The Securities and Exchange Commission's investigation into the mu- tual fund industry has taken a new turn. Last month the SEC confirmed that it had sent questionnaires to two dozen large fund families, asking them to provide details about payments made to companies that service 401(k) plans. Among the fund companies contacted were American Funds Distributors, Fidelity Investments, Invesco, Janus Funds, New York Life Insurance Co.'s investment management unit, Putnam Investments and T. Rowe Price Group.
The SEC is focusing most of its attention on revenue-sharing, in which fund companies make payments to administrators or recordkeepers of 401(k) plans, using fees drawn from fund assets, to ensure that their products are among those offered as part of a 401(k) program.
"We are asking why funds are included in particular 401(k) plans," says Lori Richards, director of the SEC's office of compliance inspections and examinations. According to Ward Harris, CEO of McHenry Consulting and the first to release news of the SEC's questionnaire, the letter demanded that mutual fund firms answer the questions in writing no later than July 30. (The SEC would not confirm the deadline.)
One part of the SEC investigation concerns a range of administrative fees generally known as subtransfer agency fees. These charges, which cover recordkeeping and administrative services, do not have to be disclosed in the prospectus of funds that are part of a company's 401(k).
"Somewhere between 50 and 60 different structures of fees are collected off 401(k) plans," explains Trisha Bram-bley, whose consulting firm, Newtown, Pennsylvaniabased Resources for Retirement, has negotiated reduced fees for its plan sponsor clients. "It's a bit of a shell game. If it's cheap over here, then there must be more charges elsewhere."
Fees have multiplied, Brambley points out, as participants have demanded such specialized services as self-directed brokerage windows, wireless access to their 401(k) accounts and other costly add-ons. These fees come in one of two forms: either they are asset-based, drawn directly from the plan participants' accounts, or they are flat fees, charged on a per-participant or per-plan basis.
The payment structure is further complicated by the fact that some plan sponsors do not know which fee pays for what service. "Knowing the cost of each service is far more important than knowing the cost of the whole," asserts Mat-thew Hutcheson, a Portland, Oregon based consultant who also works with plan sponsors to reduce their fees. Hutcheson has repeatedly encountered plan sponsors who don't know how much they are paying their service providers and are so confused that they may be paying twice or even three times for the same service.
"I'd say that 99 percent of plan sponsors are not looking critically at the fees they are paying," says Edward Siedle, a former SEC attorney who is now president of Benchmark Cos., a consulting firm that investigates money management practices on behalf of pensions. "Even some operators of the largest defined contribution plans simply have not peeled the onion nearly far enough."
Subtransfer agency fees are collected by the plan administrator (also known as the recordkeeper) from the investment manager; the investment manager, in turn, collects these charges by deducting a pool of fees directly from plan assets. Subtransfer agency fees usually range from 5 to 25 basis points but can run as high as 65 basis points, according to Stephen Lansing, president of Orlando, Floridabased Sentinel Fiduciary Services, which consults with plan sponsors. Subtransfer agency fees are built into the overall expense ratio for funds; neither the plan administrator nor the investment manager is legally required to identify the subtransfer agency component of the expense ratio to a plan sponsor.
In some cases the sub-transfer fees include charges for education and communication services to participants as well as such shareholder services as custody for the underlying securities or multi-currency accounting for international funds. In other cases shareholder service fees are broken out as separate charges, again ranging from 5 to 25 basis points.
Occasionally, all these administrative fees are supplemented by another umbrella charge, known as a wrap fee. This fee can include investment sales commissions, for a total charge of roughly 5 to 100 basis points. The wrap fee is levied on top of a mutual fund's internal expenses.
Those are just the asset-based fees. The administrator -- which may be either a stand-alone entity or an arm of the company that owns the plan's asset manager -- also frequently collects flat fees paid directly by the employer out of its corporate treasury. Per-participant fees can range from $10 to $250 per person per year, depending on the structure of other charges. Some recordkeepers, for example, charge separate fees for voice response systems or Internet access; others include such extras in the flat fees per participant. Per-plan charges generally run about $2,500 a year for small plans but can be much higher for larger plans. Some 401(k)s pay both per-plan and per- participant administrative fees.
Between the asset-based fees and the flat fees -- some of which go to cover the same expenses -- "there's double-dipping, even triple-dipping, dipping into the money managers' pockets and even more directly into the participants' pockets," says consultant Siedle.
Certainly, administrators cope with a lot of gritty paperwork for their money -- keeping tabs on individual participants' contributions, their account balances, their loan payments and other withdrawals. In addition, most recordkeepers take care of government filings, making sure that the retirement plan complies, for example, with the laws and regulations of the Department of Labor and the Internal Revenue Service.
Sometimes, however, their fees can pit the interests of plan participants against those of the plan sponsor. This past winter Diana Minard, the comptroller of Kennewick, Washington based Pay Plus Benefits, who also chairs the trustees' board for her company's $5.1 million 401(k) plan, received a proposal from her plan administrator to restructure Pay Plus's various fees. The proposition: reshuffle the payment allocation so that a 111-basis-point fee came out of the company's treasury and a 96-basis-point fee came from the participants' assets. At first glance, the proposal looked like a money-saver for Pay Plus, since its flat fee had been slightly higher at 116 basis points.
But on closer inspection Minard realized that the fees that came from the participants' plan assets would have increased an average 19 basis points a year. "We decided not to do it for a combination of two reasons," explains Minard. "First, the change clearly would not have been in the best interests of our participants and their beneficiaries. But also such a change would have violated our fiduciary responsibilities."
Jennifer Marconi Flodin, COO of Chicago-based Plan Sponsor Advisors, contends that administrators can make handsome margins on these fees. She calculates that it costs recordkeepers $81 per participant per year to run a 401(k) plan with 500 participants. The per-participant costs fall as the plan gets larger and economies of scale begin to kick in. One of Flodin's clients has 531 participants and $33 million in assets. It pays a flat fee of $16,641, a subtransfer agency fee of 20 basis points ($66,000) and a wrap fee, for unspecified administrative purposes, of 8 basis points ($26,400). With other plan expenses, the grand total comes to $870 per participant.
The DoL has approved these bundled fee arrangements since their inception in the 1980s. In late May, however, the department launched a campaign to educate plan sponsors about their fiduciary duties, which include obligations to keep plan costs prudent and to demand a full accounting of all fees charged and services rendered. The education program targets employers with fewer than 1,000 employees; those firms generally pay higher fees.
"Our own investigations have discovered a troubling lack of understanding among fiduciaries about their responsibilities," said labor undersecretary Ann Combs at a press conference in May.
To date, the Labor Department has not brought any enforcement actions against employers for their failures as fiduciaries to demand complete fee disclosure. But that could soon change. As of October of this year, the DoL will have boosted its field-office staff by more than half, bringing the total number of government employees reviewing potential fiduciary failures up to 645.