[Podcast]: Steps to Reduce Risk of Claims Associated With 401K Plans
In this episode of the Proskauer Benefits Brief, partner Myron D. Rumeld and associate Joseph Clark discuss participant-directed defined contribution (DC) plans and the lawsuits against the fiduciaries and service providers which are responsible for administering them. We will examine the best practices that can achieve favorable results for plan participants and the practices that can avert litigation or enable plan fiduciaries to effectively defend themselves if there is litigation. With the proliferation of DC lawsuits in recent years, be sure to tune in for this very important issue impacting plan sponsors and fiduciaries.
Joe Clark: Hi, and Welcome to the Proskauer Benefits Brief. I’m Joe Clark and today I’m joined by Myron Rumeld. Today we’re going to discuss lawsuits against the fiduciaries and service providers that are responsible for administering participant-directed defined contribution plans, also known as DC plans. There’s been a proliferation of these lawsuits in recent years, a result of which is there’s been an increased focus among plan sponsors and fiduciaries on best practices with respect to selecting and retaining investments and the service providers administering these types of plans. In discussing best practices we consider both the practices that will achieve the best result for plan participants and the practices that are more likely to avert litigation or, if there is litigation, enable plan fiduciaries to effectively defend themselves. So the first thing we want to talk about is the most commonly asserted claims. Let me begin, Myron, by asking you, as of late what have been the most commonly asserted claims.
Myron Rumeld: Thank you Joe. Generally speaking the claims have focused both on the fees charged for planned investment products and other administrative services and on the performance of the investment products offered to plan participants. Let’s look first at the excessive fee claims. There has been a large variety of claims related to plan fees. The most frequently asserted claim is for the fees charged by particular investment funds as being too high compared to fees of comparable funds. Related to these claims is the claim challenging the inclusion of actively managed funds. The argument here being that index funds generate the same types of returns and sometimes better but are much cheaper. Other claims are a bit more esoteric. They might include claims that the plan wasted money by maintaining more than one recordkeeper or by offering too many investment options thereby diluting the plan’s leverage, its ability to negotiate lower fees because the plan assets are spread too thin or a claim of failing to select the lowest cost share class for any particular type of investment product. There also are claims alleging hidden revenue sharing payments that generate excessive fees of which the participants would typically not be aware or that the fee structure has become excessive with the passage of time because the fees are calculated as a percentage of the total amount of plan assets when perhaps a participant by participant fee as per participant fee would have been a cheaper alternative for the plan in the aggregate.
Joe Clark: So in addition to excessive fee claims you also mentioned claims alleging underperformance of investment funds. It seems like these claims would often go hand in hand with excessive fee claims because an investment is more likely to be challenged if its performance appears not to justify the fees being charged.
Myron Rumeld: Well that’s right the underperformance claims will typically track the arguments with respect to the fees in that a claim that a plan needlessly offered managed funds when index funds perform just as well will seek recovery not only of the allegedly excessive fees but of the net underperformance. At the end of the day it’s the performance net of fees that is really the measure of whether the plan or the participant suffered any damages. Similarly a challenge to the use of proprietary funds will seek recovery not only of the fees charged by these funds but of any related investment underperformance as well.
Joe Clark: And just to make the point these claims about fees and performance they aren’t limited to the selection of the investments, right? We have the Supreme Court’s ruling in the Tibble case that fiduciaries have a duty to monitor investments even after they’ve been selected.
Myron Rumeld: That’s right. The Supreme Court said that even after the investment selection process is completed and even if you’ve engaged in the most perfect process for selecting an investment or selecting some other service provider, fiduciaries retain a duty to monitor the investments and the other service providers and remove any ones that are no longer prudent to retain, and that could be due to the fees becoming excessive or the performance turning out to be poor. So even if the Trustees have done a bang up job in the selection of an Investment Manager or the selection of some other service provider they need to continue to monitor these services in order to mitigate litigation risk. Unfortunately, while the Supreme Court identified the claim it provided us with very little guidance about how to go about exercising this monitoring responsibility.
Joe Clark: So given that the Plaintiffs’ bars become a lot more active in this space, what would you suggest planned fiduciaries do to avoid getting roped into litigations like this?
Myron Rumeld: It’s hard to avoid these cases, these claims all together given the very active plaintiffs’ ERISA bar that we’re dealing with. Large plans are certainly going to be a target because large plans create the opportunity for large damages claims and any time a large plan suffers in an adverse investment result, for whatever reason, the plan is, you know, likely going to be on the radar screen of the plaintiffs’ bar and we may be seeing website advertisements, you know, seeking participants who are unhappy with the plan’s performance so that they can find some plaintiffs to file a class action with. But that having been said, there are some things that plans can consider doing that would at least make, that would at least make these plans less attractive candidates for claims and to make the claims more defensible if litigation is commenced, and these things generally relate to the overall principle that a claim is viable if it can give rise to an inference of an imprudent process. So the steps that we typically focus on that plans can take in advance is a protective measure or the types of things that may make it less likely for Court to think that any inference of imprudence could be drawn. So here’s some examples. One is it’s probably a little safer to offer a mixture of actively managed and passive index funds. As this would reduce the risk of a claim that the participant is obliged to pay the higher fees associated with the actively managed funds.
I also think it helps to try to avoid a lineup of exclusively proprietary funds. So if a banking institution, for example, is offering a menu of investments in its 401k plan, even if that institution has a full menu of its own investment products, it’s probably a little safer if participants are offered other choices, nonproprietary products, because that will tend to reduce any possible inference that the products were chosen just because they could generate fees for the plan sponsor but rather that there was an objective effort being made to offer up the best products for the plan participants.
Finally it never hurts to err on the side of providing more information to participants even if you go beyond what ERISA requires to be disclosed to participants. Obviously bad, incorrect, misleading communications can be a separate source of a claim but generally speaking if you are able to provide participants with fulsome information about their investment choices and the fees associated and, even better, something about what the competition is offering or what index funds are offering, it may make it a little easier for us to prevail on a Motion to Dismiss particularly because we are limited on a Motion to Dismiss in what types of documents we can refer to but if there are documents that are part of the plan materials made available to the participants, we may have an opportunity to cite those documents even on an initial Motion to Dismiss.
Joe Clark: So wouldn’t it be safer to avoid risk by just not including products that have been challenged by the plaintiffs’ bar or offering only plan vanilla off the shelf funds? And I’m guessing you’re going to say no.
Myron Rumeld: So I don’t think it’s a good idea for any plan sponsors or fiduciaries to adjust their practice just for purposes of avoiding litigation or just based on recent trends. Trends will change so, for example, right now it may seem as if investments in managed products are more likely to generate claims because in recent years there’s been evidence, at least for certain sectors of the market, that index funds have performed as well or better with lesser fee structures. But that is unlikely to remain the case forever in a down market. We could very well see circumstances where the managed funds do perform much better because they’re better hedged against the down market and we could very well see a new trend of litigation against plans that offered exclusively index funds and didn’t provide participants with the opportunity to invest in managed funds. So I think that rather than chasing current trends, we would all be better off just offering a diversified menu of investment products and focusing on the information that we provide to the participants so that they remain well informed. As to whether it’s a good idea to stick to exclusively plain vanilla products, I don’t think there’s any disputing that the more imaginative a plan is with respect to the types off investment products it offers, the more risk it has of litigation in the event that one of these investment products does not perform well. But I think the objectives should always be to give the participants the best chance of having healthy retirement savings, while at the same time preserving your ability to defend yourselves by taking some of the steps I referred to a few minutes ago.
Joe Clark: Thanks for joining us today on the Proskauer Benefits Brief. Stay on the lookout for more legal insights on employee benefits and executive compensation and be sure to follow us on iTunes.