Some Lessons for Corporate 401(k) Plan Sponsors from the Litigation Explosion

May 16, 2018 | Blog, P-Solve

The number of lawsuits against 401(k) plan sponsors, recordkeepers, and advisors has exploded.[1] No 401(k) plan sponsor is immune: in 2016, a Minnesota body shop with 116 participants and under $10 million in assets was sued.[2]  And settlements have been large, totaling hundreds of millions of dollars by some estimates, led by mega plans such as Boeing’s and Lockheed Martin’s, each of which agreed to pay $60 million.[3]   Allegations against corporate 401(k) plan sponsors include violations of the fiduciary duties of loyalty (putting participants first) and prudence (following an informed process).

 

Claimed violations include:

  1. Using more expensive share classes than necessary (e.g., retail shares where institutional shares or CITs were available),
  2. Retaining an allegedly unsuitable manager, which underperformed relative to an alternative index fund or peer group,
  3. Failure to monitor recordkeeping fees, resulting in excessive payments; and,
  4. Offering a money market fund instead of a stable value fund.

 

Many of these complaints are a confusing mix of allegations of manager unsuitability and conflict of interest.  All claim that participants were injured financially by breach of some fiduciary duty owed, and seek to make participants whole.

 

Some complaints have led to large settlements, as noted, while others were rejected at the motion to dismiss stage of the lawsuit. Judges have mostly reaffirmed that sponsors don’t have to act with perfect foresight; don’t have to offer the cheapest possible fund; and, don’t have to offer a stable value fund.

 

Some ERISA attorneys think that these complaints are something of a fishing expedition, with no apparent pattern other than seeking big payoffs. After all, many lawsuits have been brought largely by lawyers who previously might have been impolitely characterized as “ambulance chasers.”

 

This is not to say that breaches of fiduciary duties of loyalty – putting participant interests first – and prudence – making informed decisions guided by experts according to a clear process – didn’t occur. Defendants may have neglected to monitor manager fees and performance, or record-keeper fees and services, etc. We simply don’t know.

 

For retirement plan sponsors, the moral of the story is to make all decisions according to a reasonably prudent process and with participants’ interests in mind, and to keep a record of all decisions. Taking clear meeting minutes is an important part of this process. A good outside advisor can help with this.

 

Another take away: retirement plan sponsors should have a clear rationale for manager and service provider selection; one that is well-reasoned, informed, and revisited from time to time. Additionally, while retirement plan sponsors do not have to use the least expensive possible funds or service providers, fees must be reasonable relative to services provided. This probably means occasional competitive bids for record-keeping services. Ideally, a record-keeper won’t have to be replaced but from time to time this may be necessary.

 

Regarding manager selection, using only index funds is no guarantee against getting sued. Index funds, no less than active managers, must be selected prudently: make sure any index funds you offer are priced competitively and track their benchmark closely. Also, if you choose to offer active managers, keep in mind that active management is a “zero-sum game” – because investors in aggregate are the market, one active manager can only win at the expense of another – and that the average active manager must underperform its benchmark after fees [4]. Active management is very hard: all active managers claim to have skill, but few actually do. If you are not an expert in manager selection or have not retained an expert, it may a good idea to use only prudently-selected index funds.

 

Finally, remember that ERISA is about the process you follow, not about results over which you had no control. Plan sponsors don’t have to be clairvoyant. They do have to act as a reasonably prudent expert would.

 

So, in summary, litigation has mushroomed, and smaller plan sponsors are vulnerable. Complaints have also become more refined. Plan sponsors should be on guard. The best defense is to act prudently, loyally, and document decisions.

 

P-Solve is a global retirement benefits consulting firm, with offices in London, Boston, Denver, and Chicago. Our 60 consultants provide investment, actuarial, and strategic advice to our corporate, public and Taft-Hartley clients in the US and UK. For more information about our defined contribution advisory services, please contact the author at marc.fandetti@psolve.com or (781) 373 6913.

[1] Twenty-nine complaints were filed in 2016, up from 12 in 2015 and 5 in 2014 and the most since 14 were filed in 2007. Investment News, Jerry Schlichter’s fee lawsuits have left an indelible mark on the 401(k) industry, September 23, 2018.

[2] Plansponsor, Retirement Plan Excessive Fee Suits Move Down Market, May 24, 2016. The claim was later dropped.

[3] Investment News, 10 Big Settlements in 401(k) Excessive Fee Lawsuits, July 13, 2017.

[4] This may not strictly be the case, due to changes in the market portfolio.