For example, Amazon.com has thousands of affiliate marketers who sell product through Amazon by placing links from their web sites to the promotional item at Amazon.com. When a consumer makes the purchase, a percentage of the purchase is paid to the web site as a commission for marketing that item. Governor Brown just signed into law a requirement that on-line retailers like Amazon begin collecting sales tax on transaction where a California based affiliate will receive payment. This law will force retailers to set up new systems to collect, track and forward tax revenue to California.

Tax Changes Behavior

Will this change Amazon’s behavior? It already has. All California based affiliate contracts with Amazon were canceled as of today because of this law.

What will that mean to California?
1. Website owners who rely on affiliate revenue will no longer promote Amazon.com since they no longer have an affiliate contract.
2. This will result in less sales and less revenue to California residents who are also affiliates. California will have less income to tax as income tax.
3. While it may be relatively small, it will have a negative impact on business activity and hurt our struggling economy.

I am sure about the facts since Capitalmarketsu.com Magazine is, or rather was, an Amazon affiliate. It won’t mean a great deal to this site since we didn’t sell many books anyway. But, there are many Internet businesses that are the sole business of the owner and they cannot stay in business if they have no affiliate contracts. For  Capitalmarketsu.com Magazine this has been more of an accommodation to our readers and an attempt to monetize to some degree the site and offset the expenses of operating. At the end of this column are the pertinent parts of two letters I received from Amazon detailing this termination and its cause.

Increasing or decreasing taxes does change behavior of both consumers and businesses. Tax policy is, therefore, very important in the process of bringing the United States out of the current extreme slowdown. Our politicians should be looking at the way to use tax policy to increase economic activity, not slow it down. Increased economic activity will result in additional revenue to government through increased sales and income.

For some politicians, the word “revenue” is a euphemism for “higher taxes.” They equate higher taxes with increased revenue, but that isn’t necessarily true. On the other hand, increased economic activity does always result in increased revenue – to the individual family/tax payer and to the government. I wish politicians would quit using deceptive language and speak plainly. When they mean higher taxes, they should say higher taxes. When they say increased revenue they should mean increased revenue.

So much for my soap box.

PC Magazine ran this story today, California Passes Law Forcing Web Retailers to Charge Sales Tax and CNN Money ran this story, Amazon drops California associates to avoid sales tax.

Hello,
For well over a decade, the Amazon Associates Program has worked with thousands of California residents. Unfortunately, a potential new law that may be signed by Governor Brown compels us to terminate this program for California-based participants. It specifically imposes the collection of taxes from consumers on sales by on-line retailers – including but not limited to those referred by California-based marketing affiliates like you – even if those retailers have no physical presence in the state.
We oppose this bill because it is unconstitutional and counterproductive. It is supported by big-box retailers, most of which are based outside California, that seek to harm the affiliate advertising programs of their competitors. Similar legislation in other states has led to job and income losses, and little, if any, new tax revenue. We deeply regret that we must take this action.
As a result, we will terminate contracts with all California residents that are participants in the Amazon Associates Program as of the date (if any) that the California law becomes effective. We will send a follow-up notice to you confirming the termination date if the California law is enacted. In the event that the California law does not become effective before September 30, 2011, we withdraw this notice. As of the termination date, California residents will no longer receive advertising fees for sales referred to Amazon.com, Endless.com, MYHABIT.COM or SmallParts.com. Please be assured that all qualifying advertising fees earned on or before the termination date will be processed and paid in full in accordance with the regular payment schedule…

Regards,
The Amazon Associates Team

Hello,
Unfortunately, Governor Brown has signed into law the bill that we emailed you about earlier today. As a result of this, contracts with all California residents participating in the Amazon Associates Program are terminated effective today, June 29, 2011. Those California residents will no longer receive advertising fees for sales referred to Amazon.com, Endless.com, MYHABIT.COM or SmallParts.com. Please be assured that all qualifying advertising fees earned before today will be processed and paid in full in accordance with the regular payment schedule…
To avoid confusion, we would like to clarify that this development will only impact our ability to offer the Associates Program to California residents and will not affect your ability to purchase from Amazon.com, Endless.com, MYHABIT.COM or SmallParts.com.
We have enjoyed working with you and other California-based participants in the Amazon Associates Program and, if this situation is rectified, would very much welcome the opportunity to re-open our Associates Program to California residents. As mentioned before, we are continuing to work on alternative ways to help California residents monetize their websites and we will be sure to contact you when these become available.
Regards,
The Amazon Associates Team

To change behavior, add or delete a tax.

We’re all hearing about the tragedy in Japan, with horrific photos and video footage of the aftermath of the earthquake and 10-meter Tsunami.  The humanitarian disaster, with thousands dead and tens of thousand homeless, will continue to capture the world’s attention.  If you can bear to look, here’s some remarkable Japanese TV footage of the tsunami roaring into the Japanese coastline:

But what impact will the disaster have on the global economy and investment portfolios?  Japanese stocks fell 6.2% on Monday after a 1.72% drop on Friday.  While significant, this decline is actually less than the 7.5% decline that followed the 1995 Kobe earthquake.  London’s Guardian newspaper reported that the Bank of Japan injected 21.8 trillion yen ($266.9 billion) into the Japanese economy, as a measure to limit the financial devastation wreaked by the crisis.

The hardest-hit Japanese stock is likely to be Tokyo Electric Power Company, which has had to close power plants and is fighting core meltdowns in three nuclear facilities.  Toyota, which is now the world’s largest car maker, has announced that it will close 12 assembly plants across the country until at least Wednesday night, causing $72 million a day in losses.

The disaster also had a counterintuitive impact on global oil prices, crude prices actually fell 3% on Friday and slid further on Monday as analysts expected lower demand in the short-term from the world’s third-largest oil consumer.  Longer-term, prices could be pushed up.  Japan typically receives about a third of its energy from nuclear power, but its power capacity fell by more than one-fifth as 11 reactors went off-line.  Japan may be bidding against the world for oil supplies, since oil and gas are the most plausible energy replacements to its nuclear generators.  Of course the additional demand comes as Libyan oil fields have come off-line.

How the disaster will affect other countries is uncertain.  U.S. shares fell 1%, and European shares dropped 1.5% on Monday, but the U.S. News & World Report web site quoted several international economists who believe that the damage is unlikely to spread, and who expect the high-savings Japanese to rebuild quickly and efficiently.  The Japanese do hold about 10% of U.S. government debt, so if the Japanese decide to repatriate funds to pay for a massive cleanup and rebuilding effort, it could raise government bond rates.

The U.S. News & World Report analysis further speculated that the Japanese auto industry may have to temporarily curtail shipments of the Toyota Yaris, Scion xD and xB, Honda CR-V, Accord and Fit and Acura TSX and RL.  Dealer networks normally carry a 30-day supply of autos, so the shortage won’t become immediately apparent; a bigger issue is whether Japanese auto makers will be able to find replacements for the parts suppliers whose factories were destroyed, and whether U.S.-made models will suffer from a shortage of parts shipped from Japan.

Best

Worst

Take a Good Look

When to Buy Gold

See if you can relate to this situation: the struggling U.S. economy experiences severe unemployment, and a falling dollar spooks investors.  The stock market seems to be in a protracted tailspin, and the situation in Afghanistan is increasingly alarming.  So you look for an alternative investment, and find… gold, which is generating impressive returns after a long dormant period.  In fact, the precious metal has been testing all-time highs, and there are plenty of newsletters, touts and analysts that see a lot more legs to the rally.

Gold more than doubles

As familiar as this sounds, it’s actually a pretty good description of the latter months of 1979 and early 1980, when the price of gold rose from $400 an ounce in November 1979 to $850 by the middle of next January.  Investors who poured dollars in — expecting more of the same — were sorely disappointed; by the end of March 1980, gold was back to selling at less than $500 an ounce, leaving investors who bought at the peak holding a stunning 40% loss for the quarter.  Holding on didn’t help; by the end of the stock market run-up in early 2000, an ounce of gold was selling for under $300 an ounce on the spot markets.

Today, of course, you’re hearing a similar refrain, as the shiny metal has tested all-time highs almost monthly, most recently leaping from a little over $1,150 an ounce in late July to its latest all-time high, just over $1,365 in the middle of October.  (The price has since fallen into the $1,340 range.)  Is it time to jump on this bandwagon and ride the gains up to (according to some bullish newsletters) $2,000 an ounce or higher?  Or is gold an overpriced investment ready to go bust?

What the price of gold should be

One of the interesting problems with gold in your portfolio is how hard it is to get a handle on what its price SHOULD be.  You can’t compare its price to its earnings, like a stock, because when you put gold in your safe deposit box, there ARE no earnings.  But there are ways to help decide whether the current price is being driven by fundamentals or yet another mania – a gold bubble which will, as bubbles do, pop.

The first is to look for the source of the demand.  Back in January, when gold was still riding the crest of investor disillusion with the global economy, the Commodity Online web site interviewed Miguel Perez-Santalla, vice president of marketing at the German precious metals producer Heraeus Precious Metals Management.  Heraeus fabricates precious metals products for industrial use, but Perez-Santalla said that at such high prices (which have since gone higher), physical consumption of gold has fallen dramatically.  “The gold investment market is the main demand driving the price up,” he said in the interview.  “Everything is being delivered on the Comex and to the London warehouses.”

Loosely translated, that means that industrial users are waiting for the price to fall, and they will get their wish as soon as investors stop outbidding each other.

Another way of looking at the reasonableness of gold’s prices is to look at the cost of extraction and refining—in other words, the cost per ounce of getting gold out of the ground and into the hands of jewelry makers, industry and investors.  This information is not always easy to find, but an article on the MineWeb web site back in April 2007 estimated that gold mining companies were spending $401 an ounce in overall costs.  More recently, in October of this year, an article suggested that today’s extraction costs run between $500 and $600 an ounce—or a little less than half of what you would pay today on the spot market.

Loosely translated, that means that investors are buying at far higher prices than it costs to produce an ounce of gold.  In fact, the disparity today at least challenges the record disparity back in early 1980.

Finally, you could look at supply and demand issues.  If there is a worldwide shortage of gold, or much more is being used than is being produced, then this would justify a dramatically rising price.  To get reasonable estimates of gold supply and demand fluctuations, you could go to the World Gold Council’s web site, which notes that gold production over the past five years has been relatively stable: about 2,485 tons a year.  In general, new mines are replacing the depleting production of current ones, so there has been little significant expansion in global output.  It can take up to ten years to get a new mine started, which means that gold mining companies can’t take instant advantage of today’s higher prices.

Recycled gold

However, the World Gold Council notes that as prices rise, the market begins to see more recycled or scrap gold- a category which includes people selling gold jewelry.  Between 2004 and 2008, recycled gold contributed 28% to annual supply flows; a chart says that this amounts to another 1,016 tons a year.  (The remaining supply flow comes from sales by central bankers, which may or may not continue in the future.)

Mine production and recycling together account for roughly 3,500 tons of gold coming into the marketplace each year.  How does that compare to demand?  According to the World Gold Council, jewelry demand—by far the largest market for gold—amounts to 2,436 tons a year.  Industry uses another 493 tons—for a total of just under 3,000 tons between the two.

Loosely translated, that means that more gold is coming onto the market than industry and the jewelry manufacturers appear to need.  There is no supply/demand imbalance, unless you count thousands of eager investors looking for more price run-ups or a hedge against inflation.

Gold: An inflation hedge?

And is gold a reliable hedge against inflation?  Since gold’s peak in early 1980, the annual inflation rate dropped, but cumulative inflation increased—as gold was falling in value through the next two decades.  According to InflationData.com, gold’s 1980 peak spot price reached $2,250 if it were measured in today’s inflation-adjusted dollars, and it dropped to an inflation-adjusted $370 two decades later.  If gold had been an effective inflation hedge during that 20-year period, the price would have remained the same in inflation-adjusted terms.

The InflationData organization makes a good point: gold has been a lousy inflation hedge for long periods of time, but it does appear to be a pretty good “crisis hedge.” That is, when people are frightened of events like the Soviet invasion of Afghanistan, as they were in 1979-1980, or when they are concerned about the global liquidity crisis and its economic hangover (as they have been for the past couple of years), gold takes off.  When the panic subsides, so too does the price of the precious metal.

Of course, we can’t predict whether the current fear of a double-dip recession or other nameless anxieties will continue to drive gold higher.  But history suggests that as soon as people start feeling more secure about the world situation, gold will suddenly leave its investors holding significant losses.

Investing or speculating in gold?

The question we have to wrestle with is: if we invest in gold, are we investing, or speculating?  If we’re speculating, is the best time to do it at near-record high prices?

References:
Commodity Online interview with Perez-Santalla

MineWeb article on gold extraction costs in 2007

MineWeb article, October 2010

World Gold Council supply/demand statistics

InflationData.com analysis of gold as an inflation hedge

Chart of gold price runup in 1979-80

Review of events in 1979

Various charts of recent gold prices

Planning allocations between entities and beneficiaries is even more critical with higher tax rates on the horizon.

By Sonja Pippin, Ph.D. – Journal of Accountancy

New tax laws will have a significant impact on the taxation of trusts. If you, or someone you know, is acting as trustee to an irrevocable trust, then you need to pay attention to this article.

Estates and nongrantor trusts must file income tax returns just as individuals do, but with some important differences. For one, their income is taxed at either the entity or beneficiary level depending on whether it is allocated to principal or allocated to distributable income, and whether it is distributed to the beneficiaries. And because their exemption amounts, tax brackets and related thresholds haven’t been indexed for inflation or modified for tax relief to the extent those for individuals have, they can be subject to higher tax rates at much lower levels of income. With the new Medicare tax on investment income on the highest tax brackets, estates and trusts pay still more taxes on incomes over $11,200, as opposed to $200,000 or $250,000 for individuals.

In this and other ways, the Patient Protection and Affordable Care and the Health Care and Education Reconciliation acts of 2010 (PL 111-148 and PL 111-152, respectively) affect trusts’ and estates’ income taxes and have introduced discrepancies that tax practitioners can review with their clients who administer trusts and estates. This article reviews some strategies for more tax-efficient allocation of income and principal by trusts and estates.

For the complete article, go to Income Tax Accounting for Trusts and Estates in the Journal of Accountancy

Navigating Structured Products

by Brian Harris, Senior Editor, Dimensional Fund Advisors

In recent years, structured products have gained favor among retail investors in Europe and the US. Investment banks promote these securities as sophisticated tools to help investors manage downside risk, enhance returns, or achieve other investment objectives.

Sales have grown briskly since 2006, and despite a decline after the 2008 market crisis, some industry sources expect a rebound in sales and a flurry of new products in the future.1 With this in mind, it may be useful to understand how the products work and to evaluate the costs, benefits, and tradeoffs before considering one in your investment strategy.

Basic design of structured products

A structured product is a contract that promises to pay a future amount based on the performance of an underlying asset, such as a stock, market index, or commodity. The payoff is typically linked to a preset formula. Most structured products are designed to either preserve capital or enhance returns, and are typically issued as notes.2 The notes offer a specific payout over a designated period or at maturity, and the final payout depends on the performance of the underlying asset as well as the value of the derivatives written on it. Since the product typically is issued by an investment bank, the investor is exposed to the credit risk of that entity.

One common product, a principal-protected note, generally offers a minimum return equal to the original investment, plus a potential return tied to performance of an underlying asset, such as a stock market index. If the index drops during the term, the investor gets his money back, but if the index rises, he may receive the upside gain, but usually only a part of the underlying asset’s gain. Structured products can be replicated by portfolios composed of an interest-bearing instrument, such as a certificate of deposit or zero-coupon bond, equity securities, and options or other derivative securities whose performance is linked to the underlying index.3

The following summarizes a few common characteristics of structured products:

•    Complex design: Most products have a complex design, which can make analysis of pricing, risk exposure, and potential outcomes more difficult. Some investors equate this complexity with higher potential returns, when, in fact, it may only mask high fees and risk. Worse yet, investors may not understand the range of possible outcomes. During the 2008 market crisis, some investors learned a hard lesson when the issuing firm went bankrupt or when their structured product experienced losses from poor performance of the underlying asset.

•    Substantial cost: These products tend to carry a significant markup and costs that in some cases are difficult to quantify, especially if an investor lacks the technical knowledge to analyze the underlying components of the strategy.

•    Replication: The payoff of virtually any structured product can be replicated in a portfolio by holding the underlying securities, then buying or selling derivatives written on those securities. In many cases, the costs associated with the replication portfolio are much lower than the structured product itself.

•  Tradeoffs: In return for receiving a prescribed payout, investors must accept a tradeoff in the form of a lower return and/or limited upside potential. When evaluating a structured payout, remember that there is no free lunch in the risk-return tradeoff. To pursue higher expected returns, you must accept more risk. If you do not want to bear the risk, you must transfer it to other investors and pay them for taking it.

•    Multiple Risks: First, there are the inherent risks of the underlying security (e.g., the stock or index). Investors also are exposed to credit risk of the issuing firm. The contract is an agreement with the issuer to make a pre-determined payment in the future, and thus, it is contingent on the firm being able to deliver. Liquidity risk is another issue. Although many structured products are listed and traded on exchanges, they may be difficult to sell, especially in a volatile market. To avoid a potential liquidity problem, investors should consider the time horizon of the product and attempt to match its maturity to their anticipated financial need or objective.

• Tax considerations: It is also important to check tax consequences. Some instruments may have certain appeal under the current tax rule. But, often, tax consequences differ according to the investment situation (e.g., whether one buys at the issuance or in the secondary market).

Who might benefit?
A structured product might help an investor who needs a specific payout at a designated point in the future and who is willing to pay another party to shoulder much of the uncertainty. But this benefit generally comes at the expense of lower yield or limited upside potential.

One example may be an individual who currently holds restricted company stock whose value may account for a significant portion of his total wealth. Although he might prefer to diversify this exposure, company rules may prohibit a sale until some future date. A structured product might provide protection against the downside risk of the company’s stock (even though this might mean giving up the upside potential of the stock), and at the same time, provide better-diversified exposure to an equity index, such as the S&P 500.

Perhaps most important, investors who are considering a structured product should consider why they even need a highly structured payoff in the future—and if so, whether the payoff can be structured by other means in the portfolio. In many cases, the strategy can be replicated at a lower cost, and perhaps with less risk. Many investors would prefer an alternative that is less complex and more transparent. And as the recent credit crisis taught many investors, it is wise to avoid investing in things you do not understand.

Endnotes

1 Larry Light, “Twice Shy on Structured Products?” Wall Street Journal, May 28, 2009.

2 A reverse convertible bond is one example of a yield enhancement tool. It pays investors a higher coupon rate than other comparable bonds due to its higher risk. This risk comes in the form of the issuer having the option to pay off the debt with either cash or a predetermined number of common stock shares. The method of payment at time of maturity will depend on the stock price, and the issuer will pay with common stock when it is advantageous to do so. The reverse convertible bond was popular until the last market crisis, when many investors experienced heavy losses when they were paid off with lower-value stock shares.

3 A call option provides the holder the right to buy the underlying security at a given price at a certain time in the future. A put option provides the holder with rights to sell the underlying security at a pre-specified price on maturity date. (American-style options can be exercised before the maturity date, whereas European-style options can be exercised only on the maturity date.) An option holder will exercise the put or call option only if the payoff is positive.

Dimensional Fund Advisors is an investment advisor registered with the Securities and Exchange Commission. This material on structured products is provided for informational and educational purposes only and should not be considered investment advice or an offer to buy or sell securities.

What the new credit card law means for you

by Connie Prater – FoxBusiness.com

Credit card users can expect the most dramatic changes in credit terms, interest rates and fees in decades now that most major provisions of a new federal credit card law have gone into effect.

The new normal for credit cards is more transparency and easier-to-understand terms, but at a higher upfront cost. Credit card issuers and credit industry analysts say the credit card reform law makes credit cards more costly for all users and unaccessible for low-income families and people with bad credit. The law likely means the return of routine annual fees, fewer rewards cards and the possibility that credit card bills will be payable immediately rather than after a month-long grace period.

The new normal for Credit Cards

President Obama signed the Credit CARD Act of 2009 into law May 22, 2009, following passage days earlier in the Senate and the House.

What does the credit card law mean for cardholders? Millions of credit card users will avoid retroactive interest rate increases on existing card balances and have more time to pay their monthly bills, greater advance notice of changes in credit card terms and the right to opt out of significant changes in terms on their accounts. That will take the surprise out of “gotcha” fine print and give consumers time to shop around for better deals if they don’t like the new terms. The requirements are being phased in. The first batch took effect Aug. 20, 2009, and the majority of provisions started on Feb. 22, 2010, while some begin on August 22, 2010.

The Fed just announced final rules for the third phase of the Credit CARD Act — which takes effect on August 22, 2010. Those rules say, among other things, that late payment fees will be capped at $25 in most cases. Also, if consumers exceed their spending limits, they can’t be charged more than the excess amount.

The law has fundamentally changed the way credit card issuers market, bill and advertise credit cards.

Here are the highlights of the credit card law:

To view the rest of this article go to What the new credit card law means for you

By Katherine Hobson – Wall Street Journal

A survey of big employers finds they expect their health-care costs to rise nearly 9% next year and plan to share some of that burden with employees via higher premiums and higher out-of-pocket limits.

The survey included responses from 72 members of the nonprofit National Business Group on Health, which represents large companies such as General Electric, Microsoft and General Motors. It parallels pretty closely another survey on employer health-care costs, by PricewaterhouseCoopers, that we reported on a few months back.

Some tidbits from the report, which you can find on the company’s website:

For he rest of this story, go to Big Employers Estimate Health-Care Costs Will Rise 8.9% in 2011

America’s baby boomers—those born between 1946 and 1964—face a problem that could weigh on the economy for years to come: The longer it takes for the economy to recover, the less money they’ll have to spend in retirement.

Policy makers have long worried that Americans aren’t saving enough for old age. And lately, current and prospective retirees have been hit on many fronts at once: They have less money, they earn less on what they have, their houses aren’t rising in value and the prospect of working longer to make up the shortfall has dimmed significantly in a lousy job market.

“We will have to learn to make do with a lot less in material things,” says Gary Snodgrass, a 63-year-old health-care consultant in Placerville, Calif. The financial crisis, he says, slashed his retirement savings 40% and the value of his house by about half.

Banks, home buyers and bond issuers are all benefiting as the U.S. Federal Reserve holds short-term interest rates near zero to support a recovery. But for many of the 36 million Americans who will turn 65 over the next decade—and even for the 45 million who have another decade to go— the resulting low bond yields, combined with a volatile stock market, are making a dire retirement picture look even worse.

Low yields present retirees with a difficult choice: Accept the lower income offered by safer bonds, or take the risk of staying in the stock market. Either way, their predicament could put a long-term damper on the consumer spending that typically drives U.S. growth.

“If these rates stay as low as they are, then a lot more people are going to be hurting,” says Jack Van Derhei, research director at the Employee Benefit Research Institute. The non-partisan outfit estimates that if current conditions persist, nearly three in five baby boomers will be at risk of running short of money in retirement. “There are going to be many luxury items that will simply have to be eliminated,” for retirees to make ends meet.

Despite the market’s rebound from the lows of 2009, nest eggs remain severely impaired. As of the first quarter of 2010, net household assets—homes, 401(k) plans, pension assets and other investments minus debts—stood at $54.6 trillion, down 18% from the end of 2007. That’s an average of about $171,000 per person, much of which is concentrated in the hands of the wealthiest.

At the same time, the return people can hope to earn on their assets has fallen, particularly for those who switch into bonds or annuities to guarantee a fixed income. The average yield on U.S. government, corporate and mortgage bonds stands at about 2.4%, while stock-market valuations suggest a long-term return of about 6%. At those levels of return, some 59% of people aged 56 to 62 will be at risk of not having enough money to cover basic living and health-care costs in retirement, estimates Mr. Van Derhei. If market returns are higher—8.9% for stocks and 6.3% for bonds—the picture isn’t a lot better: The percentage at risk falls to about 47%.

Before the recession hit, many economists assumed people would solve their retirement problems simply by staying in the work force longer. Now, “the recession has blown that idea out of the water,” says Alicia Munnell, director of the Center for Retirement Research at Boston College and co-author of a 2008 book that advocated working longer.

Older workers, who typically fared better than their younger counterparts in recessions, have been hit just as hard by layoffs this time around. As a result, the fraction of people 65 or older who are working has leveled off after a long period of growth. As of July, it stood at 15.9%, down from 16.3% in mid-2008.

For the rest of this article, go to the Wall Street Journal.

For decades, high fees have quietly but steadily eaten away at the value of 401(k) retirement plans. Now employees are making headway in legal battles to force employers to lower costs.

Employees of Edison International won a big victory this month when a federal judge ruled that the company’s 401(k) fees were excessive and said employees were entitled to recover an as-yet-undetermined amount of overcharges.

U.S. District Judge Stephen Wilson said in an 82-page decision that Rosemead-based Edison did “substantial” harm by failing to negotiate lower prices with the outside firm running the 401(k). A large company such as Edison easily could have gotten a better deal on three of the mutual funds in its plan, but simply didn’t try, the judge said.

The Edison case is one of more than two dozen lawsuits filed against U.S. employers in recent years. The suits allege that companies allowed 401(k) providers to stuff the plans with high-cost investments in exchange for reducing the administrative costs paid by the employers themselves.
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The most prominent case accuses Wal-Mart Stores Inc., which is famous for squeezing suppliers for lower prices, with failing to negotiate the lowest fees for its 401(k) participants. The plaintiffs got a boost late last year when an appellate court ruled that the closely watched case could proceed.

The Edison ruling could influence the outcome of other suits and turn up the pressure on employers to pay closer attention to 401(k) fees, experts say.

“It’s a big development,” said Fred Reish, a partner at Reish & Reicher in Los Angeles who is not involved in the case. “It will encourage plaintiffs’ attorneys to continue to litigate and will encourage [employers] to look for lower-cost share classes for their plans, which will ultimately benefit the participants.”

Retired Edison employee Fred Suhadolc, a lead plaintiff on the suit, said he and other employees were dismayed at the high fees in their plan because they thought the company would do its best to keep them low. Unfamiliar with the stock market and 401(k)s, Suhadolc said he never understood the fees and still has no idea how much he overpaid.

“It’s frustrating and disappointing that you expect to be treated honestly and fairly, and when you find out that you’re not you almost feel cheated,” said Suhadolc, a former maintenance mechanic at an Edison subsidiary in Illinois.

Edison declined to comment.

It’s difficult to determine the financial toll of excessive 401(k) fees, but some experts say they collectively drain tens of millions of dollars a year from unsuspecting investors.

At Edison, for example, an average employee who invested exclusively in the three funds would have paid more than $300 a year in unnecessary fees, estimated Jerome Schlichter, the St. Louis attorney who represented Edison employees. That does not include foregone investment gains on that money.

For the rest of this story go to Employee allegations of excessive 401(k) fees gain ground.