(February 1, 2002) An End to 401(k)s |
In March 2001, when we wrote an article about the dangers
of 401(k)s, the response from industry insiders was, "Are
you crazy? 401(k) plans are a great deal for both
participating employees and sponsoring companies. They're a
win-win!" Then came the Enron debacle. How many times have
we heard that word"debacle" in the last month? Now
politicians in Washington are talking about the way to
"fix" 401(k)s. Watch out when politicians claim to be
knowledgeable about investment matters. Most likely they've
only been briefed on the subject for a half-hour by a
member of their staff. The simple truth of the matter is
that there is no way to fix 401(k)s. 401(k) retirement
plans should be eliminated.
Does that sound radical? 401(k) plans are founded upon the fundamentally flawed notion that employers should be trusted to oversee employee retirement funds, yet should not be held responsible, except in extreme cases, for the results of their trusteeship. In traditional defined benefit pension plans, if employers made poor investment decisions that resulted in reduced pension assets, it was the employer who had to make up the difference between the assets and liabilities of the fund. The employer was motivated to handle retirement assets carefully and paid the price if he didn't. In 401(k)s, virtually all the risks have been shifted onto the employee. As a result, employers have little to lose and lots to gain by making decisions based upon their own interests, compromising the interests of the participants. Unfortunately, what is good for employers often is not good for workers. The way to fix 401(k)s is to keep employers' hands away from workers' retirement assets. Yet employer "riskless dabbling" with employee retirement assets is central to 401(k)s.
Employers should not be selecting investment alternatives for workers to choose from. For example, its clear that financial services companies that offer only their own mutual funds in their employee retirement plans are not motivated by what's best for their employees. These companies are interested in building their businesses upon the backs of their employees. Hardly a single mutual fund company with a sales load structure could justify offering only its own mutual funds to its employee 401(k), based upon fees and performance. These fund companies almost always have higher fees and worse net performance than no-load funds. Do the trustees of these plans, who are affiliated with the employer, ever include competitors' mutual funds? No plan that we've seen does. They won't do so because if they admitted, when they were wearing their trustee hat, that their funds weren't the best, then they might as well get out of the business of peddling their funds to the public. Similarly, companies that push their stock on employees with lock-up periods aren't concerned with whether there is adequate diversification of employee retirement assets. They're motivated by their own self-interest.
Employers should not be trustees of workers' 401(k) retirement plans because an obvious conflict of interest exists. If there is any single cause of the Enron debacle and the current lack of confidence in the marketplace today it is because we, as a society, have gone too far in the direction of tolerating conflicts of interest. Financial analyst, auditor, pension consultant, lawyer, politician and regulator conflicts of interest have become so commonplace and the corresponding risks so imperceptible, that we have come to accept preposterous scenarios. The risks related to these conflicts are considered theoretical only or exaggerated and no effort is made to quantify the resultant harm.
For example, for the past sixty years, we have all known that mutual fund directors, hand-picked by mutual fund companies, serve no useful watchdog function. Despite the many articles and studies that have been written on this subject, the fiction that they protect shareholders interests persists. Mutual fund directors protect the interests of mutual fund companies, not shareholders. Any representation to the contrary should be considered fraudulent. Yet the Securities and Exchange Commission has allowed funds to misrepresent to investors that their interests are protected by these directors. How much money have investors lost as a result of this permissible fiction?
A few years ago the SEC, the government agency charged with "the protection of investors," testified in federal court that investors who lose money with money managers should not be permitted to see the results of the agency's investigations of these managers. Thank you SEC for arguing against Freedom of Information Act access to information related to investor losses. Whose interests is the SEC protecting-investment firms or investors? How much has this secrecy cost investors? How many investors would be saved from financial ruin if the facts behind these frauds were made public? Will the details behind Enron's dealings ever be made public in full?
Today we have a Chairman of the Securities and Exchange Commission who formerly represented the auditors he is charged with regulating. Would we give responsibility to a former attorney for the Cali Cartel to enforce laws against drug dealing? Of course not. The Attorney General of the United States, the President and most of our elected officials in Washington received contributions from Enron. Yet these men are now to be trusted to investigate Enron's wrongdoing and establish safeguards to prevent future harm? Each and every one of them is in some way responsible for what happened. Is there not a single credible investigative firm with absolutely no ties to Enron that could be retained to look into the matter? If there is, why do we permit individuals subject to conflicts of interest to conduct the investigation?
Getting back to the 401(k) issue, in our opinion the problems with these plans are only beginning to show up. More outrageous 401(k) cases are in the pipeline. Wal-Mart earns a place right along Enron in the 401(k) Hall of Shame by, according to the Wall Street Journal, "offering workers the""opportunity"" to dip into their 401(k) accounts to pay for the 30% the company raised employee payments for health insurance. Apparently the company neglected to mention the adverse tax consequences related to such withdrawals. Many other 401(k)s are loaded to the gills with employer stock. Now that Enron has caused the public to focus on 401(k) issues, we're confident a lot more abuses will be uncovered.
In our March 2001 alert we identified four categories of risk related to 401(k)s: investment risk, record-keeping risk, employer-business risk and regulatory risk. All of these categories of risk have been identified in connection with the Enron debacle. The company made poor investment choices, a change in administrator/record-keeper caused employees to be denied access to their accounts, the employer's business tanked and the regulators are stumped at what to do. In that article we mentioned that IRAs posed far fewer risks. In our opinion, the best course would be to eliminate 401(k)s and allow individuals a single retirement account or IRA. Employers would be permitted to contribute to employee IRAs but would have no say as to how the account was managed. Contribution maximums should be increased and employment status, i.e., self-employed versus company employed, should become irrelevant. I currently have one 401(k), one IRA and two SEP-IRAs. Why? There is no need for these multiple accounts. Indeed, it is far more difficult, as well as more costly, to manage retirement funds spread across multiple accounts than funds held in a single account.
Our suggestion: Eliminate 401(k)s and keep employers' hands off workers' savings. If workers are taking all the risks related to saving for their retirement, give them one simplified account to watch over and allow no one but the worker himself to meddle with it.