In September 2006, eight
Fortune 500 companies were named in
class action lawsuits alleging they failed to
monitor and disclose 401(k) fees under so-called
revenue-sharing arrangements. To protect your
company or client, watch for these red flags when
reviewing a 401(k) plan offering:
Determine how expenses in group
annuities compare to publicly traded funds.
Group annuity plan participants
don’t own mutual funds—they own a share of a pool
of assets. As a result, account statements show
prices of “unit shares,” not fund shares. Unit
shares do not correlate with any publicly traded
mutual fund. This hides the underlying expense
ratios of the annuities.
Find out what “fees waived” means.
In many cases, the broker’s sales
proposal says administrative fees are “waived” or
“included.” The point of such language is that the
employer has no out-of-pocket expenses, but such
statements ignore that participants pay for the
services out of their investments. The Department
of Labor (DOL) says that an employer must “ensure
that the fees paid to service providers and other
expenses of the plan are reasonable in light of
the level and quality of services provided.” See
Don’t confuse the proposal or the
adoption agreement with the actual contract.
The proposal is a sales document,
meant to show the provider in the best light. The
adoption agreement helps fit desired plan
provisions into a “prototype document.” But the
contract is typically delivered after a verbal
agreement has been made, or even after a letter of
intent has been signed. The contract should be
signed only after it has been thoroughly reviewed.
Don’t allow a provider to begin the
installation process prior to delivery of the
full contract. Frequently,
enrollment meetings are held before the contract
is delivered and signed. This benefits the
provider by making it awkward for the employer to
Examine unspecified “recurring charges.”
Often, marketing materials or fund
information pages will say, “the reported past
performance does not reflect the annuity’s
mortality and expense risk charge and other
recurring charges.” Employers should determine
what the recurring charges are and what the impact
of such charges is on the plan and participant
holdings over time.
Watch out for onerous surrender charges.
Surrender charges lock a plan
sponsor into a plan, regardless of plan
performance or poor service. Surrender charges
often start at 5% and decrease by 1% each year,
finally disappearing after five years. The charges
can make it extremely costly for a company to
change plan providers down the road.
Get a written explanation of fund
expense ratios. Funds may be
labeled “no-load” when they carry no front-end or
back-end sales charge, but some plan providers use
“no-load” funds that have higher-than-average
expense ratios. A fund’s expense ratio in your
proposal may be, for instance, 1.06%. But when you
check that fund’s expense ratio on the fund
company’s Web site, you may find the same fund has
a maximum expense ratio of 2.35%.
Ken Weber is the president of
Weber Asset Management, Inc., Lake Success,