Fiduciary Fundamentals: 401(k) Plan Excessive Fee SuitsPDF
A Call to Evaluate Your Plan Governance
For the fourth year in a row, excessive fee lawsuits are the hottest trend in ERISA fiduciary litigation. The number of excessive fee suits filed against 401(k) plan fiduciaries skyrocketed in 2020 and has remained unusually high ever since. To navigate the enduring threat of excessive fee suits, fiduciaries should review and strengthen their processes for plan governance, including for selecting and monitoring plan service providers and fees. This second installment in the Fiduciary Fundamentals series will provide a high-level how-to for fiduciaries seeking to bolster their practices in light of this continuing litigation trend.
As a key component of their fiduciary duty of prudence, 401(k) plan fiduciaries must carefully select and monitor plan service providers (e.g., record-keepers, investment advisers and managers) and ensure that fees paid to such providers are reasonable given the services provided to the plan. Generally, fiduciaries do not need to secure the lowest prices for plan services, but service provider fees must reasonably reflect the specific services performed by the service provider, the size and needs of the plan, the types of fees charged, the investment options offered under the plan and the net returns relative to the risks among available investment options.
Excessive fees are a significant concern for plan participants – because service providers are often paid out of plan assets, any fees owed or paid to providers reduce the return to participants. Due to compounding investment returns, even small increases in fees can have a meaningful impact on participants’ plan accounts. According to a 2019 Department of Labor report, a 1% difference in 401(k) plan fees and expenses can reduce a participant’s account balance at retirement by 28%.
As such, excessive fee lawsuits are typically brought as class actions on behalf of all participants in a 401(k) (or other ERISA retirement) plan. Plaintiffs allege that retirement plan fiduciaries breached their fiduciary duties by, among other things, subjecting participants to excessive service provider fees.
Any plan may be the subject of an excessive fee suit. Although early excessive fee suits largely targeted multibillion-dollar 401(k) plans, this trend has changed. According to fiduciary insurance data, 40% of excessive fee suits filed in 2022 related to plans with less than $1 billion in assets and 20% related to plans with less than $500 million in assets.
Once sued, plan fiduciaries can face steep costs to dispose of an excessive fee suit. Historically, defendants’ success at the motion to dismiss stage has been rare; today, despite a maturing body of case law, it remains inconsistent. As a result, defendants often face the decision of proceeding through extensive discovery or settling. Neither option is budget-friendly – although continued litigation racks up legal defense costs, most settlements in 2022 ranged from $500,000 to $4 million, with the largest settlement totaling $32.5 million. These settlements are often funded by fiduciary insurance carriers.
Unfortunately, you cannot proactively prevent an excessive fee lawsuit against your 401(k) plan. However, your best defense to such a suit – an informed and well-documented fiduciary governance process – is well within your control and capability. Armed with this evidence of good plan governance, you may defeat claims of fiduciary breach, including claims related to excessive fees, as efficiently as possible. As important, you will reduce your visibility as a target to potential class counsel.
Process as Protection
Although ERISA does not set specific standards for 401(k) plan fees, it emphasizes the prudence of fiduciaries’ actions and decisions in plan governance. Central to the concept of prudence is process. Thus, plan fiduciaries best position themselves to withstand claims of fiduciary breach when they establish and follow an informed process for plan governance.
Is your organization’s ERISA governance structure robust enough to defeat claims of fiduciary breach? Use the self-evaluation below to determine how your existing practices compare to current best practices.
1. Do you maintain a prudent fiduciary process?
There is no one-size-fits-all prudent fiduciary process. Every plan’s process may look different, depending on the size of the plan, the needs and goals of plan participants, the resources of the plan sponsor, etc. To establish a fiduciary process specifically tailored to your plan, consult a member of our Employee Benefits team.
By way of example, establishing a prudent fiduciary process could mean forming a plan committee to oversee the administration of the plan and creating a written governance policy document that clearly defines the governance process. Such document should, among other things:
- Set forth any delegations of authority and outline responsibilities of plan parties;
- Set the frequency at which responsible parties must meet and identify agenda items for such meetings; and
- Establish how actions with respect to the plan are approved and how actions and meetings are documented and archived.
2. How much do you and your plan decision-makers know about ERISA and about your plan?
Each of your plan fiduciaries and committee members should fully understand applicable ERISA rules and their responsibilities with respect to your plan, and each should have the time and expertise necessary to fulfill their responsibilities. When time and/or expertise may be lacking, consider hiring experts (consultants, legal counsel or investment advisers) to support your fiduciary process. Hold periodic ERISA updates or trainings to ensure fiduciaries and committee members stay informed about changes in law and industry trends.
3. Do you periodically evaluate your plan’s service providers to ensure the services provided and fees paid are appropriate for your plan?
To protect against an excessive fee suit specifically, your fiduciary process should include diligent evaluation and monitoring of your plan service providers. When engaging a service provider, request disclosures of both direct and indirect fees. Ensure that the types of fees and the total amount charged to participants is reasonable given the services the plan will receive and the size and needs of your plan. (This often requires expert assistance.) During the term of your service provider contract, assess the provider’s performance and continue to monitor direct and indirect fees collected. Conduct a market check on plan services and fees at least once every few years through a request for proposal or request for information.
4. Do you follow and document your fiduciary process?
To best equip your plan to defend allegations of fiduciary breach, you should show how you follow your fiduciary process through consistent documentation. Record all material fiduciary actions, the reasoning behind fiduciary decisions, meeting minutes for your plan committee and any legal or financial advice on which you rely in administering your plan. In other words, demonstrate that you carry out your fiduciary duties in an informed and prudent manner.
When drafting internal documentation, be clear and consistent. Documentation should include necessary contextual information and should be written and maintained in the way in which you would want to present it to an outside party.
5. Do you have fiduciary insurance coverage for your ERISA plans? Do the terms of your coverage align with the terms and operation of your plan?
Fiduciary insurance can insulate your plan fiduciaries from the financial burden associated with fiduciary litigation, including legal defense costs. Without fiduciary insurance, if your plan committee or other plan fiduciaries are sued for breach of fiduciary duty, each individual fiduciary may be held personally liable for the alleged losses sustained by your plan.
If you have fiduciary insurance, review the terms of your coverage to ensure the terms accurately reflect your plans and the governance structure of each. For example, if your policy lists the specific ERISA plans and plan fiduciaries covered, make sure all of your plans are included and all of your plan fiduciaries are accurately identified. Know your coverage parameters and verify that such parameters are appropriate given the size of and risk associated with your plans.
As excessive fee suits continue to proliferate, the trend reminds us of the importance of understanding and adhering to foundational ERISA concepts, such as good plan governance. Stay tuned for the third installment of our article series to explore similar fiduciary fundamentals.