Retirement lawsuits are on the rise, causing plan sponsors to stay vigilant in an effort to protect themselves from litigation.
Experts warn that 401(k) plan sponsors should be prepared as litigation relating to high fees, lack of investment options or poor investment options and breach of fiduciary duty shake the industry.
Fee lawsuits have “exponentially increased over the past two years,” says Nancy Ross, a partner in the litigation and disputes practice area at Mayer Brown in Chicago. “We saw a lot of it last year and we are seeing a lot of it this year.”
The biggest argument made by plaintiffs in these cases is that their workplace defined contribution plans offer high priced retail mutual funds as an investment option rather than negotiating to take advantage of lower cost institutional mutual funds, she says.
“Companies and plan fiduciaries really need to take a look at their investment options and particularly their mutual funds. It is not an argument that they immediately need to remove any retail funds they have. Courts look beyond allocations that are too expensive to determining how they play in the whole lineup of investments,” Ross says. That said, retail mutual funds are a neon light flashing on the plaintiff’s radar screen, she adds.
Fred Reish, a partner at Drinker Biddle & Reath in Los Angeles, believes that investment expenses will continue to be a source of litigation.
“That focus will certainly include, and may concentrate on, the selection of the share class that is appropriate for the plan,” he says. “Larger plans have access to a wider range of share classes, including very low-cost share classes. Unfortunately, many plan sponsors have not paid enough attention to the share class issue and, as a result, have put themselves at risk.”
The debate over investment expenses extends to the debate over actively managed funds vs. passive or index funds.
Reish calls that debate “largely academic. The courts recognize that well-managed, reasonably priced ‘active’ funds can be prudently selected and offered by participant-directed plans.”
There also have been cases involving target-date funds, Ross says. They either say that the investments included were too expensive, too risky or didn’t perform well.
“More plaintiffs firms have jumped on the bandwagon because, in my view, so many cases have been settled and the settlements have been significant,” she says. When one large firm settles for $50 million, other law firms want a piece of the action, she adds.
If a case like this can get past a motion to dismiss, “insurance companies in particular will come in and decide it is a cost of doing business. Rather than pay the cost of discovery, they will settle,” Ross says.
The cost of doing business
Another popular claim is that 401(k) plans are using proprietary funds, meaning that the record keeper includes its own proprietary products in its 401(k) plans when there may be less expensive or higher-performing products on the market, Ross says.
“There is nothing inherently wrong with offering your own products, so they have to argue they are too expensive and didn’t perform well for what they were paying,” she says.
Emily Costin, a partner in the Washington, D.C. office of Alston & Bird, says that this type of suit is becoming more popular because plaintiffs’ attorneys need to find lawsuits that will get past a motion to dismiss in court. Suits over suitable investments have tapered off, she says, because “the law is so clear now they can’t rely on hindsight,” she says. “Nobody can predict the market. They have shifted away from that.”
Suits that tend to go forward are those that relate to self-dealing or proprietary investments.
“There is definitely a target out there for claims of the slightest hint of self-dealing or proprietary products. That is something that can get past a motion to dismiss. Even the appearance of a conflict of interest is most likely to get past the dismissal phase,” Costin says.
Another area that will continue to see litigation in the retirement plan space is about revenue sharing and compensation to record keepers, Reish says.
“Those two issues are connected at the hip because revenue sharing payments are generally made to record keepers as ‘indirect compensation.’ Under the rules, the indirect compensation, when added to the direct compensation charged to the plan, must be reasonable in the aggregate,” he says. “Unfortunately, some plan sponsors don’t calculate the amount of indirect compensation that their record keepers are receiving and, as a result, they place themselves at risk.”
Both direct and indirect compensation need to be calculated and then benchmarked against appropriate expense levels, either through a benchmarking service or through an RFP process, he adds.
Another trend developing in the plan market is plaintiffs asserting imprudence or excess compensation by advisers who consult with plans and plan committees, Reish says.
“We have seen a few cases on that, but it is too early to know if that will continue,” he says.
He also believes that plan litigation will continue to move from the mega plan space to mid-sized and smaller plans.
“Now that the law is better developed about the responsibilities of plan fiduciaries, it will be easier to apply those concepts to mid-sized and smaller plans,” Reish adds.
Document and prove
To protect themselves against retirement plan lawsuits, companies must first have a process in place and make sure they are following it. They must document all of their decisions and prove that they monitor their fees regularly, Costin says.
“Individuals are human and not expected to know everything about running a plan. If you are asked to be a fiduciary for a plan in your company, you are not expected to know everything but you are expected to go out and get the expertise you need,” she adds. That could mean seeking out legal or investment advice and documenting that you did go out to find that expertise.
Unfortunately, the markets are always changing and plan fiduciaries can’t plan for everything, Costin says. That means that the best defense against litigation is to prove that you or your retirement plan committee made the best decisions for your plan participants at the time and that you revisit those decisions on a regular basis.
“Every plan is different; every participant base is different; every company is different. As long as fiduciaries are engaged in a regular documented process and show why decisions were made and that they were made for the best interest of participants that is the key thing. It doesn’t always necessarily mean the cheapest investment option or the cheapest recordkeeping fee,” she says.
Ross adds that the Employee Retirement Income Security Act is “all about process. If you can prove you have a good process, you’ve got a home run.”
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