By Fred Reish and Bruce Ashton
The Supreme Court decision in Tibble v. Edison International held that 401(k) plan fiduciaries have a duty to prudently monitor a plan’s investment options … in this case, whether retail or institutional share classes were prudent for the Edison plan. The Ninth Circuit Court of Appeals had already held that the Edison fiduciaries breached their duties by selecting retail share classes where institutional share classes were available. And, before that, the trial court had said that there was a “duty to ask” about the share classes that were available to the plan.
What does that mean for 401(k) plans?
First, it means that there is a duty to use the plan’s (or the provider’s) “purchasing power” to select the appropriate, and least expensive, available share class of a mutual fund (unless other material factors would justify a more expensive net cost). Keep in mind, though, that when discussing share classes, it is the same investment pool for all the share classes; the only differences are the expenses being charged against the investment. So the question is, “Why would fiduciaries pay more than they need to for the identical investment?”
Second, at first blush that would seem to mean that plans should always use institutional share classes when they are available to the plan (directly or through the provider). However, the issue is more complicated than it appears, because the institutional shares are not always less expensive than retail shares. For example, when revenue sharing is considered (and used to reduce the expense ratio to its “net cost”) the true, cost of the retail shares may be -- and frequently is -- less expensive.
As the DOL said in its Tibble brief, “Put simply, wasting beneficiaries’ money is imprudent.” In other words, the DOL concluded that it is a fiduciary breach to overspend for an investment. When the net cost of retail shares (after offsetting revenue sharing) is less expensive than the cost of institutional shares, fiduciaries would be overspending to use the institutional shares (unless there were material factors that justified the difference).
We recently addressed these issues in a white paper for John Hancock, which can be found here. The paper reviews the method of returning revenue sharing to participants, which John Hancock utilizes, as well as generally discusses the legal and risk management issues related to the use of revenue sharing in 401(k) plans.