Serial No. 106-87


Printed for the use of the Committee on Education

and the Workforce

Table of Contents













Table of Indexes *











Tuesday, February 15, 2000




House of Representatives


Subcommittee on Employee-Employer Relations


Committee on Education and the Workforce


Washington, D.C.








The Subcommittee met, pursuant to call, at 10:00 a.m., in Room 2175 Rayburn House Office Building, Hon. John A. Boehner, Chairman of the Subcommittee, presiding.

Present: Representatives Boehner, Talent, Petri, Ballenger, McKeon, Hoekstra, Fletcher, Andrews, Kildee, McCarthy, and Holt.

Staff Present: Christopher Bowlin, Professional Staff Member; Amy Cloud, Staff Assistant; David Connolly, Professional Staff Member; David Frank, Professional Staff Member; Rob Green, Workforce Policy Coordinator; Patrick Lyden, Professional Staff Member; Mark Zuckerman, Minority General Counsel; Cedric R. Hendricks, Minority Deputy Counsel; Michele Varnhagen, Minority Labor Counsel; Peter Rutledge, Minority Senior Legislative Associate; Woody Anglade, Minority Legislative Associate; Brian Compagnone, Minority Staff Assistant.

Chairman Boehner. A quorum being present, the Subcommittee on Employer-Employee Relations will come to order. We are holding this hearing today to hear testimony on the effects of ERISA on the world of pensions and investments after 25 years. Under Committee Rule 12-B, opening statements are limited to the Chairman and the Ranking Minority Member of the Subcommittee. This will allow us to hear from our witnesses sooner and to help our Members keep to their schedules.

Therefore, if other Members have opening statements they may be included in the record, and with that I ask unanimous consent for the hearing record to remain open for 14 days to allow Member statements, witnesses written testimony and other materials to be submitted for the record. Without objection, so ordered.






This past September, the Employee Retirement Income Security Act, or as we all know it, ERISA, turned 25 years old. ERISA was intended to provide a safe, honest and efficient structure for protecting pension benefits for America's private sector employees. By and large it has done that. ERISA has been a success story. Our challenge is keeping it a success story, making it as reflective and responsive as possible to the challenges and opportunities of today's world.

Economically, the world is a far cry from that of 1974. Instead of recession, unemployment, and high inflation, we are enjoying robust long-term growth, low inflation and unimagined economic and personal opportunities. Today and for the next several months, this Subcommittee will hold a number of hearings to determine how to make sure American workers and retirees can take full advantage of those opportunities.

Part of that will consist of personal opportunities for individual retirement savings, technology and the demands of a global market, tremendous innovations in this area. To most people in 1974, personal savings meant a bank account. Now it means IRAs, Roth IRAs, annuities, mutual funds and a whole range of investment products that go well beyond what was available to the average American 25 years ago.

Economists predict this year, that for the first time, nearly 50 percent of all Americans will have invested in some form of equity. Equity investment can represent great opportunities, but it can represent great risk as well. No one could have anticipated this trend when ERISA was written in 1974. And to the extent that we can enhance private access to expert investment advice in education, I think we will have served our constituents well.

We are seeing our economy change right before our ideas. Our largest companies used to be manufacturing firms that had taken decades to develop and had workers and facilities throughout the world. Today most jobs are being generated by small, information sector employers, which can become global powerhouses with some new ideas and a few keystrokes on a computer. Companies like Yahoo can build more market value in months than more traditional companies gained in decades.

The pace of change is dramatic and it shows no signs of slowing down anytime soon. And it has a vast impact on how pension fund money is invested. To the extent we can make pension retirement investment more efficient, allowing participants to maximize their returns on their investment and allowing them access to better information about their investment options, I think we will have served our constituents very well.

To start this process, we will be hearing from four leading authorities on the need for reform. Next month we will hear from those employees and employers who have been helped or hampered in their retirement security plan by current law, and from private sector participants on how to modernize the system. Later we will hear from our nation's regulators. Last July, this Committee reported HR1102, the bi-partisan Portman-Cardin Comprehensive Retirement Security and Pension Reform Act.

This bill, which included 24 amendments to ERISA, makes retirement security available to millions of workers by expanding small business retirement plans, allowing workers to save more, enhancing portability, making pensions more secure, and cutting red tape. We are now looking to the next step in pension reform. In the Committee's consideration of the Portman-Cardin bill, I worked closely with my colleague Rob Andrews, our Ranking Member, and I look forward to working with him closely again on this project.

The hearings in the process will be bi-partisan and every courtesy and opportunity will be extended to each Member of the Subcommittee, Republican or Democrat, who wishes to play a constructive role in this process. And I want to make clear at the outset of these hearings that they will not be about reducing pension fund security, they will be looking at how to maintain pension fund security while providing more flexible regulatory framework to reflect the modern economy in financial services.

I also believe however that in today's economy the great risk of being left behind in a regulatory structure needs to reflect this so that we are not left behind. This is how I hope to focus these hearings. And I would now like to yield to our Ranking Member, Mr. Andrews, for whatever opening statement that he may have.










Mr. Andrews. Thank you very much, Mr. Chairman. I first want to commend and thank you for not only the word, but also the deed of a constructive bi-partisan process that is beginning today. I want to reflect the spirit of John's remarks and indicate that we on our side are interested in learning about this issue and improving this law. And I look at today as the beginning of a process that will help us collectively discern the way to improve this law.

I look forward to not only the hearings, but our cooperative work together as we did on Portman-Cardin. I view this process as being about an unchanging principle and two changing circumstances. The unchanging principle that is enshrined in the 1974 ERISA Act, is that we want to make sure that pension funds are as solid as the Rock of Gibraltar for Americans.

That there is not one iota of doubt that every dime and every dollar invested in a pension fund is protected, is solid and secure and has a back up system behind it for those exceedingly rare circumstances when investment decisions turn out to create difficulties or market conditions turn out to create difficulties. ERISA is a success story. It is a success story that has affirmed the principle of solid pension investments.

I view this as a collective enterprise to build on that principle, not weaken it. I view this as a collective enterprise to be sure that the next generation of Americans will be even surer than we are that their pension assets are secure. And I think that this is a great step in that direction. The two changing circumstances are these. The first change in circumstance is a direct result of the wisdom of ERISA that our predecessor enshrined in the law 26 years ago.

The data shows that before ERISA was written there were assets of $260 billion dollars invested in pension plans, or I should say shortly after ERISA was enacted in 1975. That $260 billion dollar number has grown to $2.7 trillion dollars in the 26 years that we have had ERISA. The number of Americans, who participated in a pension plan in 1975, was 38.4 million. The number of Americans who participate today is 66.2 million people. So the changing circumstances that ERISA has created and fostered have been a very good.

More people are covered, more assets are included, and more Americans have a higher quality of life because we have this structure in place. The anxieties and abuses that, in part, led to ERISA's enactment in 1974, are now very, very, very much the exception. Well run, well-managed, sound plans are now very much the rule and we aim to keep it that way.

The other changed circumstances are the ones that John eludes to, and that is the dynamic changes in the financial market place. The financial market place of 2000 was unimaginable in 1974. The idea that banks would be doing something other than issuing checking accounts and mortgage loans and passbook savings accounts was a rather foreign idea. And the idea that there would be new institutions that we didn't even really have a name for, which engaged in securities and insurance and other kinds of financial transactions as well as orthodox banking, could not have been imagined in 1974.

The idea of cable television networks that spend the entire day broadcasting financial news about the Dow Jones Industrial Average and the NASDAQ average that are watched not only by Wall Street financiers, but by gas station attendants and waiters and waitresses and truck drivers and people of all different occupations and walks of American life, could not have been thought of in 1974.

I would venture to say that many Americans ten years ago did not know what the Dow Jones Industrial Average was. And today many of them regularly check it on their home computer or the television when they walk by to see how their pension portfolio is doing. That is a good thing. That is a very good thing. And what I think we have is a chance to do in writing good bi-partisan legislation, and to enhance that opportunity.

So I look forward to this as the beginning of a collaborative process. I take the Chairman's words at their face value because they have been absolutely true in this process. We look forward to a constructive dialog as to how to continue to enshrine that bedrock principle of the solid dependability of pension funds, to continue the success story of ERISA in covering more people and including more assets, and taking due account where prudent, of the changing financial circumstances that could be incorporated into the law, so that we don’t weaken the protections of ERISA.

I believe that no one here has that agenda, and that we may optimize the returns and the performances of ERISA funds, so that we may get the finest and most prudent performance for plan beneficiaries of all walks of life around the country. I am delighted that we have four distinguished individuals joining us today who bring great expertise to this discussion. And frankly, who bring a point of view, but not a partisan point of view, to the discussion that I think is very, very helpful.

I thank the Chairman for having the hearings and look forward to the testimony.

Chairman Boehner. Thank you, Mr. Andrews. I would like to introduce our witnesses. Our first witness will be John H. Langbein, Chancellor Kent Professor of Law and Legal History at Yale University. Professor Langbein teaches pension and employee benefits law and is co-author of the leading law school text on the subject. He served as a Reporter/Drafter for the Uniform Prudent Investor Act.

Our next witness will be Michael S. Gordon, Esq. of the Law Offices of Michael S. Gordon in Washington, D.C. Mr. Gordon was the Pension Counsel to Senator Jacob Javits during the drafting of ERISA in the early '70's.

Following him will be John B. Shoven, the Charles R. Schwab Professor of Economics at Stanford University. Professor Shoven served as Chairman of the Stanford Economics Department from 1986 to 1989. He was Director for the Center for Economic Policy Research from 1989 to 1993, and the Dean of the School of Humanities and Sciences from 1993 to 1998. He was a Consultant for the U.S. Treasury Department from 1975 to 1988.

Our final witness will be Teresa Ghilarducci, Associate Professor of Economics at the University of Notre Dame. She was a member of the Advisory Board of the Pension Benefit Guaranty Corporation, and is a Trustee of the State of Indiana Public Employees Pension Fund.

And before the witnesses begin their testimony, I would like to remind the Members we will be asking questions of the witnesses after the complete panel has testified. And with that, Professor Langbein, you may give us your testimony.





Professor Langbein. Thank you so much. I appreciate the opportunity to be here. I have submitted some prepared testimony. Let me just summarize it briefly in a somewhat different order from that in which it appears. I would like to echo both your opening remarks in which each of you have indicated, in your view, that ERISA, in its handling of investment matters under ERISA fiduciary law, has been a success story, and I certainly want to endorse that.

I think ERISA has laid a few eggs. I think ERISA has some mistakes, particularly the preemption area, and some things to atone for. But I think on balance, ERISA investment law has been a real triumph. It did what Congress asked it to do; it cleaned up the scandals of looting of plans, kickbacks, and all the rest that had been discovered in the McClellan Committee and other Congressional investigations. And it did a splendid job.

The future raises different problems. And the largest problem in the investment area, I think, is how we are going to adjust to the defined contribution revolution. The defined benefit plan is what Congress had in mind when it created its regulation of ERISA, and that is where the problems were. Today almost all of the growth in the pension plan world, dollar bills, participants, plan formation, any measure you want, and all of the growth is in the defined contribution plan. There are many reasons; most of them are pretty well understood.

Among them the facts that career patterns have changed, and the intrinsic portability of defined contribution plans is an attraction. Another is the fact that the investment experience and defined contribution plan inures directly to the benefit of the employee rather than in effect to the employer as it does under a defined benefit plan. And we have had a bull market since 1982, and thus there is a lot of attraction to the idea that you get to keep the gain rather than the employer.

So we understand a lot about why the defined contribution tilt has occurred. The big problem, and the problem on which I think Congress needs to help out are very simple to tee up and it is this. The defined contribution revolution has shifted the responsibility for the conduct of the investment function from the people who used to do it, namely expert corporate treasurers and their financial advisors, from experts to individual workers on the shop floor or the office floor or wherever. That is the big transition.

The result is that you have tens of millions of people who are inexpert at investment matters and have every reason to be inexpert at investment matters, who have now been placed in charge of a very daunting function, which is the investment of ever- larger sums of money to last them across decade after decade after decade. The evidence that we have suggests that they have not done it, this investment function, as well as they could.

In particular, they tend to be under-invested in equity early on in the life cycle. They tend not to do well in making the asset adjustments later in life as they age on. There is a body of knowledge that counsels people about what they ought to do, and the big problem is that ERISA has impeded our ability to get good investment advice to individuals because it treats as a fiduciary anybody who renders that investment advice.

What I think is needed is a changed attitude toward that function to allow employers to arrange for investment intermediaries and other advisors to assist individuals in tailoring their investment program. They need the guidance, they want it and right now ERISA is terrifying employers from taking part in this work and assisting their workers to get the most out of their investment.

Obviously the long-term danger is that you are going to have bunches of people who are under-invested who are, therefore, without the kinds of accumulations that they need for long-term retirement. In my prepared statement, I have referred to two other issues, which I would be delighted talk about as time permits. One is I have talked about the dangers of the very large concentrations of employer stock that show up in some forms of defined contribution plans, especially 401(k)'s.

There is a large body of economic wisdom about why this is folly. It produces a massive under-diversification. In addition, it worsens the under-diversification that already adheres when workers have already got their human capital tied up with an employer. The last place they need to be is to have their diversifiable financial capital with the employer. And there is a lot to be done in this area if Congress would tackle it, although there is some vested interest the other way.

One last word which is, I have opened my statement with a discussion of why I think the prohibited transactions law in ERISA should be abolished root and branch. It is basically a redundant scheme that adds transaction costs. It is beloved by the regulators in the Labor Department. It is beloved by the lawyers who get to run their meters complying with it. It achieves absolutely nothing except adding transaction costs to all sorts of utterly benign transactions.

I have explained in my prepared statement why it is that the policy is not wrong. But that ERISA's existing law of loyalty and prudence under 404(a) does the job splendidly without the need to have this duplicative system. Thank you.






Chairman Boehner. Mr. Gordon.






Mr. Gordon. Thank you, Mr. Chairman; I appreciate the opportunity to participate in these hearings.

As a an ex-Congressional staffer I believe in following the rule of the three B's; be bright, be brief and be gone. A hearing like this is long overdue and although it is to be expected that ERISA's 25th anniversary would be a proper occasion for a thorough evaluation of the law's pluses and minuses, I believe ERISA oversight needs to be performed much more often. I hope this Subcommittee will set the example in this regard.

Secondly, I think the Subcommittee is to be commended for reviewing ERISA in a bi-partisan way. That is how ERISA was enacted and that is exactly what the ERISA participants and beneficiaries expect and what they deserve. In my prepared testimony, I have emphasized that there are three major public policy principles underlying ERISA, which should serve as effective guidelines for bi-partisanship.

First, ERISA plans should live up to high standards because they are heavily tax-subsidized. Second, government interference with voluntary ERISA plans should be kept to a minimum. Federal interventions should be reserved for serious problems. And third, Congress must step in and provide greater safeguards if employee benefit funds are being manipulated in such a way as to undermine confidence in the good faith of plan sponsors and defeat the reasonable expectations of large numbers of participants.

Now applying those principles, I believe that, contrary to Professor Langbein my colleague and good friend, ERISA's prohibited transaction approach should not be weakened because it still remains the best way of curbing insider corruption in ERISA funds. I also think that in connection with one of the issues that may be puzzling the Subcommittee about active cross trading, that we should wait before rushing to judgment on statutory relief measures.

See whether there is a feasible exemption that can be promulgated under the DOL's authority right now and not also automatically conclude that the SEC rules that govern investment managers in this regard are adequate. They may be, they may not be. We need to find out some more about that.

The second area that I would like to draw the Subcommittee's attention to is that this whole cash balance conversion controversy has raised rather significant issues of public policy because these conversions would not, in my opinion, have taken place in the absence of huge pension plan surpluses and efficient ERISA rules governing those surpluses.

In my prepared testimony I suggest that Congress should first amend ERISA to provide safeguards that assure that participants receive the benefits they have earned before the cash balance conversion, as well as a post-conversion benefit that makes up for the loss of reasonably anticipated benefits by mid-career and older workers. There is a good part of the older worker, mid-career community in this country that regards these cash balance conversion situations as a form of Pearl Harbor, and it is going to have to be addressed.

Secondly, because the existing pension surplus rules seem to be manipulated, so as to exacerbate the tendency toward the concentration of wealth, I explain why that is so in my prepared testimony. I think we are going to have to take another look at the rules governing surplus funds and see whether or not the result that we have been avoiding so far, may be the necessary one; an equitable reapportionment of the surplus between the plan, the employer and the participants.

And finally, to reverse the decline in ERISA plan coverage, which I suggest is primarily due to the growth of the small business sector and the incapacity of the small business sector, notwithstanding all the incentives and simplification, to deal with the ordinary commercial product. Because of the extreme volatility of the small business sector, I suggest that we look at other models. Principally, the adoption of a special, statutorily created, tax qualified, multi-employer plans for small business, which would have complete portability. All the employer would have to do would be to send in the contribution check. Not file any reports, not take any fiduciary responsibility, etcetera.

And I also suggest the adoption of special, statutorily created, tax qualified, non-employer based occupational plans for these non-conventional employees, these transient employees, part-time employees, and contingent workers; people who flip between independent contractor and employee status. I think it is unrealistic to try to place responsibility on the employer system for covering them. I see no reason why they can't get a pension plan the way they get health, which is they don't have to rely exclusively on employer-sponsored plans.

And with that I would like to wind up by indicating that one very troublesome issue is employers have reduced coverage deliberately, not because of economic reasons necessarily, but simply because of financial accounting rules or for other reasons. And this is the situation of employers reducing or eliminating retiree health coverage after an employee has retired and is receiving such benefits. This is the most disturbing situation.

The current situation in the courts is pretty devastating to retirees. The courts basically hold that these benefits are in the form of a gratuity. Even if they have been promised and earned by the employee before the employee retires, the employer can take them away at will. This is exactly the situation that existed prior to ERISA with regard to pensions, and why the pension law was passed. That is exactly what the courts held before ERISA on pensions, and now with regard to retiree health benefits. I think that this is a situation, which requires some type of ERISA treatment.

Thank you very much.






Chairman Boehner. Thank you, Mr. Gordon.

Professor Shoven.





Professor Shoven. I want to commend you for holding this timely set of hearings. I agree with the rest of the panelists that ERISA should be considered a success. The private pension system in the U.S. is solvent, secure and run with integrity. Still I think that there are reasons for modernization and re-examination. The financial world has changed dramatically since 1974.

It is hard to remember, but there were no IRA accounts, there were no 401K accounts. The defined benefit pensions were predominant. Mutual funds had less than one percent of the assets they have today, $35 billion instead of $5 trillion dollars. Index funds didn't exist. Broker's commissions were high. The two largest companies in the world, in terms of market capitalization today, Microsoft and Cisco Systems, did not exist.

The financial world has changed so dramatically that we need to see whether the law is working in this new era. I also want to stress that pensions are an incredibly important component in our economy. They account for the bulk of all of the savings in the economy, by some measures 100 percent of the saving. The aggregate assets in pensions are roughly the same as the aggregate value of all residential real estate in the country. On the eve of retirement the average household has a more valuable pension than the value of their house or the value of their future social security receipts. So pensions are an engine of saving which finances investment in economic growth. We need to preserve and strengthen it.

In terms of reforms my concern is that the current regulation and taxation of pensions is needlessly and harmfully complex. I do believe that that is part of the story for the dramatic decline in the traditional defined benefit plan. And one thing that all policy makers should have in mind, as you are thinking about changing policy towards pensions, is why is it that no firm is introducing new defined benefit pension plans? Essentially no one has done that for the last 20 years.

Ted Groom of the Groom Law Group and I have developed a ten-part plan for modernizing ERISA and the laws with respect to pensions. I will just tick off the ten points. We would replace the existing non-discrimination rules with a very simple rule that every pension plan feature is offered to every employee. We would liberalize the benefits allowed by pensions. Defined benefit pensions would be allowed to pay up to 100 percent replacement rate. People could contribute up to 25 percent of their pay to defined contribution plans with no absolute dollar limits. We would increase and equalize the contribution limits in IRAs and 401(k)’s at the level of $15,000.00. We would expand the Roth Approach, the prepayment approach, to all vested defined contribution plans. We would repeal the 50 percent excise tax on reversion of excess assets in defined benefit plans. And we would repeal the complex minimum distribution rules.

Now in terms of the issues of this Committee, we would reduce the role of PBGC, in particular we would outsource the operations of terminated plans to the private insurance industry. We would rethink and be inclined to eliminate many of the prohibited transactions rules. As you know, if we simply, consistently enforce pre-existing law requiring fiduciaries to be prudent and loyal to the interest of plan participants and beneficiaries, then those prohibited transaction rules are redundant. In many cases redundant rules are worse than worthless because they make increased transaction costs and discourage pension creation.

Finally, we would, as I think everybody here would, encourage financial education and planning by firms and households. And the way we would do that is allow firms and households to seek advice using before tax dollars. Seeking financial advice would be tax deductible.

In terms of just expanding very briefly on the roles of PBGC, it clearly is an important function for the defined benefit world to have these benefits guaranteed. But there is no need for the government to actually pay out monthly checks to those in terminated plans. Most terminated plans today are operated by the insurance industry. It is only those terminated by the PBGC that the government runs itself.

I guess I will stop there, but I will be happy to expand on this agenda.






Chairman Boehner. We realize that it is very difficult to share with us all of your information in five minutes, but as we get into the questions we will have ample opportunity to explore this.

Professor Ghilarducci.

Professor Ghilarducci. Yes, I probably prepared more than five minutes worth, too. I realize I do echo.

Chairman Boehner. We are lenient here.






Professor Ghilarducci. Okay, thanks. Your opening comments were very encouraging. We do have to congratulate ERISA for forcing people, employers, and workers to put money aside for their retirement. ERISA did change the psychology about pension protection. No more dirty deals and put your money aside, and it worked. Also Professor Langbein is right. There is a revolution. The shift from professionals to amateur investors is quite right.

Where the corporate treasurers or professionals used to run this money, we now see a shift, meaning a larger percentage of amateurs, individuals, and workers are running our money. But it can be overstated. There are a lot of good practices out there that ERISA reform legislation should be mindful of. What happens on the street, what employers do should be often incorporated into law. And I will talk about some of those best practices.

I have 11 proposals for ERISA reform and they don't overlap at all with Professor Shoven's. And I have lots of recommendations about what not to change. Key is what we are talking about is the prohibited transaction rules that prevent, very specifically, cross trading in actively managed accounts, and investment managers using their own brokerage firms to do the trades.

Now despite the theoretical arguments about how this would lower costs and perhaps mean more pensions, in practice there are $1 trillion dollars worth of funds out there, thousands of funds in the public sector who are not covered by ERISA, face the same world that ERISA funds do and they do not allow cross trading in active accounts. And do not allow investment managers to use their own brokerage.

We must look to that world to see why not. You are not prevented to, why aren't they doing it? And there are some very good reasons. In fact the firms, investment management firms recommend to their own money managers to not trade with their brokerage accounts. So inside the firm they say too much conflict of interest here, just avoid it. I sit in Indiana; we have a much smaller fund than say the California public fund.

If we wanted to sell when California wanted to buy, the real possibility that the internal judgment of the manager about what price, what process they would undertake to cross trade from one account to the other, the real possibility that it would be biased towards the larger fund is not worth the cost savings to the smaller fund.

If pension funds allow managers to use their own brokers, they are inviting the managers to move securities around for their own benefit. These are firms that look after themselves. Let me give you an example. Client A's return is lagging Client B's, because of reasons that have nothing to do with the manager; maybe how the flow of contributions came in, maybe when some of the advices came in.

The incentive to put some good stocks into Client A's account at the expense of Client B, is very much there and it would be impossible, nearly impossible, according to the experts, to discover that. That is the key practice that no fiduciary, and I sit as one, would allow to happen that has so much possibility for conflict of interest that we couldn't monitor. We would be held accountable. They could take my house. It would be negligent, it would be wrong.

Also ERISA prohibitions allowing this cross trading could actually raise costs of transactions, because only the largest firms, Barclays, for instance, markets their ability to cross trade in their passive accounts. It is a very attractive reason to pick Barclays. Pension funds, especially those that are small and medium are vulnerable, don't have the Counsel to say avoid it, and would be lured to pick that manager based on these initial costs.

The competition for managing money would disappear because, again, it is the larger firms that can take advantage of that. Monopoly prices would go into effect and basically lifting the prohibitions would cause more monopolization in the industry. Also, you know, the U.S. industry, especially around the Asian crisis, has been very important in helping the American government argue for nations to brave pressure from their bankers in Malaysia, Indonesia, and Japan, and put in place policies for financial transparency.

But if you lifted ERISA prohibitions against this, as Professor Langbein has suggested, then you would be taking a bulk of American equity trades off the market and make our urgings for transparency hypocritical and a bit ironic. Well how should we reform ERISA?

We should make sure we anticipate human behavior. We should tackle this problem that Mr. Gordon spoke of; declining pension coverage. I mean health insurance coverage is declining and so is pension coverage.

And we should, as I said, encourage the best practices among employers. We should minimize, keep on minimizing the self-dealing and conflict of interest in financial management. The stark fact in the pension world is that pension coverage is falling. The voluntary savings, even if they are in Roth, in 401(k)’s and IRAs, are inadequate for people's retirement. And only in particular cases are these great financial gains in Wall Street actually going to workers' pensions or actually going to "Main Street."

One out of five workers who are offered a 401(k) that could, and 40 percent who can’t, don't even participate. The median 401(k) balance is about $5,000.00, probably a little more for women, about twice that for men. In 1998, the Federal Reserve was a bit surprised that the assets going into defined contribution plans, the place where we say the revolution is occurring, is lower and a smaller amount than the assets going into defined benefit plans, the kind of plans we say are leaving the pension world.

The Federal Reserve had some explanations for that. It looks like people aren't saving for retirement because they are drawing out this money before they retire. Which comes back to my warnings to anticipate human behavior when you do pension reform because humans have a hard time deferring gratification. If the money is sitting there, and they have a reason to use it, they will spend it.

Humans are myopic; we are shortsighted. We also, this is coming up in the behavioral financial literature, suffer what is called saliency. We also suffer from overconfidence. Saliency means that we think what just happened is more likely to happen even though it is infrequent. Plane crashes; people avoid going on the airplanes right after a plane crash.

It was a Vanguard Fund Officer that pointed this out at the Economics Association meetings in Boston just last month. He said that they have the biggest problems in teaching their clients about financial risk. But they realize that their client knows that there is a risk in the stock market. They know they aren't guaranteed a ten percent return. So they recognize as a risk that their return might fall below ten percent. It is as if nobody remembers the 1970's when the stock market didn't beat inflation.

We also suffer from overconfidence. We think we are better looking than our relatives or strangers think we are. Ninety percent of us think that we are better drivers. No offense, but we are human. Therefore, we tend to remember our good investments and do not report our bad investments.

Mr. Andrews. The record should reflect you are now describing any Member.

Professor Ghilarducci. That is right, you know.

Mr. Andrews. Okay.

Professor Ghilarducci. If you look at yourselves then you understand why voluntary savings in individually managed accounts can actually be asking for trouble, and we just might as well anticipate that. Education can help, but human nature is very powerful. It is experience that usually causes people to change.

There is another reason why pension coverage is declining; the amount of money put towards pensions. I already said defined contribution plans are declining. This is very worrisome because we are in an expansion and people are getting older. Right when they should want more retirement security, they do not. A lot of it is what Professor Gordon said. Large corporations that can't afford to cover their workers in pensions and health insurance don’t.

We can be unfair and call that "Micrsoftian" behavior, but lots of workers who are regular workers were categorized by them as temporary, contingent, and part-time workers. Time Warner is another company that just doesn't seem to have the corporate responsibility there was once to cover their employees in insurance plans. The non-discrimination tests actually work. They say, as you know, you can't have a tax deduction for your pension if you only cover your top paid people.

McDonald's Corporation takes that non-discrimination test very seriously. And they automatically enroll all of their workers in their 401(K), and if you don't want to be in it, you have to opt out in writing. They have almost 100 percent coverage. Why do they do that? It is a good company, but also because of the non-discrimination rules.

I see that my time is gone, but may I just say that we should pay attention to the many workers who are temporary, contingent, part-time, and flip between statuses, which have pensions. Those are employees in multi-employer networks, such as construction workers, garment workers, and coal miners. They have a wonderful health and pension system. ERISA Reform should actively encourage those networks.

This shift from "DB" to "DC" has been overstated. When workers have a say in the way their funds are managed, it seems as though Wall Street gains do go to the workers. I have a 20 year file of plans and it seems that when plans are collectively bargained, and when the funding and pensions are watched and negotiated over, the increases in earnings to the funds actually go to increasing workers' pensions. Otherwise what happened was that it went to reduce employer's contributions. My testimony describes that it is not just because non-union employers are going to "DC" plans. Union workers, when they have representation, put more money in "DB" and "DC" plans.





Chairman Boehner. Thank you, Professor; we appreciate your testimony and the testimony of all of our witnesses today.

Well, let us just get right into this. Professor Langbein, Professor Ghilarducci says that we shouldn't have cross trading, it would be hypocritical on our part as a nation after the advice we have given those in Southeast Asia. I saw you making some motions with your body as the Professor was giving testimony. I will let you respond.

Professor Langbein. I think it is important to distinguish between the question whether you want to do something about forms of self-dealing, on the one hand, and the question whether you need to have prohibitive transactions rules to do it on the other.

The point that I would develop is that the printed transaction rules in general produce a vast body of over regulation, which is why we have this enormous prohibitive transaction exemption practice in which ERISA lawyers have to go in hat in hand to the Labor Department and beg to be allowed to engage in relatively innocuous transactions.

Chairman Boehner. Now what would be the average length of time for one of those exemptions to work its way through the system?

Professor Langbein. I am the wrong person to ask. I saw Don Meyers here in the room, he would know. It is months and months and months. And there is a faster track and a less fast track, but this is a time consuming and expensive process. And the simple truth is that most forms of conflict of interest, any kind of self-dealing, are all thoroughly prohibited under the existing loyalty rules. You don't need to have this elaborate structure of further duplicative prohibition.

That is the concern that I have with the prohibitive transaction world. It is just that it doesn't add anything. We all agree, everybody on this panel and everybody in this room I think agrees that forms of self-dealing and imprudence in general are wrong. But ERISA (404) takes care of that. You never have to get to the (406) to (408) structure which I view as just completely cost productive.

Chairman Boehner. Mr. Gordon, I think you have something to say.

Mr. Gordon. Well, this brings back a sense of deja vu redux, pardon the redundancy Professor Langbein. This argument has been going on for a long, long time, and in my testimony I tried to give the history of the prohibited transactions approach and why it came to be the way it is. It is important to note that every administration, both Democratic and Republican, has supported a prohibited transaction approach.

Originally, when ERISA was just a glint in the eye, there was an attempt to see whether it would be possible to rely entirely on the exclusive loyalty rule. The exclusive loyalty rule basically is derived from the biblical injunction that no man can serve two masters, and as applied by the courts at common law, it was strictly applied. There are no exceptions. If you add only an exclusive loyalty rule and nothing else, then standing by itself, whether the arrangement was prudent or not, under the exclusive loyalty test, cross trading and virtually every other type of innocuous form of conflict of interest would be barred.

And one of the reasons, if not the principle reason why the prohibited transaction approach was developed in the very early days was because the industry itself foresaw the problem of what would happen if there was nothing more than the exclusive loyalty test. There would be constant litigation that would bar all kinds of arrangements, some of which were very customary, not only among pension plans but among service providers to pension plans as well.

So the prohibited transaction approach was really an effort to try to soften the exclusive loyalty test by listing the key types of worrisome conflicts and providing an exemption process, which understandably has its awkward moments, as a way of getting around, finessing if you will, this problem of how you apply a strict loyalty test without injuring the industry much more than it needs to be or to deal with these issues.

Chairman Boehner. Professor Shoven, you outlined ten recommendations you had for the Subcommittee. If you took the ten points and in your mind they were all enacted, what is the result of those ten points in terms of assisting American workers in terms of maximizing returns for their retirement security?

Professor Shoven. Well, I think you would have more participation. You would have more savings in the economy and therefore a stronger, more rapidly growing economy. You would have more advice available to participants and you would also put the defined benefit and defined contribution plans on a more level playing field. But probably the greatest benefit would be that with fewer rules workers would be able to adjust to new opportunities much more easily.

When I hear that, my understanding is these exclusions take three to 12 months. I come from Silicon Valley, and that sounds like forever. They are very expensive to litigate. This strikes me as a serious problem. But everybody here would want to insist that we preserve the integrity of the system and my view is this does that, and it makes more opportunities available to participants.

Chairman Boehner. Mr. Andrews.

Mr. Andrews. Thank you. I appreciate the excellence of this panel. Really it lived up to our expectations and we appreciate that. I want to challenge each of the two polar views on the prohibited transaction rules and these questions are intended so I can learn something from the answer. They are not rhetorical questions. And I want to begin with Mr. Gordon.

On Page 5 of your written statement, you talk about the prohibited transaction rules as serving the superior prophylactic purpose of deterring corruption in ERISA fund management by requiring plan fiduciaries to live up to higher standards of conduct than the market might otherwise require them to observe. Picking up on Professor Langbein's point, can you describe to me a set of facts that would be barred by the prohibited transaction rules that are not also barred by the traditional fiduciary principles found elsewhere in the statute.

What do the prohibited transaction rules add to the underlying fiduciary prohibitions already in the law?

Mr. Gordon. Well, that is a very good question, Representative Andrews. The prohibited transaction rules are a subspecies of the exclusive loyalty rule. They were framed as the primary types of examples or the primary types of transactions that the reformers were concerned about. These were concerns that were not based upon abstractions. These were concerns that flowed from particular examples. They were the Central State Teamsters Pension Fund, insider transactions and abuses.

There were all kinds of corporate insider arrangements, and manipulating of funds, particularly in regard to loans to the employer or to parties in interest, or what we now call parties in interest of the employer; business entities that were associated with the employer. Loans which on the surface were for a fair, adequate consideration, but when those deals exploded later on, the terms of them could not be fulfilled, and the horse had bolted the barn.

It was too late to do anything about it under the prudent standard or the exclusive loyalty standard. As I have indicated before there was this concern as to what would happen if you relied entirely on the exclusive loyalty test. There was a great deal of concern about this, both among the reformers as well as among the industry. So really the prohibited transaction approach was a way of trying to size up, through the exemption, the key to what was the exemption process.

Prohibited transactions would not have worked and would never have been enacted without the exemption process. The exemption process is supposed to bring in an element of objectivity, for the parties engaging in the so-called disloyal transaction, which does not comply with the strict loyalty test.

Mr. Andrews. Is it a fair statement based on what you just said, that the value of the transaction rules expressly prohibits certain transactions before they begin rather than characterizing them as illegal after they have happened? Because it really doesn't create a new procedure, does it? It simply creates a second track substantive standard, it is not a procedure.

Mr. Gordon. I agree with that and it is a choice between whether you apply the strict common law concepts, no matter where that leads. And bear in mind that some courts have held, under the exclusive loyalty test, that where there is a conflict of interest arrangement, even if it was beneficial to the plan, the fiduciaries have to disgorge any profits that they have made in that connection.

Mr. Andrews. Okay. I appreciate that, thank you.

I wanted to just quickly ask the Professor something, which is sort of a challenge to the other polar position. Mr. Gordon says that all the evidence demonstrates that despite the prohibited transaction rules, the asset and investment earnings growth of ERISA pension plans have simply been phenomenal and show no signs of letting up. Which raises the point; if it "ain't" broke, don't fix it. I mean are you arguing that removal of these rules would make a significant gain in the performance of plans? Can we quantify the gain that you allege would occur?

Professor Langbein. Let me first say that I think your question to Mike Gordon was extremely incisive. Let me say further that I think there is nobody in America who knows more about ERISA and has a deeper sense of public spirit about it than Mike Gordon, and Mike couldn't answer your question. Mike did not tell you how ERISA-prohibited transaction law created any substantive standard whatever that is not already present in the loyalty and prudence norms in the statute. There aren’t any.

Mr. Andrews. I would certainly hold the record open and give him a chance to supplement. But I would ask you to tell me whether or not the changes you propose would in any way materially affect the performance of the funds?

Professor Langbein. The answer is you can't measure that which you have prohibited. The predicate of your question is, in these boom times over the last years we have had a lot of growth in assets. The question is would we have had less transaction costs associated with that growth and therefore a higher net, and would we have prohibitited transaction norms that affect the investment process in two ways?

One is they make costly that which is done. The other thing that they do is they stop some things that would be beneficial. It is very hard to price either.

Mr. Andrews. Because I want my colleagues to have their turn, I just want to conclude with one brief question, which I would ask you to answer in writing, if you could. It goes to Professor Ghilarducci's point that perhaps we don't have to speculate about the opportunity cost of not removing the prohibited transaction rules. Perhaps we can look at the $1 trillion dollars worth of assets in non-ERISA pension plans.

(A) Is that an analogous set of facts? (B) If not, why not? and (C) Does the track record of the non-ERISA public plans validate or undercut your point? And again, I don't want to take up my colleagues' time, but if you could supplement your answer, maybe when I come back to you, if I come back to you, you could answer that.

Chairman Boehner. Mr. Petri.

Mr. Petri. Thank you, Mr. Chairman. I would like to thank you and commend both you and your Ranking Member for having this hearing and for the excellent panel that we have.

I wanted to pick up a little bit on Professor Ghilarducci's comment that we have to be very mindful of human nature in all of this and broaden it to ask if we shouldn't also be mindful of the human nature of bureaucrats and governments a little bit? The argument on prohibited transactions would be pretty theoretical and not too important if in fact the transaction costs or the delay or the bureaucracy worked well and efficiently.

But I am curious. I am fighting with the Labor Department, or not fighting, but weighing in, trying to help them because they are going after Barclays saying they are violating prohibited transactions by evening out their index to counts at the end of each day without dealing with independent brokers. This would take millions of dollars from government employees' pensions each year for nothing.

I hope that is right. If you disagree with my interpretation of prohibited transactions, there are people there who are loyal government employees who think everything is a prohibited transaction, as best I can tell, if it is done within yourself for efficiency purposes. You should do it at arms length even if you are protected by an index from doing anything that is self-serving. So they don't understand the purpose of the law.

I have a question. Should we be expanding all of these protections to Indians and the Bureau of Indian Affairs and their handling of trust funds for Indians? As you know, the government employees there at least are in court and the Judge is saying a lot of wild things. And should we be worrying about expanding these protections to state and local employees and their programs? It is not just private companies that seem to have problems with fiduciary responsibilities.

Professor Ghilarducci. I know you are asking a question about human nature and bureaucracies, but let me clear up a misconception. The Department of Labor, as I understand it, is allowing and recognizes the benefits of cross trading in these passive accounts that Barclays is so good at. But they don't allow it in these active accounts where they can make judgments about what stock to put in what client's, the example about the big and large fund.

Mr. Petri. So if they were talking about there is a reason to question, you would say they were wrong too?

Professor Ghilarducci. About?

Mr. Petri. Indexed accounts, the government account.

Professor Ghilarducci. That is right, they are allowing that.

Mr. Petri. A dumb question.

Professor Ghilarducci. Right, as a fiduciary we hired Barclays because they had low transactions costs. Maybe this short view will help answer this question.

If we worried about high costs of lawyers running to the Department of Labor, we would have to worry about cost everywhere. A fund would much rather have 20 money managers that couldn't cross trade competing for their business than two that could. Because if you have 20 that can't, you are going to have much lower fees because they will be fighting with each other to get our business, but not so if there is only two. So we have to be careful of the rules that would minimize the competition.

Chairman Boehner. Mr. Kildee.

Mr. Kildee. Thank you, Mr. Chairman.

Mr. Chairman I have been on this Committee now for 24 years. I came in slightly after Mr. Gordon and Jacob Javits wrote this bill. And for years I have said that there are only three people who really understood ERISA. That was Phyllis Borzi, John Erlenborn and my neighbor, Don Meyers. And I am glad to add you four to that list because you are hard to find. It is a very complex area of the law.

But let me ask you this question, Mr. Gordon. You mentioned something that has happened to a lot of employees in Michigan; the unilateral reduction or elimination of health care benefits. I come from a state replete with the auto industry. And the auto industry has at least one company that I am aware of, that with a letter through the US Mail, reduced the benefits for their white-collar workers or saw bid workers.

Now they did not do that with their union workers because there is a contract there and at least for the length of the contract they are committed to that. Is there a solution that Congress can apply because I receive hundreds of letters from people who look old and were confident that they had health care and found out that unilaterally it was withdrawn or eliminated for the most part? Could you comment on that?

Mr. Gordon. Yes. First of all, let me say that it is only by the luck of the draw that collective bargaining or bargain plans, protect the retirees from those plans. That is because of a sixth circuit decision known as the Yardman Case. All the other circuits do not universally agreed on The Yardman Case. And just recently, in a case in the third circuit called the Skinner Engine Case, the court held that the retirees’ benefits were terminable at the end of the collective bargaining agreement.

So if there was a three-year collective bargaining agreement and it was not renewed, and even though the original retirees, who may have retired years before that collective bargaining agreement had expired and had been receiving health benefits for all those years until this court decision, now they are out in the cold just as much as the non-collective bargaining retirees. As I said in my remarks, this is a situation that closely resembles, not entirely, but closely resembles the situation that existed in pension plans prior to the enactment of ERISA. Employers were illegally able to not pay pension benefits to people who had earned a certain amount of credits because they had not achieved perfection under certain vesting rules or there were no vesting rules and had not reached normal retirement age.

Or, even after they had reached normal retirement age and were provided with pensions under pre-ERISA law, they could be divested under certain circumstances of those pensions. Now ERISA changed that. You may well ask why didn't they do something about health plans at the same time? And the reason is because nobody was complaining about health plans. There were no, I repeat, no unilateral cut offs of retiree health benefits at the time that ERISA was being drafted. Now I think the reason for that was because the phenomena of medical cost inflation of a serious nature had not come on the scene.

What can Congress do about it? It seems to me that the minimum that Congress can do is to try to provide protections for those who are the most vulnerable. Those are people who have retired. At least with respect to active workers, you can say they can vote with their feet. If they don't like having their benefits reduced, they can go somewhere else. But retirees have no place else to go.

So the least Congress can do is to say, well once you make these benefit promises to retirees you have to keep them, otherwise don't make them. Nobody is forcing you to make promises, but once you make them you are going to have to keep them. And for employers who are worried about cost problems related to retirees, let me tell you on the basis of my personal experience in handling these plans, employers know all kinds of ways of limiting their cost. The typical way is to put in a lifetime maximum on retiree health benefits or couple it with an annual maximum on certain benefits. There are all kinds of things that can be done.

Once those provisions are put in the plan and everybody knows where they stand, those promises should be kept. Congress should pass an amendment to ERISA, which insists that those promises be kept.

Mr. Kildee. I particularly appreciate your last statement. You feel that Congress should do for health benefits what it has done for the other benefits.

Mr. Gordon. Right.

Mr. Kildee. Just quickly, Mr. Gordon, if I may.

I have read the pamphlet. I was bombarded with mail when this happened in Michigan. The first part of the pamphlet, the opening part said, you have got a great life, you are going to have all this and you are going to have this, you are going to have this, you are going to have this, and it goes through all of "this." And then on the very back page in very small print it says, these may be adjusted.

It was there, but no one ever really thought that they would be adjusted. And in personal lives it became rather catastrophic when it was adjusted.

Mr. Gordon. There is a certain amount of litigation that has gone on as to whether that was adequate disclosure. I would say, with a few exceptions the courts have agreed that even though ERISA says that you have to notify a participant of the circumstances under which the participant may be disqualified, may not receive, may forfeit or not get benefits, that employers do not have to say right up front in their plan summaries that we have the right and may act on that right to take away your benefits.

Instead, the courts say just because they reserve the right to amend or terminate the plan, the participants should have figured out that that gave them the right to take away these benefits. I don't know who is right or wrong about this subject anymore and I don't really care. I think the damage has been done and I think it is going to be very difficult to try to get the courts to change their minds about these views. I think Congress has to act.

Mr. Kildee. Thank you very much.

Chairman Boehner. The gentleman from North Carolina, do you have any questions about ERISA pensions?

Mr. Ballenger. Yes, I sure have.

In fact, if I may, I am approaching it from a different viewpoint maybe than most here because I founded a manufacturing firm and still have some large commitment to that firm. And I would like to pose a question to anybody. First of all, I know health insurance coverage for retirees. If somebody retired 20 years ago and they had health insurance, obviously nobody projected that medical costs would explode the way they have and so there is a difficulty there that I don't know how you would approach.

On patient coverage, we had a defined benefit package for a while, and again because of government regulations and so forth it just appeared to me that it was too difficult to do it. So we went back to a defined contribution plan and it reduced the need for the creation of 401(k)'s. ESOP's also made it simpler to go into a defined contribution plan, which wouldn't destroy you if you didn't have to meet the regular thing.

And then finally on temporaries; my temporaries last for a month and either they are hired or they are fired. Bigger companies, on the other hand, operate enumerable people on a temporary basis so that they don't have to pay fringe benefits, which to my way of thinking is unconscionable.

Having stated those three problems there, the only answer I come up with is more government regulation, which I am definitely not for. Does anybody have an answer to any of those problems? It appears to me that they are the basis for what is wrong. And at the end, when you finally get through with all that, who dreamed up the idea of minimum distribution? That doesn't sound like anybody would ever come up with something stupid like that.

Chairman Boehner. Only a gentleman his age would ask a question like that.

Mr. Ballenger. At my age that is very important to me. Go ahead; excuse me, anybody that would care to take that on.

Professor Shoven. Let me get on the minimum distribution. I agree with you. I think minimum distribution requirements are hard to justify. People that think that the pension system is providing a generous tax subsidy think that there should be a limit to that subsidy and therefore the money should be taken out and taxed. I think the right way around that is simply to tax the pensions, if the money is still there at death, and then the receipts would be taxed.

But it is an extremely complicated law, this minimum distribution law. It forces people to "dis-save" when we are trying to get the country to save. It really makes no sense whatsoever. I am not sure if this is an answer to your question, but it will maybe clarify the differences between Professor Ghilarducci and myself. Her view, I think, is that human nature is worrisome and, we can't trust that people will make the right decisions for themselves. And certainly there are some cases where that is true.

My view is that human circumstances are incredibly heterogeneous and that the people actually can make better decisions for themselves than the government can make for them. In both cases people make mistakes, but I think that it is better, once you have established a fair system with integrity to let people make their own allocation decisions rather than have the government say you should do this and you should do that and you must save in a pension and so forth.

So I think those are the philosophical differences that you are hearing. It is probably a philosophical difference between the two sides of the aisle, but I just wanted to highlight that. I hope that the minimum distribution requirement can receive bi-partisan opposition.

Professor Ghilarducci. Okay. I am for people making their own decisions; it is the only way you learn. But it should not be individually directed. Voluntary accounts should not be the basis for our employer, work-based system.

In the few studies about how women and men differ in terms of their investment, they found that women actually get a higher return on their 401(k) accounts than men do. Why? Because women don't trade. So what we think are good practices, employers having lots of bells and whistles, 24-hour access, 30 funds to choose from, actually can be a tyranny of choice and in fact it encourages more trading and you just lose your rate of return on trades.

The more important, more fundamental question you raise, I talk about it in my written testimony. And it is very hard to talk about it because it is a massive shift in the way workers and employers are dealing with each other. I have talked about and you did too, that employers that can afford whatever complex regulations there are, can certainly afford a lack of cross trading, and just are not providing social assurance for their workers.

The commitment to the worker is gone. Even in cases where it makes sense. Even Microsoft workers stay longer than a month. I don't think it is government regulation that is the answer. It is, workers themselves demanding more from their employers. Every article about the expansion pointed out that despite the expansion, despite profits, workers aren't getting higher wages, aren't getting health insurance, and aren't getting pensions. Why?

It seems as though employers can compete without delivering up those benefits. So I would hope that if you do anything, that ERISA rewards the good employers and protects them from the competitive practices that undermines our system of good practices.

Chairman Boehner. Mr. Talent.

Mr. Talent. Thank you, Mr. Chairman.

Professor Ghilarducci, didn't you say in your testimony that real wages have been going up and that is the problem? Employers have been putting the money into wages rather than into pensions.

Professor Ghilarducci. No.

Mr. Talent. Isn't that indirectly in response to the preferences of the employees, which you said you don't like, but nevertheless the employers are being responsive to that because they are trying to get the employees? See, if they adopt the same paternalistic attitude you do, they don't get the employees, because those people will go someplace else. Although I agree a little bit with your paternalism, I didn't mean that as critical as it sounds. Go ahead.

Professor Ghilarducci. Yeah, it seems as though workers that are free agents that negotiate on their own, are being offered compensation packages that have mostly money, not insurance. So real wages aren't going up as a proportion of paid wages that are going up. That is really interesting. Executives and clerks are the fastest growing occupations that are just paying money.

In union cases where workers get together, look to the long-term, and have a fixed contract, the behavior is completely reversed. It seems as though when workers and employers get together, they can actually put human nature in a good track and say, we have to defer gratification a bit, lock in my pensions, and lock in my health insurance. That is what I was pointing at.

Mr. Talent. You know it could simply be that areas of the economy that tend to be unionized are those that are more amenable to these kinds of pensions. See, I am familiar with how the small business sector works. I am the Chairman of the Small Business Committee.

Professor Ghilarducci. Yes.

Mr. Talent. And I talk to hundreds of small business people and I will tell you that a government regulation is something that they are very concerned about. I wonder if anybody has ever quantified the cost of that concern, or in other words, "monetized" the value of that. They are so concerned about any field that is heavily regulated because they don't have the resources to deal with it, or to anticipate what changes might occur.

And I just feel very strongly that what we are doing is creating a distortion in compensation packages for small business people away from pensions or savings towards up front wages because it is just much easier, and it is much less risky to pay in the form of wages than it is in the form of pensions. So to the extent that employees want the pensions, all the regulations have put small businesses at a tremendous competitive disadvantage in getting good employees, vis-a-vis larger business, because they can't offer as much.

Would anybody like to comment on that? It is one of the reasons I like your ideas, Professor Shoven.

Sure Mr. Gordon, go ahead.

Mr. Gordon. Well, I also have spent a good part of my career legally servicing small business clients. And as I point out in my testimony, I think the biggest problem, aside from government regulation, is the sheer volatility of their existence. For every new small business that is created annually, maybe two or three go out never to come back again. And we need to be concerned about this, much more than I think we have been, because it also turns out that just about two out of every three new jobs are created by the small business sector.

If we don't try to find some type of solution to the coverage issue for small business then I think that we are going to really have great difficulties in the coming decades on this. Now I agree that I think something needs to be done about the reduction of complexity and burdensomeness, particularly paperwork burdens. This has been going on for a long time. But maybe one of the ways of resolving this is to switch the model so that instead of relying so heavily on the individual small business employer or entrepreneur to carry this burden, we have some other type of system.

That is why I think that we ought to look into some type of tax-qualified, through the statute, multi-employer small business model. It should go way beyond the master prototype plans that have been merchandised by the industry over all these years, but the small businessperson still would have to take on some burden, and some risk which is a problem to them.

Mr. Talent. If you have withdrawal liability in there, you can just forget it. They won't do that.

Mr. Gordon. No, you don't need withdrawal liability in it. You don't need withdrawal liability, anymore than you have withdrawal liability in TIAA/CREF.

Mr. Talent. Okay.

Mr. Gordon. You don't need that.

Mr. Talent. If there is some voluntary means where they could pool that is set and secure, they might be very interested in it.

Mr. Gordon. Yes.

Professor Shoven. If you have 15 employees and you want to offer a pension, the costs of complying with the regulations are prohibitive. Certainly for a defined benefit plan, but even a defined contribution plan you have the non-discrimination test which is a costly thing to comply with. The plan that I propose is that every feature of your plan be available to every employee. A simple plan would be much more cost effective and allow this firm with 50 employees to offer a pension. I think there is real concern with the small employers.

Let me just raise one other thing that Professor Langbein mentioned at the beginning that I think the Committee wants to address somewhere along the line. We are relying now more on individual participants to manage their own finances, and we need to look at whether any of the regulations are causing people to hesitate to provide advice, and whether this is appropriate. I think there are situations where people who are in a position to give advice are afraid to because of the legal consequences of giving this advice. I think the whole general subject of providing advice to people with individual accounts is an important area.

Professor Langbein. I want to follow up with Congressman Talent, on your remark about withdrawal liability and how devastating it has been. This was Congress' low point in ERISA in my judgment, coming back and hitting up a bunch of people who thought they paid their bills and now were required to pay twice. And the result is that it really sounded the death knell of the multi-employer system. Multi-employer plans are still out there, but you are not having new formation in any significant way in the multi-employer sector.

Title IV of ERISA, which created the Pension Benefit Guaranty Corporation, basically killed off new defined benefit plan creation and limited it to large firms. There was a way to have avoided that. There is a deep sense in which Title IV was unnecessary. Sometimes if I want to be provocative I will say that PBGC is the single silliest government agency ever created because it addresses a non-problem.

It is addresses the problem of what you do when plans terminate and are under funded. And the question that Congress should have asked and didn't because it was kowtowed to by Labor Unions in the 1970's is why let under funding be created in the first place?

It is the creation of past service credits systematically, almost always under collectively bargained plans, which gets these plans under funded and creates the risk. We could have had a defined benefit plan world, which would have worked for small employers, if we had not gone the path of pension insurance. But I think that that is past and I don't think that we can reopen that at this point.

And that is why we are left with these defined contribution plans as the only vehicles practically available to small employers. There is a very important statistic, Peter Drucker used to quote and I never knew where he got it. I am not above believing that he could have made it up just to be helpful to us all. The statistic is that 70 percent of all businesses are at any one time, failing businesses. The point being that this is not somebody that you want to look to, long-term, as your pension paymaster.

We have to get the pensions off the balance sheets of the companies. Which is why you get driven either to these devices we have, the defined contribution, or the defined benefit plans with separate trusteeship.

Mr. Talent. Mr. Chairman, could I ask just one more question? I think it bears on this.

I wanted to ask Professor Ghilarducci and anybody else who wants to comment. I tend to agree that the government needs to be involved. I mean we are involved, heavily now, in trying to create a retirement safety net for people precisely because through good circumstances or bad there are too many people who won't or can't take care of themselves and provide for their own retirement.

But this is why we have social security. This to me is the big thing looming in the background that we haven't picked up here. Fourteen percent of people's compensation goes automatically to social security. Now the Congress is eventually going to address that with how we are going to try to make that system better and more productive. But given that we have that amount of money federally mandated and going to insurance, it doesn't make sense to say, okay, that is what we have to take care of the problem you are talking about.

And we can afford to be more generous and allowing people freedom over the rest of their retirement because we have this. If we eliminated that and said we want to go to a model where we just have mandated, private insurance accounts, then it seems to me you are absolutely correct. We have to say at least a certain percentage of those accounts we are going to watch how you manage because we don't want you investing your retirement security in the lottery, for example, or something like that.

Professor Ghilarducci. If you want to stay in the middle class in your retirement, you need a supplement to social security. Social security keeps you above the poverty line, if you are a low-income worker. So that is why there is the demand for safety on that tier. On top of that tier, the supplement to social security, is this tier that we can play around with, invest when we want, and invest the way we want.

But I think the problem here is not so much about advice or about allocation or even cost of transactions, as it is actually about getting over 50 percent of the workforce who doesn't have a supplement, into something. This is why I go back to the McDonald's example. Now that is a large corporation. They spend their money on getting people in, just making sure they have 100 percent.

But there also are, Professor Langbein, multi-employer plans whose networks are being created now among small employers with peripatetic workers in Silicon Valley. It would be interesting for us to see what some small employers, probably geographically, are doing because they feel responsible to their workers, and they know a stable work force, if they are connected to a region and are secure. So these multi-employer plans actually shouldn't be dismissed. They are very interesting for small employers that are undercapitalized with skilled workers that go from job-to-job to actually get social insurance.

Also we should note that we are not seeing a real wholesale substitution of defined benefit plans for defined contributions. Most employers, who do provide some coverage for their employees, provide both DBs and DCs. The small business world, though, is different. I am talking about the large employers there.

Mr. Gordon. I would like to shift back to a question that was raised by Mr. Petri on the bureaucracy, if I may. I am disturbed, notwithstanding my vigorous defense of the prohibited transaction system, over bureaucratic foot dragging delays, and other problems of that nature whether they take place in connection with prohibited transaction exemptions or in other deals as well. Obviously the statute was meant to be administered in some type of efficient manner and if it is not being done that way then that is a problem independent of whether the principles on which the statute is based are sound or not.

At one time it was proposed, I think in the late 1970's, that there be a time limit for going up or down on prohibited transaction exemptions by the Department of Labor. One couldn't take forever to do it. There are problems with that as well, because there may be certain circumstances where the complexity and the nature of the prohibited transaction exemption request is such that it requires more time than a routine petition would require.

Still it seems to me that some kind of effort ought to be made to review the exemption process itself and see what the problems are. I mean it has been 25 years. How long has this cross trading petition been pending with the Department of Labor? It has not been just for 60 days or a year; I think it has been even longer than that. If there are problems that the Department of Labor has, then they ought to be forthright and come right out and find out what it is so the parties can sit down and see if there is a viable basis for an exemption.

But just hiding out on this subject for months and months on end, that is indefensible. And this Committee in performing its oversight function, I hope, will get into that.

Chairman Boehner. We certainly have them here over the next several months and that issue will be raised.

As an employer myself who has set up both a defined contribution pension plan and defined contribution profit sharing plan for four employees at the time, I know firsthand the expense that was involved in making that decision and in proceeding with it. I was of the view, when I set my plans up, that to set up a defined benefit plan for my employees probably was not an honest calculation on my part.

But I, as a small employer, would be around for 75 years to guaranty that they would get the benefits that I was promising them. And I frankly made the decision that putting the money into their own accounts for them to assist in directing the benefits was the most honest thing that I could do as an employer and the best thing for them. They could watch their accounts grow. So I am a big believer of defined contribution plan.

We all like to believe that companies ought to have some social responsibility and provide for an employee for the rest of their lives, but what company today can honestly look their employee in the eye and say, I will be there for you, that far in advance.

I think it is a pipe dream. Now having said that, Professor Shoven, you mentioned in your testimony that you thought the decline in defined benefit plans had to do with the complex rules associated with them. I want you to elaborate a little bit more on that.

Professor Shoven. Well, I do think that that is one of the reasons for the declines. The rules are extremely expensive to comply with. I have looked at small employers where the cost of compliance is comparable to the money that you are actually giving the employees. Giving a dollar to the employees costs two dollars when you take the compliance into account. So for a small employer it doesn't make sense.

I actually don't think we are going to go back to a defined benefit world. We should make the playing field more level so that defined benefit plans have a possibility of being introduced, but I think with the rate of change in the work force, the interest in portable benefits, and the participation in equity markets that people seem to prefer, I don't think we are going to go back. I think we should actually have a level playing field, and we should design our program for the reality that the defined contribution system is probably the future.

Chairman Boehner. So your point is that the current rules, in your view, tend to push people away from defined benefit plans towards defined contribution plans?

Professor Shoven. Let me give you an example. If you have a defined benefit plan, let us talk about the anti-reversion rules. You fund your promise and if the assets perform poorly you of course have to put more money in. If the assets perform well, you can't claim the assets. If you are over funded you can't reclaim them or at least not without an almost prohibitive tax.

So you look at that and you say, well I don't want to get into this game. Why would I want to get into a game where if I lose, I lose, and if I win, I don't win? So there is a number of factors like that which employers say is just not worth getting into that business. We have already, in my view, killed new entrance into the defined benefit world. If we regulate them further, well, it will just kill them all the more.

Chairman Boehner. Mr. Gordon, would you have a comment on that?

Mr. Gordon. Well, I don't place the great emphasis on over regulation or complicated regulation as being the reason why the defined benefit universe has faded. I am not saying it hasn't played a role, hasn't played a factor, but I think that there are problems as far as small business is concerned, which you have eluded to, Mr. Chairman, that would have existed even if there had been much less complex regulation.

And it was right for the Congress and ERISA to insist that these plans be funded in some type of reasonable way and that is a commitment that many small business people simply can't make regardless of PBGC. It is a fact of life. I think that the reasons for the decline of defined benefit plans are much more related to the changes in our national economy, principally the shift from manufacturing to services. Most of the older established defined benefit plans, which relied on a long-term, permanent, loyal work force over a large, large period of years, were in the manufacturing sector.

That is where the bell weather blue ribbon plans were created and established and everybody copied them. That is where trade unions were the strongest. We also have a decline in the trade union movement. It is very clear. And so those are two major factors. The growth of the services sector of the economy and the new kinds of employment patterns that we are seeing there, don't really lend themselves to defined benefit plans.

The historic function of the defined benefit plan was to provide past service. That is service that was earned by the employee before the inception of the plan. And it was designed to assist older, loyal, long-time workers, so that they could retire with dignity for all their years of service. Otherwise, there really isn't that much of a big difference between defined benefit plans and defined contribution plans.

The one thing that defined contribution plans could never do, is provide past service. It would have bankrupted the employer at the inception. So that was the genius of defined benefit plans. Now if you are no longer interested in having a work force of a permanent long-term nature, and the more you shift to the services sector of the economy, the more that becomes the name of the game, then defined benefit plans aren't as functional for that sector of the economy as DC plans.

And I don't think that we should get all, you know, upset about it. I think we should change complexity if it is too complex just for the case of making it less complex. But I don't think we should worry about whether it is going to have a good impact on defined benefit plan formation or not. And I think Professor Langbein is right that we have to do much more to see to it that employers are relieved of unnecessary burdens, which could be handled by professionals in the 401(k) area. And if the rules promoting greater diversification of 401(k) plans are strengthened so that will happen, that will encourage greater protection for workers.

Chairman Boehner. Mr. Andrews.

Mr. Andrews. Thank you, Mr. Chairman.

First, Congressman Holt has two questions, which, without objection, I would like entered into the record.

Chairman Boehner. Without objection, so ordered.

Mr. Andrews. Thank you.

Second, although I would disagree with Professor Langbein's characterization of PBGC, I understand the spirit of his point. I think the PBGC is an essential redundancy in the system that adds a layer of protection that is quite necessary.

I am very interested in the idea that Congressman Talent put forth and several panelists responded to about some sort of voluntary pooled approach to small business plans. I would suggest that we have two models for this. One is the prototype plan that already exists, where one can get very expedited approval by submitting a prototype plan. I think we can build on that and create a national prototype plan that could be voluntarily joined by an employer who would have the benefits of great portability for the employee. I do concur with Congressman Talent's point that a disengagement tax or cost would doom the prospects of such a plan. But I think the idea of creating a voluntary, complimentary, not replacement, but complimentary system to social security is a very intriguing idea that would probably win support on both sides of the aisle.

The question that I wanted to raise was if we assume for the sake of argument, and I know the Professor would not want to assume this, that we still have prohibited transaction pools and our mission were to improve the exemptions process to make it work better, more efficiently and fairly, what suggestions do the panelists have to improve the exemption process? And I would be interested in your responses now and certainly in your written responses down the road.

Chairman Boehner. Professor Langbein.

Professor Langbein. I think I will pass to Mike Gordon on that. I just don't hang around Washington enough to know which little finger I would stick in that dike.

Mr. Andrews. I fully understand. I do understand.

Mr. Gordon. You see the problem with Professor Langbein is he never had to work up here. He doesn't realize that he has been given a command. I take it as a command. I am not sure. I think there are two areas that have to be looked at, even if they have been looked at before, they now have to be looked at again. One is why does it take so long?

Why can't things be speeded up? What is the problem? Is there a huge backlog and what is the reason for the huge backlog of petition requests? Why can't some of these be consolidated more frequently into class action treatments and so on? And so the first question is one of time. And I think that probably things could be done in that area to try to speed up the response of the agency, but I would like to hear what their problems are.

The second thing and maybe more important is, in areas that give them real problems, instead of holding hearings and waiting for comments before they move, whether or not it would be desirable for them to propose earlier on, more specifics outlining the problems rather than trying to guess what the problems are. And outline some of their proposed alternative solutions and then have comments brought forth.

Mr. Andrews. I would just note for the record, our data indicate that 51.75 percent of the class exemptions take over 18 months to resolve. That is an eternity.

Mr. Gordon. That is too long.

Mr. Andrews. It is a very serious problem.

Mr. Gordon. It is too long.

Mr. Andrews. Professor?

Professor Shoven. Other than agreeing it is too long, I don't have anything specific.

Professor Ghilarducci. But I want to point out that I think that the voluntary small business networks are the way to go. That would take some creative solutions.

I also want to point out, Mr. Chairman that you contributed to your employees defined contribution plan.

Chairman Boehner. I contributed all of it. There were no employee contributions.

Prfoessor Ghilarducci. And most participants of 401(k) plans don't have employer match, and don't have any employer contributions. So not all DC plans are alike.

Mr. Andrews. The Chairman has always been very liberal in every respect.

Chairman Boehner. Generous.

Professor Ghilarducci. DCs are good, they make sense, and workers like them especially when the stock market is going up. If we had this hearing within six months of a decline in the Dow and the S&P 500, it would be a very, very different hearing. We would be talking about expanding PBGC or FDIC coverage for DC plans. We would be talking about Mr. Kildee's constituents all over the country that have failed promises. And we probably should anticipate a crash in the stock market when we do pension reform.

Mr. Andrews. I am glad she is not Alan Greenspan. Could you answer my question, though?

Professor Ghilarducci. No, I don't know. Sorry.

Chairman Boehner. I think that last comment we will make off the record. Just kidding! Let me just say, does any other Member, Tim?

Mr. Petri. Quick question. Speaking of a switch from defined benefit to defined contribution, we did that with the federal employees recently. We talk about small employees and their problems and networking, what would be wrong with just opening up the federal retirement system to everyone who wanted to participate in it in America and let their employer put money in and then it is protected? It has indexed accounts, there are limited options, we are watching it closely and it would be low overhead.

I suppose, if we are worried about transaction costs and middle men costs and regulatory costs, none of those would exist, would they, if we were to do something simple like that? Maybe there is something really wrong about it, but I would like to know what it is.

Professor Shoven. Well there are private sector defined contribution accounts that can compete with that plan on cost and everything else. I, myself, am in a defined contribution plan with a total cost of six basis points and I challenge anybody that has a more efficient one. But let me just comment on the question of choice between defined benefit and defined contribution.

I am actually Chairman of compensation of a major Silicon Valley company and we are in a very tight labor market and we have to decide what it takes to attract employees. If our company were to offer a defined benefit pension plan that would be of very little help in attracting employees, whereas a 401(k) plan with a match helps. I just cannot imagine, at least from sitting in Silicon Valley, how the defined benefit plans can compete in today's labor market.

Chairman Boehner. Mr. Kildee.

Mr. Kildee. Thank you, Mr. Chairman, just one question here.

To what degree does the Financial Service Modernization Act, which Congress passed recently not with my vote, create greater opportunities for conflicts of interest within financial supermarkets? I am particularly worried about the effect of these conflicts on the investment advice workers and retirees receive and can ERISA be strengthened to protect fund beneficiaries from these conflicts? Anyone.

Professor Langbein. Well, the existing structure is, in my judgment, too protective. That is we are protecting workers from learning anything when we are talking about the defined contribution world. And that is indeed the problem.

The Labor Department has interpreted the language of investment advice in Section (321) in ERISA and related provisions in the (400)'s to prohibit any kind of tailoring of advice to give people real close guidance on the life cycle. On why it makes sense in a particular circumstances to have a lot of equities when you are young and then how you move out as you get older in life. You have less chance to make it back if markets go down and therefore you need to move away from it, as you get older, and things of that sort.

Particularized to the circumstances of individuals, their other assets, other income in the family, and things of that sort, you need to work with people in defined contribution plans to help them tailor an investment program. Even within the choices that are available. And what is wrong is that right now we treat that as a fiduciary function and there is a lot of fear in the employer community that, if there is a down market, people who follow this kind of guidance will turn around and treat the employer or other provider as a fiduciary under ERISA and there will be serious litigation costs and liability risks.

So the concern I think is very broadly held by employers who have the right motivation here, which is to try to help their employees get better investment returns. Right now they are basically prohibited from doing it. They are prohibited from doing it directly, and they are prohibited from doing it by having an investment intermediary come in because the investment intermediary runs up against these same rules.

So that is the spirit in which my initial suggestion this morning was directed. I do not believe that the growing homogenization of financial services bears on this particular problem. This is special to the justified naiveté of most workers with investment products. Most people have better things to do than sit around and watch the ticker tape. And I don't fault them for that. I think that we ought to be running a system which is more friendly to helping unsophisticated individuals stay unsophisticated and still make intelligent choices.

Mr. Kildee. Anybody else have any comment?

Mr. Gordon. To a large extent it depends upon what role the SEC is going to play in connection with regulating the activities of those involved in either investment management or investment advice. But obviously what was referred to as the homogenization of financial institutions could lead to even more conflicts of interest rather than less. I mean the potential for it is there. One of the reasons why the pre-modernization era created basic walls between various kinds of institutions was because there had been bad experience during the Depression with conflicts of interest.

And as recently as the S&L disasters we found out that one of the reasons for the S&L disasters was because of imprudent insider transactions, loans and that sort of thing. So it is a potentially worrisome thing. The real question is, insofar as it comes up in an ERISA context, is the ERISA exemption procedure up to dealing with the issue in a realistic, pragmatic way? That is the real issue. If it is, then it can discriminate between those situations, which are really potentially abusive and need to be controlled more tightly and those, which are not. It shouldn't be left up to the industry to decide unless there is strong evidence that the role of the SEC is sufficiently vigorous that it will take care of these issues.

Right now we don't know the answer to that. As far as the investment advice issue that Professor Langbein is concerned about, it does seem to me that we ought to find ways to permit employers to delegate the investment advice function in such a way as they do now in connection with regular, defined benefit plans to registered SEC investor advisors. They can clear the way from financial responsibility by delegating to a registered SEC investment manager.

Now we may not be able to come up with precisely the same type of technique in connection with 401(k) plans, but there is no reason why we can't see if we can provide an avenue for them to delegate to experienced, approved investment counselors as advisors to help these participants in such a way without bringing down the roof.

Professor Shoven. It is not just the employers that are hesitant to give advice. It is also what you might call the managers of these new financial supermarkets.

At Schwab, for instance, you can buy 4,000 different mutual funds, but the company is extremely hesitant to give advice because of the fiduciary consequences in doing so. And we need to look into exactly how we can get advice, and how it can be more easily attainable to people who are managing their own money.

Professor Ghilarducci. The best think employers can do is get workers into the funds, to get them contributing and then the basic advice that they give them actually works. Frito Lay just won an award because they put the advice in a plastic bag. Thirty other companies won an award from Pension Investment Magazine for other creative ways that they are getting the advice message out to workers to save and to split it between risky and non-risky. Saving in the first place is where you get most of your money anyway by making the right allocation.

And then after that, which of the 4,000 funds you are going to put your money into is such a small part of saving for retirement. So for employers the best function is not to give the right advice about what mutual fund to choose, but to get employees into the plan.

Chairman Boehner. I want to thank all of the witnesses for their valuable time and their testimony today and thank my colleagues for their active participation. These hearings will continue over the next several months.

If there is no further business, the Subcommittee will stand adjourned.


Whereupon, at 12:10 p.m., the Subcommittee was adjourned.