Cleaning up the Cesspools

By: Frank Armstrong, CFP, AIFA
A recent US Supreme Court case could go a long way toward clearing up the 401(k) landscape. In LARUE v. DEWOLFF, BOBERG & ASSOCIATES, INC., ET AL. the court held that an individual may sue defined contribution plan sponsors for any breach of fiduciary duty. While the specific facts of this case revolved around a simple administrative error, the court went far beyond administrative procedures in their ruling. They specifically cite Section 409 of ERISA which states:
“Any person who is a fiduciary with respect to a plan who breaches any of the responsibilities, obligations, or duties imposed upon fiduciaries by this title shall be personally liable to make good to such plan any losses to the plan resulting from each such breach, and to restore to such plan any profits of such fiduciary which have been made through use of assets of the plan by the fiduciary, and shall be subject to such other equitable or remedial relief as the court may deem appropriate, including removal of such fiduciary. A fiduciary may also be removed for a violation of section 411 of this Act.” 88 Stat. 886, 29 U. S. C. §1109(a).
This language was crystal clear and unambiguous. Plan sponsors of substandard plans must be hearing footsteps today. The threat of litigation and personal liability may be the only way to get some plan sponsors attention. Meanwhile, the plaintiff’s bar can help but have noticed an opportunity.
While certainly not true of all 401(k) Plans, many fall far short of their fiduciary obligations to prudently manage employee funds.
A fundamental problem with 401(k) Plans is that while employees provide most or all of the funding, and bear most or all of the costs, the employer or plan sponsor provides the plan structure and a limited set of investment options. In many cases, the employee is faced with the fatal choice of selecting the least awful choices. Some plans are so costly and ineffective that the employee might rightly decide to opt out.
As Boomers reach retirement, more than just an isolated few will view their accumulations and ask: “Why so little? After all these years the account balances should be more. What happened?” At that point they might begin to compare prudent fiduciary standards with actual plan practices. The failure will certainly be found in the breach.
The employee (or his legal team) may not have to look far:

  • Safe Harbor under Section 404(c)
    Section 404(c) provides plan sponsors with a degree of safe harbor for employee directed accounts. But, contrary to what many employers believe, the requirements extend beyond simply offering a few mutual fund choices. In fact, there are 74 points and many single spaced pages of Section 404(c) which must be satisfied before the employer obtains safe harbor under that section. Few plans will meet the stringent requirements for appropriate diversification of asset classes, prudent selection of funds, cost disclosure, and education requirements that enable employees to make prudent decisions.
  • Costs
    Its never prudent to waste beneficiaries money. So, it may be hard to justify a M&E charge inside an annuity group contract, separate account charges for each fund, high expense mutual funds, costly SMAs (Separately Managed Accounts), special share” costs above retail cost, transaction fees, commissions, 12(b)-1 fees, surrender costs, custodian fees, and record keeping charges. While none of these charges are necessarily evil, and many are warranted, the sum totals born by participants can become abusive. Costs are a dead drag on performance, and it’s the responsibility of the plans fiduciaries to insure that each cost is appropriate for the function performed, and that the totals are not excessive.
    Hidden costs are a huge concern for the Labor Department. They have campaigned for greater disclosure and transparency. Additionally, to assist plan sponsors to identify costs they published a cost analysis spreadsheet published on their website at:
  • Conflicts of Interest
    ERISA clearly states that plans must be run in the exclusive best interest of the participants. Fiduciaries must be diligent in preventing conflicts of interest and insure that where they exist they are fully disclosed. But that obligation doesnt just apply to the plan sponsor. It extends all the way down the chain to investment advisors, consultants, fund managers, administrators and record keepers. The entire chain must act prudently and in the exclusive best interest of plan beneficiaries. So, conflicts of interest that potentially can affect plan performance like soft dollar policies, revenue sharing, best execution, pay to play, proprietary funds, preferred funds lists, order flow, and position in the trading queue must be thoroughly examined, documented, disclosed and accounted for.
    This is another grave concern of the labor department. They recently released a study that found that more than half of the “pension consultant” firms were paid directly by the managers they recommended. See: STAFF REPORT CONCERNING EXAMINATIONS OF SELECT PENSION CONSULTANTS.
    To assist plan sponsors to identify potential conflicts of interest DOL published: “Selecting And Monitoring Pension Consultants – Tips For Plan Fiduciaries” See:
  • Underperformance
    If the participants fund choices underperformed the appropriate market index she might rightfully wonder why. For instance, She might wonder how her domestic large company stock fund could have returned 3.5% per year less than the S&P 500 index for 11 years without being replaced. Can there possibly be a good answer for that? Were the funds prudently selected, appropriately monitored, compared to the proper index, and replaced if necessary in a timely manner? What was the rationale for not selecting a passive investment (index fund)? Where is the documentation, what was the procedure, were the funds selected in accordance with the Investment Policy Statement?
  • Disclosures
    ERISA requires significant disclosures to plan participants. If the plan didnt disclose costs, performance, and conflicts of interest as noted above to the plan participants, then the participants might wonder why that information wasnt provided as required by law.
  • Education
    If the plan seeks safe harbor under Section 404(c), the plan sponsor must provide education to enable participants to build appropriate portfolios that match their objectives, time horizons and risk tolerance. The days when a plan can throw 50 or so mutual funds at the employees and let them figure it out are long gone. How is the employee to know that two tech funds are not prudent diversification, or that the “safe” bond fund is a guarantee to get no real (inflation adjusted) growth over her entire career? Either approach might easily lead to disaster, and the employee might wonder how that could have happened.
  • Bundled Approach
    It’s far too easy for the plan sponsor to cede total control to an organization that claims to handle everything. Almost by design, a bundled approach where one organization takes on all the roles required to operate the pension, leads to mischief. While a one stop shop sounds attractive to an overworked HR department or plan sponsor, the bundled approach can cloak critical cost, conflict of interests, and encourages non-involvement by the plan fiduciaries. After all, XYZ Insurance Company handles all that for us. But, when the employee looks under the hood, what she finds may not be too pretty.

Class Action
There were already a number of class action suits winding their way through the court system now on excessive fees and conflicts of interest. While this case dealt with an individuals right to sue, the very broad language of the ruling cant help but bolster any case citing fiduciary breach.
Today word spreads at the speed of the Internet. Going forward, when one employee uncovers a breach, its unlikely to be a secret for long. Those breaches that apply to the plan as a whole are much more likely to result in a class action suit against the plan sponsors and fiduciaries. This has not escaped the attention of the plaintiffs bar.
Because regulators have been unable and/or unwilling to apply well known fiduciary standards to pension plans, the employees best hope of improving the plans they are offered may be through the courts.
403(b) and 457 Plans
All 457 Plans for state and municipal employees are exempt from ERISA, and 403(b) plans that are solely comprised of participant contributions are also exempt. While this case dealt solely with ERISA accounts, 403(b) and 457 Account Sponsors should not infer that they will escape similar attention from disgruntled participants.
The Best Defense
Plans that have well established and documented fiduciary standards have little to fear. Fiduciary compliance is the best defense against litigation. Prudence is not based on results, but on process. While prudent procedures and practices increase the probability of a good outcome for participants, plan sponsors are not being held accountable for guaranteeing investment results.
Prudent practices for pension plans are neither a mystery or difficult to implement. Additionally, companies may find that total plan costs actually decrease when appropriate controls are installed.
Firms that are not certain that their practices pass muster might start with a self assessment of their plan which is available on line at Simply answer 22 easy questions about their fiduciary practices. Each question will be fully explained with appropriate citations and documentation. If they can answer all the questions yes, they can sleep well at night. If not, they need to hire a qualified independent œprudent fiduciary” who acknowledges his/her fiduciary status in writing to assist them to overhaul their process from the ground up.
Additionally, firms may wish to conduct a consultant’s fiduciary audit, or apply for Cefex certification of their procedures.
The clock is ticking. The Supreme Court case will lead to additional pension litigation. Fiduciaries that have breached their responsibilities will find themselves personally liable. Plan sponsors should adopt to the new reality and govern themselves accordingly.

By | 2018-11-28T23:29:59+00:00 September 28th, 2012|Blog|

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