How do I determine if my fees are reasonable?
There are no clear, "bright-line" standards for determining fee reasonableness.
An investment fiduciary is allowed to receive reasonable compensation for services rendered, or for the reimbursement of expenses properly and actually incurred, in the performance of his/her duties with the covered account (e.g. plan, IRA).
Whether compensation paid to an investment fiduciary for services rendered to an account is “reasonable” depends on the facts and circumstances of each case. DOL regulations provide little guidance on what facts and circumstances will cause compensation to be deemed reasonable or unreasonable. Under current DOL regulations, compensation is not reasonable if it would be considered excessive under the federal income tax regulations on compensation for personal services that constitute an ordinary and necessary trade or business expense.
The rules clearly state fees do not need to be the lowest, but they can’t be excessive. Excessiveness is measured by the market value of the services and the cost of providing the goods and services.
In DOL advisor opinions and court decisions, reasonable compensation has frequently been measured by comparisons with what other service providers charge for comparable services under comparable circumstances. For example, the DOL declined to respond to a request for an opinion on the reasonableness of fees where the requestor had not submitted information showing what a comparable, reputable, independent professional firm would charge under comparable circumstances. A court found that the reasonableness inquiry must focus on the objective standard of how much a prudent ERISA trustee would have determined was a reasonable payment for the service. In another case, fees were found to be reasonable based on expert testimony regarding what other firms charge for the same services.
Two examples of ways to determine whether fees are reasonable include:
- Market price: What similar institutions are charging for equivalent products and services.
- Activity based cost accounting: Activity based cost accounting is the way the accounting profession determines the cost of a financial service. It is objective, and requires that all the products and services a fiduciary makes available be subject to an analysis of their cost. Once cost is determined, the fiduciary can superimpose its reasonable profit margin on the result. A reasonable profit margin is the economic incentive a fiduciary needs to present its products and services to the market place. There is no magic number that equates to reasonableness. The DOL Rule mentions that a fee can be disproportionately larger than the cost of the service
A reasonable fee is determined by consideration of all relevant factors regarding the fiduciary and non-fiduciary services provided. These include not just the amount of the actual fee, but also the tangible and intangible factors providing the necessary context for evaluating the fee. A reasonable fee is not the same thing as the cheapest fee. A fiduciary is not obligated to pick the cheapest fee, but must avoid a fee that is excessive. Here are some of the factors relevant to evaluating fee reasonableness:
- Fiduciary’s skill and expertise
- Time devoted to the fiduciary’s duties
- Amount and character of account property
- Degree of difficulty
- Level and type of responsibility
- Risk assumed
- Nature and cost of the services
- Quality of such party’s performance