BETA
This is a BETA experience. You may opt-out by clicking here

More From Forbes

Edit Story

Fidelity 401(k) Price-Fixing Scheme Cost Retirement Savers Plenty

This article is more than 10 years old.

Fidelity Investments (Photo credit: Wikipedia)

Fidelity has long been a dominant player in the 401(k) retirement plan services marketplace, offering both administration and record-keeping of plans, as well as mutual fund money management to companies and their employee plan participants. In 2011, the mutual fund powerhouse was #1 in Top Record Keepers ranked by assets and participants.

Not surprising, when, in 2004, the Fidelity behemoth unilaterally decided that it would limit the rebates or discounts rival mutual funds could offer on the 401(k) platform it administered for corporations, the impact was felt throughout the marketplace.  Fidelity 401(k) clients for certain, and perhaps indirectly all 401(k) investors, paid the price. Not only were plan mutual fund-related costs potentially inflated but, worse still, the investment performance of plans may have suffered since better performing non-Fidelity funds may have been excluded on the basis of disclosed costs that had been manipulated behind-the-scenes by Fidelity.

Anyone who believes that the marketplace for 401(k) plan services has been competitive over the past three decades or that there have not been widespread systemic abuses in the retirement savings industry, should study closely what Fidelity admits it did for four years from 2004 through 2008—until Forbes drew attention to the practice and Fidelity relented. By the way, it is likely that Fidelity was not alone in these practices and that they may continue at other 401(k) adminstrators.

Here’s what Forbes writer Mike Maiello wrote in his October 13, 2008 piece, Fighting For you Dear Reader:

“After repeated inquiries by Forbes, Fidelity Investments has reversed its fiat that rival mutual funds limit the price breaks they give to get into 401(k) retirement plans Fidelity administers for corporations. The discounts--technically rebates of expenses that might equal 1% of assets--often topped 60 basis points and in effect go straight to investors. For competitive reasons Fidelity would have to match the hefty cuts to get business for its own funds line. In 2004 Fidelity ordered the discounts be cut in half--"to level the playing field," it explained. But amid public criticism of high 401(k) fees, rivals screamed price-fixing. A Fido flack said the new move was long in the works.”

Here’s my understanding of how the policy worked: If a mutual fund adviser wanted to have its funds offered on the Fidelity 401k platform, the adviser had to agree to limit rebates to no more than 35 basis points related to equity funds or 25 basis points related to fixed income funds to retirement plan clients of Fidelity.

25 to 35 basis points may not sound like a lot of money but, remember, billions of 401(k) assets under management were potentially involved and the rebates should have been paid annually to Fidelity's 401(k) customers..

When I first got wind of these agreements involving most of the nation’s largest mutual funds in 2008 and discussed it with Forbes editor Neil Weinberg, I was baffled. I had never seen a retirement plan administrator by letter refuse to accept contractually agreed-upon compensation from an unaffiliated mutual fund company—compensation that it had been previously enjoying. Turn away money? It made no sense.  This is a capitalist, for-profit world we live in, is it not? In fact, the pervasive abuse I was focused upon at the time was 401(k) record-keepers pocketing payments they received from mutual fund money managers, i.e., not disclosing the revenue sharing amounts to plan clients, as opposed to turning away money. Had the world gone mad?

The explanation for this anomaly soon became apparent: refusing to accept these discounts from non-Fidelity funds ensured that Fidelity funds on its 401(k) administration platform did not have to match them. Allowing the discounts would have been good for, at a minimum, Fidelity’s 401(k) plan clients, saving them perhaps 35 basis points, but not-so-good for Fidelity—a fact which Fidelity apparently admitted to Maiello. “Leveling the playing field” did not benefit Fidelity’s 401(k) clients one iota.  

To my knowledge, Fidelity never disclosed to 401(k) plan sponsors or participants that it had decided from 2004 to 2008, in order to bolster its own bottom line, to refuse to accept the fee discounts, rebates or revenue-sharing fund managers had agreed to pay and had been paying. I also cannot imagine how when it relented on this policy in 2008, Fidelity could have explained to 401(k) plan fiduciaries its failure to pay rebates for four years and the sudden price discounts related to non-Fidelity fund options. Presumably, when the moment Fidelity dreaded arrived and rebates suddenlybegan to flow to its 401(k) clients (in 2008), Fidelity had to reduce the fees related to its own funds to “level the playing field” or face losing assets under management. It seems to me that under applicable law, ERISA, instituting such a policy, or reversing, is highly problematic.

Employers that hire Fidelity to provide 401(k) administration have always been told they can freely choose between Fidelity and non-Fidelity funds as investment options.  In my experience, freedom to choose, in industry parlance “open architecture,” rarely truly exists. 401(k) plan administrators or record-keepers almost always attempt to steer clients into proprietary products and services. The challenge for employers and participants is to understand the unique devices different plan administrators employ to lead clients into their own funds and the related dangers.    

There’s a lot of blame to go around for the failure of 401(k)s to achieve their even limited potential to provide retirement security to workers. Investors should not rush to conclude that they or unforeseen market forces are entirely to blame for the poor results of their 401(k) accounts.  I can assure you that there have been longstanding 401(k) abuses that have been concealed from employers and participants by the industry. Even regulators have failed to grasp the extent of industry skimming.

In a truly competitive environment, with the requisite transparency, Fidelity’s policy of capping 401(k) revenue sharing would have had economic consequences. The fact that it did not reveals that in the retirement plan industry, pricing machinations are not readily apparent.

Before you pour any more of your life’s savings into flawed 401(k) retirement vehicles, I suggest spending some time educating yourself about past industry misconduct—because, in ever-evolving forms, it persists to this day.