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Chapter 9 In Fighting Power Interests book 

Genuine Financial Transparency: Case Study Demonstration

2006-2011

Alexander the Great untied the Gordian Knot with his sword. Previous attempts to solve the impossible entanglement were unsuccessful by conventional thinking. Whoever unraveled the maze would become King of ancient Phrygia. Zeus was so pleased with Alexander’s shrewdness he granted royal status and a lifetime of great victories.

The 403b was our “Knot.” The previous eight chapters showed commendable attempts to solve the monopolized 403b, lost to the ethers, rife with vast complications and conflicts of interests. The relentless cartel of TSA sales to PreK-12 school districts could be attributed to minuscule political will by school boards and unions, liability-phobic benefits staff and powerful insurance interests. Our conventional approach by appealing to those in power did not work: the press, unions, districts and state legislators.  Where was our Alexander?

George Tischler cut through the entrenched inertia following Alexander’s example. This witty and genteel Los Angeles Unified School District (LAUSD) benefits administrator challenged the status quo with raw guile. Rather than a sword he wielded a new plan sidestepping the decades-old obstacles, complete with transparency so deep it scared the elephants from the room.

What? A School District Benefits Official Cares?

            Mr. Tischler had help. The Economic Growth and Tax Relief Reconciliation Act allowed school districts to offer 457b plans. IRS regulations required districts to assume increased 403b responsibility and allowed them to hire a Third-Party Administrator (TPA). Hence, Mr. Tischler pulled a coup-fourré around the corrupted 403b world by taking advantage of these two laws. Brilliant. With George’s leadership LAUSD hired a TPA for assistance while offering a lower cost 457b plan. A perfect fit, right?

A great experiment with the country’s second largest school district was born. The 403b aware group and I had many questions:

• Who was Mr. Tischler? What was the 457b plan?
• Which vendor will be the TPA?
• Will the Board of Education approve this new program?
• What kind of investments will be included and what are the costs?
• Will the 457b succeed in leading colleagues away from TSAs into investments which grow with the economy?

Board of Education Approval

George presented the new plan to a subcommittee of LAUSD’s Board of Education on April 23, 2006. He detailed the differences and advantages of the 457b plan over the established 403b. Quoting from the minutes (edited):

The 457(b) Plan, upon approval by the Board, will be offered to District employees later in the year. He stated that the 403(b) Plan offers many products, including mutual funds; 80% of the sales are annuities offered by insurance companies. Insurance companies that offer lower growth with annuities and may charge higher fees and may have early withdrawal penalties. He noted that high fees over time result in a significant decrease in savings for employees…. The [457b] money is held in trust by LAUSD, which allows institutional pricing at lower fees. Finally, employees get oversight of services from the District, a financial consultant and an investment committee….

His assessment of the 403b mess was spot-on. He understood that insurance products charge excessive fees and explained why the district needed a lower cost plan. Lower costs and increased performance with mutual funds render more money into educators’ nest egg. Previous benefit staff, unions and the Board of Education never understood that simple concept. George got it.

LAUSD Hired a TPA

Sandy Keaton, David Goldberg (United Teachers Los Angeles’ Treasurer) and I were at the board meeting. We were shocked and disappointed when George announced that American Insurance Group-Variable Annuity Life Insurance Company (AIG-VALIC) won the bid. George introduced AIG-VALIC’s Senior Vice President to address the board.

The VP pulled no punches, “We can do this for .15%  because of the institutional pricing and the size of LAUSD alone demands a low rate!” (fifteen basis points, bsp, each basis point is one hundredth of one percent). He kept repeating the infamous word in the Tax Shelter Annuity world: “Guarantees!”

How can they charge a price which competes with Vanguard’s index funds? George just stated that he wanted a new lower cost plan for the district (lower cost than the 403b). But another insurance company? This offer was suspect right out of the gate.

In my opinion LAUSD’s Request for Proposal (RFP) worked right into AIG-VALIC’s sales pitch. Districts want to know the plan costs nothing—no hit on the general fund. The suspiciously low bid handily beats the competition and the TPA cost was a major factor. TIAA CREF applied but the higher fifty-five bps gave them little chance. Was it possible AIG-VALIC’s fifteen bps was just a shill figure for gullible board members to be followed by higher costs? It didn’t take long to find out. Mercer Consultants showed us the next step in this now familiar dance.

Mercer Consultants

Mercer’s rep marched to the podium with a briefcase and stacks of reports, wearing a smartly dressed dark suit. I got a heads-up about Mercer from my professional friend, Brian Cressey. Without hesitation he said “Mercer is the crème de la crème of retirement plan consulting firms.” Their website showed they’re a huge international firm with a broad presence in the investment consulting business.

The Mercer consultant, a Midwestern middle-aged woman reported the 15 bps was not the total cost, “there is additional 27 bps from revenue sharing.” Within minutes the cost had increased to 42 bsp (15 + 27 = 42). Isn’t that almost three times the cost of what the Senior VP just said?

27 More Bps? Now My Head was Spinning

AIG-VALIC has a right to charge fees. In my opinion, however it’s misleading to announce 15 bps, following up with an additional 27 bsp, rationalizing that it’s “the industry standard” by Mercer. Okay, if the cost was the industry standard, why the binary presentation about fees? We would agree 42 bsp is reasonable. Shouldn’t the VP be proud of announcing 42 bsp in the first place and be done with it?

Games People Play with YOUR Money

AIG-VALIC and Mercer were colluding in my opinion, an example of how the industry made financial information confusing and complicated. This time the audience and Board members recognized the tactic. More fees would come. The unknown cost of the investments—this omission was a huge concern.

But there were two other issues I brought up in my public speaker opportunity (edited for brevity):

What Mr. Tischler and the benefits administration now propose is a low fee 457 by strangely offering a contract to one of the biggest insurance companies in the country. Think about this: V.A.L.I.C. That spells out Variable Annuity Life Insurance Company. Is this the company that’s going to fix the problem of selling high priced products? AIG-VALIC is not the answer to the problem of high fees and low performance because that’s what it’s done for decades. I have concerns that AIG-VALIC will use their position to sell more 403bs to offset the low 457b fees.

Because other speakers were also concerned about about AIG-VALIC selling 403bs and the 15 bsp were now 42 bps, benefits administration convened a special meeting two weeks later.

Twenty people showed up. Three teachers, myself included, and the UTLA Treasurer were present. The rest included George and his staff, Mercer reps and the AIG-VALIC Senior Vice President. LAUSD’s procurement and contract staff sat on the periphery of the room away from the table and never said a word. It was a strange meeting with nobody in charge. After the introductions LAUSD’s staff, the Mercer rep and the AIG-VALIC’s rep sat there waiting for a few seconds. Defined contribution plans have seldom been discussed publicly. The tension was evident. The staff and financial consultants may have been unfamiliar with answering questions about fees and were anxious with the UTLA’s treasurer present—but this was the beginning of genuine transparency.

The allegation about AIG-VALIC selling 403bs was discussed first. AIG-VALIC would be the TPA record-keeper for both plans, known as the “common remitter.” Would AIG-VALIC take advantage of their common remitter position to sell the expensive 403b insurance products? He sidestepped the conflict of interest question by agreeing on-the-spot they would not sell new 403bs and would focus on the 457b plan.

Next we discussed the 27 bps. Mercer rep repeated what she said to the Board. She was unwavering and had to say what the AIG-VALIC VP said was accurate. Huh? The VP didn’t say 42 bps—he almost shouted “15 bps.”

Nobody spoke for a few minutes. We should have challenged this dual presentation by keeping AIG-VALIC’s feet-to-the-fire with 15 bps. We were not familiar with revenue sharing and did not challenge the additional cost. Revenue sharing refers to a portion of the investment expenses which are kicked-back to AIG-VALIC. The source and delivery of this revenue were not transparent and will be shown in detail later in this chapter. The UTLA treasurer, two teachers and I lacked sufficient knowledge or backing from the teacher’s union to yank support.

We prevented AIG-VALIC from selling new 403bs which turned out to be a positive move to protect the hardworking employees of our district. In retrospect, however, I should have motioned to the UTLA Treasurer and the other two teachers for a huddle talk out in the hallway about strategies for holding AIG-VALIC’s fees to 15 bsp.

School District’s Love Affair with Insurance Companies                                                   

PreK-12 school districts are rampant with insurance companies’ 403b products. So, choosing an insurance company should not be a surprise. We experienced this dance before—this decision to select AIG-VALIC was contradictory to Mr. Tischler’s vision. The American Federation of Teachers’ (AFT) also produced an empty promise with their brilliant Shark Attack article (AFT_Special_Report Shark ATTACK) and then stabbed everybody in the back with another insurance company. Was this a new form of bait and switch? —singing on-key at the audition but choking at the Met. The full Board of Education approved the 457b plan in June, 2006.

The History of 457b

            Our 403baware group knew little about Mr. Tischler’s plan. We had a lot to learn in a few weeks. Inaugurated in 1978, the 457b was the third and last deferred compensation retirement plan. The tax-deferred feature was the same as the 403b and 401k. There are two differences: (1) assets are held by the employer, and (2) the participant can transfer funds to an IRA without federal penalty only upon separation from service. For instance, if you are 55 and retire you can transfer 457b money to an IRA (with a 403b you have to wait until 59.5). Likewise, you cannot transfer a 457b to an IRA at any age if you are still working. There are pros and cons of each plan. Simultaneous contributions to both plans are allowed. Depending on employees’ eligibility older workers can save up to 40,000 dollars or more using the catch-up features. The best part of the 457b plan was next.

Insurance Regulations are MOOT

              Mr. Tischler’s plan included mutual funds (the funds selected will be discussed). The hideous insurance code which regulates the 403b will not affect the 457b. So, LAUSD was free to do what is right. While we thought LAUSD selected the wrong TPA the selection process was by competitive bid, forbidden in 403b plans by the state insurance code. George and his colleague David (another benefits administrator) and the Mercer rep said the committee will select the investments, not AIG-VALIC.

An independent financial consultant would be hired to interface between the district and employee groups, provide training and recommend funds for inclusion. Okay, we know AIG-VALIC was the TPA and Mercer would be the financial consultant. But wait a second, what were “employee groups?”

When George spoke about “oversight of services,” he meant what he said—employees. To everybody’s surprise benefits invited all eight of the district’s unions to staff this new oversight committee: teachers, administrators, school site support personnel, buildings and trade, school police etc. The reps would meet every month with benefits administrators, the Chief Financial Officer’s (CFO) rep and a Board of Education representative. I was invited to be a Member-at-Large and Sandy was asked to represent United Teachers Los Angeles (UTLA).

How often does a large school district include this range of personnel on the same team with the mission to plan and implement a new low-cost, best-in-class retirement plan? This was the first inkling that behind-the-scene decisions were history. The 403b/TSA sales force faced a new era of low-cost competition and oversight for the first time. What a novel idea and great opportunity to improve the quality of all voluntary retirement plans. What could go wrong?

The 457b’s Potential for Greatness–Transparency

Our oversight committee began meeting in July, 2006 at LAUSD headquarters–the “Beaudry.” This 29-story building contains about 3,000 employees who meander through the halls every week. The 928,000-square-foot triangular shaped leviathan is located on Beaudry Street downtown Los Angeles, due west of the famous multisilo hotel, the Bonaventure. The Beaudry is infamous for its warped floors.

Our meeting room occupied the northeast corner on the 28^th floor offering a spectacular view. We can see downtown Los Angeles to the east above the busy Pasadena/Harbor Freeway and north beyond the hills of Dodger stadium. Looking down we can see the former Belmont High School, the most expensive school built in the country. The meeting room has the obligatory long and spacious mahogany corporate table surrounded by cushy, oversized swivel chairs. The business and power symbolism was a long way from my farm-boy, small-town Wisconsin roots.

The same Mercer lead consultant was assigned to our committee. Mercer’s contractual obligation was to advise our committee for the purpose of launching the new plan by January 1^st, 2007.

The following administrative tasks were completed first.

• The committee mission statement
• Committee bylaws
• The Investment Policy Statement (IPS)

This involved legal staff and union perusal to ensure we followed the Employment Retirement Income Security Act (ERISA) requirements for a diversified portfolio. ERISA requires an IPS for 401ks, but not 457b nor 403b plans. Our committee followed the ERISA guidelines so the 457b investments’ financial data such as past performance, industry ratings and risk are systematically monitored. Investment changes had to be justified by similar procedures used by many plan consultants and TPAs. These procedures were detailed in the Investment Policy Statement.

UTLA’s Treasurer, David Goldberg, attended meetings, sent the unions’ legal counsel and hired a financial consultant to study the arrangements. This attorney ensured the volunteer collective bargaining members were not liable for committee recommendations. The union’s financial adviser oversaw the proceedings and answered our questions.

After establishing the bylaws for committee membership we appointed alternates and created ad hoc committees. The legal fiduciary was the district’s CFO as directed by the Board of Education. The IPS was signed by the CFO and the committee was ready to make specific fund recommendations.

Total Costs to Participants Finally Revealed

Investment costs are the most protective pieces of information in the financial industry, hermetically sealed from public view for good reason. If people found out how much they were paying over several decades they would realize how all those hidden costs and expenses eat at the heart of growth for their final next egg. They might revolt. Thus, the industry takes extreme precautions in how they reveal costs. The dance before the school board reflected decades of orchestrated marketing.

Investment costs must be revealed somewhere in the fine print of the multipage, complicated prospectus. But it’s up to consumers or committee members to add the scattered pieces together. You already got the first lesson when the AIG-VALIC VP reported the first level of costs and Mercer tacked on a second. There are more to come.

The next task was to distinguish distracting noise from the information you need. Complicated investment costs have one inherent purpose—encourage confusion and discourage transparency—ever so subtly.

In September our committee administrative foundations were completed. We were an official LAUSD chartered committee. We could see the extent to which the financial profession disguised their fee structures. Revenue sharing was literally hidden.

Mercer handed out a glossy, colorful, spiral-bound 23-page folder entitled “LAUSD Deferred Compensation Plan.” The professional looking handout provided an overview of 1 quarter, 1-year, 3 years and 5-year past performance. In my opinion the investment data provided was mostly noise. Past performance should never be the determining factor for selecting investments. Noise was “interesting” investment statistics but add little value to our committee’s job. What was important was to select low cost funds that are from the core asset classes: large, mid and small-cap, bonds and international.

It doesn’t matter if you are helping your brother-in-law, your sister, your folks with their retirement plan or discovering your broker/adviser’s shenanigans with your portfolio, always, ALWAYS follow the costs. From their initial presentation to the Board several months before, I wanted to know the total cost to LAUSD employees. The mutual fund costs were published on page 9 called “Fund Expense Analysis.” “At last,” I thought. Table 1 illustrates each fund, asset class, fund expense ratio, revenue sharing and the peer group average expense ratio.

Table 1

	Asset Class	Fund Exp. Ratio	Revenue Sharing	Average Inst. Expense Ratio
American Growth Fund R4	US Large Cap Equity	0.68%	0.35%	0.88%
Vanguard Growth & Income	US Large Cap Equity	0.40%	0%	.70%
Vanguard Extended Market	US Equity (Index)	0.25%	0%	na
Vanguard Dev Market Index	Int Equity (Index)	0.29%	0%	na
American Europacific R4	International Equity	0.83%	0.35%	0.98%
PIMCO Total Return Admin	US Fixed	0.68%	0.25%	0.62%
Dreyfus Bond Market Index Inv	US Fixed (Index)	0.40%	0.35%	na
Dreyfus Cash Management	Money Market	0.30%	0.10%
Dreyfus S & P 500 Index	US Equity (Index)	0.50%	0.40%	na
VALIC – Fixed Interest	Stable Value			na
TRP Income (ADV)	Lifestyle	0.89%	0.35%	na
TRP 2010 (ADV)	Lifestyle	0.93%	0.35%	na
TRP 2020 (ADV)	Lifestyle	1.01%	0.35%	na
TRP 2030 (ADV)	Lifestyle	1.05%	0.35%	na
TRP 2040 (ADV)	Lifestyle	1.05%	0.35%	na
Davis NY Venture A	US Large Cap Equity	0.89%	0.25%	0.74%
Turner Mid Cap Growth	US Midcap Equity	1.20%	0.40%	0.93%
Janus Mid Cap Value (inv)	US Midcap Equity	0.92%	0.25%	0.74%

Hide the Costs at all Costs

Do you see the total cost to the buyer? Was this an oversight? Mercer’s data do not include the AIG-VALIC’s 15 bsp, so the total cost was omitted. Thus, Mercer’s Table One was incomplete, this time they omitted what the AIG-VALIC VP announced to the board. Why convince the Board of Education and the human race proclaiming that AIG-VALIC could administer our plan for 15 bsp and exclude it in Table 1? This was funny. Does anyone care about “Average Institutional Expense Ratio?” It was not in the best interests of consultants to show the total cost—it was in our best interests. All employees deserve to know.

Revenue sharing costs were colored gray in Table 2 to show they are hidden. They imbed the cost in the mutual fund expenses.

Table 2 presented a completed Table of the investments with 15 bsp added. The right column showed the total costs. Nothing complicated or omitted. For example, the “American Growth Fund R4” was first.  The Revenue Sharing cost of .35% was embedded in the Expense Ratio column, .68%. Thus, the total cost was calculated by adding the mutual fund expense ratio and the TPA cost (.68% + .15%) for a total of .83%.  The revenue sharing costs are already part of the .68%, so don’t add it. Clever, isn’t it? Now a twelve year-old can understand the scheme.

 Table 2

	Exp. Ratio (ER)	Rev Sharing embedded in ER	TPA Cost	Total Cost to Participants
American Growth Fund R4	0.68%	0.35%	0.15%	0.83%
Vanguard Growth & Income	0.40%	0%	0.15%	0.55%
Vanguard Extended Market	0.25%	0%	0.15%	0.40%
Vanguard Dev Market Index	0.29%	0%	0.15%	0.44%
American Europacific R4	0.83%	0.35%	0.15%	0.98%
PIMCO Total Return Admin	0.68%	0.25%	0.15%	0.83%
Dreyfus Bond Market Index Inv	0.40%	0.35%	0.15%	0.55%?
Dreyfus Cash Management	0.30%	0.10%	0.15%	0.45%
Dreyfus S & P 500 Index	0.50%	0.40%	0.15%	0.65%
VALIC – Fixed Interest				NA
TRP Income (ADV)	0.89%	0.35%	0.15%	1.04%
TRP 2010 (ADV)	0.93%	0.35%	0.15%	1.08%
TRP 2020 (ADV)	1.01%	0.35%	0.15%	1.16%
TRP 2030 (ADV)	1.05%	0.35%	0.15%	1.20%
TRP 2040 (ADV)	1.05%	0.35%	0.15%	1.20%
Davis NY Venture A	0.89%	0.25%	0.15%	1.04%
Turner Mid Cap Growth	1.20%	0.40%	0.15%	1.35%
Janus Mid Cap Value (inv)	0.92%	0.25%	0.15%	1.07%

Notice that Vanguard does not enter into revenue sharing agreements. The 40 bsp for the Vanguard Extended Market Index was an outstanding cost. I have no problem with the ten funds which have a total cost of 1% or less. Why didn’t AIG-VALIC or Mercer present Table 2 to the board of education? A .83% cost for American Growth R4 was not expensive for an employer sponsored retirement plan. While I personally prefer to invest in Vanguard, I have no problem with the American Fund’s investment philosophy of low turnover, low-cost expense ratios. Their front-end commissions of 5.75% are waived in most plans, including this plan.

Most Expensive Funds

The remaining eight funds were too expensive, in my opinion. All five Lifecylce T. Row Price funds, Turner Mid-Cap Growth, Janus Mid-Cap Value and Davis NY Venture A cost over 1.0% total cost. At 1.35% Turner Mid-Cap Growth, the highest cost fund, would grow in somebody else’s pocket other than our employees. That fund was numero uno on the list for replacement.

If you invest in Turner by 2044 you will pay too much. You cannot ignore the math. 1.35% fee may sound reasonable, but over 30 years, the fee will diminish a nest egg by 18.85%.  Eighteen percent less money was too much for handholding and filling out enrollment forms. More important, it was not fair for some colleagues to pay three times more for Turner Mid-Cap than for Vanguard Extended Market Index. Will the participants know these cost differences?

Watch Out!

The lack of regulations for transparency speaks to the ethics in the industry. This practice was widespread including 401k plans. But the buck-stops-here—our committee demanded transparency. Most employer-sponsored retirement plans do not require transparency. It took two boards of education meetings, a special meeting and several oversight committee meetings to obtain the data I needed to create Table 2. The point is no matter how wonderful, insightful and clever George was in designing a new plan or how big and prestigious the consulting firm, it was the committee who calculated the total costs and required transparency.

Mercer Did One Thing Right—Include Index Funds

Using index funds for passive investing was not discussed in detail in this book. A list of my favorite books examining the advantages of the passive over actively managed strategy are in the reference section. For brevity, index funds are an ideal fit for retirement plans because they are broadly diversified in the major asset classes, are low-costs and easy to monitor.

Mercer was commended for offering four index funds out of 18 (Dreyfus S&P 500 Index, Dreyfus Bond Market Index, Vanguard Extended Market Index and the Vanguard Developed Market Index). In Mercer’s customized design for LAUSD they wrote: “Participants who prefer to construct their own portfolios have a choice of the four index and nine actively managed funds.”

The Dreyfus S&P 500 Index included revenue sharing which increased the cost. This original index was created and launched in 1976 by the legendary Vanguard founder, John Bogle. Revenue sharing was included in many mutual fund companies in addition to Dreyfus. Many industry consultants embraced index funds with one huge caveat—you guessed it—revenue sharing. Mercer selected the Dreyfus S&P 500 and the Dreyfus Bond Market Indexes to share revenue with AIG-VALIC.

The Dreyfus S&P 500 Index was used as evidence in the Daniel Hall and David Hamblen vs National Education Association class action suit of excessive 403b costs:

“…one option offered to Plan participants is a Dreyfus fund designed to track the Standard and Poor’s 500 stock index. The total operating expense for the Valuebuilder [NEA’s plan] Dreyfus stock index fund in 2006 was 0.30%. That is over three times the 0.09% operating expense on Admiral Shares in Vanguard’s 500 Index fund. Prudent fiduciaries do not select investment options costing three times more than a comparative product” (p. 29).

Was Mercer acting as a “prudent fiduciary?”

Share Classes Led to Revenue Sharing

Revenue sharing sounds great, if you are being shared with. Except there was one little secret–it’s shared between the fund company and the plan record keepers, the TPA. Learn which funds have revenue sharing by identifying their share class designation.

Share class is a classification system given to stocks and mutual funds. They are designated by letters of the alphabet: “A Shares,” “B Shares,” “C Shares,” “D Shares,” “E Shares” and “Z Shares.” Mutual fund A Shares, for example, have front-end loads (commission paid to the adviser on buying) while B Shares or C Shares have back-end loads (commissions paid on selling). Share classes pay the brokers, advisers, managers and the TPA (AIG-VALIC) compensation. Be aware not all mutual fund companies use the same share class definitions provided here.

I made this easy to understand by avoiding investments with share class designations in my portfolio. It’s too expensive. Look up the ticker symbol on Yahoo finance to see the share class. Don’t you want the fund which keeps earnings in your pocket? Choose investments which do not ding you every year with bloated charges. Vanguard and TIAA CREF do not share revenue, the primary reason why I used TIAA CREF for my 403b during my last six years of teaching.

What Happened to the Committee’s Recommendations?

Armed with the total cost information in Table 2, we proposed three fund changes to the selection of funds. The funds selected for removal were the most expensive (the expensive T.R. Price were part of a series of Target Date funds which required more time to find a lower cost replacement). It was the committee’s job to select the funds so we requested three individual funds be replaced:

Table 3

Asked to be Removed:                                              Replaced by:

1. Turner Mid-Cap Growth (1.35%)                          1a. Dreyfus Mid-Cap Index PESPX (.65%)*

2. Janus Mid-Cap Value (1.07%)                             2a. Pioneer Mid-Cap PYCGX (.84%)*

3. Davis New York Venture A (1.04%)                     3a. Davis NY Venture Y DNVYX (.79%)

*From AIG-VALIC Initial Recommendations, page 2 of Investment Structure and Fund Line-up Recommendation Report for LAUSD Deferred Compensation Plan (July 2006).

Suggested replacement funds were in the asset class to accommodate the diversification requirement of the Investment Policy Statement. We made it clear the total costs above 1% were too high. These alternatives cost less than 1% total. With the amount of expected assets coming from thousands of potential LAUSD customers, it makes sense to offer funds charging less than 1%, a little less than three times the original 42 bps. We are only following-up on what the AIG-VALIC’s VP said to the Board of Education: “… because of the institutional pricing and the size of LAUSD alone demands a low rate.”

The committee was unaware that the .27% additional cost was in the AIG-VALIC/LAUSD contract. When we recommended lower cost funds, our financial consultant ignored us. I was floored. I thought the Mercer’s slate of fund choices was a starting point because it’s the committee which selects the investments. I was wrong. Mercer would not even consider AIG-VALIC’s recommendations, 1a or 2a in Table 3.  Then I discovered that the infamous 27 bsp was in the contract, quoting, “The target amount of such income is 0.27% and was taken into account in determining the administrative charges….” Mercer had an agenda and the committee was not a partner.

Revenue sharing was a contentious issue. The committee was so divided the Chair warned us with an email edict not to go against the consultant’s recommendations. We underestimated the consultant’s influence on the benefits administration and the committee Chair. He wrote, “Mercer is not willing to recommend the three funds you want to select because in their expert opinion they do not achieve our stated goal.”

Really? In my “expert” opinion, the Chair overlooked two procedural facts about the committee process and one was his own:

1. Once again, two of the funds were AIG-VALIC’s Initial Recommendations. The committee members took a fiduciary position trying to eliminate the highest costing funds and still pay AIG-VALIC’s 42 bps. The three funds we recommended charged fees higher than 42 bps. So, what was the problem?

2. The Chair forgot what he and Mercer reported to the Board of Education. He answered a question from one of the Board members about the selection process, “…in terms of selecting the program, this will be handled by the investment committee.” Mercer repeated what the Chair of the committee said at the Board of Education.

Our recommendations were legitimate and in complete accord with the IPS. It’s only three of the eighteen funds to lower costs and still pay what AIG-Valic needed—not a threat to Western Civilization.

Some committee members were going to vote no, but others were not knowledgeable about the machinations. With the district under pressure to get this plan running, there was no time to get everyone up to speed. I told the committee I would not vote for this selection of funds. Three of those funds were above the average cost and my sole rationale. The Chair’s blessing convinced enough members to vote for Mercer’s recommendations. In spite of absences at the next meeting, a quorum was reached and the committee approved Mercer’s hard-line recommendations.

I was disgusted and angry as I was misled into thinking that the committee selected the investments. Furthermore, we were unable to hold AIG-VALIC’s feet-to-the-fire. The mistake we made by not pressing AIG-VALIC and Mercer about the 42 bps came back to slap us upside our heads.

Victory for the Participants

  At the next meeting, one of our bright and savvy committee members, Alan, brought a 401k lawsuit that was in the mainstream news. He started talking about the article and how the lack of transparency, especially revenue sharing, had precipitated a lawsuit against the sponsoring company. He warned about a similar fiduciary breach might incur with our district over the hidden revenue sharing costs.

He proposed a motion which AIG-VALIC would reveal all costs to district employees, including revenue sharing to all group and individual presentations. If AIG-VALIC was going to charge higher fees than the 42 bps, then by golly, the committee demanded full transparency of those additional costs.

The AIG-VALIC reps balked. They fought the transparency proposal all the way to the exit. They warned us as they were walking out the door like a gunslinger backing out of the saloon with both guns firing, “we will have to check our legal department about this!” I thought, “oh, please, how pathetic.” Mercer wasn’t present to be their supportive mouthpiece.

LAUSD administration supported the committee’s demand for transparency. How could they not? The publicized lawsuit case was a perfect example which legitimized our motion. It passed unanimously. Nothing scares a school district more than legal responsibility.

Excerpts from Kathy Kristof’s L.A. Times article

Financial columnist, Kathy Kristof, attended the meeting and plansponsor.com republished her Los Angeles Time’s article October 23, 2006 (Click here for full report). Here are excerpts:

According to the LA Times, in meetings this summer, teachers serving on an advisory committee learned that the funds in the district’s 457 plan would assess an average annual fee of 0.27% on account balances for revenue sharing.    According to the report, AIG VALIC initially opposed explicitly disclosing this fee separately to teachers, preferring instead to leave it as an embedded component of the 0.72% investment management fee charged by each fund.  

… in response to the criticism from Schullo and others, school district benefits manager David Holmquist pressed AIG VALIC to fully disclose the revenue-sharing fees.   “The committee wants full disclosure,” Holmquist told AIG VALIC Vice President Ron Gatti….   However, Gatti resisted, saying that disclosing general administrative fees of 0.15% and fund management fees, which will average 0.72%, would be sufficient.   “I’m afraid the revenue sharing would just confuse people,” Gatti said, according to the report.

United Teachers Los Angeles, also threatened to withhold its support for the 457b plan unless full disclosure was made.

Are you “confused?” Confusion, safety and fear are primary tools to scare newbie investors into thinking that they must turn their investments to the high priests of finance.

Finally, a decision to require full transparency we made came to fruition during those dark days when Mercer, AIG-VALIC and the Chair controlled the debate. We were proud of this achievement. We failed to replace the three costliest funds but won the transparency battle and earned media coverage. Our committee’s ruthless attention to the transparency of fees paid off big time by looking out for the employees’ best interests.

Time to Move On

The 457b was in place. The AIG-VALIC reps were sent to the field to enroll and accept employee contributions. The committee began its routine of viewing progress reports. By January, 2007 the process of selecting our next financial consultant started. The Mercer Consultants contract had expired. Our Bylaws required committee members in the “…selection and evaluation of the investment adviser and other consultants to the Committee….” Two committee members volunteered to participate with district procurement staff to select the next consultant.

Selecting an Ethical, Competent and Independent Consultant

Plan consultants are as good as their investment philosophy and knowledge of laws and regulations. I thought we needed a consultant who respected the committee process, shared a goal of reforming the 403b too and confident enough to learn from the committee.

Our ad hoc committee read the returned bids, ranked them on the specifications, discussed and debated our ratings. The five who scored the highest were invited for interviews.

SST Benefit Consultants (SST), especially their lead consultant, Barbara Healey, were endorsed by the esteemed Bob Architect, Senior Tax Law Specialist and 403 (b) guidance author. 403b reformed minded friends wrote additional support letters on SST’s behalf.

With a bitter pill swallowed about Brian Cressey’s accolade of  Mercer Consultants, SST would have to show evidence they’re right for us:

• ethical and independent, looked after the best interests of LAUSD employees
• willingness to listen
• respect for the committee process
• training for committee members on defined contribution plans

As a selection committee member I could see first hand how they interacted with us. I had one concern—SST’s philosophical bias towards active-management.

SST Consultants were selected. They had good “people skills” and they recognized the California 403b was rampant with conflicts of interest. They had a long history of experience with 403bs, 457bs, and large non-profit employer plans. They possessed a broad and detailed knowledge of IRS, pension and California laws. Despite their investment philosophy, they were on the right side in other areas:

• get educators away from high-priced TSAs
• invest in real funds
• keep costs low
• support full transparency
• agreed that the 403b domination by the insurance industry was inappropriate.

SST Consultants started working with us in July, 2007. On day one they smiled from ear-to-ear. LAUSD was a huge opportunity and a challenge for any consulting firm. They earned their place with us. We were happy too. Most of the committee members were elated and looking forward to a better working experience.

Our bylaws state that one of the responsibilities was to educate the committee. SST wasted no time. By September they scheduled an all day educational workshop on defined contribution plans. SST updated the Investment Policy Statement (IPS) and began researching replacements of the funds which Mercer strong-armed. First on the list to eliminate, you guessed it—Turner Mid-Cap Growth—one of the three funds which we picked a year earlier!

Not so fast. First the New Chair

Not everyone accepted SST with open arms. Along with a new consultant LAUSD appointed a new Chair. According to the Bylaws our committee Chair was the LAUSD Benefits Administrator. David moved to another position and his assistant was appointed. A fight between the new Chair and the lead consultant ensued before the committee chairs were warm.  It was a petty issue on emails among committee members and SST. The new Chair chastised Barbara for sending the agenda to the committee members, because the Chair had not approved it first. Who cares? Agenda items were never a problem before. If there were changes we sent it out again. But another problem escalated. Two meetings were cancelled with a day’s notice which enraged members. Problems shifted from Mercer to this new Chair. But the good news was this bona fide control freak retired.

Benefits appointed a temporary Chair. She was great. She suggested this author serve as the alternate Chair. The committee agreed. This helped with scheduling of meetings. But something a little more important transpired—she demonstrated respect for the members’ time and commitment.

We went straight to work on revising and updating the Investment Policy Statement (IPS). We could not make those fund changes mentioned above without the updated IPS approved by the CFO. The IPS is an important legal document which guides and focuses the committee on monitoring the plan with the assistance of the financial consultant. The IPS accomplishes four things:

1. Provides the objectives and purposes

2. Assesses the needs of the plan’s participants

3. Creates guidelines for how investment options are selected and illuminated.

4. Establishes procedures for monitoring the investment policy on a continuous basis

While we were waiting for approval we had plenty of other work to do. Our committee was active, creative and too idealistic. We sometimes forgot who we were working for—a huge bureaucracy. But we pressed on regardless.

We did not get an education plan from AIG-VALIC. In response we created our own ad hoc education committee. For examples, we started from public relations ideas to make sure all employees were made aware of a new plan, knew the difference between a 403b and a 457b, using the district’s TV station to broadcast small video clips and showed how costs eat into a retirement nest egg. These ideas were in the discussion phase with some resistance by district staff because of their decades old fear with confusing publicizing and endorsing.  Our financial education plan was the only item that became a reality, thanks to UTLA member, Sandy Keaton.

Sandy and I stopped our 403baware meetings because of our committee involvement. Sandy became UTLA’s (Teacher’s Union) Retirement Issues Chair. As part of our committee’s education initiative she began coordinating and implementing investment workshops at UTLA headquarters. She asked the 457b reps, SST and outside professionals to provide presentations. These professionals must be on the same philosophical investment page as our committee to steer educators away from TSAs into low-cost broadly diversified mutual funds. She offered about two all-day Saturday investment workshops a year.

In the meantime AIG-VALIC started reporting problems accessing schools. Most of the 700 school site principals did not realize LAUSD had a new plan. Consequently the AIG-VALIC reps were shown the exit, preventing the reps from making presentations to staff. We discussed several ideas for publicizing the 457b, passed a motion and sent it to the CFO as well.

Several months elapsed and our healthy discussions disintegrated into a frustrating buzz. Without approval from the CFO we couldn’t change any of the funds. The IPS was in the land of CFO administrivia, unsigned.

But first there was good news. Benefits administration appointed a new permanent Chair—it was the venerable Mr. George Tischler. George was welcomed. His honeymoon didn’t last, however. He was soon engulfed with angst and frustration because the CFO was ignoring our IPS motion. Two of our most coveted members threatened to quit, believing that their time was not valued.

SST Talks to CFO

In a desperate attempt to get things moving, our lead consultant talked to the CFO. She told her to respond to the committee motions. The consultant might have scared the bejesus out of her by threatening that as the fiduciary she could be personally liable. Finally the CFO approved the IPS.

We had more motions. We went to work replacing the funds which we had talked for two years. Once again they were on “hold.” This time George talked to the her. Ghastly isn’t it? But it’s how major decisions are often handled in the lofty towers of power.

First it was Mercer, then the Chair, and now it was the CFO who was the obstacle. Like a dysfunctional family, one member takes on the role of the “identified patient.” It’s so typical. It seems most behemoth bureaucracies have weak links which take turns screwing things up. They seem unresponsive, blame employee turnover, or wish problematic issues will resolve themselves. Our committee membership was stable but affected by bureaucratic disregard.

In the morass of our committee business, there was supposed to be this order: the committee passes a motion which sent to the CFO for either approval, rejection or a request for more information. Here are dates to show how slowly this system was working. The Investment Policy Statement (IPS) was sent in the fall of 2007 and it sat on her desk for a year before she signed it. SST recommended the following fund changes, passed by the committee and sent to the CFO in December 2008 and then sent again in the fall of 2009 and were not approved by the CFO until the spring of 2010. Noticed that the dreaded Turner Mid-Cap Growth was finally removed.

Table 4

Removed                                                                    Replaced by

1. Turner Mid-Cap Growth TMGFX (1.35%)*               1a. American Century Heritage TWHIX (1.16%)*

2. Vanguard Grth & Income VQNPX (.52%)*                2a. American Funds Fund. R4 RGAEX  (.81%)*

3. Dreyfus S&P 500 PEOPX (.65%)*                             3a. Fidelity Spartan 500 Index FUSEX  (.25%)*

*Total costs including the .15% TPA fee.

The above problems with our district-bloated-bureaucracy paled in comparison to the next incidents which shocked all.

Our Former Mercer Lead Consultant works for AIG-VALIC

Business Wire Press Release June 6, 2007 (Link to AIG-VALIC Press Release) reported that our former Mercer lead consultant now works for AIG-VALIC!   During those heated revenue sharing debates, another member and I accused the Mercer lead consultant to her face of “taking care of AIG-VALIC interests over the participants” Of course, she denied it vehemently. But doesn’t it make sense now? I think our instincts were right. It didn’t matter that there might be implications of impropriety involving both AIG-VALIC and Mercer as hired contractors by LAUSD. Of course, I am not talking about anything illegal—these companies have legends of attorneys. In my opinion this is a blatant “in-our-face” ethical and conflict of interest issues.

If the Mercer lead consultant had considered our recommendations, worked with the committee by accepting one or two of our recommendations (out of the three), we would have no problem who ever she worked with. But she didn’t. She ignored our recommendations and offered other funds which were just as expensive. She wanted no part of reducing revenue sharing by considering our fund recommendations, in spite of both her and our Chair telling the Board of Education the committee selects the investments. In my opinion she did not act on the behalf of our employees when she defended the AIG-VALIC Vice President misleading statements to the Board of Education with his flat-out lie about costs.

My opinion was not imagined. Read what the teacher’s union financial consultant said in an email about Mercer’s selection process:

“I think we all agree that the fund selection process was tainted and I think everyone will feel better once SST has done their analysis, and taken the “stench” of Mercer off the funds.  If the funds offer any revenue sharing benefit, so be it; as long as that factor is not taken into account in the selection process, and it is disclosed to the participants, it will only reduce the overall cost of the plan for each participant.  I think at this point, everyone feels that Mercer (in concert with AIG, probably) selected many of the funds based on their willingness to share revenue, and not whether or not the funds themselves were best in class.  This doesn’t pass the smell test, as rightly pointed out by the committee.”

Please explain this clause which was also in the AIG-VALIC/LAUSD contract? “Contractor will also take all necessary steps to avoid the appearance of conflict of interest….”[emphasis is mine]. Did AIG-VALIC’s decision to hire our former consultant have no impact on our employees when she defended high-fee revenue sharing which would benefit AIG-VALIC?

In my opinion, the committee and visitors witnessed firsthand how she stood up for AIG-VALIC’s interests. Mercer’s contract with LAUSD expired in December 31, 2006. We were told by her Mercer colleagues four months later that “she had moved on.” Wouldn’t make perfect business sense for AIG-VALIC to offer her a position after the LAUSD/Mercer contract expired? Her performance with our committee did not hurt her changes, heck, in my opinion, it practically guaranteed employment.

Russell Olsen, author of the Handbook for Investment Committee Members, wrote about the responsive relationship of consultants/advisors with committee members:

“The adviser and his people must be the source of expertise and the ones who do the work, but they should always remember that the investment committee is the one deciding on the objectives and policies, making the actual investment decisions, and shouldering the final responsibility. The adviser cannot be moving in one direction and the committee in another.”(Bold is mine)

I doubt if this transfer of employment heralded the national mischief AIG found itself in soon after.

AIG went Bankrupt

In the wee hours of Monday morning September 15, 2008, Lehman Brothers, the fourth largest investment bank, declared bankruptcy. Lehman’s event was reported to have triggered the 2008-2009 financial meltdown. In the ensuing months the entire country and the world experienced the greatest economic collapse since the Great Depression as a series of financial institutions declared bankrupcy. AIG caught our committee’s attention for good reasons.

AIG, the parent company of VALIC also declared bankruptcy and was on the news every day. For the record VALIC was not in financial trouble. The UTLA Treasurer reported several anxious teachers called him about the AIG. He verified with me that AIG-VALIC was only the TPA. He was relieved. But its ownership by AIG posed significant and damaging image problems in the minds of the 1000 LAUSD’s employees enrolled.

Even VALIC agreed their relationship to AIG threatened their professional reputation. At the beginning of VALIC’s contract with LAUSD, VALIC renamed itself to “AIG-Retirement.” They may have done this to polish their tarnished veneer by disavowing the word “annuity” from their name. But the new “marriage” to AIG had to end. AIG-Retirement was out and their original name VALIC in.  Someday they may get it right.

AIG-VALIC Breach of Contract?

The final incident pushed the committee into a nuclear reaction. AIG-VALIC rep reported to the committee that he had 5-7 reps out in the field for over a year. The contract states: “The service provider [AIG-VALIC] shall provide fifteen (15) representatives dedicated solely to provide group meetings, educational sessions, and one-on-one retirement and asset allocation counseling for LAUSD employees….” In my opinion this was a breach of the agreement. Putting all of the above allegations together resulted in contractual and public image implications that were too transparent to ignore. The committee passed a motion recommending to the CFO that VALIC’s contract be terminated.  It passed but not unanimous. George and the district staff voted against termination. They said this move would disrupt the 1000 employees already enrolled. To let this go by would breach our oversight duties.

Our motion was sent to the CFO for a response and to the general counsel, contracts and ethics departments for direction. We never got a response and we didn’t press for one. As far as the committee was concerned the termination matter was closed. AIG-VALIC contract was in its final two years anyway. The termination motion was recorded and official. Let future auditors deal with any consequences.

Other Measures Passed

After an extensive study by UTLA’s legal staff and in anticipation of the new IRS 403b regs, on April 20, 2008 the teacher’s union terminated the “union approved” 403b vendor policy. In a memo UTLA’s David Goldberg wrote for members:

“UTLA has in the past endorsed various companies that provide 403(b) accounts for members.  With these dramatic new changes affecting teacher retirement investment options, UTLA Board of Directors has decided to cease the endorsement of any 403(b) vendors. Effective immediately, no TSA or 403(b) vendor is endorsed or supported by UTLA.”

Our committee took up this issue by revising the district bulletin, BUL-6178.0.

Quoting the Bulletin: “No agent may solicit employees, advertise or distribute promotional materials for the purpose of insurance policies, solicitation of contracts for tax-sheltered annuities, 403(b) voluntary retirement savings…Presentations on retirement, personal finance, or insurance are not permitted on LAUSD property other than by official representatives of the LAUSD 457(b) plan, CalSTRS and CalPERS.”

Lessons Learned and Looking Forward

We are a seasoned committee with five years of service meeting about ten times per year. LAUSD asked committee members to participate in the next RFP process. We’re never in control of what happens outside our district, but we will recommend to the CFO to hire the next TPAs. Our five powerful weapons:

1. George Tischler, who created the vision, the plan and the policy of employee oversight.

2. An independent financial consultant in SST. SST recommended the replacing some of the active managed funds with index funds and understands and respects the committee process as outlined by author Russell Olsen’s quote above.

3. Committee members who know about fees and low-cost indexing and will continue to press for the lowest cost, best-in-class investments.

4. Benefits administration, SST Consultants and committee members are united in one vision to reform school districts’ defined contribution plans, both 403b and 457b.

5. Due to UTLA’s leadership terminating their “union approved” policy, campus access limited to district sponsored 457b plan reps.

6. The vision of the entire committee was to have an “open architecture.” The platform has a TPA, record keeper and a list of mutual funds. That’s it. The 457b plan discussed throughout this chapter is an open architecture plan. No need for numerous insurance companies that were out of control. The committee and SST wanted the 403b to mirror our 457b platform, so that committee recommendations rested with LAUSD, not to obscure insurance codes that demanded districts to allow “all willing vendors.”

7. A closer look at the Stable Value fees. This was one area that the committee needs more information. Because of the 2008 Stock Market crash this fund had a huge amount of inflows. Employees were afraid to invest in the equities offered. The committees knew about the “spread” but we never knew how much the TPA was earning.

7. Lastly the committee needs a closer follow-up on its motions.

New RFPs

SST and LAUSD contracts wrote two RFPs to select two new TPAs with the committee’s five-year experience to draw from. Two changes: 1. a fixed cost replaced the controversial revenue sharing so all employees pay an equal fee and, 2. two independent TPAs, one each for 403b and 457b plans replaced the problematic “common-remitter.”  The next Chapter will chronicle the next phase when the committee recommended and the CFO accepted two new TPAs.

 Summary

Employee Oversight: The Best Initiative LAUSD Implemented

Mr. Tischler got everything he wanted and then some when he masterminded and delivered his vision to undo the “Knot.” His reward was a committee which implemented his vision and more by demanding full and unrelenting transparency. The Los Angeles Unified School District must be commended for their exceptional demonstration of 457b transparency. George Tischler and his staff circumnavigated the tyrannical 403b regulations which benefit a few financial industry cronies and their decades-old sense of entitlement, hypocrisy and corruption by simply offering a low-cost plan.

What visionaries. It takes guts to invite non professionals who ultimately pay for the program into the decision-making process. The best transparency advocates are employees, those people who ultimately pay for the decisions. The open process led directly to fiduciary responsibility which reduced liability. That’s good for everybody.

There are many financial consultants and TPAs out there. They are like the mass producers of American automobiles, who whip out employer sponsored retirement plans off-the-shelf and recommend them to employers. In spite of our employer selecting an insurance company and the financial consultant ignoring the value of the committee process, we prevailed with transparency.

VALIC was forced to shut down expensive 403b sales and required to disclose 457b costs to employees. Furthermore our committee recommended an ethical and independent financial consultant leading to swapping out the expensive funds and replacing it with two lower cost options.

If you are a benefits plan administrator, the employees deserve to know the full extent of the costs. If you are an employee of your employers’ oversight committee, the author hopes this chapter will inspire you to finish the job and make significant improvements to what your TPA and the financial consultant recommends to your employer-sponsored plan.