The DOL’s proposed regulation on selecting investments, including alternative assets, 2026-06178.pdf, identifies six factors that need to be considered in the process of selecting any investments for participant-directed plans, such as 401(k) plans and private sector 403(b) plans. The six factors are: Performance, Fees, Liquidity, Valuation, Performance Benchmark, and Complexity. The proposal describes each of those factors and provides 20 examples of their application.
In my post, Alternative Assets (9), I discussed the second factor, Fees. This article looks at the first DOL example of the application of the Fees factor.
The example is:
(1) Example. Fees; Customer service—
(i) Facts. The named fiduciary of a plan (e.g., the plan sponsor or plan investment committee) considers five stock funds that follow similar strategies in passively tracking the same index. The named fiduciary evaluates the funds with the assistance of a third-party investment advice fiduciary within the meaning of section 3(21)(A)(ii) of ERISA and finds that the five funds have had similar historical risk-adjusted returns and liquidity, and that the funds have very different ratings for customer service and communication. The named fiduciary selects the fund with the highest fees and highest rating for customer service and communication. This fund offers knowledgeably staffed call centers dedicated to retirement plan investors, short wait times, clearly written investor communications, safe and easy online access for participants, and published surveys and ratings that demonstrate an exceptional commitment to customer service. The difference between the funds with lowest and highest fees is one quarter of one basis point.
Comment: I will discuss the service issue at the end of the quoted example. However, for the moment, I want to address the example’s use of five competitive funds for an investment slot in the plan’s menu. As you may remember from earlier posts, in the proposal the DOL requires that fiduciaries consider a reasonable number of investments before making a decision. Some examples use three funds as a suggested reasonable number; this one uses five. As a practical matter, I don’t think that 3 or 5 is a statistically valid number for determining whether the fees are reasonable or representative of the expenses of a particular asset class and investment style. For example, a limited number of small cap index funds would not be enough to have confidence that the common costs for that type of investment had been properly determined. Fortunately, there are quality investment data services that use much larger databases to produce information that is statistically valid. Once that information is obtained, it could then be compared to a small number of funds under consideration.
(ii) Analysis. A plan fiduciary must consider a reasonable number of similar alternatives before selecting a designated investment alternative. Although the determination of what constitutes a reasonable number is dependent upon the specific facts and circumstances of each case, section 404(a)(1)(B) of ERISA and paragraph (h) of this section do not require a plan fiduciary to consider every similar alternative available in the market. Likewise, whether alternatives are similar is dependent on the specific facts and circumstances of each case. After considering a reasonable number of similar alternatives, a plan fiduciary must determine that the fees and expenses of the designated investment alternative are appropriate, taking into account its expected risk-adjusted returns and the value the designated investment alternative brings in furthering the purposes of the plan. All else being equal, a plan fiduciary must rely on the value proposition of a designated investment alternative with higher fees and expenses than similar alternatives with lower fees and expenses when choosing that designated investment alternative.
(iii) Conclusion. The named fiduciary in this example does not fail to satisfy section 404(a)(1)(B) of ERISA and paragraph (h) of this section solely because it did not select the alternative with the lowest fees and expenses. The named fiduciary enlisted the services of an investment advice fiduciary within the meaning of section 3(21)(A)(ii) of ERISA. The named fiduciary considered and determined that the five specific alternatives were a reasonable number of alternatives to have considered, taking into account the role of the designated investment alternative in furthering the purposes of the plan, their similar strategies, historical performance, and liquidity. In addition, the named fiduciary considered and determined that the higher fees and expenses are appropriate considering the value of increased customer service and communication. [The bolding throughout the article is mine]
Comment: I don’t have a problem with the conclusion or the reasoning. However, I don’t think the facts in the example are realistic. In my experience, participants may call a plan’s recordkeeper for information, but I haven’t seen participants call the mutual fund managers or distributors to ask for information. Maybe my experience is too limited, but I don’t think so.
This may indicate that the DOL needs to issue an RFI, request for information about how participant-directed plans work and what services are provided to participants. Based on my reading of the regulatory package as a whole, I think there is a need for the DOL to have information about the prudent practices of smaller and mid-sized employers and their plans.
I also think that the DOL should have emphasized that the cost of the additional services cannot exceed the value of the services to the participants. That is, there is a weighing requirement; the fiduciaries must balance the additional value against the additional cost. If you read between the lines, the DOL appears to suggest that in its statement that the additional cost was only “one quarter of one basis point”.
In the preamble’s discussion of the example, the DOL makes its point clearly:
6.2. Fee Examples
Paragraph (h)(1) of the proposed regulation provides an example demonstrating that a plan fiduciary is not considered imprudent solely because it selected a designated investment alternative with higher fees than other alternatives that have comparable risk-adjusted returns. Consistent with case law, this example illustrates that the duty of prudence does not include a categorical requirement to always select the alternative with the lowest fees even within a group of alternatives with comparable risk-adjusted return. In this example, the plan fiduciary prudently exemplary customer service as the value proposition of the designated investment alternative with higher fees, compared to the other similar alternatives being considered.
Concluding Thoughts
By and large, I agree with the points made by the DOL. However, I am concerned that their examples are inconsistent with how participant-directed plans work—and particularly smaller and mid-sized plans.
Nonetheless, the point is a good one. Fees and costs must be reasonable, but value is part of the equation, that is, if services are valuable for participants, then it is prudent to pay reasonable amounts to obtain that value.
