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Published in Print: June 7, 2006, as Unions’ Deals With Brokers Raise Issues

Unions’ Deals With Brokers Raise Issues

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The New York state attorney general’s office is close to announcing a settlement with the 525,000-member New York State United Teachers over a relationship between the union and ING Group, a large financial-services company based in the Netherlands.

In that arrangement, the union’s Member Benefits division—a separate trust that provides voluntary, supplemental benefits to members—receives $3 million a year, about $6 per member, from ING. In exchange, the union recommends the company’s products, mostly annuities, to NYSUT members.

The union, in a statement, says the fee is used to “enhance” retirement and other benefits already offered to members, as well as to cover the costs of running the retirement plan. But the attorney general questions whether union leaders had disclosed the relationship to their members, and if they are looking out for members’ best interests.

Kathleen Murphy, the president of ING’s retirement-services business in the United States, based in Hartford, Conn., defends the partnership, maintaining that the annual fee—1.68 percent of an investor’s balance—is disclosed in a prospectus as well as in brochures given to members.

Such practices, in which teachers’ unions and school districts give investment companies entrée to their membership and employee rolls, are not exclusive to New York. Brokers are granted access to schools, and to teachers and other employees, across the country.

While New York authorities are investigating whether any wrongdoing has been committed in the Empire State, experts question the wisdom of giving carte blanche to investment brokers anywhere across the country.

Edward Seidle, a federal securities lawyer and a former regulator at the U.S. Securities and Exchange Commission, says many union members are probably unaware of the deals being made between the companies and union officials.

“They’re thinking this is a company that is so committed to teachers that they’re giving us money—like a good-faith donation,” he said.

The product such brokers are generally selling is known as the 403(b), from the section of the federal tax code that allows educational institutions and other nonprofit organizations to provide tax-deferred retirement plans. Forbes magazine first wrote about the relationship between teachers’ unions and investment brokers last year.

According to the SEC, which regulates the investment industry, variable annuities are contracts in which investment companies make periodic payments to the purchaser, beginning immediately or at some future date. Annuities provide a death benefit to a beneficiary if the customer dies before payments begin.

Annuities are also tax-deferred, meaning that the customer doesn’t pay taxes on the income and the investment gains from the annuity until the money is withdrawn.

The SEC, however, advises investors that Individual Retirement Accounts and other investment products, such as employer-sponsored plans, also offer tax-deferred advantages.

‘Demystifying’ the Process

“Teachers, more often than not, learn about the 403(b) through a sales pitch,” said Dan Otter, a former elementary and middle school teacher who now gives advice to other teachers on saving for retirement. “I don’t blame these companies, but the problem is that the employer, particularly at the K-12 level, takes no control of the situation.”

His own search for information—after he was given one of those sales pitches—even gave birth to a Web site offering up-to-date information to educators. Six years ago, Mr. Otter and John Moore, another former teacher, started www.403bwise.com, which seeks to “demystify” the investment process.

The site includes testimonials from anonymous teachers who say they “fell prey,” as one writer described, to poor investment advice.

“The rep came to my school and suggested that before I invest in mutual funds, I should build some equity in what I thought was the equivalent of a money market,” another writes. “In a couple of years, I thought I could then move the money into mutual funds without penalty. At no time did she explain to me that as an annuity, the money cannot be touched until I am 59 years old without severe withdrawal penalties, or that she would collect significant fees.”

According to a hypothetical model on the 403bwise site, if someone invested $10,000 in a plan with low fees, such as a mutual fund that charged annual fees of 0.41 percent, and earned 6 percent a year on that money, 30 years later he or she would have $51,276. In an annuity, which charges fees of almost 2 percent annually, the investor would have accrued only $32,810.

John Abraham, the deputy director of research for the American Federation of Teachers—NYSUT’s parent union—said providing teachers with some guidance was exactly the reason the AFT established its own 403(b) plan with ING in 2004.

“Teachers were getting bombarded by sales reps on their own,” he said. “The reps would hang out in the break room, buy you a sloppy joe, and just work you over.”

It was because of complaints from teachers about disappointing investment experiences that the 1.3 million-member national union—after a three-year process involving surveys of members and focus groups—launched a pilot program in Connecticut, Louisiana, Ohio, and the District of Columbia. The pilot, Mr. Abraham said, is different from the arrangement with NYSUT, which he said the state affiliate worked out on its own in 1989.

The AFT does not receive a fee from and does not endorse ING, he said.

“What we say to people is that we think we have negotiated pretty good fees, but if you can get a better deal, great,” he said. “What we want is for our members to understand how much money they really need to retire in dignity.”

That doesn’t mean, though, that sales representatives aren’t still sometimes taking advantage of potential customers, Mr. Abraham acknowledged.

“Could something fall through the cracks? Absolutely,” he said. “There has to be oversight at the local, state, and national level.”

The National Education Association, with 2.7 million members, has an arrangement similar to the one at NYSUT with a company called Security Benefit, based in Topeka, Kan., according to Forbes.

Larger Probe

In New York state, the office of Attorney General Eliot Spitzer has been investigating whether NYSUT has properly disclosed its relationship with ING to members, and whether the ties between the union and the company amount to unfair marketing practices.

In a May 25 statement, union President Richard Iannuzzi confirmed the investigation and said he would continue to keep members informed of developments.

Mr. Spitzer’s investigation has been part of a larger, two-year probe he has been conducting into public and private retirement plans.

Just last month, his office and the Connecticut state attorney general’s office reached a settlement with the Hartford Financial Services Group, under which that company will pay $20 million in restitution and fines, and agrees to changes that will make the marketing of its retirement products a fairer and more transparent process.

In that case, insurance brokers were receiving bonuses as rewards for pushing Hartford products to pension-plan managers working for corporations and nonprofit organizations. As part of the settlement, Hartford has to stop making the payments for three years, and then support state legislation to limit such payments in the future.

In an apology to pension-plan managers, the company said: “It was wrong to withhold [from public disclosure] the full amount of compensation paid to brokers in connection with the placements of these annuities.”

Mr. Seidle, the former SEC official, advises would-be investors against annuities.

“There is no reason to have an annuity within a retirement plan,” said Mr. Seidle, who founded Benchmark Financial Services, an organization in Lake Worth, Fla., that specializes in uncovering pension fraud, money-management abuses, and other wrongdoing involving securities brokerages. “Variable annuities are extremely high-cost investment products, and the performance is always horrendous.”

High fees should be the first warning sign against an investment product, Mr. Seidle says, and the second should be a union’s or another organization’s endorsement.

“The products that you see in these plans are getting endorsements,” he said. “That’s how they get in the door.”

The arrangement like the one between ING and NYSUT allows representatives for the company—often a former teacher or someone else familiar to the school community—to have access to the potential customers.

Experts like Mr. Seidle say many teachers are sold on the personalized service these company representatives offer and don’t consider purchasing lower cost plans because no one is in the schools trying to push them.

“It’s critical to understand that excessive fees permit the payment of bribes or whatever you want to call it,” Mr. Seidle said.

Companies such as the Valley Forge, Pa.-based Vanguard Group, which sells low-cost products, can’t afford to have someone in the schools providing that face-to-face sales pitch, he added.

But Ms. Murphy of ING says her company also offers “do-it-yourself” investment options that don’t include contact with a representative.

“Our experience is that the vast majority of people want some help managing their retirement,” she said.

Members of NYSUT, she said, are paying competitive fees that are well below the market rate—1.68 percent of their balance, compared with 2.34 percent.

She agreed with Mr. Abraham of the AFT that there are certainly examples of ING and other investors “who picked the highest-cost fund and didn’t get good returns. But the allegation that the fees eclipse the returns is false.”

Even for NYSUT members, however, annuities are still more expensive than low-cost mutual funds, which might charge about 0.2 percent a year.

New IRS Rules

Teachers’ unions aren’t the only organizations endorsing or otherwise offering links to investment options such as annuities. School board members’ associations and various public-employee groups, such as municipal associations and police and fire organizations, also are likely to have plans recommended to them.

The problem, Mr. Seidle and others say, is that such groups often don’t understand annuities because they are highly complex products.

“They’re thinking all companies charge the same,” Mr. Seidle said.

Another problem, says Mr. Otter, the former teacher, is that in some cases, teachers have too many choices. Teachers in the Los Angeles Unified School District, for example, can choose from more than 150 plans, he points out.

“I challenge anyone who has not heard of [403(b)s] to make informed choices,” he said.

George Tischler, the director of benefits administration for LAUSD, said districts can’t exclude 403(b) providers as long as they meet the requirements set forth by the Internal Revenue Service. But to provide employees with another option, his office is recommending to the school board a contract with AIG Valic to offer an alternative 457 plan, which is similar to a 403(b) but does not include annuities.

Under a 457, participants would pay low fees, and the district would monitor the fund.

“We will investigate the marketplace for them and make it easier for our employees,” Mr. Tischler said, adding that the school board is still reviewing the plan.

The IRS, Mr. Otter added, has also approved some new regulations that should improve the situation for teachers. Beginning next year, employers offering 403(b)s must have written documents explaining their plans. And employers, including K-12 districts, will have to take more responsibility for those plans by monitoring their investment performance.

“The hope is that if employers are required to monitor investment offerings, they are sure to demand better products,” Mr. Otter wrote in an article on his Web site last year.

More Information Needed

Some districts are trying to streamline the range of choices for employees even before the new IRS rules take effect. John Kevin, an investment specialist for the 139,000-student Montgomery County, Md., school system, has already trimmed the list of vendors approved by the district, and told Teacher Magazine, Education Week’s sister publication, that he would like to cut the current list of 14 down to six—three low-cost options and three with higher-cost full representation.

Under Mr. Kevin’s leadership, the district also offers a Web site to help teachers better understand the investment process.

Jack Silver, a 1st grade teacher in the Chicago public schools and a former trustee for the district’s pension plan, said he thinks unions or districts should hold more informational workshops for teachers on topics such as annuities and other investment products.

“Most teachers don’t know the difference between a small-cap and a large-cap fund,” he said, referring to terms used to gauge a company’s size by its capitalization. “These companies are making a lot of money on commissions from teachers who aren’t educated financially.”

Mr. Seidle contends that the unions should do a whole lot more than just offer seminars.

“All of these unions who have collected fees should be forced to give the money back,” he said, adding that any damages should take into account the loss of investment income teachers received as a result of poor advice.

“The $3 million that NYSUT has been getting is dwarfed by the investment underperformance,” he said.

Vol. 25, Issue 39, Pages 1,19

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