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97–046 PDF 2004

S. Hrg. 108–716

OVERSIGHT HEARING ON SECTION 529 COLLEGE

SAVINGS PLANS: HIGH FEES, INADEQUATE DISCLOSURE, DISPARATE STATE TAX TREATMENT,

AND QUESTIONABLE BROKER SALES PRACTICES

HEARING

BEFORE THE

FINANCIAL MANAGEMENT, THE BUDGET, AND 

INTERNATIONAL SECURITY SUBCOMMITTEE

OF THE

COMMITTEE ON 

GOVERNMENTAL AFFAIRS 

UNITED STATES SENATE

ONE HUNDRED EIGHTH CONGRESS

SECOND SESSION

SEPTEMBER 30, 2004

Printed for the use of the Committee on Governmental Affairs

(

(II)

COMMITTEE ON GOVERNMENTAL AFFAIRS 

SUSAN M. COLLINS, Maine, Chairman 

TED STEVENS, Alaska 

GEORGE V. VOINOVICH, Ohio 

NORM COLEMAN, Minnesota 

ARLEN SPECTER, Pennsylvania 

ROBERT F. BENNETT, Utah 

PETER G. FITZGERALD, Illinois 

JOHN E. SUNUNU, New Hampshire 

RICHARD C. SHELBY, Alabama 

JOSEPH I. LIEBERMAN, Connecticut 

CARL LEVIN, Michigan 

DANIEL K. AKAKA, Hawaii 

RICHARD J. DURBIN, Illinois 

THOMAS R. CARPER, Delaware 

MARK DAYTON, Minnesota 

FRANK LAUTENBERG, New Jersey 

MARK PRYOR, Arkansas

MICHAEL D. BOPP, Staff Director and Chief Counsel 

JOYCE A. RECHTSCHAFFEN, Minority Staff Director and Counsel 

AMY B. NEWHOUSE, Chief Clerk

FINANCIAL MANAGEMENT, THE BUDGET, AND INTERNATIONAL 

SECURITY SUBCOMMITTEE 

PETER G. FITZGERALD, Illinois, Chairman 

TED STEVENS, Alaska 

GEORGE V. VOINOVICH, Ohio 

ARLEN SPECTER, Pennsylvania 

ROBERT F. BENNETT, Utah 

JOHN E. SUNUNU, New Hampshire 

RICHARD C. SHELBY, Alabama 

DANIEL K. AKAKA, Hawaii 

CARL LEVIN, Michigan 

THOMAS R. CARPER, Delaware 

MARK DAYTON, Minnesota 

FRANK LAUTENBERG, New Jersey 

MARK PRYOR, Arkansas

MICHAEL J. RUSSELL, Staff Director 

RICHARD J. KESSLER, Minority Staff Director 

NANCI E. LANGLEY, Minority Deputy Staff Director 

TARA E. BAIRD, Chief Clerk 

(III)

C O N T E N T S 

Opening statements: Page 

Senator Fitzgerald ............................................................................................ 1

Senator Lautenberg .......................................................................................... 5

Senator Pryor .................................................................................................... 18

Prepared statement: 

Senator Akaka .................................................................................................. 49

WITNESSES 

THURSDAY, SEPTEMBER 30, 2004

Steven T. Miller, Commissioner, Tax Exempt and Government Entities Division, Internal Revenue Service ........................................................................... 7

Mary L. Schapiro, Vice Chairman and President, Regulatory Policy and Oversight, NASD .......................................................................................................... 9

Ernesto A. Lanza, Senior Associate General Counsel, Municipal Securities 

Rulemaking Board ............................................................................................... 11

Hon. Michael A. Ablowich, Treasurer, State of New Hampshire, on behalf 

of the National Association of State Treasurers ................................................ 23

Jacqueline T. Williams, Executive Director, College Advantage Savings Plan, 

Ohio Tuition Trust Authority, on behalf of the College Savings Plan Network ....................................................................................................................... 25

Martin M. Noven, Deputy Chief of Staff, on behalf of Judy Baar Topinka, 

State Treasurer, State of Illinois ........................................................................ 27

Richard O. Davis, Deputy Executive Director for Finance and Administration, 

Utah Higher Education Assistance Authority ................................................... 29

Daniel McNeela, CFA, Senior Analyst, Morningstar, Inc. ................................... 30

Mercer E. Bullard, President and Founder, Fund Democracy, Inc. .................... 32

ALPHABETICAL LIST OF WITNESSES

Ablowich, Hon. Michael A.: 

Testimony .......................................................................................................... 23

Prepared statement .......................................................................................... 90

Bullard, Mercer E.: 

Testimony .......................................................................................................... 32

Prepared statement .......................................................................................... 123

Davis, Richard O.: 

Testimony .......................................................................................................... 29

Prepared statement .......................................................................................... 112

Lanza, Ernesto A.: 

Testimony .......................................................................................................... 11

Prepared statement .......................................................................................... 65

McNeela, Daniel: 

Testimony .......................................................................................................... 30

Prepared statement .......................................................................................... 114

Miller, Steven T.: 

Testimony .......................................................................................................... 7

Prepared statement .......................................................................................... 51

Noven, Martin M.: 

Testimony .......................................................................................................... 27

Prepared statement .......................................................................................... 107

Schapiro, Mary L.: 

Testimony .......................................................................................................... 9

Prepared statement .......................................................................................... 56

Page

IV

Williams, Jacqueline T.: 

Testimony .......................................................................................................... 25

Prepared statement .......................................................................................... 103

APPENDIX 

The chart entitled ‘‘Value of a $10,000 investment after 10 years’’ .................... 164

The chart entitled ‘‘Value of a $10,000 investment after 18 years’’ .................... 165

The chart entitled ‘‘Growth in Section 529 Plans 1996–2004’’ ............................ 166

The ‘‘529 Plan Information’’ chart from the Morningstar website ....................... 167

Barbara Hafer, Treasurer, Commonwealth of Pennsylvania, prepared statement with an attachment .................................................................................... 170

Tim Berry, Indiana State Treasurer and NAST President, National Association of State Treasurers ....................................................................................... 180

Questions and Responses to Senator Lautenberg from Mr. Miller, Mr. Lanza, 

Ms. Schapiro, Mr. McNeela, and Mr. Bullard ................................................... 186

(1)

OVERSIGHT HEARING ON SECTION 529 COLLEGE SAVINGS PLANS: HIGH FEES, INADEQUATE DISCLOSURE, DISPARATE STATE 

TAX TREATMENT, AND QUESTIONABLE 

BROKER SALES PRACTICES 

THURSDAY, SEPTEMBER 30, 2004

U.S. SENATE, SUBCOMMITTEE ON FINANCIAL MANAGEMENT, THE BUDGET, AND INTERNATIONAL SECURITY, OF THE COMMITTEE ON GOVERNMENTAL AFFAIRS, Washington, DC. 

The Subcommittee met, pursuant to notice, at 10:30 a.m., in 

room SD–342, Dirksen Senate Office Building, Hon. Peter G. Fitzgerald, Chairman of the Subcommittee, presiding. 

Present: Senators Fitzgerald, Lautenberg, Carper, and Pryor. 

OPENING STATEMENT OF SENATOR FITZGERALD 

Senator FITZGERALD. This hearing will come to order. I would 

like to begin by welcoming all of our witnesses who are present 

today, and by thanking them for taking time out of their schedules 

to be here. 

Today, we are conducting an oversight hearing on Section 529 

College Savings Plans, State-sponsored investments that are designed to encourage families to save money for their children’s college education. Section 529 refers to the Internal Revenue Code 

section that authorizes and confers special tax treatment on these 

entities, and it shouldn’t be confused with IRS Section 527, which 

confers special tax treatment on those political groups that are now 

so controversial in the current Presidential campaign. 

Section 529 College Savings Plans are instrumentalities of the 

various State Governments. The States usually organize the plans 

as trusts which, in turn, typically invest the plan assets in mutual 

funds managed by third party asset managers. 

Today’s hearing will build on two previous hearings in which this 

Subcommittee examined mutual fund management and governance, mutual fund fees, and the adequacy of fee disclosures. 

Because they typically invest their assets in mutual funds, all of 

the same problems that are prevalent with mutual funds—high 

fees, inadequate disclosure, and questionable brokerage sales practices—are also prevalent with Section 529 College Savings Plans. 

But as problematic as ordinary mutual funds may be, many Section 

529 plans are even more problematic. That is because the State 

Governments which run Section 529 plans are exempt from most 

2

of the Federal securities laws, including the Investment Company 

Act of 1940. Indeed, the Securities and Exchange Commission does 

not have jurisdiction over the State Governments which run the 

college savings plans. 

Section 529 plans are also more problematic than ordinary mutual funds, at least in my judgment, because they carry an extra 

layer of fees. With an ordinary mutual fund investment, the consumer may pay a fee to a broker who steers him or her into a mutual fund and then pay ongoing management fees to the fund manager. With a Section 529 plan, the consumer may not only have to 

pay a brokerage fee and ongoing fees to the fund manager, but in 

addition will almost certainly have to pay one-time and ongoing 

fees to the State Government that sets up the plan. 

In other words, with Section 529 plans, the State Governments 

interpose themselves as additional middlemen and take additional 

fees from investors. State fees associated with Section 529 plans 

can include enrollment fees, application fees, account maintenance 

fees, program management fees, administrative fees, and assetbased fees. 

As our earlier hearings pointed out, fees charged to mutual fund 

investors when they are stated as a percentage of the assets sound 

de minimis and trivial, but small differences in fees add up to very 

large differences in investment returns over time. Just as investors 

are free to experience the miracle of compounding returns, so, too, 

they are free to experience the tyranny of compounding costs. 

We had a chart in an earlier hearing that showed one percentage 

point of fees over 40 years of investing will cut someone’s retirement nest egg by 45 percent, and that math has all been worked 

out and it actually is true. You have to recognize that those fees 

compound over time, and each year there is money that is not in 

your account that you are no longer earning a return on. 

Given the additional fees that college savings plans charge over 

and above ordinary mutual funds, it is probably safe to say that 

no one would invest in Section 529 plans if they weren’t tax advantaged. In fact, the tax advantages are probably the only reason to 

invest in Section 529 plans. 

It is, then, a fair question whether the additional fees which 

States charge to Section 529 plan investors carry any benefit. I am 

going to be asking questions about that today. Clearly, Congress 

could devise a means of authorizing Section 529 plans that would 

eliminate the dead weight fees that the State Governments charge. 

State bureaucrats might not like it, but the millions of American 

families which have Section 529 accounts would be a lot better off. 

There are now about 6.8 million Section 529 accounts holding 

about $54 billion in total assets as of the middle of this year. 

Few things in life are more important to parents than the education of their children, and few things in life are more expensive 

than a college education. Over the last 10 years, the cost of attending college has increased a whopping 40 percent. According to the 

College Board, the average cost of a 4-year post-secondary education is currently $42,544 for State universities and $107,416 for 

private colleges and universities. The price tag for higher education 

is expected to continue rising, likely outstripping any gains in average household earnings. 

3

1The chart entitled ‘‘Value of a $10,000 investment after 10 years,’’ appears in the Appendix 

on page 164. 2The chart entitled ‘‘Value of a $10,000 investment after 18 years,’’ appears in the Appendix 

on page 165. 

The hearing we are holding today will address a number of the 

vexing issues and concerns which analysts and commentators have 

raised regarding Section 529 plans. We hope to make saving for 

college easier for average American families. 

Even before the hearing begins, though, I have several suggestions for how we might do that. First, Section 529 plans have a 

complex cost structure which makes it difficult for investors to compare and select plans in an informed manner. At a minimum, Congress ought to simplify and improve fee disclosures so that families 

can more easily compare Section 529 plans on an apples-to-apples 

basis. 

Second, in some cases, high fees and commissions are charged 

not only by the broker and the State, but also some mutual funds, 

in fact, charge a higher fee to Section 529 plan participants than 

they do to regular mutual fund investors in the same fund. Some 

analysts have questioned whether these high fees offset the tax advantages of investing in a Section 529 college savings account, and 

as we have heard before, small differences in fees can result in 

enormous differences in returns over time. 

This chart was actually prepared from a hypothetical example 

that the Securities and Exchange Commission included in a memorandum prepared by SEC staff who are studying Section 529 plans 

for Chairman Donaldson and delivered to House Banking Committee Chairman Oxley.1 This shows that actually under certain 

circumstances, you may be better off investing in a fully taxable 

but low-cost, low-fee ordinary mutual fund than you would be investing in a tax-advantaged college savings plan that charges very 

high fees. 

Theoretically, you may be brought into a Section 529 plan by a 

broker, and thus pay a 51⁄2 percent sales load for Class A shares, 

and then have to pay 2 percentage points in aggregate annual fees. 

Assuming an 8 percent annual return, then after 10 years, you 

would be worse off than if you had gone into a fully taxable fund 

that only charged 50 basis points or 1⁄2 of 1 percentage point in annual fees and had no load. Even if you paid a 10 percent capital 

gains tax at the end when you took the money out, you would have 

$1,625 more on an original $10,000 investment. Again, that example came from the Securities and Exchange Commission. 

Another chart, if you could put chart 2 up,2 this is a comparison 

of a low-cost Section 529 plan with a high-cost Section 529 plan. 

The Rhode Island J.P. Morgan Higher Education Plan is a very 

high-cost plan. It has a 4.75 percent sales load, 135 basis points, 

or 1.35 percentage point annual expense ratio, and a $25 annual 

fee. If you invest $10,000 in that Rhode Island fund for 18 years, 

you will have $7,700 less than if you invest in the Utah Educational Savings Plan Trust. Utah has a Vanguard fund underlying 

it. Vanguard only charges 10 basis points for their management 

fee. The State of Utah, however, as you can see, interposes an additional 17 basis points in fees, bringing the total expense ratio up 

to 27.5 basis points, but that is still way better than being in the 

4

Rhode Island fund, in which you pay a $25 annual fee. After 18 

years, you will have $7,700 more in the Utah fund. You will have 

$37,000 as opposed to $29,000 for your kid’s education. 

So the bottom line is that in a high-cost college savings plan, the 

brokers and fund managers, together with a new actor, the State 

Governments which set up the plans, in effect can swallow up the 

tax benefits, leaving the uninformed consumer worse off than if he 

or she had invested in a fully taxable but low-cost mutual fund. 

Now, according to Morningstar, the five worst plans are offered 

by the States of Wisconsin, Arizona, Wyoming, and Ohio. That is 

only four States—oh, Arizona has two of the five worst. OK. 

[Laughter.] 

The five best are offered by Utah, which we just saw, Nevada, 

Virginia, Michigan, and Alaska. Now, some of those may have 

changed, I understand, since some of these reports have come out. 

Possibly some of the worst States have improved their plans, and 

they can certainly set that record straight. 

Quite simply, in my judgment, Congress should act to make sure 

that investors and not State bureaucrats, brokers, or fund managers capture the tax benefits from Section 529 plans. Right now, 

there are too many middlemen, including State bureaucrats, that 

are feeding at the Section 529 college savings trough. 

Third, several areas of disclosure warrant increased scrutiny of 

Section 529 plans. These disclosure issues include the level of disclosure required, the type of information disclosed, and the manner 

in which the information is presented. Under the Investment Company Act, ordinary mutual funds have to provide annual and semiannual disclosure discussing the fund’s performance, listing its 

holdings, and providing the fund’s financial statements. Unfortunately, Federal securities laws do not require Section 529 plans to 

make even these limited disclosures. Congress should, in my judgment, at a minimum, at least provide the minimal disclosures that 

are now provided by regular mutual funds. 

Fourth, while Federal tax advantages are standard for all Section 529 College Savings Plans, State tax treatment varies from 

State to State, sometimes holding residents captive to a given 

State’s home State plan. Congress, in my judgment, should encourage States to compete amongst themselves and discourage protectionist measures which lock State residents into substandard State 

funds. Congress could easily make these improvements. 

The growth in the college savings plan industry has no doubt resulted in growing pains. While Section 529 plans were created 

under the Federal tax code for use under State law, no comprehensive regulatory regime was created to oversee this new financial 

product. Although lacking in enforcement powers, the industry’s 

trade group, the College Savings Plan Network, issued voluntary 

disclosure principles in May 2004 to help enhance uniformity of fee 

disclosure across the industry. This morning, we will hear from the 

College Savings Plan Network about their progress in this effort. 

In addition, several agencies are also examining Section 529 

plans. They are subject to anti-fraud rules and broker dealer sales 

practices. Earlier this year, Securities and Exchange Commission 

Chairman William Donaldson announced the creation of the Chairman’s Task Force on College Savings Plans to study the fee discloVerDate 0ct 09 2002 08:28 Dec 16, 2004 Jkt 097046 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 C:\DOCS\97046.TXT SAFFAIRS PsN: PHOGAN
5

sure issue in the sale of Section 529 plans. The SEC is expected 

to report its findings before the end of this year. 

Additionally, the NASD, whom we will also hear from this morning, has been investigating alleged misconduct by securities firms 

in the sales of Section 529 plans. Mary Schapiro is here, chomping 

at the bit, waiting to go. 

Our other witnesses will address statutory and regulatory guidelines for Section 529 plans and those who sell them, discuss investor and consumer concerns regarding these State plans, and make 

recommendations for change. We will also hear from two witnesses, 

one from my home State of Illinois and the other from the State 

of Utah, who will discuss their State’s Section 529 plans. 

Again, I want to thank our witnesses for being here today. Before 

I introduce them, I would like to turn to Senator Lautenberg, who 

has graced us with his presence this morning, and welcome him to 

make an opening statement. 

OPENING STATEMENT OF SENATOR LAUTENBERG 

Senator LAUTENBERG. Thanks very much, Mr. Chairman. I assume that the audience here noted that neither of the weaker 

plans was from New Jersey or from the State of Illinois, and the 

Chairman wasn’t sure that I was going to be here, so that the truth 

is obvious. 

Mr. Chairman and all of our guests here today, this is an important hearing. The economy is in the doldrums. Real family incomes 

are declining while costs for tuition continue to rise and that 

makes college more and more unaffordable for many Americans. 

And yet post-secondary education has never been more important 

for people entering the workforce. According to the Department of 

Labor, college graduates earn nearly twice as much as workers who 

have only a high school diploma. 

Because of these circumstances, the Section 529 College Savings 

Plans are crucial. But the problems that are there need attention, 

as we will see today, and those problems can and must be fixed. 

The problems that we need to address include the following: 

First, because Section 529 plans are run by States, they are only 

loosely regulated by the Securities and Exchange Commission. Section 529 plans are not subject to most of the securities laws, and 

as a result, we are seeing problems that parallel the ones in recent 

mutual fund scandals. 

Also, too many layers of investment management are involved, as 

we have heard from our Chairman. As a result, investors are paying such high fees that in some instances, those fees actually cancel 

the benefits that these tax savings plans have. 

We need to look at ways that Section 529 plans are regulated 

and administered to make them more investor and beneficiary 

friendly. Section 529 plans are complex. Tax rules vary from State 

to State. Many of the plans do not have understandable or meaningful disclosures. 

Mr. Chairman, I know firsthand how important a college education is and I know how it can be out of reach for the ordinary 

person. When I returned from Europe at the end of World War II, 

the only way I could afford to go to Columbia University—which 

was a dream of mine—was on the GI Bill, and I want to improve 

6

Section 529 plans because I want to make sure that everyone who 

wants to go to college and is willing to do the work can go to college. An educated person is an incomparable asset for our country, 

far more valuable than some of our natural resources. No matter 

how precious the other assets are, we have got to focus on this one. 

We have got to do whatever we can to seed, grow, and harvest an 

educated society and we intend to do that. 

Mr. Chairman, I commend you for holding this hearing and I 

want to apologize because I have another function to go to. I would 

ask that the record be kept open so that any questions for our distinguished guests can be submitted in writing. 

Senator FITZGERALD. Absolutely, and thank you for being here. 

I have to say, even though you are a member of the other party, 

I think that we are probably better off—small investors certainly 

are better off—now that you have returned to the Senate after a 

brief retirement. 

Senator LAUTENBERG. That is very kind. 

Senator FITZGERALD. I am retiring now on January 2, so you may 

have to pick up——

Senator LAUTENBERG. Think about it a couple of years and see 

how you feel. 

Senator FITZGERALD. You may have to pick up a couple of these 

issues, and you might be able to eliminate some of these fees after 

I am gone. 

Senator LAUTENBERG. You have an advantage, Mr. Chairman, 

having come from a business background. I really believe that. 

Senator FITZGERALD. Yes. 

Senator LAUTENBERG. This is not to discourage or dissent with 

any opinions about our attorneys and other professionals. We have 

doctors and lawyers. We almost have an Indian Chief, and he is 

about to retire, unfortunately. But the fact of the matter is that a 

business background, Mr. Chairman, I think is invaluable. So we 

may as well gloat while we can and thank all of you. 

Senator FITZGERALD. Well, thank you. I just want to add that 

since we did those hearings on the high fees before, several mutual 

funds have announced they are lowering their fees. Fidelity has 

lowered them down to 10 basis points on their index funds. So even 

though we didn’t pass legislation yet, I think the focus on those 

high fees has helped. Thank you very much, Senator Lautenberg. 

I would like to now introduce our witnesses. Our first witness is 

Steven T. Miller, who serves as Commissioner of the Tax Exempt 

and Government Entities Division of the Internal Revenue Service. 

Mr. Miller’s division oversees the administration of tax laws relating to employee plans, tax-exempt organizations, and government 

entities. Before joining his current division in June 2004, Mr. Miller served as the Director of Exempt Organizations within the IRS. 

We would also like to welcome back our second witness, Mary L. 

Schapiro. She appeared first before this Subcommittee in November 2003 on the mutual fund trading practices and abuses. Ms. 

Schapiro currently serves as Vice Chairman and President of Regulatory Policy and Oversight at NASD. Prior to assuming her duties 

at NASD, Ms. Schapiro was appointed the Chairman of the Commodity Futures Trading Commission in 1994 by President Clinton. 

Before that position, she served as a Commissioner of the SecuriVerDate 0ct 09 2002 08:28 Dec 16, 2004 Jkt 097046 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 C:\DOCS\97046.TXT SAFFAIRS PsN: PHOGAN
7

1The prepared statement of Mr. Miller appears in the Appendix on page 51. 

ties and Exchange Commission from 1988 to 1993, when she was 

appointed Acting Chairman of the SEC. So she has been Commissioner and Acting Chairman of the SEC and Chairman of the Commodity Futures Trading Commission—a very impressive background. 

I would also like to welcome Ernesto A. Lanza, who is the Senior 

Associate General Counsel of the Municipal Securities Rulemaking 

Board, the MSRB. The MSRB is a self-regulatory organization established by Congress to develop rules regulating securities firms 

and banks involved in underwriting, trading, and selling municipal 

securities. Mr. Lanza joined MSRB in 1997 after practicing law as 

a public finance attorney. 

I would like to thank all of you for being here. In the interest 

of time, it is usually best if you can just introduce your written 

statements into the record and we will make them a part of the 

permanent record of the Committee. We ask, as best as possible, 

if you could summarize your remarks within 5 minutes. I won’t be 

too tough on that, but in order to keep the hearing going, we would 

like to stick to that 5 minutes. 

Mr. Miller, I thank you for being here and you may proceed. 

TESTIMONY OF STEVEN T. MILLER,1 COMMISSIONER, TAX EXEMPT AND GOVERNMENT ENTITIES DIVISION, INTERNAL 

REVENUE SERVICE 

Mr. MILLER. Thank you, Mr. Chairman, for the opportunity, and 

I would ask that my written testimony be entered into the record. 

Thank you for inviting us today. My division, as you mentioned, 

is responsible for ensuring that Section 529 programs meet the exemption requirements under the Code. I will divide my remarks 

into two parts, first, a general overview of the tax rules, and second, how the Service interacts with Section 529 programs. 

As you mentioned, Section 529 of the Internal Revenue Code 

exempts qualified tuition programs provided they meet certain requirements. The first requirement is that the program has to be established and maintained by a State, an agency or instrumentality 

of the State, or by one or more post-secondary institutions. Thus, 

the plan either needs to be a State-run program or a program established or maintained by private colleges or universities. 

Second, the operation of the program is limited to one of two designs. State programs may be either pre-paid or a savings program. 

Those programs established by eligible private colleges and universities may offer only the pre-paid design. Under pre-paid design, 

the person purchases actually credits or certificates for qualified 

education expenses. Under a savings plan maintained by a State, 

a person contributes to an account that is established for the purpose of meeting a designated beneficiary’s education expenses. The 

balance in the account can go up or down depending on what the 

investment does over time. 

When we talk about qualified higher education expenses defined 

in Section 529, we are talking about tuition, fees, supplies and 

equipment required for either enrollment or attendance at an eligiVerDate 0ct 09 2002 08:28 Dec 16, 2004 Jkt 097046 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 C:\DOCS\97046.TXT SAFFAIRS PsN: PHOGAN
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ble educational institution. Certain room and board expenses are 

also included in that. 

The third requirement is that the individual must be designated 

at the time that you make the contribution to the plan. 

Other requirements include the fact that only cash can be contributed to these plans, and that there is a separate accounting 

with respect to each beneficiary in the plan. With respect to college 

and university programs, those programs must employ a trust instrument, and an interest in the program may not be used as security for a loan. 

The Code has one final requirement that I will mention. The 

ability to select and change investments in a program is limited 

under Section 529. Contributors and beneficiaries may not direct 

the investment of earnings or contributions. That does not mean, 

however, that a program violates the requirement if selection is 

permitted among various broad-based investment strategies that 

are designed exclusively for the program. 

Turning to rules relating to contributions under Section 529, 

there is a limitation on the amount that can be contributed. Those 

amounts are limited to amounts that are necessary to provide for 

a beneficiary’s qualified expenses. There is no statutory dollar limitation, but proposed rules in the area indicate that 5 years’ worth 

of expenses can be funded through one of these accounts. 

Contributions are not deductible for Federal income tax purposes, and as you mentioned, whether a State deduction is available quickly depends on the State law. 

Let me move to tax rules on distributions quickly. Distributions 

are not taxed if they are used to pay qualified expenses. The earnings component might be subject to income tax if it is not used for 

those expenses and will be subject to a 10 percent additional tax, 

as well, in many instances. 

There are also special estate and gift tax rules that we briefly 

discuss in the written testimony. 

That is a quick outline of some of the tax rules. Let me talk very 

quickly about how the IRS administers the section. 

State programs are not required to come to us for a ruling that 

they are a Section 529 plan. In contrast, private colleges and university plans must come in to the IRS to be approved as a Section 

529 plan. Coming in, they will request a private letter ruling. I 

think it is important to note that Section 529 doesn’t require plans 

to follow a prototype, so that all plans that come in are different 

and there are discussions with our staff concerning whether they 

meet the requirements before we can confirm status. 

In terms of reporting, a program generally has no requirement 

to file a tax or information return regarding its operations with the 

IRS. This is consistent with our treatment of other State Governmental entities. If there is unrelated business income tax due, then 

we do require a Form 990–T. In terms of reporting to the participants, a program is required to provide an annual account statement showing the total account balance, the contributions to the 

account, earnings, and any distributions. A plan is also required to 

issue a Form 1099–Q for each designated beneficiary who has actually received a distribution, and also where there is a transfer between plans, a 1099–Q will occur, as well. 

9

1The prepared statement of Ms. Schapiro appears in the Appendix on page 56. 

I see my time has run out and so has my testimony, Mr. Chairman, so I am willing to take any questions. Thank you. 

Senator FITZGERALD. Thank you, Mr. Miller. Ms. Schapiro. 

TESTIMONY OF MARY L. SCHAPIRO,1 VICE CHAIRMAN AND 

PRESIDENT, REGULATORY POLICY AND OVERSIGHT, NATIONAL ASSOCIATION OF SECURITIES DEALERS 

Ms. SCHAPIRO. Thank you very much, Mr. Chairman. It is a 

pleasure to be back before this Committee. We are very grateful to 

have this opportunity to talk about Section 529 College Savings 

Plans. We also have a longer statement that we would like to submit, with your permission, for the record. 

NASD is the world’s largest private sector regulator of financial 

services. We regulate every broker dealer in the United States, 

about 5,200 of them, that do business with the public. Last year, 

we brought more than 1,400 enforcement actions and barred or 

suspended more than 850 individuals from the securities industry, 

and I am sorry to say these are both record numbers. 

Our interest in scrutinizing Section 529 sales stems in part from 

their having become hugely popular. Every State offers at least one 

Section 529 plan and there are now about 80 available. Our investor protection duty compels us to examine sales practices of all investment products and most particularly those that generate a high 

level of investor enthusiasm. 

This morning, I would like to briefly cover three topics. First is 

our investigative efforts regarding Section 529 plans. The second is 

the need for standardized disclosure among plans. And finally, our 

efforts to help educate investors about them. 

By way of background, Mr. Chairman, NASD does not regulate 

the State issuers of Section 529 plans nor do we directly regulate 

mutual funds that are offered as investment choices in Section 529 

plans. As you pointed out, Congress has authorized the MSRB to 

regulate sales of Section 529 plans. We enforce the MSRB’s rules. 

In 2003, we began hearing allegations of inappropriate recommendations of brokers selling Section 529 plans. We undertook 

a review of six firms, chosen based on the number of customer complaints and the sales volumes of particular plans. We wanted to 

learn about the suitability of the recommendations investors were 

getting and about the procedures firms had for ensuring the efficacy of those recommendations. Since last year, we have expanded 

our review to include 12 additional firms in order to have a more 

comprehensive and representative sample of the firms we regulate. 

We were surprised to discover that in some cases, more than 95 

percent of the dollar value of Section 529’s sold came from sales to 

customers who are not residents of the States in whose plans they 

invested. Selling an investor an out-of-state plan is not necessarily 

a problem. It may be that the underlying investment companies offered by the in-state plan could provide inferior portfolio management or a relatively limited array of investment choices. As you 

point out, the fees associated with the in-state plan could be very 

high. And, of course, some States don’t provide a tax deduction or 

10

other benefit. Consequently, another State’s plan might be a perfectly suitable recommendation. 

But since half the States offer State tax deductions for residents 

investing in their plans, and some are quite significant, the fact 

that out-of-state sales exceeded 95 percent in some cases led us to 

wonder if broker dealers were doing suitability analyses before 

making recommendations and whether they were giving their customers all the information they needed before deciding which plan 

to buy, in-state or out-of-state. 

Our sales practice investigations have also included reviews of 

advertising and marketing materials. In a number of cases, we 

have required firms to significantly revise advertising to be more 

balanced, to disclose risks as well as potential rewards, and to disclose more prominently the fees and tax implications of Section 529 

investing. And finally, we are reviewing suitability, breakpoint, and 

supervisory issues, as well. 

Most importantly, however, retail investors have been ill served 

by the lack of uniform disclosure among Section 529 plans. Such 

disclosure would allow easy comparison in making investment 

choices. The lack of transparency concerning fees and expenses, 

disparate State tax policies and rates, share classes, and other features of Section 529 plans have led to significant investor confusion. We strongly support a uniform disclosure regime for Section 

529 plans. 

With this lack of uniformity in mind, NASD has increased its effort to educate investors about Section 529’s. We have two tools on 

our website to help investors in this area. Our booklet, ‘‘Smart Saving for College,’’ details all of the features of Section 529 College 

Savings Plans as well as other college savings vehicles, including 

Coverdell Education Savings Accounts, prepaid tuition plans, custodial accounts, and even U.S. Savings Bonds. 

We also offer an online Section 529 expense analyzer which can 

calculate for investors how fees and expenses affect their returns. 

The analyzer explains the many different Section 529 plan fees and 

provide guidance on where to find them in the Section 529 disclosure documents. It also provides prompts that help investors to 

make the best possible comparison between plans. 

We recently issued an investor alert, advising investors to be 

aware of certain facts, including that contribution limits and State 

tax treatment vary from State to State, that investment options 

vary broadly, from high-risk stock funds in some plans to more conservative short-term bond funds in others, and that there are wide 

disparities among fees and expenses from plan to plan. 

More positively, I would note, as you did, that several States 

have been working to make their Section 529 plans clearer and 

more attractive to investors by lowering enrollment and management fees and expanding investment options. 

In closing, Mr. Chairman, NASD is committed to protecting investors by ensuring that they have all the information they need 

to make informed investment choices and that the brokers they 

work with adhere to just and equitable principles of dealing. We 

will, as appropriate, continue to broaden both our educational and 

regulatory and investigative efforts with regard to Section 529 College Savings Plans. 

11

1The prepared statement of Mr. Lanza appears in the Appendix on page 65. 

Thank you again, and I am happy to answer any questions that 

you might have. 

Senator FITZGERALD. Thank you, Ms. Schapiro. Mr. Lanza. 

TESTIMONY OF ERNESTO A. LANZA,1 SENIOR ASSOCIATE GENERAL COUNSEL, MUNICIPAL SECURITIES RULEMAKING 

BOARD 

Mr. LANZA. Yes. Thank you, Mr. Chairman, Members of the Subcommittee. My name is Ernesto Lanza, Senior Associate General 

Counsel of the Municipal Securities Rulemaking Board. I appreciate this opportunity to testify today. I ask that our written statement be admitted into the record. Thank you. 

The MSRB is a self-regulatory organization established by Congress to write rules covering the municipal securities activities of 

brokers. Because shares in Section 529 plans are municipal securities, our rules apply to brokers in this market. 

Congress sought to protect investors in municipal securities 

through MSRB regulation of broker activities while exempting 

State and local governments from Federal securities laws. MSRB 

rules, therefore, must recognize that unregulated State and local 

governments may act in their best judgment in widely divergent 

ways. Further, we are prohibited by statute from using broker regulation to indirectly require issuers to produce disclosure materials 

for customers. In contrast, Congress provided for interlocking mutual fund regulation covering all parties so that mutual fund 

broker rules fit hand-in-glove with issuer rules. 

Within this statutory landscape, the MSRB has adopted a comprehensive set of broker rules in the Section 529 plan market. Our 

primary customer protection measures which establish standards of 

fair practice and professionalism require that brokers deal fairly 

with all persons and not engage in any deceptive, dishonest, or unfair practice. 

When a broker recommends that a customer invest in a specific 

Section 529 plan, the broker needs to first conclude that this investment is suitable for the customer. The broker can’t steer customers toward a particular share class just to increase his commissions, and the broker can’t steer customers away from available 

break-point discounts. Brokerage firms can’t conduct sales contests 

or use incentives that may cause individual brokers to act unfairly 

toward customers. These marketing rules will soon be strengthened 

by a pending proposal banning most forms of non-cash sales incentives. 

Unlike in the mutual fund market, the MSRB is legally prohibited from setting broker fees. However, our fair commission rule 

should effectively keep Section 529 broker charges at a level consistent with if not lower than broker charges for the comparable investment in the mutual fund market. 

Full and timely disclosure is central to investor protection and to 

the health of the Section 529 plan market. We require brokers to 

disclose to their customers at the point of sale the material facts 

about that investment. Also, a broker that markets an out-of-state 

Section 529 plan must let the customer know that he or she may 

12

lose out on a State tax break by not investing in-state. Then, by 

no later than settlement, the broker must deliver the Section 529 

plan’s program disclosure document to the customer. 

On Section 529 plan advertisements, we provided extensive guidance on a number of specific items of disclosure and we are moving 

towards comprehensive standards that will greatly improve the 

quality and comparability of performance data in advertisements. 

Because of the political environment in which State and local 

governments operate, the MSRB also has unique conflict of interest 

rules. These rules, G–37, dealing with political contributions, and 

G–38, on outside consultants, apply equally to the Section 529 plan 

market. 

The MSRB strongly encourages vigorous enforcement of these 

rules by the SEC, NASD, and the bank regulators. These are the 

agencies that enforce our rules. It is worth noting, however, that 

our broker rules do not apply when State personnel market their 

own Section 529 plans directly to investors. 

Now, turning to the other topics for this hearing, the MSRB has 

long been an advocate for the best possible disclosure practices in 

the Section 529 plan market. The needs of investors dictate that 

disclosure be based on six basic characteristics: Comprehensiveness, understandability, comparability, universality, accessibility, 

and timeliness. 

The MSRB applauds the College Savings Plan Network’s first 

steps at addressing the need for such disclosure through its draft 

voluntary disclosure principles. Meaningful success in this area 

will require the ongoing commitments of the issuer community. 

In cases where Section 529 program costs exceed those of comparable mutual fund investments, this can often be attributed to 

the extra layering involved in plan structures, either from fund of 

funds structures with expenses incurred at two levels, or from costs 

incurred for State agency public policy initiatives for in-state or 

lower-income residents, such as subsidized fees, matching grants, 

or scholarships. In our view, these activities are within the purview 

of the States. We strongly believe, however, that all material program expenses must be fully disclosed to investors. 

Finally, on variation of State tax treatment, we have been at the 

forefront of ensuring that brokers inform their customers of the 

possible loss of State tax benefit for out-of-state investments. The 

MSRB believes that any State tax benefit is one of many appropriately weighted factors that can influence a customer’s investment decision but should not necessarily always be the controlling 

factor. 

The MSRB takes no position on States providing or withholding 

State tax benefits based on their own public policy determinations. 

We believe that comprehensive and easily accessible centralized 

disclosure of State tax treatment would enhance the market and 

provide investors with the tools needed to make meaningful investment choices. 

Thank you for inviting me to testify this morning. I will be happy 

to take questions. 

Senator FITZGERALD. Thank you. I thank all of you very much. 

I appreciate your being here. 

13

We have been joined by Senator Pryor from Arkansas. Senator 

Pryor is welcome to make an opening statement if he wishes to, or 

ask questions. 

Senator PRYOR. I really don’t have an opening statement. I was 

just down on the floor a few moments ago doing the intelligence 

issue, which I know most of the Committee Members are very interested in that because that has come to our Committee, so I don’t 

have any opening statement, but you go ahead and ask questions. 

Senator FITZGERALD. Well, thank you. 

I wanted to start with Ms. Schapiro and ask you about the 

NASD’s investigations. You began your investigations of the sales 

of Section 529 College Savings Plans because you heard of numerous customer complaints, as I understand it. What types of complaints were you getting, and is it the complaints that were to such 

an extent that it caused you to begin the investigation? 

Ms. SCHAPIRO. Thank you, Mr. Chairman. We received several 

customer complaints. They related largely to investor confusion 

about State tax deductibility issues, quite honestly, but also about 

some of the fees that are associated with investing in Section 529 

plans. 

What really spurred our interest in this area, though, as I said, 

is the tremendous growth in assets invested in Section 529 plans 

and whether when a product becomes very popular very quickly, 

broker dealers have in place adequate supervisory and compliance 

procedures to ensure that the product is being sold appropriately. 

Senator FITZGERALD. Now, did you get people complaining that 

after they were in the plan for a while, they realized that they 

weren’t getting a tax benefit because maybe they had invested in 

an out-of-state plan? 

Ms. SCHAPIRO. Yes, that kind of question, and a number of the 

complaints were not received by us directly but were reported on 

in the press as well as received at some of the brokerage firms 

where investors had sent complaints. 

Senator FITZGERALD. So then you follow up on them. Now, during 

NASD’s investigation of 20 securities firms, it was discovered that 

18 firms had made sales of out-of-state Section 529 plans which accounted for 84 percent or more of total sales and the other two 

firms had percentages of 69 percent and 37 percent. These figures 

are pretty astounding. 

What criteria are you using to evaluate any possible violations 

of MSRB rules? Mr. Lanza has testified that the MSRB rules require the brokers to explain the possible loss of tax benefits by 

going out of State. Is that what you are looking for, to see if the 

brokers explained to consumers that they might lose tax benefits? 

Ms. SCHAPIRO. Yes. We want to ensure that they fully explain to 

investors—first of all, that they did the suitability analysis, that 

they determined that the Section 529 plan, if they recommended a 

particular one, was, in fact, suitable for investors, including the underlying investments of that Section 529 plan, a stock fund versus 

a bond fund, for example. And then secondarily, whether they explained the presence of a State tax benefit that might exist for the 

investor who chose to buy their home State’s plan if, in fact, there 

was one. About half the States don’t give any State tax deduction 

for the contributions, but about half do. 

14

1The chart entitled ‘‘Growth in Section 529 Plans 1996–2004,’’ appears in the Appendix on 

page 166. 

So we also focused our second round of inquiries on firms that 

were selling particularly to residents of States where there was an 

in-state tax benefit to see if they were doing a better job of disclosing that information. 

Senator FITZGERALD. Have you had any settlements yet with brokerage firms? 

Ms. SCHAPIRO. No. We are still in the information gathering part 

of this investigation. We are looking at their sales literature to understand whether they are accurately and adequately disclosing 

risks. We look at the training materials to see whether firms are 

adequately training brokers to make all the explanations and disclosures that they need to make. We are looking at the offering 

memoranda, the dealer agreements between the plans and the 

dealers, as well as customer complaints, and then the transaction 

data, which allowed us to come up with the chart that is in the 

written testimony that demonstrates the very high percentage of 

out-of-state sales.1

Senator FITZGERALD. Would you have any recommendations at 

this point based on what you found so far? 

Ms. SCHAPIRO. Well, I would say that we strongly recommend 

that there be uniform disclosure of fees, expenses and tax issues 

with respect to Section 529 plans. It strikes us as incongruous that 

there is very detailed, specific and formatted disclosure for mutual 

funds, but investors who are basically investing in mutual funds 

but do so through the Section 529 program are not getting anywhere near that kind of uniformity of disclosure. Without uniform 

disclosure, you don’t have comparability and you put investors——

Senator FITZGERALD. It is not just that there is not uniform disclosure, there really doesn’t have to be any disclosure. There is no 

mandate that they disclose the fee, really, is there? 

Ms. SCHAPIRO. We cannot require, nor can the MSRB require the 

issuers, the States, to disclose particular information. 

Senator FITZGERALD. Congress could, though. 

Ms. SCHAPIRO. Yes, that is right. 

Senator FITZGERALD. Congress has said that the States are exempt from our securities regulations except for maybe in a couple 

areas, but they are certainly exempt from the Investment Company 

Act, which imposes certain requirements such as having a semi-annual statement that mutual funds have to give. I thought those disclosures were inadequate, and I wanted to beef them up. But, in 

fact, in the case of Section 529 College Savings Plans, the States 

don’t even have to give those minimal disclosures that mutual 

funds give. 

Mr. Miller, you mentioned in your testimony, you went through 

the IRS requirements and you said there is no requirement that 

the fees be disclosed. Is that correct? 

Mr. MILLER. There is a requirement to give an annual account 

statement that shows contributions, earnings, and any distributions, but I am unaware of anything that would indicate that. 

Senator FITZGERALD. And Congress dictated that law, right? I 

mean, we drafted that law and you are just enforcing that. 

15

Mr. MILLER. I believe so. We have rules out in terms of——

I think we probably could go beyond that, Mr. Chairman. 

Senator FITZGERALD. Well, could the IRS go beyond the rules 

that are out there and require a disclosure of the fees? 

Mr. MILLER. The disclosure on the fees—I think the answer probably is yes. The problem, Mr. Chairman, is it would be too late in 

the plan by that point because the account balance information is 

once you are in the plan. There is no requirement under the code 

for disclosure prior to entry into the plan. So the timing would sort 

of miss, I believe. 

Senator FITZGERALD. OK, but could you draft a rule pursuant to 

Section 529 that required, say, from now on, that every plan participant would receive an annual or at least semi-annual statement 

that included the fee, not just an account statement that tells you 

how much money you have at the end of the year, but showed you 

the fee? Could the IRS——

Mr. MILLER. I would have to check on that, but I believe the answer is that we could. 

Senator FITZGERALD. I would encourage you to look at that. We 

don’t have to wait around for Congress to get to revising the statute. If you have that authority, take that up with people because 

we are dealing with a vehicle that was supposed to encourage people to save for college, and there are tax advantages here, but it 

looks like high fees are gobbling up a lot of the tax benefits. The 

SEC isn’t a player here. There is no one to regulate these programs 

except possibly the IRS. I know it is not your usual area, but you 

are the only ones who potentially have any authority. So I would 

encourage you to take that up with the Commissioner. 

Mr. Lanza, would you have any recommendations you would 

want to add here? I know that the MSRB has proposed an extensive set of draft amendments to its advertising rules that would improve the quality and comparability of performance data. If adopted, these rules would only apply to broker dealers. Since the rules 

would not apply to the States which also sell the plans directly, 

how can we ensure consistent dissemination of information? 

Mr. LANZA. Right. I should start off by saying that we, in fact, 

are a broker dealer organization and therefore our mission is to 

regulate broker dealers, and so we typically have not opined as to 

what it is that issuers should or should not be required to do. We 

clearly have stated that disclosure is fundamental to——

Senator FITZGERALD. Could you require the broker dealers to disclose what the State plans——

Mr. LANZA. Well, we do require at the time of trade that broker 

dealers provide disclosure to the customer of all material information about the program so that if there is a material fee, expense 

or cost, that is covered by our disclosure obligation. But again, it 

only applies to broker-sold plans. It would not apply to non-brokersold plans. 

Senator FITZGERALD. Right. So if somebody buys it directly from 

the State, there is nothing you can do about it. 

Mr. LANZA. That is correct. 

Senator FITZGERALD. So they are likely to get more information 

if they go through a broker. However, they are also likely to pay 

a load. 

16

Mr. LANZA. There is a trade-off, but certainly the States are making an effort, it seems, to try to create uniform disclosure and we 

are hopeful that effort will work. 

Senator FITZGERALD. Would any of you have any recommendations for Congress on what we might be able—I mean, there is 

nothing any of you can really do about this because you don’t have 

any powers over the State Governments that are administering 

these plans. Does it make sense to you that we have this additional 

layer of fees interposed by State Governments? Why couldn’t Congress just design Section 529 plans that would allow you to go directly to Fidelity or Vanguard or any one of the mutual fund companies and open a Section 529 plan and not pay a fee to a State 

Government? Do any of you want to venture forth on that? 

Ms. SCHAPIRO. I probably shouldn’t, but I will. That is something 

that clearly should be considered and an option that the Congress 

ought to consider very carefully. There is a tremendous amount of 

confusion because of the different way the plans are administered 

and the different, particularly tax issues associated with the contributions at the State level. But I also think that if we could have 

very clear, very concise disclosure for investors about fees and expenses on one page, so that they could not only see what happens 

with their in-state plan, but compare across plans within their 

State and across all the States and then make an informed investment decision, that would be a tremendous step forward. The comparability from our perspective, whether it is mutual funds you are 

talking about, variable annuity sales, or Section 529 plan sales, it 

is absolutely critical for investors to be informed of choices. 

Senator FITZGERALD. Do any of you see any reason why college 

savings plans need to be run by State Governments? Is there something I am missing here? All I see is an additional layer of fees. 

Do any of you see any benefit to having the State Governments be 

involved? I suppose the one benefit is the tax benefit. If they are 

not running them, they are probably not going to give you a State 

tax benefit, right? 

Mr. LANZA. I would let the States speak for themselves, but it 

is a policy question between the Federal and State Government as 

to where things should lie. Some States provide certain benefits 

that they believe are beneficial to their residents and others may 

not. Again, it is a policy decision, at least from the MSRB’s view, 

between the States and the Federal Government. 

Senator FITZGERALD. Well, the Federal Government could simply 

make them all tax-exempt, Federal and State tax-exempt, and that 

would be the end of it, and you could go and just buy them directly 

online and not pay an additional layer of fees. Am I missing something here? Can you think of a benefit that having an additional 

middleman, in addition to the brokers and in addition to the fund 

managers, having the State Governments get in there and get their 

paws on a fee? Can you articulate a benefit we get by setting it up 

this way? 

Mr. MILLER. The only thing I would mention, Mr. Chairman, is 

that the history of these plans is that they grew out of the States, 

and so in the 1980’s and 1990’s, that is how these things were created out of State plans, and when the Congress acted in 1996, that 

is what was in front of it at that time——

17

Senator FITZGERALD. Were there any State plans prior to 1996, 

or was it in 1996 the State Treasurers Association came to Washington——

Mr. MILLER. No. There were, in fact, plans in the 1980’s and 

1990’s that States had set up and their tax treatment was a point 

of discussion and contention, to some extent. That was clarified in 

1996. So that gives some background as to why we are where we 

are today. 

Senator FITZGERALD. So it was just clarified in 1996. It arguably 

may have been—they may have been tax advantaged before 1996? 

Mr. MILLER. There would be a court case that indicated that that 

was the case. We lose a court case against Michigan’s Education 

Trust. 

Senator FITZGERALD. Oh, I see. OK. So in 1996, we made the internal build-up in the accounts tax advantaged by Federal statute, 

and then in 2001——

Mr. MILLER. Distribution side. 

Senator FITZGERALD [continuing]. We made distributions from 

the plan, and then the funds have really grown since that time, is 

that correct? Making the distributions tax-exempt when used for 

educational purposes, that has caused additional quick growth. 

Mr. MILLER. We are not tracking that at the Service. Inferentially, that would seem right, but I would look to other people to 

answer that question. 

Ms. SCHAPIRO. I would agree with Mr. Lanza. It is really a question of where the authority ought to lie, with the Federal Government or the State Governments. I will say that it would provide a 

tremendous simplification for the brokerage industry to have some 

uniformity here with respect to the tax treatment across all the 

States and would help with sales practice issues, quite honestly. 

Senator FITZGERALD. It is really tough for the brokers, too. They 

may make a mistake, because you have to know the tax laws in 

all 50 States, then, in order to be able to fully educate your customers, right? 

Ms. SCHAPIRO. MSRB rules don’t require them to specifically 

analyze the different tax treatments of every State. They do have 

to give general disclosures—such as ‘‘there may be an in-state tax 

benefit versus going out of State.’’ But nonetheless, good brokers 

really do want to be able to explain what the impact on the value 

of an investment is of a tax benefit at the State level as well as 

the impact of expenses——

Senator FITZGERALD. So the broker’s only obligation is to say to 

the customer, if you go out of State, you might lose a tax benefit. 

I don’t know, but you will have to look this up. He doesn’t have 

to tell you, I am recommending this plan and——

Mr. LANZA. That is a baseline obligation. If you are marketing 

an out-of-state plan, the duty is to let the customers know that 

they may be missing out on an in-state benefit. 

Senator FITZGERALD. That is a pretty minimal requirement. I 

would think a lot of brokers are going to want to know a lot more 

than that. Say if you are a broker in my State of Illinois and somebody is going to go out of State, you are going to want to know 

what happens to your Illinois customers as far as their taxes are 

concerned. So maybe from the standpoint of your rules, they don’t 

18

have a duty of going further, but I would think a lot of diligent brokers out there would be forced to study the tax laws very carefully 

here. That seems to me it imposes an additional enormous obligation on them. 

Ms. SCHAPIRO. I think that is absolutely right. Brokers really do 

want to be able to give that information to their customers. In addition, brokerage firms are working very hard to increase the number of States plans that they sell so that they can have within their 

menu of investment options one that is an in-state plan for as 

many of their customers as they can. That creates a lot of administrative burden on the firms. 

Senator FITZGERALD. Thank you all for your testimony. I appreciate it. 

Senator Pryor, do you have any questions you would like to ask? 

OPENING STATEMENT OF SENATOR PRYOR 

Senator PRYOR. Let me just say, Mr. Chairman, I think you have 

done a great job of quizzing the panel and defining some very important issues here. I think I share your concerns about the confusing nature and some of the details of this policy that we have 

on the books today. 

I would say this, and I think everybody pretty much in the room 

and probably in the Congress would agree that I think as a matter 

of national policy, it is a good thing for us to get more people to 

go to college. I think that we should find ways here in the Congress, whether it is through our tax code or whatever, but we need 

to find ways—if it is creative, so be it—but find ways to incentivize 

people to go to college. 

I think, really, if you look at the Section 529’s, that is probably 

the original intent of this, is to allow investors, allow people to look 

at their options and have this as a viable option for them to really 

give them a tax incentive, an advantage, if you will, in sending 

their children to college. So that concept is totally acceptable to me. 

In fact, I think it is something that we need to keep on the books. 

But at the same time, some of the ways this program is implemented, whether it was intentional or unintentional, I don’t know 

and we can’t speak for all of that, but I do think it is time for us 

to revisit this. Mr. Chairman, I appreciate your leadership on this 

because I think you have really laid out the issues and helped us 

define the issues so that we can proceed on this and hopefully have 

some positive restructuring of the Section 529 program. 

So let me just make a couple observations, but really ask a few 

questions, and that is in looking at the Section 529 savings plans, 

I think it is confusing. As I understand it, there are at least, or 

about, six possible fees that could apply, and depending on what 

you are doing and what your circumstances are, you may get one 

or a combination of those fees. My impression is that there is just 

not a very good system in place to disclose all of this to the investor. Is that fair? Ms. Schapiro, I don’t want to pick on you, but is 

that a fair statement? 

Ms. SCHAPIRO. That is a fair statement. 

Senator PRYOR. I guess my first question is, why don’t we just 

adopt—I know you all can’t do it, but why doesn’t Congress just 

adopt a uniform fee, just a flat or very easy to understand formula, 

19

just a uniform fee that would apply to this? Do you all see any 

problem with just a uniform fee in some way? Does that create a 

problem? 

Mr. LANZA. It would be a different approach than currently exists 

elsewhere in the marketplace, but I see no legal problem. 

Senator PRYOR. All right. Well, let us talk about that. What currently exists in the marketplace today? 

Mr. LANZA. Typically, for example, the MSRB—and again, our jurisdiction is limited to broker dealers—we are statutorily prohibited from setting fees. The Congress’s determination at the time 

that we were created, and I believe it also applies in general to the 

NASD, was that market forces should be left to operate. So we certainly don’t have any kind of mandate to create any kind of fixed 

fees. 

Senator PRYOR. OK. I see these as a little bit different, like the 

Chairman said, because the State has a role in this, but anyway, 

that is good. 

Ms. SCHAPIRO. There actually is, under NASD rules with respect 

to mutual funds, an 8.5 percent cap on sales charges in funds 

where there are no 12b–1 fees or services assessed. Otherwise, it 

is a 6.25 percent cap. But generally, fee caps and limits and the 

dictation of fees has not been done by the government or by the 

Congress but rather set in the marketplace. Critical to the marketplace functioning with respect to the competition among fees is disclosure that investors can understand so that they can make informed choices about whether they want to pay particular fees or 

not——

Senator PRYOR. Right. 

Ms. SCHAPIRO [continuing]. And so that they can understand 

what the impact of multiple levels of fees are on their investment’s 

return over time. 

Senator PRYOR. Right. As I understand, the SEC has mandated 

the so-called ‘‘plain English’’ rule so that investors, when they read 

materials, etc., most investors, at least, can understand it or at 

least come closer to understanding it than if it is just filled with 

legalese. I think the National Association of State Treasurers and 

the College Savings Plan Network have come up with what may be 

considered their version of this. It is kind of voluntary disclosure 

principles, guidelines, etc. 

These are voluntary disclosure principle guidelines. Do you know 

how many are complying with these voluntary disclosures? Do we 

have a sense of what everybody is doing out there? 

Mr. LANZA. I don’t have a figure. I understand that some States 

have begun to implement it. Others are, I believe, waiting for the 

SEC Chairman’s task force report. But again, I am not the person 

to speak to that. 

Senator PRYOR. I guess what is puzzling to me about this is, and 

maybe it is because of my Attorney General background where we 

did a lot of consumer protection work, but it is just puzzling to me 

where the States would not want their consumers to have full 

knowledge and a clear understanding of what they are getting 

themselves into. I am puzzled by that. I know that you can’t speak 

for them or speak to that. 

20

Let me ask you just one last question. Is it your opinion that the 

States and the investment community are doing enough to allow 

parents and students to make intelligent investment decisions, or 

do you think that we need to review and revise what we have on 

the books today? 

Mr. LANZA. Clearly, we believe disclosure can be improved. I 

mentioned the six characteristics that we think disclosure needs to 

bring in, which is that it be understandable, comprehensive, comparable, universal, accessible, and timely. All the information that 

anyone needs needs to be available in a timely manner and in a 

simple manner and in a way that they can compare one State 

versus the other. 

Again, we are hopeful that the CSPN disclosure principles will 

get them there. It is not an easy process. It will take a lot of work 

and real vigilance. 

I will mention that MSRB also regulates broker dealers in the 

municipal bond area, which has clearly had a longer history, and 

over time, disclosure practices have improved in that market, as 

well, even though there is no mandatory set of requirements for 

disclosure. So certainly it is possible. I just can’t predict where it 

will go. 

Ms. SCHAPIRO. I think improving disclosure is key, too. We have 

developed a one-page disclosure document that would lay out for 

investors what fees they pay to buy and own a Section 529 plan 

and then, out of those fees and expenses that they pay, what is 

paid to the brokerage firm and to the broker for selling that plan. 

I don’t know if it is perfect, but it is that kind of point-of-sale, simple, one-page disclosure that allows for comparability across different plans that I think would be the greatest service we could 

provide investors in this area. 

Mr. MILLER. That is not really a tax issue for our side of it. 

Senator PRYOR. Thank you very much, Mr. Chairman. 

Senator FITZGERALD. Senator Carper from Delaware has joined 

us. You are free to ask any questions or we can bring up the second 

panel. 

Senator CARPER. Let me just ask a question of each of the witnesses, if I could. Thank you for being here. I apologize for not 

being here to hear your testimony, but I would just ask that you 

briefly give me a take-away or two, what you would have us take 

away from this hearing. 

Steve Miller, you are about the third Steve Miller we have had 

testify in this Congress. 

Mr. MILLER. There are a lot of us. 

Senator CARPER. I always ask the same thing, like what have 

you been doing since your recording career sort of leveled off—— 

[Laughter.] 

But you still look young. You look great. 

Mr. MILLER. Thank you. [Laughter.] 

What we testified on, Senator, were the basic requirements for 

exemption for a qualified tuition program under Section 529. There 

is nothing explicit in that that really deals with the disclosure area 

to prospective customers, and I think that is a take-away. 

Senator CARPER. All right, thanks. Ms. Schapiro. 

21

Ms. SCHAPIRO. I sound a bit like a broken record, but I would say 

that the key take-away from our perspective would be the need for 

uniform disclosure concerning fees, expenses, tax treatment, and 

all the other unique features of Section 529 plans that go well beyond the underlying mutual fund investment, things like the rollover options and designation of beneficiaries and so forth. 

Senator CARPER. Thank you. Mr. Lanza. 

Mr. LANZA. I spoke to the broker dealer obligations to customers 

and I think, as Ms. Schapiro said, we believe disclosure really is 

the key in this marketplace because it is complex and there are lots 

of features and the best thing for investors as well as the broker 

dealers who market to investors is to be able to understand the 

marketplace and understand all the key features. So we urge the 

issuer community to really work on quality, comparable, timely, 

and comprehensive disclosure. 

Senator CARPER. I don’t know if any of you have children of your 

own, but some of you may, but if you are giving advice to people 

who have children, about to have children, someday have children, 

what they might want to keep in mind as they prepare for their 

children’s education as it relates to the Section 529’s. What would 

you have them keep in mind? 

Ms. SCHAPIRO. I do have children. I have two daughters, both of 

whom have Section 529 plans. I also serve on the board of a college, and so I see from that perspective what tremendous burdens 

are placed on families who are trying to pay for a particular private 

school education, but even today, public school education. My advice would be to start saving day one. The day the child is born, 

open a Section 529 plan. Look for one with the lowest possible fees 

and expenses, with a good reputation on the part of the mutual 

fund complex that underlies the Section 529 plan, and make regular contributions to it, watching the investment very carefully, of 

course, so that if there are issues that arise over time, you can 

make the appropriate changes. 

Senator CARPER. Good. Thank you. What college? 

Ms. SCHAPIRO. Franklin and Marshall in Lancaster, Pennsylvania. 

Senator CARPER. We know where that is in Delaware. 

Ms. SCHAPIRO. That is right. [Laughter.] 

Senator CARPER. Gentlemen. 

Mr. MILLER. I think that the most likely take-away on that is 

that you really do need to do your homework because the plans are 

very different, and that is really what we would suggest, as well. 

Senator CARPER. All right. 

Mr. LANZA. I don’t think anyone in their right mind would want 

to take financial advice from me, but we have college savings plans 

as well for our children. We think they are very helpful. We were 

very careful in our selection, making sure they met with our——

Senator CARPER. What did you consider when you were making 

those selections? 

Mr. LANZA. Well, it is a matter of personal choice. I tend to go 

for the low-cost indexed type of funds. Others have other views towards the mutual fund industry in general. Some like more actively managed. In my case, it is more of an index fund, so I went 

in that direction. 

22

Senator CARPER. All right. 

Mr. LANZA. But it is a matter of what your personal investing 

style is. 

Senator CARPER. How old are your children? 

Mr. LANZA. One is 11. The other one is six. 

Senator CARPER. Ms. Schapiro. 

Ms. SCHAPIRO. Eight and ten. 

Senator CARPER. Eight and ten, all right. Mr. Miller. 

Mr. MILLER. Five years old. 

Senator CARPER. Five years old, OK. Fourteen and sixteen, and 

we have a plan for each of our boys, too. Thank you very much. 

Senator FITZGERALD. Thank you to this panel of witnesses. I did 

want to tell Senator Pryor there definitely are huge variations in 

fees. I am going to have my staff try and get you something that 

has been worked up by Morningstar. We are going to hear from a 

Morningstar witness. You might want to take a look at the fees 

they charge in Arkansas, too. I won’t state those publicly, but you 

might want to take that up with your Treasurer back home. 

All of you, you have been great. We appreciate your time. Thank 

you so much for coming here. 

Now, I would like to welcome our witnesses for panel two. Our 

first witness on this panel is the Hon. Michael A. Ablowich, who 

is the Treasurer for the State of New Hampshire. Treasurer 

Ablowich began his 2-year term in January 2003 and is responsible 

for cash management and investment of more than $300 million 

daily, banking relationships, debt management, and trust fund 

management. Treasurer Ablowich also is statutorily appointed to a 

number of State committees, including the New Hampshire Municipal Bond Bank and the New Hampshire College Tuition Savings 

Plan Advisory Commission. 

Our second witness is Jacqueline T. Williams, who serves as the 

Executive Director of the Ohio Tuition Trust Authority. The Ohio 

General Assembly created the Tuition Trust Authority in 1989 to 

promote savings for higher education. Prior to her current role, Ms. 

Williams held leadership roles as Chief Administrative Officer for 

the Ohio Bureau of Workers’ Compensation and the Director of 

Consumer Services for the Ohio Consumers Council. 

Our third witness is from my home State of Illinois. Martin M. 

Noven serves as Deputy Chief of Staff to Illinois State Treasurer 

Judy Baar Topinka. Mr. Noven joined the Treasurer’s Office in 

1993 and his responsibilities include supervision of all legal, legislative, and policy matters, including program creation and new initiatives. Mr. Noven is responsible for the implementation and supervision of Bright Start, the college savings program established 

by Treasurer Topinka. 

Our next witness is Richard O. Davis. Mr. Davis is the Deputy 

Executive Director for Finance and Administration for the Utah 

Higher Education Assistance Authority. The Authority is a subsidiary organization of the Utah State Board of Regents that oversees the operation of the State’s student loan secondary market activities, guarantor operations, and the Utah Educational Savings 

Plan trust. 

Our fifth witness is Dan McNeela, who is a senior analyst at 

Morningstar, an independent investment research firm. Mr. McVerDate 0ct 09 2002 08:28 Dec 16, 2004 Jkt 097046 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 C:\DOCS\97046.TXT SAFFAIRS PsN: PHOGAN
23

1The prepared statement of Mr. Ablowich appears in the Appendix on page 90. 

Neela has researched mutual funds for Morningstar since October 

of 2000 and is the firm’s lead editorial analyst covering Section 529 

College Savings Plans. 

Our final witness is Mercer Bullard, whom we welcome back before this Subcommittee. Mr. Bullard also testified at our mutual 

fund hearings in November 2003. Mr. Bullard is the founder of 

Fund Democracy, a nonprofit membership organization that serves 

as an advocate and information source for mutual fund shareholders and their advisors. Mr. Bullard also is an assistant professor of law at the University of Mississippi, where he teaches in 

the areas of securities and banking regulation, corporate finance, 

and contracts. I know one of my staff members was keeping 

abreast of the conference you held on mutual fund ownership down 

in Mississippi, and you have been a great advocate for investors. 

We thank you for being here. 

To the best of your ability, please try to summarize your remarks 

within 5 minutes. We will take your full written statements for the 

record, and we will make them part of the record. Thank you all 

for being here. 

I would like to begin with Treasurer Ablowich from New Hampshire. I went to Dartmouth College in Hanover, New Hampshire, 

so I have some connection to your State. Welcome. 

TESTIMONY OF HON. MICHAEL A. ABLOWICH,1 TREASURER, 

STATE OF NEW HAMPSHIRE, ON BEHALF OF THE NATIONAL 

ASSOCIATION OF STATE TREASURERS 

Mr. ABLOWICH. Thank you very much, Mr. Chairman and Members of the Subcommittee. My name is Michael Ablowich. I am the 

Treasurer of the State of New Hampshire and trustee of both the 

UNIQUE College Investing Plan and the Fidelity Advisor Section 

529 Plan, both of which are sponsored by our State. I would like 

to have my written testimony entered into the record of this Subcommittee, please, Mr. Chairman. 

Senator FITZGERALD. Without objection. 

Mr. ABLOWICH. I am also a member of New Hampshire’s College 

Tuition Savings Plan Advisory Commission and a member of the 

College Savings Plan Network, which is an affiliate of the National 

Association of State Treasurers. CSPN coordinates State college 

savings efforts by harnessing the collective resources of States to 

improve industry practices and develop self-regulating policies. 

It is my sincere pleasure to be here today to speak with you 

about Section 529 College Savings Plans, the State of New Hampshire’s perspective, and philosophy regarding these plans and how 

States are making them successful. 

The States have been working with Congress for over a decade 

to increase access to college by helping families overcome one of the 

greatest barriers to college, the ever-increasing cost of higher education for their children. 

New Hampshire’s story is really no different in this case. We 

began our Section 529 plans in 1998 and since then, residents in 

New Hampshire and other States have responded to these plans 

with excitement and enthusiasm. More than $3.3 billion has been 

24

invested in more than 330,000 accounts in our two programs combined. That high level of response is even more amazing when you 

consider that we started these plans a couple years before one of 

the most challenging financial markets in history. 

Investors clearly understand the need for higher education and 

the principle of saving early and regularly in a tax advantaged account. Of course, while periodic investing strategies do not guarantee a profit or protect against loss in a declining market, investing in a Federal income tax-free vehicle like a Section 529 plan 

may be one of the simplest and best ways for families to start saving for college. 

Our Section 529 plan is built on the foundation of putting investors and beneficiaries first. We make every program decision with 

the interests of our investors in the forefront, and while we maintain an outstanding relationship with our private sector partner, 

our first priority is always to our investors, the plan participants. 

That is why New Hampshire currently has two Section 529 plans 

to choose from, each offering investors a different method of deciding on which investment options are best for them. 

The UNIQUE College Investing Plan is sold directly to investors 

and the Fidelity Advisor Section 529 Plan is marketed to investors 

through intermediaries, like financial planners or brokers. Both 

plans give investors a wide range of college savings options to satisfy their college savings goals. Our retail UNIQUE plan is designed with smaller investors in mind, but these investors, they 

can get started with as little as $50 and $50 monthly contributions, 

or for a one-time contribution of $1,000. It is our goal to offer solid 

investment choices to attract a wide range of investors with varying risk tolerances and investment philosophies. 

Everyone talks about the amount of money saved in Section 529 

plans, and it is substantial, but I believe the more important statistic is the number of accounts. I really don’t care whether people 

are saving $50 or $50,000 as long as they save. I am also not concerned whether they save in one of our two Section 529 plans or 

in another plan or, frankly, in their name in a traditional bank 

savings account or some other method. The important thing is that 

parents are making plans for one of the most important investments in their lives, their children’s education. 

In New Hampshire, we have worked to develop college savings 

awareness to ensure that every resident, regardless of income, understands and has easy access to the Section 529 plan and other 

college financing options. We have also made this decision simpler 

for our residents by allowing them to receive favorable State tax 

interest and dividends tax treatment regardless of the plan they 

participate in. 

The States have a legitimate vested interest in making college 

more affordable and accessible to their citizens. In New Hampshire, 

the Treasurer’s Office is responsible for our Section 529 plans, as 

is the case in most States. We have been entrusted with looking 

after the hard-earned dollars of families who are saving for their 

children and grandchildren’s education. 

Our Advisory Commission meets regularly to review plan operations, the performance of securities markets, and performance in 

each of the portfolios and investment options available to our invesVerDate 0ct 09 2002 08:28 Dec 16, 2004 Jkt 097046 PO 00000 Frm 00028 Fmt 6633 Sfmt 6633 C:\DOCS\97046.TXT SAFFAIRS PsN: PHOGAN
25

1The prepared statement of Ms. Williams appears in the Appendix on page 103. 

tors. We have worked hard to ensure that our Section 529 plans, 

whether bought directly or through financial advisors, offer competitive fees that are fully disclosed to all investors. 

We also spend much time reviewing the performance of each 

portfolio to ensure that investors are earning competitive returns 

net of fees compared to the appropriate benchmarks. This allows 

me and our commission to exercise full and effective control over 

the program as well as oversee our private sector program manager. Every significant decision made regarding the plan, whether 

investment-related or administrative, is analyzed and approved by 

the commission. The roles of the Treasurer and the Advisory Commission and the terms of the contract with Fidelity Investments, 

our plan administrator, have been approved consistent with the 

process used for all State contracts. 

After listening to the customer concerns regarding disclosure and 

transparency, the National Association of State Treasurers and the 

College Savings Plan Network have undertaken an effort to create 

voluntary disclosure principles. These principles were adopted in 

draft form with input from our private sector partners this May at 

the Network’s annual meeting. The National Association of State 

Treasurers has also adopted the principles at its annual conference 

earlier this year. 

The goal of the principles is to provide a framework for disclosure so that investors can easily understand his or her own State’s 

plans compared to other Section 529 plans on an apples-to-apples 

basis. 

Senator FITZGERALD. You have got to wind it up. 

Mr. ABLOWICH. Can I have 2 more minutes, Mr. Chairman? 

Senator FITZGERALD. We will give you time in the question and 

answer segment. We have got to give everyone an opportunity. We 

want to stay to that 5 minutes, so please watch these lights. We 

will come back to you. 

Mr. ABLOWICH. Thank you, Mr. Chairman. 

Senator FITZGERALD. Thank you very much, Treasurer. Ms. Williams. 

TESTIMONY OF JACQUELINE T. WILLIAMS,1 EXECUTIVE DIRECTOR, COLLEGE ADVANTAGE SAVINGS PLAN, OHIO TUITION TRUST AUTHORITY, ON BEHALF OF THE COLLEGE SAVINGS PLAN NETWORK 

Ms. WILLIAMS. Thank you, Mr. Chairman and Subcommittee 

Members. I am Jackie Williams, Executive Director of the Ohio 

Tuition Trust Authority and I appreciate the opportunity to share 

one State’s perspective on Section 529 plans and hopefully clear up 

some misperceptions and highlight the enormous value these plans 

provide to America’s families. 

Our agency is an independent State agency governed by an 11-

member board comprised of business, education, and elected leaders in our State. In 1989, Ohio was one of the first States in the 

country to offer a Section 529 qualified tuition program. The General Assembly created the plan to make higher education more affordable and accessible for all Ohio citizens. Since inception, our 

26

State provided tax-exempt earnings to encourage early savers. Only 

11 States have fewer college graduates than Ohio, and a recent report by our governor indicates that our economic future depends on 

increasing participation in higher education. 

The Tuition Trust first offered a unit-based prepaid plan designed to keep pace with tuition inflation at Ohio’s public universities. The plan enjoyed wide acceptance and market success. Long 

before I became an employee of the plan, I financed the education 

of my two sons through the guaranteed program. 

In 1994, the Ohio General Assembly and Ohio voters approved 

a constitutional amendment putting the State’s full faith and credit 

backing behind the plan if it could not meet future obligations. 

In 1996, Ohio’s plan fell under guidelines established by Congress establishing qualified State tuition programs and adding Section 529 to the Internal Revenue Code. These changes have encouraged more States to offer college savings plans and expanded their 

ability to offer new investment choices and tax incentives. Legislation to take advantage of the Federal changes was approved unanimously by the Ohio General Assembly in 1999, and this also created new investment options and added a $2,000 annual State tax 

deduction on contributions. 

Launched in the Fall of 2000, College Advantage included the 

original prepaid plan and the new actively managed investments. 

We were one of the first States to offer both a director-sold and an 

advisor-sold program. We found that many savers wanted investment advice from financial professionals and were willing to pay to 

receive it and that there were also do-it-yourself investors who 

wanted to make their own investment decisions and wanted a 

broad range of low-cost options. With product enhancements and 

improved distribution, we have over 266,000 beneficiaries in Ohio 

alone. 

The Federal Tax Act of 2001 permitted a tax exemption on earnings on funds when they were used for qualified higher education 

expenses. When that law took effect in June 2001, there were a 

million-and-a-half U.S. children with Section 529 accounts valued 

at $9.5 billion. Three years later, Section 529 plans have become 

the preferred college savings vehicle, with 6.8 million accounts valued at over $54 billion. Unfortunately, unless extended by Congress, the Federal law will expire after December 2010. 

For 15 years, our organization has worked very hard to educate 

people to determine what kinds of products and features to offer, 

how best to inform and educate, and how to distribute products to 

a broad cross-section of the public. Each investment manager is selected through a rigorous competitive process subject to State procurement laws. 

We currently work with two investment firms, Putnam Investments, which provides actively managed investment products, and 

the Vanguard Group, which provides passively managed index 

funds. Recently, we selected an Ohio bank to develop a Section 529 

banking product. Our goal is to make investment vehicles available 

to savers at every level of income, education, and investment experience. 

We encourage families to save through flexible contribution 

methods, such as electronic funds transfer, payroll deduction, and 

27

1The prepared statement of Mr. Noven appears in the Appendix on page 107. 

online investing. Participants pay no application or service fees. 

Ohio residents pay no annual account fees. And account fees are 

waived for non-residents who are participating in systematic investing. A College Advantage account can be opened for as little as 

$15. 

And while expense ratios vary by investment, our direct-sold 

plan offers some of the industry’s lowest fees and our advisor-sold 

fees are about average for advisor-sold actively managed funds. Obviously, enhancing disclosure of fees and performance is a very 

high priority of ours and we fully support CSPN’s direction on this. 

Earlier this year, we took a leadership position and disclosed all 

of our fees on a single page in our opening statement. I would just 

like to say that there are a number of organizations that rate Section 529 programs, and I think in many cases they have done a disservice to the people who read their reviews and have not shed 

light on these plans. Frankly, much of their information has a very 

long shelf life, and these plans are dynamic ones which can change 

the day after these articles are written. For example, the Rhode Island J.P. Morgan fund no longer exists. So clearly, it is in the best 

interests of States, as well, to make sure that our information is 

out there and that the organizations reporting on them are using 

accurate, timely information. Thank you very much. 

Senator FITZGERALD. Thank you, Ms. Williams. Mr. Noven, welcome. 

TESTIMONY OF MARTIN M. NOVEN,1 DEPUTY CHIEF OF STAFF, 

ON BEHALF OF JUDY BAAR TOPINKA, STATE TREASURER, 

STATE OF ILLINOIS 

Mr. NOVEN. Thank you. Good morning, Chairman Fitzgerald and 

Members of the Subcommittee. I would like to enter my written 

comments into the record, as well. 

Senator FITZGERALD. Without objection. 

Mr. NOVEN. Thank you. We appreciate the opportunity to present 

this testimony. I personally appreciate your inviting me to testify 

on behalf of Treasurer Topinka. She feels very strongly about a 

number of the issues that you are discussing and appreciates the 

opportunity to share her views on the matter. 

When these State Section 529 programs were set up, they were 

set up so that there would be someone looking out for the interests 

of consumers. They were set up by States so they would have a 

product to offer their investors in-state and their consumers instate that would be protected by someone who was looking out for 

their interests so they could feel comfortable that they weren’t paying high fees, that they weren’t getting false information. 

In that spirit, Treasurer Topinka created the Bright Start College Savings Program. It wasn’t an easy program to start. Legislatively, we had a difficult time getting authority. We were actually 

forced by the banking industry to include some unique provisions 

in our law that made it more difficult to have a successful program. 

For example, all contributions and applications have to go through 

Illinois banks to participate in the Illinois plan, and banks even 

have the option, although very few actually—it is a negligible 

28

amount have actually taken advantage of it—to have some deposits 

on hand as part of the investments that are in the participants’ 

portfolio. 

So we worked very hard to get a plan together. We were glad 

that despite the fact that we had a hard time getting people to respond to the RFP and some of the responses that we did get had 

inflated fees because of our unique requirements, we were able to 

negotiate a contract with Smith Barney that gave us one of the 

lowest-cost programs in the Nation. It gave a tremendous amount 

of control to the Treasurer to protect consumers. And also, with 

their affiliation with Citibank, they were able to comply with our 

enabling legislation. 

We are extremely pleased with the success of the Bright Start 

program. We have more than 100,000 accounts that have been 

opened. Our performance places us among the top in the Nation. 

We have done all of this without engaging in the problems that you 

have mentioned: The high fees and commissions, the questionable 

sales practices, the inadequate disclosure. We feel very strongly 

that all of these are important things that we need to consider. We 

applaud the efforts of the Federal regulatory agencies that are 

looking at some of these issues. We think it is important. 

When the largest programs in the Nation, the ones that are 

growing the fastest and being sold most aggressively and have the 

most consumer assets, are the ones that are least consumer-friendly and are the ones that charge consumers the highest fees so they 

have the least amount of assets to grow, like you mentioned on the 

charts that you have, we have got a real problem here and we are 

glad that it is being looked at. 

We have been fighting that battle in Illinois, as well, where two 

dollars is being invested out of State in these high-priced brokersold plans for every dollar that is being invested in-state. The performance of these plans has not been better than Bright Start. The 

broker fees are higher in these plans. These citizens are paying 

higher fees and not getting the tax benefits in Illinois. That has 

caused some concern in Illinois, and instead of the brokerage community dealing with this conflict by changing their selling practices, they have come after us with a fleet of lobbyists in Springfield, trying to force us to extend those benefits to encourage Illinoisans to go to plans that are not in their best interests as a consumer. Those are the concerns we have. 

We have tried to extend our State tax benefits to any other State 

plan that will agree to adequate disclosure and the industry killed 

the bill. We tried to extend it to any plans that had reasonable 

sales charges. The industry killed that bill. We offered—it was a 

legislative proposal, it didn’t get to the bill form—if other States 

would treat Illinois residents as well as they treated their own and 

not charge extra fees and commissions to help pad their State 

treasury, extend the tax benefits to them, and the industry rejected 

that proposal. 

So we have been working very hard on this issue. On a state-bystate level, we fear that States are competing with each other for 

assets as opposed to looking out for consumers, as was the original 

intention of this bill. We very much welcome the chance to address 

these issues. 

29

1The prepared statement of Mr. Davis appears in the Appendix on page 112. 

Senator FITZGERALD. Thank you very much, Mr. Noven. Mr. 

Davis. 

TESTIMONY OF RICHARD O. DAVIS,1 DEPUTY EXECUTIVE DIRECTOR FOR FINANCE AND ADMINISTRATION, UTAH HIGHER EDUCATION ASSISTANCE AUTHORITY 

Mr. DAVIS. Thank you, Mr. Chairman. Mr. Chairman, Members 

of the Subcommittee, my name is Richard Davis, Deputy Executive 

Director for Finance and Administration for the Utah Higher Education Assistance Authority, which is a subsidiary board of the 

Utah State Board of Regents. We manage the Utah Section 529 

plan as part of our role to provide financial and informational assistance to Utah residents. 

The Utah plan was set up in 1996 as a State agency and is governed by a 17-member Board of Directors comprised of members 

from both private and the public sector. In response to the burden 

of increasing costs of education, the Board of Directors was charged 

with creating a safe, simple, and low-cost college savings program. 

The Board made a conscientious decision to create a plan that 

charges the lowest fees possible. To maintain these lower costs, the 

Board has chosen to offer its plan, manage it internally, and market it directly to investors. For example, a Utah account with a balance of $10,000 will pay, on average, between $50 and $60 of fees 

per year, depending on the investment options. 

A Utah savings account may be established with no enrollment 

fees and an initial deposit as low as $25 per family. Once this account has been created, there are no deposit requirements and the 

account holder may choose a payment schedule that meets their 

specific needs. 

We have ten investment options utilizing nine Vanguard mutual 

funds and the Utah Public Treasurer’s Investment Fund, which 

mirrors the attributes of a money market account. We have four 

static investment options where the allocation of funds remains the 

same throughout the entire time the account is open and five different age-based options, all of which provide portfolios that change 

the allocation of funds to become more conservative as the beneficiary approaches college enrollment. 

Residents of Utah also benefit from a State tax deduction of up 

to $1,470 currently, or $2,940 on a joint return. 

As a confirmation of the value of this decision to offer a low-cost 

college savings plan, Utah has been consistently rated by various 

investment research organizations and financial magazines and 

other third parties as among the top five Section 529 plans in the 

Nation. Although we only market within the State of Utah, 80 percent of our participants are non-Utah residents, out of State. 

We recently began a new pilot program which provides matching 

funds for low-income families in Utah. We provide a matching incentive of up to $300 per year for 4 years for families with incomes 

up to 200 percent of the Federal poverty level. 

As a member of the College Savings Plan Network, Utah supports the effort to create a voluntary disclosure system among the 

various plans. We are currently working towards developing and 

30

1The prepared statement of Mr. McNeela appears in the Appendix on page 114. 

refining our own offering materials to meet the objectives of the 

disclosure principles and plan to provide materials that will help 

consumers make more informed and objective comparisons of fees 

and expenses. 

Mr. Chairman, Section 529 plans in general and Utah in particular have proven to be very successful among families as they 

plan for their children’s education. Congress set out to create a 

simple and easy-to-understand process to assist participants save 

money for college. We believe this goal is being accomplished every 

day through the continued growth in these plans. 

Thank you, Mr. Chairman and Members of the Subcommittee. I 

appreciate the opportunity to speak here and would be pleased to 

address any questions. 

Senator FITZGERALD. Mr. Davis, thank you very much. Mr. 

McNeela. 

TESTIMONY OF DANIEL McNEELA,1 CFA, SENIOR ANALYST, 

MORNINGSTAR, INC 

Mr. MCNEELA. Thank you. I ask for my written testimony to be 

entered into the record. 

Senator FITZGERALD. Without objection. 

Mr. MCNEELA. Thank you for the opportunity to appear before 

this distinguished Subcommittee. My name is Dan McNeela. I am 

a senior analyst with Morningstar, Inc. My testimony focuses on 

the shortcomings of Section 529 plans and the steps that can be 

taken to ensure that the generous Federal tax breaks are not 

squandered. 

Some of our greatest concerns relate to the host of costs investors 

pay to participate in a Section 529 plan. Investors face enrollment 

fees, account maintenance fees, administrative fees, management 

fees, and in many cases, broker fees. Some of those costs are dollarbased while others vary depending on the amount of assets an investor has in the plan. Most Section 529’s exacerbate this problem 

by burying this important cost information in the back of a 100-

page-long program disclosure document. At its worst, the complexity of the cost structure and the reluctance to make this information easily accessible and understandable amount to deceit on 

the part of Section 529 providers. 

When all the costs are added together, too many Section 529 

plans appear to be prohibitively expensive. One reason these plans 

cost so much is that several groups have lined up to collect fees. 

With States, fund companies, brokers, third-party administrators 

all putting their fingers in the pie, it is no wonder that investors 

can end up with a knuckle sandwich. 

With several plans having investment options whose costs approach or exceed 2 percent of assets, investors’ ability to capture 

needed investment gains is significantly impaired. States offering 

Section 529 plans need to provide more disclosure on how fees are 

used and how investment managers are chosen. Only by opening 

up these decisions to public scrutiny can citizens feel comfortable 

that the plans are being operated for their benefit. 

31

The final area in need of improved disclosure is performance 

evaluation. To grasp how well a plan is performing, investors need 

to see the performance of relevant benchmarks alongside the plan’s 

returns. If this is done properly, plans saddled with poorly performing funds and high cost structures will have few places to hide. 

As a supplement to those numbers, plans should provide investors 

with a written commentary explaining why the investment options 

did better or worse than their benchmarks. 

This distinguished Subcommittee must decide what, if anything, 

must be done on a Federal level to assure that Section 529 plans 

reach their full potential. Toward that end, I submit the following 

recommendations. 

First, bring uniformity to standards for disclosure and transparency by appointing the SEC to set the regulatory environment. 

With the SEC in charge, all plans will be required to comply with 

the same set of rules. That measure will increase investor confidence, make comparisons between plans easier, and allow for 

alignment with rules and protections already being enforced as 

they relate to mutual funds. 

Second, ensure that the Section 529 marketplace is competitive 

by granting the Federal tax break only to plans that promote fair 

competition through the adoption of the following standards. First 

would be State tax laws on contributions and withdrawals should 

be applied uniformly to all Section 529 plans with no special status 

afforded to a State’s own plan. Twenty-six States offer a deduction 

or tax credit on contributions, but typically that benefit is not bestowed on those who find an out-of-state plan more compelling. 

Four States grant tax-free withdrawals for citizens who opt for the 

home State plan, but require beneficiaries to pay State tax on 

qualified withdrawals from out-of-state plans, and Illinois and Mississippi residents who choose an out-of-state plan give up both benefits. 

Also, we think it is important to require uniform access to Section 529 plans. Some States have seen fit to create two distinct 

plans, one geared to in-state residents while the other is for outof-state residents. This two-tiered system can impact the range and 

quality of the underlying investment options. 

Third, we would require uniform fee schedules regardless of residency. In addition to restricting access, some States have created 

a special low-cost share class that is available only to its residents. 

Out-of-state investors can’t buy the lower-cost shares and usually 

must pay a sales load and higher ongoing expenses to access the 

plan. Certain plans also waive annual maintenance fees only for instate residents. 

States protect themselves from competing plans and favor their 

residents over out-of-state investors because they have little motivation to act otherwise. Only the Federal Government is in position 

to set appropriate ground rules that will promote fair competition 

and ensure freedom of choice for investors. By ensuring a competitive marketplace, the Federal Government will guarantee that tax 

benefits has bestowed upon Section 529 plans are not squandered. 

I thank you for your time and I will take any questions. 

Senator FITZGERALD. That was excellent. Thank you very much. 

Mr. Bullard. 

32

1The prepared statement of Mr. Bullard appears in the Appendix on page 123. 

TESTIMONY OF MERCER E. BULLARD,1 PRESIDENT AND 

FOUNDER, FUND DEMOCRACY, INC 

Mr. BULLARD. Thank you, Chairman Fitzgerald and members of 

the Subcommittee, again for inviting me to appear today. It is an 

honor and a privilege to speak on this very important issue and I 

would like my written testimony to be added to the record. 

Senator FITZGERALD. Without objection. 

Mr. BULLARD. Today, I am going to deal with the four issues that 

were listed in the title of this hearing: High fees, fee disclosure, 

questionable sales practices, and disparate State tax benefits. 

High fees and fee disclosure are actually closely related. Seventy 

years of Federal securities regulation have taught us that effective 

fee disclosure can promote price competition and mitigate high 

fees. 

There is no coincidence that since the adoption of the mutual 

fund expense ratio and fee table, for example, mutual fund assets 

have increased substantially as investors have been drawn to the 

product’s transparency and accessibility. Mutual fund fee disclosure 

rules have led investors to migrate to lower-cost funds, and these 

rules, these mandatory rules, have thereby created wealth by reducing costs. Effective fee disclosure rules have provided Americans 

with more money to finance their children’s education and their retirement. 

Effective fee disclosure did not come about voluntarily. It came 

about only as a result of SEC rulemaking. Low-cost providers have 

a strong incentive to provide fee transparency, but high-cost providers have an equally strong incentive to obscure their fees. Effective fee disclosure should be standardized, transparent, understandable, and comprehensive, but most of all, it must be mandatory. Only when the high fees charged by high-cost providers are 

required to be disclosed will the markets be able to operate efficiently to bring down fees. 

Sponsors of Section 529 plans have flatly rejected this model for 

fee disclosure. Fees for many Section 529 plans are extremely obscure. Section 529 plan sponsors argue that fee disclosure should 

be voluntary and left to the markets. The disclosure principles, for 

example, proposed by the College Savings Plan Network strongly 

emphasize that ‘‘the guidelines are not intended to suggest that alternative disclosure practices may not be acceptable or a comprehensive list of disclosure matters that must be addressed in connection with Section 529 plans in order to fulfill their responsibility 

of State issuers to their account owners.’’

As long as obscure fee disclosure is an acceptable alternative to 

transparent fee disclosure Section 529 plan fee disclosure will not 

promote price competition and thereby reduce fees. Section 529 

plan sponsors that charge high fees have a strong disincentive to 

provide standardized disclosure that will only put them at a disadvantage to their low-cost competitive. It is essential that Section 

529 plan fee disclosure be mandatory. 

Congress should also consider addressing high fees by limiting 

certain fees. Mutual fund sales charges are already subject to 

33

NASD rules that limit the amount of sales charges that can be imposed. Section 529 plans should be subject to the same limits. 

Limiting sales charges would also reduce high fees while addressing another issue, the issue of questionable sales practices. By 

bringing sales charges in Section 529 plans into line with mutual 

fund sales charges, the extra incentive to push inappropriate Section 529 plans over mutual funds would be removed. But this step 

is not enough. Brokers will still have economic incentives to sell inferior Section 529 plans that pay higher sales compensation, as indicated by Mary Schapiro’s testimony earlier this morning. Brokers 

may receive higher compensation for selling one Section 529 plan 

than another plan, even though the services provided to the broker’s client are the same. The situation exists because we allow investment products to pay brokers to push the product, the functional equivalent of a bribe. 

What is even more troubling is that such differential compensation is not required to be disclosed to the investors. Investors 

should be made aware of the dollar amount of brokers’ incentives 

to recommend one product over another, whether or not it is in the 

best interests of the client. In addition, Congress should begin to 

unravel the regulatory structure that effectively requires that sales 

compensation depend on which product the broker sells rather than 

the quality of the services the broker provides. 

The last issue, disparate State tax treatment, arises from States 

granting State tax benefits with respect to contributions to in-state 

plans while denying these benefits for contributions to out-of-state 

plans. This is not surprising, as Congress has essentially authorized the States to engage in the business of developing and selling 

financial products and it should be expected that they, like any 

other enterprise, will seek to gain advantages over their competitors, such as by limiting State tax benefits to their own investment 

products. This practice distorts market incentives, however, as it 

may cause an investor to choose an inferior State Section 529 plan 

that offers a State tax break over a superior out-of-state plan that 

does not. Congress should consider requiring that States afford 

equal tax treatment on all Section 529 plans. 

This disparate State tax treatment issue is really a part of a 

broader problem with Section 529 plans. Governments are good at 

funding public projects, and providing tax breaks for their citizens’ 

education fits squarely within that role. Developing, managing, and 

marketing financial services products is not something that we 

should expect governments to do as well as markets. Congress 

should expect issues like a disparate State tax treatment issue to 

arise and become increasingly problematic. 

By asking State Governments to invest in the infrastructure 

needed to support Section 529 plans, Congress created a vested 

governmental interest in their continued growth, regardless of 

whether the markets continue to believe that Section 529 plans 

provide an efficient way to save for education. This was illustrated 

during a recent House subcommittee meeting in June where a 

State Representative noted that lifetime savings accounts would 

threaten the viability of Section 529 plans. Congress needs to be especially vigilant in protecting against the distortions in the finanVerDate 0ct 09 2002 08:28 Dec 16, 2004 Jkt 097046 PO 00000 Frm 00037 Fmt 6633 Sfmt 6633 C:\DOCS\97046.TXT SAFFAIRS PsN: PHOGAN
34

1The chart entitled ‘‘Value of a $10,000 investment after 18 years,’’ appears in the Appendix 

on page 165. 

cial services marketplace that governmental sponsorship of private 

enterprise invariably creates. 

Thank you again for the opportunity to appear here today. I 

would be happy to take questions. 

Senator FITZGERALD. Thank you. 

We are going to have some good basis for questions between this 

side of the panel and that side of the panel based on all that testimony. 

I want to start out asking Mr. McNeela and Mr. Bullard, you 

both basically seem to go in the same direction I went in my opening statement where I was questioning what benefit we get by allowing the States to run these plans and just charge an extra fee. 

Is there any benefit that you can see to having the States run these 

plans? Why can’t people go to a mutual fund provider and open a 

Section 529 plan and cut out this additional layer of fees? 

Mr. BULLARD. That is precisely what Congress decided to do with 

403(b)s, 401(k), IRAs, Roth IRAs, and Coverdell accounts. The entire list of accounts that have been created for tax-deferred purposes have done that and done it very well. There is absolutely no 

reason why States should be in the business of creating and developing and marketing these products, thereby essentially putting 

them in competition with industry. 

Senator FITZGERALD. And do all the States charge an additional 

fee for their services? Mr. McNeela, would you know? Are there any 

States that don’t charge an additional fee? 

Mr. MCNEELA. I am not aware of any States that don’t charge 

fees. I know Utah does have a money market option that they provide at no cost to investors, but outside of that, I am not aware of 

any other State that doesn’t charge fees. 

Senator FITZGERALD. If I could refer to this chart that I put up 

earlier 1 and I showed how much better somebody would do if they 

were in the Utah plan as opposed to the Rhode Island plan, which 

Ms. Williams pointed out no longer exists, and that is a good thing, 

but Utah, as I understand it, you are ranked as one of the best 

year in and year out by Morningstar. Mr. McNeela will confirm 

that Utah has one of the best plans. They use Vanguard as your 

underlying fund provider. 

My understanding, your total expense ratio is 27.5 basis points. 

Only 10 basis points of that is Vanguard, am I correct, and another 

17 basis points is charged by the State of Utah? Is that correct, Mr. 

Davis? 

Mr. DAVIS. Mr. Chairman, the Vanguard fees can range, depending on the option selected, up to 42 basis points. That is the highest. 

Senator FITZGERALD. So you are not just allowing people to invest in index funds? Vanguard’s index funds are very low. You 

have some that have expense ratios as high as 43 basis points at 

Vanguard? 

Mr. DAVIS. Yes, sir. 

Senator FITZGERALD. Are they not index funds? 

Mr. DAVIS. They are index funds, but not just——

35

Senator FITZGERALD. International index? 

Mr. DAVIS. Yes. 

Senator FITZGERALD. OK. But is it true that you impose an additional cost on—the State of Utah charges an additional fee on top 

of whatever Vanguard charges, right? 

Mr. DAVIS. That is correct. 

Senator FITZGERALD. And how much is that? 

Mr. DAVIS. That is $5 per $1,000 of account, up to $25 max. 

Mr. MCNEELA. But I believe there is also an administrative fee 

that is added on, and largely those expenses are to pay for customer service calls, administration of the plan in terms of servicing 

and sending out the account statements, unless I am missing something, because the Vanguard would just be providing the investment management expertise of the index funds and administering 

the accounts would be the responsibility of Utah and there would 

be costs associated with that. 

Mr. DAVIS. That comes out of the $25. 

Mr. BULLARD. Chairman, just to add to the issue of the extra 

layer of fees, that layer of fees will exist no matter what economic 

or regulatory structure is used because the way these work is just 

like 403(b)s, 401(k)s, and all those other types of investments. All 

the investments are pooled by some kind of intermediary who 

keeps track of the accounts. What actually goes into the mutual 

fund is one large account. So there will inevitably be those costs. 

And in 401(k)s, employers typically pick them up——

Senator FITZGERALD. Wait a second——

Mr. BULLARD [continuing]. IRAs, you pay an account fee. 

Senator FITZGERALD. OK——

Mr. BULLARD. So there is a parallel in all of the privately offered 

similar——

Senator FITZGERALD. Well, 401(k)s, yes, but I know some of them 

have expense ratios, total expense ratios as low as 10 basis points, 

for example. But what would prevent someone from going to—if 

Congress authorized individuals to open Section 529 plans directly 

at mutual fund complexes, what would prevent somebody from 

going into, say, a Vanguard and getting an index fund-based account that had a total expense ratio of 17 or 18 basis points? 

Mr. BULLARD. And that is exactly what would happen, but there 

will be people who live in a market channel where they are going 

to use an intermediary for whatever investment they make and——

Senator FITZGERALD. They might——

Mr. BULLARD [continuing]. They will get high-cost Section 529 

plans——

Senator FITZGERALD. There will be some who go, but now, with 

the current set-up, you have consumers paying brokerage commissions, loads. You have them paying management fees to the fund 

complexes. And then you have them paying a fee to the State Governments. I am just trying to figure out what benefit the State 

Governments bring for their additional fees. Now I will let the 

Treasurer defend this. 

Ms. WILLIAMS. Mr. Chairman. 

Senator FITZGERALD. Yes. 

Ms. WILLIAMS. Can I just make one statement? First of all, if an 

individual were to go to a mutual fund company and attempt to 

36

open a mutual fund, there is no mutual fund that I am aware of 

that you could get into for a $15 minimum. Mutual fund companies 

typically have very high minimums in order to come into many of 

those funds, and I think the States look at it from the perspective 

that we are trying to make these programs available to residents 

of every income level and that is why we establish very low points 

of entry for people who come into these plans. So I think that many 

people who are now able to have very small Section 529 accounts 

would never be able to go into a mutual fund because they simply 

do not have the initial investment amount that would allow them 

the opportunity to get into the fund. 

One thing I would like to correct that Mr. McNeela mentioned, 

you do not have to be an Ohio resident to participate in our lowcost options, and I would be happy to provide him with a copy of 

our offering statement. 

Senator FITZGERALD. Mr. Noven. 

Mr. NOVEN. I do think there is an importance in having someone 

that is overseeing what is being done in this area for people who 

are saving for college that is actually looking out for the consumer. 

In the State of Illinois, we have been able to add value in a number 

of ways. One, we have been able to get institutional share classes 

for investors that they wouldn’t get on the street. For 99 basis 

points in Illinois, that is an all-in fee. There is no account maintenance fees or set-up fees or annual fees, or any other types of additional——

Senator FITZGERALD. Of that 99 basis points, how much is paid 

to Smith Barney and how much does the State of Illinois retain? 

Mr. NOVEN. Smith Barney provides us 5 basis points to administer the program. We have a unique statute that the Treasurer 

drafted intentionally that any monies that we bring in with the 5 

basis points that is above what is needed to actually pay for the 

expenses of administering the Bright Start program, anything 

extra, in excess of that, is refunded as a dividend to participants 

or will reduce the fee of the program. So it is not a money-maker 

for the State of Illinois. 

Senator FITZGERALD. So is your net fee lower than the 99 basis 

points? 

Mr. NOVEN. It will be in the future unless we issue dividends. 

One way or the other, now that we have had a successful program——

Senator FITZGERALD. OK, but of that 99 basis points, how 

much—is Smith Barney keeping all but 5 basis points of that? 

Mr. NOVEN. Well, out of the 94 basis points that are remaining, 

all the internal fund management fees are paid out of that. A 

broker commission is paid out of that, so it is not charged to consumers if a financial advisor sells the product and——

Senator FITZGERALD. It is not possible for a consumer to pay a 

load——

Mr. NOVEN. No. 

Senator FITZGERALD [continuing]. Going in——

Mr. NOVEN. No. Smith Barney pays the load out of their fee because we didn’t want consumers that use financial advisors to be 

treated less well than——

37

Senator FITZGERALD. Are all the Smith Barney funds that you 

allow Bright Start participants, are they all index funds? 

Mr. NOVEN. No, they are actively managed funds. We actually 

have some non-Smith Barney funds. We have a lot of control to 

switch funds and make sure that consumers have funds that are 

performing and are doing well. We recently put in—actually, now 

it is probably a year and a half ago—we substituted an MFS fund 

that on the street would cost a consumer 180 basis points just in 

the fund management fees, not talking about a sales load or any 

other added fees, if they bought it on the street. They can get that 

as part of the 99 basis points through our program. So we have 

been able to negotiate some benefits for——

Senator FITZGERALD. Why would you allow—I mean, 88 percent 

of mutual funds, actively managed mutual funds, underperform the 

market, and they underperform the market almost by the exact 

amount of their fees. The markets returned, on average, a little bit 

under 12 percent over the last 20 years, and the average mutual 

funds returned about 2 percentage points, which is exactly their 

fees. I mean, why would you even encourage residents to go into 

an actively managed fund if they are just going to pay higher fees? 

Mr. NOVEN. There certainly is the age-old debate as to whether 

you are wiser to invest in an actively managed product or an indexed product. I think everyone would agree, if you are not looking 

out for your investments, if you are not an informed consumer, if 

you don’t have a State entity looking out for you and making sure 

those funds are performing with enough extra benefit to justify the 

fees, then you would be better off to invest in index funds. We are 

not a passive investor as the State Treasurer of Illinois——

Senator FITZGERALD. If I invested in a Bright Start index fund, 

will I pay less than the 99 basis points? 

Mr. NOVEN. Well, we don’t have an index fund that is currently 

offered, although we are looking at——

Senator FITZGERALD. There are no index funds that are offered? 

Mr. NOVEN. In Bright Start? No, there aren’t. We are looking to 

expand our offerings. I don’t want to go down that road, but the 

Treasurer is——

Senator FITZGERALD. Fidelity’s index funds charge 10 basis 

points now. They have lowered their fees to 10 basis points. 

Mr. NOVEN. We have had a fortunate run, Senator, but we are 

lucky to have outperformed the index, our benchmarks and outperformed what an index fund would have done. Of course, you 

never know how it is going to look over time, but so far, we have 

been successful and we are committed to trying to give the best investment product we can to consumers. 

Senator FITZGERALD. Mr. Ablowich. 

Mr. ABLOWICH. I guess, Mr. Chairman, one of the comments I 

would make is with regards to active management. While I think 

that your chart is an accurate mathematical calculation of the 

value of fees net of expenses and a return, I think one of the other 

things that we would emphasize in our plan is that we use 100 percent actively managed funds. We also use, which a lot of plans do, 

so-called age-based portfolios, so that when you first start out investing for your child—and I have a 101⁄2-year-old son that I participate in our plan for. When I opened the account for him when 

38

he was younger, it is much more—it is more heavily weighted in 

equities and over time it shifts more towards fixed income and 

cash. 

So in your example, let us assume you have a constant 8 percent 

compounded annual return. But what we think customers are concerned about is not necessarily seeing a straight line up at 8 percent, but as the markets go up and down, capture the up side, but 

also, when your child is ready to go to college, make sure those dollars are there. You may not be willing to accept the volatility when 

your child is a junior in high school or a senior in high school when 

you are waiting to pay tuition perhaps in 11⁄2 or 2 years from now. 

Senator FITZGERALD. Your New Hampshire Fidelity Advisor, the 

sheet that I have, suggests that it has a maximum expense ratio 

of 130 basis points. Is that right? 

Mr. ABLOWICH. That would be for the advisor-sold product, that 

is right, Mr. Chairman. Again, two products, one advisor-sold, 

broker-sold plan. There are some people who like working with a 

broker. The broker will give them that personal advice with regards to the unique plan, or assuming a Fidelity advisor——

Senator FITZGERALD. That includes Fidelity’s fee and whatever 

you take? 

Mr. ABLOWICH. Correct. 

Senator FITZGERALD. How much do you retain of that 130 basis 

points? 

Mr. ABLOWICH. In the 130 basis points you are looking at there, 

I am assuming that includes not only the underlying fee on all the 

mutual funds, but also 30 basis points that is split between the 

State and Fidelity investments, and there is probably in that number, as well, a trail for the broker that sold the advisor-sold product. Which is standard mutual fund pricing. 

Senator FITZGERALD Our Federal mutual fund, the Thrift Savings Plan, would any of you care to guess what we pay in expense 

ratios——

Mr. BULLARD. I was in it, and it ranges between about 5 and 8 

basis points. 

Senator FITZGERALD. Yes. It is going to be like 5 basis points for 

our total expense ratio. It is all index funds. We are lower than any 

of the private sector index funds out there but you get much lower 

expenses by going into low-cost index funds. I am just having trouble understanding, other than the tax advantages of having a Section 529 plan, it seems to me if the fees are so high in so many 

of these, so much higher than just index funds that anybody can 

go to, why would anybody be in the Section 529 plans but for the 

tax advantages? 

Mr. ABLOWICH. I think one of the issues to consider, Mr. Chairman, is the issue of the active management and an age-based portfolio, that you can’t have that security over time. You may be willing to take more risk at the beginning, but for some investors, they 

are not willing to sit down every year and constantly review their 

portfolio to make sure they have the right amount of risk given the 

investment horizon that they are looking for. 

So part of that cost, we believe, also goes to help an active management so that over time, you become more conservative, and 

39

again, limit that risk at the end of the period when they are ready 

to pay for tuition. 

Mr. BULLARD. Those lifestyle funds are also available in the private marketplace. There is nothing unique about Section 529 plans 

that provides you can only get them there. In fact, if Section 529 

plans were run like IRAs, you would have exactly the same funds 

being offered privately. 

Mr. MCNEELA. Right. And Utah, primarily using index funds, 

has age-based options, as well, that get more conservative as the 

child moves up to college age. So the bulk of that asset allocation 

decision can be handled easily in the framework of an index fund. 

The only potential for active management to surpass that is if they 

made a market call saying that the stock market was highly valued 

and pulled below to a low level of stocks relative to bonds to kind 

of mitigate some volatility. But it is questionable about how much 

benefit there is to that effort. 

Mr. BULLARD. If I could just put a face on Mr. Noven’s point 

about protecting the residents of Illinois from high-priced products, 

Mississippi has a $20,000 deduction for contributions to its plan, 

but this year, I plan on investing in the Utah plan because I would 

give back all of that tax deduction in a matter of years because 

Mississippi’s products are more expensive. I wonder how Mr. 

Noven explains to his constituents why those who choose lower-cost 

investments—and that would be easy to do at 99 basis points—why 

they are deprived of the Illinois State tax benefit if they go outside 

to get a better product than what Illinois is providing, not to mention the fact that Mary Schapiro’s testimony shows that your argument is simply failing. We have got 95 percent of these brokers, 

whether or not the State tax benefit is available somewhere else, 

going somewhere else. 

So the plan isn’t working. It deprives people of choice. And it 

ends up—and it has ended up for me costing me more money because I won’t be able to use the Mississippi State tax benefit. 

Senator FITZGERALD. If I can defend Mr. Noven, that may not be 

his responsibility. That is probably our State legislature that enacted the tax laws that penalize you if you go out of State, is that 

correct? 

Mr. NOVEN. What we did in Illinois is we sought to get the tax 

benefits to our residents when 35 States offered tax benefits to 

their own residents and it was primarily a state-by-state program. 

We sought to give those same benefits to our residents that other 

States got in their home States. 

What we have recently tried to do is promote legislation that 

would give the tax deduction to plans that were low-cost plans. We 

don’t think that the State should, as a government, provide a tax 

incentive for people to make bad financial decisions by going to the 

fastest-growing, highest-cost programs in the Nation. 

The industry hired lobbyists to kill the bill that would have extended these benefits to other low-cost programs because they don’t 

want the other low-cost programs to get traction. It is truly a consumer issue. 

We agree with you. I agree with what these folks are saying, 

other than 99 basis points being high because that is an all-in fee. 

That is not one of five different fees that is being charged. And if 

40

you look relative to other programs, it is one of the lowest cost in 

the Nation. 

Senator FITZGERALD. Do you agree with Mr. Bullard’s comment 

earlier that Congress should act to limit the States’ abilities to 

offer the tax benefits only to their own benefits? 

Ms. WILLIAMS. Mr. Chairman, can I just say that, coming from 

a State where we do offer a tax deduction, we feel that it is the 

State’s exclusive prerogative to decide whether they are going to 

offer a tax deduction and to whom to offer it. Frankly, very few 

States would be willing to extend a tax benefit to plans over which 

they exercise no fiduciary oversight. 

The other thing is that States lose tax revenues by providing deductions. 

Senator FITZGERALD. We require you to give tax benefits for 

401(k)s, don’t we? 

Ms. WILLIAMS. Well, that, I don’t know. I can’t address the 

401(k). I do know that with a Section 529 plan, in Ohio, you can 

only get the State tax deduction on contributions if you participate 

in our plan. However, on withdrawal of the funds, the withdrawals 

are State tax-free and the State allows that consideration for any 

plan. 

So I think the key is for States to provide effective product offerings so that they can be competitive, but I think that States are 

going to——

Senator FITZGERALD. But they are enacting protectionist legislation protecting——

Ms. WILLIAMS. Well, we certainly aren’t——

Senator FITZGERALD [continuing]. Their own State’s program 

from competition. 

Ms. WILLIAMS. We certainly aren’t, and I think that if these programs, particularly in a time of difficult State budgets, if our State 

were required to extend State tax benefits to any plan operating in 

the country, what would end up happening is that the State would 

withdraw the tax deduction for all plans, which I really think is 

what some in the industry want. If they can’t provide a competitive 

product and be competitive without the State tax benefit, then perhaps they shouldn’t offer a plan. But I think that the State has the 

prerogative to offer a State tax deduction only for their own plan 

if they want. 

Senator FITZGERALD. Mr. Bullard. 

Mr. BULLARD. So what you are telling Ohio residents is, we will 

give you a State benefit. We really want you to be able to afford 

college. But we will only give you the State tax benefit if you buy 

my product. 

Ms. WILLIAMS. That is exactly what we are telling Ohio residents, but we have told any Ohio resident that there are a wide 

variety of options available and we ask that they be very well educated. It is in our benefit as a State in the final analysis if every 

single child in our State has a Section 529 plan, whether it is ours 

or another State’s, because that means that there are resources 

available for that child to attend college, and hopefully they will 

stay in our State and contribute to the economy in our State. So 

we try to be competitive by offering a very wide variety of product 

offerings, and by the way, we do happen to have a tax deduction. 

41

Senator FITZGERALD. Mr. Noven, when you mentioned you would 

like the money to be invested in-state, with Illinois, you appointed 

Smith Barney as your agent as trustee and they are not based in 

Illinois. They are part of Citibank and they are based in New York. 

So the money isn’t invested in Illinois, is it? 

Mr. NOVEN. Yes, but I don’t believe I made that statement. If I 

did, I didn’t mean to state that. Also, to the previous question, if 

Congress——

Senator FITZGERALD. There is no real benefit when a lot of the 

States say, we want to keep this invested in-state. The money is 

really not invested in-state unless you are in New York or Massachusetts or maybe California or Philadelphia, where Vanguard is. 

In most States, it is not an issue. The money is not going to be invested in-state even if the plan is sponsored by a State. 

Mr. NOVEN. We are not talking about those assets actually being 

invested physically in-state. There are two things about having assets in Bright Start that are important to Illinois consumers. One, 

we believe it is a tested program. We are looking out for consumers 

and they are not being charged excessive commissions and fees. 

They are getting adequate disclosure. The Treasurer is not seeking 

to get any assets of any individuals in the State if they would do 

better in their home State because of tax benefits. We are running 

a consumer-friendly program that we feel good about, so we feel 

good about having our consumers in it. 

Also, there are economies of scale when it comes to college savings programs. We have 100,000 Illinois families that are invested 

in Bright Start and if Bright Start is raided by out-of-state programs that are entering into this broker bidding war to get brokers 

to ‘‘sell mine, sell mine,’’ then Illinois residents are hurt, and 

100,000 Illinois families will be hurt because our program will not 

be able to be viable unless we compete by paying brokers high fees, 

and we don’t want to enter into that bidding war. We want to have 

a nice even playing field. We would welcome Congress taking control of some of these issues. 

Senator FITZGERALD. How do consumers in Illinois benefit from 

having to go through the State of Illinois to invest in a college savings plan? And I would ask you that and also Ms. Williams. I 

mean, why do we need to have the State Governments involved in 

college savings programs at all? 

Mr. NOVEN. If Illinois——

Senator FITZGERALD. Shouldn’t you just be able to go online on 

Vanguard and open your own college savings account and just pay 

Vanguard’s fee and not a fee to the States? 

Mr. NOVEN. If Illinois consumers went directly to buy all the 

funds that are part of Bright Start currently, they would pay higher fees overall than if we hadn’t put this program together, we 

wouldn’t have negotiated institutional share classes that were 

lower using the economies of scale. We are bringing a billion dollars to a vendor. We are able to use, in the same way that we do 

with our Illinois Funds Investment Program in Illinois that I am 

sure you are familiar with——

Senator FITZGERALD. States haven’t negotiated low fees. Some of 

them have negotiated awful fees. 

Mr. NOVEN. Right. 

42

Senator FITZGERALD. The Rhode Island J.P. Morgan Higher Education Fund, 4.75 percent sales load, 135 basis points annual expense ratio, annual fees. You get clobbered in some of them. 

Mr. NOVEN. We agree, and those are the programs that we are 

unwilling to provide our tax benefits to and give consumers an incentive to join, because those are the types of programs that are 

not a good deal for Illinois consumers. 

Senator FITZGERALD. But will you provide your tax benefit——

Mr. NOVEN. To Utah? Absolutely. We tried to. We tried multiple 

pieces of legislation that would have given the tax benefit to people 

who invest in Utah. It is a wonderful program. It has got good fees. 

People should——

Senator FITZGERALD. The legislature defeated it? 

Mr. NOVEN. Yes. Well, the brokerage industry defeated it because they want to sell that plan over there that is on your chart 

and they don’t want to——

Senator FITZGERALD. Has anybody seen patterns of the brokerage 

industry coming in trying to—Mr. Bullard, would you——

Mr. BULLARD. I mean, that is exactly what I would expect them 

to do. But, in fact, whether or not you provide your in-state tax 

benefit to those out-of-state plans, the brokers are going to sell the 

out-of-state product and so that theory is not succeeding. All you 

are really accomplishing is the people in Illinois who want to buy 

a better plan, that is, the Utah plan, are unable to do that and get 

the same State tax benefit that those who invest in your high-cost 

plan, your 99 basis point plan, get. 

Mr. NOVEN. Some day, I would like to sit down with you and talk 

about fees and show you what our fees are so we can all talk from 

the same——

Mr. BULLARD. The best thing that a State——

Mr. NOVEN [continuing]. But I would like to say, as a fiduciary, 

as State Treasurer, we feel an obligation not to provide a financial 

incentive to make it easier for brokers to put people in a plan that 

is not in their best interest and I think the Treasury has an obligation to do that as a policy maker. 

Mr. ABLOWICH. Mr. Chairman, one thought I had for you is that 

when we are talking about broker-sold programs in the Section 529 

area, the pricing is really not that much different than broker pricing for any other mutual fund product. I know that your Subcommittee has worked, discussed this issue of the mutual fund industry and fees and governance and oversight and transparency. 

The National Association of State Treasurers and CSPN has a long 

history of supporting thoughtful efforts in this area. 

To the extent that those efforts are successful and costs come 

down and transparencies improve, all of those benefits are ultimately passed on, as well, to Section 529 investors, as well. I think 

that is important to mention, because this pricing that you are 

talking about exists today not just in Section 529, but in retirement 

plans and so on. 

The other thing I would offer is that we heard from the NASD 

that they are investigating and gathering information about questionable broker practices. At this point, we don’t have any specific 

instances of where brokers are making unsuitable, or not taking 

into account the suitability of investors. But to the extent that 

43

there are those documented cases, I welcome—and I know all of my 

colleagues do—getting that information so that we can work with 

our plan administrators. 

And then also when I go back to Concord, I can walk upstairs 

to see our State Securities Regulator and ask him or her, is this 

something that we should be—what are you doing in this area? 

Here is something you should be aware of, as well, because those 

State Securities Regulators are typically on the front line of working with those individual investors. So that is another important 

point I wanted to bring up for your information. 

Ms. WILLIAMS. Mr. Chairman, can I just say that I think one of 

the things that the States do, long before the savings plans were 

offered, we worked to offer a prepaid plan. We have a full-service 

organization. We have marketing representatives who live in various regions of our State who work with very small organizations. 

Increasingly over the years, we have decreased the average age of 

enrollment in our plan to 5 years of age. We work with over 2,000 

employers in our State to offer payroll deduction because we believe that small investors should have access to these investments, 

as well. 

Unfortunately, with the high minimum entry in most of these 

mutual funds, the average consumer would never have the opportunity to participate in these mutual funds were it not for the fact 

that we allow them to get in with as little as $15. That has been 

the fact since we first started our savings program and we are 

going to continue to require that people be able to get in with as 

little as $15 and can save as little as $15 a month if they want to 

do it in a systematic way. They could not do that if they were enrolling directly with a mutual fund company. 

Senator FITZGERALD. What about the disclosures, or the lack of 

disclosures, in the Section 529 area? We have had repeated testimony that the State Governments as trustees of these plans are exempt from the Investment Company Act of 1940 and don’t even 

have to make the minimal disclosures that ordinary mutual funds 

have to make. How do the Treasurers feel about that, Mr. Noven. 

Mr. NOVEN. Go ahead, Mr. Ablowich. 

Mr. ABLOWICH. I think that the disclosure principles we put together are certainly a very important first step. They are not going 

to be perfect. That is why we have asked the NASD—well, we 

haven’t asked the NASD—the Securities and Exchange Commission and the MSRB to comment on what was prepared to get their 

feedback. Even before we received their feedback, around 30 States 

have already started adopting these principles and incorporating 

them into their disclosure documents. 

Senator FITZGERALD. Do these principles require a dollars and 

cents disclosure, or are all the expenses stated in percentage 

terms? 

Mr. ABLOWICH. They are used in dollars and cents disclosure, 

Mr. Chairman. 

Senator FITZGERALD. They are? OK. That is good. Mr. Bullard. 

Mr. BULLARD. They provide for dollar disclosure of dollar fees. 

They do not require a dollar disclosure of individualized costs and 

expenses that you are paying. They include an example that is 

44

1The ‘‘529 Plan Information’’ chart from the Morningstar website appears in the Appendix on 

page 167. 

similar to the mutual fund example on a hypothetical investment, 

but not individualized cost disclosure. 

Senator FITZGERALD. Mr. Noven, did you have something to——

Mr. NOVEN. I was going to say, we support the work that the 

College Savings Plan Network is doing on these disclosure requirements but we think they need to be mandatory. We think they 

need to go further. The Treasurer feels especially strong about disclosing the fact that there may be tax benefits that a resident may 

be giving up, so that people know that. We have that notification 

in our glossy brochure, not on page 85 of a program disclosure 

statement. We feel very strongly about disclosure. We think it is 

a great first step. We should go even further. 

Senator FITZGERALD. I would like to let Mr. McNeela have a 

chance to talk for a second. 

Mr. MCNEELA. Just from my perspective, it is hard for investors 

to have confidence that they are getting all the information they 

need when the disclosure requirements are voluntary and the fund 

company or the plans can choose to follow some of the requirements that are recommended but ignore others at their discretion. 

It makes very little sense to me to allow that situation to exist. 

Senator FITZGERALD. You have prepared a chart that is available 

on the Morningstar website,1 apparently, that discloses the fees for 

Section 529 plans, and you have the program manager’s fees on the 

left and then the expense ratio on the right. Are the program manager fees the fees paid to the State Governments? Do they include 

the expense ratio charged by the underlying fund manager? 

Mr. MCNEELA. The program manager fees typically do not include underlying fund fees, but they can include broker compensation in the form of 12b–1 fees. 

Senator FITZGERALD. OK. Where it says the Alaska John Hancock Fund charges a maximum program manager fee of 165 basis 

points, is that in addition to the maximum expense ratio of 130 

basis points? 

Mr. MCNEELA. Yes, it is. 

Senator FITZGERALD. It is? So we are up to, like, 3 percentage 

points in total fees on that fund? 

Mr. MCNEELA. It is not always appropriate to add maximums 

and maximums together because sometimes they will give you a 

discount on one or the other, but yes, that sounds possible that 

total expenses could be well in excess of 2 percent if a B or C Class 

share was sold which had large 12b–1 fees, administrative fees, 

and underlying fund fees, as well. 

Senator FITZGERALD. Now, on the Illinois Bright Start plan, they 

list a program administration fee at 99 basis points, but then they 

say an additional 65 basis points is paid in expenses? 

Mr. NOVEN. That is incorrect. That is an error in the chart. 

Mr. MCNEELA. And that was my qualification—I am sorry, if I 

could just talk to that for one minute—where Illinois has a flat fee 

of 99 basis points regardless of——

Senator FITZGERALD. And that includes the expense ratio——

45

Mr. MCNEELA. But they also make an effort to break out the 

costs for underlying fund fees and administrative fees and those 

vary depending on the investment options, but the total always 

comes out to 99 basis points. 

Senator FITZGERALD. So even if you invest in a lower-cost fund, 

you will still pay 99 basis points? 

Mr. NOVEN. You are paying 99 basis points to invest in a fund 

that is usually 180 basis points on the street, but you are also paying 99 basis points to invest in a fund that may be 65 basis points 

on the street because there are the extra administrative fees that 

are charged by the vendor to comply with the IRS regulations. 

Senator FITZGERALD. But it is always 99 basis points and no 

other charges? 

Mr. NOVEN. Right, and we thought that was the best way to disclose fees to consumers, to not have a $30 account maintenance fee 

that is paid every year. If you have a small balance, that is a huge 

percentage. So all those other little expenses that consumers may 

not be aware of that they are going to get socked with going forward——

Senator FITZGERALD. Now, you disclose the 99 basis points. Do 

you disclose it in dollars and cents? Do you explain the impact of 

the fees paid by consumers over time? Do you show them how 

much their savings erode over 18 years of investing by paying 

those fees? 

Mr. NOVEN. We certainly incorporate that into the discussion, 

and we are very interested in——

Senator FITZGERALD. And if I am in Bright Start, do I get an annual account statement? 

Mr. NOVEN. And monthly statements and regular reporting. 

Senator FITZGERALD. And monthly statements? 

Mr. NOVEN. Yes. And we will be glad to give you copies of what 

we do. We are very proud of the way we do it and how we disclose 

information. We would be glad to share it with you. 

Senator FITZGERALD. That would be very expensive to send 

monthly statements. 

Mr. NOVEN. We have a vendor that is required to do that. 

Senator FITZGERALD. Solomon Smith Barney is required to do 

that, but that adds to their whole—they probably charge you more. 

Mr. NOVEN. Well, we believe we negotiated a good contract. 

Senator FITZGERALD. All right. Ms. Williams. 

Ms. WILLIAMS. I would just say that I think that a lot of States 

have made a lot of progress in this matter. In fact, we do have one 

page in our document that shows what all the program fees and 

expenses are. 

I appreciate Morningstar and other organizations who are looking at these matters, but I guess my concern is how frequently is 

the data updated to reflect changes in State programs? I know that 

in June, Mr. McNeela and I had a conversation regarding where 

they get their information in order to be able to display it and how 

often it is updated. So I think it is a good thing and I think that 

will put pressure on States to make sure their information is accurate. I just want to make sure that the information is reflected accurately and is up to date. 

46

It is in the best interest of the State to make sure that they adhere to these disclosure guidelines and, in fact, that they go beyond 

the voluntary disclosure guidelines, because clearly, as it becomes 

easier to compare plans, their plans are going to suffer by comparison if they have made it very difficult for people to be able to find 

the information they need to make a valid comparison. 

So my only request would be that information is timely and up 

to date and accurate, because many times, articles have been written, comparisons have been made, and information is simply not 

accurate, and that has accrued to the detriment not only of the 

State programs, but also consumers who are trying to make valid 

comparisons and who often find themselves paralyzed into doing 

nothing regarding savings. All the while, college expenses continue 

to escalate. 

Senator FITZGERALD. You don’t want to ever offer a bad plan because it will stay with you forever, hang out there on the Internet 

and people will see it, even if you have withdrawn a bad plan. 

Ms. WILLIAMS. That is right. 

Senator FITZGERALD. So maybe the lesson is never to offer a bad 

plan. But listen, all of you have been terrific. I posed some tough 

questions—Mr. Davis, do you have something to add here? 

Mr. DAVIS. One comment, Mr. Chairman. As I sat here between 

crossfire on my left and right, I thought about your question, what 

do States add, and I think it is important for you to know that 

there are a fair number of middle- and low-income people in our 

State who have not been served and are not currently served by 

the free market of the Smith Barneys and the Fidelities of our Nation who are now saving. We are working on that and we are seeing a tremendous support of that. The fact that we have put together a fairly decent program cost-wise which has drawn a fair 

number of out-of-state investors, we are seeing much more progress 

in the State, which the intent of the Board was to accomplish. And 

so that is where our success comes from. 

Senator FITZGERALD. Do all of your States competitively bid out 

your asset management? 

Ms. WILLIAMS. We certainly do, yes. 

Mr. NOVEN. Yes. 

Mr. ABLOWICH. Yes. For the record, yes. 

Mr. DAVIS. We manage internally. 

Senator FITZGERALD. You manage—well, you have Vanguard, 

though. How did you select Vanguard? 

Mr. DAVIS. The State Treasurer has dealt with them, among others——

Senator FITZGERALD. Is there a bidding process or a request for 

proposal or how did they do that? 

Mr. DAVIS. We piggybacked on the State Treasurer’s contract initially and have stayed there. 

Senator FITZGERALD. OK. In Illinois, I understand you are about 

to rebid? 

Mr. NOVEN. We are bidding an advisor-sold plan. We are concerned that consumers that work through financial advisors are not 

being offered a low-cost, low-commission, quality program that 

would suit their needs. We are concerned that most of the brokerVerDate 0ct 09 2002 08:28 Dec 16, 2004 Jkt 097046 PO 00000 Frm 00050 Fmt 6633 Sfmt 6633 C:\DOCS\97046.TXT SAFFAIRS PsN: PHOGAN
47

age commissions that are being paid—everyone has risen up to the 

5.75 percent, all trying to jockey for position——

Senator FITZGERALD. What percentage of your participants pay a 

brokerage commission? 

Mr. NOVEN. Well, none of our participants pay a brokerage commission——

Senator FITZGERALD. They can’t. 

Mr. NOVEN. They cannot. Smith Barney absorbs that. 

Senator FITZGERALD. OK. 

Mr. NOVEN. But a lot of folks that go to brokers that do not want 

to sell the Smith Barney product, they do want to have a product 

to sell consumers in Illinois, their consumers that work with them, 

and if we could find a consumer-friendly advisor-sold plan, we 

think we would be providing a real service to Illinois consumers. 

So we are looking at that, as well. 

Senator FITZGERALD. So most people are still going to their brokers to figure out where to get one of these, and they don’t realize 

that their broker is going to get paid a fee out of their savings in 

order to steer them into a plan. 

Mr. NOVEN. A very large fee, right. 

Senator FITZGERALD. Yes, but now, will that change as the SEC 

is now going to require a statement at a point of sale? 

Mr. BULLARD. As currently proposed, it wouldn’t include any reference to the State tax advantages. But it is simply unrealistic to 

think that a broker is going to give up any compensation at all in 

order to recommend an Illinois product. I mean, it is just not going 

to happen and it is not realistic to think that has any kind of deterrent effect. 

Mr. NOVEN. We actually have a lot of selling agreements with a 

lot of folks and there are—while I share his skepticism about brokers, there are a lot of brokers who are doing the right thing, using 

a low-cost college savings program as a way to build trust with the 

client and make money off of other products. We actually think 

that is the right way to go. We are not going to be competing with 

the most expensive plans in the Nation because they will follow the 

money, but there are a core group of brokers that we believe will 

do the right thing——

Senator FITZGERALD. Vanguard is the second largest mutual fund 

in the country. It has done that largely by having the lowest cost. 

When John Bogle was the Chairman, the company never advertised. It is much younger than Fidelity, which goes back to the 

1940’s. Bogle founded Vanguard in the 1970’s, and it grew to the 

second largest just on word of mouth, because of having the lowest 

fees. 

So if your fund is really a good deal and it is going to get high 

rankings from Morningstar, consumers will figure that out, won’t 

they? Even without brokers and without paying loads, you will 

have money migrate to your fund. 

Mr. NOVEN. If consumers would figure it out on their own—I 

think brokers talk them out of that when they go into their office 

frequently. If consumers would figure it out on their own, the largest programs in the Nation right now would not be the ones that 

charge consumers the most money. We don’t think the system is 

working, which is why we are excited about——

48

Senator FITZGERALD. What is the largest right now in the country? 

Mr. NOVEN. I think Virginia is the largest one. I think they have 

got something like 7——

Senator FITZGERALD. But that is a pretty good plan, at least according to Morningstar, isn’t it? 

Mr. MCNEELA. It is a broker-sold plan, but it is a quality plan 

with terrific investment choices and flexibility. 

Senator FITZGERALD. Who is the underlying manager? 

Mr. MCNEELA. The American Funds. 

Senator FITZGERALD. OK. And Nevada also has a top plan, 

doesn’t it? 

Mr. MCNEELA. Right. Nevada primarily uses Vanguard, at least 

for one of their plans. 

Mr. BULLARD. Mr. Noven’s point really just tells us that most 

people buy through intermediaries, so logically, the plans that use 

intermediaries are going to be the largest. 

Senator FITZGERALD. OK. 

Ms. WILLIAMS. Mr. Chairman, about half of our State residents 

have purchased directly from our agency and the other half have 

used financial intermediaries. 

Senator FITZGERALD. Maybe we should just cap what kind of a 

load or commission can be paid to the brokers. 

Mr. BULLARD. Well, the first step would be to apply expressly to 

brokers of Section 529 plans the NASD limits——

Senator FITZGERALD. Which are? 

Mr. BULLARD [continuing]. Which MSRB cannot legally do. 

Senator FITZGERALD. Right. So there is no limit now. 

Mr. BULLARD. Well, the MSRB can impose a fair and reasonableness standard, but they can’t expressly state that we always consider that to be the NASD limit. So there are going to be cases 

where——

Senator FITZGERALD. If a fee is paid, if a load is paid to a broker, 

say a 6 percent load, is that disclosed to a Section 529 purchaser? 

Mr. BULLARD. Not in dollars, but, of course, that is also true for 

mutual funds and the SEC proposal will, one way or another, address that in both contexts. 

Senator FITZGERALD. And require a dollar——

Mr. BULLARD. Both for Section 529 plans and for mutual funds. 

Senator FITZGERALD. OK. But right now, there is technically no 

limit on the load? 

Mr. BULLARD. Technically, no limit other than the MSRB’s fair 

and reasonable standard. 

Senator FITZGERALD. Unbelievable. 

Mr. NOVEN. We tried that in Illinois. We tried to provide a tax 

benefit to any State that would agree to charge a load that was 

under a certain cap. It was a 4 percent cap, and we thought that 

was a reasonable amount of compensation for a financial intermediary. That is what brought all the brokers out of the woodwork 

and that is why there is a fleet of lobbyists working on the issue 

in Illinois. You should see how full our conference room was after 

we tried that in Springfield. It is a hard issue to tackle. 

Senator FITZGERALD. OK. All right. Well, thank you all. You have 

been great——

49

Mr. BULLARD. Chairman, if I could just take a second——

Senator FITZGERALD. Yes. 

Mr. BULLARD. I don’t know if I will be back here by the end of 

the year, but I wanted to thank you for your leadership on financial services issues, especially over the last 12 months or so, and 

hope that you will continue the battle—either rejoin the Illinois 

Senate race or continue the battle outside of your tenure here in 

the Senate. 

Senator FITZGERALD. I am hoping somebody takes up the issue 

after I am gone, and my last day is January 2, but I certainly appreciate the help you supplied, Mr. Bullard. You were a great witness a year ago at this time, and I do think our hearings on high 

fees led to some of the fund complexes lowering their fees, as we 

have seen. That will, over time, result in a lot more money for savers. 

I want to thank all the witnesses today. I would like to mention 

that Senator Akaka, the Subcommittee’s Ranking Democratic 

Member, wanted to be here but was unable to attend. He will submit a statement for the record. 

[The prepared statement of Senator Akaka follows:]

PREPARED STATEMENT OF SENATOR AKAKA 

Thank you, Senator Fitzgerald for your continued leadership in helping Americans understand more fully the opportunities and risks available to them as investors. As a father and grandfather, I know the considerable burden facing young people and their families when it comes to financing college educations. As a former 

educator, I believe that investing in an education is one of the most important investment an individual can make. 

In response to rapidly escalating college tuition costs, Congress amended the Tax 

Code in 1996 to create tax-advantaged programs to help families save for college. 

These programs are called 529 plans after the section in the Tax Code. One of the 

programs is a college savings plan. These plans offer investors the opportunity to 

contribute to a trust fund and accrue tax-free interest if funds are withdrawn solely 

to pay for education expenses of a selected beneficiary. Qualified 529 college savings 

plans are sponsored by states which may directly administer their plans or select 

companies to manage the funds. 

These state-sponsored savings plans offer families and individuals the ability to 

save for education expenses at any accredited public or private educational institution, including colleges, universities, law or medical schools, and most community 

colleges. Earnings accumulate on a tax-deferred basis and distributions used for 

qualifying education costs are tax-free. Non-qualifying distributions are subject to 

a ten percent federal tax penalty and possible state tax liabilities. As with other investment vehicles, investors pay assorted fees to cover account costs, and the plans 

provide no guarantee of a specific rate of return. 

Recently, the true costs of 529 college savings plans have generated substantial 

attention. Many individuals have questioned the basis of plan fees and whether 

these fees diminish the tax benefits of the plans. Moreover, because the plans are 

not governed by federal investment or securities laws, there is inconsistent oversight 

and lack of transparency associated with these plans which has further elevated 

public concern. This situation is similar to the problems the Subcommittee examined in the mutual fund industry. 

I firmly believe that transparency and accountability must be a priority of the investment industry. Brokers and investment employees should disclose the costs and 

terms of the products they sell and provide a potential investor with the information 

needed to make informed decisions. An accurate assessment and picture of investment costs and returns should remain paramount. 

Because 529 college saving plans are state-sponsored and not regulated under federal securities laws, the Security Exchange Commission (SEC) cannot require the 

same registration and reporting requirements that exist for mutual funds. However, 

six months ago SEC Chairman William Donaldson formed the Chairman’s Task 

Force on College Savings Plan to examine the structure and sale of the plans, and 

I look forward to this review. 

50

There are questions to be asked: Should federal securities laws govern some aspects of 529 plans because investors now face inconsistent disclosure policies that 

may result in unforeseen fees? How do states select plan managers, and how are 

fees and costs to investors allocated? 

Moreover, as long as investors in a college savings plan may opt to purchase a 

plan offered by a state where he or she does not reside, consumers must be able 

to compare different state plans in order to make informed investment decisions. 

Due to the complex nature of these plans and the lack of meaningful disclosures, 

I believe there should be strong financial literacy and investor education programs. 

Such programs are necessary so that investors may choose the plan that best meets 

their financial situation and savings goals. Furthermore, promoting transparency 

will undoubtedly enhance the financial benefits of these plans and the educational 

opportunities they put within reach of plan recipients. 

I look forward to working with Senator Fitzgerald and our colleagues to help investors better understand 529 college savings plans. I also wish to thank today’s 

witnesses for sharing with us their concerns and recommendations.

Senator FITZGERALD. The record will remain open for 1 week, 

until next Thursday, October 7. 

With that, this hearing is adjourned. Thank you all very much. 

[Whereupon, at 1:05 p.m., the Subcommittee was adjourned.] 

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