‘Retirement Guardrails,’ With Quinn Curtis

QUINN CURTIS: OK. So thank you very much for that introduction. I'm really excited to be here and share this work with all of you. This book project is a story about the menu. Not that menu sadly, a less glamorous menu, retirement plan menus.

And I've been thinking and writing about retirement plans for the last 12 years, really since I joined the law school often with my co-author on this project Ian Ayres. And our question here was given evolution in the industry, evolution in the law, is it possible to design menus that make it more likely that people are going to make effective choices as they save for retirement? So I'm going to talk about the law and economics of menus, talk a little bit about the wave of fee lawsuits that have really affected this industry, and then talk about menu design and the concepts of guardrails toward the end.

So let's start with the law and economics of the menu, and we'll begin with the economics. And I can be pretty brief here. What behavioral economics tells us unequivocally is that menus matter, that how we frame and present choices is going to affect the choices that people make. And the canonical example of this in the retirement plan space is that if you give someone a menu that has a balanced fund and a value fund and then you add another value fund to the menu, suddenly they shift their assets more toward value. They just use the representation in the menu as a kind of proxy for how much they should weight two particular investments.

This affect is so strong that even if you give people two index funds that track the same index but one is more expensive, they'll kind of split their money between them because we teach them to diversify after all, right? And so this means the construction of the menu is going to have important impacts on how people make decisions in these plans, which brings us to the law of the menu.

We've actually developed quite a bit of law in this area. And for our purposes, the important issue is this 404(c) Safe Harbor. So the rule is if I'm a plan sponsor assembling a plan, I'm a fiduciary.

But if I give you a menu, if I give you a diversified list of options and I let you make choices over that menu, then you're responsible for those choices. And this sets up what seems to be a nice clean division of labor. The plan sponsor, the employer is a fiduciary in constructing the menu. The participant makes choices over the menu is responsible for those choices.

But what happens when things meet the real world is a little more complicated. So let's imagine a sort of company A's 401(k) plan here. It's got a nice list of 30 choices, well chosen, low cost, good options. And then right at the end, it's got two S&P 500 index funds and one is 3 and 1/2 times as expensive as the other.

Now needless to say, you don't want to do this. You want to pick the low cost fund if you can to include in the plan. But we know from the research that if this happens, people are going to pick them both. Some people are going to end up in that more expensive fund.

And so how should we think about that in terms of division of labor, right? The employer is a fiduciary for assembling the menu, and it seems like maybe they didn't do a great job. But no harm would come to people participating in the plan but for choosing the more expensive option when a cheaper option was available. Suddenly this division of labor looks a little bit more messy. And how's the law going to handle this?

Well, we've had more than a decade of lawsuits against plans alleging excessive fees to sort this out. And I want to take us back to the early years of this litigation, 2009, Hecker versus Deere, the tractor company John Deere. Early in my career, I was discussing this case and embarrassed myself as a former Ohioan by describing them as a lawn mower company. They're a tractor company.

And Hecker-- it wasn't a great menu by today's standards certainly. But it had a brokerage window in it. So you could go to the brokerage window. You could get 2,500 things. And the court said, look, you had 2,500 options. How can you complain that there were a few bad ones in this menu?

Right around the same time, we have this case Braden v. Wal-Mart. And in the Wal-Mart case, Wal-Mart, famous for putting the screws to its suppliers, offers 14 retail share classes in a multibillion dollar retirement plan. And the court looks at that and says, there's really nothing you were going to do as an employee on that menu that was going to work out particularly well for you. And so, together, these cases-- and so Wal-mart's responsible for fiduciary breach in that case.

I mean, there's no split here. This is a framework that says if there was some possibility of you being successful over the menu, then that's on you for making a bad choice. But if the menu was entirely bad, then that's on the employer. And I say this is a path not taken because between 2009 and today, there have been close to 200 lawsuits. And these cases have never exactly gone away.

But plenty of courts, even as we've never quite pinned down the law, have been receptive to the idea that including some bad options in a menu can be a fiduciary breach. And so this brings us to this issue of fee lawsuits. And we wanted in this project to take the opportunity to look at these empirically.

And the first question that you want to ask is who's getting targeted? Targeting high cost plans seems to be a threshold consideration for these doing any good in the world. And the thing that absolutely jumps off the page is the only plans that are getting sued are very, very, very large plans, like three, four orders of magnitude bigger than the other ones.

Now that in and of itself isn't a huge problem because big plans have lots of people and lots of money. We want them to be good. And so we ask, well, OK, conditional on being big, do they look expensive? Actually, yeah, they seem to be targeting relatively expensive plans.

Do the fees go down afterwards? Well, that's a little noisy to measure, and it's a little more borderline. But there's some evidence that three years after the lawsuits filed, the fees in these plans look a little bit lower.

Across the industry, like the time period from about 2006 to today, a really strong downward trend. I'm sure there are different opinions on the efficacy of these lawsuits and the link to the downward trend. But I don't think there's any doubt that people who operate these plans have the risk of a lawsuit, first and foremost. Then they focus the mind of plan administrators on keeping fees as low as possible. And they do seem to be targeting fairly expensive plans.

2016, the Jerome Schlichter, who sort of invented this fee litigation, targeted about a dozen private university plans, 403(b) plans, with lawsuits. And one of them was Northwestern. This case goes to the Supreme Court in 2021. And all of a sudden, the Braden-Hecker, Walmart and John Deere framework is before the court, had never really been settled in all this litigation, and the question is presented.

Is it a fiduciary breach to just have one bad option in an otherwise good menu? And I, as a scholar in the space, was concerned where this could go because a rule that says, hey, as long as you had some good options, there's no liability is a rule that says long menus are great. Make it as long as possible. The only thing liability creating would be leaving something off the menu. And if that's the case, the empirics tells us that that's not really going to lead people to make effective choices.

So I got together with some other investment law scholars. We filed an amicus brief, and said, look, the core of the fiduciary duty in building these plants is to put a reasonable menu together. Not every option in the asset management space is one that should be in a 401(k) menu. And there should at least be the possibility of bringing a claim to say, hey, that option shouldn't have been included. It was indefensible. That's a fiduciary breach.

So we file our brief, and we wait. And I'm a little nervous about the direction this is going to take. But I'm also excited because, finally, the glamorous light of the Supreme Court is going to shine on my little corner of academia. And maybe I'll get in the newspaper or on CNBC or something. And the opinion comes down, and here's what I get, a boring ERISA case that I did not follow.

[LAUGHTER]

OK, message received. Honestly, the court itself, I think-- it was a nine-page opinion, unanimous, came down like six weeks after it was-- no one seemed to be too enthusiastic about this except me. But I think on the law, at least as a matter of keeping the quality of menus high, they got the answer that I think is the right answer. If fiduciaries fail to remove an imprudent investment from the plan within a reasonable time, they breached their duty. And so the Braden-Hecker framework kind of fades away.

But for us, this is just a starting point because now the Supreme Court says, OK, you have this duty to craft these menus reasonably. But what does that mean? Like this is just a threshold question. It doesn't tell us exactly what we should do.

And, moreover, we see this increase in quality. Costs are going down. Choices are becoming more streamlined. As menus get better, the choices people make are going to be the more important component in them not doing well, they don't do well, right? We can give you a good menu, and you can still do something damaging to your financial welfare. So we wanted to ask, can menu design help participants make better choices? And this is the guardrails concept.

So before we get there, we said let's do a thought experiment. These issues of fiduciary duties in this context are so fraught with the lawsuit questions. Let's set that aside. If you were really to align the incentives of an employer with the participants in the plan, if your CEO got a bonus if people did really well investing their retirement assets, would they just give you a lengthy menu and say, go, go have at it? It seems doubtful. They'd ask some questions, questions that we actually have data on. Every plan has information like this.

What are people actually doing in the plan? How are they investing their funds? Are they sufficiently diversified? Are they on the right glide path? Are there options in the menu that when we look at how people are using them that just seems like they're doing more harm than good?

And are there tweaks we can make the nudge people in a productive direction without harming people who might have actually unique financial needs? So these are questions that can be asked in a structured way, can be answered with data that's on hand for most plan fiduciaries. And we think they should be asking these questions.

And to get some empirical traction on this, we add participant-level data from the UVA plan, anonymized. And I have nothing bad to say about the UVA plan. It's a very nice plan. I'm a happy participant in the plan, which is good, just to be clear.

But when I started here, the plan had 300 options in the menu, 300. It was like the cookout menu of retirement plans. Just I can't even eat there. it's too much. I'm overwhelmed. And predictably, with that much choice, we were able to detect some issues.

This one is just an example, but we had a gold fund, very uncommon thing to have in a retirement plan. We had a gold fund. Back of the envelope, like how much of your portfolio should be in gold? Probably less than 5%. I think Greg Mankiw said like 2% maybe. Wasn't a popular choice.

But among the people who decided to invest in gold, boy, did they invest in gold. 50% had more than about 36% of their portfolio. 25% of them more than 70%. 18% had 90% of their portfolio invested in the gold fund, and it's not hard to look at this in a small number of people taking it and say that's probably not helping people to have that option on the menu. That's probably doing more harm than good.

And so more generally, we sort of tease out three themes, overcommitment to high cost options. Some people are just all in on the fairly expensive stuff or just insensitive to fees. Overconcentration in sort of specialized sector funds that create diversification issues. And then people with really wonky risk exposure given their age in both directions, the 25-year-old and the money market fund is as concerning in a sense as the near retiree who is still all in equities.

So the good news, most people use target date funds. And the target date funds people have mixed opinions on, but they don't seem to us to have these glaring issues. The bad news among people who don't, 27.1% have some evident issue in their allocation.

So cool thing about the data-- so remember these lawsuits come in 2016. UVA being a state school I don't think was at risk. But they felt like maybe it's a time to take a look at our 300 item menu. They streamlined it down to just over 40 options, divide them into tiers, very nice, modern, well-curated menu.

Again, happy to participate in UVA's plan. But we had this in our data. And so we can say interesting things about it potentially.

So this is one way of looking at portfolios, a mean variance plot. So on the vertical axis is return. Returns are good. We want to be high on the graph. Risk is bad. We want to be left on the graph. You can't take risks. You have to take risk to get returns.

And so there's some frontier out there. And you want to be up by that line. And our Goldbugs are not up by that line. But we reformed the plan, take away a bunch of the options, including the gold fund, map them into more standard investment options, and, look, up closer to the line.

This happens across the other parts of the plan too. So this is an aggregate. This is all the portfolios in the plan, again, mean and variance and yellow dots here are post-reform. There's a lot of overlap. But check it out.

You don't want to be in this rectangle. Every dot in that rectangle almost is blue, pre-reform. So these are portfolios that look particularly bad and get mapped into portfolios that look halfway decent. And looking at this empirically, we see uncompensated risk going down. We see fewer suspect choices.

And, interestingly, people tend to stay put. Like if you were doing something on purpose that was weird, we would think you would try to get back to where you were, but people kind of just stay put. And so this streamlining seemed to be a really positive reform, which I think was the reason it was undertaken. I think that other schools and institutions that have streamlined their plans have seen similar results.

But there was an interesting limitation to this. Why does menu design need to be completely binary? Why is it just an issue of putting something in or out of the menu? Looking in the plan and aggregate, there were really only 10% of portfolios that had some presumptive problem.

Streamlining the plan touched 30% of portfolios. It may have been a little bit more aggressive of an intervention that was necessary to get the benefits. And so we suggest this notion of guardrailing as a policy tool that we're not using much, but maybe we should. So ideas-- a hard guardrail, just no more than 10% in the gold fund. Anything more than that, take it to your brokerage account outside the 401(k) space.

Interestingly, in plans that have company stock, they always cap it because actually they have some liability exposure if the stock goes down. So we know this is feasible. But we don't see it ever implemented with respect to other types of investments. Softer guardrails-- are you sure you want to do this? You seem a little bit young to have everything in a money market fund. Is that your intention? An opportunity to educate people.

And then dynamic things-- so this revision of the plan moved a lot of people. But we only do it once. Like wouldn't it make sense to more regularly look for problematic allocations and nudge people, again, either soft or hard?

And an example here is not in the UVA plan. But we saw it in a plan that had a brokerage window. People put stuff in the brokerage window. You pay for that. And thinking they were going to do something with it, and they let it sit in a money market fund forever. And after three months, pull it back into the main plan, dynamic reallocation to respond to choices that just seem to not make any sense.

So why don't people do this? Well, you start touching people's assets, you're surely increasing potential fiduciary liability here. But, hey, streamlining is more high touch than this. Taking something out of the fund plan altogether and moving the assets is a stronger intervention, and that's a regular feature of the industry. It's pretty unclear legal territory.

You would want the DOL to say, hey, we think this is OK before undertaking these kind of interventions. But we do do this with company stock. When the company is facing significant liability, they're willing to intervene this way.

And maybe there's just a participant perception of paternalism. Maybe some people in this room feel like this all sounds a little bit paternalistic. But our argument is really twofold. One is this entire framework is premised to the extent there's a policy argument for it on the idea that the employer's assembling the menu adds value somehow. It's inherently paternalistic.

But even then, the idea of guardrailing can be choice enhancing. Things that don't make sense to include in the menu if they can be used in unlimited ways might make sense to include if we can put a little bit of a guardrail around it. And so this might actually improve flexibility, rather than being something that we need to view as a restraint.

So conclusion, plans seem to be getting better even since I've started studying them. These fee lawsuits, though numerous and varying in quality, are in general targeting fairly expensive plans. Streamlining seems to have positive effects on investor risk exposures. But guardrails might actually be a more nuanced and better tool to get those benefits while retaining some more flexibility. So I will leave it there. And I'm happy to take questions if anyone has any.

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