ERISA’s exclusive purpose and prudent expert rules (encapsulating the fiduciary duties of loyalty and prudence to the plan) are the standards of conduct that apply in evaluating whether the fiduciary authorized payment of fees that were excessive or unreasonable.
ERISA Sec. 406 makes it a prohibited transaction for a fiduciary to cause a plan to enter into an arrangement with a service provider unless, under the exemption set forth in ERISA Section 408(b), the arrangement (1) is on the whole reasonable to the plan, (2) engages the vendor to perform only services that are necessary for the efficient operation of the plan, and (3) provides for no more than reasonable compensation to the vendor. ERISA Sec. 408(b)(2) specifies that no amount of direct or indirect vendor compensation will be reasonable, unless payment by the plan occurs after the vendor makes the prescribed fee and other disclosures to the responsible plan fiduciary.
In November 2011, Deloitte Consulting updated its 2009 study of so-called “all-in” 401(k) plan fees. See the website for the study listed under “ERISA Resource Links” to the right of this page. The study found that fee arrangements fall into two major expense categories (investment versus administrative or recordkeeping) and are payable in the forms of hourly, flat fee and asset-based formulations. Furthermore, plan sponsors have widely varying methods of allocating the responsibility for paying these fees among participants, the employer and the plan. To normalize the fee structure variation, the study employed the notion of the “all-in” fee. The ‘all-in’ fee includes all administrative or recordkeeping fees as well as investment fees (i.e., the investment option’s total expense ratio) paid from any source whether they are assessed at the plan, employer or participant level, including revenue sharing.
Focusing on the typical defined contribution plan participant’s experience, the study found that in 2011 the median ‘all-in’ fee as a percentage of plan assets was 0.78% (or as an annual per participant dollar amount – $248). The 10th percentile participant is in a plan with an “all-in” fee of 0.28% of plan assets (or $122 per participant per annum) and the 90th percentile participant is in a plan with an “all-in” fee of 1.38% of plan assets (or $558 per participant per annum).
The plan’s payment of excessive fees is a form of “fiduciary loss” to the plan, for which the responsible fiduciary is exposed to liability on the legal theory that approving the payment was either imprudent or disloyal to the plan or both. ERISA Fiduciary Administrators LLC (“EFA”) thoroughly scrutinizes the mandatory fee disclosures prescribed in Sec. 408(b)(2) (as well as the information provided by the vendors for the completion of Schedule C to the annual Form 5500). We subject these data to regular benchmark testing of fees paid by comparable plans to monitor the reasonableness of total administrative fees paid by the plan directly or through a revenue sharing arrangment to each vendor.
Reasonableness is admittedly a vague concept. However, the U.S Department of Labor has articulated some objective criteria that we follow. For example, reasonableness of a vendor’s fees should be based on sufficient data to make a comparisons across multiple vendors on an “apples-to-apples” basis, meaning plans of comparable size and complexity. Fee “Benchmarking” is an appropriate tool. EFA relies on market data collected through an objective process that focuses on fees for specific services, but also gives weight to qualitative factors, e.g. the expertise and stability of the vendor’s management team, maintenance of internal quality assurance controls, history of providing service, size of client base, and the applicable rationale for determining fees. In many cases simple competitive bidding based on a uniform RFP process elicits relevant distinctions among vendors.
The reasonableness of the vendor service arrangement is not solely a question of the reasonableness of the vendor’s fees. EFA scrutinizes all vendor administrative service agreements and fee arrangements (including separate revenue sharing agreements) to insure that (1) the services the vendor was engaged to perform are the services it is actually performing, (2) that these services are non-duplicative, i.e. not being performed by any other vendor, and (3) are necessary for the efficient operation of the plan.