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The General Dynamics Settlement: A Peek Into the Dark Side of 401(k) Plans

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It's no secret I believe the 401(k) system needs serious reform. The recent settlement of a class action complaint against General Dynamics Corporation for alleged chicanery relating to its $6 billion plan validates my cynical view.

In the Complaint (No: 3:06-cv-698), filed in the United States District Court for the Southern District of Illinois, the allegations (which were denied by General Dynamics), were chilling. They included charges General Dynamics hired former employees to act as Investment Administrator of the plan, despite their lack of qualifications and experience, the Investment Administrator engaged in self-dealing transactions by designating itself as investment manager for some of the funds in the plan, the Investment Administrator engaged in conduct which increased costs to plan participants, failed to negotiate readily available lower fees from mutual funds included as options in the plan, paid excessive fees for recordkeeping services, and failed to capture readily available income streams which would have benefited the plan, among other misdeeds.

While this plan has some unique wrinkles (hiring former employees in a no-bid manner to manage this mega-plan seems particularly egregious), the way the plan was allegedly run is no different than most plans I have reviewed, and perhaps better than some.

These plans are typically managed for the primary benefit of the employer and the investment adviser. Secondary beneficiaries include recordkeepers and, most of all, the mutual funds included as options in the plan. Employees are the caboose of this profitable train.

The settlement provides for a modest payment of $15.15 million to be paid by defendants' insurers. There are 85,000 participants in the plan. That comes to about $178 per participant, before further reduction for attorneys' fees and administrative costs. I suspect the net per participant will fall to the $75 range, if that.

The settlement does include changes in the way the plan is managed, which could have a positive impact on future returns of the participants. General Dynamics will hire an independent consultant and an independent fiduciary and will make other changes. I don't know who these people will be and that could make a huge difference.

If I was the independent fiduciary, I would eliminate all actively managed funds from the plan options and would insist employees be offered a selection of pre-allocated, globally diversified portfolios consisting solely of low cost stock and bond index funds, Exchange Traded Funds or passively managed funds. For employees who wish to speculate with their retirement assets, I would offer a directed brokerage option so they would have access to a full range of stocks, bonds and mutual funds, although I would insist on employee education to discourage them from doing so. Fees for all vendors would be negotiated at arm's length, using a competitive bidding process, and would be fully transparent.

Implementing these changes would be real reform. Based on historical data, they would also increase returns of the plan participants by as much as 300% over the long term.

I'll be waiting for the call.

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