Fiduciaries of very large plans who wouldn’t think of not haggling with a dealer over the price of a new car or a hotly negotiating a business deal have sometimes neglected to leverage their plan’s size to negotiate lower 401(k) fees. The result is a sharply increased risk of being sued.
A few years ago, Wal-Mart entered into an expensive settlement of a lawsuit challenging its use of retail mutual funds in its 401(k) plan and requiring changes in its fiduciary practices. One of the contentions in the suit was that Wal-Mart’s fiduciaries didn’t use the plan’s size to invest in institutional class funds that made the same investments with lower fees than the retail funds Wal-Mart made available to participants. (Only large investors are eligible to invest in institutional class finds.)
We have just had another lawsuit filed against a jumbo 401(k) plan (with over $5.5 billion in assets) sponsored by Delta Airlines which underscores the need for fiduciaries to use their plan’s bargaining power.
The newly filed suit names the plan committee as defendants and also challenges the class of funds selected for investment as not having the lowest fees available.
Some of the other allegations in the Delta complaint are similar to those made in recent suits filed against the university sponsors of 403(b) plans. For example, it is alleged that the Delta plan had 200 investment options prior to 2011. In addition to resulting in participant confusion, the complaint alleges that consolidation of these funds, many of which were in the same asset class, would have increased the plan’s bargaining power. Though not mentioned in the Delta complaint, it’s also possible that having so many funds could be a fiduciary breach, since there will inevitably be a mix of good and not-so-good funds in such a large menu. The complaint cites survey results indicating that the average 401(k) plan has only 14 options. Shouldn’t the fiduciaries have tried to winnow the menu down to the best funds?
The following additional arguments were made in the Delta complaint:
· The inclusion of many funds of the same type mimicked an index fund but without the low fees that would have applied if actual index funds were selected for the menu.
· Using funds with higher fees can’t be defended, because studies show that funds with higher fees don’t outperform other funds over the long haul.
· The fiduciaries should have regularly solicited competitive bids for recordkeeping services.
· Plan recordkeeping fees should be determined as a flat fee per participant rather than a percentage of assets. It doesn’t cost more to administer a plan with more assets or to service larger accounts.
· The fiduciaries should have monitored the amount of revenue sharing payments going to the recordkeeper on top of the basic recordkeeping fee, and should have negotiated for a refund of any revenue sharing payments that caused the plan to overpay for the value of services provided.
Some of these claims seem to be an attempt to convert opinions into hard-and-fast rules — for example, is it never appropriate to select a fund with higher fees? Individual managers can beat the averages and might generate good net returns. However, others, if true, are just describing a failure to follow prudent procedures. How many of these practices apply to your plan?
Don’t forget the agreement
One of the biggest mistakes fiduciaries can make is starting off by simply accepting the service provider’s form service agreements. Not only the fees, but other provisions of these agreements are negotiable. For example, size can be leveraged to get better indemnification provisions or to remove mandatory arbitration provisions that the plan sponsor may not want. It is always useful in these situations to have input from an ERISA attorney who negotiates these provisions on a regular basis and know the right things to ask for.