“Verizon Wireless bowed to a torrent of criticism on Friday and reversed a day-old plan to impose a $2 bill-paying fee that would have applied to only some customers.”
—New York Times, Dec. 30, 2011
If a $2 per month fee can reverse the decision of the nation’s largest cell phone company, what will happen when 401(k) participants see they are being charged thousands in fees for services that do not benefit them?
That is the big question looming ahead when the Department of Labor’s (DOL’s) 401(k) fee and expense disclosures go into effect April 30, 2012.
If the $2 fee is any indication, plan sponsors should be concerned.
The reasons: the lackluster market returns over the past decade, the S&P 500 Index ending 2011 at about the same point where it started (closing December 30 at 1257.60, versus 1257.64 a year ago), and the electorate in an agitated mood in an election year. All of this should awake plan participants from their slumbers to ask: “What am I paying for and why am I paying so much in my 401(k)?
Once participants see the importance of fees, they will be shocked. A 1998 DOL study found that a difference in 1% in fees between two separate 401(k) plans produces a difference between the low- and high expense funds of 23% after 35 years (assuming a 9% annual return). That is 23% in lost returns to participants, a sum which is only aggrevated by the flat-investment return environment affecting most investors over the past decade.
This poses a huge problem for everyone involved in the 401(k) plan marketplace, from the human resources department, to mutual fund companies and recordkeepers, and ultimately the company executives in charge who negotiated these expensive contracts in the first place.
Certainly, when plan participants, as well as any mutual fund investor, begins asking questions, there will be a lot of explaining to do.
Worse, for the plan sponsors, when intelligent comparisons can be made between plans of similar sizes, class action lawyers will have a new informational database to find out which plan sponsors have been negligent in their duties.
Hot Spots to Watch
The new DOL regulations will focus on a number of key areas that should be of special interest to investors, including:
–The amount of administrative fees and expenses the plan sponsor pays to the fund’s recordkeepers;
–The amount it receives in a little known practice common in the mutual fund and insurance industries known as “revenue sharing.”
Revenue sharing is the practice of making cash payments by mutual fund companies to selling agents, who promote their mutual funds to investors. Outside of 401(k) plans, fund companies pay brokers and financial planner’s revenue sharing historically ranging from about 25 to 150 basis points (one-quarter of 1% to 1.5%) of invested assets per year to promote their funds over the competition. Revenue sharing payments also vary based on a mutual fund’s share class.
Administrative expenses will also be compared. “Plan sponsors are openly asking whether a participant with a $400,000 401(k) balance should pay ten times more in administrative fees than another participant with a $40,000 balance in the same plan,” according to Bill McClain of Mercer. “This does not make sense since it costs the same to administer both accounts, regardless of their account balances.”
While the new DOL regulations do not go into effect until April 30, 2012, there have been numerous class action lawsuits related to revenue sharing which show potential problems. Among the companies targeted have been Principal Financial, Boeing, Deere, Lockheed Martin, and Kraft Foods.
At best, this will be a spring of discontent as plan participants start asking some tough questions to their plan providers. If plan participants push hard enough, they could recoup some of this lost money they overpaid in expenses, fees and revenue sharing that could at least begin to compensate for their market losses over the past decade.
To plan participants, this would be found money. To recordkeepers and the mutual funds which engaged in revenue sharing deals that did not benefit plan participants, it would be a the wake-up call they need to change their business model.