Two recent developments deal with an employer’s selection of mutual funds for its 401(k) plan and other service providers for its retirement plans. The first development is the issuance by the Department of Labor of regulations that will govern the 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, other things being equal, employers must pick the lowest cost mutual funds and other service providers for their retirement plans.
The new DOL regulations go into effect in July of 2011 and will require mutual fund companies, recordkeeping services, and other third party administrators to disclose to employers and plan administrators all of the fees that are being charged with respect to their services including revenue sharing arrangements between mutual fund companies and recordkeeping/administrative service providers. These regulations are designed to provide employers with a complete picture of fees and financial arrangements between various parties that are 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 will be able to analyze whether it is better off with a “bundled” package whereby a bank or mutual fund company is providing administration and recordkeeping services as well as investment services, or an unbundled approach with the administration and recordkeeping services provided by someone other than the party providing investment services.
In the California case, Tibble v. Edison International, (DC CD California, 7/8/10), the judge 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. This case was the first victory for a group of plaintiffs’ lawyers from St. Louis who have been filing class action lawsuits all over the country claiming violations of fiduciary duty whenever large employers did not pick the lowest cost providers for their mutual funds and other administrative services. Most of the other cases have been dismissed by the district courts, but the plaintiffs got some traction in California when the fiduciaries (the employer) failed to produce any evidence that it had investigated the difference between the higher priced retail class funds and the lower priced institutional class funds. This case will probably be appealed, but in the meantime, it stands for the proposition that, other things being equal, fiduciaries must select the lowest cost provider.
These two developments mean that employers will now have more information about fees being charged by various service providers and an added incentive to review the fees and the other attributes of the alternative service providers, and document their reasons for choosing one service provider over another, especially if they do not choose the lowest cost provider. We all know that other things are rarely equal and there are often valid reasons for choosing someone other than the lowest cost provider. In the mutual fund arena, the funds with consistently superior results do not necessarily have the lowest fees or expense ratios and fiduciaries are not required to reject a mutual fund with a superior track record just because their fees are higher. In the California case, the facts were that 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 who are responsible for selecting service providers for 401(k) plans. Those principles are that fiduciaries are required to act in a sound and businesslike manner in making choices on behalf of their plans. They are expected to analyze the options available to them, choose the option that they believe will serve the best interests of their plan participants, and document their reasons for making the choice.
Fiduciaries are not expected to pick the winners in each case. They are merely expected to do their homework and have valid reasons for making the choices that they do. If they are challenged in the future, they will be judged on the process they used in making their decision, not on whether their choice proved to be the best performer.
Employers and other fiduciaries should take their duties seriously and perform them conscientiously, but should not be worried about being liable to plan participants if the providers they choose do not perform as well as they expected.
If you have any questions about your fiduciary duties with respect to your employee benefit plans, please contact a member of our Employee Benefits Practice Team.