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The law firm of Schlichter, Bogard & Denton has had a very good couple of weeks. After winning two high profile 401(k) fee lawsuits, courts have approved the payment of more than $31.9 million in legal fees. The defendants in these cases were Lockheed Martin Corp and Ameriprise Financial, fiduciaries of their respective 401(k) plans. The plaintiffs, represented by Schlichter, were 401(k) participants. The 401(k) participants claimed their plan fiduciaries failed to protect them from excessive fees – a primary fiduciary responsibility. The courts agreed, awarding participants $90 million in damages.
These settlement fees got me thinking about the DOL’s proposed fiduciary rule. Would the proposal, if implemented, give trial lawyers more fodder for excessive 401(k) fee lawsuits? I think it would.
Complicated carve-outs and exemptions
The DOL proposal does not establish a uniform fiduciary standard for all retirement plan financial advisors. Instead, it includes carve-outs and exemptions. Most notably, it allows insurance agents or brokers to receive commissions, or other indirect compensation (e.g., 12b-1 fees) that can vary based on the advice given, as long as the “Best Interest Contract” Exemption (BICE) applies. Under a uniform standard, these financial advisors would be obligated to charge a level fee, or in other words, a fee that is independent of the advice given.
The problem with the BICE and the other DOL carve-outs is their complexity. Drinker Biddle is a law firm with one of the most recognized ERISA practices in the country. In an analysis of the DOL’s fiduciary proposal, they said, “BICE would provide an exemption permitting broker-dealers to receive variable and indirect compensation based on their advisors’ non-discretionary recommendations. However, BICE imposes disclosure and other requirements that may be practically impossible, or prohibitively expensive, to comply with.”
Opening the door for 401(k) fee lawsuits?
It’s the complexity of the DOL carve-outs and exemptions that could expose 401(k) plan sponsors to unnecessary liability. When hiring a financial advisor, 401(k) plan sponsors have a fiduciary duty to assess “the reasonableness of the compensation (direct and indirect), and determine any conflicts of interest that may impact the service provider’s performance.” A BICE will almost certainly make these assessments more difficult.
When a financial advisor is paid variable compensation like commissions or 12b-1 fees, there will always be the specter of self-dealing. That makes the BICE hazardous for 401(k) fiduciaries. Why? There is blood in the water right now. Trial lawyers like Schlichter are winning 401(k) fee lawsuits and cashing in with large settlements. To my knowledge, none of these lawsuits involve a level fee financial advisor. In my opinion, advice given by financial advisors that can manipulate their own fees will always be an easier target for trial lawyers than advice given by advisors that charge a level fee, regardless of a BICE.
Be careful what you wish for
Insurance agents and brokers lobbied hard to kill a 2010 fiduciary proposal that outlawed commissions and other types of variable compensation altogether. After that, the DOL went back to the drawing board and released a new proposal this year that permits variable compensation as long as an onerous BICE applies. I think this concession is a bad deal for both 401k fiduciaries and participants. Plan sponsors will have a tougher time assessing financial advisor fees and participant returns will likely continue to suffer due to conflicted investment advice.
Ironically, I think the BICE will also be a bad deal for the financial advisors fighting to keep their variable compensation. The complex BICE requirements will make compliance expensive and give fodder to trial lawyers looking to prove excessive 401k fees due to conflicted investment advice. I also think these advisors will have a tougher time competing with fee-only advisors that won’t need to have their clients sign a complicated BICE disclosure document
While a uniform fiduciary standard would be disruptive to the retirement plan industry in the short-term, I believe it’s in the best interest of all retirement plan stakeholders – participants, fiduciaries, and even financial advisors – in the long-term. The only group that won’t benefit are trial lawyers. I can live with that.
