Just out of Reish:Reasonable Doubts?

Figuring fees and explaining expenses

Fees and expenses continue to be a hot topic for the Department of Labor and 401(k) fiduciaries, and the expectations are rising. ERISA's fiduciary responsibility rules and prohibited transaction restrictions require that fiduciaries avoid paying more than reasonable amounts from plan assets. While "reasonable" sounds reasonable, its application can be problematic. Consider that, for any given service there is a fairly tight range of costs charged by different providers. On the other hand, information on costs is not always readily available, and information on the quality of those services can be even harder to find. The process of evaluating the right combination of services for any particular plan is akin to putting together a recipe, one that is perhaps borrowed from a family friend, but is subsequently tailored to one's particular tastes and nutritional requirements.

For our purposes, the most important considerations are:

Is the service or investment necessary for the plan to operate successfully? Does it advance the primary purpose of the plan: to provide retirement benefits?

Once the need is identified, the fiduciary should examine the competing investments and services and determine the range of quality and costs. Higher cost does not always mean higher quality.   For example, there is compelling data that demonstrates that, in most cases, mutual funds with lower expense ratios will outperform their most expensive brethren.

Based on the analysis of that information, fiduciaries should be able to determine a reasonable range of competitive prices. To the extent that most providers fall within a limited range of costs, that is likely to be the range of reasonableness. (For example, if the cost of a particular service clearly exceeds the "range" of costs for similar services, the fiduciaries should not select that much-higher-cost provider unless they can identify the benefit to the plan and the participants of paying the additional amount; the added value must equal or exceed the added cost.)

Once the service or investment has been acquired, fiduciaries need to monitor the quality, cost, and effectiveness. For example, is the provider of participant-level investment advice actually being used by the participants? Is the investment educator or enroller producing good results—in the level of participation, participant deferrals, and investment of those deferrals? Have the needs of the plan changed? Have new services become available? Has the cost of competitive services dropped?

In order to evaluate fees and expenses, we need to include equal parts of competitive pricing, needs of the plan, anticipated quality of the services, ongoing oversight, use and effectiveness of the service, and, perhaps, independent advice. Then, heat to a high level of competence and stir at least annually.

As services and investments get combined, it becomes more difficult to understand exactly what the plan is paying, who is getting the money, and what a particular service costs. For example, if the mutual fund complexes are revenue-sharing with your recordkeeper, that effectively reduces the "true" costs of the investments and increases the amount paid for recordkeeping. However, since the payments by the mutual funds enable the recordkeeper to reduce its charges to your plan (hopefully, by the identical amount), the revenue-sharing is a wash. Nonetheless, conservative fiduciaries will want to understand the flow of money beneath the surface—if, for no other reason, not every provider is doing dollar-for-dollar offsets. Other revenue-sharing often can take place with brokers, investment advisors and consultants, and third-party administrators.   Fiduciaries have the duty to know of those payments and to ensure that the plan and participants are receiving reasonable levels of service in return. Fiduciaries need to be aware of additional charges, such as wrap fees, surrender charges, and market value adjustments.

Sunshine alone can protect a plan from unreasonable expenses. Beyond that, though, fiduciaries have a legal duty to know about those costs—and to evaluate them prudently.

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— Fred Reish

Fred Reish is managing director and partner of the Los Angeles-based law firm of Reish Luftman Reicher & Cohen. A nationally recognized expert in employee benefits law, he has written four books and more than 100 articles on ERISA, IRS and DoL audits, and pension plan disputes. His recent writings include: "Enron, 404(c) and the Personal Liability of Corporate Officers," Journal of Pension Benefits (Winter 2002) and Participant Directed Investment Answer Book (Panel Publishers, 2002).

PS
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