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5 responses to “DOL Smacks 401k Adviser for 12b-1 Fiduciary Breach. Plan Sponsors Next?”

  1. Ron Rhoades

    Great article, Chris.

    I would add some comments, which are an excerpt from a blog post I wrote recently about the Tibble v. Edison meeting:

    While other factors (other than fees and costs) are indeed a consideration, I would note that a substantial body of academic research suggests that the level of mutual fund fees and costs is a very substantial and often the best indicator, on average, of the long-term returns of the mutual fund relative to funds with the same investment strategy (i.e., same asset class). I suspect that future cases arising under ERISA, especially after the “Definition of Fiduciary” rule is adopted, will explore this academic research in detail, and then apply it.

    In the interim, there is no question that a fiduciary adviser bears responsibility to ensure that all of the fees and costs borne by the client are substantively fair and reasonable. Each and every fee and cost expended should be for services (or management) which is believed to result in value to the client. Fees that don’t add value to the client are suspect. In this respect, as I opined in an earlier blog post (http://scholarfp.blogspot.com/2013/03/12b-1-fees-rias-and-registered.html) that revenue-sharing payments in the nature of 12b-1 fees are highly suspect – and fiduciary advisers (regardless of how registered) would do well to avoid all mutual funds which possess 12b-1 fees. The Tribble court, in dicta, also noted the area of 12b-1 fees as an area for further exploration by the courts, stating:

    “Mutual funds generate this revenue by charging what is known as a Rule 12b-1 fee to all investors participating in the fund. Edison takes the position that because that fee applies to Plan beneficiaries and all other fund investors alike, the allocation of a portion of that total 12b-1 fee to Hewitt is irrelevant. As it put the matter at oral argument: “the mutual fund advisor can do whatever it wants with the fees; sometimes they share costs with service providers who assist them in providing service and sometimes they don’t.” This benign-effect, of course, assumes that the ‘cost’ of revenue sharing is not driving up the fund’s total 12b-1 fee and, in turn, its overall expense ratio. It also assumes that fiduciaries are not being driven to select funds because they offer them the financial benefit of revenue sharing. The former was not explored in this case and the evidence did not bear out the latter, but we do not wish to be understood as ruling out the possibility that liability might—on a different record—attach on either of these bases.”

    So, as you see, even a recent court decision brings into doubt the validity of 12b-1 fees under ERISA, and suggests possible plan sponsor liability on account of such fees being present.

    I repeat my warning – if you are either a registered representative of a broker-dealer firm, or an investment adviser representative of a registered investment adviser firm – be extremely wary of recommending any mutual fund share class that includes 12b-1 fees. This is ESPECIALLY so under ERISA.

  2. Lynne McAuley

    A couple of other points. As a former DOL employee, my guess is that DOL did not want to over-reach before the effective date. It’s pretty much the same as a parent saying to their kids, “if you aren’t in your room by the time I count to 10, you are going to be sorry.” The parents have to count to ten. But after counting to 10, it is all fair game since DOL has been letting everyone know what to expect.

    Imagine if this same situation would occur now. DOL would first pursue the case against the service provider to learn the basic facts. It potentially would get a fair amount of information during that case and open up separate cases on the plan sponsors and come at it that way. That’s what I would do if I were still there.

    Also, what is important is that the prohibited transaction violation was a 406(b) violation instead of a 406(a) violation. The 406 (b) violations involve self-dealing for which there is NO EXEMPTION. So the CSP might comply with 408(b)(2), which gives the CSP a pass re: 406(a)(1)(C). However, potentially, the disclosure could allude to a potential 406(b)(1) violation on the part of the CSP. Suppose the responsible plan fiduciary did the typical due diligence and maybe even read the disclosure. Now suppose the responsible plan fiduciary did not follow-up with any meaningful questions or consider the implications. This could result in a 406(b)(2) violation where the fiduciary did not protect the plan against the adverse interests of another party. How long do you think a provider will be successful under those circumstances?

    Another scenario that makes me pull my hair out is as follows. Okay, suppose the CSP decides to change his or her business practices going forward because from now on, it should be obvious that he/she has been overpaid. Going forward, the plan pays much less. However, the plan is not made whole because the plan has been paying way too much for quite some time. The plan sponsor can not just move on. The responsible plan fiduciary must calculate what has been lost and what group of participants (if not all of them) have been harmed.

    We are in for some interesting times.


  3. BPP401k.com Newsletter 04.03.13 Benefit Plans Plus 401k

    […] DOL Smacks 401k Adviser for 12b-1 Fiduciary Breach. Plan Sponsors Next? Little more than seven months ago, the U.S. Department of Labor issued a press release it had reached a settlement with a Connecticut investment adviser for claims involved a breach of fiduciary duty. The August 23, 2012 release is entitled “USI Advisors of Glastonbury, Conn., agrees to pay $1.27 million to 13 defined benefit pension plans following US Labor Department investigation.” At the time, except for a few industry rags and a local Connecticut newspaper, very little attention was paid to that DOL release. Last week changed all that. Source: Fiduciarynews.com […]

  4. Michael McMorris

    Dear Mr. Carosa:

    I have been perusing and enjoying your blog posts. Good stuff. But I think an important point was overlooked in the above discussion regarding the USI case. You asked why the DOL didn’t pursue the 13 plan sponsors for prohibited transactions or fiduciary breaches for excessive fees or imprudence. Perhaps they should have fined them because of prohibited transactions. But pursuing them for excessive fees? Don’t forget that these are defined benefit plans. Not DC plans. This is an important distinction because, while a participant’s account balance in a DC plan is net of investment fees, a participant’s benefit in a DB plan is based on a benefit formula and is unaffected by fees (unless the fees are so excessive that they cause the plan to be so underfunded that the benefits cannot be paid, which is highly unlikely). Unlike DC plan sponsors, a DB sponsor bears the investment risk and has a direct financial incentive to make sure the plan is not paying excessive fees because the sponsor is responsible for funding the plan and covering any investment losses/shortfalls. In effect, any imprudence by the sponsor that results in excessive fees or even poor investment results will already penalize the sponsor. So I don’t think that DB plans should be painted with the same broad fiduciary/regulatory brush as DC plans.

    Of course, I am not excusing imprudence. Nor prohibited transactions.

    I’d be interested in your take on the new fiduciary standard as it relates to DB plans versus DC plans. Also, what new considerations are there in terms of trustee-directed DC plans versus participant-directed DC plans? And what about DC plans with participant-directed brokerage accounts instead of a daily val mutual fund platform? Have you opined recently on these topics in light of the latest fiduciary discussion?

    As a side note, do you believe it would serve all plan participants if the DOL focuses more on educating sponsors about their fiduciary obligations than on enforcement? Then would the sponsor be more prudent and not need to pay so much for fiduciary/legal advice? What are your thoughts?

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FiduciaryNews provides essential information, blunt commentary and practical examples for ERISA/401k fiduciaries, individual trustees and professional fiduciaries. Our chief contributor is Chris Carosa.

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