401(k) Fee Lawsuits Raise New Issues For Plan Sponsors, Providers

Editor: Would each of you tell our readers something about your professional experience?

Pianko: I've worked in the ERISA area since shortly after the statute was enacted. I've been fortunate over my career to have been exposed to virtually all of the specialty areas within employee benefits (from ERISA fiduciary issues, plan drafting and governance to executive compensation) and also to the differing needs of a wide range of clients, from entrepreneurs to Fortune 100 entities.

Kelly: I started out doing commercial litigation at a small Wall Street boutique. After about ten years I left to go in-house at Chemical Bank, where I served for a time as the sole employment lawyer and then became head of the litigation department. In 1988 I joined Epstein Becker & Green, the bank's outside counsel, where I have been engaged in employment litigation and general commercial litigation.

Editor: How did you come to Epstein Becker & Green? What were the things that attracted you to the firm?

Pianko: I was a law school classmate of Jeff Becker, the quarterback of our Law Review football team. He called me in 1990 and asked if I'd team up with him again at his firm. I was greatly impressed by the atmosphere at Epstein Becker and also the interplay between the employment law and health practices and the benefits field. I have found that support from these groups is crucial to my own practice.

Kelly: I came to the firm from a different direction, and at Chemical Bank I had worked with Ron Green. He asked me to join the firm to do trials in the employment area and to help build the commercial litigation practice. I was attracted to the firm because of its entrepreneurial spirit and the extraordinary quality of its work. I think these attributes are reflected in its growth. When I arrived 20 years ago the firm consisted of 120 lawyers. Today it has 400, 120 in New York alone.

Editor: Towards the end of 2006 a series of class action law suits were filed against 401(k) plan sponsors alleging, among other things, that they had breached the fiduciary duty they owe to participants under ERISA by engaging in "revenue sharing" with providers offering investment vehicles for the participants. For starters, what is meant by "revenue sharing?"

Pianko: Revenue sharing is the term used to describe the fact that a typical 401(k) product is a form of one-stop shopping. The vendors - and they can be broker-dealers, insurance companies, banks, mutual fund complexes, payroll companies, and so on - come into the market with a platform, which includes all the record-keeping and administrative services that are needed to operate a 401(k) plan. In addition, the platform includes access to the mutual funds and other co-mingled investment vehicles for plan participants to choose in investing their 401(k) accounts.

Revenue sharing reflects the fact that, under applicable securities laws, mutual fund companies are permitted to pay for certain services. These fees may be paid by the fund directly or by some fund affiliate, such as a fund advisor. The most typical example of these fees are 12b-1 fees. So, revenue sharing refers to payments by the fund or an affiliate to the vendor of the platform that the plan sponsor has adopted as the investment and record-keeping vehicle for its 401(k) plan.

Editor: What are the plaintiffs alleging?

Kelly: The plaintiffs are generally employees of a single company. Having invested in an employer-sponsored 401(k) plan, they are bringing an action - in which they claim to represent a class of their fellow employees - against the company, its directors and management, alleging an ERISA violation for breach of fiduciary duty. The allegation comes down to a charge that the individual defendants imprudently permitted the fees that Howard has described to be paid by the plan itself. A variant charge is that, knowing such fees were being paid, they failed to disclose this fact to the plan participants.

They allege that revenue sharing is part of a "pay to play" operation and essentially a kickback. There are also allegations of unnecessary payments, where, for example, a fund holds stock in some index vehicle - where there is no need for management or research - and fees continue to be paid.

Pianko: Putting this into the ERISA context, plan fiduciaries must be prudent in examining and selecting the funds to be made available to plan participants for their directed investments. For example, a fee based on an actively managed fund may be appropriate; but that fee may be excessive if there is a "style drift" and it is being run as an index fund. The allegation in that case could be that the plan fiduciary breached its fiduciary responsibilities by not picking this up.

In the context of revenue sharing, the key question is whether the plan fiduciaries are required to monitor the aggregate fees being received by the platform vendor from a variety of revenue-sharing arrangements with the mutual funds which have been selected for investments directed by plan participants. Further, if these fees are a specified percentage of the assets invested, what may be reasonable payment in terms of services rendered at one point may be considered unreasonable as the assets increase in value (the services remain essentially the same). Accordingly, the legal issue relates to the duty of the plan fiduciary to determine the reasonableness of the overall fees received by the vendor.

Kelly: This type of question makes for enormously complex litigation. The ERISA regulatory framework is very technical, and determining whether a particular activity falls within the requirements specified in the statute and regulations is often difficult. Even if ERISA does apply, we are faced with factual issues. What is reasonable? What information was available to the fiduciaries?

Editor: What advice do you have for plan sponsors who may be subject to this type of suit by plan participants?

Kelly: At this point I think these lawsuits have entered everyone's consciousness. It is incumbent, accordingly, on plan fiduciaries to consider doing a thorough audit of the cash flows incurred under any plan that they offer their employees. This entails bringing in outside experts, accountants and lawyers to be sure, but also the kind of specialized expertise that really understands the complexities of this arena. It is also important, as part of this process, to do some comparison shopping to see what alternatives are available.

Pianko: I agree. The vendors themselves will provide the revenue sharing numbers when asked. The next step is to evaluate the data (with appropriate professional assistance) and decide what other alternatives are available. Overall, the need is to have a proper governance structure in place.

Editor: If plan administrators have a fiduciary duty to select funds with competitive returns - which may not be available since most mutual funds are subject to these fees - does that not put the administrators of 401(k) plans into an extremely difficult position?

Pianko: It does, but these are economic and competitive realities and it is proper to find out how vendors are charging for administrative and record-keeping services and whether there are reasonable alternatives which increase performance.

The plan fiduciary has a duty to look for the best performing funds, and fees can be a significant factor. The ERISA prudence standard is that of a comparable fiduciary. If my plan consists of 500 million dollars, I am held to the standard of a reasonably prudent person in a comparable position - with fiduciary responsibility for a substantially similarly sized plan.

Kelly: The difficulty, of course, comes out in a jury trial, where the judgment of a particular person is being assessed in circumstances where there was no one else doing precisely the same thing.

Pianko: We talk about ERISA as process-driven. There needs to be a plan governance structure in place with the appropriate processes - to gather, assess and deliberate on information concerning comparable products available in the market and to secure and evaluate the advice of duly qualified experts. If the fiduciary's deliberations are appropriate, and pursuant to a proper governance structure, the exposure to liability is dramatically reduced. Too often, people think that 401(k) plans run by themselves. There is a need for constant attention and monitoring. Fiduciaries need to exercise their responsibilities diligently and on an ongoing basis.

Editor: There are also class action suits pending against 401(k) plan providers. Could you give us an overview of these suits?

Kelly: Yes. There are not that many of these suits, but they seem to be on the increase. Essentially, they say that the definition of a fiduciary under ERISA includes, if not necessarily the plan providers across the board, certain activities of the provider with respect to the plan assets. These actions have been brought not only by the plan participants but also, interestingly, by the plan trustees, the internal fiduciaries. In a way, this is an inevitable consequence of the situation where the plan sponsor and the internal fiduciaries are sued by the plan participants, but the plan provider is not. In that event, the defendants are going to try to bring the provider into the suit as a third-party defendant, and the argument they will use is that they have done everything required of them and liability belongs with the provider. If it turns out that the plan sponsor and/or the fiduciaries are liable, they are going to try to claim reimbursement from the plan provider.

Pianko: If you look at ERISA, the question is whether the plan provider's level of involvement rises to that of fiduciary status as opposed to a vendor of services. For example, suppose the provider screens the funds available on its platform; say, it offers a hundred different mutual funds. The plan committee selects only ten as the "menu" made available to plan participants. Is the provider a fiduciary because it presents a platform of only one hundred funds? What if the only funds on the platform have revenue sharing features? A body of law exists as to whether a person not affirmatively designated as an ERISA fiduciary can be classified as one by reason of their actions. That body of law will be applied to the particular fact patterns at issue in these cases.

Editor: What about the future? Is it likely that there will be more class action suits raised by plan participants?

Kelly: Yes. There is a real financial incentive for the plaintiffs' bar to bring these actions, particularly if they can obtain class action certification.

Pianko: I think we are going to see more of a focus on market efficiency with new products appearing in the 401(k) marketplace. This will be driven by plan sponsors focusing on these issues and the desire of the provider community to remain competitive.

From the plan fiduciary's perspective, it is important to continue to focus on overall performance. That is the essential driver, the maximization of yield for the plan participants. I think that, in addition to new products, we will see an increased focus on process, on plan governance and on establishing proper procedures to monitor performance. I believe that all of this will lead to a more efficient distribution system.

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