Commentary: Retirement funds: Proposed fee disclosures

Daily Record (Rochester, NY), May 14, 2008 by Azanda Donaldson

In the radio series "The Hitchhiker's Guide to the Galaxy," the great super computer, Deep Thought, is asked the Answer to the ultimate question of life, universe and everything. After 7.5 million years of computing, Deep Thought comes up with the answer: 42.

In December 2007, the Department of Labor (DOL) issued proposed regulations that would require service providers to disclose information designed to assist fiduciaries in assessing the reasonableness of fees charged for employee benefit plan services and whether those providers have any conflicts of interest. After considering the scope of these proposed regulations, assistance from Deep Thought may be required.

There is a statutory exemption from the dreaded prohibited transaction violation for plan service providers, as long as their services are deemed to be necessary and reasonable. The plan's fiduciaries must determine objectively whether a particular arrangement meets this requirement. Under the proposal, the service providers must furnish specific information to the "responsible plan fiduciary." Further, this is not a one-time deal. It will be ongoing, as modifications and other factors affect how plans are administered and charged.

According to the Federal Register, the proposed regulation affects three categories of service providers: (1) those who provide services as a fiduciary under ERISA or under the Investment Advisers Act of 1940; (2) those who provide banking, consulting, custodial, insurance, investment advisory, investment management, recordkeeping, securities or other investment brokerage or third- party administration services; and (3) those who receive any indirect compensation in connection with accounting, actuarial, appraisal, auditing, legal or valuation services. In other words, this proposal is not just targeting the mutual fund industry but all entities that provide services to employee benefit plans.

The DOL has already prepared a worksheet that is designed to "help" with the calculations. It is 11 pages long. Unlike the annual 5500 reporting, which requires detailed information from plans that have over 100 participants, there does not appear to be any relief for the smaller employer.

It is no surprise that the DOL has been looking at fees that retirement funds pay, as the assets themselves have grown tremendously. According to the Investment Company Institute, as of the third quarter of 2007, retirement assets were at $17.8 trillion. In 1995, this figure was $7 trillion. Retirement funds are also a growing share of household assets. In 1974 retirement assets represented 12 percent of household assets; in 2007, they were 39 percent.

Annual revenues to service providers from these assets are significant: At 1 percent of assets, this figure would be $178 billion; at 2 percent, $356 billion; at higher rates, even more. 401(k) plan participants generally have no idea what is being charged to their accounts as most of the fees are deducted from the returns. Most participant statements do not show any fee information; the reports on the funds themselves typically only show the basic fund charge. It is noteworthy, though, that recently a number of participant statements are showing expense ratios for the funds.

The DOL is aware that there are fee sharing arrangements above the basic expense ratio that add an additional layer of fees. It is these arrangements that the DOL wants quantified to the plan sponsor and, ultimately, the participants. Not only the DOL, but the SEC is looking at fee disclosures, particularly the 12(b)-1 fees that mutual funds charge.

The SEC also wants more transparency. The mutual fund industry, understandably, already is protesting, as are the retirement service providers and fiduciaries who are concerned about the amount of additional paperwork that will be required. Also, there are certain expenses that are simply very hard to decipher, such as the underlying fees for a money market fund within a portfolio which varies on a daily basis depending on the cash flows from purchases, sales, deposits, and withdrawals.

When these disclosure requirements are finalized -- and a number of practitioners are of the opinion that this proposal will emerge in some final form -- hopefully, it will not take a super computer to do the calculations and will take less than 7.5 million years. Although, who knows, the answer may turn out to be 42.

Azanda L. Donaldson, is a vice president at Karpus Investment Management, a local independent, registered investment advisor managing assets for individuals, corporations, non-profits and trustees. Offices are located at 183 Sully's Trail, Pittsford, 14534 (585) 586-4680.