(June 1, 2007) An Extreme Makeover Due For Defined Contribution Plans: 401(k), 403(b) and 457s All Under Attack
Date: Monday, July 13 @ 23:11:42 CDT
Topic: Money Matters

401(k), 403(b) and 457s All Under Attack

"In the past large defined contribution plans overseen by unsophisticated employees with other corporate duties, without an investment consultant or investment policy statement to guide them, utilizing well-known mutual fund families exclusively (without competitive bidding), failing to monitor best execution, revenue sharing, securities lending, custody arrangements and other issues, was the norm. At a distance these plans may have seemed adequate. Upon closer scrutiny, its clear they're in need of an extreme makeover."

Patterns Emerge

"Daddy, there's a constellation on my window," my four year old daughter said to me as I was driving her to pre-school the other morning. Since I had no idea what she was talking about, I turned to look at her seated behind me. She pointed to water drops on the outside of the window beside her. I laughed when I finally figured out what she was trying to say. "Oh, that's condensation," I laughed, "not a constellation."

"Daddy, it's a constellation," she said firmly. She is a very headstrong little girl. (Wonder where she gets that from?)

"No honey, a constellation is a pattern in the sky made up of stars. Water on the car window in the morning is condensation," I said feeling a little less patient.

"Daddy, it's a constellation," she explained. "The water drops look like a man with one leg jumping on a pogo stock. Don't you see it?

And then I finally "got it." "Yes, honey, you are right. It is a constellation." So much for the wisdom of fathers.

Connecting the Dots

Now that the mutual fund scandals are ancient history and the SEC (speaking on behalf of the mutual fund industry) assures us that the few problems that ever existed in the industry have been eliminated (none of which the SEC uncovered on its own), attention has shifted to abuses involving retirement plans that generally use mutual funds- the defined contribution plans. Of course the demise of traditional retirement plans, i.e., defined benefit plans, and the emergence of defined contribution plans as the sole source of retirement savings for most workers is also driving the focus on defined contribution plans. Today it is imperative that defined contribution plans operate efficiently and with integrity because for most Americans these plans are all they will have to rely upon in retirement.

Unfortunately, we estimate that well over 90% of defined contribution plans are not operated properly. That is, fiduciaries with responsibility for the plans are not knowledgeable, do not commit enough resources to these plans and indeed are not financially motivated to use their best efforts. Unlike defined benefit plans, where corporate sponsors are ultimately responsible for ensuring that retirement obligations to employees are met, defined contribution sponsors who fail to diligently manage plans heretofore have escaped liability.

Things are changing. But to fully appreciate the magnitude of the changes in the air, you have to connect a lot of dots before the constellation is revealed.

When you do connect the dots, a pattern emerges. Defined contribution plans are under attack. And it's a broad based attack. 401(k), 403(b) and 457 plan practices are all currently the subject of legal challenges.

401(k) cases

Some of the sponsors of 401(k) plans, such as Deere and Boeing, are being sued by participants alleging failure to monitor costs and other fiduciary breaches. These are some of the nation's largest plans, the sponsors of which certainly have the resources to ensure that the plans are prudently managed. If these plans are deficient, then presumably the vast majority of 401(k)s are in even worse shape.

In an April 1, 2006 article in Employee Benefits News entitled, "Lawsuits targeting 401(k) fees have yet to emerge," a lawyer at The Groom Law Group is quoted as saying, "Rather than going after plans based upon high fees, lawyers are more apt to focus upon how the plan provider is selected by the employer and sue for conflicts of interest. Conflicts of interest are easier to prove than determining appropriate levels of fees." So much for that prediction.

At a recent industry conference lawyers at Morgan, Lewis singled out those nasty "underemployed plaintiffs' lawyers for blame. In other words, defense lawyers that have been advising their plan sponsor clients for decades at inflated hourly rates, amounting to millions annually, who were blind to abuses their clients are now being sued over, are good guys. This is civilized lawyering-slowly bleeding corporations to pay for bad legal advice. These guys get paid fat fees on an hourly basis despite their performance. Lawyers who recognize the abuses and seek redress on behalf of participants and only get paid if they're right, are bad guys. Interesting how that works.

It's the mutual fund scandals all over again. While virtually every mutual fund that was victimized was represented by supposedly independent legal counsel (i.e., white shoe law firms chosen by mutual fund advisers), regulators never sanctioned those legal firms that raked in hundreds of millions in legal retainers over two decades for providing advice that utterly failed to protect their supposed clients- the mutual fund investors. How many legal malpractice claims were filed against those over-employed, bloated, asleep-at-the-wheel lap dogs? None that we know of. They got to keep the investors' money, even as the mutual fund advisors were forced by regulators to pay-up. Payment for poor performance is what the defense bar thrives on.

Initially we were skeptical about the likelihood of cases involving the level of fees paid by 401(k) plans succeeding, largely because of our focus upon really egregious wrongdoing. But we have now concluded, after extensive research, that these cases regarding fees are well-founded. We frankly underestimated widespread incompetence among the parties charged with responsibility for handling the nation's defined contribution plans, as well as their arrogance. Given the current legal environment, in our opinion, no defined contribution plan sponsor should smugly conclude he is not at risk or unduly rely upon the assurances of his legal advisors.

403(b) and 457 Plans

With respect to 403(b) and 457 plans, variable annuities involving fees in excess of 5% annually and multi-million dollar annual endorsements paid to unions and other organizations are current targets of litigation and there's more to come.

Who would have thought that this broad-based attack upon defined contribution plans would follow the well- documented demise of defined benefit plans? Anyone with half a brain. The handwriting was on the wall.

The truth is that defined contribution plans have been a mess since their inception. The mutual fund and insurance companies that marketed to these plans failed to realize that the products they designed to be sold to defined contribution plans had to meet higher applicable fiduciary standards. Instead the same or substantially similar retail products were sold and retirement investors were subjected to retail expenses and abuses related to revenue-sharing, directed brokerage, soft dollars and securities lending. Worst still are the high cost variable annuities with mutual fund clones that pervade the governmental defined contribution plans. There is simply no reason why defined contribution investors should be paying retail mutual fund fees or investing in tax deferred variable annuities offering illusory insurance protection. Variable annuity products are so laden with fees that insurance companies can easily afford to pay kick- backs to unions and other non-profits for steering participants. These unions were apparently too stupid to connect the dots and ask where the money for the endorsements was coming from, i.e., straight out of their members pockets. Or perhaps they knew they were selling out their members and didn't care. So what if members were charged 1-4% more annually than necessary? Apparently union need for operating income trumped their members' need for retirement security. What were they thinking? Was it that the booming stock market would take care of everyone?

Extreme Makeover

So now the national focus is shifting away from unsustainable defined benefit plans, promises American's corporations say they can no longer afford to keep or, viewed from the corporate perspective, the need to free the nation's corporations from their legacy labor costs (old promises made to old workers) so that they can compete in the global marketplace.

Today the focus is upon sponsors of defined contribution plans that have not diligently fulfilled their fiduciary duties regarding conflicts of interest, excessive costs, abusive practices and investment performance related to management of these plans. In the past large defined contribution plans overseen by unsophisticated employees with other corporate duties, without an investment consultant or investment policy statement to guide them, utilizing well-known mutual fund families exclusively (without competitive bidding), failing to monitor best execution, revenue sharing, securities lending, custody arrangements and other issues, was the norm. At a distance these plans may have seemed adequate. Upon closer scrutiny, it's clear they're in need of an extreme makeover.

The only hope that defined contribution plans will provide retirement security for participants who increasingly rely almost exclusively upon them, is if these plans are massively improved. Litigation has a way of bringing about rapid change.

This article comes from Pension fraud Investigations, money management abuse

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