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403(b) Lawsuits — Fees vs. Value

David R. Blask

The drumbeat of lawsuits against large 403(b) and qualified plan sponsors continues: Cornell University, Northwestern University, Columbia University, Duke, Emory, Johns Hopkins, the University of Pennsylvania, and Vanderbilt have all had lawsuits filed by the law firm of Schlichter, Bogard & Denton. In the words of the firm, “Each of the suits alleges breaches of fiduciary duties that caused investors to pay millions of dollars in excessive fees. Among the allegations in the suits is that the defendant universities improperly included high-cost investment options in their plans, and also charged improper fees for recordkeeping, administrative, and investment services.”

Naturally, the publicity surrounding these suits is causing concern among employers sponsoring much smaller 403(b) plans. Will they be sued for offering plans with excessive fees or “high-cost investment options”? Should they move to a single provider who offers the lowest fees?

The suits against university 403(b) plans, and the earlier litigation against large corporations’ 401(k) plans, typically involve a single vendor. The issue most frequently raised concerns the expense ratios of the share class offered to participants. Thus, moving to a single vendor is no defense against such a lawsuit and it seems ingenious to suggest otherwise. While there are no guarantees against a lawsuit, the size of these retirement plans suggest the attorneys are following Willie Sutton’s advice to go “where the money is.”

Employers also need to understand the fundamental differences between a 401(k) and a 403(b) plan. Bob Toth, in a recent MarketBeat column described the legal differences between the two types of plans. A trust owns the 401(k) investments while the 403(b) plan participant is viewed as the shareholder of the plan’s investments. Bob’s article provides a useful discussion on how these differences may affect the success of litigation.

Finally, we should consider the requirements of ERISA and the Department of Labor (DOL). While governmental 403(b) plans are exempt from ERISA, examining it as a guide to “best practices” is a good idea. Section 404(a)(1) of ERISA requires a fiduciary to, in part,:

1. Act solely in the interest of plan participants and their beneficiaries;
2. Act for the exclusive purpose of providing benefits to plan participants and their beneficiaries and defraying reasonable expenses of administering the plan;
3. Exercise the same care, skill, prudence, and diligence that a prudent person acting in a like capacity and familiar with such matters would exercise in the conduct of an enterprise of a like character and with like aims;

The requirement to “act solely in the interest of plan participants” does not prohibit service providers from receiving compensation. ERISA section 408(b)(2) refers to services provided to plans being permitted “as long as no more that reasonable compensation is paid.” This relates to the issue of share class since different share classes provided differing levels of compensation to advisors. So what is “reasonable compensation”? Here is where the recent DOL fiduciary regulations provide guidance. The following quotations from the preamble to the Best Interest Contract Exemption regulations make it clear that reasonableness depends upon the type and quality of services provided as well as what is customary in the marketplace:

“At bottom, the standard simply requires that compensation not be excessive, as measured by the market value of the particular services, rights, and benefits the Adviser and Financial Institution are delivering to the Retirement Investor.

“No single factor is dispositive in determining whether compensation is reasonable; the essential question is whether the charges are reasonable in relation to what the investor receives. Consistent with the Department’s prior interpretations of this standard, the Department confirms that an Adviser and Financial Institution do not have to recommend the transaction that is the lowest cost or that generates the lowest fees without regard to other relevant factors.”

Public school districts frequently authorize multiple 403(b) providers with different levels of service and differing products. As the plan sponsor, it is prudent to make sure that the different levels of fees and expenses are proportional and reasonable based on the level of service plan participants receive. Require providers to document the different services they provide and make sure all fees are properly disclosed. A high-cost, low-service provider is not acceptable in today’s environment. That is very different from concluding that the current round of litigation mandates moving to a single low-cost provider. We have plenty of examples of districts taking that route only to see plan participation drop substantially.

David R. Blask, CPC, TGPC, AIF, is Senior Pension Consultant, Lincoln Investment.

Opinions expressed are those of the author, and do not necessarily reflect the views of NTSA, or its members.