VOICES FROM THE INDUSTRY: Could employees file suit over retirement plan fees?

In fewer than two years, workers have filed 30 lawsuits against their employers regarding fees charged to the employees’ 401(k) plan accounts.

Half of the lawsuits have been filed by a single St. Louis law firm. Ten suits have been filed in Illinois. Employers that have
been sued include Bechtel Corp., General Dynamics Corp., International Paper Co., Kraft Foods Global, Inc., Lockheed Martin Corp., Northrop Grumman Corp., United Technologies Corp. ABB, Inc., Deere & Co. and Unisys Corp.

In order to offer a 401(k) plan to employees, an employer must typically hire:

a recordkeeper to track deposits, withdrawals, loan repayments, investment elections, investment returns and vesting percentages in the plan,

a custodian of the plan assets,

a person to cut benefit checks to participants, and prepare related tax forms,

a person to handle investment trades.

Sometimes the employer pays for these services, and sometimes the fees for these services are charged to the 401(k) accounts of the employees participating in the plan. It is permissible to charge these fees to participants’ accounts so long as the fees are for necessary services, are pursuant to a reasonable contract, and no more than reasonable compensation is paid.

Excessive, improper fees

The complaints generally allege that 401(k) plans have paid excessive and improper fees to service providers and have failed to disclose the fees to participants. In particular, the cases focus on “revenue-sharing” arrangements by which mutual fund companies “share” with service providers a portion of the revenue that the mutual fund companies receive due to participants’ investment of their accounts in the mutual fund.

The revenue may be a percentage of the money invested in the mutual fund. A service provider may “charge” the employer only $500 or $1,000 for plan administration. However, after revenue sharing, the service provider may actually receive $10,000 or $20,000 or more for its services.

Revenue-sharing arrangements that are based on a percentage of plan assets have generated larger and larger fees over the years as plan assets have increased. The essence of the complaints filed against employers is that the fees paid to service providers as a result of this indirect “revenue-sharing” compensation are excessive because they are not correlated to the services provided, but are correlated to the assets in the plan. Growth in plan assets may not result in a corresponding growth in the level of services.

Recently amended complaints have also alleged that the employer has not properly accounted for other revenues to service providers, such as finder’s fees, revenue
related to certain share classes and float income. In addition, participants allege that employers have improperly offered actively managed mutual funds as 401(k) investment options, rather than cheaper index funds.

In some case, initial court decisions have favored employers and service providers, and cases have been dismissed in whole or in part. In other cases the initial court decisions have gone against employers and service providers.

Participants have also brought lawsuits against several financial institutions, such as Aegon, Bank of America, Citigroup and Wells Fargo, for offering proprietary mutual funds in their own 401(k) plans.

Several lawsuits have also been brought against Fidelity Management Trust Co. and Fidelity Management & Research Co.

In addition to the pending litigation, bills introduced in Congress would require employers that sponsor 401(k) plans to obtain from service providers and provide to participants detailed fee disclosures and conflict-of-interest information.

The United States Department of Labor has issued regulations requiring employers to provide extensive information on direct and indirect fees paid to service providers, beginning with Form 5500 reports filed in 2010 for the 2009 plan year.

Historically, revenue-sharing arrangements have often not been disclosed by service providers to employers. Therefore, the U.S. Department of Labor has proposed regulations requiring service providers to disclose certain information to plan sponsors, including all of their direct and indirect compensation, and the potential for conflicts of interest that may affect the service provider’s performance. The Department of Labor is also working on new disclosure regulations.

What should an employer do?

Review fee arrangements with service providers to identify all direct and indirect compensation paid to providers-especially any revenue-sharing arrangements.

Benchmark fees paid to current service providers to fees charged by other service providers for similar services.

Look for alternatives to paying recordkeepeers asset-based revenue-sharing payments.

Determine whether any service provider has a conflict of interest such that its compensation is correlated directly to its advice; if so, do additional due diligence to confirm that its advice is sound.

Disclose to participants all fees that are assessed to their accounts.

Include at least one index fund among the investment options offered by the plan.

The obligations of employers will become more clear over the next few years as the litigation progresses through the courts, regulations are adopted, and legislation is passed. However, in the meantime, each employer should take a closer look at how fees are calculated and paid to the service providers for its 401(k) plan.