Fiduciary Breach Lawsuit Issues Explored - Topic #2: Asset-Based vs. Per-Participant Fees

With more than 100 lawsuits filed against the fiduciaries of defined contribution retirement plans for breach of their responsibilities, litigation has plagued the retirement plan industry over the past decade. While the original lawsuits focused on large corporate 401(k) plans, litigation has expanded to include large healthcare organizations and higher education institutions, with more than twenty suits filed against these sponsors since 2016. Other lawsuits have even trickled down to medium- and small-sized retirement plans, rendering all plan sponsors as potential targets.

The claims in these lawsuits cover a broad range of topics and issues related to actions taken or not taken that may have limited the potential growth of plan participant account balances. Most of the claims focus on fees charged in the plan, or investments used that have not performed adequately to yield the return participants should have received.

Last month, we provided an in-depth exploration of active versus passive investments as one of the topics alleging fiduciary breach. This month, we discuss asset-based fees versus per-participant-based fees as it relates to the defined contribution lawsuits.

Topic #2: Asset-Based Fees versus Per-Participant Fees

A claim asserted by plaintiffs in many of the defined contribution plan lawsuits is that retirement plan fiduciaries allow recordkeepers to charge fees based on assets in the plan, through revenue-sharing arrangements, when they should charge a flat-dollar amount per participant. The argument behind this claim is that the cost for providing recordkeeping services to participants should be roughly the same, regardless of the amount of assets a participant has in his/her account. The implications of an asset-based fee structure are that as assets grow, the recordkeeper will receive more fees for performing the same work, as opposed to the per-participant fee model, where recordkeepers only receive higher fees when they provide more work, as the plan adds additional participants. In some of these lawsuits, the plaintiffs cited industry experts claiming that the fees for most large plans should not exceed $35 per participant.(1)

Historically, the majority of plans have had their recordkeepers charge fees on an asset basis, through revenue sharing arrangements. Just as the investment managers for the mutual funds included in plan lineups charge asset-based fees, so do the recordkeepers, incorporating those fees into the expense ratios of the investments. Only in the past 5-7 years has there been serious discussion about, and some migration to, charging per-participant fees for recordkeeping services.

In some of these lawsuits, this claim has survived the motion-to-dismiss stage. Judge Forrest in Sacerdote v. New York University dismissed some of the plaintiff’s claims, but allowed this one to carry through to the discovery phase.(2) In Cunningham v. Cornell University, the plaintiffs put forth a similar claim that, “Defendants failed to solicit bids from vendors on a flat per-participant fee.” The presiding judge took a similar view to this claim and denied the motion-to-dismiss stating that it “plausibly stated a claim for relief at this stage.”(3)

However, not all judges have held the same view. Various judges have found that this argument about charging per-participant fees instead of asset-based fees lacked sufficient merit. In the Divane v. Northwestern University case, the defense was successful in having the claim dismissed. This was in part because the defense emphasized how per-participant fee structures disproportionately impact participants with smaller account balances. Per-participant fees of $75-$100 or more can devour a significant portion of smaller account balances, whereas the impact is less severe for participants with higher account balances. From this perspective, the judge concluded that it is not inherently imprudent to allocate fees on an equal percentage of assets basis, as opposed to an equal fee basis. The judge referenced Hecker v. Deere, where the Court concluded that, “it did not violate ERISA to use revenue-sharing for plan expenses. Thus, there is nothing wrong, for ERISA purposes, with the fact that the plan participants paid the record-keeper expense by the expense ratios they paid. The facts, as the plaintiffs alleged them, do not constitute a breach of fiduciary duty.”(4)

In the case of White v. Chevron Corporation, the plan fiduciaries showed that they had negotiated with their recordkeeper to introduce lower-cost share classes of the investments, out of which asset-based fees were being paid. Additionally, they migrated from an asset-based fee to a per-participant fee during the time frame in question in the lawsuit against them. Because of this, the judge dismissed this particular claim, citing that it was clear that the defense had been considering fee alternatives and concluded that moving to a fee per participant made sense.(5)

This issue was also debated at trial in Sacerdote v. New York University. In this case, the judge sided with the defense because the defense was able to show that it had previously debated the merits of asset-based fees versus per-participant fees. New York University (NYU) had even conducted a request for proposal (RFP) for recordkeeping services during the time frame in question in the lawsuit and requested that each vendor respondent provide its fees in two ways, both as an asset-based fee and as a per-participant fee. Seeking proposals using both types of fees demonstrated that NYU was considering alternatives.

NYU ultimately retained their asset-based fee model and was able to show good reason for doing so. The proposals from the different recordkeepers all considered the fees needed to cover the costs for the subsequent three years. Each calculated the fees incorporating cost-of-living adjustments over the three-year period. That total was then divided by the anticipated total number of participants over that same time frame. The result was that the flat fee per participant was more expensive than the asset-based fees in year one, and in some cases, in year two. Therefore, it was prudent for NYU to keep the asset-based fee for the plan.(6) This is an important consideration because many recordkeepers will charge a flat fee that incorporates an annual increased amount, whereas the asset-based models do not, leading to potentially lower initial costs.

Issues with the Per-Participant Fee Model

The concept that all recordkeeper fees should be no more than $35 per participant for most large plans is flawed because it assumes that all recordkeepers provide exactly the same services for all plans. Even plans that have an identical number of participants and the same total plan assets may have very different service models. For example, some plan sponsors use the recordkeeper’s personnel to deliver onsite education and/or advice to the employees. Depending on the employer, the recordkeeper might provide this service once a quarter, once a month, or even every day. By contrast, some employers do not need the onsite service. It is unreasonable to expect that the cost for providing recordkeeping, plus onsite education, should be the same as the cost for providing only recordkeeping. This is one example of how service differentiation will impact the cost of recordkeeper services.

Another issue is the assumption that the asset-based fee always leads to higher costs. Aside from scenarios like the example from the NYU case, there is an expectation that the value of the plan assets will always increase. Naturally, this is not always the case, as many plans encountered when the market declined in the fourth quarter of 2018. With the downturn in the stock market, many plans experienced an asset reduction during that quarter. During times like these, and certainly during a recession, plan assets will shrink, thereby leading the recordkeeper to deliver the same services for less compensation.

What Does this Mean for Plan Sponsors?

The overriding message is that there is no right or wrong way to charge plan fees. Both asset-based fees and per-participant fee methods are used by many plans. The retirement plan committee should consider exploring both options and understand how each method may impact their plan’s participants. Having reviewed both options, the committee can make an informed decision about which model to use. It should then document this decision and the rationale behind the outcome in its meeting minutes or summary notes.


(1) Divane v. Northwestern University, Compliance 2016

(2) Sacerdote v. New York University, Dismissal 2017

(3) Cunningham v. Cornell University, Dismissal 2017

(4) Divane v. Northwestern, Memorandum Opinion & Order 2018

(5) White v. Chevron Corporation, Dismissal 2016

(6) Sacerdote v. New York University, Opinion & Order 2018

Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice. Opinions expressed are those of the author, and do not necessarily represent the opinions of Cammack Retirement Group.

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