In our reviews of investment advisory agreements for retirement plans, we are often disappointed by the lack of clarity about the extent of the fiduciary responsibilities being accepted by the advisers. In many cases, that is due to a lack of understanding of the legal responsibilities that are associated with fiduciary status, as well as a lack of knowledge of the scope of activities that the law – and the courts – might include under the heading of “investment advice.”

These problems were illustrated in a recent court decision where the plaintiffs sued a bundled 401(k) provider and an associated investment adviser (that is, an adviser whose services were offered in connection with the provider’s 401(k) platform). The complaint asserted that an investment adviser to a retirement plan owes a duty to the plan to evaluate both investment expenses and revenue sharing. In its ruling on a motion to dismiss, the Court said:

“In essence, the adviser would have this Court accept the extraordinary proposition that an investment adviser, acting in a fiduciary capacity, that is retained to evaluate investment options for a Plan nevertheless has no obligation to perform the following basic duties:

  • Investigate the amount of fees charged in relation to potential investments;
  • Investigate the financial arrangements that the mutual funds offered to 401(k) profit sharing plans have with “service providers” and similar entities, such as the 401(k) provider, and the effect of those arrangements upon mutual fund fees;
  • Determine the impact that the mutual funds’ financial arrangements with service providers have on the costs and fees associated with the investment options offered to 401(k) profit sharing plans;
  • Determine the extent to which the service provider’s financial arrangements with mutual funds affect the investment options that are offered to 401(k) profit sharing plans—from which the investment adviser chooses mutual funds to recommend.

In summary, the adviser would have this Court hold that an investment adviser, although a fiduciary, has essentially no duties to a 401(k) profit sharing plan related to investment advice for which it is evaluating investment options. Such a holding would be directly contrary to the letter, and spirit, of ERISA.”

We have deleted the names of the adviser and the provider since this quote is from a preliminary ruling and does not reflect findings on the facts after a contested trial. Subsequent to this ruling, the case against the adviser was settled.

Also, to be fair to the investment adviser in this case, its ability to recommend mutual funds was limited to a pre-set and finite list of investments. The adviser agreed that, since the plan sponsor had already limited its plan to those funds, the adviser was not obligated to provide additional information about the costs or the revenue sharing.

Because of those arguments and the fact that the case was settled, the case cannot be considered as ultimate authority on this subject, but instead is a good illustration of the importance of specifically dealing with expenses and revenue sharing in investment advisory agreements.

In our experience, most 401(k) investment advisers do consider the expense ratios of the investment alternatives (e.g., the mutual funds). However, it is not clear from some of their advisory agreements whether they must take into account the costs embedded in the expense ratios that are used to subsidize recordkeeping and other plan services. Also, many advisers are willing to examine and evaluate payments from the investments to service providers (for example, recordkeepers), but it is often considered a separate service for a separate fee. Unfortunately, though, many advisory agreements are silent on that issue – exposing the advisory firms to potential claims.

Investment advisers need to consider the full range of potential fiduciary responsibilities and claims, and need to draft their agreements accordingly.