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(PLANSPONSOR.com) – A court found ABB Inc. and Fidelity breached some fiduciary duties owed to participants in ABB’s retirement plans.

Specifically, U.S. District Judge Nanette K. Laughrey of the U.S. District Court for the Western District of Missouri found the ABB defendants violated their fiduciary duties to the plans when they failed to monitor recordkeeping costs, failed to negotiate rebates for the plan from either Fidelity or other investment companies chosen to be on the plans’ platform, selected more expensive share classes for the investment platform when less expensive share classes were available, and removed the Vanguard Wellington Fund from the investment menu and replaced it with Fidelity’s Freedom Funds.

http://www.plansponsor.com/Employer_to_Pay_for_Failing_to_Monitor_RK_Costs.aspx

Korte Commentary:

Participant lawsuits surrounding excessive fees in defined contribution plans are becoming so common that this story is hardly “news”, but we think it serves as excellent example of the potential pitfalls associated with bundled recordkeeping and investment management relationships.

In many bundled arrangements, explicit recordkeeping and administrative fees are often waived if a certain percentage of a plan’s assets are invested in the provider’s proprietary funds or other funds offered on its fund platform. These “free” recordkeeping structures limit the spectrum of investment options from which a plan sponsor can choose for its participants and the lack of transparency surrounding revenue sharing and fee rebates creates litigation exposure and increases regulatory scrutiny.

At Korte Consulting, we are firm believers that investment option selection should serve as the primary basis for choosing the optimal vendor/service arrangements, not the other way around. When thinking about investment design, plan sponsors should be asking themselves the following questions:

1. What investments (and investment structure) is the most appropriate for our workforce?
2. What service/vendor arrangement is most appropriate to support the investment structure?
3. Which vendors are best equipped to deliver the necessary services?

Bundled structures can be effective in the right situations, but only if the plan sponsor can show that investment performance and fees are commensurate with other options available to the plan on an unbundled basis.

DC Plan Investment Structure Pitfalls

• Avoid allowing administration/recordkeeping to drive investment decisions.
• Aside from company stock, closed menu investment structures in a bundled arrangement create greatest exposure to fiduciary litigation (from employees, beneficiaries, or the Department of Labor).
• Bundled structures with closed menus tend to have lower administrative costs, but higher investment fees.
• Investment management fees are largest component of total plan costs, representing an average of 74% of all-in fees and expenses.
• Bundled arrangements inhibit fee transparency if not structured carefully and often make it more difficult to meet the new 408(b)(2) fee disclosure and reporting requirements that will go into effect on July 1, 2012.

(PLANSPONSOR.com) – Kraft Foods Global agreed to pay $9.5 million to settle a lawsuit over excessive fees for its 401(k) plan investments.

In the long-running case of George v. Kraft Foods Global, Inc., et al., the plaintiffs allege that Kraft violated its Employee Retirement Income Security Act (ERISA) fiduciary duties by allowing excessive fees, holding excessive cash within the plan’s company stock funds and offering imprudent funds as investment options.

Last July, U.S. District Judge Ruben Castillo, of the U.S. District Court for the Northern District of Illinois concluded that a jury could find that “a reasonably prudent business person with the interests of all the beneficiaries at heart” would have banned actively managed funds from their 401(k) plan as they had done in the Kraft defined benefit plan because they had concluded that active funds did not consistently outperform index managers.

www.plansponsor.com/Settlement_Entered_in_Kraft_Excessive_Fees_Case.aspx

Korte Commentary:

We believe this case highlights a number of often overlooked issues facing plan sponsors that offer their employees both a defined contribution plan and a defined benefit plan.

1. Too often, plan sponsors fail to coordinate the management of their DB and DC plans. Coordination facilitates idea sharing, reduces litigation exposure, and improves governance.

In practice, we find that many corporate plan sponsors administer their DB and DC plans separately with little coordination. In many organizations, human resource professionals are responsible for administering the DC plan, while trained investment professionals on the Treasury/CIO side of the organization are responsible for the DB plan. Redundancies, excessive costs, and inconsistent investment philosophies are often the result.

The Kraft case suggests that plan sponsors have an obligation to implement consistent investment philosophies across both plans, or else expose themselves to litigation. Or, if the plan sponsor manages the DB and DC plans differently by design, the decision process and rationale behind it must be defensible and well documented in the plans’ investment policies. If active management was considered inappropriate for the DB plan, why should DC plan participants have been placed in active investment options, particularly if they have higher fees than passive options?

2. All plan design and investment-related decisions, including decisions to maintain the status quo, must be formally documented on a regular basis.

With respect to the court’s finding that the company stock fund maintained excessive cash, the court opinion states that there was no evidence that Kraft made a reasoned decision about the structure of its DC plan investments. “Despite all this discussion of investment and transactional drag, we can find nothing in the record indicating that defendants ever made a decision on these matters. The record does not tell us whether this persistence is the result of a deliberate decision to maintain the status quo or whether it was caused by the fiduciaries’ decision to table the matter.”

In addition to on-going investment risk and performance monitoring, we advise our clients to conduct periodic investment structure reviews at least bi-annually. It is just as important to document a decision to maintain the status quo as it is to document changes.

Questions that DC plan sponsors should be asking include:

• Are we in the lowest cost vehicle for each investment option? Do collective trusts or separate accounts offer fee savings over traditional mutual funds?
• Do we really understand the fees we are paying to our recordkeeper and investment managers? How much are we actually paying for “free recordkeeping”? Does bundling recordkeeping with investments actually result in lower all-in fees, or simply inhibit transparency and constrain our investment option choices?
• How much liquidity is required in each investment option? What cash levels are appropriate to minimize performance drag? Have we explored alternative cash equitization options – such as futures, ETFs, or index funds?

3. The way forward: DB/DC master trust pooling as the solution.

For many plans concerned about reducing costs, increasing transparency, and improving governance, one solution has been to create a combined DB/DC master trust. Through a master trust, multiple DB and DC plans can share the benefits of common investment management approaches while still retaining their status as distinct plans. Investment accounts are typically unitized and valued on a daily basis to facilitate daily trading in the DC plan.

Master trust pooling reduces the complexity of administering and governing the investments of multiple plans. More importantly, the cost savings can be considerable, particularly with the use of separately managed accounts, where investment management fees can be up to 25% to 40% lower than using institutional mutual funds. Since investment management fees typically represent up to 75% of a plan’s total expenses, even small savings can have a huge impact on total costs incurred by the plan sponsor and plan participants.