Supreme Court ruling could lower 401(k) fees

The Supreme Court’s recent decision allowing workers to sue the administrators of their 401(k) plans is a landmark decision that will lead to the end of the retail mutual fund industry’s dominance of this marketplace. The result will likely be lower costs for all employees nationwide.
The issue in the case, LaRue v. DeWolff, was whether the Employee Retirement Income Security Act permits an individual 401(k) account holder to sue plan administrators for breaching their fiduciary duties.
The plaintiff, James LaRue of Southlake, Texas, said the value of his account plunged $150,000 when administrators at his retirement plan failed to follow his instructions to switch to safer investments.
Since the language of ERISA refers to recovering money for the ‘plan’ rather than for an individual, the question was whether a participant can sue solely for himself. In a unanimous decision, the Supreme Court said he could.
This decision benefits the 50 million U.S. workers who have invested $2.7 trillion in 401(k) plans. In fact, the advent of 401(k) plans is largely responsible for the growth of the retail mutual fund industry. Thirty years ago, employers controlled company pension plans. But these became expensive, so companies began replacing them with employee-funded 401(k) plans, featuring mutual funds as the investment choices available. Today, such retirement accounts represent nearly half of all the money invested in mutual funds.
Your employer has a fiduciary obligation to operate the retirement plan in your best interests. But are your best interests being served if the plan is charging you unacceptably high fees?
The average retail mutual fund charges 3 percent per year, according to Morningstar and academic studies. Yet comparable exchange-traded funds, such as those I use for my clients, charge 90 percent less.
Wouldn’t it seem that employers have a legal obligation to make sure that your retirement plan is helping you lower your investment costs from 3 percent to 0.3 percent?
I predict that the Supreme Court ruling will lead to class-action lawsuits filed on behalf of workers. These lawsuits will argue that employers are violating their fiduciary duty by limiting investment choices to expensive retail mutual funds. They will cause employers to offer ETFs as choices in their retirement plans.
By reducing fees, the chance for retirement security for millions of Americans will be dramatically increased.
Mutual fund companies tend to hold a disproportionate amount of stock in the companies that hire them to administer their 401(k) plans, according to a new working paper published by Harvard Business School.
To understand the implications of this study, consider this scenario: Widget Inc. hires Acme Mutual Fund Co. to operate the Widget 401(k) plan for Widget employees. The study found that:
1) Acme is likely to buy 47 percent more Widget stock for its stock funds than the average fund. Yet Acme’s fund managers are no better at predicting Widget’s future performance than other fund families.
2) By holding all those Widget shares, Acme gets to vote on proxy matters, and it votes significantly more in favor of management-friendly provisions than other shareholders.
3) During its first two years as trustee, Acme significantly increases its holdings of Widget stock. In the year after Acme stops being trustee, it decreases its holdings in Widget by the same amount.
4) During times when other funds are selling Widget stock, Acme buys. The study says that while other funds are decreasing their holdings an average of 2.6 percent, trustee funds increase their position by an average of 11.45 percent.
One way to avoid this conflict of interest, say the paper’s authors, is to require that retirement plan trustees be independent of the mutual fund providers. Until that happens, though, be aware that your plan’s trustees might be more interested in keeping your employer happy than doing the same for you.
Financial Adviser Ric Edelman can be reached at money@ricedelman.com.