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Ruling Forces Advisors to Pick Appropriate Fund Share Classes

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A recent Court of Appeals decision will likely force retirement plan advisors to ensure they have selected the appropriate mutual fund share class for their plans—a potentially daunting task, says Fred Reish, partner and chairman of the financial services ERISA team at Drinker Biddle & Reath.

In Tibble v. Edison International, the Ninth District Court for the Central District of California on March 21 decided that “fiduciaries have an obligation to select appropriate share classes for their plans,” Reish says. “Closely related to that is the trial court’s admonition that fiduciaries must ask about the available share classes.”

Participants in the Edison 401(k) Savings Plan alleged in 2007 that 401(k) plan fiduciaries breached their duties by including certain investment options in the plan, such as retail-class mutual funds, and engaged in revenue sharing.

Fred ReishThe Tibble decision, Reish (right) explains, focused on “the reasonable expense ratios for plan investments,” and “ERISA imposes both a fiduciary rule and a prohibition on spending more than reasonable amounts for operating a plan, including the investment costs.”

However, Reish notes that “rather than looking at the evaluation of mutual fund expenses in the traditional way—that is, comparing expense ratios to those of other funds—the trial court found, and the appellate court agreed, that plans must use their purchasing power to select the appropriate share class.”

What does this mean for advisors to a retirement plan? The practical consequence of the decision, Reish says, is that “advisors should make recommendations based on the share classes available and must educate plan sponsors about the available share classes, including their costs, and plan sponsors (typically acting through their plan committees) must understand that multiple share classes may be available and must investigate which are best for their plan and participants.”

But that could be a “daunting task,” Reish asserts, as some mutual funds may have 10 or more share classes. “That could include, for example, A, B, C, I, R-1, R-2 shares, and so on. This will place an additional burden on advisors…and, in that sense, may favor advisors who focus on retirement plans.”

An even more complicated scenario may ensue, Reish says. “Share classes for mutual funds and separate account ‘classes’ for group annuity contracts may, for these purposes, be virtually identical. If that is true, advisors will need to educate plan sponsors on the classes available in group annuity contracts. Then, advisors will need to help plan sponsors select the appropriate separate account class for that particular plan.”

Since some insurance companies offer group annuity contracts with 10 or even 15 separate account classes, Reish explains, “advisors will need to be more attentive to the alternatives that are available and will need to work with plan sponsors to understand the share and separate account classes (including the revenue sharing and compensation aspects) and to select the appropriate classes based on the size and needs of the particular plan.”

Read A Look at Declining Expense Ratios on AdvisorOne.


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