Magazine

Compliance Consult | PLANADVISER January/February 2017

Recent 403(b) Litigation

At issue are reasonable fees and share classes.

By David Kaleda editors@assetinternational.com | January/February 2017

PAJF16_Article-Image-Comp-Con-_David-Kaleda-Portrait_Tim-Bower.jpgArt by Tim BowerRecent months have seen a wave of new litigation, against several large 403(b) plans maintained by prominent private universities. The lawsuits, which claim breaches of fiduciary duties under the Employee Retirement Income Security Act (ERISA), are in some respects similar to 401(k) fee litigation cases. However, other aspects of these suits are relatively novel, as they appear to not only challenge the fundamental nature of 403(b) plans, but also target common 403(b) plan practices that have long been understood to be consistent with fiduciary standards.

Advisers to 401(k) and 403(b) plans and their clients should become familiar with the new litigation, as it may be indicative of future trends in litigation over fees.

Plans intended to meet the requirements of Section 403(b) of the Internal Revenue Code (IRC) are offered by nonprofit, private-sector employers that allow employee contributions to the plan and often make employer contributions as well. For such plans, the employer, its officers and its employees often act as fiduciaries, and as such are subject to ERISA’s fiduciary duty provisions.

Pursuant to IRC Section 403(b), the plan must provide retirement benefits through an annuity contract that meets the code’s requirements. Mutual funds held in a custodial account are also permissible 403(b) investments but are treated as amounts contributed to an annuity. The plan normally purchases one or more group variable annuity contracts or custodial accounts through which participants may invest employee and employer contributions in a number of investment options. These include insurance company pooled separate accounts and mutual funds, some or all of which may be proprietary to the issuer of the contract. The participants also typically have the option to annuitize the payment of their retirement benefits and purchase other insured retirement benefits under 403(b) annuity contracts.

Additionally, it is not uncommon for large 403(b) plans to offer group annuity contracts issued by several insurance companies, or custodial accounts with multiple custodians. If there are multiple issuers, each one, or its affiliates, may provide recordkeeping services with regard to its respective contracts.

 The recent 403(b) lawsuits involve a number of allegations commonly raised in 401(k) fee litigation. Such allegations include claims that the fiduciaries: 1) offered high-cost investment options when lower-cost options were available; 2) included more expensive share classes when lower-cost share classes for the same investment options were available; 3) allowed the payment of excessive revenue sharing by investment options to the plan’s recordkeeper or its affiliates; and 4) allowed the payment of excessive recordkeeping fees.

By asserting such allegations, the plaintiffs are essentially asking the courts to apply a much more expansive standard of fiduciary conduct than what many fiduciaries would argue is required under ERISA. For example, the plaintiffs take the position that, for certain asset classes, a fiduciary has no basis to offer an actively managed investment option when a lower-cost, passively managed fund is available in the same asset class. In addition, the plaintiffs challenge the practice of using an assets under management (AUM) formula for the payment of recordkeeping fees from participant accounts. In this regard, the plaintiffs allege that such fees should be charged to participant accounts on a flat-dollar rather than an AUM basis.

The plaintiffs also suggest that making available too many investment options or allegedly duplicative investment options are ERISA violations. In addition, they allege that the use of multiple recordkeepers for a single plan constitutes a breach of fiduciary duty. Notably, the complaints are also critical of annuity products in general, including fixed and life annuities that guarantee income or protect against longevity risk.

Importantly, the recent wave of 403(b) plan lawsuits is still in the very early stages. It is reasonable to expect that courts will ultimately conclude that many of the allegations of fiduciary breaches are unfounded. That said, the breadth and expansive nature of the allegations are concerning. Indeed, the plaintiffs allege that certain practices, long understood to be consistent with fiduciary duties or not fiduciary at all, may constitute violations of ERISA.

In any event, the litigation is a reminder that the plaintiffs’ class action bar is still very much focused on plan fees as a basis for suing fiduciaries. Further, if they have not recently done so, 401(k) and 403(b) plan fiduciaries and their advisers should view this as an opportunity to conduct a fresh review of their plans to ensure compliance with ERISA and to assess thei

David Kaleda is a principal in the Fiduciary Responsibility practice group at the Groom Law Group in Washington, D.C. He has an extensive background in the financial services sector. His range of experience includes handling fiduciary matters affecting investment managers, advisers, broker/dealers, insurers, banks and service providers. He served on the DOL’s ERISA Advisory Council from 2012 through 2014.