“Advisors and plan sponsors need to change their procedures in order to avoid litigation risk,” says Loeper. He added that “a key step is that attempting to outperform by not being fully diversified is going to be Exhibit 1 in future cases that exploit the LaRue ruling for any lone participant that underperformed or bore excessive expenses.” Advisors and sponsors will need to abandon their value proposition of their past services born from the defined benefit plan era, because those services were fundamentally based on the notion of the advisor providing selection and monitoring guidance in an attempt to out perform the investment policy benchmark. But, with those services, such bets against the investment policy benchmark had no impact on the plan participant in a defined benefit plan. The plan sponsor bore the risk and the reward of investment bets against the investment policy benchmarks. Loeper said that those same antiquated defined benefit processes are frequently the standard services being provided to participant directed defined contribution plans today, completely ignoring the impact of the risk such bets introduce to any one participant of potentially under performing at an inopportune time for the participant.
The new proposed regulations even go so far as making the point that, “The Department (of Labor) is taking this opportunity to reiterate its long held position that the relief afforded by section 404(c) and the regulation thereunder does not extend to a fiduciary’s duty to prudently select and monitor designated investment managers and designated investment alternatives under the plan.” Loeper contends that betting against policy benchmarks by not being completely diversified will frequently fail the basic ERISA test of the “clearly prudent” diversification standard and subject sponsors and advisors to large settlements.
In addition to proper diversification, fiduciaries and plan providers need to insure that fees are reasonable, as required under ERISA. Loeper shared with us a striking illustration of the potential repercussions of excessive fees. Consider an example where a married couple each contributes $3,500 (including matching funds, adjusted annually for inflation) to a 401(k) plan, starting at age 25. At age 65, they will have accumulated a combined portfolio of nearly $2.5 million, assuming a return of 7.5% each year. However, a plan provider charging 1.5% in excess fees will have netted over $1 million over the same time frame. The couple, investing modestly over a 40 year period, will have sacrificed returns sufficient to make a millionaire out of the investment provider through excess fees.
Loeper notes that 401(k) advisory services have evolved from its roots in the defined benefit era. In defined benefit plans, the company bore the risk of underperformance or excess fees in active bets against investment policy benchmarks. If pension funds failed to meet their targets, the cost was a greater contribution on the part of the company. In the 401(k) world the cost of underperformance is passed to the plan participant, and the remedy, as established by LaRue, may be legal actions against the fiduciaries.
