In prior posts ( June 15, 2010 and December 17, 2009), I pointed out that even though plaintiffs were losing their lawsuits challenging 401(k) plan fees, the legal issues were still far from settled. The Court of Appeals for the Eighth Circuit reinstated claims against the huge WAL-MART 401(k) Plan, challenging the use of retail instead of comparable institutional class mutual funds for the plan, and new law and regulations could be forthcoming.
We have just had a decision from a federal district court in California, Tibble v. Edison International, in which the court ruled on the issue of retail versus institutional funds and found that the Investment Committee of a 401(k) plan and other defendants violated ERISA's duty of prudence by selecting retail mutual funds rather than identically invested institutional funds as available plan investments. The court did rule against plaintiffs earlier and in this decision on some of the issues that have repeatedly been raised in these suits; for example, the court ruled that revenue sharing in and of itself was not a prohibited transaction. However, this decision sends a strong message to 401(k) plan fiduciaries that they must become more actively involved in fund selection and comparing fees.
Large fund families typically offer two identically managed classes of shares in the same fund: an institutional class for large investors, which typically has a lower expense ratio, and a comparable retail class with higher fees for smaller investors. The retail class shares selected for the plan provided for revenue sharing; the institutional class shares did not. The Investment Committee received advice from Hewitt, an outside adviser, in selecting investments, but the court ruled that consulting experts was not a complete defense to ERISA imprudence charges, stating that the fiduciary "must make certain that reliance on the expert's advice is reasonably justified."
In ruling against defendants on the prudence claims, the court rejected their defense that their accounts were not large enough to satisfy the minimum investment requirements for institutional funds. Evidence was introduced that these minimums were typically waived for larger 401(k) plans such as the Edison plan upon request, and that the fiduciaries had made no effort to ask about or request waivers. Failure to ask thus became the crucial factor in the court's decision.
The duty of loyalty was also an issue because plaintiffs said the fiduciaries picked funds with revenue sharing to reduce the fees Edison paid rather than making the selection solely in the interest of the participants to whom the duty of loyalty runs. Even though Edison paid the plan fees that were offset by revenue sharing, and higher expense ratios reduced participant investment return, the court ruled that ERISA's duty of loyalty was not violated when Edison fiduciaries selected the retail funds and that funds were not selected in order to increase revenue sharing.
Had participants paid all expenses, the court might have instead asked whether the fiduciaries had compared the dollar benefits of revenue sharing against the additional fees.
Damages have not been determined yet, but they will include participants' lost investment opportunity as well as return of excessive fees.
In addition, the Department of Labor has just issued interim final regulations, to be effective in 2011, requiring new fee disclosures by service providers to hiring plan fiduciaries, and has announced that new participant fee disclosure regulations are forthcoming.
Investment fiduciaries of 401(k) plans can best protect themselves by understanding as much as possible about the fee structures of plan investments, by taking cues from the Tibble case, and by monitoring proposed and future law changes to identify best practices they should be following now.
Caro Buckmannl has practised in the employee benefits field for over 25 years, advising clients on all aspects of employee benefits and retirement plans, including questions relating to 401(k), defined benefit and employee stock ownership plans, welfare plans, fiduciary responsibility, prohibited transactions and plan asset issues arising in investment fund formation.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
