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5500 Preparer's Manual for 2012 Plan Years
The premier resource in the field of Form 5500 preparation, 5500 Preparer's Manual will help you handle the required annual Form 5500 filings for both pension benefits and welfare benefit plans.
Plan fiduciaries may have breached their fiduciary duties by failing to deliberate and make a documented reasonable decision regarding means of reducing investment and transactional costs associated with a unitized company stock fund, according to the U.S. Court of Appeals in Chicago (CA-7) in George v. Kraft Foods Global, Inc..
Company stock funds under 401(k) plan
A company maintained a 401(k) plan, pursuant to which participants were allowed to direct individual contributions to designated mutual funds. Two of the funds were company stock funds (CSFs) which invested exclusively in the common stock of the company and its parent company. The plan also offered various multi-stock funds.
Unitized stock fund
The participants' claim with respect to fiduciary mismanagement of the company stock funds was based on the structure of the CSFs as unitized stock funds. Under the unitized funds, participants owned units of the fund, rather than shares of the company stock. The CSFs invested almost exclusively in the company's common stock but also contained a small amount (5 percent of the overall value of the fund) of cash or similar highly liquid investments (i.e., cash buffers). Thus, the value of the CSF funds unit was determined by the value of the stock as well as by the value of the fund's cash buffer.
The cash buffer in the funds provided an effective hedge against declines in the value of company stock. However, the participants claimed that the unitized structure of the CSFs caused "investment drag" and "transactional drag" that decreased the return on the investments. Investment drag is a consequence of the cash buffer. Because the return on the cash component of the CSF is lower than the return of the stock component, having cash in the funds when the stock appreciates results in lower returns than could have been expected if the cash portion of the fund had been used to buy more stock.
Transactional drag refers to the transaction costs incurred by a fund in connection with participant transactions (i.e., requests to buy and sell funds). Such costs include brokerage commissions, SEC fees, and other expenses associated with a trade.
Unitized funds allow administrators to net requests to buy and sell against each other in order to minimize transaction costs. However, when transaction costs are incurred they are deducted from the overall value of the fund, rather than allocated to the specific participant who initiated the transaction. Thus, because each participant bears a pro rata share of the fund's total transaction costs (regardless of the number of transactions actually initiated by the participant), infrequent traders effectively subsidize the activities of frequent traders. This incentive to frequent trading also results in higher transaction costs for the fund.
Plan participants claimed that the investment and transactional drags associated with the unitized structure of the CSFs caused investments in the CSFs to underperform direct investments in company stock by $83.7 million between 2000 and 2007. Accordingly, participants charged that the fiduciaries breached their duties under ERISA by failing to minimize or eliminate the investment drag and the transactional drag, either by removing the cash buffer, limiting the frequency of trades, or other measures.
The trial court determined that the plan fiduciary had weighed the costs and benefits of implementing proposed solutions to the problems caused by the investment and transactional drags, but reasonably concluded that the cost of making changes to the CSFs outweighed the benefits. However, the appeals court could find no evidence in the record (e.g., documents, affidavits, deposition testimony) indicating that plan fiduciaries ever engaged in a review and made an actual determination of whether the costs of implementing proposed changes to the CSFs exceeded the benefits of reducing investment and transactional drag.
The failure to balance relevant factors and make a reasonable decision under circumstances in which a prudent fiduciary would do so, the court explained, can be a breach of the prudent man standard of care. Thus, the trial court's summary judgment order on the issue was reversed. However, the determination of whether the fiduciaries actually acted imprudently in failing to make a reasonable decision with respect to modifying and retaining the unitized structure of the CSFs would need to be resolved on remand.
Recordkeeping fees
The plan maintained the same recordkeeper since 1995. The appeals court found that there was a genuine issue of material fact as to whether the fiduciaries acted prudently in failing to solicit competitive bids before extending the contract of the recordkeeper and incurring possible overpayments up to $16 per participant per year. The court further explained that the fact that the fiduciary relied on the opinion of outside consultants as to the reasonableness of the fees, while evidence of prudence, was not a complete defense to the charge of fiduciary breach.
For more information, visit http://www.wolterskluwerlb.com/rbcs.
For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer's Benefits Reports.
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