401k Sponsors Seriously Stressed About Getting Sued

Stifled innovation is an 'unfortunate byproduct'

Even small 401k plans are turning up the stress levels.Even small 401k plans are turning up the stress levels.

Schlichter and Co. are taking a toll. More than half of 401k plan sponsors express concern over potential lawsuits, new research from Cerulli Associates finds. An unfortunate byproduct of this “rash of litigation” is that it stifles innovation in the 401k market, the Boston-based research behemoth adds.

Noting that the 401k defined contribution market saw an unprecedented number of lawsuits brought against plan sponsors and their providers in 2016, it adds the majority of litigation thus far has targeted “mega plans” that have the scale to offer the lowest-cost investment options and also present the largest revenue opportunities for the plaintiffs’ attorneys.

However, survey data shows that smaller 401k plan sponsors are also taking notice of this increasingly litigious environment, as reflected by the nearly one-quarter of small plan sponsors (less than $100 million in 401k assets) who describe themselves as “very concerned” about potential litigation.

In particular, fee-related lawsuits have been a pervasive theme in the 401k plan market in 2016, further underscoring the 401k industry’s intense focus on reducing plan-related expenses. A significant consequence of this focus on fees is an increased interest in passive investing.

Plan sponsor survey results show that the top two reasons for which 401k plan sponsors choose to offer passive (indexed) options on the plan menu are because of “an advisor or consultant recommendation” or because they “believe cost is the most important factor.”

Several defined contribution investment only (DCIO) asset managers tell Cerulli that the demand for passive products is driven, primarily, by the desire to reduce overall plan costs.

“As advisors become increasingly fee conscious, some view passive options as a way to drive down overall plan expenses, which in turn demonstrates their value to the plan,” Jessica Sclafani, associate director at Cerulli, said in a statement.

“It is also interesting to note that nearly one-quarter of plan sponsors select passive investment options because they are ‘easier for a fiduciary to monitor,'” Sclafani continued. “This reasoning is inextricably tied up with the mistaken view of some plan sponsors that passive is a way to mitigate their own fiduciary liability–a common misconception. Plan sponsors have a fiduciary duty to do what is in the best interest of the plan’s participants and their beneficiaries–if they are choosing a passive investment option simply because it is less work for them, this is not in line with the spirit of ERISA.”

“Plan sponsors feel they have little to gain by appearing ‘different’ from their peers due to the risk of being sued,” she explained.

This mindset can make plan sponsors reluctant to adopt new products, such as those focused on retirement income.

However, Sclafani concluded, “This issue may be forced if as a result of the fiduciary rule a greater amount of DC assets remain in employer-sponsored retirement plans instead of flowing to the IRA market, in which case DC plan sponsors will need to more closely evaluate the viability of using DC plans as a retirement income platform.”

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