News, Vision & Voice for the Advisory Community
Just where the line is between a legal and illegal 401(k) plan is important to know
May 21, 2013 — 5:52 PM UTC by Guest Columnist Brendan Little
Brooke’s Note: In watching the PBS Frontline documentary, largely about the 401(k) business, you can’t help but feel a sense of helplessness creeping over you. What you despair of is that many hands wash each other in the 401(k) business, the brokerage business, the mutual fund business and even in Washington where those businesses can lobby effectively. What Brendan Little explains in this column — and not without a decent dollop of self-interest that the lawyer acknowledges with good humor — is that it’s not as if consumers or plan sponsors are without legal remedies to call upon. Nor are they completely without the power to divine when their rights are being trampled. This article is a good primer for people who might want to know how to take advantage of the law. It’s also a good heads up for advisors who’s just as soon not get sued.
A recent “Frontline” documentary by PBS highlights the harm done by excessive 401(k) plan fees, but largely ignores the underused legal remedies that are already available to 401(k) participants and plan sponsors under the Employee Retirement Income Security Act of 1974.
“The Retirement Gamble” aired on April 23. Its author and director Martin Smith’s unflattering review of the retirement savings industry in America received significant press coverage, mainly, for publicizing the harm done by the fees charged to 401(k) plans. And rightly so: “Frontline” pointed to a recent AARP study that found 71% of mutual fund savers were not even aware that they were paying any fees at all. See: What RIAs must know about hidden, and excessive, fees in serving as fiduciaries to a 401(k) plan.
Others far more versed in the industry have provided excellent feedback on the documentary’s content. RIABiz’ article (See: The PBS 'Frontline’ 401(k) documentary names suspects but leaves out major culprits of the theft of the American retirement) provides an especially thorough and fair summary of the documentary’s value, in my opinion. (Editor’s note: Flattery will get you everywhere.)
For those that have or sponsor a 401(k) plan, and haven’t seen the “Frontline” report, it’s definitely worth the watch just to see the staggering effect that high account fees can have on an individual’s retirement savings.
Is it safe?
One fair criticism is that the documentary gives little attention to the many excellent 401(k) plans out there. See: Why brokers from Nationwide, LPL, Merrill Lynch and others are giving RIAs a cut of their 401(k) action. Sure, there are plans that actually do charge 2% or 3% in fees. The majority of 401(k) plans charge less and can provide an excellent savings vehicle for many individuals. The trick, many experts agree—and it is not an easy one—is figuring out whether a plan is “good” or “bad” in comparison with other available options.
As an attorney who follows the 401(k) industry, this is where the trail seems to run cold in the PBS documentary. OK, some 401(k) fees can be harmful. But how does one tell when the fees cross the line between reasonable compensation for a valuable service and excessive profits taken from unsuspecting investors? See: 10 most influential individuals in the 401(k) industry affecting RIAs in 2012, Part 2.
It’s really a two-part inquiry—one financial, the other legal. The financial aspect involves determining whether a 401(k) plan is a good investment for an individual and how to allocate between the plan’s investment options. This is the realm of financial advisors and has been well covered. The latter aspect involves a trip into the complicated and highly technical federal law known as ERISA.
As the name implies, ERISA is meant to protect and regulate employee retirement plans. It requires that plan sponsors fulfill certain fiduciary duties, e.g., that they act prudently and solely in the participant’s best interest. These duties extend to the service provider(s) that administer the plan in certain cases. In short, ERISA is supposed to make employee plans safe. See: RIAs join move to right a 401(k) wrong: Lopsided plan expenses — a non-DOL issue.
Slapping them with a lawsuit
However, a plan or its investment options might be bad from an individual’s financial prospective and not be illegal under ERISA. But what about plans—and the ones highlighted by “Frontline” are good candidates—that do run afoul of ERISA?
One option, perhaps not surprising given the source (Hey look! A lawyer suggesting people sue somebody!), is to sue your plan service provider.
Though it is mostly ignored by Smith’s report, a significant number of 401(k) participants and their employers have successfully resorted to litigation to recover excessive 401(k) fees. See: 9 things advisors to 401(k) plans must do to keep clients out of hot water.
Changing plan service providers or negotiating lower fees can certainly reduce future costs. But neither action will recover excessive fees that have already been paid. In certain cases, a plan sponsor — the employer — may even have a duty under ERISA to seek recovery of any unreasonable fees paid by its employees.
No bright line
A new rule issued last year by the U.S. Department of Labor does require greater disclosures of fees by 401(k) service providers. Make no mistake: The rule also places the burden of monitoring the fee information contained in these lengthy disclosures squarely back on employers and participants. As a recent Forbes article concludes, “It’s still up to the 401(k) participant to take action.” See: Fidelity tries out new DOL-influenced 401(k) fee disclosures on clients — and gets plenty of response.
While there is no bright-line rule, some red flags that might be associated with ERISA-violating 401(k) fees are:
• The service provider offers its own funds, or an affiliate’s funds, as investment options.
• The annual fees or expense ratios of the plan’s investment options are significantly above average for that type of investment—e.g., 0.77% for mutual funds, 0.58% for target date funds, and 0.12% for index funds. See: How BrightScope is using technology to create order in a messy 401(k) market.
• The service provider engages in revenue-sharing agreements in which an investment fund pays back part of its fees to the service provider
• The plan offers few low-cost funds or only actively managed funds; See: How RIAs can rule the 401(k) realm by becoming advocates for plan sponsors — and start by eliminating eight marketplace conflicts.
• The service provider charges “separate account” or “wrap” fees on top of the fees charged by an underlying investment fund
• The plan investment options include retail share classes where institutional shares, which have lower costs, are available.
401(k) plan participants, sponsors, and financial advisors are right to be concerned about the problems identified in 'The Retirement Gamble,’ but they should not forget what can already be done about it. To me, this means having a suspect plan reviewed by an attorney with experience in recovering excess plan fees.
Some will no doubt point out that more litigation about 401(k) fees will just result in more fees for attorneys at the expense of 401(k) account holders. Several considerations suggest this likely isn’t the case. To start, ERISA separately provides for attorneys’ fees to be paid in addition to any recovery for damages. So, while many plaintiff’s attorneys work on a contingency fee basis — meaning they are paid a portion of the recovery — actions to recover 401(k) fees under ERISA do not necessarily need to result in sharing of the recovery with the lawyers.
As to driving up plan costs in general, many 401(k) plans are already paying these costs through the extensive liability insurance policies purchased by many 401(k) service providers. Most important, litigation serves as an important deterrent by identifying and penalizing those service providers that are responsible for the egregious fees identified in “The Retirement Gamble.”
Brendan Little is an attorney at the law firm Levy, Phillips & Konigsberg LLP. He practice focuses on class action litigation and whistleblower matters. Prior to joining LPK, Brendan completed a two-year clerkship for a U.S. District Court Judge and has also worked in the litigation division of the New York State Attorney General’s Office. He is licensed to practice in Washington State and currently resides in New York City and can be reached at email@example.com
This article is solely the author’s opinion and is not legal advice.
Share your thoughts and opinions with the author or other readers.