In Practice July 14, 2010

Vanguard Touts Auto Design Advantages

About a quarter of eligible defined contribution plans recordkept at the Vanguard Group are using Vanguard’s auto plan design, up from only about 1% in 2005. 

Reported by

Among all Vanguard DC plans using auto enrollment in 2009, the average participation rate was 86%, where plans using voluntary enrollment had an average participation rate of 59%, Vanguard said in a Web site article about its auto plan design, One Step.  

If not implemented carefully, Vanguard said an auto pan design may produce unintended consequences for plan sponsors such as creating a large pool of low savers.  

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“Although automatic enrollment is an important tool for boosting participation, it may not get participants on track to a financially secure retirement if their deferral rates remain low,” said Ellen Kranick, manager of the Vanguard auto plan program. “Full autopilot plans help resolve that issue by gradually increasing deferral rates.”  

According to Vanguard, plan sponsors also can benefit from an auto plan design through:  

  •  A reduction in recordkeeping and administrative burdens,   
  •  An improvement in nondiscrimination testing outcomes,   
  •  An increase in deferral rates for highly compensated employees as a result of improved testing, and   
  •  A mitigation of fiduciary risk. 
(Cont...)

Auto Deferral Hikes  

According to the article, Vanguard recommends sweeping existing participants into the automatic annual deferral increases if their rate is below the rate needed for the full company match. 

Kranick believes this is an important element of a successful implementation. “As with eligible nonparticipants, low savers who are already in the plan should have access to the same benefits as new hires,” she said. 

In Vanguard plans that use voluntary enrollment, participants have an average deferral rate of more than 6%. But because the dominant default deferral rate for autopilot plans is 3%, new participants in these plans have an average deferral rate of just 3.7%.  

According to Kranick, this is why annual deferral increases are such an important part of autopilot plans. Without automatic annual increases, she noted, participants who are automatically enrolled tend to stay at their original deferral rate.  

Kranick also pointed out that the early years of saving for retirement are critical, so a 3% initial deferral rate may not be enough, even with annual increases. This is why, when plan sponsors are considering adopting autopilot plan design, Vanguard recommends starting participants at a 4% to 6% deferral rate—preferably 6%. 

Balanced Fund Use  

The use of balanced funds as defaults has increased tremendously over the past four years, so today, 56% of the default funds used in all plans at Vanguard are target-date funds and 19% are other balanced funds. Among plans designating a QDIA, 80% use target-date funds and 20% use another balanced fund as the default.  

Kranick said: “Our research continues to show that target-date funds, in particular, help provide more appropriate diversification for most participants. And we find that once they’re defaulted into a fund, inertia tends to keep them there.” 

More information is at http://www.vanguard.com/.  
Compliance July 14, 2010

Court Buys Retail vs. Institutional Share Fee Claims

Even though the bulk of their claims were thrown out, 401(k) participants still won a key legal victory in a suit against their employer when a judge ruled the selection of three retail-class funds constituted a fiduciary breach. 

Reported by

U.S. District Judge Stephen V. Wilson of the U.S. District Court for the Central District of California declared that Southern California Edison (SCE) and its plan fiduciaries violated the duty of prudence imposed by the Employee Retirement Income Security Act (ERISA) by not properly investigating the differences between selecting retail shares instead of institutional shares.   Wilson’s 82-page ruling in Tibble v. Edison International was significant because the court accepted an often-advanced claim in 401(k) excessive fee suits that fiduciaries violate their ERISA-imposed duties by not adding less-costly institutional shares to their plans.  

“Had the Investments Staff and the Investment Committees considered the institutional share classes when adding these funds in 2002 and weighed the relative merits of the institutional share classes against the retail share classes, they would have realized that the institutional share classes offered the exact same investment at a lower cost to the Plan participants,” Wilson contended. “Thus, Defendants would have known that investment in the retail share classes would cost the Plan participants wholly unnecessary fees.”  

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In regards to the three funds that were the focus of the fiduciary breach finding, Wilson turned aside defendants’ arguments that the fact they were taking the advice of Hewitt Financial Services (HFS) when they opted for the retail shares negated any fiduciary breach. (The three funds were the William Blair Small Cap Growth Fund, the MFS Total Return Fund, and the PIMCO (Allianz) RCM Global Tech Fund.)  

Wilson commented:   “While securing independent advice from HFS is some evidence of a thorough investigation, it is not a complete defense to a charge of imprudence.”  

The court likewise rebuffed defense claims that they couldn’t look further into institutional shares because of mandatory investment minimums placed on those shares. Wilson argued that the fiduciaries should have asked for a waiver of the minimums and noted that the fund managers involved had never turned down a similar request from a similarly sized plan (The plan had $3,172,539,477 in  assets as of December 31, 2005.) “Defendants’ failure to do so constitutes a breach of the duty of prudence,” the court concluded. 

Wilson rejected the plaintiffs’ arguments that the plan fiduciaries opted for retail shares because they wanted to maximize their revenue-sharing revenue given the retail shares’ higher fees. The court said there was no evidence that the plan fiduciaries considered revenue-sharing when they selected the retail-class funds.

(Cont...)

Finding of No ERISA Breach 

Wilson found no such breach in the plan’s decision to go for retail shares of three other funds - the Berger (Janus) Small Cap Value Fund, the Allianz CCM Capital Appreciation Fund, and the Franklin Small-Mid Cap Value Fund - based on the fiduciaries' actions within the legal statute of limitations, which Wilson said began on August 16, 2001.  

The court also threw out breach claims regarding the State Street Global Advisors Money Market Fund. Wilson ruled that the fund's management fees fell well within the range of competitive, reasonable money market fund fees. 

“Where the undisputed evidence establishes that the Money Market Fund significantly outperformed its market benchmarks net of fees for 9 years, and Plaintiffs can only present evidence that, at most, two money market funds charged lower fees than the Money Market Fund at some point from 1999 to 2007 while several others charged comparable or even higher fees during the same period, Plaintiffs cannot meet their burden of showing that investment in the Money Market Fund was imprudent,” Wilson wrote in the ruling. 

Calculating Damages 

Regarding damages, Wilson ordered plaintiffs’ lawyers to recalculate the “substantial damages” incurred by the fiduciaries’ actions.  

Wilson wrote: “The Court concludes that, despite the stated mandatory minimum investments for the institutional share classes, Defendants could have invested in the institutional share classes of the William Blair, PIMCO, and MFS Total Return funds at the time the funds were first added to the Plan. Thus, for each of the three funds, damages should run from the date the Plan initially invested in the funds, July 2002, to the present.” 

Plaintiffs filed the suit as aclass action on August 16, 2007, against Defendants Edison International, Southern California Edison Company, the Southern California Edison Company Benefits Committee, the Edison International Trust Investment Committee the Secretary of the SCE Benefits Committee, SCE’s Vice President of Human Resources, and the Manager of SCE’s Human Resources Service Center. 

Glenn Tibble, William Bauer, William Izral, Henry Runowiecki, Frederick Sohadolc, and Hugh Tinman, Jr. were selected as named plaintiffs.

Wilson certified the case as a class action on June 30, 2009, and then threw out most of the plaintiffs’ original claims in orders issued July 16 and July 31, 2009.  

The latest Wilson ruling is here.   

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