Monday, December 18, 2006

401(k) Excessive Fee Litigation - It's Not About Total Fees

I am not sure that Plan sponsors understand the nature of the 401(k) excessive fee litigation. They continue to take solace in the fact that their overall mutual fund expenses may be competitive. Even if their overall fund expenses are competitive, the "revenue sharing" allocations made from the "investment" manager or affiliate to the "recordkeeping" company or affiliate can be quite different on a per person basis depending on factors such as average participant balances. It is this plan to plan difference in per person administrative fees when compared to a relatively homogenous set of services that seems to be the basis for the excessive fee charges detailed in these recent suits.

Here is a ficticious example. Assume two $100 Million 401(K) plans, both using the same mutual funds, which we'll say have an average fee of 1%, and the same recordkeeper. Of that 1%, the investment management company gets .6% while the remaining .4% in "revenue sharing" goes to the "recordkeeping" company.

Further, assume that Plan A has 1000 employees and Plan B has 5000 employees. In 1 year for both Plan A and Plan B the "investment" company would receive $600K in revenue while the "recordkeeping" company would receive $400K.

Participants in both plans pay investment management expenses of .6% for every dollar of their invested assets. Investors with higher asset balances would pay a higher dollar value of investment management fees, though that would be expected. Using asset base as a basis for investment management fee generation seems fair and reasonable.

The issue arises in using the same asset base as a basis for determining what each participant pays for services, which we presume are roughly the same for both plans (recordkeeping, internet and phone access, research, materials etc). Plan A with 1000 employees pays $400($400k/1000) per participant for services while Plan B pays $80($400k/5000)per participant for their services.

This differential in per participant fees between the plans, as I understand it, is at the heart of the "excessive fee" complaint. In this case, Plan A is paying $320 more per participant in "excess fees" for plan services than Plan B. The fiduciaries of Plan A, according to the perspective taken in these complaints, were responsible for making sure these fees were reasonable in light of services provided. If services provided are roughly similar in both plans then to what do they attribute the cost differences?

While the courts will decide if there is merit to the charge that service providers fees can be "unreasonable" even within the context of reasonable overall fees, plan sponsors with either; very large plan asset balances, very large participant balances or plans with very strong asset growth might be most exposed to this kind of litigation.

Thursday, December 14, 2006

Excessive Fee Suit Finds Fidelity

The WSJ reported today that Schlicter Bogard and Denton has filed suit #11 against Fidelity and 401(k)Plan sponsor Deere & Co for improper, undisclosed and excessive fees. According to the article, the suit alleges that 1/3 of the fees collected by Fidelity go to revenue sharing and that the nature of a flat revenue sharing fee structure disproportionately benefits service providers as individual asset balances grow. Another allegation is that the Plan had a long standing agreement to select only Fidelity products.

It will be interesting to review the details of this complaint since this is the first major excessive fee suit filed against a servive provider.

Sunday, December 03, 2006

Private Equity - Less of an "Alternative"

Retirement plan fiduciaries have been confronted by a host of new fiduciary issues over the last few quarters. PPA, SFAS No.158 & excessive fee litigation have been widely addressed. Less recognized are some significant capital market trends that promise to have a growing impact on investment fiduciaries. Among others, substantial innovation in the derivatives market is adding complexity, uncertainty and risk to the fiduciary oversight process. The rapid development of private equity markets will also influence the investment opportunity set that retirement plan fiduciaries must consider providing and monitoring for their plans and participants.

The Committee on Capital Markets Regulation, an independent, bipartisan committee composed of leaders from business, finance, law, accounting and academia just released a study concluding that the US capital markets are becoming less competitive due to excessive regulation, enforcement and class action litigation. The dramatic increase in the use of private U.S. markets is indicated by these study statistics.
  • 5% of the value of worldwide initial public offerings was raised in the U.S. last year,versus 50% in 2000.
  • the U.S. share of total equity capital raised in the world’s 10 top countries has declined to 27.9% so far this year from 41% in 1995.
  • private equity firms, almost non-existent in 1980, sponsored more than $200 billion of capital commitments last year
  • since 2003, private equity fundraising in the U.S. has even exceeded net cash flows into mutual funds and going private transactions have accounted for more than a quarter of publicly announced takeovers.
The benefits of private equity investing are addressed in an Update by the Center for International Securities and Derivatives Markets.
"Private Equity is generally regarded as an investment which offers investors the opportunity to achieve superior long term returns compared to traditional stock and bond investment vehicles. The long-term high returns of private equity represent a premium to the performance of public equities. Private equity provides higher return opportunities relative to traditional asset classes primarily through their ability to participate in a vast and growing marketplace of privately held companies not available in traditional investor products as well as their ability to create value by proactively influencing invested companies’ management and operations, thereby providing the opportunity to gain excess return over conventional stock and bond investments."
A substantive competitive decline in the US public capital markets would certainly have financial and economic implications that should be considered in future fiduciary decisions on market and asset class opportunities. Moreover, an increasing share of global capitalization allocated to private equity may particularly disadvantage defined contribution plan investors which generally can't access this asset class. As private equity becomes an accepted component of modern portfolio building practice by pension plans, endowments and other “qualified” investors, DC plan fiduciaries may in the future find it imprudent not to provide access to some level of private equity investment.

Friday, December 01, 2006

GAO Concludes 401(K) Fee Disclosures Inadequate

The Government Accountability Office (GAO) completed an examination of fee levels and disclosures for 401(k) plans and concluded that current disclosure practices are inadequate for investors, plan sponsors and regulators. The GAO recommends that ERISA be amended to require that; service providers disclose all revenue sharing compensation, participants receive information on all fees related to each investment in the plan and that plan sponsors provide summaries of all fees paid by either the Plan or its participants. According to the study:

"fees that 401(k) plan sponsors are required by law to disclose is limited and does not provide for an easy comparison among investment options. The Employee Retirement Income Security Act of 1974 (ERISA) requires that plan sponsors provide participants with certain disclosure documents, but these documents are not required to contain information on fees borne by individual participants. Additional fee disclosures are required for certain—but not all—plans in which participants direct their investments. These disclosures are provided to participants in a piecemeal fashion and do not provide a simple way for participants to compare plan investment options and their fees. Labor has authority under ERISA to oversee 401(k) plan fees and certain types of business arrangements that could affect fees, but lacks the information it needs to provide effective oversight. Labor collects information on fees from plan sponsors, investigates participants’ complaints or referrals from other agencies on questionable 401(k) plan practices, and conducts outreach to educate plan sponsors about their responsibilities. However, the information reported to Labor does not include all fees charged to 401(k) plans and therefore has limited use for effective oversight and for identifying undisclosed business arrangements among service providers. Without disclosing these arrangements, service providers may steer plan sponsors toward investment products or services that may not be in the best interest of participants and may cause them to pay higher fees."