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Government Scrutiny of 401(k) Fees Is Likely

Defined contribution fee disclosure requirements, which haven’t significantly changed since the 1970s, may be getting a facelift as federal regulators look to increase plan sponsor and participant awareness.

Under the Employee Retirement Income Security Act, plan fiduciaries have the obligation to choose a fund menu in which the fees must be at a reasonable level given the services and their quality. Yet, it’s not an issue “on the radar screen of most plan sponsors,” Brent Glading, managing director of the Glading Group, a consulting firm that helps employers negotiate prices with 401(k) providers.

However, fee disclosure has been on regulators’ radar screens.

In December, the Department of Labor’s Advisory Council on Employee Welfare and Pension Benefit Plans sent four recommendations to Secretary Elaine Chao outlining ways to improve disclosure. The recommendations are being reviewed, and the Labor Department hopes to propose a new disclosure policy this year, says Ann Combs, assistant secretary for the Department of Labor’s Employee Benefits Security Administration.

More transparency, disclosure

For plan participants, the council recommends that sponsors provide a “profile prospectus” of each investment option – an easy-to-understand summary of the full prospectus.

In addition, participants should receive a document, like a glossary, that explains all the terms used in the prospectus to allow for better disclosure, the council advocates.

For plan sponsors, council members want recordkeepers to make available a statement of expenses expressed as a ratio for each investment option and identify which expenses are paid entirely or in part by the plan sponsor. The DOL also should provide a sample model disclosure format that is available on its Web site for sponsors.

Although ERISA was never set up as an investment statute, DOL has a role in intervening in this area, says Mercer Bullard, president and founder of investor advocacy group Fund Democracy Inc. and assistant law professor at the University of Mississippi.

Bullard told the advisory council that he believes 401(k) participants do pay higher fees than other investors because the fees are less transparent, and the existing ERISA 404(c) requirements are not very effective in promoting more transparency, he says.

Bullard complained that the Securities and Exchange Commission has the authority to bring cases against providers with excessive fees, but has never done so and neither has the DOL. The SEC is investigating where providers’ revenue-sharing arrangements and other fees improperly influence how employers select retirement plans, but no charges have been filed in the investigation as of press time.

Out of sight, out of mind

Retirement plan costs have a critical influence on retirement savings for participants, argues Stephen Utkus, principal of Vanguard’s Center for Retirement Research. The center is part of The Vanguard Group, which administers more than $215 billion of defined contribution plan assets for more than 3,200 plan sponsors.

Simply put, lower fees lead to higher balances for participants and give them a better chance for retirement security. “Understanding fees is critical for the plan sponsors,” Utkus says.

Costs incurred by defined contribution retirement plans are either flat fees for participants’ accounts, usually paid by the employer, or asset-based fees usually charged against the investment return of individual participant accounts, Utkus explains. Over the past decade, there has been a shift from flat fees to all asset-based fees, which are less visible to both plan sponsors and plan participants.

“It’s the out-of-sight-out-of-mind mentality,” Utkus observes. “People will scream and shout about a $10 trading fee in their IRAs, but won’t complain over a high expense ratio in their 401(k) plans.”

Employers are abandoning their fiduciary duties if they are unaware of all the costs for both the plan sponsor and participant, Glading maintains. An overall expense ratio is important, but so is a breakdown of all the fees charged to the plan. For example, some providers charge a 90% to 120% profit margin on recordkeeping services, he says.

To decode the myriad fees paid by plan participants and sponsors, Utkus proposes plan sponsors use an “all-in fee expense ratio.” The ratio is a more comprehensive measure of cost than what is currently disclosed by most providers and is easily accessible for the plan sponsor. (See graphic.) If all providers used the all-in fee expense ratio, plan sponsors would have an apples-to-apples cost comparison, he says.

The 401(k) market is inefficient because plan sponsors have limited access to a vendor’s cost basis and revenue-sharing agreements, Glading argues. Getting data from providers can be difficult, but an employer can also request proposals from other vendors to get a benchmark for total plan costs, he says.

Evaluating whether 401(k) plans need to lower their fees doesn’t have to be a complex process, Utkus notes. “If a company’s plan has doubled in size and it’s still paying the same level of fees, they need to ask for lower fees from their vendor,” he says.