Financial services firms that want to use their own products and services for their defined contribution plans are facing a growing body of case law that so far is not going their way.
Financial institutions may invest their own 401(k) plan assets in mutual funds, insurance contracts and other investment vehicles they or an affiliated company might manage, and they might also provide services like record keeping. The Department of Labor has granted a number of class exemptions for these proprietary activities, but compliance with these exemptions and fiduciary standards is getting increased attention from regulators and lawyers representing plan participants in class-action lawsuits.
Among the practices being questioned by regulators and attorneys recently are investments in mutual funds advised by corporate affiliates of the plan sponsors, purchase of group annuities from the firm or affiliates, pooled separate accounts and bank collective trusts or deposit vehicles. Other red flags are reimbursement to the sponsor for plan expenses or revenue sharing, inclusion in the 401(k) plan of higher-cost or lower-performing proprietary products, and having the plan “seed” or launch a new product before it is available on the open market.
Officials at the Department of Labor's Employee Benefits Security Administration “are willing to commit the necessary resources” to scrutinize the practices, while plaintiff lawsuits “are gaining more traction,” said Ivan Strasfeld, senior adviser at Fiduciary Counselors Inc., an independent fiduciary firm in Washington, who until 2012 directed EBSA's office of exemption determinations. Said Laura Rosenberg, vice president for finance at Fiduciary Counselors: “We are seeing increasing litigation surrounding the use of proprietary services and products by in-house plans of financial institutions.”
Although financial firm plan sponsors might be making what they consider good choices, regulators can exact penalties and excise taxes for decisions they question.
Even more expensive are the lawsuits. In June 2013, attorney Jerome Schlichter won a $35 million settlement against Prudential Retirement Insurance Annuity Co., a unit of Prudential Financial Inc., and Cigna Corp. in a class-action lawsuit for Cigna 401(k) participants alleging a breach of fiduciary duty in plan management. The settlement does not allow for any investment options advised by Cigna or a Cigna subsidiary and called for independent monitoring of plan decisions, including hiring of record keepers.
Mr. Schlichter, managing partner for Schlichter, Bogard & Denton LLP in St. Louis, has six similar lawsuits pending against 401(k) plan sponsors, including ones sponsored by Massachusetts Mutual Life Insurance Co., and Ameriprise Financial Inc. Mass Mutual spokesman David Potter said his company is seeking to have the case dismissed. “The complaint fails to state a single reason why MassMutual should not make available its award-winning investment products and services to its employees and sales force,” he said.
Mr. Schlichter believes there should be more transparency in these decisions. Financial firm plan sponsors “need to take their duty very seriously to avoid self-dealing and avoid the temptation of just putting their products in. If they do (use their products or services), they should be prepared to show that they have a process that does not favor them. It's something that should have strong justification ... with the same kind of analysis that they have for other products,” he said.