Serial No. 106-95


Printed for the use of the Committee on Education

and the Workforce

Table of Contents


















Thursday, March 9, 2000




Committee on Education and the Workforce


Subcommittee on Employer-Employee Relations


U.S. House of Representatives


Washington, D.C.

The Subcommittee met, pursuant to call, at 10:30 a.m., in Room 2175, Rayburn House Office Building, Hon. John A. Boehner, Chairman of the Subcommittee, presiding.

Present: Representatives Boehner, Petri, Fletcher, Andrews, Romero-Barcelo, Tierney, Wu, and Holt.

Staff present: David Frank, Professional Staff Member; Christopher Bowlin, Professional Staff Member; David Connolly, Jr., Professional Staff Member; Amy Cloud, Staff Assistant; Patrick Lyden, Professional Staff Member; Deborah Samantar, Office Manager; Michele Varnhagen, Minority Labor Counsel/Coordinator; Peter Rutledge, Minority Senior Legislative Associate/Labor; Woody Anglade, Minority Legislative Associate/Labor; and Brian Compagnone, Minority Staff Assistant/Investigations.

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 ERISA reforms that would make retirement more secure for American workers. Under Committee Rule 12(b), opening statements are limited to the Chairman or Ranking Minority Member of the subcommittee. This will allow us to hear from our witnesses sooner.

With that, I ask unanimous consent for the hearing record to remain open for 14 days to allow member's statements or witnesses' written testimony and other materials to be submitted for the record. Without objection, so ordered.

This is the second in our series of hearings on how ERISA needs to be updated so that its future can be as successful as its past. In our first hearing, the Subcommittee heard from a number of national experts on what changes are necessary to make ERISA's regulatory structure for investing pension assets, both defined contribution and defined benefit plans, more secure and productive.

We heard about the growth of defined contribution plans and the increased responsibility that means for individuals. We heard about areas of regulation that may be redundant and may needlessly prevent individuals and plan sponsors from making investments that might otherwise best suit their needs. And we heard about two global shifts in our economy, from stagnation to growth, and from large employers to small employers, and about what these shifts mean to our Nation's overall retirement security.

Today and tomorrow we are here to listen to more ideas about updating ERISA for the new economy. We will hear new perspectives on how to provide employees better access to sophisticated investment advice, and we will hear some ideas for structural reforms that will make the system more efficient and save retirees money while preserving the safety that has been ERISA's hallmark.

The stock market's roller coaster performance over the last few weeks has been strong evidence in particular for helping employees get more sophisticated investment advice through their employer and elsewhere. Defined contribution plans, and the employee's investment responsibility that goes with them, are clearly on the rise. And, in addition, nearly one in two Americans have invested in equities in some form, and we also know that that number is on the rise.

Both trends show that workers don't want to be left behind the kind of strong, long term stock market growth we have seen over the last 18 years, but they also show that when individual stocks rise or fall as quickly as they have over the last few weeks, workers planning for their retirement need more specific investment education and advice. They need education on how to allocate their retirement savings, but many workers also would like specific advice on stocks and mutual funds and other investment opportunities that go beyond generalizations.

They can pay for this themselves, of course, if they can afford it. But if employers want to make high quality investment advice available to their workers and the law says they can't, then there is a problem, I think, with the law. A law that now prevents workers from receiving adequate investment education and advice is not protecting workers.

I also look forward to hearing other ideas on how to make the underlying regulatory structure more efficient and more able to preserve retirement security in response to changing market conditions and opportunities. With the power of compounding interest, a dollar saved today means $17 that is available for a worker who retires in 30 years, and $45 for a worker who retires in 40 years. If we can streamline our regulatory system in ways that increase efficiency and continue to preserve security, we should.

As has been and will be the case throughout this project, this hearing certainly has been bipartisan. We have made every effort to accommodate our colleagues on both sides of the political aisle, and I look forward to continuing to work with my colleagues as this process continues.

I would now like to yield to my distinguished Ranking Member, the gentleman from New Jersey, Mr. Andrews.







Mr. Andrews. Thank you, Mr. Chairman. Good morning.

We have every reason to be hopeful and optimistic this morning. Advances in medical technology, environmental protection, nutrition, give us reason to believe that Americans are going to live quality lives for many, many years. The idea of our children living to be 100 years old and living a quality life is well within our grasp, and that is wonderful news.

With that news, though, there are some responsibilities for rethinking our financial system as to how people support their economic needs when they retire. Chairman Boehner is to be commended for thinking about those questions and the legislative responsibilities we have in response to those questions in this series of hearings. He is correct that both the spirit and the reality of this process has been bipartisan and has been truly designed to try to find good answers to these questions. I commend him for that and support his continued efforts.

This morning we are interested in some specific questions that we look forward to the ladies and gentlemen on the panel addressing. As the Chairman said, one of the phenomena of recent years has been more people holding more self-directed accounts; that is to say, more people making more decisions that will be critical for their financial health for years to come.

I think that is a very good thing in many ways, but it is a development that is not without risk and new issues. One of the specific issues we would like to hear about this morning are the present set of laws and rules which govern the giving and receiving of investment advice. Are there adequate safeguards for those who receive the advice? Are there undue restrictions on those who would give it? Is there a proper allocation of responsibility and authority between those parties? What might be done to facilitate and enhance both the quality and availability of that advice that is offered to people?

There are other questions that we look forward to, but I think all of them fall into three general points: The first is, how can we build on the existing success of ERISA and make pensions even safer than they are today? How do we build on the tremendous progress that has been made in the 26 years since the law was signed?

The second question is, how can we expand pensions and have more people share in them? How can we encourage more employers to fund and maintain more plans for more people?

And then, thirdly, I think we need to focus on the question of how we can encourage optimal and safe performance for pension plans. How can we reduce unnecessary administrative costs? How can we cut through the thicket of any unnecessary burdens? But, also, how can we maintain the protections that have made ERISA what I believe to be an unqualified success over the last 26 years?

So I appreciate the chance to hear the distinguished panel this morning, and would again thank the Chairman for having this hearing.

Chairman Boehner. Thank you, Mr. Andrews.

For those of you who may not be familiar with the buzzers that went off, those five lights indicate that the Members have two votes on the floor of the House and we have approximately 9 minutes before the end of the first vote. And to be fair to our witnesses and to have a more organized hearing, I think it would be more appropriate that the Members now go to vote, and we will resume in approximately 20 minutes. With that, the Committee will stand in recess.





Chairman Boehner. If everyone would take his and her seats, I think we will resume. There could be a number of votes on the floor today, and we don't want to waste any valuable minutes.

It is my pleasure to introduce our witnesses, and let me thank them for their efforts to come here and to give us their testimony and their advice. Our first witness today will be Mr. Allen Reed. Mr. Reed is the President of the General Motors Investment Management Company. Mr. Reed will be testifying today on behalf of the Committee on Investment of Employee Benefit Assets (CIEBA) of the Financial Executives Institute.

Our next witness will be Mr. Daniel P. O'Connell. Mr. O'Connell is the Corporate Director of Employee Benefits and Human Resources Systems for United Technologies. Mr. O'Connell has been with United Technologies Corporation since 1978, and is testifying today on behalf of the ERISA Industry Committee (ERIC).

Next will be Mr. Damon Silvers. Mr. Silvers is an Associate General Counsel of the AFL-CIO. Mr. Silvers responsibilities at the AFL-CIO include issues involving benefit fund investment policy, corporate securities and bankruptcy law, mergers and acquisitions.

Following Mr. Silvers will be Professor Joseph Grundfest. Professor Grundfest is a Professor at Stanford Law School and a cofounder of Financial Engines, Inc. Financial Engines is an internet-based investment advisory service.

The next witness will be Eula Ossofsky. Ms. Ossofsky is the President of the Board of Directors of the Older Women's League. She currently serves on Governor Angus King's Elder Advisory Committee, as well as on Congressman Tom Allen's Senior Advisory Committee.

Our sixth and final witness today will be Margaret Raymond. Ms. Raymond is the Assistant General Counsel at Fidelity Investments. She will be testifying on behalf of the Investment Company Institute (ICI).

Before our witnesses begin, I would like to remind the Members that we will be asking questions of the witnesses after the complete panel has testified. In addition, Committee Rule (12) imposes a 5-minute limit on all questions.

I would like to invite our witnesses to testify. There is a timer in front of you. It will be set at five minutes. We would like to ask our witnesses to summarize their testimony. If you go a little longer, you are not going to get your head taken off. Don't worry.

With that, Mr. Reed, you may begin.





Mr. Reed. Thank you. Good morning, Mr. Chairman, and ladies and gentlemen of the Subcommittee. My name is Allen Reed, and I am here on behalf of CIEBA, the Committee on Investment of Employee Benefit Assets of the Financial Executives Institute. CIEBA is an organization representing 140 of the largest corporate pension funds in the United States. Our membership consists of corporate financial officers who administer and manage, as fiduciaries, the investment of over $1 trillion in retirement plan assets on behalf of 15 million plan participants and beneficiaries.

I would like to begin my comments by saying that the fiduciary rules defined in 1974 by ERISA have actually worked quite well. Today, however, I would like to focus on two specific areas of concern to CIEBA members. First is the availability and importance of investment advice to participants in defined contribution plans; and, second, the application of the ERISA prohibited transaction rules, and in particular with respect to an activity referred to as cross trading.

In the 4-year period ending December 1998, the number of participants in the defined contribution plans of CIEBA members alone increased from 4.6 million to 5.3 million, and the assets in those plans doubled from $234 billion to $471 billion. This indicates the average participant account grew from $51,000 to $89,000, and with the strong returns in 1999, the average account balance is likely approaching $100,000 at the beginning of this year.

Now, rising rates of "DC" plan participation and increasing contribution rates suggest that these accounts are certain to become larger and more important to our plan participants in the future. Given the importance of these plans, it is not surprising that the most frequent question asked by plan participants is, "how should my funds be invested?"

In response to this need, the vast majority of plan sponsors provide some form of investment education to their employees. However, employers are careful not to provide investment advice because of the fiduciary risk that is related to providing such advice, and also the recognition that investment advice is best provided in the context of the facts and circumstances surrounding the individual plan participant. In short, plan sponsors have done an excellent job of providing investment education, but obtaining investment advice is still the responsibility of the plan participant.

In recognition of this need, CIEBA urges Congress and the Department of Labor to find a way for participants to be able to retain their own investment advisors. It is our belief that plan sponsors would not be reluctant to make advisory services available to their plan participants, provided they were protected from the liability related to such advise. Also, to encourage plan participants to seek investment advice, they should be allowed to pay for advisory services by payroll deduction on a pretax basis.

Now, let me turn to the second issue that I would like to bring to your attention, and that is the application of the prohibited transaction regulations. While these rules have been effective in discouraging abuses, they have also had the effect of restricting the investment opportunities available to ERISA plans.

A very good example of the problems sometimes encountered in the application of these rules is the current controversy over cross trading. Where a fund manager has two accounts, one wishing to buy a security and the other wishing to sell the same security, the manager would prefer to cross the trade between the two accounts rather than going to a broker and transacting two separate trades, each with its attendant transaction cost.

Under the current prohibited transaction rules, such a transaction is not permitted for an ERISA account. CIEBA estimates that denying cross trading opportunities to plan participants results in additional costs of about $500 million per year for the U.S. equities alone, which of course represents only a segment of the overall securities market.

It is clearly our belief that the benefits of cross trading clearly outweigh the potential risk. However, the Department of Labor has thus far been unwilling to provide an exemption to the prohibited transaction rules that will allow plans to fully realize the opportunities for cost reduction through cross trading.

On the other hand, the Securities and Exchange Commission allows mutual funds to engage in cross trading subject to appropriate policies and procedures. The result of the two different regulatory standards is that a manager can cross trade for mutual fund accounts but is required to exclude ERISA accounts from such transactions.

In summary, CIEBA would like to see the prohibited transaction rules applied in a manner that evenly considers the benefits and risks associated with certain transactions, and an exemption process that is more responsive to the wide range of investment activities available to ERISA participants.

In closing, I would like to express my appreciation for the opportunity to discuss these issues before the Subcommittee, and I look forward to working with Members of your Committee as you further consider ERISA reforms. Thank you.




Chairman Boehner. Mr. O'Connell?




Mr. O'Connell. Good morning. My name is Dan O'Connell, and I am the Chairman of the ERISA Industry Committee, generally known as ERIC, which is a nonprofit association committed to the advancement of the employee benefit plans of America's major employers.

In this statement I will focus on ERIC's proposals regarding the Pension Benefit Guaranty Corporation (PBGC) and on issues regarding investment education and advice provided by sponsors of defined contribution plans. Other issues are addressed in ERIC's written testimony, which I ask be included in the record in its entirety.

In establishing the PBGC, Congress ordered the agency to do three things: first, encourage the continuation and maintenance of voluntary private pension plans for the benefit of their participants; second, provide for the timely and uninterrupted payment of pension benefits to participants and beneficiaries under defined benefit plans; and, third, maintain premiums at the lowest level consistent with carrying out its obligations.

Today the PBGC's failure to use realistic assumptions in measuring its own financial condition and the liabilities of single employer defined benefit plans, and its failure to provide guidance regarding its practice of intervening in business transactions, jeopardize the first and third of these statutory mandates.

As a result, employers are forced to pay to the government money that would otherwise provide additional benefits and administrative assistance to plan participants.

Employers are also forced to pay variable rate premiums, and to notify participants that a plan is under funded when in reality the plan has sufficient assets to pay plan liabilities.

Participants and beneficiaries of plans that the PBGC is trustee of receive fewer of their non-guaranteed benefits because the PBGC assumes that a greater portion of available plan assets must be reserved to pay benefits guaranteed by law.

Parties to a business transaction that pose no real threat to retirement security are forced to allocate plan assets in a manner contrary to economic reality, or are prevented from transferring pension liabilities when it is in the employees' interest to do so.

And industries engaged in multiple business transactions, which today covers virtually every industry, are increasingly reluctant to sponsor defined benefit pension plans.

This situation has come about because the PBGC uses outmoded and inappropriate models and an unrealistic interest rate to value its liabilities and to measure employer obligations. In some business transactions, the agency has reportedly prevented the transaction from moving forward, including by interceding with lending institutions to hold up the transaction, all without benefit of published regulations.

ERIC's proposals urge Congress to require the PBGC to use more realistic assumptions. ERIC's proposals also protect the PBGC's current and future financial condition by establishing a reserve cushion and an automatic premium adjustment. In the event of a single economic downturn, today the PBGC would be forced to come to Congress for a bailout. Under ERIC's plan, premiums and reserves would adjust automatically, protecting the PBGC's financial condition.

ERIC also proposes that the PBGC publish the standards it will use to determine when to intervene in business transactions. PBGC's standards should make clear the agency will intervene only when there is a real risk that the transaction will materially increase the agency's long-term exposure to unfunded pension liabilities.

ERIC also appreciates the Committee's interest in improving the ability of employers to provide investment education and advice to employees in participant-directed defined contribution accounts. It is prepared to form an advisory group to work with you as you advance your considerations in this area.

ERIC believes that employers should be explicitly relieved of liability for the investment decisions of participants, where the company has made investment advice and counseling available to plan participants in a prudent and responsible manner. As a result, employees would benefit from expert assistance that reflected their personal circumstances, and employers would be protected from the threat of unnecessary and inappropriate litigation.

My company has faced many challenges as we have wrestled with how to improve programs for our own employees. We provide as much employee education as we can. We need to know when we have crossed the line to personal investment counseling, and we need protection from liability for advice programs prudently established. Today that line is unclear.

An employer who wants to provide employees access to investment advice will be concerned that an investment advisor could be accused of self-dealing under ERISA, unless that advisor has a prohibited transaction exemption from the Department of Labor, a costly, cumbersome and lengthy process. If the employee has to pay for investment advice, our experience indicates that many may not take advantage of the offering.

Adequate tools to provide investment advice programs to groups of employees are now becoming available or rapidly being developed. Participants who do not read paper-based communications often react well to Internet technology, which also provides an alternative to seminars that are costly and difficult for a company to administer.

Recently tools such as interactive worksheets on computer disks have become available that incorporate income or assets from sources other than the employer's plan. However, no system can replace the necessity of judgment and the acceptance of risk.

Even the most sophisticated of tools may still oversimplify participants' circumstances. Typically it cannot, without great expense, model an employer's plans unique rules and investment options, and may not be able to distinguish appropriately between comparable funds.

Employers can act prudently in the selection of investment advisors but they cannot monitor individual advice provided to thousands of people, especially when it is based on assumptions that those individuals make. Guidance from the Department of Labor and perhaps statutory changes will be needed to establish a favorable regulatory framework for employers to provide employee access to investment advice.

Thank you, and I will be pleased to answer any questions you have at the appropriate time.





Chairman Boehner. Mr. Silvers?




Mr. Silvers. Thank you, and good morning, Mr. Chairman. My name is Damon Silvers. I am an Associate General Counsel of the American Federation of Labor and Congress of Industrial Organizations. On behalf of the AFL-CIO, our member unions, our more than 2,000 union-sponsored pension funds, and our 13 million working members and 3 million retirees, I would like to thank you, Mr. Chairman, Representative Andrews, and the Subcommittee for convening these important hearings and for providing the AFL-CIO an opportunity to participate in these discussions.

I should note as an opening that my testimony today addresses retirement benefit issues under ERISA, and does not address the impact of ERISA on our health care system for active workers.

While unions, labor-sponsored funds, and individual workers all have frustrations both with ERISA and its administrators, there is a general consensus among the member unions of the AFL-CIO that ERISA is a success insofar as it applies to pension plans, and that a great deal of the credit for its success goes to the implementation of the Act by the Pension and Welfare Benefits Administration and the Pension Benefit Guaranty Corporation.

Two measures of the success of ERISA in the pension area are the long-term downward trend in plan defaults and the historically low plan default rates currently being reported by the PBGC. In light of this success, and in the context of the historically anomalous returns on the equity markets in the last few years, we urge caution in making changes to ERISA's system of statutory protections for worker pensions.

ERISA seeks to protect workers' pension funds from conflicts of interest, agency costs, and labor market imperfections. These threats to working families' retirement security are as real today as they were in 1975. If anything, the growing concentration of financial services in a few firms creates more opportunities for pension fund clients of these firms to fall victim to conflicts of interest.

Consequently, the AFL-CIO is strongly opposed to any weakening of the prohibited transaction rules, including removal of the bans on cross trading in actively managed accounts and the ban on providers of investment management services to defined contribution plans also providing investment advice. The prohibited transaction rules provide clear guidance to fiduciaries, and protect funds against transactions that present conflicts of interest that cannot be economically monitored.

A reversion to ERISA Section (404)'s simple duty of loyalty standard, as some have suggested, would be inadequate for policing these types of transactions because the standard in (404) cannot be economically monitored, either by trustees or regulators. I have enclosed with our written testimony our detailed comments on the cross-trading issue before the Department of Labor.

Similarly, the AFL-CIO opposes efforts to gut nondiscrimination rules and contribution limitations aimed at preventing the tax subsidy to retirement plans from subsidizing plans that are structured to provide disproportionate benefits to high-wage employees, or to effectively shelter income across generations from taxes. However, we believe that the elimination of compensation-based limits, such as those contained within the Internal Revenue Code, Section (415), that would allow participants in defined benefit plans to retire early and benefit from growth in plan assets are long overdue.

Finally, it should come as no surprise that we are strongly opposed to any measures that would either encourage reversions in single employer plan assets or diminish the protections the PBGC offers all pension plan participants.

The AFL-CIO is extremely concerned about the extent to which America's working families' retirement security is subject both to our low rate of personal savings and to investment risk due to the decline of the defined benefit pension plan. Despite all the talk of 401(k) millionaires, it is a sobering fact that the majority of American workers today are not covered by any kind of pension plan, and that the median defined contribution plan has assets of under $10,000. The AFL-CIO is eager to work with the Subcommittee to consider steps that would encourage increased employer participation in defined benefit plans, while maintaining the protections ERISA currently affords pension plan beneficiaries.

The Subcommittee has already heard a number of ideas for making defined benefit plans more attractive to employees in its earlier hearing. The AFL-CIO encourages the Subcommittee to explore ways of mandating portability in existing defined benefit plans, and rather than encouraging reversions of excess assets, look for ways to ensure that beneficiaries of significantly over funded plans receive benefit increases.

At a minimum, any effort to reverse the trend away from employer-provided pensions should seek to put an end to the kind of two-tier workplaces exemplified by Microsoft. In this new American workplace, people who work side-by-side for years are divided into "employees" with benefits ranging from pensions to access to company soccer fields, and other are classified or misclassified as "temps" or "outside contractors" with no benefits, and in some cases not even employer social security contributions.

Nonetheless, in part the shift to defined contribution plans reflects the attractiveness of portable benefits in an age of employment insecurity. The labor movement has some experience in this area. Many of the AFL-CIO's oldest affiliate unions came into being out of efforts to provide pensions, health and life insurance to workers in highly mobile occupations like construction. We believe the lessons of that experience are that portable defined benefit plans can work, but they work fairly for their beneficiaries only when the beneficiaries have an independent voice in their plan's management, a voice which they can use to ensure that, for example, the gains from the bull market are returned to the beneficiaries in the form of increased benefits.

As other countries such as Britain and Sweden reform their pension systems to include worker voice in fund governance, it is increasingly clear that one area where ERISA could do with some modernization is in increasing beneficiary involvement in fund governance. It is truly a vestige of paternalism, that the majority of the trillions of dollars invested for workers' benefits is done through funds that are governed completely without the participation of those same workers, even on an advisory committee, and that goes for the management of defined contribution plans as well as defined benefit plans.

In conclusion, the AFL-CIO would like to commend the Subcommittee for convening these hearings on a set of complex but vital issues. We would be pleased to be of further assistance to the Subcommittee as it continues its work in the area of employee retirement security. Thank you, Mr. Chairman.






Chairman Boehner. Professor Grundfest?




Prof. Grundfest. Good morning, Mr. Chairman, and thank you. I am Joseph Grundfest, Professor of Law and Business at Stanford Law School. With Nobel Laureate William Sharpe, I also co-founded Financial Engines, Inc. Financial Engines is a federally registered investment advisor which operates entirely over the Internet, and which most recently was selected by Forbes magazine as the best financial planning site available on the Internet.

In the opening statement that initiated these thoughtful and extraordinarily well-crafted hearings, Chairman Boehner clearly articulated this Subcommittee's goal. The Chairman explained, and I quote, "To the extent we can make pension and retirement investment more efficient, allowing participants to maximize their returns on their investments, and allowing them access to better information about their investment options, we will have served our constituents well."

We at Financial Engines couldn't agree more. We, too, believe that plan participants should be helped to maximize the returns on their investments and should have better information about their investment options. We are here to propose simple and realistic sets of ERISA reforms that place plan participant interests first.

These reforms create a level playing field on which mutual fund providers and independent advice providers alike can fairly and openly offer advice to plan participants. The advice will be offered in an environment free of the motive and opportunity to shade recommendations so as to advance the provider's interest over the employee's interest. The advice will be subject to basic assurances of integrity and of competence.

Simply put, we want to create an environment where innovation and competition can work for the benefit of the employee who is working hard and trying to save for her retirement, not for the benefit of some intermediary who stands to make a profit by shading its advice in one direction or another.

Before outlining our proposed level playing field reform, it is important, I believe, to be candid about the problems that already exist in the industry. These problems can grow far worse if inappropriate modifications to ERISA become law.

It should be clear to all that whether the help available to a participant is characterized as education or as advice, there is an overriding public interest in assuring that the assistance provided is unbiased and that it promotes the best interests of the plan participant. Indeed, if help reflects a hidden agenda or if it is designed to make money for someone other than the participant, giving help can be worse than giving no help at all. It would also be contrary to Chairman Boehner's goal of allowing participants to maximize returns on investment.

Financial Engines is therefore concerned that increased efficiency not come at the expense of the basic integrity of the advice provided to plan participants. This concern over the integrity of the process, however, is not merely hypothetical.

Indeed, there is a real and present danger that certain information services provided by at least one major mutual fund family contain characteristics that are not in plan participants' best interests. These information services can cause plan participants to select funds that charge higher fees and to make inferior asset allocation decisions.

This testimony first describes these real world dangers, and it then suggests a set of reforms that will allow greater efficiency and integrity in the process.

At least three distinct dangers are raised by this fund family's practices. First, the fund family uses an arbitrary "bucketing" rule that can drive participants into higher fee funds that have inferior risk/return characteristics for plan participants. The fund relies on a statistical technique that fails to recognize the significance of fees in projecting future fund performance. And, third, the fund family fails to deduct fund fees or even to provide useful information about how to deduct such fees when calculating the probable amount of assets the participants will have available at retirement.

In respect for the time of the Committee, I will describe only one of these three problems and then refer the members to the Submission. The "bucketing" rule: The information service at issue imposes an arbitrary portfolio allocation rule on all equity allocations by plan participants. Specifically, the advisor's Form ADV filed with the Securities and Exchange Commission reads as follows:

"We require that the weight of any one pooled stock investment is no more than 25 percent of a participant's total assets. The 25 percent maximum stock weight constraint provides portfolio manager and investment option diversification."

Simply put, this rule requires that a plan participant's equity assets be allocated among at least four different equity fund "buckets" with no more than a quarter in any one bucket. As an initial matter, it is important to observe that nothing in modern portfolio theory supports the imposition of such a four-bucket rule.

It is also clear that this rule limits the amount that any plan participant can place in the lowest cost mutual fund to only 25 percent of the fund assets. The other 75 percent will have to go into funds that charge higher fees. That limitation applies even if the low-cost alternative is most suitable for that particular plan asset.

The testimony describes an example in which there is a hypothetical set of eight funds with fees ranging from 20 to 120 basis points. If this fund family's own advice would, absent this constraint, place all of the assets into a fund charging a fee of 20 basis points, this arbitrary bucketing rule would prevent that recommendation from being offered.

And instead, under the best of circumstances under this modest hypothetical, the bucketing rule would steer only 25 percent of the assets to the index fund with the 20 basis point fee; a quarter would go to a fund with a 50 basis point fee; a quarter to a fund with a 60 basis point fee; and a quarter to a fund with a 75 basis point fee. In this example, the average fee paid over the allocation is 51 basis points, or 31 basis points more than would be paid if all of the investor's assets were in the primary S&P 500 fund. Needless to say, if the bucketing rule caused assets to be allocated to funds with even higher fees, the results would be even worse.

The plan participant is thus paying an extra 31 basis points per year for an asset allocation that is inferior to the one that would result from simply investing in the superior alternative. She is paying more and she is getting less because she is using the fund provider's information service. Meanwhile, the fund provider is capturing a larger share of this employee's retirement savings in the form of fees. Who, I ask, is helped, and who, I ask, is hurt by this practice? The answer I think is clear.

In the written submission we also outline in some detail a proposal that would allow mutual funds to provide advice over their own assets, independent advisers to provide advice, but to do it subject to appropriate safeguards that limit the motive and the opportunity to engage in practices of this sort. Again, I would refer Members of the Committee to the written submission. Thank you for your attention.





Chairman Boehner. Thank you. Ms. Ossofsky?




Ms. Ossofsky. Mr. Chairman and distinguished Members of the Subcommittee, I appreciate your invitation to testify today on the importance of pensions in the economic security of older women.

As president of the Older Women's League, known as OWL, the only national grassroots membership organization dedicated exclusively to the unique concerns of women as they age, I can assure you that this topic is an issue near and dear to the hearts of our members. OWL salutes the importance of financial education, but there are a number of significant barriers for women in access to pensions that must be addressed for education to work for all women.

Let me be specific about the realities of women's lives that so greatly impact their access to pension benefits. The average woman now spends 11.5 years out of the work force to attend to care giving responsibilities. That is time she is not vesting in a pension or paying into social security.

Most women do not have access to pensions. Only one in five women who work for firms with fewer than 100 employees are covered by a pension plan. Women also change jobs more frequently than men, making vesting in a pension difficult, 3.8 years versus 5.1 years for men. Most plans vest only after 5 years.

Women are more than twice as likely as men to work part time. Women earn only about 74 percent of what men earn for the same work. Over a lifetime on an average job, this adds up to about $250,000 less in earnings for a woman to save and/or invest in her retirement.

Marital status is a primary determinant of the amount of pension benefits and income that an older woman receives. The poverty rate for elderly women living alone is five times that for married older women. The shift away from employer-paid pensions toward pretax savings plans could diminish women's retirement income security. Unlike defined benefit plans, the government does not guarantee these voluntary plans. If the investment fails, the brunt of the blow falls on the employee.

Women are risk adverse. Women are frequently labeled risk adverse because on average they invest more conservatively than men. When you have less to invest and more to lose in a poor investment, you probably invest more cautiously. Women are not reticent investors. In fact, at every income level, women contribute a higher percentage of their annual earnings to their 401(k) type plans than men do. Women earning less than $10,000 a year contribute, on average, 5.5 percent of their annual earnings to 401(k) type plans, compared to men with these low earnings who contribute 3.8 percent.

Women live an average of 7 years longer than men, which compounds all these problems. All of these factors make it difficult for women to meet the requirements for pension benefits, and often result in their receiving smaller benefits than men.

A number of public policy changes could improve women's pension status. Let me briefly describe OWL's 10-point reform plan.

Proposal one, lower the vesting requirements from 5 years to 3 years for most private pension plans.

Proposal two, institute portability provisions in defined benefit plans. Lack of portability in all but a few defined benefit plans means that if a woman changes jobs before retirement, her pension will be based on her final wages, and inflation will erode the value of her benefit over time.

Proposal three, extend pension coverage to part-time and temporary workers. Current law allows employers to exclude people who work less than 1,000 hours a year from their pension plans. Part-time and temporary workers would be protected by reform legislation providing pension credits to all employees working 500 hours or more a year.

Proposal four, educate employers about simplified employee pensions. This type of pension allows employers to contribute a percentage of the employee's salary to a defined contribution plan without administrative expenses or filing requirements. They therefore provide a viable alternative to more complicated pension plans. Women working for small firms would especially benefit from the adoption of such plans by their employers.

Five, enact pay equity legislation. Research consistently shows that pension coverage and income are associated with higher wages.

Six, voluntary individual pension accounts should have the same spousal protections as defined benefit plans. ERISA requires the employer to offer the joint and survivor option as the first option, and the worker can choose a single life annuity only if their spouse signs a waiver. If the pension plan is a 401(k), there is no requirement for an annuity disbursement, much less a joint and survivor option. Under current regulation, divorced women have more pension protection than married women.

Seven, modify joint and survivor annuities. Even though the Retirement Equity Act of '84 required private pensions to pay survivor benefits, unless a spouse waives this protection in writing, the widow typically receives only about two-fifths the amount received while her spouse was alive. Women would benefit from a reform providing that either surviving spouse would receive a benefit equal to two-thirds of the benefit prior to the death of a spouse.

Eight, improve pension division upon divorce. The Retirement Equity Act made it possible for private pension plans to pay benefits directly to divorced spouses. However, many women do not know to ask for a share of their spouse's pension before divorce proceedings.

Nine, eliminate pension integration, which is a significant problem for low-paid women and men who lose a portion of their pension benefits when employers deduct from those pensions the value of the social security benefits. Elimination of pension integration in defined benefit plans would improve the retirement security of low-wage women and men.

Ten, institute cost-of-living adjustments in defined benefit plans. Because such plans are rarely indexed for inflation, the value of benefits erodes after retirement. The impact of inflation is especially hard for women, who typically live longer than men. Requiring employers to index private pensions would help to correct this imbalance.

Pension education and counseling is important, and will help some women, but it will not significantly change the economic status of most women in retirement until we reform the system to work better for her. And if pension reform doesn't work for women like me, it just doesn't work.

Thank you, and OWL looks forward to working with you on some or all of these proposals.






Chairman Boehner. Thank you. Ms. Raymond?


Ms. Raymond. Good morning, Mr. Chairman and other distinguished Members of the Committee. I am Margaret Raymond, Assistant General Counsel at Fidelity Investments. Fidelity is the Nation's largest mutual fund and the number one provider of services to the 401(k) retirement plans.

Today I am also testifying on behalf of the Investment Company Institute, which is the national association of the American mutual fund industry. We appreciate this opportunity to testify.

Another speaker today has suggested that mutual funds and other intermediaries have delivered investment products that contain hidden biases and unsound investment principles. Let me state for the record that we disagree with the premise that there are such secret agendas, hidden biases or undisclosed fees. Fidelity and the mutual fund industry must comply with strict prohibitions on conflicts of interest and the most rigorous and comprehensive fee disclosure requirements of any regulated financial product.

You already know about the striking growth of 401(k) plans, and it is the very success of 401(k) plans and other defined contribution plans that rely on participants to make investment decisions that makes today's topic of investment advice and education so compelling. From our vantage point as the leading service provider to 401(k) plans, we have been able to study participant investment behavior using actual data from 5 million participants and 5,400 plans to assess the state of the system and investment behavior.

You have each been provided a copy of this report which is entitled Building Futures: How American Companies Are Helping Their Employees Retire, and that report provides some encouraging news about investment behavior. Participants generally are investing in ways consistent with their long-term objectives and are not engaging in the kind of risky trading practices during periods of market volatility. But the report also shows some areas that need improvement. Participants, at least some of them, continue to need additional investment assistance.

Since 1996, ERISA regulations have allowed retirement service plan providers like mutual funds to deliver robust, interactive investment education to participants, including asset allocation models mentioning specific investment options, so long as certain criteria are met, and the criteria are designed to ensure appropriate substance and full disclosure. Fidelity's own Internet-based investment education product, called Fidelity Portfolio Planner, has been structured to meet the requirements of these regulations. Today 1.2 million participants have access to the tool.

Portfolio Planner provides asset allocation targets and model portfolios with actual investment options available to participants in their plan for four categories of hypothetical investors. This educational tool, and others like it, demonstrates the effectiveness of good ERISA regulation. The regulatory safeguards mean that participants can get the investment education they want while being protected from materials that contain undue bias or unsound investment principles.

Because the investment methodology used in Fidelity Portfolio Planner is, as it must be under the regulations, objective and sound, the tool actually selects investment options for model portfolios objectively, in an unbiased way, and indeed, where warranted, it proposes funds other than Fidelity-managed products. The proof of the objectivity of this tool is demonstrated in the results. Plans offering the tool have not experienced a substantial inflow into actively managed Fidelity mutual funds; if anything, these plans have experienced a slight outflow from Fidelity funds.

But it is not only good regulation that has contributed to the success of investment education. Fidelity and other mutual fund companies have a long tradition of providing education to customers, and are unwilling to risk their reputation by providing biased and unsound information. Our customers' trust is too valuable for us to jeopardize.

But investment education, no matter how robust, can't satisfy all participants. Our defined contribution report illustrates that participants aren't monolithic, and not every participant needs or wants the same level of investment guidance.

It is easy to understand why some participants want more. Even under the 1996 regulations, there are some services that Fidelity would like to provide and that participants need, but that cannot be provided as education. For example, when market appreciation has caused a participant's portfolio to fall outside of their desired asset allocation, Fidelity doesn't believe that it can suggest to that participant that he or she rebalance their 401(k) portfolio, without crossing the advice line.

Despite the marketplace demand for advice, only a handful of plans make ERISA investment advice available to their participants today. Why? Well, we believe that the answer lies in the structural impediment in ERISA. Service providers like the mutual fund industry that have earned the confidence of plan sponsors and participants, are prohibited under the current structure from providing ERISA investment advice. As a result, only a narrow group of investment advisors today can provide ERISA advice to participants, and they are almost always stranger to the participants and to the plan sponsor.

This is where Congress can help. The problem lies in ERISA's prohibited transaction rules. Today, neither a mutual fund company nor its affiliate can provide advice with respect to its own mutual funds, no matter how prudent and appropriate the advice, how objective the investment methodology, or how much disclosure is provided to participants. Participants who want investment advice have been disserved by this prohibition, because the service providers they trust, like mutual fund companies, are unable to provide what participants want and need.

This absolute prohibition is unnecessary, given the protections already contained in ERISA's fiduciary standards. Investment advice that is driven by greed and bias will not pass muster under ERISA fiduciary principles of prudence and diligence, nor will it satisfy ERISA's exclusive benefit rules, which require fiduciaries to put the interests of participants first. Mutual fund companies and others interested in offering investment advice are fully prepared to accept their fiduciary responsibilities under ERISA for this advice. It is that standard, the prudence standard, not the independence of the provider that will assure that investment advice will be prudent and appropriate and that plan participants will be protected.

In addition, if the investment advisor is governed by the Investment Advisors Act, there are additional protections under Federal law such as suitability requirements. Some participants want and need investment advice. The prohibited transaction rules have imposed an unnecessary impediment to the provision of advice by those who have already earned participants' and plan sponsors' confidence, and we ask that you consider legislative relief to the prohibited transaction rules to solve this problem.

Thanks again for the opportunity to testify before this Committee. I would like to request that my written statement and Fidelity's Defined Contribution Report be made a part of the record, and that we be allowed to provide an additional statement addressing the mechanics, the investment tools, and the particulars raised by Professor Grundfest as part of these proceedings in the next week or so.






Chairman Boehner. Thank you, Ms. Raymond, and all of the written statements will be made part of the record. And, as was announced earlier, all Members and witnesses will have 14 days to enter additional information for the record.

As we are all aware, there is continued movement and explosive growth toward defined contribution plans. One of the concerns over the last 5 years or so has been that self-directed defined contribution plans weren't earning the type of return on investment that was sufficient to meet the needs of employees who would retire. Have we seen, over the last several years, any significant increase in the return on investment in these self-directed accounts? Mr. Reed?

Mr. Reed. Mr. Chairman, I can't address the return on investment, but I will tell you that the allocation to equity type investments has clearly been rising steadily over the last 5 years. And if you include both employer stock and equity investments, our participants are now investing about 70 percent of their accounts in equity investments. That is up from about 50 percent 5 years ago.

Chairman Boehner. Ms. Raymond?

Ms. Raymond. We do have statistics that demonstrate that account balances are growing as people continue their participation in a plan. We don't have statistics that specifically track investment options.

Chairman Boehner. So it is clear that with the rising market and the information about the rising market, that more employees have been moving in the direction of buying equities, which was the concern if we go back a period of time.

Professor Grundfest, do you have any information? You have obviously tracked this.

Prof. Grundfest. Yes. The situation depends very much on the individual choices made by the individual. In the aggregate, a shift towards larger equity exposures would appear to be beneficial for many people planning for their retirement.

However, people have to be very cognizant of the fact that along with that shift comes the risk associated with a greater equity exposure, and we believe that it is extraordinarily important that people be adequately informed of the risks and the rewards that come along with putting more of your money in the stock market. We think it can be done. We think it can be done prudently. But we think it also has to be done in an environment of full disclosure.

Chairman Boehner. Well, I couldn't agree more that full disclosure is the answer. Professor, as I listen to your testimony today and I read your written testimony, it appears a rather cynical view of those sitting around you about their intentions and all of the bad things they could do. I can only wonder, considering the company that you founded, that the current set of rules provides a nice niche, and on the surface, anyway, it appears that you have a significant conflict of interest that may have influenced your testimony.

And I bring it up because, as most of you will find out, I don't have secrets. I like to put everything up on the table, and I want to give you an opportunity to refute what some, looking through the record, might distinguish as a problem.

Prof. Grundfest. First of all, thank you very much for raising those questions, Mr. Chairman. I should emphasize that the testimony does not suggest that these or similar practices are widespread in the mutual fund industry, and it says so expressly.

And in particular, in our experience there are many mutual fund advisors that recognize the importance of independent participant investment advice. We are proud of the many strategic relationships we do have with members of the mutual fund family, and we can present many examples of funds that don't engage in practices at all similar to the ones that we have been discussing this morning.

Accordingly, I think it is very important to understand that we are speaking only about one example of one firm's practices, and we are not suggesting for an instant that this is a widespread practice in the mutual fund field.

Chairman Boehner. I do appreciate that, because as I read the testimony and listened today, I was getting the wrong impression.

Let me ask you this other follow-up question. Given that I would imagine everyone sitting at the dais today would recognize that more information, more advice to employees would benefit the employee and benefit their retirement security, why not, with a prudence test and full disclosure of fees, would it not be appropriate for the mutual fund industry as an example, or employers, to provide more specific and tailored investment advice to their employees?

Prof. Grundfest. We agree entirely, and in fact our proposal lays out a three-part procedure that would indeed allow mutual funds, sponsors and the like, to offer advice.

The key to that proposal, Mr. Chairman, is we believe the regulatory environment must eliminate the motive and the opportunity to shade the advice in favor of anyone other than the participant. If those safeguards are in place, we believe that a full, fair, open playing field, subject to provisions of competence and integrity, should be created, and that indeed is our legislative proposal.

Chairman Boehner. Let me just have one more follow-up. Under current ERISA law, as a plan fiduciary, they have a fiduciary standard where they must always act in the interest of the participant.

Prof. Grundfest. Yes, sir.

Chairman Boehner. I suspect what you are saying is that that isn't sufficient.

Prof. Grundfest. It is an issue that people may have differences of opinion about, as to whether the practices, which are disclosed and available with filings in the SEC are consistent with those obligations.

Let me also observe that many opportunities to shade advice are found only by people with a relatively sophisticated understanding of the algorithms and the mathematics that go into the advice that is provided over the Internet. That raises a second level of concerns, and I think would be an appropriate area for caution as people move forward in creating this level playing field.

Chairman Boehner. Mr. Andrews?

Mr. Andrews. I would thank all the witnesses for excellent testimony.

Ms. Ossofsky, my mother worked for 48 years, 34 of which she was paid for, the rest of which she put up with me during 14 very difficult years, I am sure. When she retired in 1981 at the age of 62, she had one pension check that came from her last employment. This was as a public school secretary, which gave her the princely sum of about $1,300 a year in pension income in addition to her social security.

I think you make a compelling point about special attention that needs to be paid to older women in trying to address their retirement problems. I was particularly interested in your fourth recommendation about the subject of simplified employee pensions, where employers can voluntarily make contributions with a plan without bearing the administrative cost of setting up their own plan. What steps do you think that we could take to encourage more employer participation in such plans?

Ms. Ossofsky. I'm sorry. Would you repeat that? I'm a little nervous.

Mr. Andrews. Please. I am, too, so relax.

I thought the fourth point of your testimony, about the use of the simplified plans, was very, very interesting.

Ms. Ossofsky. Right.

Mr. Andrews. And you suggested that we do some things to encourage more employers to use those plans. What might we do? What kinds of things do you think would be workable?

Ms. Ossofsky. You know, I really would like to defer to staff on this.

Mr. Andrews. Sure.

Ms. Ossofsky. May I?

Mr. Andrews. Please do. I am sure the Chairman would consent to holding the record open to supplement the record on that.

Ms. Ossofsky. Would you, Chairman?

Mr. Andrews. Well, I mean in writing.

Ms. Ossofsky. Yes. We will submit it. I truly am not prepared to answer. I had others that I was prepared to answer, but not that one.

Mr. Andrews. This is my specialty.

One of the previous panels we had touched on this as well. One of the small business witnesses talked about more participation by small businesses in these voluntary simplified plans. I think it is a very good idea, one in which we may find some real cooperation.

Ms. Ossofsky. Excuse me.

Mr. Andrews. Yes, ma'am.

Ms. Ossofsky. One of the things is the portability and also the reduction of the time that pensions would start. Reducing it to 3 years rather than to 5 years might help the woman's situation.

Mr. Andrews. I appreciate that. I also believe that the spousal annuity provisions are very important to talk about.

Ms. Ossofsky. Absolutely.

Mr. Andrews. Mr. O'Connell, I think that you put forward a very important analysis of PBGC's model for determining premiums. One of the points you make is you hypothesize that the present model causes PBGC intervention in some proposed transactions invalidly, that they are overestimating certain liabilities, and therefore intervening in certain transactions in which they shouldn't. That seems to be the premise.

How often does that happen? How many times a year does PBGC intervene in proposed transactions, and what is the consequence of it?

Mr. O'Connell. I can't answer that quantitatively from a perspective of ERIC or our own situation as an employer. I can tell you, in regards to our circumstances in the course of the past year, we had at least two instances, in which the PBGC was involved, one a quite substantive acquisition. I'm sorry; in this case it was a divestiture, and in the other an acquisition. Let me address the larger of the two of those, because the dollars involved are far more significant.

We had an inquiry from PBGC, as that transaction was unfolding, and answered that inquiry in this manner: "We do not intend to transfer pension assets in connection with this deal." But that intention was largely the result of our knowledge that PBGC would have intended to become a participant in that arrangement. In our circumstances that could have added over $100 million, in fact maybe close to $200 million, to the cost of the transaction.

The consequence of that is regrettable, from our perspective, because what it meant was, we held assets in our company-sponsored plan, and created a frozen benefit for the individuals whose employment with United Technologies was terminated. Since there were no assets transferred to the buyer, the individuals then began with a new benefit in that plan. The consequence of all of that from the perspective of an individual is two pieces of a pension benefit which, when added together, do not produce anywhere near the same amount of benefit.

So from our perspective, that intervention or the reality that that intervention would likely have occurred created a situation where we did not make that transfer, and the ultimate losers in that were the employees.

Mr. Andrews. Thank you very much.

Chairman Boehner. Mr. Tierney?

Mr. Tierney. Thank you, Mr. Chairman. I want to thank all of the witnesses today.

Professor Grundfest, let me ask a question. You caution against allowing mutual funds to provide investment advice to participants because of the conflict of interest aspect of it and the incentive that might be there to steer participants to a higher fee.

Prof. Grundfest. But I agree that they should be allowed, subject to appropriate safeguards, to offer such advice.

Mr. Tierney. Okay, and that is clear now, so you don't have a direct prohibition against it, you want to just place some safeguards.

Prof. Grundfest. Appropriate safeguards, and I think we should do what is in the best interest of the plan participants, of course.

Mr. Tierney. Ms. Raymond, let me ask you a question. How would we assure that mutual fund industry folks provide objective investment advice to plan participants?

Ms. Raymond. I think there are already regulatory standards or legislative standards in place. I think the ERISA fiduciary standards do get you there already. I think the Investment Advisors Act standards already get you there.

But if there is any doubt on that score, I think that legislation can be crafted. As you craft the exemption to the prohibited transaction rule that allows this kind of advice to occur, certainly standards can be introduced there. So I think that if you aren't of the opinion that you have got enough standards, safeguards, certainly some can be introduced.

Mr. Tierney. Would one of those safeguards be an equalization of fees?

Ms. Raymond. I don't think that that is really appropriate.

Mr. Tierney. Well, that exists now, is my understanding.

Ms. Raymond. We will address some of the points that have been made about the fee principles that we have gone through, in writing later.

Mr. Tierney. But let me just interject for a second. Right now my understanding is, and correct me if I am wrong, that one of the ways that you can get an exemption is to indicate that you are equalizing the fees.

Ms. Raymond. That is for discretionary management.

Mr. Tierney. Right.

Ms. Raymond. There is some question in the industry as to whether that works for advice products. The exemption is only for discretionary management, where a participant would relinquish total control. Our experience is while there are some people who want to do that; it doesn't fill the bill for lots of folks.

Mr. Tierney. In an instance where fees might not even be the question, but where the fear might be that some rogue investment manager might make a decision based on a particular client, wanting to favor one over the other who is a bigger client or some other concern, how would employers and labor monitor that? How would they make sure that that in fact wasn't happening?

Ms. Raymond. How would employers monitor that? Is that the question?

Mr. Tierney. Employers or labor organizations or people that would be concerned about it.

Ms. Raymond. I think that you can monitor that by asking a lot of questions. If you are the plan sponsor retaining the services of an investment advisor, you can ask a lot of questions about the methodology that will be used.

It is also worth noting that the method of choice for starting to deliver these kinds of services to participants is the Internet. Just as Financial Engines uses the Internet, Fidelity uses the Internet. It is really the tool and technology of the future. That actually provides, in and of itself, some interesting safeguards, because if you think about it, Internet-delivered products have to be very quantitative, and the idea of a rogue individual sitting in some kitchen and steering some person wrong is much less likely to occur in an Internet-based world of investment advice.

Mr. Tierney. Thank you.

Mr. Silvers, what do you say to all that?

Mr. Silvers. I think we have a sort of basic view here that the types of risks that defined contribution plans entail for individual workers are only compounded when their sources of advice are subject to a conflict of interest. I think we are interested in looking at what Professor Grundfest has in mind in terms of protections that he thinks are suitable in this area.

We obviously don't have any companies that provide any of these services. Our view is that we are very suspicious of the provision of investment advice by mutual fund companies in the context of 401(k) plans, and our view is I think informed by our own knowledge of the ability of our local unions in collective bargaining to monitor this type of conflict of interest.

I think that there is an issue across the board here, when one moves from the prohibited transactions approach to conflict of interest transactions, or to the general fiduciary duty approach. It is impossible in our view when you make that kind of transition, for certainly the individual worker, and in most cases the small employer or the union local, to effectively monitor whether or not these duties are being complied with.

There is, I think, a great deal of experience, and ERISA was originally adopted in the context of that experience. A general admonition to someone who is subject to a conflict of interest, to be loyal to a weak and under informed party, is frankly not worth the paper it is printed on.

Chairman Boehner. I hate to cut the gentleman off, but as the gentleman knows, we have got several minutes before we are due on the floor for a vote, and this could last for some time. And so, by agreement of the Members, we are going to adjourn the hearing so that you don't have to wait around for an hour. We are going to recess the hearing until tomorrow.

But let me just thank each of the witnesses for your excellent testimony. This information is very helpful to us and to the Members as we attempt to develop the course that we plan on taking, so I want to thank you for your testimony.

As most Members and staff know, tomorrow we will have a second panel. And with that, the hearing is in recess until 10:30 a.m. tomorrow, Friday, March 10th, when we will hear from our second panel. Again, thank you very much.

Whereupon, at 12:10 p.m., the Subcommittee recessed, to reconvene at 10:30 a.m. Friday, March 10, 2000.

Table of Contents




















Friday, March 10, 2000




House of Representatives,


Subcommittee on Employer-Employee Relations


Committee on Education and the Workforce


Washington, D.C.

The Subcommittee met, pursuant to call, at 10:30 a.m., in Room 2175, Rayburn House Office Building, Hon. John A. Boehner, Chairman of the Subcommittee, presiding.

Present: Representatives Boehner, Petri, Fletcher, Andrews, and Holt.

Staff Present: David Frank, Professional Staff Member; David Connolly, Jr., Professional Staff Member; Ben Peltier, Professional Staff Member; Amy Cloud, Staff Assistant; Rob Green, Workforce Policy Coordinator; Patrick Lyden, Professional Staff Member; Deborah Samantar, Office Manager; Cedric R. Hendricks, Minority Deputy Counsel; Michele Varnhagen, Minority Labor Counsel/Coordinator; Peter Rutledge, Minority Senior Legislative Associate/Labor; Woody Anglade, Minority Legislative Associate/Labor; and Brian Compagnone, Minority Staff Assistant/Investigations.

Chairman Boehner. The Committee is called to order. We will resume our hearing from yesterday. Yesterday we did in fact recess the hearing so that we could move into today's hearing quickly.



This continues our hearing, as I said, on modernizing ERISA for the needs of today's workers and retirees. We had an excellent panel yesterday. Although we had to move the hearing along rather quickly because of votes on the floor, I found the testimony and discussion extremely helpful and look forward to another excellent panel today.

I would like to offer a few observations of my own. First, try as we might no one can bring back a world where most jobs are long-term positions with large, stable employers who can offer cradle to grave pension coverage. That is not the world that we live in today. In the world that we do live in the workers are assuming new levels of risk and opportunity as they invest toward their own retirement. However, investment information, advice, and education haven't necessarily kept up with this new level of responsibility. We need to close that gap and the importance of closing the advice gap has been a recurring theme in the testimony we have received.

Second, we heard a good debate yesterday on structural changes that will ultimately save money for pension participants in a safe secure manner. I hope that continues today. It goes without saying that every dollar not spent on needless compliance costs is another dollar that can be invested, and can increase in value and benefit our constituents' retirement security. It also goes without saying that a regulatory structure, which discourages innovation, is one that denies our constituents the kinds of products and services, which will help them meet their retirement security needs.

With that I would like to recognize our distinguished Ranking Member, Mr. Andrews.



Mr. Andrews. Good morning. Thank you, Mr. Chairman. I want to thank yesterday's panelists for their excellent presentations and for understanding the demands of the House schedule. The truncated nature of the questioning by no means implied a lack of interest by the Members of the Subcommittee or a lack of commitment to producing good, sound, bipartisan legislation. I am equally looking forward to this morning's panel as we begin to develop the arguments.

I think what has characterized the first couple of hearings are two very positive developments. The first is a public education function both for the Members of Congress and for the general public as to the long-term gravity of the issue in front of us, which I would continue to define as a life expectancy curve that is outpacing an income curve. We are all culturally oriented around here toward focusing on the next 6 months or maybe even the next 2 years. This is a 40 or 50-year horizon and beyond that we are looking at. I think it is very important that we begin to think about ways to bring those two curves closer together so that as our life expectancy and the demands on our time increase so do the resources and the opportunities for people.

The second positive development is that although there are clearly differences in perception and differences in prescription as to what ought to be done, I am beginning to see areas of overlap emerge. I am beginning to see areas of commonality among all of the witnesses that suggest ways that we can work together. Between the two political parties we can identify problems that have good solutions and identify problems that require further debate and discussion.

I am encouraged by the way that we have proceeded and I very much look forward to hearing from the ladies and gentlemen this morning.

Chairman Boehner. Thank you, Mr. Andrews. Today's first witness will be Ken Cohen. Mr. Cohen is Senior Vice President and Deputy General Counsel for Massachusetts Mutual Life Insurance Company in Springfield, MA, where he is responsible for State and Federal legislation and regulatory issues. He will be testifying on behalf of the American Council of Life Insurers (ACLI).

Our second witness will be Marc Lackritz. Mr. Lackritz is President of the Securities Industry Association located here in Washington. Mr. Lackritz has extensive experience with Capitol Hill and serves on a number of financial boards and advisory groups.

Following Mr. Lackritz will be David Certner. Mr. Certner is the Senior Coordinator for Economic Issues for the Department of Federal Affairs of AARP. He is a former Chairman of the Department of Labor's ERISA Advisory Committee.

The next witness will be Mr. Louis Colosimo. Mr. Colosimo is the Managing Director for Morgan Stanley Dean Witter & Company in New York. Today he is here testifying on behalf of the Bond Market Association.

Following Mr. Colosimo will be Mr. John Hotz. Mr. Hotz is the Deputy Director and Technical Assistance Project Coordinator at the Pension Rights Center here in Washington.

Our sixth and final witness for the day is Ms. Deedra Walkey. Ms. Walkey is Assistant General Counsel for the Frank Russell Company in Tacoma, WA.

With that you will notice that we do have a timer in front. When it is green it will go green for 4 minutes. When it gets to 4 minutes it will go yellow. When it goes to red, your 5 minutes is up. Having said that, we don't have any votes on the floor today. I have a 1:40 p.m. flight and I intend to make it. Between now and then if you go over, don't be overly concerned about that.

Mr. Cohen.



Mr. Cohen. Thank you, Chairman Boehner and distinguished Members of the Subcommittee. My name is Ken Cohen and, as Chairman Boehner said, I am Senior Vice President at Mass Mutual. I am testifying today on behalf of the American Council of Life Insurers, the major trade association of the life insurance industry. The ACLI wishes to thank the Subcommittee for the opportunity to testify today on this important topic and we welcome your review of ERISA.

Since ERISA was enacted 25 years ago, Title I, the labor law provisions of ERISA, have only really drawn congressional scrutiny. Given the dramatic changes that have occurred in the last 25 years, it is an appropriate time to review these rules and to make sure that we have a safe and secure retirement system that works for all Americans into the 21st century.

Although ERISA has largely been successful in protecting plan benefits, certain aspects of the regulatory structure have unfortunately impeded innovation and imposed significant costs on plan sponsors as well as those who provide services and investment to plans. These costs are ultimately borne by working Americans, either directly or indirectly, in the form of lower benefits or lack of pension coverage or by plan participants whose choices of investment products may be needlessly limited by ERISA's regulatory constraints.

In addition, there are significant opportunity costs imposed on the economy as a whole. If we can remove unnecessary regulations, participants will benefit through lower costs and more innovative products and services. More broadly, the economy will be stronger and offer even more opportunities for growth and job creation. In our view, the question before us is not whether to update ERISA's regulatory framework to address the sweeping changes that have taken place over the last 25 years, it is how that modernization can best be accomplished.

When ERISA was enacted, the Nation's private retirement system was built around traditional defined benefit plans. Since 1974 there has been a significant shift in the retirement plan universe away from defined benefit plans toward define contribution plans like 401(k) plans. This shift coupled with the proliferation of investment vehicles creates one of the fundamental challenges for the private retirement system. Plan sponsors and participants increasingly require investment services, including participant education, asset allocation assistance, and increasingly specific investment advice. Further development of these services is critical to ensuring that the defined contribution plan and IRA assets are invested in ways that will provide optimized benefits to plan participants. The law should be restructured in such a way as to encourage efficient delivery of such services.

During the last 25 years there have also been striking changes in the financial services industry. Clearly with the recent enactment of the Gramm-Leach-Bliley Act, the last barriers to a fully integrated financial services industry have been removed. In this regard we commend Chairman Boehner for the critical role he played in this effort. We expect consolidation in the financial services industry to accelerate, making problems posed by ERISA's current prohibitions against dealing with affiliated parties even more difficult and costly further reducing plan participants' retirement savings choices.

Today insurance companies offer a variety of financial services through subsidiaries, including individual and group insurance, brokerage, and mutual funds, as well as trust and administrative services. We are able to offer a broad range of products and services to 401(k) type plans that include both affiliated and unaffiliated mutual funds, stable value investment options, including GICs, brokerage services, record keeping, individual account statements, and participant education.

While we have a significant interest in all aspects of Title I of ERISA, the most important focus for the Subcommittee in our view should be the fiduciary and prohibited transaction rules. We believe that ERISA's trust and fiduciary rules have generally worked well. These rules have been flexible and responsive to changes in the retirement plan and investment markets over the last 25 years. There are, however, fundamental problems with ERISA's prohibited transaction rules. These rules involve real and significant compliance costs, which are ultimately borne by plan participants and beneficiaries without significantly improving benefit security beyond the protections already provided by ERISA's fiduciary rules. They also inhibit the development in marketing of new and innovative investment products that would give plan participants additional choices and flexibility in their retirement planning.

We have identified two broad alternatives to reforming ERISA's prohibited transaction rules. The first approach involves a fundamental structural change to the prohibited transactions. The second approach involves significant but more incremental changes to the statute.

The first alternative would be to amend ERISA's Section (406) so that transactions would not be prohibited if the transaction was carried out on arm's-length terms, the transaction involved a service or product that was necessary or appropriate for the operation of the plan, and where appropriate the material terms and fees associated with the transaction are clearly disclosed in advance to the plan fiduciary or the participants. This legal framework would create a more flexible set of prohibited transaction rules that would be responsive to changes in the retirement plan marketplace and investment products.

Such a change, in our view, would not undermine the protections that ERISA provides for plans and participants. Assets would still have to be held in trust, fiduciaries would still have to act prudently and solely in the interest of plan participants. Fiduciaries who breach these duties would still be subject to the full panoply of civil remedies and criminal prosecution. Transactions that would otherwise be prohibited would be permitted to proceed where they are non abusive and in the interests of plan participants.

Our second approach is more incremental. That approach would be to make a number of discrete changes to ERISA's prohibited transaction rules that would ease their administration without fundamentally changing the statute. Congress would follow ERISA's current model of exempting certain transactions that would be found to be in the interest of plans.

While not as sweeping or flexible as the first alternative, each of these changes would be a significant improvement as compared to current law. The incremental approach would be accomplished first by adding a new series of statutory exemptions to Section (408) (b) of ERISA. Congress would update ERISA's statutory exemptions to take into account changes in the retirement plan and financial services marketplace over the last 25 years. The most important new exemption would cover investment education and advisory products. Such an exemption should be broad, covering mutual funds, individual securities, insurance and bank products. The exemption should rely on disclosure and concept, but it should not regulate the services or fees associated with investment education and advice products.

A second change would be to narrow the definition of the party and interests to include only those persons who can act on behalf of a plan in a manner that is adverse to the interests of participants. For example, the definition should be modified to exclude service providers and their affiliates because they do not have authority to act on behalf of the plans. Under this approach parties and interest would be limited to employers, unions, and certain fiduciaries.

A third change would be to revise the statutory standards for individual and class exemptions. The process for obtaining an exemption from the Department of Labor is too time consuming and DOL too often imposes conditions that restructure the design and underlying economic terms of products and services. A solution is to revise the statutory findings that apply to issuing an exemption. An appropriate standard would be to require DOL to define whether an exemption is administratively feasible and protective of the rights of beneficiaries. The Department of Labor should not have to conclude, as it does under present law, that a transaction is affirmatively in the interest of plans. It is the plan fiduciary's job to determine that a transaction is prudent and in the interests of its participants. Other procedural requirements such as the imposition of certain time frames might also be considered.

A fourth change would be to create a self-proactive program for prohibited transactions. Parties that inadvertently violate these rules should be permitted to correct the violation within a certain time period after discovery without having to pay an excise tax. We believe that there is support within the Department of Labor for this approach.

Today my testimony is focused on the need for reforming ERISA's prohibited transaction rules. However, there are many other areas within Title I of ERISA worthy of review, including the application of the co fiduciary rules and what expenses a plan may pay. We would appreciate the opportunity to continue to work with the Subcommittee and to supplement the record as we develop further thoughts.

With that, I thank you for the opportunity to testify today.





Chairman Boehner. Thank you, Mr. Cohen. Our panel will notice that I just decided to turn off the lights in front so that nobody feels overly constrained. Don't get carried away.

Mr. Lackritz.





Mr. Lackritz. Thank you, Mr. Chairman. Mr. Chairman, Congressman Andrews, members of the Subcommittee, I am Marc Lackritz, President of the Securities Industry Association. We represent more than 740 broker-dealers who provide services to the hundreds of thousands of private and public pension plans that hold over $9 trillion in assets in the capital markets.

We very much appreciate the opportunity, Mr. Chairman, to appear before you and comment on the regulatory structure surrounding the investment of ERISA assets. While our industry has been changing dramatically because of new technology, globalization, and competition, just last year Congress boldly enacted financial services, modernization legislation; the Gramm-Leach-Bliley Act.

Mr. Chairman, your leadership in that effort was critical in making that possible and we want to thank you again for your effort in that area. We think that modernizing ERISA is now a very natural follow-up to the changes offered last year in the financial services industry. Retirement security of course is of critical importance to all Americans, particularly the 76 million baby boomers who turn 50 at the rate of one every 9 seconds over the next 14 years, and start turning 65 in only 11 years.

The private pension system is a vital part of our retirement system for millions of Americans. However, archaic restrictions, high compliance costs, and missed investment opportunities are having an adverse impact on the very individuals that the restrictions were designed to help.

I just want to emphasize three points this morning. First, plan participants must have access to investment advice. Secondly, the ERISA statute should conform with the Internal Revenue Code and securities laws to the fullest extent possible and, finally, the prohibited transactions rules of ERISA should be revised to relieve both the workload on the Department of Labor and the compliance burdens for service providers and plan sponsors.

When ERISA was enacted, there was little consideration given to the section prohibiting transactions between pension plans, their investment advisors and the advisors' affiliates. However, both the financial industry and the world of private pensions have changed dramatically since 1974, as I know you have heard from a number of other witnesses. The forces of technology, globalization, demographics, and new competition have created a vibrant, diverse, and highly competitive financial services industry offering a wide range of new products and services and widely available information in the marketplace for both institutions and increasingly, individuals.

Moreover, Wall Street has become Main Street as almost half of all households are invested directly or indirectly in equities up from a level of only 19 percent as recently as 1983.

The world of pension plans is changing even more dramatically, moving from a system dominated by defined benefit plans in 1974 to one dominated by defined contribution plans today. This massive shift leaves many more individuals to bear the responsibility for their own financial security and retirement. In addition, the Securities and Exchange Commission rules, which really were the template for many of the ERISA class exemptions, have not changed substantially over the last 25 years. Unfortunately, the ERISA framework hasn't kept up with these changes. A number of statutory changes would significantly benefit both the plans and the participants in these plans.

First, restrictions on the provision of investment advice to plan participants must be eased. Today more than 50 percent of ERISA assets are in defined contribution plans that provide for investment direction by their participants. As a result millions of Americans are today responsible for investing for their own retirement security and making investment decisions for increasingly significant amounts of assets. Participants are increasing their knowledge of investment management, risk and return strategies, and asset allegation, but as these assets grow they want and need guidance on how best to invest their retirement assets.

Their contributions would be of little value if participants did not have the advice that would enable them to invest with confidence. Therefore, I would urge you to enact a statutory exemption for advice based on the kind of disclosure that is the hallmark of the securities laws. For example, a statutory exemption could require the disclosure of all fees to affiliated parties and all conflicts of interests as well as comparable past performance information.

The sunshine of disclosure, Mr. Chairman, would be far more effective for participants than a statutory ban on the very information that they really need. This one statutory exemption would probably eliminate more than a dozen pending exemption requests all of which are complicated and time consuming. It would also eliminate the expense and workload of addressing the problem provider by provider through the exemption process.

Secondly, we are very concerned that the rules governing institutional funds are very inconsistent making compliance needlessly complex. We think it would be much more constructive for the agencies to coordinate their initiatives so that the industry is put to the expense of making its case just once. We think that the result would be significant savings to the plans and their participants. We cited a couple of examples in our written testimony that is before the Subcommittee. There are a variety of changes that Congress could make that would go a long way to reducing the workload of the Department to free up staff to deal with more universal investment issues while still protecting participants beneficiaries.

The fiduciary standards of ERISA fully protect plans and participants from any conflict of interest. These standards include a prudent person test and require that fiduciaries act solely in the interests of the plan. Section (406) (b) (2) is a redundant statutory provision and has no analog in the tax code. We believe that repeal of this provision is warranted in light of the fact that ERISA contains sufficient protections against conflicts of interest without it. We also think that section (406) (a) needs to be refocused to mirror the protections that are contained in a thrift savings plan created more than 10 years after ERISA with a hindsight that enabled Congress to build a much better model.

The Federal Employees Retirement Savings Act prohibits sales and exchanges of property and the producing of services only where the transaction is not for adequate consideration. This change alone, Mr. Chairman, would eliminate a huge number of very common prohibited transactions.

I won't go into further detail about the rest of our recommendations because they are explained in our written testimony that has already been submitted to the Subcommittee, and I would ask that it be included in the record, Mr. Chairman.

Chairman Boehner. All statements under unanimous consent agreement yesterday will be included in the record. Members and witnesses will have 14 days to submit additional information if they please.

Mr. Lackritz. Thank you.

In closing, Mr. Chairman, we firmly believe that reform and modernization of the prohibited transaction rules and the process are needed to recognize the dramatic changes in the financial services industry, the increased responsibilities of the investing public, and instances of regulatory inconsistency. These changes are quite urgent and necessary to help the more than 53 million people now participating to achieve their retirement objectives through these plans much more effectively and efficiently. We look forward to helping you achieve these goals, Mr. Chairman.






Chairman Boehner. Thank you. Mr. Certner.




Mr. Certner. Mr. Chairman, my name is David Certner and I am happy to be here on behalf of AARP. AARP is pleased with this opportunity to explore a number of issues for ERISA reform. AARP believes that it is critical that we begin to address the continued gaps in pension coverage, adequacy, and portability.

Pension coverage has been stagnant for the past 25 years at just under 50 percent. In addition, the continued shift of defined contribution plans, particularly 401(k) plans, and the newer shift to cash balance plans has raised important questions of equity and long- term benefit adequacy. As a first step we must improve coverage. While we must focus on small business, the financial instability of many small employers is an obstacle that legislation alone simply cannot easily remedy. However, we can improve the current coverage rules to ensure that there is greater coverage for more full-time and part-time workers who are currently excluded from a plan.

In 401(k) type plans a related problem is participation. Individual account plans generally require an employee to first contribute before receiving any plan benefits. For the one in four workers who do not contribute there is no employer benefit or any tax subsidy. Unfortunately, it is those most in need of the added retirement savings who are the ones least likely to contribute. Lower wage workers often have too few available resources to contribute or don't realize the value of contributing. Younger workers, another group that often fails to contribute, are the ones that will lose the enormous advantage of having the compounding over time.

The payroll deduction feature of 401(k) plans is a great advantage since the money that is automatically withheld from the paycheck is obviously not spent. Some plans have adopted automatic enrollment. By that I mean the employee is automatically signed up for the plan but then can choose to opt out having experienced higher participation rates. Other strategies such as employer minimum contributions or enhanced tax benefits for lower paid worker participation may also help to increase participation.

In addition, we should also reduce vesting periods for all plans. With a mobile work force 5-year vesting means too many workers never earn benefits. This is particularly true for women whose average job tenure is only 3 years.

AARP strongly supports pending pension portability proposals, which currently enjoy widespread support. However, we urge this Committee to go further and require automatic rollovers of lump sum amounts. Under current law even with notice and tax penalties too many employees, nearly 3 out of 4, choose to cash out their pension amounts. Rather than permit individuals to automatically receive lump sums and then choose whether or not to preserve them, the law should require that the lump sums be automatically saved with the individual then having the choice of whether to withdraw the funds. We should be encouraging retirement savings, not cash-outs.

The shift to self-directed accounts has also meant the dramatic shift in investment responsibility. Unfortunately, many individuals have no investment experience and little time or desire to learn about the financial marketplace. Individuals tend to be more conservative investors with less risk tolerance than professional investors. While the amount of information today is greater than ever before, most individuals need the ability to sort through that information. Many individuals simply want to be told by their employer or someone they trust how to invest their money. The question is how best to balance the needs of employees for more investment guidance with the fiduciary restrictions on investment advice.

Current safe harbors, which permit employers to provide asset allocation models to their employees, can provide valuable guidance to employees without rising to the level of investment advice. However, some may wish to provide more specific investment recommendations. AARP believes that any such advice should continue to be subject to the fiduciary rules, be protected from conflicts of interest, and based on sound investment principles. One troubling feature in self-directed plans, particularly for large employers, is the high percentage of funds in one asset, employer stock. Not only does this run counter to proper diversification principles, but also employees may find that both their job and their retirement security are dependent on the fortunes of one employer. Better disclosure of the risk of employer stock is necessary. In addition, some plans restrict an employee's ability to diversify employer stock and AARP urges that these restrictions be prohibited.

The latest trend for traditional pensions is the conversion of cash balance plans. These plans try to mimic the popularity of 401(k) plans by creating hypothetical individual accounts. However, because cash balance plans are defined benefit plans the typical cash balance formula violates current law that prohibits reducing benefits based on age.

In addition, absent any transition relief older workers generally see significant reductions in their benefits when the plan is converted to a cash balance plan. This is precisely the type of result the current law was intended to prevent. Any legislation in this area must continue to protect older workers. For the most part ERISA has been a great success in ensuring greater benefit security and adequacy.

However, gaps still remain and AARP looks forward to working with this Committee to examine and implement needed changes. Thank you.






Chairman Boehner. Mr. Colosimo.





Mr. Colosimo. Thank you, Mr. Chairman, and good morning. I am pleased to be here this morning representing the Bond Market Association's views on ERISA and how the law affects pension fund participation in the markets for bonds and other related debt instruments. The Bond Market Association represents firms like my own that create, sell, and trade these various debt instruments. My written statement addresses in detail our views on ERISA and in the interests of time I will focus on what we see to be the single most important grievance with the law.

We all seem to agree over the last 25 years that ERISA by many measures has been a successful initiative, but over time its deficiencies have also become painfully apparent. From our perspective the most troublesome aspect of the Act is the rules governing the so-called prohibited transactions. Perhaps the easiest way to describe our view of the prohibited transaction rules is by a simple analogy. Suppose you had a checking account at a bank and you were subject to a consumer version of the prohibited transaction rules. If that were the case you would be prohibited from doing virtually any other business with the bank that held your account and with any of that bank's affiliates for that matter. You couldn't buy notes issued by that bank, you couldn't have a brokerage account with a securities firm that was associated with the bank, you couldn't use the bank as trustee, you couldn't buy insurance through the bank. All other services offered by the bank would be off limits to you unless you had applied and received a series of exemptions granted by the governing authority.

Further assume that applying for those exemptions would involve a lengthy and expensive process. This essentially gives you an idea of what the pension funds face under the current prohibited transaction rules and in particular under the provisions that include service providers as so-called parties in interest. Under those rules the pension plan is not allowed to do any other business with firms or their affiliates who provide services to the plan. A direct example of a pension plan that has a custodial account at a particular bank, under the prohibited transaction rules without an exemption that plan cannot buy a note issued by the bank, it cannot trade securities through that bank, and if the bank happens to be based in a foreign country the plan can't lend securities to the bank.

These restrictions apply not simply to the bank but again to all affiliates of the bank, even partners and joint ventures. There is no justifiable purpose for these restrictions and, furthermore, currently they provide no protection or benefit to the pension plans. Yet the only way around them is to file an exemption request with the Department of Labor, which again is a costly process and can take years to finalize. We don't fault the Department of Labor for this. The Labor Department staff does as good a job as they can with the resources they have under a law that is again seriously flawed.

In the exemption relief request filed last year by the Bond Market Association through my firm, the Department of Labor staff has been as responsive and as accessible as anyone could expect. As a matter of fact, I would like to specifically acknowledge the staff for their efforts and responsiveness to date. That being said, the financial market simply moves too fast for the exemption process to keep up with. Financial products continue to evolve at a rapid pace. Globalization and consolidation in the markets have become hallmarks of the industry. Including service providers in a definition of parties and interest simply doesn't make sense anymore, if it ever did.

That is why our testimony calls for changes in the law in this regard. We also call for many of the prohibited transaction rules to exempt transactions conducted at arm's length. This would bring ERISA rules much more into line with the rules for privately managed portions of Federal employee pension funds under the Federal Retirement System Act. Again there is more detail on that request under our written statement.

We believe these two modest changes would significantly improve ERISA as it relates to pension plan participation in the capital markets. As the Subcommittee continues its examination of the issues related to ERISA we urge you to consider these proposals.

Thanks again for the opportunity to be here this morning, and I would be happy to address any questions following the rest of the testimony. Thank you.





Chairman Boehner. Thank you. Mr. Hotz.





Mr. Hotz. Good morning, Mr. Chairman, Members of the Subcommittee. My name is John Hotz, and I am the Deputy Director of the Pension Rights Center. The Center is the Nation's only consumer organization dedicated solely to protecting and promoting the pension rights of American workers, retirees, and their families. As such I think you can anticipate that my testimony will sound a little different than what we have already heard. On behalf of the Center, I thank you for inviting us to testify this morning.

I am also the Director of the Center's Technical Assistance Project, which provides training and technical assistance to 10 pension information counseling demonstration projects that are funded by the U.S. Administration on Aging. These projects have helped return more than $20 million in pension benefits to Americans facing pension difficulties. I have personally assisted over 500 clients and can tell you that the issues they face are very real.

ERISA's investment-related rules were designed to protect plan participants through information and disclosure, standards for fiduciary conduct, and a system of effective enforcement and appropriate remedies. Although achieving those objectives to a great degree, significant gaps remain. Some of the results are of shortcomings in the law itself, others can be traced to limited Department of Labor resources and to efforts to reduce administrative burdens for employers. Newer problems have also arisen as a result of significant changes in the ways that private retirement plans are designed and operated.

One of the most troublesome issues that participants face is the lack of adequate plan information. ERISA's information and disclosure requirements have time and again been pared back, making it almost impossible for participants in some plans to get the information they need. Now Congress is considering legislation that includes a provision proposing to eliminate the requirement to distribute semiannual reports, a result that would significantly undercut existing protections for participants.

The semiannual report, or SAR, is the only document that participants in pension and profit sharing plans automatically receive that lets them know whether their plan has gained or lost money during the year and how much it is paying in administrative expenses. It can also alert participants to questionable financial arrangements and defaults on plan loans. The Department of Labor will investigate such events. However, resource limitations make the Department's efforts in this area at least partially dependent on well-informed participants.

Both the Labor Department's ERISA Advisory Council and the Secretary of Labor Arguments that the SAR is a burden to employers and that almost nobody reads them have been viewed as unpersuasive. The SAR is a fill-in-the-blanks form that is easy for employers to complete and to distribute. It reminds workers that the money in the pension fund is theirs and that they have rights with regard to its responsible management.

If this Congress is serious about protecting the rights of plan participants, it should commit to mandating that useful plan information be provided, not only to the majority of participants that will not encounter significant problems with their pension but, most importantly, to the minority of participants who inevitably will.

With regard to ERISA's investment-related rules, it has been our experience that the most troubling shortcomings have been in the area of small plans. Although most are well managed, participants in small plans can be particularly vulnerable to mismanagement, fraud, and even embezzlement.

One of my clients was a participant in a small company's profit sharing plan. She left the company fully vested in her benefit but she left the money in the plan. Two years later she was notified that certain employees of a bank, the trustee for the profit sharing funds, had stolen the plan money and that her benefit would be reduced from over $8,000 to less than $3,000. This was her pro rata interest in the amount the employer recovered from the bank of the FDIC insurance. The participants lost out first because theirs was a defined contribution plan, not insured by the Pension Benefit Guarantee Corporation. In addition, the plan's trustees did not have nor were they required to have fiduciary insurance.

These participants continue to lose out because no private lawyer has yet been persuaded to take this case. Fiduciary breach cases are complex and lengthy, yet regardless of the extent of harm caused or wrongfulness of the fiduciary conduct, ERISA allows no compensatory or punitive damages.

These are all areas ripe for reform. Investment-related problems in larger plans tend to be qualitatively different from those in small plans, and are far more sophisticated and extremely difficult to detect. In the interests of streamlining reporting for employers, the Labor Department has made the task of uncovering these issues even more difficult over the years. Specific problems with large plans are covered in detail in our written testimony.

A new wave of investment-related issues is sweeping across large and small plans alike as a result of the shift from employer paid and employer managed plans to employee paid and increasingly employee managed savings plans. A frequently encountered problem is employer delay in paying out employee's 401(k) money when that employee leaves the plan. Although many 401(k) plans are written to allow distributions upon termination of employment, individuals often face delays of several months, sometimes years prior to receiving their money. In some instances these individuals are in danger of losing their homes or unable to cover their medical expenses.

We hope the Subcommittee will consider developing legislation to impose strict time frames for 401(k) payouts and appropriate penalties for unreasonable delay.

Other issues are the result of increasing reliance on mutual funds to administer 401(k) and other individual account plans. In a case handled by the New England Pension Assistance Project the employer had transmitted pension contributions to a mutual fund over a period of years and then changed to a new type of plan. When the client reached retirement age and sought a distribution, she was told that her account balance was zero. The Department of Labor investigated and concluded that the employer had met its ERISA fiduciary standards but that the Department of Labor had no jurisdiction over the mutual fund. The Project then went to the Securities and Exchange Commission, which admitted jurisdiction over the mutual funds but stated that the last employer contribution occurred too many years ago for the SEC to take any current action. Because the client planned to use the money for her retirement she felt no need to inquire earlier. The SEC has since agreed to write a letter to the fund but not without significant prodding by the New England Pension Project.

Our written testimony further develops this new wave of pension problems brought on by the proliferation and popularity of 401(k) type plans.

I would like to conclude my comments by thanking the Subcommittee for its interest in this critical area of the law. We trust that the members will remain mindful that the primary purpose of a pension plan is to provide benefits to its participants, and that as specific reforms are evaluated, the question will be asked how will this measure help those participants who need help the most.

Thank you very much.





Chairman Boehner. Thank you, Mr. Hotz. I am sorry I mispronounced your name.

Ms. Walkey.





Ms. Walkey. Good morning, Mr. Chairman, and other distinguished Members of the House Education and the Workforce Subcommittee on Employer and Employee Relations. I am Deedra Smith Walkey, Associate General Counsel of the Frank Russell Company. Thank you for the opportunity to share our thoughts in the area of investment advice.

Frank Russell Company is one of the world's leading investment services firms, providing investment management, advisory and other services to clients in more than 30 countries. Entering its sixth decade of service, Russell manages approximately $60 billion in retirement plans for investors of all types and sizes. Russell's defined contribution business serves more than 4100 plans and approximately $14.8 billion in assets under management. Russell is also one of the world's largest consultants to retirement plans, consulting clients in more than 30 countries on the investment of $1 trillion.

As a leading provider of investment services and popular educational products, Russell has witnessed firsthand the need to provide customized investment education and advice to employees participating in retirement plans. The underlying cause of this need is the emergence of 401(k) and other self-directed plans. Many of these plans leave rank and file employees responsible for making the investment decisions on which their future retirement security and the well being of their families may well depend. Many employers would like their employees to have the tools needed to ensure that they make the best possible investment decisions, but many service providers like Russell are prohibited from providing advice tools to employers and employees because of the provisions of ERISA.

The source of this problem is the issue of whether the product provides investment advice under ERISA, causing the provider to be a fiduciary subject to the fiduciary responsibility rules. If a firm is providing investment advice so as to be a fiduciary and also manages some of the underlying investment options used by the plan, the Department of Labor takes the position that the arrangement could violate the prohibited transactions rules of ERISA because the firm could give the advice that would cause it to receive higher investment fees.

I am sure you are wondering why anyone other than Russell and its competing investment firms is concerned about this. The problem is that our education product in some cases does not go far enough. Russell produces a popular educational product called LifePoints. We have taken three-quarters of a million people through the program since 1994. Employees work through the exercise book collecting information on their current circumstances, retirement goals, risk parameters, and investment options. Employers select our LifePoints product from a range of products available on the marketplace because of its educational approach and because of Russell's representation. In many cases we also are in a unique situation to know and understand their plan and plan options. We may provide information to a plan specific website. We may have met with employees inside educational sessions. We may serve as their plan trustee. We always provide at least one of the plan investment options.

But instead of working through the LifePoints exercise book or another educational product and going straight to implementation, the employee would say I have defined my goals and have a range of possible investments, what do you recommend? Employees actually using our Russell material must receive a range of possible fund combinations in a hypothetical scenario without a specific recommendation to meet these goals in order for Russell to stay within the safe harbor. Many employees walk away feeling dissatisfied. This dissatisfaction could keep them from making investment decisions or worse yet not contribute to their retirement plan.

In our sessions around the country employees have told us that there are three reasons why they do not make contributions to their retirement plans. One, I am too young; two, I can't afford it; three, it is too confusing. Educational materials can respond to the first two of those reasons. A product that could offer advice along with education could be one way for plan sponsors to respond to that third concern.

Why is now the time to fix the problem? More and more of us have the opportunity to invest our retirement money in funds we selected. In addition, plans have an increased number of options and employees have more at stake because their account balances have grown as 401(k) plans have matured. All of us, including your constituents, are bombarded every day with information, much of it regarding investments and the returns of stock markets. News programs run the market ticker on the bottom of the screen. Any employee with access to the Internet over cable TV or at work or on home PC receives information on a regular basis.

Retirement is a long-term prospect. For some it is a long way off. For others it is nearly here but it could last a long time. Decisions regarding retirement should be based on individualized long-term goals and the long-term prospects for the economic markets, not on the latest market drop or increase reported on MSNBC. Employer sponsored education programs containing real investment advice with recommendations and a means for implementation, individualized to an employee's investment option, age, and circumstances, reviewed and presented at regular intervals, give employees the opportunity to avoid the urge to change investment allocations based on daily market changes which, is a costly form of second-guessing engaged in by many by creating and retaining a long-term plan.

As noted in our written materials, financial services are creating these advice materials and we believe that Russell should be able to create this kind of product. Providers like Russell are subject to the fiduciary provisions of ERISA and we take that responsibility very seriously. Employees will ultimately make an investment allocation decision based on the information they have. They will obtain the advice someplace or they will go with a default option in their plan. The question is whether their plan sponsors have had the full range of investment advice providers available to them just like they have access to a whole range of investment fund providers.

The option to select a firm like Russell should not be denied to a plan sponsor because of the provisions of ERISA. This problem could be solved if the giving of investment advice on the selection of a firm's own investment product were not a prohibited transaction under ERISA.

Alternatively, the DOL and Congress could provide an exemption permitting firms like Russell to furnish investment advice about their own products as long as certain information is disclosed. In fact, this is how we handle these issues with many of our non-ERISA clients. Either alternative would go a long way in providing reform in the ERISA area, and would help ERISA adjust to the 401(k) marketplace, and the investment circumstances of your constituents.

We believe that the Department of Labor has done an excellent job of interpreting a difficult statute and we look forward to continuing our good working relationship with them and assisting the Committee in any way that we can. Thank you again for the opportunity to testify.







Chairman Boehner. Let me thank you, and thank all of the witnesses for their excellent testimony. While I am thinking of it, let me thank our staffs on both sides of the aisle for the job they have done in helping to bring us to our third hearing and in all honesty choosing the great witnesses that we have. Good job to the staff.

Mr. Cohen, do you think that the prohibited transaction rules that we have had a chilling effect on the development of new financial products that would better help our constituents manage their risk or conversely maximize their returns?

Mr. Cohen. Unquestionably, Mr. Chairman. I want to be clear on this. This is not simply a matter of the Department of Labor not doing its job effectively. The Congress made a conscious decision in 1974 to take what is in effect a belt and suspenders type of approach. On top of the fiduciary rules and prohibited transaction rules, which are very broad, Congress said the quid pro quo was that exemptions would be available on a reasonably flexible basis to deal with transactions where conditions could be opposed to protect plan participants. While this was occurring in the early years after the statute was enacted, frequently through class exemptions, in recent years the process has become the narrow end of a funnel. It has been very difficult for our competitors and us to offer sophisticated and innovative new products because of these rules.

There are really three problems. One, which is the least of the problem, is the cost. Cost for getting an exemption for us ranges from $60,000 to $100,000, not much of an issue some would say for a $200 billion corporation. On the other hand, it is an additional cost of doing business.

More importantly, there is a delay factor. A typical transaction takes 12 to 18 months, but a sophisticated transaction often takes far longer. We have had exemptions that have taken us as long as 4 years. One of our major competitors has had a transaction that took 7 years. Given the fact that our business cycle is rapidly accelerating, we are offering new generations of products to keep up with competitors on a 1-year or 2-year cycle. That just doesn't work.

But the most serious problem is the fact that the Labor Department is insisting on conditions that change the underlying economic terms of transactions so that the original concept that was innovative, at the end of the day really cannot be offered. Our competitor's view that I was referring to regarding the prohibited transaction, after 7 years when they looked at all of the conditions there was no longer a prohibition. There were so many conditions imposed upon the transaction that it was cleansed of any of the broad rules under the prohibited transactions rules that may have caused the problem in the first place. This is clearly an impediment to delivering new innovative products and services to plan participants.

Chairman Boehner. Mr. Colosimo, in your written testimony you refer to the 1986 Federal Retirement System Act where they exempted arm's-length transactions from the prohibited transactions rules. What has their experience been? Have there been any self-dealing instances of other problems?

Mr. Colosimo. That law did in fact take the step that we are requesting here. To our knowledge, there have never been any abuses given that change. That is one of the reasons that we feel that ERISA should follow that suit, absolutely.

Chairman Boehner. We have heard over the three hearings that we had from the three panels of witnesses about the prohibited transaction rules. We have had what I would describe as limited testimony about what is prohibited under ERISA and relating that to the current SEC guidelines for non-ERISA plans, and it has been referred to here this morning.

Mr. Lackritz, can you give us a picture of the SEC prohibited transaction rules and the ERISA prohibited transaction rules to help paint a picture that might make this clearer for us?

Mr. Lackritz. I would be happy to, Mr. Chairman.

Chairman Boehner. You can't take an hour to do it, so I understand you may not be able to paint a picture of it.

Mr. Lackritz. Mr. Chairman, you don't have to worry about that. I don't have more than a couple minutes at best.

I think the easiest way of looking at it is to look at the different paradigms incorporated in both statutes and compare them. I think the easiest way of thinking about the securities laws broadly is that the securities laws were passed with the premise that sunshine and disclosure were the best disinfectant with the mandate that significant information had to be disclosed to the public and that there was competition to assure that markets would in fact allocate risks and capital appropriately.

When the ERISA statute was passed, the disclosure paradigm of Justice Brandeis was sort of ditched in a way or at least changed. Instead the paradigm became one of mandates and controls and prohibitions rather than trusting the marketplace and participants to in fact make these decisions. The entire section on prohibited transactions was sort of thrown into the legislation at the last moment in order to avoid what people correctly and appropriately saw as potential conflicts of interest arising in a context of a world of defined benefit plans where you had administrators and plan sponsors acting on behalf of participants. The concern was that there wouldn't be self-dealings, conflicts of interest, and there wouldn't be fraud and that kind of thing.

So there were specific prohibitions put in there. But that rule has really changed dramatically. You don't have a small coterie of professionals acting on behalf of millions of beneficiaries any more, you have millions of beneficiaries taking the responsibility to act themselves and you have a much wider range of options and alternatives that are available to the public. So what we need now, I think, that what we have seen over the last 25 years is the disclosure paradigm of the securities laws has really helped to give rise to the most dramatic growth in the capital markets and investments that we have ever seen.

I think I mentioned in my testimony the number of Americans invested directly or indirectly 25 years ago was about 15 percent in the markets. It is now half. The level of assets in these markets has grown dramatically and the amount of capital the system has been able to raise has grown dramatically. I think this disclosure paradigm of Justice Brandeis has shown itself to have worked very effectively.

Chairman Boehner. Mr. Hotz, I want to bring you into this because we all know that ERISA's great success has been the fact that it has brought more security and protection to plan participants. No one would argue that it has been a great success. But it is clear that the world of 25 years ago was dominated almost entirely by defined benefit plans and that over the last 25 years there has been this giant movement towards defined contribution plans. From where I sit the acceleration toward more defined contribution plans does not seem to want to slow down in any way, shape, or form. So if you accept my premise, how do we help participants maximize their returns for their own retirement while providing the security and safety that has been the hallmark of ERISA?

Mr. Hotz. Obviously that is a very complex question that touches on every element within ERISA.

But just going back to a piece that I touched on at the beginning of my testimony, I would say perhaps the greatest tool that we have to empower participants in any plan, regardless of whether it is a defined benefit plan or a defined contribution plan, is effective information. I would agree with you that ERISA has been profoundly successful in many areas, but as with any area of the law, you generally don't have to worry about the people that are following it. You worry about the people that don't follow it, or the plans that don't follow the law. And that is why it is so important to mandate adequate disclosure and information to participants and to build and to effectively fund an enforcement entity that can ensure that that information gets into the hands of participants.

Chairman Boehner. I am sure I have overstepped my time, but before I recognize Mr. Andrews, let me ask you this question: How much evidence of plan corruption do we see today? I read a vast amount of information on a daily basis. I have a bad habit of getting up too early. I do think if there were more evidence of this, I would have seen it, but I am trying to get a feel for how well the law is working and, more importantly, how well people are obeying the law.

Mr. Hotz. Again, it is a difficult question. In my work as a public interest attorney focusing on pension issues, with the vast majority of my clients being disadvantaged elderly women, the individual nature of their cases, or the small value of their cases, are the kinds of cases that are not going to ever see the inside of a courtroom. I don't want to jump and say corruption, but where pension problems exist in some of the most devastating cases, there is no way to collect those statistics except through the Administration on Aging's pension information and counseling projects.

I personally designed a data collection system for those projects, and if you would like to see some of the data that system has generated, pick an ERISA topic and I can probably give you several horror stories.

Chairman Boehner. Okay. Mr. Andrews.

Mr. Andrews. Thank you, Mr. Chairman. I want to thank all the witnesses for excellent testimony. We look forward to continuing the dialog as the process goes on.

Mr. Cohen, you make the point that there are burdensome transaction costs that the prohibited transaction rules impose upon plans and, therefore, beneficiaries. And you have given us a micro estimate of the effect it has on your company. Do you have any macro estimates? Do you have any evidence that would show us what the cost of these additional burdens has been on the system? And if not, we certainly want to hold the record open for you to give us that information.


Mr. Cohen. I don't, but I just want to make a point about this. It is very difficult to come up with the true cost, because what has happened is transactions that might otherwise go forward now are never going to the Department of Labor. There has been a chilling effect and I am going to speak for the entire industry because I know we are typical of this. When we sit around with our businesspeople the conclusion is often reached that it is not practical to go forward, even with transactions thought to be innovative

Mr. Andrews. I understand that. I know it is very difficult to quantify what didn't happen, but let me make a suggestion that whether based on survey data or based upon extrapolation of valid anecdotal data, one would probably make a fair estimate of the number of transactions that get chilled and would assign some kind of value to them, and come up with some kind of model. If you can, I would be interested.

Mr. Lackritz, I want to ask you questions related to this. You made a comparison of ERISA plans to the Federal Employees Retirement Plan. And I have two questions with respect to that analysis. First, because the prohibited transaction rules do not apply to the FERS plan, I would assume that the transaction costs burden would be less on the FERS plan than it is on ERISA plans. Is it? Is there any data that you could show us?

Mr. Lackritz. I am not positive, but my understanding is that it is less the per-transaction expense.

Mr. Andrews. I think this question will get to what you want to say and relate to us. How do you respond to the argument that that is an unfair analogy? There are people in the Department of Labor who would say that the FERS plan is qualitatively different than ERISA plans. Most of the funds involved are passive index-type funds, there is a different kind of financial dynamic going on, and you are comparing apples to oranges. What is your response to that?

Mr. Lackritz. I think in response to that specific concern, obviously plans are going to be different, but from the standpoint of its overall architecture, the Federal Employees Retirement Plan is a defined contribution plan in the broad sense that the private pension plans are moving in the same direction. It is streamlined in the sense that the number of investment choices is limited. But that certainly doesn't preclude any private plan from offering those same sets of limited options. If they offer the same set of options that the employees retirement plan would be offering, a set of index funds, you would still have higher transaction costs.

Mr. Andrews. Isn't one key difference that there are no circumstances under which the employer benefits financially from an investment choice by the employee since the United States Government is really not in the business of raising capital?

Mr. Lackritz. Sure.

Mr. Andrews. Doesn't that eliminate that very large category?

Mr. Lackritz. Can I add one thing to your previous question? Are there any quantifiable amounts that have been denied or lost as a result of the prohibited transaction rules?

I want to draw attention to the one number the group CIEBA, the Commission on the Investment of Employment Benefit Assets, has pulled together regarding the prohibited transaction on cross-trading, which I think has come up a couple times in the previous hearing. The prohibition on cross-trading within the pension plan has actually cost about $500 million of lost opportunities for pension beneficiaries alone.

Mr. Andrews. We heard that yesterday, and I am interested, since the record is still open, in seeing that fleshed out. Thank you.

Mr. Certner, I wanted to ask you a question about the automatic rollover provision that you proposed. Do you have any evidence as to the aggregate benefit that would have for pensioners and then the aggregate cost it would be to employers? I assume that what happens under present law is that assets which never vest are forfeited assets which accrue back to the benefit of either the plan or the employer in some way. So there would be a cost associated for the employer. Do you have any information on that?

Mr. Certner. We are not talking about non-vested assets. We are talking about seized assets, whether they are in a defined benefit or a defined contribution context, where the individual has earned a $4,000 benefit in their plan, either in a 401(k) plan or a defined benefit plan, and they terminate employment. The employer generally will cut that individual a check. From our experience, particularly when you are at amounts that are lower or individuals are younger, that money tends to disappear into the economy, which may not be necessarily bad, but it doesn't go into a retirement savings account. While this money could be rolled over to another IRA or another plan, more often than not it just gets spent.

Mr. Andrews. Do you have any numbers on the increase in the pension accounts of employees that would occur if the vesting level were dropped?

Mr. Certner. That is by lowering the vesting periods from 5 to 3 years as opposed to the automatic rollover?

Mr. Andrews. Excuse me. I mischaracterized the question at the beginning. I meant to say the 5- to 3-year change.

Mr. Certner. Our understanding is that the cost would not be significant in the defined benefit context because you are talking about people, for example, who are only there 3 years, but are not there 5 years. Obviously, if they stayed the extra 2, they would get the funds anyway. Usually at that point in a defined benefit context, the amount of money that someone has earned is fairly small anyway, so you are really talking about the opportunity to get additional funds accumulated over a lifetime.

Mr. Andrews. I am interested to know if there is any research on what the number would be, because there is a cost. I assume it is rather small, but I would like to know what it is if you have some research on that.


Chairman Boehner. Would the gentleman yield?

If I recall correctly from my own plan, we had to go back in and revise the plan when Congress reduced the maximum vesting period from 7 years to 5 years. In my own particular plans that I have set up for my employees, we have a 3-year vesting. So the options, and anybody can respond, as I understand them today are that it is a minimum of 3 years and a maximum of 5 years for vesting. Is that correct?

Mr. Certner. Well, the employer can choose to have a vesting period for as little as 1 year. Traditionally most use a 5-year period. Some use a graded period from 3 to 7 years. But the employer can certainly choose to go lower. Most, I believe, now choose a 5-year vesting period.

Mr. Andrews. I had a question about the automatic rollover provision. As a practical matter, how would this work? Let's say that I was working for an employer, and I resign. I would certainly never be terminated. I have a defined contribution account, and there is a 24-month period where I have no other employer. Presumably we could pass a law that says that the employer must take the funds and deposit them into some other protected account. Where would it go?

Mr. Certner. I think there would be two choices in that situation. One, when the individual signs up for the plan they could designate how they want the money rolled over should they resign. Secondly, since many may not make that choice, you could have an option for the employer to create a default mechanism so that the money would automatically go to a provider of their choosing that met certain qualifications, such as a legitimate IRA provider. The money would automatically roll over or go to a designated institution.

Mr. Andrews. The final question I have plays on something both Ms. Walkey and Mr. Hotz said.

In talking about the idea of investment advice I think I understand Ms. Walkey’s position that per se it should not be a prohibited transaction for the employee of a mutual fund to give advice to a plan enrollee that would have the employee buy products of that mutual fund. Provided that there is full disclosure, and assuming that all the fiduciary protections are still in place, it just should not be prohibited per se. Mr. Hotz said in another context that effective information, quote/unquote, is the key element.

Is effective information enough here? In other words, if we had a provision that said that the mutual fund would have to clearly and in a timely manner disclose the difference in fees paid by the employee, and the difference in risks, prior to the decision being made, is that enough effective information to justify elimination of that particular prohibited transaction category, in your opinion?

Mr. Hotz. I would think so, if the information were thorough. And as you said, we are not eliminating the possibility of fiduciary liability.

Mr. Andrews. Not only that, we are assuming it still exists.

Mr. Hotz. When I say full and fair disclosure, I mean the experience of the Department of Labor in this. I think it yields many areas where we would streamline these prohibited transaction rules. We are not opposed to that.

Mr. Andrews. This will be my final question for Mr. Colosimo. I don't want to miss him.

If I understand your position correctly, under the facts that you posited, if a pension fund retained the services of a bank’s trust department as trustee services for the fund, and the fund wishes to purchase a bond that the bank or one of its subsidiaries is marketing or otherwise issuing, presently that is a prohibited transaction for which there has to be an exemption gained. If I understand your position correctly, it should not be a prohibited transaction, and it should fall under the rubric of fiduciary principles. Do you think that those fiduciary principles are enough, because wouldn't they be applied retroactively after the deal took place?

In other words, if this were, in fact, a bad decision that ran afoul of fiduciary responsibilities, isn't the horse already out of the barn? Isn't there some need to have a review or analysis of this before the transaction takes place?

Mr. Colosimo. I don't believe so. I think that the fiduciary obligations are prospective, as well as after the fact.

Mr. Andrews. And the remedy is only after because the bond has already been purchased.

Mr. Colosimo. The remedy is retroactive.

Mr. Andrews. Let's assume it was motivated more by the interest of the bank in marketing the bond than the fiscal financial health of the fund. There is a determination made that is the case, and it is a violation of fiduciary duty. What remedies exist to protect the plan participants from that happening? I mean, you can win, but what can you recover against?

Mr. Colosimo. Difficult to answer, but I think it might be such that that is one of the benefits that we provide, and that is a secondary market. So if there is a problem, there is the ability to return that security back to the market, if there was some type of violation.

Mr. Andrews. I think that is a really intriguing answer. The reason I asked the question was I have an interest in exploring the viability and practicality of certain insurance products that would permit such a transaction to take place provided that there were adequate financial resources standing behind the situation. I am very interested in exploring that. Thank you.

Chairman Boehner. As I read your testimony Mr. Colosimo, before I recognize Mr. Petri, you not only maintain the fiduciary responsibility, but you also require that it meet the arm's length test.

Mr. Colosimo. Yes, absolutely.

Mr. Andrews. If the Chairman would yield, those tests would be applied after the transaction has taken place and been challenged. That is my point.

Chairman Boehner. But they couldn't, if they didn't meet the arm's length test; they couldn't proceed. That is a pretty clear test in the law.

Mr. Andrews. But they couldn't proceed if someone went to court and filed a suit to enjoin them from doing it. They could proceed if, in their judgment, it met the arm's length test. That is my point.

Mr. Colosimo. Just to be clear, again, we are very much in favor of fiduciary responsibility and obligation and disclosure and all of the other protections that ERISA does afford, regarding the very narrowly focused issue that we find to be problematic.

Chairman Boehner. Mr. Petri.

Mr. Petri. Thank you. I want to use my time to give the very informative panel members a chance, if they wish to comment on some of the ideas and suggestions that other panelists have made. It seems you fall a little bit into two camps. The providers look at the problem of taking care of changing circumstances, the prohibited transaction framework, and allow a lot more innovation and diversity than is out there in the real world. There doesn't seem to be a real disagreement on the part of Mr. Hotz on that, as long as they do it in a responsible way, and try to allow for faster, innovative deals in this area. Is that correct?

Mr. Hotz. Generally speaking, we would like to see the prohibited transactions remain in the law. The primary issue that I see as an attorney representing individual participants, particularly in an arena of diminishing quality and quantity of information, is how do you find out what used to be a prohibited transaction has occurred? How does the average participant learn of that?

It seems a highly valued element of this system to have the government looking at these transactions. And as we have seen with the development of the cash balance plans, the financial services industry and the products and services that they provide will always move faster than the law. It is important that we have someone looking at the kinds of transactions that are taking place to see if there is a need for new concerns in new areas with these new products. Of course, we don't want to inhibit the economy. We want to allow these organizations to offer new and innovative products. And to the extent that we can streamline the process, we are interested, but let's not throw the baby out with the bath water.

Mr. Petri. Could you respond to Ms. Walkey's comment that there are two worlds out there? There are many around the globe, and you are dealing with non-ERISA as well as ERISA. You face the same fiduciary and other issues, but you have, in fact, in the real world developed many solutions that involve disclosure.

The question is are there horror stories out there in the non-ERISA world that lead us to say we need to keep this in place, or can we rely on the Brandeis idea of disclosure and holding people accountable in the new world of ERISA as they are in the rest of the world?

Mr. Hotz. I know that roughly 30 percent of the cases handled by the Administration on Aging pension counseling projects are in the pre- or non-ERISA realm. I would be happy to go back and analyze the data that I have, to see how many of those that are non-ERISA, which includes your State and local plans as well as your Federal plans, railroad, et cetera, enter the fiduciary or could touch on prohibited transaction areas. I don't have that data in front of me.


Mr. Certner. I want to get back to that I think there is a fundamental problem here, at least for a 401(k) plan participant. It is not the lack of innovative new products. It is really much more basic than that, which is basic asset allocation issues and where among the many options that may be offered to me should I best be putting my funds. It is a much more basic question, I think, from the individual's point of view.

Some of the asset allocation models that the employers have developed, and, say, if you are this age with this risk allocation, these are the kind of investment products you should have and stay with over the long term, they can certainly be helpful. But even for many people today, even that is too confusing. They may not know what their risk tolerance is, for example. And so they want to just be given a little bit more detailed, specific, individualized information about among these eight investment choices in my plan, what percentage of my money should go into each one of these products. And for that you would have to go a step further and give a specific investment advice. As long as that advice can be nonbiased, quality advice, I think there is not a problem with it.

The question is how do we make sure that that advice is not biased or not conflicted? And if we have a service provider, for example, with their own products in the plan, you have naturally set up a situation where there may be a tendency to steer an individual towards those products.

Now, you can do that for example, if the individuals want to go out and pay the service provider on their own for advice. That certainly could happen, and there wouldn't be an ERISA fiduciary problem. If you are dealing within the plan context, you may want to be a little bit more careful about the kind of bias that may seep into that process.

Ms. Walkey. If you are doing it within the plan context, that plan service provider is subject to the provisions of ERISA and is subject to the prudent person standard and the standard of acting for the sole and exclusive benefit of plan participants and their beneficiaries. If they are acting outside of the plan, they may not be subject to those same rules and requirements. We believe that providers that are providing that type of information take those responsibilities very seriously.

Mr. Petri. Do any of you have any comments at all on Mr. Certner's suggestion about the vesting period? Are these important issues? Why was it 5 years? Is there some magic in that, or should it be shorter? Is there a consensus on that?

Mr. Cohen. I would just say, Mr. Petri, that since ERISA was enacted, the vesting periods have on several occasions been shortened. There are proposals in legislation today to shorten them again. And while the ACLI doesn't have a position on this, to respond to Mr. Andrews, there is data out there from the Joint Committee on the costs involved with shortening them again. The costs are in a range of magnitude that some think are reasonable, but some of the employer groups still think they are excessive.

Mr. Petri. Thank you.

Chairman Boehner. Mr. Holt.

Mr. Holt. Thank you, Mr. Chairman.

Let me start, if I may, with a question for Ms. Walkey. There is a lot of discussion about materials that are simple and straightforward and the difference between advice and education. There still remains this fundamental proposition that gives me uneasiness. How can a financial entity provide what you would call the best possible advice in a completely objective manner when the financial entity can receive higher fees based on the investment advice they give?

Ms. Walkey. I would go back to my earlier comment to note that the service provider that is creating this model and the structure of the model is subject to the fiduciary provisions of ERISA, and they take those seriously. They must have developed the model to ensure that it operates in a way that is for the exclusive benefit for plan participants and their beneficiaries. So we are already subject to those rules.

That said your model is also created not knowing what the different fund options are going to be for the variety of plans that you are servicing. So your model is created on some type of an objective standard that we would put together at Frank Russell, with the experience and the information on investments that we have garnered over the years of service that we have provided to large and small plans.

So we are building an objective model. We don't necessarily know in building that model what plan options might be Russell plan options. We are going to have other plan options in there as well so we couldn’t shape the advice to always pick the Russell plan. The model is going to be built not knowing necessarily what the options are.

Mr. Holt. Okay. Well Mr. Certner, if the industry were able to secure an investment advice exemption, what would be an appropriate penalty to deter self-interest and abuse? How liable should employers and plan sponsors be? Do you have any thoughts on that, or perhaps other members of the panel as well?

Mr. Certner. Well, as I take it, I think the employers for the most part are almost trying to stay out of that situation of providing investment advice. So the question for the employer is can they make advice available to the individuals in the plans that need it?

Individuals in the plan can certainly go out and engage somebody, such as Frank Russell or others on their own, and it would not be an ERISA problem. If the employer brought in an independent person who was not affiliated with any of the funds, again, that would not be a problem. If you bring somebody in who even has some involvement with some of those funds, perhaps you can pass that through a filter of independence, say, having had a third independent party verifying the model or whatever else is being used. That may also be a way of making sure that this advice is nonbiased.

I think we would want to deal with that up front and make sure that whatever advice they are getting is nonbiased and not a conflict without having to worry about coming in after the fact and figure out what penalties are and how to restore what may have been lost opportunities for people.

Mr. Holt. So you would rather not address the penalties? You are saying if we can talk about the filters and so forth that we can worry about penalties later?

Mr. Certner. It is always better to make sure it is clean up front rather than worrying about how to penalize folks after the fact. If you are in wrong funds, you can end up with quite a messy situation.

Mr. Holt. Yes, sir.

Mr. Lackritz. I think from the standpoint of addressing the issue about the penalties, I think we favor strong penalties and adequate, tough enforcement just like there is in all of securities laws. I think strong enforcement with a club behind the door or a tough cop on the beat is absolutely critical to ensuring the integrity of all these markets.

I guess in response to your question about shaping or biasing advice, there are lots of protections that already exist in the laws that currently are on the books. In the commercial realities of the marketplace, they act as enormous disincentives for people to do that, not only from the standpoint of the fact that a firm’s major asset in financial services is their reputation. That is, first and foremost, the most important asset that any financial services provider has, and they don't want to risk that from the standpoint of providing biased information. But on the other hand, there are all these protections ranging from fiduciary responsibilities on the one hand to suitability obligations under securities laws on the other.

Mr. Holt. I suppose you would say ERISA safeguards.

Mr. Lackritz. Some of those are really duplicative of what is already in the law and in the statute. Plus at the same time you have so much more widespread information. If we have disclosure of these material facts to investors, and you have competition, that produces a terrific opportunity for many more individuals than you have currently under this restrictive model.

For example, the restrictions on investment advice that are currently prohibited under the prohibited transaction provision now, means that for the last 10 or 12 years most participants in these plans have really only two assets, they have their homes, and they have their pension plan. Where are they going to get investment advice? They don't have other accounts with other firms, and so where do they get that advice?

What this means, since they can't get investment advice from ERISA, is that many of them have not allocated their assets most wisely during the 10 or 12 years of incredible run-up in some of the markets. They have missed enormous opportunities for the equity market certainly over the last 15 years, which have greatly outperformed other classes of financial assets. So you have really denied them enormous opportunities, and that is what we are trying to change.

Mr. Holt. Thank you. And before I yield my time back, I just wanted to thank the Chairman and Mr. Andrews for this really very helpful series. I find it very educational. I am pleased you are doing this on the 26th anniversary of ERISA. Thank you.

Chairman Boehner. Mr. Fletcher.

Mr. Fletcher. Thank you, Mr. Chairman. I have one brief question. I certainly appreciate all of you being here. Sorry I missed the first part of it. Let me ask Mr. Hotz a question, and then ask Mr. Lackritz to comment on it also and Ms. Walkey if possible.

Let me make sure I understand. The law of prohibited transaction applies equally across the board with the defined benefit versus the defined contribution plan. Is that right, even though I know it is very difficult to apply? Help me understand how this prohibited transaction applies to the entire ERISA program.

Mr. Hotz. Actually I may not be the best person to address the technical aspect of your question. I deal mostly in the participants' rights arena. So perhaps someone else could volunteer to give a detailed explanation of the prohibited transaction.

Mr. Fletcher. Let me get back with you, because you are concerned with the customer, if you will, and how that applies, too.

Mr. Cohen.

Mr. Cohen. Let me try to answer that. The permanent transactions apply to all employee benefit plans, defined benefit, defined contribution and wealthier benefit plans like health plans as well. So it applies to the universe of employee benefit plans.

Mr. Fletcher. That is what I understood. Apparently it was written at a time when there was very few defined contribution plans. The reason I ask Mr. Hotz is that if we were to look at either eliminating the prohibited transaction law or changing it in some way, what would you recommend so that it would be more tailored toward defined benefits and defined contributions that may not be applicable in a lot of ways?

Mr. Lackritz. I can try to address that, Mr. Fletcher.

I think that the better way of looking at it in terms of tailoring it more toward those kind of plans would be to look at it from the standpoint of who is taking responsibility for investing these assets longer term. When the law was originally written, you really had a very small group of investment professionals that were managing, controlling and advising with respect to investing these assets. And that has devolved to the point where you now have literally millions, and 53 million individual participants who have responsibility for their own investment and retirement security. Therefore, the notion that you have a set of prohibited transactions between a small group of professionals versus the world now that we have millions of individuals who are responsible themselves means that we can't look at the world quite the same way.

What we need to do is to find a way. We are not suggesting eliminating these prohibited transaction rules completely. What we are suggesting is to modify them in a way that preserves the opportunity for law enforcement that I think Mr. Hotz alluded to earlier, and that Mr. Certner discusses, to make sure they remain in place. We need to streamline the exemption process so that we don't have long periods of time where the beneficiaries are deprived of the opportunities that would have existed had the process moved along a lot more quickly. That is the concern.

I think that is the opportunity that we have in front of us. That is really what we are trying to accomplish.

Ms. Walkey. If I can add to that, we have seen areas in which the statute has been changed, either by class exemption or by other methods, to address the growing 401(k) participant number of plans. We have seen that in 404(c), where we have allowed for self-directed participation in plans. I think that there could be statutory changes or class exemptions that could address these issues for defined contribution plans in order to allow for an advice/education component that would step outside of the interpretive bulletin 96-1. I think there are ways to draft the provisions to make sure that it is applicable to defined contribution plans.

Mr. Certner. I would agree with that.

I think the current exemption process contemplates that issues like this could be done under the statute by getting a class exemption or other kind of exemption from the Department of Labor. I think I hear a general complaint here that sometimes the process takes too long. I think we would certainly be all for trying to speed up that process as well.

Mr. Fletcher. Mr. Chairman, that is all the questions I have. Thank you.

Chairman Boehner. I have a couple other areas that I want to explore briefly; not to prolong this, but two areas.

Ms. Walkey, you talked about the reasons why people don't sign up. They are too young, they can't afford it, or it is just too confusing; an issue that Mr. Hotz talked about in terms of getting more participation.

How do we do that? Is it more educational advice on the front end? Do we actually encourage more people to participate?

Ms. Walkey. I think we would have to do two things. We would have to make employer-sponsored pension plans attractive to employers so they continue to offer plans that are responsive to their employees.

Where Frank Russell would come in is we think you can increase participation with education that provides a range of descriptions of what retirement can do for you, and by providing education on a regular basis, not the first time you enter into the plan. At that point you get an education booklet, you go through the worksheet, and you don't look at it again for 6 or 7 years when you are thinking about possibly changing employers. We would like to see that done on a more regular basis. We think we could do that on a more regular basis if we were providing an education and advice product, and we were doing it in an economical and feasible way for the employer.

Mr. Certner. I think we have seen a number of attempts over the past years to try to boost participation. For example, education, I think, has helped to get more people in the plan. Employers providing matching contributions has helped boost the number of people in plans. But we do seem to top out somewhere. Depending on the plan it may be three out of four participants. Sometimes we can get higher than that.

In general I think it is because of those things you cited: The people are too young, and they are not thinking about retirement because that is something we can think about tomorrow; or they are just lower-income folks who just don't have that kind of disposable income or certainly have other priorities, and the retirement income side is just not a high as priority.

The problem is how do you get those folks into the plan. Some have tried automatic enrollment where everybody is automatically in the plan and you have to get out. That seems to get people in there a little bit quicker. It may be better to use a tax code to try to provide some additional incentives maybe not just for the individual, but also for the employer. If you think about today's plans, we provide employer benefits and a tax subsidy for the people who do contribute. But the people who don't, they don't get anything out of it. Maybe we can try better tax incentives for the employer to make contributions on behalf of those lower-income folks who are just not going to contribute on their own.

Chairman Boehner. Let me change directions a bit. We have been talking about prohibited transactions in all of our hearings. We certainly had a broad discussion of it today. And as I have listened to all of the witnesses, including the six that are here today, there is a general recognition that we need to make some changes, and we can go in either one of two directions. We can provide more resources to the Department of Labor, maybe tweak the class exemptions to bring them up to today, or we can go in the direction of a more flexible framework that anticipates that we are going to continue to see dramatic changes in the market.

Mr. Cohen, you spent some time outlining this picture and didn't quite give us any idea of what direction you would prefer to go in. What would be the difference between these approaches?

Mr. Cohen. Well, I mean, I certainly would prefer to see some structural changes to the prohibited transaction rules that build in more flexibility. I think the problem is not just the Labor Department, or the time frames, or the processes, et cetera. The problem is that the world is changing very quickly and you need a statute that can stand the test of time better than the prohibited transaction rules have. The fiduciary rules have held up well because they are broad, they are conceptual, and they have proven to be flexible.

Prohibited transaction rules need some additional flexibility. There is so much built-in redundancy in these rules that they have become a constraint. And in our testimony we have set forth at least two structural approaches, which we believe would allow more flexibility without impairing protections to plan participants and beneficiaries, which is all our common goal.

Chairman Boehner. Now, Mr. Hotz, in response to someone else's questions, you specifically mentioned that you believe that we ought to continue to have the prohibited transaction rule. We ought to look for other ways to try to speed up the process, while acknowledging that, given the speed of change in the market place, we are going to have our hands full.

Now, I would like to ask you to respond to Mr. Cohen's testimony regarding his desire for a broader, more structural change.

Mr. Hotz. Not having had a chance to fully review the details of what his proposal is, I would prefer to take some time and get back to you within our 2-week time frame and present an opinion that reflects the actual staff of the Center, if that would be acceptable.

Chairman Boehner. That would be fine.


It would be very helpful, because I think the objective that we all have is keeping the participant in mind, and how we can best help participants help themselves to plan for the road to retirement security. And while the idea of 25 years ago places all of this responsibility on the fiduciaries on a number of levels, we know that the whole world has changed.

As we look down the road, empowering individuals to help themselves, I don't think we have any choice but to go in that direction. But as we go in that direction, there are certain safeguards that are going to have to be put in place. I think all of us agree that trying to find those safeguards in this context needs to be fair, flexible, and enduring.

Mr. Hotz. If I may, the focus on empowering participants is really twofold.

I am hearing a lot of emphasis being placed on giving them the power to manage their own investments. While I think that is important, we should also keep in mind that, particularly given the structure of today's system and ERISA's reliance on civil enforcement, a key element of empowering participants is giving them the information to enforce their rights when something goes wrong, and not just educating them about how to build retirement wealth, but how to fix the problem when something goes wrong.

Chairman Boehner. Fair enough.

Mr. Andrews.

Mr. Andrews. If the Chairman would yield for just one moment, I also appreciate the testimony and wanted to make a couple of comments on my own about what we have heard during the first two hearings. I hear consensus, if not unanimity, on the argument that the basic precepts of ERISA, voluntary employer cooperation, strong fiduciary standards, work. We want to reaffirm them and strengthen them.

The second thing that I hear a consensus on is that there is a desire to get more people covered by plans and to make their assets go as far as we can make them go. I think that is a mix of greater incentives for employers, and better performance for employees. It may be vesting employees sooner with more rights. I don't know that there is consensus on that, but we certainly have an interest in it.

And then finally on these more mechanical issues, I think that we are approaching a verbal consensus. It is difficult to translate that into law, but on the issue of prohibited transactions, I don't hear any of the witnesses saying they want to restore a day when self-dealing was the norm. No one wants to do that. I don't know if we ever had the day when it was the norm, but when it was more rampant than it is now, let's put it that way. I do hear everyone saying that burdening plans and, therefore, beneficiaries with needless transaction costs make no sense. So what we want to try to do is figure out a way to accommodate those two goals.

On the issue of educational advice very clearly we have a practical problem. We have millions of people having the authority and the right to make decisions about their retirement investing and not having many tools with which to do that. And what I am hearing here is some consensus that we want to empower those who are most likely to be on the scene to give that advice to do so, but we want to do it in a way that there are airtight protections. The advice must be clearly understandable, objective, and not motivated by self-interest, and must provide objective information to the beneficiary. Now, again, finding a legislative formula to accomplish this is difficult, but I think that is a fair synopsis of what we have heard from a lot of the witnesses here.

The other point that I would make is that, and there is not consensus on this but we certainly have an interest in it, there is a recurring theme about older workers in general and older women workers in particular who are egregiously, egregiously unprepared for their retirement because of the way the system has worked over the years. I am not interested in assigning blame for that, probably because the United States Congress would get most of it. But I think that there is an acute and real problem that exists today, and we want to avoid in the future. It has a specific impact on the millions of women who find themselves late in their lives or in the middle of their lives with very thin financial resources. And I appreciate Mr. Certner's testimony particularly in that regard. I think he gave us some very interesting points on that.

With that, that is all I have.

Chairman Boehner. Thank you, Mr. Andrews. And I couldn't agree more with the outline of what we have heard and the consensus we have achieved

With regard to the concern about older women and others, as most of the members of the panel and others know, many of the provisions dealing with some of these concerns were dealt with in the Portman-Cardin legislation and in the areas within this Committee's jurisdiction such as the catch-up provisions for people coming back to the workplace, especially women, and the expansion of the ability to put away more, and generally the idea that we ought to encourage more employers to offer pensions and have more participation. Even though it was placed in a piece of legislation yesterday that some of us, probably all of us have problems with to some extent it did in fact pass. We remain hopeful that those changes to ERISA can, in fact, be enacted this year.

We also know that what we are embarking on is really a second step looking at the regulatory structure around ERISA on its 25th anniversary to see where it can be improved for the benefit of plan participants.

And so with that, I want to thank all of our witnesses again for their excellent testimony and those of you who have shown your interest. The Committee will stand adjourned.

Whereupon, at 12:25 p.m., the Subcommittee was adjourned.