401(k) Fee Lawsuits Shouldn’t Scare Employers Into Low-cost Options

Employers received a wakeup call last month regarding how much they need to know about the fees being charged to participants in their 401(k) plans.

In September, the St. Louis-based law firm of Schlichter Bogard & Denton filed lawsuits against nine companies alleging that they violated pension laws by allowing their 401(k) participants to be overcharged by the managers of the plans.

The suits, which were filed in U.S. district courts in Illinois, California, Connecticut and Missouri, name Northrop Grumman, Lockheed Martin, Boeing, General Dynamics, United Technologies, Bechtel Group, Caterpillar, Excelon and International Paper as defendants.

If successful, the suits could cause employers to shy away from higher-cost investment options for their 401(k) plans, but that’s not necessarily the right course of action to take, experts say.

In some cases, a fund with a higher management fee may still be a more sound investment because it has better performance than lower-cost funds over an extended period of time,” says Michael Maryn, a partner in the Washington, D.C., office of Sonnenschein Nath & Rosenthal.

Plan sponsors need to determine whether the fees being charged are reasonable. That requires more analysis than many companies do today, says Don Stone, president of Plan Sponsor Advisors, a Chicago-based consulting firm.

“First they need to look at what other plans of their size are paying,” he says.

Record keepers and fund companies often will provide this information.

Beyond that, employers need to make sure that the costs of their 401(k)s and investment options “pass the reasonableness test,” Stone says.

“If you are paying for an actively managed fund and not getting the value of it, that’s a problem,” he says.

Determining whether fees are reasonable can be challenging, particularly with products like managed accounts, which are supposed to be customized to the needs of the investor, says Kyle Brown, a consultant at Watson Wyatt Worldwide.

Managed accounts often charge 25 basis points on top of the expenses of the underlying investments because they are customized to the needs of the investor, and thus are supposed to perform better than an average mutual fund. The providers of these options usually ask participants for information about themselves to customize the portfolio accordingly.

But what if an employer automatically enrolls employees into a managed account program–are those participants really getting all the benefits that the option is supposed to provide? Brown asks. “If the employee doesn’t fill out any forms, then the provider only knows their income, age and contribution amount,” he says. “If they don’t have more information to work off of, it might be difficult to demonstrate that the fees are reasonable.”

To address this issue, employers need to justify the decisions they make in choosing their investment options, says Martha Tejera, president of Tejera & Associates, a Bainbridge Island, Washington-based retirement consulting firm.

“If companies are choosing between providers, and one provider has higher fees, they need to ask why,” she says.

Some employers may decide to offer higher-fee investment options and just absorb the added expenses rather than pass them on to plan participants, says Maryn at Sonnenschein Nath & Rosenthal.

“Companies may reduce their fiduciary exposure by paying the expenses themselves,” he says. The result of that might be, however, that companies cut in other places, like their 401(k) match or other compensation or benefits.

No matter what happens with these lawsuits, employers should be prepared to deal with the issues involving understanding 401(k) expenses, Brown warns.

“Even if these suits don’t go through, the Department of Labor has projects in the works regarding understanding 401(k) expenses,” he says. “This is going to be an issue all employers need to pay attention to.”

—Jessica Marquez