The retirement security of millions of American workers is increasingly tied to an investment vehicle that most have never heard of, and whose dramatic growth over the last 40 years has received almost no regulatory or academic scrutiny.

With nearly $7 trillion dollars in assets, “collective investment trusts” (CITs) are replacing mutual funds on the investment menus of employer-sponsored retirement plans.[1] CITs now hold nearly 30 percent of all assets in defined contribution plans, up from just 13 percent a decade ago.[2] The size of CITs has made them important not only as retirement savings vehicles, but also as institutional investors. CIT providers are now lobbying Congress to expand access to CIT investments.[3]

What Are CITs?

Like mutual funds, CITs are pooled investment vehicles that combine assets from eligible investors into a single fund with a specific investment strategy. CITs are functionally similar to mutual funds and in some cases may hold the same underlying investments. But CITs are not mutual funds. Indeed, CITs and mutual funds are subject to very different governance and oversight regimes.

Mutual funds are set up by investment management companies, are available to the general public, and are regulated by the Securities and Exchange Commission (SEC). In contrast, CITs are set up by banks or trust companies, available to individuals only through employer-sponsored retirement plans, and regulated primarily by the Office of the Comptroller of the Currency (OCC) and, in some cases, by the Department of Labor (DOL).

Relative to mutual funds, CITs face fewer registration and reporting requirements and fewer restrictions on the types and composition of permissible investments. CITs and CIT interests are exempt from registration with the SEC under the Investment Company Act of 1940 and the Securities Act of 1933. CITs do not need a registration statement or a prospectus. Although CITs, like mutual funds, may hold shares of public companies and exercise the corporate voting rights afforded such shares, CITs are not subject to the securities law requirements to publicly disclose their voting records or to give fund investors voice in fund governance. Instead, in a CIT structure, exclusive management responsibility rests with the bank trustees who cast votes on behalf of the trusts.

Industry participants cite lower compliance and marketing costs as a key reason CITs have lower fees than do comparable mutual funds. Morningstar reports that “when comparing the net expense ratio of CIT tiers and mutual fund share classes of the same strategy, CITs are cheaper 88% of the time; and considering only the least-expensive CIT tier and mutual fund share class, CITs are cheaper 92% of the time.”[4] The cost differences matter because even seemingly small differences are compounded over decades in retirement savings accounts.

In an environment where retirement plan sponsors have faced significant litigation risk over excessive retirement plan fees, the existence of lower fee options that offer investment strategies that are the same or similar to those offered by mutual funds has precipitated the exodus out of mutual funds in favor of CITs. At the same time, the management companies that once lobbied intensely against bank-run CITs have set up trust subsidiaries and affiliated banks to establish their own CITs.[5]

In my working paper, I offer several considerations for a robust analysis of the retirement security and corporate governance tradeoffs associated with CITs.

First, while lower fees and flexibility are important, the savings must be weighed against the additional risks associated with CITs. Compared with mutual funds, CITs face fewer limitations on the types and composition of potential investments and are subject to different liquidity, pricing, reporting, and redemption rules. The SEC has begun to raise concerns about the risks stemming from such regulatory gaps and the “financial fires” that could spread in the absence of consistent regulation.[6] Simultaneously, because they are subject to fewer disclosure and reporting requirements, it is harder to compare CITs across retirement plans. Whereas price and performance data for mutual funds are readily available to the public, comparable data for CITs is not. Industry participants have recognized the need to improve transparency, particularly with respect to the disclosure of all-in costs.[7] In the absence of robust, publicly available information, the ability of analysts and private plaintiffs to provide oversight and enforcement is necessarily limited.

Second, the regulatory framework for CITs developed within the context of defined-benefit pension plans, which are increasingly rare in the private sector. The rise of defined contribution plans alters the regulatory calculus and necessitates closer examination of the regulatory framework to protect individual retirement plan participants who hold CIT interests. When the decision was made to allow CITs to operate outside the securities law requirements, the potential risks of investing in CITs were borne by employers who, in the context of defined benefit plans, were ultimately responsible for paying the promised pension benefits to employees, irrespective of how the underlying investments performed. Today, however, a wide swath of the general public is exposed to CITs and directly affected by their performance. The current regulatory structure defers to a bank regulator to oversee a retirement savings vehicle and places great responsibility on employer intermediaries, who may not have the resources or expertise to provide effective intermediation between CITs and individual participants. Furthermore, litigation involving CITs has shown that some asset managers and other service providers may be motivated to push retirement plan participants into newly formed, affiliated CITs. Such cases raise the possibility of conflicts of interest that can arise when asset managers are rushing to enter the CIT market.

Finally, the governance of CITs and their role as institutional investors deserve further examination. Unlike investors in mutual funds, investors in CITs have no voting rights and, at the same time, have limited exit rights. Further analysis is needed to assess the effectiveness of the intermediation and oversight provided by plan sponsors and the impact of subjecting some CIT trustees to the fiduciary standards under the Employee Retirement Income Security Act.  Furthermore, unlike mutual funds, CITs are not subject to proxy voting disclosure requirements, and there is no public accountability for how bank trustees or their subadvisors cast votes. In 2002, after the SEC finalized new requirements for the disclosure of proxy votes by mutual funds, there was some indication that the OCC was “weighing whether to require bank trust departments to disclose how they cast proxy votes on behalf of the clients whose money they manage through investment pools.”  At the time, mutual funds complained that the SEC rule had excluded CITs and had thus created “an unlevel playing field.”[8] The OCC never did enact such rules for CITs. Two decades and trillions of dollars later, asset managers are able to level the playing field themselves by setting up CITs and encouraging retirement plans to move their assets out of mutual funds and into collective investment trusts. To the extent that the same considerations that prompted proxy vote disclosure requirements are still important, the disclosure requirements for CITs merit closer examination.

As collective investment trusts continue to replace mutual funds in retirement plans, and as Congress considers expanding access to CITs, the costs and benefits of such investment vehicles must be evaluated carefully to ensure that they promote both retirement security and robust corporate governance in the United States.

ENDNOTES

[1] Gary Gensler, Chair, Sec. & Exch. Comm’n, “Bear in the Woods,” Remarks Before the Investment Company Institute (May 25, 2023), https://www.sec.gov/news/speech/gensler-remarks-investment-company-institute-05252023#_ftnref27 (noting that “[c]ollective investment funds are estimated to be $7 trillion, $5 trillion at the federal level and $2 trillion at the state bank level”).

[2] See Lia Mitchell, Morningstar Ctr. for Ret. & Pol’y Stud., 2023 Retirement Plan Landscape Report: An In-Depth Look at the Trends and Forces Reshaping U.S. Retirement Plans (2023).

[3] Brian Croce, House Committee Advances Bill Allowing 403(b) Plans to Offer CITs, Pensions & Invs., May 25, 2023, https://www.pionline.com/defined-contribution/house-committee-advances-bill-allowing-403b-plans-offer-cits.

[4] Mitchell, supra note 2, at 25.

[5] Management companies such as Fidelity, Vanguard, and State Street have all started to offer CITs through affiliated trust companies or banks.

[6] Gensler, supra note 1.

[7] Jasmin Sethi, Morningstar Inc., Lia Mitchell & Aron Szapiro, Ctr. for Ret. & Pol’y Stud., CITs: A Welcome Addition to 403(b) Plans(2020) (noting the “limited” transparency of CITs); Cerulli Assocs., CIT Provider Survey 7 (2019) (finding in the survey that less than a quarter of CIT providers publicly report “all-in” costs); Howell E. Jackson, A System of Fiduciary Protections for Mutual Funds, in Fiduciary Obligations in Business (Arthur Laby & Jacob H. Russell eds., 2021) (noting that “e[ven proponents of CITs recognize the need to improve product transparency, including more comprehensive disclosure of all in-costs”).

[8] Kathleen Day, Trusts May Be Next to Get Proxy Rules, Wash. Post, Jan. 31, 2003, https://www.washingtonpost.com/archive/business/2003/01/31/trusts-may-be-next-to-get-proxy-rules/a5727e48-ec75-44a2-82b0-7fe7635af0c5/.

This post comes to us from Professor Natalya Shnitser at Boston College Law School. It is based on her recent article, “Overtaking Mutual Funds: The Hidden Rise and Risk of Collective Investment Trusts,” available here.