Private Pensions
Conflicts of Interest Can Affect Defined Benefit and Defined Contribution Plans Gao ID: GAO-09-503T March 24, 2009Conflicts of interest typically exist when someone in a position of trust, such as a pension consultant, has competing professional or personal issues. Such competing interests can make it difficult for pension plan fiduciaries and others, in general, to fulfill their duties impartially and could cause them to breach their duty to act solely in the interest of plan participants and beneficiaries. The proliferation of consulting work and the complexity of business arrangements among investment advisors, plan consultants, and others have increased the likelihood of conflicts of interests for both defined benefit (DB) plans, where investment risk is largely borne by the plan sponsor and defined contribution (DC) plans, where such risk is largely borne by the participant. Given the potential financial harm conflicts of interest may pose to DB and DC plans, GAO was asked to report on (1) the effects undisclosed conflicts of interest may have on the financial performance of DB plans, and (2) the vulnerabilities that conflicts of interest may pose for DC plan participants. GAO interviewed a variety of experts, reviewed the Department of Labor's (Labor) legal and regulatory authority and analyzed government and industry data associated with terminated plans.
GAO's analysis of available data on pension consultants and plans revealed a statistical association between inadequate disclosure and lower investment returns for ongoing plans, suggesting the possible adverse financial effect of such nondisclosure. Specifically, our econometric analysis using ongoing defined benefit (DB) plans and Securities and Exchange Commission (SEC) study data on pension consultants registered as investment advisers, who adequately disclosed their conflicts of interest and those who did not, detected lower annual rates of return for those ongoing plans associated with consultants that had failed to disclose significant conflicts of interest. These lower rates generally ranged from a statistically significant 1.2 to 1.3 percentage points over the 2000 to 2004 period. Since the average return for the ongoing plans that used consultants who did not have significant disclosure violations was about 4.5 percent, the model implies that the average returns for ongoing plans that used consultants who failed to disclose significant conflicts was 3.2 to 3.3 percent for the period. Because many factors can affect returns, and data as well as modeling limitations limit the ability to generalize and interpret the results, this finding should not be considered as proof of causality between conflicts and lower rates of return, although it suggests the importance of detecting the presence of conflicts among pension plan consultants. GAO's analysis of data from a 2005 SEC staff report examining 24 registered pension consultants, including 13 that failed to disclose significant conflicts in conjunction with other sources of data also showed that, in 2006, these 13 consultants had over $4.5 trillion in U.S. assets under advisement, which included private DB and DC plan assets. Conflicts of interest can have adverse effects on both DB and DC plans. Our study focused exclusively on DB plans and less information exists on the extent or nature of conflicts of interest in the DC plan environment. However, because the risk of investment is largely borne by the individual participant in DC plans, participants are vulnerable to any decision, including those involving conflicts of interest, that could result in higher fees or other outcomes that can lower investment returns for participants. Given the multiplicity of parties involved in today's 401(k) plan arena, many opportunities exist for business arrangements to go undisclosed. Problems may occur when pension consultants or other companies providing services to a plan also receive compensation from other service providers. Without disclosing these arrangements, service providers may be steering plan sponsors toward investment products or services that may not be in the best interest of participants. Labor has published proposed regulations to improve the information disclosed about the various business arrangements among service providers. However, those proposed regulations are currently awaiting review and approval by the new Secretary of Labor. We are currently conducting a review of Labor's revisions to the Form 5500 Schedule C, which could provide some information to Labor about previously undisclosed business arrangements.
GAO-09-503T, Private Pensions: Conflicts of Interest Can Affect Defined Benefit and Defined Contribution Plans
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United States Government Accountability Office:
GAO:
Testimony:
Before the Subcommittee on Health, Employment, Labor and Pensions,
Education and Labor Committee, House of Representatives:
For Release on Delivery:
Expected at 10:30 a.m. EDT:
Tuesday, March 24, 2009:
Private Pensions:
Conflicts of Interest Can Affect Defined Benefit and Defined
Contribution Plans:
Statement of Charles A. Jeszeck, Acting Director:
Education, Workforce, and Income Security:
GAO-09-503T:
GAO Highlights:
Highlights of GAO-09-503T, a testimony before the Subcommittee on
Health, Employment, Labor and Pensions, Education and Labor Committee,
House of Representatives.
Why GAO Did This Study:
Conflicts of interest typically exist when someone in a position of
trust, such as a pension consultant, has competing professional or
personal issues. Such competing interests can make it difficult for
pension plan fiduciaries and others, in general, to fulfill their
duties impartially and could cause them to breach their duty to act
solely in the interest of plan participants and beneficiaries. The
proliferation of consulting work and the complexity of business
arrangements among investment advisors, plan consultants, and others
have increased the likelihood of conflicts of interests for both
defined benefit (DB) plans, where investment risk is largely borne by
the plan sponsor and defined contribution (DC) plans, where such risk
is largely borne by the participant. Given the potential financial harm
conflicts of interest may pose to DB and DC plans, GAO was asked to
report on (1) the effects undisclosed conflicts of interest may have on
the financial performance of DB plans, and (2) the vulnerabilities that
conflicts of interest may pose for DC plan participants.
What GAO Found:
GAO‘s analysis of available data on pension consultants and plans
revealed a statistical association between inadequate disclosure and
lower investment returns for ongoing plans, suggesting the possible
adverse financial effect of such nondisclosure. Specifically, our
econometric analysis using ongoing defined benefit (DB) plans and
Securities and Exchange Commission (SEC) study data on pension
consultants registered as investment advisers, who adequately disclosed
their conflicts of interest and those who did not, detected lower
annual rates of return for those ongoing plans associated with
consultants that had failed to disclose significant conflicts of
interest. These lower rates generally ranged from a statistically
significant 1.2 to 1.3 percentage points over the 2000 to 2004 period.
Since the average return for the ongoing plans that used consultants
who did not have significant disclosure violations was about 4.5
percent, the model implies that the average returns for ongoing plans
that used consultants who failed to disclosure significant conflicts
was 3.2 to 3.3 percent for the period. Because many factors can affect
returns, and data as well as modeling limitations limit the ability to
generalize and interpret the results, this finding should not be
considered as proof of causality between conflicts and lower rates of
return, although it suggests the importance of detecting the presence
of conflicts among pension plan consultants. GAO‘s analysis of data
from a 2005 SEC staff report examining 24 registered pension
consultants, including 13 that failed to disclose significant conflicts
in conjunction with other sources of data also showed that, in 2006,
these 13 consultants had over $4.5 trillion in U.S. assets under
advisement, which included private DB and DC plan assets.
Conflicts of interest can have adverse effects on both DB and DC plans.
Our study focused exclusively on DB plans and less information exists
on the extent or nature of conflicts of interest in the DC plan
environment. However, because the risk of investment is largely borne
by the individual participant in DC plans, participants are vulnerable
to any decision, including those involving conflicts of interest, that
could result in higher fees or other outcomes that can lower investment
returns for participants. Given the multiplicity of parties involved in
today‘s 401(k) plan arena, many opportunities exist for business
arrangements to go undisclosed. Problems may occur when pension
consultants or other companies providing services to a plan also
receive compensation from other service providers. Without disclosing
these arrangements, service providers may be steering plan sponsors
toward investment products or services that may not be in the best
interest of participants. Labor has promulgated regulations to improve
the information disclosed about the various business arrangements among
service providers. However, Labor‘s regulations are currently suspended
pending approval by the new Secretary of Labor. We are currently
conducting an audit of Labor‘s revisions to the Form 5500 Schedule C,
which could provide some information to Labor about previously
undisclosed business arrangements.
What GAO Recommends:
GAO is not making recommendations at this time.
View [hyperlink, http://www.gao.gov/products/GAO-09-503T] or key
components. For more information, contact Charles Jeszeck at (202) 512-
7215 or jeszeckc@gao.gov.
[End of section]
Mr. Chairman and Members of the Committee:
I am pleased to be here today to discuss how conflicts of interest can
affect participants in private pension plans. As you know, a conflict
of interest typically in a pension context exists when someone in a
position of trust, such as a pension consultant, has competing
professional or personal interests. Competing interests can make it
difficult for a plan's fiduciaries and others, in general, to fulfill
their duties impartially and could cause them to breach their duty to
act solely in the interest of plan participants, or beneficiaries. The
challenge to sound pension sponsorship posed by financial conflicts of
interest is largely a consequence of the changes experienced by
financial markets over the last 30 years. In fact, the pre-ERISA world
of 1974 never anticipated the multiplicity and complexity of financial
instruments that have expanded both investment opportunities and risks
for plan fiduciaries.
Regulators and others have analyzed how conflicts of interest have
affected defined benefit (DB) plan performance. Congressional interest
in how fees affect 401(k) plans has focused attention on business
arrangements or conflicts of interest between plan sponsors and third
party providers that can increase the fess charged to 401(k)
participants. DB and defined contribution (DC) plan fiduciaries use the
variety of service providers that have become available to help them
assess choices. While conflicts of interest are not necessarily
inherent in the provision of such financial services, the prevalence
and the proliferation of consulting work and the complexity of business
arrangements among investment advisers, plan consultants, and others
have increased the potential for such conflicts to occur.
My comments today are based on findings from several recent reports
[Footnote 1].My remarks focus on (1) the effects undisclosed conflicts
of interest may have on the financial performance of DB plans and (2)
vulnerabilities that conflicts of interest may pose for DC plan
participants.
Before I discuss our key findings, some background on the U.S. pension
landscape would be useful. Today, roughly half of all American workers
participate in employer-sponsored retirement plans. Private sector
pension plans are classified as either defined benefit (DB) or defined
contribution DC plans. DB plans promise to provide, generally, a
monthly retirement income for the life of the participant that is based
on salary, years of service, and age at retirement, regardless of how
the plan's investments perform. With DB plans, the risk of poor
investing or low rates of return fall largely on the plan sponsor. In
contrast, benefits from DC plans are based on the contributions to and
the performance of the investments in individual accounts, which may
fluctuate in value. One type of DC, or individual account, plan is the
401(k) plan. Unlike DB plans, the risk of low rates of return under DC
plans falls largely on the individual participant.
Over the last several decades the number of DC plans has continued to
increase, while the number of traditional DB plans has declined. Today,
DC plans account for the majority of private sector retirement plans
and participants.
Figure 1: Comparison of Defined Benefit Plans with Defined Contribution
Plans, 1985 and 2005:
[Refer to PDF for image: multiple vertical bar graph]
Year: 1985;
Defined benefit plans: 170;
Defined contribution plans: 462.
Year: 1987;
Defined benefit plans: 163;
Defined contribution plans: 570.
Year: 1989;
Defined benefit plans: 132;
Defined contribution plans: 599.
Year: 1991;
Defined benefit plans: 102;
Defined contribution plans: 598.
Year: 1993;
Defined benefit plans: 84;
Defined contribution plans: 619.
Year: 1995;
Defined benefit plans: 69;
Defined contribution plans: 624.
Year: 1997;
Defined benefit plans: 59;
Defined contribution plans: 661.
Year: 1999;
Defined benefit plans: 50;
Defined contribution plans: 683.
Year: 2001;
Defined benefit plans: 47;
Defined contribution plans: 687.
Year: 2003;
Defined benefit plans: 47;
Defined contribution plans: 653.
Year: 2005;
Defined benefit plans: 41;
Defined contribution plans: 711.
Source: U.S. Department of Labor (1985-2003 data); Investment Company
Institute (2005 estimates).
[End of figure]
Meanwhile, the financial services industry and the DB pension system
have also changed significantly since the 1970s. The globalization of
financial markets, as well as technological and international
regulatory changes, has facilitated the development of new financial
instruments and the complexity of investment opportunities.[Footnote 2]
Consequently, the financial services industry has responded to the
growing need for assistance with managing, investing, transferring,
settling, valuing, and holding pension assets. In 2005, over 81 percent
of large public/government plans used an investment consultant and 42
percent of private pension plans did so.[Footnote 3] As of October 31,
2005, there were more than 1,800 SEC-registered investment advisers
that indicated on their Securities and Exchange Commission (SEC)
registration forms that they provide pension consulting services.
[Footnote 4]These firms vary widely from small one-person operations to
large organizations employing hundreds. Some firms only provide pension
consulting, while others may have started as pension consultants, but
then added additional business operations such as brokerage and money
management.
A conflict of interest is typically a situation in which someone in a
position of trust, such as a pension plan trustee or investment
adviser, has competing professional or personal interests. Such
competing interests can make it difficult for a plan's fiduciaries and
others, in general, to fulfill their duties impartially and could cause
them to breach their duty to act solely in the interest of investors,
plan participants, or beneficiaries. Having a conflict in and of itself
does not constitute a breach of fiduciary duty. However, given the
potential of financial harm to plan sponsors and participants, concerns
have been raised about the extent and nature of these conflicts of
interest.
Inadequate Disclosure of Conflicts of Interest by Pension Consultants
May Reduce Rates of Return for DB Plans:
Although no complete information is available on the prevalence of
conflicts of interest, pension plan consultants assisting significant
numbers of pension plan sponsors may have such conflicts as a result of
their affiliations or business arrangements with other firms which
could affect the advice they provide to these sponsors. The Securities
and Exchange Commission (SEC) through its examination and enforcement
has identified potential conflicts of interest among money managers
that could result in harm to clients, including pension plans. A May
2005 study by SEC staff on conflicts of interest among pension
consultants registered as investment advisers revealed that 13 out of
the 24 consultants examined that had provided services to sponsors of
pension plans, including ongoing DB and Pension Benefit Guaranty
Corporation (PBGC)-trusteed DB plans, had failed to disclose
significant ongoing conflicts of interest to their pension fund
clients.[Footnote 5]
These ongoing conflicts took a number of different forms. For example,
SEC found that 13 pension consultants or their affiliates had conflicts
of interest because they provided products and services to pension plan
advisory clients, money managers, and mutual funds on an ongoing basis
without adequately disclosing these conflicts. SEC staff also found
that the majority of pension consultants examined had business
relationships with broker-dealers that raised a number of concerns
about potential harm to pension plans. For example, in certain directed
brokerage arrangements, a pension consultant may convince a pension
plan client to direct their money manager to place plan trades through
a broker-dealer that was affiliated with the consultant as a means for
paying advisor fees a plan owed to its consultant using a portion of
the brokerage commission paid on such trades. These arrangements raised
concerns that plans might not have received the best price for each
trade--or "best execution"--because the directions given to a plan's
money manager by the plan may have restricted the money manager's
ability to select a broker-dealer that was the best able to execute a
trade. These arrangements raised the additional concern that
consultants might be overpaid because the plan did not always know when
the fee had been paid in full, as brokerage commissions were being used
to pay the fee rather than checks drawn on the plan's checking account.
These consultants also had extensive relationships with DB pension
funds. In particular, they:
* had over $4.5 trillion in U.S. assets under advisement, including
private DB and DC plan assets, as well as public pension plan and other
types of assets as of 2006;[Footnote 6]
* provided advisory services to 36 percent (9 out of 25) of the largest
plan sponsors, in terms of claims, currently trusteed by PBGC since
2000;[Footnote 7]
* provided advisory services to 14 percent (12 out of 86) of the plan
sponsors that were trusteed by the PBGC in 2005; and:
* provided advisory services to 24 percent (1,009 out of 4,203) of the
sponsors of ongoing DB plans between the years 2000 and 2004.
Association between Inadequate Disclosure of Conflicts and Lower Rates
of Return:
Using data from the SEC conflicts of interest study and ongoing DB
pension data, we conducted an analysis that revealed a statistical
association between inadequate disclosure and lower investment returns
for ongoing plans, suggesting the possible adverse financial effect of
undisclosed conflicts. Specifically, we conducted an econometric
analysis on pension consultants in the SEC study, both those that
adequately disclosed their conflicts of interest and those who did not.
[Footnote 8] We found lower annual rates of return for those ongoing
plans associated with consultants who had failed to disclose
significant conflicts of interest, with lower rates generally ranging
from a statistically significant 1.2 to 1.3 percentage points over the
2000 to 2004 period, depending on the different model specifications
tested.[Footnote 9] Since the average return for the ongoing plans that
used consultants who did not have significant disclosure violations was
about 4.5 percent, the model implies that the average returns for
ongoing plans that used consultants who failed to disclose significant
conflicts was 3.2 to 3.3 percent for the period. We did not find
significant differences in returns for those plans that had
associations with both types of consultants. As of year-end 2004, our
sample of ongoing plans represented assets of $183.5 billion for these
plans, and average assets were $155.3 million.
While the results suggest a negative association between returns and
plans that are associated exclusively with pension consultants with
significant undisclosed conflicts of interest, they should not be
viewed necessarily as evidence of a causal relationship. These results,
like those of most studies, should be understood in of the context of
their modeling and data limitations. Although the analysis controlled
for plan size, funding level, performance of asset markets, differences
in plan fiscal years, and other key variables, other unknown, omitted
factors could have influenced the results of our analysis. While this
result gives an indication of the potential harm conflicts of interest
may cause in the aggregate, these results cannot be generalized to the
population of pension consultants since the consultants examined by the
SEC were not selected randomly. In addition, while these findings are
consistent with the views of the experts we interviewed concerning the
adverse effect that complex service-provider-related conflicts of
interest can have on pension plans, we cannot rule out the possibility
that some other differences between the plans could explain the
differences in estimated returns.
Regardless of any global statistical relationships, a detailed audit
would be needed to uncover a conflict of interest in any one plan.
Independent experts and officials stated that though a typical first
step to identify harm related to a conflict of interest is to examine a
plan's investment returns, determining whether any financial harm is
caused to an individual pension plan by a conflict of interest requires
a detailed forensic audit to identify any accrued harm from a conflict
of interest. Such audits are fairly elaborate requiring at a minimum, 5
years worth of service-provider-specific documents including contracts
with the plan sponsor, fees charged, payment and other financial
transactions between service providers and those involving plan
fiduciaries.
Financially costly as conflicts of interest might be in the DB plan
context, their risk is largely borne by the plan sponsor and not the
participant. In most instances, the benefits of DB plan participants
are not affected by fluctuations or even long term declines in a fund's
rate of return. Plan sponsors must pay for the benefits they have
promised to their employees, increasing contributions to the plan as
necessary to cover those benefits. In the event that a plan sponsor of
an underfunded plan goes bankrupt, insurance provided by the PBGC will
pay most benefits promised to participants.[Footnote 10]
Participants Could Be More Vulnerable to Potential Adverse Effects of
Conflicts of Interest in DC Plans like 401(k) Plans:
While our study focused on DB plans, conflicts of interest can affect
DC plans. Because the risk of investment is largely borne by the
individual participant in DC plans, participants are vulnerable to any
decision, including those involving conflicts of interest which could
result in higher fees that can lower investment returns for
participants. For example, research by one industry group showed that
36 percent of responding sponsors either did not know the fees being
charged to participants or mistakenly thought no fees were charged at
all. A registered investment advisor (RIA) told us that if a "free"
401(k) plan has been selected by the sponsor, it was unlikely that
sponsor used an RIA to examine the underlying fee structure, and, as a
result, a sponsor may select an arrangement that reduces an employer's
fees at the expense of the higher embedded fees paid by participants,
which we were told may involve a fiduciary breach under certain
circumstances.
In prior work,[Footnote 11] we also found that some plan sponsors do
not understand their service providers' revenue sharing arrangements or
may be unaware of potential conflicts of interest. For example, a
service provider that assists a plan sponsor in selecting investment
options for the plan may also be receiving compensation from mutual
fund companies for recommending their funds. The service provider may
not disclose this business arrangement to the plan sponsor, and as a
result, participants may have more limited investment options and pay
higher fees for these options than they otherwise would. These
limitations and higher fees could translate into lower rates of return
on participants' accounts and ultimately result in reduced retirement
income.
Given the multiplicity of parties involved in today's 401(k) arena,
many opportunities exist for business arrangements to go undisclosed.
Problems may occur when pension consultants or other companies
providing services to a plan also receive compensation from other
service providers. Without disclosing these arrangements, service
providers may be steering plan sponsors toward investment products or
services that may not be in the best interest of participants. In
addition, plan sponsors, being unaware, are often unable to report
information about these arrangements to Labor on Form 5500 Schedule C.
SEC also identified certain undisclosed arrangements or conflicts of
interest in the business practices of pension consultants in its study.
Plan sponsors pay pension consultants to give them advice on matters
such as selecting investment options for the plan and monitoring their
performance and selecting other service providers, such as custodians,
administrators, and broker-dealers.[Footnote 12] In its report, SEC
highlighted concerns that these arrangements may provide incentives for
pension consultants to recommend certain mutual funds to a 401(k) plan
sponsor and create conflicts of interest that are not adequately
disclosed to plan sponsors. Plan sponsors may not be aware of these
arrangements and thus could select mutual funds recommended by the
pension consultant over lower-cost alternatives. As a result,
participants may again have more limited investment options and may pay
higher fees for these options than they otherwise would.
Finally, significant differences in ways that advisers and other
providers are compensated may have important implications for the
sponsor's oversight, including identifying potential conflicts of
interest. Experts noted that a sponsor may opt for what appears to be a
"free" 401(k) plan (with no record keeping fees for the employer)
without understanding that the providers' compensation may be passed on
to participants by embedding fees in the plan's investment options. In
other cases, specific fees that are considered to be "hidden" may mask
the existence of a conflict of interest. Hidden fees are usually
related to business arrangements where one service provider to a 401(k)
plan pays a third-party provider for services, such as record keeping,
but does not disclose this compensation to the plan sponsor. For
example, a mutual fund normally provides record-keeping services for
its retail investors, i.e., those who invest outside of a 401(k) plan.
The same mutual fund, when associated with a plan, might compensate the
plan's record keeper for performing the services that it would
otherwise perform, such as maintaining individual participants' account
records and consolidating their requests to buy or sell.[Footnote 13]
Without disclosing these business arrangements, service providers may
be steering plan sponsors toward investment products or services that
may not be in the best interest of participants. In addition, plan
sponsors may not know what entity is receiving the compensation and
whether or not the compensation fairly represents the value of the
service being rendered. If a plan sponsor does not know that a third
party is receiving these fees, they cannot monitor them, evaluate the
compensation in view of services rendered, and take action as needed to
protect the interest of plan participants.
Labor Has Proposed Regulations to Address Conflicts of Interest Issues
but the Regulations Have Not Been Finalized:
Labor has proposed regulations to improve the information disclosed to
plan fiduciaries about the various business arrangements among service
providers.[Footnote 14] Labor's proposal would provide that (in order
to qualify for the contracting or reasonable arrangements exemption to
ERISA's prohibited transactions provisions) any contract or arrangement
to provide services to an employee benefit plan would have to require
the service provider to disclose the compensation it will receive,
directly or indirectly, and any conflicts of interest that may arise in
connection with its services to the plan.[Footnote 15]Labor believes
that in order to satisfy their ERISA obligations, plan fiduciaries need
information on all compensation to be received by the service provider
and any conflicts of interest that may adversely affect the service
provider's performance under the contract or arrangement.
Labor's proposal would also require that service providers specify
whether they will provide services to the plan as a fiduciary, either
as a fiduciary under ERISA[Footnote 16] or as a fiduciary under the
Investment Advisers Act of 1940.[Footnote 17] Service providers would
have to disclose any financial or other interest in transactions
involving the plan in connection with the contract or arrangement. The
proposal also defines a reasonable contract or arrangement as one that
requires the service provider to disclose its relationships with other
parties that may give rise to conflicts of interest.[Footnote 18] If
the relationship between the service provider and this third party is
one that a reasonable plan fiduciary would consider to be significant
in its evaluation of whether an actual or potential conflict of
interest exists, then the service provider must disclose the
relationship.
Finally, Labor recognizes that service providers may have policies or
procedures in place to manage real or potential conflicts of interest.
For example, a fiduciary service provider may have procedures for
offsetting fees received from third parties (through revenue sharing or
other indirect payment arrangements) against the amount that it
otherwise would charge a plan client. Accordingly, the proposal
provides that a reasonable contract or arrangement would require
service providers to state whether or not any such policies or
procedures exist and, if so, to provide an explanation of these
policies or procedures and how they address conflicts of interest.
Labor views this requirement as an opportunity for service providers to
educate plan fiduciaries about how they address potential conflicts of
interest.
At this time, Labor's proposed regulations are suspended pending
approval by the new Secretary of Labor. We are currently conducting an
audit of Labor's revisions to the Form 5500 Schedule C, which could
provide some information to Labor about previously undisclosed business
arrangements.
Concluding Observations:
Conflicts of interest can adversely affect both DB and DC plan designs,
with the primary difference being in who bears the cost of their
potentially adverse effects on their rate of return. The threat posed
to participants in account based retirement plans like 401(k)s, now the
primary plan design in the United States, is quite direct. Since
workers largely bear the risk of investment under this plan design, any
factor, any decision that reduces the account's rate of return can have
potentially irreversible consequences for the participant's retirement
income, depending on her age and personal circumstances.
The recent national and worldwide economic turmoil has amplified the
enormous complexity risk workers face with respect to their retirement
security. In this uncertain environment, fiduciaries of all plan types
must utilize a variety of service providers to help themselves and plan
participants assess choices. While conflicts of interest are not
necessarily inherent in engaging service providers, the likelihood that
conflicts of interest exist has significantly increased over the years
given the complexity and nature of business arrangements among
investment advisers, plan consultants, and others. To the extent that
financially harmful conflicts of interest exist, they pose a potential
threat to the investment confidence of sponsors and participants and to
the retirement security of employees.
As we have noted in past reports, updating regulations to better
reflect the impact of undisclosed business arrangements among 401(k)
service providers will help Labor provide more effective oversight of
401(k) plans and likely result in reduced fees for 401(k) plan
participants. Without such changes, Labor will continue to lack
comprehensive information on all fees being charged directly or
indirectly to 401(k) plans and 401(k) plan participants' returns are
likely to continue to be affected by some conflicts of interest.
Mr. Chairman, this completes my prepared statement. I would be happy to
respond to any questions you or other members of the subcommittee may
have at this time.
GAO Contacts:
Charlie Jeszeck (202) 512-7215.
Staff Acknowledgments:
In addition to the above, Tamara E. Cross, Kimberley M. Granger, Joseph
Applebaum, Lawrance Evans Jr., Gene Kuehneman, Monica Gomez, and
Craig Winslow made important contribution to this report.
[End of section]
Footnotes:
[1] Defined Benefit Pensions: Conflicts of Interest Involving High Risk
or Terminated Plans Pose Enforcement Challenges, [hyperlink,
http://www.gao.gov/products/GAO-07-703] (Washington, D.C.: June 28,
2007); Private Pensions: Changes Needed to Provide 401(k) Plan
Participants and the Department of Labor Better Information on Fees
[hyperlink, http://www.gao.gov/products/GAO-07-21], (Washington, D.C.:
November 16, 2006); and Private Pensions: Fulfilling Fiduciary
Obligations Can Present Challenges for 401(k) Plan Sponsors,
[hyperlink, http://www.gao.gov/products/GAO-08-774] (Washington, D.C.:
July 16, 2008).
[2] GAO, Financial Regulation: Industry Changes Prompt Need to
Reconsider U.S. Regulatory Structure, [hyperlink,
http://www.gao.gov/products/GAO-05-61] (Washington, D.C.: Oct. 6,
2004).
[3] For consultant usage information, see Thomson Nelson, Annual Report
of Pension Fund Consultants 2006 (New York, N.Y.: 2006).
[4] For information on SEC's pension consultant examination, see SEC,
Speech by SEC Staff: Conflicts of Interest in Pension Consulting,
(Washington, D.C.: Dec. 5, 2005), [hyperlink,
http://www.sec.gov/news/speech/spch120505lr.htm] (accessed 2007).
[5] See U.S. Securities and Exchange Commission, Office of Compliance
Inspections and Examinations, Staff Report Concerning Examination of
Select Pension Consultants (Washington, D.C.: May 16, 2005.) The
report's findings were based on a 2002 to 2003 examination of 24
pension consultants. See [hyperlink,
http://www.sec.gov/news/speech/spch120505lr.htm] (accessed 2007).
[6] Pensions and Investments periodical's list of Top 25 consultants
ranked by U.S. institutional, tax exempt assets, 2006. 9 of the 13
consultants made the list of Top 25 consultants.
[7] We constructed this analysis so that we looked at plans sponsors
rather than plans. For example, PBGC's 25 largest trusteed sponsors
since fiscal year 2000 had a total of 67 plans and comprised 70 percent
of the total claims against the agency between 1975 and 2006.
[8] Our analysis is based on a data set we constructed by matching SEC
consultant data with financial information compiled from the Form 5500
database on 1,111 plans over 5 years. Of those, 983 were associated
with the 13 consultants identified by the SEC as having provided
services to DB plans that had serious disclosure problems, while 39
were associated with 11 consultants that either were in compliance or
had minor inadequacies with disclosure and another 89 that were
associated with both types of consultants. A complete discussion of our
econometric approach, including model specification, variables used,
data sources, estimation techniques, and limitations, is provided in
appendix II in [hyperlink, http://www.gao.gov/products/GAO-07-703].
[9] These include an ordinary least squares specification with time-
fixed effects and various random-effect and fixed-effect model
specifications. "Fixed-effects" helps to control for the potentially
large number of unmeasured forces that can explain the difference in
plan returns. See appendix II in [hyperlink,
http://www.gao.gov/products/GAO-07-703].
[10] PBGC also faces long term financial challenges. GAO, Pension
Benefit Guaranty Corporation: Long-Term Financing Risks to Single-
Employer Insurance Program Highlight Need for Comprehensive Reform,
[hyperlink, http://www.gao.gov/products/GAO-04-150T] (Washington, D.C.:
Oct. 14, 2003), GAO, Defined Benefit Pensions: Plan Freezes Affect
Millions of Participants and May Pose Retirement Income Challenges,
[hyperlink, http://www.gao.gov/products/GAO-08-817] (Washington, D.C.:
July 2008)
[11] GAO, Private Pensions: Fulfilling Fiduciary Obligations Can
Present Challenges for 401(k) Plan Sponsors, [hyperlink,
http://www.gao.gov/products/GAO-08-774], (Washington, D.C. July 2008).
[12] Office of Compliance Inspections and Examinations, Staff Report
Concerning Examinations of Select Pension Consultants (U.S. Securities
and Exchange Commission: May 16, 2005)
[13] These fees are known as subtransfer agent fees.
[14] 72 Fed. Reg. 70,988-71,005 (Dec. 13, 2007).
[15] 29 U.S.C. §§ 1001-1461. ERISA is the primary federal law governing
the sponsorship and operation of private sector employee pension plans,
including DB plans. Among various statutory exemptions to ERISA's
prohibited transactions is one for contracting or making reasonable
arrangements for services necessary for the operation of the plan if no
more than reasonable compensation is paid for those services. 29 U.S.C.
§ 1108(b)(2).
[16] ERISA is the primary federal law governing the sponsorship and
operation of private sector employee pension plans, including DB plans.
29 U.S.C. §§ 1001-1461 It has requirements relating to the standard of
conduct of plan fiduciaries 29 U.S.C. § 1104 . Not all of these
consultants and service providers are at all times fiduciaries under
ERISA. However, fiduciaries that breach their plan duties are
personally liable for making up losses to the plan, restoring any
profits made through the use of plan assets, and face removal as plan
fiduciaries. 29 U.S.C. § 1109.
[17] 15 U.S.C. §§ 80b-1 - 80b-21. SEC regulates certain money managers
and pension consultants under the Investment Advisers Act of 1940
(Advisers Act), which requires those firms meeting certain criteria to
register with the commission as investment advisers. Regulations under
the act permit pension consultants to plans having an aggregate value
of at least $50,000,000 to register with SEC. 17 C.F.R. § 275.203A-2(b)
(2008). According to SEC, investment advisers have a fiduciary
obligation under the Advisers Act to provide disinterested advice and
disclose any material conflicts of interest to their clients. When an
adviser fails to disclose information regarding material conflicts of
interest, clients are unable to make informed decisions about entering
into or continuing the advisory relationship.
[18] Specifically, service providers would be obligated to describe any
material financial, referral, or other relationship it has with various
parties (such as investment professionals, other service providers, or
clients) that creates or may create a conflict of interest for the
service provider in performing services pursuant to the contract or
arrangement put cite in. 72 Fed. Reg. 71,005.
[End of section]
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