Throughout the past decade, retirement plan sponsors have come under fire from a myriad of class action lawsuits brought forth by participants who claimed the fiduciary responsibilities of their plan sponsors were breached. Following are some best practices related to the focus areas of these recent lawsuits.
The Employee Retirement Income Security Act requires plan fiduciaries to make sure that reasonable fees are being paid to service providers and investment managers for the services provided. Unfortunately, the Department of Labor (DOL) doesn’t provide a specific definition or process for determining reasonable fees but instead leaves that responsibility up to the discretion of the plan sponsor. Almost all retirement plan class action lawsuits have had claims of unreasonable expenses being charged to plan participants, so fee monitoring is often one of the most critical fiduciary duties of a plan sponsor. While investment performance cannot be predicted or controlled, fees paid are one component of an investment plan that can be controlled through negotiation and ongoing monitoring of investment option share classes.
While it’s important for plan sponsors to understand the “all in” cost of a plan, and to make sure it’s reasonable, it’s perhaps even more important to understand various cost components, such as fees charged for investment management, investment consulting custody/trustee services, and recordkeeping/administration. For example, there are more than 10 share classes of some mutual funds, all with unique cost and revenue-sharing structures. Plan sponsors often overlook specific considerations for the share classes used in a plan. These share classes and revenue sharing arrangements should be monitored closely for changes at the fund level.
To help determine if fees are “reasonable,” plan sponsors should benchmark their plan costs relative to other plans of similar size and service level. Lastly, we recommend plan sponsors develop a fee policy, detailed in writing or as part of an investment policy statement that outlines the considerations and decisions related to controlling and monitoring plan costs. A fee policy is a prudent management tool that documents the due diligence process the plan sponsor should follow regarding plan fees.
Understand the differences between money market and stable value funds
While both money market and stable value funds are used in retirement plans to provide participants with an investment option that focuses on capital preservation, there are differences between the two:
- A money market fund that invests in short-term, high-quality cash instruments, like commercial paper or repos, has daily liquidity and is typically structured to maintain a value of $1.00 per share. It’s therefore appropriately viewed as “cash.”
- A stable value fund typically invests in short-to-intermediate term, high-quality bonds that are then “wrapped” or insured by a third party to protect against those bond prices fluctuating over short-term periods.
Earlier this year, lawsuits were filed against some plan sponsors claiming the low returns of money market funds over the last several years made them an inferior plan option to stable value funds, which performed much better over the same time frame.
Plan sponsors can help protect themselves from liability by ensuring that their fund selection and due diligence process follows fiduciary best practices. It’s critical to review and understand the differences between money market and stable value funds as potential investment options that offer capital preservation to participants. While the lawsuits claim stable value funds were a superior option, there are several reasons why a plan sponsor may choose either option over the other including how the fund fits with the rest of the options offered in the plan, fees, and how quickly participants can access the money. The most important thing for plan sponsors to remember is to document the review process and rationale for the decision that’s made and then to continue monitoring that decision at appropriate intervals.
Know your target date funds
Target date funds have surged in popularity as an effective “all-in-one” tool for plan sponsors to help participants become retirement-ready. According to a recent study, 401(k) plans now have more assets invested in target date funds than in equities and over half of all participants invest their entire balance in a target date product. As these products continue to gain popularity, they’re likely to face more legal scrutiny. Plan sponsors should be prepared to defend their fund selections against potential future litigation.
Many plan providers may encourage plan sponsors to use the provider’s proprietary target date fund series. While this may be appropriate, plan sponsors must go through an appropriate due diligence process to determine if the target date fund offered is an appropriate selection.
Interestingly, one of the latest lawsuits to garner headlines was filed against fiduciaries of the Wells Fargo 401(k) plan and was related to the plan’s use of proprietary target date funds. The suit claims the proprietary nature of the funds, in addition to fees charged and performance considerations, violates the fiduciary duty of loyalty and engages in an act of self-dealing. Although the case is still open as of December 2016, it reiterates to plan sponsors the importance of fully understanding the target date fund they offer, how it compares to other options within the industry, and the criteria used for making an investment option selection.
Key aspects of a target date fund series that plan sponsors should review include, but are not limited to structure (e.g. fund of funds), asset allocation, investment strategy, glide path specifics, and fees.
Failure to ask the appropriate questions or devote the proper amount of time to a retirement program can be costly for plan sponsors. It can lead to participant complaints that increase the likelihood of a DOL audit, penalties for operational failures, or class action litigation. It’s critical that plan sponsors protect themselves by enacting the proper policies and procedures to fulfill their fiduciary responsibilities today and avoid potential courtroom costs in the future.