Fiduciaries Held Liable for Selecting Retail Mutual Funds

August 5, 2010

Congress, the courts, and the Department of Labor continue to address issues of 401(k) plan fees and expenses. The Labor Department’s interim final regulation on disclosure of pension plan fees became effective July 16. Legislation on plan fees is still under serious consideration by the House Education and Labor Committee. In addition, mutual fund fee regulations were proposed and released by the Securities and Exchange Commission on July 22.

As earlier WorkCite articles have highlighted, several courts are dealing with class action lawsuits claiming that ERISA fiduciaries breached duties of prudence and loyalty by selecting 401(k) investment options with unreasonably high fees and failing to disclose those fees properly to participants. See “Seventh Circuit Refuses Rehearing on 401(k) Plan Fees Decision” and “Plan Fees: Fiduciaries Must Focus on Float.” One of these plan fee cases has now been tried, Tibble, et al., v. Edison Int’l., et al., U.S.D.C (C.D.Ca.) Case No. CV 07-5359 SVW (AGRx), and the outcome gives fiduciaries guidance on evaluating and negotiating 401(k) plan fees.

Fiduciaries Were Imprudent for Not Choosing Institutional Funds under the Circumstances

The Tibble trial focused on responsibilities of the Edison International fiduciaries and their selection of the participant-directed 401(k) plan’s mutual fund investment options. Plaintiffs were the class of participants in Edison’s 401(k) savings plan, which contains more than $1 billion in assets.

The court determined that the Edison plan’s fiduciaries violated their ERISA duty of prudence when the fiduciaries chose to invest in retail shares of mutual funds rather than the institutional shares of the same funds. This was an easy conclusion for the court to reach for those funds that provided “the exact same investment at a lower cost to Plan participants.” The court reasoned that:

  • Retail share classes generally charge higher fees to participants than the institutional shares, which results in lower returns to participants.
  • Large employer plans have a duty to exercise their bargaining power to benefit participants. Even though institutional shares often require a minimum investment requirement, the fiduciaries should have negotiated a waiver of that requirement, if applicable.
  • Investment of plan assets in retail funds is not a per se fiduciary breach; however, failure to properly investigate and evaluate a particular investment decision is a breach of the duty to act prudently.
  • Obtaining independent advice is evidence of the fiduciaries’ investigation, but is not a complete defense.
  • In Tibble, the defendants relied upon the advice of the plan’s record keeper, but the court found that the defendants had an obligation to do further investigation prior to making certain mutual fund investment decisions.
  • “[D]amages [to the plaintiff class] should account for the fact that had the Plan fiduciaries not invested in the more expensive retail share classes, the Plan participants would have more money invested and therefore would have earned more money over the course of time.”

Lessons from the Tibble Case

  • Large employers and retirement plans should use their bargaining power to negotiate lower fees for participants.
  • Relying on recommendations of independent investment advisors without further investigation may not meet the fiduciary standard of prudence. Fiduciaries must make certain that their reliance on advisors’ advice is reasonably justified.
  • Fiduciaries should carefully document their evaluation and negotiation of fees and overall investigation concerning the selection of 401(k) plan investment options.
  • Although fees are important, they are only one part of the analysis of a fund. ERISA does not require plan fiduciaries to select the cheapest fund available; rather, they must select funds in accordance with ERISA’s prudence standard, which places great emphasis on process and documentation.
  • Therefore, fiduciaries should carefully document the selection process and why selections were made, especially where funds with higher fees are selected. To determine whether a fund has higher fees, the fiduciary should obtain a survey of fees charged by comparable funds as part of the selection process.
  • Changes in fund names, ownership or management should prompt a new due diligence review of the fund.