Attention: This post is an early version of Chapter 9 in my book Fighting Powerful Interests. You can download the entire book for free by clicking here. 

Chapter 9

2006-2011

Alexander the Great untied the Gordian Knot with his sword. Previous attempts to solve the impossible entanglement by conventional approaches were unsuccessful. 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 the minuscule political will by school boards and unions, liability-phobic benefits staff and powerful insurance interests. “Conventional approaches” to those in power—unions, districts and state legislators—did not work. In some cases, our attempts backfired. I was left wondering if the TSA sales force were laughing all the way to their bank, amused at the spectacle. Even numerous press reports failed. 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 obstacle, complete with transparency so deep it scared the elephants from the room.

What? A School District Benefits Official Cares?

            Mr. Tischler had federal help. The Economic Growth and Tax Relief Reconciliation Act allowed school districts to offer 457b plans. The new 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 by taking advantage of these two laws. Brilliant. With George’s leadership, LAUSD hired a TPA for 403b administrative assistance while offering a low-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 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 genuine investments which grow with the economy?

Board of Education Approval

George presented the new plan to a subcommittee of the LAUSD’s Board of Education on April 23, 2006. He detailed the differences and advantages of the 457b over the 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 insurance companies 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 the company’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 annuity world: “Guarantees!”

How can an insurance company charge a price which competes with Vanguard’s index funds? George just said that he wanted a new lower cost plan for the district (lower cost than the 403b). But another insurance company? The plan 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 fifteen bps handily beat 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 familiar dance.

Mercer

Mercer’s rep marched to the podium with a briefcase and stacks of reports, wearing a neatly 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 said?

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. If the cost reflects the industry standard, why the binary presentation about fees? All agree 42 bsp was reasonable. Shouldn’t the VP be proud of announcing 42 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 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 AIG-VALIC selling 403bs, benefits administration convened a special meeting two weeks later.

Twenty people showed. Three teachers and David, 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.

After the introductions, there was silence for a few seconds. It was a strange meeting with nobody in charge. Defined contribution plans have seldom been discussed publicly. The tension was obvious. The staff and financial consultants may have been unfamiliar with answering direct questions about fees or concerned with the UTLA’s treasurer present—but this was the beginning of genuine transparency.

The allegation about AIG-VALIC selling 403bs was discussed first. They 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 their 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 VP said was accurate. Huh? The VP didn’t say 42 bps—he shouted “15 bps.”

Nobody spoke for a long while. 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. Details will be shown later in this chapter. The UTLA treasurer, two teachers and I lacked enough knowledge or backing from the teacher’s union to apply pressure.

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, the UTLA Treasurer and the three teachers should have had 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 after their brilliant Shark Attack article and then stabbed everybody in the back by choosing 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 learned much in a few weeks. Inaugurated in 1978, the 457b was another tax-deferred compensation retirement plan. The 403b and 401k tax-deferred benefit was identical. There were two administrative 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 retired 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. Each plan had pros and cons. Simultaneous contributions to both plans are allowed. Depending on employees’ eligibility older workers can save up to $40,000 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—LAUSD was free to do what was right. While we thought LAUSD picked the wrong TPA the selection process was by competitive bid. George and his colleague David (another benefits administrator) and the Mercer rep said the committee will select the investments, not AIG-VALIC nor the state’s Insurance Commissioner’s Office.

An independent financial consultant would be hired to provide training and recommend funds for inclusion and interface between the district and employee groups. “Employee groups?” When George spoke about “oversight of services,” he meant it—employees. To everybody’s surprise benefits invited all eight of the district’s unions to send representatives to this new committee: teachers, administrators, school site support personnel, buildings and trade, school police and the rest. The reps would meet monthly with benefit’s administrators, the Chief Financial Officer’s (CFO) and a Board of Education rep. I was invited to be a Member-at-Large and Sandy was asked to represent UTLA.

How often does a large school district include this range of employees on the same team with the mission to plan and implement a new low-cost, best-in-class retirement plan? Behind-the-scene decisions might be history. First it was AFT and now the 2^nd largest school district in the country offering full transparency and asking for employee buy-in. What a novel idea and great opportunity to improve the quality of all voluntary retirement plans. Finally, the 403b/TSA faced competition for the first time.

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. 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. To the east was downtown Los Angeles above the busy Pasadena/Harbor Freeway and north beyond the hills was Dodger stadium. The most expensive school built in the country, the former Belmont High School was below. The meeting room includes the obligatory long and spacious mahogany corporate table surrounded by cushy, slightly worn, oversized swivel chairs. The business and power symbolism is a long way from my farm-boy, small-town Wisconsin roots.

Mercer’s contractual duty was to advise our committee to launch the 457b 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 verified by similar procedures used by many retirement plan consultants and TPAs. These procedures were detailed in the Investment Policy Statement.

UTLA’s Treasurer, David Goldberg, was terrific. He attended meetings, sent the unions’ legal counsel and hired a financial consultant. The union’s attorney ensured the volunteer collective bargaining members were not liable for recommendations. The union’s financial adviser oversaw the proceedings and answered investment related questions.

In September our committee administrative foundations were completed. We were an official LAUSD chartered committee. The legal fiduciary was the district’s CFO as directed by the Board of Education. The CFO signed the IPS. Now the committee was allowed to make specific fund recommendations.

Total Costs to Participants Finally Exposed

Investment costs are the most protected pieces of information in the financial industry, hermetically sealed from public view for good reason. If people realized how much they paid long-term, they would revolt. Thus, the industry takes extreme precautions in how costs are revealed. The dance between Mercer and VALIC 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, similar to locating and repieceing the Titanic. You already got the first lesson when the AIG-VALIC VP reported the initial and Mercer tacked on a second layer of costs. There are more to come.

Professionals love to throw numbers around as a clever maneuver to distract us. Complicated investment statistics have one inherent purpose—encourage confusion and discourage transparency—ever so subtly. You don’t need to take a statistic class. Discover how to recognize the distracting noise from the information you need.

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. It was important to select low-cost funds that reflect the core asset classes: large, mid and small-cap and international stocks (equities) and bonds (fixed accounts). Our IPS states:

To comply with ERISA section 404(c), a plan must:Offer at least three diversified “core funds” representing a broad range of investment alternatives; each core fund must itself be a diversified portfolio of investments.

In my opinion the investment statistics all over Mercer’s handout were mostly noise. Past performance should never be the determining factor for selecting investments. Noise may be interesting, but adds little value to our committee’s job. We kept with the ERISA 404© requirement.

Where were the revenue sharing costs?

Next was the information we had been wanting for months. The committee could see the extent to which the financial profession disguised their fee structures. Before we search for the revenue sharing costs, we need to know what we are looking for.

According to Gnabasik’s thoughtful definition, “Revenue Sharing is the universally accepted form of paying for the cost of defined contribution recordkeeping expenses” (Introduction to Excess Revenue: A New Paradigm for Lowering Plan Costs, 2006, p. 6). He says few people know about them. Committee members had never heard of revenue sharing before the 457b plan was announced. Over the summer, however, we became knowledgeable about revenue sharing and recognized our responsibility to expose, reduce or eliminate them. The committee knew our employees, whom we represent, would be paying the costs.

Know Thy Share Class System

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. Easier still commit to your memory that Vanguard and TIAA CREF do not share revenue.

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, 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

Note:Revenue sharing is literally hidden.

	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? Mercer’s data do not include the AIG-VALIC’s 15 bsp. Table 1 was incomplete, this time they omitted what the VP proudly announced to the Board. After the enthusiasm about the tiny TPA fee, it was hilarious when Mercer excluded the 15 bsp in Table 1? “Average Institutional Expense Ratio” is an example of useless noise. We wanted the total cost. Exposing the total cost was in the employees’ best interest we represent.

The Finished Table 1, presented below, is a completed profile of the investments’ total costs. Revenue sharing costs were colored gray to show they are hidden. For example, the “American Growth Fund R4” the revenue sharing .35% was embedded in the Expense Ratio column, .68%.

The right column showed the total costs with the 15 bsp added. Nothing complicated or omitted. Thus, the total cost was calculated by adding the mutual fund expense ratio and the TPA cost (.68% + .15%) for a total of .83%.  Clever, isn’t it? Now a middle-school student can understand the scheme.

A Demonstration of Genuine Transparency

Let’s face it folks, the industry is not going to do this for us. The lack of regulations for cost transparency speaks to their ethics. If genuine transparency were required by regulations, we still have to do our homework. The practice of hiding costs is widespread, including 401k plans. But the buck-stopped-here—our committee demanded transparency on total costs. Considerable sleuthing and calculations were prepared to obtain the data to create a more accurate Finished Table 1 below. Regardless of George’s new program design and the “crème de la crème” consulting firm it was the committee who got the total costs.

Finished Table 1

(Note: Revenue Sharing is embedded in the Expense Ratio. The amount, in gray, showed how much of the expense ratio is shared with AIG VALIC)

	Exp. Ratio	Revenue Sharing Amount      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 Vanguard does not enter into revenue sharing agreements. The 40 bsp for the Vanguard Extended Market Index was an outstanding low-cost. The ten funds costing less than 1% were satisfactory.

Why didn’t AIG-VALIC or Mercer present the Finished Table 1 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. Only use this fund in your employer sponsored retirement plan as their gruesome front-end commissions of 5.75% were waived.

Most Expensive Funds

The remaining eight funds were too expensive. 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 costing fund, would grow in somebody else’s pocket other than our employees.

Turner was numero uno on the list for elimination. If you invest in Turner at 1.35% fee, you will diminish your nest egg by 18.85% over 30 years. Eighteen percent less money is too much for hand-holding 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?

Mercer Did One Thing Right—Include Index Funds

Using index funds for passive investing is not discussed in detail in this book. Resources examining the advantages of the passive over actively managed strategies 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, easy to monitor and often outperform most managed funds.

Mercer was commended for offering two genuine index funds (Vanguard Extended Market Index and the Vanguard Developed Market Index). Unfortunately, they also recommended two “copycat” index funds, Dreyfus S&P 500 and Dreyfus Bond Market Indexes. Stay away from copycat index funds—revenue sharing was an added cost dragging down index-like performance.

The identical 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).

 

Our Investment Policy Statement with Mercer’s name on each page states, “The safeguards to which a prudent investor would adhere must be observed,” p. 18. Prudent refers to the decision making of selecting funds “as if they were his/her own.” Was Mercer acting as a “prudent investor?”

What Happened to the Committee’s Recommendations?

Armed with the total cost information in our Finished Table 1, we proposed three fund changes illustrated in Table 2:

Table 2

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).

Our purpose was to drive down the cost of the expense ratio by choosing another share class. Reducing costs puts more money in our employees’ accounts. The three funds selected for removal were the most expensive. It was the committee’s job to select the investments.

Suggested replacement funds were in the same asset class to accommodate the diversification requirement of our Investment Policy Statement. These alternatives cost less than 1% total. It did not make sense to offer investments charging more than 1%, when both VALIC and Mercer said the TPA will need only.42%. We are merely 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.”

I thought the Mercer’s slate of fund choices was a starting point because it was everybody’s understanding the committee selects the investments. Mercer’s ignored our suggested three funds. Instead, they suggested funds which had been just expensive as the funds we wanted replaced. Then the committee discovered 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….”

We realized that 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 Mercer’s influence on the benefits administration, some members 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, Mr. Holmquist overlooked two procedural facts about the committee process:

1. 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 confirmed what Mr. Holmquist said.

 

1. Two of our recommended funds were AIG-VALIC’s initial recommendations which had revenue sharing.

 

I would assume those funds have revenue sharing agreements otherwise the TPA would not include them. The committee members took a fiduciary position, trying to lower the highest costing funds and still share revenue with AIG-VALIC’s. The three funds we recommended were in the identical asset class. Our recommendations were legitimate and in agreement with our 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.

The committee members who understood the ruse were overruled due to the Chair recommendation and urging to get this plan into action. In spite of absences at the next meeting, a quorum was reached and the committee approved Mercer’s hard-line recommendations. Disgusted and angry, I realized the duplicitous cabal was steamrolling us.

Victory for the Participants

  At the next meeting, one of our many bright and savvy committee members, Alan, shared a 401k lawsuit clipping from the mainstream news. The lack of transparency of 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 in which AIG-VALIC would reveal all costs at 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 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’ll have to check our legal department about this!” I thought, “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 401k 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 articleOctober 23, 2006. 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 and fear are primary tools to scare investors into thinking they must hand investments over to the high priests of finance.

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

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 we commenced the process of selecting our next financial consultant. Thankfully, the Mercer Consultants contract had expired. Our Bylaws required committee members for the “…selection and evaluation of the investment adviser and other consultants to the Committee….” Two committee members volunteered to participate in the ad hoc selection committee.

Selecting an Ethical, Competent and Independent Consultant

Plan consultants are as good as their investment philosophy and knowledge of laws and regulations. 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 Healy, were endorsed by Bob Architect, Senior Tax Law Specialist and 403 (b) guidance author, mentioned previously. Our 403b reform 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 of committee members on defined contribution plans

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

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

• Get educators away from high-priced TSAs
• Invest in stocks that grow with the economy
• Keep costs low
• Support full transparency
• Agreed the insurance industry domination of the 403bs was inappropriate, stagnate and illiquid products which don’t grow with the economy and thus, not in the best interests of PreK-12 educators.

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. Committee members were looking forward to a better working experience.

Our bylaws mandate that one of SST’s responsibilities was to train the committee. They 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. On the list to eliminate first, you guessed it—Turner Mid-Cap Growth—one of the three funds which we picked for elimination a year earlier.

Not so fast. First the New Chair

Not everyone accepted SST. With SST, LAUSD appointed a new Chair. According to the Bylaws our committee Chair was the LAUSD Benefits Administrator. A fight between the new Chair and the lead consultant ensued before the committee chairs were warm. It was a petty power play issue about exchanging 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. Subsequently, two meetings were cancelled with one day’s notice enraging members. Problems shifted from Mercer to this new Chair. The good news was this bona fide control freak retired.

Benefits appointed a temporary Chair. What a difference. She demonstrated respect for the members’ time and commitment. To keep our meetings on schedule, she appointed the author as the alternate chair.

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 or eliminated

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

While we were waiting for approval, we had plenty of other work to do. Our committee was active, creative and too idealistic. It fell to us to create an education plan for employees. We proposed to use 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, but resisted by district staff because of their decades-old fear of confusing publicizing and endorsing.

VALIC’s $500,000

SST informed the committee that VALIC provided $125,000 each year for five years ($500,000) for administration. This is a common agreement between vendors with large school districts to assist in growing the plan and to assure the district doesn’t tap into general fund money. After pressing for an audit, we got an accounting from the CFO’s rep. Some of the money was used to pay benefits staff time spent at our committee meetings and other administrative expenditures. Benefits always said no when we discussed using it for education purposes. We didn’t pass a motion to let the CFO decide. We were waiting for previous motions. The CFO is the committee’s supervisor who has the final say on committee recommendations and ideas.

Thanks to the UTLA rep, Sandy Keaton, as UTLA’s Retirement Issues Committee Chair, she coordinated and implemented investment workshops at UTLA headquarters. She asked the 457b reps, SST and outside professionals to provide presentations. Sandy and I learned early on to vet financial professionals before allowing them to present. She offered two all-day Saturday investment workshops a year, which continue attracting 80 grateful teachers to each workshop.

ACCESS

AIG-VALIC reported problems accessing campuses. Two issues: First, most of the 700 school site principals and the union’s Chapter Chairs did not realize LAUSD had a new plan. The policy was to only allow the “Union Approved” 403b vendors to present. 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.

These healthy discussions disintegrated into a frustrating buzz after a year had passed. Without approval from the CFO we couldn’t change any of the funds. The IPS was in the land of administrivia, ignored and unsigned. Meanwhile, benefits administration appointed a new permanent Chair—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 us. Two of our most coveted members threatened to quit, convinced their time was not valued and that CFO had dropped the ball.

In a desperate attempt to get things moving, our lead consultant talked to the CFO. The consultant must have scared the bejesus out of the CFO by threatening she could be personally liable as the fiduciary. Finally the CFO approved and signed the IPS. We had more motions. We went to work replacing the funds which we had discussed two years previously. Once again, those motions 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.

Like a dysfunctional family, one member takes on the role of the “identified patient.” 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. First, it was Mercer, then the Chair, and now it was the CFO who was the obstacle.

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 were not approved and signed by the CFO until the spring of 2010. Noticed we removed the dreaded Turner Mid-Cap Growth.

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 .42% 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

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’s 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 spectacle was a blatant “in-our-face” ethical and a conflict of interest issue.

If the Mercer lead consultant had considered our recommendations, worked with the committee by accepting one or two of our recommendations, we would have no problem whomever she subsequently worked with. But she didn’t. She categorically ignored our recommendations and offered funds just as expensive. She wanted no part of reducing revenue sharing, in spite of both her and our Chair telling the Board of Education the committee selects the investments.

Our teacher’s union’s 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.”

The AIG-VALIC/LAUSD contract included this clause:

“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 the public witnessed firsthand how she stood up for AIG-VALIC’s interests. Her performance with our committee did not hurt her chances to work for AIG-VALIC. Heck, in my opinion, looking out for AIG-VALIC’s best interests was the perfect “job interview.”

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)

 Ary Rosenbaum, Esq. wrote in his newsletter speaking to both financial consultants and TPAs:

“If you betray the trust of your clients and those you work with, it can take a lifetime to rebuild that trust and that reputation. … and just a lapse in judgement to destroy it. … Never lose sight of your way.”

I doubt if this transfer of employment heralded the national mischief AIG-VALIC 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 weeks 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 reason.

AIG, the parent company of VALIC, also declared bankruptcy and was in the mainstream news every day. For the record VALIC was not in financial trouble. However, our participants did not know this. The UTLA Treasurer reported several anxious teachers called him about AIG. He was relieved that VALIC was only the administrator. Still, VALIC’s relationship with AIG posed significant and damaging image problems in the minds of their enrolled LAUSD’s employees.

VALIC apparently decided the relationship to AIG threatened their reputation. VALIC changed their name again. At the beginning our contract, VALIC renamed itself “AIG-Retirement.” They may have done this to polish their tarnished veneer by disavowing the word “annuity” from their name. But the marriage to AIG had to end and their original name “VALIC” was back.  Someday they may get it right.

AIG-VALIC’s Breach of Contract

The final incident pushed the committee into a nuclear reaction. AIG-VALIC admitted to the committee they breached the contract with only 5 reps out in the field. 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….”

 Putting all of the above allegations together resulted in contractual and public image implications which were too transparent to ignore. The committee recommended VALIC’s contract be terminated.  Our motion was sent to the CFO for a response and to the general counsel, contracts and ethics departments. Our motion was ignored and we didn’t press for a district response. Our committee’s attorney was unsure of a stance. The termination matter was addressed and closed. AIG-VALIC contract was in its final two years anyway.

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 to 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, the 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 and updating the district bulletin, BUL-6178.0.  We inserted that the only reps allowed on campuses were from the 457b plan. 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 (2006-2011) 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 potent principles:

1. Our Committee Chair, George Tischler, 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.

3. Committee members who know about fees and low-cost indexing, eliminating Revenue Sharing and will continue to press for transparency and best-in-class investments.

4. Benefits administration, SST Consultants and committee members were united in one vision to reform school districts’ 403b by the “open architecture” platform with the TPA selected by competitive bidding.

5. Due to UTLA’s leadership terminating their “union approved” policy, campus access landed back in LAUSD’s control and limited to district sponsored 457b reps.

The 457b plan discussed throughout this chapter is an open architecture plan. We did not need numerous, out-of-control insurance companies selling who-knows-what with no accountability. The committee and SST wanted the 403b to mirror our 457b platform, so committee recommendations rested with LAUSD’s committee, not an obscure, iron-clad insurance code which demanded districts to allow “all willing providers.”

 Next

1. Stable Value fees were one area in which the committee needs additional training. Because of the 2008 Stock Market crash this fund had huge inflows. Employees were afraid to invest in the equities offered. The committee knew about the “spread” but never knew how much the TPA was earning from the spread (Spread is the difference between the interest credited to the investor and what the TPA is earning from the market).

2. The committee needs effective follow-up on its motions.

3. Using the $500,000 for financial literacy programs and to grow the plan.

New RFPs

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 “approach” to undo the “Knot.” His reward was a committee, which put into practice 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 with the 457b plan.

What a visionary. It takes guts to invite nonprofessionals in the decision-making process. The employees are the best transparency advocates, the people who ultimately pay. The open process led directly to fiduciary responsibility which should reduce liability. Which is good for everyone.

Many financial consultants and TPAs are lurking for jobs. 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 a financial consultant who ignored the value of the committee process, we forced VALIC to shut down expensive 403b sales and required disclosure of 457b revenue sharing costs. Furthermore, our committee recommended an ethical and independent financial consultant which led to swapping out the expensive funds with 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 implement significant improvements to what your TPA and financial consultant recommend for your employer-sponsored plan.

 Genuine Financial Transparency: Case Study Demonstration

For all employees who take advantage of your employer’s tax-deferred retirement plan, whether a 401k, 403b or 457b.

You will discover how a financial oversight committee made up of your peers work with financial consultants, third-party administrators and the 2nd largest school district in the country when launching a new 457b plan. It is a fascinating story brought to life only because of the courage of a Los Angeles Unified School District Benefit’s administrator, George Tischler, and the Oversight Committee he envisioned and created. Mr. Tischler wanted oversight and he got oversight, perhaps a little more than he bargained! This post covers five years from the 457b start in 2006 to 2011.

Furthermore, the committee selected and recommended to the CFO a new committee financial consultant that listened and respected the committee. These events were great moments for our committee and for the employees that we represent.