Since 2006, a raft of lawsuits have been filed by participants in both 401(k) and 403(b) retirement plans. Large corporations such as General Electric, Philips North America, Mutual of Omaha, and Home Depot have been sued in connection with perceived deficiencies in how they managed their 401(k) plans. Institutions of higher education are not immune from this onslaught. 403(b) lawsuit defendants are among the most prestigious institutions of higher education, including Brown University, Columbia University, Duke University, Emory University, University of Southern California, and Yale University, just to name a few.
Several factors are at play in the steady increase in litigation. One is the flood of high dollar settlements. Lockheed Martin paid $62 million to settle a lawsuit against allegations relating to the menu of funds it offered, the imposition of excessive fees, and the fact that too much of the workers’ investments were held in low-yielding money market funds operated by a bank with which Lockheed had a business relationship.
The feeding frenzy is further fueled by a Supreme Court ruling in a case brought against Edison International. The Court determined that a plan sponsor’s fiduciary responsibility extends beyond its initial review and selection of plans to offer participants, and made it clear that it viewed the fiduciary’s responsibility as an ongoing one. This would require that a fiduciary constantly monitor other investment options and modify menus accordingly. The case raised the specter of the potential for additional lawsuits as the ruling called into question the six-year statute of limitations relating to objecting to a plan’s management.
Why are institutions having so much difficulty following the rules? Part of the problem is the relative lack of formal guidance as to what will and will not run afoul of the regulations. According to a recent study (“401(k) Lawsuits: What Are the Causes and Consequences,” issued by the Center for Retirement Research at Boston College (the Center)), rather than spell out specific guidance on how plan fiduciaries should act, the Department of Labor (DOL) has historically emphasized taking enforcement action. Consequently, a fiduciary might not find out that they are in violation until the DOL launches an investigation or a lawsuit is filed.
According to the Center, the three main allegations prevalent in most lawsuits are inappropriate investment choices, excessive fees, and self-dealing. An examination of several recent cases bears this out.
In a case brought against General Electric, the plaintiffs assert that GE selected its own proprietary funds in lieu of funds offered by third parties. According to the plaintiffs, the reason for this selection was not that these funds provided the best likelihood of a high return for the participants, but rather that the GE funds provided greater profit to GE.
Another common allegation is that self-dealing leads to excessive fees. Plaintiffs have asserted that Mutual of Omaha, as plan sponsor, and United of Omaha, a wholly owned subsidiary of Mutual of Omaha, offered a plan menu that included “multiple United of Omaha-branded investments, each of which invests 100% of its assets into another publicly available investment fund,” all while charging “significantly higher fees” than are charged for the underlying funds.
A recent case against Home Depot combines several of these complaints. Plaintiffs assert that Home Depot has selected poorly performing funds for its 401(k) plan, permitted investment advisers to charge unreasonable fees, and essentially allowed a kickback scheme between an investment adviser and the plan’s record keeper to go unchecked.
As mentioned at the outset of this article, it is not only 401(k) plans that have come under attack. 403(b) plans are also being challenged. Many of these lawsuits are based on the same issues commonly claimed against 401(k) plans, including inefficient and costly use of multiple record keepers, lack of a competitive bidding process, failure to monitor fees, offering high-fee actively-managed funds and maintaining poor performing investments.
A lawsuit against the University of Rochester is about administrative costs. The plaintiffs claim the university failed to exercise its bargaining power to demand lower cost for administrative services. The suit alleges the university did not take proper measures to understand the cost of administrative services, to properly advise participants of the administrative fees, and to act prudently with such information. Other 403(b) cases have included assertions that advisers offered too many similar investment options. This “dizzying array” of options is alleged to have confused participants, making it difficult to for them to make a well-reasoned choice.
Litigation and DOL investigations are generally thought to improve the environment for participants. But, as some sources suggest, certain aspects of the current cycle of litigation may ultimately negatively impact the overall quality of investments made available to plan participants. Fiduciaries might only offer “safe” investments and deprive some participants of innovative new investment vehicles. And that, in the long term, may not be in the best interests of participants.