This week, Congress is taking up a relatively simple set of changes to how 401(k) plans work. And yet again, the Investment Company Institute picks the wrong side of the fight—the side of active management.

Back in 1999, I stood in front of an ICI meeting arguing for increases in portfolio disclosure requirements. At the time, it was hard to imagine the 10-year boom we've seen in ETF assets, and the increasing willingness of alpha-seeking managers to make daily disclosures of their portfolios. I was called naïve and foolish, and perhaps I was.

Yesterday, the Committee on Education & Labor kicked a bill (full text) for consideration down to Congress that feels awfully similar—it would require a boatload more disclosure of what really goes on inside 401(k) plans, and mandate the inclusion of at least one passively managed option for participants. (The bill's full name is the Fair Disclosure and Pension Security Act of 2009.)

Here's what the ICI said in their entirely rational press release, which is what the mainstream press will pick up:

"The bill fails to define clearly the vital disclosures investors need, while layering on unnecessary and potentially inaccurate information that will only confuse employers and workers. The proposed legislation also sets a dangerous precedent by giving Congress the job of selecting investment options for plans."

But let's get into the meat. What did the ICI really object to? Well, in their letter to the committee, they had two big issues. The first was that there was TOO MUCH disclosure required:

"… accountants, valuation service providers, printers, and custodians who have no direct relationship with a plan could suddenly be subjected to detailed fee disclosure as a result of having provided services to investments used in a 401(k) plan. Disclosure focusing on those relationships, rather than the aggregate costs of an investment option, will needlessly complicate the information received by plan sponsors and participants, and create needless additional costs ultimately borne by 401(k) plans."

Oh yes, by all means. Please protect me from all this detailed information, ICI. After all, I don't really need to know how much "mere" service providers like custodians are making off my 401(k) plan. Is it "needlessly complicated" when my car mechanic breaks out parts from labor, so I can see where he's gouging me?

The Real (Raw) Deal

What they're really objecting to is the devil’s handshake that big active mutual fund shops have made with mid-sized 401(k) sponsors for decades: We'll give you your 401(k) services for "free" and we'll just pay for it out of all the little basis point fees nobody ever looks at in the underlying funds’ expense ratios.

The second objection was about this draconian sounding “giving Congress the job of selecting investment options" bit.

Surely that has to be terrible right? Lord knows I don't want to hand my retirement over to a bunch of politicians. But here's what the ICI really said to the committee:

“H.R. 2989 sets a dangerous precedent by effectively requiring plans to include an indexed investment option meeting specific requirements. It is inappropriate for the government to pick investment options for private 401(k) plans."

The Devil's In The Details

Note here actually that the ICI has a point, and it's one I don't disagree with in principle as a voting libertarian. But the problem actually isn't just the idea of the government saying "thou shalt index"—I don't really have a problem with that. The problem with the bill is the peculiar language they use to define what kind of index fund a plan sponsor needs to offer if it wants to take advantage of safe harbor provisions. The definition from the bill:

"102: (a) '(6) ‘(A) which is a passively managed investment with a portfolio of securities that is designed to be representative of the United States investable equity market (including representation of small, mid, and large cap stocks) or the United States investment grade bond market (including Treasury, agency, non-agency, and corporate issues), or a combination thereof …"

Now I totally see how they ended up with this, as it's clearly designed not to favor one particular index. But the irony (as the ICI correctly points out) is that the one index fund most plans already offer—the S&P 500—fails the test. Good news for total market funds I suppose, but still curious.

Perhaps even more interesting, burred in the bill is this little gem requiring a plan to disclose for every investment option:

"'111: '(b) '(2) '(B) ‘(v) whether the investment option is actively managed or passively managed in relation to an index and the difference between active management and passive management …"

In other words, if you put a large-cap growth fund in there along side your Vanguard S&P 500 fund, you're going to have to point out that they are different animals, and, shockingly, how.

That's my kind of disclosure.

Shining A Brighter Light

But here's the thing—I think it's fairly clear why we have the ICI on one side of this bill, and someone like Mercer Bullard from Fund Democracy on the other. (Mercer's 40+ page letter of support for the bill is some of the best advocacy I've read on the subject.)

Taken as a whole, the bill, imperfect or not, shines a very bright spotlight on the fee-burial that's taken place in the 401(k) industry for far too long.

While most large enterprises have made wise choices and provide substantial disclosure to employees, many midsize businesses simply signed up with a single fund provider because it was easy and "free."

Add to that, the legislation would provide additional coal into the firebox of the indexing freight train, and I believe that's an unadulterated good. It's not perfect—legislation never is—but the ICI's got their head in the sand on this one.

P.S.: The Bill does have other provisions as well, but they seem less controversial—primarily making it a no-no to have "independent investment advisors" in a 401(k) plan who get compensated differentially based on which investments a given employee chooses under the umbrella of a plan.

Nobody seems to be objecting to strenuously too those provisions.