Most employers sponsoring 401(k) and 403(b) plans are well aware of the large number of lawsuits filed over the past decade or so alleging breach of ERISA fiduciary duty related to plan investment funds and service providers. Unfortunately for plan sponsors (and their employees who serve as investment related fiduciaries), the pace of these lawsuits has increased this year, with more than 50 class action lawsuits filed since the beginning of 2020.
While the specific claims in these lawsuits vary, the most common allegations include that a plan's fiduciaries:
- Paid excessive fees to the plan's record keeper
- Failed to solicit competitive bids for record keeping and other plan services
- Paid excessive investment management fees for investment funds
- Maintained higher fee mutual funds when lower cost share class mutual funds or similar, alternative investment vehicles were available at lower fees
- Failed to timely remove underperforming investment funds
- Failed to properly monitor investment decision makers
Given the increasing pace of this litigation, now is a good time for every plan sponsor to evaluate its own fiduciary processes related to investment funds and service providers. In doing so, plan sponsors should consider and be able to answer four important questions: How much? Why/What? How do you know? Can you prove it?
This question establishes the facts resulting from an employer's fiduciary process. It includes:
- How much are fees for each investment fund?
- How much of this cost are investment management fees and how much are other fees (e.g., 12b-1 fees)?
- How much of a fund's cost is revenue sharing and how much, if any, of the revenue sharing is rebated back to the plan or to the investment fund that generated it, or otherwise used for the plan's benefit?
- How much fees are paid for by participants and on what basis?
- How much does the plan pay from plan assets to its record keeper, investment adviser, auditor, attorney, or other service providers?
- How much is a reasonable fee to pay plan service providers, taking into account the specific services provided?
This question gets to the heart of fiduciary procedure – how and why decisions were made.
- Why is each investment fund in the plan's fund line-up, and what purpose does each fund serve?
- Why are some asset classes used but not others?
- What is the rationale for including actively v. passively managed investment funds?
- Why is a specific share class (if applicable) used and what dollar level of investment is necessary to include a lower (or lower net) cost share class?
- Why does the plan's investment line-up include (or not include) alternative investment vehicles such as collective investment trusts?
- What index and/or benchmark is an investment fund compared to, and why?
- What happens if an investment fund underperforms its peers and/or its benchmark (or other criteria) over various time periods?
- What are the criteria (quantitative and qualitative) for a plan considering changes to its investment line-up?
- If the plan's record keeper or investment adviser is paid as a percentage of plan assets, why, or if paid a fixed fee, why?
- What services is the plan entitled to receive from its record keeper, investment adviser and other service providers, and does the plan actually use these services?
How Do You Know?
How do a plan sponsor and its employees serving as plan fiduciaries (e.g., investment committee members) know the answers to the first two questions? Answering "how do you know" requires plan sponsors and fiduciaries to understand how their plans operate and tie decision making to actual process.
- Who are the fiduciaries responsible for plan investment and service provider decision making?
- Do the fiduciaries receive and review investment reports? How often?
- Do these reports clearly explain how the plan's investment line-up performed compared to peers and benchmark (and other criteria) and over various time periods?
- Do the fiduciaries receive and review a periodic analysis of fund fees and know what is necessary for the plan to access lower cost share classes or alternative investment vehicles?
- Do the fiduciaries receive and review the required annual ERISA 408(b)(2) disclosures?
- Do the fiduciaries regularly consult with an investment professional?
- Do the fiduciaries receive and consider information about changes in an investment fund's manager, ownership, research capability, and other non-investment factors?
- Does the plan periodically go to market (RFI, RFP, etc.) for its record keeper and investment adviser, to help it understand current market fees and services?
Can You Prove It?
This question addresses a plan's internal record keeping and a plan sponsor's and fiduciary's ability to integrate and restate the answers to the first three questions.
- What documents designate the individuals responsible as fiduciaries for plan investment and service provider decision making and their acceptance of these responsibilities?
- Do the fiduciaries meet and keep written minutes of their meetings, and if so, how detailed are the minutes? Do they reflect recommendations made by professional advisers and substantive discussions among the fiduciaries?
- Does the plan maintain written material provided by its service providers and for how long?
- How accurately can the plan's fiduciaries answer the first three questions or how much effort would it take to be able to do so?
The ability of plan sponsors and fiduciaries to answer these and similar questions is an important part of a prudent fiduciary process. It is also a key element of maintaining a retirement benefits program that will be better able to help employees prepare for a financially viable retirement. Plan sponsors that need assistance in establishing and effectively maintaining a "best practices" based fiduciary process should seek experienced legal counsel and professional investment advice.
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.