Senate Hearing Focuses on 401(k) ‘Securities Lending’ Practice

Employers and employees often unaware of consequences

The Senate Special Committee on Aging held hearings Wednesday into how securities lending affects plan sponsors and investors in workplace retirement plans.

The hearings, held in conjunction with the release of two government reports on the subject, featured recommendations  to help employers and employee participants better understand the practice of "securities lending" in 401(k) plans, something that prevented some investors from withdrawing their money during the economic crisis.

Securities lending can be a relatively straightforward way for plan sponsors and participants to increase their return on 401(k) investments, according to the Government Accountability Office. However, securities lending can also present a number of challenges to plan participants and plan sponsors. GAO was asked to explain how securities lending with cash collateral reinvestment works in relation to 401(k) plan investments, who bears the risks, and what are some of the challenges plan participants and plan sponsors face in understanding securities lending with cash collateral reinvestment.

“The economic downturn showed that securities lending is not a free lunch,” said Sen. Herb Kohl, R-Wis., chairman of Special Committee on Aging. “It was upsetting to hear reports about some 401(k) participants actually losing money within their 401(k) accounts due to these practices. Some employers were restricted from accessing their workers' retirement savings in investments that lent securities. This is troubling because employers are required by law to be able to change the investment options offered in their 401(k) plans.”

Securities lending is a complex financial transaction that goes on every day, often without employers and employees even knowing it is going on within their plans, Kohl said.

If they are aware, he added, many do not understand the added risk. Ultimately that risk lies with 401(k) participants because banks share the cash collateral profits but not the losses—so the banks always win.

Last November, the Committee began an investigation of the securities lending market. It surveyed employers that sponsored the 30 largest 401(k) plans and found that all had at least one investment option that engaged in securities lending at some time in the previous five years. However, after the downturn, five of these employers stopped participating in securities lending. The Committee also surveyed the seven largest banks in the securities lending market. In 2010, these seven banks provided services to 570 different employer-sponsored plans with a total of roughly $1.3 trillion in assets.

“401(k) plan participants share any gains but fully bear any losses from cash collateral pool investments in the case of securities lending with cash collateral reinvestment,” Charles Jeszeck, acting director of education, workforce and income security for the GAO, said before the senate committee.  “Plan participants only receive a portion of the return when the reinvested cash collateral earns more than the amounts owed to others engaged in the transaction. In the past few years, risky assets in the cash collateral pool, which lost value and were difficult to trade, caused realized and unrealized losses to 401(k) plan participants.”

The Dodd-Frank Act requires the SEC to propose rules by July 2012 to increase plan transparency.

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