If you had a choice between two share classes of the same mutual fund — the only difference being that one class charged higher fees and was therefore guaranteed to have poorer returns — the choice would not seem to be difficult.
But trustees of one corporate 401(k) plan — the type of defined-contribution plan that is increasingly the only kind of retirement plan available to American workers — decided to take the one that charged higher fees.
Before we get to the details, let's address the question of why such high-cost funds would be chosen in any case.
At Edison, the trustees of the plan signed up for so-called retail classes of several mutual funds offered by firms like
Each of the funds in question had an ''institutional'' class as well, which generally required a substantial minimum investment but had no such fee. At issue in the litigation is whether the trustees of the 401(k) plan violated their fiduciary duties by not even considering the institutional class, although they could have invested in it.
A third of 1 percent does not sound like a lot, but compounded over 20 or 30 years it can add up. If you invested
As with most 401(k) plans, employees could choose from a list of funds. Some had lower fees than the funds in question. But they also had different investment objectives.
It costs money to manage a 401(k) fund. Records must be kept for each plan participant, and each participant has the right to move money around, generating record-keeping and transaction expenses.
Edison, like many companies, told workers it would pay those administrative costs. It could have chosen otherwise, but changing such a provision would no doubt anger a lot of workers.
Instead, Edison had a deal to force the workers to pay through the back door. The 12(b)1 fees that were deducted from their investments in the ''retail'' funds were rebated in a way that allowed Edison to use them to pay the 401(k) costs. The net result was that Edison's profits were a little higher, and employee investment returns a little lower, than would have been the case if the trustees had chosen the institutional classes of shares.
That practice was challenged by
That law is enforced by the
It quoted from a previous
In the case the
The judge said that in the case of three funds, however, the decision to use the retail funds had been made recently enough that the statute of limitations did not apply and awarded
The appeals court upheld that decision, leading to the appeal to the
''No prudent fiduciary would pay fees that are higher than necessary,'' the
Edison argued that overturning the appeals court ruling would provide little protection for employees but ''would needlessly increase plan costs and thereby discourage plan formation, undermining Erisa's most important objective.''
So far, the fact that cases have been filed against numerous plans does not seem to have discouraged the growth of 401(k) plans. Companies have been abandoning defined-benefit plans, with their open-ended costs in case investments do not perform well. And costs of 401(k) plans have been declining, apparently in response to the threat of litigation. Edison dropped the disputed funds years ago, after the suit was filed.
At the heart of many of the cases filed by
The government clearly has an interest in preventing such conflicts. But it also has an interest in allowing companies to make reasonable decisions that will not be second-guessed if they do not turn out well.
The law says that companies are entitled to some deference in making such decisions, a fact that the chief justice emphasized in the case cited by the lawyers for Edison. But lower courts have split on just how much deference is warranted, and the
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