401(k) investment fees continue to be a key concern, both in terms of fiduciary liability and impact on plan participants. What some are overlooking is a use by some mutual funds of a multi-level 401(k) investment fee structure that arguably attempt to skirt both the requirement for investment adviser registration and the “best interests of the client ” fiduciary duties required of investment advisers.
One of the key fiduciary duties of ERISA plan sponsors and other ERISA fiduciaries is to control a plan’s costs, specifically to avoid unnecessary and excessive fees and other costs. Most mutual fund companies offer a separate class of shares for pension funds. These pension fund shares often offer reduced fees and/or waive any loads generally required for purchase of retail shares of the fund.
The expenses are usually disclosed in a fund’s prospectus. However, since the disclosure is generally made by reference to a fund’s trade symbol and share class, many plan sponsors, fiduciaries and plan participants may not recognize the fund’s fee disclosure. For instance, Fidelity Investments pension related funds are classified as “K” shares. American Funds pension related funds are classified as “R” shares.
American Funds had three funds in the most recent ranking of leading 401(k) mutual funds: American Growth Funds of America, American Fundamental Investors and American Washington Mutual. What stands out about the “R” shares offered by these three funds is the fact that they offer six different fee structures for each fund, ranging from a high total fee of approximately 140 basis points (1.44% – 1.39%) to a low total fee of approximately 30 basis points (0.34% – 0.30%).
Studies have shown that investors rarely read a mutual fund’s prospectus. Unfortunately, my experience has been that the same is true of 401(k) plan sponsors. In some case, the plan sponsors seem to glance over a prospectus, but do not take the time to actually understand the information, choosing to blindly rely on whatever their plan service provider tells them.
Using the American Funds’ six various fee structures, an obvious question should be why there are six different fee structures at all. Given the ERISA’s mandate as to controlling costs, why would anyone choose anything other than the lowest fee structure. After all, it is the same fund, same underlying performance.
Anyone taking the time to review the fund’s prospectus for these three funds would quickly notice that the primary reason for the large difference in “R” shares fees is the amount of 12b-1 fees charged by each variation of “R” shares. Most of the American Funds R-1 shares charge a 12b-1 fee of 100 basis points (1%).
What’s interesting about the 1 percent 12b-1 fee is that it is the same basic fee charged by registered investment advisers. So, it would appear that non-registered investment advisers are attempting to charge an investment advisory fee without registering as an investment adviser or advisory representative, and the fiduciary duties that go along with such a designation.
The “R” charging the lowest fees are the R-5 and R-6 shares, each carrying fees in the 34-30 basis points range. The obvious difference between the R-5 and R-6 shares and the other “R” shares is that the R-5 and R-6 shares imp0se no 12b-1 fees.
12b-1 fees are supposedly charges for ongoing services provided by an investor’s financial adviser. As a former compliance director, I would suggest that more often than not, no such ongoing service is provided by financial advisers and that 12b-1 fees are simply provided to financial advisers as an inducement to continue selling a mutual fund’s products.
In any event, there is simply no basis under ERISA to offer multiple pricing options for 401(k) mutual funds. Such options are inconsistent with both ERISA’s mandate to control investment fees and expenses. Both 401(k)/404(c) plan sponsors and other ERISA fiduciaries need to carefully review the prospectuses for all investment options with a plan to protect against such potential liability traps. Plan participants need to also review all prospectuses to protect against potentially abusive situations so they can protect their financial security by alerting their plan’s fiduciaries to such ERISA violations.
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