Retirement Plans Trends in 401(k) plan litigation
Plan sponsors should stay current on trends in litigation and use them to inform and strengthen their plan management process
At a glance section
At a glance section
- The landscape of ERISA lawsuits is constantly evolving.
- It is important to continuously assess investments selected for a plan, particularly target date funds.
- Following the guiding principle of putting participants’ interests first and having a robust due diligence process is the most effective way to mitigate risk.
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Over the past decade, many retirement plan sponsors have faced lawsuits alleging that they breached their fiduciary duties. Initially, these cases focused on high fees but more recently the scope has broadened. It is important for plan sponsors to be aware of this evolution in plan litigation since it can help them strengthen their due diligence processes to mitigate these risks.
Index funds are not a silver bullet
Since many ERISA lawsuits have historically focused on high fees, some plan sponsors have looked to low cost index funds to try to eliminate litigation risk. However, the idea that the inclusion of index funds on its own may be enough to protect against litigation is flawed. While many index funds (and asset allocation funds built primarily from index funds) have generally been competitive, having them in a lineup does not excuse plan fiduciaries from conducting the appropriate level of due diligence on the selected index funds or seeking out the lowest cost share classes of the mutual funds (whether actively managed funds or index funds) available to the plan. This has been evidenced by a number of relatively recent cases.
On December 6, 2021, the Supreme Court decided the case of Hughes v. Northwestern. One of the arguments in this case was that plan sponsors breached their fiduciary duty by not offering the lowest cost share classes of certain active funds in the plan. When the case was heard by the Seventh Circuit Court, the defendants successfully argued that the inclusion of these higher cost share classes was offset by the fact that the plan’s menu offered a selection of low cost index funds. The Supreme Court ruled differently, making the point that it is the responsibility of a fiduciary to monitor the expenses of all investments in the menu and including index funds as menu options do not change this requirement.1
Since July 29, 2022, lawsuits have been filed against the plans of 11 large companies including Microsoft, Capital One and Booz Allen. These complaints all allege that the suite of BlackRock index-based target date funds offered in each of the plan lineups were “vastly inferior” to other target date alternatives. They argue that, had the plan fiduciaries objectively evaluated the funds, they would have selected a more appropriate option. The complaints specifically mention that it appeared the defendants chased low fees instead of considering the risk and return objectives of the funds.2
In early 2023, the suits involving Microsoft, Capital One and Booz Allen were dismissed by District Courts.3 Despite this development, the complaint itself exposes the error in assuming that offering index-based solutions alone may be enough to fend off potential litigation.
Target date funds become a focus of litigation
Today, target date funds play a significant role in 401(k) plan investment menus. Reportedly 98% of 401(k) plans now include them as menu options, they represent approximately $1.8 trillion in 401(k) assets and they are taking on a greater percentage of plan assets each year.4 At the same time, target date funds are relatively complicated for plan sponsors to assess, since they invest across multiple asset classes and offer a glidepath. This makes them a potential target for law firms.
In a recently filed suit, plaintiffs alleged that a fiduciary committee harmed participants by creating a custom target date fund suite for their plan, using standalone funds. Since the inception date of the series was the day that they were made available in the plan, the participants alleged that the funds had an untested investment strategy and thus were inappropriate.5 Similarly, a different plan sponsor was sued in May of 2022 for adding a relatively new suite of target date funds to its plan’s lineup. Among other items, the complaint alleges that, at the time of addition, the funds had a novel, untested management style and asset allocation glidepath and no established track record.6
Plan sponsors must be aware of such risks and understand their duty in vetting a target date fund’s asset allocation and glide path. It is not enough to be familiar with the underlying funds composing a strategy. A holistic assessment of risk and return is necessary, as is reviewing the demographics of a plan and selecting a “To Retirement” or “Through Retirement” glidepath as appropriate.
Looking toward the future
Beyond having an understanding of past and current litigation, it is helpful to also keep an eye on other recent developments that may provide insight into potential future litigation. In this respect, it may be useful to examine the risks being considered by insurers offering fiduciary coverage. One example is that questionnaires issued by some of these insurers now ask if a plan is offering target date funds that are proprietary to an affiliate of the plan’s recordkeeper. This suggests that there may be risk for the plan, especially if plan fiduciaries selected a recordkeeper’s proprietary fund to take advantage of recordkeeping fee credits in the absence of a thorough investment due diligence process. Even in cases where recordkeeping fees are potentially lower by using a proprietary product, these benefits need to be weighed against the strategy’s expected risk-adjusted performance.7
Another possible litigation trend may be that more arguments over ERISA fiduciary breaches may be forced into open court as opposed to being settled in arbitration. In early February 2023, a federal appellate court ruled that a case involving an ESOP plan governed by ERISA could be heard as a class action lawsuit, despite the plan document containing an arbitration clause. The decision was made on the grounds that the clause, which prohibited arbitrating claims on a class basis, was in conflict with the plaintiff’s rights under ERISA by restricting available remedies. This matter is not very clear-cut. District courts have ruled both for and against requests from defendants to move cases to arbitration in the past. However, this trend could potentially be further sustained by a bill introduced by Congress in 2022, and passed by the House (pending in the Senate), that would forbid the use of arbitration clauses in the context of ERISA plans.8
Conclusion
The difficulty posed by the types of ERISA lawsuits we are now seeing is that through selective comparisons of fees and performance, it is theoretically possible to find fault with almost any fund or strategy in a plan’s menu. As a result, it may not be practical to fully litigation-proof a plan. For this and other important reasons, plan fiduciaries should focus on the fundamental principle of putting participants’ interests first and implement a robust due diligence process that can be demonstrated with thorough documentation. Following this principle along with making prudent decisions for your plan’s investment menu is the best way to mitigate risk. We strongly encourage Plan Sponsors who don’t have a well-defined and executed diligence process to seek guidance and advice from subject matter experts.
For more information on Retirement Plan Services, please visit our website.
2See, e.g., Bracalente v. Cisco Sys., Inc.
, No. 5:22-cv-04417 (N.D. Cal. July 29, 2022).
