Retirement Plan Pitfalls: What Recent Fiduciary Lawsuits Can Teach Employers

Employers who sponsor 401(k) and 403(b) retirement plans have been targets for fiduciary lawsuits about the expenses and investments in their plans. In some cases, the settlements and judgments are for staggering amounts. But, it doesn’t have to be that way. Instead, those settlements and judgments can serve as a roadmap for other employers to avoid lawsuits or, if they are sued, for winning the case. This article discusses some of the cases where employers paid large settlements or were on the losing end of judgments, and the lessons learned from those cases. By understanding where the risks are, employers, and their officers who serve as fiduciaries, can avoid these problems.

The most common allegations in the complaints are listed below, together with comments for plan sponsors, and their officers and plan committee members, to consider. For ease of reading, this article refers to plan fiduciaries—the officers and managers who make plan decisions—as committee members, since most employers set up committees to make decisions about their plan operations.

• The Supreme Court has held that there is a duty to monitor a plan’s investments, service providers and the costs of both.

The Supreme Court’s decision means that, in addition to the legal requirement to make prudent decisions, plan committees must regularly review, or “monitor”, those decisions to ensure that they continue to be prudent. For example, as a plan grows in size it may be come entitled to less expensive investments or to lower costs from its service providers. Because of this requirement, yesterday’s decision may not be appropriate for today’s circumstances.

• There is continued litigation about investment expenses.

One of the most common allegations by plaintiffs’ attorneys is that a plan has investments that are too expensive. Plan committees, working with their investment consultants, should obtain and consider information about the expenses of investments for similar plans, that is, plans with about the same amount of assets and the same number of participants. By properly benchmarking their plan’s investment expenses and selecting investments that are reasonably priced relative to those available to similar plans, committee members can protect themselves and their employers against one of the most common claims.

Then, as the Supreme Court decision said, committee members should periodically monitor (that is, re-benchmark) their investment expenses. If circumstances have changed, and the expenses of some of the investments are too high, the committee members should consider removing and replacing those investments.

• A major investment expense issue is the appropriate share class.

A little known fact in the retirement plan world is that mutual funds have different share classes, with different expenses. In other words, a plan can “purchase” the same mutual fund, but with different expenses.

Typically, as plans grow in size, they become eligible for lower cost share classes of a mutual fund—perhaps even of a mutual fund that the plan already offers to the participants. Plaintiffs’ attorneys often sue plan committees on the basis that their plans didn’t select the lowest cost share class of a fund. The attorneys claim that the committee members are liable for breaching their fiduciary duty to avoid paying unreasonable costs for plan investments, since the same mutual fund was available at a lower cost…just for the asking.

But, how can committee members know when their plan is eligible for a lower cost share class of a mutual fund in the plan?  It’s possible for a committee to find that information if they have the right resources and do in-depth research. However, as a practical matter, most committees hire an investment consultant who has experience with 401(k) and 403(b) plans similar to theirs. Those consultants have access to publications and databases with information about share classes and the eligibility requirements.

• Plaintiffs’ attorneys often allege that “revenue sharing” is imprudent.

Unfortunately, most plan committees are not familiar with the concept of revenue sharing. Simply stated, it refers to payments among the plan’s service providers and investments that are not obvious. Most often it occurs where the plan’s investments pay money to a plan’s recordkeeper. There is nothing inherently illegal or imprudent about that.

But, of course, nothing is “free”. The plan’s investments are often more expensive when revenue sharing is paid (for example, as compared to a less expensive share class when there isn’t any revenue sharing).

What does this mean to plan committee members?

First, it means that the committee members should be aware of any revenue sharing that is being paid. Then they need to consider the impact of that revenue sharing on the investment costs that the participants are paying. If the increased cost to the participants is not offset by the benefit to the plan of the revenue sharing payments, it’s possible, perhaps even likely, that plaintiffs’ attorneys (or even the Department of Labor) could asset liability for the committee members for selecting overly expensive investments.

That raises the question of, how could the revenue sharing benefit the plan?  Typically, the revenue sharing is paid to the plan’s provider, that is, the plan’s recordkeeper. If the recordkeeper offsets those payments against its fees, that benefits the plan. But committee members should understand whether it is being offset, as well as whether the recordkeeper’s fees are reasonable, when considering both the direct charges and the revenue sharing.

Committee members may not have the information necessary to initially determine, and then periodically monitor the compensation of their plan’s recordkeeper. For example, one way to comply is to compare their plan’s expenses to reasonable costs for plans with similar amounts of assets and numbers of participants. While plan committees may not have that information, experienced investment consultants have ready access to benchmarking data.

• Should recordkeeper fees be calculated as a percent of assets, a set dollar amount, or a cost per participant?

The primary provider for 401(k) and 403(b) plans is often called a “recordkeeper’. A common allegation by plaintiffs’ attorneys is that committee members should be liable for allowing their plans to pay too much for recordkeeping services. As a part of that, the attorneys claim that the only proper way is to calculate recordkeeping fees as a per-participant cost.

On the first issue, whether a plan has paid too much for recordkeeping services, the law says that plan committees, as fiduciaries, cannot let their plans pay unreasonable amounts for those services. To protect themselves, committees should periodically benchmark their plan’s recordkeeping fees against the fees paid by similarly-situated plans. If the fees are reasonable, the law is satisfied.

As that suggests, while plaintiffs’ attorneys say that the fees must be calculated on a per-participant basis, that’s not the law. The rule is that the costs must be reasonable. It doesn’t matter if the fees are calculated as a fixed dollar amount, a percent of assets, or a per-participant cost, so long as the total amount is reasonable.

That leads to a related allegation. Some people think that the lowest cost, or cheapest, investment or service provider must be chosen by the plan. That is not the law. Instead, the rule is that a plan’s expenses must be reasonable.

• Do committees have to select passive investments (i.e., index funds) as opposed to actively-managed funds?

Plaintiffs’ attorneys often assert that committees have violated their fiduciary responsibilities by selecting actively-managed mutual funds rather than index funds. But, is that really a fiduciary violation?

No court has found that it is a fiduciary breach to use actively-managed mutual funds. The law simply does not speak in terms of active versus passive investments. Instead, it requires that fiduciaries select well-managed, reasonably priced investments. Those investments can be managed in an active or passive manner.

• The use of independent investment consultants.

The issues discussed in this article—investment expenses, share class eligibility, and provider fees—are the primary subjects of fiduciary breach litigation…and therefore should be among the main focuses of plan committees. To complicate matters, though, committee members usually do not have the information needed to make prudent decisions about those issues. That includes comparative information about investment expenses, benchmarking data for similarly-situated plans, and eligibility criteria for share classes.

While that is a problem, there is a solution. Investment consultants who work with similar plans have access to all of that information, as well as an understanding of how to use the information to make prudent decisions.

In addition, several courts have pointed to the use of experienced consultants as evidence that a plan committee was prudent in its decision-making. Perhaps the single most important step that a committee can take for fiduciary compliance is to engage a qualified investment consultant.

Concluding Thoughts

The role of committee members as fiduciaries can seem perilous. But it doesn’t have to be that way. Many plans are managed successfully without being sued and without being investigated by the Department of Labor.

Two important steps for a safe journey though the fiduciary thicket are to (i) learn about the decisions that are most likely to be challenged, and (ii) have compliant practices for those decisions that will minimize the risk of those challenges. A key to having that knowledge and those compliant practices is to work with an investment consultant who can provide fiduciary education and the information that committees need to consider.

This content was authored by Fred Reish. Fred Reish is a partner with the law firm of Faegre Drinker who specializes in retirement law, focusing on fiduciary and best interest standards of care, prohibited transactions, conflicts of interest, and retirement plans.

The views expressed in this article are those of Fred Reish, and not necessarily of Faegre Drinker or HUB International. The article is for general information only and is not intended to provide investment, tax or legal advice, or recommendations for any particular situation. Please consult with a financial, tax or legal advisor on your circumstances.

HUB International’s retirement plan fiduciary advisors provide ongoing guidance on your plan’s setup and management to ensure it meets regulatory compliance guidelines and the interests of your employees. Contact HUB to request an assessment of your organization’s retirement plan.