Is more always better? Not according to a recently filed lawsuit against Duke University claiming that a plan offering more than 400 investment choices caused “participant paralysis” and an inability to make investment decisions.
The lawsuit — similar to those filed against institutions such as MIT, New York University, Johns Hopkins and Yale —claims that offering too many options is a fiduciary breach. The lawsuits also claim that any participant with a plan that has multiple record keepers pays excessive recordkeeping fees.
More and more lawsuits are being filed to challenge plan fees and investments. Plaintiffs are asking the courts to make new law in this area.
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These developments strongly support that plan fiduciaries should not become complacent just because they haven’t been sued. Here is a summary of the targets and theories in the new lawsuits:
403(b) plans are a new target
Duke, NYU, Johns Hopkins and Yale sponsor 403(b) plans. Lawsuits against fiduciaries of 403(b) plans are a major development and may signal the beginning of a whole new phase in fee litigation. 403(b) plans, like 401(k) plans, permit employees to make pre-tax contributions, but only tax exempt employers may sponsor 403(b) plans.
Although Section 403(b) has been in the Internal Revenue Code for a long time and many — but not all — 403(b) plans are subject to ERISA, 403(b) plans have not traditionally received much attention from the Department of Labor. Many are in “set it and forget it” mode, and the governance policies haven’t been updated to reflect fiduciary best practices. This makes them ripe targets for fee litigation.
Too many options
This charge also affects 401(k) plans and might indicate a fiduciary breach. Duke, for example, might think it is a good thing to offer more than 400 funds to maximize choice, but many funds with high fees and lagging performance are in that mix. The high number of funds could indicate the fiduciaries have abdicated their responsibility to review and select the best, most prudent investment options for the participants. The lawsuit also argues that there should not be multiple funds in the same asset class.
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Too many record keepers
This seems to be a 403(b) issue because 401(k) plans typically do not have multiple record keepers. In using different record keepers for different investments — Duke has four and Johns Hopkins reportedly has five — fiduciaries have unnecessarily subjected participants to inefficiencies, which result in multiple and excessive fees.
Splitting business and asset classes defeat lower fees
Wal-Mart was sued because its 401(k) plan offered retail rather than lower-fee institutional class funds; the plan fiduciaries of this huge plan did not use their bargaining power to obtain lower fees. This is a similar argument, and both 401(k) and 403(b) plans can be targets. The Duke complaint argues that using multiple record keepers and offering multiple funds in the same asset class also prevents leveraging size to get the lowest fees. Plaintiffs also contend that plan participants should pay flat fees rather than fees with asset-based revenue sharing for recordkeeping because there is no increase in the value of the services provided simply because assets go up.
Using a money market fund rather than a stable value fund
Stable value funds are capital preservation funds like money market funds but guarantee a minimum return. An argument raised in a lawsuit recently filed against Franklin Templeton Investments is that, given the low money market rates available today, failure to use stable value funds can be a fiduciary breach.
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New proprietary fund cases
New cases have been filed against Franklin Templeton Investments and private investment firm Neuberger Berman challenging the use of proprietary funds in their own 401(k) plans, and Allianz Life recently failed to dismiss a lawsuit challenging its proprietary funds. The Neuberger Berman case focuses on one of those funds, the Value Equity Fund, which allegedly had high fees and a poor performance record, even though Neuberger Berman offered many non-proprietary funds.
Every provider that puts its own funds in its plans seems to be vulnerable to this charge, as it exposes the fiduciaries to allegations that the funds were selected only to provide additional fees to the sponsor and its affiliates. Any fiduciaries who automatically select their provider’s target date funds without investigating whether there are better funds from other sources are also vulnerable.
Annuity Investments and CREF Stock Fund
The Duke complaint makes a number of allegations that investments from annuity providers are problematic. It argues investments offered through TIAA-CREF, a major 403(b) provider, have excessive fees. (TIAA-CREF is not a defendant). These investments include a fixed annuity that charges a penalty fee to withdraw all funds on termination of employment and the CREF Stock Fund, an expensive underperforming fund that was allegedly put in the lineup without investigation simply because TIAA-CREF said it was required. Complaints also allege that mutual funds provided through variable annuities have multiple layers of unnecessary and excessive fees and contain charts showing the claimed markup.
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It will be interesting to see whether new law is made from these lawsuits because most of past cases were settled. An exception was the Supreme Court decision in Tibble v. Edison (2015) setting forth an ongoing duty to monitor investments. The settlements not only provided monetary recoveries to participants, but also included agreements to follow specific better plan practices, such as engaging independent fiduciaries, going forward. Any plan fiduciaries who have not reviewed their own practices would be well-advised to put their own best practices for reviewing fees and investments in place before a court decision or settlement forces them to adopt new procedures or to hire an independent fiduciary not of their choice.
