Wednesday, May 20, 2015

A (small) Victory for Investors

Give us greater choice and simpler rules, not more litigation

Hey ... it's 401(k) week here at VA11 Independent! Not that I'm offering a plan, just a couple of posts on the subject.

This week the Supreme Court ruled in the case of Tibble v. Edison International, making it "easier for 401(k) plan participants to sue employers for offering investment options that erode their retirement savings through excessive fees." As reported by Michael A. Fletcher of the Washington Post, Edison International employees "argued that the company offered six mutual funds with higher fees than identical institutional funds that were available but not offered to participants in Edison’s retirement plan."

Attorney Jerome Schlitcher, who represented Edison employees before the Court as well as others bringing suit to challenge high fees, said: “This is a victory for workers and retirees in 401(k) plans because it makes very clear that there is an ongoing duty on the part of fiduciaries to make sure fees are reasonable and investments are prudent." I'm sure Mr. Schlichter feels that the decision is a victory for investors, that he feels a little richer himself, and that he'd welcome more work like this.

I see employers reacting in one of three ways:
  1. Spend more time and money to search for the lowest fee funds to avoid the risk of litigation
  2. Decide it's not worth the time or money and take the chance that litigation does not occur, thus putting the burden of litigation and continuing high fund fees on employees
  3. Just give up sponsoring 401(k) plans, leaving employees with lesser tax-deferred options
Edison International has almost 14,000 employees who can band together to litigate; that's probably not the case for employees at smaller companies.

My preference? Increase annual IRA limits to equal those of 401(k) plans (currently $18,000 a year if you're under 50) and allow once-a-year rollovers from 401(k) to IRA. These two changes to the IRS code would put competitive pressure on mutual fund fees and shine a bright light on IRA rollover fees (which are zero with many investment firms already).

401(k) investors are not that much different than Tesla car buyers: they are forced to go through middlemen. In fact, for my 401(k), I have to go through three layers: employer, benefits broker, and plan administrator. For investors the Tesla analogy may not be right though: even after the middleman they may not get the right product at the right price,

I know I harp on this 401(k) v. IRA thing quite a bit, but it really gets down to a level of responsibility that we need to talk about. If you're a believer in traditional employer-provided pensions you're likely welcome the Court's opinion that an employer's "continuing duty to review investments includes a duty to remove imprudent investments". (BTW – the justices didn't define "imprudent investment".) If you're like me and believe that the responsibility for picking "prudent investments" lies with the investor in a competitive market offering many low-fee choices, then maybe this opinion makes you wince.

We often hear that our average financial IQ is low. If so, part of that responsibility lays with Congress – not because we're not sufficiently "protected" but because they provide us with an impenetrable, arcane tax code where consumers are mired in complexity and competition takes a backseat to entrenched interests. Simple investment products with straightforward, cogent rules serve us best – without the added cost of middlemen.