Viewpoint: How to Minimize the Risk of Retirement Plan Litigation
Many employers have paid millions to settle lawsuits brought to them based on their excessive fees in their retirement plans. It's the employer's responsibility to ensure that retirement plans are created for the most benefit for those who partake in it. Read this blog post to learn more.
What do Estee Lauder and Costco have in common? Both are defending themselves against lawsuits alleging mismanagement of 401(k) accounts, as retirement plan litigation under the Employee Retirement Income Security Act (ERISA) proliferates.
LinkedIn was added to the list in August, when a class-action lawsuit was filed alleging the firm mismanaged its 401(k) plan. And, on Sept. 18, a federal judge rejected a petition by AutoZone Inc. to dismiss allegations of ERISA violations filed by 401(k) plan participants.
In recent years, employers as different as Princeton University and WalMart have paid millions of dollars to settle lawsuits brought by employees alleging excessive fees in their retirement plans.
At the heart of many of these cases are allegations that employers' retirement plan oversight committees tolerated high fees and poor investment performance. Retirement plan committee members are fiduciaries who, under ERISA, are responsible for ensuring that the plan operates in the best interest of its participants.
Attracting Lawsuits
Companies settling ERISA lawsuits are typically accused of failing to pay adequate attention to the retirement plan, such as by failing to remove or replace poor or overly expensive investment choices and allowing vendors to charge above-market fees. The old adage that an ounce of prevention is worth a pound of cure is relevant here.
Law firms are combing through ERISA plan annual filings to identify worthwhile 401(k) targets, looking for expensive or poorly performing investments and high recordkeeping costs. ERISA complaints now include tables and charts comparing a targeted plan's investment performance and expenses with average or best-available practices, to persuade courts that a trial is in order.
Law firms comb through ERISA plan filings to identify worthwhile targets.
Adopting Best Practices
Plan sponsors can't completely eliminate the risk that they will be sued by current or former plan participants, but companies can minimize the risk by adopting best practices—such as those listed below—for making plan investment and management decisions.
FORM AN ACTIVE RETIREMENT PLAN OVERSIGHT COMMITTEE.
The committee should include interested employees, including representatives of HR, finance, legal and rank-and-file employees. A well-functioning committee has a range of talents and perspectives to help it make effective decisions.
The committee should operate under a written charter, setting out the responsibilities of the committee and its procedural rules for appointing members, holding meetings, voting, and hiring advisors and experts as needed, for example. The charter need not be overly rigid or specific but should be drafted to reflect how the committee will operate.
PROVIDE PERIODIC FIDUCIARY TRAINING FOR COMMITTEE MEMBERS.
ERISA is complicated, and committee decisions have direct impacts on employees' retirement income. Committee members must act solely in the interest of plan participants and make decisions as a "prudent expert." Ask vendors to have their top technical experts conduct training, and ensure that the training is tailored to plans of your size.
WRITE AND ADOPT AN INVESTMENT POLICY STATEMENT.
While having an investment policy statement (IPS) is not generally a requirement for 401(k) plans, it is an important document as it may help show that the committee acted prudently and in the plan's best interests in evaluating investments. The IPS should include specific language describing the process by which investments are selected, monitored and replaced when necessary.
It is not advisable to list the plan's current investments within the IPS, as this list may change over time and the IPS may not always be consistent with the website your participants visit to manage their accounts.
MINIMIZE INVESTMENT FUND EXPENSES.
Sponsors of 401(k) plans have spent millions of dollars settling allegations that they had overly expensive funds, in many cases retail-share classes rather than institutionally priced investments.
The expense ratios that 401(k) plan participants incur for investing in mutual funds have declined substantially since 2000, reports the Investment Company Institute, a trade association for financial services firms. In 2000, 401(k) plan participants incurred an average expense ratio of 77 basis points (0.77 percent) for investing in equity mutual funds. By 2019, that figure had fallen to 39 basis points (0.39 percent), which is a 49 percent decline.
For plan sponsors of all sizes, it is imperative to document efforts to maintain the lowest possible investment expenses.
COMPARE INVESTMENT PERFORMANCE.
How do your plan's funds compare to similar offerings? There is no shortage of high-performing, low-expense funds to choose from in each investment category. While the retirement committee can't forecast future investment performance, it can determine prudent funds based on their track record.
If investment evaluation isn't your forte, get expert help from an investment adviser that accepts fiduciary responsibility for investment recommendations.
DROP UNDERPERFORMING FUNDS.
If the menu needs to be revamped, just do it. The small inconvenience of explaining to employees why changes are being made is better than responding to document requests arising from litigation for failing to let go of underperforming funds.
MONITOR REVENUE-SHARING.
Many mutual funds share a small portion of their expense ratio fees with plan administrative firms, which may reduce the costs that plan sponsors pay administrative firms for services such as recordkeeping of participants' investments, providing statements and distributing literature. Fund share classes with no revenue-sharing, however, have lower expense ratios and slightly better investment performance.
If revenue-sharing is in place for any fund being offered through the plan, audit it periodically—at least annually—and ensure that it is reducing plan expenses that might otherwise be paid by participants.
PAY VENDORS WITH FLAT-DOLLAR FEES.
All plans should grill their recordkeepers and other vendors on whether they charge the very lowest administrative fees available. When plan sponsors don't pay administrative fees themselves, a best practice is to charge participants a flat recordkeeping fee (perhaps subsidizing small balances) rather than using revenue-sharing funds to pay the recordkeeper a fee based on the percentage of assets in plan accounts.
If plan sponsors engage an investment adviser, it's also preferable to pay them a flat-dollar fee rather than a fee that fluctuates based on plan assets. Advisers should not be thinking about how recommended changes in a fund lineup will affect their pay.
In all circumstances, evaluating fees on a flat-dollar amount or dollars per participant will provide useful comparisons to fees based on a percentage of assets under management in the plan.
MAINTAIN CONSTANT VIGILANCE ON ADMINISTRATIVE FEES.
Recordkeepers and other vendors negotiate best when they perceive that they may lose you as a customer. As a fiduciary, you and your team need to play hardball at times. Don't worry about hurting the feelings of the vendor's personnel—you're the fiduciary with potential liability, they're not. Benchmark your administrative fees and consider issuing a request for proposal (RFP) for administrative services every few years.
Even though plans may not have changed much, vendors have, and they should be able to lower costs or provide additional services.
DOCUMENT YOUR DECISIONS, BUT BE SMART ABOUT IT.
Maintaining good records is a must but understand that any and all plan-related documents can wind up in the hands of class-action attorneys. Meeting minutes and e-mails should be carefully written and demonstrate a prudent process, to avoid casting the plan or committee in a bad light.
GET IT IN WRITING.
Vendor contracts should be negotiated, not rubber-stamped. Keep track of promises made in RFP responses and finalist presentations. A vendor's oral promises should be documented within their service agreement. Insist on performance guarantees so your plan will be compensated for any service lapses.
DON'T ACCEPT FORCED ARBITRATION WITH ANY VENDORS.
Fiduciaries should not sign away their option to use federal courts to resolve conflicts with vendors. Plan sponsors can always choose to arbitrate a dispute, as vendors prefer this. Just don't sign any contracts agreeing to compulsory arbitration of any and all disputes.
PROTECT AGAINST IDENTITY THEFT.
Ensure that hackers don't steal your employees' account balances. Ask recordkeepers about their security practices, experiences in defeating hackers, and resources committed to maintaining strong cybersecurity.
Obtain a written commitment in the service agreement that the vendor will reimburse participants who followed account security guidelines and, through no fault of their own, had their accounts depleted.
Summing Up
There are several things a company can do to protect against 401(k) litigation. Have the retirement plan run by a committee of dedicated, knowledgeable employees. Hire independent expert advisers to help with investments, vendor oversight and training. Make sure that all fees are competitive, using benchmarking and RFPs as needed. Use an objective fund scoring methodology and replace underperforming investments. Document decisions and pay attention to process.
SOURCE: Scott, P. (22 September 2020) "Viewpoint: How to Minimize the Risk of Retirement Plan Litigation" (Web Blog Post). Retrieved from https://www.shrm.org/resourcesandtools/hr-topics/benefits/pages/minimize-risk-of-retirement-plan-litigation.aspx
Awaiting fate of fiduciary rule, plan sponsors turn attention to fee reasonableness
Uncertainty around the fiduciary rule has muddied the waters for retirement plan sponsors and service providers who are still trying to wrap their heads around the role they are expected to play under the regulation. But while plan sponsors await the rule’s fate — which was vacated in a March ruling by the U.S. Court of Appeals for the Fifth Circuit — experts say fee reasonableness should remain a priority.
The fiduciary rule brought fee reasonableness — meaning that while benchmarking your retirement plan against others, your plan's fees should not be too high above the average — top of mind for many employers, says Shelby George, senior vice president, advisor services, at investment firm Manning & Napier. “It is often associated with confusion, both because the DOL never specifically defines what fee reasonableness is, and because it is an area where there has been an enormous amount of ERISA class action lawsuits,” she says. “If you are already accepting fiduciary responsibility, be cognizant that fee reasonableness is a key part of what you are evaluating in your fiduciary capacity.”
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Those who don’t accept fiduciary responsibility will still have to keep reasonable compensation in mind because it is a foundational principal that applies throughout the world of financial advice, including the Internal Revenue Service, the Securities and Exchange Commission and the Financial Industry Regulatory Authority.
“Much of our understanding of what is and is not reasonable was shaped by ERISA class action lawsuits and allegations that have been made,” George says. “Those lawsuits were focused not on the fiduciary rule, but fiduciary responsibility to act in the best interest of plan participants. You need to make sure as fiduciaries you are only passing costs on to plan participants that are reasonable in light of the services they are receiving.”
Most tests of whether fees are reasonable don’t look at the value provided in return for the fees being charged, she says. Many assessments will look at market data and will conduct fee benchmarking both for advisory fees and investment management fees. If the fees being charged in a plan are much higher than what others are charging, the fees may not be considered reasonable.
A more subjective test will look at the value of the services being provided for the fee.
“The assessment needs to look at whether the value of the service is commensurate with the fee that is charged. That is very subjective and could be different depending on who is doing the evaluating. There is so much confusion over fee reasonableness,” George says.
Staying the course
In March, the U.S. Court of Appeals for the Fifth Circuit vacated the fiduciary rule. If that decision stands, the fiduciary rule will go away in May and the industry will go back to following the five-part fiduciary test that was used previously. Until the rule is either sent back to the full Fifth Circuit for a rehearing or is reviewed by the Supreme Court, however, the fiduciary rule’s best practices for when someone is considered a fiduciary will remain in effect.
Norma Sharara, a partner in Mercer’s employment practices risk management group in Washington, urges plan sponsors to keep following the rules as they have been. After the Fifth Circuit’s decision, she says, it is uncertain what the Department of Labor will do next.
“The DOL has a couple of choices. One is to do nothing,” Sharara says. “There’s no secret the Trump administration is not a fan of this rule. Some people are wondering why they would challenge what is a good outcome for them politically.”
The DOL could defend the agency’s right to make its own rule, she adds, by asking the Fifth Circuit to rehear the case with a full complement of judges. The Fifth Circuit opinion handed down on March 15 was made by only three Fifth Circuit justices out of 17. If the DOL opts for this course of action, she says, that request has to be filed by April 30. If the DOL doesn’t ask for a full circuit review or ask for an extension, the rule will be officially dead in May.
If the Fifth Circuit denies a rehearing, the DOL must file a petition with the Supreme Court to review the decision within 90 days of the denial.
“We don’t know that until we see what the Labor Department is going to do. The third option is to withdraw the rule. It seems to be what the Trump administration thought it could do when it took office last year,” Sharara says.
In the meantime, “plan sponsors and investment advisers need to stay the course to see what the Labor Department does next. It is a game changer for investment advisers,” she adds.
If the rule is officially killed, the fiduciary rule will go back to where it was since 1975. If that is the case, it is up to plan sponsors to reconnect with all of their plan service providers to make sure they know who is acting as a fiduciary to their retirement plan, she says.
Source: Gladych P. (2 April 2018). "Awaiting fate of fiduciary rule, plan sponsors turn attention to fee reasonableness" [Web Blog Post]. Retrieved from Employee Benefit News.
