Client Advisory: Fiduciary Liability – Excessive Fee Litigation

March 2021

Over the past several years, plaintiff lawyers have filed hundreds of lawsuits against companies and their retirement plan fiduciaries, alleging that they have paid excessive fees to external plan advisors for managing their investment funds and/or for record-keeping and other administrative services. Prior to 2017, most of these lawsuits were brought against larger companies and plans, in part, because of the substantial fees plaintiff’s lawyers would stand to make from any settlement or judgment.

However, as the number of plaintiff firms filing lawsuits in this space has increased, a growing number of suits are now being directed against smaller and mid-size plans. As evidence of this increased frequency of litigation, 60 “excessive fees” cases had been filed through the first 8 months of 2020 versus 20 cases in all of 2019. Disclosure1 As the increase in ERISA litigation has blossomed, so too, have defense costs with class action litigation being much more expensive to defend than single plaintiff actions. Fiduciary Liability insurers are now re-underwriting this line of coverage to account for their increased loss costs associated with this heightened litigation.

The Employee Retirement Act of 1974 is a federal law that sets minimum standards for most voluntary retirement plans in private industry. ERISA covers two types of retirement plans, being defined benefit plans and defined contribution plans.

• A defined benefit plan guarantees a specified monthly benefit payable to a plan participant at retirement with the benefits covered by federal insurance through the Pension Benefit Guaranty Corporation (PBGC).
• A defined contribution plan does not guarantee a fixed payment, but rather, are plans in which an employee contributes money to a plan (often matched by the employer) that is then invested on behalf of the employee to be paid out upon his or her retirement. The value of the account fluctuates dependent upon investment gains or losses.

This article focuses on litigation emanating out of the administration of defined contribution plans that include, for example, 401(k) and 403(b) plans. A 401(k) plan is a company-sponsored retirement  account that employees can contribute to and to which employers may make matching contributions. A 403(b) plan resembles a 401(k) plan, but they serve employees of public entities and other tax-exempt organizations rather than private sector workers.

Responsibility for regulating and enforcing the provisions of ERISA lies with the Department of Labor, whose general approach to overseeing retirement plans has been through its own enforcement actions or through litigation (mostly privately initiated). 401(k) and 403(b) plans are administered by appointed employees called “fiduciaries” or by a third-party manager contracted by the employer. Any person or entity who exercises control or authority over plan management or assets, who administers the plan or who provides investment advice maintains a fiduciary relationship with the plan participants and beneficiaries. The primary responsibility of a fiduciary is to discharge their duties solely in the interests of participants and beneficiaries. Any administrator who breaches their fiduciary duties may be held personally liable for financial losses resulting from a breach of those fiduciary duties.

The first spike in ERISA litigation occurred between 2008 and 2010 when plaintiff attorneys filed more than 200 cases. Disclosure2 Many of these cases fell into three categories: 1) inappropriate investments, 2) excessive fees, and 3) self-dealing.

• Inappropriate investments were the initial driver of private litigation in this area. These allegations asserted a lack of plan asset diversification, inclusion of an employer’s own stock in high concentrations and/or investing in poor performing industry-focused sectors.
• Self-dealing cases typically involve an allegation that a fiduciary failed to act solely for the benefit of the plan participant or beneficiary, and that the plan administrator breached its fiduciary duty of loyalty and prudence. For example, when an investment manager offers their own proprietary line of mutual funds rather than unaffiliated choices, or chooses to offer the employer’s own investment fund that had poor performance potential, they could be subject to self-dealing litigation. ERISA specifies that a fiduciary must show the care, skill, prudence, and diligence that a prudent person acting in like capacity and familiar with such matters would. Fiduciaries must avoid all conflicts of interest and may not engage in transactions on behalf of  the plan that might benefit parties related to the plan, such as other fiduciaries, service providers or the plan sponsor.
• As to excessive fee litigation, ERISA requires that fiduciaries ensure that the services provided to their plan be necessary and that the cost of those services be reasonable. Even for those plans that allow participants to direct their investments, fiduciaries need to take steps to keep participants aware of their rights and responsibilities under the plan. Fees associated with a plan are generally of three types: administration fees (i.e. day-to-day costs for things such as recordkeeping); investment fees (fees for investment management services that typically, are deducted directly from investment returns); and individual service fees (fees charged for individual services to any particular participant). Thus, the typical fee-based allegations include that “the plan sponsor failed to manage the administrative expenses of the plan by ensuring the lowest possible recordkeeping costs; failed to ensure the lowest possible cost of investment management; or breached fiduciary duties by offering underperforming or ill-suited investment options to plan participants.”

Plaintiff lawyers argue that the sophistication of tools available to them has enabled them to be more particularized in their pleadings as required by the courts in order to avoid having a case dismissed on a pre-discovery motion. Defense attorneys counter that most of these complaints are actually generalized with little to no detail or specificity provided. Some companies and plans are being sued by multiple law firms in different courts resulting in lead plaintiff battles, protracted litigation, potentially conflicting rulings and increased defense expenses. The net result is that these cases have become more expensive for companies to litigate. Certain prominent ERISA firms note that partner rates can exceed $800 per hour while taking a case through trial can run in excess of $5M.

In view of the significant increase in fee litigation, fiduciary liability insurers have reacted predictably in an effort to manage and  reduce their overall exposure. Specifically, most fiduciary insurers are adding separate and higher retentions for class action claims. In addition, some fiduciary insurers are reducing limits, while at the same time premiums have and will continue to increase. Some fiduciary insurers are also imposing sub-limits for ‘excessive fees’ litigation. From an underwriting standpoint, fiduciary liability insurers are now requiring more detail on plans generally and require Excessive Fee Questionnaires to be completed.

Outside of insurance implications and recognizing the likelihood of continued litigation growth in this area, what can a plan administrator do to avoid litigation? Here are a few practical suggestions:

• Know your obligations as a plan fiduciary
• Document the process and all records relating to the selection and retention of plan service providers
• Negotiate fees, re-evaluate on an ongoing and frequent basis, and consider periodic Requests for Proposals for your plan service providers
• Make all appropriate disclosures to plan participants and beneficiaries
• Avoid all conflicts and the appearance of improprieties
• Seek legal advice when and where necessary
• Be sure to have adequate and responsive Fiduciary Liability insurance in place to protect personal assets – as a plan fiduciary you may be held personally liable for any damages
• Populate fiduciary committees with individuals having the requisite skillsets, e.g., accounting and finance backgrounds