PLANADVISER previously spoke with Jerry Schlichter, founder and managing partner at the law firm Schlichter, Bogard & Denton, back in 2014.
Retirement plan fee litigation was already a growing concern at that time, and it has remained so. Just the same, Schlichter’s firm has remained highly active in the space, representing a variety of classes of plaintiffs suing their employers for alleged mismanagement of retirement plan assets.
In a new interview, Schlichter reflected on changes he has seen in the industry over the last five years. In his estimation, a lot of good has come from the significant amount of litigation that has occurred under the Employee Retirement Income Security Act (ERISA). At the very least, he said, many participants in defined contribution (DC) retirement plans today pay lower fees for investments and recordkeeping as a result of plan sponsors making changes to avoid becoming the targets of firms like Schlichter, Bogard & Denton.
Independent data supports this assertion—at least the fact that retirement plan fees have fallen. For example, the 401k Averages Book 19th Edition (for 2019) shows the average total plan cost for a small retirement plan (100 participants/$5,000,000 assets) declined from 1.25% to 1.24% over the past year, while the average total plan cost for a large retirement plan (1,000 participants/$50,000,000 assets) declined from 0.95% to 0.93%.
Many advocates for retirement industry reform, Schlichter included, argue these numbers are still too high when stacked against the level of service received by the typical retirement plan participant. Still, according to the data, investment fees continue to decline. All model participants covered in the 401k Averages Book, except one, enjoyed a year-over-year decrease in total investment costs of between 0.01% and 0.03%. Larger plans experienced greater decreases. In addition, total 401(k) plan costs declined for most plans sizes. Nineteen of 24 scenarios saw a decrease in total plan costs from last year, while the other five remained unchanged.
According to Schlichter, when his firm first became active in the ERISA area, it was common for revenue sharing to be used to pay recordkeeping fees, and for plan sponsors to pay uncapped asset-based fees. So, as the markets went up and participants saved more, the recordkeeping fees went up without the addition of any value or services.
“We contended and it has been upheld in multiple courts that recordkeeping fees have little to do with asset size or account size,” Schlichter said. “This is an important development. We also helped to establish that no loyal or prudent fiduciary should permit the use of more expensive retail share classes for a fund when there is a cheaper-but-otherwise-identical offering easily available. That’s another general principal you can point to that has been established by this litigation.”
Looking forward, Schlichter said, retirement plan fee litigation will continue, even as the industry moves slowly towards what he views as a fairer and more transparent pricing infrastructure. He added that he understand that other attorneys and industry analysts debate the broader impact of ERISA litigation, with some saying that plan sponsors’ legitimate fear of becoming a target of litigation has stifled innovation and the willingness to adopt innovative solutions. One commonly cited example is the failure of lifetime income products to make much headway into DC plans. Participants say they want access to guaranteed income opportunities in the retirement plan context, but many sponsors say they want stronger “safe harbor” liability protections before they will consider adding annuities to a 401(k) plan. Incidentally, such a safe harbor provision is included in the retirement reform packages making their way through Congress.
Learning from the original 401(k) fee cases
Tussey v. ABB was among the first examples of a 401(k) plan excessive fee case that entered a full trial. Just this year, after 12 years of litigation, the parties proposed a $55 million settlement—the final result of more than a decade of litigation, court ordered non-monetary remedies and multiple appellate court rulings.
Schlichter represented the plaintiffs in the case and, in his words, faced a “scorched earth defense, which has commonly been a tactic used against my firm over these years of working in this area.”
“It is a matter of public record that, as of the completion of the trial, the defendants collectively paid $42 million in attorneys’ fees alone,” Schlichter said. “This is not counting expenses for expert witnesses, which were multiple millions more.”
Asked how he feels or thinks about the very large fees paid to attorneys (on both sides) working on retirement plan lawsuits, Schlichter said the large fees are a result of the complexity of the litigation, which can require many thousands of hours of intellectual labor. He argued that fiduciary insurance firms are also partly responsible, as they have adopted a very aggressive policy of counseling their clients to fight against these cases, up and down the federal courts.
As profit-seeking institutions, there is no doubt that fiduciary insurance providers have a financial motivation. But providers of fiduciary insurance push back strongly against the narrative that they would hold their own interest above clients’ needs in any given lawsuit. Fiduciary insurance providers have very specific contractual obligations and are required by state regulators to operate with good faith.
According to Schlichter, one broader positive outcome of the long-running Tussey case is that there is now greater awareness among plan sponsors that fiduciary insurance policies can be structured as “wasting policies.” This means that the cost of defense comes out of an overall coverage limit.
“There have been unfortunate cases where the sum of available insurance money that could have paid a fair settlement has instead been wasted in the fight,” Schlichter said. “I would say that plan sponsors are much more aware of this issue than they were before this litigation trend picked up. They know more about how their policies work and what the risks are.”
In the 12 years since Tussey vs. ABB was filed, Schlichter said, federal judges have learned to look much more carefully at “what is going on in the weeds, what is going on with plan fees and what fiduciaries and sponsors are doing to monitor their plans.” At the outset of the litigation trend, he recalled, there was far more deference given to plan sponsors and fiduciaries.
“Some plan sponsors’ original defense was to argue they were totally immune from this kind of litigation because their total plan costs were in line with the broader industry,” Schlichter said. “But as we successfully contended, that is not what the law says. There is a duty to look at each cost and assess its reasonableness on its own. So, let’s say that the expense ratio of all your funds is very affordable, that fact in itself is not a defense for having excessive recordkeeping fees.”
The next 10 years of litigation
“There is no question that in terms of the big picture, a lot of sponsors have made significant improvements to what they are doing in their plans as fiduciaries,” Schlichter said. “Investment and recordkeeping fees have come down dramatically, and that’s a great thing for American workers. I’ve seen estimations that fees are down by $2 billion a year for participants, which is meaningful.”
In Schlichter’s opinion, moving forward, the rigors of fee compression and retirement industry competition could lead to new fiduciary issues.
“We’re expecting to see something of a Whack-a-Mole game by providers as their fees are squeezed,” he said. “Recordkeepers, especially, will need to find other avenues of revenue to replace the reduced revenue from lower fees in retirement plans. For example, you are seeing questions about the role of recordkeepers in taking confidential personal information from plan participants and using this data to market products and services outside the plan, such as IRAs, 529 plans, insurance and wealth management.”
Schlichter’s position on this type of cross-selling is that it is improper under ERISA.
“We argue that people’s plan information and data should be protected and only be used in the plan for purposes of the plan and the benefit of the client,” he said. “It should not be used to the benefit of the recordkeeper to sell products outside the plan.”
This issue has already come up in the recent Vanderbilt 403(b) lawsuit settlement. As part of the settlement, the plan sponsor agreed to contractually bar this type of data-based cross-selling moving forward.
“Plan sponsors need to be tuned into this issue and be fully informed about the cross-selling that is going on in their plans, at the very least,” Schlichter said. “They need to know what is being done with participant data, and unless the participant gives consent, we think cross-selling shouldn’t be done.”
Schlichter also pointed to the potential influence of adviser industry M&A activity on the issue of cross-selling under ERISA.
“There is a lot of merger and acquisition activity going on among advisers that deal with retirement plans and that offer wealth management,” Schlichter said. “It is an important part of this trend is to examine the cross-selling motivations of advisers and how these are impacting their treatment of clients.”