Avoid ERISA Litigation – Heed the Common Red Flags

Any size retirement plan can run into serious trouble when sponsors aren’t careful. With some planning though, a qualified retirement plan doesn’t have to be the target of ERISA litigation. This reminder of the most common red flags leading to litigation may prove beneficial.

Reasonable Expenses

Of course, you can’t promise consistently strong investment performance. But plan sponsors can, and must, ensure that plan expenses are reasonable.

When a plan’s investment portfolios are performing well, it’s easy to pay less attention to the recordkeeping costs and investment management fees. But when performance is lackluster, excessive plan expenses stick out like a sore thumb. Ideally, sponsors should schedule regular, independent reviews of plan expenses and fees every three to five years as part of the due diligence. Benchmarking services are available to help plan sponsors through the process.

Opaque Fee Structures

In the past, complex and opaque fee structures such as revenue-sharing arrangements between asset managers and third-party administrators made it harder to get a handle on cost. But, with the U.S. Department of Labor’s fee disclosure regulations now in their fourth year, pleading ignorance is no excuse. In fact, it never really was.

Mutual fund shares with built-in revenue sharing features still exist, but, with required disclosure statements, it’s easier for participants and administrators to understand what they are. Although these built-in revenue sharing features aren’t inherently bad, they tend to be associated with funds that have higher expense charges.

It may be safest not to incorporate such funds into the plan — absent a sound reason that can be explained to participants. In some plan fee litigation, courts have deemed fee-sharing arrangements a payoff to an administrator to recommend those funds, subordinating its assessment of the funds’ merits as sound investments.

Bundled Services

Another expense-related red flag that could trigger litigation is exclusive use of a bundled plan provider’s investment funds. This can also raise questions about the effort that a sponsor has put into investment performance evaluation.

If a bundled provider’s funds are used exclusively, plan sponsors could give the appearance of not performing their fiduciary duty to seek out the most appropriate and competitively priced funds. In fact, the odds are slim that one bundled provider can provide the best investment options in all of the desired investment strategy categories and asset classes. When retaining a bundled provider, sponsors should question whether the recommendation of primarily proprietary funds could result in a conflict of interest, if better performing and lower cost funds are available on their platform.

Share Classes

Even when a plan’s investment lineup features funds from multiple asset management companies, there is a significant risk if the funds in the investment menu are in an expensive share class. Individual investors, unless they have very deep pockets, generally have access to only retail-priced share classes. In contrast, retirement plans, even small ones, typically can use more competitively priced institutional share classes. The failure to use institutionally priced share classes has been at the heart of many class actions against plan sponsors.

Different share classes of the same mutual fund have different ticker symbols; that’s one easy way to determine what’s in the portfolio. Fund companies that offer shares with sales loads typically offer more variations, with “A,” “B” and “C” categories of retail shares, and an institutionally priced “I” share class without embedded sales charges.

Having some “high-cost” investments in the fund lineup isn’t in itself a reason that the sponsor will be deemed to have breached their fiduciary duties. There may indeed be good reasons to offer them as options to participants, notwithstanding the higher costs.

Investment Policy Statements

The concept of “procedural prudence” is embedded in ERISA and case law. This means plan sponsors must establish — and follow — policies and procedures to safeguard participants’ interests, and set the criteria used to evaluate vendors, including asset managers.

Create an investment policy statement (“IPS”) to articulate the vision for plan investments overall, and the investment options you want to make available to participants. The IPS should clearly state:

  • What kind of assets you’ll include in investment options,
  • The degree of investment risk and volatility that’s acceptable,
  • How you’ll assess investment performance, and
  • When you’ll change managers.

Although having an IPS isn’t required, doing so can show that the sponsor is exercising procedural prudence — provided that they can document compliance with it. Merely signaling prudence won’t hold up in court. Following carefully crafted procedures and policies will go a long way toward preventing missteps that could lead to litigation in the first place. Bottom line, if there is an IPS in place, sponsors need to be sure to follow it.

Next Steps

Avoiding ERISA litigation is on every plan sponsor’s wish list. Reviewing expenses, fee structures and bundled services, and creating and following an IPS, can go a long way to prevent litigation. A periodic review of these areas should be the norm, in good times and bad.

© 2017

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