Evaluating Fiduciary Risks

Over the past decade, the retirement plan industry has been subject to a wave of litigation under the Employee Retirement Income Security Act. Allegations have included breaches of fiduciary duty in connection with excessive fees for both investment management and record-keeping services.

In a presentation at the 2013 SVIA Fall Forum, Jeremy Blumenfeld, a partner in the Labor and Employment Practice Group at Morgan, Lewis & Bockius LLP, said these ERISA lawsuits can be segmented into three categories. In the first, cases tend to be filed only against plan sponsors. In the second, service providers are named as defendants, too, making all communications between sponsors and vendors subject to discovery. In the third, claims are brought against service providers by class-action lawyers representing groups of small retirement plans.

A few trends can be discerned, Blumenfeld said. One is that while there is no “magic number” in terms of what is a reasonable investment management fee, plaintiffs’ attorneys have tended to focus on actively managed investment options, which are usually more expensive than passively managed options. Another is that plaintiffs’ attorneys often try to discern which retirement plans are most profitable to service providers, and allege that those are the plans being overcharged.

Three current cases bear close watching, Blumenfeld said. One is a lawsuit filed by plan participants against ABB Inc. in which a U.S. district court in Missouri awarded $35.2 million in damages against ABB and related defendants. That case is on appeal, Blumenfeld said. It revolves around an allegation that the plan substituted one investment option for another not because it thought the new option would outperform but because it would generate revenue for one of the plan’s service providers. “There wasn’t proof of this,” said Blumenfeld, whose firm represented ABB. “The principal evidence the plaintiffs offered was the fact that the investment option selected underperformed the option that was taken out. That led to roughly half of the damages in that case. The case is now on appeal and is certainly something that will affect the industry and how these cases are brought and litigated.”

Another case to watch, he said, is a lawsuit pending against ING Life Insurance and Annuity Co. relating to whether or not ING was a fiduciary with respect to the investment options selected by its plan sponsor clients. It is similar to another suit that was brought against John Hancock Life Insurance Co., which was dismissed without trial by a district court in New Jersey earlier this year, and is also now on appeal.

There has been no particular focus on stable value funds in the fee litigation cases filed to date, Blumenfeld said. Rather, stable value has been treated like other investment options. In an ongoing class-action case involving Lockheed Martin, for example, plaintiffs have charged that they didn’t earn as much as they could have in their stable value fund because its portfolio of safer, less risky investments underperformed one of the Hueler stable value indexes, which averages results for multiple stable value funds. “Of course, if you’re picking an index that is based on an average of a lot of different investment options, by definition about half will underperform,” Blumenfeld noted. He said the case includes other absurdities. For example, of the four named plaintiffs, three had not invested in the Lockheed Martin stable value fund at all, and the one who had did so during a period in which it outperformed the Hueler Index.

In yet another case, involving Cigna Corp., participants in the company’s 401(k) plan challenged not only the performance of the plan’s stable value fund, but also argued that it should have had a more diverse collection of wrap contracts. The plaintiffs also complained about the fund’s crediting rate not matching the performance of the fund’s underlying investments. Cigna denied liability but settled the suit for $35 million. As part of the settlement, it agreed to hire an independent consultant to monitor and advise on the stable value fund and other investments in its 401(k) plan.

The lesson for service providers, Blumenfeld said, is to make sure their clients understand the products and services they’re buying, and, to the extent possible, put that information in writing and keep reminding clients of it. “It doesn’t do them any good if they forget or don’t understand, and it doesn’t do you any good,” he said.

Blumenfeld also recommended that service providers and plan sponsors alike establish and document prudent processes for choosing and managing stable value products. Areas to be mindful of include performance, fees, wrap costs, wrap diversification, and crediting rates.

On the regulatory front, Michael Richman, of counsel to Morgan, Lewis & Bockius, updated Forum participants on what’s been happening in the year since plan sponsors and service providers became subject to new disclosure requirements under ERISA sections 408(b)2 and 404(a)5. The former requires service providers to disclose information about their fees and fiduciary status to their plan sponsor clients, while the latter requires sponsors to disclose information about plan expenses to plan participants.

Richman noted that 408(b)2 allows service providers to make disclosures once and forego annual updates unless something changes. However, he said, a number of providers are doing annual updates anyway to make sure they didn’t miss any changes and to ensure that all their clients have up-to-date information. Meanwhile, the Department of Labor is considering mandating a new “Form of Disclosure” guide under 408(b)2 that could serve as a roadmap for finding disclosures in the documents provided to plan sponsors. However, he said, the initiative is apparently on hold under pressure from industry trade associations.

In other regulatory developments, Richman said the DOL is still considering whether to broaden the circumstances under which a service provider could be deemed a fiduciary under ERISA. The DOL has said it will re-propose such a rule, but it has not done so yet and action, Richman said, does not appear imminent.

Elsewhere, both the DOL and the Securities and Exchange Commission are considering new rules for target-date fund disclosures. The DOL had expected to issue a final rule in November of this year, Richman said, but it now appears that will not happen.

Finally, Richman noted, the DOL has issued an advance notice of proposed rulemaking that would impact defined contribution plans. Plans would be required to include in the benefit statements sent out to plan participants an estimate of what a participant’s account balance might be worth in terms of lifetime income. The DOL is currently reviewing comments on its proposal.

In terms of Department of Labor investigations, Richman said it’s hard to discern trends because little information about them is made public. He did note, though, that the DOL has made a number of general requests to service providers asking for broad amounts of information. “When you drill down, it turns out that, in some of the ones we’ve seen, the focus is on certain issues: abandoned plans, which is an issue for the Department of Labor if a company is gone and there is no fiduciary to wind down the plan,” he said. “There’s a DOL initiative, and some regulations out there, that allow the Department of Labor to step in, or for a process where a service provider appoints someone to take over the plan and wind it down.”

The DOL also appears to be looking into trade errors made when a plan moves its assets to another provider, Richman said.

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