The May 18, 2015 ruling by the Supreme Court in the Tibble v. Edison case reinforces the fiduciary responsibility of the plan sponsor and underscores the degree to which the sponsor is vulnerable to law suits from plan participants. At issue was the statute of limitations for determining damages in the event of a lawsuit. In essence, the court ruled that the 6-year statute of limitations did not apply to mutual funds held in a 401k plan. A twenty-year employee holding a high cost mutual fund for 19 of those years may be eligible for a damage award for the entire period the fund was in the account.
Who pays? The sponsor does. Why? Because in addition to his or her responsibilities in running the company, they are also expected to know the many levels of fees in the mutual fund business. This is a perfect example of Harry Truman’s iconic The Buck Stops Here sign in the Oval Office.
But in fact, the buck stops before it even gets to the plan. While the participant pays up front, and the sponsor may pay eventually, the broker is often paid up front and then year after year after year.
How does it work? Many if not most of the 401k plans that I review still hold class ‘A’ shares of their mutual funds. The American Funds Growth Fund of America (AGTHX) is the 4th largest mutual fund in the country by assets under management in 2014. Their Class ‘A’ shares have an expense ratio of 0.66%, a very competitive cost, and a 12b-1 fee (trailing commission) of 0.25%, about average for funds with trailing commissions. What makes this fund expensive for participants in a 401k plan is the up front commission. For purchases of less that $10K, an investor pays a 5.75% for every dollar contributed to their 401k plan.
5.75%. How does this effect their retirement account? If the S&P 500 returned 8% the next year, the Growth Fund of America would have to be up 14.6%, a whopping 82.5% increase over the averages, for our participant to end up with the same amount of money. That’s a steep hill to climb even for the best of funds. And it happens deposit after deposit, year after year.
Not for the broker, of course. They get paid up front.
In a nutshell, while the buck stops at the plan sponsor the money stops at the broker.