Recent high-profile lawsuits include a new twist: targeting DC plan sponsors for excessive fees. Even though some of the investments were low-fee index mutual funds, the DC plan could have used essentially identical—and cheaper—vehicles.
Low Cost May Not Be the Last Word on Low Fees
Defined contribution (DC) plan fees have been in the crosshairs in the past few years, and the scrutiny is only getting more intense. Plan sponsors, their advisors, service providers, the courts, journalists and plan participants are asking a lot of questions about fees.
Front and center in the latest lawsuits is whether fees were “reasonable”—a significant term used by the Department of Labor in its rules, regulations and guidelines for DC plan fiduciaries. At first glance, it would appear that the passive (index-like) mutual funds cited in the lawsuit should be considered low-cost by definition.
But the DC plans under attack are quite large and used investor-share (retail) classes of the mutual funds instead of identical institutional-share classes with lower fees. The plans also used mutual funds as the underlying vehicles for their target-date offerings despite having access to the same target-date options in a lower-fee collective investment trust (CIT) structure.
Waiting Can Be a (Personal) Liability
We’ve been long-time advocates for large enough DC plans to use CITs whenever possible—including for target-date solutions. CITs are pooled vehicles similar to mutual funds, but they’re sponsored by trust companies or banks and available only to qualified retirement plans. And they typically cost less than mutual funds because they have lower compliance, marketing and administrative costs. Also, large DC plans may be able to negotiate more favorable advisory fees than those offered through a comparable mutual fund, which lacks that flexibility.
Each year, the recordkeeper availability and understanding of CITs increases. According to Cerulli Associates, asset managers view CITs as the best investment-vehicle format for plans with $250 million or more in assets—and a viable option for plans with assets as low as $25 million. Consequently, the use of CITs by plan sponsors is growing.
That greater availability also stokes the coals of greater fiduciary responsibility. One big complaint connected to those recent lawsuits is timing. Yes, the suit notes, the DC plan did switch to the CIT format for its target-date funds in 2013, but could have—and should have—made the move several years earlier.
Fiduciary Responsibility Includes Vigilance over Reasonable Fees
Understanding fees—and concluding they’re reasonable—has always been an ERISA-mandated fiduciary responsibility of DC plan sponsors. But today’s heightened focus on reasonable fees also comes with legal ramifications and armies of plaintiffs’ lawyers ready, willing and able to take plan sponsors to task if fees are unreasonable.
In a nutshell, ERISA requires plan fiduciaries to act in the best interest of plan participants “with the care, skill, prudence, and diligence” of an expert. Failing to meet this high standard can create personal liability for the fiduciary. Fiduciaries aren’t required to guarantee results, but they have to follow a prudent process when they make decisions. And while fees are only one factor to consider when plans and participants choose investments, those fees can substantially impact the growth potential of a participant’s account.
We strongly urge plan sponsors to always be on the lookout for lower-cost options for any strategy—active or passive. Often, that option may mean CITs or even separately managed accounts, if they’re cost-effective, based on plan assets. And best practices would also suggest that plan sponsors look into unbundling recordkeeping and asset-management contracting. This would help eliminate another fee hot button: revenue sharing, which is the long-standing practice of using payments associated with a plan’s investments to pay for plan recordkeeping or other services.
There’s no dispute over whether or not revenue sharing is legal; recent court decisions have reaffirmed that it is. But certain revenue-sharing arrangements may contain potential inequities, so plan fiduciaries and their advisors should consider CITs or mutual fund share classes that don’t use any revenue sharing.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.
"Target date" in a fund's name refers to the approximate year when a plan participant expects to retire and begin withdrawing from his or her account. Target-date funds gradually adjust their asset allocation, lowering risk as a participant nears retirement. Investments in target-date funds are not guaranteed against loss of principal at any time, and account values can be more or less than the original amount invested—including at the time of the fund's target date. Also, investing in target-date funds does not guarantee sufficient income in retirement.