This year will see big changes in the 401(k) industry, which manages some $2.9trn (€2.2trn) of assets on behalf of 40m US citizens. Many factors will push in favour of radical transformations: the lawsuits filed against several sponsors and providers of this kind of defined contribution (DC) plans, the Democrats regaining control of the Congress and being willing to introduce more worker-friendly policies, and the new provisions already introduced by the Pension Protection Act of 2006. Sponsors will have to review how well implemented their fiduciary duties are, while service providers will have to change their fee structures, which is at the centre of current lawsuits.

The latest suit was filed in December 2006 in US District Court in Connecticut on behalf of participants in the retirement plan for the Orange County, Florida against the ING Goup for requiring revenue-sharing payments. Beside the Dutch financial group, so far only one other service provider has been sued, Boston-based Fidelity group for its management of the 401(k) plan for farm-equipment maker Deere & Co of Moline, Illinois (also named in the complaint).

Other defendants include Lockheed Martin, General Dynamics, United Technologies, Bechtel Group, Caterpillar, Exelon, International Paper. And all the cases have been filed by the same law firm based in St Louis, Schlichter, Bogard & Denton, which apparently is investigating a number of 401(k) plans of other large
companies.

All the suits argue that 401(k) participants pay excessive fees, because service providers demand revenue-sharing payments and sponsors fail to understand, control, disclose and maybe reject this system.

The revenue-sharing scheme is defined in the lawsuits as: "The transfer of asset-based compensation from brokers or investment management providers (such as mutual funds, common or collective trusts, insurance companies offering general insurance contract and similar pooled investment vehicles) to administrative service providers (record-keepers, administrators, trustees) in connection with 401(k) and other types of defined contribution plans."

The allegation is that these payments "bear no relationship whatsoever to the cost of providing the services", but are sort of kickbacks paid by money managers in order to be included in the retirement plans. So the plaintiffs ask disgorgement of the revenue-sharing and an injunction on this practice in the future.

"Employers have a legal duty to oversee 401(k)s with the same care they do traditional pensions, but the incentive isn't there because employees bear the brunt of the costs," explained Jerome Schlichter, lawyer at Schlichter, Bogard & Denton. Fidelity and ING, as well as the plan sponsors, have denied any wrongdoing and promised to fight the allegations.

But participants have not been able to protest or at least choose the cheapest funds offered, because "fees in these plans are not transparent", said Alicia Munnell, director of Boston College's Center for Retirement Research, which estimates DC plans lag behind returns on traditional pension plans by one percentage point a year mainly because of higher fees.

Recently the Department of Labor has proposed changes to the plan sponsors' reports, which should detail all fees that are paid out of plan assets or by participants, including a list of fees by type and the revenue-sharing agreements. The new Congress will discuss the issue and will hold hearings about it.

Industry advocates, such as the Investment Company Institute (ICI), insist 401(k) fees are not that high considering the administrative, participant-related, regulatory and compliance services provided. An ICI report found that 86% of 401(k) plan assets are invested in stock mutual funds with an average total expense ratio of 0.7%, about half of the 1.54% simple average for all stock funds, and below the industry wide asset-weighted average of 0.9%.The latest DC survey conducted by Plansponsors.com reveals that indeed fairness of fees and fee disclosure are the weak spots among the nearly
5,000 respondent plans. "We asked plan sponsors to rank the attributes that were most important in an adviser," explained Plansponsors' researchers. Independence is only the fourth criterion. Their ability to negotiate on behalf of the plan, reasonableness of fees, and transparency of fees barely registered, ironically so, in view of the recent focus on such matters. The researchers say: "Consistently, if surprisingly so, reasonableness and transparency of fees were well down the list of plan sponsor priorities in evaluating defined contribution service providers."

Topics