BNA Pension and Benefits Blog

As expected, the 401(k) fee disclosure case against Deere & Company was the first to be decided, since the District Court for the Western District of Wisconsin has a reputation as a "rocket docket."  Many people, myself included, had thought the complaints in these 401(k) fee cases contained sufficient fact allegations that courts would wait until after discovery to decide them. Unexexpectedly, the court dismissed the case based on the complaint and the plan documents. Hecker v. Deere & Co., Case No. 06-C-719-S (W.D. Wisc. June 21, 2007). The facts of the Deere plan may, however, distinguish it from most other plans and make it less significant as a precedent in the other pending 401(k) fee cases, at least at the motion to dismiss stage.

The SPD provided that:

The costs of administering the Plan are paid by the Company. Participants incur no transaction fees or sales loads on funds purchased and sold through the Plan’s standard plan options.... All fund investors indirectly pay any fund-level expenses, such as management fees, asset-based sales charges (12b-1 fees), and other fund expenses, as detailed in the fund’s prospectus....

Of the 26 funds specifically offered by the plan, 23 were Fidelity Funds. However, the plan also offered a mutual fund brokerage account through which participants could select from among 2500 other mutual funds unaffiliated with Fidelity. Fidelity received direct payment for its trust services from Deere; the plan paid no additional fees to Fidelity.

The court concluded that:

The disclosure in the reports and prospectuses accurately reflect the expenses actually paid to the fund manager for fund management as evidenced by the allegations that the same fees are charged to all retail fund customers. To the extent that the charge includes profit, it is unlikely that the fund sponsor would know or be in a position to control its redistribution among related corporations, corporations, a fact conceded in defendants’ brief. There is no evidence of intent in the statute or regulations to reach this type of detail.

The court found that the recent proposals to expand disclosure of indirect fees and provide additional disclosure supported the conclusion that such expanded disclosure is not required under current law.

There appears to have been no dispute that the Deere plan satisfied the ERISA section 404(c) requirements other than requirements related to fee disclosure. The court concluded that the existing regulations do not require disclosure of revenue sharing, only the amount of the fees which were adequately disclosed. Nor did the court feel that disclosing the revenue sharing arrangements would have enhanced the participants' investment decisions:

In assessing the likely return on an investment the fees netted against the return are certainly relevant, but knowing the subsequent distribution of those fees has
no impact on the investment’s value.

The court concluded that the participants had adequate opportunity to choose funds other than the designated Fidelity Funds because of the mutual fund brokerage window and therefore their investment in the designated funds and therefore they exercised the requesite control over the investments in selecting the Fidelity Funds to insulate the Deere fiduciaries from any liability under section 404(c)'s safe harbor even if the plaintiffs could prove that the fees in the Fidelity Funds were excessive.

Most plans don't offer a brokerage window, so the Deere case is clearly distinguishable. However, the court's conclusions about the extent of disclosure required under current law, both under the general ERISA provisions and section 404(c), would protect most plan fiduciaries if followed by other courts. Stay tuned for the rest of the story, since there are still a number of these cases pending.

Much has been made of the fact that employers are increasingly turning to 401(k) plans rather than defined benefit plans. Employers are implementing a number of strategies to help employees achieve retirement security in this brave new world. Most of these strategies, such as automatic enrollment and automatic increases in participant deferrals, focus on the asset accumulation phase. At the BNA conference earlier this year on Redesigning Pension Plans and Executive Compensation, Henry Eickelberg of General Dynamics talked about an innovative program that a number of large employers negotiated to help their employees buy annuities at reasonable prices.

The employer group isn't offering the annuities in their qualified plans but instead is making them available to employees for both plan rollovers and direct investment. The annuities include both fixed annuities, with and without inflation protection, and variable annuities. The group negotiated low commissions (.5% on the fixed annuity product). The good news is that these annuities are not limited to the employer group but are available to the public so other employers can bring them to the attention of their employees and financial planners can consider them for their clients. You can check them out at on the website for the Elm Income Group.

Years ago, before the Department of Labor issued its guidance on purchasing the safest available annuity for participants in terminating plans, Interpretive Bulletin 95-1, I advised a client that the standard was "Would you purchase an annity for your mother (not your mother-in-law) from this carrier." So I was intrigued years later by an article that Ron Gebhardstbauer wrote for the Women's Institute on a Secure Retirement (WISER) on the advice he gave his mother at age 77. She began receiving the required minimum required distributions at age 70 1/2 and he determined  that she would do better with an annuity than with the annual payouts, with the added advantage that she wouldn't see her annual payouts decrease as she got older. (Ron is the Senior Pension Fellow for the American Academy of Actuaries and the former Chief Actuary for the PBGC, so he can readiy figure these things out, unlike the rest of us.) I recently checked with Ron and his mother is still enjoying her annuity in her mid-80s.

You may be able to find a better deal through your own plan. I compared the payout on a single-life annuity for a male age 70 from Elm for someone who has $100,000 to invest to the same annuity offered by the federal Thrift Savings Plan (TSP), the 401(k) plan for federal employees. The annual payout under the Elm annuity was slightly less ($814 compared with $834 from TSP). Similar results for a female beginning payouts at age 60 ($605 from TSP versus $664 from Elm). However, most employers don't offer annuities to their DC plan participants and, even if they do, they may not have rates as competitive as TSP. The Elm annuities are definitely worth checking out. And kudos to the employer group that made an effort to bargain these good rates for their employees.

I'd be interested in hearing about any other sources for annuities that offer better rates. With the increasing elimination and freezing of defined benefit plans, employees will need to engage in self-help on the payout side of the 401(k) ledger just as they have to do on the investment side.

As 401(k) plans become the major source of retirement savings,  Congress, GAO, DOL and the SEC are all turning their attention to the issue of 401(k) fees. Last fall, Gao issued a reprt on Changes Needed to Provide 401(k) Plan Participants and the Department of Labor Better Information on Fees at the request of Congressman George Miller, now Chair of the House Education and Labor Committee.  Last week, the Committee held a hearing on "Hidden 401(k) Fees Undermining Retirement Security?"  If you missed the hearing, you can view it on line at the Committee's website, where the written testimony of the witnesses is also posted.

The DOL has indicated that they will be launching a number of new initiatives to increase disclosure of 401(k) fees, particularly the payment of indirect fees to service providers. The DOL has already proposed a revision of  Schedule C of the Form 5500 which would require annual disclosure of indirect fees. Recognizing that plan fiduciaries often have difficulty getting information about indirect fees, the Department is planning to propose an amendment to the statutory prohibited transaction exemption that permits service providers to be paid (ERISA section 408(b)(2)) to require service providers to provide information about indirect compensation so that plan fiduciaries can determine if their total fees are reasonable. The Department is also expected to issue a request for informtion about 401(k) disclosure of fees, both direct and indirect, to plan participants.

Meanwhile, in a speech to the ABA Business Law Section last week, Andrew Conohue, Director of the SEC's Division of Investment Management, indicated that the SEC is working with the DOL to determine how fee disclosure should be made to 401(k) plan participants. He also indicated that the Commission staff is reviewing the rule that permits mutual funds to pay 12b-1 fees.

Plan fiduciaries should be continuing to request information about indirect fees from service providers such as investment managers, investment consultants, recordkeepers and trustees to determine whether the fees paid by their 401(k) plan are reasonable. Since many fees paid by 401(k) plans are asset based, fiduciaries should review the total paid annually as plan assets grow. Also, fiduciaries should move to institutional shares of mutual funds as their investments reach the minimums for such shares. Finally, fiduciaries should benchmark the fees they are paying against industry averages.

Fiduciaries shouldn't lose sight of the fact that the key is the return participants are getting net of fees, so fees shouldn't be the only consideration. However, compared on a net basis, lower fees will often result in better performance.

Every week it seems the courts find some new way to cabin participant rights and remedies.  In Langbecker v. Electronic Data Systems, 39 EBCases 2352, 2007 U.S. App. LEXIS 1125 (January 18, 2007) the Fifth Circuit, in a split decision found a doozy.  Since the DOL issued its 404(c) regulation in 1992, it has been generally understood that section 404(c) did not relieve fiduciaries from liability for limiting or designating investment options in a 404(c) plan.  This view was contained in the preeamble to the regulation as a gloss on regulatory language limiting 404(c)s relief to losses which are "the direct and necessary result of that participant's or beneficiary's exercise of control."  29 C.F.R. sec. 2550.404c-1(d)(2)(1).  In fairness, this view also informs examples included in the regulation itself. See examples 8 and 9 of the regulation.

The debate over whether the DOL had the authority to adopt the position in the preamble turns on whether the language in the statute and the regulation itself are sufficiently ambiguous to permit the DOL's interpretation.  The DOL is entitled to Chevron or Auer deference if there is ambiguity.  Ambiguity is in the eye of the beholder, it seems--and this opinion itself cannot seem to make up its mind about the statute, saying in one place that the statutory language leaves the question open, and in another that neither the regulation nor the statute are ambiguous. 

But what about common sense.  Should plans be able to offer just 3 options or four with employer stock, one or more of which are imprudent, and then argue that 404(c) means there is no liability simply because the participant chose that imprudent option, even without knowledge of its imprudence. 

I think the reasoning of EDS is deeply flawed, and consequently the petition for rehearing en banc supported by AARP, NELA, the Pension Rights Center, and the DOL itself has a good chance of being granted.  But it is the court's lack of sensitivity to the consequences of its decision that troubles me the most.  Assuming the majority felt that it had no choice but to issue the decision that it did, it could have acknowledged rather than denied the extraordinarily harsh results its decision could produce.  Instead, the reader is left wondering whether the court is actually pleased by its vision of an Act that provides participants with no protection against the selection of unacceptable investment alternatives.   If  Congress really meant  to have ERISA work this way, Congress should be asked to think again.  I prefer to think that Congress was not so foolish, but that's hardly a surprise coming from someone who helped write the 404(c) regulation.

In the PPA, Congress endorsed (and well it should have) automatic enrollment 401(k) plans by adopting legislation to make it easier for employers to sponsor such plans.

One issue addressed by the PPA was the appropriate default investment option, since some if not many employees automatically enrolled in such plans will not designate an investment choice. Will a plan fiduciary have liability simply because of the type of default investment option to which salary deferrals are mapped in the absence of participant direction? In particular, will the plan qualify under ERISA section 404(c) as a self-directed plan?)

The PPA directed the Department of Labor to issue rules on permissible default investment options when an employee does not direct how assets are to be invested. The DOL issued proposed regulations in September.

Under the proposed regulations, a plan may use one of three alternative types of funds as the default investment for automatic enrollment plans. The default options are essentially the following: (1) a life-cycle or retirement-date type funds; (2) balanced funds; or (3) individually managed accounts in which assets are allocated on a life-cycle model. The regulations do not permit the use of money-market or stable value funds because the Department of Labor does not believe such funds will generate sufficient returns to provide adequate retirement savings.

I am sympathetic to the Department’s position about money-market and stable value funds, but I wonder whether there should be a window period, perhaps three to six months, where a plan could temporarily park a participant’s initial contributions to a plan in a money-market or stable value fund. (After the window period funds would be mapped to one of the qualified default investment vehicles currently identified in the proposed regulations.)

Use of a “safe” fund for a window period might temper the inclinations of some employees to opt out of participation in response to an early loss of principal. It might also make it more likely that some employees will actually consider how they want their money invested rather than simply having the plan direct contributions to a qualified default fund. (I am assuming that some employees who might accept the default investment chosen by the employer would think about where they wanted their money invested if it would otherwise sit for a few months in a money-market fund. Of course, one could argue that employees might be better off in the plan’s qualified default investment than they would if they make their own investment decisions.)

In any event, employers often know their workforces better than the Department of Labor does and if an employer thinks that a money-market fund is appropriate for its workforce for a relatively brief period of time, the Department should probably respect the employer’s insight.

There would be another advantage to permitting the employer to use a money-market default fund for a brief period of time. Under the proposed regulations, a participant must be given notice, 30 days before initial investment of funds, about the plan’s investment options. Presumably this is in the regulation because it ensures that every employee has either selected an investment option or impliedly consented to the plan’s default investment fund before they have contributed to the plan. If there is loss to principal, the employee will have expressly or impliedly consented to the investment fund in which the loss occurred.

But some observers think that employees do not like to see their paycheck decline after a month of employment and that seeing such a decline may cause some to opt of plan participation (to get their paycheck up to where it was the first month of employment). So how do we square this concern with the Department’s concern that participants might suffer a loss before having time to select an investment option? By mapping the contributions to a risk-free fund until the employee has time to choose another investment option. And if the employee does not exercise that right within the specified window period, then the employee’s account gets automatically mapped to a permissible default fund. (And if the employee decides to opt out, the employee can get their contributions returned without loss of principal.)

Before posting this, I spoke with Marc Iwry, who tells me that he and some others submitted comments to the Department of Labor along these lines. Their comments, in my view, deserve careful consideration. Given this blog, its no surprise that this is my view!

Employers are being inundated with a press of new guidance issued by government agencies on many new employee benefit requirements with which the failure to comply can result in some fairly stiff penalties.  Guidance such as that issued by Treasury at the beginning of this month on section 901 of the Pension Protection Act of 2006 (the Act) which establishes participant diversification rights for publicly traded employer securities held in defined contribution retirement plans (other than certain ESOPs).  While the guidance is certainly welcomed because it fills some "need to know" gaps in the short run, the Notice raises some immediate significant areas of concern for employers.

The Act establishes as a new plan qualification requirement (new Code section 401(a)(35)) for investment diversification applicable to publicly traded employer securities held by defined contribution plans and certain ESOPs.  IRS Notice 2006-107, provides guidance on the new Act diversification rules, one of which requires 30 days advance notice to participants before the first day that participants are eligible to direct diversification of their accounts out of employer securities.  The Notice provides employers with some breathing space and advises employers that the new participant notice requirement can be satisfied as late as January 1, 2007, for calendar year plans.  This still means, however, that employers have to figure out who must get the notice and what the notice should say and send it by year end. 

One issue is whether employers that already allow participants to diversify out of employer stock (i.e., their plans already contain full diversification rights), have to advise participants by January 1, 2007, of their right to do so, which likely would be duplicative especially if the information already is contained in an SPD).  The Notice contains a model notice (requiring customization), but the IRS has requested comments on ways to improve the model notice.

While the reason for the new statutory provision is to ensure that participants in defined contribution plans (sponsored by publicly traded employers) receive diversification rights where the employer's plan invests in comapny stock, has a company stock fund or matches employee contributions with company stock, as a result of ENRON and the spate of litigation that followed in its wake, many employers already have modified their plans to allow employees to diversify out of employer stock.  What is hitting many employers who have already provided for diversification out of employer stock in their defined contribution plans is how to comply with these notice requirements.  Does it make sense for an employer to send out 50,000 notices to employees in its 401(k) plan by the end of the year telling them about a right they already have (and presumably already know about)?

Some government representatives at Treasury and the IRS have pointed to an alternative purpose of the employee notice -- to educate employees concerning the importance of diversifying their investments.  When asked whether an employer needs to send notices (by year end) to employees in plans that already contain the required diversification, these representatives have suggested that notices may still be required.

Should publicly traded employers with defined contribution plans holding company stock send out notices before the end of the year even if their defined contribution plans satisfy the diversification requirements of the statute?  Although some practitioners think this is absurd, this practitioner thinks it is better to be safe than sorry.  Any thoughts?

ERISA fiduciary litigation isn't calming down, it is just switching subjects.  As the stock drop cases  wind down, they will be replaced (in fact, are already being replaced) by hidden or excessive fee cases.  This should really come as no surprise to anyone.  Most of us in the industry have known about these hidden payments (commissions, shelf space fees, etc.) for years, but never mentioned them in polite society. 

It took Elliott Spitzer to shine a light on these arrangements and, once he did, virtually everybody agreed that they were indefensible (not that service providers shouldn't get paid, but that their fees should be known to the payor, who would then be in a position to comparison shop).  Now everybody is getting into the act.   Both the SEC and DOL are acting as though they just found out that these arrangements exist and are telling plan fiduciaries to ask questions.  DOL is going to require greater disclosure on Forms 5500 and is considering amending the section 408(b)(2) regs. to require knowledge of fees as a pre-condition to a determination of reasonableness. 

If only it were that easy.  No matter how much disclosure the government may require, people will figure out new ways to be paid.  In fact, there are so many ways now, that full disclosure would probably create something as difficult to prepare and read as a prospectus.  Great for the service providers who prepare them, but of little practical use to plan fiduciaries, let alone participants. 

In my view, for greater disclosure to become effective, it must be accompanied by greater simplicity.  I don't think either DOL or the SEC currently has the authority to dictate how fees will be paid (as long as prohibited transactions are avoided), and the chances of Congress passing an ERISA equivalent of a truth-in-lending disclosure statement appear nil.  This doesn't mean that the problem won't be solved.  It just means that the problem will be solved by class action litigation--a boon to the lawyers, but to no one else.

What I don't understand is why the industry groups, such as ICI or ACLI don't come forward to take the lead.  This can easily be accomplished by standardized disclosure statements coupled with a commitment to receive or pay no fees not covered by those statements.  This would probably be a net plus to the members of those associations, since, I assume, mutual funds and insurance companies pay more secret fees and commissions than they receive. 

It seems to me the end result is both inevitable and desirable--full disclosure (in an understandable form) of all fees paid or received by a service provider in connection with a plan's business.  There are four ways to get there; legislation, litigation, regulation (to the extent possible) and industy initiative.  The latter, I think, is most desirable, but least likely to occur.  The least desirable is litigation, and that is how I think it will happen. 

Any thoughts or comments?

The general direction given to those of us in the position of being a guest commentator for a week on this new blog was to “write about something that interests you”.  I’m not sure Sarah’s directions would quite encompass my interest in how well the Bears are doing this year and pondering how long this glorious winning streak will last as well as what the post-season will bring—so I will not write about what really is of interest to me—although I’m sure if I did, there would be a lot of interesting comments and other points of view expressed.  So let’s look for something else of interest.

Company stock is always fun, so let’s go there.

We seem to be near the end of the “stock drop” litigation explosion, which has given many plan sponsors heartburn, even if they were not involved in litigation.  Much has been written and discussed as to what steps should be taken to avoid or minimize potential exposure to the issues and many plan sponsors have made changes to their plans and/or committee structures.  But before they can catch their breath, along comes the new kid on the block—the Pension Protection Act of 2006.

The PPA has provisions focused on 401(k) plans which have a company stock option as part of their structure and adds new diversification requirements along with mandated information notices to participants addressing the benefits of diversification of their plan accounts.

Since company stock has had a long history in retirement plans, one would assume plan sponsors will not retreat wholesale from continuing to provide the option, especially since there are financial benefits to making matching contributions in company stock, but will the option stay the same?  Will plan sponsors comply and continue the option in their 401(k) plans?  Will plan sponsors reconsider continuing the option? Or will the option be continued in a different form—such as moving it to a stand alone ESOP—in order to keep certain restrictions on diversification?  If it is moved, will the fact that it was once part of a 401(k) plan have any taint?

A small focus, but seemingly one with a potential for attracting a great deal of interest.  What thoughts, dear reader, do you have?