401(k) Fee Suit Claims Payment for Services not Rendered

The Boston Globe reports that the Northrop Grumman suit alleges the company’s plan invests in “shadow index funds,” which are charging the fees of managed funds. So, while plan participants are paying for active management of funds they are invested in, they are not receiving that service.

Shadow index funds claim active portfolio management but actually practice near-indexing so their returns will not fall far from their benchmark, the Globe explains. Using a statistic called the R-squared, which measures how much of a fund’s performance can be explained by an index, a fund is considered a shadow index fund when the R-squared is 95 or higher.

The Northrop lawsuit claims that every one of the nine fund offerings in its 401(k) plan that claim active management have actually scored as shadow index funds for the past six years. What this means is that management could have been paying two to three times more for these funds than necessary. The Globe points out that, while it is possible to manage an index fund with expenses as low as 10 basis points, some funds that qualify as shadow index funds have expenses up to seven or eight times that much.

While the group of lawsuits against plan sponsors, including Northrop, that was revealed in the media last month (See Lawyer: Excessive Fee Suits Not an Organized Anti-Plan Campaign ) included common charges of excessive fees and lack of fee disclosure to participants, there are other allegations specific to each case. Those allegations address such things as how fees are calculated on company stock accounts, the use of non-institutional class shares by large 401(k) plans, and the apparent lack of disclosure to participants of hard-dollar fees (which are disclosed to regulators) (See IMHO: “Best” Cases? ).

Last week, news emerged that, in addition to ignoring payments made to service providers and failing to disclose them to participants, Boeing Co. is being accused of charging too much in management fees for the employer stock fund option in its 401(k) plan and holding too much of that fund’s assets in cash (See Details Reported on Boeing 401(k) Fee Suit ).