Some 401(k)s Pose Legal Risk for Employers

A 401(k) retirement plan can work well for workers and employers—but that's not always the case.

By Matthew Mogul, Associate Editor, The Kiplinger Letter

October 9, 2006

More employees are taking their bosses to court over 401(k) retirement plans, launching class-action lawsuits that take aim at hard-to-find investment fees usually charged by middlemen. In some cases, employers don't even know about the fees charged for everything from administration support to help in selecting the right mutual funds.

For now, it's mostly big blue-chip companies in the crosshairs. Suits seeking class-action status were recently filed against such heavyweights as Bechtel, Boeing, Caterpillar, Exelon, International Paper, Lockheed Martin, Northrop Grumman and United Technologies. The lawsuits say the firms failed to live up to their fiduciary responsibilities to ensure that plan fees were "reasonable" and that workers weren't overcharged.

Some suits also name individual members of fiduciary committees as defendants. And future suits will likely include brokers as well as insurance companies and mutual fund firms that manage 401(k) assets. Smaller businesses may be at risk as well because they farm out much of the work of managing their 401(k) plans to vendors and don't have the time to stay on top of the details.

To get your employees the best deal—and to protect your firm from a lawsuit—consider this advice from the experts:

• Know what the fees are and where they are going. While about two-thirds of fees go to managing assets, the other third goes into an undefined black box of administrative costs. Find out exactly what these costs are for and question whether they're necessary.
• Look hard for hidden fees by reviewing all compensation agreements between investment funds and the service providers helping you pick funds. Often the service provider will say it's not charging a fee, but under commissions or revenue-sharing deals with mutual funds, it is receiving compensation that directly raises prices. In addition, there may be a conflict of interest if providers favor funds with the best commissions.
• Shop around periodically. Firms should annually compare their 401(k) fees with funds of similar sizes by soliciting bids from other plan providers or by looking at the Labor Department's FreeErisa.com Web site.
• Keep all your paperwork. Sounds like common sense, but too many companies have been sloppy about keeping the records up to date. This paper trail will come in handy if an employee or lawyer starts asking questions.
• Tell your employees as much as you can about the fees they're paying. Disclosure will help protect against lawsuits and will ultimately lead to lower fees as funds and brokers are forced to compete for your business.

The government is moving to help with all this, but it will take a while. In 2008, the Labor Department will require companies to disclose many indirect fees in annual regulatory filings. Currently, plan sponsors must list fees charged only for sales, marketing, management and "other" (such as recordkeeping). Proposed changes will likely break down the "other" category to show line by line where the money is going. A breakdown of administrative charges is also likely.

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