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First, some background. Tussey was one of several class-action lawsuits filed against big companies in 2006 by law firm Schlichter, Bogard & Denton, alleging that the companies had taken actions related to 401(k) plan fees and costs that weren’t in the best interest of participants. Therefore, plaintiffs argued, plan sponsors had breached their fiduciary duty under the Employee Retirement Income Security Act.
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Tussey was the first of the cases to be adjudicated. In 2012, a district court ruled in favor of the plaintiffs, finding that the U.S. arm of ABB had committed a raft of 401(k) fiduciary breaches. They included failure to monitor record-keeping costs; not taking advantage of opportunities to negotiate volume-based rebates for administrative services; acting in its own interest rather than plan participants’ interest; and replacing a low-cost, well-performing fund from Vanguard with higher-cost funds from Fidelity without prudently deliberating the change, and switching (“mapping”) participants from the old fund to the new funds. The court ordered ABB to reimburse plan participants $35.2 million.
The company appealed the decision. Then, last March, the Eighth Circuit Court of Appeals affirmed the lower-court ruling on some of the claims, upholding $13.4 million from the earlier judgment. The remaining $21.8 million rests on the fund-replacement and mapping matter, which was sent back to the district court with instructions to use different standards in reaching a decision.
Tussey is widely regarded as a landmark case, holding a 401(k) plan sponsor liable for abusive practices concerning plan fees and costs. Similar cases, notably ones involving Lockheed and California utility Edison International, remain to be decided; at press time, the Supreme Court was deciding whether to take on the Edison case. Some companies have already settled suits brought by the Schlichter firm, including Caterpillar, General Dynamics, and International Paper.
All of these cases involve large companies—no surprise, given that such class actions are expensive and time consuming to bring, dampening attorneys’ interest in taking on any but the biggest. But that doesn’t mean smaller plan sponsors can relax.
“Many companies have still not gone through a documented process to determine if the fees being charged are reasonable for the services rendered,” says Greg Marsh, senior vice president of Bridgehaven Financial Advisors, which provides such benchmarking and other 401(k) advisory services to small and midsize plan sponsors. “It’s one of the biggest risk positions on CFOs’ plates, because it’s not their ‘day job’ and not high on their totem pole.”
While small plan sponsors are unlikely to be hit with private litigation, their 401(k) programs are still potentially subject to random Department of Labor audits, or could be brought into the crosshairs by employee complaints, says Marsh. “The original judgment in the ABB case was 2.4% of plan assets,” he notes. “You may be a small company with just a $20 million plan, but 2.4% of that is $480,000.” He adds, “This isn’t something that’s going away.”
How can plan sponsors minimize fiduciary risk and avoid litigation? Experts advise the following:
1. Really understand your plan. CFOs should put in the time to fully understand all the fees in the company’s 401(k) plan and how the plan is paid for. “Devoting sufficient time for the monitoring, the analysis, the vetting of funds and expenses may take away from time spent on running the business,” says Jerome Schlichter, partner at Schlichter, Bogard & Denton. “But that comes with having a 401(k) plan. You’ve got to carve out the time to operate it as if it’s your own money.”
2. Keep the focus on participants. Avoiding a breach of fiduciary duty starts with the simple principle that any fiduciary involved in a 401(k) plan must act in the exclusive interest of plan participants. The kind of self-dealing that the court said ABB practiced is an example. ABB in effect subsidized favorable pricing for non-401(k) services provided by Fidelity, such as for health-plan and payroll management, with the higher investment-management fees charged to plan participants who were shifted to the Fidelity funds.
“For any service provider in the plan, be careful that it’s not providing other corporate services paid for by the company—or if it is, that you’ve done [a request for proposal] and gotten bids and made sure the rates are market rates,” says Schlichter.
3. Benchmark, benchmark, benchmark. Each year, benchmark the fees in your plan against those in comparable plans (at companies in the same industry, with similar asset sizes and employee participation rates). The documentation will enable you to negotiate lower fees with service providers that are out of step with market norms, notes Marsh.
4. Beware of bundling. In many cases 401(k) services are bundled, with plan sponsors hiring an investment-fund provider that also offers record keeping and other administrative services. It’s a big reason why the DoL toughened up regulations requiring disclosure of fees for investment management and plan administration in 2012. Before then, providers of bundled services often buried administrative costs in investment costs and quoted the plan sponsor a single consolidated cost, making it difficult to benchmark administrative costs.
While bundling is still commonplace, many 401(k) experts advise plan sponsors to unbundle plan services and seek bids for each category of service. (Schlichter, in fact, predicts that large plan sponsors will eventually be required to do that.) Says Josh Cohen, managing director, defined contribution, at Russell Investments: “Many plan sponsors went to a bundled platform and considered it outsourcing, thinking the provider would take care of everything for them, without appreciating that they still had a fiduciary responsibility to monitor fees and investment options.”
5. Watch out for revenue sharing. To win business, investment-management firms often agree to use a portion of their revenue to pay recordkeepers’ fees. Schlichter considers it a red flag when that payment is based on a percentage of plan assets and suggests plan sponsors be wary of the practice. “Record keeping is a commodity service that has nothing to do with asset size,” he says. “If one person has $75,000 in his account and someone else has $7,500, it doesn’t cost 10 times more to keep the first person’s records. Remember, the plan sponsor must determine that all fees are reasonable.”
When revenue sharing is used, plan fiduciaries should be able to demonstrate that this structure was better for plan participants than choosing a different class of investment (without revenue sharing) and paying the administrative fees directly, says Andrew Liazos, a partner with law firm McDermott, Will & Emery.
6. Don’t float. In the original ruling in Tussey, ABB’s record-keeper, Fidelity, was ordered to pay plan participants $1.7 million, representing float income that the court said rightfully belonged to the plan. Float arises between when funds are received from plan sponsors’ payroll systems and when they are invested. The appeals court vacated that ruling, saying plaintiffs had not proved that the amount in question represented actual plan assets. But Liazos counsels that plan sponsors should be aware of the float issue. “Where there is any sort of compensation a service provider is receiving, and there is no record of [float income] being part of [what] plan fiduciaries considered the total aggregate compensation should be, that’s a problem,” he says.
7. Don’t pay retail. A special admonition to sponsors of large plans: stay away from retail investments. “An employee of a large company should get the benefit of the employer’s size in the fees charged to the plan,” says Schlichter. “That plan can get institutional rates and shouldn’t have retail funds in the lineup. Warren Buffet doesn’t pay retail, and neither should an employee of a company with a billion-dollar 401(k) plan.”
