Small Employers on Notice

Fiduciary Focus Important for Any Size Employer

Recently, an alleged violation of fiduciary responsibility lawsuit has gained the attention of those in the employee benefits business mainly due to the fact that the charge was against a small employer.  The nature of the charges was not the reason for its considerable attention, but the fact that the filing implicated a small employer, as opposed to a large employer.  Large employers have faced comparable charges and eventually were required to compensate participants based on the charges and rulings.  Although the plaintiffs in this case eventually withdrew their complaint, it’s still worth taking a closer look at why the case filing itself matters in today’s employee benefits industry.

The Case

A class action lawsuit was filed, and later dropped, by the employees of LaMettry’s Collision Inc. against their employer which charged that the key executives had breached their fiduciary duty on the basis that the Plan paid excessive administrative, investment and recordkeeping fees at their expense.  The Plan itself was valued at $9.2 million in assets, which included 114 active participants.  The Plan Trustees, the CEO and CFO, were the only Company individuals which were named as defendants, as opposed to also including the plan’s recordkeeper and/or its brokerage and advisor representative.  If charges were also against the latter, it would have been required to prove that they too held fiduciary duty to the plan participants, which would have been a challenging assertion to substantiate.

The plan offered the following investment options: 11 mutual funds, seven pooled separate accounts, and a guaranteed investment contract offered by the broker.  Per the complaint filed, the retail-priced investment options selected by defendants “likely offered no additional services at all compared to equivalent or lower fee institutional funds.” The asset-based fees for two of the retail-class shares of two funds identified were 1.17% and 1.3%, vs. 0.73% and 0.69%, respectively, for the institutional-share classes of those funds.

Per the complaint, the defendants allegedly failed to take into consideration the possibility of lower-fee funds and also did not actively monitor the current fund fees in comparison to those lower-fee funds available. Furthermore, there did not appear to be any value-added services which would have justified the higher fees charged within the designated funds, or for which the plan participants paid excessive fees, which were hundreds of thousands of dollars.

Recordkeeping Concerns

The plaintiffs’ lawsuit also included a charge that the plan overpaid for recordkeeping services. The complaint detailed that recordkeeping is needed for every defined-contribution plan and that prudent fiduciaries must solicit requests for proposals from companies that provide recordkeeping services in order to make an effort to control plan costs.

The annual charge for recordkeeping services totaled $113,000, which was calculated as a 1.22% asset-based fee to the plan. The plaintiffs claimed that the plan participants could potentially be in better financial condition if those services were charged on a more competitive per-participant annual fee basis.

In addition, the charges stated that the defendants failed to properly disclose the revenue-sharing fees paid by asset managers to the recordkeeper.  Lastly, the plaintiffs had reservations about the plan paying an annual cost of over $50,000, which was an average of 0.58% of an umbrella administrative fee for which, the complaint alleged, participants received little or no value.

ERISA’s fiduciary standards as litigated over the years place great emphasis on the process by which fiduciaries arrive at their decisions. The plaintiffs zeroed in on that issue, charging that the CEO and CFO “did not have a prudent process — or any process — for the consideration, selection, evaluation, or active monitoring of these funds or their fees with respect to alternatives, including lower fee funds.”

On Notice

The fact that plaintiffs’ attorneys were willing to undertake a class action case against a smaller retirement plan puts small employers on notice that they too face defending themselves in such a case if they haven’t properly taken precautionary actions which are required of them based on their fiduciary duty. Because the case was dropped “without prejudice” it could, in theory, be resurrected. Although this is unlikely, let this filing be a valuable lesson to all employers:  no matter the size of your company, take all measures necessary and required of you to follow all fiduciary rules.

Sidebar: How to Allocate Recordkeeping Fees Equitably Among Participants?

The question now being asked based on the increased awareness and focus on plan costs is, what measures should plan sponsors take to prevent participants from experiencing what could be considered “excessive” recordkeeping fees? The answer: sponsors have several choices when allocating fees, which are as follows:

Employer funds. The simplest choice, albeit the most costly to sponsors, is to pay recordkeeping fees from employer funds. The reasonableness of fees is then a non-issue from the participants’ perspective.  Nonetheless, according to a survey conducted by Fidelity Investments, this approach is only used by about 20% of sponsors.

Revenue-sharing agreements. When participants bear some or all of the cost of recordkeeping fees, it’s essential that the fees not only be reasonably priced, but that they also be shared equitably. Ask recordkeepers to use revenue-sharing fees they receive from asset managers to offset recordkeeping charges that would otherwise be imposed against participant accounts.

However, some funds, mainly actively managed stock funds, share more revenue with recordkeepers than others. To avoid having revenue-sharing arrangements disproportionately benefit participants with investments in high-revenue-sharing funds, have the recordkeeper aggregate revenue-sharing amounts equally among all participants.

R6 share agreements. Lastly, another approach is to limit plan investments to “R6 shares.” This is an emerging class of funds that are lower in cost but don’t share revenue with recordkeepers. Accounting transactions are simplified for recordkeepers by investing in these types of investments, however, the charges against individual participant accounts are not as evident and it does not negate the fact that those costs still exist and must still be paid.

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