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Actions and inaction on the part of 401(k) plan fiduciaries can create liabilities
Retirement plan fiduciaries are under attack. Between regulators enacting additional oversight requirements, the media on the lookout for suspicious retirement plan administration and the inevitable participant lawsuits, fiduciaries must feel as if the world is looking over their shoulder.
On some level, scrutiny can be a positive thing. If plan fiduciaries thought the employee population was always privy to their closed-door policy meetings, they would undoubtedly be more conscientious and careful in their determinations for the plan.
But it can also have a negative impact. The threat of potential backlash from plan participants can lead to fiduciary inaction and failure to complete all steps to continuously monitor and improve their retirement plans. Given the breadth of participant interests, it is rarely possible to please all plan constituents with decisions regarding the replacement of investments or restructuring of fees. Fiduciaries must shed this paralysis and be able to adhere to their duty to act in the best interests of plan participants. By adhering to the standard of the “prudent expert,” sponsors can regularly review the plan’s investments and fees, and act to improve the plan as a whole.
The following story is an example of an organization that did not take such steps, and found itself on the wrong side of a costly court verdict.
St. Louis-based ABB Inc., a provider of power generation systems, maintained two defined contribution retirement plans: one for its union employees and one for its nonunion employees. Multiple internal committees maintained governance over the administration of the two plans. Fidelity provided a variety of services to the plan through its various business units: Fidelity Investments for mutual funds, Fidelity Research for investment advising services and Fidelity Trust for recordkeeping, as well as education and other plan services. Originally, plan fees were paid through an annual per-participant fee, but over time ABB Inc. restructured the fees to be paid through revenue-sharing arrangements.
Not Following Its Own IPS
One of ABB Inc.’s missteps involved its
Investment Policy Statement (IPS). ABB Inc. had implemented an IPS to help govern the decisions of its fiduciaries. An IPS is not expressly required in the administration of a defined contribution retirement plan; however, it is strongly encouraged. A well-written IPS establishes guidelines for monitoring the plan’s investments, and provides a road map for making key fiduciary decisions. It is also one of the first items requested when the Department of Labor conducts an audit of a retirement plan.
However, ABB Inc. failed to follow its own IPS and did not make adjustments to the document when its internal practices differed from the written specifications. In its failure to follow the IPS’s provisions, ABB Inc. created a far worse situation than in not having an IPS at all. By having an IPS, ABB Inc. established guidelines for how the investments would be handled within the plan. Not complying with those guidelines was one of the key items cited by U.S. District Court Judge Nanette Laughrey in her March 2012 decision in
Tussey v. ABB Inc.
---------------------------------------------------------------------------------------Failure to follow its Investment Policy Statement created
a far worse situation than not having an IPS at all.--------------------------------------------------------------------------------------
Selecting High-Cost Investments
The court determined that a
revenue-sharing arrangement resulted in the plans overpaying for recordkeeping services by as much as $136 per participant per year. The court also found that in order to ensure “revenue neutrality” for the record keeper, the plan fiduciaries selected investment options with expenses that were higher than other available investment options. They did this in violation of the IPS.
Failing to Monitor and Renegotiate Recordkeeping Revenue
Another fiduciary breach noted by the judge was that ABB Inc. had monitored only the total expense ratio for the plan’s investment, but not the required recordkeeping services fees from the vendor. The expense ratio of a mutual fund is comprised of the investment management fees plus administrative costs, with the potential addition of some revenue-sharing amounts. Plan sponsors frequently use revenue-sharing amounts in the investment options to offset the required recordkeeping fees.
Since the expense ratio is the actual amount paid by the plan participants, keeping the average expense ratio low is important. However, even mutual funds with low to mid-range expense ratios can include high revenue-sharing amounts. In the
ABB Inc. case, the judge considered it a breach of fiduciary duty when the plan sponsor failed to monitor and benchmark the required recordkeeping revenue. Even though the overall fund fees were reasonable, they could have been lower if the plan sponsor had been more diligent in acting in the participants’ interests.
With the growth of the plan assets over time, the revenue received by the record keeper grew far beyond what it needed to administer the plan. ABB Inc.’s failure to negotiate lower required revenue, and then reduce the revenue-sharing amounts within the plan’s investment options, was also viewed as a breach of fiduciary duty.
Replacing Low-Fee with High-Fee Funds
Finally, ABB Inc. replaced mutual funds having low expense ratios with funds having high expense ratios. In itself, this action is certainly not prohibited, but there should be a valid reason. ABB Inc.’s rationale for the change appears to have been to generate more revenue-sharing amounts, which would thereby lower the direct fees that ABB Inc. would have to pay out of its coffers.
Earle Allen is vice president, retirement, at
Cammack LaRhette Consulting.
The above article is reposted with permission. © 2012, Cammack LaRhette Consulting.
Related SHRM Articles:
SHRM Online Retirement Plans Resource Page
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