Supreme Court Ruling Benefits Employees Stuck With High Fees in 401(k) Plans

NEW YORK (MainStreet) — A Supreme Court ruling on Monday could lead the way for employees to file more lawsuits to fight back against the expensive mutual fund options and fees chosen by their employers in their 401(k) plans.

The Supreme Court ruled in a 9-0 decision that Edison, a Rosemead, Calif. public utility company, had a “continuing duty to monitor” the options they offered employees for their retirement plan. The decision will likely set a precedent for additional lawsuits in the future as employees have been fighting back against high 401(k) fees.

The employees of Edison had sued the company, arguing that they were forced to use more expensive investment options when Edison could have offered lower cost funds.

The U.S. 9th Circuit Court of Appeals had thrown out the suit originally, because by the time the employees sued, these investment choices had been offered for over six years and it was past the statute of limitations. The Supreme Court held that the claims were not barred by the six-year statute of limitations for the Employee Retirement Income Security Act (ERISA), a federal law.

In its ruling, the court said “a trustee has a continuing duty to monitor trust investments and remove imprudent ones,” said Justice Stephen Breyer. The statute of limitations did not apply in this case, because the company continued to offer the same expensive mutual funds years after they were first chosen in 1999.

While the high court did not give guidance on how often investments should be monitored or by whom, this means companies will need to develop processes, said Michael Graham, a partner in the employee benefits group at McDermott Will and Emery in Chicago.

“This puts more direct onus on employers to set up and maintain a process to be in compliance,” he said. “This seems like a win for plaintiffs.”

This decision will likely result in additional lawsuits which will try to clear up the issue of “what the duty to monitor really means,” Graham said. “It provides a wake-up call for employers to make sure they have the benchmarks and processes in place to document their continuous monitoring of investments and fees going forward in an effort to satisfy their fiduciary duties and avoid litigation.”

The case has been sent back to the lower courts in California, which will determine whether Edison’s actions constituted the breach of fiduciary duty that the employees originally sued over.

This ruling is good news for employees who have been frustrated by the scant alternatives companies have offered in their retirement plans, resulting in a limited number of mutual funds with high fees and conflicts of interest.

“The Supreme Court ruling has opened up the floodgates to lawsuits and with this ruling it will be easier to sue an employer over breaching the fiduciary duty,” said Grant Easterbrook, co-founder of Dream Forward Financial, a new low-cost 401(k) plan based in New York. “It is significant that the Supreme Court chose to rule on this case in the first place and then came out unanimously in favor of employees. That sends a strong message.”

Retirement plans should be regulated by the Department of Labor to determine which fees are reasonable and how they are disclosed to employees instead of through the court system, said Jamie Fleckner, a partner and chair of ERISA litigation at Goodwin Procter in Boston.

“The court system is not a good mechanism to affect larger goals,” he said. “This is an important threshold for plaintiffs and may embolden some lawyers to bring more cases.”

While there is a not a “one-size-fits-all approach,” some employers believe they have the resources and expertise to manage retirement programs, because they “know their employees best,” while other businesses outsource these benefits, Fleckner said.

The Supreme Court ruling is a win for employees, because “employers have an obligation to continually monitor whether or not the plan is cost-effective and employers can't just set up a plan once and forget about it,” said Easterbrook.

Employers need to revamp their exiting plans to provide more transparency on their fees, provide funds with lower costs and regulate the conflicts of interest.

“More 401(k) administrators will be forced to change their business model,” Easterbrook said. “If your clients are being hit with lawsuits, you will be forced to address the issues with high fees, conflicts of interest and transparency. The industry is ten years behind where it should be.”

Employees have been fighting back against high 401(k) fees and recent lawsuits have proven that the courts are siding with them. Other lawsuits in the past few years have settled in the favor of the employees. Even financial services companies are not immune from this growing issue. Ameriprise Financial, the Minneapolis-based financial services company agreed to pay $27.5 million while Lockheed Martin, the Bethesda, Md.-based defense firm paid $62 million. Other lawsuits include Nationwide, the Columbus, Ohio insurance company, Fidelity, the largest 401(k) plan administrator in the nation and based in Boston, ING, the Amsterdam-based bank and International Paper, the Memphis pulp and paper products company.

Fees Add Up Quickly

The fees assessed in 401(k) plans are complicated, so examine the plan carefully. The first set of fees are the ones assessed by the mutual funds and 401(k) plans are “notorious for using very expensive mutual funds often, because the plan sponsor or the employer receives a credit against the fees they pay to manage the plan from including these funds, said David Twibell, president of Custom Portfolio Group in Englewood, Colo.

The fees “can eat up nearly 30% of your retirement savings over ten years, even a seemingly small annual fee such as 1.27%, which is the average U.S. mutual fund fee,” said Mitch Tuchman, managing director of Rebalance IRA in Palo Alto, Calif.

A second category of fees are those that are passed through to the participants by the employer. They can vary quite a bit, because the company has wide latitude in deciding which fees to pass onto the employee participants, said Twibell. In some cases, the employer picks up all the fees, but more often than not, the employee foots most of the bill.

The two fees add up, with some employees who end up paying over 2% in additional management and administrative fees, which is $2,000 in unnecessary fees on a $100,000 retirement account each year.

“Imagine someone who keeps their funds in their former employer’s plan for a decade or two, which happens more often than you might think,” Twibell said. “Now we’re talking as much as $40,000 in unnecessary fees. There aren’t many people that can afford to throw away that kind of money for no real purpose.”

--Written by Ellen Chang for MainStreet

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