Fiduciary Responsibility and Mutual Fund Fees


Fiduciary responsibilities can be stressful for any business administering a 401(k) plan, with investment-related responsibilities being especially daunting. One of the most difficult investment-related responsibility is ensuring participants are paying reasonable fees for their mutual funds. This can prove to be difficult to find the cheapest, yet most effective option due to the sheer amount of investment options. Operated by money managers, a mutual fund is a vehicle made up of money collected from multiple investors to invest in securities.

Mutual fund companies make their funds available to 401(k) plans in various share classes, but they can charge a wide range of fees, creating confusion for fiduciaries. As a 401(k) plan sponsor, it is integral to monitor and understand the fee structures implemented by mutual funds to ensure your participants are being charged fairly.

Fiduciary Responsibility and Fees

Fiduciaries often are aware of administrative and disclosure requirements, but sometimes become negligent when choosing funds with reasonable fees. Even those who are aware can inadvertently fail to select the best mutual fund. While 401(k) fees have decreased in recent years because of litigation and various Department of Labor (DOL) regulations, mutual funds can still charge indirect fees that DOL would deem unreasonable.

Unfortunately, fiduciaries with little knowledge regarding fee structures may authorize a plan to charge fees, decreasing participant balances. Providers of 401(k) plans don’t have that responsibility, and employers are often left responsible for failing to choose the lowest-priced share class available.

Types of Fees

In general, when it comes to mutual funds, there are two categories of direct and indirect fees; shareholder expenses and operating expenses.

Shareholder expenses apply to investor transactions and account maintenance. This includes sales loads and redemption, purchase, exchange and account fees. Sales loads are easiest to understand as commission to the broker who sells the fund. The sales load can be applied at purchase (front-end) or sale (back-end) sales load, but the commission is paid to an outside broker.

Like sales loads, redemption and purchase fees are collected at purchase or sale. However, the amounts are paid to the fund company instead of a broker. Shareholder expenses also include account fees that can be assessed on funds without sales loads or that fall below a minimum balance.

Operating expenses are charged to cover regular and reoccurring fund expenses, such as management fees paid from fund assets to the investment advisor managing the portfolio. Passive funds such as index funds are less expensive because they require less advisor activity.

Also, distribution fees and service 12b-1 fees are paid from fund assets for marketing and selling fund shares to compensate brokers who market the fund. These types of fees are commonly called “revenue sharing”. Revenue sharing is a process of deliberately overcharging at the funds expense ratio level to pay other vendors such as the broker or recordkeeper. Other expenses can include custodial, legal, accounting and other administrative expenses.

Key Points to Consider

Mutual funds are legally obligated to disclose all fees in their prospectus and they usually put information for all share classes in one single prospectus. Responsibility for verifying these fees falls on plan fiduciaries. Mutual funds can make periodic changes to their share classes, so frequent review is necessary.

The impetus once again is on the fiduciary to understand the differences in share classes and how they compare. For those who prefer not to review a prospectus on a regular basis, no-load shares would appear to be an easy pick. There are no commissions to be paid (Revenue Sharing) and expense ratios can be low, although close attention should be paid to other shareholder expenses.

N shares are most often provided by no-load mutual fund providers. These shares have neither an up-front or deferred sales charge. If a no-load fund company wants to offer a fund with different expense levels for different types of investors, the fund will have more than one class of shares.

Institutional shares (aka I shares) are generally only available to institutional investors with minimum investment amounts of $250,000 or more. In cases of 401(k) plans, breakpoints can be met to use the institutional share class fund, which typically has lower expense ratios than other share classes.

There are also Class R shares, sometimes known as retirement shares, which do not have a “load” (front-end, back-end or level). These shares have 12b-1 fees that typically range from 0.25% – 0.50%. These mutual funds are only available through employment-based retirement accounts, meaning you cannot purchase them on the open market. Often carrying annual expenses, Class R shares are intended to provide income in future years rather than short-term lump-sum payments.

It is wise to take advantage of any matching contributions your employer may make when you contribute to your own 401(k). However, be sure to pay attention to the expense ratio, especially if there is no employer match. Therefore, you may choose to open your own account and find a no-load fund.

Fiduciary Burden

While those basics can help an uninformed fiduciary navigate the fees associated with mutual funds, they will not cover all fiduciary responsibility to ensure reasonable fees. Mutual funds can charge a range of percentages of fees, and the SEC does little to regulate the amount charged.

The most important thing for fiduciaries to keep in mind is that while mutual fund fees can fall along a large continuum, all hold similar security. Also, more-expensive funds do not necessarily equate with better service. A higher management fee does not guarantee the fund will perform any better than a passive index fund.

Fee summary sheets and prospectuses should be reviewed regularly to prevent expensive funds from being the only option for plan participants.

Securities and Advisory services offered through LPL Financial, a registered investment advisor. Member FINRA/SIPC.

This information is not intended as authoritative guidance or tax or legal advice. You should consult your attorney or tax advisor for guidance on your specific situation.

Brian Menickella is a co-founder and managing partner ofThe Beacon Group of Companies, a broad-based financial services firm based in King of Prussia, Pa.

The Beacon Group of Companies and LPL Financial are separate entities.

Investing in mutual funds involves risk, including possible loss of principal.

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