How to keep your 401(k) clients out of court

The organizations getting hit with retirement plan lawsuits are low-hanging fruit

Sep 10, 2018 @ 10:58 am

By Blaine F. Aikin

While 401(k) lawsuits show no sign of letting up, the man at the forefront of class-action retirement plan litigation foresees a day when this will change.

"Ultimately, it may be that 401(k) cases end because [retirement plan] sponsors change their practices. That's happening now," attorney Jerry Schlichter of Schlichter Bogard & Denton said in a January podcast interview.

Mr. Schlichter's optimistic forecast for less litigation may well hold true if plan sponsors and their advisers heed the relatively straightforward lessons lawsuits can teach.

Three types of fiduciary breach claims dominate in retirement cases: (1) inappropriate investment options, (2) excessive fees and (3) self-dealing. This is evident to observers of litigation and has been affirmed in a May study of over 400 cases conducted by Boston College's Center for Retirement Research.

Inappropriate investment options violate a duty of care. Fiduciaries are required to act with the care, skill, prudence and diligence expected of others acting in a like capacity under similar circumstances. It's intended to be a high bar that requires expert-grade capabilities to fulfill key obligations.

The Boston College study notes that "plan fiduciaries have tended to face this kind of litigation when their funds have experienced persistently poor historical performance compared to similar 'benchmark' funds." Inadequate due diligence and failure to monitor investments and service providers are weaknesses litigators look for.

The charge of "excessive fees" is now the most common of the Big Three types of claims. It is the type of claim that can play particularly well for plaintiffs in court. Expenses are quantitative (which makes it easier to compute damages), they are becoming more transparent and they can be benchmarked to identify marketplace outliers. A red flag example of a potential excessive-fee case waiting to happen is the use of retail-class fund shares when like-kind and lower-cost institutional shares could have been chosen.

Self-dealing occurs when a plan fiduciary places its own interests above the interests of the plan and the plan's participants and beneficiaries. It's a central claim in the 40-plus cases brought against financial services firms. Plaintiffs typically allege that the company populated its own retirement plan with poorly performing, excessively expensive proprietary funds that do not withstand the scrutiny of thorough and objective due diligence analysis.

The shock, cost and reputational damage of being hauled into court is often compounded by the misery of being stuck there for years. One of the first big cases — Tussey v. ABB — is still in court after more than 11 years. This case was filed in 2006 by the Schlichter law firm and resulted in a $36 million award for the plaintiffs in 2012. It has bounced around in various review venues ever since.

To put the cost of prolonged litigation in perspective, defendants paid their attorneys more than $42 million during the first decade of Tussey litigation. Millions more went to pay expenses.

In the podcast interview, Mr. Schlichter was asked about the cases he declines to pursue. He said he rejects far more cases than he accepts. The cases are far too difficult, time-consuming and costly to litigate unless he is confident the plaintiffs will ultimately win. Thousands of hours of time and millions of dollars of expense are invested by plaintiffs' counsel, which would be wasted if a lawsuit were unsuccessful. There must be clear evidence of imprudent decision-making, exorbitant expenses or egregious self-dealing to justify taking a case.

Stated more bluntly, the organizations getting pulled into court are low-hanging fruit. They exhibit plan practices that are obviously not in participants' best interests. At a bare minimum, all plan sponsors should make sure they have the following four fiduciary obligations covered:

• Implement prudent processes to vet, select and monitor investment options, advisers and other service providers;

• Avoid conflicts of interest that subordinate the best interests of participants and beneficiaries to those of the plan sponsor or service providers;

• Compare and control costs by benchmarking investments, and use requests for proposal processes to select service providers that charge fair and reasonable fees for necessary services; and

• Consult with qualified fiduciary advisers if in-house plan fiduciaries are not experts.

There is a big difference between having processes that are sufficient to stay out of court and having processes that are worthy of recognition for excellence. Retirement plan advisers who provide fiduciary consulting have a golden opportunity to allay sponsors' fears of litigation and refocus them on making their retirement plans the highly valued employee benefits they are intended to be.

Blaine F. Aikin is executive chairman of fi360 Inc.


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