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.

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

As fiduciaries under ERISA, plan sponsors must consistently “monitor and remove imprudent investments.” And whether fees are excessive or not is relative to the quality of services provided.

For example, plaintiffs argued that NYU imprudently maintained investments in the CREF Stock Account and TIAA Real Estate Account. They demonstrated these funds had consistent 10-year track records of underperformance compared to similar, lower-cost funds. The judge ruled plaintiffs plausibly supported this claim. She also found their claims of excessive recordkeeping fees to be sufficient, because evidence demonstrated that experts in the recordkeeper industry found their administrative fees to far exceed those of similarly-sized and organized plans.

Kaleda adds that annuities in particular have often come under fire in these lawsuits.  

“Plaintiffs in these cases seem to be biased against insurance as an investment option,” says Kaleda. “All we talk about these days is lifetime income protection, so there could be reasons to have annuity options. But the way these complaints are written suggests that you shouldn’t have these.”

John Morahan, senior vice president of Risk Strategies Company in Chicago, tells PLANADVISER this may have to do with the complexity behind annuities. “I think that many of the employees don’t really understand these products,” he says. “And I don’t think they are explained properly, so that leaves fiduciaries at risk of breaching fiduciary duty to employees.”

Considering projections of low returns for the long-term and reports of growing longevity risk, proper education around these products could benefit participants as well as fiduciaries.

Nonetheless, even taking the most careful steps as a fiduciary won’t guarantee you’ll be spared from litigation. Here is where fiduciary liability insurance can pay off.

NEXT: Setting up the right defenses 

Fiduciary liability insurance is designed to protect insured parties against claims alleging the breach of their fiduciary duties to the plan or allegations that they committed errors in plan administration. And while having this type of insurance is common among large plans, protections and lack thereof can vary significantly from policy to policy.

Morahan says plan sponsors should pay close attention to the wording around claims made against non-indemnifiable individuals. These would be fiduciaries who aren’t protected with potential reimbursement for losses by existing insurance policies governing the university.  

“Generally, there are limitations on a university’s ability to indemnify individuals found liable in shareholders’ derivative suits,” explains Morahan. “This means that insurance is the last line of defense. And if there is a $25,000 insurance deductible, individuals considered fiduciaries will need to pay this out of their assets.”

However, plans with zero-dollar deductibles for non-indemnifiable claims are available.

“As the litigation against these large universities works its way down to mid-size and smaller universities, these colleges may not have the money to buy the right kind of limits,” says Morahan. “It’s important that the fiduciaries facing non-indemnifiable claims have a zero dollar deductible so they won’t have to pay plan losses out of their own pockets.”

Another area Morahan suggests scrutinizing is the language surrounding personal conduct exclusions. Some policies won’t help cover legal defenses against a specific claim such as one alleging dishonesty or fraud.

“The language for these exclusions must be carefully reviewed and negotiated,” suggests Morahan. “The objective is to make sure the insurer defends the insured until there is a final non-appealable adjudication. Many insurers use language that allows them to exit the defense of litigation early.”

Universities should also make sure they understand how the policy defines key terms like “insured,” who is protected under the policy; “wrongful act,” what will it protect and what won’t it protect; and “loss,” what has to happen for the plan to invoke coverage. In addition, it is key to make sure the right coverage limits are set. 

“Make sure the coverage amount is adequate,” suggests Kaleda. “Talk to an insurance broker and make sure it covers the right people.”

This task will undoubtedly become more complicated as the Department of Labor’s fiduciary rule undergoes implementation, even as provisions are being challenged and the rule faces backlash from President Donald Trump.

“A lot more providers that interact with your plan can become fiduciaries because of the rule,” says Kaleda. “So many interactions with a 403(b) plan are now investment advice. You might have people in your benefits department that inherently become fiduciaries if they’re not careful. Make sure that liability insurance policy is broad enough that it will cover incidents where people you didn’t think were fiduciaries became one.”

“Plan sponsors need to pay better attention to who is managing their retirement options and making sure they are putting best practices in place,” Morahan concludes. “Pay attention to the fees embedded in these plans, know who is being paid what. And if you’re paying one provider differently than another, know why.”