New regulations from the Department of Labor (DOL) and the Employee Retirement Income Security Act (ERISA) may expose business owners to personal liability for excessive retirement plan costs. This means that a business owner’s personal assets may be exposed, should an employee decide to bring a lawsuit against the employer for breach of fiduciary duty. Most business owners do not have a solid understanding of retirement plans or the proper guidance needed to absorb this liability. Inside of 401(k) plans, 403(b) plans and 457 plans, lay an abundance of hidden fees and compensation arrangements. The most troublesome aspect of these fees is the majority are never shown on account statements. Investment expense ratios, turn-over fees, 12b-1 fees, fee sharing arrangements, third party administrator fees, custodial fees, and brokerage fees, are just the tip of the iceberg. The abundance of hidden fees inside retirement plans has led to an overwhelming number of lawsuits against employers, as well as heavy fines for breaches of fiduciary duty by the Federal Government.
These issues have become more common since the 2008 US Supreme Court case LaRue v. DeWolf, Boberg and Associates, Inc. where the court opened the door for employees to sue plan sponsors for breach of fiduciary duty. This landmark case allowed for two potentially costly concerns: First, the court found in favor of the plaintiff, allowing for potential future lawsuits against plan sponsors’ personal assets. Secondly, the court found that an individual could sue their employer for breach of fiduciary duty. Prior to this case, the legal precedent was that breach of fiduciary duty cases were typically brought under class action litigation. The subtle changes in legal precedent may lead to more lawsuits against smaller employers. As it stands now, if an employee feels disgruntled regarding their retirement plan, they no longer have to convince a group of fellow employees to join in class action litigation.
The employer has a fiduciary liability under the retirement plan. Most plan sponsors do not fully understand or recognize these responsibilities to their employees and that breaching those responsibilities may lead to liability. For business owners, this means personal assets could be at-risk. In the last two years, there have been a massive number of lawsuits filed against plan sponsors. In 2009 alone, US District Courts adjudicated 9,300 lawsuits against employers for breach of fiduciary duty in retirement and health benefit plans. Many of these suits were against small business owners and non-Fortune 500 companies.
Most retirement plans consist of mutual funds, either through brokerage platforms or insurance products like variable annuities. According to the DOL, there are up to 26 hidden fees in most mutual funds. Inside variable annuities, the fees can be much higher. The overwhelming majority of these expenses are not displayed on account statements or the prospectus. For plan sponsors and employees alike, this revelation may come as a shock. The most common fee shown for owning a mutual fund is the expense ratio, but in addition to the expense ratio, other costs can add 2% to 3% in annually expenses. I have seen fees as high as 7% per year. The amount of investment expenses inside a plan are directly related to the liability the business owner holds.
Many are under the false impression that retirement plans are free. In fact, a recent study by the American Association of Retired Persons(AARP) found that 71% of employees believe they do not pay any retirement plan fees. Many business owners also erroneously believe that their plans do not include any fees. This is typically due to the idea that providers have not charged up-front fees, but hidden costs in these plans eat up massive amounts of retirement savings. A typical Google search of XYZ 401(k) plan can provide data from independent retirement research firms like Bright Scope. Now an employee can see the amount that excessive fees may be costing them over the course of employment. For plan sponsors, this prospect should be frightening.
Plan sponsors are required to provide employees with transparent and accurate fee information. Beginning August 31, 2012, employees are required to have all associated fees disclosed through account statements. Business owners and plan fiduciaries will have to itemize these fees, according to the service provided. Should the fees for any particular service be deemed too costly, it could be considered a breach of fiduciary responsibility. Business owners need to be prepared to review retirement plans services in order to comply with these new regulations and protect themselves from litigation and penalties.
The key is suitability, not disclosure. Just because fees and arrangements are disclosed, it does not make them suitable for employees. Understanding the differences and limiting the scope of the plan sponsors’ fiduciary liability is where a strong partner can add value and security. Under ERISA, employers face fiduciary scrutiny, but they have little liability as to the performance of the actual plan. For ERISA-covered plans, fiduciary oversight is more about the process than it is the results. Business owners can eliminate the majority of potential plan concerns by properly structuring and utilizing the services of independent fiduciaries with experience in managing retirement plans. While the full scope of potential liabilities could encompass an entire book, by understanding the liabilities in this article, you can take the first steps towards protecting your retirement and financial security.
