Litigation in the 401k space is not new. The recent spate of lawsuits (10 and counting) against large plan sponsors who hired the all-passive BlackRock target-date funds for their defined contribution (DC) plans has me thinking about a paper I wrote back in 2018, Defined Contribution Investments On Trial: In Defense of an Institutional Approach, as these views still resonate four years later.
In my opinion, it is critical that plan sponsors not put their fear of litigation before doing the right thing for their plan participants. To best support their employees’ retirement income goals, plan sponsors should take an “institutional approach” to their investment menu that leverages the scale and fiduciary oversight offered by the DC retirement system.
An institutional approach shares similar principles to that of other institutional investors like defined benefit (DB) plans, endowments and foundations, sovereign wealth funds and high-net-worth investors. This often includes a thoughtful mix of active and passive management and broad asset class diversification, including alternative investments.
The market volatility over the last few years and the shift in capital from public to private markets further bolsters the investment case for such an approach, particularly for the average American worker who historically has not had access to more diversified asset classes like private real estate and private equity. This is even more important within target-date funds, where most workers rely on experts to professionally manage their retirement assets.
Unfortunately, in my experience, many plan sponsors are instead taking a “simple approach,” where the primary focus is minimizing fees and maximizing investment simplicity, with a heavy or exclusive use of passive management. Even plan sponsors who employ an institutional approach to meet their DB plan liabilities don’t always adopt these same approaches for their DC participants.
I believe those that are taking this simple approach merely to avoid litigation risk is a mistake, and one that is pointed out in some of the complaints in the recent lawsuits. This quote, taken from one of the complaints, highlights this trend: “As is currently in vogue, defendants appear to have chased the low fees charged by the BlackRock TDFs without any consideration of their ability to generate return.”
To be clear, I have no insights into the merits of these specific cases, as I don’t know the fiduciary process that these plan sponsors went through, and I have no reason to believe they acted imprudently. Indeed, BlackRock is a highly capable and respected target-date fund provider that many plan sponsors and advisors view favorably.
That being said, reading through the press coverage, I’m surprised by the comments from industry experts who were shocked that class action lawyers had the audacity to sue companies that selected a low-cost BlackRock target-date fund. Now, it does appear that many of the claims in the suits are based on backward-looking performance results, not on investment process, but so are many of the suits against those who hired active managers. I’m not suggesting these suits have merit either, but sadly we live in a world where if you are a large plan sponsor, you are a target.
So, what should a plan sponsor do? If you are a plan fiduciary and think selecting only low-cost passive options for your fund lineup will make you less likely to get sued—this recent spate of lawsuits should have you reconsidering. ERISA fiduciaries are required to do what’s in the best interest of participants and can do so by:
- Making prudent investments: Look to institutional peers, such as defined benefit plans, for guidance. In most cases, they are not taking an all-passive approach.
- Utilizing experts: If you don’t have the expertise in-house to make certain decisions, advisors are available to help you implement such investment approaches.
- Evaluating fees: Make sure fees are reasonable; this does not necessarily mean selecting the lowest cost option.
- Documenting decisions: Whatever you decide, make sure you document your decision-making process and rationale for your selections to show that you’re taking your fiduciary role seriously.
Of course, taking these steps can’t guarantee that plan sponsors won’t get sued, but now we know taking the simple approach won’t either. Importantly, sponsors should focus on what they can control: demonstrate that they’ve engaged in a prudent investment process and have provided plan participants with access to institutional-quality portfolios.
Editor’s Note: The preceding op-ed contributed to 401(k) Specialist was written by Josh Cohen, CFA, Managing Director, and Head of Client Solutions for PGIM DC Solutions.
SEE ALSO:
• A New Door Has Opened in 401k Target Date Fund Lawsuits
• Performance-Based Target Date Lawsuits Cause Industry Concern