401(k) lawsuits are nothing new, but their numbers have been on the rise. A record number of suits were filed in 2020, more than double the amount filed in 2018 and an 80% increase over 2019, according to Groom Law.
The initial upsurge in lawsuits from more than a decade ago was focused primarily on conflicts of interest and excessive participant fees. Recent lawsuits have homed in on investment results, and two trends have emerged:
The recent legal challenges have upended the strategies of many plan sponsors to fill up plan menus with passive index funds in the belief they are lower cost and less likely to be challenged from a fiduciary perspective.
But the truth is, passive funds have not been exempted from these challenges. Consider the following lawsuits against 401(k) plans that used passive investments:
These cases are consistent with what Groom Law Group, a firm specializing in ERISA law, had earlier concluded in a paper commissioned for Capital Group: that passive strategies do not reduce fiduciary liability.
Ironically, active funds may be less vulnerable to a fee challenge. With an active fund, a plan sponsor can argue that the higher fees are justified because they can potentially offer better risk-adjusted results.
Fee-related litigation may have formerly dominated the headlines, but recent settlements involving two of the largest retail employers have pivoted on results, not fees. Walgreens reached a $13.75 million settlement in a lawsuit that accused the plan of selecting passive target date funds that were “chronic poor performers.”‡ Lowe's reached a $12.5 million partial settlement in a lawsuit that accused the company of investing $1 billion in plan assets in an underperforming and unpopular growth fund.§
These lawsuits and subsequent settlements make it clear that plaintiff attorneys have raised the bar on what plan sponsors need to do to get their participants the best investment results possible.
This may be a welcome development, as strong investment results can meaningfully improve participant outcomes. Consider the hypothetical scenario below. Early in a participant’s career, at age 25 in the example, 94% of their account balance comes from contributions. Fast forward to the traditional retirement age of 65 and roughly 70% of total wealth can come from investment returns while just 30% is from contributions. Boosting results on that 70% can meaningfully move the needle for retirement readiness, demonstrating the compounding value money creates while making money.
Returns matter more than you think
That’s why investment selection might be the most important decision plan sponsors make. Even small increases in returns can dramatically improve outcomes, adding years of retirement spending.
As a retirement plan professional, you have a unique opportunity to help plan sponsors identify the right investments to pursue dignified retirements for participants. While no metric can predict results for any fund or manager, consider these three metrics when looking for funds that have generally been associated with stronger equity results over the long run (especially with active funds):
While the pace of 401(k) lawsuits shows no signs of slowing down, the best way to manage 401(k) litigation is to avoid being sued in the first place. And while a prudent process is essential, it may not be enough when investment results are now being targeted along with fees.
These screening factors above may enhance the manager selection process, which in turn could help plan sponsors select investments that may have the potential to deliver the best long-term investment outcomes to their participants. And better participant outcomes, at the end of the day, is the noble quest all of us in this industry share.
*Rebecca Moore, “Details of Settlement of Anthem Fee Suit Revealed,” April 9, 2019, and "Parties Reach Settlement Agreement in Anthem 401(k) Excessive Fee Case," PlanSponsor, February 22, 2019.
†Greg Iacurci, "Philips North America reaches $17 million settlement in 401(k) lawsuit," Retirement Plan Adviser, May 15, 2018, and Rebecca Moore, "Settlement Reached in Excessive Fee Suit One Day After Lawsuit Is Filed," PlanSponsor, May 14, 2018.
‡Rob Kozlowski, “Settlement agreement reached in ERISA lawsuit against Walgreens,” Pensions&Investments, October 26, 2021, and Brown-Davis et al. v. Walgreen Co. et al. - 1:19-cv-05392 (2019). https://www.classaction.org/news/class-action-claims-walgreens-retirement-plan-shorted-employees-300-million.
§Amanda Umpierrez, “Lowe’s Reaches Settlement in 401(k) ERISA Case,” Planadviser, June 1, 2021.
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