During the past few years,
the 401(k) industry has adjusted to an increasing volume of litigation over fee transparency and reasonableness. Most of that litigation has focused on the role of revenue sharing within investment menus and the appropriateness of using retail mutual funds versus institutionally-priced investment vehicles.
A new front in the 401(k) litigation battles appears to have opened as Fidelity is now being sued for offering the investment advice service of Financial Engines on its recordkeeping platform. The lawsuit alleges that Fidelity is receiving a portion of the fees that Financial Engines charges its clients in order for Financial Engines to be an available provider on its platform, thereby increasing the cost of the investment advice and violating Fidelity’s fiduciary responsibility.
Financial Engines is a registered investment adviser that provides retirement plan participants with automated investment management of their in-plan account balance using proprietary technology. This type of solution is frequently referred to as a “managed account” and it is becoming more prevalent within the retirement plan industry. Financial Engines is a provider of managed account services, primarily to large plan sponsors. As of May 1, 2016, Financial Engines manages approximately $113 billion in assets for 401(k) participants.
Managed accounts are often times marketed to plan sponsors and participants as an ideal investment advice solution that provides “customized” investment advice based on participants’ demographics and self-disclosed personal information such as assets held outside of the plan, spousal income, and spousal investments. Proponents of managed accounts believe that the addition of participants’ personal information results in a better investment solution compared to target date funds that only use a participant’s age or retirement date as a single input in determining an appropriate investment recommendation.
The drawback to managed accounts are the higher fees associated with the service. While most services offer a free point-in-time investment recommendation, managed account providers make their money by charging participants that opt into their service an ongoing asset-based fee based on the participant’s account balance. These fees can usually run between 25-60 basis points depending on the managed account provider, the type of implementation chosen, and the level of usage within the plan. A 2014 U.S. Government Accountability Office (GAO) review found concerns with the level of fees charged by managed account providers and whether the potential benefits exceeded these costs.
For plan sponsors, managed accounts present a fiduciary challenge. While they may be beneficial for some participants, they are rarely free, leaving plan sponsors to evaluate the reasonableness of the fees charged in light of the value of the services rendered. The Fidelity lawsuit demonstrates the challenge plan sponsors may have in evaluating fee reasonableness for these products as there is little, if any, disclosure of the revenue sharing between the managed account provider and the recordkeeper in many cases. While Delta – as the plan sponsor – was not a named party in this particular matter, this case opens potentially a new line of litigation not yet seen before whereby the plan sponsor may be subject to litigation in future cases.
Further, the structure of the products makes it very difficult to evaluate the performance of a managed account provider because each participant may receive a slightly different recommendation based on their personal circumstances. In many cases, the managed account providers struggle to provide the necessary level of transparency to make an informed decision about the quality of the advice that is offered to participants. Compounding these issues is the fact that most recordkeepers limit the availability of managed account providers to one, or maybe two, options on their platform.
High fees, lack of transparency, and limited choices are a recipe for fiduciary trouble, and plan sponsors should tread cautiously. In many instances, plan fiduciaries may view these types of solutions as an optional “add-on” for participants, and if the participant selects the managed account solution and pays an additional fee, then caveat emptor. Unfortunately, as plan fiduciaries, we are not given the luxury of dumping this choice on the participants. While a managed account offering may be beneficial to a certain segment of the participant population within the plan, as a plan fiduciary, be sure to conduct the requisite due diligence before adding a managed account solution: understand how the product works, the advice it will provide, and the associated costs to participants. It is the responsibility of the plan fiduciary to collect all relevant information (or that which the fiduciary should know to be relevant) to make an informed decision before turning participants loose with an additional fee for a managed account solution.