Managing Retirement Planning Costs: When Acceptable Industry Practice Takes a Multi-Million Dollar Wrong Turn
Employers, as plan sponsors, and the individuals in the employer’s organization that oversee the plan sponsor’s duties, are "fiduciaries" owing a duty to manage the plan in the best interest of the plan participants. Liability may arise when decisions are made to reduce overall costs under the plan of the employer without considering how such actions will affect the participants on an individual basis. "Revenue sharing" is a common compensation practice throughout the 401(k) industry and a good example of a situation where such liability risks may arise.
Revenue sharing occurs when a mutual fund offered as part of a plan’s investment portfolio includes the plan’s cost of record-keeping in its fund management fee. In other words, for a single "shared" fee, the mutual fund provides investment and record keeping services. Mutual funds and other service providers typically market shared revenue as being costs "saved" by the plan and its participants because one entity is performing two (or more) functions. Other kinds of revenue sharing can occur between separate firms providing these same or similar services, but the premise is still the same. The "shared revenue" model is intended to be used to offset administrative expenses like recordkeeping, which are expenses that are usually borne by the plan participants. However, this shared revenue is a variable cost that is typically based on percentage of the plan’s assets (as opposed to a flat, per-participant charge). As such, as plan assets grow, the fees charged will grow. Plan fiduciaries can be caught off guard when these fees exceed the benefits of the services provided.
That is exactly what happened in a case that was recently decided in federal court in the Western District of Missouri, and resulted in a $35.2 million verdict (plus attorneys fees) against the employer, its pension and benefits committees, and the individual director of the pension committee, all of whom were fiduciaries under the employer’s plan. In Tussey v. ABB, a record keeper (Fidelity Trust) was selected in an RFP process originally based upon a per-participant hard-dollar fee. ABB (the employer and plan sponsor) soon agreed to move to a revenue sharing system in which Fidelity Trust began doing additional work for ABB, such as payroll, health plan recordkeeping and defined benefit and nonqualified plan administration, in exchange for a percentage fee based on the size of ABB’s plan assets, which was very large. Because of the variable nature of the shared revenue arrangement and the size of the plan, the fees soon grew too large and the court found multiple fiduciary duty breaches for failure to track the fee escalation.
The main takeaways from Tussey derive from the activities that the court found to be deficient on behalf of the plan fiduciaries and employer, which the court described as follows:
• ABB failed to monitor the costs or to independently calculate what it was allowing the plan to pay;
• ABB should have at least "benchmarked" the fees it was paying against other service providers, to compare the reasonableness of the fees;
• ABB never attempted to leverage the plan’s very large size to decrease the fees it was paying, even after ABB was told by an outside consulting firm that it was overpaying; and
• ABB had information about how the investment habits of plan participants could affect the availability of revenue sharing, which the court inferred gave ABB a "reasonable basis" for conducting a deeper investigation into the fees ABB was being charged.
The court explained that simply monitoring the overall expense ratio was insufficient because monitoring on a percentage basis alone does not show the actual dollar amount of fees being paid. For example, a one percent fee may sound good, but if the plan assets are $5 million, that fee is $50,000, which raises the question whether $50,000 is a reasonable fee for the services provided.
The ABB court noted that the plan fiduciaries in question "were not concerned about the cost of recordkeeping unless it increased ABB’s expenses," and emphasized that the fiduciaries owed their first duty to the plan participants - not the employer. While the court recognized the selection of funds and services was motivated by a desire to decrease fees, the court made it clear that the fiduciaries bore a great responsibility to monitor the fees, explore the methods of fee generation and not just accept Fidelity Trust’s sales and marketing statements and invoices at face value.
In sum, ERISA plan fiduciaries such as investment committees, plan administrators, trustees and the employer/plan sponsor bear a tremendous responsibility in taking care of their 401(k) plan and its participants, all while monitoring costs as part of those duties. Failing to adequately scrutinize services and fees can expose even the best intentioned fiduciaries to potential liability in an ever changing landscape, where fee and service bundling are becoming routine practice. The revenue sharing in Tussey was solicited by the service provider and approached by the fiduciaries as a cost savings mechanism, yet the exact opposite result was achieved. Consulting your legal team when making such fiduciary decisions, especially in light of new, heightened disclosure requirements placed on plan service providers and fiduciaries, can prevent many unexpected consequences and actually save costs.