By Paul Petillo
Beginning this past Monday, the subject of competitiveness was placed high on the docket as business and governmental leaders meet to mull the fate of our financial standing in the world. Discussion of the topic was begun in earnest soon after the appointment of Henry Paulson as Treasury Secretary in 2006.
Bringing his very profitable experience at the helm of Goldman Sachs, Mr. Paulson was left with the somewhat difficult task of unifying President Bushıs pro-business agenda. Since replacing John Snow, who had wandered off message, focusing his efforts on deficit reduction and corporate governance, Mr. Paulson has been actively pursuing a quite different approach.
His belief that, "we must rise above a rules-based mindset that asks, 'Is this legal?' and adopt a more principles-based approach that asks, 'Is this right?'" is at the core of this conference.
Gathering former Treasury Secretary Robert Rubin, ex-Fed chairman Alan Greenspan, and a host of business leaders including Jeffery Immelt, CEO of General Electric, Mayor Michael Bloomberg of New York, John Thain of the NYSE and Ann Yerger, former executive of the Council of Institutional Investors to discuss the direction of the US financial markets, Mr. Paulson hopes to set in motion the perceived reforms that business insists will level the global playing field. Wall Street investment firms are well represented on the commission as well.
The assemblage was lightly peppered with dissenting voices in Warren Buffet, who believes that the capital markets are not only healthy but globally attractive and Arthur Levitt Jr., President Clintonıs SEC chairman, whose impassioned editorial in the Wall Street Journal recently suggested that these business leaders should leave well enough alone. Mr. Levitt pointed out that these business leaders had compromised the Financial Accounting Standards Board and the government Accounting Standards Board to such a degree as to make them a moot agency. Greenspan defended Sarbanes-Oxley.
Billed as a weeklong debate, the topics on the table have been greatly discussed by both Mr. Paulson and recently by the US Chamber of Commerce. At risk is the chance that should these business leaders fail to reach a decision, the United States will falter under the weight of its own regulations.
The group would like to change the way Sarbanes-Oxley is applied. To do this, the commission has recommended that the Act, often cited as a knee-jerk reaction to the demise of Enron and WorldCom and an unnecessary costly accounting rule, be rolled into the Securities and Exchange Act of 1934. This would give the SEC the power to pick and choose what should come under the regulatory requirements.
Business has sought to eliminate this legislation since its inception. But since its passage, the cost of accounting, which forces the CEO to sign-off on financial statements, has been drastically reduced.
Worried that too few accounting giants remain Arthur Anderson collapsed in 2002 collapsed as a result of their poor auditing practices moving (and weakening) SarbOx, many in the group suggested would allow greater flexibility and increased openness to American stock exchanges. Among those most vocal on this subject was John Thain.
Currently, there are only four major accounting firms remaining. Mr. Paulson has urged Congress to allow these firms to raise capital, whether on the open market or through private equity. This would allow the remaining firms to better weather any litigation and possibly loosen the new conservative nature prevalent in the industry.
Once this is done, restructuring the SEC, also on the agenda would be a matter of closing one division (the inspections department which monitors the activity of brokerage firms), diluting its oversight into one of informality with the securities industry. The suggested changes have been touted as efficiency based, eliminating overlap while at the same time
Christopher Cox, the head of the SEC has resisted these changes so far standing behind the current high standards already in place. His commission has begun the subtle shift away from investor protection to a more business responsive stance.
Mr. Cox, who has met extensively with his British counterparts and has made it clear that adopting their more lax regulations, is not in this countryıs best interest is expected to join the meeting on Wednesday.
The commission does have one item on the agenda worth consideration. They have recommended the portability of employee 401(k) plans to make increased participation more likely.
Yet this one step forward is accompanied by one step back. The mandatory enrollment of employees at all companies (excluding the smallest) through payroll deduction would increase market involvement but the main beneficiaries would not be the investors but the financial firms that service them.
And lastly, the group will focus on corporate guidance. Signing off on your companyıs next quarter can come with its problems and the suggestion to eliminate this guidance is widely cheered by CEOs nationwide. These company chiefs understand that failure to meet analyst expectations can result in their companyıs share price dropping. On the flip side, beating expectations is often greeted with exuberance first and skepticism second.
By removing this exercise, chief executives suggest that their companies would be allowed to take additional risk over longer periods of time. Acting as investor advocates, financial firms analyze this quarterly guidance and offer recommendations to their clients.
Numerous other institutions also keep a watchful eye on this type of report hoping to cull some insight on not only the short-term performance of the company but the overall health of the sector in which it operates.
If you were looking for some sort of investor protection from these weeklong discussions, you would do well to search elsewhere. With corporate profits at an historic high of 8% of GDP, the idea of implementing further changes can seem opprobrious.
Unfortunately, only a few of the suggested changes require Congressional approval. The remainder requires the likes of Mr. Buffet or Mr. Levitt and hopefully Mr. Cox to stand tall against this wave of business-friendly regulation. Our country still provides the safest environment in which to conduct business and the most profitable markets in which to list. When like minds met, the consensus is a foregone conclusion.
Today's Commentary: 03.14.07
Better than Lawyers:
Should 401(k) Investors Sue?
By Paul Petillo
Mike Smithers from IndexEdge.com wrote me several months back wondering whether the recent wave of litigation aimed at company sponsored retirement plans had caught my eye. They had. While the lawsuits are very interesting indeed, it never ceases to amaze me, I wrote, how the obvious is so often the easiest overlooked.
I know that the average 401(k) investor simply opens their quarterly statement or checks their portfolio online but rarely ventures far beyond the performance of their holdings. The wealth of information that is ignored is well documented by fund companies.
This makes the insistence of web-based publications of prospectuses somewhat suspect. Once the document is placed online, tracking the usage becomes much easier. This makes streamlining information for the end-user subject to editorial placement based on historical requests. But that is another story.
To read the prospectus in its current format finds a publication that is clouded with optimistic musings from the fund manager, performance numbers masked by the reshuffling of holdings at year end to boost investor interest in the hope of garnering some additional contributions, and now that the year 2002 has fallen by the wayside when they tally and tout their five year returns. This makes is difficult to find a good and clear picture of a fundıs results or future prospects.
People like me spend countless hours preaching vigilance when it comes to buying mutual funds. Look for good managers we tell them. Search out reasonable fee structures, and pay close attention to lengthy performance histories we repeat. And yet, when they open their 401(k), they simply ignore everything and buy the best performance.
While Larry Swedroe, author of "The Only Guide to a Winning Bond Strategy You Will Ever Need" might call this flawed human trait recency, I prefer to think of it as urgency. Too many investors want results now and push their investments much harder than they need to and when they do, they are forced to assume risk where risk is not needed.
Who would slight the plans for pandering such a weakness? As long as the basic tenet of capitalism remains - there will be winners and there will be losers - fund companies will do what they can to survive. But the companies who sponsor these plans are another matter.
Companies rejoiced, albeit silently, at the creation of the 401(k) and with new Pension Protection Act the deal was sealed. The lion's share of a company's pension costs was relieved when this happened. In return, the government demanded just a little fiduciary oversight.
That oversight starts with explaining enrollment and continues right on through with helping the employee pick the right fund(s) for them. Instead, we have default enrollments into money market accounts, actively managed funds that are far from it (just ask the average employee what their fund's R-value is and I guarantee you they will have no clue) and inappropriate offerings that entice the average person to take outsized risks.
R-value is assigned to actively managed mutual funds as a way to track their resemblance to the indexes they compare their performance. The higher the R-value, the closer that fund is to actually being an index. The higher the R-value - usually anything above 90 is considered suspect - the lower the corresponding fee should be. Some funds with high R-values may charge fees almost ten times higher than a comparative index.
Retirement is a tricky thing and a more elusive target. Each lost percentage point (or even percentage of a point) in fees puts the day of reckoning, the day when the employee realizes that what they have saved will not be enough a little closer. At the heart of the lawsuits is the belief that fund companies and the third party administrators of these plans have entered into a greased palm relationship with the corporations that hired them.
While I don't think lawyers are the answer, the adamant corporate denials seem suspect. Could it be that the cost of a more expensive plan is financially beneficial to the corporation as the litigation asserts? Could a company be that callous as to skim a percentage point of potential returns from their workers to enrich their own portfolios? As long as GAAP allows companies to include the value of pensions as a balance, shouldn't companies without them be allowed to skim some profit from their employee's futures? Of course the answer to these questions rests, at least according to the pending lawsuits, on which side of the issue you are.
Like the urge to sue, I have heard calls for audits as the answer to this incredibly vexing problem. While the costs are minimal, they are still seen as an expense. The fund companies and the plan administrator are at fault. In a world where choice is often sold as diversity, they have the upper hand. They have the ability to spin retirement solutions in such a way as paint a picture of wealth management without ever mentioning risk or cost. More choices does not necessarily turn into more wealth.
I see the solution as having one of three options or even a combination of all three.
Perhaps the solution is as simple as limited diversity. Perhaps 401(k) plans should be limited to six to eight choices and no more. The first choice would be to stock the plan with funds all clearly labeled as index offerings. But the problem with that solution is one of taxes. Indexed funds are probably best kept in a taxable account outside of a retirement account because of their inherent tax efficiency.
Actively managed funds (with low R-values and equally low expenses) often have higher turnover ratios making them more of a tax burden. The funds would do best in an account that is designed to defer the tax bill. The key is to offer only funds to employees. No stocks and no ETFs
The second choice would be to fill the plan with lifestyle funds. While this method of investing is still unproven - who knows whether a fund investing for an employee who won't retire until 2040 will provide the right mix of investments - it is a better option for the uninitiated. Lifestyle funds rebalance automatically - in theory anyway - over time providing a mix of equity and fixed income diversity as the worker ages. All the worker needs to do is invest and do so with more than just meeting the company match.
The last choice should be incentive based. Perhaps the plan should have an expense ceiling. If they are held at 1% to 1.25%, it might provide the incentive to actively enlist each and every employee to participate. The plan could shave tenths of a percentage point off the expense ratio as an employee reached a new threshold of participation (for every 5% the employee contributed, they might get a 0.1% fee kickback, which could be invested as well).
I hate the sound of litigation. The S.E.C. should be rattling the administrator's cages. The government should be pressuring the companies and the employee should get their collective head's out of the sand. Plans would adjust to investors who were wise to avoid high fee funds, high R-value offerings, and limited disclosure. While they may not be able to walk with their money, using their plan's offerings more judiciously would send a cohesive and much less expensive message.
