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A Lesson in Fiduciary Responsibility and Share Classes

Knowledge | October 21, 2014

There are few larger responsibilities than that of someone else’s money. As a qualified retirement plan sponsor, one is considered a plan fiduciary, and thus, their responsibility falls into the category of “someone else’s money.”

As part of this heavy load, we’ve found that it’s imperative that plan sponsors are able to understand not only the funds assigned to their plans, but the associated fees and expenses, and how to translate this into something they can work with.

Why Should You Care About Fund Expenses?

As stated on the DOL website, the Employee Retirement Income Security Act (ERISA) sets standards of conduct for those who manage an employee benefit plan and its assets. These standards set forth the responsibilities of a fiduciary, including:

  • Acting solely in the interest of plan participants and their beneficiaries and with the exclusive purpose of providing benefits to them
  • Carrying out their duties prudently
  • Following the plan documents (unless inconsistent with ERISA)
  • Diversifying plan investments
  • Paying only reasonable plan expenses

Two recent court cases highlight the importance of evaluating, and just as importantly, understanding all expenses associated with plan investments as part of a fiduciary’s liability management and investment due diligence.

In the case of Tibble vs. Edison International, current and former beneficiaries sued their employer’s benefit plan administrator under ERISA claiming that their pension plan had been managed “imprudently and in a self-interested fashion.” Of particular interest was the theory that Edison had “failed to investigate the possibility of institution-share class alternatives.” The court later concluded that, “Edison did not exercise the ‘care, skill, prudence, and diligence under the circumstances that ERISA demands in the selection of these retail mutual funds.”

Similarly, in the case of Tussey vs. ABB, a group of participants in a 401(k) plan sponsored by ABB, Inc. claimed that ABB breached its fiduciary duties by permitting excess fees to be charged against the plan and its participants. Ultimately, the decision held that the plan fiduciaries did breach their fiduciary duties to the plan and they were ordered to pay $35 million in damages.

In both cases, the court specifically questioned the fiduciary’s role in evaluating fees and expenses associated with plan investments.

One of the claims against ABB in Tussey vs. ABB was that ABB “Utilized more expensive share classes in the investment alternatives when lower cost share classes were available.”

In an evaluation of Tibble vs. Edison, John Carl of Napa-Net.org concludes, “While the case addressed several issues, one of the key findings was that, in keeping with the ERISA requirement to evaluate the reasonableness of expense ratios for plan investments, fiduciaries have an obligation to compare and select appropriate fund share classes for their plans.”

It’s clear then that understanding what a share class is and how it relates to fund expenses is essential in carrying out a fiduciary’s full responsibility.

What is a Share Class?

Many mutual funds offer multiple share classes and these each come with different costs. For example, one particular fund may offer six types of share classes. Each of these classes charge varying fees, which ultimately affect the investor’s return. However, keep in mind that the fund’s investment portfolio, objectives and policies remain the same across all share classes.

The varying fees charged by each class include a sales charge, as well as annual fees and expenses, which are based on different shareholder services and/or distribution arrangements.

As you might expect, fee differences can often be seen in the volume of shares purchased. To illustrate, consider grocery shopping – you are likely to find better prices at Costco than you will at Albertsons as a result of bulk discounts. (And a bit more complex: Albertson’s may receive a different price than New Season’s based upon the quantity of products it purchases from each distributor, or a particular negotiated pricing structure.)

There are a variety of issues that you face as a plan fiduciary. Some simple – documenting/recording your investment committee decisions, and some more complex – understanding the fees associated with fund share classes. What you need to know is that we can help.

At BCI Group, we provide retirement services including fiduciary liability management, investment due diligence, employee education and market analysis. Because our sole focus is on delivering quality retirement plan services, we share an affinity for and a commitment to this very specialized industry.

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