Crystal Ball What litigation might be coming to 401(k) plan sponsors?

I am frequently asked about the biggest risks for 401(k) plan sponsors. In effect, the question is: What will plan sponsors be sued for in the future? If the answer were obvious, every-

one would be taking steps to improve their practices and the risk would disappear. Also, I am mindful of Casey Stengel’s warning: “Never make predictions, especially about the future.” That said, these are my “best guesses” regarding future 401(k) litigation:

First, let’s look at past 401(k) litigation. There have been two major waves of high-profile litigation—company stock cases and revenue-sharing cases. In many ways, the company stock law-suits were predictable, because company stock is a nondiversi-fied investment, meaning that the losses can be large—perhaps even total. As a general principle, lawsuits are generated by large losses—and where large losses occur, so does litigation.

The second wave dealt with revenue sharing. The claims were that excessive amounts were being paid by mutual funds to recordkeepers, advisers and consultants, who “shared” them. The plaintiffs’ attorneys also argued that the cost of those “indi-rect” payments was embedded in the investments, making them unreasonably expensive. In some cases, those payments were explained poorly or nondisclosed. That brings us to a second principle of litigation—if money is moving from one person to another without being clearly disclosed to, and evaluated by, the fiduciaries, the likelihood of litigation grows.

Another feature of the company stock and revenue-sharing cases is that the rules about fiduciary responsibility were unclear. For example, how responsible is a plan committee in evaluating the company stock investment? When does company stock need to be removed from a plan? After years of litigation, we have more but incomplete clarity. In regard to revenue sharing, the courts are split on the responsibilities of plan committees to use the “purchasing power” of their plans to select lower-cost invest-ments. And there is not much guidance about how to evaluate money paid from investments to providers. On that last point, the Department of Labor (DOL) 408(b)(2) disclosure regulation will significantly impact the information given to plan commit-tees and their responsibility to evaluate it.

So, what will future 401(k) litigation be about? One poten-tial issue is the allocation of plan expenses among participants’ accounts. For instance, some investments pay revenue shar-ing to service providers and thereby pay part or all of the plan’s

operating costs. However, other investments may make none of those payments. As a result, participants who invest in mutual funds that pay revenue sharing may bear the costs of operating a plan, while participants in other investments pay nothing. A graphic example is where half the participants invest in mutual funds that pay revenue sharing and the other half are in a com-pany stock fund that pays no plan-operating fees—participants invested in the mutual funds end up paying the entire cost of operating the plan. In this case, ask yourself, “Are the expenses being allocated fairly?” While law does not require “fairness,” plaintiffs’ attorneys like to point out when the behavior of 401(k) fiduciaries is fundamentally unfair.

From a legal perspective, the issue is whether the alloca-tion of the revenue sharing is prudent. There is little guidance about the proper allocation of revenue sharing in 401(k) plans. Therefore, a plan sponsor may believe that its allocations are appropriate because nothing prohibits them. On the other hand, from a plaintiffs’ perspective, nothing in the law supports a con-clusion that revenue sharing can be allocated without analysis and decisionmaking by the fiduciaries.

One more thought on the subject: There is analogous guid-ance from the DOL about the allocation of expenses, saying that plan committees must make prudent decisions about it, mean-ing the committees must engage in a process to make informed and reasoned decisions. Based on that guidance, the failure to evaluate the allocation of the revenue sharing may be a fiduciary breach. The key is to be attentive to this issue because, as Yogi Berra said, “The future ain’t what it used to be.”

In my next column, I will discuss other issues ripe for litigation.

Fred Reish is chair of financial services ERISA practice at

the law firm of Drinker, Biddle & Reath. A nation recog-

nized expert in employee benefits law, he has written four

books and many articles on ERISA, IRS and DOL audits

and pension plan disputes. Fred has been presented the

Institutional Investor Lifetime Achievement Award and the

PLANSPONSOR Lifetime Achievement Award. He is one of

the 15 individuals named by PLANSPONSOR magazine as

“Legends of the Retirement Industry,” and also one of five

individuals acknowledged as Retirement Plan Adviser

Legends by PLANADVISER magazine.

Just out of Reish

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