Litigation – plan fees

(Warning – rambling musings follow.  May be boring.)

This ASPPA news article (I think it is available to non-members) caught my eye.  ASPPA said “Another “excessive fee” lawsuit was settled recently — but what’s more interesting than the settlement amount is the speed with which it was reached and how it’s going to be spread among the parties.”  I guess that is a valid observation; you can read the article for that take.

I’ve never been able to find details on these suits, specifically when they talk about different share classes – but I did on this one, in the complaint itself, not the settlement and found it interesting (in a dry, boring sort of way…).

The basis of the first part of the complaint is that they used retail shares when institutional shares were available.  Looking at one specific fund, they say that American Funds Income Fund could have been used with R-5 shares instead of A shares.  The total difference in fees is .29% (59 basis points vs 30 bps).  For those who don’t know (and I think that many in this industry are appallingly unaware of such details), A shares have a built-in trail commission, aka 12b-1 fee, generally .25%, so the 12b-1 fee is part of the total fund fee.  R-5 shares have no built-in distribution or 12b-1 fee.  They are designed to be used in a fee-based platform, where an advisor charges a separate fee.  I think that’s a significant point, and makes the direct comparison tenuous, because they are ignoring those other fees that doubtless would be charged.  (Although I doubt .25% is the going rate for such a plan; I have no idea but 5-10 basis points still generates an awful lot of revenue on $1 billion – “One billion dollars, bwa-ha-ha.”)

They go further and compare the fund to Vanguard’s “VBALX” (I think they mean VBTLX, Total Bond Market Index), with expenses of .08%.  Again, I think it is fair to say that in most plans, there would be some kind of an advisor fee built in, so the direct comparison is at least a bit misleading.  And…I’ll be careful not to give investment advice here…let’s just say that there is a difference between active and passive investing, and I think there can be value in paying a manager.  For AF Income Fund of America, the actual management part of the fee structure is .22%, and I think that is (more than) reasonable.

My conclusion on this part is that the fees were probably excessive, but probably not as excessive as their comparison would lead one to believe.  (Incidentally, the complaint states that the institutional share fees were less than the retail share fees in every case, but in the settlement, Novant claims that some retail share fees were less than some institutional.  Shrug.)

Next (there’s more!) they go on to the recordkeeper, GreatWest.  They note that direct compensation to GW increased from $195,000 in 2009 to $2,400,000 in 2010 “without providing additional services.”  (And $3,500,000 in 2011.)  While I’m sure there were some additional services, I find it hard to argue this point.

Then they go on to the broker, and note that commissions went from the $800,000 range in 2009 and 2010 to $1,900,000 in 2011, “…despite Davis’ limited services not changing in any material way…”  (Ouch.)  I am having a hard time arguing with that.  They use the term “kick-backs” repeatedly and it’s pretty ugly.  There’s some other nasty business going on with gifts and co-ventures that I won’t get into.

Finally, there is a Fraud and Concealment section.  Novant apparently bragged that “certain fees were waived” (I guess the reference is to A shares purchased at Net Asset Value, which is no big deal) and that “the checks for all administrative expenses are written by Novant.”  I don’t know if they say that any checks were actually written, but I’m sure if they were they were for trivial amounts.  Sigh.  “Hogs get slaughtered” comes to mind.

My take on all of this…I’m not a lawyer, but I think there is a saying to the effect of “bad fact cases make bad law.”  That’s in part what I see here; there was some greed (understatement) and they probably got what they deserved.  I just have a real bug up my butt about the DOL’s obsession with fees, and they definitely relied on and quoted heavily from the DOL regs in the complaint.  I agree that when a broker “takes” 75 bps as a trail commission instead of 25 bps – and that is what really drives the pricing – it might be egregious (depending on plan size).  But saying that management fees of 22 bps vs 8 bps is a 175% increase is hysterical and misleading.

I deal mostly in the smaller plan market and am pretty confident that we not only have nothing to be afraid of, but are under the radar.  Still, there are some things in here that are cause for concern.  Thanks for listening if you got this far.