Compliance

The Right Course: What Can 403(b) Plan Sponsors Learn from Litigation?

A review of fiduciary governance and the liability insurance policy can help 403(b) plan sponsors steer clear of the litigation whirlwind hampering the industry today.

By Javier Simon editors@strategic-i.com | September 18, 2017
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Fiduciaries of 403(b) plans will have to pay extremely close attention to recordkeeping fees and investment options to avoid getting caught in a whirlwind of 403(b) lawsuits. 

The ongoing 403(b) plan litigation surrounding a handful of major universities has many plan sponsors wondering whether their institutions might be the next target. However, several steps can be taken to prevent a lawsuit—and to establish defenses in the event one arises.   

David Kaleda, a principal in the fiduciary responsibility practice at Groom Law Group in Washington, D.C., tells PLANADVISER that now is a critical time for plan sponsors to review fiduciary governance structures and to make sure they know exactly who is a fiduciary to the plan.

“It’s important you make sure you have good processes and procedures in place to minimize fiduciary risk, especially when it comes to investment selection and what’s paid to service providers,” says Kaleda.

In fact, high-cost investments and excessive revenue sharing fees seem to lie at the heart of allegations drawn against these plans.  

Common accusations include offering expensive investment options when similar, low-fee options are available; offering higher cost share classes when lower priced shares for the same funds are available; allowing payment of excessive revenue sharing by offering investments proprietary to the recordkeeper or its affiliates; and allowing payment of overall excessive recordkeeper fees.

For example, plaintiffs accuse Yale University and New York University of charging participants excessive fees because both plans use multiple recordkeepers. It’s important to note that nothing in the Employee Retirement Income Security Act (ERISA) requires a plan to have a sole recordkeeper.

Still, it’s important for plan sponsors to know how revenue sharing works, who is getting paid, what they are getting paid, and weather those fees are reasonable and in the participants’ best interests.

“Revenue sharing does not have to be inherently bad,” explains Kaleda. “Where fiduciaries have a problem is not understanding how much they are paying and what they are getting.”

In the case of NYU, its Faculty Plan retains Vanguard and TIAA-CREF as recordkeepers, and it offers proprietary funds from both firms as investment options. Inclusion of one investment option required NYU to also maintain TIAA-CREF as a recordkeeper and offer another specific investment option. Plaintiffs argued that this breached fiduciary duty and “loyalty,” because it prevented fiduciaries from independently assessing the prudence of each investment.

A federal judge dismissed most claims against NYU, and ruled this contractual arrangement on its own was not sufficient to support a breach of loyalty claim.

The judge said that to make that case, plaintiffs would have to “allege plausible facts supporting an inference that the defendant acted for the purpose of providing benefits to itself or someone else.” In other words, plaintiffs could not prove that NYU retained these recordkeepers for the benefit of either party without first considering the participants’ best interests—a task that should be paramount to every fiduciary.

The judge also dismissed claims that NYU breached fiduciary duty by offering higher-cost retail share classes of certain funds when lower-cost institutional share classes were available. Once again, nothing in ERISA requires plans to offer the cheapest share classes. But, everything involving fees charged to participants must be reviewed with the utmost scrutiny, for reasonableness. 

In NYU’s case, the judge noted that retail shares can offer participants certain advantages over institutional shares, such as a higher degree of liquidity. In this sense, the judge ruled it was not clear participants would gain from lower expense ratios at the expense of lower liquidity, so inclusion of institutional shares “does not always demonstrate an unwise choice.”

“It’s not an automatic loss that you have retail share classes instead of institutional,” says Kaleda. “Where you have a problem is if you can’t justify why you had one or the other, particularly if it is more expensive.” 

Plaintiffs also argued the plan offered too many investment options—more than 100—which confused participants and diminished the plan’s bargaining power in securing cheaper investments. The judge noted that nothing in ERISA requires plans to limit investments, even if it enhances their ability to offer cheaper investments.

NEXT: Claims plaintiffs successfully argued, and how