Floodgates are opening after US Supreme Court Northwestern 403(b)Case. [i] Most Hospitals not affiliated with public universities are subject to ERISA laws. Hospitals tend to have a higher percentage of high fee funds and a much higher risk of litigation.
Why are hospitals at such high risk? My take is that the 403(b) culture with its mix of ERISA and non-ERISA plans tends to have higher fee providers especially those associated with insurance companies. My other theory is that Hospitals face so much litigation on health care issues that this litigation is not seen as material by senior management. GAO recently did a report confirming that 403(b) s are not as sensitive to fees. [ii]
Here is the list of the 21 ERISA class actions I have found against hospital and health care 403(b)s and 401(k)s. Columbus GA Regional Hospital, Aurora Health WI Iowa Healthcare, Henry Ford 401k , Henry Ford 403b, Spectrum Health, Mercy Hospital Health IL Kalenda NY Barnabas Health. Rush University Medical Center, MedStar Health MD, Boston Children’s Hospital Corporation, Froedherdt WI, B.Braun Medical Inc.PA, Allina Health plan, Emory Healthcare, Bon Secours. Settlements I have found include Norton Ky ($5mm), Southcoast MA Hospitals Group ($2mm), Bronson Healthcare ($3mm), Novant Health ($32mm).
Many hospitals do not have independent consultants and one Lockton actually paid $2.5mm of the $5mm Norton Hospital settlement. [iii] Many hospitals still use revenue sharing which is a magnet for litigation. [iv] Hospitals are also high users of annuities. [v]
For most hospitals who have not paid attention and lowered fees already substantially it is only a matter of time before they face litigation. Even larger physician groups will soon be subject to litigation as well. Plans doing half fixes will not avoid litigation and some who have already settled may be sued a 2nd time.
401(k) Revenue sharing is a scheme that is sold to 401(k) plans sponsors who are too cheap to pay the administrative costs out of company funds, and thus are willing to trick participants into paying for it by an increase in fees in high-cost mutual funds and even higher cost annuities.
Heavy industry lobbying has kept this practice barely legal. However, I see Revenue sharing alone as a sign of a fiduciary breach since I have never seen it documented correctly, which turns into a shell game that increases fees, which has been confirmed in a 2021 study by experts from the Federal Reserve and leading Universities. Higher fees are not associated with better performance; to the contrary, “The future performance of revenue-sharing funds is weaker than that of non-sharing funds. The bulk of the under-performance is driven by higher fees, though revenue sharing funds display lower performance even after accounting for fees.”[i]
Revenue sharing does not hold up during litigation and this has been confirmed by Fiduciary Liability Insurance industry which put much higher litigation risk on plans with revenue sharing and either denying coverage or raising rates significantly. [ii]
There is no reason to go through the complicated non- transparent contortions of revenue sharing record-keeping if there is nothing to gain. In some cases, the rebates may be delayed, giving the float on the money. It is also unclear where rebates go if a participant leaves or transfers out of the fund. There is little or no accountability as the recordkeepers has unlimited ways to divert these rebates toward administrative expenses they set and control.
There are other forms of hidden revenue sharing in and out of 401(k)s such as shelf fees that firms like Wells Fargo require a manager to pay over $500,000 to just be considered. [iii]
The burden is on the plan and the recordkeeper to provide a full and transparent accounting of the entire revenue sharing process which we have not seen Revenue sharing will continue to be a litigation magnet.
Many if not most 401(k) consultants for 401(k) plans under $1 billion have serious conflicts of interests which in itself can be a fiduciary breach and contribute to excessive fees. While the number of conflicted consultants and level of conflicts in mega plans is still significant it is less prevalent. A Plan Fiduciary with a conflicted consultant takes on much greater fiduciary risk of getting sued.
Ignorance of conflicts is no excuse. Even comedians like John Oliver have done videos on 401(k) advisor conflicts and if you have not seen it please watch at https://www.youtube.com/watch?v=gvZSpET11ZY
Attorney James Watkins states that Consultants/Advisors recommending cost-inefficient/imprudent investment options to a plan sponsor, knowing that the plan is held to a fiduciary standard, violates duty of fair dealing, which is actionable as a breach of contract per SCOTUS (Shaw v. Delta Air Lines).
Jennifer Cooper published a report on the US consultant industry in 2013 based on the ADV report filed by RIA’s.[i]
They found numerous conflicts. The most common being dually registered consultant/advisors who are also brokers or have affiliated brokers. [ii]
Dr. Nicole Boysen of Northeastern University in Boston has written a paper that shows consultant/advisors (RIAs) that both charge fees and commissions (dual registration) use higher fee lower performing mutual fund families that kick them back the most in “revenue sharing” Boysen created a list of high fees underperforming mutual funds preferred by dual registered RIAs, which include the American Funds, JP Morgan, MFS Fidelity, PIMCO.[iii] Conflicted consultants are also known to manipulate statistics using cherry-picked benchmarks to make higher fee funds look better.
From a Forbes story by former SEC attorney Edward Siedle:
In recent years the U.S. Department of Labor, the Securities and Exchange Commission, and the General Accountability Office have all advised companies sponsoring retirement plans that conflicts of interest related to investment consultants to plans are widespread and that these conflicts have resulted in reduced returns, as well as higher fees for retirement investors. [iv]……..
While every investment consultant I’ve ever met claims to provide objective, independent advice, the industry is rife with conflicts. If the gatekeepers vetting and recommending money managers to plans are corrupt, then the plan’s entire investment program may be tainted. [v]…………
In fact, consultant conflicts are more pervasive than ever today and, with the growth of alternative investments, consultant secret profits, as well as damages, related to these conflicts have skyrocketed. Most plan sponsors, even the largest, haven’t a clue about the abuses and, unfortunately, aren’t looking for answers. [vi]
The SEC and FINRA from 2018-20 fined dozens of Dual Registered RIA firms for excessive mutual fund fees around Share Class violations and Revenue Sharing in 401(k) and retail accounts. [vii]
· SEC – Merrill Lynch (Bank of America) – Share Class Violation April 17, 2020
· SEC- Wells Fargo (Bridgehaven) Share Class March 11, 2018
· SEC Morgan Stanley (Greystone) Share Class November 7, 2019
· SEC LPL 3/11/19 (Fiduciary First)
· FINRA AxaEquitable 19
· SEC MML Mass Mutual Sept 21 Rev Sharing Share class violations
· SEC VALIC Financial Advisors Inc. AIG-VALIC July 28, 2020 Rev Sharing Share class violations
· SEC VOYA Financial Advisors Inc ING-VOYA Dec. 21, 2020 Share class Rev Sharing Share class violations
· SEC PRUCO Securities, LLC Dec 23, 2020 Rev Sharing Share class violations
· FINRA PIMS (Prudential) June 2020
· SEC PRINCIPAL Securities, Inc. March 11, 2019 SEC Rev Sharing Share class violations
· SEC TRANSAMERICA Sept 30, 2020 fee gauging TA FINRA Share Class Variable 2020 annuities 2014 Fee Gauging
Any fiduciary who used these so-called consultants in the last 6 years has some serious fiduciary liability in a court case.
Any fiduciary who did not fire these so-called consultants after these SEC fines could have additional liability.
The following consultants have the ability to participate in conflicted activities like revenue sharing. Not every plan especially some of the largest ones, may have direct conflicts at a given point in time. This is especially true of Strategic Advisors a Fidelity affiliate as Fidelity has thousands of conflicted and non-conflicted plans.
LARGE CONFLICTED CONSULTANTS ie DUALlY REGISTERED
CAPTRUST Cammock
Lockton
Sageview
Newport Capital
CBIZ
ADVISED ASSET GROUP LLC owned by Empower (formerly known as Great Western Strategic Advisors owned by Fidelity).
Plan Sponsors should look at the independence of their advisor/consultants and their regulatory record. Do they take ERISA fiduciary liability in their contracts?
If the consultant is lacking in fiduciary responsibility they should be fired. If these conflicts caused damage you should consider legal action.
[i]US Pension Investment Consultants A Report for Fiduciaries, Internal Audit and Risk Management Professionals in 2013[i] Diligence Review Corporation led by Jennifer Cooper, CF
I contend that the Good version of Stable Value is still the best low risk investment for 401(k) plans. With an estimated $700 billion in assets, Stable value is typically 15% to 30% of assets in many DC plans. Stable Value’s popularity with participants is well deserved. It’s combination of principal protection like a money market and solid returns closer to an intermediate bond fund are unmatched among 401(k) choices. Stable Value in recent years has had yields nearly triple that of Money Market. A recent Wharton study has confirmed the superior risk/return profile of stable value funds compared to money market and bond funds. [i]
There has already been litigation against firms that did not offer stable value at all and only offered money market. Plans who want to avoid litigation need to get the Good versions of Stable value which are the diversified synthetic GIC based products.
All Stable Value funds use Guaranteed Investment Contracts (GIC’s) to provide them book value accounting, which allows for a smoothing of returns and no negative periods. There are 3 basic categories of stable value: 1. the original General Account or Traditional GIC (Ugly) 2. Insurance Company Separate Account GIC (Bad) 3. Synthetic GIC sometimes known as a wrap. (Good)
Mega ERISA 401(k) plans abandoned General account GIC’s almost 30 years ago after the Executive Life and Confederation Life defaults of 1992.Large ERISA plans for the most part abandoned Insurance company Separate Account stable value 20 years ago and have almost all converted to Synthetic GIC’s. Many mid-size and multi-employer plans access synthetic stable value via over 30 Stable Value Pooled Funds which are Bank Collective Trusts with well-known names such as Fidelity, Vanguard, T. Rowe Price, and others since stable value is not offered in mutual funds. With synthetic GIC’s the plan owns the underlying bonds usually 95% to 100% of the total value, while with the insurance company separate account and general account the plan does not own any securities but owns a contract with the insurance company. All the large independent consultants recommend synthetic stable value as evidenced in this recent February 2022 article in Plan Sponsor quoting Willis Towers Watson.[ii]
NAGDCA the association representing public DC plans in a September 2010 brochure had the following characterization of General Account stable value. Due to the fact that the plan sponsor does not own the underlying investments, the portfolio holdings, performance, risk, and management fees are generally not disclosed...[i]
Ben Bernanke spoke in 2008 in defending the AIG bailout saying, “Workers whose 401(k) plans had purchased $40 billion of insurance from AIG against the risk that their stable value funds would decline in value would have seen that insurance disappear.” I contend that an ERISA plan should not take on the single entity credit risk and liquidity risk of an insurance Company especially in the aftermath of AIG and in the so-called end of too big to fail?
The largest providers of the Bad and Ugly versions of Stable Value are Prudential, Principal, Lincoln, TIAA, MetLife, NYLife, MassMutual,John Hancock, Great West, Transamerica. You tend to still find them in 403(b)s, smaller 401(k)s and of course 457 plans which are exempt from ERISA. These bad and ugly versions of stable value are litigation magnets with their hidden fees many times in excess of 200 basis points (2%) along with high single entity credit risk.
Synthetic stable value options which are transparent, diversified and have low fees are widely available for any 401(k) plan over $50 million in size. Using bad stable value or skipping stable value increases your litigation risk. Even then with good stable value you still need to look at fees between options.
Chris Tobe, CFA, CAIA is a leading expert on Stable Value http://www.christobe.com/stablevalue/ writing dozens of articles and the only book “The Consultants Guide to Stable Value” published this century.
SCOTUS recently announced its much anticipated decision in the case of Hughes v. Northwestern University.1The significance of the decision cannot be overstated, as it dramatically changes the “rules of the game” for 401(k) and 403(b) retirement plans,
Hughes was the last piece of what I am referring to as the “Fiduciary Responsibility Trinity.” The trinity is composed of three key ERISA related decisions-Tibble v. Edison International2, Brotherston v. Putnam Investments, LLC3, and Hughes. Given the heavy reliance that the Supreme Court and the First Circuit Court of Appeals, as well as the Solicitor General, placed on the common law of trusts, an argument can be made that the logic set out in the trinity decisions is equally applicable to all investment fiduciaries.
So why are the trinity so important? Here are key quotes from each decision.
Tibble:
We have often noted that an ERISA fiduciary’s duty is ‘derived from the common law of trusts.’ In determining the contours of an ERISA fiduciary’s duty, courts often must look to the law of trusts.4
The Restatement (Third) of Trusts is a restatement of the common law of trusts. So, the Court is recognizing the Restatement as a legitimate resource in addressing fiduciary questions.
Under trust law, a trustee has a continuing duty to monitor trust investments and remove imprudent ones. This continuing duty exists separate and apart from the trustee’s duty to exercise prudence in selecting investments at the outset…. Rather, the trustee must ‘systematic[ally] conside[r] all the investments of the trust at regular intervals’ to ensure that they are appropriate….In short, under trust law, a fiduciary normally has a continuing duty of some kind to monitor investments and remove imprudent ones.5
Brotherston:
Congress sought to offer beneficiaries, not fiduciaries, more protection than they had at common law.6
[A]ny fiduciary of a plan such as the Plan in this case can easily insulate itself by selecting well-established, low-fee and diversified market index funds. And any fiduciary that decides it can find funds that beat the market will be immune to liability unless a district court finds it imprudent in its method of selecting such funds, and finds that a loss occurred as a result. In short, these are not matters concerning which ERISA fiduciaries need cry “wolf.”7
[T]he Restatement specifically identifies as an appropriate comparator for loss calculation purposes ‘return rates of one or more. . . suitable index mutual funds or market indexes (with such adjustments as may be appropriate).’8
In Brotherston, the lower court had ruled that the plan participants’ expert could not calculate alleged damages by comparing actively managed funds within the plan with comparable index funds, the copurt ruling that that would constitute comparing “apples to oranges.” The First Circuit’s decision effectively discredits the “apples to oranges” argument.
Hughes:
The Seventh Circuit erred in relying on the participants’ ultimate choice over their investments to excuse allegedly imprudent decisions by respondents. In Tibble, this Court explained that, even in a defined-contribution plan where participants choose their investments, plan fiduciaries are required to conduct their own independent evaluation to determine which investments may be prudently included in the plan’s menu of options…. If the fiduciaries fail to remove an imprudent investment from the plan within a reasonable time, they breach their duty.9
The Seventh Circuit had dismissed the plan participants’ case on the basis of the “menu of options” argument, which said a mixture of both prudent and imprudent investment options within a plans was permissible, as it provided plan participants with more choices. SCOTUS effectively discredited the “menu of options” defens
Going Forward Bottom line, the combined impact of the trinity decisions is that cases will now be decided based on their merits, not on legal fictions such as the “apples and oranges” and “menu of options” defenses. This should result in more protection for plan participants in the form of fewer dismissals of 401(k)/403(b) …as long as the attorneys for plan participants properly plead such cases to meet SCOTUS’ plausibility standard for pleading.
James W. Watkins, III, is a licensed attorney (41 years), specializing in securities and ERISA law, a Certified Financial Planner™ professional (32 years) and an Accredited Wealth Management Advisor.™ He has extensive experience in evaluating the legal prudence of various types of investments, including mutual funds, and advising 401(k)/403(b) pension plans on both designing and monitoring plans to ensure legal compliance.
Collective Investment Trusts (CIT’s) can be helpful to a 401(k) plan and its participants, or it can cause harm.
There is a general assumption that CIT’s are regulated by the Federal Government Office of Comptroller of the Currency (OCC). Some CIT’s are regulated by the OCC while many others are regulated by one of 50 state bank regulators. This allows CITs to choose their own state regulator who may have the most lax oversight.
Many of the most popular CITs in 401(k) have been shown to be superior to mutual fund versions as being identical in holdings but lower fees. Some plans have been sued for using higher priced mutual funds when identical lower cost CIT’s were available. The largest target date funds of Vanguard, Fidelity, and T.Rowe Price all have identical CIT funds to their SEC regulated Mutual funds which I believe are a better fiduciary choice.
Stable Value Funds are currently not offered in mutual funds, so CIT’s have been the best avenue for many plans to deliver synthetic based stable value. Most of the best Stable Value CIT’s are in the Heuler Pooled Universe, and include the SV CIT’s of Vanguard, Fidelity, T.Rowe Price, Invesco, Galliard. Of course, even among this group fees vary.
Most synthetic Stable Value CIT’s have been run adequately with one exception. A JPM stable value CIT used a JPM broad bond CIT, which put in another JPM CIT with a Private Equity like structure technically private debt. This Private debt blew up during the 2008 financial crisis and this has cost JP Morgan over $400 million in damages in 401(k) litigation.[i][ii]
However, I fear that CIT’s will be used to hide high fee high risk investments in the guise of improving return or risk.
In my previous paper “Private Equity in 401(k) -a Fiduciary Time bomb”[iii] I outline the excessive fees, massive risks and unproven performance in that asset class which also applies to private debt and other alternatives.
The other high fee high risk investment that has been and will continue to be hidden in CIT’s are annuities. I touch on all the fiduciary flaws in annuities including general account stable value plus the 200 basis points in hidden fees[iv]
This type of layering from JPM is what I expect to see in Target Date CIT’s with annuities, private equity, private debt and other alternatives especially in weakly state regulated CIT’s. I fear state regulators will allow in risky high fee complex investments they do not even understand, to appease Wall Street managers.
Even a small allocation of alternatives ie Private Equity or annuities to a Target Date CIT or Stable Value CIT , with the excessive risk, lack of outperformance and excessive fees make it a Fiduciary Risk.
If you have underlying alternatives or annuities or are seriously considering it in a CIT, get an independent legal opinion that the actual underlying Annuity and Private Equity contracts pass ERIA fiduciary muster. Make sure your fiduciary liability insurance cover Annuities and Private Equity- many do not.
CIT’s with a strong Federal regulator like the OCC are preferable. However, some state regulated CIT’s which are exact clones of SEC registered mutual funds are probably OK. Fiduciaries need to dig down to the security level of every CIT to make sure there are no hidden risks and fees.
The insurance lobby has spent millions of dollars pushing out so-called education via the American College and even getting Congress to pass the SECURE Act, to push Lifetime Income but most of the sophisticated plans sponsors are not biting and for good reason.
One of the most basic fiduciary principles is diversification – i.e., you do not put all your eggs in one basket. Most investment policies for a fixed income portfolio will limit single entity credit risk to 5% of that option. However, thousands of plans are tricked into taking on 100% exposure of a single insurance company with many annuity products including lifetime income. 100% single entity credit risk and liquidity risk is a serious fiduciary issue.
Many advisors are paid well via backdoor commissions to push annuities on plans. These commissions come via the advisor or an associate having an insurance license. Is this commission disclosed? Is it a prohibited transaction?
Insurance companies brag to stock analysts that they make over 200 basis points (2%) in hidden spread on annuity products. Is this reasonable? Is it disclosed? Is it a prohibited transaction?
In the contract does the insurance company say that they accept ERISA fiduciary duties? Does the contract have a downgrade clause that allows the investor out if the company is downgraded, or do they have to ride it all the way to default?
Doing due diligence on the annuity contract is difficult. What state was it issued out of and is regulated by? How solid is that states regulatory framework? What is the minimum capital requirement for this contract for that state? How large is the insurance reserve pool for that state (hint many are $0)?
The Federal Reserve itself has expressed concerns about the high risk of the insurance company general account products and the flimsy nature of the state guarantees backing the insurance contracts.[i]
The insurance lobby insists the SECURE Act can act as a fiduciary Get Out of Jail Free Card. In light of recent Supreme Court decisions, should plan sponsors be willing to take that risk?
Chris Tobe, CFA, CAIA is an expert on insurance products writing the book the Consultant and Plan Sponsors Guide to Stable Value, and dozens of articles. He served as a VP for Transamerica for 7 years in annuity product management. http://www.christobe.com/stablevalue/
The CommonSense 401k Project 