Data & Research July 21, 2007

IMHO: Lies, Damned Lies, and Statistics

I am fortunate enough to have access to a vast array of studies, research, and surveys about this business.

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Even more fortunate to have access to a PLANSPONSOR research arm that provides an opportunity not only to gather and analyze, but to pose our own questions to a remarkably diverse audience. Still, as Mark Twain once famously wrote, “There are three kinds of lies: lies, damned lies, and statistics.’ ⁽¹⁾

We recently ran coverage of a survey⁽²⁾ that spoke to trends among defined benefit plans. That engendered the following response from a reader:

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Isn’t it interesting how perspective can rule the most simple things? The article you refer to that shows defined benefit plans decreasing in number is such a case. Mercer deals with the larger corporate plan sponsors. Their plans are underwater for numerous reasons and are being terminated in wholesale lots. On the other hand, small companies are making defined benefit plans the plan du jour. There are several reasons for this; larger tax deductions, demographics, insecurity with Social Security, the investment experiences of 1999-2002, the desire for a “guaranteed” benefit, etc. Our company is the largest pension administration firm in Florida, and we have set up five defined benefit plans to every three defined contribution for four consecutive years. Our experience has been shared by virtually all TPA’s in the small-company market all over the country.

Now, I have no independent validation of that reader’s claims, but I heard from a number of advisers and providers that support smaller employers that the rumors of the defined benefit plan’s demise is, to draw on another quote from Mr. Twain, “greatly exaggerated’.

Surveys Say?

In our business, we must constantly guard against the favorable positioning of some survey results vis-à-vis the interests of a sponsoring organization; or the extrapolation of too much conclusion from too small, or unscientific, a sampling. Generally speaking, I favor sharing as much information/insights as possible—with as much full disclosure about the size of the sampling and/or the interest(s) of the sponsoring organization as possible. In our coverage, we try very hard to position—as high in the story as possible—the size of the sampling, the sponsoring organization, and where it seems applicable (and not obvious), some indication of possible motivation in putting out the information. It’s not that they necessarily would be pushing a specific result—sometimes it just influences their perspective on the proper conclusion to be drawn from the data.

The challenge, of course, is that some data are simply more available. Larger providers tend to have larger client bases, and client bases of larger clients, to draw on, and/or larger budgets to pay other organizations to gather that information (generally from plans that fit their targeted plan demographics). Moreover, the use of “averages’ frequently, if unintentionally, obscures the reality in small samplings. And when averages are averaged—well, it’s Katie, bar the door!

In my experience, human beings are inclined to focus on surveys that reinforce their own version of reality, rather than one that challenges it. Still, market trends are a significant motivator of plan sponsor behavior. That’s not illogical, IMHO—in an environment where complex financial decisions fraught with personal and professional risk are the order of the day, “what everyone else is doing’ can offer a compelling reality check. But only if the reality is real—and not just “lies, damned lies, and statistics.’

When considering data that purports to offer insights, it’s worth knowing:

Who sponsored/conducted the survey?
What are they selling?
Is the conclusion supported by the data?
Does that conclusion “fit’ with those drawn by similar surveys?
How unbiased is the survey sampling?
How scientific is the survey sampling?
How similar is the survey sampling to your perspective/size?

⁽¹⁾ While the original quote is attributed to Benjamin Disraeli, Twain popularized it in the U.S. in “Chapters from My Autobiography.’

⁽²⁾ The article, Poll Finds DB Closures Paired with DC Improvements,’ is online at http://www.plansponsor.com/pi_type10/?RECORD_ID=37981

Compliance July 21, 2007

SIFMA and ICI Release Comments About 12b-1 Fees

In comment letters to the Securities and Exchange Commission (SEC), neither group suggested that the SEC abolish the fees, asking that the Commission keep them, although perhaps with refinements.

Reported by

Alison Cooke

Although agreeing with the SEC’s initiative to review Rule 12b-1, the Securities Industry and Financial Markets Association (SIFMA) stipulated that 12b-1 fees were not meant to be a temporary solution, and said that since its inception, “Rule 12b-1 has been a success; curtailing or withdrawing the rule would harm investors and competition in the marketplace.’

Both SIFMA and the Investment Company Institute (ICI) argued that 12b-1 fees (used by over 70% of funds, according to ICI) allow for economies of scale, since they are able to allow smaller intermediaries to offer a broader choice of funds to their clients, and the fees also allow for smaller funds to get increased distribution through larger intermediaries.

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In the letter, SIFMA said those participating in the SEC’s recent roundtable seemed to agree that the fees “support legitimate and necessary administrative and investment services for fund shareholders and that the utilization of 12b-1 fees has been impacted by the wholesale shift in shareholder servicing from funds to intermediaries, the substantial decline in front-end sales loads (or the converse) and the increased need of investors for continuous advice.’

“Rule 12b-1 is an integral part of the structure and success of the mutual fund industry,” ICI Acting General Counsel Mary Podesta wrote in the letter. “The rule and its associated fees allow investors the option of paying distribution costs over time, give investors access to funds that otherwise might not be available to them, and compensate financial intermediaries, on whom so many fund investors depend.”

Disclosures

However, although the administrative and investment services offered to shareholders have changed significantly in the 27 years since the rule was enacted, “It may be appropriate to improve disclosures for the benefit of investors and fund boards, but it would be a major mistake for the SEC to withdraw or substantially curtail Rule 12b-1, or otherwise to restrict the fee arrangements that have fostered innovation, flexibility, and investor choice.’

Therefore, transparency enhancements are needed to ensure that the existing disclosures match the current uses of 12b-1 fees, SIFMA said. ICI also asked for new disclosures provided by funds in the prospectus and other documents, and by intermediaries at the point of sale that describe the purpose of the 12b-1 fee, “to give shareholders a better understanding of the nature of the fee and clarification of the responsibilities of mutual fund boards in approving and overseeing 12b-1 plans.’

In regards to the nine factors that should be considered when fund boards are evaluating 12b-1 fees, both SIFMA and ICI suggested that the SEC update the guidance regarding those factors.

Assessing the Fees

Although some have called for making 12b-1 fees levied at the individual account level, instead of taking it from fund assets, according to Podesta, “There are significant tax and operational disadvantages to imposing 12b-1 fees at the account level that likely would outweigh the benefits of this approach” because externalization would increase investors’ tax costs, reduce the tax efficiency of funds, and require extensive overhaul of fund operating and recordkeeping systems.

To read the full text of SIFMA’s comment letter, please visit: http://www.sifma.org/regulatory/comment_letters/48614797.pdf. Prior to the roundtable, SIFMA provided a white paper on the history and purpose of Rule 12b-1 and other revenue streams as background material for the discussion. The full content of the white paper can be found at: http://www.sifma.org/regulatory/pdf/12b-1MFWhitePaper6-13-07.pdf.

ICI’s letter can be read at http://www.ici.org/new/07_sec_12b-1_com.html#TopOfPage. In 2004, according to an ICI study, the bulk of 12b-1 fees were paid to compensate brokers and financial advisers for ongoing shareholder services (52 percent) and for initial assistance in a fund purchase (40 percent). Only 2 percent of the fees were used to pay for promotion and advertising of funds. That study can be found at http://www.ici.org/pdf/fm-v14n2.pdf.