SCOTUS 9-0 ERISA decision – confirms my view on Annuities as Prohibited Transactions
By Chris Tobe, CFA, CAIA
The Supreme Court ruled unanimously in favor of 401(k) Transparency, while also placing the burden of proof on plan sponsors alleging that they are protected under an exception to the Prohibited Transaction rules. This rule facilitates forcing disclosures on conflicts of interest and hidden fees.[i] Investments that the managers have the potential for a conflict of interest are labeled “Parties of Interest” in the DOL/IRS 5500 forms attached financials for ERISA plans. These parties in interest have the burden of proof that they have an exemption from the Prohibited Transactions rules.
Fixed Annuities, known as IPG’s, are prevalent in large ERISA DC plans. The largest IPG is TIAA Retirement Choice Annuity which is central in the Cornell plan and, along with Fidelity, the focus of the SCOTUS decision.
I believe that all annuities are prohibited transactions due to the inherent conflict of interest issues, and in most cases, the annuity issuer and annuity salesperson are labeled in plans as parties in interest. Prohibited transaction exemptions are subject to meeting certain requirements. But the DOL does not even attempt to enforce them. Many plans just blindly accept the claims of annuity salesmen that these contracts have a “get out of jail free card” in the form of a PTE.
Prohibited Transactions Exemption PTE 84-24
Annuities for decades have claimed Prohibited transaction exemptions behind PTE 84-24. However, plans are responsible for verifying that the prohibited transaction exemptions apply to the insurance products they put in their plans. This SCOTUS decision and future similar cases may force accountability for the first time.
ERISA PTE 84-24, which is based on the Restatement of Trust, states the annuities must meet the following requirements called the Impartial Conduct Standards and Written Disclosures and Policies and Procedures backing up these standards. Most annuities I have seen do not even come close.
The Impartial Conduct Standards have 4 major obligations. A. Care Obligation B. Loyalty Obligation C. Reasonable compensation limitation D. No materially misleading statements (including by omission)
Care Obligation This obligation reflects the care, skill, prudence, and diligence – similar to Prudent Person Fiduciary standard. Diversification is one of the most basic fiduciary duties. Fixed annuities flunk this with single entity credit and liquidity risk. Diligence is nearly impossible with misleading, nontransparent contracts, and the lack of plan/participant ownership of securities.[ii] The Federal Reserve in 1992 exposed the weak state regulatory and reserve claims.[iii]
Loyalty Obligation Annuity contracts are designed to avoid all fiduciary obligation with no loyalty to participants. Secret kickbacks and commissions place the financial interests of the Insurers and their affiliates over those of retirement investors. In most cases, the annuity investor has little chance of even breaking even on the investment. The exemption requires the advisor to show their loyalty with a “Fiduciary Acknowledgement Disclosure.” Annuity contracts avoid any fiduciary language or responsibility.
Reasonable compensation limitation Annuities have a total lack of disclosure of profits, fees and compensation – effectively denying any chance for a prospective purchaser to make an “informed decision.” They also have secret kickback commissions.[iv] A number of lawsuits have settled with claims of excessive secret fees and spreads. An insurance executive bragged at a conference of fees over 200 basis points (2%) in 2013. [v]
No materially misleading statements (including by omission) Annuities have numerous material misleading statements, including the total lack of disclosure of spread/fees. They claim principal protection, but some fixed annuity contracts recently have “broken the buck” and violated their contracts. The written disclosures under weak state regulations omit critical information on risks and fees also prevents any opportunity for an “informed decision.”
GOING FORWARD
While Annuities are by far the largest area involved, I believe SCOTUS’ Cunningham decision will result in some significant consequwemces:
ERISA class action 401k litigation will explode especially against conflicted products like annuities[vi]
Plans are now talking about taking legal action against vendors, who tricked them into these non-transparent products[vii]
Plans will be more reluctant to take on non-transparent products like annuities[viii]
Plans will be more reluctant to take on non-transparent products like crypto and private equity[ix]
Plans will be more reluctant to do non-transparent administrative practices like revenue sharing[x]
Plan Sponsors with fixed annuity contracts should demand : 1. A MFN clause to make sure they have the best rate. A MNF (Most Favored Nation) clause is a clause that states that money managers are getting the lowest fee for their pension clients. 2. A downgrade lause that allows liquidity at full book value if the insurance company issuing the annuity is downgraded.
Annuities are clearly prohibited transactions that do not qualify for an exemption but have used their lobbying power in Washington and in states, to exempt themselves from all accountability. This recent SCOTUS decision may help get accountability and transparency in plans through litigation.
“Cerulli Edge—U.S. Retirement Edition,” finds that as of 2024, 91% of asset managers believe guaranteed lifetime income options carry a negative stigma. “Annuities continue to face perception issues due to high fees, complexity, lack of transparency, and concerns about insurer solvency, all of which deter plan participants,” says Idin Eftekhari, a senior analyst at Cerulli. “The tradeoff between liquidity and a guaranteed income stream is unappealing for many participants.[iii]
The argument that you need annuities to provide lifetime income is debunked as well.
Cerulli also points to lower cost transparent liquid methods of providing monthly income called “structured drawdown strategies” as superior alternatives to annuities.[iv]
Annuities are a Fiduciary Breach
I wrote in 2022 that all annuities are a fiduciary breach [v] While Guaranteed Income Annuities are still small in 401(k)s, I believe they are being used to justify even worse annuity products like IPG Fixed Annuities and Index annuities. Immediate Participation Guarantee (IPG) is a Group fixed annuity contract (GAC) written to a group of investors in a DC Plan and not individuals. [v]
IPG group annuities have no maturity, and set whatever rate they want without a set formula.
Annuities are contracts that are an ERISA Prohibited Transaction. Annuity providers claim their products are subject to Prohibited Transaction Exemption 84-4, but I have found that most annuities I have seen do not qualify for the exemption.[vi]
Annuity contracts are regulated by weak state insurance commissioners, and most plan sponsors are clueless to that fact. The National Association of Insurance Commissioners (NAIC) sets weak national standards, but some state insurance commissioners have even weaker regulations. NAIC’s prime goal is to prevent any national regulation or transparency as evidenced in this letter to Congress. [vii] NAIC is currently trying to hide insurers Risk Based Capital (RBC) scores to hide significant risk from consumers. [viii]
There is an attempt to hide annuities in Target Date Funds in weak state regulated CIT’s in which I testified on to the DOL Advisory Committee in July 2024.[ix]
Annuity contracts shift all the fiduciary burden from themselves to the plan. Thus, the burden of proof is on plan sponsors regarding if their plan annuity qualifies for an exemption from being classified as a prohibited transaction.[x]
Annuities Credit & Liquidity Risk High & Getting Higher
A recent Federal Reserve paper exposes poor state & offshore regulation of Life Insurance companies that issue Annuities. The FED’s main problem is the hiding and understating of credit, liquidity & leverage risks.[xi]
The FED economists contend that life and annuity issuers make investments in what amount to loans to risky firms look stronger by funneling the weak loans through arrangements — such as business development companies, broadly syndicated loan pools, collateralized loan obligations, middle-market CLOs and joint venture loan funds — that qualify for higher credit ratings.[xii]“These arrangements seek to shift portfolio allocations towards risky corporate debt while exploiting loopholes stemming from rating agency methodologies and accounting standards.”[xiii]
Insurance risk experts Larry Rybka, Thomas Gober, Dick Weber Michelle Gordon highlight the addition of risks from Reinsurance in a recent trade publication. Rybka says The life insurance and annuities industry, he said, has become “like the Wild West.” Carriers are abusing reinsurance,”[xiv] “It’s a shell game and, in general, the regulators are not paying attention,” said Dick Weber,[xv]Gober says It’s not just offshore reinsurers that can largely skirt U.S. accounting standards, he said. There are also “captive” reinsurance companies within the U.S. mostly in Vermont, South Carolina, and Delaware. “The lack of transparency with these affiliated reinsurance companies, both captive and offshore, is the single biggest threat to U.S. policyholders and annuitants,” said Gober.[xvi]
Michelle Gordon says that advisors should check the creditworthiness of any insurance companies they recommend to clients, she said, though most don’t or can’t because of lax ratings standards. “The non-codification of insurance advisement results in sub-optimization of consumer protections,” she said.[xvii]
Fiduciaries should be aware of these risks and have a duty to defend and justify these risks if they put annuities in their plans.
The recent Sixth Circuit decision in Johnson v. Parker-Hannifin Corp. indicates a possible 2025 trend in fiduciary litigation in favor of plan participants according to attorney Jim Watkins in his latest piece. [i] The ruling confirms that in most cases participants do not have adequate information and disclosure until discovery and that premature dismissal is unfair to participants.
The lack of transparency and disclosures in 401(k) plans requires the discovery process to give plan participants a fair shot at recovery of damages from poorly managed plans. This decision seems to recognize these facts and puts the burden of proof to show a prudent fiduciary process on the plan sponsor, which requires discovery.
The 401(k) type plans being litigated are a small fraction of the total 700,000 plans in the U.S. Around 7,000 or 1% are $100 million or more in assets which are the ones currently large enough to litigate. Of this 7000 around 5000 are low (Vanguard) to below average cost (Fidelity) recordkeepers. This leaves around 2000 that are worth while litigating for plaintiff attorneys. The DOL EBSA is understaffed having to cover 700,000 plans, so many participants rely on litigation or the threat of it to drive better outcomes. My analysis is limited to these top 1% of plans.
Current Disclosures
The IRS/DOL 5500 form and accompanied financial statement is the major and primary form of public disclosure. It lists total assets of the plan and the number of participants. It lists an aggregate total of administrative costs. Financials usually have a list of investment options, but does not disclose their fees, or even what share class they are so you can look up the fees. It usually lists the recordkeeper. Plaintiffs’ attorneys to narrow down potential poorly managed cases primarily rely on their ability to spot high fee recordkeepers and high fee funds just by their names. There is no disclosure of administrative or fund fees or performance, so no data to show the level of damages.
Participant statements are a mixed bag. Some have partial fee information, some do not. in 2012, the DOL mandated annual 404a-5 participant disclosures due to this lack of information. Some plans include these with their quarterly statements, but many firms send it out in a separate not easy to understand piece of paper and participants typically throw it away. However, participants can request these 404a-5 disclosures without discovery.
404a-5 disclosures essentially only provide an accurate description by ticker for the SEC registered mutual funds in the fund. This is a small step forward because some plans do not even provide ticker (which shows share classes) on statements (or 5500) which has only one real purpose – to hide fee information. Once the ticker is disclosed, data like performance and fees can be easily found on the internet. So the disclosure of fees and performance on the 404a-5 is merely creating an impression of additional transparency.
I believe target date funds in SEC registered mutual funds were designed to hide fees and manipulate performance. They bundle funds into other funds, and without sub-fund level detail, it is nearly impossible to evaluate their performance and fees. The aggregate fee & performance data from the 404a-5 disclosure statements is a start, but far from a complete means of evaluating funds.
404a-5 statements have totally inadequate disclosure on collective investment trusts (CITs), a growing sector in the large plan market, especially with target date funds. CITs often have inadequate state oversight and regulation, which requires little or no disclosure.[ii]
404a-5 statements also have totally inadequate disclosure on insurance products, especially with regard to IPG Fixed Annuities, but also regarding index annuities,and the new fad lifetime annuities.[iii]
The 404a-5 disclosures only cover the most recent 10 year period. SEC mutual fund share class violations constitute a small fraction of the damages in current cases.
It is the current inadequate disclosures from the 5500 and 404a-5 statements that makes discovery essential. Most of what plaintiffs need in discovery is information that really should have been disclosed already in both the 5500 and 404a-5 statements..
For the state-regulated insurance products and CIT’s, a plaintiff needs the same level of information on fees/spreads that you would receive in a SEC registered Mutual Fund. Defense attorneys want to block this information since it can reveal prohibited transactions and hidden fees.[iv]
The 6th Circuit stated that “The ultimate question is whether the fiduciary engaged in a reasoned decision-making process.” [v]401(k) plan fiduciaries hold monthly or quarterly meeting. To determine if this was a prudent process, at a minimum, you need the minutes and materials from these meetings. Defense attorneys want to block access to this information because it almost always reveals flaws in a plan’s oversight.
According to attorney Watkins:
“Based upon my experience, I submit the real reason that the plans oppose any type or amount of discovery is to conceal the fact that (1) the investment committee never developed a prudent process for managing the plan, but rather blindly accepted the recommendations of the plan adviser or other conflicted, and (2) the fact that the plan never conducted the independent investigation and evaluation required under ERISA, but blindly accepted the recommendations of others.” [vi]
In my ownexperience, I regularly find a clueless committee without even an investment policy, driven by blind reliance on a conflicted broker or consultant who receives undisclosed hidden compensation from recommending high fee high risk products.[vii]
This information is readily and easily available at a minimal cost to the plan and should have already been disclosed.
Additional Discovery
Administrative costs, which include record keeping costs, are totaled on the 5500 form, and you can divide this number by the amount of participants. Many lpaintiff firms may file a claim if they find a number above $40 a participant per year. The defense’s argument is often that number is not correct, basically that they lied on their DOL/IRS form, offering convoluted and self-serving reasons for the alleged error. They basically want the court to take the story that what they really charged was less than what they told the DOL/IRS, hoping that the3 plaintiff and the court will take their word for it without documentation. The participants have no access to any information on these administrative costs. This information is convoluted and complex, so much so that few committees understand it. It needs extensive discovery to get to the details.
Because of the lack of transparency in administrative costs. plaintiff’s need at least some limited discovery. In a recent Sixth Circuit case, Forman v. TriHealth 40 F.4th 443, 450},, Judge Sutton of the Sixth Circuit spoke out in this issue, stating that too many ERISA actions alleging a breach of fiduciary duties were being inequitably and prematurely dismissed without allowing plaintiffs any discovery whatsoever:
This is because “[n]o matter how clever or diligent, ERISA plaintiffs generally lack the inside information necessary to make out their claims in detail unless and until discovery commences. . . . If plaintiffs cannot state a claim without pleading facts which tend systemically to be in the sole possession of defendants, the remedial scheme of the statute will fail, and the crucial rights secured by ERISA will suffer.” “Plausibility requires the plaintiff to plead sufficient facts and law to allow ‘the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.. Because imprudence “is plausible, the Rules of Civil Procedure entitle” the plaintiffs “to pursue [their imprudence] claim . . . to the next stage.”
Sponsors many times select vendors that cherry-pick their own state regulator for both insurance products and most collective investment trusts (CIT)s.[viii] Sponsors typically do not have any documentation that these products are exempt from prohibited transaction restrictions. You need extensive discovery to get the details on fees and risks in these products.
Most discovery needed by plaintiffs is information that should be public or at least accessible to plaintiffs already, so it is essential to have it in most cases. Some more detailed discovery is needed to accurately compute the damages.
It is unfair to put the burden of proof on Plaintiffs who are blocked from seeing the information they need to prove damages. The burden of proof needs to be on the plan sponsor who controls all the information. [ix]
Crypto, Private Equity, and Annuity contracts are impossible to Benchmark because of a lack of transparency accountability and liquidity. Valid Benchmarks require investable securities. These issues make it nearly impossible for any of these contracts to be exempted from being a prohibited transaction in an ERISA plan. [i]
According to the CFA Institute, a valid benchmark should meet the following criteria:
Specified in advance: The benchmark is defined before the evaluation period begins.
Measurable: The benchmark’s return can be calculated regularly and in a timely manner.
Unambiguous: The identities and weights of the securities in the benchmark are clearly defined.
Reflective of current investment opinions: The manager is knowledgeable about the securities in the benchmark and their factor exposures.
Accountable: The manager is aware of and accepts responsibility for the benchmark’s performance and constituents.
Investable: The assets of the underlying index are available for purchase by investors.
These attributes are impossible for contract-based investments like Crypto, Private Equity, and Annuities since you do not own any securities. There is no accountability, they are ambiguous and use different forms of accounting than securities.
Benchmarks can work when you compare a security-based active investment fund with a security-based index fund as highlighted in Brotherston vs. Putnam.[ii]
These are one sided contracts, not securities, in favor of the vendor and to the detriment of the investor. Looking at these from an ERISA particularly 401(k) context these contracts have severe fiduciary issues which I feel prevent them from an exemption from prohibited transaction rules. The Burden of Proof is on the Plan Sponsor to document that these contracts are not Prohibited Transactions.[iii]
I think the conflicted contract nature of these investments allows them to manipulate or avoid benchmarks altogether. While plan sponsors should never have entered into these contracts in the first place, how do you hold them accountable for the damages they have caused participants. If you compare them against benchmarks to the lower risk investments they should have invested in, it conceals the damages. You must find comparable contracts with the same types of high risk to find the actual damages.
Annuity Contracts
I wrote last month that Annuities should not be allowed in 401(k)s as Prohibited Transactions. Annuities are a Fiduciary Breach for 4 basic reasons. [iv]
Structure -weak cherry-picked state regulated contracts, not securities and useless reserves [viii]
These breaches make it impossible for most annuity products to qualify for exemptions to Prohibited Transactions which need to fill these 4 major obligations. [ix]
A. Care Obligation
B. Loyalty Obligation
C. Reasonable compensation limitation
D. No materially misleading statements (including by omission
I do not believe few if any annuities meet these 4 obligations, and the
burden of proof is on the plan sponsor that the annuities they use in their ERISA plans have a valid exemption. [x]
I have extensive experience showing damage by annuity contracts in large 401(k) and 403(b) plans. These are primarily fixed annuity IPG contracts within the broad category of stable value with no maturity and discretion by the insurer to pay rates that maximize their profits, at the detriment of participants. Some Fixed Annuity providers will claim money markets as a benchmark, despite having over 20 times the risk. The Federal Thrift Savings Plan has a high-quality stable value product, the G fund which they state is impossible to benchmark. [xi]
Single entity Fixed annuity providers have attempted to compare to the diversified Hueler Stable Alue Index despite having 10 times the risk. The proper comparable has been to other IPG fixed annuities with single entity risk, which has used in over a dozen cases specifically comparables like TIAA and MassMutual cited in detail in 2 ERISA Hospital Cases: Columbus, GA and Norton Hospital.
Private Equity Contracts
Private Equity contracts have mostly been contained in non-ERISA plans but this may be changing. Economic and Policy Research’s Eileen Appelbaum said “Much as private equity firms may wish it were different, they have been mostly unable to worm their way into workers’ 401(k)s and abscond with their retirement savings,”[xii]
Private Equity flunks all the impartial conduct standards in numerous ways.
Private equity offering documents generally prominently state (in capital, bold letters) that an investment in a private equity fund is speculative, involves a high degree of risk, and is suitable only for persons who are willing and able to assume the risk of losing their entire investment. Can engage in borrowing, or leverage, on a moderate or unlimited basis. No assurance of diversification since funds generally reserve the right to invest 100 percent of their assets in one investment. Heightened offshore legal, regulatory, operational and custody risk.[xiii]
Private Equity has a myriad of conflicts of interest, self-dealing practices. The investment manager determines the value of the securities held by the fund. Such a valuation affects both reported fund performance as well as the calculation of the management fee and any performance fee payable to the manager. [xiv]
Private Equity has business practices that may violate ERISA. Private equity fund offering documents often disclose that investors agree to permit managers to withhold complete and timely disclosure of material information regarding assets in their funds. Further, the fund may have agreed to permit the investment manager to retain absolute discretion to provide certain mystery investors with greater information and the managers are not required to disclose such arrangements. As a result, the fund you invest in is at risk that other unknown investors are profiting at its expense—stealing from you. [xv]
Plan sponsors will have a tough time justifying Private Equity as being exempted as a prohibited transaction given these facts. With such a lack of controls on the contracts, benchmarks are mostly useless.
Private Equity Benchmarks have been manipulated in U.S. public pensions to get higher bonuses not only for the Private Equity managers but for public government staff. [xvi] Private Equity benchmarks typically add a premium of 2%-6% to small cap index for leverage and liquidity. I think the high end of this range could be appropriate for damage comparisons given the fiduciary issues of the assets.
Crypto Contracts
Crypto has not been used extensively in ERISA plans as of now, but it is increasing.[xvii]
It was first discovered in Brokerage Windows, in which plans feel they have less fiduciary accountability. Companies running Brokerage Windows have been paid $millions by Crypto companies to put their options on their Brokerage Window Platform. In the article, “401(k)s with Bitcoin Should Expect Lawsuits: Lawyers,” the trade publication “Ignites” quotes Jerry Schlichter as saying that. Any employer who would follow the Fidelity lead by offering cryptocurrency and a 401(k) plan is exposing itself to very serious risk of a fiduciary breach…. As an unproven, highly volatile investment, Bitcoin would test the prudence standard under the Employee Retirement Income Security Act….The account will carry a fee of up to 90 basis points plus undisclosed commission fees, which would be 20 times as much as a simple index fund. Any 401(k) plans with a brokerage window will be subject to severe fiduciary liability unless they can prove they have provided 100% prudent options. This will most likely lead to much more litigation and many more settlements, as the cost of proving 100% prudent options will be extremely expensive. [xviii]
Burden of proof is on plan sponsors that Prohibited Transactions crypto in their plans qualify for a Prohibited Transaction Exemption. I have seen no evidence that any form of Crypto has met the qualifications for an exemption.
The Department of Labor in 2022 severely questions the reliability and accuracy of cryptocurrency valuations. A major concern is that cryptocurrency market intermediaries may not adopt consistent accounting treatment and may not be subject to the same reporting and data integrity requirements with respect to pricing as other intermediaries working with more traditional investment products.[xix]Under that guidance, which the DOL issued last month (April 22), employers could be responsible for risky crypto trades their workers make in workplace 401(k)s. The DOL’s employee benefits enforcement agency will launch what it’s calling “an investigative program” that requires plan officials to “square their actions with their duties of prudence and loyalty” if they allow crypto investments in self-directed accounts, according to the guidance.[xx]
The CFA institute writes. The unfortunate reality is that none of the proposed valuation models are as sound or academically defensible as traditional discounted cash flow analysis is for equities or interest and credit models are for debt. This should not come as a surprise. Crypto assets are more similar to commodities or currencies than to cash-flow producing instruments, such as equities or debt, and valuation frameworks for commodities and currencies are challenging. Custody is challenging and there is significant technological risk. As recently as 2018, researchers uncovered a bug in the bitcoin code that, if left unchecked and exploited, could have led to significant (theoretically infinite) inflation in the issuance of new bitcoin [xxi]
The lack of any valuation parameters makes benchmarks impossible. Comparisons should be flexible. One of the main comparisons should be the most popular Crypto asset Bitcoin.
Corrupt Structures
Crypto, Private Equity and Annuities in ERISA plan are mostly hidden in corrupt structures. Besides brokerage windows poorly state regulated separate account annuity products and Collective investment Trusts are places to hide these prohibited assets.
Over 50% of 401(k) assets are in Target Date Funds which are made up of underlying funds. This allows for less transparency of the underlying funds.
However, historically the largest structure for Target Date Funds has been SEC registered Mutual Funds. Mutual Funds have transparency and fiduciary standards that do not allow Crypto, Private Equity and Annuities. [xxii] Federal OCC regulated Collective Investment Trusts (CITs) have transparency and fiduciary standards that do not allow Crypto, Private Equity and Annuities.[xxiii] However, many state regulated CIT’s have weak or no transparency or fiduciary standards, so you can allow Crypto, Private Equity and Annuities.
Currently I believe the biggest threat of prohibited investments like Crypto, Private Equity and Annuities will be hidden in target date funds structured as state regulated CIT’s that I outlined in my DOL Advisory testimony in July 2024.[xxiv]
Conclusions
Since Crypto, Private Equity, Annuity contracts are impossible to Benchmark you need to use Comparables. To make valid comparisons you have to compare them to other prohibited transactions that are materially similar, and looking at those similar funds with the best performance is valid for damages.
Annuities should not be allowed in 401(k)s. ERISA created the concept of Prohibited Transactions to prohibit any investments with clear Conflicts of Interest. I testified to the ERISA Advisory Council – US Department of Labor in July of 2024 on the danger of allowing annuities to be hidden inside of Target Date Funds. [i] I have co-written a paper with Economics Professor Tom Lambert on the excessive risks of annuities.[ii]
Perhaps with the exception of Crypto and Private Equity no investment better describes what should be a prohibited transaction more than annuity contracts.
Annuities are a Fiduciary Breach for 4 basic reasons.[iii]
Single Entity Credit Risk
Single Entity Liquidity Risk
Hidden fees spread and expenses
Structure -weak cherry-picked state regulated contracts, not securities and useless reserves
So why do we still see annuities in 401k plans? The reason is intense lobbying by the insurance industry, that has blocked any transparency or oversight.
Annuity providers claim to be barely legal by relying on an Prohibited Transaction Exemption (PTE 84-4) a “get out of jail free card” obtained by $millions of lobbying by the insurance industry.
Biden Fiduciary Rule
The new Biden Fiduciary rule would provide transparency that would further expose these annuity products’ conflicts of interests. The insurance industry has forue shopped in Texas in the Fifth Circuit for judges who agree with blocking transparency to block it for now.
At the Certified Financial Planner Board of Standards Connections Conference in Washington October 2024, DOL officials called out annuities as prohibited transactions. [iv] Ali Khawar, principal deputy assistant secretary for the Employee Benefits Security Administration, laid out the reasons why the Biden Labor Department continues to fight for a fiduciary rule ““To me it continues to be kind of nonsensical that you’re expecting any of your clients to walk into someone’s office and have in their head: ‘I’m dealing with this person who’s going to sell insurance to me, this person is relying on [Prohibited Transaction Exemption] PTE 84-24, not [PTE] 2020-02. Those things shouldn’t mean anything to the average American. And we shouldn’t expect them to.”
broker-dealer space transformed what it means to be in the advice market,” Khawar said. “When we looked at the insurance market, though, we didn’t quite see the same thing.”
Under the National Association of Insurance Commissioners’ model rule, for example, “compensation is not considered a conflict of interest,” Khawar said. “So there are pretty stark differences between what you see in the CFP standard, the Reg BI standard, and what has now been adopted by almost every state, one notable exception of New York, which has adopted a standard that is significantly tougher than the NAIC model rule.”[v]That process is “the CFP standard, the DOL standard, it’s the SEC standard for investment advisors and it’s Reg BI,” Reish continued. What it’s not? “The NAIC model rule,” Reish said.
“The NAIC model rule does not require the comparative analysis[vi]
Khawar added: “It’s not going to matter whether you’re providing advice about an annuity, a variable annuity, fixed income annuity, indexed annuity, security or not.” The goal with the 2024 rule, Khawar added, is to “have a common standard across the retirement landscape so that all retirement investors would be able to make sure that when someone is marketing up front best-interest advice, that that’s the standard they’d be held to by the regulator and the customer.”
Under the Employee Retirement Income Security Act, “being a fiduciary is critical to the central question of whether or not the law or consumer protections have fully kicked in or not,” Khawar added.
The Government Accounting Office wrote a piece in August in support of the Biden Fiduciary rule. They saw the problem as so severe that they suggested that IRS step in to help the DOL Better Oversee Conflicts of Interest Between Fiduciaries and Investors especially in the Insurance Annuity Area. [vii] Senator Elizabeth Warren in defense of the Biden Fiduciary rule prepared a report on the numerous conflicts of interest in annuity commissions and kickbacks. [viii]
Annuities days of hiding behind PTE 84-4 are over
Prohibited transaction exemptions are subject to meeting certain requirements. They include
The Impartial Conduct Standards.
Written Disclosures.
Policies and Procedures
Annual Retrospective Review and Report
The Impartial Conduct Standards have 4 major obligations.
A. Care Obligation
B. Loyalty Obligation
C. Reasonable compensation limitation
D. No materially misleading statements (including by omission)
Care Obligation
This obligation reflects the care, skill, prudence, and diligence – similar to Prudent Person Fiduciary standard. Diversification is one of the most basic fiduciary duties. Fixed annuities flunk this with single entity credit and liquidity risk. Diligence is nearly impossible with misleading nontransparent contracts, and the lack of plan/participant ownership of securities. The Federal Reserve in 1992 exposed the weak state regulatory and reserve claims.[ix]
Loyalty Obligation
Annuity contracts are designed to avoid all fiduciary obligation with no loyalty to participants. Secret kickback and commissions place the financial interests of the Insurers and their affiliates over those of retirement investors.[x]
The exemption requires the advisor to show their loyalty with a “Fiduciary Acknowledgement Disclosure.” Annuity contracts avoid any fiduciary language or responsibility.
Reasonable compensation limitation
Annuities have a total lack of disclosure of profits, fees and compensation. They have secret kickback commissions.
A number of lawsuits have settled with claims of excessive secret fees and spreads. An Insurance executive bragged at a conference of fees over 200 basis points (2%) in 2013. [xi]
No materially misleading statements (including by omission)
Annuities have numerous material misleading statements, including the total lack of disclosure of spread/fees. They claim principal protection, but some fixed annuity contracts recently have broken the buck and violated their contracts. The written disclosures under weak state regulations omit critical information on risks and fees.
Most plans with annuities do not have Investment policy statements, since most fixed annuities would flunk them on diversity and transparency and not be allowed. Annuities cannot provide the transparency to follow CFA Institute Global Performance Standards (GIPS) so they do not comply.[xii] Most 401(k) committees with insurance products do not review such annuity products, since they clueless on what they are. Consultants for plans with annuities do not review the annuities most of the time since they are conflicted and they themselves receive kickbacks from annuity providers.
Annuities as a Prohibited Transaction
Annuities hide most of their compensation. They are typically secret no bid contracts with no transparency and numerous conflicts of interest. They are subject to weak state regulations (sometimes categorized as NAIC guidelines). Many times they are a party of interest and shift profits from annuities to make other fees appear smaller.
Annuities are clearly prohibited transactions, but have used their lobbying power in Washington and in states to exempt themselves from all accountability.
Testimony to ERISA Advisory Council – US Department of Labor by Chris Tobe, CFA, CAIA July 10, 2024
I want to concentrate on the largest QDIA – Target Date Funds. Target Date Funds (TDF’s) are now above 50% of all 401(k) assets. They deserve more fiduciary oversight by regulatory structure and internal policy – not less. Historically Target Date Funds in SEC registered mutual funds have been a solid norm. The industry wants to insert high fee high risk non-transparent contracts like Annuities, Private Equity and Crypto into Target Date funds, but SEC registered mutual funds transparency requirements prevent them, so they seek to open up other structures particularly Collective Investment Trusts (CITs).
Target Date Funds are the dominant default option or QDIA (Qualified Default Investment Alternatives) in most plans resulting in the highest level of fiduciary responsibility. They are the most non-transparent plan investment option and the easiest to hide fees and play performance games. Despite the high level of fiduciary risk, TDF’s are specifically designed to avoid accountability and thus need the most scrutiny.[1]
QDIA History
I have been involved in the QDIA issue for over 17 years when I wrote and signed the 2006 QDIA letter for AEGON Institutional Markets In late September 2023 I, along with former Assistant Labor Secretary Phyllis Borzi, briefed the White House Office of Management and Budget (OMB) and the Department of Labor on the proposedFiduciary Rule now out but under legal attack. I emphasized the severe fiduciary issues that surround contract products like annuities and private equity. I urged the need for strong fiduciary standards especially as annuities and private equity are being put in Target Date funds which are QDIA’s which need the highest level of transparency and accountability.[1]
Federally Regulated Structures
I believe the highest levels of transparency and accountability are in federally regulated investment structures with underlying federally regulated securities. No matter the structure plans and participants need transparency down to the underlying SEC registered stocks and bonds. Not a dead end to a piece of paper or a contract with no federal protections.
SEC registered mutual funds, while not perfect, are a fairly transparent structure that in general provides the accountability needed for the QDIA. The fiduciary analysis that James Watkins did earlier depends on the transparency of SEC Mutual Funds. Once we get away from Federally regulated mutual funds the issues with transparency and accountability multiply
I think the DOL to properly regulate needs a partner federal regulator in investments– i.e. the SEC on mutual funds, with CIT’s perhaps the OCC to ensure protection of retirement assets.
Target Date CITS
Collective Investment Trusts or CITS have grown by $ billions especially as Target Date Funds in the QDIA role.
There is a general assumption that CITs are regulated by the Federal Government Office of Comptroller of the Currency. Some CITs are regulated by the OCC while most used in 401(k)s are regulated by one of 50 state bank regulators. This allows CITs to choose their own state regulator who may or may not have lax oversight. [1]
Some CITs have full transparency down to the security level and are clones of established mutual funds such as Vanguard and Fidelity and are actually superior because of lower fees to the mutual funds, but many do not. In May 2023, SEC chair Gary Gensler sounded the alarms on CIT’s “Rules for these funds lack limits on illiquid investments and minimum levels of liquid assets. There is no limit on leverage, requirement for regular reporting on holdings to investors…”.[1]With these lax rules they can hide high fees and high risks in non-securities, contracts such as private equity, crypto and annuities.[2]
Accumulation 99% – Decumulation1%
Small 401k balances are the biggest threat to retirement security. The median balance reported by Fidelity in May was only $28,900[3] Fees are a major drag on balances over time.
For Decumulation just make withdrawals on a calculator without the added fees and risks of an annuity there is already a low-cost solution. Many 401k plans on web site give you a withdrawal amount for a certain number of years. The Decumulation issue is primarily a sales push by the annuity industry
On Longevity Risk I am more concerned with participants outliving their weak state regulated insurance company than outliving their income. Risk and high fees on annuities create more problems than they solve.
Annuities are sold not bought. I spent 7 years in institutional annuity product design with AEGON/Transamerica.I believe if participants were ever given full disclosures on inflation adjusted income, fees and risks in annuities they would never choose them themselves. According to the Federal Reserve[1] and my latest submitted paper[2] annuity risks are excessive.
Starting only in the last month the trade press has started saying the quiet part out loud mentioning the fact spread/fees are not disclosed could be problematic for putting annuities into target date funds.[3] These spread/fees have been some of the best kept secrets in investments slipping out last in 2013 when an executive bragged at a conference, they were over 200 basis points. [4] Under any fiduciary analysis annuities should be prohibited transactions and are only allowed under an exemption.[5]
The annuity industry is trying to get the DOL to aid them tricking or forcing their products onto participants. This requires the use of cherry-picked state insurance regulators for the insurance contracts and the use of cherry-picked state banking regulators to hide these products in poorly state regulated CIT’s. [6]
Participant support you see in industry polls is driven by the perception of an annuity as close to the size of a social security payment. The average person has 12 different jobs, and with the median balance would produce an annuity of maybe $250 a month. [7] Since Social security is indexed to inflation, and annuities are not, most will be immaterial in $$ to social security (5% to 10%). Participants, when given a choice and full transparency, will for the most part avoid annuities.
I am perplexed why the DOL would help in blocking transparency to participants
Mutual funds are not perfect
While they are the most transparent vehicle currently, Target Date Mutual Funds are not without issues. Changes and differences in Asset Allocation are not easy to follow and understand by participants. James Watkins calls it the Black Box issue around changing asset allocations. Here is what I said in my Pensions & Investments piece in May.
Yet even in an SEC regulated mutual fund, performance can be manipulated more easily in Target Date Funds. For example, a 2040 fund could have a 90% Equity/10% Fixed allocation with high fees and outperform in most time periods a 2040 fund with a 80% Equity and 20% fixed allocation with low fees. Performance manipulation games are even easier in a state regulated CIT. If the performance is not broken down by asset class and risk adjusted for asset allocation it is useless to a fiduciary.[14]
QDIA Recommendations
QDIA investments should be held to the highest fiduciary standards of transparency and accountability.
I would never recommend a state regulated annuity product because of the excessive hidden fees and risks for any part of a 401k plan. I would never recommend Private Equity or other non-regulated contract for any part of a 401k plan. I would never recommend Crypto or related non-regulated products to any part of a 401(k) plan.
Blessing any of these products for the QDIA creates many risks in the future
SEC registered Mutual Funds are OK for now, but outside them structures should have 100% underlying plan/participant ownership in SEC registered securities – stocks and bonds. This can be tested by using investments which can and are willing to adhere to CFA Institute Global Investment Performance Standards (GIPS) [2].
Collective Investment Trusts (CIT’s) should be Federally regulated by the Office of Comptroller of Currency (OCC), not by the weakest of 50 cherry picked state banking regulators.
The DOL should be pushing for more transparency, not allowing less.
BIO
Chris Tobe, CFA, CAIA has over 20 years’ experience working with 401(k) investments as a consultant and currently is the Chief Investment Officer for Hackett Robertson Tobe. His opinions do not necessarily reflect those of HRT. He works directly as a consultant to retirement plans and serves as a litigation consultant on many ERISA cases. He writes a column for the Commonsense 401K Project and has an upcoming book 401k Investments- Target Date and Stable Value
To invest in annuities, you must look the other way at one of most basic investment principals -diversification, i.e., “do not put your eggs in one basket”[1]
In my latest submitted paper, cowritten with economist Tom Lambert, ““Safe” Annuity Retirement Products and a Possible U.S. Retirement Crisis,” we expose the fact that the “emperor has no clothes,” as the life insurance Industry has flooded billions of dollars into advertising, lobbying, commissions, and trade articles with misinformation on annuities with everyone afraid to call out the obvious fiduciary problems – single entity credit and liquidity risk. Excessive monopolistic profits through secret spread fees have remained hidden with no federal regulation or oversight.
We disprove the misleading claim by insurance companies that annuities are primarily backed by a portfolio of high-quality fixed income securities. We show that only 12.5% of the portfolio of the highest rated insurer, TIAA, is highly rated securities (AA & AAA bonds).
We reveal the weakness of the state guarantee associations behind annuities, which are so flimsy they cannot even get the lowest junk grade rating from S&P or Moody’s.
We show that annuities have the highest liquidity risk of any investment in retirement plans. Even when an annuity provider’s credit risk is downgraded, investors cannot get out, even when downgraded to junk and are stuck in a death spiral all the way to default.
Hopefully, the Department of Labor’s new fiduciary rules will be enacted and protect participants in private sector retirement plans from these risks.[2]
Plans and Investors need greater transparency and true fiduciaries, not insurance salesmen – advisors who do not have insurance licenses and who will not be tempted by the huge commissions in annuities.
I want to applaud the Biden Administration on bringing Annuity Junk fees into the light of day to protect investors.
I want to focus on the effect of annuity junk fees in current ERISA protected defined contribution plans (I will address401(k) and 403(b) and cover rollover junk annuity fees in another article.) While the White House release mentions the savings in current plans from index annuities, I think that fixed annuities savings could be much larger over $9 billion a year. (It is important to note that fixed annuities and index annuities in government defined contribution plans in both 457 and 403(b) are not protected by ERISA and add to many more billions of dollars.)
My $9 billion a year comes from industry figures on General Account fixed annuities at $386 billion and separate account fixed annuities at $76 billion in ERISA defined contribution assets. [i]
However, it is important to note that the largest provider of fixed annuities in defined contribution plans (governed by ERISA) is TIAA, which has substantially lower fees and commissions, than the other mainstream insurance providers
Fixed annuities for the most part do not disclose fees and are rate based. For example, when a similar competitive fixed annuity in a plan like TIAA pays 4% many insurers only pay 2% – pocketing the spread. Bloomberg quoted an insurance executive bragging about these hidden 2%+ in fees at a Wall Street conference.[ii] These hidden spread fees have the same negative effect on investors that disclosed mutual fund fees have.
HOW DO I KNOW THIS I currently consult on excessive fees in insurance products. I spent 7 years making insurance products for Transamerica Life (TA), one of the largest U.S. insurance companies. I was an officer of seven different TA companies governed by four different states. I saw the need for federal intervention, as insurers had the ability to select the state regulator with the loosest regulations and lowest capital requirements.
RISKS One of the most basic fiduciary principles is diversification. Annuities make a mockery of this principle with their single entity credit and liquidity risk. [iii]
After the first annuity risk crisis in 1992 the Federal Reserve wrote a major paper on the weakness of state regulations in the insurance area. [iv]
In 2008 Federal Reserve Chairman Ben Bernanke said about these annuity products “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.”[v]Even when the federal government steped up to control risk in annuity products after the 2008 financial crisis, the insurance industry used its immense lobbying ability to thwart regulations and maximize profits. [vi]
ACCOUNTABILITY In light of recent money market rates of over 5%, these low 2-3% annuity rates in 401(k)’s in far riskier products are especially troubling, costing investors billions of dollars in retirement savings while taking much higher risks.
Hopefully, these junk fee rules will slow the growth of these high fee high risk products inside of 401k plans. The latest con game is selling annuities under the guise of Guaranteed Income. [vii]
Hopefully, this junk annuity initiative will expose some of the 401(k) target date funds which are burying index and fixed annuities inside weakly state regulated Collective Investment Trusts (CIT)s. [viii]
Hopefully, 401(k) consultants who claim to be somewhat independent will be exposed by showing how they use their insurance licenses for additional backdoor commissions.[ix]
Hopefully, within 401(k) plans they will either replace fixed annuities with diversified lower risk synthetic stable value products or at the minimum pay competitive rates like TIAA. [x]
This Biden Annuity Junk Fee initiative will save retirement investors billions. Please do not let the Insurance Industry water it down to line their own pockets.
Chris Tobe, CFA, CAIA is a national expert on excessive fees in retirement plans. He has written 4 books and dozens of articles on transparency, excessive fees & corruption in investments. His own firm Tobe Consulting has advised on over 70 ERISA legal cases on behalf of investors who have lost money through risky and/or high fee investments. He serves as Chief Investment Officer for a minority woman owned pension consulting firm out of New Orleans the Hackett Robertson Tobe group
The Investment Policy Statement (IPS) for a pension plan or other investment pool is a critical element in the governance and is a main fiduciary control on investments.
As stated in the IFEBP Investment Policy Handbook, “If an employee benefit plan does not have an investment policy statement, it does not have an investment policy.”[i] Chris Carosa, in his Forbes column, says a “401(k) IPS is a legal document that serves as the solid compliance backbone of the plan”.[ii]Josh Itzoe in his book, the Fiduciary Formula, says about an IPS, “I believe a written investment policy is the only way to demonstrate a thoughtful process and make well informed, prudent investment decisions consistent with the fiduciary requirements imposed by ERISA.” [iii]
A major U.S. regional ERISA law firm for plans remarked,
Since most plans maintain an IPS, not having one can be seen as ‘outside the lines’ and may subject the plan’s fiduciary compliance to greater scrutiny. In fact, it is not hard to imagine a plaintiff’s firm arguing that a plan’s failure to have an IPS is de facto evidence of a fiduciary breach.[iv]
In the CFA standards for Pension Trustees says “Effective trustees develop and implement comprehensive written investment policies that guide the investment decisions of the plan (the “policies”).” [v]The CFA Code assumes any investments of any size will have an Investment Policy Statement (IPS).
The Society for Human Resources Management (SHRM) outlined the percentage of defined contribution plans with an Investment Policy Statement. Basically 90% for plans over $50mm in 2008, most likely much higher today[ii] The complete breakdown was as follows:
$10 million or less – 68%
$10 million to $50 million – 78%
$50 million to $500 million – 90%
$500 million to $1 billion – 89%
More than $1 billion – 92%
I believe any plan without an IPS is in fiduciary breach and they should be reviewed annually. [i].
by James W. Watkins, III, J.D., CFP Board Emeritus™ member, AWMA®
Recent developments in the 401(k) and 403(b) litigation arena suggest that a major change is coming to said landscapes, none more so than the amicus brief that the Department of Labor’s (DOL) recently filed with the 11th Circuit in connection with Pizarro v. Home Depot, Inc. (Home Depot).
But first, a little background. First, in Hughes v. Northwestern University1, SCOTUS upheld the provisions of ERISA Section 404(a) by ruling that each individual investment option within a plan must be legally prudent. Then, in Forman v. TriHealth, Inc.2, the Sixth Circuit suggested that dismissal of 401(k) actions based on the alleged cost of discovery to plans is premature and inequitable, Chief Judge Sutton stating that
“This wait-and-see approach also makes sense given that discovery holds the promise of sharpening this process-based inquiry. Maybe TriHealth “investigated its alternatives and made a considered decision to offer retail shares rather than institutional shares” because “the excess cost of the retail shares paid for the recordkeeping fees under [TriHealth’s] revenue-sharing model….” Or maybe these considerations never entered the decision-making process. In the absence of discovery or some other explanation that would make an inference of imprudence implausible, we cannot dismiss the case on this ground. Nor is this an area in which the runaway costs of discovery necessarily cloud the picture. An attentive district court judge ought to be able to keep discovery within reasonable bounds given that the inquiry is narrow and ought to be readily answerable.”3
“The fact that other courts have not suggested the use of “controlled” discovery has always interested me, it that is seems perfect for 401(k)/403(b) litigation. In controlled discovery, the plaintiffs would submit all discovery requests to the court for approval. As Judge Sutton suggested, since the only discovery that would be needed at this preliminary stage would be regarding whether the plan complied with the legal independent and objective investigation and evaluation requirement, the discovery request could be as simple as “any and all materials relied upon by the plan sponsor in determining that each investment option with the plan was legally prudent, including, but limited to reports, analyses, third-party research and analyses, notes, advertisements, articles, books, magazines and other publications.”4
The DOL Amicus Brief On February 10, 2023, the DOL filed an amicus brief (DOL brief) with the 11th Circuit in connection with the Home Depot case. I believe that the DOL’s amicus brief may be instrumental in finally creating a universal and equitable application of the ERISA in the legal system.
As a fiduciary risk management counsel, I am actually more interested in the macro aspects of the amicus brief since it would have a much broader national application. For that reason, I am not going to get into the specifics of the Home Depot case. The amicus brief gave a brief analysis of the issues involved in the case. The brief identified the question before the 11th Circuit:
“Whether, in an action for fiduciary breach under 29 U.S.C. § 1109(a), once the plaintiff establishes a breach and a related plan loss, the burden shifts to the fiduciary to prove the loss is not attributable to the fiduciary’s breach.”
The brief then addressed the issues with the district court’s ruling and the issues that the 11th Circuit should consider.
“The district court did not grapple with whether to import trust law’s burden shifting rule because it erroneously that this Court in Willett had already decided that plaintiffs exclusively bear the loss-causation burden in ERISA cases. But Willett did not even consider burden shifting, let alone reject it. If anything, Eleventh Circuit precedent—including Willett itself—supports applying trust law’s burden shifting rule to ERISA fiduciary breach cases.”5
“While Willett did not explicitly address burden shifting, other Eleventh Circuit cases have endorsed the rationale behind it. This Court has long acknowledged that ERISA “embod[ies] a tailored law of trusts” and has cautioned that courts should engage in a thorough analysis before determining that a “prominent feature of trust law” does not apply where ERISA is silent. Useden, 947 F.2d at 1580, 1581 (recognizing the “incorporation of procedural trust law principles” in ERISA). To determine whether a rule should be incorporated into ERISA’s common law, the Eleventh Circuit instructs that “courts must examine whether the rule, if adopted, would further ERISA’s scheme and goals.” 6
“Moreover, by adopting burden shifting, this Court would promote uniformity in the governance of ERISA plans by aligning with its sister circuits that already apply a burden-shifting framework for proving loss causation in ERISA fiduciary breach cases.”7
As I said, I believe that the DOL’s amicus has a far greater implications for 401(k)/403(b) litigation. The DOL’s amicus brief essentially adopted the earlier argument of both the 1st Circuit Court of Appeals in their Brotherston decision, and the Solicitor General in its amicus brief to SCOTUS. All three noted that trust law supports the idea that in cases involving a fiduciary relationship, the general rule that a plaintiff must prove all part of its cases, is replaced by shifting the burden of proof as to causation to the fiduciary/plan sponsor.
“As the Supreme Court and this Court have recognized, where ERISA is silent, principles of trust law—from which ERISA is derived—should guide the development of federal common law under ERISA. Trust law provides that once a beneficiary establishes a fiduciary breach and a related loss, the burden on causation shifts to the fiduciary to show that the loss was not caused by the breach. That is why five circuits have held that once an ERISA plaintiff proves a fiduciary breach and a related loss to the plan, the burden shifts to the fiduciary to prove the loss would have occurred even if it had acted prudently.”8
“When a statute is silent on how to assign the burden of proof, the “default rule” in civil litigation is that “plaintiffs bear the burden of persuasion regarding the essential aspects of their claims.” But “[t]he ordinary default rule, of course, admits of exceptions.” Id. One such exception is found in the common law of trusts, from which ERISA’s fiduciary standards derive. Tibble v. Edison Int’l, 575 U.S. 523, 528 (2015). Trust law provides that “when a beneficiary has succeeded in proving that the trustee has committed a breach of trust and that a related loss has occurred, the burden shifts to the trustee to prove that the loss would have occurred in the absence of the breach.”9 (citing Restatement (Third) of Trusts § 100 cmt. f}.
“As Judge Friendly explained, ‘Courts do not take kindly to arguments by fiduciaries who have breached their obligations that, if they had not done this, everything would have been the same.’”10
“This burden-shifting framework reflects the trust law principle that “as between innocent beneficiaries and a defaulting fiduciary, the latter should bear the risk of uncertainty as to the consequences of its breach of duty.” Trust law requires breaching fiduciaries to bear the risk of proving loss causation because fiduciaries often possess superior knowledge to plan participants and beneficiaries as to how their plans are run.”11 (citing Restatement (Third) of Trusts § 100 cmt. f.)
Citing Brotherston, the amicus brief notes that
“Given that an ‘ERISA fiduciary often . . . has available many options from which to build a portfolio of investments available to beneficiaries,’ the First Circuit reasoned that ‘it makes little sense to have the plaintiff hazard a guess as to what the fiduciary would have done had it not breached its duty in selecting investment vehicles, only to be told ‘guess again.”” The court thus held that “once an ERISA plaintiff has shown a breach of fiduciary duty and loss to the plan, the burden shifts to the fiduciary to prove that such loss was not caused by its breach.'”12
“[T]rust law’s burden-shifting rule ‘comports with the structure and purpose of ERISA,’ which is “to protect ‘the interests of participants in employee benefit plans and their beneficiaries.’ To require that the plaintiff—who has already proven a breach and a related loss—also prove that the loss would not have occurred absent the breach ‘would provide an unfair advantage to a defendant who has already been shown to have engaged in wrongful conduct, minimizing the fiduciary provisions’ deterrent effect.’”13
The amicus brief went on to address the general position of federal circuit court jurisdictions with regard to shifting the burden of proof on causation in ERISA actions.
“The First, Second, Fourth, Fifth, and Eighth Circuits unequivocally hold that, once a plaintiff has proven a breach of fiduciary duty and a related loss to the plan, the burden shifts to the fiduciary to prove that the loss was not caused by the breach.14
Going Forward As I said earlier, I believe the DOL’s amicus brief has the potential to have a significant impact in 401(k) and 403(b) litigation, especially when combined with the Northwestern and TriHealth factors. While I see numerous issues that plan sponsors will need to consider, I believe that three key issues that will need to be considered are selection of and reliance on third-party consultants, reconsideration of fiduciary disclaimer clauses, and inclusion of annuities in pension plans, in any form.
While the district court cited the 6th, 9th and 10th circuits in support of not shifting the burden of proof as to causation, the DOL pointed out that in the cases cited by the district court, “the Sixth and Ninth Circuit cases did not directly address loss causation at all.”15 As for the 10th Circuit’s refusal to adopt shifting the burden of proof on causation, the DOL pointed out that the 10th Circuit’s position was purportedly based on the 11th Circuit’s misinterpretation of of its own decision in Willett.16
1. Selection and Reliance on Third-Party Consultants It continues to amaze me that plan sponsors blindly rely on the advice of mutual funds and insurance agents rather than experienced ERISA attorneys. Despite the warnings of the courts that such practices are in clear violation of ERISA, the courts have warned plan sponsors that such practices are impractical.
“A determination whether a fiduciary’s reliance on an expert advisor is justified is informed by many factors, including the expert’s reputation and experience, the extensiveness and thoroughness of the expert’s investigation, whether the expert’s opinion is supported by relevant material, and whether the expert’s methods and assumptions are appropriate to the decision at hand. One extremely important factor is whether the expert advisor truly offers independent and impartial advice.”17
“[The plan sponsor] relied on FPA, however, and FPA served as a broker, not an impartial analyst. As a broker, FPA and its employees have an incentive to close deals, not to investigate which of several policies might serve the union best. A business in FPA’s position must consider both what plan it can convince the union to accept and the size of the potential commission associated with each alternative. FPA is not an objective analyst any more than the same real estate broker can simultaneously protect the interests of “can simultaneously protect the interests of both buyer and seller or the same attorney can represent both husband and wife in a divorce.”18
Whether voluntarily or as a result of a decision by SCOTUS, I believe that there is little doubt that the Restatement’s position on the shifting of the burden of proof as to causation will become the universal rule in ERISA actions.
2. Reconsideration of Fiduciary Disclaimer Clauses They have never made sense from a fiduciary liability standpoint. They make even less sense now with the consensus position of the DOL, the 1st Circuit Court of Appeals, and the Solicitor General on the shifting of the burden of proof as to causation.
As I have explained to plan sponsors, trustees and my other fiduciary risk management clients, this is basic argument an ERISA should make in claiming that granting a plan adviser a fiduciary disclaimer clause is in itself a breach of one’s fiduciary duties.
So, you hired a plan adviser because you did not feel confident in your ability to properly evaluate the prudence of investment options for the plan; yet you agreed to provide the plan adviser with a fiduciary disclaimer clause, arguably releasing the plan provider from any liability for providing poor investment advice and harming the plan participants, resulting in the selection and evaluation being right back in your hands, and in so doing, essentially acknowledged your negligence and a breach of your fiduciary duties.
As I tell my clients, if a plan adviser feels the need to request a fiduciary disclaimer clause, in essence telling you they have no confidence in the quality of their advice, should that not raise a huge red flag for plan sponsors? Don’t go there!
3. Inclusion of Annuities in Pension Plans “Guaranteed income for life” But as my late friend, insurance adviser Peter Katt, used to say, “at what cost?”
Annuity advocates refuse to acknowledge the inherent fiduciary liability issues with annuities. With SECURE and SECURE 2.0, visions of sugarplums danced in the heads of every annuity advocate.
Annuity advocates like to try to ignore the potential fiduciary liability issues by discussing all the various “bells and whistles” that annuities offer. And I used to engage in such nonsense, forgetting the sound advice to “never argue with someone who believes their own lies.”
Even before the DOL’s amicus brief, I warned my clients that annuities were a fiduciary trap. Smart plan sponsors do not voluntarily assume unnecessary fiduciary liability exposure.
I tell my clients that whenever considering potential investment options for a pension plan or a trust, use this simple two question test:
1. Does ERISA or any other law expressly require you to include the specific investment in the plan/trust? 2. Would/Could the inclusion of the investment potentially expose you and the plan/trust to unnecessary fiduciary liability exposure?
I have been receiving calls and emails telling me that some annuity agents have been telling plan sponsors that SECURE and/or SECURE 2.0 require them to include annuities in their plans. Simply not true. I have told my clients to actually recite the two question test to any annuity agent. FYI – with regard to annuities, the answers are “no” to question number one, and “yes” to question number two.
Plan participants that want to invest in an annuity are obviously free to do so – outside the plan where there would be no potential fiduciary liability issues for a plan sponsor.
Many plan sponsors unnecessarily expose themselves to fiduciary liability exposure because they do not truly understand their fiduciary duties under ERISA. ERISA does not require a plan sponsor to offer a specific investment simply because a plan participant would like to invest in the product. Again, they are free to open a personal account outside the plan and invest in any product they are interested in.
I predict significant changes in ERISA litigation over the next two years, as SCOTUS is called on to resolve the two remaining primary issues blocking a unified standard for determining 401(k)/403(b) litigation-the ‘apples and oranges” argument and the shifting the burden of proof on causation. The 1st Circuit, the Solicitor General and the DOL have already properly decided the issues. Now all that is left is for SCOTUS to officially endorse their arguments in order to guarantee plan participants the rights and protections promised them by ERISA.
Copyright InvestSense, LLC 2023. All rights reserved.
This article is for informational purposes only, and is neither designed nor intended to provide legal, investment, or other professional advice since such advice always requires consideration of individual circumstances. If legal, investment, or other professional assistance is needed, the services of an attorney or other professional advisor should be sought.
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