Whether your company is small or large, chances are you offer your employees a 401(k). Yet even this well-intentioned benefit has become target practice for attorneys, with lawsuits against companies ranging from those with tens of millions of assets in management down to a Minnesota auto body repair company with barely 100 participants and less than $10 million in assets.
The uptick in litigation is likely due to the increased press from the recently vacated Department of Labor fiduciary rule. The Securities Exchange Commission recently released their proposed version related to advice which may also go nowhere as nothing really changes for investment advisers, and it appears brokers must only follow the ‘best interests’ protocol. In other words, the SEC fiduciary rule is not really a fiduciary rule. Still, due to the mainstream coverage by national and industry press, both plan sponsors and participants have been impacted. Thanks to this increased attention, causing confusion and concern, the environment is ripe for legal activity. Lawsuits will undoubtedly continue, with experts saying that law firms are becoming increasingly opportunistic.
In fact, another potential variable related to the uptick in litigation may be the Department of Labor fee disclosure requirements implemented in 2012. Such requirements placed annual disclosures on plan and investor related fee information, which might have impacted litigation frequency. Here are some concrete, practical steps you can take to help your plan participants and also give your company the fullest extent of protection possible against potential litigation.
Making a list, checking it twice
The Department of Labor lists the following fiduciary responsibilities for plan sponsors:
· Acting solely in the interest of plan participants and their beneficiaries with the exclusive purpose of providing benefits to them.
· Carrying out their duties prudently.
· Following the plan documents (unless inconsistent with ERISA).
· Diversifying plan investments.
· Paying only reasonable plan expenses.
Long before the proposed Department of Labor fiduciary and fee disclosure rules, plan sponsors were always the key fiduciary per the Employee Retirement Income Security Act of 1974. As a fiduciary, your responsibilities begin and end with acting in the best interest of your participants and their beneficiaries. This is the yardstick against which all of your activities must be measured, and relies on you behaving in the very manner that is intrinsic to a fiduciary, in good faith and trust.
Investment fund selection
Carrying out your duties prudently more or less boils down to offering plan investments that meet your stated benchmark or investment objective at fair fees.
FThis is not as easy as it sounds when many plan sponsors have multiple service providers including investment advisory firms, recordkeeping service providers or platforms, and firms that provide compliance and plan document services (otherwise known as TPAs).
One trend that we are on the tail end of in our industry is the reduction of mutual fund expenses and the proliferation of index funds, which are increasingly being promoted based on their low cost and high correlation to meeting stated benchmarks.
This is not necessarily a bad thing. In fact, for many plans on a standalone review basis it is an excellent decision. However, every service provider has lowered their fees and revenues substantially in the last 10 to 15 years except for investment advisors, especially in small and middle markets. As it happens, investment advisory firms can charge more for their services under a 3(38) model whereby they are solely responsible for the investment menu.
In relation to reasonable services and fees, it is only benefiting the plan sponsor, but not the participants if the plan is paying these expenses. If the company is paying the expenses for the 3(38) out of pocket and all other variables are held equal, one can argue the fiduciary is absolutely thinking of the participants and their beneficiaries. For plans that are charging investment advisory fees to the participants, the plan sponsor is still a fiduciary and is responsible for selecting and monitoring the hired 3(38) adviser.
Another confusing component is the total fees related to the investment funds. Some platforms have a wrap or annuity fee on top of the investment fees and others may leverage revenue sharing from the funds to pay other service providers. These variables must be incorporated in your selection process of all service providers and a review of the investment fund.
Finally, many in our industry misrepresent Section 404(c), as it is explained as a protection to the plan sponsor in regard to potential lawsuits from participants from the plan’s investment menu. The details are key here, especially with the investment menu. ERISA 404(c) only provides protection from a lawsuit related to the participant’s selected investments, while the plan sponsor is still on the hook for the investment menu.
Emphasis on cost
Paying only reasonable plan expenses is the Department of Labor’s final commandment, but it is certainly not the least important as most litigation to date has been focused on excessive fees. While reading some industry articles, one can walk away thinking they must hire low cost service providers and choose index or low cost investment fund selections. This can’t be further from the truth. Selecting a low-cost service provider often leads to more work for the plan sponsor and can potentially increase their risk related to plan document, compliance tests, and recordkeeping administration issues.
Fiduciaries can, and should, feel comfortable selecting premium service providers as the overall fees must be reasonable for the commensurate services provided per your due diligence. As a plan sponsor, when assessing your fiduciary responsibilities, remember to address all situations in the best interest of your participants. Associated fees and compliance regulations are also critical to note, however, without offering your due diligence, plan participants will become skeptical of your strategies. Even with the fiduciary rule changing, priorities remain the same.
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