Litigating Fees and Prudence- How do they relate?

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Litigating Fees and Prudence- How do they relate?

Much of the current litigation against 401(k) providers addresses the improper allocation of fees under the Employee Retirement Income Security Act (ERISA) section 406. But is it possible that the actual argument falls under ERISA section 404, the prudence standard? How is litigating fees and litigating prudence connected?

What is prudence? 

The definition of prudence and its application in allocating fees is a murky area. ERISA 404((a)(1)(B)) states that a fiduciary must act “with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.”

Put more simply, prudence requires the fiduciary to invest assets and allocate fees as if they were for himself. This process includes avoiding excessive risks, only charging reasonable fees, and considering the time horizon of the investor as well as the overall portfolio. The idea of prudence addresses the decision-making process, not the outcome of the investments. An investment does not have to do well to be considered prudent, but it must be part of an overall well-diversified investment portfolio.

How is this defined in court? 

A recent Plansponsor article considered the idea that perhaps the idea of prudence when it comes to “excessive fees” has not yet been clarified in the courts. Court cases such as Hecker vs. John Deere and Tibble vs. Edison seem to give contradicting advice on how thorough plan sponsors need to be when it comes to offering the most “reasonable” fee.

Since the cheapest fee is not always the best option, where does this leave plan fiduciaries in deciding how reasonable is reasonable? Even if a “reasonable” fee is determined, does that mean that the employer was also prudent? There are many questions that still lie in the courts as plan sponsors try to navigate a complicated compliance issue.

How, then, does one stay compliant when the lines are so blurry? 

Avoiding the risk of litigation is forefront on the mind of many plan fiduciaries. Though some answers will come from the results of current and future court rulings, there are a few common ways to stay compliant.

The first is to document everything. Documentation of the recommendations made, and the process of research and investigation behind those decisions, will lend to less risk of imprudence. It is recommended that the documents explain the methods used to investigate an investment or fee, and that the process and reasoning behind the decision is exemplified.

For an adviser, documentation should explain why a recommendation was right for the plan. For a plan fiduciary, the documentation should describe the investment decision made based on the recommendation of the adviser.

The second suggestion is to regularly benchmark fees. Fees need to be evaluated in terms of the value received in exchange for the cost. According to the Department of Labor, fees are considered unreasonable when they are excessive. That statement does not provide much guidance, but the best chance for compliance is to compare fees to those of similar organizations and investments. If measured against the averages of comparable companies, and if participants are getting a high value in comparison to cost, then compliance is likely.


Though prudence in excessive-fee cases is yet to be truly defined, there are tools to stay near compliance. Some may like to remember the adage, “a pure heart and an empty head are no defense to a breach of fiduciary duty claim.” We like to state that “a pure heart with a well-defined and documented compliance plan can be considered prudent.”

Samuel J. Sweitzer
Samuel J. Sweitzer
Founder and President of Anson Analytics, Inc. - an RIA firm specializing in Research Based Investment Management for Corporate Retirement Plans and Private Investors. Sam is a Chartered Financial Analyst (CFA) and currently serves as Anson's Chief Investment Officer. Sam resides in South Metro Atlanta with his wife and two daughters.

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