Nowhere to Hide on Hidden 401(k) Fees

With plan participants increasingly litigious, plan sponsors must take care that investment and administration expenses are "reasonable."

The fiduciaries found liable were not only the employer plan sponsor but also members of the plan investment and benefits committees, the vice president of human resources, and the manager of the sponsor’s Human Resources Service Center.

In concluding that the fiduciaries breached their duty of prudence, the court emphasized that there was no evidence that the fiduciaries investigated the difference between the retail-class funds and the institutional-class funds. Had the fiduciaries weighed the relative merits of the two fund types, said the court, “they would have realized that the institutional share classes offered the exact same investment at a lower cost to the Plan participants.”

Plaintiffs representing the plan participants in this class-action suit argued that, when deciding to invest in the retail share classes rather than the cheaper institutional share classes, the defendant fiduciaries were improperly motivated by a desire to capture more revenue sharing for Southern California Edison (SCE), even though doing so increased the fees charged to plan participants. Plaintiffs argued that defendants put the interests of SCE in offsetting the plan’s record-keeping costs through revenue sharing above the interests of the plan participants in paying lower fees. To support that claim, plaintiffs relied primarily on a series of e-mails, generally between members of SCE’s investments staff and human resources department.

To determine whether the decision to invest in retail share classes constituted a breach of the duty of prudence, the court examined whether the fiduciaries engaged in a thorough investigation of the merits of the investment at the time the funds were added to the plan. The finding was that “there is no evidence that defendants even considered or evaluated the different share classes when the funds were added to the Plan.”

The court further emphasized that the presentation materials the SCE investment staff, prepared for Plan Investment Committee meeting at which the Investments Staff recommended adding these funds to the plan, “contained no information about theinstitutional share classes.” According to the court, “The Investment Staff simply recommended adding the retail share classes of these funds without any consideration of whether the institutional share classes offered greater benefits to the plan participants. Thus, the plan fiduciaries responsible for selecting the mutual funds (the Investment Committees) were not informed about the institutional share classes.”

Specifically, the court said, the defendants did not present evidence of: the recommendations the investment consultant made to the investment committee; the scope of the consultant’s review; whether the consultant considered both the retail and the institutional share classes; whether the consultant provided information to the investment committee about the different share classes; what questions were asked regarding the recommendations; and what steps the investment committee took to evaluate the consultant’s recommendations. Thus, while reliance on a consultant’s recommendations may be justified in some circumstances, in this instance the court could not conclude that such reliance was prudent or reasonable.

What Fiduciaries Can Do

It is imperative that employer plan fiduciaries establish best-practice governance standards relating to the identification and disclosure of “hidden” fees so they can demonstrate the robustness of their analysis and conclude that 1) the compensation paid directly or indirectly to investment and administrative service practices is no more than “reasonable,” and 2) actions of the service providers are monitored to assure that any fee offset to which the plan is entitled is correctly calculated and applied.

“Reasonableness of fees” is not easily ascertained. Service providers normally disclose fees otherwise required to be disclosed, such as 12b-1 fees, but not indirect fees they receive from mutual-fund vendors, which are typically prevented from disclosure by agreements that service providers claim are confidential or proprietary. Accordingly, it may be difficult to conduct a forensic investigation and the “adversarial” negotiation necessary to identify embedded and undisclosed fees.

That is the purview of an independent ERISA attorney. In-house and plan counsel, as well as accounting or consulting firms, may not be able to offer confidentiality as a result of the “fiduciary exception” to attorney-client privilege. Making all efforts to establish and preserve confidentiality is critical in the event of litigation for excessive fees that may come to light as the result of a forensic plan-expense review.

Jeff Mamorsky is co-chair of the global benefits practice at law firm Greenberg Traurig.

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