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CCH® PENSION — 10/10/11

ERISA fiduciaries not required to exclude retail funds from plan investment menu

Administrators of a 401(k) plan did not breach fiduciary duties under ERISA by including retail mutual funds among the plan's investment options or requiring participants to pay fund expenses, the U.S. Court of Appeals in Chicago (CA-7) has ruled.

Retail funds in plan investment menu

A company's participant-directed 401(k) plan offered participants 32 investment options, including 24 mutual funds that are open to the public (on the same terms and at the same cost). The funds are no-load vehicles that do not charge investors a fee to buy or sell shares. Purchases and sales occur at net asset value, calculated daily. The no-load funds cover expenses by deducting them from the assets under management. Thus, the fund does not assess an annual flat price per investor (i.e., capitation fee) but assesses fees as a percentage of capital under management.

Plan participants brought suit under ERISA, charging that the plan administrator breached fiduciary duties by: (1) including retail mutual funds among the investment options (instead of restricting the options to wholesale or institutional funds exclusively); and (2) requiring participants to bear the expense of the funds, rather than having the plan bear the costs.

CCH Note: In Hecker v. Deere, the 7th Circuit held that a plan that offered 25 retail mutual funds with expense ratios ranging from 0.07% to just over 1% annually provided an acceptable array of investment options, as the expense ratios were set against the backdrop of market competition. The wide range of investment options, the court stressed, allowed the plan to comply with ERISA's fiduciary requirements. In subsequently denying a petition for rehearing, the court affirmed that the company's election to accept retail fees without negotiating presumptively lower wholesale fees did not constitute a breach of fiduciary duty. The trial court in the instant case found Hecker controlling and dismissed the participants' claims on the pleadings.

Should the plan have paid fund expenses?

Initially, the court noted that the claim that the plan should have paid the fund expenses directly, allowing participants to realize the gross rather than the net return, involved a question of design (and not administration) to which ERISA's fiduciary requirements do not apply. In designing a plan, the court explained, an employer is not subject to a fiduciary duty to make the plan more valuable to participants by providing additional funds to cover operating expenses.

Should plan exclude retail funds?

The plan provided eight alternative options to the retail mutual funds. However, the participants maintained that the plan should not have offered any retail funds, but restricted investment options to wholesale or institutional funds. According to the participants, a plan that offers only institutional vehicles will incur lower average fees.

The court initially noted that Hecker rejected a similar argument because of the benefits of competition offered by retail funds. Specifically, the retail funds provided mark-to-market benchmarking that, the court reasoned, allowed participants to better understand and compare fees.

After next observing that institutional shares do not always have lower expenses, the court further explained that institutional investment vehicles have lower liquidity, in that participants may not transfer funds between investment vehicles without incurring a fee.

CCH Note: Implicit in the court's reasoning was the understanding that funds with the lowest fees will not always be in the best interest of participants. Participants have the right, the court suggested, to select more expensive funds that provide such benefits as daily valuation and greater liquidity. Retail funds provide benefits that participants may value over lower costs and need not be excluded from a plan's balanced investment menu.

Concluding that the employer did not breach any fiduciary duties under ERISA in including retail funds in the plan investment options or requiring participants to pay fund expenses, the court affirmed the dismissal of the participants' claims.

Source: Loomis v. Exelon Corp. (CA-7)

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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