Crystal Ball, Part 2Help sponsors manage 401(k) plan risk

In last month’s column, I discussed two major waves of 401(k) litigation—company stock cases and allocation of revenue sharing. This month, I cover two more potential areas for lit-

igation—“excessive” payments to service providers and expense ratios of mutual funds.

Excessive payments to service providers. Disclosures under 408(b)(2) will alert plan sponsors—and, ultimately, under 404(a)(5), participants—to the amounts of revenue sharing and other indirect payments made to service providers. It is inevitable that, in some cases, those amounts will be excessive (or, in the words of the law, “unreasonable”). For attentive plan sponsors, those excessive payments will be identified during the process of eval-uating the 408(b)(2) disclosures, for example, by benchmarking the disclosed amounts against appropriate data. However, I am concerned that plan committees will fail to evaluate and bench-mark those payments. If my fears prove to be well-founded, it will almost inevitably lead to litigation.

Expense ratios of mutual funds. While the courts are split over how much responsibility plan sponsors have to evaluate the expenses of mutual funds, it is possible that one of those cases could reach the Supreme Court in the near future. And if one does, it is very likely the court could rule that plan fidu-ciaries do, indeed, have a heightened responsibility to review the available funds and to select those appropriate for the “pur-chasing power” of the plan. For example, a billion-dollar plan should, as a practical matter, be able to obtain institutionally priced mutual funds and collective trusts, while a smaller plan may need to pay higher prices for retail funds—but, even then, with a waiver of front-end commissions. In that case, the prac-tices of plan sponsors, particularly of larger ones, will almost immediately come under scrutiny. As a word of advice, plan sponsors should focus on this possibility, to make sure the expenses of their mutual funds are appropriate for the size of their plan. Even in this context, the good news is that the use of revenue sharing to pay for the cost of operating a plan is not prohibited, and, of course, the cost of revenue sharing is embed-ded in the expenses of mutual funds. The issue is not whether revenue sharing may be used, because it may, but whether the amounts are excessive, as measured both by the payments to service providers and the costs imposed in the plans (i.e., the expense ratios).

As a final thought, there is one commonly mentioned theory for potential litigation that I disagree with. From time to time, speakers and writers suggest that litigation might occur because 401(k) plans are producing inadequate retirement ben-efits. That is, there is a growing concern that 401(k) plan-holders are not accumulating enough money to allow them to retire with a reasonable standard of living, and some critics imply that plan

sponsors may be held account-able for this shortfall. I have found nothing in the law indi-cating that plan sponsors or fiduciaries are obliged to oper-ate their plans to produce “ade-quate” benefits, other than the general requirement that fidu-ciaries act prudently in fulfill-ing their duties. Nonetheless, the fiduciary standard is evo-lutionary, not static. In the years ahead, a greater burden may fall on fiduciaries, such as plan committee members,

to help participants accumulate benefits that are adequate for retirement. That could include, for example, projections of retirement income and gap analysis. For the moment, though, these remain in the realm of best practices.

Only time will tell if some, or even all, of my predictions are off-target. It’s not easy to forecast future litigation, but anticipat-ing the key issues will help manage the risk in your 401(k) plan.

Fred Reish is chair of financial services ERISA practice ,

at the law firm of Drinker, Biddle & Reath. A nationally

recognized expert in employee benefits law, he has written

four books and many articles on ERISA, IRS and DOL

audits, and pension plan disputes. Fred has earned the

Institutional Investor Lifetime Achievement Award and the

PLANSPONSOR Lifetime Achievement Award. He is one of

the 15 individuals named by PLANSPONSOR magazine as

“Legends of the Retirement Industry,” and also one of five

acknowledged as “Retirement Plan Adviser Legends” by

PLANADVISER magazine.

Just out oF Reish

if my fears prove to be well-founded, it will almost inevitably lead to litigation.

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