What are the Plaintiff’s Claims Surrounding 401(k)/403(b) Fiduciary Breach Litigation?

At current count there are over 100 cases in the courts based on fiduciary breach including excessive fees, inappropriate investment choices, self-dealing including exclusive use of proprietary funds.  The majority of these cases are class actions in which an employee is named as the representative of the employee class.  Some of these cases were dismissed for lack of proper supporting documentation for plaintiff claims and some were dismissed based on proper use of “process” as discussed in a prior topic even though the result was less than optimal. 

Excessive fees may be mutual fund fees or third-party vendor fees, e.g. multiple record keepers.  Most mutual funds have several share classes including A shares, B shares, R shares and I shares.  Each of these share classes carry different expense ratios, typically the I shares, the Institutional shares, have the lowest expenses and are generally not available to an individual investor due to the very high minimum purchase requirements.  By way of example the Fidelity Advisors Growth Opportunities Fund Class A has an expense ratio as reported by Morningstar of 1.05% while the same fund Class I has an expense ratio of 0.78%.  In several of the court cases the plaintiffs take the position that considering the size of the plan, some times more than eight figures, institutional shares should have been offered rather than retain shares.  Regarding third party vendors plaintiffs have taken the position that if one record keeper were engaged to provide services to the plan rather than multiple providers a lower fee could be negotiated due to economies of size.

In some cases, e.g. Brotherston v. Putnam Investments, the employees of Putnam alleged that Putnam loaded the plan with only Putnam funds to their own benefit rather than offering funds that were in the best interest of the participants based on cost and performance.  This is a common thread in many cases currently being litigated against mutual fund companies for their own plans.  In another case in which Jackson National was named as the defendant it was alleged that 89% of the more than $600 million of the plans assets, “…were invested in high cost and poorly performing Jackson National proprietary funds,” and that most of those options were, “virtually identical” to funds that other institutions offered at “a fraction of the cost.”  The proposed settlement was $4.5 million cash and material changes in the fund structure. 

While we address self-dealing there is one circumstance that is clearly a case of lining the pockets of the plan’s vendor.  In this case the fund company who was also the record-keeper engaged a third-party investment advisor, took a 25% kickback from the investment advisor and to hide the fact established a separate entity to receive the kickback.  This brings us to a related issue, revenue sharing, which is a payment made by fund companies to record-keepers to encourage them to include the fund company’s mutual funds in the plan.  While totally legal the revenue sharing must be used for the benefit of the plan participants not the plan sponsor or other third parties.  The plan fiduciary should be requesting a report on all revenue sharing received, who it was paid to and for what use.

In a prior fiduciary topic relating to “process” it was noted that DOL’s focus is on following a process and not necessarily the end result in choosing funds to offer to employees and vendors to service the plan and can protect fiduciaries against fiduciary breach.

Stephen Abramson, CPC          APS Pension Services Inc.        steve@apspension.com