A recent hearing of the Connecticut Retirement Security Boardset the stage for a controversial proposal — that 401(k) planparticipants be tested for financial literacy before they’reallowed to invest in high-cost or esoteric funds.

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The idea was presented by Ian Ayers, the professor at Yale LawSchool who made headlines in 2013 for sending letters to some 6,000plan sponsors saying that their plans had been identified as “highcost” based on his review of Form 5500 data filings in2009.

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The industry, as might be expected, reacted with fury at Ayersfor publishing data comparing 401(k) plan expenses and fees, andespecially for suggesting some plans might have been violatingtheir fiduciary duty.

The industry also was incensed at his suggestion that providers“improve plan menu offerings, including adding lower-fee options,both at the plan and fund level, and consider eliminating high-feefunds that do not meaningfully contribute to investordiversification.”

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Not only did they attack Ayers for using 2009 data, they termedhis letters “harassment” — although others hailed his efforts tocall attention to the fee structures used in plans and said thatthe age of the data wasn’t really the issue. Yale itself disavowedhis research.

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In any case, Ayers is now proposing that the state ofConnecticut not only “[guide] employees away from high-cost plansand assures that the CT fund options are low cost and welldiversified” but also test participants for financialsophistication to screen out those who might not understand all theramifications of “high-cost or esoteric funds.”

Specifically, Ayers said they should be tested “for awareness of 3potential mistakes regarding: diversification, risk-returnsuitability, excess fees.”

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Ayers also reportedly advocated that CRSB should “use itsauthority to issue a ‘scarlet letter’ to every major Connecticutemployer with an average plan and fund level cost that exceeds 100basis points. The letter would advise employers that, “You willfail [in your fiduciary obligations] if your plan contains adefault investment fund that costs more than 50 basis points.”

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Whether the board will follow his advice remains to be seen.

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