Hidden Agenda?

Smaller employers as well as advisers could become entangled in the current wave of 401(k) fee lawsuits, if a recently filed case is a harbinger of things to come.

Bruner v. VLP Corp. Servs., LLC, filed June 26 in U.S. District Court District of Kansas, centers on the 401(k) plan at a Wichita, Kansas medical practice, Orthopaedic & Sports Medicine at Cypress, LLC (OSM). The plan’s three trustees—doctors in the practice—filed the suit on behalf of the plan and its participants. Previous 401(k) fee suits focused on very large corporations, but the plan’s 2007 Form 5500 indicated that it had $2 million in assets, says Gregory Ash, an Overland Park, Kansas-based partner at law firm Spencer Fane Britt & Browne LLP, who recently was retained by two of the lawsuit’s defendants. (He was interviewed prior to being retained.)

Defendants named in the suit include the plan’s custodian The Charles Schwab Corp., its former recordkeeper VLP Corporate Services, LLC (which the plan replaced in early 2008), and investment consultant SJP Advisors, LLC. Reports have suggested that VLP and SJP are affiliated. VLP’s in-house legal counsel, Christine Mora, says they “are not under the same ownership structure,” but declines to comment further.

The lawsuit filing is unclear on the advisory firm’s role, but gives the impression that, while not hired as an adviser by the employer, SJP got involved in recommending investments to the sponsor, says Sherwin Kaplan, a counsel at law firm Nixon Peabody LLP in Washington and a former U.S. Department of Labor official. “[SJP] was not an adviser to the plan, but acted solely as a subadviser to the model portfolios,” Mora says. All management fees paid to SJP were “fully disclosed” to the employer and “continuously available to the plan sponsor and its participants through the VLP Web site,” she says.

The complaint’s accusations include charging excessive fees, SJP and VLP effectively setting their own compensation by disbursing plan assets to themselves via Charles Schwab Trust Co. without the sponsor’s knowledge, and failing to adequately disclose the revenue-sharing they received. Because the providers effectively exercised fiduciary control over the plan for the purposes of enriching themselves, the complaint says, they violated ERISA.

The complaint compares the recordkeeping fees it says were charged by VLP with those of its replacement, Allen, Gibbs & Houlik, LC (AGH). If the plan “had engaged AGH in 2007 instead of VLP to provide recordkeeping services, compensation paid to the recordkeeper for the Plan would have been $2,425 instead of $15,106,” the complaint says, adding that the services provided were “virtually identical.”

The suit also claims: “Defendants replaced mutual fund shares with higher-cost shares of a different class of the same mutual fund in order to receive higher compensation without providing any additional services for the additional compensation.” Some previous fee suits argued that revenue-sharing is inherently illegal. “These guys do not ever say that revenue-sharing is wrong: They say that there was improper revenue-sharing, undisclosed revenue-sharing,” Kaplan says. “A lot of the prohibited transactions [the plaintiffs] talk about would be legal if there was full disclosure and the plan sponsor was making the decisions.”

An attorney for the plaintiffs, Kurt Harper of the law firm Sherwood, Harper, Dakan, Unruh & Pratt, LC, in Wichita, Kansas, declined to discuss the case.

Defendants’ response

While Schwab spokesperson Michael Cianfrocca says the company generally does not comment on pending litigation, he adds: “It is important to note, however, that Schwab’s fee information was made available to the plan sponsor, and the Schwab fees were relatively low in terms of dollar amount and as a percentage of plan assets. Schwab remains committed to working with plan sponsor clients to provide competitively low fees.”

Kaplan is asked why he thinks the lawsuit included Schwab among its targets. “First, Schwab is a deep pocket.  Second, according to the complaint, the plaintiffs went to Schwab originally, and Schwab brought in the other providers. Third, Schwab is a known name and has its reputation to consider. This might make it want to settle rather than go to trial.” 

David Park, a VLP partner, says in an interview that he finds the lawsuit’s claims baffling. “The allegation that there was some sort of hiding by us is really very confounding,” he says. “The irony of this is that we have been preaching open architecture and total visibility for so long.”

VLP operated only within the guidelines of its service agreement with the sponsor, Park says. “Nowhere in there do we have any discretion or control,” he says, adding that it specifically stated VLP was not a fiduciary. The recordkeeper did not go beyond the activities or fees specified in the service agreement, he says, including unauthorized transfer of plan assets.

As for the fee allegations, “They are not making a valid comparison” with the replacement recordkeeper, Mora says. The plan originally came to VLP as a startup plan with no assets, Park says, and the fee structure for start-up plans differs from multimillion-dollar plans. “We feel that our fees were industry standard,” Mora says. She adds that the complaint alleges “that VLP received total compensation of $17,018.40 for 2007 for providing recordkeeping services, which is a complete misstatement of fact. VLP has reviewed its billing to OSM, which averaged $3,000 per year for recordkeeping services since 2003.”

Asked to respond to the claim that the providers steered the sponsor to higher-cost investment options, Park says, “All we do as a vendor is provide them a platform; they could have chosen any of the investments. We never made recommendations to the plan sponsor.”

 “The thing that is remarkable about this case is that it is a very small plan,” says Fred Reish, Chair of the Employee Benefits Practice at law firm Reish & Reicher in Los Angeles. “I am surprised to see a lawsuit for a plan with less than $10 million or $20 million in assets. My reaction was, ‘Where is the money?’” Still, he expects the fee lawsuits to “hit the mid-market—$25 million to $100 million in assets—next, as local and regional plaintiffs’ firms become more familiar with these cases.”

“It is such a small plan and there are so few dollars that appear to be at stake,” Ash says, “but the larger importance is in the fact that small plans are not immune from this scrutiny and potential litigation.” The sorts of large corporations previously sued typically have a fiduciary committee with well-established procedures that they document and carefully follow, he says. “In the small-plan market, it is much more likely that plan sponsors have not paid attention to the fees, which puts them more at risk.”

However this case turns out, Kaplan already sees messages for advisers, vendors, and employers. “A lot of advisers and providers are waiting for the Labor Department to come out with regulations or Congress to act, and they say, ‘Why should we disclose if we are not forced to?’” he says.

If the case’s allegations prove true, he says, “The way they could have avoided a lot of these problems was to be much more transparent in the first place.”