Too Many Investment Options May Increase Litigation Risk

Is giving plan participants a wide range of investment options a good thing? One would think so, but recent class action lawsuits targeting seven universities, including New York University, Duke, Yale and MIT, are showing that providing these large number of investment options is good up until a certain point. Although in its early stages, the litigation is already offering a cautionary note for plan sponsors who are offering a large amount of investment options. Though 401(k) plan sponsors are more familiar with these types of claims than others, this indicates the first time nonprofit organizations have been directly focused upon.

Offering Choices

The lawsuits imply there are at least two problems when offering too many fund choices:

  1. Overwhelming participants, and
  2. Incurring excessive costs.

Another potential problem: fiduciaries may lack the ability to oversee the performance of several funds.

The “Defendant provided a dizzying array of duplicative funds,” according to the complaint in Sacerdote v. New York University. The complaint states that NYU offered over 70 investment options to participants.

To put it in perspective, that over 70 investment options seems excessive, a survey determined that 15 was the average number of funds being offered among defined contribution plans, with the exclusion of target date funds. The plaintiffs contend that this lower number of options “provides choice of investment style while maintaining a larger pool of assets in each investment style and avoiding confusion.”

Spinning Heads

When participants are provided with excessive numbers of choices, as the studies conducted indicate, participants have less confidence and will ultimately make no decisions regarding their options.  Thus, by offering a large number of options, according to the plaintiffs, plan participants are not being served by the plan fiduciaries to the best of their ability and in the best interests of the participants, which is required under ERISA.

Be aware, however, that the complaint did not offer any statistical evidence that participants had made inappropriate investment choices. The organizational culture at many universities provides great deference to employees’ confidence in their aptitude to make complex decisions.

Whether that confidence is appropriate under ERISA is to be determined. Each plan sponsor will need to present evidence that it reviewed the demographics of its own employee population when factoring whether the number of options for plan investments is overwhelming.

Purchasing Power

With regards to cost factors, the evidence may perhaps be simpler to assess. The suit criticizes NYU on two fronts: utilizing three record keepers and an excessive number of funds. The complaints allege that these failures cost tens of millions of dollars in retirement funds. As is not uncommon with nonprofit organizations that sponsor 403(b) plans, their retirement programs consist of multiple recordkeepers with different investment options. Employees have the ability to select among all offered recordkeepers to invest their funds.

The plaintiffs believe that clear benefits are provided if a single recordkeper is engaged by the plan.  For example, using a single recordkeeper may increase purchasing power and permit sponsors to negotiate lower, transparent investment fees which are charged to the participants.

The complaint also states the same argument with respect to the number of investment options. The plaintiffs proclaim that plan sponsors can “dramatically reduce participant-borne costs while improving employees’ retirement readiness by reducing the number of investment options, utilizing an ‘open architecture’ investment menu, and packaging the options within a tiered structure.”

Another criticism leveled by the plaintiff is that the plan includes many actively managed stock funds, whose costs are usually greater than those of passive index funds.  The complaint states, “to the extent managers show any sustained ability to beat the market, the outperformance is nearly always dwarfed by mutual fund expenses.”

Reviewing Options

The cases referred to above are still in their infant stages; however, take note that no matter what strategy you’ve employed to select your investment options, if your plan includes dozens of options, this could be a red flag and warrant a breach in fiduciary responsibility.  It’s recommended that you be proactive and review your investment options now to prevent the potential of dealing with this issue later in court.

© 2016

 

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