investment-related information in hard copy to those participants who request a paper copy.
The Department Should Consider Allowing Detailed Information About Investment Options to be Primarily Available Online
As a complement to the short summary document we recommend, the Department should also revise its rules for delivery of more detailed information. We believe that a new approach will be most effective in meeting investor needs and preferences.
Based on what we know investors want and will use, we recommend that plans have the option to make more detailed documents—such as a mutual fund prospectus, the list of portfolio investments of a commingled fund, and contract details of insurance products—available online or in paper copy upon request. Our research demonstrates that this approach will meet investor needs. Participants who want to learn more about an investment will be able to do so, without overloading other participants with information that is not important to them. Those who want more information will be able to get it. The remaining group, which our research suggests is the vast majority of investors, will receive the essential information they need, in a form they are likely to use.
III. Pension Protection Act Recommendations
Our final recommendations relate to investment issues under the recently enacted Pension Protection Act of 2006. Section 624 of the Act provides that a participant will be treated as having made an investment election (and therefore 404(c) relief will be available to plan fiduciaries) when a participant is invested in a default option meeting requirements established by the Department. Section 621 provides 404(c) relief when a plan changes investment options and reallocates participant accounts among the new and remaining options (commonly known as “mapping”).
These two provisions are aimed at the same problem—what a participant-directed plan should do when the plan has not received an investment election from a participant. In implementing these two provisions, the Department should harmonize their operation to apply to situations in which a participant investment election is not available. For example, the Department needs to make clear that the new default rules apply not just to new contributions, but also to existing accounts where there is no investment election. A participant may have existing contributions but fail to provide investment instructions, a beneficiary may inherit an account after the death of a participant, or an alternate payee could have a new account established after a divorce. The issue also will arise when plan sponsors move participants with no election on file from a prior default like a money market to a new option after the Department’s default guidance is finalized.
The Department also should address another important issue that arises when investment options are changed. Under the Pension Protection Act, mapping relief applies only when the “mapped” investment option has similar risk and return characteristics to the investment option being eliminated. It is not clear what the plan sponsor should do if there is no similar option, or if there are more than one new or remaining options that could be considered to have similar risk and return characteristics. We recommend that the plan be allowed to place that portion of a participant’s account into the default investment established for the plan. Because plans must provide notice about mapping at least 30 days in advance, participants and beneficiaries will have an opportunity to opt out of the default investment if they decide it is appropriate to do so.
Given the Department’s recent focus on defined contribution plans and the passage of the Pension Protection Act, the ERISA Advisory Council has a unique opportunity to address how the Department can build on these efforts to assure defined contribution plans help Americans to save for a secure retirement. The Institute believes that the type of streamlined disclosure outlined here—that covers all investment products and plans and leverages the power of the Internet—is critical to empowering participants in self directed plans to manage their accounts. The Institute applauds the Advisory Council’s work in identifying the best approaches to fulfill ERISA’s mandate to protect participants and beneficiaries.
11 ICI members include 8,791 open-end investment companies (mutual funds), 652 closed-end investment companies, 195 exchange-traded funds, and 5 sponsors of unit investment trusts. Mutual fund members of the ICI have total assets of approximately $9.273 trillion (representing 98 percent of all assets of US mutual funds); these funds serve approximately 89.5 million shareholders in more than 52.6 million households.
2 “The Influence of Automatic Enrollment, Catch-Up, and IRA Contributions on 401(k) Accumulations at Retirement,” Perspective, Vol. 11, No. 2, Investment Company Institute (July 2005).
3 “The U.S. Retirement Market, 2005,” Fundamentals, Vol. 15, No. 5, Investment Company Institute (July 2006).
5 Fund prospectuses must include a fee table that provides standardized information about a fund’s expense ratio, which covers the 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. In addition, fund prospectuses are required to include a bar chart showing annual total returns for each of the last 10 calendar years.
6 Not all self-directed plans operate under 404(c). See, e.g., Jenkins v. Yager, No. 04-4258, __ F.3d __ (7th Cir. Apr. 14, 2006) (compliance with the Department’s 404(c) regulation is not the exclusive means by which a plan sponsor can allow participants investment control over their account).
7 Understanding Investor Preferences for Mutual Fund Information, Investment Company Institute (2006). The study included in-home interviews with 737 randomly selected investors who had purchased shares in stock, bond, or hybrid mutual funds outside retirement plans at work in the preceding five years. Although this study focused on investors who purchased mutual funds in the retail market, we believe its findings are relevant to the decisions participants make in employer plans. The research summary is attached.
8 Our most recent study’s results are consistent with research we conducted in May 1996, which found that fund past performance, risk, and fees and expenses are the three most frequently mentioned items reviewed by shareholders. See Profile Prospectus: An Assessment by Mutual Fund Shareholders, Vol. 1: Institute Research, May 1996, p. 22. See also Understanding Shareholders’ Use of Information and Advisers, Spring 1997, p. 21.
9 Nearly nine in ten of shareholders prefer a summary of mutual fund information, either by itself or along with a detailed document. Eight in ten prefer a concise, to-the-point description of an investment rather than a very detailed description. Understanding Investor Preferences for Mutual Fund Information, supra note 7.
11 Statement of the Investment Company Institute on Disclosure to Plan Sponsors And Participants Before the ERISA Advisory Council Working Groups on Disclosure (Sept. 21, 2004). See also Letter to Secretary Lynn Martin re: ERISA Section 404(c) Regulation from Institute President Matthew Fink (Feb. 12, 1992)
12 When the Institute testified before the Advisory Council in 2004, our recommendation did not include historical performance. In response to questions from Advisory Council members in 2004 and based on our recent research, we believe that historical performance should be included in the investment summary.
13 See Institute Statement to Securities Exchange Commission in connection with SEC Interactive Data Roundtable (June 9, 2006).
15 Fidelity Emerging Corporate Market Small Business Retirement Solutions Study (April 2006) (finding that significant percentage of small employers perceive cost as a major barrier to offering a 401(k) plan).
16 See, e.g., Internet Availability of Proxy Materials, Proposed Rule, SEC Release Nos. 34-52929; IC-27182 (Dec. 8, 2005), 70 Fed. Reg. 74598 (Dec. 15, 2005); Municipal Securities Rulemaking Board Notice 2006-19, MSRB Seeks Comments on Application of “Access Equals Delivery” Standard to Official Statement Dissemination for New Issue Municipal Securities (July 27, 2006). The European Union has adopted provisions allowing prospectuses to be made available solely in electronic form, with paper copies delivered only upon request. See Art. 14(2) of Dir. 2003/71/EC (Nov. 4, 2003) (adopting directive on the prospectus to be published when securities are offered to the public or admitted to trading).
18 “Mutual Fund Shareholders’ Use of the Internet, 2005,” Fundamentals, Vol. 15 No. 2, Investment Company Institute (February 2006). In this survey, households owning funds include those holding mutual funds through retirement plans at work, IRAs, or taxable accounts. The research summary is attached.
20 As in the case of the general population, mutual fund investors’ Internet access has increased sharply across all demographic groups. In the past five years, among fund investors age 65 or older, Internet access more than doubled, from 30 percent to over 60 percent. Internet access among fund investors with a high school education or less almost doubled, to 72 percent. Among fund investors with household incomes less than $50,000, Internet access increased by almost two-thirds, to more than 75 percent. See “Mutual Fund Shareholders’ Use of the Internet, 2005” supra note 18.
21 Paul Schott Stevens, Remarks at the National Press Club “Revolution in Real Time: Using the Internet to Inform Investors Better” (Feb. 14, 2006).