Remarks Of Richard Y. Roberts Commissioner* U.S. Securities and Exchange Commission Washington, D.C. "Simplified Prospectuses and Defined Contribution Plans" The Fourth Annual P&I Defined Contribution Conference Pensions & Investments and International Business Forum New York City, NY February 1, 1995 ____________________ * The views expressed herein are those of Commissioner Roberts and do not necessarily represent those of the Commission, other Commissioners or the staff. I. Introduction I appreciate the opportunity to speak to the Fourth Annual P&I Defined Contribution Conference presented by Pensions & Investments in conjunction with the International Business Forum. My remarks will focus on the need for employees in participant- directed defined contribution plans to receive adequate information about their investment choices, and the desire of plan sponsors to provide that information while avoiding liability. I will offer what I believe is a partial solution to both employee and plan sponsor concerns: namely, the provision of a simplified prospectus to employees in participant-directed defined contribution plans regarding each underlying mutual fund or other securities-related investment. II. Status of Department of Labor/Commission Efforts Before I proceed further, I do wish to update you on the status of Department of Labor ("Labor") and Securities and Exchange Commission ("Commission") efforts regarding the investment information provided to 401(k) plan participants. As you may recall, there were discussions last year between Labor and the Commission regarding a joint research effort that would study the effectiveness of existing regulation and of industry initiatives related to participant investment education. The idea was a good one: not only because the issue was worth looking into, but because the use of a joint study framework would demonstrate that both Labor and the Commission were committed to participants having adequate information related to ensuring their retirement security and not, as some critics have suggested, to some kind of "turf war" between the two agencies. Since the agreement, the approach taken by Labor and the Commission has changed somewhat, and the two agencies have agreed to proceed with a study of the issues, which study I understand is currently being undertaken by the Employee Benefit Research Institute ("EBRI"). The two agencies' objectives, however, have not changed, and I view the new approach as a positive, practical step. It is my understanding that no preliminary findings -- either from EBRI or Labor -- have been published to date. III. Defined Contribution Plans Defined contribution plans have been growing steadily, in terms of numbers, participation rates, and assets, for some time now. According to one study, the total number of private defined contribution plans nearly tripled between 1975 and 1990, from 208,000 to 599,000. Among those employees able to participate in a 401(k) plan, the most popular type of defined contribution plan, one study indicates that 67% of employees did so in 1993, compared with 39% in 1983. Still another study indicates that, since 1987, assets in 401(k) plans have grown from $189 billion to over $400 billion, and recent press reports indicate that the amount of monies invested in defined contribution plans as a whole is well over $700 billion. If these trends continue, and I expect that they will, defined contribution plans will be the predominant type of pension plan in the not-too-distant future. And as members of this audience know, positive trends such as these tend to generate increased regulatory scrutiny. Unlike a defined benefit plan, where the employer makes the investment decisions and bears the risk of loss, a defined contribution plan generally places the responsibility and the risk of investment choice on the employee. As a result, poor investment choices with respect to an employee's defined contribution plan results in diminished retirement income. I have always adhered to the view that an employee who decides how to invest his or her assets in a defined contribution plan is as entitled to adequate information about investment options as any other investor. However, I understand that ERISA's disclosure rules, in the past, only required disclosure about the plan itself. Thus, plan participants were not necessarily receiving the information they needed to make an informed choice about their retirement assets, possibly the most important decision about their finances they will ever make. In 1992, the Commission's Division of Investment Management's "Protecting Investors" Study (which I will refer to as the "Staff's 1992 Study" or the "Study") recommended legislation to remove the current exemption in the Securities Act and in the Investment Company Act for interests in collective trust funds and separate accounts in which participant-directed defined contribution plans invest. The Staff's 1992 Study also recommended legislation amending the federal securities laws to require the delivery of prospectuses for the underlying investment vehicles to plan participants who direct their investments. I recognize that the Study's recommendations remain extremely controversial in many quarters, in part because they represent only a partial solution, since their implementation still would not result in federal securities disclosure requirements being applicable to all participant-directed defined contribution plans. Further, I acknowledge that Labor's Section 404(c) regulations serve as a partial solution to the lack of investment information for some plan participants. Labor's 404(c) regulations reduce the exposure of a plan's sponsor to liability for losses in participant accounts and, at the same time, provide employees more information about, and more control over, their investment choices. While the new rules are voluntary, a plan that does not conform to the rules cannot claim immunity from lawsuits by employees who are disappointed with their investment return. In brief, the 404(c) regulations require that a plan offer at least three diversified investment vehicles, each of which has different risk and return characteristics. Further, the plan must permit participants to transfer among the vehicles at least once within each three month period, and more frequently for volatile investment vehicles. Finally, the 404(c) rules require the sponsor to assure that plan participants are given, or can obtain, the information necessary to make an informed investment decision. At a minimum, sponsors must give employees information about each investment option, including its objectives, risk and return characteristics, and type of portfolio assets, as well as information about transfer procedures, the expenses and performance of each investment option, and a prospectus for any vehicle which is registered under the Securities Act. Despite this initiative, I continue to be fuzzy as to what constitutes "investment education" and what constitutes "investment advice." I suspect that the line between these two terms also is unclear to many plan sponsors. I understand that many sponsors avoid telling participants where they should allocate their funds, for fear that participants could later sue if their investments sour. This is an unfortunate circumstance, since this is the area where plan participants probably need the most help. I know that some sponsors are going beyond the relatively modest requirements of the 404(c) rules and are attempting to comply more closely with the spirit of the regulations by providing basic retirement planning information in the form of seminars, individual consultations, and regular publications. I note that the recent EBRI publication, "Retirement in the 21st Century: Ready or Not," highlights some of these programs. I commend those plan sponsors who have taken an aggressive approach to investor education and urge others to follow suit. Sponsors should remember that Labor's rules require them to "assist" their employees in making an "informed decision." While trends in 401(k) investor participation are moving in the right direction, as I noted above, approximately one-third of employees who qualify for 401(k) plans still do not contribute, and another study found that 60% of those who do contribute, select low- risk, low-yield vehicles such as money market funds or guaranteed investment contracts. Thus, for many participants, an informed decision may need to start with the basics of retirement planning and an understanding of risk versus reward, even though the 404(c) rules do not explicitly require this. I also understand that a number of defined contribution plans have transferred from a bank or insurance company collective fund operation to a mutual fund operation, because information about the former plans can be difficult to obtain. As I mentioned earlier, separate accounts and collective funds are exempt from the registration and regulation provisions of the Securities Act and the Investment Company Act, and thus do not have to provide prospectuses or to calculate the value of their portfolios on a daily basis. This lack of daily valuation, in particular, can affect account transfers and the ability of participants to be informed of the current value of their accounts. Of course, banks and insurance companies can convert their collective investment vehicles into registered mutual funds, which must price assets daily and provide prospectuses and shareholder reports, and I understand that many have. I am encouraged by Labor's 404(c) rules; they appear to represent a significant step in closing the information gap which currently exists in the defined contribution area. Unfortunately, the rules are voluntary, and ERISA does not apply to every pension plan, such as governmental plans. Because this information gap has yet to be completely filled in, the Commission, Labor, and industry must consider additional initiatives to ensure that every defined contribution plan participant receives sufficient disclosure about his or her investment options. IV. Simplified Prospectus Even if you believe, as I do, that the disclosure requirements found in the federal securities laws are superior from a quality standpoint to the information required by the 404(c) rules, this by itself does not end the analysis as to what information would best serve defined contribution plan participants or what form that information should take. In fact, the disclosure rules mandated by the federal securities laws and which protect pension plan participants are by no means perfect. There is some argument, for example, as to whether current federal securities law disclosure rules require the delivery of a mutual fund prospectus to only the administrator or sponsor, or also to the plan participant. Although I have not analyzed this issue thoroughly, I am preliminarily of the view that the Commission has the authority to require by rule the delivery of mutual fund prospectuses to plan participants. Of course, even if the Commission determined that it has such authority, there may be policy reasons mitigating against adopting such a rule. Further, the views of Labor should be carefully considered during this process, and it would be my preference that any Commission effort be coordinated with Labor. Whether or not the Commission pursues such rulemaking, I am not convinced that the best mechanism for delivering information to plan participants is the provision of complete funding-vehicle prospectuses regarding each available plan investment. It is my impression that few plan participants would read these prospectuses or understand them; a small minority may even be more confused about their options than they are at present. The Staff's 1992 Study recognized this problem to some extent in the context of direct-marketed mutual funds. The Study recommended that the Commission adopt a new rule that would permit investors to buy mutual fund shares directly from advertisements ("off-the-page"), albeit for reasons predominately unrelated to investor confusion. These off-the-page ads would be required to contain standardized and essential information about the fund, and for all practical purposes would be a substitute for a complete prospectus. But while the Commission proposed an off-the-page rule in March 1993, the proposal has encountered substantial opposition, particularly from state securities regulators, and no longer appears to be a Commission priority. Many investors, however, continue to view prospectuses as too long and complicated, and do not wish to read them. In concept at least, investors may be more inclined to read the essential information if presented in some simplified format before making an investment decision. I am sure that this would be the case with respect to defined contribution plan participants, who otherwise would receive complete prospectuses regarding investments with which they had little or no interest. Since the off-the-page proposal now appears to be on the Commission's back burner, other means of encouraging simpler, better disclosure must be pursued. Therefore, I have become an advocate for using a simplified prospectus in appropriate circumstances. I believe that money market funds should be the first investment vehicle with respect to which the Commission permits and/or encourages simplified prospectuses. Money market funds offer relative safety of principal in comparison to other types of funds, a high degree of liquidity, shareholder services, and a stable net asset value. Nevertheless, many investors view money market funds as competitive alternatives to bank accounts, and even many banks now offer such funds. While it once made sense for money market funds to use the same registration form and prospectus format as other funds since they invested in only a few types of fairly simple securities, money market funds now invest in a greater variety of portfolio securities. Since the registration form requires the fund to describe each kind of security in which it may invest, lengthy and technical prospectuses have resulted that do not make for easy reading or comprehension. An investor who views the fund as an alternative to a checking account probably is not interested in a technical discussion of Eurodollar certificates of deposit. The use of a simplified prospectus for underlying investment vehicles in defined contribution plans would be supported by a different line of analysis than with respect to money market funds. Modifications to the traditional mutual fund prospectus requirements for money market funds would be premised on tailoring the information provided to the particular investment vehicle. In contrast, with respect to defined contribution plan participants, prospectus modifications would be premised on the needs of a particular class of investor. For defined contribution plan participants, the objective is to ensure that more information gets directly into their hands than is currently the case, and that this information is presented in a readable, comprehensible format. I am of the view that simplified prospectuses, if designed properly, may, in fact, be more responsive to the needs of defined contribution participant investors than requiring the delivery of complete prospectuses. A simplified prospectus would outline the underlying investment vehicle's investment objectives, types of portfolio securities purchased, key performance data and performance comparisons if appropriate, risk levels, and other important information, in a short, concise, easy to read fashion. I know that for some members of this audience, what I have just proposed is not a novel concept. Press reports indicate that some service providers to defined contribution plans already make available shortened versions of prospectuses to participants. Moreover, at the time the Staff's 1992 Study was published, several banking executives critical of the Staff's legislative recommendations offered, as their own alternative, the development of simplified disclosures for pension beneficiaries which would be distributed to beneficiaries on a semi-annual or more frequent basis. As I stated earlier, the Commission may be able to act by rule to effectuate delivery of information to plan participants with respect to underlying mutual fund investments. In other cases, there would need to be voluntary industry initiative, or other regulatory or legislative action. I urge the industry, Labor and other regulators, to reconsider what information should be provided to defined contribution plan participants and what form that information should take. V. Conclusion With the increasing popularity of defined contribution plans, the industry is poised to become the predominant type of pension plan. To ensure continued success, however, eligible employees must be convinced that it is in their best interest to invest in these plans, and, then, how to make wise investment decisions. Clearly, the way to encourage intelligent investment decisions, at a minimum, includes providing investor education programs and providing investment-specific information directly into employees' hands. In this area, I would favor consideration of a simplified prospectus approach -- a rare instance where less disclosure can be better disclosure. Let me conclude by saying that I noted with amusement that yesterday's panel regarding regulatory developments from the IRS and Labor was annotated in your agenda, "a discuss[ion of] the latest efforts of the two departments to complicate plan sponsors' lives." I was delighted that my agency was not included on that list, and it is my fervent hope that even if my modest recommendations bear fruit that you will not feel compelled to include the Commission on any future agenda as a "complication."