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There has been a series of 401(k) fee lawsuits filed in recent months, following on the success of the plaintiffs in Tibble v. Edison and Tussey v. ABB . In this article we review the sorts of claims plaintiffs are bringing (in cases against the respective fiduciaries of the Anthem Inc., the Chevron Corp., and the Oracle Corp. 401(k) plans) and consider what lessons sponsor fiduciaries can draw from them.
401(k) fee litigation is evolving along two lines of attack. With respect to investment fees, plaintiffs are claiming that sponsor fiduciaries have violated ERISA by including higher-fee funds in the plan’s fund menu when there are “identical” lower cost investments available. And plaintiffs are claiming that revenue sharing arrangements that aren’t regularly reviewed and capped are generating excess recordkeeping fees.
The most straightforward example of the “Identical lower cost investments” line of attack is Tibble v. Edison, a case in which the court found that the plan had used a higher-priced retail share class when there was a lower-priced institutional share class of the same mutual fund available. The court found:
Plan fiduciaries simply failed to consider the cheaper institutional share classes when they chose to invest in the retail share classes of the William Blair, PIMCO, and MFS Total Return funds. Defendants have not offered any credible explanation for why the retail share classes were selected instead of the institutional share classes. In light of the fact that the institutional share classes offered the exact same investment at a lower fee, a prudent fiduciary acting in a like capacity would have invested in the institutional share classes. [Emphasis added.]
At this point we can accept as more or less settled law that selecting a (higher-priced) retail share class, when a (lower-priced) institutional share class is available, presumptively violates ERISA. That presumption can be rebutted by a “credible explanation” by fiduciaries of their selection of the higher priced fund.
The key element of the Tibble decision for current litigation is the language (above) in italics. Plaintiffs’ lawyers have seized on the concept of an alternative share class providing “the exact same investment at a lower fee” and extended it to situations beyond the retail vs. institutional share class at issue in Tibble.
Institutional vs. lower-priced institutional. The complaint against Anthem fiduciaries (filed at the end of December 2015) includes a claim that the inclusion of an institutional fund in a plan’s fund menu violates ERISA where there is an identical even-lower-priced alternative institutional fund available. In that case (according to the complaint) the plan included a fund with an expense ratio 4 basis points. Plaintiffs are arguing that ERISA is violated because there was an identical fund available that charged only 2 basis points. The complaint recently filed (in February 2016) against the Chevron plan’s fiduciaries includes a similar claim.
Mutual fund vs. separate account or collective trust. The Anthem and Chevron cases also include a claim that ERISA is violated when a plan menu includes a mutual fund where there is a lower-priced investment vehicle, e.g., a separate account or collective trust, available for the identical investment strategy.
Lower priced alternatives with a similar investment strategy or “style.” This argument has been made (again, in Anthem and Chevron) with respect to actively managed funds – that it was imprudent to select a high-priced actively managed fund of a particular style (e.g., small cap value) when there were lower-priced alternatives pursuing the same style. This claim is given added credibility when the higher-priced alternative underperforms the lower-priced one or the relevant benchmark.
Just to be clear, these are arguments in plaintiffs’ complaints, not court decisions – we do not know whether courts will agree with them.
All of these arguments are driven by the fundamental challenge facing plaintiffs’ lawyers: how do you prove that investment fees are too high? Retail vs. institutional share classes, as Tibble demonstrated, are the low-hanging fruit. Institutional vs. lower-priced institutional share classes are a pretty easy next step. The plaintiffs’ lawyers seem to want to extend this theory-of-attack to (1) lower priced investment vehicles using an identical strategy and (ultimately) (2) lower-priced investments using the same “style.”
Thus, plaintiffs in the recently filed cases have argued that the “available lower-priced alternative” claim can be made with respect to investments that have the same “objective.” Put bluntly, they seem to be arguing that since, for instance, all S&P 500 funds have the same objective (tracking the S&P 500), the only differentiator is fees. Thus, the fiduciary must identify and select the lowest-priced S&P 500 investment vehicle available to the plan. And if it doesn’t, it has violated ERISA.
That argument is easier to make with respect to passive investments. With respect to active management strategies, defendants can argue (back) that no two active management strategies are identical. To deal with this challenge, plaintiffs’ lawyers in the Anthem and Chevron cases are arguing that using a “separate account/collective trust,” rather than a mutual fund, lowers the cost of any investment. Quoting the Chevron complaint: “[b]ased on published rates alone … the Plan could have had the same advisers manage the same [actively managed] funds in a separate account for the Plan at … less than half the cost.”
Again, whether and to what extent the courts will buy these arguments remains to be seen.
Litigation is, of course, always over what has happened in the past, and there is not a lot that sponsor fiduciaries can do about that. Hopefully the courts will construe this new standard narrowly – e.g., to share classes in the same fund.
Going forward, there is (obviously) no substitute for a rigorous review of current fees and a process that produces either (1) the lowest fee alternative or (2) documents credible reasons for choosing a higher fee alternative. As always, process is the ERISA fiduciary’s Plan A.
The Anthem and Chevron cases also include a claim that plan fiduciaries violated ERISA by including a money market fund and not including a stable value fund in the plan’s fund lineup. Plaintiffs’ argument is that stable value funds achieve the same result as money market funds – preservation of principal – while providing higher returns. Whether a court will buy that argument remains to be seen – money market funds and stable value funds are investing in different slices of the investment frontier/yield curve. Neither investment strategy is per se imprudent. Why, under ERISA, one must be preferred over the other in a 401(k) plan fund lineup is not clear.
Since Tussey v. ABB, plaintiffs in 401(k) fee cases have been focusing on revenue sharing-based recordkeeping fees. The more recent complaints (including the Oracle complaint (filed in January 2016), as well as Anthem and Chevron) follow Tussey, asserting that sponsor fiduciaries did not know how much revenue sharing was being paid for recordkeeping and did not bargain to limit it to a competitive amount.
Let’s be clear right up front. Courts (and the DOL) have said repeatedly that revenue sharing is not “illegal.” Indeed, it is possible in some cases to pay less for recordkeeping via revenue sharing than under an explicitly priced arrangement.
That said, revenue sharing does present some challenges. The fundamental problem stems from revenue sharing’s assets-under-management fee model. It appears that courts are buying plaintiffs’ argument that the right way to evaluate the reasonableness of recordkeeping fees is on a per-participant flat fee basis – that piece of the Tussey case was affirmed by the court of appeals.
To conform to that approach, fiduciaries generally will want to (1) determine what revenue sharing is being paid for recordkeeping, (2) convert that amount to a per-participant fee, and (3) make sure that that fee is in line with the explicit fees being paid by other, comparable plans.
The easiest allegation for plaintiffs’ lawyers to make in these cases is that as market values have gone up over the last five years, plans that have not reviewed their revenue sharing arrangements have simply paid more (in assets-under-management fees) for the same service.
Where a plan is using revenue sharing to pay for recordkeeping fees, here is what the plaintiffs’ lawyers in Chevron say plan fiduciaries should do:
Because revenue sharing arrangements, if used to pay recordkeeping costs, provide asset-based fees instead of flat per participant rates unrelated to asset size, prudent fiduciaries must monitor the total amount of revenue sharing a recordkeeper receives to ensure that the recordkeeper is not receiving unreasonable compensation. A prudent fiduciary who allows asset-based revenue sharing to be used to pay recordkeeping costs ensures that the recordkeeper rebates to the plan all revenue sharing payments that exceed a reasonable, flat, per-participant recordkeeping fee that can be obtained from the recordkeeping market through competitive bids. … To ensure that plan administrative and recordkeeping expenses are and remain reasonable for the services provided, prudent fiduciaries of large defined contribution plans put the plan’s recordkeeping and administrative services out for competitive bidding at regular intervals of approximately three years, and monitor recordkeeping costs regularly within that period.
That isn’t law, it’s just an argument in a lawsuit, but it does show what plaintiffs’ lawyers are looking for.
We want to note one other set of lawsuits that involves (at least in part) 401(k) fee issues – the complaints filed against Massachusetts Mutual Life Insurance Company, Prudential Retirement Insurance And Annuity Company, and Fidelity Management Trust Company over their stable value policies. These are suits against providers – not sponsors – alleging ERISA fiduciary violations based on provider fee and (in the Fidelity case) management practices. Plaintiffs’ allegations are generally novel and it’s not at all clear that a court will buy their theory of the law.
That said, stable value is (obviously) a major feature of many 401(k) plan fund lineups, and if plaintiffs are able to win one or more of these cases it will have an effect on sponsors – affecting the stable value products available and, possibly, laying the groundwork for challenges to sponsor stable value policy.
In conclusion, we can only repeat what have been the two themes of this article: Sponsors should generally have procedures designed to produce the best available deal for their participants. And sticking to those procedures will be the best defense against any possible lawsuit.