Over the past few years, there has been a plethora of litigation regarding tax-qualified retirement plans that invested in or permitted participants to invest in the stock of the plan sponsor.
These cases alleged various breaches of fiduciary duty under the Employee Retirement Income Security Act of 1974, as amended, and they frequently resulted in a settlement with the employer (or plan fiduciaries), or with a fiduciary liability insurance policy footing the bill.
There was a great deal of conjecture about what the next wave of fiduciary breach cases would be. It now appears that we have the answer: plan fees. Unlike the company stock controversy, which mostly affects larger employers, this issue has the potential to affect every retirement plan, but particularly 401(k) plans.
Financial professionals who work with employers and 401(k) plans need to be following this new wave of cases to protect themselves and understand what employers and their legal advisors are thinking about plan investment fees and related issues.
On Sept. 11, 2006, 7 class action lawsuits were filed. Those suits focused on investment-related fees paid by several 401(k) plans sponsored by Fortune 500 employers. Several other plan sponsors have since been sued. The complaints filed in the suits allege a variety of breaches by fiduciaries of their duties under ERISA, which, according to the complaints, resulted in the plans and their participants paying excessive fees and expenses. The excess fees and expenses reduced participant plan accounts and, ultimately, the amount of funds the participants will have for their retirement, the complaints allege.
The lawsuits name the plan fiduciaries, the plan sponsors, the members of the sponsors’ boards of directors, and individuals involved with plan administration and plan investments as defendants. If the plaintiffs in these suits are successful in achieving significant recoveries, it is likely they will set the groundwork for future lawsuits or other legal action regarding fees charged to participant accounts.
…the assets of a plan shall never inure to the benefit of any employer and shall be held for the exclusive purpose of providing benefits to participants in the plan and their beneficiaries and defraying reasonable expenses of administering the plan.
ERISA Section 403(c)(1).
ERISA requires plan fiduciaries to discharge their duties with respect to a plan “solely in the interest of participants and beneficiaries and:
A. For the exclusive purpose of:
(i) providing benefits to participants and their beneficiaries; and
(ii) defraying reasonable expenses of administering the plan;
B. With the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.”
ERISA Section 404(a)(1) A & B.
Under ERISA, fiduciaries are held to the standard of a “prudent expert,” which means good intentions that result in poor performance for a plan because of a lack of knowledge or expertise may still constitute fiduciary breaches. The lawsuits filed to date allege plan fiduciaries violated the fiduciary standard of prudence even though the practices being challenged are common throughout the 401(k) industry. The following types of fiduciary breaches have been alleged in the complaints:
1) Causing the plan to enter into agreements with service providers that resulted in the plans paying excessive fees and fees that were not solely for the benefit of plan participants.
2) Failing to examine, review and monitor the fees being paid by the plan.
3) Failing to inform and educate itself of trends and practices in the retirement, financial investments and securities industries that impact the fees paid by the plan.
4) Failing to understand the compensation methods used by 401(k) plan vendors.
5) Permitting revenue-sharing arrangements that share asset-based compensation earned by investment managers with other service providers.
6) Failing to establish, implement and follow procedures to prudently and properly determine if plan fees and expenses were reasonable and incurred solely for the benefit of plan participants.
7) Failing to disclose to participants the fees and expenses being paid from the plan and how they impact participant accounts.
8) Failing to discover, disclose and stop the plan’s payment of excessive fees and expenses.
9) Appointing plan fiduciaries who did not carry out their fiduciary responsibilities under ERISA and failing to monitor their performance and replace them when appropriate for failing to carry out their duties.
10) Causing fees to be paid for purposes not permitted by ERISA.
The complaints request the fiduciaries be required to make up any and all losses suffered by plan participants as a result of these alleged breaches of fiduciary responsibility. Since the employer frequently indemnifies plan fiduciaries for actions that do not involve negligence or willful misconduct on the part of the plan fiduciaries, any recovery may ultimately be paid by the employer or its fiduciary liability carrier.
The complaints are currently proceeding through the courts. One defendant has achieved a dismissal of a portion of the claim which ties the administrative fees to investment losses, and another has moved to dismiss the entire complaint due to the defendant’s alleged compliance with ERISA ?404(c). The complaints are still in an extremely early stage and should be monitored as they develop.
The issue of plan expenses and fees has also received heightened scrutiny from the regulatory agencies. As part of a 2005 investigation by the U.S. Securities and Exchange Commission into the practices of pension consultants, the SEC reviewed their compensation methods.
The U.S. Department of Labor has proposed changes to the annual reports required to be filed by pension plans–IRS Form 5500–that would require more detailed disclosure on the compensation paid to service providers and the identification of providers who fail to provide the required fee information.
The DOL has also discussed an amendment to ERISA’s prohibited transaction exemption rules. The amendment would expand the requirement that plan sponsors consider information about compensation in selecting service providers, and the DOL recently held hearings on the compensation practices of service providers in the 401(k) industry.
The DOL has recently released its “regulatory agenda,” highlighting topics that will be the subject of regulation in the coming months. The disclosure of plan fees is prominently noted. As a preliminary step toward such regulation, the DOL released a request for information and input regarding current fee disclosures, and opinions of members of the public regarding how the rules should be changed. Given the increased attention to plan fees and expenses, regardless of the outcome of the lawsuits that have been filed, we can anticipate further involvement by the regulators in this area.
The allegations seem to assert that commonly accepted fee structures are inherently improper and that plan fiduciaries have failed to properly evaluate them and protect the interests of plan participants. Whether the fees being paid by a plan are excessive and whether fiduciaries breached their responsibilities under ERISA in evaluating plan fees and expenses will have to be considered on a plan-by-plan basis.
In light of recent lawsuits and the focus of regulators on plan fees and expenses, plan sponsors and fiduciaries should review their current procedures for evaluating plan expenses, as well as the information on plan fees and expenses that have been provided to participants. Disclosure to participants of fees and other investment information, in addition to potentially protecting a fiduciary from liability for the issues described in this article, may be required to take advantage of certain relief from responsibility for investment selections made by plan participants.
To the extent they have not done so recently, plan sponsors and fiduciaries should review their existing service provider fee arrangements and disclosures in detail, including any revenue sharing arrangements. It is important to keep in mind, however, that fiduciaries are not obligated to make their decisions solely based on the fees charged to the plan. However, cost is a key factor in the decision-making process of choosing a service provider.
As always, consideration should also be given as to whether those charged with reviewing plan fees and expenses have the requisite expertise and experience to properly evaluate them. Documenting and establishing a record of a prudent fiduciary process having been undertaken in evaluating the reasonableness of the fees and expenses paid by a plan, relative to the services provided, may facilitate a defense against a lawsuit or inquiry on plan fees and expenses.
Additionally, adequate disclosure of fee and expense information to participants may help the fiduciary establish some insulation for the responsibility of selecting more expensive products, particularly where fees differ among various investment alternatives (e.g., mutual funds).