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At least a dozen class action complaints have been filed against companies sponsoring 401(k)-type retirement plans and the fiduciaries that administer those plans. This article examines the allegations of those suits and provides insight into the arguments that the companies and fiduciaries may use to defend. For almost a decade, the governmental agencies regulating retirement plans and investment activity have expressed concern about fees and expenses associated with investments under participant-directed defined-contribution retirement plans (401(k) plans). In 1998, the U.S. Department of Labor issued a report entitled, “Study of 401(k) Plan Fees and Expenses,” highlighting the inadequacy of information available to plan fiduciaries regarding so-called “hidden” fees associated with investment products and services. See www.dol.gov/ ebsa/ pdf/401kRept.pdf. In 2005, the U.S. Securities and Exchange Commission (SEC) issued a “Staff Report Concerning Examinations of Select Pension Consultants,” raising concerns that revenue-sharing arrangements of retirement plan advisers could taint the advice provided to retirement plan fiduciaries. See www.sec.gov/news/ studies/pensionexamstudy.pdf. In 2006, the Government Accountability Office (GAO) issued a report entitled “Private Pensions: Changes Needed to Provide 401(k) Plan Participants and the Department of Labor Better Information on Fees,” acknowledging that investment providers and plan service providers (collectively, “service providers”) sometimes limit fee disclosures to retirement plan fiduciaries in an attempt to steer the fiduciary to more expensive products and services. See www.gao.gov/new.items/d0721.pdf. In addition, concerns have arisen that incomplete fee disclosures prevent plan participants from appreciating the cost of these products and services and, ultimately, diminish the retirement benefit to participants and their beneficiaries. Similarly, obscurity of service-provider fees and expenses impedes government agencies’ ability to effectively oversee investment fees and expenses. In partial response to these concerns, the Labor Department has proposed changes to Form 5500, the annual report for benefit plans, to require more extensive disclosure of fees and expenses. Suits filed In the fall of 2006, a plaintiffs’ class action firm in St. Louis filed a number of Employee Retirement Income Security Act (ERISA) fee-based lawsuits asserting lost-opportunity claims focusing on the payment of allegedly excessive fees and expenses by 401(k) plans. See, e.g., Beasely v. International Paper Co., No. 3:06-CV-00703 (S.D. Ill. Sept. 11, 2006). Specifically, plaintiffs in the fee cases allege that the fiduciaries breached their ERISA duties by allowing or causing their plans to pay excessive fees and expenses to service providers. Ironically, all but two of these fee cases omit as defendants any of the service providers that allegedly overcharged. As of Dec. 23, 2006, companies targeted in the fee cases included Bechtel Corp., Boeing Co., Caterpillar Inc., Fidelity Investments, International Paper Co., Kraft Foods Global Inc., Principal Insurance Co. and United Technologies Corp. Other plaintiffs’ firms have indicated that they will jump on the ERISA fee litigation bandwagon, initiating “investigations” of various 401(k) plans’ fees and expenses and stating that they expect to file their own fee cases soon. There is nothing novel in asserting a breach of fiduciary duty under ERISA when unreasonable fees or expenses have been paid with plan assets. But the pending fee cases include a novel twist. They do not assert that the value of the services provided was less than what the plan paid; rather, they claim that service providers leveraged their plan business by entering into arrangements with third parties that generated additional revenue for them, and that the plan fiduciaries breached their ERISA duties by not taking these payments into account in negotiating lower service-provider fees. Revenue sharing is a common practice among service providers in the employee benefit plan industry. An investment company whose mutual funds are investment options in a 401(k) plan may pay a broker more than the broker’s cost of executing trades in return for investment research. Similarly, a mutual fund may use a portion of its fees to pay a third party for services necessary to administer or market the mutual fund. There is nothing per se illegal or improper with revenue-sharing arrangements. However, revenue-sharing payments can be used for improper purposes (such as buying service-provider loyalty), and the lack of transparency of these arrangements raises concerns as to the ability of fiduciaries to distinguish the legitimate payments from the illegitimate ones. Some of the more prevalent forms of revenue-sharing arrangements associated with 401(k) plans are soft dollars (excess brokerage commissions used to pay for investment research); subtransfer agent fees (excess transfer agents’ fees for executing, clearing and settling purchase and sale orders paid to a subcontractor to maintain the records and accounting associated with the purchases and sales); variable-annuity wrappers (fees and expenses for services associated with administering a variable annuity that are “wrapped” into a single fee and charged to the plan); and 12b-1 or distribution fees (excess commissions used to market the shares of a mutual fund). The complaints in the fee cases define the term “revenue sharing” broadly, as “the transfer of asset-based compensation from brokers or investment management providers (such as mutual funds, common or collective trusts, insurance companies offering general insurance contracts, and similar pooled investment vehicles) to administrative service providers (record-keepers, administrators, trustees) in connection with 401(k) and other types of defined contribution plans.” The expansive scope of this definition would encompass almost all forms of revenue sharing. The fee cases take aim at the effect of revenue-sharing arrangements on the reasonableness of payments made from the plan to plan service providers. The plaintiffs allege that the fiduciaries’ failure to understand revenue-sharing arrangements leads to excessive payments and is a breach of the ERISA duties of prudence and loyalty. ERISA’s duty of loyalty requires fiduciaries to discharge their duties solely in the interest of plan participants and their beneficiaries, and for the exclusive purpose of providing benefits and paying reasonable expenses of administering the plan. The duty of prudence requires the fiduciary to act with the care, skill, prudence and diligence under circumstances then prevailing that a prudent person, acting in a like capacity and familiar with such matters, would use in the conduct of an enterprise of a like character with like aims. 29 U.S.C. 1104(a)(1). The plaintiffs’ view of the fiduciary duties under ERISA may be at odds with Labor Department guidance. The agency has consistently said that an ERISA fiduciary must objectively assess the qualifications of each service provider, the quality of the work product and the reasonableness of the fees charged in light of the services provided. In theory, the plaintiffs in the fee cases would require ERISA fiduciaries to identify and consider all revenues received by a service provider that are in some way attributable to the plan’s business and balance them against the value of the services received by the plan. The Labor Department, however, appears to require that the fiduciary determine only whether what the plan pays is no more than the value of the product or service provided. In this vein, the Labor Department acknowledged in its 1998 401(k) plan fees and expenses report that hidden fees are difficult to identify and, thus, a fiduciary could overcome lack of information regarding hidden fees by obtaining multiple bids from investment product and service providers and determining which provided the most value for the cost. Thus, it is questionable whether a fiduciary’s failure to consider revenue-sharing arrangements alone is sufficient to support a breach of fiduciary duty claim under ERISA. Moreover, under ERISA a fiduciary’s conduct is measured in the context of the circumstances then prevailing. In this regard, reports issued by the SEC, Labor Department and GAO acknowledge the difficulty of identifying and understanding these fees. At the very least, these reports provide support for the proposition that, under the circumstances previously and currently prevailing, it is unlikely that a prudent fiduciary familiar with investments would consider revenue-sharing arrangements when investing his or her plan’s retirement funds. Thus, even if fiduciaries are required in the future to understand revenue-sharing arrangements and adjust service-provider compensation accordingly, past failures to do so would not rise to the level of a fiduciary breach under ERISA. Share class selection Another claim asserted in some of the fee cases is that the fiduciaries selected a more expensive class of shares when a less expensive class was available in the same mutual fund. Certain investors, such as large retirement plans, can qualify as “institutional” investors, which provides them the opportunity to purchase “institutional” shares as opposed to “retail” shares. Institutional share classes have lower expense ratios because they do not have imbedded in the expense ratio certain sales loads or fund marketing fees. On its face, this claim has some logic; however, there are important factors that can influence a fiduciary’s determination of the prudence of one share class over another. For example, institutional share classes are not subject to all of the SEC’s protective regulations for retail share classes (because institutional investors are perceived as more knowledgeable and better able to protect themselves). If a fiduciary selects an institutional share class with a lower expense ratio, it is likely that the service provider (record-keeper) would seek direct payment from the plan for the services it is providing for which it is not receiving revenue-sharing compensation. This direct payment might be higher than the fee embedded in the expense ratio of the retail share class. Thus, the mere selection of retail class shares over institutional class shares is not per se a breach of fiduciary duty. In addition, many of the fee cases allege that improper management fees were incurred with respect to the “company stock” fund under the plan, an investment option that entails investing in securities of the company sponsoring the plan. The plaintiffs in the fee cases assert that because these funds comprise a single security, there is nothing to manage. Thus, the payment by the plan of an investment management fee allegedly is a breach of fiduciary duty. Also, plaintiffs in the ERISA fee cases assert that the fiduciaries have a duty to reduce the cash or cash equivalents in company stock funds to as close to zero as possible, to allow the plan participants to achieve earnings equal to what a private investor in the stock would receive. However, if a fiduciary has a continuing duty to evaluate company stock funds to be sure that they remain a prudent choice and a duty to adjust the cash position of a company stock fund so that there is sufficient cash to pay benefits and plan expenses, paying a reasonable fee for those management activities would not be a breach of the fiduciary duties under ERISA. ‘Inappropriate benchmarks’ A number of the fee cases allege that plan fiduciaries used inappropriate benchmarks to measure the performance of certain investment options under the plans, and that the lagging performance of those investment options was the result of the alleged excessive fees and expenses. This claim is best demonstrated by the inappropriate benchmark claims aimed at the company stock fund under the plans. The plaintiffs assert that benchmarking the company stock fund against, for example, the Standard & Poor’s 500 index, as opposed to the performance of the company’s publicly traded stock, is a fiduciary breach. They allege that their target company’s stock consistently outperformed the participants’ investment in the company stock fund and that the use of the company’s stock as a benchmark would have highlighted the impact of the asset management fees and the cash positions under those funds. However, benchmarks are not used to demonstrate the impact of fees or liquidity positions; benchmarks are used to measure performance of an investment, to assist in determining whether to maintain that investment as a choice under the plan. An individual who, outside a plan, invests in a company’s stock is investing for himself only; a plan fiduciary who elects to include company stock as one choice on the company’s 401(k) plan investment menu must maintain sufficient cash equivalents in the fund to properly administer the plan. That cash component will normally degrade the fund’s performance compared to the market performance of the stock. In the case of company stock funds, at least, the benchmark allegations in the fee cases should be given short shrift by the judiciary. Each of the fee cases asserts that the protections offered by � 404(c) of ERISA are not available to the plan fiduciaries. Section 404(c) relieves plan fiduciaries from liability for losses incurred by a participant from his exercise of control in directing the investment of his account under the plan. In order for a participant to be able to exercise control, plan fiduciaries must disclose specific information listed in the regulations interpreting � 404(c). The plaintiffs in the fee cases allege that the information provided to the participants regarding fees and expenses paid by the plan was unclear and incorrect, and that they received no information regarding the revenue-sharing arrangements of plan service providers. Without this information, the plaintiffs assert, they were unable to make informed decisions regarding their plan investments and, therefore, did not have the opportunity to exercise the control anticipated under � 404(c). However, the � 404(c) regulations provide that a plan does not fail to provide participants the opportunity to exercise control over their individual accounts merely because it imposes charges for reasonable expenses for carrying out investment instructions, so long as procedures are established to periodically inform participants and their beneficiaries of the actual expenses incurred with respect to their accounts (the plaintiffs assert that participants are not so periodically advised). Again, if the key measurement of a reasonable expense is what the plan paid compared to what it received (and not what the service provider received in addition to what the plan paid), these � 404(c) claims would fail. However, if the plaintiffs in the fee cases succeed with their � 404(c) claim, the door would be opened wide for plaintiffs to seek earnings that the participants would have realized on the value of the portion of the fees and expenses that are alleged to be excessive. Moreover, nonapplicability of � 404(c) would create the potential for fiduciary liability for any losses incurred with respect to any fund that is offered under a plan’s menu. Under the ERISA fiduciary regime, the old adage that “knowledge is power” translates to “knowledge is prudence.” The recent fee cases underscore the importance of the knowledge requirement under ERISA. The extent to which these fee cases will more clearly define a fiduciary’s duty with respect to the reasonableness of fees or expenses and duty of disclosure under � 404(c) is unclear. What is clear is that at the very least the fee cases will increase fiduciary diligence and scrutiny of fees, expenses and revenue sharing. The big question is whether the fee cases will compel service providers to incorporate a greater degree of fee transparency. However, fiduciaries can diminish their exposure to excessive fee and expense claims by querying those providers regarding fees, expenses and revenue-sharing arrangements and validating the reasonableness of their plans’ fees, expenses, services and investment products. Steven J. Sacher, a partner in Kilpatrick Stockton’s Washington office, practices employee benefits law, focusing on fiduciary responsibility issues under ERISA. Matthew A. Olson, an associate in the firm’s Washington office, works on fiduciary responsibility matters and other ERISA and tax code compliance issues.

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