The dispute between Yale Law School professor Ian Ayres and a trio of lawyers from the respected law firm Drinker Biddle & Reath LLP is fascinating. Professor Ayres recently sent letters to 6,000 plan sponsor clients in which he asserted the costs of their 401(k) plans were excessively high. The letters strongly implied that high fees could constitute a breach of fiduciary duty owed by plan sponsors to participants in the plan.
Drinker Biddle, which is counsel to many plan sponsors, fired back with a memorandum pointing out purported deficiencies in the letter. These deficiencies included alleged failures to consider recent cost reductions, plan design differences and services in relation to costs, and the impact of revenue sharing. Drinker Biddle also noted the use of outdated information and raised other technical issues.
The debate obscures the real area of concern, which was brilliantly framed in an Aug. 15 TIME magazine article by Christopher Matthews entitled "America Can't Afford Wall Street's Terrible Investment Advice." Matthews notes the surprising issue that has caused our dysfunctional Congress to come together in a rare display of bipartisan support. And what is this issue? Members of both parties are asking the Department of Labor to reconsider plans to impose a fiduciary duty on investment professionals who provide advice to 401(k) plans and other retirement accounts.
Being a fiduciary means an adviser must act solely in the best interest of plan participants. Currently, brokers and insurance companies have limited fiduciary responsibilities. For example, they can accept "revenue sharing payments" from funds that want to be included as an investment option in the plan, and they can refuse to include low-cost index funds that don't make these payments, even though the expected return of the low-cost index funds is higher over the long term. A true fiduciary could not make that choice without violating its fiduciary obligations to plan participants.
Here's what's missing in the debate between Professor Ayres and Drinker Biddle. As I pointed out in a recent blog, the odds of a portfolio of 10 equally weighted actively managed funds (rebalanced annually) beating its benchmark over a 10-year period has been calculated to be only 0.055 percent. Over longer time periods, the odds are even worse. Clearly, participants in 401(k) plans would have higher expected returns if their investment choices were limited exclusively to portfolios of low-management-fee index funds, passively managed funds or exchange-traded funds, at different levels of risk. The only justification for the inclusion of actively managed funds with higher expense ratios is to generate fees for the mutual fund industry and the recipients of "revenue sharing payments."
Matthews summed it up best: "With a retirement-savings gap that's been estimated to be as much as $14 trillion, and Washington fighting over how much we need to cut Social Security, the American retirement system simply can't afford to support an investment industry that makes billions from deliberately confusing its clients and steering them toward expensive products that shrink retirement accounts over time."
Kudos, Mr. Matthews and Professor Ayres. Thanks for standing up for hard-working Americans.
Dan Solin is the director of investor advocacy for the BAM ALLIANCE and a wealth adviser with Buckingham Asset Management. He is a New York Times best-selling author of the Smartest series of books.
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