Pension advisors have long known that they can be doomed to the misery of litigation if they steer investors to higher-fee managed funds, even if they do so while respecting their fiduciary duties.
Now they are learning that they can be damned if they don’t, that is, if they don’t recommend high-fee funds and instead opt for low-fee alternatives that promise less risk. but possibly lower returns over time.
Plaintiffs’ attorneys have begun promoting the innovative idea that pension trustees should be legally liable when these low-cost funds turn out not to perform as well as other proposed investments.
A recent round of class action lawsuits targets the trustees of 11 large corporations, including Citigroup, Microsoft, Cisco Systems, Booz Allen Hamilton and Capital One Financial. These actions blame the companies for choosing to direct employee 401(k) investments into relatively low-fee BlackRock LifePath index funds, which are 10 target date funds. Funds of this type are designed to maximize an investor’s returns on a specific date, usually the expected start of a person’s retirement. Since these funds tend to shift money into conservative investments as their target dates approach, they often charge lower fees compared to riskier alternatives.
In the past, many lawsuits alleging breaches of fiduciary duty — including one that went to the U.S. Supreme Court last year — questioned retirement planners’ decisions to put investors’ money into higher-fee funds when low-fee options are also available. Now, recent low-cost plan lawsuits are crossing a “new frontier in attempts to impose negligence liability on plan trustees,” according to a short “friend of the court” presented in the Booz Allen Hamilton case.
The brief – filed Oct. 17 in court for the Eastern District of Virginia by the American Benefits Council, the ERISA Industry Committee and the American Retirement Association – argues that the class action lawsuits are the latest in a tsunami of lawsuits that plan sponsors and retirement advisors have faced in recent years. Since 2020, according to the brief, there have been more than 180 lawsuits in federal courts alleging breaches of duty of care by fiduciaries. And since 2015, plan sponsors have paid more than $1 billion in settlements for such cases and $330 million in legal fees.
The retiree groups’ brief asks the federal court in charge of the prosecution to dismiss the case outright. Failure to do so, the memoir warned, could result in a “dead end situation” and put “recoil in the driver’s seat.” This, according to the brief, could leave trustees “wondering which investment option, if any, is safe.”
The fiduciary obligations associated with U.S. pension plans are based on the Employees Retirement Income Act 1974, or ERISA. The law requires pension trustees to act prudently, diversify plan investments to minimize the risk of significant losses, and disclose conflicts of interest.
The 11 recent class action lawsuits have been filed in jurisdictions across the United States for about a week and a half. The law firm filing the lawsuits – Miller Shah, based in Chester, Connecticut – uses similar language in each complaint to allege that the defendants made low fees the sole criterion for their choice of investment funds. for retirement savers in 401(k)s.
Take, for example, the company’s lawsuit against Citigroup, which was filed July 29 in U.S. District Court in Connecticut. Miller Shah argued in the filing that “as is currently fashionable, defendants appear to have sought the low fees charged by TDF BlackRock without any consideration of their ability to generate a return.” The law firm also argued that “any objective evaluation of the BlackRock TDFs would have resulted in the selection of a more consistent, better performing, and more appropriate TDF suite.” According to the lawsuit, Citigroup’s plan had 109,634 participants as of Dec. 31, with balances of $17.9 billion.
Attempts to reach Miller Shah’s lead attorneys on the case, James Miller and Laurie Rubinow, were unsuccessful.
Andy Banducci, senior vice president of pension and compensation policy for the ERISA industry committee, said a standard is needed to determine when cases alleging breaches of ERISA’s fiduciary duties are admissible in court. courts. If all plaintiffs have to do to sue is point to funds that, in retrospect, have performed better than those savers have invested in, then the flood of lawsuits will only grow.
“The real question is: what should these complaints include if they survive a motion to dismiss? Banducci said. “Because if they survive, the next step is very expensive discovery and very expensive litigation.”
Banducci said the pension industry would like to see the courts adopt a standard based on ERISA’s requirement that plan trustees act “with care, skill, prudence and diligence in the circumstances when in force that a prudent man acting in a like capacity and familiar with such matters would be employed in the conduct of an enterprise of the same character and having the same objects.”
The main question, he said, would be: can the plaintiffs in a given lawsuit demonstrate that a reasonable person could not have made the decisions made by the trustees being sued? If the answer is “no”, then Banducci and his colleagues argue that the claim should be dismissed outright.
If the judges overseeing the latest round of class action lawsuits admit them in court, Banducci said he has no doubts the defendants will be successful. The reason, he said: The plaintiffs argue that the target date funds in which their money was invested underperformed other funds of the same type. The flaw in this argument, Banducci said, is that it relies on an unfair comparison.
The funds targeted in the Miller Shah class actions use “descent paths to retirement”, meaning they tend to focus money in conservative investments that will hold their value when a person retires , regardless of market downturns.
The lawsuits liken these funds to glide paths “until retirement.” These latter funds tend to hold more money in stocks and other riskier investments, even as retirement date approaches.
Nevin Adams, head of retirement research at the American Retirement Association, agreed with Banducci that he hopes judges will dismiss the cases. He said that once such a lawsuit is accepted, pension trustees will find themselves under pressure from their insurers to settle. In the past, most have ended up doing just that.
“You’ll see a settlement in a year,” Adams said. “For law firms, it funds your cash flow. You’re playing for that quick settlement.”
Miller Shah has won settlements in similar class action lawsuits against people like Coca-Cola and Safeway. He has also represented plaintiffs in at least one of the most prominent trust cases alleging high fees, Smith vs. Commonspirit Health, which was decided in June. 21.
Law firms that win a class action lawsuit filed on a contingency fee basis can reap up to 30% of the amount settled. And because investments like BlackRock target date funds are widely adopted by financial planners, litigants can file large numbers of lawsuits without having to do a lot of language adaptation to fit each individual case.
Adams said he has heard of plaintiffs named in such lawsuits receiving between $5,000 and $25,000. But for anonymous class action members, the settlement payout often amounts to less than $100.
Meanwhile, the costs to defendants can be enormous and send liability insurance expenses skyrocketing.
“In a sea change in the industry over the past two years, nearly all fiduciary liability policies covering excessive charges and underperformance claims now feature seven- and eight-digit retention figures,” says the friend of the court brief, “which means plan sponsors have to pay the first $10 or even $15 million in legal fees before liability policies start paying out to defend negligence claims, and premiums associated with these fonts have also continuously increased.”
Adams said rising costs and the threat of liability will cause some employers to reconsider offering a 401(k) plan.
“The bottom line is: what does it cost the company to continue their game,” he said. “What does it cost the employer to even offer a plan?”
It’s the latest twist for pension trustees waging legal battles over high fee allegations. The case that went to the Supreme Court — Hughes v. Northwestern University – dealt a blow to the industry earlier this year, when the High Court ruled that Northwestern University’s 401(k) advisors could not be immune from fiduciary duty claims simply because that they had offered employees a wide variety of investment funds for a range of fees. The high court concluded that they instead had a responsibility to review each of the funds individually to ensure that they offered only prudent funds and weeded out the unwary.
But the Supreme Court also recognized that selecting prudent funds is far from a simple matter. “Sometimes,” he wrote in his ruling, “the circumstances facing an ERISA fiduciary will involve difficult trade-offs, and courts must give due consideration to the range of reasonable judgments a fiduciary may make based on of his experience and expertise.
This case has been referred to an appeal court, which has not yet rendered a final decision. The precedent it set, meanwhile, hasn’t stopped the pension industry from bringing down claims in other cases involving allegations of high fees.
In Smith vs. Commonspirit Healthfor example, an appeals court dismissed a dispute over excessive fees after finding in part that “a plan fiduciary does not necessarily act unreasonably simply by including an actively managed fund that happens to be underperforming or cost more than any passively managed fund”.
Banducci said that despite the new wave of litigation, courts are likely only beginning to grapple with the intricacies of fiduciary duty.
“I don’t see this area of litigation diminishing anytime soon,” he said. “Unfortunately, it is ultimately the participants who pay the price.”