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529 E-ditorials

05-4: The 529 marshals have arrived
Joe Hurley
Tuesday, August 30th 2005

About a week ago I contacted the office of New York State Attorney General Elliot Spitzer to ask if they had initiated any action with respect to the Utah Educational Savings Plan. As you may already know, Utah authorities discovered last year that Dale C. Hatch, who at that time was executive director of the state’s 529 plan, had been stealing money from the program trust fund. Was the NY attorney general on top of this situation?

The Utah 529 plan has over one billion dollars in assets, with the large majority of that money coming from non-Utah investors. Although I am a resident of New York, I have a 529 account in Utah plan as well as in 32 other states, and I know that I am just one of thousands of interested parties. Even John Roberts, the current U.S. Supreme Court nominee and a resident of Maryland, has money in Utah’s 529 (more than $200,000 according to his financial disclosure forms).

The job of Mr. Spitzer’s office and other state securities regulators is to protect the little guys like you and me from bad apples. At least that is what their trade organization, the North American Securities Administrators Association (NASAA), tells us. And, in fact, these civil servants have made many headlines over the past few years by wrestling huge settlements from the largest brokerage firms, mutual fund companies, and other financial product purveyors for various misdeeds.

To be perfectly honest, however, I don’t expect Mr. Spitzer’s office to be very responsive to my inquiry, even if they eventually do get back to me. Going after mutual fund companies and brokerage firms is one thing; but picking a fight against another state? That could be considered bad form and might threaten the collegiality at NASAA conferences. But if the states aren’t completely willing or able to protect our interests, is there anyone else who is?

The answer to that question now appears to be “yes.”

The U.S. Securities and Exchange Commission announced this past month that it had stepped into the 529 arena, initiating a cease-and-desist action against UESP and a civil action against former director Hatch. What is surprising about this development is that only 18 months ago the SEC told Congress that it did not have the authority to police 529 plans. In response to an inquiry from House Financial Services Committee Chair Michael Oxley, the SEC explained that as municipal securities, 529 plans are exempt from SEC registration, and therefore the SEC’s only means of asserting jurisdiction over a 529 plan is under its broad anti-fraud powers. That is precisely what they relied on in Utah’s case.

The SEC actions have served as yet another wake-up call to the states, following criticism about fees and program disclosures voiced during last year’s House and Senate committee hearings. To be fair, Utah authorities deserve credit for taking aggressive actions to clean up their act even before the SEC got involved. Dale Hatch had been fired and prosecuted, investor accounts were reimbursed, outside consultants were brought in, accounting and internal control systems were redesigned, and disclosures were improved. We should also acknowledge the vigorous self-regulatory efforts of the states working together as a group. New program disclosure guidelines have been developed by the College Savings Plans Network (an affiliate of the National Association of State Treasurers) and recently approved by its members. State legislators, treasurers, and 529 plan oversight boards seem to be increasingly vigilant and willing to make statutory and programmatic changes when necessary for the protection of its 529 plan participants. Most states have placed the accounting and custody of 529 assets in the hands of some of the largest and most respected investment firms in the nation, making it highly unlikely, if not impossible, for the Utah situation to occur. And with regard to the sale of 529 plans by brokers, we’ve seen a ramp-up in regulatory notices and compliance enforcement coming from both the Municipal Securities Rulemaking Board and the NASD (these do not directly affect non-broker 529 plans like Utah’s).

In spite of the progress made by the states in self-regulating their college savings programs, it’s natural to think that some states will do a better job than others. And until the NASAA decides to put this issue on their agenda, I don’t think you can expect a state attorney general to be your backstop. Perhaps the best decision made by Utah in the wake of its 529 scandal was to accept the SEC’s findings, and not fight it on jurisdictional grounds. To me it’s an indication that the states and the federal government are willing to work together in the best interest of 529 investors.

Ironically, the SEC is not immune from giving out misleading information to investors. Simultaneous with the announcement of its settlement with Utah, the SEC released its new guide “An Introduction to 529 Plans.” While helpful in many ways, the guide perpetuates the widespread but incorrect belief that the prepaid-tuition type of 529 plan permits you to buy future tuition “at today’s prices.”

In almost all state-run prepaid plans you are buying future tuition at a price higher than current tuition rates. In some plans, this premium can be substantial enough that it will take years of tuition hikes before it is earned back. The private-college Independent 529 Plan is different, as its member colleges must offer a discount from their current tuition rates.

Rarely will you find a prepaid tuition plan offering future tuition tied strictly to current tuition rates. And since the price of the prepayment contract is one of the primary factors in the decision to enroll in this type of 529 plan, the SEC really ought to do a better job in explaining it.

» 05-4: The 529 marshals have arrived - 08/30/05
» Our 5.29th-year anniversary - 06/29/05
» 05-2: 529s and the new Bankruptcy Act - 04/28/05
» 05-1: Reform or Deform? - 02/27/05
» 04-6: Perspectives on the 529 debate - 12/28/04
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