ERISA Litigation over 401(k) Plans Has Fiduciaries Pushing Back
ERISA litigation surged in 2016 and 2017, reports Bloomberg’s Bureau of National Affairs, with more than 50 litigation matters related to 401(k) plans filed with federal courts in each of those years.
The widespread adoption of 401(k) defined contribution plans is one reason behind the growth in litigation. More than $5 trillion is now invested in 401(k) plans, and adoption rates in the corporate world have grown from 12 percent of plans in 1983 to 73 percent of pension plans in 2016. Defined benefit plans, which many corporations and municipalities have found to require unsustainable funding levels, have increasingly been replaced by 401(k) plans in the past 20 years.
According to a recent report from the Center for Retirement Research at Boston College titled “401(k) Lawsuits: What are the Causes and Consequences,” 401(k) lawsuits can be grouped into three major categories:
1) Inappropriate investment choices;
2) Excessive fees; and
The Employee Retirement Income Security Act of 1974 (ERISA) governs the administration of 401(k) plans, and the U.S. Department of Labor (DOL) is charged with enforcing ERISA. Rather than publishing specific guidelines that plan fiduciaries must follow, however, the DOL has often chosen to take enforcement actions after plan participants file litigation challenging the actions of plan fiduciaries.
This article will explore each of the three ERISA litigation categories in more detail.
CATEGORY 1: INAPPROPRIATE INVESTMENT CHOICES
ERISA enforcement is based on the statute’s “prudent man” rule, which requires that investment options be selected in a careful manner intended to avoid large losses.
ERISA fiduciaries must be able to demonstrate that they followed a prudent process in selecting investment options, even if the ultimate investment returns were not as expected. Litigation can result after a fund has experienced poor performance over relatively long periods of time, for example, when compared to similar funds.
The inclusion of an employer’s own stock in a 401(k) plan has also been the subject of much litigation, particularly after the Great Recession, although this type of dispute has abated in recent years.
CATEGORY 2: EXCESSIVE FEES
ERISA requires that plan fiduciaries pay “reasonable” fees for investment and related services. Most litigation in this regard involves the plaintiff alleging the payment of excessive investment or administrative fees, which thereby erode plan participant returns.
Courts have consistently held that in choosing which funds will be offered, fiduciaries must select funds that charge no more than a reasonable investment fee. Fiduciaries must routinely assess whether the fees continue to be reasonable when compared to alternative funds available.
In assessing the reasonableness of the investment fees, fiduciaries are expected to compare a fund’s fees to other funds with similar risk and return and asset class characteristics. The fiduciary also must take steps to show that it offered the lowest-cost version of a specific fund available to the plan.
The reasonableness of administrative fees can be more difficult to determine due to lack of historic benchmark data. This has changed in recent years, particularly following a 2012 DOL regulation that requires service providers to identify all relevant fees to the plan fiduciary.
CATEGORY 3: SELF-DEALING
ERISA litigation involving claims of self-dealing, according to the Boston College report, often allege that the fiduciary failed to act “for the exclusive purpose of (i) providing benefits to participants and their beneficiaries; and (ii) defraying reasonable expenses.”
The financial services industry has been the subject of many self-dealing claims. Often this involves a bank or investment firm that offers their own poor-performing funds as selections for plan participants. The allegation is that the fund favors the sponsor more than the plan participant. New investment fund offerings that have not yet established a history of investment returns have also been targeted.
FIDUCIARY EFFORTS TO MINIMIZE ERISA LITIGATION RISKS
Many ERISA fiduciaries are beginning to use more passively managed mutual fund options, like index funds, as one way to decrease litigation risks. Fiduciaries that adopt passive investments have less risk of significantly underperforming other index funds on performance and fee benchmarks.
Another risk management technique being used by plan sponsors is to offer fewer investment options. In the past, many fiduciaries offered a wide variety of asset class choices such as industry-specific equity funds, commodities-based funds, and niche-oriented fixed income funds. This often resulted in claims from plan participants that they did not fully understand the associated potential for higher fees and increased investment risks.
Fiduciaries are also increasing fee transparency because of 401(k) litigation, due in part to the DOL’s 2012 regulation requiring service providers to disclose their fees to plan fiduciaries. These increased disclosures have resulted in increased transparency for plan fees as well as lower fees.
ABOUT THE AUTHOR: Mark Johnson, Ph.D., J.D.
Mark Johnson, Ph.D., J.D., is a highly experienced ERISA expert, including matters relating to ERISA litigation. He is a former ERISA Plan Managing Director and plan fiduciary for a Fortune 500 company, Dr. Johnson has practical knowledge of plan documents as well as an in-depth understanding of ERISA obligations. He works as an expert consultant and witness on 401(k), ESOP and pension fiduciary liability; retiree medical benefit coverage; third party administrator disputes; individual benefit claims; pension benefits in bankruptcy; long term disability benefits; and cash conversion balances. He can be reached at 817-909-0778.
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Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.