Measurably Different Evaluating the Reasonableness of Plan Fees in Light of the New Disclosures presented by Mike Falcone Managing Director, East Region mikef@401kadvisors.com Paul Powell Managing Director paulp@401kadvisors.com 2012 401(k) Advisors. All rights reserved. 120 Vantis, Suite 400 Aliso Viejo, CA 92656 949.460.9898 800.959.0071 949.460.9893 fax Securities offered through Financial Telesis, Inc. Investment Advisory Services offered through 401(k) Advisors. Financial Telesis, Inc. is not an affiliate of 401(k) Advisors. Disclosures This material is intended to provide general information only and nothing in it should be acted upon without consultation with qualified professional advisors. Receipt of this material does not create a client relationship between the recipient and 401(k) Advisors 1 1
Evaluating Plan Fees Why should you care about plan fees? Fiduciary responsibilities New disclosure regulations Recent fee litigation How do you find out what your plan is costing you? Making sense of retirement plan fees Sample provider disclosure How can you determine if your fees are reasonable? The Fee & Investment Benchmarking process Case Study 2 Industry Snapshot Retirement plan data 500,000 participant-directed individual account plans $5 trillion in total assets $50 billion in annual fees Average total plan cost is approximately 1.00% of plan assets Actual fees range anywhere from 0.50% to over 2.50% of plan assets Are these fees reasonable? Where do your plan fees fall? Sources. Department of Labor, 401(k) Book of Averages 3 2
Plan Sponsor Knowledge of Fees 13% of plan sponsors do not know what types of administrative fees are added to their company stock fund 19.4% of plan sponsors that have funds with revenue sharing do not know what proportion of their funds pay revenue sharing 16% of plan sponsors are uncertain if their plan offers and ERISA (expense reimbursement) account 37.5% of plan sponsors that credit revenue back to plan participants do not know how this happens Source. Deloitte study 4 Why Should You Care About Plan Fees? 3
Fiduciaries and Their Responsibilities Who is a Fiduciary? You are a Fiduciary under ERISA if you: Exercise discretion and control over plan management or disposition of assets Render investment advice Have authority over plan administration Are a named Fiduciary Are a fiduciary by functions of your responsibilities (not just by name) 7 4
Fiduciary Responsibilities A fiduciary must act solely in the interest of the plan participants, their beneficiaries and alternate payees Carry out their duties prudently Follow the terms of the plan document (unless the documents are inconsistent with ERISA) Diversify plan assets Pay only fair and reasonable expenses 8 Recent Fee Litigation 5
Tussey v. ABB & Fidelity Eastern District of Missouri: March 31, 2012 81-page opinion provides a roadmap on the fees issue Will be appealed, but until then, is the best case on the subject Provides guidance on what to do and what not to do Background Facts ABB sponsored 2 Defined Contribution (DC) plans: Union and Non- Union The CBA provided that any administrative costs of the Union Plan which exceeded the costs of the Non-Union Plan would be paid by ABB out of corporate assets Fidelity was the record-keeper for both plans and also provided other services to ABB (i.e., Defined Benefit, Health & Welfare, Payroll, etc.) Mercer was the consultant 6
Investment Policy Statement Required rebates (e.g., revenue sharing) to be used to offset administrative costs Provided a process for selecting and deselecting investments Required the use of least expensive share classes Required the negotiation of most favorable rates based on plan size and bargaining power Issue: Failure to Monitor No evidence that plan fiduciaries knew what Fidelity was earning through revenue sharing No evidence that plan fiduciaries knew if administrative fees were reasonable (e.g., never conducted a market benchmark) Plan fiduciaries did nothing when Mercer told them they were paying too much for administrative services 7
Issue: Replacement of Vanguard Wellington Fund with Fidelity Freedom Funds Did not follow the Investment Policy guidelines Made the change for revenue sharing reasons and impact to ABB, not for what was solely in the best interest of plan participants Replaced a good fund with poorer funds Issue: Selecting More Expensive Share Classes Violated Investment Policy guidelines Fiduciaries (as opposed to settlors) made allocation decisions between what was paid by the Plan and what was paid by ABB Used money generated by revenue sharing in DC plans to subsidize expenses related to other non-dc plan services 8
Issue: Failure to Negotiate Rebates Fiduciaries took no steps to negotiate the best possible fees (they didn t even know what they were paying) Violated Investment Policy Guidelines Ignored Mercer s written report Seemed more concerned with saving the company money than with reducing plan fees Issue: Float Income Fidelity was a fiduciary because it exercised discretionary control over the use of float income: To pay itself more than its Trust Agreement allowed it to receive To benefit third parties whose funds were intermingled with plan assets 9
ERISA Violations Failure to follow plan documents (IPS) Conflict of interest (company vs. plan) and prohibited transactions Prudence (failure to monitor, consider relevant issues and document properly) Failure to follow Exclusive Benefit rule (did not put participants first) Damages Failure to Monitor: $13.4 million, assessed to ABB Improper mapping from Vanguard Wellington Fund to Fidelity Freedom Funds: $21.8 million, assessed to ABB Improper use of Float Income: $1.7 million, assessed to Fidelity 10
Takeaways Have a prudent and well-documented process to monitor plan expenses: Know what they are Benchmark against the market Have and follow an ongoing process and document what you ve done Avoid conflicts between the plan and its sponsor: Separate sponsor ( settlor ) from fiduciary functions Do not use the revenue generated from plan to subsidize the company or its other employee benefit plans If your consultant reports to you in writing, do something Make sure your Investment Policy Statement is not a straightjacket Conclusions Fee cases are here to stay (at least for the foreseeable future) Know what you are paying and what you are getting for it Have a process in place to monitor fees and make sure you follow it There is no free lunch: know how you are paying for free services 11
Fees and the New Disclosure Regulations Under Section 408(b)(2) Preamble The Employee Retirement Income Security Act (ERISA) requires plan fiduciaries, when selecting and monitoring service providers and plan investments, to act prudently and solely in the interest of the plan s participants and beneficiaries. Responsible plan fiduciaries also must ensure that arrangements with their service providers are reasonable and that only reasonable compensation is paid for services. Fundamental to the ability of fiduciaries to discharge these obligations is obtaining information sufficient to enable them to make informed decisions about an employee benefit plan s services, the costs of such services, and the service providers. 23 12
Covered Service Providers Covered Service Providers (CSPs) include the following ERISA fiduciary service providers to a covered plan or to a plan asset vehicle in which such plan invests; Investment advisers registered under Federal or State law; Record-keepers or brokers who make designated investment alternatives available to the covered plan (e.g., a platform provider ); Providers of one or more of the following services to the covered plan who also receive indirect compensation in connection with such services: Accounting, auditing, actuarial, banking, consulting, custodial, insurance, investment advisory, legal, recordkeeping, securities brokerage, third party administration, or valuation services 24 Overview Covered Service Providers (CSPs) are required to provide responsible fiduciaries with information Assess reasonableness of total compensation, both direct and indirect, received by the CSP, its affiliates, and/or subcontractors; Identify potential conflicts of interest; and Satisfy reporting and disclosure requirements under Title 1 of ERISA 25 13
Applicability Applies to ERISA-covered defined benefit and defined contribution plans Does not apply to: Simplified Employee Pension Plans (SEPs), SIMPLE retirement accounts, Individual Retirement Accounts (IRAs) Certain annuity contracts and custodial accounts described in Internal Revenue Code section 403(b) Employee welfare benefit plans Applies to CSPs who expect at least $1,000 in compensation to be received for services to a covered plan 26 Class Exemption Final rule includes a class exemption from prohibited transaction provisions of ERISA for responsible plan fiduciaries that enter into service contracts without knowing that the CSP has failed to comply with its disclosure obligations Exemption requires Upon discovering the failure, the plan fiduciary must request in writing, that the CSP furnish the information If CSP fails to comply within 90 days of the request, the plan fiduciary must notify the Department of Labor of the disclosure failure 27 14
Key Requirements Information required to be disclosed by a CSP must be in writing CSPs must disclose the services to be provided and all direct compensation (directly from the covered plan) and indirect compensation (from any source other than the plan sponsor, the CSP, an affiliate, or subcontractor) to be received CSPs who disclose indirect compensation also must describe the arrangement between the payer and the CSP, as well as sources of indirect compensation, plus services to which compensation relates Compensation disclosures by CSPs must include allocation of compensation made among related parties when such allocations occur as a result of charges made against a plan s investment or are set on a transaction basis CSPs may use electronic means to disclose information 28 Ongoing Obligations Changes CSPs must disclose changes to initial information as soon as practicable, but no later than 60 days from when provider is notified of such change Disclosures of changes to investment-related information are to be made annually Reporting and Disclosure Requirements CSPs must disclose compensation or other information related to their service arrangements upon request of the responsible plan fiduciary or plan administrator, reasonably in advance of the date upon which such person states they must comply with ERISA s reporting and disclosure requirements 29 15
Effective Date Effective for both existing and new contracts or arrangements between covered plans and CSPs as of July 1, 2012 Must be furnished no later than August 30, 2012 30 How Do You Find Out What Your Plan is Costing You? 16
Making Sense of Retirement Plan Fees The Services You Are Procuring Recordkeeping Cost Technology Services Plan Sponsor Compliance Accounting Employer/Employee Reports Processing Payroll Deposits Quality Assurance Standards Plan Document, SPD Discrimination Testing 5500 Filings ERISA Resources Web-based Tools Automated Voice Response System Loan/Withdrawal Processing Billed Fees Online Enrollment Investment Management Fees Asset Based Fees Participant Revenue Sharing Disclosure Investment Philosophy Quantitative Analysis Qualitative Analysis Scorecard SM Fund Ranking Enrollment Materials & Meetings Individual Advice Solutions Participant Statements Bi-lingual Support Communications Investment Management 401(k) Advisors. Measurably Different 401k-20012-00 33 17
Components of Plan Costs Administrative Fees Investment Fees All costs associated with managing the investments Services to operate the plan: Recordkeeping, Trustee, Compliance, Communications Plan Consulting Fees Advisory fees paid to a registered investment advisor or commission paid to a broker Always paid for by plan participant Paid for by plan sponsor and/or participant Paid for by plan sponsor and/or participant 34 General Cost Observations The vast majority of total plan costs are paid for by participants through revenue sharing Plan pricing will vary significantly Plan assets Participants Average account balance Service requirements 35 18
Fee Considerations How much does it cost? Who s going to pay? Plan sponsor Plan Participants How are they going to pay? Direct-billing Asset-based fees Per participant charge 36 Revenue Sharing Defined The following are characteristics/sources of revenue sharing Any investment fee or expense in excess of what is needed to manage the assets in the plan Revenue that is paid (shared) with one or more of the following Broker, consultant, advisor Investment company (whose fund is an option in the 401(k) plan) Outside third party administrator or recordkeeper The net dollars kept by the plan provider after payment of revenue to other sources Administrative/recordkeeping fees and expenses which are imbedded in total investment fees 37 19
The Pieces of Revenue Sharing 12-b1: Distribution expenses paid by mutual funds from fund assets. Includes commissions to brokers, marketing expenses and other administrative services. Investment Management: Fees for managing investment assets. Charged as a percentage of the assets invested and deducted from the investment return. Investment Management Fee 12-b1 Fees Shareholder Servicing Fees Sub-TA (Agency Transfer Fees) Shareholder Servicing: Revenue shared by the mutual fund company with the service provider. Asset / Wrap Fee: Additional fees layered on top of total investment fees. Sub-TA: Brokerage firms and mutual funds often contract recordkeeping and other services related to participant shares to a third party called a subtransfer agent. 38 Share Classes Defined Many mutual funds offer the identical money manager with several different investment management expense options varying the revenue sharing shared with third parties Each investment management expense option is a different share class 39 20
Share Class Matters American Funds Growth Fund of America Share Class 2 nd QTR Return 1 Year Return 3 Year Annl Ret 5 Year Annl Ret Expense Ratio Revenue Sharing R1 6.40% 13.60% 6.31% 3.34% 1.43% 1.05% R3 6.27% 13.19% 6.83% 2.86% 0.97% 0.65% R4 6.21% 12.95% 7.14% 2.59% 0.68% 0.35% R6 6.13% 12.62% 7.50% 2.37% 0.33% 0.00% 40 How Services Are Paid For Model 1 Administrative Fees Investment Fees All costs associated with managing the investments Services to operate the plan: Recordkeeping, Trustee, Compliance, Communications Plan Consulting Fees Advisory fees paid to a registered investment advisor or commission paid to a broker R6 Share Class 41 21
How Services Are Paid For Model 2 Administrative Fees Investment Fees All costs associated with managing the investments Services to operate the plan: Recordkeeping, Trustee, Compliance, Communications Plan Consulting Fees Advisory fees paid to a registered investment advisor or commission paid to a broker R4 Share Class 42 How Services Are Paid For Model 3 Administrative Fees Investment Fees All costs associated with managing the investments Services to operate the plan: Recordkeeping, Trustee, Compliance, Communications Plan Consulting Fees Advisory fees paid to a registered investment advisor or commission paid to a broker R3 Share Class 43 22
The Fee & Investment Benchmarking Process Objectives A fiduciary must act solely in the interest of the plan participants, their beneficiaries and alternate payees to ensure that only fair and reasonable expenses are being paid The process should be comprehensive, measurable and documented and done so with the care, skill, prudence and diligence that a prudent person familiar with such matters would exercise 45 23
The Benchmarking Process 46 Information Needed for Benchmarking Plan demographics Asset allocation Summary Plan description Current service offerings Current expense structure Most recent Form 5500 filing 47 24
Choosing Benchmarking Recipients Financial strength Retirement plan experience Demographic compatibility Expertise with specific nuances of the plan Delivery philosophy (may want to choose a variety) Asset Manager Proprietary Funds only Proprietary and Defined Outside Mutual Fund offering Proprietary and Open Architecture Proprietary and Outside Separate Accounts Asset Gatherer Sub-advised Funds only Sub-advised and Defined Outside Mutual Fund offering Sub-advised and Open Architecture Defined Outside Mutual Fund offering Defined Outside Separate Account offering Open Architecture Unlimited Outside Mutual Fund access 48 Cost Analysis of Incumbent Existing Plan Assets / Allocation Provider Vendor 1 Asset Class Assets Assets % Fund Expense Revenue Revenue Cost ($) Ratio Sharing Sharing ($) Large Blend $1,316,776 6.24% LC S&P 500 Index (PGI) 0.73% $9,612 0.58% $7,637 Large Blend $567,756 2.69% LargeCap Blend II (TRP) 1.32% $7,494 0.78% $4,428 Large Growth $931,956 4.42% AF Growth Fd of Amer 0.93% $8,667 0.60% $5,592 Large Growth $340,519 1.61% LargeCap Gr I (TRP) 1.30% $4,427 0.80% $2,724 Large Value $688,327 3.26% Amer Cent Eq Inc A 1.22% $8,398 0.55% $3,786 Mid Blend $220,286 1.04% MC S&P 400 Idx (PGI) 0.74% $1,630 0.58% $1,278 Mid Growth $853,474 4.04% Janus Adviser MCG 1.16% $9,900 0.50% $4,267 Mid Value $164,888 0.78% MCV I (Goldman/LA) 1.57% $2,589 0.86% $1,418 Small Blend $469,322 2.22% SC S&P 600 Idx (PGI) 0.73% $3,426 0.58% $2,722 Small Growth $138,249 0.66% Lord Abbett Dev Grth 1.13% $1,562 0.40% $553 Small Value $414,337 1.96% Amer Cent SCV 1.74% $7,209 0.55% $2,279 Int'l Stock $1,732,876 8.21% AF EuroPacific Growth 1.07% $18,542 0.60% $10,397 Fixed Income $2,150,895 10.19% PIMCO Total Return 1.15% $24,735 0.70% $15,056 Cash $8,265,182 39.17% Fixed Income Option 0.65% $53,724 0.65% $53,724 Asset Allocation $86,380 0.41% LifeTime Strat Inc 1.25% $1,080 0.73% $631 Asset Allocation $447,323 2.12% LifeTime 2010 1.34% $5,994 0.76% $3,400 Asset Allocation $702,639 3.33% LifeTime 2020 1.39% $9,767 0.77% $5,410 Asset Allocation $1,093,840 5.18% LifeTime 2030 1.42% $15,533 0.78% $8,532 Asset Allocation $373,937 1.77% LifeTime 2040 1.44% $5,385 0.79% $2,954 Asset Allocation $141,546 0.67% LifeTime 2050 1.46% $2,067 0.79% $1,118 Total Assets $21,100,508 100.00% Weighted Expense Ratio (EE paid) 0.96% $201,740 0.65% $137,906 Asset Charge (EE or ER paid) 0.10% $21,101 Billed Fees (ER paid) 0.05% $10,000 TOTALS 1.10% $232,841 0.65% $137,906 Information presented here is intended for client use only. 49 25
Comparison to Other Providers 50 Current Investment Opportunities Imperative to have a robust way (more than just returns) of comparing investment opportunities Illustration of the Scorecard System 51 26
Comparison to Other Providers 52 Identify Next Steps Renegotiate fees Look for opportunities to improve investment lineup Identify potential service enhancements 53 27
Case Study Desired Objectives Benchmarking for due diligence purposes Not sure if the fee structure was competitive Education on all of the new services available in the marketplace Potential Improvement of the Investment Lineup 55 28
Background Information Plan demographics: approximately 800 total participants Asset allocation: approximately $50 million spread among 26 funds, including a managed account option Plan description: Safe Harbor employer matches 100% on 1 st 3% and 50% on next 2% Current service offerings: all services outsourced to incumbent record keeper Current expense structure: no hard-dollar/direct-billed fees all covered through fund revenue sharing (53 basis points, or 0.53%) 16 basis points (0.16%) to advisor (employee of incumbent provider) $40,000 ERISA Budget (approximately 8 basis points) Remainder (29 basis points, or 0.29%) to record keeper/administrator 56 Benchmarking Recipients One Asset Manager One Asset Gatherer Two Open Architecture 57 29
Results (see handout) Total Plan cost Incumbent: 0.98% of assets Bidding vendors: Range of 0.59% to 0.72% Average of 0.65% Net recordkeeping cost per participant Incumbent: $191 Bidding vendors: Range of $86-$150 Average: $114 Investment score Incumbent: 9.18 Bidding vendors: 9.50 58 Outcomes Total plan cost Restructure lineup: lower priced share class for many funds Average expense ratio decreased from 0.98% to 0.79% Result: savings of approximately $100,000 Net recordkeeping cost per participant: Incumbent lowered recordkeeping/administration revenue requirement from 29 basis points ($191 per participant) to16 basis points ($104 per participant) Result: savings of approximately $70,000 Other costs: Advisor compensation reduced to $50,000 fixed fee (savings of approximately $30,000) ERISA budget revised to permit unused portion to be redistributed to participants 59 30
Conclusions Conclusions / Action Steps Establish and follow a prudent process for understanding, monitoring and documenting fees, services, and investment opportunities General benchmarking of fees: Annually Specific benchmarking of fees & investment opportunities to the marketplace: Every 2-3 years Full RFP vendor analysis: any time you are unhappy/uncertain with the services being delivered, the fee structure, or the investment lineup, or at least every 4-5 years 61 31
Conclusions / Action Steps Include meaningful and comprehensive fund analysis as part of your fee benchmarking/rfp analysis Accept only full and transparent fee disclosures from all service providers And remember all complex challenges have easy to understand, wrong solutions! No one said being a Fiduciary is easy, but creating a Best Practices Retirement Plan will reap employees rewards for many years to come 62 Questions & Answers Thank You! Mike Falcone Managing Director, East Region mikef@401kadvisors.com Paul Powell Managing Director paulp@401kadvisors.com 63 32