Compliance May 23, 2022

Is the Traditional Fiduciary Insurance Model at Risk?

One legal professional at a fiduciary insurance firm argues that the ‘indiscriminate nature’ of recent ERISA lawsuit filings could eventually culminate in a crisis for the retirement plan industry’s current approach to risk management and fiduciary insurance.
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Regular readers of PLANADVISER will know that retirement plan litigation is a frequent topic of coverage for the publication, and that there has been no shortage of lawsuits to report on. Far from it, in fact.

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As noted by Daniel Aronowitz, managing principal at the fiduciary insurance firm Euclid Fiduciary, the pace of filings in 2022 has been extremely rapid, with at least 25 cases filed in the first four months of the year. Aronowitz expects to see anywhere from 75 to 100 cases filed by the end of 2022, and that most of them will come from plaintiffs represented by the same law firm: Capozzi Adler, out of Harrisburg, Pennsylvania.

His projection is comparable to the approximately 99 cases filed in 2020, when their frequency spiked. The number of cases dipped to at least 49 last year, with the exact number of cases depending on the specific type of action one defines as an ERISA excessive fee case, Aronowitz says. For Euclid, this category includes class actions that target investment underperformance of a defined contribution investment option, even if the case does not technically allege excess fees as one of its primary claims. 

“We have seen some speculation that the rate of cases declined in 2021 as plaintiff firms waited on the Supreme Court to decide the Northwestern case,” Aronowitz says. “The real difference was that the Capozzi law firm filed over 40 cases in 2020, but it filed only 11 cases in 2021. The firm appears to be back with a vengeance in 2022, however, filing 16 of the first 25 cases this year. This tiny law firm with only seven ERISA lawyers—and only $3.9 million in their own sponsored defined contribution plan—has terrorized corporate America by continuing to file the majority of recent excessive fee cases.”

Aronowitz’s criticism may seem harsh to someone not well-versed in the ERISA fiduciary risk management world, particularly given the optics involved in ERISA excessive fee cases. Generally speaking, firms representing the interests of ERISA plaintiffs say they are doing important consumer protection work on behalf of novice investors whose life savings are tied up in the DC plan system. For its part, Capozzi Adler declined to be interviewed or to answer written questions about their litigation philosophy and strategies for this article.

In essence, Aronowitz believes that Capozzi Adler’s main goal in pursuing its highly aggressive litigation agenda—with such a small team of attorneys seeking to represent so many distinct groups of clients in highly complicated and legally demanding matters—is simply to secure settlements and generate sizable attorneys’ fees. As a general rule, plaintiffs’ firms can take up to a third of the gross settlement amount in any given case, and many of the cases involve settlement demands in the millions of dollars. 

“The plaintiffs’ bar continues to file fiduciary malpractice lawsuits alleging excessive recordkeeping fees based on exaggerated fees—based on flawed representations of the fees participants are actually paying,” Aronowitz says. “They are taking advantage of the fact that most federal court judges are not highly experienced experts in ERISA fiduciary litigation. Such cases might represent only a few percent of their annual case load, and so they are naturally hesitant to dismiss such cases prior to discovery, especially given the consumer protection rhetoric that is used to dress up the complaint.”

Aronowitz suggests that the immediate aftermath of the Supreme Court’s Hughes v. Northwestern excessive fee decision has not been helpful to plan sponsors. Even before this ruling, courts denied most motions to dismiss, using a “minimal threshold” standard to evaluate the plausibility of excessive fee and underperformance claims. Aronowitz says he worries the hurdle for motions to dismiss has been moved even higher by the Supreme Court, and he expects settlements to continue apace.

“The most common excess fee claim filed this year is against plans that allegedly have high recordkeeping fees and investments in high-fee retail share classes, led by a concerted attack against plans in the active Fidelity Freedom target-date funds,” he explains. “From our perspective on the fiduciary insurance side, the most concerning development is that plaintiffs have been filing cases challenging isolated actively managed investments in plans with otherwise low fees.”

Specifically, Aronowitz takes issue with the fact that Capozzi Adler’s cases allege excessive fees based on the total compensation paid to recordkeepers as recorded in the annual form 5500 filing.

“In reality, this total compensation number includes significant transaction costs that do not constitute plan recordkeeping fees, and they do not reflect revenue-sharing amounts that may be rebated to the plan,” he says. “Plaintiff lawyers use these inflated numbers to mislead the courts into believing the plan fiduciaries are somehow guilty of gross fiduciary malpractice. By doing so, they are breaching a lawyer’s professional duty of candor to inform the court that every participant has received the correct and accurate recordkeeping fees from a Department of Labor mandated participant fee disclosure four times a year. Plaintiff law firms and their clients have the correct numbers available to them, but nonetheless they continue to file misleading lawsuits.”

As an example, he points to the case filed by Capozzi Adler on May 2 against O’Reilly Automotive Inc.  The lawsuit from former O’Reilly employees alleges that the recordkeeping fee was $49.55 per participant in the last year listed in the lawsuit.

“That number is wrong,” Aronowitz says. “Plaintiffs ignored the truthful data from their participant fee disclosure that the actual recordkeeping fee was a very reasonable $31 per participant. Why does this keep happening over and over? Because no court to date has required accurate pleading of plan fees based on DOL-mandated disclosures. There has been no ramification for this shameful business practice, and plaintiff firms like Capozzi Adler will keep doing it until the courts or the Department of Labor put an end to this nonsense.”

Aronowitz says the current state of affairs is not solely to blame on one law firm, or on the handful of firms that file nearly all ERISA excessive fee cases in a given year. Rather, it is a systematic issue that also involves the behavior of fiduciary defendants and their attorneys.

“This may not be a popular opinion, but I also feel the defense lawyers are, to some extent, responsible for the pace of cases, and this is because they seem to file a motion to dismiss every single time a client faces an excessive fee challenge,” Aronowitz observes. “That is actually not helpful for the overall health of the DC plan system, because they are seemingly taking the position that every single excessive fee case ever filed is illegitimate. Of course, that is not true. Some cases have obvious merit.”

This blanket approach, he argues, sends the wrong signal to the judges who have to rule on these cases and decide whether discovery is appropriate.

“We have to be honest and see that, in the case of Northwestern University, for example, the fees being charged were in fact relatively high,” Aronowitz says. “They were using multiple recordkeepers with uncapped fees, and the court took notice of this.”

Simply put, when every case is suggested to be spurious, it adds to the hesitancy of judges to dismiss plaintiffs’ claims.

“Look, I get it. Just like the courts, the lawyers also handle these cases one at a time, and they are going to defend their clients aggressively, because that is just what they do,” Aronowitz says. “My take is that we need to have more perspective. I would have settled the Northwestern case, not taken it to the Supreme Court, but I would fight a case like the one targeting Kroger.”

Aronowitz says the current environment is unsustainable from the fiduciary insurer’s perspective, such that it could become nearly impossible for well-known plan sponsors to adequately insure their fiduciary liabilities at an affordable rate. In fact, the fiduciary insurance model has already changed, he says, and the vast majority of policies are now written with multi-million-dollar retention amounts, which effectively function as sizable deductibles for the insured plan sponsors.

“There was a time when fiduciary policies sometimes had a $0 retention or a very modest deductible,” Aronowitz says. “Those days are long gone. Back in 2016, a defendant like Northwestern University would have paid only the first $50,000 or so of their defense, and then the insurance firm would pay everything thereafter, up to the policy limit. Now, the retention figure for a large university seeking to acquire fiduciary insurance may be upwards of $5 million or $10 million. Up to that point, the insurer doesn’t pay anything.”

Aronowitz says this change may be the one thing that can slow down the rate of settlements, in that plan sponsors would have to use their own coffers to pay settlements. This fact may, in turn, lead to more cases being litigated fully and ruled on in a way that resolves some of the surrounding issues. But that hope is cool comfort to the plan sponsors facing suit now, or to those who will in the future.

“Right now, these factors are an existential risk to the fiduciary insurance business as it exists today,” Aronowitz concludes. “We could easily reach a point where big universities and big hospital systems, and other types of employers that tend to be targeted with these suits, could find it impossible to afford adequate insurance.”

Compliance April 25, 2022

New RMD Rules Mean the End of an Era for IRAs

Advisers should revisit planning for those who were counting on the 'stretch‘ IRA.
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Art by Kate Hicks

When tax-deferred individual retirement accounts were introduced in 1974, they were designed for workers who were not part of a qualified plan. Later, they became available to all working taxpayers in the U.S., and since money in traditional IRAs is tax-deferred, they have become a common tax and estate planning tool.

At a certain age, currently 72, and when IRAs are bequeathed to a beneficiary upon the death of the owner, funds must be drawn down. So-called required minimum distributions must be taken.

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Earlier this year, the IRS published proposed regulations which will tighten rules about the time periods over which the distributions must be taken by eliminating the so-called “stretch” IRA provision for most cases when the beneficiary is not the spouse. The regulations are a result of the SECURE Act, passed by Congress in 2019. Effectively, the government is shortening the time period for taking funds to 10 years, which means a larger amount of money must come out of the IRA over a shorter amount of time and be taxed.

Under the old rules, some beneficiaries were able to take the money out of the accounts over decades. If an IRA owner named a child or a grandchild as the beneficiary, the beneficiary could stretch or extend distributions, and thereby the tax deferral, for 40, 50, 70 or even 80 years, according to Ed Slott, CPA and professor of practice at the American College of Financial Services. “I think the IRS rules are the final nail in the coffin for IRAs as an estate planning vehicle,” Slott says. “Congress got what they wanted. They’ve turned the IRA into a lousy vehicle for wealth transfer and estate planning because of all this confusion and high taxes after death.”

The IRS’ publication of a 275-page document of proposed Treasury regulations about RMDs, which applies to all qualified plans and IRA holders, has the market abuzz, and plan sponsors and plan advisers alike are fielding calls about what participants can and should do given the changes.

Because many retirement plan participants and beneficiaries roll their plan funds into IRAs, PLANADVISER spoke to several experts who explained the intricacies of the changes and shared their thoughts on how plan advisers and plan sponsors can respond.

Get Educated on the New Rules

The new rules are complex, hence the large number of retirement savers who are now concerned that they need to make a change in their planning. Financial advisers should educate themselves on what’s changing and why, engage with their clients and offer up alternatives, such as Roth IRAs or life insurance. And although plan sponsors cannot offer advice, they’ll likely get questions and should understand why there is confusion and to whom to direct participants for help.

Slott suggests first identifying those clients with the largest IRAs, i.e., those with balances that will probably not be consumed in the clients’ own lifetimes. These accounts are the ones that are most likely to be left over to the next generation and fall under the new rules about RMDs. Owners of these IRAs will be interested in knowing if their intended plan will still hold up.

“The last thing an adviser wants to hear when a client has died is the beneficiaries asking, ‘How come you didn’t update this plan? You didn’t know the rules changed? Now we are going to have to take all this money out in 10 years, and the taxes are going to cost us a fortune,’” Slott says.

Ronald Cluett, of counsel at Caplin & Drysdale in Washington, D.C., recommends that plan sponsors look at how their plan treats RMDs, as each plan is different and the plan document might not yet have been fully updated to reflect the new rules. “What happens when someone dies? What happens when someone hits normal retirement age after leaving the company? Start there,” says Cluett.

This is important to review, even if a majority of a plan’s members will roll over to an IRA before they are forced to take RMDs from the plan. “Familiarize yourself with the terms of the plan that you’re administering, because some of the nuances of these rules may not be what you’re dealing with day in and day out,“ Cluett says. “Plan sponsors have some flexibility in which options the plan offers to participants.“

Run Educational Campaigns and Engage Participants

Plan sponsors can begin to communicate directly with participants, educating them on the changes and their options, and referring them to advisers for one-on-one conversations.

Keith Huber, an investment adviser and plan adviser at OneDigital in Baltimore, says the changes are a chance for sponsors to talk to their participants about timing, which can get confusing as required beginning dates have changed over the years and are expected to continue changing. “We don’t think sponsors should be giving advice, but it’s important for them to make participants aware of changes that may have ramifications,” he says.

Cluett also suggests learning the specific facts about any plan participants with questions, since there won’t be a one-size-fits-all response to many of them. In addition, he recommends that plan sponsors reach out to their service providers to understand how those providers understand and intend to apply the terms of their plan.

Exemptions

When the stretch IRA was eliminated by the SECURE Act, it did come with multiple categories of exemptions besides the surviving spouse. They include a disabled person, a minor child (but not a grandchild) of the deceased IRA owner or plan participant and someone no more than 10 years younger than the IRA owner. Congress named these special beneficiaries “eligible designated beneficiaries.” According to Slott, there’s yet another “unwritten” category of EDBs. “This is something financial advisers need to know because it’s not really in the law, but you just have to know it,” says Slott.

The SECURE Act is effective for inheritances received in 2020 or later, Slott explains. If a beneficiary, such as a grandchild, inherited in 2019 or earlier, that person would be grandfathered under the old rules and thus able to stretch. But when that beneficiary dies, his beneficiary will no longer be able to stretch, he says.

Part of the confusion in the market comes from an old rule referred to as the “at least as rapidly” rule, Slott says. Under this rule, once disbursements begin to the IRA holder, the beneficiary must use the same process for disbursement. Slott says, “In other words, RMDs, once they’re turned on by the IRA owner during their life, can’t be turned off by the beneficiary.”

The confusion stems from the IRS essentially saying that both the “at least as rapidly” rule and the 10-year rule can apply to the same beneficiary if death was after the required beginning date of distributions. “So they sort of have the old stretch IRA for nine years. And then a balloon payment at the end of year 10. Then everything has to come out. This was the fly in the ointment that changed all the planning and is causing confusion,” he says.

Bipartisan Support

The changes in the rules generally enjoy bipartisan support. They come as lawmakers recognize that people are living longer and working later in life, and that stretched IRAs can keep money out of the tax system for extremely long periods.

Despite the current confusion and the complexity, RMDs are not to be taken lightly, Cluett says. “Mistakes with RMDs can create a host of tax and legal issues for the plan and/or the participant who received an incorrect RMD, or didn’t receive one when they should have received one.”

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