By James M. Breslow
Published on Mar 3, 2015 by FRONTLINE
It can be hard to make sense of the fees that can accompany a typical 401(k), and that confusion can carry a steep price tag. In 2012, for example, a study from the public policy think tank Demos found that fees can cost a median-income two-earner family nearly $155,000 in lost savings, eating up nearly one-third of their investment returns.
But the cost of investing in a workplace retirement plan, like a 401(k), might not be so high, says attorney Jerome Schlichter, if some businesses paid closer attention. Employers have a legal obligation to follow what’s known as the fiduciary standard — meaning they must put their employees’ interests before any other consideration — but that’s not always what happens, according to Schlichter.
With more than $6 trillion invested by Americans in 401(k)-type plans, the Supreme Court has chosen to get involved. Last week, the high court heard arguments in a class-action case by Schlichter that could help decide whether workers can sue their employer for failing to meet its fiduciary duty.
Workers in the case, Tibble v. Edison International, allege that the company, Edison, improperly picked retail class shares for the firm’s retirement plan, rather than an identical class of institutional-grade shares that came with lower fees. The workers say the California utility company made the decision in order to keep its administrative costs down by $8 million — a charge the firm denies. If the workers win, the case could set off a wave of similar suits across the country.
The high-stakes case is just the latest in a nearly decade-long crusade by Schlichter to push companies to cut plan costs and improve their fee disclosures. Over that time, the St. Louis attorney has settled seven major suits with companies including Kraft Foods Group and Lockheed Martin, for a total of $187 million. His efforts have earned him nicknames such as “Lone Ranger of the 401(k)’s” and “Public Enemy No. 1 for 401(k) Profiteers,” but his critics in the mutual fund industry say that such lawsuits have the adverse effect of driving up costs for businesses and their employees.
FRONTLINE spoke to Schlichter about the employer fiduciary standard, the criticisms of his approach and whether the 401(k) model is working. Here’s an edited transcript of that conversation.
What’s the problem as you see it with how some employers are handling their employees’ 401(k) plans?
There’s been a sea change in the American retirement system — which has traditionally been the defined benefit model [where] the risk of the market or fees is all on the employer, to the 401(k) model, the defined contribution model, meaning the employer puts in a match, and it’s then the employee’s money and the employee’s risk. So the employer doesn’t have any incentive, financially, to watch carefully what’s going on. But the employer has a duty to work for the sole benefit of the employees, because it’s their money. And that’s what often causes problems.
Some employers do everything right. Others, however, because they’re not paying attention, or because they may even be doing self-dealing, allow excessive fees or imprudent investments in a plan.
Ten years ago we began getting more and more questions by people concerned about their retirement, [from people who] couldn’t figure out what’s going on in their 401(k) plan. And a couple things really stood out. One, employees in big 401(k) plans for big companies were paying retail fees, and yet the billion-dollar plan shouldn’t have its employees paying retail fees because they can get much better rates because of their size. Warren Buffett doesn’t pay retail. Neither should an employee of a large company plan. And the law requires that the employer make sure fees are reasonable and appropriate. So size matters, and yet employers weren’t doing that.
Another thing that people don’t have any idea of — even some sophisticated financial people — is how are record-keeping costs paid for in a 401(k) plan. Every 401(k) plan has to have somebody to keep track of your balance, contributions and withdrawals. And that can be done for a flat rate, say $30 a person per year. It has nothing to do with asset size. If you have $50,000 in your 401(k) plan, and I have $5,000 in mine, it doesn’t cost any more to give you that monthly statement.
Yet what we saw was that there were many, many employers having their employees pay for record keeping through asset-based charts. That is, through something that’s based on the size of their assets, so that the bigger their plan, the more they paid for the same record keeping. That really had become an industry practice for which there’s no justification.
If there are lower-cost options out there, how come employers aren’t automatically providing them to employees? Why are they instead ending up with retail plans that come with higher costs?
Two reasons. One is what I call “asleep at the switch.” These are not employer assets, it doesn’t affect the company’s bottom line, so sometimes what you’ll have is whoever is in charge of the 401(k) plan also has a day job, they’re in charge of human resources or something. So they’ll have the quarterly meetings at 4:00 in the afternoon on Friday, and everybody’s looking at their watch, wanting to go home, and it doesn’t matter what happens to that 401(k) plan. It doesn’t affect their bonus, it doesn’t affect their salary, and it doesn’t affect the company’s bottom line. So there’s no financial incentive. It’s a legal duty the employer has to make sure this money is handled for the sole benefit of the employees, but there’s not a financial incentive.
The second thing that we’ve found is there’s clear self-dealing on the part of some employers. And by that I mean using the employees’ retirement assets to benefit themselves. For example, in the case of [power and automation technology company] ABB, the company was using Fidelity not only for their record keeping and their 401(k) plan, but also for their own record keeping for their payroll processing, their health and welfare plan, their pension plan for executives. It turned out, and the judge found, that those corporate services paid for by the company were being provided at a loss by Fidelity, while the 401(k) plan, where services are paid for by the employees, Fidelity was making a 51 percent profit. Meaning, as the judge found, that the employees were subsidizing corporate expenses with their own assets. And that’s absolutely illegal.
Editor’s Note: ABB later appealed, and in 2014 the U.S. Court of Appeals for the Eighth Circuit in St. Louis upheld a portion of the judgement by a Federal District Court awarding $13.4 million to the participants in the case. A $1.7 million judgment against Fidelity was reversed by the higher court.
Is there a clear-cut example of a conflict of interest that’s built into the model of the industry that might not be illegal, but is ethically questionable?
Cross-marketing is a problem in 401(k) plans, for example, where say a mutual fund company comes in and says, “We’d like your 401(k) business and then we’ll also provide you services.”
Say it’s a bank. So a bank gets involved in a 401(k) plan, and then the bank makes a line of credit to the company, or loans, or banking services to the company.
Whenever you have people who are providing services to the 401(k) plan also providing services to the employer, there is a need for a bright line that says the employees are not subsidizing corporate expenses with their retirement assets. It’s a temptation for employers, to say OK, we can benefit ourselves. We can get cheap loan rates from a bank, all we have to do is give them some 401(k) business. But you can’t do that. You can’t mix your own company’s interests with the interests of the employees. The company wears two hats, and when it’s operating the 401(k) plan, it takes off its corporate hat, and puts on the hat of protecting the employees. That bright line has to be sharp and clear and followed.
I’m guessing most employees would never know this was happening. Is there one piece of advice you’d give someone with a 401(k) to make sure that the fees in their plan are not higher than they should be?
If they’re paying more than a half a percent in expenses on the funds in plan, that’s a red flag, and they should ask the employer why they’re paying that much. And if they have any doubt or question, they can call the Department of Labor, [which] oversees all 401(k) plans.
The mutual fund industry has argued that your efforts actually hurt savers in the long run — that stricter fiduciary requirements make plans more expensive for employees and employers alike. How do you see it?
When we filed these cases, we heard the same kind of rhetoric. The sky will fall if these cases are allowed to proceed. Employers will stop offering 401(k) plans. They’ll be so much more expensive because employers are going to have to do so much more. And what happened now, eight-and-a-half years later, after the first cases were filed? There are record sums of money in 401(k) plans. There are more 401(k) plans than ever, and the sky didn’t fall. As a matter of fact, even more so, the 401(k) model is the American retirement system. The sky won’t fall. Fees won’t go up, they’ll go down. They have gone down as a result of these cases.
There are large financial institutions — specifically mutual fund companies — that have a vested interest in keeping things from being transparent, from people understanding what they’re being charged. So adding a fiduciary standard will simply mean that there will be protection for people who really think they’re getting somebody on their side advising them. Yet, as the mutual fund companies have stated over and over again, they are not in the business of working for the best interests of individuals. Their interest is in making the most money they can.
So disclosure — and that standard will produce better transparency, greater transparency, and will ultimately mean more savings for people who are putting money in retirement plans or just investing.
On a much more basic level, is the 401(k) model actually working, or is a there better option out there for the American retirement system?
The 401(k) model surprisingly was never intended to be the American retirement system. It was developed haphazardly. A lawyer actually found this provision in a law and set it up for a particular small company, and then it was quickly expanded, greatly. It’s going to be with us, it’s not going to go away. So in an ideal world could there be a better system devised? Yes. But this is the system we have, and if operated properly by employers who take their fiduciary duty seriously, then it’ll be a good thing for American workers.