A New Door Has Opened in 401k Target Date Fund Lawsuits

• A new wave of lawsuits alleges that BlackRock’s target date funds (TDFs) have underperformed.
• These lawsuits open the door to a related and scandalous breach of fiduciary duty—excessive risk.
• Just as excessive fees were ubiquitous, so too is excessive risk in TDFs. It is manifesting as excessive losses, a harm last seen in 2008.

The retirement industry is buzzing about new lawsuits against plans that use Blackrock target date funds (TDFs). Law firm Miller Shah LLP has charged a host of plan sponsors with breaching their fiduciary responsibilities by making low fees their sole selection criterion, regardless of performance and other considerations.

They allege that Blackrock’s TDFs underperformed and fiduciaries weren’t looking. The low fee requirement is ubiquitous because many have lost lawsuits for paying excessive fees.

The courts will decide the merits of these new lawsuits. The necessary consequence is that a new door has opened, a door that can and should address a severe crime in the same manner that lawsuits successfully corrected excessive fees.

The new door is excessive risk. Most target date funds are taking undue risk near their target dates.

Underperformance in TDFs

TDF lawsuits have focused on excessive fees. This new door focuses on performance-related cases. Until now, low-risk TDFs traditionally underperformed, but the pendulum is swinging to high-risk fund underperformance, with losses that exceed safer funds.

The difference now is that excessive risk is becoming painfully obvious. The excessive risk was rewarded, but that doesn’t make it right. The duty of care holds fiduciaries responsible for harm to participants that should have been avoided. It’s like our duty to protect our young children, covering electrical outlets and installing cabinet latches.

Defaulted participants deserve and want to be protected as they near retirement.

Excessive risk redux   

It isn’t the first time we’ve observed the excessive risk breach of the duty of care. In 2008, TDFs for those near retirement lost more than 30%, creating a public outcry that should have brought lawsuits, but did not. I wrote about the potential for lawsuits in Target Date Fund’ Safe Harbors’ Attract A Minefield Of Possible Litigation.

At that time, I interviewed a prominent ERISA attorney and asked him why there were no lawsuits, to which he replied:

Regarding fund companies: “Mutual funds are protected by a very narrow statute of limitations and those cases had to be filed back in 2009, no later than early 2010 to make it through…since no one had the right data to present to the teams who could afford to take this on effectively at that time, they were not filed and the mutual fund providers escaped the liability for their wrongdoing. We will need another 2008 to get them.”

Regarding plan fiduciaries: “Bottom line with fiduciaries, they believe any line of crap their providers tell them when it comes to DC plan monies. They simply do not vet these products effectively, some because they don’t know where to start, others because it’s not a priority. They should be sued for the adoption of the vehicles and could be successfully litigated against, but the apple is much smaller for the plan cases rather than the provider cases.” 

This time, it’s different because:

• The plaintiff’s bar is primed and ready to pursue wrongdoing. I am personally speaking to a few law firms about preparing for significant losses in TDFs, possibly even bigger than 2008. The harm to participants could be disastrous.
• In 2008, TDFs held only $200 billion. Now there’s more than $3.5 trillion. The stakes are much higher. 
• Our 78 million baby boomers were not in the Risk Zone in 2008. Most will spend this decade in the Risk Zone.
• TDF risk has increased, rather than decreased, since 2008 because the riskiest won the performance race. At one point, Fidelity proudly announced a risk increase to compete with the likes of T. Rowe Price.
• Safety standards for TDFs weren’t recognized in 2008, but are now, and discussed below.

The new door has a safety standard

This new door for lawsuits is not underperformance per se. It’s excessive risk manifested in excessive investment losses. The definition of “excessive” can be found in surveys of participants and consultants. These surveys report that a loss of more than 10% by someone near retirement is excessive.

The door requires a safety standard. Until now, Vanguard TDFs have been the standard, but a recent Congressional inquiry holds that the Federal Thrift Savings Plan (TSP) is a better standard. The idea is that TDFs should be safe at the target date. The TSP is only 30% in risky assets at the target date, while the industry is 85% risky, as shown in the following.

Two types of TDFs: Safe and Risky

Most fiduciaries only know about the risky group of TDFs, and believe that they can’t all get sued, equating popularity with procedural prudence. But most fiduciaries paid excessive fees until lawsuits stopped it.

The safe group of TDFs is small. The TSP is joined by the Office and Other Professional Employees International Union (OPEIU), one of the largest AFL-CIO unions, and the SMART Target Date Fund Index.

The following shows the recent performance of the two groups:

The industry (risky) has “excessive “(below 10%) losses of 11.2% in its 2020 funds versus losses of only 3% for the Safe group.

Conclusion

There are good reasons to expect continuing deepening losses in stock and bond markets that will be felt most by those near retirement in TDFs. It will get worse.

The greater the harm, the greater the foul.

The door is open to correct this breach of the fiduciary duty to protect participants who default their investment decision to their employer. Most assets in TDFs are there by default. It is the most popular Qualified Default Investment Alternative (QDIA).

The plaintiff’s bar is watching and will act in the next 2008-like debacle.

Ron Surz is President of Target Date Solutions, a DBA of PPCA inc. He is also the author of Baby Boomer Investing in the Perilous Decade of the 2020s. He can be reached at Ron@TargetDateSolutions.com.