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Employer selection of 401k plans Do your homework
Two recent legal developments address the selection by employers of mutual funds for 401(k) plans and other service providers for retirement plans.
The first development is the issuance by the Department of Labor of regulations that will govern fee and revenue-sharing information that mutual funds and other service providers must furnish to employers and administrators of retirement plans.
The second is a ruling by a U.S. District Court in California that, all other things being equal, employers must pick the lowest cost mutual funds and other service providers for retirement plans.
The new DOL regulations go into effect in July 2011. They will require mutual fund companies, recordkeeping services and other third-party administrators to disclose to employers and plan administrators all fees charged for their services, including revenue-sharing arrangements between mutual fund companies and recordkeeping/administrative service providers.
The regulations are designed to provide employers with a complete picture of fees and financial arrangements between various parties providing services to their plans.
The information will show employers how all of the service providers are being paid. Thus, if your 401(k) plan is managed by a bank or mutual fund company, you will be able to understand the amount you are paying for administration and recordkeeping services, and the amount for investment services.
With this information, an employer can analyze whether it is better off with a "bundled" package through which a bank or mutual fund company provides administration, recordkeeping and investment services, or an "unbundled" approach through which administration and recordkeeping services are provided by someone other than the party providing investment services.
In the California case of Tibble v. Edison International, decided this summer, the court ruled that the employer breached its fiduciary duties with respect to its 401(k) plan by selecting "retail" class mutual funds rather than "institutional" class funds with lower fees when the latter were available.
The decision was the first victory for a group of plaintiffs' lawyers from St. Louis who have been filing class action suits throughout the U.S. claiming violations of fiduciary duty when large employers did not pick the lowest cost providers for mutual funds and other administrative services.
Similar claims had been dismissed by the district courts, but the plaintiffs gained traction in California when the fiduciary — that is, the employer — failed to show that it had investigated the difference between higher-priced retail class funds and lower-priced institutional class funds.
The case will probably be appealed, but it currently stands for the proposition that, all other things being equal, fiduciaries must select the lowest-cost provider.
These two developments mean that employers will have more information about fees and an added incentive to review the fees and other attributes of the alternative service providers, and document reasons for choosing one service provider over another, especially if they do not choose the lowest cost provider.
There are often valid reasons for choosing someone other than the lowest cost provider. In the California case, the same mutual fund was offered in two different classes — one for retail customers and one for institutional customers — and the defendant was large enough to have qualified as an institutional customer.
These developments bring us back to the guiding principles for employers and other fiduciaries responsible for selecting service providers for 401(k) plans.
Fiduciaries are required to act in a sound and businesslike manner in making choices on behalf of their plans. They are expected to analyze available options, choose the option they believe will serve the best interests of plan participants and document their reasons for making the choice.
Employers and other fiduciaries should take their duties seriously but should not be worried about being liable to plan participants if the providers they choose do not perform as well as expected. They are not expected to pick the winners in each case. They are merely expected to do their homework and have valid reasons for their choices.
If challenged in the future, they will be judged on the process used in making a decision, not on whether their choice proved to be the best performer.
Larry Titley is an employee benefits partner in the law firm of Varnum LLP.