The lawsuits, Terraza v. Safeway and Lorenz v. Safeway are two of a spate of recent ERISA lawsuits that focus on the obligation of fiduciaries to offer prudent investment options within the framework of 401k plans.
Beyond the evidence this settlement offers that aggrieved plaintiffs can succeed in these lawsuits, two things are notable. First, Safeway’s retirement benefits committee members were unfamiliar with the plan's investment policy statement, summary plan description and other basic documents, and were thus ill-equipped to monitor the plan’s investment opportunities. Second, the fees paid by the plan to third-party service providers involved a revenue-sharing component.
Section 404a1B of ERISA requires fiduciaries of a defined contribution retirement plan to use care, skill, prudence and diligence, and to act in the same way that someone familiar with such matters would act with respect to fiduciary obligations. At a minimum, that implies familiarity with the plan document, summary descriptions distributed to participants and basic investment policies.
Failing in these basic duties can subject plan fiduciaries to personal liability under ERISA section 409 for any losses resulting to the plan. Rarely do the fiduciaries lose their houses, cars and bank accounts, however, because of bonds and fiduciary insurance. The potential is there, however.
More to the point, the utter lack of basic knowledge on which fiduciary responsibility could be exercised suggests an abandonment of responsibility for investment decisions to third party providers, who labor under no fiduciary obligations. No supervision and no obligation spell trouble.
Revenue-sharing agreements with service providers
Revenue-sharing is a method of paying those who provide services to 401k plans. This method does not necessarily constitute a violation of ERISA fiduciary duties. But it invites scrutiny. The practice is at the root of allegations about excessive fees in many 401k plan mismanagement lawsuits, including Terraza and Lorenz.
All 401k plans require three basic administration services – asset custody, participant recordkeeping and third-party administration. The cost of these services can be paid for directly – from participant accounts, or indirectly – out of plan investments. Those who manage 401k plans often prefer an indirect payment structure. One form of indirect fee payment is revenue-sharing.
Revenue-sharing fees may be paid under a variety of complicated formulas that take into account both participant headcount and total plan assets. In an ideal world, those two factors would move in tandem but sometimes they do not, as when a very rich plan has relatively few participants or when it has lots of participants but the investments do very poorly. This can, and often does, lead to allegations of excessive fees.
Secondly, the practice of paying for administrative services out of investment income can make it very difficult for participants to understand what fees are being paid and whether they are “reasonable,” as required by ERISA. This is especially true when different investment options offered by a plan use different revenue-sharing formulas. Plan expenses can be very difficult to police, even for plan fiduciaries who are familiar with basic plan documents. They can be impossible for participants to monitor.
Finally, some passively-managed investment options, like index funds, which may be good for plan participants over the long run, do not participate in revenue-sharing schemes. This may discourage plan fiduciaries from offering them, in part because the fiduciaries are reluctant to charge participant accounts directly for administration costs.
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What should 401k plan participants do?
Two steps are important. Plan participants must monitor the activities of plan investment committees and other fiduciaries. Well-run plans make regular efforts to educate fiduciaries about the extent and nature of their responsibilities. Part of that education should include information about the potential for personal financial liability on the part of ERISA fiduciaries.
Secondly, plan participants must demand full transparency about the payment of administrative fees. When plan participants are unable to follow the money, they have no way of knowing whether they are being adequately protected under the law.