A Simple Solution to the 401k Fee Lawsuit frenzy?

Divorce recordkeeping from advice to offer better protection

Maybe investment advisors should get out of the record keeping business.Maybe investment advisors should get out of the record keeping business.

Preparing for retirement is a big a business. An estimated 52 million American workers have over $4 trillion in more than half a million 401k plans. That’s a lot of money by any reckoning, and yet most plan participants have no idea how much of what they put away out of each paycheck actually goes toward their retirement savings and how much is eaten up by the 401k fee.

That is starting to change following the Department of Labor’s ruling that retirement plan sponsors are fiduciaries required to act in the best interests of plan participants. Transparency regarding fees has been a major emphasis of the DOL effort to reform the retirement plan system.

Since the election, there has been speculation in many quarters that President-elect Trump will either outright rescind the rule or instruct his Administration not to defend the several lawsuits currently making their way through the federal courts. Regardless of whether or not this particular rule ends up going into effect, transparency of fees and acting in the client’s best interest is both good business and the direction in which the advisory profession is trending.

The revelation of some of the previously opaque fee arrangements entered into by plan sponsors and providers has led to a flurry of lawsuits from disgruntled participants looking to recoup some of their losses. While many of the initial suits were aimed at plan sponsors and their advisors, in recent months recordkeepers have increasingly been added to the target list.

Among the most recent suits filed is Marshall v. Northrop Grumman Corp. which alleges that the plan paid nearly $10 million in administrative fees on top of millions of dollars in recordkeeping fees to Hewett Associates, a third-party recordkeeper, which also had an arrangement to share in fees paid to another plan provider, Financial Engines, for advice and management based on the level of assets in the plan.

Financial Engines’ revenue sharing arrangement with Voya Financial is also a factor in a lawsuit filed against Voya Financial and Nestlé’s 401(k) plan alleging that Voya was paid “excessive and unreasonable fees” for financial advice that was ultimately provided by Financial Engines.

In these and several other cases where recordkeepers have found themselves on the wrong end of litigation, it’s because the companies involved were doing more than just keeping the records. They were either industry giants with investment platforms who also have divisions that perform recordkeeping or firms that engaged in revenue sharing with plan advisors and investment product providers.

In this climate, particularly with the increased scrutiny from the Department of Labor regarding virtually everything having to do with retirement, it no longer makes sense for the firms actually involved in the process of managing retirement assets to be also providing recordkeeping services.

Many of the plan providers who also offer recordkeeping got into the business in the first place because it gave them a change to maximize the revenue available from plans with which they were already working. But in the face of increased litigation and the potential for winding up in court, a number of the larger firms are making moves to divest themselves of such operations.

Ideally recordkeeping should be a separate function handled by a third party who is neither the plan sponsor, its advisor, nor a provider of investment products to the plan. There is no reason why plan participants should pay anything other than a flat fee for administration and recordkeeping because the value of the service provided is the same regardless of the asset level in the account.

One of the big problems with retirement plans that the DOL seeks to address with its emphasis on fiduciaries is that plan participants often have no idea how much of the assets in their accounts are lost to fees every year. Having an independent, third-party firm providing the recordkeeping for a simple flat fee per account, regardless of the account balance, provides a safe separation between the plan sponsor, the advisor making investment recommendations and the providers of the investment solutions.

At the end of the day, the retirement industry needs to separate the firms who are making money from assets from those that are just a processing engine with no stake in the game. The checks and balances inherent in such a structure can ultimately greatly reduce the potential for litigation. And that’s advantageous to the plan sponsor, the advisor, and perhaps most importantly, the people all the money really belongs to—the individual plan participants.

Bob Ward is Chief Revenue Officer with Vertical Management Systems (VMS).

4 Comments on "A Simple Solution to the 401k Fee Lawsuit frenzy?"

  1. Excellent post and I agree with your assessment. Unbundling using flat fees is a great way for plans to increase fee transparency, reduce costs, improve accountability, and reduce plan sponsor liability. I think a common provider could provide both services, if they were competitive at both and there was full and clear articulation of the fees and that they would not be shared in any way. However, I don’t think it would occur with much frequency.

  2. While we are in the divorcing mood, why would a plan sponsor use a recordkeeper that receives revenue sharing. We have reviewed thousands of Paychex and ADP 401k plans. Paychex on average is receiving .25% in rev sharing from the pay to play funds on their platform. On other plans they CHARGE an asset based fee starting at 0.46%….for what exactly. They are a recordkeeper. Not a fiduciary, not providing participant advice. So why? We see plans where ADP receives over 0.60% in rev sharing, with an average about 0.55%. That is insane.

    Plan sponsors unwittingly choose these companies as a matter of convenience, i.e. integration with payroll. That convenience though is Not in the “sole” best interest of the plan participants. However, thank you Paychex and ADP, we look forward to the next 500 plans that convert to us from your 401k, where the plan sponsor will have integration with payroll without the needless scenario of paying more in fees than necessary to line the pockets of Paychex and ADP.

  3. Another solution would be to have the plan sponsor pay the recordkeeping fee and the investment advisor fee outside of plan assets as a business expense. Participants only pay internal mutual fund expenses on an institutional share class basis. Most, if not almost all, of the fiduciary issues surrounding expenses are eliminated. Plan sponsors need only to monitor investment performance. It doesn’t eliminate all fiduciary exposure, but it would remove the “reasonable” fee litigation avenue.

  4. I am all for this! Of course I work for a firm that does recordkeeping & compliance only (we are not in the investment or advisory business). We have NOTHING to sell to your participants.

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