INSIGHT: Tips for 403(b) Plan Fiduciaries in Light of Recent University Litigation

Over the last several years, participants in 403(b) retirement savings plans have brought about two dozen lawsuits against plan sponsors and fiduciaries. Universities with large 403(b) plans have been the target of most of these lawsuits, but employers in the health care industry have been targeted as well.

In the early stages of the 403(b) litigation, results have been mixed, but the recent litigating should serve as a reminder to plan sponsors and fiduciaries to take appropriate steps to minimize their risk of litigation.

Below are some key issues to consider in light of this recent litigation.

Ensure Fees are Not Excessive

Plaintiffs in the 403(b) litigation allege that the plan fiduciaries breached their duties by allowing plans to pay excessive fees. For over a decade, retirement plans (including 401(k) plans) have been subject to litigation challenging the fees paid by plans.

The 403(b) litigation shows that plans sponsored by tax-exempt organizations are not insulated from these lawsuits. Plan fiduciaries should carefully consider the fees that are paid by plans, including the fees for recordkeeping, administration, and investments.

Some fees, such as direct fees, can be easily traced, while other fees, such as indirect fees charged by service providers are more difficult to analyze and must also be carefully reviewed. When reviewing these fees, plan fiduciaries should be cognizant that the various fee structures often result in multiple layers of fees that all must be considered.

As plaintiffs in the recent litigation have identified, service providers often bundle their services and seek to lock plans into using services or investment funds of an affiliate. Plan fiduciaries should review the reasonableness of these arrangements.

Plan fiduciaries should also consider the methodology for how fees are passed on to participants, and whether the structure is appropriate. For example, some plaintiffs in the 403(b) litigation allege that participants should be charged on a per-participant basis rather than based upon a percentage of the assets in their account.

Consider Whether Multiple Recordkeepers Are Appropriate

A common claim in the 403(b) litigation is that if a 403(b) plan uses more than one recordkeeper, plan fiduciaries may have breached their duties to participants because the use of multiple recorkeepers results in higher fees that are ultimately passed on to the participants.

However, there are historical and structural reasons that 403(b) plans may wish to use multiple recordkeepers. For example, plan sponsors may wish to give participants choices that are not available with only one recordkeeper. Plan sponsors may also be unable to consolidate recordkeepers without the consent of participants.

While the 403(b) litigation is still in its early stages, thus far, some of these claims have survived the motion to dismiss stage of the litigation. Fiduciaries of 403(b) plans that use multiple recordkeepers should closely watch the outcome of this litigation. They should also document both their reasons for using multiple recordkeepers and as well as how such structure benefits participants or is necessary for the plan.

Review Underperforming Investments

Plan fiduciaries have a duty to monitor a plan’s investments, which has been a common theme in not only the 403(b) litigation but also the ongoing 401(k) fee litigation cases. These cases demonstrate that just because investments may have been prudent at the time they were inserted into the plan’s investment lineup, plan fiduciaries cannot assume that continuing to offer such investments is prudent.

Accordingly, fiduciaries must regularly consider whether their plans offer investment options that provide lower returns or are more expensive than comparable investment options.

Look for the Lowest Cost Investment Classes

The 403(b) litigation should remind plan fiduciaries to consider whether they are including the lowest cost share class possible under their particular circumstances. For example, a common complaint is that based upon the size of a plan, institutional shares of a mutual fund should have been offered to participants but retail or investor class shares were offered instead.

If a plan offers retail or investor class shares, the plan’s fiduciaries should be prepared to explain why such offerings are appropriate.

Consider Offering Passive Investments Fund Options

Similar to allegations in recent 401(k) fee litigation cases, some of the plaintiffs in the 403(b) litigation allege that plan fiduciaries acted imprudently by including certain actively managed investment funds instead of passively managed funds in the investment lineup.

Active investment funds generally have higher fees than passive investment funds, and, often, lower investment returns for what some perceive as similar investment classes.

The current state of the litigation shows that plan fiduciaries are not required to include passive investments funds or exclude active investment funds in a plan’s investment lineup. However, plan fiduciaries should consider the mix of investment options of both active and passive investments funds that are offered, recognizing that many participants desire the option to invest their retirement savings in low-cost passive funds.

Consider the Appropriate Number of Investment Options

In the 403(b) litigation, some plaintiffs have alleged that a fiduciary breach has occurred because too many investment options were included under the 403(b) plans.

Some of the 403(b) plans that are subject to litigation offer several hundred investment options. Plaintiffs allege that having too many investment options results in confusion with participants causing lower participation, as well as the inability of plans to leverage their scale to receive lower fees.

While, thus far, plaintiffs have been generally unsuccessful on these claims, in light of this litigation, plan fiduciaries should consider whether the number of investment options could cause confusion among participants, lower plan participation due to “decision paralysis” among employees, or prevent the plan from appropriately leveraging its size in order to offer a class of shares with lower fees. Because of the structure of 403(b) plans, fiduciaries may determine that, under their circumstances, a large number of investment options are appropriate.

As the 403(b) litigation continues, plan fiduciaries should monitor the progress of these cases and consider the steps they could take to minimize their risk of litigation.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Steven D. Einhorn is a partner in the New York office of Brown Rudnick LLP. He represents public companies, private companies and tax exempt organization with respect to a broad range of employee benefits and executive compensation matters.