Magazine

Insights | Published in September 2016

A Bad Juxtaposition

The recent law suits against 403(b) plans seem to argue that they should be mirrors of 401(k) plans—but anyone who works with 403(b)s knows that is not the case.

By Alison Cooke Mintzer | September 2016
PS-Portrait-Article-Insights.jpgTen years ago, the retirement plan world was rocked by a series of what are now generally referred to as the “revenue sharing” or “excessive fee” lawsuits. These class-action participant suits took aim at a number of mega retirement plans with billions of dollars in plan assets.
 
These early batches of court cases attacked two main practices related to fees: the use of revenue sharing—i.e., paying or offsetting recordkeeping fees with investment fees—and the use of retail mutual fund shares when the plan would have qualified for lower-priced options such as institutional share classes.
 
The law firm representing the participants, Schlichter, Bogard & Denton, has since become a “household” name in the industry—although most of the cases didn’t make it to trial. Over the decade, only one has been decided in court, and that was won by the plaintiffs. However, nine have been settled, which may stem from the sheer costs to the plan sponsors to fight these lawsuits, but which have sadly served to further the attorney’s case that something wrong must have been going on.
 
This summer, the law firm found a new target, in 403(b) plans—specifically large university plans—and made some of the same allegations plus new ones. Not only did it replay the familiar notes about the use of retail vs. institutional share classes and revenue sharing, but it added the new theme of active management expenses being unworthy of the costs. The new cases also brought some new charges specific to 403(b) plans, namely that the huge fund menus with overlapping choices were inappropriate, as were the multiple recordkeeper relationships.
 
The suits are interesting because they seem to argue that these plans should be mirrors of 401(k) plans—anyone who works with 403(b)s knows that is not the case. In fact, until eight or nine years ago many of them were not subject to the Employee Retirement Income Security Act (ERISA) and therefore not held to a fiduciary standard. Plan sponsors became subject to ERISA only if they matched into the plan, and, in many cases, those employer contributions were made into another plan or there was a pension offering.
 
Before the Internal Revenue Service (IRS) rules requiring more oversight of 403(b) plans, most schools and universities offered them as a payroll deduction opportunity and allowed for true participant direction. This meant participants could meet one on one with various providers and select products such as individual annuities in which to invest.
 
The advent of the rules has provided 403(b) plan sponsors with an incentive to reduce the number of providers and investment options and streamline their plan design, but that shouldn’t mean what existed before was wrong or a breach of responsibility.
 
This is one of the lawsuit ramifications I find most difficult to accept. I tend to give plan sponsors and plan fiduciaries the benefit of the doubt. I know how challenging it is to review a plan and how difficult to look at a participant base and feel confident the choices you make are the best ones for them.
 
When a plan makes changes, this should be without being cited as admitting its previous plan design options or choices were inappropriate. Don’t get me wrong—I think the previous plan designs of 403(b) plans were dizzying, but I also know much of that was driven by participant direction and that, for many plan sponsors, trying to consolidate the fund menu and number of providers has been a multi-year process. 401(k) plans have had 30 years to evolve their plan design to where it is today—403(b) plans have had eight. Plan design best practices evolve, and, as I’ve said many times before, plan participants are often saving in a plan when they wouldn’t be otherwise—fees on some savings will still result in more retirement income than no savings.
 
What will happen with these cases remains to be seen. It’s clear that having been successful at his one trial and the settlements—quite successful you might say, making millions of dollars for himself and his firm while participants get a few thousand dollars each—Jerome Schlichter will continue to attack plan sponsors with deep pockets. Plan sponsors have to do their best not to be scared, but instead hold to their responsibilities under ERISA, focusing on what is reasonable and appropriate and documenting their work. Stay strong.

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