One recent lawsuit alleging fiduciary duty violations caught the attention of many in the employee benefits business. The filing received considerable attention in legal circles not because of the nature of the charges, but instead because it involved a small employer. A string of large employers have faced similar charges and ultimately compensated participants. Even though the plaintiffs later withdrew their complaint, let’s take a closer look at why the filing of this case matters.
Employees of LaMettry’s Collision Inc. filed — and then later dropped — a class action suit against their employer charging that key executives had breached their fiduciary duty by allowing the company’s $9.2 million, 114-active-participant plan to pay excessive administrative, investment and recordkeeping fees at their expense. Noteworthy is that only the company’s CEO and CFO — both plan trustees — were named as defendants, and not the plan’s recordkeeper, its brokerage or the advisor representative. Charging them would have required proving that they too held fiduciary duty to plan participants — an assertion that would have been difficult to prove.
The plan’s investment options include approximately 11 mutual funds, seven pooled separate accounts and a guaranteed investment contract offered by the broker. According to the complaint, the retail-priced investment options selected by defendants “likely offered no additional services at all compared to equivalent or lower fee institutional funds.” The asset-based fees for two of the retail-class shares of two funds identified were 1.17% and 1.3%, vs. 0.73% and 0.69%, respectively, for the institutional-share classes of those funds.
The complaint alleged that the defendants had failed to consider the lower-fee funds and actively monitor the selected funds’ fees compared to the lower-fee funds. In addition, the lack of any additional value or services in exchange for the higher fees charged by the selected funds caused plan participants to pay hundreds of thousands of dollars in excessive fees.
The plaintiffs’ lawsuit also charged that the plan overpaid for recordkeeping services. The complaint stated that recordkeeping is necessary for every defined-contribution plan and that prudent fiduciaries must solicit requests for proposals from companies that provide recordkeeping services to control plan costs.
The plan was paying a 1.22% asset-based fee for recordkeeping services, resulting in a $113,000 annual charge. The plaintiffs claimed that if instead those services had been charged on a competitive per-participant annual fee basis, plan participants would have been in better shape.
The complaint also faulted the defendants for failing to disclose revenue-sharing fees paid by asset managers to the recordkeeper. Finally, the plaintiffs questioned the plan’s paying of an umbrella administrative fee averaging 0.58% for which, the complaint charged, participants received little to no value. This fee amounted to an annual cost of over $50,000.
ERISA’s fiduciary standards as litigated over the years place great emphasis on the process by which fiduciaries arrive at their decisions. The plaintiffs zeroed in on that issue, charging that the CEO and CFO “did not have a prudent process — or any process — for the consideration, selection, evaluation, or active monitoring of these funds or their fees with respect to alternatives, including lower fee funds.”
The fact that plaintiffs’ attorneys were prepared to take on a class action case against a smaller retirement plan puts small employers on notice that they too face defending themselves in such a case if they haven’t taken essential precautionary steps. Because the case was dropped “without prejudice” it could, in theory, be resurrected. While this is unlikely, the lesson of the filing is clear: All employers no matter their size need to follow all fiduciary rules.
Sidebar: How to allocate recordkeeping fees equitably among participants?
With heightened attention focused on plan costs, how can plan sponsors prevent participants from experiencing “excessive” recordkeeping fees? Sponsors have several choices when allocating fees:
Employer funds. The simplest choice — but most costly to sponsors — is to pay recordkeeping fees from employer funds. With that approach, whether fees are “reasonable” is moot from the participants’ perspective. However, this approach is only used by about 20% of sponsors, according to a survey by Fidelity Investments.
Revenue-sharing agreements. When participants bear some or all of the cost of recordkeeping fees, it’s important not only that they be reasonably priced, but that they be shared equitably. Ask recordkeepers to use revenue-sharing fees they receive from asset managers to offset recordkeeping charges that would otherwise be levied against participant accounts.
However, some funds, particularly actively managed stock funds, share more revenue with recordkeepers than others. To avoid having revenue-sharing arrangements disproportionately benefit participants with investments in high-revenue-sharing funds, have the recordkeeper apply aggregate revenue-sharing amounts equally among all participants.
R6 share agreements. Yet another approach is to limit plan investments to “R6 shares.” This is an emerging class of funds that are lower in cost but don’t share revenue with recordkeepers. While this simplifies accounting for recordkeeping charges against individual participant accounts, those costs still exist, and must be paid in some other fashion.