The Supreme Court is slated to hear the Tibble v. Edison case in 2015, which promises to be a landmark ruling for the corporate retirement space. The case was previously heard by the 9th Circuit Court of Appeals which ruled that the plan sponsor, Edison International, violated a section of ERISA by introducing retail-class mutual funds (along with their high expense ratios) to participants without considering lower cost institutional-class mutual funds as an alternative. Even worse, the retail-class options were stuffed with a revenue sharing model, paid by participants, in which a portion of these fees were kicked back to Edison.
My personal definition of revenue sharing is a deliberate overcharge at the fund level (which means participants are paying the overcharge) in an attempt to hide compensation for other vendors and the middlemen involved with the plan. The middlemen are certainly a necessary component of any 401(k) program, but the major issue with revenue sharing is that it lacks transparency, which makes it difficult to detect the amounts these people are getting paid. Everybody has a right to get paid, but when that compensation is covered up it creates a perception of impropriety along with an environment ripe for abuse.
It is important to understand that revenue sharing is not the issue in question in the Edison case. Nobody is suggesting that it is illegal. Rather, at the urging of the Obama administration, the Supreme Court is ruling on whether the statute of limitations should apply, or whether the employer has a continued duty to monitor the investments after the initial setup. This includes being responsible for knowing what revenue sharing is and determining if it is reasonable, which the DOL defines as usual and customary. The lower courts already determined that the employer breached its duty, but the case before SCOTUS will aim to determine to what extent.
The plaintiffs attorney stated: Fiduciaries have a continuing duty to manage plan investments prudently, and a prior failure to do so does not excuse similar failures within the limitations period.
Most employers are clueless about this practice and other issues surrounding 401(k) fees. That was a major driver behind the 2012 fee disclosure regulation. As the trustees of their plans, employers are responsible for taking care of their participants retirement well-being. Employers needed additional disclosure to adequately fulfill that duty, so that is where fee disclosure came into play.
This case should serve as a wake up call to plan sponsors. To fulfill their responsibilities and avoid penalties, employers need to make sure they are compliant. The law clearly says they must determine the reasonableness of fees in their plans, so employers need to carefully review the fee disclosure document they receive on July 1st of every year and identify if participants are incurring unreasonable fees, such as those associated with revenue sharing. If they do not understand it, they need to hire someone who does, as ERISA holds employers to a prudent expert standard.
Brian Menickella is a co-founder and managing partner of The Beacon Group of Companies, a financial services firm that offers companies and individuals advice on insurance, investing and employee benefits.
Securities offered through TFS Securities, Inc., Member FINRA / SIPC, a full service broker dealer, located at 437 Newman Springs Road Lincroft, NJ 07738 (732) 758-9300. Investment Advisory Services offered through TFS Advisory Services, a division of TFS Securities. www.finra.org
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