United States: Minimizing The Risk Of Costly 401(k) And 403(b) Investment Fund And Fee Lawsuits

Last Updated: November 29 2017
Article by Jordan Schreier

As employers who sponsor 401(k) and 403(b) retirement plans prepare their 2017 year-end and 2018 "to do" lists, they should be sure to include a review of their processes for selecting and monitoring the investment funds they make available for plan participant investment and the fees their plans pay to record keepers and other service providers.

Since 2006, more than 100 lawsuits have been filed against 401(k) and 403(b) plan sponsors and their employees responsible for selecting the plans' record keepers and investment line-ups, alleging that they breached their fiduciary duty by allowing participants to pay excessive record keeping fees and invest in underperforming and expensive investment funds. The pace of these lawsuits has increased over the past two years, with around 30 new cases filed in 2016 and more in 2017.

Under ERISA, 401(k) and 403(b) plan fiduciaries must act solely in the interest of plan participants and beneficiaries and as a prudent expert would under similar circumstances. The fee and investment lawsuits dig deep into the investment fund structure of a plan and the plan's record keeping arrangement looking for areas in which lower cost and/or better performing funds were available and less expensive record keeping may have been possible. Common allegations are that the fiduciaries breached their duties of loyalty and prudence by:

  • Failing to remove underperforming investment funds
  • Failing to offer less expensive investment funds
  • Failing to leverage plan size to negotiate lower record keeping fees
  • Failing to competitively bid record keeping services
  • Using revenue sharing and payment of excessive fees to the plan's record keeper
  • Selecting a low return money market fund as the plan's "low risk" investment option instead of a higher return stable value fund
  • Failing to select lower cost passive investment mutual funds
  • Paying record keeping fees as a percentage of assets rather than on a fixed or flat fee basis
  • Paying higher fees to the plan's record keeper so the employer can receive other services from the record keeper (e.g., payroll processing) and no or below market cost
  • Allowing an excessive number of investment fund options or duplicate options within the same asset class

Initially very large multi-billion dollar plans were targeted in these lawsuits. More recently, lawsuits have been filed against much smaller plans ($100 million range) and one case was filed against a plan with only $9 million in assets. In addition to the sponsoring employer and the direct investment decision makers, the lawsuits also typically name the employer's officers and board of directors as defendants. Due to the fact intensive nature of these cases, they can be very costly to defend.

Fortunately, there are actions an employer can take to minimize the risk of facing one of these lawsuits or improving the likelihood of success if sued. The employers that have had the most successful defenses to these lawsuits are ones that can demonstrate that they used regular, prudent fiduciary processes in investment fund and record keeper decision making. Employers reviewing their own processes should determine if they:

  • Formally designate investment fund selection decision makers (e.g., establish an investment committee)
  • Hold regular (quarterly) well-structured investment committee meetings
  • Require discussion of and decisions on topics targeted by the investment fund and fee cases
  • Prepare comprehensive meeting minutes and maintain records
  • Negotiate/review service provider contracts and understand and approve fee structures
  • Prepare investment policy statements and fee policies
  • Conduct regular fiduciary education and training

Experienced legal counsel may be necessary to effectively implement many of these steps.

Employers that review their investment fund and record keeping processes will be taking an important step in minimizing the risk of a costly breach of fiduciary duty lawsuit. In addition, implementing effective fiduciary process is an important part of achieving the ultimate objective – managing a successful retirement program that will provide meaningful retirement benefits to employees.

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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