Battling the Elements

One of the first things any new practitioner likely hears about when entering the world of defined contribution (DC) retirement plan advising today is the severe risk of litigation faced by plan sponsor clients—a risk born out of the fiduciary duties of diligence, prudence and loyalty at the heart of the Employee Retirement Income Security Act (ERISA).

Litigation, specifically lawsuits brought by plaintiffs’ attorneys and participants, is a subject advisers will continue to hear discussed, whatever their career stage, says Phil Senderowitz, managing director for Strategic Retirement Partners in Orlando, Florida. On his assessment, one of the most common reasons plan sponsors turn to advisers is to get assistance with fiduciary process governance and litigation prevention—and one of the easiest ways to lose a client’s confidence, he says, is to appear uncertain about critical compliance matters.

With the help of ERISA counsel, today’s DC plan advisers are frequently called upon to help establish granular, well-documented monitoring processes aimed at clearly defining who carries what responsibilities for the retirement plan. This effort of defining responsibilities, and ensuring their well-documented execution, is central to what advisers can do to prevent their clients from being sued and, even more importantly, from losing lawsuits, Senderowitz says.

“When it comes to helping clients avoid litigation, reviewing the appropriateness and quality of the investment menu is the one topic plan sponsors commonly think about first, but there are other avenues to consider that are potentially even more pressing at this juncture,” he says. “If you actually dig into much of the retirement plan litigation going on right now across the U.S., some of the cases are talking about poor fund returns and self-dealing, yes, but there are many others that are focused on fees related to recordkeeping, share classes and revenue sharing.”

It is important to draw these distinctions and make sure plan sponsors understand how broad their exposure is, Senderowitz says.

“It goes far beyond just leaving a poorly performing mutual fund on a menu for an extra quarter or two, out of mere oversight,” he says. “Plan sponsors are commonly sued these days for including retail share classes when cheaper, retirement-plan-specific shares were available; plan sponsors are also being sued for a failure to ensure a recordkeeper or third-party administrator [TPA] is meeting all of its responsibilities.”

Thus, the exposure is quite broad, and for that reason there needs to be a holistic approach to managing litigation risk, Senderowitz believes. The adviser can be the person who helps to coordinate much of this.

Active in Litigation Prevention

Joe Connell, an adviser/partner with Sikich Retirement Plan Services in Minneapolis, and the 2014 PLANSPONSOR Retirement Plan Adviser of the Year, agrees with Senderowitz’ assessment and argues that the role of the adviser in preventing client litigation can broadly be summed up by the maxim “an ounce of prevention beats a pound of cure.”

“Most important against the backdrop of expanding litigation is governance of process—really establishing, over time,  the retirement plan committee as an effective body that understands and embraces all of its diverse fiduciary responsibilities,” Connell says. “The adviser can provide so much support and structure during this effort before the fact—before a lawsuit gets filed.”

Connell and Senderowitz caution that plan sponsor clients face risk of litigation, and potentially severe financial penalties, from at least two fronts—from participants themselves but also from regulators, in particular the Department of Labor (DOL) and the Internal Revenue Service (IRS). Creating an effective governance process to address both concerns at once is absolutely necessary, they agree.

“One really important thing to note, from the experience of doing four Department of Labor audits in just the last two years, is that the DOL doesn’t really care that much about outcomes considered in isolation from the structure and goals of the plan,” Connell says. “Instead, it really cares about process and documentation. In private litigation, this is also more or less the case, and it is clear that plan sponsors can be quite successful defending their decisions in court when they have a strong record to point to, in order to prove they were deliberate in their decisionmaking and that they followed a rational process all along the way. When a client cannot prove this, it cannot really defend itself in ERISA litigation or in a DOL audit.”

In short, advisers must ensure both rationality of process and documentation of process, the two agree.

“As the adviser, you may very well be relied upon to be the one to ensure the client monitors and documents all of its important decisions closely, so that when the DOL auditors or private litigators eventually come knocking, as they will, you can point back and prove that the plan committee fully discharged its duties in a sober and rational way,” Senderowitz says.

“And again, it’s not just about investment performance,” he underscores. “If you have revenue sharing in your client plans, it better be clear to everyone involved how and why the fees are being allocated the way they are. If you have revenue sharing, what product is generating it, and who is generating it?”

Fee Litigation

One important theme Senderowitz says he sees these days “[is] lots of investment lineups where you have actively managed funds that will be in A-shares with 30 basis points [bps], 40 bps or even 50 bps of revenue sharing,” and these active funds stand side by side on the menu with indexed Vanguard funds. In this situation, a participant investing in Vanguard products is generating no revenue to offset his administrative expenses, while the person in the A-shares is very likely contributing excess revenue relative to what would be needed to cover his per-capita share of the overall recordkeeping costs.

You might think this would be ripe territory for a lawsuit, given the disparity, but, in fact, it is all about the documentation and the process,” Senderowitz reiterates. “As long as the investment committee has had a rational discussion and documented that discussion about why this is the appropriate and reasonable fee structure for the plan, that arrangement is completely fine.”

This is not necessarily a fair arrangement from the participant’s perspective, he allows, but if the plan officials have had the discussion and they have documentation of the rationale for their fee allocation—then the non-level arrangement is fine under ERISA.

“We cannot stress the point enough: Process and documentation are what is most important,” Senderowitz concludes.

Art by Dadu Shin

Fiduciary Liability Insurance

Speaking to a related issue, Carol Buckmann, a founding ERISA attorney with Cohen & Buckmann P.C. in New York City, says one common failure when it comes to documentation and process relates to fiduciary liability insurance.

“Every fiduciary and other person who handles plan funds is required to be bonded against losses caused by their fraud and dishonesty—that’s been a legal requirement since even before ERISA was enacted,” she says. “All too often, though, when I ask to see any supplemental fiduciary liability insurance policies, the document that arrives is not fiduciary insurance but the ERISA bond. When I inquire further, it often turns out that these fiduciaries don’t have fiduciary liability insurance at all.”

While fiduciary liability insurance is not required, Buckmann feels plan sponsors’ failure to purchase it reflects an all too common misunderstanding.

“There is a big difference [between fiduciary liability insurance] and the ERISA bond,” she says. “The plan is the named insured under the bond, which means that the plan gets the reimbursement if there’s a claim. The ERISA bond doesn’t protect the fiduciaries themselves, however, who can be personally liable for losses caused by a fiduciary breach. To protect themselves, fiduciaries need to have special coverage called fiduciary liability insurance.”

This insurance is necessary for plan sponsors and fiduciary officials as a practical matter, even though it is not legally required, she argues.

“Why not [have it]? Your corporate policy will not protect you if you are accused of fiduciary breaches—fiduciary activities are usually excluded,” she observes. “Your company’s agreement to indemnify you may be limited by state law, or worthless if your company goes bankrupt. Even if you win a fiduciary breach lawsuit, and are found to have done nothing wrong, you will have legal defense fees that could be high. Settlements and court awards in fiduciary breach cases have been substantial. Some have exceeded $50 million.”

Once the decision has been made to purchase fiduciary liability insurance, the adviser, attorney and client should closely discuss how it all works.

“There are many different policies in the market, and they are not fungible,” Buckmann notes. “They will all have deductibles and exclusions. Some will require that there be an actual claim, but others will even cover operational violations that are discovered and voluntarily corrected under the IRS’ voluntary correction program. Some will give you a say in picking the lawyer to defend a lawsuit.”

No End in Sight

Perhaps the best way to conclude this analysis is with the simple observation that the number of ERISA lawsuits winning class certification last year far outstripped the number for which it was denied. Looking across all 12 U.S. federal appellate court circuits, in total 17 groups of plaintiffs earned class action certification in an ERISA challenge in 2017, whereas just five groups of plaintiffs formally saw their appeals for certification denied, according to data shared by law firm Seyfarth Shaw LLP.

Obviously, class certification is still an early procedural step in any litigation, but the overwhelming success of ERISA plaintiffs’ attorneys in earning it across a diversity of cases is an important trend and may speak to the validity of at least some of their broad claims, attorneys warn.

Throughout 2017, federal courts issued a wide variety of rulings on procedural and substantive matters in ERISA class action litigation, adding additional layers of complexity to this discussion. The rulings touched on everything from how to assess attorneys’ fees and costs, to defining a breach of fiduciary duty, to contending with a multitude of issues such as those relating to: damages, discovery, DOL and Pension Benefit Guarantee Corporation (PBGC) enforcement litigation, employee stock ownership plans (ESOPs), independent contractors in ERISA class actions, and pre-emption, procedures and coverage—not to overlook stock drop class actions and tolling, statute of limitations and exhaustion requirements in ERISA class actions.

Asked to speak broadly about the litigation environment, David Kaleda, a principal with Groom Law Group, Chartered, in Washington, D.C., admits he is “ever amazed by the ingenuity of plaintiffs’ firms when it comes to figuring out new ways to sue people in our industry.

“One point that may ease some of the concern for the smallest plan sponsors is that the litigation wave has limits in terms of how far down-market it will move in any big way,” he says. “However, there are still many attractive targets out there from the litigators’ perspective, say in the $100 million-plus marketplace. And this is not just 401(k) plans, by any means. We’re seeing university 403(b) plans as a big new target for class action lawyers, and other categories as well.”

Not Just a Client Concern

It should be quite clear from all of this that advisers, like their plan sponsor clients and recordkeeping partners, have much to think about when it comes to avoiding litigation, and, in fact, there may be no way to entirely do that. A case in point: One advisory firm frequently featured in PLANADVISER for promoting best practices, Cammack LaRhette Advisors, was recently named as defendant in the New York University 403(b) plan lawsuit. Now known as Cammack Retirement Group, the practice was named the 2017 PLANSPONSOR Retirement Plan Adviser Mega Team of the Year.

While Cammack was, in the end, removed as a defendant by a district court judge presiding over the matter, the case still presents a fascinating microcosm for ERISA [Employee Retirement Income Security Act] watchers. Like most ERISA cases, this one has played out in fits and starts, and it was not until the third amended version of the complaint was filed that the advisory firm was explicitly accused. Adding to the drama, before Cammack was dismissed as a defendant, the suit earned class certification for some 20,000 plaintiffs; so it seemed, for at least a short time, that Cammack could have been involved in the full trial.

As of the time this article was being written, the wider matter remained unresolved, pending trial, and while it appeared that the advisory firm was off the hook, its client still faced suit, and its practices could still be reviewed in court. Therefore, the case makes it clear that defined contribution (DC) plan fiduciary breach litigation is far from just a plan sponsor client concern. Advisers must acknowledge their own risks of being pulled into litigation and take direct action to protect themselves and their business partners.