Of late, litigation against plans and plan sponsors has focused on value. What costs are involved in running the plan, what is the return as compared to those costs and how do the investment returns compare to other investments that could be made? These are all questions plaintiff lawyers ask in court, and plan sponsors should answer well before litigation is a gleam in the eye of plaintiff’s counsel.
Regulations under ERISA require certain disclosures to participants in self-directed plans regarding plan investment results as compared to appropriate benchmarks.1 The notice in which these disclosures are required to be included is referred to herein as the “404a-5 notice”. Recently a strange disparity has been observed between some of the benchmarks used in the 404a-5 notice sent out by third party plan administrators and the actual returns experienced by the plan’s investments. This disparity can be found in several places but seems to be most often apparent in the lifecycle investments. The issue is that over several measuring periods, the reported benchmark used on the notice was much higher than the return actually achieved by the fund. According to some investment advisors, the reason for this disparity is the fact that the benchmark investments are not a good match many times with the applicable fund; the investment objective, style and goals for the two funds do not match up. Advisors have been quick to point out that the differences apply to the 404a-5 notice and not how the investments may be viewed by the financial advisor or plan sponsor who generally carefully tailor their benchmarks to specific investments. However, a 404a-5 notice to participants with faulty benchmarks is a kind of fake investment news. The issue has been raised with third party administrators who are reluctant to provide custom benchmarks.
So, why is this an issue or even important? The reason is that a plaintiff’s lawyer could argue that the plan fiduciaries have not been doing their job if, year after year, the investments picked did not approach the benchmarks set for them. Put more simply, the argument is that a goal is set by the benchmark but year after year it is not met. Did the plan sponsor change the benchmark or advise participants? (Keep in mind that Warren Buffett is on target to win a half million dollar bet that an investment in a group of hedge funds over time would not beat his choice of investment in an index (think benchmark) fund. It may be reasonable that a fund does not meet or exceed a benchmark in any one year. But if the disparity is great, and it is obvious on the notice that over a number of measurement periods the return does not even approach the benchmark, one argument is that the fund should have been replaced. Of course, the other argument is that the benchmark is inappropriate, but that will not be a plaintiff’s argument. If a third party administrator, who is responsible for the notice, will not change the benchmarks, what approach should the plan sponsor take short of replacing the TPA?
Here is a possible three-pronged prophylactic correction: 1) a written request to the third party administrator that the benchmark in the 404a-5 notice be replaced with one that is closer to the benchmark that the plan’s financial advisor is actually using for monitoring the fund; 2) a discussion of the issue reflected in the minutes of the benefits committee meeting; and 3) a footnote in the 404a-5 notice to participants that the benchmark used in the notice is different from the benchmark which the plan sponsor’s independent investment advisor deems appropriate for monitoring the fund. In addition, the plan sponsor may want to consider adding to the footnote the benchmark used by the advisor and why it was chosen.
1 The regulations require that the following information, among other disclosures, be included in the 404a-5 notice: “Where a return for a designated investment alternative is not fixed, the name and returns of an appropriate broad-based securities market index over the 1-, 5-, and 10-calendar year periods (or for the life of the alternative, if shorter) comparable to the performance data periods provided under paragraph (d)(1)(ii)(A) of this section, and which is not administered by an affiliate of the investment issuer, its investment adviser, or a principal underwriter, unless the index is widely recognized and used. See 29 CFR § 2550.404a-5(d)(1)(iii) (emphasis added).
© Boutwell Fay LLP 2017, 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 May 31, 2017.