Advisers and Clients Slow Innovation to Prevent Litigation

A new survey report from Cerulli Associates examines how the unprecedented number of lawsuits being filed against 401(k) and other defined contribution (DC) retirement plan sponsors and providers have impacted the pace of innovation.

Cerulli finds more than half of plan sponsors express serious concern over potential litigation—and it’s not just mega-sized plans feeling vulnerable. Cerulli’s survey data shows that smaller plan sponsors are also taking notice of the “increasingly litigious litigation environment,” as reflected by the nearly one-quarter of small plan sponsors (less than $100 million in assets) who describe themselves as “very concerned” about potential litigation.

“In particular, fee-related lawsuits have been a pervasive theme in the 401(k) plan market in 2016, further underscoring the DC industry’s intense focus on reducing plan-related expenses,” Cerulli researchers explain. “A significant consequence of this focus on fees is an increased interest in passive investing.”

Direct polling of plan sponsors shows that the top two reasons for which 401(k) plan sponsors choose to offer passive or indexed options on the plan menu are because of “an adviser or consultant recommendation” or because they “believe cost is the most important factor.” In addition to this, several defined contribution investment only (DCIO) asset managers tell Cerulli that the demand for passive products is driven, primarily, by the desire to reduce overall plan costs.

“As advisers become increasingly fee conscious, some view passive options as a way to drive down overall plan expenses, which in turn demonstrates their value to the plan,” explains Jessica Sclafani, associate director at Cerulli.

NEXT: Passive investing associated with fiduciary simplicity 

Rightly or wrongly, Sclafani observes, nearly one-quarter of plan sponsors select passive investment options because they are “easier for a fiduciary to monitor.”

“This reasoning is inextricably tied up with the mistaken view of some plan sponsors that passive is a way to mitigate their own fiduciary liability—a common misconception,” she explains.

Put simply, plan sponsors have a fiduciary duty to do what is in the best interest of the plan's participants and their beneficiaries. This is a task that goes beyond just favoring “passive” investment options over “active” options; the cost, value, quality, complexity and objective of any investment product offered to plan participants must be carefully considered and closely monitored. In some cases active may be better, while in others passive will be the superior choice.  

“If they are choosing a passive investment option simply because it is less work for them, this is not in line with the spirit of ERISA,” Sclafani adds.

The Cerulli report goes on to suggest that one “unfortunate byproduct of the rash of litigation” is that it stifles innovation in the 401(k) market.

“Plan sponsors feel they have little to gain by appearing ‘different’ from their peers due to the risk of being sued,” Sclafani concludes. “This mindset can make plan sponsors reluctant to adopt new products, such as those focused on retirement income … This issue may be forced if, as a result of the fiduciary rule, a greater amount of DC assets remain in employer-sponsored retirement plans instead of flowing to the IRA market, in which case DC plan sponsors will need to more closely evaluate the viability of using DC plans as a retirement income platform.”

More information about this report, “U.S. Retirement Markets 2016: Preparing for a New World Post-Conflict of Interest Rule,” as well as other Cerulli Associates research, is available here.