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The Different Flavors of ERISA Fiduciaries, Redux (Part 5)

Some in-depth explanations on misunderstood subjects.

W. Scott Simon, 07/01/2010

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Much of the industry that provides services to qualified retirement plans such as 401(k) plans that are governed by the Employee Retirement Income Security Act of 1974 is, in a word, goofy.

This industry--with relatively few exceptions--is composed of plan investment service providers with nary a fiduciary bone in their bodies. These non-fiduciaries have no meaningful obligation to disclose the total costs that they bring to the table when proposing bundled or unbundled investment and administrative services to plan sponsors.

The Yawning Disconnect
This state of affairs creates a yawning disconnect: Providers have no duty to disclose costs to plan sponsors, while sponsors have the fiduciary duty under ERISA to know what those costs are. Indeed, the very heart of ERISA--section 404(a), with its great sole interest and exclusive purpose rules which are expressions of the ancient duty of loyalty underlying all fiduciary law--requires that plan sponsors, when selecting and monitoring service providers, not only to know what costs are being charged to their plans but also to know what services the plans receive in exchange for those costs.

This is a system in which non-fiduciary service providers have a monopoly on most of the important information about retirement plans; this means that many providers essentially lead plan sponsors around by the nose. We would expect this asymmetric information flow to be particularly effective against the interests of participants (and their beneficiaries) in plans sponsored by mom-and-pop firms. Many of these firms don't know any better simply because they don't have the staff to go up against the superior knowledge of such providers. All too often, this results in non-fiduciary service providers bamboozling fiduciary plan sponsors into signing off on goofy plan investment options loaded with hidden (and therefore high) costs and high risk.

Exhibit A: Wal-Mart
No one would expect, however, that the asymmetrical information flow used by many plan service providers to gain advantage over plan sponsors would be effective against, say, companies in the Fortune 500. And yet we have Exhibit A--Wal-Mart--to negate this entirely reasonable supposition. For those of you who don't know, Wal-Mart was sued by one Jeremy Braden because he believed that Wal-Mart breached its fiduciary duties owed to the participants (and their beneficiaries) in the Wal-Mart 401(k) plan. This plan (purportedly the largest in America participant-wise, with over 1 million of 'em; and $10 billion to $12 billion in plan assets) offered 10 investment options--three of which were a stable value fund, a money market fund, and Wal-Mart stock.

That left seven mutual fund options, all of which were actively managed. Braden alleged that these funds were priced at retail cost--and high retail cost to boot. And why would that be? Because Braden alleged that such pricing was present to compensate the custodian and trustee of the plan assets. Braden alleged in his lawsuit that such revenue-sharing payments made to the custodian were not paid for services rendered but instead were "pay to play" payments made by the providers of the mutual fund investment options (mutual fund companies) to the custodian in exchange for the custodian "advising" Wal-Mart to include such options in Wal-Mart's 401(k) plan. Retail-priced mutual funds being what they (often) are, Braden also alleged that the seven funds charged 12b-1 fees as well.

The Verdict: Goofiness All Around
The U.S. district court threw out Braden's case, but the U.S. Eighth Circuit Court of Appeals reinstated it at the end of last year. Even should Wal-Mart eventually prevail on all, can anyone in their right mind believe that more than 1 million participants in the Wal-Mart 401(k) plan have been well served? There is absolutely no justification whatsoever for the participants in the Wal-Mart 401(k) plan (or any size plan for that matter) to have to invest in retail-priced investment options. If Wal-Mart, with all its resources, cannot get such a basic concept right, then certainly there's a huge amount of room in the retirement plan industry for professional fiduciaries that can.

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