Momentum is building for greater transparency — and reductions — in 401(k) fees.

The estimated loss of $2 trillion in retirement plan assets has put defined contribution plans squarely in crosshairs of the nation's lawmakers, justices and public policy regulators. While talk of scrapping the DC model has died down, most experts say changes to the present system, especially the cost structure, are likely.

"The market downturn has certainly increased the focus on fees," says Karl W. Kunkle, an attorney and CPA with Schneider Downs & Co., Inc., a wealth management advisory firm in Pittsburgh. "The change of administrations also renewed the focus on fee disclosure, including at the employer level. There's new interest in protecting participants."

Leading the charge in Congress on 401(k) fee reform are Rep. George Miller (D-Calif.), chairman of the House Education and Labor Committee, and Rep. Rob Andrews (D-N.J.), who heads that committee's Health, Employment, Labor, and Pensions Subcommittee. They recently held hearings on their bill, "401(k) Fair Disclosure for Retirement Security Act of 2009" (H.R.1984), which, in their words, "will provide American workers with clear and complete information about Wall Street fees taken from their 401(k)-style accounts."

"Especially during these troubling economic times, workers need to be able to account for every penny taken from their hard-earned savings," says Miller. "Workers should be entitled to clear and complete information about their retirement security."

He notes that current law does not require disclosure of all fees workers pay, and even when that information is available, it can be difficult for workers to find and evaluate.

Indeed, a 2007 survey by AARP found that roughly 80% percent of plan participants were not aware how much in fees were taken out of their 401(k)s. Moreover, even a seemingly small difference in the fees can make a big difference in the overall size of a retiree's final 401(k) account balance. According to the Government Accountability Office, a 1 percentage point difference in fees can reduce retirement benefits by nearly 20%.

Specifically, H.R. 1984 requires that:

• Workers must receive basic investment information, including information on risk, return, complete fees and investment objectives before enrolling in a plan.
• All fees charged against a worker's account would have to be included in the account holder's quarterly statement. The fee can be expressed as one number, but a plan participant has the right to request more details from the plan administrator.
• 401(k) service firms must disclose to employers the fees workers are charged on all investment options. Fees must be divided into four categories: administrative fees, investment management fees, transaction fees and other fees.
• Service providers must disclose financial relationships so that plan sponsors can make sure there are no conflicts of interest.
• Plan sponsors would have to offer at least one low-cost index fund to plan participants in order to receive protection against liability for participants' investment losses.
• The Department of Labor must review plan provider and plan sponsor compliance with new disclosure laws and impose penalties for violations.

A similar bill (H.R. 3185) was approved by the committee in April 2008, but never made it to the House floor. The new version appears to have more traction.

"There's no question that [the sponsors have] the votes to get this bill out of committee," says Robert Holcomb, vice president of legislative and industry affairs for J.P. Morgan Chase & Co. "I think there's a very good chance the legislation will pass the House this year. The question is what will happen in the Senate. Senators Herb Kohl (D-Wis.) and Tom Harkin (D-Iowa) have a bill that's not that different, but it's moving slowly."

Mandatory index fund

To ensure that employees have access to the lowest-cost funds available, H.R. 1984 requires 401(k)-style plans that seek limited employer liability to include at least one index fund in its investment lineup. The rationale is that index funds are less expensive and generally outperform actively managed mutual funds.

"When Jack Bogle, founder of Vanguard, testified before the full committee in February, he made a compelling argument in favor of providing every worker with the option to invest his or her retirement savings in an index fund," Rep. Andrews says. "Under H.R. 1984, we provide a strong incentive to employers to ensure an index fund option is offered to their employees."

The addition of the index fund requirement is a reflection of the economic downturn, says Holcomb. He explains that in order to receive 404(c) coverage, the bill requires a plan to include an investment option that meets the following criteria:

• Is an unmanaged or passively managed mutual fund with a portfolio of securities designed to substantially match the performance of the entire U.S. equity market, bond market or combination of the two.
• Offers a combination of returns, risks and charges likely to meet retirement income needs at adequate levels of distribution.
• Is described in the terms of the plan as offered without any endorsement of the government or plan sponsor.

"Of course, we all know that selection of investment options is a fiduciary activity, and that by selecting a fund, you're saying it is the best," Holcomb comments. Plan providers and sponsors have raised questions regarding these requirements, he notes, and "I think we'll see the committee work at tidying up the provisions around index funds."

Regulations on hold

Regulations on fee disclosure and investment advice had been developed by DOL under the Bush administration, but those have been suspended pending review by Obama administration officials.

"Final investment advice regulations under the Pension Protection Act had been issued on January 16, but they've been indefinitely delayed," says Holcomb. "I don't think we'll see them issued at this point."

Other regulations on hold include guidelines on electronic disclosure, minimum required distributions and balanced funds as QDIAs, he indicates.

Other signs of 401(k) reform

There is additional evidence that plan sponsors will see activity on 401(k) reform this year.

A number of Congressional hearings have been held and will be held on the impact of the economic downturn on 401(k) plans, says Holcomb. The Senate has requested information regarding target-date funds, and Sen. Kohl has indicated that he may introduce legislation in this area. Finally, he notes, there are numerous 401(k)-related reports underway at the Government Accountability Office.

According to Holcomb, 401(k) plan reform encompasses four issues: how to increase the number of participants covered by retirement plans, how to ensure the adequacy of retirement savings, the cost of plans to participants and to tax revenues, and fiduciary duties and remedies.

"Obama talked about mandatory 401(k) enrollment in his campaign as well as auto-enrollment in IRAs for those without employer plans. I think we will see some movement toward mandatory coverage.

"We're seeing increased interest in annuities, either as a mandatory part of retirement plans or in terms of tax treatment. Congress also is looking hard at the cost of plans; fee disclosure is one aspect, but they're also concerned that the deductions available don't match the coverage."

Finally, he says, "Democrats have always pushed fiduciary duties and remedies, and I think we'll see a broadening of plan participants' ability to seek remedies."

Supreme Court to hear fees case

Meanwhile, across the street from the Capitol, the Supreme Court has turned its spotlight on mutual fund fees. The justices will decide this fall whether it is proper for money managers to charge different fees to institutional and retail customers.

In the case, Jones vs. Harris Associates LP, the plaintiff alleges that Harris violated its fiduciary duty under the Investment Company Act by charging investors in its Oakmark mutual funds more than twice the amount it charges pension funds and other institutional investors for managing similar products.

"The Supreme Court's review of Jones won't affect HR/benefit managers' lives that much because it relates to how investment advisors and mutual fund companies set their fees," explains Stephen P. Lucke, a partner with the investment advisory firm Dorsey & Whitney LLP in Minneapolis. "The legal issue in Jones is how much of an arm's-length relationship do we want to ensure between people negotiating investment advisor fees and the investment advisor? If the Supreme Court says there must be more scrutiny, it may be that fees will be lower. Or the court may decide that the market is already doing what it needs to do to ensure low fees."

Other cases involving 401(k) fees are pending throughout the country.

"The main issue being sorted out in the courts now is: When does a plan participant have the right to bring a lawsuit against the company and the individual employees who monitor the plan?" says Lucke. "Do they get a ticket into court by simply making the statement: 'The fees are too high and the returns are too low'? Or do they have to show a grounded factual basis for that? In other words, was there imprudent activity, such as the plan committee did not make careful determination that the funds were generating returns substantially below well-known industry benchmarks? It's always easy in retrospect to say that [the plan] could have picked a fund with a better return or that the fee was too high, but is that enough to get a plaintiff into court?"

Protection from lawsuits

At the end of the day, plans sponsors can't do much about court decisions, says Lucke, but they can ensure that they are compliant with their fiduciary duties in the plans they sponsor.

"You can't do much about whether mutual fund fees are lower, but you can ensure that your 401(k) investment committee reviews funds carefully and also reviews fees when considering what is a good lineup of funds."

Fiduciary liability is more about the process than the returns, agrees Kunkle.

"Is there a fiduciary process in place to evaluate the providers and the cost of the funds? Is there a written investment policy statement that lays out rules on how the provider is chosen and evaluated on an ongoing basis?

Plan sponsors in general need to be more diligent about having an investment policy and utilizing the criteria within their investment policy statement."

Plan sponsors need to understand not only their fiduciary responsibilities in this litigious climate, but also the leverage they have, Kunkle says. "They can get the service they need. When they hire outside providers, they need to be sure they're getting the full package — service from the top all the way down.

They should insist on a platform that helps them meet their fiduciary responsibility initially and on an ongoing basis."

401(k) Fair Disclosure for Retirement Security Act

Plan sponsor-level disclosure:

>> Service providers must give a written disclosure of services to be provided and total charges for those services at least 10 days prior to entering into a contract with a plan sponsor.

>> Fees must be disclosed in dollars (estimate allowed) and may also be expressed as a percent of assets.

>> Disclosure must be broken down among the following categories:

1. Charges for administration and recordkeeping.
2. Transaction-based charges.
3. Investment management charges.
4. Other charges not captured, not described above.

Participant-level disclosure:

• At least 10 days prior to first contribution, the participant will receive standardized information on the investment options in the plan and a fee comparison chart comparing the investment returns and fees associated with the plan's investment options.
• Participants will receive a quarterly statement detailing contributions, earnings, fees, closing account balance and information on how to obtain an updated fee comparison chart.

Source: J.P. Morgan