401(k) Sponsors Face New Liability: Unreasonable Fees

(Published May 10, 2007)

Sponsors of 401(k) plans have a fiduciary obligation to prudently select and monitor their plan's investments, investment options, and third-party service providers. Understanding and evaluating fees charged by those third parties are key components of a fiduciary's responsibility. Employees also have a right to know the fees their plans pay to third-party service providers. Hammering this home, class action lawsuits have been filed against some of the country's largest employers. The lawsuits allege that plan sponsors breached their fiduciary duties by allowing third parties to charge unreasonable fees to their plans. As is inevitable, lawsuits of this type reverberate with employers of all sizes. Now is a good time to assess the fees charged to your plan.

Lawsuit Details 

Third-party providers are entitled to reasonable compensation for the services they perform. Fees fall into two broad categories. Management fees, also known as investment advisory fees or account maintenance fees, are ongoing charges for managing the assets of the investment fund. They are generally stated as a percentage of the amount of assets invested in the fund. Fund management fees form the lion's share of fees paid by 401(k) plans that invest in mutual funds. They may be paid in the form of an indirect charge against participants' accounts or the plan.

Plan administration fees are charged for the day-to-day operation of a plan. They cover expenses for basic services — record-keeping, accounting, legal, and trustee services. Fees are either spread among individual accounts in proportion to each account balance (i.e., a pro rata charge) or passed through as a flat charge against each participant's account (i.e., a per capita charge).

The bottom line of each lawsuit is that plan sponsors didn't take appropriate action to reduce the fees charged to their plans; actively agreed with third parties to pay unreasonable fees; intentionally ignored the fees charged; or paid for more services than were provided by choosing so-called shadow index funds. What are they: Index funds garner relatively low administrative costs, since they’re pegged to the Dow Jones Industrials, the S&P, or some other index. Shadow index funds, on the other hand, promise active management but provide little, since in reality, they're also pegged to an index.

Take Prudent Action Now 

• Plan sponsors have a fiduciary duty to monitor the fees charged to their plans. These lawsuits show that you can't sweep this responsibility under the rug. There are several steps you can take that will go a long way toward satisfying the mandate that fiduciaries act prudently.

• Before negotiating with third-party providers, or reevaluating the services of a current third-party provider, decide what services you need (e.g., legal, accounting, record-keeping, investment management, investment education or advice). Specify the types and frequency of reports you want to receive, communications to employees, meetings for employees, and the frequency of employee investment transfers. Determine how much responsibility you want a third party to assume, and the extra or customized services you want to provide to employees (e.g., loans, Internet trading, telephone transfers).

• When soliciting third parties, even the playing field by providing all candidates with complete and identical information about the plan and the features you want. Include the number of employees and the amount of plan assets as of a specified date. Ask all potential service providers to provide a detailed report of the fees, expenses, and revenue-sharing charges associated with the plans they administer.

• Once you select a third party, monitor the level and quality of the services provided. Make sure that you receive information on a regular basis and make changes, if necessary.

Government Responses 

Mutual fund companies were supposed to have devised a voluntary fee disclosure program. They didn't, so the Department of Labor (DOL) is proposing several initiatives that should make fee disclosure easier to discern. First, the DOL has proposed greater fee disclosure on Form 5500. Second, the DOL will be proposing a new rule on fee disclosure that would require mutual funds and third-party service providers that pay certain kinds of fees, called revenue sharing, to disclose what they’re paying and to whom.

• In conjunction with these proposed rules, the DOL issued a 19-question Request for Information, RFI for short. The RFI solicits comments from plan sponsors, third-party administrators, and other parties affected by this issue. In general, the DOL is looking for input on the following topics.

• The administrative and investment-related fee and expense information 401(k) plan participants should consider.

• The manner in which that information should be provided or made available to plan participants.

• Who should be responsible for providing this information.

The DOL would like to hear from you by July 24, 2007. E-mail your ideas to e-ORI@dol.gov.

The entire RFI, which includes the 19 questions the DOL is interested in getting answers to, can be found at: http://edocket.access.gpo.gov/2007/pdf/E7-7884.pdf

It may take some time for the DOL to issue final regulations. In the interim, the Government Accountability Office (GAO), Congress's non-partisan watchdog agency, has issued a report on 401(k) fees. General conclusion: Fee disclosure is poor and needs to be revamped. The GAO also found that the information the DOL currently collects is incomplete, and, therefore, of limited use for effective oversight. GAO's recommendations: Congress should amend ERISA to require plan sponsors to disclose fee information on each 401(k) investment option, and should require 401(k) service providers to disclose to plan sponsors the compensation they receive from other service providers. Congress may be listening. For the first time, 401(k) fees were the topic of testimony before the House Committee on Education and Labor.

To read the GAO's report, surf to: http://www.gao.gov/new.items/d0721.pdf

Related Topic(s): Benefits