A Question of Balance

The much-maligned 401(k) plan is being beefed up. So are the penalties for failing to manage it well.

For plan sponsors, one of the biggest challenges of these proposed disclosure requirements will be figuring out how to account for revenue-sharing and soft-dollar arrangements that are common among 401(k) vendors and present them to plan participants in a way that can be easily understood. Some plan sponsors may decide that the simplest way to do that is to eschew the types of investment options that enable those arrangements, such as mutual funds with lush expense ratios and 12b-1 marketing fees.

That might mean stocking your plan’s investment lineup with low-cost index funds or even exchange-traded funds (ETFs). In fact, this disclosure issue was another reason Stanford opted to emphasize index funds in its investment lineup. “We wanted to be able to educate our employees about the importance of fees and how that played into your ability to accumulate money for your retirement,” says Diane Peck, “and the fees for the actively managed funds were not as transparent as they needed to be.”

ETFs are similar to mutual funds, but trade intraday on stock exchanges and are sold on a commission basis. They haven’t captured a big share of the 401(k) market yet, in part because many recordkeeping systems aren’t equipped to handle them, but they are making inroads.

“They’re beautifully designed for the post-2008 world where perfect clarity on fees and costs, and where money is going, are important,” says Michael Case Smith of Avatar Associates, a New York–based firm that manages about $250 million in defined-contribution assets. “When you buy an ETF, it’s just like buying a stock — here’s the cost, here’s the commission. There are not a lot of opaque or hidden fees.” His firm invests exclusively in ETFs, bundling them into collective trusts to ease administration and minimize trading costs.

Fiduciary Liability

Anyone inclined to dismiss the fiduciary liability associated with offering a 401(k) plan should think back to a case settled by First Union Corp. in 2001. The bank, acquired that same year by Wachovia, agreed to pay $26 million to compensate participants in its own 401(k) plan. They had argued that First Union had harmed them by considering only its own investment funds for the plan and by charging excessive recordkeeping fees.

There has been a wave of similar class-action lawsuits filed since 2006. Initially focused on revenue-sharing abuses, some have since been amended to include complaints that plans acted improperly by offering actively managed mutual funds rather than index funds as investment options, or by offering mutual funds instead of generally less expensive separate accounts.

To be sure, there is no law against offering actively managed mutual funds, which still capture more investment dollars than index funds. But now more than ever, plan sponsors that do offer them must be prepared to defend their decision.

It really isn’t time to retire the 401(k). But it is time to retire any lingering notion that plan design can be treated lightly. It is vital not only to the future retirement security of your employees, but also to your own goal of offering a good plan without putting you or your organization in fiduciary jeopardy.

Randy Myers is a contributing editor to CFO.


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