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Courting Disaster

Confusion over 401(k) plan fees is triggering lawsuits and congressional inquiries. What can plan sponsors do to head off trouble?

Russ Banham
CFO Magazine

May 1, 2008

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Last summer, when a federal judge dismissed a suit brought by employees of John Deere & Co. alleging that they were charged unreasonable and poorly disclosed fees in their 401(k) plans, companies may have been tempted to breathe a sigh of relief. A number of such suits have been brought over the past two years, making companies acutely aware of a fiduciary responsibility that few seem suitably prepared to address.

Turns out that relief was short-lived. In March, the Department of Labor (DoL) lent its weight to the employees' side of the case, filing a brief in support of their claim as they pursue an appeal. It's the latest salvo in the battle over 401(k) fees, namely how to accurately assess and communicate them to employees.

Over the years, as more providers have gotten into the defined-contribution business, their fees and behind-the-scenes revenue-sharing arrangements have become so complex that plan-expense comparisons are virtually unattainable. And that's a problem. If plan sponsors can't ascertain the true cost of their defined-contribution plans, they certainly can't explain fees to plan participants, who pick up many of these expenses. The upshot has been litigation against more than a dozen plan sponsors and intense scrutiny of 401(k) fees by Congress and the DoL. The latter is in the midst of receiving public comment on proposed guidelines to make fees more reasonable and transparent.

Rather than wait for the DoL to issue new regulations, some companies have called in retirement advisory firms to analyze and benchmark the hodgepodge of fees that they and their employees pay for the services rendered by 401(k) providers.

Doubts about the suitability of fees affect a wide swath of plan sponsors. According to a study released in March by Chatham Partners, while 79 percent of plan sponsors believe understanding their 401(k) plans' overall costs is important, only 58 percent feel confident they do. Thirty-four percent said they found it difficult to compare one plan's fees with another's, and only 38 percent say their provider discloses its revenue-sharing arrangements with partner firms.

Were these respondents able to obtain full disclosure of what they're really paying for — many providers give out only a bottom-line number — they would find wide disparity. According to data compiled by HR Investment Consultants, for a plan covering 500 participants with average account balances of $50,000, the shared fees paid by plan sponsors and participants ranged from $211 to $822. "Given today's legal climate, employers should be wary if they are paying more than the average cost [$599]," says Joe Valletta, a principal and co-author of the investment advisory firm's 401(k) Averages Book.

Wariness, indeed, makes sense given the lineup of companies alleged to be in violation of the Employee Retirement Income Security Act of 1974 (ERISA). Companies ranging from Boeing to RadioShack are embroiled in litigation filed by employees over the reasonableness and disclosure of the 401(k)-related fees they have paid.

None of the cases have been settled, although a lawsuit filed by employees of Deere & Co. against Fidelity Investments, the company's trustee and record-keeper for its $2.5 billion 401(k) plan, was dismissed last July. (However, as of March, the DoL has become involved and is asking the judges to reconsider.) Nevertheless, increased due diligence seems in order, given sponsors' fiduciary obligations to protect the interests of employees. "If a sponsor doesn't know how the bundled fees are broken down into different buckets, it cannot compare them with the fees charged by other providers," says Pamela Hess, director of retirement research at Hewitt Associates. "Yet sponsors have a legal obligation to make sure their contracts are reasonable."