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Aug. 23 — The recent round of lawsuits against college retirement plans is noteworthy for many reasons: the prominent schools targeted, the billions of dollars at issue and the big-name law firm behind it all.
Somewhat lost in all the coverage, however, is a factor just as significant as the flashy names and big dollars: the idea that a retirement plan sponsor can face legal liability for giving plan participants too many choices.
Each of the colleges sued this month, from Yale to Johns Hopkins to Northwestern, is accused of including too many investment options in the retirement plans they offer to employees. According to the complaints filed by Schlichter Bogard & Denton, the law firm leading the decadelong litigation charge against 401(k) plan fees, a reasonable number of investment options for a billion-dollar plan is about 15. Duke and Johns Hopkins are accused of having 400 and 440 funds, respectively, and the other targeted schools aren’t far behind.
This concept—that too much choice in a retirement plan is a bad thing—has been “percolating through some cases for a long time” but “hasn’t necessarily come to a head in any one case,” Thomas E. Clark Jr., of counsel to Wagner Law Group in Boston and formerly of Schlichter Bogard & Denton, told Bloomberg BNA Aug. 18.
But isn’t choice supposed to be a good thing? Shouldn’t a large lineup of funds make it more likely that individual investors will find appropriate and high-quality places to put their retirement savings?
Not according to the research cited by Schlichter. Pointing to recent papers by academics and consulting firms like Aon Hewitt and Towers Watson, Schlichter argues that an oversized investment lineup confuses plan participants, promotes “decision paralysis” and drives up fees.Recent Lawsuits Against College Retirement Plans
Cassell v. Vanderbilt Univ.Cates v. Trs. of Columbia Univ.Clark v. Duke Univ.Cunningham v. Cornell Univ.Divane v. Nw. Univ.Henderson v. Emory Univ.Kelly v. Johns Hopkins Univ.Munro v. Univ. of S. Cal.Sacerdote v. N.Y. Univ.Sweda v. Univ. of Penn.Tracey v. Mass. Inst. of Tech.Vellali v. Yale Univ.
The idea that investors suffer from “decision paralysis” in the face of too many options has been around for more than a decade.
A 2003 working paper by the Pension Research Council found that for every 10 funds added to a retirement plan, the rate of plan participation drops by nearly 2 percent. The paper makes a case for “libertarian paternalism,” wherein retirement plan sponsors include only a limited number of high-quality investments so that investors aren’t overwhelmed by too many choices.
Schlichter advances another argument against oversized investment menus: By spreading plan assets across hundreds of different funds and providers, plans are less able to use huge piles of money as bargaining chips in negotiating lower fees. Under this theory, a plan with $100 million in one fund would be able to score a better deal on fees than a plan with $1 million in 100 different funds.
Another problem with excessive choice? A kind of faux-diversification that keeps fees needlessly high. According to several of Schlichter’s lawsuits, a plan with many actively managed funds in the same investment style will wind up with “an index fund return,” despite paying the “much higher fees” associated with active management.
Reading a Schlichter complaint might make someone conclude that any retirement plan with certain characteristics—actively managed funds, too many funds in a single category, or too many funds, period—can and should be sued. But surely there’s some wiggle room between absolute best practices and liability for fiduciary misconduct—right?
Yes, says Brian M. Pinheiro, a partner with Ballard Spahr LLP in Philadelphia who advises retirement plan sponsors, including higher education institutions.
“I think it’s true on some level that if you have hundreds and hundreds of funds, it’s hard to expect your employees to make a rational decision,” Pinheiro told Bloomberg BNA Aug. 18. “On the other hand, having more funds than a given employee could reasonably deal with doesn’t necessarily mean it’s a breach of fiduciary duty. It might not be a best practice, but I think there’s a gap between breach of fiduciary duty and what is the absolute best practice in a retirement plan.”
In Pinheiro’s view, the real risk associated with an oversized investment menu is that it can be difficult for plan fiduciaries to monitor hundreds of different funds at a time.
“As a fiduciary, you’re supposed to be selecting and monitoring these funds to make sure they have prudent performance,” Pinheiro said. “If you have 500 funds, it’s theoretically possible that you’re monitoring all 500 funds on a quarterly basis, but in all likelihood that’s not happening.”
Wagner Law’s Clark said that these cases are likely to turn on fiduciary process, and not on finding the magic number of funds to offer.
According to Clark, fiduciaries accused of offering too many investments won’t face legal liability if they can show that they arrived at that decision by using a prudent process.
“These cases are going to be won and lost on what kind of process the fiduciaries engaged in,” Clark said. “If they engaged in a good, prudent process that they can back up with documentation, then second-guessing is going to be hard. If you didn’t have a process, then these cases are going to potentially be painful for the fiduciaries.”
Another theme running through the university lawsuits is that the world of higher education retirement plans is in the midst of a shake-up.
Indeed, several of the lawsuits—those against Vanderbilt, Northwestern, Johns Hopkins, USC, MIT and Yale—indicate that the defendant universities revamped their plans in recent years, either by reducing record keepers, investment funds or both. The complaint against USC, for example, quotes communications the university sent plan participants explaining how the consolidation would lower expenses and simplify their retirement savings.
This move toward retirement plan consolidation has been happening throughout the higher education universe, Ballard Spahr’s Pinheiro said.
“Some of these plans had 400 or 500 investment options available,” Pinheiro said. “That was very common 10 years ago, and I think you still see it from time to time, but more often you see those types of employers trying to get their arms around it and trying to get to a smaller, more manageable lineup of investment options.”
Clark agreed that the industry is trending toward simplified investment menus after emphasizing more expansive lineups for several years.
With the industry already trending in this direction, will Schlichter’s litigation blitz encourage more universities to simplify their retirement plans and seek lower fees?
Both Pinheiro and Clark saw that as a possibility.
According to Clark, if the Schlichter lawsuits succeed—either by surviving motions to dismiss, winning trials or forcing settlements—change is likely to trickle down throughout the world of university retirement plans.
Pinheiro said that Schlichter’s prior successes have had a “profound effect” on the 401(k) industry by driving down the market for fees. The same could hold true for the world of higher education, he said.
“Given that history, I think it’s certainly possible that we’re going to see plans move to have fewer vendors and fewer investment options,” Pinheiro said. “Everybody in the higher education world is paying attention to this.”
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