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New Rules Will Have Fiduciary Impact

Next year, new federal rules requiring fee disclosures from 401(k) plan providers make it imperative for companies sponsoring plans to ensure that fees are reasonable. Employers that start preparing now for the new disclosure regime will be ahead of the game.

Monday, November 7, 2011
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Companies sponsoring 401(k) plans have long been responsible for ensuring that fees are reasonable. Yet the amounts of these fees haven't been easily accessible to employers or employees -- until now.

But beginning next year, new rules from the U.S. Department of Labor require 401(k) plan providers to use an easily understandable format to automatically disclose all fees for plans and investments in the plans.

When employees receive their account statements, some may be surprised or angry to learn how much money is being deducted from their accounts to pay investment-management fees. And much to their chagrin, they'll learn that they've actually been paying for the plan itself.

Though the new rules will ultimately benefit plans, they will create a new burden of accountability for employers and increase the workload of HR professionals.

As these rules supply the missing piece of the fee puzzle, employers will no longer have an excuse for failing to fulfill their duties regarding fees under the Employee Retirement Income Security Act of 1974, which effectively prohibits employers from entering into arrangements involving unreasonably high fees.

The new rules have teeth, and enforcement will be rigorous; DOL is preparing to hire thousands of new agents to conduct compliance audits. Violations can bring hurtful fines, and even if a violation is not found, merely responding to a DOL investigation or employee complaint is costly in time and money.

Should there be any substance to the complaint, an employer could be held liable for damages from lawsuits brought by employees, as ERISA requires plan fiduciaries to steadfastly put participating employees' interests ahead of their own. This role carries considerable responsibilities and risks, including significant regulatory and legal liability.

A case in point: A lawsuit brought by employees of Wal-Mart Stores Inc. claims the behemoth retailer breached its fiduciary duty by including mutual funds in its 401(k) plan whose retail-level fees lacked the steep discounts typically obtained by large plans. Similar lawsuits will likely proliferate in the newly expanded disclosure era, as employees learn the total amounts they're paying in fees.

Proactive Steps

To avoid becoming the target of lawsuits and regulatory sanctions, companies must act now to make the extensive preparations necessary to deal with the new DOL rules. The first step is to conduct a full plan review, either internally or by using a consultant or adviser who is completely independent and is thus free of conflicts of interest. 

Federal rules prohibit brokers from engaging in the fiduciary activity of advising employees on the suitability of specific investments. Despite this, brokers typically have the lead role in servicing 401(k) plans. Because brokers can't be fiduciaries, the responsibilities for fiduciary duties for these plans -- and the risks involved -- stay with the employers.

By contrast, registered investment advisers (registered with the U.S. Securities and Exchange Commission) are legally permitted to be fiduciaries. Under the new DOL rules, service providers are required to disclose whether they are fiduciaries, and employers are required to ask.

These rules also require employers to evaluate newly required disclosures from consultants and providers concerning any compensation arrangements they may have with other companies. If service providers receive any compensation from plan providers, this could taint their advice.

One reason for this requirement is to highlight compensation arrangements that influence which investments plan providers choose to include among plan offerings. Conflicts of interest in this area abound. For example, investment companies pay providers "revenue-sharing" fees, which amount to legal kickbacks. 

Also, many investments in 401(k) plans carry commissions -- known as 12(b)1 fees -- that ultimately increase an investment's expenses by that amount. Further, some plans that are provided through insurance companies offer mutual fund-like investments that carry substantial added costs called "wrap" fees.

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Investment companies pass these expenses along to plan participants in the form of indirect fees, but workers typically aren't aware of them because they aren't currently disclosed. Nor are employees typically aware of most other fees -- including those for the plan itself -- because they aren't included in quarterly account statements, which report investment returns after fees are taken out.

Under the new rules, these statements must include tables showing actual investment returns and expenses separately so employees will know what their investments are earning and what they're paying for this performance.

Unfortunately for employees, the new DOL rules don't go far enough. They don't require the amounts of indirect fees be disclosed to employees, only to the plan. In employees' statements, these amounts regarding mutual funds are typically hidden within the larger figure for the expense ratio, a measure of what it costs an investment company to run a fund. 

Still, the amounts of fees that are explicitly presented on employees' statements will come as a shock to many, sending them straight into the offices of HR professionals. This is another reason it's a good idea to get out in front of the new requirements by reviewing plans now. 

Though jarring, the content of the new disclosures will be a helpful wake-up call for employers and employees. Shining a light on 401(k) plan fees will eventually make the market for providers more competitive, driving down fees.

Ultimately, the new disclosures will lead to better, lower-cost plans, more objective professional services and improved fiduciary oversight. As a result, employees will be able to make more informed investment choices. In the meantime, however, HR professionals have their work cut out for them.

William Kring, CFP®, AIF®, is founder of Kring Financial Management, a Registered Investment Advisor firm based in Atlanta. The firm operates 401k ProAdvisor, which provides a comprehensive suite of retirement-plan consulting services, including fiduciary audits, expense benchmarking, request-for-proposal process management, 401(k) investment management/monitoring and participant advice. This article expresses the opinions of the author and does not constitute legal or investment advice.

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