Fiduciary Decisions and the Fee Transparency Movement

By Jose V. Sanchez, HBW Advisory Services LLC May 6, 2011

Updated added: 2/2/2012:

DOL Extends Deadlines for Service Provider and Participant-Level Fee Disclosures by 3 Months

On Feb. 2, 2012, the U.S. Department of Labor's (DOL) Employee Benefits Security Administration (EBSA) issued its long-awaited final rule, "Reasonable Contract or Arrangement Under Section 408(b)(2) – Fee Disclosure," requiring covered retirement plan service providers to disclose to plan sponsors the administrative and investment costs associated with their plans. The final rule extends the effective date to July 1, 2012, for new and existing contracts or arrangements between service providers and plans covered under the Employee Retirement Income Security Act (ERISA).

Another set of required fee disclosures, from plan sponsors to 401(k) plan participants (participant-level fee disclosures), is set to take effect 60 days after the service provider fee disclosure deadline. Due to the extension of the effective date of the final rule, plan administrators for calendar year plans now must make the initial annual disclosure of "plan-level" and "investment-level" information (including associated fees and expenses) to participants no later than Aug. 30, 2012, and the first quarterly statement (for fees incurred July through September) must be furnished no later than Nov. 14, 2012.

To learn more, see the SHRM Online article "DOL Final Rule Extends Deadlines for Service Provider and Participant-Level Fee Disclosures by 3 Months."

Recent regulations and court decisions are bearing down on 401(k) plans in the U.S. and requiring them to be more forthcoming with employees about plan fees—and whether plan participants or their employers are footing the bill. As a result, plan sponsors might find their interests best served by a fiduciary that assumes legal responsibility for the complex and cumbersome task of servicing a 401(k) plan’s investment decisions.

A December 2010 SHRM Online article, “FeeDisclosureRulePutsSpotlightonInvestmentCommittees,” explored some of the difficulties that employer-sponsored plans encounter when services are bundled. It advised, “Investment committees should review their funds’ investment performance and check fees regularly, even when service contracts with vendors don’t identify charges for recordkeeping or other administrative duties that employers sometimes mistakenly think are free.” Let's take the article’s advice a bit further and caution that fees should be transparent and easily compared.

Courts Weigh In

Court rulings are finding a duty by plan sponsor fiduciaries to negotiate fees.A 2010 federal court decision in Tibble v. Edison International is a case in point. The district court judge in the Edison case ruled that the company's 401(k) fees were excessive and that the plan did “substantial harm” to participants by offering retail share classes of three mutual funds when lower-cost institutional share classes were available for a plan the size of Edison's. As a result, Edison’s employees were entitled to recover a portion of the overcharges.

The Edison case is one of more than two dozen lawsuits filed against U.S. employers in recent years. In this litigious American business environment, more suits are likely to be forthcoming by employees who claim that their 401(k) fees are excessive.

The 401(k) investment fund provider in Edison did not lower fees willingly, nor was it obliged to do so. But because lower available fees weren't negotiated for, a fight between the company and some of its employees ensued and the HR department was caught in the middle. The Edison decision created a legal precedent that fiduciaries have an obligation to negotiate fees and fee structures with investment fund providers.

Companies want the goodwill of their employees and they want to help them provide for their retirement. In addition, they use employee benefits to compete for human capital. However, many companies tend to misunderstand or to minimize their legal responsibility for ensuring that their plans are compliant, transparent and efficient until trouble erupts. Edison is a cautionary tale for companies that do not understand their legal position and available fiduciary alternatives fully.

Many companies tend to misunderstand or minimize
their legal responsibility
until trouble erupts.

DOL Weighs In

If Edison’s legal troubles are insufficient reason to put some sunshine on the plan’s costs, a fee transparency initiative by the U.S. Department of Labor (DOL) should be. A DOL interim final rule that will take effect on Jan. 1, 2012, requires service providers disclose information (known as "section 408(b)2 disclosures") to help plan sponsors understand the reasonableness of fees charged for plan services.

The 408(b)(2) disclosures will help companies identify potential conflicts of interest and remove them before legal action is undertaken by employees. In addition, a companion DOL final rule, which also takes effect on Jan. 1, 2012, requires plan sponsors to make standardized quarterly fee reports to participants.

While employees will view fee transparency positively, HR managers might find that they lack the processes or experience to confidently comply with the new rules, making the 401(k) burden more cumbersome than any noncore element of a business should be.

A good ERISA fiduciary has the expertise and processes to help a company comply with regulations. While there are several kinds of fiduciary and nonfiduciary arrangements, one of the most straightforward ways to transfer investment-decision liability is to engage a full-scope ERISA section 3(38) investment fiduciary.

ERISA 3(38) Investment Fiduciaries

Companies too often believe the plan’s financial professional protects them from litigation. The financial professional might not be a fiduciary and might contend that it provides only general recommendations, not specific investment advice subject to the fiduciary rules.

Companies can counter much of the legal liability for their plan's investment decisions if they contractually transfer the fiduciary responsibility of managing investment assets to a 3(38) fiduciary. This frees a company from many of the duties and the legal liabilities of running a 401(k) plan. If a service provider’s status as a fiduciary is not in writing, sponsors should assume that the fiduciary is not acting as a 3(38) fiduciary (always ask a service provider to commit its fiduciary status in writing).

Bear in mind that the process by which the plan sponsor evaluates, selects and oversees a 3(38) fiduciary still must be in accordance with fiduciary standards.

While a 3(38) fiduciary must be paid for its services and thus represents an additional cost, plans using a 3(38) fiduciary for investment decisions can reduce significantly the possibilities of major litigation problems. And while the cost of a 3(38) fiduciary is known, the cost of litigation and damages is unknown.

Matthew D Hutcheson, a nationally recognized authority on qualified plans and fiduciary responsibility, explains the difference between an investment advisor and a 3(38) fiduciary in simple terms. In his article, "Unscrambling Fiduciary Confusion," he says it is like “the difference between someone in the back seat (i.e., the investment advisor) of a car giving directions to the driver (i.e., the plan sponsor) and someone who has the keys and actually has the responsibility to drive the car (i.e., the 3(38) fiduciary).”

Companies balancing their 401(k) responsibilities face an ever-changing landscape of regulations and court decisions. Some plans have the wherewithal to stay abreast of these developments. For those companies that do not, transferring investment fiduciary liability to a 3(38) fiduciary might mitigate the risk of being questioned by employees, unions and regulators about conflicts of interest and whether companies are acting with prudence when making 401(k) investment decisions.

Jose V. Sanchez is an investment advisor representative at HBW Advisory Services LLC in Simi Valley, Calif., a privately held registered investment advisory firm specializing in the development of process-driven plans and strategies. He is one of the firm’s retirement and wealth management specialists. Investment advisory services offered through HBW Advisory Services LLC. HBW Insurance & Financial Services, Inc. and HBW Advisory Services LLC are separate entities that do not provide legal or tax advice.

Related Articles—SHRM

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