From the September 2010 issue of Treasury & Risk magazine

Perils of Paying Retail

Scrutiny of the fees that 401(k) plan participants pay for their retirement accounts is only likely to increase after a California court ruling in July. Edison International, the $12.4 billion utility, was found to have violated its duty under ERISA when it used retail shares of mutual funds, instead of cheaper institutional shares, for three of the investments in its defined-contribution plan. The lawsuit, Tibble v. Edison International, was one of a number of cases in recent years alleging that 401(k) plans entailed excessive fees or fees that were not properly disclosed. A spokesman for Edison would not comment on whether the company plans to appeal.

In his decision, Judge Stephen Wilson of U.S. District Court for the Central District of California said that there was no evidence the company considered the different share classes available. If they had, "they would have realized that the institutional share classes offered the exact same investment at a lower cost to the Plan participants," he wrote.

Wilson rejected Edison's defense that it received advice from Hewitt Financial Services. He also rejected its argument that its plan did not meet the investment minimum required to use institutional shares, citing evidence at the trial that investment managers commonly waive such minimums for plans the size of Edison's.

"To the extent companies are offering retail funds, as opposed to institutional funds, they really need to revisit the decisions they made," says Eric Paley, a partner in the labor and employment group at law firm Nixon Peabody. Companies should look at whether they considered institutional funds or asked their provider about getting them, Paley says. "If they don't have records indicating they went through a deliberative process, that would be a cause for concern."

Tess Ferrera, a member of the law firm Miller & Chevalier, says the key for plan sponsors is to document their decision-making.

"The court doesn't really say that investing in retail funds with a higher expense ratio and revenue sharing is per se bad," Ferrera says. "The court said the real problem was an absence of evidence that the fiduciary had considered the differences between the retail and institutional funds in terms of cost to justify selecting the retail funds."

The case is "a wake-up call" for companies, says Bill McClain, a defined-contribution consultant in Mercer's retirement business."They need to be sure they have proper oversight in place."

More and more plans have been moving to institutional shares, he notes. "The bigger the plan, the more opportunity there is to move to lower-cost share classes."


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