June 1, 2007

Fiduciary Responsibility for 401(k) Fees and Expenses

The costs charged to 401(k) plans and the indirect revenues received from plan providers have been the subject of a great deal of media attention, fiduciary litigation, and anticipated DOL guidance.

Because of that, fiduciaries are becoming increasingly more concerned about their responsibilities for understanding and evaluating costs and revenue sharing. This newsletter has several short articles on different aspects of that topic.

This article discusses the DOL’s view of the responsibility of plan fiduciaries. In a 1979 advisory opinion, the DOL explained that its interpretation of ERISA was that plan sponsors, and their officers and committee members who serve as fiduciaries, must understand and evaluate the compensation paid to all providers to the plan, including compensation that was paid indirectly. (Indirect compensation will be discussed in another of the short articles in this newsletter.) Specifically, the DOL stated:

“. . . the responsible Plan fiduciaries must assure that the compensation paid directly or indirectly by the Plan to [the provider] is reasonable, taking into account the services provided to the Plan as well as any other fees or compensation received by [the provider] . . . The responsible Plan fiduciaries therefore must obtain sufficient information regarding any fees or other compensation that [the provider] receives with respect to the Plan’s investments . . . to make an informed decision whether [the provider’s] compensation for services is no more than reasonable.”

More recently, as a part of its proposed changes to the Form 5500, the DOL explained that, in its view, fiduciaries were required to monitor expenses at least annually:

“The Department believes that an annual review of such expenses is part of a plan fiduciary’s on-going obligation to monitor service provider arrangements with the plan. . . .”

However, there is no explicit requirement in ERISA that fiduciaries review costs and revenue sharing on any specific time frame. Instead, the general requirement is that the plan operations be reviewed as frequently as is needed for the specific issue. In our view, expenses typically do not change so quickly that they would all require an annual review. On the other hand, fiduciaries should make sure that the annual charges of any service provider do not exceed the amount in the contract with the provider.

Regardless of the frequency, a prudent review of costs and revenue sharing requires that information be gathered about all of the expenses charged to the plan and about all the compensation paid, directly or indirectly, to any service providers. Without gathering that information, the fiduciaries cannot properly review it and reach an informed and reasoned decision, as is required by ERISA.

Once gathered, the information should be reviewed by the fiduciaries should and compared to (i) the costs for similar services in the competitive marketplace and (ii) the value to the plan (that is, are the investments and services actually benefiting the participants and is that benefit worth the cost?).

The information reviewed by the committee, as well as any documentation related to the analysis, should be placed in a due diligence file and retained for at least six years.

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