Fiduciaries: Beware of Those Hidden Costs
By Sylvia Bell, JD, Senior Manager of Employee Benefits Services, Alpern Rosenthal
Sponsors of retirement plans are continually faced with many decisions relating to the plans they sponsor. Recently, several lawsuits have been filed for claims relating to those decisions. The purpose of this article is to provide a clearer understanding of how retirement plans are operated in order to determine how to avoid similar litigation.
You (sponsors) may have been told that if the plan provides for “self direction” you have fulfilled your fiduciary responsibility and are “off the hook.” However, that advice does not go far enough to provide information that will help to avoid legal problems. Self direction is a technical way of saying that participants choose how they want to invest their salary deferral in the 401(k) plan. However, participants really only choose between funds that the plan sponsor selected to be in the plan. Hopefully, plan sponsors choose funds which performed well in the past as well as funds that have reasonable fees associated with them. Plan assets are really the crux of many of the recent lawsuits relating to 401(k) plans. Self direction and appropriate fiduciary action are necessary to avoid participant legal action.
The complaints in the recent lawsuits allege that the fiduciary failed to:
- Effectively scrutinize the fee arrangements
- Monitor the service provider arrangements
- Adapt the operations as the plan assets increased.
Scrutinizing fee arrangements involves the plan sponsor interviewing two or more vendors and asking difficult questions about areas of which the plan sponsor may not be familiar. Often, decisions are made by an employee whose brother-in-law or fraternity brother sells a particular product and who assures the employer that the funds are great. The "selected vendor" may show charts that report the fantastic past performance and minimal fees, but all too frequently the discussion about the fees does not happen. Sometimes fees are assumed to be reasonable, but commonly the diligent review of fees doesn't happen to avoid an awkward conversation. Plan sponsors really cannot shirk this fiduciary issue without risking exposure to potential claims of breach of fiduciary duty.
Even when the employer attempts to perform the required due diligence to engage the vendor or third party administrator, he doesn't continue to monitor the service provider operations. He often just assumes that once the provider is selected his job is done and that the plan can operate that way indefinitely. Most plans grow and change and the service fees associated with them should be monitored periodically to determine if the selected service provider is still appropriate.
Plan operations may need to be changed periodically to accommodate the growth of plan assets. Large plan assets afford different types of options such as reduced fees or changing to lower cost institutional shares. Smaller plans often have no leverage to negotiate fee arrangements or to get sufficient information relating to fee disclosure. Plan sponsors should be aware of how the size of the plan assets affects the cost of operating the plan.
Case law dictates that when a fiduciary duty is imposed, equity requires a stricter standard of behavior than the comparable standard at common law. Generally, this means that a fiduciary has a duty to avoid situations where (1) there is a conflict between personal interests and fiduciary duty, and (2) the fiduciary duty conflicts with another fiduciary duty. It is obvious that the fiduciary must not profit from their fiduciary position without express knowledge and consent of those for whom the fiduciary is acting. It appears clear that knowing as much as possible about situations that may affect the growth of the plan assets is imperative to fulfill a fiduciary duty.
Anything less than full disclosure regarding the fees in the plan, prevents participants from fully understanding the cost of the products and services. The participant’s lack of knowledge could potentially diminish their retirement benefits. For example, a participant may not know that there are fees associated with each trade that they make or that fees are imposed whether or not they trade at all.
For a participant selling stock valued at $50,000, a reasonable charge for that transaction would be approximately 1% ($500), but it is also very possible that the fee for the same transaction could be 2%. The difference between a fee of $1,000 and $500 may not make a significant difference in someone's retirement income. However, if that same transaction occurs several times over the life of an individual's retirement plan, it could make an appreciable impact.
The Department of Labor has taken the position that plan sponsors must know the direct and indirect compensation paid to all persons providing services to a plan. The idea that not knowing or ignoring the fee structure involved in the plan is expected for plan sponsors. Participant complaints claim that revenue sharing payments are plan assets and since plan fiduciaries are responsible for all plan assets, “not knowing” can arise to a breach of duty.
The standard that binds fiduciaries is “reasonableness.” This standard applies to revenue sharing, communication and general operation of the plan. Protecting yourself from potential liability means involvement. Knowing the various facets of the plan and how the service providers and contracts in which the plan is a party affect the plan is required. Knowledge is the key to understanding which also seems to be the key to diligent fiduciary duty.
Sylvia Bell, JD, is the Senior Manager of Employee Benefits Services
for Alpern Rosenthal. She can be reached at 412.281.2501, ext. 335 or
at sbell@alpern.com.
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