If it seems like just about every week you hear about another lawsuit being brought against a 401(k) fiduciary, the reality is it’s actually much more than that.
Over 90 lawsuits were filed against defined contribution plans for excessive fees alone in 2020 according to fiduciary liability insurance provider Euclid Specialty, while a Bloomberg Law analysis found only about 20 were filed in all of 2019.
Groom Law Group found just over 200 new ERISA class actions were filed in 2020, an all-time record that represents an 80% increase over the number filed in 2019 and more than double the number filed in 2018.
“As 2021 begins, this trend shows no sign of slowing down, with important developing issues related to fee and performance litigation for smaller retirement plans,” states a Jan. 3, 2021, Groom Law Group article on the topic.
The spike in cases, Bloomberg Law said, can be explained by the maturing body of law under the Employee Retirement Income Security Act (ERISA), an emerging blueprint for filing and litigating cases, new tools available to plaintiffs’ attorneys, and even the global pandemic.
This growing threat of litigation is leading to another trend—one of fiduciaries outsourcing plan investment responsibility.
Fiduciaries are personally liable for losses caused by their fiduciary breach, and advice from their plan vendors about investments is not fiduciary advice required to be in their best interests, points out Carol Buckmann, a highly respected employee benefits and ERISA attorney who is a co-founding partner of Cohen & Buckmann in New York.
Buckmann recently wrote a blog about why fiduciaries should consider outsourcing plan investment responsibility, opining that plan sponsor fiduciaries who take a “do-it-yourself” approach to plan investments face huge potential exposure for underperforming investments and excessive plan fees, and should at least consider outsourcing their investment responsibilities to an investment manager or outsourced chief investment officer (OCIO).
She cited a recent survey by Callan that found 21.6% of surveyed 401(k) plans hired an investment manager described in Section 3(38) of ERISA to manage plan investments, up from 15.9% in 2018. A different survey by PGIM indicates that 15% of defined contribution plans and 24% of mid-sized defined contribution plans had outsourced chief investment officers (OCIOs).
“There is a trend toward outsourcing, and the surprise is that more plan sponsors haven’t chosen an outsourcing option in light of their potential liability if they adopt a ‘do-it-yourself’ approach,” Buckmann said.
In an interview with 401(k) Specialist, Buckmann said it’s not only the biggest plans that risk litigation anymore.
“Plaintiff ’s counsel started with the largest plans, but their targets have moved down to smaller plans over time,” Buckmann said. “Claims will typically go back six years (the usual statute of limitations for fiduciary breach), and claim damages for excessive fees and lost investment return, and these can be substantial amounts even for medium-sized and smaller plans.”
Excessive Fee Risks
Lawsuits are being brought against 401(k) fiduciaries, primarily from a handful of law firms specializing in class action 401(k) lawsuits, for a variety of reasons.
They almost always fall into one of three categories—excessive fees, inappropriate investment options and self-dealing. But it’s clear the recent rise in litigation has been particularly focused on fees.
“These lawsuits allege that defined contribution plan administrative and investment fees are too high, and that any investment performance that lags any plaintiff-asserted benchmark—a moving target—is actionable negligence that should generate huge indemnity payments and high attorney fees to the firms bringing these lawsuits,” Euclid Specialty wrote in a December 2020 white paper, further stating the rise in cases is the result of opportunistic attorneys rather than true discontent among participants.
The finding for or against a plan fiduciary doesn’t always hinge on whether fees are too high, but whether any decisions were arrived at following a prudent process and with participants’ interests at heart. ERISA requires that fiduciaries follow a careful, prudent process to ensure that plans pay no more than reasonable fees for necessary services.
These lawsuits (and perhaps the mere threat of them) have been accompanied by an increase in the use of passive investment options and a fall in investment and administrative fees.
“Excessive fees can cover recordkeeping and service provider fees as well as investments, so I would say that is probably the biggest risk today. Plans that don’t have passive index fund options are a target as both having excessive fees and being inappropriate investment options,” Buckmann said. “But I think we are going to see more of a focus on target-date fund selection and claims that inappropriate target-date funds were picked in the future, both because these funds represent a large percentage of assets in most plans and also that they unfortunately often get selected without much investigation of their performance compared to peer target-date funds.”
Why Some Resist Outsourcing
With 401(k) lawsuits surging and increasingly targeting smaller plans, why would a plan sponsor want to keep going the “D-I-Y” road and not take steps to better protect themselves against litigation risks?
Beyond some newer plan sponsors without significant assets thinking their plan doesn’t yet need the types of services outsourced investment fiduciaries provide, Buckmann cited two main reasons.
“One is the desire to retain control over decision making, and the second is a failure to understand the full scope of fiduciary responsibilities and fiduciary liability exposure, including personal liability for losses caused by fiduciary breach,” Buckmann said. “In addition, some smaller plan sponsors may not know how to go about finding the right provider, or that they can hire people to help with RFPs.”
Here’s one place advisors can step in.
Advisors could help with the request for proposal (RFP) to find the new providers and assist in reviewing and monitoring the outside providers, which many plan sponsors lack the expertise to do, Buckmann said. “If the advisor’s organization provides investment management or OCIO services, the benefit of outsourcing should certainly be discussed with the advisor’s clients. I think that advisors who put their client’s needs first will have a competitive advantage.”
The RFP should be designed to find candidates with proven experience in ERISA plans.
Given the level of litigation and enforcement actions, hiring the right professional is crucial, Buckmann noted. Failure to do a good RFP or opting to hire social connections without investigating their qualifications could be a costly mistake.
If a company fiduciary or owner can’t get comfortable giving up control, outsourcing may not be a good fit. An investment advisor will give professional advice while leaving the actual decision-making in the hands of the company fiduciaries, at the cost of remaining responsible as co-fiduciaries for investments.
“I think there is sometimes a view that advisors may be advising themselves out of a job if they recommend outsourcing and their firm doesn’t provide it,” Buckmann said. “However, if they encounter situations where the plan sponsor fiduciaries aren’t on top of things, they would better serve the plan sponsor by recommending outsourcing. There may still be a role for them if there is an investment manager or OCIO.”
One other consideration: Employers joining new Pooled Employer Plans (PEPs) debuting this year as a result of the SECURE Act (see related article on page 22) may have access to fiduciary investment services through their plans.
Why OCIOs?
What does an OCIO do that a 3(38)-investment manager doesn’t do? An investment manager will select a plan’s investments and may construct model portfolios for the plan to use. OCIOs can help the plan obtain institutional quality investments, such as custom target-date funds, and they can leverage assets to obtain lower fees.
Buckmann notes that OCIOs can provide investment management services—as would a 3(38)-investment manager—but an OCIO can be a “named fiduciary” of the plan and provide more extensive services. “OCIO arrangements vary, but in addition to helping the plan obtain institutional quality investments, an OCIO may take responsibility for functions such as plan design, plan communications, documenting plan investment decisions and plan governance,” Buckmann said. “Many lan sponsors lack the time and expertise to handle these functions well.”
From the courts’ perspective, the main responsibility of a plan fiduciary is to follow a prudent process in making plan-related decisions. But litigation-proof documentation isn’t easy to accomplish.
That being the case, many companies look to fiduciary liability insurance to protect themselves. These policies, while not legally required by ERISA, are specifically designed to protect against the legal liability arising out of their role as fiduciaries. It typically covers associated legal costs to defend against claims of errors and a breach of fiduciary duty.
Unfortunately, but understandably, the proliferation of 401(k) lawsuits has resulted in a serious spike in fiduciary liability insurance premiums—and the coverage is getting increasingly difficult to purchase. The policies are becoming more restrictive, with more exclusions, lower caps on coverage and higher retention fees to renew policies.
Pensions & Investments reported last October that fiduciary liability insurance premiums are up a staggering 35% as a result of costly awards and settlements.
As insurers adjust premium rates and coverage limits, many plan sponsors will likely face a gap between the coverage they need and what they can afford. Others will look to obtain coverage from multiple insurers to get around coverage limits—if they can afford to.
“I advise clients to purchase as much coverage as they can reasonably afford because litigation is expensive even if you win, and the required plan bonding coverage doesn’t protect them,” said Carol Buckmann, an employee benefits and ERISA attorney with Cohen & Buckmann.
“Some fiduciaries rely on corporate indemnification promises, but those may not mean much if the plan sponsor is in financial difficulty,” Buckmann added. “Fiduciaries may also think E&O policies will protect them, but I often see E&O policies that specifically exclude coverage as a plan fiduciary. For all those reasons, fiduciary liability insurance has become a practical necessity, even though it is not legally required.”
Veteran financial services industry journalist Brian Anderson joined 401(k) Specialist as Managing Editor in January 2019. He has led editorial content for a variety of well-known properties including Insurance Forums, Life Insurance Selling, National Underwriter Life & Health, and Senior Market Advisor. He has always maintained a focus on providing readers with timely, useful information intended to help them build their business.
