Supreme Court Wades Into Battle Over Fee Litigation

The Supreme Court will decide the fate of “excessive fee” litigation against defined contribution plans, as it has agreed to hear the case of Hughes v. Northwestern University.

This form of litigation has been a scourge of corporate America over the past years. Legions of plaintiff’s lawyers have filed suits alleging that plan sponsors have breached their fiduciary duties by causing plans to pay fees that substantially exceed fees for alternative, available investment products or services. There is a thriving and complex cottage industry that supports this litigation deluge. Other than the plaintiff’s lawyers, no one likes this litigation, least of all corporate officers and directors.

ERISA is quite clear: fees paid by plans must be reasonable and plan fiduciaries must act as prudent experts in their decision-making processes with respect to the retirement plans that they oversee.

In order to protect the $35.4 trillion held by U.S. retirement plans (ICI, June 16, 2021), ERISA imposes the highest standard of care on plan fiduciaries. Absent these high standards, retirement plans would quickly devolve into an unlimited feeding trough for a wide range of financial service providers. In effect, the fiduciary standards protect America’s pool of retirement assets.

ERISA does not dictate specific behaviors or actions on behalf of plan sponsors. Instead, they are given a wide berth in how they meet the standards of prudence and reasonableness. ERISA reflects a free market, capitalist spirit in that it allows plan sponsors the agency and creativity for meeting these standards. But, meet the standards, they must.

In our American system, the courts are uniquely capable of determining whether the standards are met: whether actions are prudent or reasonable.  

As much as they may protest, plan sponsors are not helplessly left to the vagaries of litigation. Instead, there are scores of lawyers, consultants and independent fiduciaries who possess expertise in guiding plan sponsors with respect to best practices. Since plaintiff’s lawyers must invest their own time and resources in their litigation, once they catch wind that a plan sponsor has adopted its own rigorous fiduciary processes, they will likely lose interest in a particular defendant and move on to one who has been less diligent. Plan sponsors are not unwitting victims here.

Of course, litigation is an unpleasant nuisance to corporate America. However, this type of fee litigation effectively helps preserve the assets accumulated by hard-working Americans. After all, every dollar paid to service providers, is one less dollar funding someone’s retirement. 

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ERISA Settlement Mandates Fees and Independent Fiduciary Oversight

In a recent ERISA class action settlement, a 401(k) Plan sponsor with close to $2 billion in assets was forced to pay millions of dollars in damages and appoint an independent third-party fiduciary to oversee aspects of their plan. For all plan sponsors, this introduces the real possibility they could be forced to engage independent oversight for their retirement plan.

It makes sense. Managing retirement plans is much more complicated than it used to be. There is a field of landmines that didn’t exist in years past. And litigation is on the rise, having already forced plan sponsors to pay more than $1 billion in recent years.

Experts say there’s more trouble on the way. The next wave of litigation is expected to focus on Target Date Funds and their increasing use as default investment options. And it won’t just affect the larger plans. Recent trends have shown that plans with $100 million or less can be targets.  Plan sponsors argue that they’re capable of their own retirement plan management, but the courts increasingly disagree.

While most lawsuits contest the high fees of investment offerings, court decisions really come down to whether the sponsor has fulfilled its fiduciary duty to the plan participants. Since this falls ultimately on the shoulders of retirement plan fiduciaries, it’s an easy call for courts to mandate the involvement of an independent third party.

Progressive sponsors will look to get ahead of the change. To avoid the combined costs of legal fees, management time, and reputational damage, they will look for their independent fiduciary oversight on their terms.

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John Hancock ERISA Settlement Includes Appointment of Independent Consultant

For years, ERISA experts (lawyers and fiduciaries) have acknowledged the added value of appointing independent expert fiduciaries to run and monitor retirement plans. Corporate America has been slow to take up this opportunity. Senior executives try to manage their plans internally until they confront litigation, which drains their resources and reputation.

The Department of Labor, and now increasingly the courts, are recognizing that independent expertise is the best model for prudent management of retirement funds. The word is getting out. In fact, the wave is building that independent oversight is best industry practice.

Given the old adage, “pay me now, or pay me later”, corporate executives have a choice: Get ahead of the wave and turn to an independent fiduciary now or continue the status quo until the uglier wave of ERISA litigation knocks you over. As any beach-lover knows, once you are caught in the tumult of a churning wave, turned upside down, gasping for breath, it’s too late to seek the protections of calmer waters.

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Bitcoin – Irrational Exuberance 2.0

By Mitchell Shames

The other day I received a survey in my inbox to the effect of: “should institutional investors start thinking about Bitcoin?”

The question is so preposterous in my mind that I both deleted the survey and couldn’t help but wonder if markets have crossed the threshold into another era of Irrational Exuberance – Alan Greenspan’s characterization of the dot.com boom… and, bust.  

Every day there are articles and postings about potential new “investments” – Bitcoin, NFT’s, and SPAC’s. Each is touted as either the next great investment opportunity OR the next tulip mania. To be fair, at this point, we simply don’t know. New technologies are always enticing and alluring. But for retirement plan fiduciaries, the unknowns should always temper unbridled enthusiasm.

Fiduciaries hold discretion, with respect to investment decisions, over other people’s retirement assets. Vast numbers of employees are relying on these assets to fund their retirement. Given the magnitude and the implications of this responsibility, fiduciaries are charged with acting prudently. Each investment decision is judged against this standard of prudence.

Over the past decades (it’s almost 50 years since ERISA was enacted) norms of investment decision-making have developed around the investment of plan assets. Whether assessing a manager or a strategy, analysis of past performance is a central principle in making investment decisions. Legions of consultants stand ready to assist plan fiduciaries in determining whether a manager or strategy fits within an asset allocation plan or within investment guidelines. Most of these analytics include a detailed review of investment performance.

When it comes to most of these new investment opportunities, however, there simply is no performance history. There should be no need for a survey. Right out of the box, these assets should not be eligible for ERISA qualified plans. But, yet, they are quite enticing.

The pandemic has stretched on long enough. Corporate earnings took a significant hit in 2020.  As we begin to come out of the global quarantine there are glimmers of revived economic output. The pent-up demand is staggering; so is the urge to make up for the lost time and the lost earnings. Bitcoin, NFT’s and SPAC’s play into the zeitgeist of the moment.

Retirement plan fiduciaries must stick to tried and true, prudent methodologies. Certainly, they must assess the performance of the plan investments through the pandemic. But, while annual performance is important, performance also must be viewed over longer periods; three, five, and ten years. If a review indicates that changes to a portfolio might be warranted, they must start with the investment guidelines for the plan and the assumptions underlying the guidelines. By necessity, this needs to be a deliberative, careful, and yes, a prudent process.

Bitcoin, NFT’s, and SPAC’s are the glittery new objects in the investment universe. The allure of outsized investment returns is powerful. Fiduciaries, however, should know better. They must exercise prudence before committing retirement funds to these assets.

Yes, I am skeptical. However, I also know that as a fiduciary, I must keep my eye on these new investments, as well as others that come onto the horizon. While they might not be prudent today, who knows what the next five or ten years may bring.

But, today, surveys regarding Bitcoin are premature.

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Plan Sponsors Must Focus on Cybersecurity – How Broad Are Their Fiduciary Shoulders?

Corporate America loves to manage its retirements plans. The motivation for this is unclear as the upside is limited, and the downside keeps increasing. With creative litigation exploding and expanding the burden, now, plan sponsors can add cybersecurity to the laundry list of competencies that are required of plan fiduciaries. 

In the old days, retirement committee members were covered if they understood the basic asset allocations of their pension plans and the selection of its asset managers. In retrospect, the fiduciary life was much simpler then. With the introduction of 401(k) plans, skill sets had to expand to include selection of investment options and a host of service providers, including recordkeepers and administrators. Importantly, as a result of a decade’s worth of “fee litigation”, these fiduciaries now need to understand the intricate pricing techniques of the mutual fund industry. This includes multiple share classes, revenue sharing, and expense benchmarking.

Recently, there has been an uptick in ERISA litigation focusing on cybersecurity. The risks here are high, as plan participants aren’t just accessing their accounts electronically to monitor their progress and make investment selections, they are also making withdrawals. Furthermore, the recent CARES act allows certain plan participants to take in-service distributions and loans. Practically speaking, courtesy of the pandemic, electronic activity within Plans has increased significantly. Already cyber-thieves have managed to create false accounts, false passwords and have been able to initiate fraudulent withdrawals from retirement plans.

Like it or not, plan fiduciaries have now been thrown into the wild world cybersecurity. In order to stay a step ahead of cyber criminals, protect participant assets and stay out of the crosshairs of the plaintiffs’ lawyers, best practices must evolve quickly to include cybersecurity issues.  

ERISA lawyers and consultants are now compiling detailed diligence monitoring lists to assure that recordkeepers and administrators have adopted state of the art cybersecurity capabilities and safeguards. And recently, the U.S. Department of Labor has issued new cybersecurity guidance for plan sponsors. If mastering mutual fund fee structures wasn’t enough of a burden, now plan fiduciaries must dig into the nitty gritty of electronic account access, password policies, and control testing. And, while they are at it, insurance and fidelity bond coverage must now be reviewed to explore coverage in the event of a cybersecurity loss.

Remember, it is not good enough for plan fiduciaries to have a “passing” knowledge of these issues, nor even reasonable knowledge. Instead, plan fiduciaries and investment committee members must be “prudent experts. Imagine being the head of Human Resources, the General Counsel, or a senior treasury official, and having to add cybersecurity expertise to the already long list of fiduciary responsibilities? No doubt in the time of COVID-19 their plates are already full with their day jobs. How broad are their shoulders?

As the world continues to evolve and as the risks and responsibilities of running a retirement plan continue to increase, plan sponsors should be thinking differently. Delegating fiduciary oversight to an independent fiduciary can relieve investment committees from these responsibilities. Let the independent fiduciary be an expert on the various fee structures crafted by the mutual fund industry. Let an independent fiduciary implement, monitor and be responsible for cybersecurity policies and procedures. Doing so would allow company executives and investment committee members to focus on their own bottom lines. And it would allow them to focus on generating earnings rather than on the business of running and maintaining a retirement plan.

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The Hidden Dangers of Target Date Funds

ERISA experts warn that Target Date Funds are ticking time bombs of potential losses and liabilities. In fact, they expect the funds to be the next big thing in ERISA litigation, possibly eclipsing fee and expense litigation.  

TDFs have grown 1,200% over the past decade and are now estimated to hold $2.8 trillion of American’s retirement assets. They are effectively packaged as simple alternatives to standard 401(k) investment options. One fund, one investment, one transaction to glide plan participants to a secure retirement; an attractive turnkey decision that any retirement committee might make. 

For the retirement industry however, these funds are the Holy Grail of 401(k) offerings.   Regulations allow plan sponsors to set Target Date Funds as default investment options for a plan. Employee’s then pour their assets into “set it and forget it” products, paying more in fees then the old stable value alternatives. Research shows that most plan participants don’t change these investments very often. So in industry parlance, these are “sticky assets” and they can generate a decades long revenue stream for the fund companies. Everyone seems to be happy, plan sponsors, fund companies, and plan participants. 

However, while glossy marketing materials present an illusion of simplicity, Target Date Funds consist of an extraordinarily complicated infrastructure of financial and operational tasks and functions. A Target Date Fund portfolio requires sophisticated investment assumptions and determinations about markets, interest rates, portfolio construction, asset allocations, and more. Much of it happens beyond the vision and understanding of most fiduciary retirement committees.   

This matters now more than ever because the fine print of Target Date Funds shifts ultimate fiduciary liability to the plan fiduciaries (often senior management of the plan sponsor), and that liability is potentially personal to these fiduciaries. Soliciting advice from consultants and advisors likely does little to mitigate this ultimate potential liability.

For plan sponsors, the best defense is a good offense. Get underneath the investment jargon to understand the rationale for the investment strategy and the execution of the strategy. The list of factors that need to be reviewed for each component fund within the strategy is extensive and includes: investment performance and risk analytics; expenses; plan demographics; and the investment management teams directing the investment portfolios. Examining the fiduciary processes of each component fund is also equally critical. The details can make all the difference. 

Most importantly, fiduciaries must understand, and sign off on, the Target Date Fund’s “glide path” – a formula that over time, shifts the asset allocation of the portfolio consistent with the projected termination date of the Target Date Fund.  

Glide paths are unique to Target Date Funds and have never been deployed on a mass scale before. In theory, the formula works, but track records are limited and are based upon assumptions that may or may not apply to a particular plan. For instance, does the glide path match the demographics of the plan? In addition, Target Date Funds often delegate broad discretion to the fund managers. But what happens if a fund shifts an allocation into an alternative asset class, such as private equity? Do the plan fiduciaries understand (and approve) this shift in allocation? 

Bottom line, retirement plan fiduciaries need to be attuned to the potential trouble spots – both those that are obvious today, and those that may be lurking down the road. Remember, the lifetime of a Target Date Fund can span anywhere from 20 years to even 50 years and beyond. Investing in one is a marathon, not a sprint. 

Target Date Funds are a prime example of the rising complexity and cost of retirement plan options. Plan participants are investing their nest eggs with a single provider, for decades. Ultimately, plan sponsors are on the hook for potential liabilities based on intricate details that their retirement committees may not be equipped to evaluate. The most prudent course is to delegate these decisions to qualified experts who are willing accept the fiduciary responsibility of managing them. 

As fiduciaries, we know there are no single decisions when constructing a retirement plan investment strategy. Essentially, we approach Target Date Funds the way GM constructs and assembles a Cadillac. Because the company incorporates hundreds of components from different manufacturers, specialists check the quality of every component, and another team assembles them into the cars you see on the road. It’s GM’s responsibility to apply expertise to every facet of its product and to assume liability for the vehicle’s performance. That’s important – after all, you’re not just buying a car that looks nice in your driveway, you need to have confidence in the safety and integrity of your car as you and your family hit the open road. 

Saving for retirement is similar – you need to be confident that the investment vehicle you have selected will deliver you safely to your destination.

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