Retirement plans' newest legal battle: low-fee funds, not high-cost ones

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Retirement advisors have long known they can be damned to litigation misery if they steer investors into higher-fee managed funds, even if they do so while adhering to their fiduciary duties.

Now they're learning they can be damned if they don't — that is, if they don't recommend high-fee funds and instead go for low-fee alternatives that promise less risk but perhaps smaller returns over time. 

Plaintiffs' lawyers have begun promoting the novel idea that retirement fiduciaries should be legally liable when those low-fee funds turn out not to perform as well as other investments that were on offer.

A recent spate of class-action lawsuits takes aim at fiduciaries at 11 large companies including Citigroup, Microsoft, Cisco Systems, Booz Allen Hamilton and Capital One Financial. The actions take the companies to task for choosing to direct employees' 401(k) investments into relatively low-fee BlackRock LifePath Index Funds, which are 10 target date funds. Funds of this sort are designed to maximize an investor's returns by a specific date, usually a person's planned start of retirement. Because these funds tend to shift money into conservative investments as their target dates approach, they often charge lower fees compared with riskier alternatives.

In the past, many lawsuits alleging breaches of fiduciary duty —  including one that made it to the U.S. Supreme Court last year — have questioned retirement planners' decisions to put investors' money into higher-fee funds when low-fee options are also available. Now the recent lawsuits looking at low-fee plans are moving into a "new frontier in attempts to impose imprudence liability on plan fiduciaries," according to a "friend of the court" brief submitted in the Booz Allen Hamilton case.

The brief — filed on Oct. 17 in the Eastern District Court of Virginia by the American Benefits Council, the ERISA Industry Committee and the American Retirement Association — argues  that the class actions are the latest washout from a tsunami of lawsuits that plan sponsors and retirement advisors have faced in recent years. Since 2020, the brief said, there have been more than 180 suits in federal courts alleging breaches of fiduciaries' duty of prudence. And since 2015, plan sponsors have paid more than $1 billion in settlements over such cases and $330 million in legal fees.

The retirement groups' brief calls on the federal court overseeing the suit to dismiss the case outright. Failure to do so, the brief warned, could give rise to a "no-win situation" and put "hindsight in the driver's seat." That, the brief said, might leave fiduciaries "wondering what, if any, investment option is safe."

Fiduciary duties related to U.S. retirement plans are grounded in the Employee Retirement Income Act of 1974, or ERISA. The act requires retirement fiduciaries to act prudently, diversify plan investments to minimize the risk of large losses and disclose conflicts of interest.

The recent 11 class-action lawsuits were filed in jurisdictions across the U.S. over roughly a week and a half. The law firm bringing the suits — Chester, Connecticut-based Miller Shah — uses similar language in each complaint to allege that the defendants made low fees the sole criterion for their choice of investment funds for retirement savers in 401(k)s.

Take, for instance, the firm's suit against Citigroup, which was filed on July 29 in the U.S. District Court in Connecticut. Miller Shah contended in the filing that "as is currently in vogue, Defendants appear to have chased the low fees charged by the BlackRock TDFs without any consideration of their ability to generate return." The law firm also argued that "any objective evaluation of the BlackRock TDFs would have resulted in the selection of a more consistent, better performing, and more appropriate TDF suite." According to the suit, Citigroup's plan had 109,634 participants by Dec. 31, with balances of $17.9 billion. 

Attempts to reach the lead Miller Shah lawyers on the case, James Miller and Laurie Rubinow, were unsuccessful.

Andy Banducci, the senior vice president of retirement and compensation policy at the ERISA Industry Committee, said what's needed is a standard to determine when cases alleging breaches of ERISA fiduciary duties are admissible in court. If all plaintiffs need do to file suit is point to funds that, in hindsight, performed better than the ones retirement savers invested in, then the flood of legal actions will grow only more torrential.

"The real question is: What do these complaints need to include if these complaints are going to survive a motion to dismiss?" Banducci said. "Because if they do survive, the next stage is very expensive discovery and very expensive litigation."

Banducci said that the retirement industry would like to see courts adopt a standard based on ERISA's requirement that plan fiduciaries act "with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims."

The main question, he said, would be: Can the plaintiffs in a given suit show that a reasonable person could not have made the decisions made by the fiduciaries who are being sued? If the answer is "no," then Banducci and his colleagues argue the claim should be dismissed outright.

If the judges overseeing the latest round of class-action suits admits them to court, Banducci said he has no doubt the defendants will be successful. The reason, he said: The plaintiffs are contending that the target-date funds their money was put into underperformed other funds of a similar sort. The flaw in that argument, Banducci said, is that it rests on an unfair comparison.

The funds targeted in the Miller Shah class actions make use of "to-retirement glide paths," meaning they tend to concentrate money in conservative investments that will hold their value at the time a person retires, regardless of market downturns.

The lawsuits compare those funds with "through-retirement" glide paths." Those latter funds tend to hold more money in stocks and other riskier investments even as a retirement date approaches.

Nevin Adams, the head of retirement research at the American Retirement Association, agreed with Banducci that he hopes judges will dismiss the cases. He said once a suit of this type is accepted, retirement fiduciaries will find themselves under pressure from their insurers to settle. In the past, most have ended up doing just that.

"You'll see a settlement within a year," Adams said. "For law firms, that funds your cash flow. You're playing for that quick settlement."

Miller Shah has won settlements in similar class actions against the likes of Coca-Cola and Safeway. It has also represented plaintiffs in at least one of the more prominent fiduciary cases alleging high fees, Smith v. Commonspirit Health, which was decided on June. 21.

Law firms that win a class-action lawsuit brought on a contingency fee basis can rake in as much as 30% of the settled amount. And because investments like BlackRock target-date funds are widely embraced by financial planners, litigants can file a large number of suits without having to do much tailoring of the language to fit each individual case.

Adams said he has heard of named plaintiffs in such lawsuits receiving anywhere from $5,000 to $25,000. But for unnamed members of a class action, the settlement payment often comes to less than $100.

Meanwhile, the costs for defendants can be huge and cause  outlays for duciary liability insurance to skyrocket

"In a sea change across the industry over the past two years, almost all fiduciary liability policies covering excessive fee and underperformance claims now feature seven- and eight-figure retention numbers," the friend of the court brief states, "meaning that plan sponsors must pay the first $10 or even $15 million in legal fees before liability policies will begin to pay out to defend imprudence claims, and the premiums associated with these policies have also continually risen."

Adams said that mounting costs and the threat of liability will have some employers' reconsidering the decision to offer a 401(k) plan.

"The bottom line is: What does this cost the company to continue its match," he said. "What does this cost the employer to even offer a plan?"

It's the latest twist for retirement fiduciaries waging legal battles over allegations of high fees. The case that went before the Supreme Court — Hughes v. Northwestern University — dealt the industry a blow earlier this year, when the high court found that 401(k) advisors at Northwestern University could not be shielded from fiduciary duty claims simply because they had offered employees a large variety of investment funds carrying a range of fees. The high court found they instead had a responsibility to scrutinize each of the funds individually to make sure they were offering only prudent ones and eliminating imprudent ones.

But the Supreme Court also acknowledged that the selection of prudent funds is far from a simple matter.  "At times," it wrote in its decision, "the circumstances facing an ERISA fiduciary will implicate difficult tradeoffs, and courts must give due regard to the range of reasonable judgments a fiduciary may make based on her experience and expertise." 

That case was remanded to an appeals court, which has yet to issue a final decision. The precedent it set, meanwhile, has not prevented the retirement industry from knocking down claims in other cases involving allegations of high fees. 

In Smith v. Commonspirit Health, for instance, an appeals court dismissed an excessive-fee dispute after finding in part that "a plan fiduciary does not necessarily act unreasonably merely by including an actively managed fund that happens to perform worse or cost more than any given passively managed fund."

Banducci said that despite the new flurry of litigation, courts are likely only beginning to grapple with intricacies of fiduciary duty. 

"I don't see this area of litigation shrinking anytime soon," he said. "Unfortunately, it's ultimately participants who are paying the price."

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Retirement 401(k) Lawsuits Litigation Target date funds
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