In Loomis v. Exelon, the U.S. Court of Appeals for the Seventh Circuit held that a plan administrator did not breach its ERISA fiduciary duties by offering “retail” mutual funds with higher administrative fees, instead of only “institutional” mutual funds, as part of its 401(k) investment line-up.  In coming to this conclusion, the Seventh Circuit affirmed its 2009 ruling on this issue in Hecker v. Deere.  The court also ruled that there was no fiduciary duty to have the plan bear such administrative fees, as opposed to the plan participants. 

By way of background, mutual funds can offer different classes of shares.  Retail shares are offered to the general public and generally deduct expenses from assets under management based on a fixed percentage of assets under management (often referred to as the “expense ratio”).  Institutional shares, which also use the expense ratio model to assess fees, are typically offered only to larger or “high-value” investors, which can include ERISA-governed plans, and typically have higher minimum investment requirements than retail mutual funds.  However, institutional shares tend to have lower administrative fees and expenses than retail shares.  

In Loomis, participants in the company 401(k) plan claimed that the plan’s fiduciaries breached their fiduciary duties on two primary grounds.  First, they claimed that the plan administrator should have selected only institutional mutual funds for the plan’s investment options, based on the rationale that institutional mutual funds always have lower expense ratios than retail mutual funds.  Second, they argued that the employer, and not the plan’s participants, should have been required to pay the expenses charged by the plan’s investment vehicles.

In rejecting the claim that the plan fiduciaries breached their fiduciary duties by offering retail mutual funds, the court relied on its analysis of this issue in the 2009 case of Hecker v. Deere.  Just as in Loomis, the court in Hecker was required to examine whether a plan administrator breached its ERISA fiduciary duties on the basis that the retail mutual funds’ fees were “excessive,” as compared with the fees charged by institutional mutual funds.  The court began its analysis by examining whether the 401(k) plan at issue offered a sufficient mix of investment options to plan participants and beneficiaries, for purposes of compliance with the U.S. Department of Labor’s regulations under ERISA Section 404(c).  If a 401(k) plan fiduciary complies with the 404(c) regulations and a plan participant or beneficiary exercises independent control over the assets in his or her individual account, then the 401(k) plan fiduciary will not be liable for any loss or breach of ERISA’s fiduciary duties that is the direct and necessary result of the participant’s or beneficiary’s exercise of control.  Under the 404(c) regulations, the 401(k) plan fiduciary must provide at least three investment options and permit the participants or beneficiaries the opportunity to give instructions to the plan with respect to those options at least once every three months.  The court in Hecker concluded that the plan did offer a sufficient mix of investment options – it offered 25 retail mutual funds and access to a brokerage service that made available for investment an additional 2,500 funds managed by different companies.

The court then rejected the claim that the retail mutual funds’ fees were excessive for two reasons.  First, the court noted that the retail mutual funds’ were not imprudent where they were the same fees charged to the general public.  Second, as the court explained:

The fact that it is possible that some other funds might have had even lower ratios is beside the point; nothing in ERISA requires every fiduciary to scour the market to find and offer the cheapest possible fund (which might, of course, be plagued by other problems).

In light of Hecker, the court in Loomis concluded that the company 401(k) plan’s offering of a total of 32 investment options, which consisted of an array of high-risk, high- and low-expense, and potentially high investment options, constituted a sufficient mix of investment options for purposes of the DOL’s 404(c) regulations, and, regardless of that regulation, such broad offerings within the plan prevented plaintiffs from arguing that offering any retail funds was a breach of fiduciary duty.  Following the reasoning in Hecker – that retail mutual funds’ fees were not excessive because they are set by a market that is open to the general public -- the court in Loomis likewise concluded that the fees of the retail mutual funds offered under the company 401(k) plan were not excessive.  The court also noted that retail mutual funds generally had certain advantages over institutional funds – daily valuations and more liquid – which could make up for higher fees, and pointed to an amicus brief filed by the Investment Company Institute, which contained data showing that institutional funds did not always have lower expense ratios than retail mutual funds.  In other words, the court disagreed with plaintiffs’ premise that offering retail funds (regardless of mix of investments) was inherently a bad thing.

The court quickly disposed of the participants’ claim that the employer, and not the participants, should have paid the expenses associated with investing in mutual funds as a “non-starter.”  It explained that an ERISA 401(k) plan fiduciary’s duties are limited to the requirements of honest and prudent management of the assets under his or her control and did not govern the amount the employer contributed to the plan. 

Loomis is the latest appellate decision to consider whether retail mutual funds charge fees in an amount and manner that makes them inappropriate for inclusion in a 401(k) plan’s investment line-up.  In Renfro v. Unisys Corp., decided August 19, 2011, the Third Circuit concluded that a 401(k) plan’s mix of 73 investment options, which had a variety of risk and fee profiles, including low-risk and low-fee options, did not support a claim for breach of fiduciary duty based on excessive retail mutual fund fees.  In Braden v. Wal-Mart Stores, Inc., decided in 2009, the Eighth Circuit applied a similar analysis but reached a different result based on the facts.  There, a national company offered 10 retail mutual funds in its 401(k) plan, and an allegation that the plan’s fee arrangement involved a kickback scheme.  In Loomis, the court distinguished Braden, noting that there were no specific allegations of any impropriety or self-dealing.

What does this mean for you?  Except for the alleged impropriety in the Eighth Circuit case of Braden, claims that retail mutual funds’ fees are excessive have been non-starters where fiduciaries can demonstrate, through the scope and breadth of the 401(k) plan’s investment offerings, that they have done their due diligence in selecting and monitoring their 401(k) plan’s investment options.  Employers and 401(k) plan fiduciaries who have done their due diligence in this regard should feel very comfortable.