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.


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