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Study: SEC Fiduciary Delay Costing Retirement Investors $1 Billion per Month

February 12
00:28 2013

Two years ago, the SEC’s botched proposal for a uniform fiduciary standard was greeted with a uniform chorus of derision from both Congress and the brokerage industry. The biggest complaint was the alleged “cost” to investors should the SEC 1131983_36295805_rose_on_ice_stock_xchng_royalty_free_300hold brokers to the same standard as it holds Registered Investment Advisers under the 1940 Investment Advisers Act. The SEC asked the industry to show evidence of this cost, but, sheltered by the bipartisan boos from the political realm, never seemed to provide the promised smoking gun. It turns out, a much publicized academic research study released last month may have finally supplied the much anticipated evidence of cost – but with a surprising twist.

The paper, “It Pays to Set the Menu: Mutual Fund Investment Options in 401k Plans,” (Pool, Veronika Krepely, Sialm, Clemens and Stefanescu, Irina, January 20, 2013), is the result of work done by researchers from Indiana University and the University of Texas at Austin. Much of the media reporting focused on the study’s confirmation of what many had long suspected: trustees who were allowed to engage in self-dealing transactions often do, and often at the worst possible time. Pool et al concluded trustees with a conflict of interest are more likely than unconflicted trustees to keep and to add poorer performing affiliated funds. Worse, employees continued to invest in these poorer performing options even though they had better alternatives.

This conclusion is similar to that drawn by “Broker Incentives and Mutual Fund Market Segmentation,” (Diane Del Guercio, Jonathan Reuter, Paula A. Tkac, NBER Working Paper No. 16312, August 2010). This paper found investors earned, on average, 1% more per year by buying mutual funds directly instead of through a broker (you can read the full report in our earlier story, “Does New Study Seal the Deal for Fiduciary Standard – or Just Warn Plan Sponsors?, January 19, 2011). “Both studies look at agency problems in delegated portfolio management but they focus on very different aspects (brokers vs. 401k trustees),” says Irina Stefanescu, Assistant Professor of Finance at Indiana University’s Kelley School of Business and one of the co-authors of last month’s study.

The new study concentrates only on listed trustees. “We collected the names of the ‘plan trustees’ as they are disclosed in the 11-K,” says Stefanescu. “We have not focused on conflicted advisors.”

That conflicts-of-interest exist in the 401k service provider world isn’t surprising. “Unfortunately, it is quite common for mutual fund companies that also act a ‘non-discretionary’ plan trustee to encourage the use of their own proprietary funds,” Houston-based Robert A. Massa, Chief Investment Officer at Ascende Wealth Advisers, tells He continues, “To address this problem, I take a considerable amount of time to educate the plan committee members on delineating the differences between the services provided by the plan recordkeeper, the plan trustee and the investment provider(s). Most committee members have a hard time understanding the difference. If they hire a mutual fund company to handle all plan services on a turn-key basis, it can be difficult for the committee members to fully understand the fees and services provided because of the one-stop shopping approach. But this is the core problem. In these fully-bundled, one-stop-shopping arrangements, employers can usually offer a 401k program with great educational materials and online technology, but if they fail to perform their due diligence, they can end up with a stable of funds that may underperform the market.”

“In an ideal world, all fiduciaries that act for a plan under the auspices of ERISA should operate independently,” says Gabriel Potter, Senior Researcher at Westminster Consulting, LLC in Rochester, New York. Potter adds, “Individual advisors acting as consultants may adopt the title of ‘fiduciary’ without really understanding the legal ramifications of the decision. Investment management firms often take up the fiduciary mantle when acting as a consultant, but may be incapable of separating themselves from the inherent conflict-of-interest. It is the advisors’ responsibility to understand if their duties preclude them from being a fiduciary adviser, but the roles of a fiduciary vs. a non-fiduciary individual advisor are sorely misunderstood, even by professionals.”

Making their conclusions even more dire, the study’s sample does not include conflicts-of-interest resulting from brokerage-based “advice.”  Paula Hendrickson, Director Retirement Plan Consulting at First Western Trust in Denver, Colorado says, “Many plan sponsors join forces with a brokerage firm to develop their investment strategy and the broker has an inherent conflict-of-interest.”

But the study does reveal something that stunned even the researchers. “Perhaps the most surprising result was the future underperformance for the lowest performance decile funds,” says Stefanescu. The study concludes “We estimate that on average they underperform by approximately 3.6% annually on a risk-adjusted basis. This figure is large in and of itself, but its economic significance is magnified in the retirement context by compounding. Our results suggest that the trustee bias we document in this paper has important implications for the employees’ income in retirement.”

Just how economically significant is this result? asked Stefanescu if the authors came up with a dollar figure, but she told us, “Translating these percentages into dollars depends on various assumptions on holding periods and compounding horizons.” Still, that doesn’t prevent anyone from using published data to come up with a number.

And that’s precisely what we did.

According to the January 24, 2013 entry of January Market Size Blog, U.S. retirement assets (including IRAs, 401k plans and 403b plans) total $10.3 trillion at the end of the third quarter in 2012. The universe of trusteed plans in the “It Pays to Set the Menu” paper indicates 33% of the assets are held by “conflicted” trustees. We’ll assume this number for 403b plans and IRAs as a way of accounting for conflicted brokers. (Please note, the 33% number does not mean only 33% of the plans are advised by conflicted vendors, it only means the actual conflict occurs in only 33% of the assets. In other words, a conflicted adviser is likely to also put assets into unaffiliated funds.) A third of the total U.S. retirement assets is $3.4 trillion. Now, we take 10% of that reflecting the lower performing decile of funds and that’s equal to $340 billion. Finally, we take the average underperformance of 3.6% annually and you get $12.3 billion of lost performance each year.

That’s more than a billion dollars a month, or $24.6 billion since the adoption of a uniform fiduciary standard was first proposed.

That’s the real dollar price tag the SEC’s inaction is costing U.S. retirement investors. Go ahead. Check the math. Refine the assumptions. You’re still talking huge numbers.

Elle Kaplan, CEO & Founding Partner of Lexion Capital Management LLC in New York City explains the true tragedy of this wholly unnecessary delay as she expresses concern the indictment of studies like this might take the bloom off the rose of the 401k plan. She says, “Embedded in the term ‘conflict-of-interest’ is the key word: conflict. The fact these conflicts exist is a major problem and should be extremely troubling to all 401k plan advisers. If we are encouraging people to save for retirement, but then we give them options that are poor investment vehicles with bad returns, we are hurting the very people we are supposed to help. We are letting a few bad apples get in the way of delivering responsible options for retirement planning.”

If you enjoyed this article, you’d probably enjoy Mr. Carosa’s latest book, 401(k) Fiduciary Solutions. Published by Pandamensional Solutions, Inc., this highly recommended book contains 320 pages of insights from some of the industry’s most well-known thought leaders. 401(k) Fiduciary Solutions covers all 401k compliance issues in a single reference source. It is written for plan managers, sponsors and others with 401k plan fiduciary responsibilities. Click here to order it now direct from the publisher’s site on

About Author

Christopher Carosa, CTFA

Christopher Carosa, CTFA


  1. Joel
    Joel October 15, 11:02

    How about the trillions that are in open accounts. Add this to the pile of qualified money and you can see high massive this rip-off is.

  2. Kate McBride
    Kate McBride January 23, 15:06

    Chris — this article is even more important now than when you wrote it. If you go just from Ma 2009 and the Treasury white paper recommending financial reforms, we have 68 Billion in excess costs to investors. But I think this is very conservative. Cheers– Kate McBride

  3. Christopher Carosa, CTFA
    Christopher Carosa, CTFA Author January 23, 16:38

    You are correct. Who shall be held accountable?

  4. Jim Watkins
    Jim Watkins February 05, 15:02

    Chris – Excellent article. What makes the delay even more confusing is the fact that FINRA has repeatedly stated that brokers are required to always put a customer’s interests first. (See FINRA 11-25 and 12-25, and the various enforcement cases cited upholding such position.)

  5. Bryan Berry
    Bryan Berry February 07, 02:50

    Chris – this snowball has been picking up too much speed to not eventually get pushed through as the rule. As more and more true information gets out, one can only hope that plan sponsors – if at the very least in the $10 million and under plans will come to understand the wisdom of working with a true fiduciary. Keep up the good work.

  6. Joe Picillo
    Joe Picillo March 18, 18:18

    This issue of the SEC defining “Fiduciary,” is a perfect example of big government over-thinking the issues and making something so basically simple into a complex, mixed-up, load of mumbo-jumbo! Our courts have long ago defined the duty owed by a fiduciary, and the standard is actually much older than its first defining. Ideals and expectations of common sense, fair dealing and moral standards defined the duty of a fiduciary long before it became a term of art.

    Simply put, any fiduciary owes his/her client a duty to act in good faith and to the best of his/her ability, to do that which is in the best interests of his/her client. In the case of retirement plans, and indeed, in the case of any investor, this simply requires that a broker perform due diligence and recommend or invest in funds, stocks or otherwise that are expected to provide the greatest return to the investor – essentially the greatest yield – when considering expected growth and rate of return after costs are factored in, with consideration given to the level of risk incurred.

    Let’s use a simple example: Plan Sponsor comes to employee Broker at Brokerage Company XYZ, seeking advice about in which funds the plan should invest. Sponsor wants the Plan to earn as much as possible for the benefit of the Plan members or beneficiaries, but is looking for funds with overall moderate risk at this time. After performing a due diligence review of all available plans in the moderate risk category, the broker has determined that two plans stand out among the rest in terms of risk versus reward and expected gain or yield after annual costs. Plan A, has a lower cost resulting in a higher overall yield by a tenth of a percent. Plan B, with the tenth of a percent lower yield, pays Brokerage Company XYZ a higher fee resulting in the lower overall yield. What does the Broker’s fiduciary duty require of him/her? At the very least, doesn’t Broker have a duty to disclose the higher fee being paid to the Brokerage Company? Shouldn’t the Broker advise the Sponsor that the larger fee to Brokerage is the reason for the one-tenth of a percent difference in expected annual yield? Doesn’t the Broker owe the Sponsor full disclosure in light of the Sponsor’s known fiduciary duty to the plan members, so that the Sponsor has full knowledge upon which to base a decision on how to invest the Plan’s funds?

    Look at it as if it was an individual investor. Doesn’t an individual expect his/her broker to give the best possible advice on how to profitably invest in the market? And doesn’t the individual expect the broker to disclose Broker’s commissions and any fees on every transaction? Doesn’t the individual investor expect his/her broker to advise them if they believe an investment in which the investor is interested carries too much risk to the investor and what the risks are? Why use a broker otherwise?

    When one uses a doctor or lawyer, they expect the professional’s best advice, and their best effort to do what is in the best interest of the patient or client. Indeed, the rules governing those professions require nothing less than one’s best efforts to perform or act in the best interest of the patient or client. Doctors and lawyers are bound to adhere to specific, Rules of Ethics, or face discipline that can be as serious as losing their license to practice. When people are placing their financial futures, (or present investments), in the hands of Brokerages and Brokers, should they expect any less? Should Brokerages handling multi-hundreds of billions of dollars, and brokers handling millions of dollars entrusted to them by others be held to any less of a standard than “the best interests of the client?” Of course not! Yet, the standard continues to be “adequate.” What an absolute farce.

    Shame on the SEC, FINRA and Congress for turning such a simple concept into such a complex issue. The cost to Wall Street of holding Wall Street to a fiduciary standard should have no bearing on the fiduciary standard issue. Whatever the cost to Wall Street, if any, it will be like spitting in the ocean!

  7. Christopher Carosa, CTFA
    Christopher Carosa, CTFA Author March 18, 19:20

    Joe, thanks for the comment. In fact, the historic definition of “fiduciary,” which comes from centuries of trust law, simply and bluntly put, prohibits self-dealing. That means a fiduciary cannot enter into a transaction which generates revenue for the fiduciary. That’s a self-dealing transaction. Registered Investment Advisers have specifically been prohibited from generating transaction-oriented fees. So, disclosure doesn’t work. There is a zero tolerance for conflicts-of-interest. Disclosure does not make them go away, so don’t engage in them to begin with.

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