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Congress Holds Hearings on ERISA Reform

Congress is concerned that certain provisions of ERISA may have become outdated in the 25 years since ERISA was enacted.  To address this concern, the House Education and the Workforce Subcommittee on Employer-Employee Relations has undertaken a series of hearings to discuss current ERISA issues, and to figure out what changes may be necessary to modernize the statute.

According to Rep. John Boehner (R-Ohio), the Subcommittee chairman, some of the principal issues are in the investment area.  The economy has changed considerably since 1974, as has the nature of retirement savings.  In his opening remarks at the first hearing, he stated that “To the extent we can make pension and retirement investment more efficient -- allowing participants to maximize returns on their investments and allowing them access to better information about their investment options -- we will have served our constituents well.”  In an effort to make the hearings bi-partisan, he is working closely with Rep. Robert Andrews (D-N.J.), the ranking Democratic member.

At the first hearing, held on February 15th, the subcommittee members heard from four authorities on ERISA, drawn mainly from academia.  At the second set of hearings, held on March 9th through 10th, they heard from witnesses representing industry and industry associations, as well as labor and pension rights groups.  At the next hearing, which has not yet been scheduled, the subcommittee intends to hear from the regulators, principally the Department of Labor.

In line with Rep. Boehner’s emphasis on investment issues, the principal topics addressed at the hearings were investment advice for plan participants and the ERISA prohibited transaction rules.  Several other issues also were raised by the witnesses as possible areas for ERISA reform.

Investment Advice

Acknowledging the general shift in the pension area in favor of participant-directed defined contribution plans, the witnesses emphasized the importance of participant access to investment education and advice.  Several, such as Prof. John Langbein of Yale and Allen Reed of the Committee on the Investment of Employee Benefit Assets (CIEBA), pointed out the considerable growth of defined contribution plans in the past 25 years, placing investment risk on employees.  As a result, they said that there is a need for the employees to be able to obtain professional, individualized advice to help them manage their accounts.

The problem is in providing access to such advice.  The witnesses pointed out that current law, by subjecting investment advisors to fiduciary standards and the ERISA prohibited transaction rules, discourages employers and investment firms from making advice available to plan participants.  Prof. Langbein advised revisiting those barriers under ERISA that prevent employers and investment intermediaries from giving individualized advice to plan participants.  Kenneth Cohen of Massachusetts Mutual Life Insurance Company was more specific, suggesting that Congress provide a statutory exemption from the ERISA prohibited transaction rules for investment education and advice.  Witnesses from the Securities Industry Association and the Frank Russell Company suggested that such an exemption could rely on disclosure standards to protect plan participants.

Not all the witnesses came out as strongly in favor of creating special rules for investment advice.  The AFL-CIO was concerned about potential conflicts of interest that could arise from fund providers providing advice.  One of the strongest cautions about potential conflicts came from Joseph Grundfest of Financial Engines, an independent advice provider, citing the potential dangers of permitting fund providers to advise participants in a manner that could promote the funds’ interest in obtaining higher fees.  However, in response to questions, he acknowledged that the shady practices such as he was suggesting were not widespread in the mutual fund industry, and other witnesses challenged his assertion that fund providers were affected by “secret biases” in providing investment education and advice programs.

Prohibited Transaction Rules

After investment advice, the second major focus of the hearings was on the ERISA prohibited transaction rules.

Prof. Langbein and John Shoven of Stanford University called for the complete abolition of the ERISA prohibited transaction rules, with Prof. Langbein observing that “the prohibited transaction rules do badly what ERISA’s core fiduciary law does well.”  Prof. Langbein’s objection was that the rules are redundant with the duties of loyalty and prudence and overbroad, requiring a vast body of “excusing law” to prevent innocuous conduct from violating the prohibitions.  Any conduct appropriately forbidden by these rules, he said, is already forbidden by the core fiduciary rules of section 404(a), so that the rules serve only to prevent plans from engaging in beneficial investment transactions and increase the marginal cost of most non-public transactions.  On top of that, the regime “needlessly aggrandizes the power of the regulators,” he added.

At the other extreme, several witnesses came out against any changes to the ERISA prohibited transaction rules.  Prof. Teresa Ghilarducci of the University of Notre Dame and benefits attorney Michael Gordon emphasized the possible abuses that could result from weakening the current rules, as did the AFL-CIO testimony.  They concluded that the rules should be retained to preserve their deterrent effect.

The industry witnesses generally came out in between the two extremes.  While not calling for repeal, they described the problems created by the broad scope of the prohibited transaction rules and the difficulty in obtaining exemptive relief.  Rep. Andrews agreed, citing the statistic that half of the exemptions requested take over 18 months to be resolved.  Kenneth Cohen of Massachusetts Mutual recommended narrowing the statutory definition of “party in interest” to exclude unaffiliated service providers, and permitting transactions that meet arm’s-length terms and disclosure standards.  Most of the others focused their recommendations in this area on the more limited issue of investment advice.

A specific issue raised in connection with the prohibited transaction rules was the cross-trading of securities, a matter currently under consideration by the Department of Labor’s Office of Exemption Determinations.  Prof. Ghilarducci and Mr. Gordon did not think that Congress should take any action on cross-trades.  Prof. Ghilarducci argued that permitting cross-trading would increase rather than decrease plan costs, while Mr. Gordon said that the exemption process should be allowed to play out on this issue.  Others, such as CIEBA, argued that the exemption process should give more weight to the benefits that cross-trading has to offer.

Employer Stock Investments

Another subject raised by some of the witnesses was the ability of plans to invest in employer securities.  Prof. Langbein argued that the diversification and self-dealing rules of ERISA should apply to 401(k) plan investments in employer stock, because employer stock investments present serious risks to plan participants.  Prof. Ghilarducci argued for limiting the permitted amount of company stock in individual participant accounts.

Other Issues

Several witnesses emphasized problems with pension coverage, including Prof. Ghilarducci, Mr. Gordon, and representatives of the Pension Rights Center and the Older Women’s League.  They called for several reforms to improve coverage, such as extending coverage to part-time and temporary workers and accelerating vesting requirements.

Mr. Shoven called for several simplification measures.  These included replacing the Internal Revenue Code nondiscrimination rules and repealing the minimum distribution rules.

Current Status of ERISA Reform

At the end of the March 10^th hearings, Rep. Andrews summarized the testimony thus far.  He said that there had been general agreement that the basic precepts of ERISA — voluntary employer cooperation and strong fiduciary standards — are working.  The witnesses had generally agreed that there should be more flexibility to enable employers and service providers to give individually tailored investment advice, while protecting against biased advice and conflicts of interest.  While no one had advocated changes that would allow self-dealing, there was concern about the prohibited transaction rules burdening plans with needless transaction costs.  However, there was no consensus on any legislative steps that need to be taken to address these issues.

At the next hearing, the subcommittee members should have the opportunity to ask the regulators about the issues that have been raised to date and to explore possible solutions.  Whether the process will in fact lead to ERISA reforms, and the nature of those reforms, remains to be seen.

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