Yahoo Finance Supreme Court May Level the 401(k) Playing Field
It has long been my view that 401(k) plans are a national disgrace. They tend to be rife with conflicts of interest and geared to benefit the securities industry at the expense of hardworking Americans. Unless the system is changed, "retiring with dignity" will continue to be a goal that's out of the reach for many employees.
The statute governing the conduct of plan sponsors and advisors to 401(k) plans is the Employee Retirement Income Security Act (ERISA). It is a complex and convoluted law, filled with loopholes that the securities industry is adept at exploiting.
On Feb. 24, 2015, the U.S. Supreme Court heard oral arguments in Tibble v. Edison International . The decision in this case could level the playing field for 401(k) plan participants.
The issues in Tibble v. Edison International. The issues in Tibble seem narrow and straightforward. ERISA bars claims against plan sponsors (typically employers), unless those claims are brought within a six-year period. ERISA also imposes on employers a continuing legal duty to ensure investment options available to plan participants are prudent.
The initial issue in Tibble, upon which the Supreme Court granted review, was whether the employer, Edison International, had a continuing duty to periodically monitor investment options available to plan participants for prudence, or whether that duty ended when the investment was initially made.
Specifically, employees of the company alleged their 401(k) plan kept retail shares of certain funds (originally purchased more than six years before the claim was brought) in the plan, even though identical, lower-cost institutional shares of those funds were available. Other than cost, there were no other differences between the retail and institutional shares of those funds.
Although Edison International initially claimed it had no continuous duty, and those claims were barred by the six-year statute of limitations, at oral argument both sides did agree the duty to monitor was a continuing one. They disagreed on the scope of that duty.
Edison International contended it had no obligation to switch to the less expensive share class, because this was not the type of issue significant enough to warrant "full due diligence." The position of plan participants was that Edison International, as a fiduciary to the plan, had an obligation to make changes that any prudent investor would, which included switching to the lower-fee share class, as part of its continuing duty to monitor investment options.
Edison International's argument falls flat. Jonathan Hacker, a partner in the Washington, D.C. office of the law firm O'Melveny & Myers, undertook the task of defending Edison International's position. It was not an enviable assignment.
Hacker asked the court not to endorse the proposition "that during the periodic review process, you actually do have a duty to constantly look and scour the market for more cheaper investment options." Justice Anthony Kennedy replied, "Well, you certainly do, if that's what a prudent trustee would do."
Hacker then tried another argument, contending that switching from the more expensive fund class to a less expensive one might cause "participant confusion" because participants "don't like change unless there is a performance change" and substituting a less expensive fund would raise "a stability issue."
Chief Justice John Roberts wasn't buying it. He responded, "How was there investor confusion? It seems to me one sentence saying, 'Well, we have been paying 0.3 percent, this is 0.2 percent, that's why were changing.' They're not going to, you know, running out in the halls screaming that there's confusion about that." His remark was followed by laughter in the courtroom.
Justice Elena Kagan was even more direct, stating incredulously, "They don't like changes. They would rather have fees?"
The bigger picture. Edison International could have avoided all liability relating to investment options in its plan, if the retirement plan advisor was what is known as a "3(38) fiduciary" under ERISA. A 3(38) fiduciary takes full responsibility for selecting, monitoring and replacing investments in a 401(k) plan. By appointing a 3(38) fiduciary, employers transfer the liability for those activities from themselves to the financial advisor.
Although banks, insurance companies and registered investment advisors, or RIAs, can all become 3(38) fiduciaries, as a practical matter, only RIAs typically assume this responsibility.
A competent RIA who assumes this liability would likely limit investment options in the plan to portfolios at various risk levels (and not a hodge-podge of many individual funds). These portfolios should consist solely of low-cost index funds, exchange-traded funds, ETFs, or passively managed funds.
Advisors to plans who do not accept this liability are "3(21) fiduciaries" under ERISA. They often populate 401(k) plan options with expensive, actively managed funds and accept "revenue-sharing payments" from fund families eager to be included, creating an obvious conflict of interest.
Unfortunately, many employers don't understand the difference between 3(38) and 3(21) fiduciaries, and that's the way the securities industry likes it.
Hopefully, the decision by the Supreme Court in Tibble will do more than simply hold Edison International to a higher level of duty when monitoring the investment options in its 401(k) plan. It just might encourage employers to fundamentally change the way their 401(k) plans are structured, and convince them to appoint only plan advisors willing to undertake full 3(38) fiduciary responsibility.
The beneficiaries of this shift will be plan participants. They deserve much better.
Dan Solin is the director of investor advocacy for the BAM ALLIANCE and a wealth advisor with Buckingham. He is a New York Times best-selling author of the Smartest series of books. His latest book is "The Smartest Sales Book You'll Ever Read."
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