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A Decade of 401(k) Lawsuits – Adhere to Your Fiduciary Duties

April 1, 2020

By Brian Samuels

Senior Consultant

Brian services institutional clients by providing counsel and guidance on portfolio design, asset allocation, manager selection, investment policy statements and performance monitoring. Brian co-leads our Defined Benefit Business Council. Prior …

In March 2019, Tussey v. ABB marked the end of the longest-running 401(k) fee lawsuit in the United States.

After 12 years of litigation, court ordered non-monetary remedies and multiple appellate court rulings, the suit ended in a $55 million settlement for the plaintiffs over charges of excessive investment management and recordkeeping fees. This was the third highest settlement paid by a Plan Sponsor in a 401(k) lawsuit, short of the 2015 settlements of The Boeing Company and Lockheed Martin Corporation for $57 million and $62 million, respectively.

While the settlement itself is large in dollars, the unreported hours and resources spent on this lawsuit by ABB are surely staggering. More than ever, Plan Sponsors need to focus not only on their altruistic goal of helping employees successfully save for retirement, but on their legal responsibilities as plan fiduciaries under the Employee Retirement Income Security Act (ERISA).

Below are some ways Plan Sponsors can take to ensure they are adhering to their fiduciary duties.

Excessive Fees

ERISA requires fiduciaries to follow a careful, prudent process to ensure their plans pay no more than reasonable fees for necessary services. Typically, excessive fee lawsuits focus on investment management fees (the fees paid to investment managers or expense ratios for mutual funds) or administrative fees (primarily the fees paid to plan recordkeepers) that are argued to be excessive versus comparable alternatives.

For investment management fees, some arguments have focused on:
• Offering a higher cost mutual fund share class of the same fund when a lower cost option is available (a retail share class versus an institutional share class for example)
• Larger plans not leveraging their size by utilizing non-mutual fund vehicles such as separately managed accounts and collective investment trusts
• Offering a fund that has a higher expense than other funds in the same asset class with similar risk/return characteristics

For administrative fees a plan is charged for recordkeeping, participant services and communication, etc., the most common claims in litigation are:
• The fees are unreasonable given the size or scope of services for a specific plan
• The Plan Sponsor has not taken steps to ensure the current fee is reasonable by adequately testing the marketplace frequent enough

Inappropriate Investment Options

401(k) plans are legally obligated to offer at least three investment options: a capital preservation fund, and two other options which must be “sufficient for plan participants to create a portfolio to suit their risk-return goals”; which is typically a bond and equity option.

Other than these, ERISA is vague regarding the specific investment options that are appropriate; other than guiding fiduciaries to show “the care, skill, prudence, and diligence … that a prudent man” would when choosing investments “so as to minimize the risk of large losses.”

Common arguments regarding inappropriate investment options have focused on:
• The retention of investments with poor historical performance versus a benchmark
• Offering or replacing an existing investment with one that has insufficient performance history or manager longevity
• The use of stable value funds instead of money market funds as the plans capital preservation option and vice-versa
• Offering only passive or active options for a specific asset class
• The inclusion of the employer’s own stock as an investment option, particularly if the stock loses value

While the increase in litigation against 401(k) plans for excess fees and inappropriate investment options has certainly been a concern for Plan Sponsors, the unintended consequences from the increased scrutiny have been positive for plan participants:

Streamlined investment menus

• From a plan participant perspective, too many investment options can be overwhelming and can lead to poor decision-making, i.e. over-diversification, “over-analysis paralysis”, etc. For plans sponsors, concerns about the appropriateness of certain non-standard asset classes that were once common in 401k plans (think technology funds in the late 90’s) as well as concerns over having to monitor a larger number of investments on an ongoing basis have led to a general reduction of the number investments offered in 401k plans. Participants benefit by having a more manageable menu and by pooling their assets into fewer investments, likely qualifying the plan for lower cost share class options. For those participants who want access to an asset class that isn’t offered in their plan, the addition of a brokerage window could help address that issue.

A focus on lowest available fee share classes and vehicles

• Fear of litigation is a good motivator for Plan Sponsors to consistently check to see if they are in the lowest cost share class or in the lowest cost vehicle for a particular investment. This timing has been fortuitous as investment managers, who are battling fee compression, have continued to create lower cost share classes and vehicles. The ultimate beneficiaries here again are plan participants.

Increased offering of passive options

• Index investing has grown significantly since the 2008 global financial crisis. Concern over only offering comparably higher-fee, active, investment options has caused many Plan Sponsors to offer some type of passive investment sleeve in their plans; benefiting participants who may not want to pay more for active management.

Increased fee transparency

• Fee disclosures to both Plan Sponsors and plan participants have become the norm, as has fee benchmarking.

What can Plan Sponsors do?

Fortunately, for Plan Sponsors, ERISA focuses more on documenting and undergoing consistent and prudent processes than it does on pure results when it comes to fiduciary duty.

The following are first steps fiduciaries can take:
• Undergo periodic and ongoing analysis of the current investment menu, fund structures and all fees to reduce gaps and streamline the offerings.
• Fund performance, as well as material changes to an investment’s team, process, etc., should be reviewed and documented regularly.
• Plan Sponsors should consider investment options with lower costs, where applicable, including collective investment trusts and separately managed accounts.
• Understanding recordkeeping fees and the mechanism for how those are paid is also critical. Evaluating and benchmarking these fees, at least annually, with a robust and formal survey of the market, every several years is a good start.

For assistance with the review of your Plan’s investment line-up and associated expenses, please contact any of the professionals at Fiducient Advisors

The information contained herein is confidential and may not be disseminated or distributed to any other person without the prior approval of Fiducient Advisors. Any dissemination or distribution is strictly prohibited. Information has been obtained from a variety of sources believed to be reliable though not independently verified. Any forecasts represent future expectations and actual returns, volatilities and correlations will differ from forecasts. This report does not represent a specific investment recommendation. Please consult with your advisor, attorney and accountant, as appropriate, regarding specific advice. Past performance does not indicate future performance and there is a possibility of a loss.

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