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How Lawsuits And Labor Department Audits Are Changing The 401(k) Landscape For Employers

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The 401(k) has been the most common retirement savings vehicle since Ronald Reagan’s presidency. However, the plans offered during Reagan's era bear little resemblance to today's 401(k) plans, beyond the eponymous IRS code.

There are two main drivers transforming the 401(k) industry for employers that affect your role as a fiduciary for your workforce: a spate of class-action lawsuits and the reality of the Department of Labor’s plan audits.

New fiduciary rules will go into effect Spring 2017 that will redefine the employer’s responsibility to understand which vendors are acting in the plan’s “best interest”. Most employers honestly believe they are doing a good job managing their plan. But, hiring a well-known plan administrator, offering funds from all major asset classes, and establishing a competitive employer-match are not enough. You can no longer afford to put your company's 401(k) on autopilot as companies have learned in litigation and DOL audits.

Fiduciary responsibility and lawsuits

Employees are worried about their retirement and questioning details about their 401(k) plans. In recent years, many joined class action suits against large employers, such as Edison International, Boeing, Caterpillar and Kraft Foods. The cases generally examined whether employers were acting in participant’s best interests and their fiduciary oversight, particularly in choosing funds and keeping fees down.

Of the many lawsuits filed, Tibble v. Edison is undoubtedly the most influential, having reached the U.S. Supreme Court. Approximately 20,000 plan participants sued the energy company for offering some retail mutual funds with higher fees when comparable, less-expensive institutional fund products were available.

While the case got into esoteric ERISA statutes of limitations, the crux was Edison's fiduciary responsibility to monitor plan fund choices regularly to ensure the funds offered are competitively priced. Edison offered a wide array of funds at varying fee levels among the approximately 50 funds in the portfolio. While some employees wanted brand-name, actively managed funds, they typically have higher fees. This was an issue in the case, even though the plan had other fund options available with low fees.

Edison maintained that frequently varying the available investment choices because of fee changes confuses employees. The justices on the other hand, felt there is no confusion in telling employees, "Your fund was at .3 percent, so we are switching you to one at .2 percent."

Additionally, the decision addressed fee payments (such as 12b-1 fees) employers, brokers or plan administrators receive for offering some name-brand funds. Companies typically used "revenue sharing" to lower plan administration costs. While it will be prohibited in 2017 with the implementation of the DOL rule, there will be allowances if the conditions of a  "Best Interest Contract Exemptions" (BICE) is met.

The 2015 Supreme Court decision noted, "A trustee has a continuing duty - separate and apart from the duty to exercise prudence in selecting investments at the outset - to monitor, and remove imprudent, trust investments." The outcome reinforced employers' duties to regularly monitor plan investments, and raised concerns about revenue sharing of 12b-1 and other fees. The ruling sent a powerful message to all 401(k) plan sponsors: Doing your fiduciary duty involves more than offering low-cost funds as investment options; it also involves ensuring they are the lowest cost when first introduced and regularly thereafter.

DOL looking over shoulders and plan documentation

Besides the threat of lawsuits, employers who are 401(k) plan sponsors also have regulatory obligations to the DOL. The DOL, much like the IRS, can audit you to make sure your retirement plan fiduciary and reporting responsibilities are being handled appropriately. The audits are more common than most employers think and need to be taken seriously. A DOL 401(k) audit can result in significant financial penalties. Even if you think the odds are long that you would be audited, it is probably similar to odds of being audited by the IRS, and most people would not have a cavalier attitude about income. Even if you think an audit is a long-shot, the odds are probably just about the same as being audited by the IRS. Yet, most people wouldn’t have a cavalier attitude about income taxes, just to be safe.

The DOL audits focus on ERISA violations and are reportedly looking at employers' internal controls. Agents look for evidence of controls on eligible compensation, employee eligibility, 401(k) plan loans, in-service distributions, discrimination testing, accurate crediting of vesting, and ensuring a plan is not top heavy (favoring key, higher-paid employees). They also look for plan paperwork, such as enrollment materials, current plan documents, distribution paperwork, blackout notices, plan committee minutes, and annual notices for safe harbor plans. Audit your own plan and document your findings to show (in the event of an audit) that you take fiduciary responsibilities seriously.

Other topics the DOL is looking at these days include fees, particularly 12b-1 fees, a lack of an Investment Policy Statement, and other financial issues that have appeared in some of the lawsuits. In other words, if employees do not question plan administration, the DOL may.

Employers take heed

Offering employees a 401(k) plan is de rigueur for medium- to large- sized firms. But employers need to regularly scrutinize their plan and the funds offered. They need to be diligent in record-keeping, dissemination of documents to employees and other facets to avoid fines as a result of an audit. Furthermore, the fiduciary responsibility to regularly look at fees, funds and more in employee’s best interest was emphasized by the Supreme Court ruling.

Applying for a BICE may seem to be a reasonable option for plans that qualify. But in essence, you are giving permission to your advisor to continue to receive the conflicted method of compensation while other options exist without such conflict. Advisor firms that choose to operate under BICE are required to file with the DOL with their intention to do so and it is reasonable to assume that the DOL will carefully monitor them. You too should look carefully at the legislation and tread lightly. BICE also sends up a red flag to law firms, who have seen the results from the Edison suit, other litigation and settlements. They are making fiduciary breech litigation part of their practice. The best defense against the lawsuits and audits is for employers to make sure they are truly "managing" their 401(k) plan with employee’s best interests at heart and keeping fees down.

Brian Menickella is a co-founder and managing partner of The Beacon Group of Companies, a broad-based financial services firm based in King of Prussia, Pa.

Securities offered through TFS Securities, Inc., Member FINRA / SIPC, a full service broker dealer. Investment Advisory Services offered through TFS Advisory Services, a division of TFS Securities.