The greatest risk facing the 401(k) system is that plan service providers will be declared legal fiduciaries as a result of litigation.
That is the assessment of Steve Saxon, a principal lawyer with Groom Law Group Chartered of Washington, who spoke at a conference on life insurance products sponsored by the Philadelphia-based American Law Institute-American Bar Association Committee on Continuing Professional Education.
"The most important thing right now is the status of the service provider as a fiduciary," Mr. Saxon told the group on Nov. 8. Companies that service 401(k) plans are not currently held to a fiduciary's strict disclosure and regulatory standards.
If courts deem service providers to be fiduciaries, however, the companies offering services could incur liability for a wide range of eventualities, including plan losses, fees and possible conflicts of interest, Mr. Saxon said.
"You become a fiduciary with respect to everything that's happened to that plan, and you never thought that you were," he said.
As an example, Mr. Saxon pointed to a case filed by employees of Deere & Co. against the Moline, Ill., heavy-equipment manufacturer and Fidelity Management Trust Co., an affiliate of Fidelity Management and Research Co. of Boston that managed Deere's 401(k) plan.
A federal court in Wisconsin dismissed the lawsuit last June, ruling that the Employee Retirement Income Security Act does not require disclosure of the revenue-sharing arrangement Fidelity Trust has with Fidelity Research and Management to share fees received for the 401(k) plan.
The court dismissed claims that alleged a failure to disclose the fees to participants, Mr. Saxon said. The court also dismissed allegations that the plan charged excessive fees, since 2,500 funds were offered. Employees could have chosen low-cost options, the court found.
Courts could still rule that service providers should be considered fiduciaries, Mr. Saxon said. "That's not good news," he said.
Furthermore, the Department of Labor and Congress could move to mandate that "massive disclosures be given to participants with respect to all sorts of fees and compensation and revenue-sharing payments that are being made," said Mr. Saxon, who represents mutual funds and other financial services companies.
The Labor Department is working on a proposal for participant disclosures that is expected to be issued next year.
Legislation introduced by Sen. Herbert Kohl, D-Wis., chairman of the Senate Special Committe on Aging, and Sen. Tom Harkin, D-Iowa, as well as two other bills introduced by House Education and Labor Committee Chairman George Miller, D-Calif., and Rep. Richard Neal, D-Mass., would greatly increase disclosure requirements for 401(k) plans, Mr. Saxon said.
The legislation would require disclosure of information about investments, as well as revenue sharing and fees paid, Mr. Saxon said. Service providers would be required to disclose more details about expenses, and the information would have to be made available to participants upon requestor be posted on websites.
"I think you have a real risk of putting participants into ... an information overload situation," Mr. Saxon said.
"This legislation...will open the door wide for all sorts of information to be easily obtained by the participants, and therefore by the plaintiff's bar," he said. "The world could change fairly dramatically if this legislation goes through."
Enforcement cases brought by the Securities and Exchange Commission against brokerage firms for not disclosing revenue-sharing practices for mutual fund sales amount to "regulation through enforcement," said Jeffrey Puretz, a partner in the Washington office of Dechert LLP, a Philadelphia law firm.
There are no regulatory requirements that revenue sharing be disclosed, he said. In 2004, the SEC issued regulations barring funds from directing transactions to brokerage firms in exchange for fund sales.
Since the Labor Department bars funds that charge redemption fees for early withdrawals from receiving liability protection as default investments in 401(k) plans, Mr. Saxon predicted that either plan sponsors or the mutual funds themselves may have to pay the fees.
Under the Labor Department regulations, plan participants who are defaulted into a fund may not be charged redemption fees if they decide to move their money in the first 90 days. "Somebody is going to have to come up with that money," Mr. Saxon said. "The participants aren't."
Sara Hansard can be reached at [email protected].
