FIDUCIARY DEVELOPMENTS, PLAN FEES AND VENDOR SEARCHES. General Fiduciary Guidelines Regarding Fees. Controlling Law

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1 FIDUCIARY DEVELOPMENTS, PLAN FEES AND VENDOR SEARCHES May 21, 2014 General Fiduciary Guidelines Regarding Fees Controlling Law ERISA imposes procedural and substantive duties on fiduciaries of employee benefit plans covered by ERISA Under ERISA s framework, multiple parties may be held accountable if a plan pays excessive fees to a service provider 3 1

2 Who is a Fiduciary? Section 3(21) of ERISA defines fiduciary as a person who: has the authority to make discretionary administrative or investment decisions with respect to a plan, or for a fee provides investment advice on which it is anticipated fiduciaries will rely The plan document will identify one or more named fiduciaries for the plan The plan sponsor is often a named fiduciary Other named fiduciaries may include the administrative committee and (if separate) the investment committee 4 Fiduciary Standard of Care A fiduciary is to discharge its plan duties: Solely in the interests of plan participants and their beneficiaries With the care, skill, prudence and diligence under the circumstances that a prudent person acting in similar circumstances and familiar with these types of matters would use By diversifying investments to minimize losses In accordance with plan documents as long as they are consistent with ERISA 5 Delegation of Fiduciary Responsibility A named fiduciary may delegate fiduciary responsibilities to another party The other party becomes a fiduciary and is primarily responsible for the delegated responsibilities However, the named fiduciary retains responsibility for some level of oversight and has co-fiduciary liability 6 2

3 Co-Fiduciary Liability A fiduciary will be liable for the fiduciary breach by another fiduciary if he: Knowingly participates or conceals a known breach by the other fiduciary Fails to comply with his prudence duties and thereby permits the other fiduciary to commit a breach Has knowledge of the other fiduciary s breach and fails to take reasonable steps to remedy it 7 Appointment Power and Oversight The employer usually appoints one or more committees to serve as plan fiduciaries The employer (i.e., the Board of Directors) retains oversight responsibility over the committee and must monitor its performance If the sponsor determines that a committee is not properly performing its fiduciary role, the sponsor has a duty to intervene 8 Role of the Investment Advisor The investment advisor may assist the committee in analyzing fee arrangements by providing valuable information and guidance, but only advises the plan fiduciary about fee arrangements. The plan fiduciary makes the ultimate decision regarding fee arrangements An investment advisor does not relieve the committee from responsibility for evaluating and making decisions regarding plan fees The committee remains primarily responsible for these decisions 9 3

4 Prohibited Transactions Defined ERISA prohibits transactions between a plan and a party in interest (employer, employee, director or other affiliates, as well as service providers) ERISA prohibits transactions in which a fiduciary deals with plan assets in his own interest or in situations in which the fiduciary has a conflict of interest Lack of ill intent does not matter 10 Prohibited Transactions Exemptions Certain standard exemptions apply for example: Fiduciary may contract with service providers to provide services for the plan as long as (i) terms are reasonable, (ii) agreement may be terminated with short notice, and (iii) fees are reasonable For 401(k) plans, fees for certain services will be reasonable only if proper fee disclosure is received from service provider 11 Fiduciary Liability Exposure Monetary Remedies Liability to restore losses to the plan and/or participants Legal fees for attorneys who file suit on behalf of participants DOL penalties for amounts recovered through litigation Nonfinancial Remedies DOL consent agreement 12 4

5 Potential Defendants in Excessive Fee Cases Individual members of the committee that approved the fee arrangement The recordkeeper or other service providers that received the fees Individual members of the Board of Directors with appointment/oversight responsibilities over the committee Officers with appointment/oversight responsibility over the committee The plan sponsor 13 Fiduciary Liability Steps that Protect Fiduciaries Committee may set up processes and procedures and follow them in a prudent manner Committee may retain investment advisor, legal counsel and other professionals to assist it in performing its duties 14 Fiduciary Liability Additional Steps To Protect Fiduciaries Plan must be covered by an ERISA bond insuring the plan against theft, but this does not protect the individual fiduciaries Fiduciaries and company (but not plan) may purchase insurance for fiduciaries Plan can cover reasonable costs of fiduciary defense in actual or threatened litigation, as long as no finding of fiduciary breach results Plan sponsor may indemnify fiduciaries 15 5

6 Recent Cases On Excessive Plan Fees Lawsuits Involving 401(k) Plans Fees and Expenses Numerous lawsuits have been filed over the last several years against major corporations Alleging that the corporations 401(k) plans have been charged excessive and improper fees and have failed to disclose these fees to participants Examples: Boeing; Lockhead Martin; Exelon; Caterpillar; General Dynamics; United Technologies; Bechtel; International Paper; Kraft; Northrop Grumman; and Deere & Co. 17 Legal Basis of Fee Claims Breach of prudence/loyalty Excessive direct and/or indirect compensation to providers and failure to monitor fees Imprudent selection of investment funds with excessive fees Prohibited transactions Self-dealing Conflicts of interest 18 6

7 Key Issues in Fee Cases Did the plan fiduciaries prudently review and analyze the fees charged to the plan? (Procedural Prudence) Did the plan fiduciaries cause the plan to pay excess fees? (Substantive Prudence) Did the plan fiduciaries properly disclose to plan participants revenue sharing and other fees charged to the plan? (Disclosure) 19 Types of Fees Direct Compensation hard dollar fees Fee per participant Fee per service Indirect Compensation hidden fees Revenue sharing arrangements Asset-based fees transferred from a broker or investment manager to a service provider for a plan Typically, service provider receives portion of the investment or brokerage fees paid by a plan, based on the type and the amount of plan assets rather than on the services performed Vary based on share class Other asset-based fees charged to cover administrative fees 20 Revenue Sharing Arrangements Fees received by service providers through revenue sharing offset other fees involved in arrangement Burden for participants Increased expense ratios, decreased returns Disproportionate cost to some participants based on investment selection Litigation Issues Are revenue sharing fees reasonable in relation to services performed? Did the plan fiduciaries understand the fees being paid and prudently evaluate them? 21 7

8 Case 1: Excessive Hard Dollar and Revenue Sharing Fees Class action that alleged: $58 million in excessive and unreasonable fees paid to plan s recordkeepers and auditors In late 90s, annual fee per participant was $112, in 2007 able to lower to $52 Suit settled in 2013 for $30 million Company must also monitor plan fees and perform RFP for recordkeeper services 22 Case 2: Leveraging Size to Reduce Fees Large 401(k) plan with billions in assets Alleged fiduciary breaches: Retail mutual funds instead of institutional class funds with lower expenses Revenue sharing that constituted a kick-back to the recordkeeper Insufficient disclosure 23 Case 2: Leveraging Size to Reduce Fees Court of Appeals refused to dismiss: Such a large plan could have leveraged its size to offer lower cost funds Revenue sharing payments may have been unreasonable based on services rendered These facts suggest a flawed process Settled for $13.5 million and removal of funds with high fees 24 8

9 Case 3: The Importance of Process Plan participants alleged: Offered only actively managed funds and funds with high fees Paid excessive revenue sharing fees to recordkeeper Plan sponsor prevailed on summary judgment Process for selecting the funds considered the fees and expenses Sub-agent fees were not unreasonable by market standards Most importantly, overall fee arrangement considered in evaluating recordkeeper 25 Case 4: Sufficiency of Fee Review Process Plan sponsor used a process intended to meet prudence requirements: Hired recordkeeper after engaging in an RFP process Reviewed contract frequently, renegotiated fees on renewal Retained consultants to benchmark fees Disclosed fees in fact sheets, account statement and SPDs Participants allege: Overpaid by $28 million Disclosure was insufficient As a matter of law, prudence requires an RFP during renewal 26 Case 4: Sufficiency of Fee Review Process District court grants summary judgment to plan sponsor: No support for proposition that RFP is only way to determine whether recordkeeper fees are reasonable Regular review of fees, retained advisors, and fees reduced as result Appeals court reverses grant of summary judgment on fee claim Expert testimony regarding need for RFP presents issue of fact Eventually settled for $9.5 million 27 9

10 Recent Case: Tussey v. ABB Corp. The most recent case illustrating the importance of monitoring fees paid to service providers Participants sued plan sponsor alleging: ABB failed to calculate the amount the plan was paying recordkeeper through revenue sharing ABB failed to determine whether the pricing was competitive ABB failed to leverage the plan s size to reduce fees; and ABB failed to prevent use of plan fees to subsidize company administrative costs 28 Recent Case: Tussey v. ABB Corp. The Eighth Circuit upheld the District Court s $13.4 million judgment against the plan sponsor on the participants excessive fee claim The plan sponsor breached its duty of prudence by failing to: Calculate the amount of fees it was paying the recordkeeper under the arrangement and assess whether they were reasonable Attempt to negotiate more favorable fees Prevent payment of fees by the plan to the recordkeeper that subsidized the cost of unrelated services 29 Evaluating Plan Fees 10

11 Reasonableness of Fees Fiduciaries must ensure fees are reasonable both to satisfy general fiduciary duties and to avoid prohibited transactions Those rules require evaluation of the reasonableness of fees when service providers are selected The rules also require ongoing monitoring of the fees to ensure they remain reasonable 31 Service Provider Fee Disclosures Service providers must provide fee disclosures if they expect to receive $1,000 in compensation, and are: Fiduciary of plan Investment Advisor, or Recordkeeper or broker to a defined contribution plan that allows participants to direct their own investments Information to be disclosed in writing: Services provided Compensation to be received Capacity of fiduciary or not, and Plan investments and investment options 32 When Plan Should Receive Service Provider Fee Disclosures Timing Before contracts entered into Within 60 days of being informed of a change, and Upon request Under best practices, the fiduciaries should obtain a report periodically (at least annually) 33 11

12 Service Provider Fee Disclosures Effect on Plan Fiduciaries Helps Fiduciaries Comply Gives fiduciaries rights to receive fee information Provides enhanced transparency from service providers and additional tools to assist fiduciaries in meeting their responsibilities Plan Fiduciaries: Must make sure each service provider provides a disclosure, and report noncompliant service providers to the Department of Labor Do not have to confirm the accuracy of the disclosures they receive 34 Evaluating Reasonableness Fiduciaries should compare fees that would be charged by comparable alternative service providers for comparable services Request for information from alternative service providers Request for proposals if plan is considering possibly selecting a new service provider Generally would look at 3-5 comparable providers The type and level of services should be considered 35 Request for Information Can be done on a blind basis where service providers do not know the identity of the plan Request only a fee quote Send demographic data on the plan, such as: Total assets Basic plan design and features, and any particular services desired Number of participants Basic information about loans and types of investments 36 12

13 Request for Information Service providers are willing to participate because it is a possible source of new business Responses generally only show fees that would be charged, and not full details of the terms of the arrangement Fiduciaries can then compare fees side-by-side to determine what is considered reasonable in the market 37 Request for Proposals Solicit actual proposals from vendors to become the plan s service provider Much more involved than a request for information Not done on a blind basis, and must provide significant information about the plan and services desired 38 Participant Fee Disclosures Lack of disclosure was included in plan fee lawsuit claims Exact disclosures required regarding fees were not clear under law DOL issued new regulations requiring specific disclosures to participants about fees 39 13

14 Participant Fee Disclosures In defined contribution plans that allow participants to direct investments, the fiduciaries are required to provide fee disclosures to the participants Disclosures must be provided to new participants before they enter the plan Periodic disclosures to all participants, including quarterly and annual disclosures In addition, some types of changes to the annual disclosures require an interim notice 30 to 90 days before the change is effective Other disclosures are transaction-based, or must be provided upon request 40 Participant Fee Disclosure Examples The annual disclosure must include, for example: Plan related information Explanation of rights to direct investments and vote shares General fees and expenses that may be charged to the plan, and Individual fees and expenses that may be charged to the plan Investment related information Historical performance Appropriate benchmark comparisons Fees and expenses Direction to a website, and Any restrictions on transfers 41 Participant Fee Disclosure Examples The quarterly disclosure must include: Dollar amount of plan-wide and individual fees actually charged to the participant s account, other than through expense ratios, with an explanation of services provided Explanation that some fees were paid through revenue sharing 42 14

15 Summary Evaluating and Disclosure of Fees Failure to ensure fees paid by an ERISA plan are reasonable violates fiduciary standards and creates a prohibited transaction Fees must be monitored on an ongoing basis Service providers must provide fee information to fiduciaries upon request Fiduciaries should compare service provider fees to similar service providers, which can be done through a request for information or request for proposals The plan must provide fee disclosures to participants 43 Recordkeeping Fees and Services Action Steps Reviewing Recordkeeping Fees And Services Establish and follow a prudent process for understanding, monitoring and documenting fees, services and investment opportunities Best Practice Review recordkeeper fee disclosures once per year Rely on recordkeeper fee disclosure Benchmark fees based on market-based source obtained from party independent of recordkeeper Memorialize fee review in committee meeting minutes 45 15

16 Action Steps Reviewing Recordkeeping Fees And Services Best Practice Perform market-based fee review every 2 3 years through Request for Information Best Practice Perform full vendor search every 4 5 years through Request for Proposal May perform more frequently if unhappy with services, fee structure or investment universe 46 Establish Goals For RFP Process RFP process provides the fiduciary with the leverage it needs to negotiate fees and services and to ensure it is receiving the highest quality of services Apply more prudent person or prudent expert standard to RFP process: ERISA requires a fiduciary to use care, skill, prudence, and diligence in selecting a recordkeeper If the fiduciary does not have the necessary expertise, the fiduciary should seek the advice and assistance of an expert 47 Establish Goals For RFP Process To comply with prudent expert standard, RFP process should be performed by parties with knowledge of the plan (fiduciaries and their advisors, not company s general purchasing/procurement department) Use an outside expert Benefits Attorney and/or Investment Advisor to lead the RFP process: Comprehensive process Measurable process Documented process 48 16

17 Getting Started Establish Goals and Priorities Establish goals and priorities Important in guiding the search and selecting recordkeeping candidates Include goals in RFP to help recordkeeping candidates respond to plan s needs Sample goals Reduce fees Improve quality of services Improve quality of recordkeeper personnel Obtain broader range of services Enhance recordkeeping system Improve quality of technology Improve employee communications Improve participant services and experience Enhance compliance and reporting Enhance investment platform 49 Identify Type of Recordkeeper Desired Insurance Companies Group Annuity Contracts Mutual funds with limited fund universe Open architecture Mutual Fund Companies Proprietary funds only Proprietary funds required with limited additional fund universe Open architecture with some propriety funds preferred Independent Recordkeepers Limited fund universe Open architecture 50 Important Considerations Detailed description of recordkeeping processes How does recordkeeper perform significant functions System capabilities and controls Identify hardware and software systems SAS 70 How often updated Disaster recovery plan How is system updated to ensure compliance Communication and education Process Tailored or canned 51 17

18 Important Considerations Company organization Services provided Types of plans Sizes of plans Team that will provide service to plan Organizational chart Identify individuals and their tenure and experience Employee turnover rates Quality assurance Systems Surveys Client turnover rate 52 Important Considerations Reporting and compliance Employer reports customized or canned Participant reports customized or canned SPD preparation and distribution Trustee services Relationship to recordkeeper Services provided Trust agreement Investment platform Open architecture Revenue sharing 53 Important Considerations Participant services Voice response system Internet services Call center Conversion process Team Process Timing 54 18

19 Important Considerations Fees Fees are at the heart of all recordkeeper searches Do not have to select the lowest cost recordkeeper to satisfy prudence requirement But fees are one of the most significant factors Many recordkeeper searches focus on investments and revenue sharing Level of open architecture and availability of broad fund selection is important But focus on fund selection and revenue sharing clouds fee comparison 55 Important Considerations Fees Focus should be on bottom line fees Request fee quote assuming no revenue sharing Fees should include amounts for (i) basic recordkeeping, and (ii) other functions (e.g., loans, distributions, and QDROs) May also want to ask for sample investment fund lineup with revenue sharing Even if fiduciary will pick different funds or fund classes, helpful exercise For example, may highlight whether recordkeeper candidate that is fund manager (i) requires any of its own funds, and/or (ii) provides lower recordkeeping fees if fiduciary uses some of manager s funds 56 Important Considerations Services Agreement Ask for copy of form services agreement as part of RFP Ensure there are no deal breakers in agreement Sample of important provisions to review Will recordkeeper agree to comply with terms of plan and ERISA Compare list of services in agreement to those described in RFP Determine whether there are any performance guarantees If not, discuss these during finalists presentations 57 19

20 Important Considerations Services Agreement Analyze indemnifications Those recordkeeper candidate is willing to provide to plan Those recordkeeper candidate wants for itself Analyze any dollar limits on recordkeeping candidate s liability Usually limited to relatively low dollar amount or low multiple of annual fees Discuss during finalists presentations Review float terms and ensure in compliance with ERISA Ensure relatively short notice period for fiduciary to terminate agreement Maximum 90 days 58 Case Study Large public company unhappy with its 401(k) recordkeeper, an insurance company with significant retirement plan business Numerous recordkeeping errors requiring corrections through EPCRS Unresponsive service Lack of sophisticated systems on relative basis High fees Company had two 401(k) plans and a nonqualified plan with both pre-tax and after-tax contributions Prepared RFP tailored to company s needs 59 Case Study RFP sent to 5 recordkeeper candidates - Incumbent insurance company Bank Mutual fund company Independent with both insurance and mutual fund platforms Independent with open architecture for mutual funds After sending out RFP, had discussions with each of the candidates, especially in regard to after-tax feature in nonqualified plan Shared notes with all candidates so all had an equal opportunity 60 20

21 Case Study Analyzed all responses and prepared matrix summarizing responses Committee quickly dismissed two candidates Bank because it refused to bid on after-tax component even though it initially indicated it had that capability Independent with insurance and mutual fund platforms based on lack of necessary system and platform, which was apparent from RFP response Committee entertained finalist presentations from other three candidates The insurance company was allowed to present due to its incumbent status and to assist with comparison to new candidates 61 Case Study Going into finalists presentations, committee was undecided between the mutual fund company and the independent recordkeeper During the presentations, both companies showed the ability to provide superior services and were rated relatively equal in that regard The committee liked the independent recordkeeper based on its perceived ability to work more closely with that candidate s personnel Also, the total fee quotes for the two 401(k) plans broke down as: Incumbent - $900,000 Mutual Fund Company - $520,000, or $440,000 if used a number of the company s funds Independent Recordkeeper - $350, Case Study Through a thorough recordkeeping RFP process, the committee achieved all of its goals, including: Improved and accurate recordkeeping A higher level of services Enhanced recordkeeping personnel Open investment fund architecture Lowered fees with over $550,000 in savings 63 21

22 Contact Information Don A. Mazursky J. David Putnal Teri Forehand King Toby R. Walls