This article was prepared by Fred Reish, Bruce Ashton and Josh Waldbeser.

Letters to 6,000 sponsors of 401(k) plans, sent out by a Yale law school professor several weeks ago, generated considerable comment and controversy.  Some of the letters we reviewed suggested that the recipients were operating a “potentially high-cost plan” and that the fiduciaries may have breached their fiduciaries duties.  We sent an article by email a couple of weeks ago describing these letters and giving you a link to our bulletin on the Drinker Biddle website.  (A copy of that email is at http://fredreish.wpengine.com/mass-mailing-to-plan-sponsors-about-excess-fund-fees/)

Since the last email, we have been able to do a more in-depth analysis of the professor’s underlying study and have concluded that it has material limitations.  As a result, it does not provide a valid basis for concluding that fiduciaries have breached their duties.  We have put together an “open letter” to the retirement plan community, together with a memorandum that supports our analysis.

Chief among the deficiencies are the use of stale data, the failure to consider the plan design and services being offered by the plan and, perhaps most important, the failure to take into account revenue sharing used to pay the costs of plan administration and/or to provide a return to the participants.

You can obtain a copy of the letter and memorandum at http://www.drinkerbiddle.com/resources/publications/2013/401k-controversial-yale-letters.

I imagine that, by now, you have heard about the Court of Appeals decision in Tibble v. Edison. While the court decided a number of issues, the most important one is that fiduciaries have an obligation to select appropriate share classes for their plans. Closely related to that is the trial court’s admonition that fiduciaries must ask about the available share classes.

ERISA imposes both a fiduciary rule and a prohibition on spending more than reasonable amounts for operating a plan, including the investment costs. The Tibble decision was about the reasonable expense ratios for plan investments. However, rather than looking at the evaluation of mutual fund expenses in the traditional way (that is, comparing expense ratios to those of other funds), the trial court found, and the appellate court agreed, that plans must use their purchasing power to select the appropriate share class. The practical consequence is that advisers should make recommendations based on the share classes available and must educate plan sponsors about the available share classes, including their costs, and plan sponsors (typically acting through their plan committees) must understand that multiple share classes may be available and must investigate which are best for their plan and participants.

That could be a daunting task. Just consider that some mutual funds may have 10 or more share classes. That could include, for example, A, B, C, I, R-1, R-2 shares, and so on. This will place an additional burden on advisers . . . and, in that sense, may favor advisers who focus on retirement plans.

But, it is more complicated than that. Share classes for mutual funds and separate account “classes” for group annuity contracts may, for these purposes, be virtually identical. If that is true, advisers will need to educate plan sponsors on the classes available in group annuity contracts. Then, advisers will need to help plan sponsors select the appropriate separate account class for that particular plan. Since some insurance companies offer group annuity contracts with 10 or even 15 separate account classes, advisers will need to be more attentive to the alternatives that are available and will need to work with plan sponsors to understand the share and separate account classes (including the revenue sharing and compensation aspects) and to select the appropriate classes based on the size and needs of the particular plan.

In the future, we could see litigation where advisers did not educate plan sponsors on the availability of alternative classes and do not make appropriate recommendations.