Compliance August 20, 2007

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.
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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

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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.

IMHO August 17, 2007

IMHO: PPA’s Sway

These days, the Pension Protection Act of 2006 (PPA) is sometimes referred to as the “Pension Destruction Act.″
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That’s too harsh an assessment, IMHO, but it certainly has a foundation in reality.
Without question, the PPA (it was just a year ago Friday that President Bush signed the legislation into law) imposed some new—and for many plans, harsh—restrictions on funding and accounting for funding. Additionally, it did so after many of the worst offenders and abusers of the system were already “out’ (legislation frequently closes the barn door after the cow has escaped), and it did so at a time when many plans seemed particularly vulnerable, and many through no real fault of their own.
We may never know how many problems were averted by its passage—and by the time its new defined benefit provisions took hold, investment markets, interest rates, and contribution levels had combined to make the problems confronting pension plans much less severe than they were at the time of the law’s passage. Mind you, I’m not prepared to say that it protected any pensions, but it probably didn’t—on its own, anyway—trigger the early demise of many programs, either (though it may have accelerated the deliberations). Moreover, the PPA’s explicit sanction of the cash balance design, by some accounts, has given a new lease on life to that hybrid approach, at least in some market segments.

Defined Contribution Impact

As for defined contribution plans, I think the PPA did some good in putting structure around some of the “automatic’ solutions, and, for the very most part, took into account some of the aspects of those programs that needed tending to; notably state wage law preemption and the ability to return those “mistaken’ contributions. We now have some discrimination testing relief for plans that adopt the automatic enrollment approach codified in the PPA, and if some find the matching contribution requirement too expensive, the contribution acceleration provision distasteful, or the testing relief unnecessary (current safe harbor plans already enjoy much of that relief)—well, it’s optional, after all, not mandatory. If you like automatic enrollment, but not the PPA’s particular flavor, nothing prevents you from implementing your own version. As for the qualified default investment alternative—well, the DoL was working on this ahead of the PPA. Ironically, passage of the PPA may have actually slowed the timing of this particular enhancement—but we’ll have clarity soon enough.
The PPA’s participant notification requirements have been something of a burden, and almost certainly aren’t the aid to participant clarification that they ostensibly were mandated to provide. As for the concept of a fiduciary adviser—well, there’s perhaps not as much precise clarity there as some would prefer. But we do now understand (from the PPA and FAB 2007-01) that the plan sponsor’s fiduciary responsibility is for the selection/monitoring of the adviser, not the advice provided—and for many plan sponsors (and no doubt many advisers), that’s a welcome clarification. And within the guidelines of the PPA, there is another way for qualified fiduciary advisers to be compensated for their services.
Of course, almost overlooked in all the attention paid to the new tools included in the PPA is the fact that it removed the legislative “sunset’ on an enormous number of crucial provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001—EGTRRA—including the Roth 401(k), increased contribution limits, repeal of the multiple use test, and modification of the top-heavy rules.
All in all, there may not be much “protection’ in the Pension Protection Act—but, IMHO, there’s still a lot of good to be found there.

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