If you’re in tune with what’s going on in 401k lawsuit land, you may have heard about the recent $12 million settlement reached by Fidelity and its plan participants. For those of you not in the know, Fidelity was recently sued by its own plan participants. They claimed that Fidelity violated ERISA because they were only offered Fidelity funds, that those funds had high costs and that there were not enough index funds offered in the plan.
A recent commentary observed "the settlement could enhance Fidelity’s image as an employer.” How could anyone come to that conclusion?! Fidelity's plan rakes in huge fees for the company—because they are not just a plan sponsor, but the actual recipient of all the excess fees being siphoned off their employees' retirement accounts. Fidelity was well aware of that, as they are aware today that the actively-managed funds they offer cost many times what index funds cost and yet underperform them more than 80% of the time.
Fidelity did nothing it wasn't forced to do and despite this settlement, gave up almost nothing to get off the hook, admit no wrongdoing and minimize bad publicity. They certainly deserve no pats on the back. A $12 Million settlement on a $10 Billion plan is a drop in the bucket and most of the real problems in the plan remain—and allow Fidelity to go on over-charging—but now with an aura of propriety that belies the facts.
The reality is that every employer with mostly actively-managed funds in their plan—Fidelity’s or anyone else's—is causing at least as much harm to his participants as Fidelity was to theirs. This is due to both the high cost of the funds (and add-on fees) and their persistent underperformance against index funds. Rest assured that the average employer/participant is paying much higher fees than the Fidelity mega-plan participant is paying.
In a twisted sort of way, Fidelity has something of an excuse for their bad behavior toward employees. They are in the business of creating and selling actively-managed funds. What else would they offer their employees? If they didn't, how would they ever sell them to anyone else? This lawsuit put Fidelity in tremendous jeopardy. If it ever got to the real heart of the matter—that there is no empirical evidence or justification for high-cost, actively managed funds in a 401k plan—Fidelity would be out of business. Instead, they "settle" for $12 Million and rock on. A huge win for Fidelity.
There are more than 30 similar suits underway right now—at their core, cost is nearly always the issue. Most suits pit the participants against the plan sponsor (employer) or the plan sponsor against the provider (like Fidelity, Merrill Lynch or John Hancock). Few are like Fidelity, where the plan sponsor and provider are one in the same.
Fidelity is thus defending its very existence—they have no choice. If the court declares actively-managed mutual funds to be abusive, they are out of business.
Providers are defending big profits and quite possibly a portion of their business, but not their very existence. Merrill Lynch and Morgan Stanley have been financially impacted by the many suits they have been forced to defend—win, lose or settle—but their survival is never really threatened. The profits continue to outweigh the legal fees—so they carry on making tiny, incremental tweaks to reduce future jeopardy.
But what of the Plan Sponsor? These are the folks (along with their employees) that we care about. They are not mutual fund companies or investment sellers. They are engineers, car dealers, shipping companies, office furniture companies, sporting goods companies, etc. You're trying to succeed in your business and attract, retain and reward the people you need to make it happen. You have every reason to help your employees minimize their cost of saving for retirement and maximize their savings. There's nothing about your business that's enhanced by offering the stuff pedaled by the likes of Fidelity, Merrill Lynch or Mass Mutual. They have a major business reason to keep putting themselves in harm's way. You have every business reason not to.
The suits against investment sellers will continue and accelerate because all the evidence, over decades of data, says that actively-managed funds are a bad deal. Participants pay most of the cost and suffer the poor results and they are beginning to realize it. It helps you and your employees tremendously to quickly walk away from anyone who offers actively-managed funds or advises you to put them in your plan or invest in them personally.
If you're dealing any of the big name 401k companies (or the advisors who recommend them), don’t think for a second they have more of an incentive to look out for you and your employees than they do for their own profits or business. Or, in the case of Fidelity, the motivation to look out more for your employees than they do for their own.
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