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.
The CFA Institute Pension Trustee Code of Conduct (Code) sets the standard for ethical behavior for a pension plan’s governing body. [i] It is a global standard that applies to both defined benefit (DB) and defined contribution (DC)plans, but I believe is consistent with ERISA fiduciary standards for 401(k) plans. The Code has 10 fundamental principles of ethical best practices. I am going to focus on 5 of them, the areas where we see many plans falling short of the standards.
Principle # 2. Act with prudence and reasonable care. The point regarding seeking appropriate levels of diversification[ii] is typically followed with most larger plans; but, we do see a number of mid-size and smaller plans taking single entity credit and liquidity risk in annuities and other insurance products. [iii] A particular non-diversified insurance product, lifetime income, is trying to break into even the largest plans, but with little success. [iv]
Another point is that service providers and consultants be independent and free of conflicts of interest. [v][vi] Again, most larger plans hire independent providers, but we do see a number of mid-size and smaller plans hire dually registered consultants who not only are registered investment providers, but are also registered as brokers or insurance agents, with the ability to get a commission. [vii]
Principle #3. Act with skill, competence, and diligence. Ignorance of a situation or an improper course of action on matters for which the trustee is responsible or should at least be aware is a violation of this code. “Trustee” in this case refers to each individual on the 401(k) committee plus the plan as a whole. We have seen many 401(k) committee members lacking awareness of the investment details in options of the plan.
Specifically, this principle points out the need ror awareness of how investments and securities are traded, their liquidity, and any other risks. Certain types of investments, such as hedge funds, private equity, or more sophisticated derivative instruments, necessitate more thorough investigation and understanding than do fundamental investments, such as straightforward and transparent equity, fixed-income, or mutual fund products. [viii]
With investments that have non-SEC regulated securities like illiquid contract-based products like crypto, [ix] private equity,[x] annuities and other insurance products, [xi] many times the 401(k) committees are not aware of the risks and hidden fees and have not thoroughly investigated them on such matters, especially those buried in target date funds and in brokerage windows.
Principle #5. Abide by all applicable laws Generally, trustees are not expected to master the nuances of technical, complex law or become experts in compliance with pension regulation. Effective trustees …consult with professional advisers retained by the plan to provide technical expertise on applicable law and regulation. [xii]
Principle #3 suggests that assets that are not straightforward and transparent securities, such as crypto, private equity and annuities/insurance products contracts, require additional legal scrutiny. I would assume that no crypto product would pass a good fiduciary law audit. I would claim that it would be the fiduciary duty of the plan going into any private equity or annuity contract (separate account or general account) – to have a side letter in which the manager/or insurance company agrees to take.
1. ERISA Fiduciary duty
2 Provide liquidity if the investment experiences difficulty. With insurance products, this can be done with a downgrade clause, i.e., “in the event that the insurance company’s debt is downgraded below investment grade by any major rating agency, the plan will be returned its contract value in cash within 30 days.”
3. “Most Favored Nation Clause, guaranteeing that the manager /insurance company does not provide a lower fee or higher rate to any other plans
Ownership of underlying securities is key to a plan’s risk exposure, especially liquidity risk, and when complex instruments are involved, it is the duty of the plan committee to get competent legal advice on these investment contracts.
Principle #7. Take actions that are consistent with policies Effective trustees develop and implement comprehensive written investment policies that guide the investment decisions of the plan (the “policies”). Most of the largest plans have Investment Policy Statements (IPS). The Code expects any plan to have them.
I believe any plan without an IPS is in fiduciary breach. I believe many conflicted consultants, as discussed in Principle #2, recommend that plans do not draft an IPS since it would expose their own conflicts. Most of the riskier assets in Principles #3 and #5, like crypto, private equity and annuities, would not be allowed under a well written IPS due to the excessive risks and hidden fees involved.
Trustees should … draft written policies that include a discussion of risk tolerances, return objectives, liquidityrequirements, liabilities, tax considerations, and any legal, regulatory, or other unique circumstances. Review and approve the plan’s investment policiesas necessary, but at least annually, to ensure that the policies remain current.[xiii]Some plans may have an Investment Policy Statement (IPS), but do not regularly review it or apply it rigorously to their investments.
Select investment options within the context of the stated mandates or strategies and appropriate asset allocation. Establish policy frameworks within which to allocate risk for both asset allocation policy risk and active riskas well as frameworks within which to monitor performance of the asset allocation policies and the risk of the overall pension plan.[xiv]
While asset allocation is a major component of DB plans – US DC plans now have over 50% of their assets in asset allocated investments, primarily target date funds.[xv] In most plans, the target date funds are the Qualified Default Investment Alternative (QDIA), which makes it essential that each target date sleave be addressed in the Investment Policy Statement.
Principle #10. Communicate with participants in a transparent manner. While the DOL forces some fee disclosure on each plan investment, it is not complete with non-securities like crypto, private equity and annuities as standalone options[xvi], in brokerage windows or inside target date funds. [xvii]
Revenue sharing is a shady non-transparent way some plans make their own participants pay for administrative costs; it does not hold up under these CFA standards in my opinion. [xviii]
Given the similarity between ERISA’s fiduciary requirements and the CFA Institute Pension Trustee Code of Conduct, 401(k) plan sponsors could greatly mitigate their litigation risk by looking at the Code. Furthermore, it is just the prudent and the right thing to do as a fiduciary.
Chris Tobe, CFA, CAIA is the Chief Investment Officer with Hackett Robertson Tobe (HRT) a minority owned SEC registered investment advisor and recently was awarded the CFA certificate in ESG investing. At HRT Tobe is leading up the institutional investment consulting practice for both DB and DC Pension plans. He also does legal expert work on pension investment cases.
Past industry experience includes consulting stints at New England Pension Consultants (NEPC) and Fund Evaluation Group. Tobe served on investment committee of the Delta Tau Delta Foundation for over 20 years served as a Trustee and on the Investment Committee for the $13 billion Kentucky Retirement Systems from 2008-12. Chris has published articles on pension investing in the Financial Analysts Journal, Journal of Investment Consulting and Plan Sponsor Magazine. Chris has been quoted in numerous publications including Forbes, Bloomberg, Reuters, Pensions & Investments and the Wall Street Journal.
Chris earned an MBA in Finance and Accounting from Indiana University Bloomington and his undergraduate degree in Economics from Tulane University. He has the taught the MBA investment course at the University of Louisville and has served as President of the CFA Society of Louisville. As a public pension trustee in, he completed both the Program for Advanced Trustee Studies at Harvard Law School and the Fiduciary College at Stanford University.
At the end of each quarterly, I update the five and ten-year Active Management Value Ratio analyses for the non-index based mutual funds in the top ten funds in “Pensions & Investments” list of most commonly used mutual funds in U.S. defined contribution.
Given the recent performance of the markets, it should come as no surprise that the 5 and 10-Year AMVR analyses of the six most popular non-index mutual funds in U.S. defined contribution plans remain relatively unchanged.
Interesting to note that for both the 5 and 10-year period, only Vanguard PRIMECAP Admiral shares managed to qualify for an AMVR ranking.
Also interesting to note the importance of factoring in a fund’s risk-adjusted returns. On the 5-year AMVR analyses, factoring in risk-adjusted returns turned AF’s Washington Mutual Fund’s incremental return from (0.90) on nominal returns, to a positive 0.13. Admittedly, a small positive number, but still a significant change.
On the 10-year AMVR analyses slide, factoring in the fund’s risk-adjusted returns turned their incremental return from (0.57) (nominal) to 0.57 (risk-adjusted.) Likewise for Fidelity Contafund, where an incremental return of (0.79) (nominal) turned into a small, yet positive, 0.09.
Overall, the song remains the same, with the majority of actively managed funds being unable to overcome the combination of the weight of higher fees and cost and high r-squared/correlation of returns number to beat the index of comparable index funds
And so, we continue to see 401(k) actions alleging a breach of fiduciary duties by plan sponsors. Of note, we are seeing an increasing number of cases focusing on target date funds (TDFs). I expect to see more actions involving TDFs, as the AMVR provides compelling evidence of the imprudence of the active versions of such funds. I will post an updated analysis of the active and index versions of both the Fidelity Freedom and TIAA-CREF Lifestyle TDFs next week
Somehow some judges are buying this fallacy that participants get better recordkeeping by paying substantially more for it. They are accepting this myth without proof and are actually blocking the transparency which would expose this truth by denying discovery.
Low-Cost recordkeeper Employee Fiduciary says “There are few industries where the phrase “you get what you pay for” is less applicable than the 401(k) industry. That’s because equally competent 401(k) providers can charge dramatically different fees for comparable administration services and investments.[i] Employee Fiduciary comes out with an example weekly on huge savings in recordkeeping. [ii]
There are no material differences in quality of recordkeeping services Fidelity at $30 a head is same service as Fidelity at $90 a head. There are really no material differences that a participant can tell between any recordkeepers, they get statements and have access to a web site. –
Smug articles gloat on how courts have blocked transparency of discovery for so called differences in record keeping quality that no participants or anyone in the industry can even measure. [iii] As attorney James Watkins says “Requiring a plaintiff to plead specific information known only to the defendant, without an opportunity to discover such specifics, is obviously just an attempt to protect plans.”
In this absurd insult to justice and transparency, some judges are putting the initial burden of proof on participants where the plan is deliberately hiding the critical information needed to fulfill that burden.
In addition, revenue sharing is an another way to help hide excessive recordkeeping fees, as some judges ignore these obvious issues. A 2021 study by experts from the Federal Reserve and leading universities says 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.”[iv]
Revenue sharing does not hold up during discovery and this has been confirmed by the fiduciary liability insurance industry, which put much higher litigation risk on plans with revenue sharing and either denying coverage or raising rates significantly. [v]
There are some instances of additional administrative services couched as education that can, in fact, be harmful to participants. Especially insurance providers, and especially in hospitals which are known to provide commissioned salespeople who actually try to push participants into higher fee funds and cross-sell them on imprudent outside investments as well.
Competitive recordkeeping costs have been established at $30 to $50 per heard for plans over $200 million in assets. There are no material differences in the quality of recordkeeping. Judges are dismissing fees double to such fees for identical services. The fact that such fees are largely ignored because they are non-transparent in no way reduces the significant harm they cause to participants.
The 401(k) market differs greatly by size. 85 percent of 401k plans (534 out of 631 thousand defined contribution plans) (DC Plans) are under $5 million in size. The DOL is overwhelmed with the 534 thousand plans under $5 million, of which there are enough bad actors doing engaged in highly questionable activities, such as taking participants’ money for personal use, that they have not touched the excessive fees issue, leaving it to the legal community to address such concerns. Less than 1 percent of DC Plans are over $200 million in assets and are generally cost effective to litigate.
However, less than 1 percent is still nearly 4000 plans with over $200 million each in assets. However, within this 4000, differences vary greatly by size as well. My best guess is that less than 500 actions have been filed according to what I have found. I still believe there is room for around 2500 more actions to be filed over the next decade.
An August 2022 Bloomberg article cites $150 million in settlements over the last 3 years. Bloomberg puts the number filed at around 200 since 2019 so my estimates may be conservative.[i] Bloomberg notes that decisions issued in the seven months since the US Supreme Court Hughes decision have tended to favor plaintiffs over defendants. Bloomberg predicts that “employers negotiating future settlements may be facing higher price tags than the $1 million to $5 million range seen over the past few years.” This Bloomberg article shows a growing pace of ERISA litigation.
An August 2022 article by Fred Barstein of 401kTV also predicts the rapid growth of litigation in smaller 401(k) plans. [ii]
401(k) plans of $3 billion and more assets According to my data base there are 334 plans over $3 billion in assets. This has been the most litigated group, with well over 100 actions filed. There is still a high probability of 100 or more cases coming from this group, perhaps even more if there is double dipping, as many earlier litigating plans have gone halfway at best in lowering fees.
For larger plan administrative costs, fees above $50 a head, or even one high fee option, may be enough to trigger a suit. This could apply to plans that have already been litigated once and did not adequately cut costs the first time. Does every plan option have to been prudent even those who go through to the brokerage window? If so, this could this be litigated as high fee funds and even Crypto Currency are in widely held brokerage windows.
Many of the largest plans unitize investments with defined benefit plans. Will the new level of transparency go through to target date funds with underlying alternatives like Private Equity? Alternative contracts typically contain multiple fiduciary breaches, excessive fees along with liquidity and other breaches.
401(k) plans of $1b – $3 billion
There are an estimated 717 plans between $1-$3 billion, with probably 200 that have been litigated, leaving room for maybe 300 more.
There are lots of plans with administrative costs above $50 a head, or even more with at least one high fee option, along with all the other attributes like brokerage windows like the largest plans.
401(k) plans of $500m – $1 billion There are 961 plans between $500m $1 billion, with probably only 50 or less cases litigated. This area will probably have the most explosive growth, with well over 600 plans with high fee providers. There are many higher fee insurance recordkeepers in this group and conflicted consultants, along with share class violations in many funds.
401(k) plans of $200m – $500m There are 2259 plans between $200-$500 million. 2022 will start to see a great growth in litigation in this area. Plans in this group who start fixing their plans could greatly minimize their chances of litigation. I still guess that over 1500 plans could be subject to litigation. There are even more higher fee insurance recordkeepers in this group and conflicted consultants, along with share class violations in many funds.
403(b) plans ERISA 403(b) plans include: not-for-profit hospitals, and not-for-profit universities, private not-for-profit K-12 schools. Non-ERISA 403(b) plans include public K-12 schools, public universities and some university related hospitals.
The largest 30 or so private universities 403(b)s have already been hit with litigation. Northwestern is typical with 3 different recordkeepers Fidelity, Vanguard, & TIAA. This portion of the 403(b) market with multiple recordkeepers is unique as almost all 401(k), which is more oriented toward single record keeper, so all could be litigated around administrative costs. Fidelity and TIAA also have high-cost options and TIAA has high-cost higher risk annuity options as well. The next 100 or so private universities will be at great risk of litigation.
The big wave of 403(b) litigation will probably be hospitals. While they typically only have one recordkeeper, they are much more likely than 401(k) plans of the same size to use higher fee (especially insurance company) based platforms.
401(k) plans of $50m – $200m There are an estimated 8646 plans between $50-$200 million. I predict litigation will be low in 2022 as there are so many larger targets. However, over the next decade it could pick up. This gives plans in this size range time to clean up their plans, giving maximum value to participants while minimizing litigation risk in the future.
Higher fee insurance recordkeepers, conflicted consultants along with multiple share class violations, are rampant in this group with much higher percentage.
401(k) plans of $20-$50m and $5-20m There are an estimated 14915 plans between $20-$50 million and an estimated 69343 plans between $5-$20 million. I predict that litigation involving these plans will be rare during the next 5 years, as there are so many larger targets, but over the next decade it could pick up. This gives plans in this size range time to clean up their plans, giving maximum value to participants while minimizing litigation risk in the future.
Parting Thoughts 401(k) litigation is only in its infancy, with only 15-20 percent of the 3000 potential largest complaints filed. This number could triple if the litigation goes down to plans from $50-$200 million. All of the controversy now is mostly in the largest cases being litigated. Most of these smaller cases are much more clear-cut regarding potential fiduciary violations.
Plans can fix themselves or wait to be sued. Unfortunately, many are close-minded, relying solely on conflicted advice from brokers and insurance agents that tell plans that they are OK when they actually are not. Many plans will be in for a rude awakening.
Whenever plan sponsors and plan advisers talk about 401(k) litigation, they always point the finger at those bad ‘ol ERISA plaintiff attorneys. Since I am one of those bad folks, I respectfully disagree with such sentiments. I respectfully suggest that plan sponsors should look in the mirror to see the real party for such litigation. As the famous comic strip, “Pogo,” once said, “we have met the enemy and he is us.”
Whenever I talk with a CEO and or a 401(k) investment committee, this is the first graphic I show them. Most plan advisers insist on plan sponsors agree to an advisory contract that contains a fiduciary disclaimer clause. Many plan sponsors are not aware that they have agreed to such a provision since they are usually set out in legalese. But they are usually there.
When a plan sponsor agrees to such a clause, it waives important protections for both itself and the plan participants. With a fiduciary disclaimer clause, securities licensed advisers can claim to be subject to Regulation “Best Interest” (Reg BI) rather than the more demanding duties of loyalty and prudence required under a true fiduciary standard.
Reg BI claims that it requires brokers to always put a customer’s best interests first, including considering the costs associated with any and all recommendations. The Reg BI turns around and allows brokers to only consider “readily available alternatives,” which the SEC considers to be the cost-inefficient and consistently underperforming actively managed mutual funds and various annuity products. In whose best interests?
Unless a plan sponsor properly performs the investigation and evaluation required under ERISA, this usually results in 401(k) litigation and the plan sponsor settling for a significant amount. As we discussed in a previous post, when you consider that all of this can be easily avoided by a plan sponsor by performing a cost-efficiency analysis using our free Active Management Value Ratio, you have to wonder why plan sponsors do not better protect themselves by simplifying their plans and ensuring that they are ERISA-compliant.
My experience has been that most plan sponsors create unnecessary liability exposure for themselves due to a mistaken understanding of their true fiduciary duties. “The CommonSense 401(k) Plan”™ provides a simple solution that reduces both administration costs and potential liability exposure, resulting in a win-win situation for both plan participants and plan sponsors.
So, for plan sponsors and plan advisers, the next time you point a finger at ERISA plaintiff’s attorney and blame us for the number of 401(k) litigation cases, remember the words of my good friend, Charles Nichols, when you point at us, three of your remaining fingers point back at you. Then contact InvestSense for a free “The CommonSense 401(k) Plan” consultation at “CommonSense InvestSense.” (investsense.com)
Copyright InvestSense, LLC 2022. 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.
I have looked at dozens of retirement committee meeting minutes working with both public and ERISA retirement plans and I have seen little or no discussion of vendor due diligence around lawsuits and regulatory issue.
When firms hire an employee, they usually do a background check. From SHRM”
A background investigation generally involves determining whether an applicant may be unqualified for a position due to a record of criminal conviction, motor vehicle violations, poor credit history, or misrepresentation regarding education or work history. [i]
Given this exhaustive process for one new hire it makes sense to run the same type of background check on vendors for the employee’s retirement plan and It can be argued is the plans fiduciary duty to run one on each vendor.
While a violation may not be an immediate reason to disqualify and terminate a vendor, it would be a good fiduciary process for the plan to ask the vendor to explain the violation and why it does not affect their ability to serve the plan.
A lot of plan fiduciaries would not be surprised by 401(k) litigation if they had followed this easy fiduciary process. Many of the same firms caught by the SEC for share class violations for retail and other institutional funds are doing the same thing in 401(k) and it is showing up in litigation. Many of these firms avoid fiduciary responsibility in their contracts multiplying this risk.
Violation tracker quickly shows: Prudential has 19 investor protection violations with fines totally over $744 million.[ii] Wells Fargo has 223 overall violations 93 investor protection violations. Bank of America 264 overall violations 119 investor protection violations.
.Going to the SEC website under litigation you can easily find the following more detailed violations.
SEC Merrill Lynch (B of A) – 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 TIAAJuly 2021 misleading statements failure to disclose conflicts of interest [i]
SEC MML Mass MutualSept 21 Revenue Sharing Share class violations
SEC VALIC Financial Advisors Inc. AIG-VALICJuly 28, 2020 Revenue Sharing Share class violations
SEC VOYA Financial Advisors Inc ING-VOYADec. 21, 2020 Share class Revenue Sharing Share class violations
SEC PRUCO Securities, LLC (Prudential)Dec 23, 2020 Rev Sharing Share class violationsFINRA PIMS June 2020
SEC PRINCIPAL Securities, Inc.March 11, 2019 Revenue Sharing Share class violations
SEC TRANSAMERICASept 30, 2020 fee gauging TA FINRA Share Class Variable 2020 annuities2014 Fee Gauging
A prudent ERISA fiduciary should be aware of these violations, and/or their consultants/attorneys should have brought this to their attention. They should also be aware of any 401(k) litigation each vendor is involved in both directly and indirectly.
Each vendor’s contracts should state they take fiduciary duty as to not shift it back to the plan.
A background check for every vendor is essential for fiduciaries.
Crypto, trying to bribe its way into 401ks via Congress and with providers like Fidelity, has exposed a non-transparent dark area of 401(k) that has been on the back burner – brokerage windows. A typical plan has 12 to 16 main options, but a brokerage window could add hundreds of additional choices that so far have escaped any oversight. Fidelity stated they would put crypto as a main option and prompted this response from the DOL
“The plan fiduciaries responsible for overseeing [cryptocurrency] investment options or allowing such investments through brokerage windows should expect to be questioned about how they can square their actions with their duties of prudence and loyalty.”[i
The DOL advisory council put together a report on brokerage windows that basically said they are so immaterial, that the DOL needs to give little or no oversight to them since those in the brokerage window are aware of the additional risks.[v]
A report cites PSCSA that
23.2 percent of all retirement plans offer a brokerage window, and nearly 40 percent of those with more than 5,000 participants do. Even though brokerage windows are being offered in many plans, participants do not use them widely only 1.5 percent of plan assets are invested through brokerage windows. DOL states that custodians saw a usage ranged from .03 percent to 3 percent. [vi]
Because of their size, less attention has been paid to brokerage windows both by the DOL and the plaintiff’s bar. But with the declaration by Fidelity to offer crypto as a main option within plans and the DOL doing its job by sounding concerns, people realized that there could be crypto investing already going on in brokerage windows, with most plans not having a clue.
Fidelity, who is the largest runner of brokerage windows and who cut the deal with bitcoin to put them on their platform, are most likely receiving millions of undisclosed dollars from the crypto crowd.
Crypto is pouring millions into DC lobbying, and seems shocked that DOL did their job and did not roll over like they did with private equity investments under Trump.
Bloomberg writes that
Under that guidance, which the DOL issued last month, 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.[vii]
“This is a very damning statement about brokerage windows,” said Lisa Tavares, a partner at Venable LLP and a former IRS attorney.”
Since almost all brokerage windows have excessive fees and many have excessive risks that do not pass fiduciary scrutiny, this opens up almost any plan with a brokerage window to potential litigation.
Leading plaintiffs firm Keller Rohrback LLP is investigating whether employees and retirees have paid unnecessary fees in connection with their use of brokerage windows such as excessive fees, selecting funds based on the amount of fees shared with the brokerage firm, and selecting more expensive share classes despite the availability of less expensive classes of the same fund. They have targeted particular large firms like Continental Airlines, Kimberly-Clarke, Lilly, and Caterpillar looking for plaintiffs.[viii]
In the article, “401(k)s with Bitcoin Should Expect Lawsuits: Lawyers,” trade publication “Ignites” quotes Jerry Schlichter as saying that
Any employer who would follow the Fidelity lead by offering cryptocurrency and 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.[ix]
The defense bar is trying to talk up a structure the digital accounts to qualify for 404(c) protections. Schlichter, however, suggested that 404(c) protections would not provide a safe harbor anyway. He pointed to a Supreme Court decisionhanded down in January that found that plan sponsors could not escape their responsibility for allowing imprudent investments in their plans even if they feature them alongside prudent ones. Schlichter represents the plaintiffs in that case, the plan participants in Northwestern University’s 403(b) plan.Quoting Schlichter,
“[The Supreme Court] said, ‘No, the employer plan sponsor has the duty to furnish only prudent options,’ and the same applies here.'”
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.
50 percent of all 401(k) assets are in target date funds. I believe Target Date Funds were created to sustain higher fees. The least transparent Target Date Funds are those that are not SEC registered mutual funds. Many are in poorly state regulated annuities either in whole or in part. Many are in poorly state regulated Collective Investment Trusts (CIT)s Many CIT’s can hide private equity or annuities and their many hidden fees and risks. Many, if not most, CIT based Target Date Funds and all annuity TDF’s are a fiduciary breach based on the higher risks alone, not to mention the excessive fees.[i]
Weak Regulation 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 laxest oversight. [ii] While the SEC mutual fund regulations are not perfect, they do control for a lot of risks and provide a good amount of transparency
Prudential Day One Target Date funds provide this disclosure to plans:
Unlike mutual funds, the Day One Funds, as insurance company separate accounts or collective investment trusts, are exempt from Securities and Exchange Commission registration under both the Securities Act of 1933 and the Investment Company Act of 1940 but are subject to oversight by state banking or insurance regulators, as applicable. Therefore, investors are generally not entitled to the protections of the federal securities laws.[iii]
Principal provides this disclosure:
The CITs are not mutual funds and are not registered with the Securities and Exchange Commission, the State of Oregon, or any other regulatory body.
The Collective Trust and the Funds intend to qualify for the exclusion from the definition of an “investment company” under the 1940 Act provided for by Section 3(c)(11) of the 1940 Act. The Section 3(c)(11) exclusion is available for collective investment funds maintained by a bank consisting solely of assets of certain employee benefit plans. Accordingly, Participating Trusts will not have the benefit of the protections afforded by the 1940 Act (which, among other things, requires investment companies to have governing boards of directors with a majority of disinterested directors and regulates the relationship between the adviser and the investment company). The offering of units of the Funds (each, a “Unit”) has not been registered under the U.S. securities laws or the laws of any applicable jurisdiction. Therefore, Participating Trusts will not have the benefit of the protections afforded by the Securities and Exchange Commission (“SEC”) under the Securities Act of 1933 (the “1933 Act”) (which, among other things, requires specified disclosure in connection with the offering of securities). Neither the SEC nor any state securities commission has approved or disapproved of the Units or determined if this document is accurate or complete. Any representation to the contrary is a criminal offense
In these cases, it appears these target date funds are avoiding SEC and any kind of federal regulation. The only state regulator with any standards close to the SEC is New York and most of these funds avoid NY regulation whenever possible.
How can any fiduciary subject to Federal ERISA laws use for its main investment options target date funds that go out of their way to avoid Federal oversight?
Toxic Assets A major reason to avoid SEC oversight is to put in investments which are not allowed in SEC registered mutual funds because of risk. The other reason is to load up on assets with hidden fees which will not be disclosed under the current weak regulation.
Private equity, along with other illiquid contract investments like hedge funds, private debt, real estate is a potential fiduciary time bomb for plans and their participants. In target date funds even a small allocation to a Target Date Fund, with the excessive risk, lack of outperformance and excessive fees seem to make it a fiduciary risk. [iv]
A disclosure from Principal:
A differentiating aspect…..is exposure to alternatives (hedge fund strategies).[v] ….. Given the managers approach to asset allocation (more equities and alternatives)…. Exposure to nontraditional (commodities, natural resources, and real estate) and alternative (hedge fund strategies) asset classes is a differentiating aspect from a style perspective relative to the peer group
Principal LifeTime Hybrid CITs may invest in various types of investments including Principal Funds, Inc. institutional class shares, Principal Life
Insurance Company Separate Accounts and other collective investment trusts and mutual funds.The risks associated with derivative investments include …that there may be no liquid secondary market, Investing in real estate securities, subjects the Fund to the risks associated with the real estate market (which are similar to the risks associated with direct ownership in real estate), including declines in real estate values, loss due to casualty or condemnation, property taxes, interest, rate changes, increased expenses, cash flow of underlying real estate assets, regulatory changes (including zoning, land use and rents) and environmental problems, as well as to the risks related to the management skill and creditworthiness of the issuer.
Like high-risk hedge funds Prudential, Principal and others have the contractual right to put up gates and restrict liquidity if they are downgraded or in danger of default. They can refuse to give the plan/participant their money at any time which would be illegal in a SEC registered mutual fund
Annuities I spent 7 years at Transamerica making insurance annuity 401k products Anytime an insurance company puts something in an annuity form, they take ownership of the underlying securities put it on their balance sheet and squeeze out another 150 bps or more in spread fees. Anytime something is put in an insurance company Separate Account, same thing they take ownership and lock in a spread.
These annuities do not have SEC mutual fund oversight, and the plan does not own the underlying SEC registered securities, the insurance company does. I make the argument that any annuity is a fiduciary breach. [vi]
Prudential Day One Funds may be offered as: (i) insurance company separate accounts available under group variable annuity contracts issued by Prudential Retirement Insurance and Annuity Company (PRIAC),
Sub-Advised Investment Options include Separate Accounts available through a group annuity contract with Principal Life Insurance Co.
Fees Target Date Funds are so opaque that the actual fees and profits are hard to pin down. I estimate that many could approach 200 basis points or more.
Principal Target dates have 13 underlying funds 5 insurance company separate accounts (annuities), 4 CIT’s, 4 proprietary mutual funds, for a total of 25 share classes.
The disclosed fees are even way above most providers, so any plan using these is not trying to minimize fees.
Conclusion Any plan sponsor who invests in one of these black hole CIT funds deserves to be sued. I guess that in many cases there is a so-called consultant receiving a huge undisclosed insurance commission.
One of my favorite disclosures:
The ultimate decision as to whether a Principal LifeTime Hybrid CIT is an appropriate investment option for a plan and whether a target date fund can serve as a QDIA belongs to the appropriate retirement plan fiduciaries.
interpret this disclosure as the insurance company way of saying “if you are stupid enough to buy our high fee high risk products, it is on you, not us.”