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The Mutual Fund Scandal

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					Hooray for 401(a)



        October 22, 2004

      Linda Delivorias, Esq.
 Vice President, Aon Consulting
          301.280.7534
 Linda_Delivorias@aoncons.com
         Why All the Excitement?

Employers have three goals for their 401(a) Plans
  1. Increase the Percentage of Employees Participating
     in Retirement Plans
  2. Raise Retirement Savings
  3. Improve Asset Allocation
Employees have three goals for their 401(a) Plans
  1. Employer-funded plans
  2. Investment Advice
  3. Portability


                                                          1
          Why All The Despair?

• Volatile Equity Markets
• Mutual Fund Scandals
• Participant Lawsuits
• Hidden Fees & Expenses
• Fiduciary Liability
• Outsourcing Plan Administration




                                    2
          Overview of 401(a)
       Defined Contribution Plans
• 401(a) Plans are funded by employer
  contributions
• Employer contributions can be based on the
  amount a participant contributes to another
  retirement plan (401(k), 403(b), 457 plan)
  AND/OR criteria unrelated to participant
  contributions such as years of service or
  compensation



                                                3
       Regulatory Advantages

Statutory exemption from the following ERISA
and Internal Revenue Code requirements:
 • Titles I and IV (fiduciary duties, reporting and
   disclosure, termination insurance)
 • Participation – test for private sector employees
 • Coverage
 • Vesting – plan termination; discontinuance of
   employer contributions
 • Joint & Survivor Annuities


                                                       4
      Regulatory Advantages

• Assignment/Alienation of Benefits – QDROs
• Commencement of Benefits
• Permitted Disparity
• ADP/ACP Tests
• Top Heavy Provisions
• Schedule SSA
• Form 5500



                                              5
            Life Savers for Plans

IRS issues PLRs and Determination Letters
  • PLR – issued in response to a taxpayer request and is
    binding on IRS if the taxpayer fully and accurately
    describes the proposed transaction and carries out the
    transaction as described
  • Determination Letter – plan sponsor receives letter
    from the IRS that the form (NOT THE
    OPERATION) of the plan complies with IRS
    requirements for tax qualification



                                                             6
Internal Revenue Code Requirements

• Written Program Requirement
• Exclusive Benefit Rule – plan must be
  maintained for the exclusive benefit of
  employees and beneficiaries. Under the plan’s
  trust agreement, it must be impossible to divert
  any assets for any other purpose.
• Distribution Rules – age 70 1/2/retirement
• Contribution Limits
• Compensation Limits
• Rollover Rules

                                                     7
         Priorities & Challenges

•   Investments
•   Investment Guidance
•   Investment Advice
•   Managed Accounts
•   Fees & Expenses
•   Outsourcing
•   Plan Design
•   Fiduciary Services

                                   8
      Best Practices – Investments

• Fiduciaries Must Monitor
  – Investment policy statement
  – Fund selection – quantity, type (active, passive, lifestyle,
    lifecycle, self-directed brokerage, proprietary)
  – Ongoing fund performance & expenses
  – Significant management & cash flow changes
  – Style drift
  – Participant investment behavior
     • Participation levels
     • Diversification of investments



                                                                   9
      What’s It All About, Spitzer?

• Mutual fund advisers have recently come under close
  scrutiny for:
  – Late trading – allowing “favored” investors to place
    trades after markets close and still receive same day
    pricing
  – Market timing – allowing investors to make rapid “in and
    out” purchases and redemptions to realize short term
    gains
  – Insider abuse – senior officers, portfolio managers taking
    advantage of their positions to gain profits
  – Pay to play – investment consultants/brokers
    recommending funds based on revenue


                                                                 10
                   Who’s Involved?

     Alliance           AMVESCAP            Bank of America

    Bank One            Bear Stearns         Canary Capital
 Charles Schwab           Citigroup        Federated Investors
    Fred Alger          Janus Capital         Loomis Sayles
  Merrill Lynch      Millennium Partners      Mutuals.com
  Pilgrim Baxter     Principal Financial   Prudential Securities
Putnam Investments      Security Trust        Strong Capital
                        US Bancorp/
      UBS                                         MFS
                        Piper Jaffrey
     PIMCO           Franklin Templeton         ?????????




                                                                   11
 Responses to Fund Mismanagement

• The primary fiduciary issue:
  – Is it prudent to continue to make the fund available
    under the plan?
• Acting “prudently” is a nice concept, of course,
  but what does it mean in practice?




                                                           12
                 Assess the Risks

• Some plan fiduciaries have decided to remove plan
  assets from mutual funds that have been tarnished in the
  scandals, but that is not cost-free. Direct and indirect
  risks include:
  – The costs (in time and money) of prudently selecting a
    replacement fund
  – The possibility that the replaced fund will perform better
    than the replacement fund
  – The risk that the replacement fund will face similar
    allegations



                                                                 13
  Best Practices – Guidance, Advice
       & Managed Accounts
• Guidance – enrollment assistance, meetings,
  seminars, one-on-one assistance (not investment
  advice)
• Advice – investment advice provided by
  independent third party (fees based on usage)
• Managed Accounts – investment advice
  automatically implemented and monitored (fees
  based on account size)
• Fiduciary Duties with Respect to Selection &
  Monitoring of Providers

                                                    14
 Best Practices – Fees and Expenses

• Plan assets can be used to pay reasonable cost of
  “expenses to maintain” the plan
• Fiduciaries they need to make sure fees are reasonable
• Problem: fees are often “hidden” and not always fully
  disclosed




                                                           15
 Best Practices – Fees and Expenses

• What are the fees?
   – Record keeping
      • Per participant/plan sponsor
      • Special charges for loans, distributions, etc.
   – Compliance
   – Trustee/Custodial
   – Investment management
      • 12(b)-1 fees
      • Expense ratios
      • Commissions & finder’s fees
      • Wrap fees

                                                         16
 Best Practices – Fees and Expenses

• How to find out
  – Group Annuity Contract
  – Prospectus
  – Service Agreement
• Challenging situations
  – Insurance products
     • Guaranteed investment contracts
     • Market-value adjustments & Contingent-Deferred
       Sales Charges




                                                        17
        Best Practices – Outsourcing

• Bundled vs. Unbundled
  – Best Price
  – Best System
• Negotiate Contracts
  –   Service Guarantees
  –   Fee Guarantees
  –   Standards of Care (Gross vs. Ordinary Negligence)
  –   Indemnification




                                                          18
      Best Practices – Plan Design

• If no pension plan – percentage of compensation
• If pension plan – based on deferrals
• Vesting Schedule – Majority have immediate
  vesting
• Significant Impact on Participation in Deferral
  Plans
• Estimated Annual Costs – case by case



                                                    19
 Best Practices – Fiduciary Services

• Investment Consultant
  – Provides information to fiduciaries, but does not make final
    recommendations
  – Disavows any role as a fiduciary or co-fiduciary
• Investment Advisor and Co-Fiduciary
  – Provides guidance and specific advice
  – Serves as co-fiduciary with committee
• Cautions
  – Advisor says it is a co-fiduciary, but not in writing
  – Advisor says it is a co-fiduciary, but liability nullified by
    contract provisions

                                                                    20

				
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