Having just returned from a two-day ERISA litigation conference in Chicago, the topic of fee benchmarking is top of mind. During a rousing session about excessive fee allegations, plaintiffs’ counsel Greg Porter (partner with Bailey Glasser LLP) and defense counsel Eric S. Mattson (parter with Sidley Austin LLP) discussed fiduciary litigation, the Exclusive Benefit Rule, the concept of “reasonableness,” revenue sharing and much more. What is clear is that this type of dispute between plan participants and sponsors (and their service providers) is likely to show up with increased frequency and extend to other types of employers such as cities and states that provide retirement benefits to their workers. Although municipal plans have not yet squared off in the courtroom against unhappy employees who assert that they are paying too much in fees, recent headlines portend change.
Claims in an April 9, 2015 press release from New York City Comptroller Scott M. Stringer document a concern about the adverse impact of “high fees and failures to hit performance objectives” that “have cost the pension system some $2.5 billion in lost value over the past decade.” According to “The Impact of Management Fees on Pension Fund Value,” a ten-year “healthy” gross rate of return of 6.5 percent is actually smaller by $2.5 billion when vendor compensation is taken into account. Based on the data considered, private equity has been the largest drag on performance with total value subtracted in the amount of nearly $2 billion.
In Pennsylvania, Governor Tom Wolf is bent on closing a $50 billion pension deficit by taking actions such as lowering costs. A renegotiation of $662 million in fees paid to investment managers by its biggest state retirement systems, the Pennsylvania School Employees’ Retirement System and the Pennsylvania State Employees Retirement System, could save money and put the plans on more of an equal footing with the national average of fee levels. See “Gov. Wolf thinks pension funds paying too much in fees” by Len Boselovic (Pittsburgh Post-Gazette, April 12, 2015). Others point to an anemic contribution rate as the culprit. In “The Annual Required Contribution Experience of State Retirement Plans” (March 2015), National Association of State Retirement Administrators (“NASRA”) researchers Keith Brainard and Alex Brown categorize New Jersey and Pennsylvania as outliers due to their “notably” low Annual Required Contribution (“ARC”).
Although a few years old, a database at Governing.com presents state-specific information about change in dollar assets and management fees. Refer to “Are State Pension Funds Paying Wall Street Too Much?” by Mike Maciag (Governing, August 15, 2012). A report by the Maryland Public Policy Institute examines its experience relative to that of other state retirement plans with a specific focus on whether Wall Street advisors should charge less by eschewing actively managed strategies and adopting a passive approach instead. Click to read “Wall Street Fees, Investment Returns, Maryland and 49 Other State Pension Funds” by Jeff Hooke and John J. Walters (July 2, 2013).
Disclosure of said fees is another component of the ERISA litigation world and will surely be part of municipal lawsuits as well. In its February 18, 2015 no-action letter, the U.S. Securities and Exchange Commission (“SEC”) informed non-ERISA plan sponsors about its reporting obligations in order to avoid compliance mishaps relating to Rule 482 of the Securities Act. Each investment vendor to a reporting entity such as governmental and other non-ERISA sponsors of 457(b) deferred compensation plans, 403(b) plans and church 401(a) plans must agree in writing that it will “provide the DOL required investment information on each investment option it offers under the particular non-ERISA plan, as well as the respective fee and expense information…” on a regular basis. Click to read the SEC letter to the American Retirement Association.
Having worked as an economic expert on fee cases for plaintiffs’ counsel as well as defense counsel (depending on the matter at hand) and having carried out various research projects as a fiduciary consultant, my take is that these cases are seldom simple. Fee arrangements can reflect bundled services that must be thoroughly understood as part of the benchmarking exercise. An asset manager’s fee may be higher than another fund that generates a similar historical return because that investment company has implemented robust risk management technology or otherwise put in place protective mechanisms that are meant to protect institutional investors (and by extension, their beneficiaries). The key to unlocking fee “truth” is to examine a variety of facts and circumstances and then seek to compare vendor compensation levels against those of real peers.
In anticipation of further “excessive fee” cases that allege bad practices on the part of ERISA and non-ERISA plans, the industry will no doubt spend considerable time on what levels make sense and why.