Excessive 401(k) Plan Fees and Costs: The Coming Storm in ERISA Litigation?
One of the most -- if not the most -- high profile ERISA litigation cases of the past several years involves the Enron 401(k) Plan. Plaintiffs in the Enron case claim that Enron's senior management allowed plan participants to continue to invest their 401(k) plan monies into Enron company stock, knowing full well that investors were generally being misled regarding the value of Enron stock. Other well-publicized cases -- including a case involving the Lucent Technologies, Inc. 401(k) plan -- thrust these so-called "employer stock" cases into the forefront of ERISA litigation. In the wake of those cases, it's evident (if it wasn't evident before) that 401(k) plan sponsors that offer employer stock as an investment option to their plan participants need to evaluate that stock just as they would any other investment option.
Yet as interesting as these cases are, with their backdrops of corporate greed and "disregard for the little guy," their most sweeping legacy may not have anything to do with employer stock. After all, typically only very large companies offer their own stock as a 401(k) investment option (or use company stock to match employee deferrals). While it may seem mundane, the real impact of these cases may be the renewed focus they put on a plan fiduciary's obligation to engage in a prudent process in selecting the investments to offer to plan participants. Of course, this was always true, even if many plan sponsors turned a somewhat blind eye to the investments their plan offered.
With plan fiduciaries facing greater scrutiny than ever in the wake of the employer stock cases, what is the next ERISA litigation trap for corporate officers and directors that preside over their companies' retirement plans? The answer may be claims relating to payment of excessive fees and expenses.
One of the fundamental responsibilities of ERISA fiduciaries is "defraying reasonable expenses of administering the plan." (ERISA §404(a)(1)(A)(ii).) The typical types of expenses incurred by a plan are administrative expenses such as fees paid to accountants, attorneys, consultants and third party administrators, and investment-related expenses such as broker commissions.
The significance to a plan participant of defraying plan expenses may be every bit as great as the significance of choosing well-performing investments. On its web site, the Employee Benefits Security Administration (EBSA) -- the agency of the Department of Labor responsible for enforcement of ERISA's fiduciary liability provisions -- offers the following example of how plan-related fees can impact the account of a 401(k) plan participant:
Assume that you are an employee with 35 years until retirement and a current 401(k) account balance of $25,000. If returns on investments in your account over the next 35 years average seven percent and fees and expenses reduce your average returns by 0.5 percent, your account balance will grow to $227,000 at retirement, even if there are no further contributions to your account. If fees and expenses are 1.5 percent, however, your account balance will grow to only $163,000. The one percent difference in fees and expenses would reduce your account balance at retirement by 28 percent. (See, http://www.dol.gov/ebsa/publications/401k_employee.html.)
Using these assumptions, the reduction in value to plan accounts in a plan with 10 participants over the same 35 year period would be a whopping $640,000 -- in a plan with 100 similarly situated participants, the number would be $6,400,000.
Of course, the EBSA example assumes a $25,000 account into which no contributions are made. In reality, participants continue to make contributions during the course of their employment, so the EBSA example doesn't begin to adequately demonstrate the significance that excessive plan expenses can have on a 401(k) plan.
The bad news is that if you are a plan fiduciary -- which in this instance translates into any officer, director or other person who is responsible for monitoring investments and plan-related expenses -- you can be held liable for the losses sustained by a plan if a court concludes that the plan paid unreasonable expenses. Investment related expenses should be of particular interest to plan fiduciaries. On its web site, EBSA has singled out those expenses in discussing the obligations of 401(k) plan sponsors to monitor plan expenses:
By far the largest component of 401(k) plan fees and expenses is associated with managing plan investments. Fees for investment management and other investment-related services generally are assessed as a percentage of assets invested. You should pay attention to these fees. You pay for them in the form of an indirect charge against your account because they are deducted directly from your investment returns. Your net total return is your return after these fees have been deducted.
The good news is that a plan sponsor -- and the officers and directors responsible for monitoring plan expenses -- can protect themselves, and in doing so, can protect their employees' retirement accounts. For a fiduciary to be held liable under ERISA for paying unreasonable expenses, it isn't enough to show that the plan might have found ways to pay lower expenses. Rather, the court would have to find that the fiduciary failed to engage in a prudent process of selecting investment options and investigating the fees associated with those investment options. The key to both avoiding liability, and protecting your employees, is therefore to engage in that prudent process.
What is involved in the process? There is no single answer. The courts would decide this on a case-by-case basis. There are, however, some practical steps that fiduciaries can take to make sure they are doing all they can do to protect their plan and their employees' retirement. First, consider compiling a list of the types of fees and charges that are frequently imposed on plans. A consultant (separate from any investment managers or providers currently retained by the plan) may be an invaluable resource in creating this list. Once the list is compiled, ask the plan's investment providers how the fees being charged to your plan can be determined. The EBSA web site -- which is directed to plan participants -- sets forth a series of questions that participants should ask to determine what fees are being charged to them. (See, http://www.dol.gov/ebsa/publications/401k_employee.html#section4). If EBSA is encouraging participants to ask those questions, plan fiduciaries should be able to answer them.
Once those questions are answered, fiduciaries should-perhaps with the assistance of a consultant -- analyze the fees and expenses currently being charged to their plans, and compare them with fees offered through other service providers. If fees and expenses charged to the plan exceed those charged by competitors, the plan sponsor should find out why, and consider either negotiating a reduction in fees through the current provider, switching providers or negotiating for increased services at no added cost. The entire process should be diligently documented, and periodically repeated.
Not surprisingly, the key to avoiding litigation in connection with monitoring a retirement plan's fees and expenses just also happens to be the right thing to do by your employees. Do it, and everyone is better off.
Joe Faucher chairs the firm's ERISA litigation department and specializes in ERISA ligitation and claims against employee benefits service providers.
© 2005
Reish Luftman Reicher & Cohen. All rights reserved. The ERISA Controversy Report is published as a general informational source. Articles are general in nature and are not intended to constitute legal advice in any particular matter. Transmission of this report does not create an attorney-client relationship. Reish Luftman Reicher & Cohen does not warrant and is not responsible for errors or omissions in the content of this report.
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