401(k) Plan Fees and Expenses Lawsuits Continue to Proliferate

Over the past few months, numerous class action lawsuits have been filed against 401(k) plan sponsors and their officers, directors, and employees challenging the fees paid to plan service providers. Although many had hoped this most recent wave of 401(k) litigation would subside, it appears that several plaintiffs’ firms intend to launch another round of suits. The law firm that has instigated these suits in the past, Schlichter, Bogard & Denton, has already targeted 10 Fortune 200 companies and appears poised to go after at least 17 additional major corporations. Seattle-based Keller Rohrback, the firm responsible for the prosecution of most of the highprofile “stock drop” suits on behalf of 401(k) plan participants, recently announced that it is “investigating” at least two large plans on fees and expenses issues. Also throwing its hat into the fees and expenses ring is the plaintiffs’ class action firm SimmonsCooper, which reportedly has filed suit against Principal Life Insurance Company. The fact that these additional firms are investigating plans and filing suits suggests that fees and expenses litigation will not be the short-lived phenomenon that some had hoped or predicted.

The Investigations.

The lawsuits brought by the Schlichter firm uniformly follow on the heels of an “investigation” undertaken by the firm involving two preliminary steps. First, Schlichter lawyers place advertisements in newspapers whose distribution likely includes plan participants (e.g., in newspapers servicing the community surrounding a plan sponsor’s home office). The ads specifically identify the name of the plan, suggest that a problem may exist regarding the administration of the plan, and encourage participants to contact the firm. Once contact is made and a participant retains Schlichter, a form letter  seeking documents under ERISA section 104(b) is issued on the participant’s behalf, seeking a variety of materials, many of which are beyond the scope of the statute’s disclosure requirements. The Keller Rohrback firm encourages participants to contact it to discuss 401(k) fees and expenses at its website (www.erisafraud.com), which is specifically dedicated to the issues. We are presently counseling clients at all stages of these “investigations” and, should your company find itself in one of these firms’ sights, can help you frame the appropriate response to avoid litigation and, if litigation ensues, best defend the claims.

The Lawsuits.

Typically the lawsuits allege that plan fiduciaries breached their duties of loyalty and care to the 401(k) plan and must discharge their duties in accordance with the documents and instruments governing the plan. The suits principally seek reimbursement of any excessive compensation paid to service providers. Although the claims focus on the fees and expenses that are charged by 401(k) plan service providers, only one of the suits filed to date makes claims directly against a service provider. Instead, the complaints, so far, are almost uniformly directed at plan sponsors, the company officers responsible for the 401(k) plans, and other entities responsible for appointing plan fiduciaries (usually, the plan sponsor’s board of directors).

Under ERISA, fiduciaries have a duty to ensure that the fees and expenses paid to plan service providers are “reasonable” in light of the services provided and must adequately disclose those fees to participants. The recent lawsuits allege that “revenue sharing” payments are a compensation source for plan service providers that is not properly accounted for by plan fiduciaries in negotiating the service providers’ fees and that is not disclosed to plan participants. Revenue sharing generally refers to an arrangement whereby a mutual fund investment advisor or affiliate shares a portion of its asset-based fee with a service provider to offset the costs of participant-level recordkeeping and administrative services. The lawsuits define revenue sharing broadly to include not only monetary payments but also “other benefits” to plan service providers, including additional fees for distribution services or credit for other services such as equipment, educational materials, and/or conferences and seminars at resorts and hotels.

According to complaints, if the revenue sharing payments received by a service provider exceed the provider’s actual cost of providing recordkeeping and other services to the plan, the “excess revenue” is a plan asset that should be captured and used for the benefit of the plan and its participants.

The plan fiduciaries responsible for such arrangements with the service providers allegedly breached their duties to the plan by either failing to be aware of the revenue sharing payments that service providers received from investment funds or, if they were aware of the payments, by failing to ensure that the combined direct and indirect compensation received by the service providers was reasonable. An additional claim is that to the extent that the plan fiduciaries were aware of the revenue sharing, they also failed to disclose the expenses to plan participants and consequently are not entitled to protection against participant investment losses under ERISA section 404(c).

The complaints also raise claims related to the selection of a more expensive share class when less expensive share classes are available (e.g., investing plan assets in a class of funds with a higher expense ratio when the plan qualified for investment in an institutional class of funds with a lower expense ratio). Similarly, claims are raised for not pursuing separately managed or commingled funds with lower expense ratios and for opting for actively managed funds rather than passive or indexed funds that typically charge lower fees.

Prudent Process and Full Disclosure

These lawsuits serve as an important reminder of the importance of good fiduciary processes. Plan fiduciaries can take a number of actions to guard against being named as a defendant in one of these suits, including:

• Review and revisit fee arrangements and investment alternatives on a regular basis. Prudent process means that plan fiduciaries should know exactly how much of the plan’s assets are being paid each year to service providers, directly or indirectly, and should consider periodically (at least once a year) the appropriateness of these charges. Moreover, fiduciaries must be aware of industry compensation practices, including the growth of revenue sharing arrangements, such as additional fees paid to service providers for distribution services. Essentially, fiduciaries must be aware of the “total compensation” paid by the plan.
• Document the review and negotiation of all plan services arrangements, including investment, recordkeeping, trustee, and administrative services. It is imperative that a clear record is maintained showing that the fiduciaries investigated and considered issues related to the appropriateness of fees and that the fiduciaries are aware of the total compensation paid by the plan. Specifically, the record should demonstrate that the fiduciaries compared the fees charged to the fund with the range of other available fees. The record should also reflect that the fees are monitored on an ongoing basis via periodic market checks.
• Review the plan’s fiduciary governance structure to make sure that plan fiduciaries are clearly identified and that fiduciary authority is allocated to the most appropriate people. In addition to helping the plan to operate more efficiently, this step may limit the number of defendants named in a lawsuit.
• Provide participants with fee information. Consider extracting fee information from various sources (e.g., prospectuses, service provider reports, Form 5500s, summary plan descriptions) and providing plan participants with a brief (one- or two-page) annual plan fee report that captures all of the information. Alternatively, consider making such information available to participants on the Internet.

Conclusion

These lawsuits are largely the by-product of the increased scrutiny directed toward the structure and fee arrangements used by 401(k) plans in recent years. Much of the scrutiny has been focused on how plan service providers get paid and on the transparency of these arrangements. Fiduciaries should stay informed of the fees and expenses related to the plan, establish and maintain prudent processes for monitoring fees and expenses, and make full disclosure to plan participants.

If you would like further information regarding the issues raised in this Morgan Lewis LawFlash, please contact any of the following Morgan Lewis attorneys:

Chicago
Sari M. Alamuddin
312.324.1158
salamuddin@morganlewis.com

Charles C. Jackson
312.324.1156
cjackson@morganlewis.com

Dallas
Riva T. Johnson
214.466.4107
riva.johnson@morganlewis.com

New York
Craig A. Bitman
212.309.7190
cbitman@morganlewis.com

Philadelphia
Robert L. Abramowitz
215.963.4811
rabromowitz@morganlewis.com

Michael L. Banks
215.963.5387
mbanks@morganlewis.com

Joseph J. Costello
215.963.5295
jcostello@morganlewis.com

I. Lee Falk
215.963.5616
ilfalk@morganlewis.com

Brian T. Ortelere
215.963.5150
bortelere@morganlewis.com

Steven D. Spencer
215.963.5714
sspencer@morganlewis.com

Pittsburgh
John G. Ferreira
412.560.3350
jferreira@morganlewis.com

San Francisco
Mark H. Boxer
415.442.1695
mboxer@morganlewis.com

Nicole Diller
415.442.1312
ndiller@morganlewis.com

D. Ward Kallstrom
415.442.1308
dwkallstrom@morganlewis.com

Washington, D.C.
Althea R. Day
202.739.5366
aday@morganlewis.com.

Donald L. Havermann
202.739.5072
dhavermann@morganlewis.com

Gregory L. Needles
202.739.5448
dhavermann@morganlewis.com

Christopher A. Weals
202.739.5350
cweals@morganlewis.com