401(k) Fee Disclosure

As 401(k) plans become the major source of retirement savings,  Congress, GAO, DOL and the SEC are all turning their attention to the issue of 401(k) fees. Last fall, Gao issued a reprt on Changes Needed to Provide 401(k) Plan Participants and the Department of Labor Better Information on Fees at the request of Congressman George Miller, now Chair of the House Education and Labor Committee.  Last week, the Committee held a hearing on "Hidden 401(k) Fees Undermining Retirement Security?"  If you missed the hearing, you can view it on line at the Committee's website, where the written testimony of the witnesses is also posted.

The DOL has indicated that they will be launching a number of new initiatives to increase disclosure of 401(k) fees, particularly the payment of indirect fees to service providers. The DOL has already proposed a revision of  Schedule C of the Form 5500 which would require annual disclosure of indirect fees. Recognizing that plan fiduciaries often have difficulty getting information about indirect fees, the Department is planning to propose an amendment to the statutory prohibited transaction exemption that permits service providers to be paid (ERISA section 408(b)(2)) to require service providers to provide information about indirect compensation so that plan fiduciaries can determine if their total fees are reasonable. The Department is also expected to issue a request for informtion about 401(k) disclosure of fees, both direct and indirect, to plan participants.

Meanwhile, in a speech to the ABA Business Law Section last week, Andrew Conohue, Director of the SEC's Division of Investment Management, indicated that the SEC is working with the DOL to determine how fee disclosure should be made to 401(k) plan participants. He also indicated that the Commission staff is reviewing the rule that permits mutual funds to pay 12b-1 fees.

Plan fiduciaries should be continuing to request information about indirect fees from service providers such as investment managers, investment consultants, recordkeepers and trustees to determine whether the fees paid by their 401(k) plan are reasonable. Since many fees paid by 401(k) plans are asset based, fiduciaries should review the total paid annually as plan assets grow. Also, fiduciaries should move to institutional shares of mutual funds as their investments reach the minimums for such shares. Finally, fiduciaries should benchmark the fees they are paying against industry averages.

Fiduciaries shouldn't lose sight of the fact that the key is the return participants are getting net of fees, so fees shouldn't be the only consideration. However, compared on a net basis, lower fees will often result in better performance.

Comments

[Frank Cummings]

Nell, there’s a pleasing logic in your final point: “Fiduciaries shouldn't lose sight of the fact that the key is the return participants are getting net of fees, so fees shouldn't be the only consideration. However, compared on a net basis, lower fees will often result in better performance.” It’s pleasing, but I think its premise may be misleading, for a number of reasons - but mainly because (1) it’s at odds with the letter of the law, and (2) if it were the law, then once that door is opened, crooks and thieves could and would come through it.

First, the letter of the law. A payment from a plan to a service provider is a flat-out prohibited unless it is “reasonable compensation.” E.g., ERISA secs. 406(a)(1)(C) & (408(b)(2), IRC secs. 4975(c)(1)(C) & 4975(d)(2) (which you cite in the second paragraph of your posting). Apart from the disclosure problem, the premise of any legal challenge to such a payment is that it is unreasonable. So if you assume (in order to get to your theory) that it is not, in fact, “reasonable,” then you suggest that it should still be allowed if it’s a good deal for the participants. In other words, let’s allow prohibited transactions as long as they are a good deal for the participants. OK - but then it’s not a matter of interpreting the law - it’s a question of amending it.

Second, the policy of the law. If you propose amending the law and opening this door, who comes through it? “No harm, no foul?” Every mob figure can show that, by paying him off, you’re better off then if you don’t pay him off. That may be prudent, but to allow it as legislative policy is simply unacceptable.

[Judy Mazo]

Nell, I strongly agree with your final point, which is that ultimately the standard should be results net of fees. But periodically speakers and litigants seem to take the position that there is a duty not to overpay, even for excellent performance. For example, people complain that 75 bp on $1 billion is a lot more than 75 bp on $1 million, so the same rate of compensation for the same provider might be unreasonable if the amount is so large.

It is true that fiduciaries should press for lower fee rates as the size of the fund increases, as part of their due diligence. But do you -- or others out there -- think there is some sort of duty to pay no more than a "reasonable" rate?