Cracking Down on Fees

As legislation looms, companies can take steps now to help employees build bigger nest eggs.

The biggest benefit of the trusts is that they have inherently lower fees than their mutual-fund counterparts because they are not marketed to a broader audience, and do not have to report to the Securities and Exchange Commission (they are overseen by banking regulators instead). According to Morningstar research, average fee differentials between institutional shares of mutual funds and collective trusts can range from 1 basis point for large blend funds to 42 basis points for large value funds. Caterpillar, in fact, added the structure to its 401(k) plan in settling with employees over allegations that its investment fees were too high.

In general, a plan needs a critical mass of assets — say, $20 million to $30 million — in a particular category to make it worthwhile to move to the structure, estimates Hess. That means it’s not usually an all-or-nothing transition, but can be a gradual move from mutual funds to the trusts as assets accumulate in popular categories like large cap and stable value.

While these structures sound appealing, they face obstacles in reaching critical mass in most 401(k) plans. For one, there’s the lack of transparency that comes with the absence of an SEC registration. Experts caution that these trusts may be marketed as clones of mutual funds but contain vastly different asset classes and produce different performance. Pricing may vary if the trust has substantially less in assets than a corresponding fund, and that small size may also pose liquidity issues.

Get It in Writing

In the end, though, it is important to bear in mind that fees are only one factor in decisions about which investment options to offer employees. Although “the plaintiffs’ bar will try to push the envelope,” ERISA ultimately requires employers to follow a prudent process, rather than pick the right funds, notes Stephen Saxon, a principal at Groom Law Group, which specializes in employee-benefits law.

Having a written process in place for considering the funds and following it is the best inoculation against expensive lawsuits, say experts. Indeed, many companies, particularly smaller ones, find it prudent to hire an independent investment adviser to advise on and document such decisions. Even if sticking to the process doesn’t stop the lawsuits, it may help nip them in the bud. An appeals court affirmed a decision to drop the case against Deere, for example, on the grounds that the company had followed proper procedures. (Caterpillar, meanwhile, settled, and Wal-Mart’s case is still pending, with the plaintiff now in the so-called discovery phase of trying to make a case that Wal-Mart did not follow the right selection process.)

Meanwhile, employers can look forward to more transparency in those fees, in large part thanks to the efforts of others. Besides the regulators and legislators who are working out new reporting requirements, a new private-sector group known as the Defined Contribution Institutional Investment Association, made up largely of retirement plan consultants, investment managers, and recordkeepers, has formed to advocate for more transparency. A core belief: “There’s no reason why participants in defined contribution plans should experience lower performance than participants in pension plans,” says Lew Minsky, executive director of the group. “We’re product agnostic, but we want to make sure plan sponsors understand what their options are and don’t have any artificial barriers.”

Alix Stuart is senior editor for human capital and careers at CFO.


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