401(k) lawsuits get more complex

One recent case alleges an employer didn't appropriately take into account index-fund tracking error

Oct 2, 2019 @ 2:39 pm

By Greg Iacurci

Lawsuits targeting 401(k) plan sponsors increasingly involve issues that are complex and granular. It's a trend that's likely to continue as such litigation proliferates and one that some advisers and attorneys fear may leave employers paralyzed when it comes to retirement plan design.

The most recent quirk comes via a lawsuit filed against employer Community Health Systems Inc., a large hospital network, which was sued by participants in its $3.2 billion 401(k) plan for alleged retirement-plan mismanagement.

Plaintiffs alleged, among other things, that CHS acted imprudently in retaining an index mutual fund given its tracking error, a reference to how closely the fund tracks a market index like the S&P 500.

This particular fund, the Principal Large Cap S&P 500 index fund, allegedly lagged its benchmark by an average 9.1 basis points between 2010 and 2018, while similar funds offered by BlackRock, Vanguard Group, State Street and Northern Trust lagged by roughly 1 to 2 basis points on average. This underperformance, plaintiffs claimed, led to poor performance that lost participants some retirement savings.

Financial advisers and attorneys familiar with 401(k) litigation said they hadn't previously seen a claim involving index-fund tracking error, and that the reference to tracking error in the CHS lawsuit speaks to an evolution.

"Clearly, over the years the plaintiff's firms, as well as the defendant bar in some of these cases, have acquired additional expertise," said Duane Thompson, a senior policy analyst at Fi360 Inc., a fiduciary consulting firm. "Claims are becoming more complex and sophisticated."

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401(k) lawsuits began appearing in large numbers in 2006, when attorney Jerome Schlichter brought an initial tranche of cases alleging plan sponsors had breached their fiduciary duties under the Employee Retirement Income Security Act of 1974.

The initial volley focused on large corporations — those with multibillion-dollar retirement plans — and alleged these plan sponsors had allowed their participants to overpay for 401(k) services like administration and investment management.

Since then, the lawsuits have proliferated and expanded, reaching down to smaller plans, financial advisory and financial services firms, and different types of defined-contribution plans, such as university 403(b) plans.

The legal arguments are morphing as well. In one recent lawsuit involving the health insurer Anthem Inc., for example, plaintiffs argued that certain Vanguard index mutual funds weren't low-cost enough. Anthem should have considered alternate investment vehicles such as collective investment trust funds and separate accounts for a lower fee, plaintiffs said. Anthem settled the suit for $23.7 million in April.

Other recent cases, such as one against Northwestern University, made the argument that plan sponsors shouldn't allow record keepers to inappropriately use data such as contact information, account size and age to cross-sell proprietary non-retirement-plan-related products like insurance. Participant data, according to these proponents, is a plan asset.

Of course, not all issues will bear fruit. The Northwestern lawsuit, for example, was dismissed. However, legal experts expect the data issue to crop up in future lawsuits.

"Plaintiff's attorneys continue to look for potential violations, including violations that may not be immediately obvious [to advisers and plan sponsors]," said Andrew Oringer, co-chair of the employee benefits and executive compensation group at Dechert, a law firm.

The fear, Mr. Oringer said, is the possibility that there could be a "dampening effect" on employers' willingness to offer 401(k) plans if they'd expected it to be a simpler proposition. Indeed, this issue was raised in a few ERISA cases, such as MetLife v. Glenn and Kennedy v. DuPont, that went to the Supreme Court, Mr. Oringer said.

"It's getting a little granular," Nathan White, managing principal at Teros Advisors, said of some lawsuit arguments.

Tracking error, Mr. White said, is one factor he takes into account when providing index-fund recommendations to 401(k) clients, but it's typically not toward the top of the list of risk concerns. However, that calculus changes for clients with a significant amount of assets in index funds — tracking error then becomes a higher-risk item, he said.

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