Compliance August 1, 2024

Top Advisers: Diligence About 401(k) Plan Litigation as Crucial as Ever

Plan advisers share their expertise on what types of plans are most at risk for 401(k) litigation and how they assist clients.
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Art by Klaas Verplancke

As the risk of 401(k) plan litigation remains at a heightened level, plan advisers face increasing pressure to protect plan sponsors. The steady drumbeat of plaintiffs’ bar lawsuits, driven by both legitimate claims and by opportunistic legal actions, highlights the growing challenges advisers face as fiduciaries, according to practitioners.

With evolving retirement plan designs and expanding fiduciary responsibilities, compliance with the Employee Retirement Income Security Act remains complex and elusive. Meanwhile, experts note that litigation is no longer confined to large plans, with smaller plans also under threat. Recent legal developments, including the U.S. Supreme Court’s overturning of the Chevron doctrine, further complicate the landscape.

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Legal developments increase the need for robust risk management and vigilance among the adviser community, and top advisers shared thoughts on how to manage the evolving landscape.

Who’s At Risk

“The number of [plan litigation] cases have continued to rise,” says Robert Massa, managing director of Qualified Plan Advisors, a division of Prime Capital Investment Advisors LLC. “There are more law firms that are looking for opportunities to bring these lawsuits. Some of them are legitimate, as always, and some of them are frivolous and everywhere in between, so we have to be more diligent than ever.”

As retirement plan design branches into new areas, such as in-plan retirement income and environmental, social and governance factors, the fiduciary scope for which advisers are responsible continues to expand, Massa says. ERISA does not provide step-by-step documentation for advisers on how to stay “100% within the guidelines.”

“There’s just no such thing,” he says. “That’s part of what we teach in fiduciary training. We have this funny page where we say, ‘Here’s the exact set of standards that you need to follow as a fiduciary,’ and it’s a blank page.”

Among plans, Massa states that larger ones are still most likely to be targeted, with lawyers looking at plans with greater than $100 million in assets. He says plaintiffs’ attorneys file lawsuits for free, hoping for settlement or a favorable conclusion; going through that entire process for a $5 million plan would not be worth the cost.

Massa did note that small plans are not being ignored, however, as they still face plenty of risk with Department of Labor and IRS regulatory enforcement.

Jania Stout, a senior vice president of retirement and wealth at OneDigital, agrees, adding that plan litigation previously may have revolved around large class action suits focused on the mega market, but that is not necessarily the case anymore.

“Now we see suits that are being filed for less than $1 billion in assets, and even sometimes there’ll be that random $30 or $50 million plan that’s got some type of lawsuit,” says Stout. “As it comes down market, it’s going to impact or create more fear for plan sponsors than before.”

The pool of candidates to sue in the mega market has shrunk, and the largest number of plans are on the smaller end, so law firms are coming down market, Stout explains. Additionally, litigation risk has increased overall, as law firms have more familiarity with this type of legal proceeding.

“It used to be just maybe one, two or three,” she says. “Now we’re seeing, as I track it, over a dozen to two dozen plaintiffs’ councils out there that are running these types of lawsuits.”

Protecting Plan Sponsors

Businesses of all sizes—large, midsized or small—face inherent risks, Stout states. It could be scrutiny from a plaintiff’s attorney or from the Department of Labor after a disgruntled employee made a call; advisers need to prepare to defend their clients, regardless of plan size.

Stout says her firm has not had a client go through with a case, but they have had a client receive an exploratory letter from a plaintiffs’ law firm. They call the document a “Schlichter letter,” says Stout, named after Schlichter & Bogard, the firm that first started bringing 401(k) cases under ERISA. It’s a term used in the industry even when it’s not the Schlichter firm requesting information.

“[The plaintiff’s law firm] sent an exploratory letter to the client and started asking for a lot of information,” she says. “The good news about the situation was that we had a really good, prudent process for them. We had all their documentation. We were able to immediately work with their ERISA counsel and let the law firm know politely they’re not going to find anything here.”

Stout says advisers at her firm always tell plan sponsors not to give out information to whoever asks. Sponsors should always call their adviser and ERISA counsel before sharing sensitive information with a law firm or regulatory agency.

“It’s not that you’re hiding anything,” she says. “You want to be really careful when you’re dealing with any of those entities.”

Sean Kelly, a financial adviser and vice president with Heffernan Financial Services, emphasizes that the best practice for protecting plan sponsors from litigation is through meticulous documentation.

“In the investment policy statement that we have in place with every client, we’re really spelling out how we monitor the investments basis, what’s passing, what’s failing,” he says. “They’re all documented, written and signed.”

Kelly says his firm also offers investment committee training for clients on fiduciary responsibility. The investment committee ensures fee transparency by clearly outlining who is being charged and who is being paid. The committee is also responsible for benchmarking recordkeepers, third-party administrators and plan advisers on costs and services.

 “We make sure it’s as frequent as the DOL and ERISA recommend, making sure that everybody’s pencils are sharp,” Kelly says.

Chevron

Advisers are also paying close attention to the Supreme Court case that overturned almost 40 years of precedent requiring the federal judiciary to defer to federal agencies’ “reasonable interpretations” of federal laws, shifting instead to the previous standard by which courts can consider—but do not need to defer to—an agency’s interpretation.

Massa says that without Chevron deference, everything on both sides of the lawsuit equation changes. He says although the ruling could reduce the regulatory role of the DOL in some places of ERISA, it could also be “very painful” for plan fiduciaries.

“[The Supreme Court ruling] also opens up the question of, ‘Why the fiduciary construct?’” says Massa. “If we don’t have any guidance, then it also opens new avenues for potential ways that plaintiffs can bring suits. It’s a double-edged sword.”

Compliance August 1, 2024

Are District Court Rulings the ‘Final End’ For DOL’s Fiduciary Rule?

Two federal courts in Texas halted the DOL’s new fiduciary rule. An appeal is likely, but ERISA experts say Congress may be the next best stop for the DOL.
Reported by
Art by Klaas Verplancke

The passage of a new fiduciary rule, called the Retirement Security Rule, had the commensurate fanfare of major regulation designed by the administration of President Joe Biden and his Department of Labor to protect consumers.

But slightly more than three months after the ruling was finalized, experts say its likelihood of surviving recent federal district court losses is dim.

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“The standard for a stay is relevantly significant here, and at this point, it seems like the courts are very dubious, to say the least, [of the rule],” says David Levine, a principal and ERISA defense attorney with the Groom Law Group. “The most likely attempt by the DOL would be to appeal [to the U.S. 5th Circuit Court of Appeals], and with the history and comment of those courts, I don’t see much potential upside for this succeeding.”

The DOL, after the rulings, is so far standing its ground, saying in an emailed comment that the “rule is essential to ensuring that retirement investors are protected” by revising fiduciary standards for those giving retirement investment-related advice, including plan sponsor menu design, one-time individual retirement account rollovers and annuity sales. It is also, according to reports from a National Association of Plan Advisors session with DOL officials, working with the Department of Justice on a defense, with action coming soon.

The regulator had pulled out the stops to return to a discussion started by the administration of former President Barack Obama in 2010, passed in 2017, and eventually undone by the 5th Circuit in 2018.

In September 2023, the DOL submitted the rule to Office of Management Budget for review, followed shortly by a public comment period that received some 400 “substantive comments” and 20,000 petitions, according to the DOL’s Employee Benefits Security Administration. Biden, speaking about the new Retirement Security Rule from the Rose Garden in October 2023, tied it to the administration’s push against “junk fees” and told financial advisers: “I just want you to know: We’re watching.”

Throughout this process, the DOL’s EBSA faced industry pushback, particularly from insurance firms selling annuities. Many arguments against the rule cited the 2018 5th Circuit ruling that struck down a prior attempt to amend fiduciary standards set by the Employee Retirement Income Security Act of 1974.

EBSA officials frequently and consistently made the case that the regulator had taken into account that ruling and that this version was different, in particular when it came to defining when an adviser was “selling” a service, as opposed to acting as a fiduciary in giving retirement advice. Officials also spoke openly about the fact that lawsuits would be on the way—and they were, filed in two Texas district courts within weeks of the final rule being issued.

At the end of last week, however, those courts made what felt like relatively swift work of the buildup. Both judges, noting the need to stay the rule nationally ahead of its September 23 implementation, made clear there would be little hope for the DOL to win in their courts and expressed doubt of its chances to successfully appeal to higher courts.

‘Final End’

John Schuch, a partner in Dechert LLP, had experience working on compliance at a financial services firm amid the first fiduciary rule changes. He highlights the large amount of work and resources required to meet the new requirements and notes the Texas courts’ decisions’ noted the need to pause that work as quickly as possible before a final verdict.

“The stay is to give the courts more time to consider the merits of the case itself, but also not to cause those in the industry to have to comply with the rule while that litigation is pending,” Schuch says. “We can’t predict what the courts would rule on the merits, but each of them had pretty strong language of predicting the outcome.”

In commentary on the rule, Dechert pondered by email statement whether the rulings “could mark the conclusion of a 14-year-long effort by the DOL,” and if another circuit court decision “might indicate the final end.”

Schuch notes that the DOL, once again, faces the option of appealing to the 5th Circuit, which hears appeals from federal cases in Louisiana, Mississippi and Texas, assuming the DOL will not get a favorable result in the district courts. That appeal would require a different result—in each case, unless they were merged—from the 2018 decision that struck down the previous rule.

“They would have to win each of those at least to have the fiduciary rule go into effect,” he says. “Their immediate action is to decide whether or not to appeal.”

5th Circuit

“There can be an appeal of the stay itself to the 5th Circuit, should the DOL and DOJ want to do that,” explains Allie Itami, a partner in Lathrop GPM LLP. “However, the review should only be of the stay and not the merits [of the cases] at this point.”

A three-judge panel on the 5th Circuit might “decide in a matter of weeks” on the stay, shipping the case back to the district courts with advice to look again. Or the court could take longer and “might totally surprise everyone with a statement on the merits.”

Daniel Aronowitz, who works on behalf of plan fiduciaries, agrees with the decisions based on the argument that the “regulation goes outside of the DOL’s jurisdiction.” Even so, the president of Encore Fiduciary is “very sympathetic” to the DOL’s concerns about retirement savings not getting fiduciary care when rolling money into an IRA or an annuity.

He believes the DOL should be working on that change with policymakers.

“The DOL is in a very difficult position—they have a Hobbesian choice of either litigating and losing on appeal or appealing and returning to an unreceptive 5th Circuit,” he says. “Congress needs to take care of this, and the DOL needs to follow the proper protocol and work through them. … It’s a legislative point, the way I look at it.”

Meanwhile, with the rule stayed, financial services firms will be operating—as many detractors of the rule have pointed out—under the prior standards of ERISA, the Securities and Exchange Commission’s Regulation Best Interest and the National Association of Insurance Commissioners’ best interest standards for annuity sales, which vary by state.

Levine, of Groom, agrees that firms will now operate as they had been before the rule, but not without some confusion as to where things go next.

“My very personal view is that I think this leaves us back in flux, and we’ll see how the Department of Labor responds yet again from here,” he says.

That waiting period, according to Schuch, can be difficult for some firms who may have already started the process of meeting the requirements of the stayed rule.

“A lot of resources can get spent unnecessarily if this rule is not going to go through,” he says. “Each firm is going to be different as to what their risk tolerance is and where they are in the building of their compliance program today.”

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