United States: 401(k) Plan Fee Litigation Update

Last Updated: December 6 2016
Article by Thomas J. St. Ville

The wave of fee litigation is ongoing and has significantly increased the responsibility of 401(k) plan fiduciaries to follow well documented, prudent processes to monitor 401(k) plan fees and expenses.

Small/Mid-Sized Plans Under Attack?

Until recently, the fee-based claims against 401(k) plan fiduciaries targeted "mega-plans" – e.g., Verizon ($30B); Chevron ($19B); Intel ($15B); Oracle ($11B); American Airlines ($9B) – but two notable cases may indicate an extension of fee based claims into the small/mid-size 401(k) plan market: Checksmart ($25M) and LeMettry's Collision ($9M).

Whether an expansion of fee-based claims to the small/mid-size plan market can be characterized as a trend is still to be determined. The small/mid-sized plan market is sizable. According to an EBRI report, there are over 75,000 401(k) plans that have less than $25M in plan assets, and these plans benefit over 4M participants. Both EBRI and ICI have also reported that there appears to be an inverse relationship between the size of the plan asset pool and the level of fees incurred. This is primarily because the larger plans can leverage their size to negotiate better fee deals. On the other hand, the potential recovery from a smaller asset pool (and the corresponding attorney fee award) is considerably smaller so it is possible that these small plan cases may simply be outliers.

Evolution in the Type of the Claims

Initially the lawsuits challenged concepts such as "excess revenue sharing"; fees connected to "bundled" services; the fees associated with "retail" funds (as opposed to lower cost institutional class funds); and fees attributable to actively managed funds. The plan sponsors/fiduciaries did have some early success in defending these cases, but several high profile settlements – e.g., Lockheed Martin and Nationwide – have emboldened plaintiffs to pursue a variety and a growing number of fee-based claims against 401(k) plan fiduciaries.

These high-dollar settlements appear to have led to an expansion of the fee claims in surprising ways – including excessive fee claims against plans that offered very low cost (e.g., Vanguard) funds. These sorts of claims are notable because in several early cases – e.g., CitiGroup - the plaintiffs actually asserted that Vanguard funds should have been used because of their relatively low index-based fees. In cases against Chevron and Anthem, for example, the plaintiffs argued that the Vanguard funds offered under the plan were available in lower cost share classes and, consequently, the participants were incurring excessive fees, even though the funds offered by the plans were actually being charged fees as low as 4bps.

Expanding the Targets

In addition to pushing the envelope on the types of claims, plaintiffs in fee cases have expanded the targets of these claims to include, among others, the fiduciaries of plans in the non-profit sector. In several recent cases brought against high profile educational institutions – MIT, Yale, Columbia, Johns Hopkins – plaintiffs alleged a variety of fiduciary breaches in connection with the schools' 403(b) tax-sheltered annuity plans. While some of the features that gave rise to these claims result from the unique challenges surrounding 403(b) annuity contracts – asset-based administrative fees; revenue sharing; multiple recordkeepers – and are not prevalent in the 401(k) market, other issues raised are instructive for 401(k) plan fiduciaries. These include the need for 401(k) plan fiduciaries to be sensitive to giving appropriate consideration to lower fee share classes, as well as the need to give a higher level of scrutiny to funds that are proprietary to the plan administrator/recordkeeper.

Beyond the extension of the fee-based claims to plans outside the 401(k) market, the universe of persons who may become targets of these claims has also been expanded. The Department of Labor's new fiduciary rules have broadened the scope of potential targets of these cases, including service providers to a plan that may now be regulated as ERISA fiduciaries. Also notable among these are the excessive fee allegations that have been raised in connection with wrap insurance contracts underlying stable value funds – Fidelity/Barnes& Noble.

Observations

  • Fee litigation appears to have contributed to generally lower fees for 401(k) plans. A recent ICI report tracked plan expense ratios from 2000 through 2015 and noted a 30% decline.
  • Smaller plans will typically incur higher fees than larger plans that are able to use their size to leverage better deals.
  • The increased focus on fees may be at the expense of other fiduciary factors – e.g., quality of funds and quality of service. Driving down the costs can affect the quality and type of services available.
  • Fear of fee litigation may prevent a committee (or other fiduciary) from considering innovative ideas – e.g., lifetime income options. Balancing the benefit to participants with the risk of fee litigation is becoming difficult.

Take-Aways

  • A 401(k) committee (or other fiduciary) should develop and follow an investment policy statement; and modify or update the policy as appropriate.
  • A 401(k) committee (or other fiduciary) should document that it regularly investigates share classes and fee options to ensure that it has considered the lowest cost option for which it qualifies.
  • If higher cost funds are selected, a committee (or other fiduciary) should document the process that led to the selection of a higher cost fund as opposed to a cheaper fund - e.g., documenting the relative performance of the higher cost funds net of fees.
  • If high expense, high-risk and potentially high return funds (e.g., actively managed funds) are included, they should be offered as part of a mix of funds that includes lower expense funds - e.g., index funds that track the market or low risk, modest return bond funds.
  • Examine the use of funds that are proprietary to the plan recordkeeper. These have given rise to claims of excess revenue sharing and potential conflicts of interest.
  • Review and, if necessary, adjust ERISA fiduciary liability insurance. The threat of litigation has increased the focus on ERISA fiduciary liability insurance.
  • Even if a plan is satisfied with its current provider, consider periodically benchmarking or going out with RFP's. The RFP process can often disclose administrative and cost saving options.
  • If internal personnel are uncomfortable with committee responsibilities, consider outsourcing some or all of the process to an "ERISA 3(38) investment manager."

  • Alternative-type fee arrangements, particularly for recordkeepers, are beginning to be considered – e.g. flat fees and per participant fees.

  • Interest in "ERISA Expense Accounts" is increasing, particularly to hold negotiated reductions in "revenue sharing" amounts attributable to asset based recordkeeping fees.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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