The Duty To Ask

Last week I mentioned a revenue-sharing case that could have far-reaching implications.

That case, Tibble v. Edison International, was decided earlier this month (see “Court Buys Retail vs. Institutional Share Fee Claims”) and, IMHO, is a very interesting case for several reasons: First, most of these cases have been tossed before they actually got to trial; second, this one was decided in the plaintiff/participant’s favor (and that’s a rarer occurrence than much of the coverage and “chatter” would indicate). Moreover, here the court was far less deferential to the plan fiduciary decisions than other districts have been1.

But what I found most interesting about this case wasn’t the decision or the court’s rationale, though both will certainly have ramifications beyond this case. Nor, in large part, were the plaintiffs’ arguments any more compelling than in previous actions. In fact, like many of the revenue-sharing/excessive-fee cases filed since 2006, the plaintiffs here made a LOT of accusations—most of which were, as they have been in other cases (and rightfully, IMHO), summarily dismissed2. In this case, that included the selection of sector funds for the plan, having a money market fund on the menu rather than a stable value offering, and structuring the company stock fund as a unitized fund, rather than using share accounting.

Short Falls

Where this court did hold the plan fiduciaries3 liable was their decision to invest in retail shares rather than institutional shares of the same funds. But what I found most striking about the case wasn’t the allegations or the adjudication, but rather that what was, by outward appearances anyway, a thoughtful and sophisticated plan review structure would manage to overlook such a basic opportunity.

Here you have a large ($2-plus billion) plan that not only has an investment committee, but one separate from the benefits administration function. Moreover, that investment committee has access to, and uses the services of, an investment adviser (Hewitt’s investment consulting arm) to review/select/monitor funds. That’s a reasonably sophisticated set-up, and certainly what one might expect for a plan of this size.

Now, the plan decision-makers are aware of revenue-sharing but consistently make decisions that support the notion that they do not take that into account. In fact, the court noted that in 33 of 39 instances during the period in question, the employer made mutual fund replacements that actually decreased the revenue-sharing received by the plan, leaving the court to note, “This overall pattern is not consistent with a motive to increase revenue sharing.” In fact, the court noted that “[t]he Plan fiduciaries did not make fund selections with an eye toward increasing revenue sharing and did not put the interests of SCE above those of the Plan participants.”4

So, what do they fail to do?

Well, apparently they did not even ASK the investment fund providers to waive the minimums for investment in institutional class shares. That’s right, they never asked if those minimums could be waived—so, of course, they weren’t (particularly damning was the testimony of the employer’s expert that such waivers were routinely granted, and for plans of much smaller size). Think of it as “the duty to ask.”

As you read the court’s description of the process, you get a sense that the investment committee was attentive to an investment policy statement (IPS) that was carefully prepared and to which the committee adhered; that they met regularly, and thoughtfully conducted their review with the assistance of a professional investment consultant. The court even described a situation5 where the investment committee considered—and specifically chose—an institutional share class for a fund over a retail offering, because the institutional class met the criteria established by the IPS, whereas the retail class did not.

Yet, for all of this good structure and process, there was one thing that this particular plan sponsor failed to do: They apparently failed to ask if a “better” share class was available.

In the words of the court, “The only way a fiduciary can obtain a waiver of the investment minimum is to call and ask for one. Yet none of the Edison fiduciaries nor anyone acting on their behalf (including HFS) ever requested that the William Blair Fund waive the minimum investment so that the Plan could invest in the institutional share class. Had someone called on behalf of the Plan and requested a waiver of the investment minimum, the William Blair Fund almost certainly would have granted the waiver.”6

Retail “Sale?”

Not that using retail, rather than institutional shares was inherently wrong, even in this situation7. The court acknowledged that in defending the retail-share decision, witnesses for the defendant/employers offered three possible rationales: If the retail share class of a certain mutual fund had significant performance history and a Morningstar rating, but the institutional share class did not; to avoid confusion among participants resulting from frequent changes in the fund; or if there were certain minimum investment requirements, it might preclude the plan from investing in the institutional share classes. Judge Stephen V. Wilson didn’t say whether he would have found those arguments compelling—but then, he didn’t need to bother because, as he noted in the ruling, “None of these explanations is supported by the facts in this case.”

Rather, he noted that “[t]he Investments Staff simply recommended adding the retail share classes of these three funds without any consideration of whether the institutional share classes offered greater benefits to the Plan participants. Thus, the Plan fiduciaries responsible for selecting the mutual funds (the Investment Committees) were not informed about the institutional share classes and did not conduct a thorough investigation.”

Nor was it sufficient that the plan fiduciaries employed the services of an investment adviser. As the court noted: “While securing independent advice from HFS is some evidence of a thorough investigation, it is not a complete defense to a charge of imprudence. At the very least, the Plan fiduciaries must make certain that reliance on the expert’s advice is reasonably justified.”

It is nearly incomprehensible to me—and I would guess to most of you—that in this day and age, a plan fiduciary could be aware of the distinctions of an institutional share class7, and not take advantage of them.

Perhaps, since participants were paying the freight, the fee differential was simply out of sight and thus out of mind. But I’m guessing that the investment committee saw its duty as restricted to the selection and review of the most appropriate investment options under the terms of the IPS, regardless of cost. I wouldn’t be surprised if they saw expense management as the responsibility of the administrative committee—which, doubtless, either assumed that the investment committee’s deliberation included a consideration of fees, or didn’t feel equipped and/or empowered to inquire as to the availability of a less expensive class of shares. Perhaps both felt that their investment adviser was taking those factors into consideration. Ironically, it may well be that this program had so much structure and process that everybody thought somebody else was dealing with the one thing that now seems so obvious, it’s hard to imagine it was overlooked for so long.

Whatever the explanation, it’s clear that nobody was asking the right questions8, and thus, nobody—including the plan participants—was getting the right answer.

—Nevin E. Adams, JD

1 This writer—and the Department of Labor—have had issues with the approach embraced by the courts in more than one of these revenue-sharing suits (see “IMHO: Court “Case”, “IMHO: The ‘Burden’ of Proof”, “IMHO: Second Opinions”, “IMHO: Winning Ways”, “IMHO: The Letter of the Law”).

2 see “IMHO: Fighting Words” at

3 Plaintiffs filed the suit as a class action on August 16, 2007, against Defendants Edison International, Southern California Edison Company, the Southern California Edison Company Benefits Committee, the Edison International Trust Investment Committee, the Secretary of the SCE Benefits Committee, SCE’s Vice President of Human Resources, and the Manager of SCE’s Human Resources Service Center.

4 Nor was the revenue-sharing arrangement hidden. The use of revenue-sharing to offset recordkeeping fees was not only discussed with employee unions, the court noted that the arrangement was disclosed to participants on approximately 17 occasions after the practice began in 1999.

5 In the course of that review, Ertel realized that the institutional share class of the PIMCO Fund had a significant performance history and a Morningstar rating, whereas the retail share class did not. Ertel also realized that the institutional share class charged less 12b-1 fees to the Plan participants. Thus, the Investments Staff recommended, and the Investment Committees adopted the recommendation, that the retail shares of the PIMCO Fund should be transferred into the institutional share class. These facts are very telling: In the one instance in which the Plan fiduciaries actually reviewed the different share classes of one of these three funds, the fiduciaries realized that it would be prudent to invest in the institutional share class rather than the retail share class. Had they done this diligence earlier, the same conclusion would have been apparent with regard to all three funds, and the Plan participants would have saved thousands of dollars in fees.

6 It surely didn’t help matters any that the expert witness hired by the employer-defendants testified that he had obtained waivers for plans as small as $50 million in total assets, and from the same funds as those in question here.

7 Lest some try to rely on this decision as absolute proof that the use of retail class funds is inherently imprudent in 401(k) plans, the court acknowledged in a footnote that “[p]laintiffs are not contending, and the Court has not found, that the mere inclusion of some retail share classes in the Plan constituted a violation of the duty of prudence. The only issue here is whether it was a breach of the duty of prudence to select retail shares rather than institutional shares of the same mutual fund where the only difference between the two share classes was that the retail share class charged a higher fee.”

8 Perhaps including this court. Though there were six funds in question, only three were the focus of the ruling, and for which the plan fiduciaries were held to account for the difference in costs between the retail and institutional shares. The other three were added to the fund menu earlier, apparently outside the applicable statute of limitations, but otherwise seemed to have the same institutional/retail class issues—yet the court rebuffed those claims.

What was the difference? Well, it seems that the plaintiffs didn’t challenge the initial decision to invest (my guess would be because they knew it was outside the statute of limitations), but they did argue that there were subsequent events (change in fund name, manager, etc.) that should have triggered a fresh review, a review in which they argued the whole institutional/retail issue should have arisen, and thus they should be liable as they were in the case of the funds added later. However, this judge was apparently only focusing on the initial decision, and found no reason that the subsequent fund changes should have triggered a full review, and thus—no violation of fiduciary duty. So much for the duty to monitor.

Not-So-Quiet Period

Remember when it used to be quiet in July?

Not so this past week, with the announcement of two major retirement industry acquisitions, a significant update on fee disclosure regulations, and a ruling in a revenue-sharing case that could have far-reaching implications.

On the two industry acquisitions, LPL’s absorption of National Retirement Partners (NRP) will surely be of most interest to the adviser community (see LPL Acquiring National Retirement Partners). LPL, which had only recently launched an IPO (and is thus literally in a “quiet period”), has struggled for some time with its retirement plan focus, while NRP has had its own share of issues in the wake of the recent financial crisis. LPL’s backing should certainly prove to be restorative for NRP’s positioning, and it’s hard to imagine that a newly constituted retirement-focused unit at LPL under Bill Chetney’s leadership won’t provide a clarity of focus for LPL’s efforts in this space.

Plan sponsors may feel a greater immediate impact from Aon’s acquisition of Hewitt (see Hewitt to Merge with Aon), the rationale is that the former’s middle-market product set (especially its insurance lines) will find room to grow in Hewitt’s predominantly large-client base, while Hewitt’s large-plan expertise will be able to find new applications in Aon’s target markets. Those notions inevitably look logical on paper; time will tell if the firms’ cultures and client approaches will assimilate. That said, the new partners are projecting a LOT of cost savings alongside a $5 billion merger—and in a people-intensive business.

As for the final release of the 408(b)(2) fee disclosure regulations, the wait appears to have been worth it (see DoL Issues New Fee Disclosure Rules). I am admittedly not yet all the way through a careful reading of the interim final package, but the removal of a written-contract requirement surely meets the common sense test, while retaining the impact of written disclosures. Similarly, the approach on disclosure—a reliance on full disclosure rather than the, to my eye, more limited conflict-of-interest focus of the prior regulations, should provide plan fiduciaries with more information, even if it does bring with it a potentially greater effort in sifting for those conflicts. Finally—and this is the provision almost certainly likely to draw the most industry focus—the DoL has opted to require that “certain providers of multiple services” disclose separately recordkeeping costs.

This was one of the more controversial provisions in the earlier proposals, and the Labor Department at that time tried to craft a “Solomonic” yet practical solution for those bundled providers who continue to claim that they are simply unable to break those costs out of their integrated delivery models, by basically requiring that unbundled providers disclose those costs, while those who couldn’t (or said they couldn’t) needn’t.

I am encouraged that this new proposal does not make that differentiation. In response to my question on the issue last week, Assistant Secretary of Labor Phyllis Borzi noted that they had heard from a number of sources during the course of the process and comment periods that many plan sponsors still are under the impression that recordkeeping is “free,” and they felt it was necessary to help disavow them of that notion. Back in the day when recordkeeping was routinely priced as a discrete service, it generally was found to constitute about 20% of the total costs for a DC plan; so, IMHO, it’s certainly large enough to warrant a separate disclosure. Ms. Borzi noted that those who may (still) find it difficult to comply with the measure have a year to do so. Personally, I would argue that they should have seen it coming before now.

As for that revenue-sharing case, well, we’ll take a look at it next week—unless, of course, we have another not-so-quiet week.

Thinking "Caps"

While the spate of revenue-sharing suits has—for the moment, anyway—faded into the background, fees remain one of the most hotly debated topics in our industry.

If anything, the intensity has heightened in recent weeks, as we near the Form 5500 filing deadline for December plan-year ends, even as we anxiously await the new 408(b)(2) fee disclosure regulations from the Labor Department—regulations that might well have been at some odds with legislation proposed by Congressman George Miller (D-California) that rode through the House as part of that extenders bill before being dropped by the Senate.

The urgency behind these initiatives is two-fold: to force those who provide services to these plans to more fully and accurately disclose their fees to plan fiduciaries, and to provide participants with some idea of the monies that are being netted from their investment returns (and taken from their accounts). Ultimately, it is about helping people make better, or at least more informed, decisions about their retirement plan investments—and these initiatives are all predicated on the notion that these fees are not adequately disclosed, or sufficiently understood, at present.

That said, a report recently issued by the Transamerica Center for Retirement Studies (from its 11th Annual Retirement Survey) paints a somewhat different picture (see 401(k) Participants not as Knowledgeable as Employers Think).

Asked whether they would like to receive more information from their retirement plan provider about fees and expenses associated with their plan, two thirds of the roughly 600 employers surveyed (and these were not limited to clients of Transamerica) said no, and half of those strongly disagreed with that proposition (smaller firms were somewhat more likely to disagree strongly). Now, that’s a startling statement in view of the characterization of the current state of 401(k) fees by many in Congress and most in the media—not to mention a few in the industry itself.

Asked if those in their firm who were responsible for overseeing the retirement program had a “clear understanding of the fees and expenses associated with the retirement plan,” nearly all—94%—at least somewhat agreed with that proposition. Nearly three-quarters of those at (277) larger firms strongly agreed with that statement, as did nearly half of the smaller firms (271). Could it be that these employers weren’t interested in receiving additional disclosures because they felt they already understood?

Moreover, strong majorities of employers felt that their workers had a similarly clear understanding of the fees associated with their account; one in five strongly agreed with that statement, while roughly half were willing to say they “somewhat agreed” with the proposition. Those results, of course, stood in some contrast with workers, where only about a quarter were willing to say they were aware of fees that may be charged to their account (admittedly, nearly as many weren’t sure, while about half said they were not aware).

These are the kinds of results that tend to work legislators, consultants/advisers—and journalists—into a lather. The “common wisdom” is, of course, that retirement plans are being gouged; that retirement plan sponsors are complacent, if not complicit in the theft; and that plan participants are oblivious to it all.

We may draw some comfort from the reality that most retirement plan fees are drawn from the expense ratios applied to the various funds, ratios that are generally disclosed, if somewhat imperfectly, to plan fiduciaries and participants alike (we may not yet know the apportionment, but the gross amount is certainly ascertainable). And yet, most advisers would likely view the Transamerica Center results with scepticism, if not downright cynicism. I can hear many of you saying to yourself right now, “They may THINK they know what they’re paying, but they really don’t.”

That said, don’t YOUR clients know what they are paying?

It’s hard to know exactly what inferences to draw from the research. Perhaps the plan sponsors are being misled or maybe misinformed; perhaps they do have a workable, if imprecise, idea of the plan costs. Improbable as this might seem, they might even happen to be a uniquely well-informed segment of plan sponsors. We may know what they are thinking, but we do not know what they think they are paying, much less how realistic that assessment.

Regardless, more disclosure is surely coming and—whether they think they know and don’t, or think they do and are correct in that assumption—IMHO, it’s hard to imagine that those disclosures won’t be a positive contribution to the exercise of their fiduciary responsibilities.

Here’s hoping it keeps us all thinking, rather than leaving us all guessing.

- Nevin E. Adams, JD

Prudent Mien?

Anyone who has been paying attention to 401(k) plan litigation these past several years knows that a common trigger—perhaps the most common trigger—for litigation is the presence of company stock in the plan; more specifically, the presence of company stock that has sharply declined in value. Indeed, one has only to look at the two-month period following the struggle to contain the current oil spill in the Gulf of Mexico and the number of litigants and potential litigants circling the BP 401(k) plans to appreciate just how much more aggressive the plaintiffs’ bar has become in pursuing such actions.

That said, those who have been paying attention to how these cases have played out in court are doubtless aware that many, perhaps most, are not coming to trial at all. Rather, they have been dismissed with what, IMHO, is startling regularity, due to a “presumption of prudence.”

Now, one needn’t scour ERISA’s text to discern the boundaries of this legal construct; indeed, that would be a futile effort. Rather, it is a concept gleaned by the courts (and subsequently enshrined in legal precedent) from their understanding of the black letter of the law. It is a concept that found its footing in a 1995 case called Moench v. Robertson. Now, in that case, as in many of the new generation of “stock drop” cases (drawing their name from the fact that the action arises after the value of the stock drops), a plan participant sued a plan committee for breaching its fiduciary duty based on its continued investment in employer stock after the employer's financial condition “deteriorated.” The Moench court (the 3rd Circuit) affirmed the duty of prudence, but looked to ERISA’s diversification requirement and the allowances made for employer stock holdings in an employee stock ownership plan (ESOP), and saw there a rebuttable presumption that an ESOP fiduciary that invested plan assets in employer stock acted consistently with ERISA (bearing in mind that, since Moench dealt with an ESOP, the plan document itself called for investment primarily in employer securities).

Now, I will admit to being something of a strict constructionist in my interpretation of the law. I am suspicious of those who manage to, through some jurisprudential alchemy, wrest unexpected (and likely unintended) legal conclusions by reading between the lines of the letter of the law. Further, I am generally distrustful of a process that builds on those kinds of legal “extensions” to base future determinations that are, IMHO, often far afield from the intentions of the law itself. After all, once you have established that 2 + 2 = 5, how hard is it to argue that 2 + 5 = 10?

Ironically—certainly in view of how the resulting Moench presumption has proven to be a powerful force in dismissing many of the stock drop cases at the pleading level—though the 3rd Circuit found a presumption of prudence, it reversed summary judgment for the committee/defendants because the facts alleged (precipitous drop in stock prices, committee members' knowledge of the impending collapse, and their conflicted loyalties as corporate insiders and fiduciaries), if proven, could overcome the presumption. And that finding came in the context of an ESOP, a plan design that, if not exempt from ERISA’s fiduciary strictures, would certainly seem to warrant a certain reasonable amount of fiduciary deference in the decision to hold employer stock.

That said, today the law of the land would seem to lie squarely on the side of plan fiduciaries who continue to hold out employer stock as a plan investment, come hell or high water (literally, in some cases). In effect, this “presumption of prudence” seems to have become a magic talisman against which no claim of malfeasance can be successfully alleged, much less established, simply because the courts have discovered (a cynic might say created) a presumption that holding employer stock is appropriate.

Plan fiduciaries have long been tempted by the allure of placing employer stock in these programs, and plan participants have, in large part, responded favorably1. Frankly, I find the rapaciousness of the plaintiffs bar on such matters to be unseemly at best—some downright unscrupulous—and many of the so-called “investigations” are nothing more than a fig-leaf-cloaked excuse to troll for potential litigants. Disaster can befall the best of firms, and stock prices sometimes tumble for reasons that have nothing to do with the fiduciary management of these plans.

That doesn’t mean that plan fiduciaries can pretend that they do not know things they clearly know as corporate fiduciaries; nor, as a recent amicus brief filed by the Labor Department on the broadening application of the Moench decision states, should the securities laws “immunize fiduciaries who knowingly incorporate false SEC filings into participant communications from liability under ERISA” (see “Solis Argues for Stock Drop Case Law Change”).

In this day and age, a plan fiduciary unable to see the potential for employer-security-related litigation is perhaps unworthy of the role; and, IMHO, a dual-role plan/corporate fiduciary unable to appreciate the potential for a conflicted duty vis-à-vis his or her responsibility to the retirement plan is living in a state of active denial.

As for those not yet targeted by litigation, thus far the courts may have presumed that plan fiduciaries are entitled to a certain deference in such matters—but, IMHO, that’s stretching the letter of the law.

—Nevin E. Adams, JD



1 Nor, as some like to posture, are participants necessarily bludgeoned into investing disproportionately large sums of their retirement savings there. Sure, the match accounts for some, and perhaps displaced loyalty some more, but I have found that participants are simply more familiar—and comfortable—with that option.