401(k) Fee Litigation Offers Opportunity to Adopt Best Practices

Best practices in managing fees includes documenting fee analysis and review process; designing and maintaining investment policy statements; negotiating costs with provider; and avoiding costly investments, said litigator Nancy Ross, who represents one of the firms being sued.

Speaking on a PLANSPONSOR Web cast last week, Ross, a partner at Chicago-based McDermott Will & Emery LLP, expressed her surprise that the class action lawsuits filed by the plan participants have so far been aimed at large companies, who are the most likely to have the resources to monitor plans. There are more than a dozen lawsuits in the federal courts right now, all at different stages. They are generally class action cases filed against both large employers and certain 401(k) service providers by plan participants who allege breaches of fiduciary duty.

The Allegations

Most the complaints can be divided roughly into two charges, Ross said: failure to monitor fees paid for plan administration and investments and failure to disclose revenue sharing deals. Most of that litigation dealing with fees is in its fledgling, “housekeeping’ stages, and almost all of the companies tangled in it have filed motions to dismiss. Looking forward, Ross predicted that the lawsuits will be pared down because right now the challenges include “everything and the kitchen sink.’

According to Ross, some of the other basic claims so far brought by plaintiffs against companies range from:
• Unreasonable investment fees for mutual funds that do nothing more than shadow index funds, meaning that participants are paying for active management, but getting passive management.
• Monitoring claims brought against directors and officers who have failed to monitor fees and the investments that have been chosen.
• Allegations that investments are imprudent.

Ross made clear that, despite the fact that many of these cases bring up the revenue sharing practices, revenue sharing is not illegal; it’s that plaintiffs in some of these cases are trying to nail companies for not disclosing such agreements (See Fee Suit against Lockheed Martin to Move Forward). She said that complaints that target revenue sharing agreements often target the deals because of conflicts of interest they claim are inherent in the deals.

Ross recalled the case against Deere & Co., in which plan participants said plan fees were excessive and that revenue sharing was not disclosed. The U.S. 7th Circuit Court of Appeals said that it was up to Congress to decide whether these agreements should be disclosed, not the courts (See Deere and Fidelity Fee Lawsuit Thrown Out).

Panelist Fred Reish, a managing director and partner at Reish Luftman Reicher & Cohen, predicted that in terms of mutual fund pricing, the courts will not get involved, but rather leave that to the open market. Ross hypothesized that courts will look at the overall levels of fees, and will not parse it down to understand exactly what fees are paid to whom.

Ross says that proving how exactly plan participants were materially affected by high fees is a difficult one to make: “If mutual funds would have gone to a cheaper service provider, than the mutual fund fees would have been less than what they are charging us. There would have been a better expense ratio.’

404(c) Implications

Ross also addressed the questions of whether 404(c) plan sponsors should be held accountable for the investments picked by participants. Ross recounted a judge’s recent interpretation that because a 404(c) plan relieves plan sponsors of the fiduciary responsibility that accompanies picking investments. However, Reish disagreed with this point, saying that opinion is at odds with the traditional belief in the benefits community.

On the topic of director and manager involvement in plan fees, Ross argued that they are not hands on in these matters, and that their fiduciary duties don’t go as far as monitoring the fees being paid.

One way plan sponsors can avoid being pinned for revenue sharing arrangement is to make sure they can justify them, said Reish, meaning that everyone is getting what they sign up for. He goes on to say that the best way to prove that is documentation, so that the courts can see a process of deliberation with respect to anything to do with the plan and with setting fees. “Disclose it all,’ he recommended.

What this means for plan providers is that “plan sponsors are going to be retaining fund managers and service providers who can give them over all confidence that they have prudent practices,’ said Ross.