PWBA Turns Its Attention to High 401(k) Plan Fees and Expenses

By C. Frederick Reish and Bruce L. Ashton

The PWBA is concerned about the level of expenses paid by 401(k) plans because those costs reduce the net returns on the plan investments and, in the long run, can significantly decrease the level of participant benefits.

In July 1999, the Pension and Welfare Benefits Administration (PWBA) published a worksheet for comparing the expenses charged to 401(k) plans by the investment and service providers to those plans. The release of that worksheet was the end result of a two-year effort by the PWBA to learn about the costs paid by 401(k) plans. Its purpose was to get employers, employees, plan fiduciaries, and the media to focus on the consequences of high fees and charges to plans.

The PWBA is concerned about the level of expenses paid by 401(k) plans because those costs reduce the net returns on the plan investments and, in the long run, can significantly decrease the level of participant benefits. While the reasonableness of fees is a concern for all plans, it is particularly important for 401(k) plans because they generally bear a higher proportion of the expenses than do other types of employee benefit plans, in which the plan sponsors typically pay a larger portion of the expenses. In addition to that general concern, the PWBA has enforcement responsibility under section 404 of ERISA for fiduciary breaches that can result from the payment of excessive fees, as well as responsibility for enforcing the prohibited transaction rules under ERISA sections 406(a) and 406(b).

History of PWBA's Inquiry
On October 16, 1997, the PWBA announced that it was holding hearings to learn more about the fees and costs being charged to 401(k) plans and about the reasons for, and the consequences of, those fees. Specifically, the PWBA Notice of Public Hearing stated that the purpose of the hearings was to answer the following questions:

• In selecting and monitoring service providers, are plan sponsors being furnished with sufficient information to evaluate whether the fees and expenses associated with plan investments, investment options, and administrative services are reasonable?
• If not, what additional information should be provided to or requested by plan sponsors, and is it readily available?
• What steps are plan sponsors taking to ensure that the fees and expenses charged to the individual accounts of the plan participants are reasonable?
• Are plan participants being furnished with sufficient information about the fees and expenses associated with the investment options offered under their plan to make informed investment decisions?
• What additional information should be provided to or requested by plan participants, and is it readily available?
• Is the information regarding services, fees, and expenses disclosed to plan participants regarding their accounts provided in a manner understandable to most participants?
• Is the disclosure automatic or on request?
• If automatic, how often and to whom is it provided (plan sponsor or participants)?
• How are the services and the respective fees included in a bundled fee arrangement disclosed?
• How are the fees and expenses with respect to each of the covered services in a bundled arrangement determined?
• What actions, if any, should the DOL take to improve consideration and disclosure of fees and expenses charged to 401(k) plans?
• If action is necessary, what information should be required to be disclosed?
• Would a uniform format for disclosure be helpful to plan participants?

After the hearings, the PWBA conducted approximately 50 field investigations to learn more about the fees being charged to 401(k) plans and for discovering whether there were abusive practices in that area. While the PWBA has not announced the results of those investigations, all of the investigations have been completed and the results have been sent to the PWBA Headquarters in Washington, D.C. It is the authors' belief that the information learned from those investigations will soon be informally reflected in speeches by PWBA officials—and possibly in a PWBA report on the information gleaned from the investigations.

PWBA Brochures for Employees
On July 1, 1998, the PWBA published a 401(k) fees booklet for plan participants entitled A Look at 401(k) Plan Fees. It also released a study of 401(k) costs prepared by an outside consultant entitled Study of 401(k) Plan Fees and Expenses (the "Study"), which is a lengthy and detailed analysis of the types of expenses charged in connection with the investment and administration of 401(k) plans. Both the booklet and the Study can be found at the PWBA’s web site at www.doc.gov/dol/pwba. The Study is available only on the Internet.

In the participant booklet, the PWBA discusses the importance of fees and their effect on retirement benefits, describes the types of fees charged in 401(k) plans, instructs participants on where they can obtain information about their plan's fees and expenses, and provides participants with ten questions to ask their employers about the plan's services, investments, and fees. In addition, the brochure instructs participants that their employers have a fiduciary responsibility under ERISA to understand the fees paid by the plan, and to determine whether they are reasonable relative to the services purchased, as follows:

You should be aware that your employer also has a specific obligation to consider the fees and expenses paid by your plan. ERISA requires employers to follow certain rules in managing 401(k) plans. Employers are held to a high standard of care and diligence and must discharge their duties solely in the interest of the plan participants and their beneficiaries. Among other things, this means that employers must:

• Establish a prudent process for selecting investment alternatives and service providers.

• Ensure that fees paid to service providers and other expenses of the plan are reasonable in light of the level and quality of services provided.

• Select investment alternatives that are prudent and adequately diversified.

• Monitor investment alternatives and service providers once selected to see that they continue to be appropriate choices.

PWBA’s Publications for Employers
As a result of the testimony given at the 1997 hearings, and of information gathered during the PWBA investigations of 401(k) plans, the PWBA determined that there was a need for a standardized disclosure form to assist employers and fiduciaries in understanding 401(k) fees. After discussions with representatives of the various industry segments in the 401(k) investment marketplace, the PWBA asked associations representing the insurance, mutual fund, and banking industries to collaborate in the development of a standard form for the disclosure of 401(k) fees and expenses. In response to that request, the American Council of Life Insurance (ACLI), the Investment Company Institute (ICI), and the American Bankers Association prepared a fee disclosure form and provided it to the PWBA. On July 15, 1999, the PWBA published the disclosure worksheet, together with a brochure for employers and a press release. Copies of all three documents can be obtained from the PWBA's web site at www.dol.gov/dol/pwba. The disclosure form is only available on the Internet.

The worksheet provides for full disclosure of all investment-related expenses including, for example, front-end loads, annual asset-based charges (such as investment management fees, 12b-1 fees, trailing commissions), and back-end charges (such as contingent deferred sales charges and back-end loads). In addition, it calls for disclosure of other expenses associated with the operation of a 401(k) plan (e.g., plan document costs, annual administration expenses, compliance testing). While most of the worksheet is dedicated to the disclosure of costs, the overview makes an effort to point out that ordinarily costs are not an overriding factor:

The Employee Retirement Income Security Act of 1974, as amended (ERISA) requires employee benefit plan fiduciaries to act solely in the interests of, and for the exclusive benefit of, plan participants and beneficiaries. As part of that obligation, plan fiduciaries should consider cost, among other things, when choosing investment options for the plan and selecting plan service providers.

This 401(k) plan fee disclosure form may assist you in making informed cost-benefit decisions with respect to your plan. The purpose of this form is to help you determine the total cost of the plan. It is also intended to provide you with a means to compare investment product fees and plan administration expenses charged by competing service providers, regardless of how a particular service provider structures its fees.

Selecting a service provider requires that you evaluate and differentiate services offered by competing companies. Cost is one of the criteria, but not the only criterion, for making this evaluation. Other factors of equal or greater importance to consider include the quality and type of services provided, the anticipated performance of competing providers and their investment products and other factors specific to your plan's needs. The service provider offering the lowest cost services is not necessarily the best choice for your plan.

• Fees and expenses should be evaluated when the investments and services are initially acquired, and should be continually monitored thereafter.
• Fees and expenses should be evaluated to ensure that they are reasonable relative to the services being provided, and that those services are appropriate for the plan.
• Fees and expenses are not the only factor to be considered. Some of the other factors are investments performance, range of services, quality of services, and level of responsibility for the provider.
• The purposes of the disclosure form are: (1) to assist the employers and fiduciaries in making an informed cost/benefit analysis of the services and investments for a 401(k) plan, and (2) to provide a means for comparing investment product fees and plan administration expenses charged by competing providers. Implicit in the second objective is that employers will seek competing proposals. In fact, the overview portion of the disclosure form states, "Selecting a service provider requires that you evaluate and differentiate services offered by competing companies."

Description of the 401(k) fee disclosure form. The worksheet is divided into seven parts. Those parts are:

1. Overview.
   
2. Total Plan Expenses. This schedule compiles the cost information from the detailed schedules that follow.
   
3. Investment Product Fees (Schedule A). This schedule elicits cost information by type of investment vehicle:
   • Collective Investment Fund.
   • Insurance/Annuity Product.
   • Mutual Fund.
   • Individually Managed Account.
   • Brokerage Window.
   • Other Product.
   
4. Plan Administrative Expenses (Schedule B). This schedule requests information on services and costs in the following categories:
   • Administration/Recordkeeping Fees.
   • Participant Education/Advice.
   • Trustee/Custodial Services.
   • Compliance Services.
   • Plan Amendment Fee.
   • Loan Administration.
   
5. One-Time Start-Up/Conversion Expenses (Schedule C). This schedule requests information on costs for:
   • Start-up/conversion education program.
   • Start-up/conversion enrollment expense.
   • Installation fee.
   • Start-up/conversion plan document fee/filing fee.
   • Other.
   
6. Service Provider Termination Expenses (Schedule D). This schedule seeks information on:
   • Investment Product Expenses for termination of the investment provider.
   • Plan Administration Expenses for termination of the provider of plan administration services.
   
7. Schedule E contains definitions of the terms used in the form.

While the worksheet calls for costs to be identified and quantified, it does not require disclosure of the application of those expenses. For example, bundled providers are only required to post a single cost for the "bundle" of services they offer. It is assumed this is because the providers of bundled services were reluctant to disclose their allocated costs and profits, or because they felt they were unable to do so. However, that information would be valuable to plan fiduciaries and employers in understanding and evaluating the costs and the value of the services. Although the form contemplates a single cost for bundled providers, the same thinking is not extended to "partially bundled" investment products. For example, if recordkeeping, investment education, voice response, and Internet services are provided in connection with an investment package (e.g., a group annuity contract), but the administrative services are provided by a separate company, the form does not allow for a single pricing for the partially bundled services.

Several of the categories of services in the worksheet are too broad. For example, under Schedule B, Plan Administration Expenses, one category is labeled "VRU/Internet services." Most plan sponsors would consider that as two categories: a voice response system and a web site. Further, the services on Internet web sites vary significantly. Participant services offered on some sites, but not all, include investment transactions, account balances, retirement planning, loan modeling, investment education, and investment advice. Depending on the range of those services, the value of the web site to the plan and its participants can vary materially.

Curiously, the form does not specifically ask for information on market value adjustments to guaranteed contracts. However, in Schedule D, Service Provider Termination Expenses, there is a general category entitled "Product Termination Fee." It is not clear if this is a market value adjustment or a fee. Also, Schedule D asks for a dollar amount for termination fees (e.g., for group annuity contracts), but without providing any guidance for uniform responses. For example, should it be calculated after one year, three years, five years, or more? And on what assumptions about the value of the assets should the termination fee be based?

The worksheet omits some significant services. For example, there is no category for plan design consulting. That could include a breakout of such services as advice on controlled and affiliated service group issues, the categories of workers to be included in the plan, the method for compliance in benefit testing (for example, cross-tested or safe harbor plans), and so on. This may be the result of the form being prepared by associations from the investment industry without representation from other sectors of the benefits community.

Brochure for Employers
The PWBA brochure, A Look at 401(k) Plan Fees . . . for Employers briefly discusses an employer's responsibility to investigate the fees and expenses payable by a plan and then poses ten questions an employer should ask in process. The introductory language says, in part:

A participant-directed retirement savings plan, such as a 401(k) plan, is an important tool to help your employees achieve a secure retirement. As part of offering this type of program, you or someone you choose must select the investment options from which your employees will choose, select the service providers for the plan, and monitor the performance of the investments and the provision of services. All of these duties require you to consider the costs to the plan. This brochure can help you ask the right questions to better understand and evaluate the fees and expenses related to your plan.

You or the person you select to carry out these responsibilities must comply with the standards provided under the Employee Retirement Income Security Act of 1974 (ERISA). The federal law protects private-sector pension plans. The law's standards include ensuring that you act prudently and solely in the interest of the plan's participants and beneficiaries.

Understanding fees and expenses is important in providing for the services necessary for your plan's operation. This responsibility is ongoing. After careful evaluation during the initial selection, the plan's fees and expenses should be monitored to determine whether they continue to be reasonable. While ERISA does not set a specific level of fees, it does require that fees charged to a plan be 'reasonable.'

1. Have you given each of your prospective service providers complete and identical information with regard to your plan?
2. Do you know what features you want to provide (e.g., loans, number of investment options, types of investments, Internet trading)?
3. Have you decided which fees and expenses you, as plan sponsor, will pay, which your employees will pay and/or which you will share?
4. Do you know which fees and expenses are charged directly to the plan and which are deducted from investment returns?
5. Do you know what services are covered under the base fee and what services incur an extra charge? Do you know what the fees are for extra or customized services?
6. Do you understand that some investment options have higher fees than others because of the nature of the investment?
7. Does the prospective service arrangement have any restrictions, such as charges for early termination of your relationship with the provider?
8. Does the prospective arrangement assist your employees in making informed investment decisions for their individual accounts (e.g., providing education, information on fees, and the like) and how are you charged for this service?
9. Have you considered asking potential providers to present uniform fee information that includes all fees charged?
10. What information will you receive on a regular basis from the prospective provider so that you can monitor the provision of services and the investments that you select and make changes, if necessary?

Despite the inadequacies in the worksheet, it significantly advances the transparency and analysis of information on 401(k) fees and expenses because it provides a uniform platform for gathering that data. If the disclosure worksheet becomes the industry standard, and if employers and plan fiduciaries in fact solicit competing proposals (which the PWBA seems to suggest is required), and use the form to evaluate the range of services and costs, the PWBA's goals will largely be accomplished, and costs to participants will be reduced. Of course, plan sponsors should be mindful that other factors, such as investment performance and the quality of services, are equally or more important.

Finally, the focus by the PWBA on 401(k) plan costs will, in and of itself, increase the attention paid to those costs and ultimately have the effect of reducing plan expenses and thereby increasing benefits to participants.

© 1999 Warren, Gorham & Lamont and RIA Group, 31 St. James Ave., Boston, MA 02116-4112. Article appeared in the Journal of Taxation of Employee Benefits, Vol. 7 / No. 4, November / December 1999. An earlier version of this article appeared in the September 20, 1999 issue of RIA Pension & Benefits Week.

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