Fee Suit Litigator Discusses Best Practices

Schlichter is known for targeting large plan sponsors and service providers on a range of fee-related issues. Seven distinct 401(k) fee litigation cases in which he is currently involved seek substantial damages from sponsors and providers alike for charging or accepting excessive fees for recordkeeping and other administrative and investment-related services paid for by plan participants, he tells PLANADVISER.

Opponents of the cases argue that his firm, Schlichter Bogard & Denton, is unfairly targeting the largest service providers and sponsors at a time when fees are already falling across the retirement planning industry. They also point to 408(b)(2) fee disclosure requirements that have brought greater fee transparency to employer-sponsored plans, and argue there is nothing inherently illegal about the revenue sharing arrangements and bundled plan services frequently scrutinized in the cases.

Many of the suits brought by Schlichter’s firm are class actions, meaning significant amounts of money are at stake, adding to the controversy. For instance, Schlichter says a long-pending case against aerospace firm Lockheed Martin could come up again for trial in the next few months. The class action suit has tens of thousands of plaintiffs, all seeking compensation for investment losses, who argue plan sponsors failed to act prudently in offering subpar funds on the firm’s retirement plan investment menu (see “Lockheed Stable Value Suit to Continue as Class Action”).

Schlichter says the cases ask whether large plans have a duty to leverage their size to pursue lower fees and top-performing investment products for participants. When plans pay too much for investment services and plan administration, participants often end up subsidizing other corporate services received from the recordkeeping provider, Schlichter claims, such as payroll processing or health plan administration. It’s an argument applied widely across the fee cases, and one that causes significant stress among mega plan sponsors and providers alike.

Schlichter argued the point against Fidelity Investments in the widely watched case of Tussey v. ABB, Inc. Elements of the case are still bouncing around on appeal, Schlichter explains, after an appellate court vacated some of the decisions made against Fidelity and ABB during the initial trial. In basic terms, ABB fiduciaries were found to have breached their duties to the company’s 401(k) plan by failing to diligently investigate Fidelity and monitor plan recordkeeping costs (see “Fidelity Wins Some in Appeal of Tussey Case”).

Opinions of Schlichter’s work range widely in the industry. Like it or hate it, he says the long run of 401(k) fee litigation has demonstrated that retirement plan sponsors have a real and pressing duty to take charge of plan fees and strike a tougher bargain with service providers.

Schlichter predicts large plan sponsors will one day be required—or at least strongly encouraged—to unbundle their retirement plan services and seek competitive pricing for all the moving parts in a plan, especially as more services are offered through the Internet. He says the growth of open-architecture investment platforms is another trend for sponsors to anticipate coming out of these lawsuits.

One attorney who has squared off against Schlichter in a previous fee litigation suit, James Fleckner, a partner in Goodwin Procter’s Litigation Department and head of the firm’s ERISA Litigation Practice, says that conclusion is flat out wrong. He says Schlichter’s frequent attacks on the bundled service delivery model overlooks the efficiencies that can be obtained through that model. Bundling is widespread and readily accepted in the phone, internet, cable and other markets, he says, showing there is nothing inherently wrong with the model.

“It is entirely premature to spell the death of bundled service arrangements in the 401(k) space, given the efficiencies that can be had with that model,” Fleckner adds. “Further, as to the large plan market, consultants are often employed, and they are able to analyze fees across bundled and unbundled providers.”

Whichever perspective prevails, compliance is all about taking every opportunity to negotiate lower fees as an institutional investor, Schlichter says, and not settling for retail share classes when more attractive options could be accessed.

On the point of avoiding fee litigation, Schlichter urges sponsors and advisers to generate independent requests for proposals for all the parts of their plan—from recordkeeping to the investment lineup to the financial advice offerings. Plan sponsors do not necessarily have to unbundle the plan, he says, but they at least need to demonstrate unbundling is not the best option.

“This is what we expect to see already in the largest plans. As a sponsor, you can find providers out there that only do recordkeeping or plan administration, and they do it at a great rate without having to offer investment products as part of the deal. Sponsors must ask themselves, does my bundled service provider do better?”

Plan sponsors should keep in mind that recordkeeping and most other plan administration services have essentially become a “commodity service,” he adds. In other words, there is substantial demand for recordkeeping but less qualitative differentiation across the provider market, implying the least expensive provider should be used in most cases.

Schlichter says one common feature across defendants in the fee suits is that they often have bundled recordkeeping, advice and investment lineup services, and so sponsors fail to get the best possible rate for one or more of the independent pieces. He contends it’s also not uncommon to see plan sponsors accept poorly performing investment lineups because the provider offers free recordkeeping—equally imprudent. The Employee Retirement Income Security Act (ERISA) is very clear in its requirements for sponsors and advisers to act reasonably and prudently in negotiating plan fees, he says.

“The job of recordkeeping for a plan today really has nothing to do with the size of the assets or the investments in a plan,” Schlichter continues. “If you have a $50,000 account and mine is only $10,000, it shouldn’t cost the provider any more to furnish me with Internet access to my account or provide me with the 1(800) number for the call center than it does for you. That’s part of the myth we’re trying to break down.”

Fleckner says this point “is directly contrary to the federal court view expressed years ago that cheapest is not necessarily the best.” Fiduciaries must take into account all of relevant factors when choosing a service provider, including services, quality and fees, he says. Quality services are valuable to employers and employees alike, he adds, and may justify extra expense.

“Further, whether fees are paid on an asset-basis, per participant basis, or any other basis is not determinative to whether the fee, in the aggregate, is commensurate with and appropriate for the services rendered,” he explains. “Asset-based fees are in many ways a benefit to lower paid and new employees, who might not otherwise be able to participate in a plan if faced with a flat per participant fee.”

Schlichter, for his part, is firm in the position that sponsors should avoid asset-based recordkeeping fees, “because they can increase for no compelling operational reason as plan assets grow.” In addition, he says, “We believe a plan sponsor shouldn’t allow recordkeeping costs to be paid for out of investment expenses or as a part of a revenue sharing arrangement. That’s a red flag for us. It’s not illegal per se, but it presents the problem that when you get away from a flat recordkeeping charge, the rates your participants pay can really become arbitrary and unfair.”

He points to the market rebounds of 2012 and 2013 to demonstrate the point. “If participants paid for recordkeeping costs through asset-based charges, that means their recordkeeping fees went up as much as 20% or 30% last year for no greater level of service, it was just because asset levels increased,” he explains. “When the law requires that fees be reasonable, we feel this state of affairs is impermissible.”

Schlichter urges plan officials to aggressively monitor how fees change in better and worse markets, and ensure that there is a compelling reason for the recordkeeper to use asset-based charges. If there isn’t one, sponsors could be opening themselves up to substantial liability, Schlichter adds. Schlichter says it’s a very simple principal that employers and plan sponsors need to follow to avoid 401(k) fee litigation.

“I would just remind your readers that I’m an employer myself, and we have our own retirement plan, so I’m not oblivious to their point of view,” he says. “At the end of the day, you’re handling other peoples’ money, your employees’ money, and the duty of anyone handling anyone else’s money is a very strict fiduciary duty. It’s a duty to make sure the interest of the employees is paramount and exclusive.”

Organizations should not think of it as a waste of time for plan fiduciaries to make sure this principal is followed, he says, as a little extra research and diligence on the front end can go a long way towards avoiding potentially painful lawsuits.