Callan reviewed 165 lawsuits filed against mid- to mega-sized DC plans ($175 million to $10 billion-plus) between January 2019 and August 2022, to study trends in DC plan litigation centered on the fiduciary duties outlined in the Employee Retirement Income Security Act (ERISA). Our first post on this topic outlined our major findings. In this post we discuss the four key themes identified in our analysis of these suits.

New Spin on TDF Suits in DC Plan Litigation

Of the 165 lawsuits in Callan’s study, 31% alleged the target date fund (TDF) suite underperformed various benchmarks. Importantly, the benchmarks constructed by the plaintiffs’ counsel attempt to compare dissimilar TDFs (e.g., mixing active and passive fund families).

TDFs typically garner a large share of plan assets given their predominant status as a plan’s qualified default investment alternative (QDIA). As a result, the TDF suite selection has naturally become a growing target of DC plan class action lawsuits, with a barrage filed in 2022.

What DC Plan Sponsors Need to Know: Plan sponsors should have policies in place for the prudent selection and monitoring of plan investments, and should seek to document these processes. The target date suite, as the default investment, is often considered through a more stringent lens. Callan recommends conducting a target date evaluation at a regular cadence to demonstrate and document that the TDF selection is appropriate for the participant population, based on demographics, tenure, other benefits, etc. Plan fiduciaries should also consult with counsel, where appropriate.

Roadmap for Litigation Strategy

DC plan sponsors facing an Employee Retirement Income Security Act (ERISA) lawsuit undergo a complicated calculus in determining their litigation strategy—to settle or proceed? Some issues to consider regarding that decision are the potential strengths and defenses of the claims, concerns around potential litigation costs, desire for expedited resolution, reputational considerations, and the jurisdiction in which the claim was filed.

Based on our study, a simplistic roadmap in ERISA litigation is:

1. Lawsuit filed
2. Defendants file a motion to dismiss
3. Plaintiffs/defendants may respond
4. Motion is (a) granted, (b) denied, or (c) granted on some claims and denied on others

Out of the lawsuits included in our study, a motion to dismiss has been ruled on in 77 lawsuits. Of those, 36% were dismissed with the first motion, with nearly half dismissed due to the failure to state a claim that could be adjudicated or where relief could be granted, and 1 in 10 were dismissed for lack of standing. Only 5 lawsuits where the motion to dismiss was ruled on were dismissed with prejudice based on the first motion, and another 3 were dismissed with prejudice after the second motion. When a lawsuit is dismissed “with prejudice,” the lawsuit cannot be amended further, although the plaintiffs can appeal the decision.

Beyond outright dismissal of all claims, a quarter of the lawsuits in this group had some of the claims dismissed at the pleading stage, streamlining the allegations that need to be defended (or settled). Only 2 in 10 were allowed to proceed without any of the claims being dismissed.

What DC Plan Sponsors Need to Know: Plan fiduciaries should have a robust and thoroughly documented process in all fiduciary decisions. It is important that plan fiduciaries follow the plan document and governance documentation (e.g., investment policy statement, committee charters). Plan fiduciaries should also consult with counsel, where appropriate.

Managing Risk with Managed Accounts

Managed account services have become a new focus in DC litigation. While these types of lawsuits have yet to identify consistent claims, the potential expansion of litigation requires DC plan sponsors to carefully review the utilization and outcomes of managed account services.

A managed account product determines the appropriate investment allocations in a retirement account on behalf of participants who elect to use the service, rebalances the account on an ongoing basis, and adjusts the allocation based on the time until the participant will likely retire. Managed accounts typically seek to incorporate a participant’s total financial picture, including non-retirement assets, spousal assets, etc. The fees for this service are paid via an asset-based charge deducted from participant accounts.

Plan fiduciaries that elect to offer a managed account product are required to make prudent decisions around the provider selection. “ERISA’s fiduciary provisions require plan fiduciaries, when selecting and monitoring service providers…to act prudently and solely in the interest of the plan’s participants and beneficiaries. Responsible plan fiduciaries also must ensure that arrangements with their service providers are ‘reasonable’ and that only ‘reasonable’ compensation is paid for services. Fundamental to the ability of fiduciaries to discharge these obligations is obtaining information sufficient to enable them to make informed decisions about an employee benefit plan’s services, the costs of such services, and the service providers.” (DOL 2014 Fact Sheet, emphasis added)

The providers themselves typically are considered fiduciaries for the recommended asset allocations under ERISA section 3(38), as the provider implements the advice by taking discretionary control of the participant’s account. However, not all managed account services would fall into that fiduciary category, including retirement projections or retirement income calculations.

Of the 165 lawsuits in our study, nearly one in five include a claim made against managed account services. Of these lawsuits, 42% include allegations that the managed account service fees are too high based on the services offered. Further, 31% allege that the managed account services underperform based on other plan options (e.g., the target date fund) and 15% include allegations against the managed account provider itself, claiming that the managed account provider breached its duty of loyalty by directing assets into proprietary recordkeeper investments.

What DC Plan Sponsors Need to Know: Callan recommends conducting a managed account evaluation every three to five years, including a review of the service offered, utilization, projected returns, fees, and revenue shared with other parties. On an ongoing basis, the plan fiduciaries should monitor the performance of managed accounts as they would any other investment.

Money, Money, Money

Alleged excessive fees continue to be one of the most common claims in DC litigation. DC plans use investment management and administrative services that incur fees paid by participants, the plan, or the plan sponsor. ERISA requires plan fiduciaries to act prudently, and such prudence is demonstrated by following a process to select and monitor the suite of services and actual utilization, including a review of the fees for these services.

Nearly three-quarters of the lawsuits in our study include a breach of prudence claim based on the administrative and/or service fees. The lawsuits allege the plan fiduciary did not undertake a prudent process since the fees are allegedly excessive.

The claims of excessive fees in these lawsuits raise an issue similar to the allegations in many lawsuits around fund selection—identifying an appropriate benchmark. These lawsuits typically argue that plans should use a comparison group made up of a select group of DC plans (usually 15-20) based on publicly available fee information. Further, three out of five lawsuits with allegations of excessive fees include claims that the plan sponsor had not conducted an RFP during the class period, arguing that this process could have identified the allegedly excessive fees.

At the same time, 64% of these lawsuits include a reference to the use of revenue-sharing that could potentially be used to pay administrative or other fees. While ERISA does not include guidance on revenue-sharing, documenting the decisions made and rationale can be used to demonstrate a prudent process.

What DC Plan Sponsors Need to Know: Plan fiduciaries can seek to protect themselves against these claims by conducting regular fee benchmarking studies or formal vendor searches, negotiating fees, and documenting the use of revenue-sharing, if any. Callan recommends conducting a recordkeeper and/or trustee search every five to seven years (or more frequently if there are significant changes to the plan or population, such as a merger or acquisition), interspersed with regular fee benchmarking. These benchmarks should include an evaluation of revenue-sharing, net investment management fees, and indirect compensation. A plan sponsor should be keenly aware of the revenue generated from the plan and have documentation describing who pays for that revenue and that it is reasonable for the services rendered.

Patrick Wisdom contributed to this blog post.