As we first reported in a Benefits Alert! e-mail blast several weeks ago, a series of ten class action lawsuits filed in recent weeks challenges the fee structure employed by most 401(k) plans. These cases attack investment-related fees paid by plans to service providers, including revenue sharing arrangements between plans, mutual funds, and recordkeepers. The suits were filed against Fortune 500 employers, including Boeing, Kraft, and International Paper, by a St. Louis-based law firm.
Internet reports suggest that other plaintiffs’ firms are poised to join the fray. Although the employers and plans at issue in the current actions are very large, the theories of recovery advanced by the plaintiffs would apply to almost every 401(k) plan and plan sponsor.
Seven of the cases were filed on September 11, 2006, and three more were added after our initial report. The complaints in these cases allege similar, but not identical, causes of action. The plaintiffs are participants in self-directed defined contribution plans. Defendants include the plan sponsors, their boards of directors, investment and administrative committees of the plans, and individual executives who serve on those committees. The plaintiffs allege that the defendants breached a variety of fiduciary obligations under ERISA by subjecting the plans and their participants to excessive fees and expenses, which operated to reduce participants’ account balances.
These lawsuits come on the heels of other judicial and regulatory actions that target 401(k) plan fees. For instance, in May 2005 the Department of Labor issued guidance that outlines issues of which plan fiduciaries should be aware when selecting pension consultants. More recently, the DOL announced that it will propose changes to the regulations that govern arrangements between plans and their service providers, with a focus on fee transparency. Along with that initiative, the DOL has proposed changes to Form 5500 which would require plan administrators to disclose indirect fees, including revenue sharing payments, on the plan’s annual report.
The recently-filed class action cases also revisit an issue that was addressed earlier this year by a federal court in Connecticut. In Haddock v. Nationwide Financial Services, Inc., the plaintiffs (who were plan sponsors) argued that revenue sharing payments received by service providers were plan assets that must be used for the benefit of plans and their participants. Without reaching a definite conclusion, the Connecticut court found that such payments could constitute plan assets. That argument is also made in the recent spate of 401(k) fee lawsuits.
ANALYSIS OF THE CLAIMS
Plaintiffs in the 401(k) class actions allege that revenue sharing payments and other expenses associated with the plans were both excessive and not disclosed to plan participants, and that by accepting these fee arrangements the defendants breached their fiduciary responsibilities under ERISA. Plaintiffs contend that:
- American employees are dependent upon 401(k) plans for their retirement savings;
- Even small reductions in the return on 401(k)investments are devastating to participants;
- The most certain means of protecting 401(k) returns – and the factor most within employer control – is to reduce the fees and expenses attributable to those accounts;
- The fee structures used by third-party administrators, recordkeepers, investment consultants, and other 401(k) service providers are complex, excessive, undisclosed, and illegal; and
- By adhering to those fee structures, plan fiduciaries breach their obligations to participants under ERISA.
Though some observers have characterized the complaints as “cookie cutter” duplications of the same arguments, they are in fact more carefully tailored to the characteristics of each particular plan at issue. For instance, some of the plans offered participants the ability to invest in mutual funds that assess fees for active management, but that allegedly behave like passively managed index funds. The complaints assert that the management fees imposed by these alleged “shadow index funds” are excessive because the same returns could be obtained from a much less expensive passive index fund.
The complaints in some of the cases also contend that plans with employer stock funds charged improper management fees for such funds, or that fiduciaries allowed excessive cash to be held in unitized employer stock funds, thus diluting returns.
CHALLENGE TO SECTION 404(C) PROTECTION
Common to all of the lawsuits is the plaintiffs’ assertion that fee information was not adequately disclosed to plan participants. In some instances, the plaintiffs challenge “hidden” hard dollar payments made to service providers through master trusts. In others, the plaintiffs contend that revenue sharing payments to service providers were both excessive and undisclosed.
In each case, however, the plaintiffs argue that plan participants were not fully informed about the expenses associated with their accounts. This, they say, vitiates the protection that plan fiduciaries might otherwise have had under Section 404(c) of ERISA. Section 404(c) protects fiduciaries from liability for losses participants may incur by choosing how to invest their plan accounts. If a plan sponsor chooses to avail itself of Section 404(c), the protection from liability applies only if participants are given sufficient information with which to make investment decisions. According to the plaintiffs, by failing to provide adequate information about plan expenses, the fiduciaries did not comply with Section 404(c), and thus they remain responsible for any investment losses the participants may have suffered.
According to the complaints, the “hidden” fees and revenue sharing payments also amounted to prohibited transactions between the plans and their service providers. The plaintiffs also challenge these fees and payments as a violation of the requirement that plan assets be used solely for the benefit of participants and beneficiaries, and various other breaches of fiduciary duty. They contend, for example, that revenue sharing payments between mutual fund companies and service providers – which are common throughout the 401(k) industry – were actually plan assets which were improperly used to benefit parties other than plan participants. Each complaint seeks a recovery of excessive fees and investment losses that could add up to hundreds of millions of dollars.
WHAT CAN FIDUCIARIES DO?
These cases obviously have just been filed, and the defendants can be expected to mount a vigorous defense. Yet this is likely to be just the first in a wave of similar suits to follow which could have a tremendous effect on the 401(k) industry as a whole. If courts restrict the ability of service providers to receive soft dollar payments like revenue sharing, plan sponsors may be forced to pay out of pocket for administrative services that many thought had been provided “free” in a bundled service arrangement.
Until these issues are resolved, however, plan fiduciaries can take steps to reduce their risk of liability. These steps include:
- Asking service providers for an explanation of the expense and revenue sharing arrangements applicable to each fund in the plan, and obtaining the expertise to understand that explanation;
- Periodically reviewing the performance of the investment funds offered under the plan, including their expenses, to determine whether those funds continue to be appropriate;
- Informing participants about the fees and expenses associated with the plan; and
- Thoroughly documenting this evaluation process.
We will continue to monitor these cases, and others that may be filed in the coming weeks, and advise you of developments.