Confero Summer 2014: Auto Pilot 401k by Westminster Consulting

confero A quarterly publication of Westminster Consulting

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ISSUE NO. 7

AUTO PILOT 401K ALSO:

Opposing Views On Automated Features

Is Inertia Working Against Your 401(k) Plan? 5 Nuances to Managing Fiduciary Liability with QDIA

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Features Summer Issue 2014 â&#x20AC;˘ Issue no. 7

AUTO PILOT 401K

OPPOSING VIEWS ON AUTOMATED FEATURES

7 MISCONCEPTIONS ABOUT RETIREMENT PLAN AUTO FEATURES

In this article, Gabriel Potter gives an indepth overview of automatic features as well as their features and benefits.

A Q&A session with consultant John Edwards of Ivy Wealth Management which highlights the risk of using substandard service providers when adopting automatic features.

In spite of how effective auto features are, many plan sponsors are still holding back from adopting them due to misconceptions. This article discusses 7 common misconceptions plan sponsors have about retirement plan auto features.

www.conferomag.com | 1

Contents Summer Issue 2014 • Issue no. 7

ONE PAGE MAGAZINE

91/2 QUESTIONS

A brief overview of some recent events and notable discussions within the industry.

An Interview with Jerry Patterson — Jerry Patterson, Senior Vice President of Retirement and Investor services of Principal Financial® Group, discusses employee retirement outcomes.

RES IPSA LOQUITOR

16 10

Is Inertia Working Against Your 401(k) Plan? — A discussion on plan sponsor and retirement committee’s struggle with 401(k) interia and how auto enrollment can help combat it.

DEFINED CONTRIBUTION

ON TOPIC

5 Nuances to Managing Fiduciary Liability with QDIA — An brief overview on the inner workings of QDIAs what plans should know.

Be First, Be Smarter, or Cheat— A discussion and brief synopsis on Michael Lewis’ new book, “Flash Boys” and the controversial debate it spurs.

2 | SUMMER 2014

IN EVERY ISSUE: 2 PUBLISHERS LETTER 3 CONTRIBUTORS 4 UPCOMING EVENTS

2014 CALENDAR 1

Independence Day

AUGUST

JULY

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AIF速 Designation Training August 25, 2014 Hilton Suites Chicago | Chicago, IL This is a classroom event for students to complete their AIF速 Designation Training. Enrollment is only open to those who meet the prerequisites. Students must first complete an online course before arriving for a full day of face-to-face instruction with an fi360 faculty member. This session concludes with an in-class examination for the AIF Designation. www.fi360.com/events/detail/082514-aif-cap-chicago

SEPTEMBER

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PLAN 16 ADVISER National Conferece

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529 Conference September 16-17, 2014 JW Marriott | Orlando, FL Using a 360-degree perspective, the conference drills down into the most significant trends and challenges facing the industry today, including critical conversation and debate surrounding the latest product innovations, investment options, distribution strategies, marketing initiatives, consumer trends and much more. www.529conference.com/Default. aspx?id=4294967364

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Publisher’s Letter

confero A quarterly publication by Westminster Consulting

A quarterly publication of fiduciary ideas by various contributors within the industry.

Publisher Westminster Consulting, LLC. Editor-In-Chief Gabriella Martinez Contributing Editors Sean Patton, AIF® Thomas Zamiara, AIFA® Creative Director Welcome to the Summer of 2014.

Gabriel Potter in the feature article provides an actionable discourse on how to achieve A lot of time has been spent on the part of results when considering implementing Advisors, Recordkeepers/TPAs, Employers, the various auto-features available to the and the other folks who touch a plan on employer. how to “move the needle” when it comes to enrolling more eligible employees in a Weighing in from the legal side of the deferred compensation plan and increasing street, John Godsoe, ESQ. discusses how the amount of money an employee decides PPA, sorry – the Pension Protection Act to put away or saves. What we have of 2006, provides regulatory corridors found both in our Practice and in talking and safe-harbors to move participants off to colleagues, employers, and those in the the dime and get them in the plan, invest retirement plan business, that “moving smartly (defaulting into a QDIA of course), the needle” sometimes feels like “pushing and bump their savings rate. a string” – frustrating and varied results. Sharing stories from the dark side and how There are many opinions and suggested auto-every can go wrong is John Edwards, solutions to this objective of moving the who is with the Rhode Island firm of Ivy needle. We open this quarter’s issue of Wealth Management. The lesson learned Confero with our 9 ½ Questions segment here is that employers must do the up-front where we interview Jerry Patterson of work to assure themselves that automating the Principal Financial Group. When we various features of the plan is prudent and asked Jerry about addressing the always that you have a recordkeeper partner to misunderstood “retirement readiness” goal, can execute. he discusses Principal’s holistic approach Enjoy the issue and the remainder of your when incorporates: summer. Keep the comments coming – they • Plan design are a great help and they give us countless • Participant engagement ideas for future issues and topics. •

Measurement and interpretation of plan and behavioral data

4 | SUMMER 2014

Tom & Sean

Gabriella Martinez Contributors James Brewer John C. Godsoe, Esq. Gabriella Martinez Steve Moser, CFP® Jerry Patterson Gabriel Potter, AIF® Thomas Zamiara, AIFA®

Questions or Comments? email us at info@conferomag.com

The information contained in this on-line magazine is for general information purposes only. The information is provided by Westminster Consulting and while every effort is made to provide information which is both current and correct, Westminster Consulting makes no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability or availability with respect to the on-line magazine or the information, products, services, or related graphics contained within the on-line magazine for any purpose. Any reliance you place on such information is therefore strictly at your own risk. In no event will Westminster Consulting be liable for any loss or damage including without limitation, indirect or consequential loss or damage, or any loss or damage whatsoever arising from loss of data or profits arising out of, or in connection with, the use of this on-line magazine.

Contributors

Gabriella A. Martinez Editor Gabriella is a marketing professional with over eight years of experience. She currently holds a Bachelor of Science in Multidisciplinary Studies with concentrations in Marketing, Printing & Publishing, Photographic Arts & Sciences and Psychology from Rochester Institute of Technology. She has been a featured writer and editor in several publications including Rochester Woman Magazine and Pup Culture.

Gabriel Potter, AIF ® Contributing Writer Gabriel is a Senior Investment Research Associate of Westminster Consulting where he designs strategic asset allocations and conducts proprietary market research. He earned a B.A. in Economics and a Certificate of Business Management from the University of Rochester and an M.B.A. with concentrations in Corporate Finance and Computers & Information Systems from the University of Rochester’s William E. Simon School of Business. He also holds an Accredited Investment Fiduciary Analyst (AIF®) designation and has been quoted in Human Resources Executive Magazine and his articles have been published through fi360 and AdvisorOne.

Jerry Patterson ® Principal Financial Group Contributing Writer Jerry Patterson is senior vice president, Retirement and Investor Services with the Principal Financial Group®. He is responsible for the retail and institutional annuity businesses, retirement income management strategy and overall accountability for the individual investor business of The Principal®. Patterson joined the company in 2001 as chief marketing officer in the Life and Health segment. He recently completed a multi-year rotational assignment as Chief Operating Officer of Nippon Life Benefits, based in New York City. Before joining The Principal, he served as senior vice president at Prudential Investments, senior vice president of Annuities at SunAmerica and vice president of marketing at Manulife. He also has experience in tax accounting and tax law with BDO Seidman and Husch & Eppenberger, respectively. Patterson earned his bachelor’s degree from the University of Wisconsin-Milwaukee and his law degree from the Drake University Law School. He is a member of both the Missouri and Kansas bars.

John C. Godsoe,Esq Bond, Schoneck and King Contributing Writer John Godsoe is a member of the law firm of Bond, Schoeneck & King, PLLC and works principally out of the firm’s Buffalo, NY office. John is a member of Bond’s Employee Benefits and Executive Compensation Practice Group which is supported by 9 full-time benefits attorneys across New York State. John is a graduate of Wake Forest University and the State University of New York at Buffalo School of Law. His practice focuses on assisting employee benefit plan sponsors and fiduciaries in all areas of employee benefits law, including both retirement and welfare benefit plan compliance. Recently, a large part of John’s practice has involved helping employers with compliance and strategic planning issues related to the Affordable Care Act.

Steve Moser, CFP ® Pension Consultants, Inc. Contributing Writer Steve Moser is a Retirement Consultant with Pension Consultants, Inc. located in Springfield, MO. He has over fifteen years’ industry experience advising people on various facets of their financial lives and is a CERTIFIED FINANCIAL PLANNER™ practitioner. He has presented on numerous financial topics in group and private settings, and is a very dynamic teacher. In his role at Pension Consultants, Steve helps employers provide the best retirement plan to their employees, while minimizing risk. Since 1994, Pension Consultants have been offering in-depth unconflicted advice on every aspect of retirement plan management, and serves companies of all sizes in variety of industries in a the Midwest and Southern United States. For more information, visit www.pension-consultants.com.

James Brewer Contributing Writer James Brewer (JB) is President of Envision 401k Advisors. JB focuses on helping small companies sponsoring 401(k) or 403(b) plans save time seeking to be compliant, control costs and help owners and employees fund retirement. Acting as a co-fiduciary, JB and his associates help small businesses manage their 401(k)/403(b) legal risks by 1) delegating responsibilities to fiduciary providers, 2) improving monitoring processes, and 3) helping employees maintain financial well-being through retirement. Securities and Advisory services offered through LPL Financial, a Registered Investment Advisor. Member FINRA/SIPC.

www.conferomag.com | 5

SUMMER 2014

THE ONE PAGE MAGAZINE New Treasury Regulation Provides New Lifetime Income Options for Defined Contribution Plans The U.S. Treasury Department issued final regulations that pave the way for defined contribution plans – including 401(k) plans and IRAs – to provide participants with a new option for insuring against longevity risk. One of the ideas that has emerged among academics and industry thought-leaders is to create a new product that has come to be known as a “longevity annuity.” Companies like MetLife have made these products available in the retail marketplace. Demand has been growing, but is still limited. A major barrier, however, is that regulatory restrictions made it unattractive to use these products where they made the most sense – in qualified retirement plans. This ruling changes that. To read the article on Forbes visit: www.forbes.com/sites/jeffreybrown/2014/07/01/ new-treasury-regulation-provides-new-lifetimeincome-option-for-defined-contribution-plans/

—Forbes, 7/1/14

Early Baby Boomers Comfortable with Retirement Income

New York’s Non-Profit Revitalization Act Of 2013 Changes The Governance of Private Colleges, Universities and Schools Effective July 1, 2014, New York’s Non-Profit Revitalization Act, (the Act) fundamentally changes the governance of non-profit private colleges, universities and schools and other charitable organizations. New York, which labored under cumbersome and antiquated regulatory statutes, has created a simpler method of creating new non-profit entities. It has also adopted many of the best governance practices already employed by private schools in New York State and many other reforms long sought by charitable enterprises and their counsel. Non-profit organizations can now incorporate, dissolve and merge more easily. Boards are permitted to use modern technology like Skype and video conferencing to communicate and hold meetings and may enter into significant transactions without court approval. The Act also provides critical oversight and governance reforms to prevent fraud and improve the public trust, including stricter oversight of insider deals, more substantial financial oversight requirements, conflict-of-interest policies, and whistle-blower policies. Read the full article at: www.lexology.com/library/ detail.aspx?g=adf7b640-a0f6-4eb2-885d-dc0f186058aa —Greenberg Traurig LLP, 7/18/14

Retirement Accounts Hold Record Balances The recent stock run-up is doing wonders for retirement savings. The average balance in a Fidelity Individual Retirement Account (IRA) rose 15% on an annual basis in the second quarter to $92,600 -- an all-time high. In the same period, the average balance in a Fidelity 401(k) account also set a record, up nearly 13% annually to $91,000. The mutual fund giant credited 77% of the gains to a surging stock market, and 23% to employee and employer contributions. For the full article click here: www.ksat.com/content/ pns/ksat/news/2014/07/18/money-fidelity-401kbalances.html

—Patrick M. Sheridan, 7/18/14

Recent retirees and those about to retire are relatively comfortable and confident in their retirement income, said a survey conducted by Brightwork Partners for T. Rowe Price Group. The survey was conducted to mark the first retirements of the oldest baby boomers, who turned 65 in 2011, said Anne Coveney, senior manager of thought leadership at T. Rowe Price Group, who led the study for the firm. To read the article on pionline.com visit: www.pionline.com/article/20140730/ ONLINE/140739984/early-baby-boomerscomfortable-with-retirement-income-8212report?utm_campaign=ramp_rss&utm_source=_ rss&utm_medium=rss

— Rob Kozlowski, pionline.com, 7/30/14

Interest in Defined-Benefit Grows Among Small Business Owners According to the most recent statistics provided by the U.S. Department of Labor Employee Benefits Security Administration, published in a June 2013 report, the number of defined-benefit plans had dropped from about 180,000 in 1985 to fewer than 50,000 in 2011. However, despite the steep drop-off, financial advisors at Wells Fargo Advisors, Raymond James and other wealth management firms say that interest in such plans is climbing among one important sector: small business owners.

6 | SUMMER 2014

For the full article click here: www.onwallstreet.com/news/small_business/interest-in-defined-benefit-growsamong-small-business-owners-2689676-1.html

— Miriam Rozen, OnWallStreet, 7/1/14

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9 1/2 QUESTIONS

An Interview with Jerry Patterson Senior Vice President—Retirement & Investment Services of Principal Financial Group By Gabriel Potter, AIF®

n this issue, Jerry Patterson of Principal Financial Group talks to Confero about employee retirement outcomes.

2. An engaging participant experience –with tech savvy, engaging, easy-to-use tools and services

Retirement readiness is a subject that is much talked about around the industry. Tell me about the resources that Principal is committing to this concept?

3. Strategic measurement – at both plan sponsor and participant levels

Retirement readiness is a shift in philosophy across the industry, and we are committed significantly improving outcomes for participants. We took our 70+ years of retirement experience plus industry expertise of behavioral finance leaders and digital experts, and created our holistic approach: Principal® PlanWorks. This approach incorporates three key elements: 1. Retirement ready plan design, 18| |SUMMER 8 SUMMER2014 2013

We’ve invested considerable resources to drive superior participant retirement outcomes. For example, we tapped into leading digital experts to help create a positive, distinctive digital experience that drives action and outcomes. Our approach to plan design is rooted in behavioral finance, and turns behavioral challenges into behavioral solutions. Reports and tools help plan sponsors and advisors understand the power of retirement readiness. (http://inside.theprincipal.net/ris/retireready/index.shtm)

How does Principal define retirement readiness for defined contribution participants? It is a participant’s ability (and continued progression) to meet and maintain income goals throughout retirement. There seems to be a movement to push the conversation away from investments and fees and towards outcomes. Has the focus shifted at Principal and if so, can you tell me about those initiatives? Yes, we have definitely shifted our focus from participant accumulation (participation/deferral) to improved participant outcomes. The push began in 2012 when we commissioned a study with Brightwork Partners LLC regarding financial professionals and their role in working with plan sponsors. As a result, we learned that retirement readiness showed as an important point to plan

An Inter view with Jerr y Patterson sponsors and was a top area for financial professionals to help illuminate for plan sponsors. (Brightwork Partners LLC Study Article (PQ 11627 M)). Its been written that creating better outcomes for participants requires a commitment from both the plan sponsor and participant? Beyond saving more for retirement, what else should participants be doing to get closer to their retirement goals? Well, in this case we are talking about a participants need to know more than just their account balance. They should have a retirement goal and know where they stand. Do they have a clear picture of how much income they’ll have on the day they switch from a paycheck to “mycheck”? Do they know how long their savings may last? For many, that means saving more for retirement. They can take advantage of features/services that can help. For instance, sign up for automatic increases or be sure they’re receiving the full employer match. Retirement savings isn’t one-and-done. They should periodically review their entire retirement picture (all their employer benefits, Social Security estimates, consolidation of previous retirement accounts, etc.). There are many planning tools and calculators available to review their overall picture. Many people simply drift into retirement, failing to adjust their strategy as they get closer to retirement. For those approaching retirement, they need to be looking at creating an income that will sustain them throughout their retirement. A portion of their savings should be used to create guaranteed income to cover necessities. They should review their risk tolerance and determine how much they would be willing to keep in the market with

additional growth opportunity. They should also consider their overall health and estimate their health care coverage and costs in retirement. Lastly, they should look at social security benefits and when would be the best time to elect them.

income in retirement.1 This assumes they would need about 85 percent of pre-retirement income to maintain their current lifestyle after retirement.2 Each individual’s situation is unique, so savings and post-retirement needs may differ.

Those in retirement may want to look into the tax implications and may want to consider having both pre and posttax assets.

In addition, everyone should take care of their physical and overall fiscal health to fully enjoy their retirement. What does Principal believe are the main drivers to better outcomes? Both from the plan sponsor side as well as the participant side. For plan sponsors, plan design is critical. It can help achieve improved participation, average deferrals, and average account balances. For participants, it’s important to help participants make great decisions right away. Decisions around participating in the plan, setting deferral amounts and selecting investment allocation. Then it’s important to keep the momentum going to stay on track to and through retirement. All of these rolled into an engaging participant experience can improve savings rates, account balances, income at retirement, and “on track” indicators. Income replacement ratio comes up frequently when employee retirement readiness is discussed. Is there a general target employees should be aiming for? In general, we have found that a participant may need to save at least 10 percent of their pay (plus any employer contributions) throughout their entire career to have enough

Based on analysis conducted by the Principal Financial Group®, August 2013. The estimate assumes a 40-year span of accumulating savings and the following facts: retirement at age 65; a combined individual and plan sponsor contribution of 12 percent; Social Security providing 40 percent replacement of income; 7 percent annual rate of return; 2.5 percent annual inflation; and 3.5 percent annual wage growth over 40 years in the workforce. This estimate is based on a goal of replacing about 85 percent of salary. The assumed rate of return for the analysis is hypothetical and does not guarantee any future returns nor represent the return of any particular investment. Contributions do not take into account the impact of taxes on pretax distributions. Individual results will vary. Participants should regularly review their savings progress and post-retirement needs. Assuming pre-retirement annual gross income of $40,000. Aon Consulting’s 2008 Replacement Ratio StudyTM http://www.aon.com/about-aon/ intellectual-capital/attachments/human-capitalconsulting/RRStudy070308.pdf 2

Will there be impact to plan sponsors if not enough employees are close to achieving retirement readiness? Do you think this may come in the form of either regulation or legislation? There are people in Congress that are trying to argue that the private retirement system is failing and needs help. I would argue that they could not be farther from the truth. I believe the private system is doing a good job of offering retirement solutions that will help employees achieve their retirement goals. The biggest challenge is changing the behavior of people. People by nature are not savers and go more for the immediate satisfaction – living for today. www.conferomag.com | 9

9 1/2 QUESTIONS I won’t say “never”, but I would be hard pressed to foresee the government mandating employers to sponsor retirement plans (I won’t say never because ObamaCare is very close to that on the health side). Currently, there is not a requirement for an employer to sponsor a plan and the fiduciary requirements if they sponsor a plan does not say that they have to cover everyone nor does it say it has to be a minimum level of benefit. It is still a voluntary retirement system. There are employers that are interested in helping their employees achieve success and have made it a priority in their benefits package they provide to employees (having a plan design that would help employees achieve successful outcomes). It seems that auto enrollment combined with auto escalation of deferral rates are important contributors to a more prepared employee. What are your thoughts and what are Principal’s with regards this concept? We (both The Principal and I) agree with the importance of automatic enrollment with automatic escalation to help create better savers. Our retirement ready plan design features those two concepts along with a few others to help jumpstart retirement readiness improvement. Others include: •

Automatic escalation of 1% annually up to at least 10%

•

At least a one-time sweep of those non-participants and those deferring below the plan automatic enrollment default

Other approaches include conversations with plan sponsors about stretching employer matching contribution formulas to better incent participants to save more 18 | SUMMER 2014 10 2013

to receive the full match. There is also an opportunity to name a diversified investment option as a plan qualified default investment alternative. It gives the participant the ease of mind knowing that the plan sponsor has chosen a diversified, well-allocated investment line-up.

could be different for different groups. It really depends upon the objective of the employer and who they believe needs the most help getting retirement ready.

Plan sponsors are feeling maxed out when it comes to total employee benefit compensation. Are you seeing employers doing anything interesting when it comes to recharacterizing the match or other non-discretionary contributions?

Periodically we prepare a retirement adequacy analysis which shows at what age our employees are targeted to reach a replacement ratio (adjusted to factor in the potential erosive impact of inflation) of 85% of their final projected compensation. Depending on the company-provided defined benefit pension formula the employee participates under along with the company provided 401(k) benefit (based on the employee’s current actual deferral rate projected forward) and estimated Social Security our employee population, as a whole, is projected to be retirement ready between ages 62 and 64.

Cost does not have to be an issue when it comes to designing a retirement plan that will enable participants to have more successful outcomes. Whatever the employer’s budget, a plan design can be created to help employees achieve their retirement goals. One of the ways many employers have chose to encourage employees to save more is to stretch their match. For example, instead of a match of 100% on 4%, they stretch it to 50% on 8%. This encourages employees to save more which improves their outcomes. Many employees need help getting started and increasing their savings. That is why many employers have also implemented auto enrollment and auto increases to get people into the plan and to make annual increases thereafter. The employers realize that their employees may not necessarily do these things on their own, but know they should to be able to have successful outcomes. I have also seen employers give an employer contribution to everyone but also have a match to encourage savings by employees. The employer contribution can be the same for all or it

1/2 Question: How many of Principal’s own employees are deemed to be retirement ready?

Additional comments: The Principal has a 94% participation but that doesn’t necessarily mean everyone is retirement ready. We have a pension benefit in addition to our 401(k) benefit and when you add Social Security to the mix, I would be surprised if our number would be less than 75% on track. Not many employers have both a pension plan and a 401(k) plan today.n Jerry Patterson is senior vice president, Retirement and Investor Services with the Principal Financial Group®. He is responsible for the retail and institutional annuity businesses, retirement income management strategy and overall accountability for the individual investor business of The Principal®.

WE DON’T JUST KNOW RETIREMENT. WE KNOW HOW TO INVEST FOR IT.

Not all of your clients are the same. As an investment management leader with more than $480 billion in assets under management,* The Principal® understands that flexibility is the key to satisfying a wide variety of retirement plan needs. Which is why we offer investment options managed by more than 40 underlying sub-advisors** – including some of our own specialized investment boutiques. So while some companies do one thing and do it well, we’ve decided to push things further. Let The Principal give you an edge.

Learn more at principal.com/expertise *As of 12/31/13 assets under management, $483.2 billion. **Sub-advisors for The Principal investment options are selected using our proprietary due-diligence process that provides a rigorous and disciplined framework for identifying, hiring and retaining premier investment managers within each asset class and investment style. It is characterized by the comprehensive and continuous review of all investment managers based on our specific investment guidelines. ©2014 Principal Financial Services, Inc. All rights reserved. Insurance issued by Principal National Life Insurance Cp. (except in NY) and Principal Life Insurance Co. Securities are offered through Princor Financial Services Corporation, 1-800-547-7754, Member SIPC and/or independent broker dealers. Securities sold by a Princor® Registered Representative are offered through Princor. Principal National, Principal Life, Princor, Principal Global Investors and Principal Financial Services are members of the Principal Financial Group®, Des Moines, IA 50392. AD2713 | t131001028z

Feature

AUTO PILOT

401K By Gabriel Potter, AIF速

| SUMMER 2014 14 12 | January-March 2012

Auto Pilot 401K

One Less Thing To Worry About The typical American is short on time. Their day-to-day activities are occupied with their bills, job, home, spouse, kids, parents, politics, health, and (if they are very lucky) planning some leisure time. Planning for a retirement, decades in the future, is not a priority given the short term worries they have to contend with. The irony is that those decades can provide enormous long term benefits to future retirees through the magic of compounding interest, if only they could spare the minimal amount of attention towards retirement planning. Lawmakers were aware of this deficiency and tried to find a way to encourage greater participation in employersponsored retirement plans, without direct engagement from the employees. To this end, the Pension Protection Act of 2006 popularized and codified several automatic features for retirement savings plans. Now, it was easier for employers to use these automatic features and get employees into the plan, saving for their retirement at an acceptable rate, and investing in a properly diversified investment. Employees, already short on time, have one less thing to worry about and generally benefit from being guided into the plan without direct action on their part.

... For participants – the employees – the benefits of automatic features are simple: it is one less thing to worry about. If participants want to opt-out of automatic arrangements, it’s not particularly difficult, but for the majority of employees, automatic enrollment and retirement planning is a net benefit.” Similarly, auto-increase allows employers to automatically increase their employees’ savings rates annually. They can set a predetermined amount, normally adding 1% each year, to their savings rate. For example, it is very common for a plan to begin enrolling employees into the retirement plan, setting aside 6% per year, and increasing that rate 1% per year until they hit 10% or 12%.

Although they are growing in popularity, these features haven’t been universally adopted by every plan sponsor. In this article, we would like to describe automatic features and to discuss their advantages and disadvantages.

Finally, there are auto investment defaults – qualified investment default alternatives (QDIAs). When employers automatically enroll employees into the retirement plan, they also automatically default them into a plan-specific investment option. Meghan points out that, for Fidelity, “the majority To help us, we enlisted an advocate for automatic features, of our sponsors, roughly 80%, use a target date fund: a fund Director at Fidelity Investments, Meghan Murphy. By the that allows a person to be invested appropriately according end of this article, we hope that plan sponsors will know a to their age.” We’ve seen similar research which suggests little bit more about automated features and seriously consider Target Date Funds are the overwhelmingly popular choice implementing them. for QDIAs.

What are automatic features? There are three classic automated features you might find in a defined contribution plan, like a 401(k): auto-enrollment, auto-increase, and auto-investment defaults. Auto-enrollment is just what it sounds like. Meghan Murphy explains, “There are several auto-services which allow employers to automatically enroll employees into the retirement plan at a predetermined savings rate. 3% is the default deferral rate, although we do recommend 6%.”

Why use automatic features? For participants – the employees – the benefits of automatic features are simple: it is one less thing to worry about. If participants want to opt-out of automatic arrangements, it’s not particularly difficult, but for the majority of employees, automatic enrollment and retirement planning is a net benefit. Automatic features can increase the number of employees engaged in the retirement plan and increase the average level of preparedness. Automatic features can also simplify www.conferomag.com | 13

Feature retirement planning by adjusting retirement savings increases to coincide with bonuses or salary raises. As Meghan points out, “It makes retirement planning a bit easier and it takes the thinking out of it. When you use automatic increases with salary increases, employees never miss the money because it never hit their paycheck to begin with.” The advantage is clear for participants, but what about for the employer? A retirement plan exists primarily to attract and retain talent, and there is evidence that employees will even accept lower compensation if they receive better benefits, including higher company match to their retirement plan. In our experience employers and plan fiduciaries are deeply committed to their employees and providing them a path to a secure retirement. To this end, automatic features have a measurable positive impact to retirement readiness. Using the data of the largest recordkeeper, Meghan points out the benefits of auto-enroll: “in plans that use auto-enrollment, participation rate is about 84%. In plans that don’t use auto-enrollment, participation rate is 52%: clearly a huge impact.” Going beyond enrollment, automatic increases also advances aggregate savings rates. In Meghan’s words, “auto-enrollment gets them in the door and then you need auto increase to get them to save at the rate they’ll need to fund their retirement.” Finally, there are also strong financial incentives for a company to provide solid retirement options. Specifically, employers want their employees to retire well. Why? Productivity and cost effectiveness benefit from workforce planning. “In the long run, if you have a workforce that is prepared for retirement, there is a bigger benefit. People who aren’t prepared for retirement will work longer and they may not necessarily want to. So, now they’re coming to work and they don’t have the best attitude about it. Older employees have higher health care costs to the company. You’ll bring in newer employees with fresh ideas who are motivated to be there.”

Why not use automatic features? No action is without costs, and there are some downsides to using automatic features. For the employer, there are clear direct costs involved when adding more employees into a retirement plan with a company match. Plan sponsors may be hesitant to increase the amount of dollars needed dedicate to 14 | SUMMER 2014

company matching funds. Furthermore, the plan committees and named fiduciaries can potentially open themselves to additional liability, depending on the decisions being made. For the participants, automatic enrollment rates are generally too low for long term retirement security, and may create a false sense of security. “Many employees don’t have the financial background to make the proper decisions about their retirement. So when their employer automatically enrolls the employee at the default 3% deferral rate, they think it’s the right amount.”

I’ve decided to use automatic features. What now? If you do decide to implement automatic features, it can now be accomplished quite painlessly. Most experienced recordkeepers and service providers should be able to turn the feature on with minimal input from the employer, but there are some features to consider first. For example, we recommend having a dialogue with key vendors, including the payroll vendor to discuss which IT changes may be necessary to implement the service. Implementing auto-enroll features for new and existing employees might spur your plan committee to reconsider your retirement plan design prior to the switch. For example, company match amounts are typically set to match 100% of the employee’s salary deferrals, up to 3% of their salary. Instead of that matching structure, a plan could easily encourage increased savings by switching to a 50% company match for the first 6% of company salary. Participant retirement outcomes can be promoted with some savvy plan design without changing the cost to the employer. Finally, employers should consider is an education campaign for new and existing employees about the new options. Many companies only turn on automatic features for new employees – fresh hires, but this is a good opportunity to look at existing employees who aren’t participating or those that aren’t participating at a significant level. Anecdotally, Fidelity notes that employers who automatically enroll employees who are saving less than 4% into a 6% default experience very low opt-out rates. In other words, employees are generally ok with increasing their deferral rate to 6%, but they have limited attention to make active changes to their retirement planning.

Auto Pilot 401K

... The advantage is clear for participants, but what about for the employer? A retirement plan exists primarily to attract and retain talent, and there is evidence that employees will even accept lower compensation if they receive better benefits, including higher company match to their retirement plan.” Our retirement plan now uses automatic features. What’s next? The goal of implementing these features is increased participation in the retirement plan and increase retirement readiness for employees. Any vendor with the ability to implement this should also be able to demonstrate its impact in a short timeframe. In as little as 6 months, vendors should be able to benchmark the change in employee participate rates and provide measurable progress reports towards the company’s goals. So, when implementing these features, set the expectation with current service providers. Get an answer to your questions: based on my previous plan structure, how ready were my employees for retirement? How has that changed with the new features? Is there anything else we can do to help? In the end, automatic features are a relatively simple way to promote healthy retirement habits. To give Meghan the last word on the subject: “It’s really important for people to save early and save often. Auto-services are a huge step in that direction. People who starting saving for retirement with their first job, it just becomes second nature to them. It’s just what you should do. Anything an employer can do to get them there, where saving feels natural, is what we would encourage.” n

AN uNbiAsed ApproAch to retiremeNt plANNiNg. Planning for the future can be complicated. That’s why you need an advocate who will work to keep your retirement plan on the right path.

Pension Consultants is a preeminent retirement plan consulting firm headquartered in Springfield, Missouri. We are an independent source of retirement advice for both individuals and businesses. Our highly specialized team can offer essential insight for your financial future with: • In-depth expertise in all areas of retirement planning • Unbiased advice on which direction to go • Research-driven recommendations specific for your plan By choosing Pension Consultants, you are choosing a company that will work for your advantage, no matter what. Contact us today at 417.889.4918 or visit us online at www.pension-consultants.com to start your path to a better retirement plan.

417.889.4918 | 800.234.9584 pension-consultants.com @retireadvisers | Pension Consultants, Inc. is a Registered Investment Advisor. Securities offered through Securities Service Network, Inc. Member FINRA/SIPC. © 2014 Pension Consultants, Inc.

Res Ipsa Loquitor

RES IPSA

LOQUITOR

IS INERTIA WORKING AGAINST YOUR 401(k) PLAN?

IT MAY BE TIME TO CONSIDER AUTOMATIC ENROLLMENT

BY JOHN C. GODSOE, ESQ. 16 | SUMMER 2014

nertia. Webster’s Dictionary defines it as “the lack of movement or activity especially when movement or activity is wanted or needed.” Plan sponsors and retirement committees often struggle with 401(k) plan participation inertia. Employees who fail to enroll in 401(k) plans when first eligible often neglect to commence participation. Employees who initiate elective deferrals at low rates regularly continue that trend. Low participation and deferral rates not only harm affected employees, but they also represent lost opportunities for employers. Higher participation and deferrals rates often bring with them a number of upsides, including increased plan assets that may create the opportunity for lower plan fees and more favorable nondiscrimination

testing results allowing higher paid employees to make greater pre-tax deferrals. Luckily, plan sponsors have a quiver in their bow to combat inertia – automatic enrollment. Automatic enrollment is a mechanism under which an eligible employee who does not make an affirmative election to make pre-tax contributions to a plan is automatically enrolled in the plan at a specific pretax contribution percentage, unless the employee specifically opts out. Automatic enrollment features are not new to the 401(k) plan world, but the Pension Protection Act of 2006 (“PPA”) added provisions designed to encourage sponsors of 401(k) plans to add an automatic enrollment feature.

Is Inertia Working Against Your 401(k) Plan? Automatic ContributionArrangements Two types of automatic contribution arrangements were created by the PPA: an eligible contribution arrangement (“EACA”) and a qualified automatic contribution arrangement (“QACA”). Below is a brief description of each arrangement. Plan sponsors and committees should be advised that these arrangements contain a number of technical requirements (e.g., notice timing and content requirements) and it is advisable to confer with benefits counsel regarding these requirements prior to implementation. EACAs An EACA is an automatic contribution arrangement that is exempt from certain distribution restrictions that normally apply to 401(k) plans. A participant who is automatically enrolled in an EACA is entitled to a 90 day period to revoke the automatic enrollment and receive a withdrawal of the elective deferrals that were made on the participant’s behalf (plus earnings). The withdrawn amounts are includible in the participant’s income, but not subject to the 10% early withdrawal penalty. Plans that adopt EACAs also are able to distribute excess contributions and excess aggregate contributions to correct failed actual deferral percentage (“ADP”) and actual contribution percentage (“ACP”) tests within 6 months after the end of the plan year in order to avoid a 10% excise tax payable by the employer (this period is normally 2-1/2 months). To qualify as an EACA, a notice must be provided to participants prior to enrollment and annually thereafter. While many plan sponsors automatically enroll employees at a 3% deferral rate,

there is no required initial deferral rate to qualify as an EACA. They may be designed to automatically increase the deferral rate in subsequent years of participation. QACAs QACAs are automatic enrollment arrangements similar to EACAs but with the added benefit of including a nondiscrimination safe harbor. A plan that includes a QACA will be exempt from the ADP and ACP tests that otherwise limit the elective deferrals and matching contributions that may be received by highly compensated employees. To qualify as a QACA, a plan must satisfy the following additional requirements: •

The automatic contribution must be at least 3% the first year (and increase from 3% to 6% over the next three years). Higher contribution levels are permissible, but may not exceed 10%.

•

The plan must include a “safe harbor contribution.” The contribution may be a nonelective contribution of at least 3% of compensation or a matching contribution that satisfies certain minimum requirements.

•

Notice regarding the QACA must be provided to eligible employees prior to enrollment and before each plan year. Fiduciary Protections

Provided the requirements of Section 404(c) of ERISA are satisfied, 401(k) plan fiduciaries generally are protected from

Automatic enrollment features are not new to the 401(k) plan world, but the Pension Protection Act of 2006 (“PPA”) added provisions designed to encourage sponsors of 401(k) plans to add an automatic enrollment feature.”

claims of fiduciary liability that might arise out of the performance of investment options selected by a participant. The PPA provides plan fiduciaries with similar relief for automatically enrolled participants who are placed in default investments provided the default investment satisfies the requirements to be a qualified default investment alternative (“QDIA”). QDIAs are often target-date funds, but the regulations specify other permissible options as well. QDIA notices describing the arrangement must be provided prior to the initial investment and annually thereafter. Inertia Revisited Many of us learned about inertia in elementary school science class. We learned that matter stays at rest unless acted upon by an external force. Automatic contribution arrangements are not the solution for all retirement plans, but they can serve as that external force to initiate participant action. Plan sponsors and retirement committee members are well-advised to consider inertia’s impact on retirement plan performance and the potential benefits of automatic enrollment. n www.conferomag.com | 17

Feature

OPPOSING VIEWS ON AUTOMATED FEATURES

By Gabriel Potter, AIF

his issue of Confero focuses on the advantages of automated features. It would be remiss of us not to include at least some mention of the costs or potential disadvantages of automated features for a retirement plan. We have heard from a few consultants and plan sponsors that have had a less than ideal experience using automated plan features. We would like to share a recent Q & A session with consultant John Edwards working at Ivy Wealth Management. The conversation highlights the risk of using substandard service providers when adopting automatic features.

16 | SUMMER 2014 18 2013

Opposing Views On Automated Features

Q: Thanks for letting us speak with you and get an opposing viewpoint. A: No problem. I would just like to state for the record that I am neither for nor against auto-enrollment. I think it depends on the situation and the company demographics. Q: Tell us the story. You’ve had some bad experiences with autoenrollment. Can you tell us about it? A: Sure, it was a startup plan that happened to be with one of the payroll providers. I think it came down to their process [the payroll provider] not being as good as it could have been. The person who worked for the original payroll provider who was supposed to be receiving the enrollment forms and a lot of these were supposed to be negative-election enrollment forms because of the demographics of the employee base. We were sending the forms to him, and that person left, his boss left, and it all happened during the enrollment period. We were stuck with a lot of people that were automatically enrolled in the plan who didn’t want to be. I guess in my experience, it really depends on the demographics of the employee group and what they look like, if they’re going to participate. It created that much more of a nightmare

over the course of the next six months as people realized they were automatically enrolled into the plan, and they wanted their money out.

how to deal with any of that. I think it’s just part of people growing up and unfortunately they have to teach themselves rather than get taught.

Q: Was there something special about this demographic group and the committee should have known they wouldn’t be as interested in retirement?

Q: So, what happened? Did the plan sponsor turn off autoenrollment?

A: It was a lot of younger employees with a high turnover. Q: Do think engaging the younger demographics to think about retirement would have helped? Or do you think that there’s no way to have engaged them, even if autoenroll been in the employees’ best interest? A: It’s very tough to engage these guys. A handful do get it – the ones who ask questions when you go out to do education and positively enroll during the enrollment process. But everyone else, because of the wage-scale they’re on – I think for a lot of them, it’s one of their first jobs out of college – they don’t fully understand what they should be doing.

Maybe part of that goes back to the fact, when I went through college, that there were zero courses taught on money, planning, personal finance, or

A: No, they still have it. Some of the younger employees have set their contribution rate to 0%. Some of them actually, during that 60 day window they had, pulled their retirement contributions out. Since then, we haven’t had a whole lot of new employees that have been autoenrolled. Q: How is the plan sponsor addressing this for new employees? A: Part of the hiring process now is informing everyone about the autoenrollment form and they take care of it. The plan sponsor has also since changed their payroll provider too. Q: Maybe a takeaway idea: if we’re going to use auto-enroll, the extra education needs to be there for the younger demographics to tell them, “this is happening and it’s in your best interest”. A: Everyone understood what was supposed to happen. It’s just that the original payroll provider dropped the ball - big time.

www.conferomag.com www.conferomag.com || 19 17

Defined Contribution

5 Y

Nuances

To Managing Fiduciary Liability With QDIA By James Brewer

ou might be interested in knowing five things about qualified default investment alternatives (QDIAs) that might not be on your radar screen. Let’s start by defining QDIA. ERISA and Department of Labor regulations define how plan fiduciaries can manage the risk for investment decisions made by employees in participantdirected 401(k) plans.

20 | SUMMER 2014

A QDIA has several purposes for plan sponsors and participants: •

•

It encourages participants to select an appropriate investment for long-term retirement savings; It offers asset-class diversification to manage inflation and market risks; It can reduce a plan sponsor’s liability for losses that result from investments in the QDIA, so long as the plan is compliant; and

•

It forces participants to make an affirmative election to invest differently.

So, what are the 5 nuances plan sponsors should know? Balanced investments and managed accounts can be used as QDIAs, in addition to lifecycle or more traditional investment products. The point here is that the choice of QDIA that is best for your employees (and there can be a mix of more than one) may benefit from the perspective of an independent retirement-plan advisor. Second, you are not required to offer a QDIA, unless, of course, you want to benefit from the potential for reduced

5 Nuances to Managing Fiduciar y Liability with QDIA

fiduciary liability associated with the new guidelines. While it is somewhat easier to obtain 404(c) relief under the QDIA umbrella, if you had those 404(c) practices already in place, you can keep them intact by doing what you were doing before the PPA regulations were issued. Third, while QDIAs offer plan sponsors relief in some areas, they are still responsible for prudent selection and monitoring of appropriate QDIAs. This includes documenting the due diligence process that they followed when choosing the QDIA. According to the DOL regulations, consideration of all costs and fees are important to the selection process.

Fourth, communicate, communicate, communicate. Don’t neglect the requirement to notify any defaulting workers that they are being defaulted, and that they have a right to opt out— both at enrollment and annually. Finally, while it is true that QDIAeligible investments offer convenience to both plan sponsors and participants, they aren’t the only prudent choice for a default option. A well-considered, researched and carefully monitored investment can still be a suitable choice for many plans — even if it doesn’t meet QDIA requirements.

objective guidance to help you sort through how QDIA rules impact your plan…and determine whether a current default investment option complies with current QDIA regulations. n (1) The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. (2) Securities and Advisory services offered through LPL Financial, a Registered Investment Advisor. Member FINRA/SIPC. (3) The LPL Financial Registered Representatives associated with this site may only discuss and/ or transact securities business with residents of the following states: AZ, IN, IL, MI.

As an independent financial advisor who primarily focuses on retirement plans, I can provide the insight and www.conferomag.com | 21

Feature

MISCONCEPTIONS

ABOUT RETIREMENT PLAN AUTO FEATURES By Stephen Moser, CFP®, Consultant RetireAdvisers® Services

f you’re like the majority of plan sponsors, then one of the more important goals for your plan may be to increase the rate of employee participation1. The evidence is clear that automatic enrollment, in which employees are enrolled in their company plan unless they opt out, is very effective at increasing participation rates. In spite of how effective auto features are, many sponsors are still holding back from adopting them due to misconceptions. Below are seven common misconceptions plan sponsors have about retirement plan auto features. MISCONCEPTION

MISCONCEPTION

If we make everything automatic, employees won’t take responsibility for their own retirement planning. Most workers want to start saving for

Our employees will resent the retirement, but sometimes need a little help to overcome perceived loss of control over more their own behavioral inertia. By adding auto features, you’re of their paycheck. not taking responsibility away from your employees, you’re

The concern about upsetting your employees is the most common objection to adding auto features to a retirement plan. But according to a Harris Poll® conducted in 2007, 98% of those currently automatically enrolled agreed with the statement, “You are glad your company offers automatic enrollment.”2 And in the same poll, 79% of those who opted out of automatic enrollment still agreed with the above statement. MISCONCEPTION

aggressively, so it’s mostly the lower-paid employees who will be auto-enrolled3. As a result, the match will be based on percentages of those lower salaries only. Plus, if you start auto features just with new hires, the additional matches will be added gradually over time without causing too much of a shock to your budget.

helping them to start moving in the direction they already want to go. According to the same Harris Poll® referenced earlier, 85% of workers said automatic enrollment helped them start saving earlier than they would have otherwise4. MISCONCEPTION

The extra work and expense to our company doesn’t help our bottom line. Auto features can actually help make your

If too many new participants join company more profitable, especially when we consider the plan, the match will become too turnover. Turnover is very expensive, particularly when it expensive. involves key executives5.

Adding auto features to your plan may not be as expensive as you think. Most of your higher paid employees are already in the plan and contributing 22 | SUMMER 2014

One of the benefits executives appreciate most is the ability to contribute as much as possible to a tax-advantaged retirement plan. Unfortunately, they are often frustrated and irritated by

7 Misconceptions About Retirement Plan Auto Features having contributions returned to them at the end of the year because not enough non-highly-compensated workers are participating. Auto enrollment can increase the participation rate of low-to-moderate income employees from 20% up to 80%6.

shows that only 4% more employees opt out of autoenrollment if the starting deferral rate is 6% instead of 3%9. Plus, if an employer match is included, nearly twice as many participants (61% as opposed to 32%) reach an overall savings rate of 11% or more.

More participation from your rank and file employees means higher limits on contributions for your key executives – just another reason for them to stay with you and not look for greener pastures elsewhere.

It’s clear that employees overwhelmingly support both automatic enrollment and automatic escalation, and as a result companies are increasingly adding these features to their plans. Automatic features are a simple, cost-effective way to improve employee satisfaction, and adding these features to your retirement plan can make it easier for you to retain highly paid key executives by ensuring they can take full advantage of their tax-favored retirement contributions.

MISCONCEPTION

It will be a nightmare trying to administer all these new small accounts when employees leave the company.

The Department of Labor recognizes that keeping track of all your previous employees and administering the accounts created for them through auto-enrollment would be very labor intensive. That’s why the regulations released in 2004 allow automatic distributions and rollovers7. If an account balance is under $1,000, the account can be automatically cashed out and the funds sent to the participant. If the balance is between $1,000 and $5,000, the money can be automatically rolled over to a default IRA custodian. MISCONCEPTION

Establishing a default investment for new auto-enrolled accounts increases our fiduciary liability.

Increased risk of fiduciary liability was a legitimate concern in the past, but not since the enacting of the Pension Protection Act of 2006 (PPA). The PPA says participants “will be deemed to have exercised control over assets in his or her account if, in the absence of investment directions from the participant, the plan invests in a qualified default investment alternative.”8 As long as the default investment passes certain qualifying conditions, the liability for the choice of that investment remains with the participant, not the plan sponsor. MISCONCEPTION

Automatically enrolling employees won’t really have much impact on their retirement readiness.

It’s true that saving 1% toward retirement won’t have much of an impact on a person’s future retirement income, so why not start at a higher rate instead and add automatic annual increases? A recent study by The Principal

For more information about how automatic features might benefit your company or to add these features to your plan, please contact Pension Consultants at 417-889-4918.

See ”Plan Sponsor Survey: Structuring DC Plan Automatic Features to Pump Up Retirement Savings” by the Defined Contribution Institutional Investment Association (DCIIA), March 11, 2011. 1

See the November 7, 2007 study by Harris Interactive on behalf of Retirement Made Simpler, available at www.retirementmadesimpler.org/Library/FINAL%20 RMS%20Topline%20Report%2011-5-07.pdf 2

See “The Business Case for 401(k) Automatic Enrollment”, http://www. retirementmadesimpler.org/resourcesandresearch/businesscaseforauto401ks.shtml 3

See the November 7, 2007 study by Harris Interactive on behalf of Retirement Made Simpler, available at www.retirementmadesimpler.org/Library/FINAL%20 RMS%20Topline%20Report%2011-5-07.pdf 4

For more ways your plan choices impact your bottom line, see the February 27, 2014 blog, “The Impact of Financial Stress on Workforce Productivity”, at http:// pension-consultants.com/2014/02/the-impact-of-financial-stress-on-workforceproductivity/ 5

See Orszag, Peter and Rodriguez, Eric. “Retirement Security for Latinos: Bolstering Coverage, Savings and Adequacy.” RSP Policy Brief No. 2005-7 (July). Retirement Security Project and National Council of La Raza, Washington DC. See also “The Ariel-Schwab Black Paper,” published by Ariel Mutual Funds and Charles Schwab. October 2007. 6

See The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and Department of Labor (DOL) regulations released in 2004, as referenced in “Auto 401(k) Plan Continue to Evolve – Addressing Small Account Concerns”, http://www.retirementmadesimpler.org/ResourcesAndResearch/ Auto401kPlansContinueToEvolve.shtml 7

See the Federal Register / Vol. 72, No. 205 / Wednesday, October 24, 2007 / Rules and Regulations / Part III / Department of Labor / Employee Benefits Security Administration / 29 CFR Part 2550 / Default Investment Alternatives Under Participant Directed Individual Account Plans / Final Rule, http://www.dol.gov/ ebsa/regs/fedreg/final/07-5147.pdf 8

www.conferomag.com | 23

On Topic

Be First, Be Smarter, or Cheat. By Gabriel Potter, AIF®

“There are three ways to make a living in this business: be first, be smarter, or cheat. Well, I don’t cheat. And although I like to think we have some pretty smart people here in this room, it sure is a hell of lot easier to just be first.” — Margin Call

18 | SUMMER 2014 24 2013

ompared to the latest celebrity scandal, we will freely admit that economics and fiduciary concerns can be a dry topic. So, we are always the first to celebrate when a book on economics or finance enters the cultural conversation. Furthermore, we are especially thrilled when a book of substantive ideas does more than entertain, but has the potential to affect the economic or regulatory environment.

between the author, his primary source – IEX head Brad Katsuyama, and the beleaguered President of BATS Global Markets, William O’Brien. Of course, this fight was verbal - it didn’t escalate into a fist fight - but it definitely crossed over the line of civil discourse. Moreover, it stopped trading on the floor of the New York Stock Exchange as market makers and specialists watched stunned at the brawl.

The latest book with the potential for both engaging entertainment and changing the environment is Michael Lewis’ new book, “Flash Boys”. As high-minded as we like to be, we are a little sad to admit that some of the reason for the book’s entertainment value stems from its confrontational nature. This may be the only book on stock trading which spurred a virtual yelling match on CNBC

Let’s discuss the argument briefly: Michael Lewis’ new book, “Flash Boys” peers into the contentious world of high frequency trading. The heart of the debate is a simple question: What is high frequency trading? Is high frequency trading a legal version of arbitrage, in which traders find an identical asset in two separate markets trading at slightly different prices (usually just a penny) and

Be First, Be Smarter, or Cheat.

make profits by buying it on the cheap market and selling it on the expensive market? On the other hand, does the premium speed granted to high frequency traders constitute a type of front-running, an illegal practice where traders get to trade ahead of the public and with faster pricing information? In other words, is trading with more up-to-date information simply being first? Or is it cheating? The on-air argument, although heated, was not without substance. Each debater scored some fair points. For example, “Flash Boys” contends that the market is “rigged” to unfairly benefit those high frequency trading firms which have paid additional premiums to the market exchange. During the argument, William O’Brien asserts that the “rigged” accusation may be a needlessly provocative

term. Even if you assume the worst, how “rigged” is the market: one penny per trade? How much inefficiency can a market reasonably accept? O’Brien points out that using such incendiary language is good for making headlines but needlessly frightening to the overwhelming majority of the investing public, which does not directly compete with high frequency traders. Perhaps, however, O’Brien is a little aggressive to accuse the author of corruption, by installing fear of markets like BATS to promote an alternative marketplace, namely Katsuyama’s exchange. To its credit, Michael Lewis’ book has inspired a fresh and knowledgeable look at a business practice which deserves scrutiny. Under pressure from the New York Attorney General’s office,

BATS has had to acknowledge incorrect information O’Brien gave during the on-air debate; specifically, O’Brien did not acknowledge that some market exchanges used slower information feeds, which could be outpaced by high frequency traders. In late June 2014, the US Senate opened a hearing on “Conflicts of Interest, Investor Loss of Confidence, and High Speed Trading in U.S. Stock Markets” to further analyze and discuss these issues. The key players from the on-air scuffle will be back to debate how high frequency trading affects the public – either through destabilizing the market as a whole or by siphoning returns from widely used investment managers who aren’t paying extra for premium access. In short, this fight isn’t over. n www.conferomag.com | 25

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