For some years, section 401(k) plans sponsored by for-profit corporations have been the subject of lawsuits claiming that the costs of the plans’ investment options were too high resulting in plan participants paying excessive fees out of their retirement savings. The lawsuits charged that the plan fiduciaries had failed in their duties to prudently select investment options and were liable for damages. Some of these suits have resulted in favorable verdicts for the plaintiffs or settlements resulting in payments to the plaintiffs.
Perhaps the leading law firm in bringing these actions is Schlichter, Bogard & Denton, located in St. Louis. This summer, the Schlichter firm set its sights on section 403(b) plans sponsored by universities. The firm has brought suit against some eleven large universities claiming that the fiduciaries of the plans breached their fiduciary duties in the selection of investment options. The universities sued include Yale, NYU, MIT, the University of Pennsylvania, and Duke. Section 403(b) plans are available to certain tax-exempt organizations and are very common both in higher education and in private K-12 schools. This is the first time that tax-exempt employers, and 403(b) plans, have been the target of these types of suits.
The suits against the various universities assert claims in each case that along the following similar themes:
Plan fiduciaries did not consider lower priced shares that were available to them, in particular failing to select less expensive mutual fund share classes that are offered to plans of sufficient size. As all the plans that are defendants in these cases are very large, the plaintiffs are alleging that they qualified for the less expensive classes. The plaintiffs also suggest that the use of actively managed funds, as opposed to index funds, should be scrutinized very closely.
The plans offered their participants an overly complex menu consisting of too many funds, many of which were duplicative of asset class and investment style. This had the effect of diluting the ability of the plans to qualify for lower share classes, because there were fewer assets allocated to each fund. In addition, the plaintiffs allege that having an excessive number of funds available is an imprudent plan design because it adds too much complexity for participants.
It is common for 403(b) plans that use multiple investment vendors, such as TIAA-CREF, Fidelity and Vanguard, to also use those vendors as record keepers for the amounts invested with them. The plaintiffs claim that having multiple record keepers is more costly than having a single record keeper, because plans with a single record keeper can use the bargaining power of the total plan assets to negotiate lower fees. Therefore, it alleged, the fiduciaries did not act prudently by maintaining the plan design with multiple record keepers.
The fiduciaries did not adequately monitor the investment lineup and allowed historically underperforming investments to remain in the plan.
It should be pointed out that while plaintiffs have experienced some success in bringing these types of actions against 401(k) plans, there are historical and structural differences between 401(k) plans and 403(b) plans that may provide some defenses for how the fiduciaries managed the plans. For example, since 403(b) plans have often been funded with individual annuity contracts or custodial accounts, plan fiduciaries may not have the authority to transfer money to other investment vehicles without participant consent. In addition, the services received by 403(b) plans from record keepers may be different from those received by 401(k) plans, and thus need to be analyzed differently.
However, these cases are sending a clear message to fiduciaries of 403(b) plans to review their fiduciary procedures and ensure they are taking all necessary steps to be able to defend against such a suit. While the recent cases were brought against very large plans, it would not be surprising now to see similar suits brought against plans with fewer assets.
If a plan has not established formal fiduciary procedures that set forth a process for selecting and reviewing investments (as well as how other fiduciary responsibilities are to be addressed), now would be a good time to implement them. And if a plan has such procedures but is not following them, now would be a good time to begin. Prudent procedures with respect to the issues addressed in these suits include:
Regularly review plan investments to determine if fund costs are reasonable and the historical performance of each fund is satisfactory in relationship to the cost and similar funds in the marketplace.
Consider whether there are identical or similar funds available that have lower fees, and whether the investment lineup can be restructured to take advantage of funds that offer lower fees when the funds invested reach a minimum threshold.
Review recordkeeping arrangements and determine whether there are opportunities to reduce costs such as by switching to a sole recordkeeping arrangement.
If the record keeper is receiving revenue sharing payments, make sure that those arrangements result in the record keeper receiving a payment that is reasonable for the services it is providing.
If you have any questions regarding your fiduciary responsibilities or the implications of these lawsuits, please feel free to contact us.
© Boutwell Fay LLP 2016, All Rights Reserved. This handout is for information purposes only, and may constitute attorney advertising. It should not be construed as legal advice and does not create an attorney-client relationship. If you have questions or would like our advice with respect to any of this information, please contact us. The information contained in this article is effective as of September 30, 2016.