Public enemy No. 1 for 401(k) profiteers

Few employees can imagine that their humble 401(k) plans could become a virtual profit center for their own employers, but according to attorney Jerome Schlichter, that was exactly the case for some of corporate America's most notable names.

Mr. Schlichter landed a $35 million settlement last June in a class action against Prudential Retirement Insurance Annuity Co. and Cigna Corp. His firm spent six years representing a number of Cigna 401(k) participants who claimed the plan profited from self-dealing at the expense of its own workers.

While the Prudential/Cigna settlement is the largest, it is by no means the only case Mr. Schlichter has won against some of America's largest corporations. He has also negotiated multimillion-dollar settlements with Bechtel Corp., Caterpillar Inc., General Dynamics Co., International Paper Co., and Kraft Foods Global Inc.

In addition, Mr. Schlichter has six similar 401(k) suits pending. The defendants include Massachusetts Mutual Life Insurance Co. and Ameriprise Financial Inc.

The volley of suits has been enough to rattle not only employers but the financial services firms that serve them.

“[Mr. Schlichter] has been a disruptive force in the industry,” said Marcia Wagner, managing director at The Wagner Law Group.

The cases have caused employers and financial services firms to think twice about 401(k) fees and how they're disclosed, she said.

“Nobody is going to say that they [made changes in the way they do business] because of him, but has it happened? Of course it has,” Ms. Wagner said. “He filed a whole slew of cases against the bedrock of corporate America, and they all had that common denominator of excessive fees.”

It was employers' move from the defined-benefit pension model to a defined-contribution model — one that shifted risk from the employer to the worker — that brought 401(k) plans to the attention of Mr. Schlichter.

“My mother living on my father's pension as a widow could no more have picked stocks than she could have flown to Mars, it was so out of her league,” he said. “But she didn't have to worry about it [because] she still got the check.”

The 65-year-old attorney, founder of Schlichter Bogard and Denton, brought on board several lawyers with expertise in this corner of ERISA law and undertook a 21-month-long study of the 401(k) industry in the beginning of January 2005. He filed his first lawsuit in September of the next year.

Mr. Schlichter said his firm's research revealed scenarios in which workers were paying high retail fees for plan investments, recordkeeping costs went undisclosed and fiduciaries routinely failed to track plan fees.

Above all, revenue sharing, which is the additional compensation mutual fund families pay to record keepers and broker-dealers that work with the plan — what some call “kickbacks” — ran unchecked. Plan fiduciaries owe a duty to their workers to ensure that excessive fees aren't being charged through revenue-sharing agreements.

“It's the same [fiduciary] law as if your nephew's parents were killed in a car wreck, and you're acting as a trustee for the nephew: You must serve his interests,” said Mr. Schlichter. “You can't say, 'I'm going to have my buddy handle your money and steer kickbacks to me.'”

In addition to excessive fees, Mr. Schlichter has sued employers over investment options which favor the employer over the workers.

In the Prudential/Cigna case, for example, some $2.4 billion — close to 65% of the plan's assets — were invested in Cigna itself, according to the original complaint. That happened because the company's default investment option was a “group fixed annuity contract” that was sold by Cigna and because the company required that half of the matching contributions employees contributed to the plan had to be invested in the Cigna Company Stock Fund.

“By causing approximately 65% of the plan's assets to be invested in Cigna, defendants not only forced the plan and its participants to bear imprudent levels of risk, but also subjected them to the conflicts of interest inherent in having the plan's investment management, record-keeping and other services performed by Cigna's for-profit retirement business,” the plaintiffs alleged.

The plaintiffs in the pending cases against Massachusetts Mutual and Ameriprise Financial also claim they were placed in allegedly expensive proprietary investments that were supposedly profitable for the companies but less so for the worker.

Mr. Schlichter said that taking on a large employer was a tall order for some retirees and workers he has represented. “Even if the federal law says you are protected from retaliation, there are a lot of people who are still working and don't want to step forward because of that concern,” he said. “Others feel that it's their obligation to fellow employees and retirees to make a difference for the plan.”

Mr. Schlichter's ability to empathize with employees harkens back to his humble blue-collar upbringing in Mascoutah, Ill., where he grew up the son of a homemaker and an aircraft mechanic.

He graduated from the University of Illinois, breezing through in three years, and went on to attend the University of California, Los Angeles for his law degree. Mr. Schlichter's parents didn't have the money to cover his out-of-state tuition, so he held two jobs — legal research and janitor work — and borrowed his way through law school.

The pivotal moment that would shape Mr. Schlichter's legal career came when, during his first year of law school, he and a friend drove to an East Los Angeles warehouse to join a picket line in support of striking truck drivers. Police officers cleared the driveway of protesters and used their billy clubs to hold off picketers. Mr. Schlichter ended up getting arrested.

“At the time, there was a division between students who were civil rights and anti-war protestors and working people who often came out with statements against students,” Mr. Schlichter explained. “I thought it was important for students to support labor and workers in addition to civil rights and anti-war issues. So that's why I was there.”

Those pro-labor values were a major factor when the young law student started looking for work. He spent a summer working for Joseph Cohn, an East St. Louis, Ill.-based attorney, hoping to work on civil rights and labor cases.

While there, Mr. Schlichter was chosen as one of seven law students to work pro bono on the behalf of a group of students at St. Louis' Washington University who were protesting the Vietnam War and facing serious charges: a government building on campus burned down, and two of the protestors were facing federal time for lobbing a cherry bomb at a police officer.

When Mr. Schlichter founded his St. Louis-based firm in 1989, he modeled it after Mr. Cohn's in that he worked on a contingency fee basis.

“That's the key to the courthouse for people without the assets to take on a large company,” he said. “They can't pay an hourly rate. If lawyers can't do the work on a contingent basis, then these people have no representation.”

Naturally, not everyone's on board with the work the law firm does. Attorneys who have worked for service providers and plan sponsors note that though the suits bring changes to how employers do business, they question whether litigation is necessarily the best way to go about making those changes.

“My concern is when the decision of who to sue and what to claim is left to plaintiff's firms, the claims may not always be made against the wrongdoers solely to enforce the rights of the participants; there's probably some profit clouding that analysis,” said Jason C. Roberts, chief executive officer of the Pension Resource Institute, an ERISA consulting firm for broker-dealers.

However, even some of his critics agree that Mr. Schlichter's litigation has renewed plan sponsors' focus on establishing a prudent process with respect to the plan and defining fee policy.

Regulators never produced direct guidelines over how plan sponsors ought to evaluate and understand revenue sharing agreements, said ERISA attorney C. Frederick Reish, a partner in Drinker Biddle & Reath's employee benefits and executive compensation practice group. Though revenue sharing practices — the additional pay going from a mutual fund company to a 401(k) record keeper, a broker-dealer or even an adviser in the form of 12(b)-1 fees — were “reasonable in most cases,” others were excessive, and the lack of official guidance from the Labor Department on how to treat revenue sharing allowed employers to set these agreements on the wayside.

Employers are now paying the price in court.

“In a sense, the firm has substituted itself for the regulators,” said Mr. Reish. “By that, I mean that the level of compliance and good fiduciary practices today — especially on revenue sharing — is higher than it's ever been before. I wish it happened differently, however.”

Mr. Schlichter acknowledged that overseeing a 401(k) plan is no easy task, particularly for employers who have to worry about the everyday business of what they do. “There is a temptation to take the easy way out,” he said. “A vice president of human resources might be the head of the fiduciary committee, but her day job is to make a profit for the company in whatever way, and the time spent on the 401(k) doesn't produce profits for the company.”

Regardless of the complexity of the job, plan sponsors are still required by law to uphold the highest level of loyalty to their own workers or face the risk of litigation.

“If you work for a company with a 401(k), you get the benefit of a fiduciary who is supposed to be on your side and held to the standard of a financial expert,” Mr. Schlichter said. “For the welder, the janitor, the secretary — even the executive who doesn't want to be involved with learning about investments — they don't have to.

“The law is simple and clear: A fiduciary to a 401(k) plan must solely operate for the exclusive benefit of the employees and the retirees,” said Mr. Schlichter.