Monday, January 11, 2016

Will Fee Litigation Kill the 401(k)?

401(k) litigation is going mad. In two of the most publicized cases, Tibble v Edison and Hecker v Deere, there may have been something legitimate for plaintiffs to complain about. In the latest case, however, this one fashioned as Bell v Anthem, the litigation makes this blogger wonder why a company would offer a 401(k) plan at all.

Essentially, all of this litigation stems from ERISA Section 404(c) which among other things establishes that a retirement committee and its members individually are to act in a fiduciary manner in the best interests of plan participants with respect to the plan. For years, issues under 404(c) were not litigated, and in fact, most of us weren't entirely sure how to apply 404(c).

As plans have gotten bigger and the number of investment options has grown significantly, some attorneys have found this to be particularly fertile ground for litigation. In some cases, the issues have been judged by the courts to be clear.

As an example, suppose that XYZ Investment Company offers a large cap equity fund. Not only does XYZ offer that fund, but it has two share classes -- a retail class to which it charges accounts a fee of 80 basis points and a wholesale or institutional class to which it charges a fee of 40 basis points. This is a large difference and to the extent that a plan sponsor and committee have the leverage to have the institutional class as compared to the retail class in its fund lineup, they should.

You can do the math if you choose. Using something as simple as the Rule of 72 (you can google it if you are not familiar to estimate the results), Ms. W's account balance will double approximately every 15.6 years while Mr. R's will double about every 17.1 years. Or said, differently, at the end of 35 years, Ms. W will have roughly 3 years of excess returns over Mr. R, at least on her initial deferral. Her more recent deferrals will have smaller amounts of excess returns.

Is this material? I don't know; you tell me. Is it significant enough that the plan committee should be held liable if they opted for retail class instead of institutional? That's up to the courts.

Now, we return to Bell v Anthem. The plan in question is large. Its assets total roughly $5 billion. A plan of that size certainly has the leverage to get the least expensive share classes available for its participants, regardless of whose funds they are placing in the plan. Even the big players drool over the prospects of picking up a large mandate in a plan that big.

In the particular case, all but two of the funds offered were Vanguard funds. Vanguard has a reputation, supported by data, in the industry as having one of the lowest fee structures of anyone out there.

Of the funds that were not Vanguard, one was the Touchstone Sands Capital Select Growth Fund (Institutional Class) with a 1.31% expense ratio according to Touchstone's website. The other was the Artisan Midcap Value Fund (Institutional Class) with an expense ratio in the vicinity of 1.15% according to Artisan's website.

None of the Vanguard funds had expense ratios exceeding 0.5%. The Vanguard Target Date Funds had expense ratios of less than 0.2%. Index funds in the plan had expense ratios ranging from 24 basis points down to 4 basis points. Very few knowledgeable observers would consider those expenses to be high, and in fact, most plan advisers that I know would consider them low.

Plaintiffs, however, allege that the 4 basis point fee is too high, as there was an asset class available for the same fund that only charged 2 basis points. I saw that and wondered how material that is.

Going back again to the rule of 72, I compared the two different expense ratios. With an expense ratio of 2 basis points, an initial investment would double with a 5% gross investment return about every 14.46 years. With the 4 basis point expense ratio, it would double about every 14.52 years. That's a difference of less than one month.

Could Anthem have had the less expensive fund? Probably. Are there any complications associated with it? I haven't looked into that? Was the committee and its members guilty of some sort of fiduciary malfeasance by offering the higher cost (4 basis point) fund to its participants? The courts will have to decide that.

The issues in the suit continue. It contends that because of the size of the plan that even the Institutional Class Fund is not good enough. Instead, the suit contends, Anthem could have negotiated separate Anthem accounts at an even lower cost.

Is this practical? I don't know. Does ERISA hold fiduciaries to that standard? I don't know. If it does, would I want to be on a defined contribution plan's investment committee? Absolutely not.

My reading of ERISA suggests to me that a fiduciary is to take reasonable care in acting in the best interests of plan participants. It strikes me that reasonable care includes making good decisions. It does not strike me that reasonable care requires each committee and committee member to spend enough time to make the best decision possible.

Perhaps I am wrong though. It wouldn't be the first time.

But, let's return to the separate accounts. How long would it have taken Anthem to negotiate those separate accounts? How good a deal would they get? Since that negotiation would be on behalf of plan participants, could they charge their time back to those participants? I don't know.

Either way, if this sort of suit becomes the norm, it's time to get rid of employer-sponsored individual account plans. Businesses are in business to provide products and services. When their 401(k) plans change the way they do business, it's time to stop.


  1. 401k's are designed to throw lots of minnow's to the sharks. They should be killed off, and we should rebuild a functional retirement system.

    How honest are the fees that are reported? Lifetime funds with 0.2% expenses, sounds great! But, do those funds invest in other Vanguard funds? If so, aren't you paying another layer of fees?

    Use common sense, there is a reason bankers don't think twice about dropping enormous sums of money on lunch, while most families sweat the small stuff. We're being looted by the financial industry.

  2. Maybe a plan with $5.0 BB in assets should not be invested in mutual funds - which are, after all, a retail investment management product. Anthem does not have their Billions in pension assets invested in mutual funds.