Lawsuits against plan sponsors alleging excessive fees related to management of defined benefit and contribution plans rose 80% in 2020. This trend will continue in 2021, and these suits are big problems for underwriters and fiduciaries. Facing increased risk for liability, it’s important fiduciaries understand what’s driving this trend and what steps you can take to protect your business.
Rise in Litigation
Lawsuits against fiduciaries have gradually increased since the early 2000s. The recent spike, however, is largely attributable to the growing number of law firms pursuing excessive fee class action suits under the Employee Retirement Income Security Act (ERISA). Like securities class actions, these fiduciary class action lawsuits are generally more lucrative to prosecute under ERISA than a case representing one individual. If suits continue to be settled in the plaintiffs’ favor even more will litigate against smaller and larger plans alike, with “cookie-cutter” claims similar to prior cases.
In these suits, firms allege that their clients are enrolled in plans – 401(k)s, 403(b)s, and other retirement or health employee contribution plans – that are mismanaged and charging excessive fees. If true, these are breaches of fiduciary duties under ERISA, and companies cannot indemnify the individuals under section 409. Luckily, section 410 allows fiduciary liability insurance, providing some protection.
Understanding Your Liability
Plaintiffs may accuse fiduciaries of not meeting certain benchmark performance standards. These standards, however, are often “set” by the plaintiff and are not necessarily appropriate measurements of the plan’s potential performance. Simply comparing any plan to another isn’t accurate as all have different portfolios, varying risk levels and results. While plaintiffs can cite multiple examples of funds that are showing higher returns, fiduciaries should defend themselves with benchmarks from similar, more relevant mutual funds.
Plans are also highly vulnerable to claims for excessive fees passed to beneficiaries. Plaintiffs typically argue that investment management and servicing fees are too high, and failure to manage administrative costs, offer lower-cost investment options, explain performance and provide adequate, independent record keeping of investments. Furthermore, some mutual funds may utilize improper revenue sharing. If record keepers and third-party plan providers are not independent, fiduciaries are subject to charges of mismanagement.
Best Practices
Navigating this increasingly litigious landscape requires fiduciaries practice and document good fiduciary governance, similar to Environmental, Social, and Governance (ESG) criteria employed by some boards of directors, to help avoid and defend against fiduciary class actions:
Regular Request for Proposal (RFP). Before hiring record keepers or mutual funds, or making changes that could result in higher fees, fiduciaries can issue an RFP detailing their proposal and inviting providers to bid on plan services. During this process the fiduciary can seek a flat rate, fixed number fee per participant, rather than having the fees set as a percentage that increases as the assets grow.
Negotiate. Fiduciaries should negotiate plan fees in writing, and not just accept the quoted rates.
Provide Options. Don’t offer just the most expensive or aggressive mutual funds as the only investment options. Give people diverse choices and be as clear as possible about the risks, potential returns, and fees involved.
Investigate Mutual Funds. Are they doing revenue sharing? Could you be dragged into a lawsuit over their marketing fees? Keep diligent records of the questions you ask about their operations and how they respond.
Hire Experts. Make sure that you have qualified, independent experts to help service the plans. This includes benchmarking – don’t just rely on those generated by the mutual funds.
Document. Document. Document. Keep a careful written record of all due diligence and decisions, providing full transparency to participants.
2021 and Beyond
This increasingly litigious landscape spawned a hardened fiduciary market: higher rates, higher deductibles, reduced limits offered, restrictive terms, and much more stringent analysis. As claims surge in frequency and severity, underwriters are asking more detailed questions about the precautions fiduciaries took, and how well-documented their processes were. This is likely to be the case for the foreseeable future, with more carriers tightening their standards for unacceptable risks.
Make sure your plan is proceeding with caution and documenting intelligently. Having a specialty broker that understands the new risks, requirements, and policies will also prove invaluable when a claim does come in.
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Email me directly at bholden@risk-strategies.com.