by Fred Reish
In a year marked by one extraordinary event after another, here’s another for the books: the pace of lawsuits filed over 401(k) fees is making for a dramatic jump in 2020 over 2019 levels. In the first eight months of the year, more than 60 such cases were filed. In 2019, there were 20.
And one worrisome development? Some employers have even been sued twice this year over plans some participants claim are too expensive. After 2019, when ERISA class settlements reached $449 million, there’s cause for concern among plan sponsors and their committees that serve as primary fiduciaries. For all the time they spend on the quality of investments in their plans, the bigger bone of contention is costs – of recordkeepers and of investments.
Here’s what’s important to know about these claims and steps that can help minimize the fiduciary risks.
Recordkeeper fees: Make indirect compensation more transparent
Typically, a plan’s recordkeeper is paid by charges to the plan and participants’ accounts – “direct” compensation – and by revenue it receives from the plan’s investments – “indirect” compensation. Both must be considered when evaluating whether the recordkeeper’s fees are reasonable and fair. While plan fiduciaries can easily observe the direct payments, indirect compensation is difficult, for two reasons. The first is terminology; payments might be called revenue sharing, administrative fees, or 12b-1 fees, among others. Second, the payments are made by the investment managers (or other service providers) without being reported to the committee.
How to avoid problems: Plan sponsors should make a practice of benchmarking recordkeeper’s fees regularly – every three years is a good rule of thumb. Benchmarking services enable plan sponsors and advisers to compare costs and compensation by providing information about the direct and indirect compensation paid by “peer” plans. (A peer plan is comparable by virtue of similar total assets and numbers of participants, the primary factors in recordkeeper compensation.) Benchmarking reports combined with the guidance of an experienced plan adviser, will show committee members how their plan payments stack up.
A precautionary note, though: Average compensation does not, in and of itself, determine reasonableness. The objective is to fall in the range of reasonable fees; there’s not a single data point. Plus, the quality and quantity of services received by the plan and the participants should also influence the assessment. The plan advisor should help gauge if higher pay is merited.
Plan sponsors might also opt to go through a Request for Proposal process to get similar fee comparisons. This can be burdensome and expensive, and is why benchmarking is more often used.
Investment expenses: A complicated assessment
Investment expenses also should be evaluated based on industry averages. Most plan advisors can readily supply reports of expenses for different types of investments and help make sure that a reasonable amount is being paid.
But there’s more to it than that. As plan assets increase, lower cost “share classes” of a mutual fund become available to the plan. A mutual fund may have several share classes, all of which are invested in the same pool of investments. But each share class has a different expense ratio. Larger plans are able to invest in the cheaper share classes. A safe approach is for a plan to invest in the lowest cost share class available to it. This is complicated. Mutual funds typically have stated minimums for lower cost share classes. But some funds will, if asked, waive that requirement for retirement plans. Navigating this is where a knowledgeable adviser can be invaluable.
Another complication is that some share classes may pay revenue sharing to the plan. When the revenue sharing is subtracted from the expense ratio for that share class, it can be less expensive than a share class that appears to be cheaper. It’s another front where an experienced retirement plan adviser is invaluable.
The reality is that some of the issues facing plan committees are outside their typical member’s experience and knowledge. The law says that in their capacity as fiduciaries, committee members are not required to have that knowledge. Instead, they can hire professionals, such as advisers and attorneys, help them make prudent decisions. As ERISA litigation steps up, this is one area where they have a critical role to play.
Fred Reish is a partner with the law firm of Faegre Drinker. He specializes in retirement law, focusing on fiduciary and best interest standards of care, prohibited transactions, conflicts of interest, and retirement plans. The views expressed in this article are his, not necessarily of Faegre Drinker. The article is for general information only and is not intended to provide investment, tax or legal advice, or recommendations for any particular situation. Please consult with a financial, tax or legal advisor on your circumstances.
HUB International’s retirement plan fiduciary advisors provide ongoing guidance on your plan’s setup and management to ensure it meets regulatory compliance guidelines and the interests of your employees. Contact HUB to request an assessment of your group retirement plan.