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

The idea was presented by Ian Ayers, the professor at Yale Law School who made headlines in 2013 for sending letters to some 6,000 plan sponsors saying that their plans had been identified as “high cost” based on his review of Form 5500 data filings in 2009.

The industry, as might be expected, reacted with fury at Ayers for publishing data comparing 401(k) plan expenses and fees, and especially for suggesting some plans might have been violating their 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-fee funds that do not meaningfully contribute to investor diversification.”

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

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

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

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

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

Instant Insights /

Should 401(k) participants be tested for financial literacy?

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