Wasting 401(k) plan assets
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March 09, 2015 01:00 AM

Wasting 401(k) plan assets

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    Roger Schillerstrom

    Big employers have come out in favor of higher-fee retail mutual funds in 401(k) plans. What are they thinking? That position is an unacceptable breach in the duty of fiduciaries.

    A coalition of employer groups — the ERISA Industry Committee, American Benefits Council, U.S. Chamber of Commerce, Business Roundtable and National Association of Manufacturers — filed a brief Jan. 23 defending use of retail mutual funds in 401(k) plans in the Glenn Tibble el al. v. Edison International et al. case pending before the U.S. Supreme Court.

    The business groups represent large influential plan sponsors. Even non-member employers and policymakers look to the groups for guidance on business issues, including fiduciary duty. It's unacceptable the groups would take a position contrary to the duty of fiduciaries to act in the sole best interest of participants. In fact, they are encouraging unacceptable fiduciary oversight.

    The plaintiffs in the case challenge both U.S. Court of Appeals and U.S. District Court rulings restricting their ability to file breach of fiduciary duty claims over a six-year statute of limitations under the Employee Retirement Income Security Act. They allege Edison International breached its fiduciary duty by offering retail-class mutual funds in its $4 billion 401(k) plan when institutional-class mutual funds, identical except they charged lower fees, were available. The plaintiffs contend a plan sponsor has a duty to re-evaluate periodically investment options in a plan, an obligation not bound by a statute of limitations that might restrict questioning the initial decision to add an investment option.

    The business groups argue against a duty by fiduciaries to continually monitor funds in a plan.

    In their brief, the groups said: “Unless there has been a material change in circumstances suggesting that a full due diligence review is necessary, the fiduciary's duty to monitor does not include the obligation to revisit the initial determination to include a particular investment option in the plan. Indeed, it would be highly impractical and expensive to periodically re-create the selection process of an investment option.”

    At issue are six retail mutual funds chosen by the Edison plan investment committee: three funds added in 1999 and three funds added in 2002. Edison International put into practice for fiduciary oversight a Ron Popeil approach to cooking: Set it and forget it. In doing so, participants got burned.

    Edison argues the six-year statute of limitation precludes a ruling in favor of the participants. In a brief before the Supreme Court, Edison International contends: “There is certainly nothing requiring ERISA fiduciaries to conduct a full-scale, stem-to-stern diligence review of all investment options in a 401(k) lineup on a frequently recurring periodic basis. Any such rule would impose extraordinary administrative costs on plans, sponsors and participants, contrary to ERISA's objectives.”

    Edison contends in its brief a ruling against it would put the existence of 401(k) plans at risk, arguing, “These increased costs might well discourage plan sponsors — who will often indemnify fiduciaries for litigation expenses or purchase insurance on their behalf — from offering benefits plans, result in diminished plan benefits, or discourage qualified individuals from serving as ERISA fiduciaries at all.”

    Such an interpretation insulates a sponsor from fiduciary duty to re-evaluate investments options, and provides no incentive to do so.

    Competitive pressures compel companies to offer retirement plans. Under such pressure, companies would face a drain of talent putting their business at risk should they close their plans in the event of an adverse ruling by the Supreme Court.

    In operating their businesses, no executive at any well-run company would contract with vendors for supplies and services at retail rates when identical services are available at a lower prices, or periodically fail to re-evaluate the contracts. Yet, the groups accept a set-it-and-forget approach to fiduciary oversight of investment options vital to the retirement income of their employees.

    Fiduciary duty should not mean plan sponsors have no duty to re-evaluate investment choices, especially options that charge higher fees, which waste participant assets when identical lower-fee funds are available.

    Because 401(k) plans put risk entirely on participants, plan sponsors must fulfill their fiduciary duty to act solely in the best interest of the participants, who have only two sources of building value in their 401(k) plans — contributions, whether by employer or participants themselves, and investment returns. Fees can be a major drain on investment performance.

    As William F. Sharpe, laureate of the Nobel Memorial Prize in economics, noted in a 1991 research article, investors in lower-cost funds can achieve a 20% higher value in the long term than investors in comparable higher cost funds.

    To make up for poorly performing investment options, participants can draw on only their own resources. They cannot call on employers to come to the rescue, as employers have to do with defined benefit plans.

    The Supreme Court, which heard oral arguments in the case Feb. 24, has to decide the issue. A decision could come in spring.

    The Supreme Court case should remind all plans sponsors to challenge their investment committees and their consultants to review their investment options regularly, reminding them of their fiduciary duty to act solely in the best interest of participants.

    The Employee Benefits Security Administration of the Department of Labor should make clear in new guidance the role of fiduciaries. In fact, as a group of law professors pointed out in a brief filed in support of the plaintiffs in the Supreme Court case, the Labor Department issued clarification in 1978 noting fiduciary duty doesn't end with the decision to select an investment option.

    Employers put 401(k) plans at risk by such unacceptable actions as refusing to re-evaluate funds for better alternatives. Such actions by employers expose plans to tighter regulation by Congress and the Labor Department, which could add to their cost as well as potentially further harming participants.

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