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The Ties that Blind?

The Ties that Blind?

Fred Williams - May 2005

It may be too early to know exactly how the mutual fund trading scandal will have an impact on plan sponsors' view of the bundled versus unbundled services debate. However, there appears to be a widespread belief that the discredit being heaped on some of the biggest mutual fund families may result in the shift of traditional biases.

The Colorado Public Employees' Retirement Association (PERA) is in the process of converting administration and recordkeeping services for its $907 million 401(k) plan from ADP to CitiStreet. Katie Kaufman, director of communications and a member of the plan's investment advisory committee, says the Colorado plan's unbundled structure allowed it to readily jettison two Janus mutual funds when that firm was implicated in the trading scandal. The Colorado plan offers 16 investment options from six providers.

"For smaller plans and plan sponsors with limited internal resources, bundled services are efficient and effective," she says. "We have the ability to be flexible, and have the resources since we also run a huge defined benefit plan."

Plan sponsors' real dilemma, however, is not whether to migrate to unbundled providers but whether to offer funds from several families versus including only proprietary funds from a single firm. The consensus among industry experts seems to be that the SEC's proposed 4p.m. trading cutoff works to the benefit of proprietary-only offerings, sicne they would be able to process trades internally-and could accept participant trades later in the day, while still adhering to the 4 p.m. cutoff. Some third-party administrators expect plan sponsors might go so far as to begin limiting their investment offerings to proprietary funds in order to maintain daily valuation and one-day trade settlement.

There is, however, "l lot of doubt" that the 4 p.m. trading cutoff time will be adopted, says Christopher Guarino, president of BISYS Retirement Services. "There are enough major industry players that can show definitive evidence that it will adversely impact participants." Today, most daily valued programs allow participants to make a transfer or liquidation request up till 4 p.m. and receive the current day's price. However, if the SEC's proposal is enacted, Guarino says that the recordkeepers likely would be required to close trading by plan participants between 10a.m. and noon, depending on their location.

Yet, some in the industry do no view the early trading deadline as fatal to multifamily investment offerings in 401(d) plans.

As long-term investors, "whether participants get trades executed today shouldn't really make that much difference," says Michael Rosen, principal at Angeles Investment Advisors LLC in Santa Monica, California. "It's not obvious to me [that the 4p.m. trade deadline] is necessarily a bad thing, unless it is related to a hardship case where people need the money right away."

The mutual fund scandals will help make the economics of providing both kinds of services more transparent, says Joe Craven, director of institutional retirement services at Putnam Investments, whose firm has been at the center of the storm over market timing and improper trading. "Providers must be willing to show the value and real cost of bundling in a straightforward way. There will be no more "service included' at no cost. The regulations will require much more clarity to plan sponsors and participants.

Putnam replaced its chief executive officer after being charged last year with civil fraud by state and federal regulators, involving improper trading by portfolio managers in some of the company's funds. Putnam has been making a strong push to restore its reputation by instituting new internal controls, settling SEC charges, and dismissing at least 15 employees - including six money managers - for market timing.

The scandals also are likely to lead to a "greater focus by plan sponsors on their fiduciary responsibilities," Craven says. "Each fund must now stand on its own merits, whereas, before, any ties went to the recordkeeper."

"When we are finished, things will look different in terms of how plan sponsors are charged for services and total fees," says Bob Wuelfing, president of the SPARK Institute. However, it is still too early to guess the details, sayd Wuelfing, whose organization is the legislative arm of the Society of Professional Administrators and Recordkeepers, which is made up of 401(k) service providers.

Blurring the Line

Regardless of how the regulatory and legal issues are resolved, smaller plans probably will stick with bundled service providers, at least for the time being, says David Wray, president of the Profit Sharing/401(k) Council of America. However, the adoption of open architecture is making it possible long term for unbundling to move "down market" into smaller plans, Wray adds.

Lancet Software Development Inc.'s $1 million 401(k) plan is bundled with Principal Financial Group and includes 21 investment offerings from five outside fund families. "I think for us going unbundled would involve taking a risk," says Susan Bjork, human resources manager at Eagan, Minnesota-based Lancet, who oversees the firm's $1 million 401(k) plan. "We believe bundling is less risk and, obviously, it's a fiduciary issue. We could go unbundled, but unbundling would involve a lot more research and more resources than we have available." While none of Lancet investment options was affected, Bjork said she became troubled as the mutual fund scandal unfolded.

At larger plans, the mutual fund scandal is not likely to change pension officials' views on the use of bundled proprietary funds, predicts Nathaniel Duffield, director of trust investments at Halliburton Company, who oversees the Houston company's $4 billion defined contribution plan assets. Halliburton offers separate account investments rather than mutual funds through its plan. Yet, that did not make the plan immune from problems in the mutual fund industry, since Putnam managed one of Halliburton's international equity funds. As a result of the turmoil in Putnam's international equity funds, Halliburton dropped Putnam as a separate account manager, says Duffield.

"It was easy for us to step away from them," he notes. "In an unbundled environment, when something goes wrong with any part, you can chop off any piece and still function well. I've never been able to figure out why larger plans would go with a bundled provider. It's really a cop-out, and I would challenge any large bundled plan to put its fee structure up against our unbundled structure and compare costs."

No matter how the regulatory and legislative agendas play out, the new rules are not likely to raise the demand for bundled plan services, says Michael Weddell, senior defined contribution consultant at Watson Wyatt Investment Consulting in Detroit: "It is preposterous to think that a plan fiduciary that has already concluded that, in at least some asset classes, there are better funds out there than with a bundled provider's proprietary funds, they are going to go backwards and use funds from a bundled provider because they want participants to transfer in and out 24 hours quicker than otherwise. I just can't see that happening.