When too many choices is a BAD thing

Sometimes the rules regarding providing investment services and advice can be counterintuitive.  For years, many institutions of higher education have offered a wide variety of options to their retirement investors.  The logic is, of course, that more choices is always better. It turns out this may not always be the case.

In a previous article, we discussed the growing number of lawsuits involving 403(b) plan providers. That article focused on several components of those lawsuits, 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.  While those issues remain critical, in this article we will emphasize the ramifications surrounding a single allegation common to many of these lawsuits: that offering too many options is, in and of itself, harmful to investors. Understanding these lawsuits and reacting appropriately is critical for fiduciaries and boards of institutions that sponsor retirement plans, particularly 403(b) plans.

How can presenting a participant with as many options as possible be detrimental?  The plaintiffs in some of the 403(b) cases allege that plan fiduciaries offered multiple similar investments in every major asset class and investment style. They assert that such a large number of investments violates a purportedly well-recognized industry principle that too many choices can be confusing to participants and can prevent participants from making favorable investment choices, or any decisions at all.  Although there are several permutations of the concept, some call this inability to make a choice “decision paralysis.”

These plaintiffs are, in effect, challenging the traditional higher education retirement plan model. Under this traditional model, universities typically have multiple 403(b) plans. Each plan allows participants to select where to send contributions among numerous vendors or platforms. Little was done by the university to restrict participant choice of investment options. Almost all of the sued universities offered more than 100 investment options, with many offering more than 300.

Needless to say, universities that have been sued are defending their investment option practices. Given the general principles requiring diversification of investments and encouraging participant choice, some defendants explain that their plans were set up with various tiers of investment options that give participants, including some of the country’s brightest minds, a choice regarding how actively involved they want to be in managing their accounts.

For example, Duke University, a target of one of these lawsuits, is defending its retirement investment strategy by asserting that it provides a range of options that give employees flexibility in designing retirement plans to meet their individual needs.  Additionally, Duke points out that these investments are reviewed and carefully managed in accordance with federal law to provide low cost options and good outcomes for their employees.

Not many of the cases brought against universities have seen much activity, to date. Where activity has occurred, it has been contradictory. Emory University requested that the court dismiss the plaintiff’s allegations related solely to the quantity of investment options offered by Emory. The plaintiffs argued that having too many investment options was imprudent and resulted in participant decision paralysis. The court did not agree with the plaintiffs’ theory.  Instead, the court perceived that offering a large number of investment options did not harm participants, but rather increased their opportunities to choose the investments they preferred.

Lest one think the Emory case can be viewed as a guideline for how the courts will treat this issue, in the lawsuit against Duke, dealing with essentially similar allegations, the court permitted the plaintiffs to move forward on the claim that Duke acted imprudently by including too many investment options under its plan.  Consequently, we cannot yet look to court decisions for firm guidance.

The lawsuits might suggest that every 403(b) plan maintain as investment options a short list of index funds and offer the lowest-priced share class of each of those funds. While this might be an acceptable concept, it is not necessarily the only acceptable concept. The idea that every fiduciary committee would arrive at a similar series of options, despite the multitude of available variations, seems unlikely. In addition to potentially being unfavorable to the participants, it may not be in the best interests of plan sponsors to adopt the exact plan design advocated by the plaintiffs in these lawsuits, because none of the cases—even those that have resulted in hefty settlements—qualify as law or precedent.

So what is a plan sponsor to do? The general legal concept governing fiduciaries may be the best guidance toward understanding their duty.  If a fiduciary establishes and documents a prudent process, follows that process, and makes a decision considering only the interests of the participants and beneficiaries, it is more likely to be seen as having met its fiduciary duty. And that, when all is said and done, is at the heart of the regulations regarding investment advisers.

 

Sources:
https://www.icemiller.com/ice-on-fire-insights/publications/the-latest-on-the-higher-education-fee-litigation/
https://www.shrm.org/resourcesandtools/legal-and-compliance/employment-law/pages/university-retirement-plan-lawsuits.aspx
http://www.kutakrock.com/files/Publication/7931b67a-da2e-4df8-be3a-f930995954b6/Presentation/PublicationAttachment/16e57dc6-979a-44bc-a81b-23e589b74bfd/JPB_Winter17.pdf
http://www.truckerhuss.com/2017/02/new-wave-of-retirement-fee-litigation-the-university-403b-lawsuits/
https://www.plansponsor.com/emory-university-excessive-403b-plan-fee-suit-moves-forward
http://www.browndailyherald.com/2017/09/20/university-mishandled-retirement-funds-lawsuit-claims/
https://www.planadviser.com/brown-university-latest-target-for-403b-lawsuit/
https://www.insidehighered.com/news/2016/08/18/retirement-plan-lawsuits-could-be-just-beginning