Latest cases allege breach of duty within university 403(b) plans
Nearly a dozen of the nation's best known universities are facing litigation over their 403(b) plans, accused of similar fiduciary-duty breaches that have bedeviled 401(k) plan sponsors.
In recent weeks, Duke University, Johns Hopkins University and other big-name private universities have been sued by participants represented by the St. Louis law firm of Schlichter Bogard & Denton.
Jerome Schlichter, the founding and managing partner, is well-known for suing 401(k) plans over alleged mismanagement and high fees, negotiating multimillion-dollar settlements that include $62 million with Lockheed Martin Corp. and $57 billion with Boeing Co., both in 2015.
“The university plans are big, and they are easy targets,” said Robyn Credico, the Arlington, Va.-based defined contribution practice leader for Willis Towers Watson PLC. Some have moved slowly in making improvements for fear of participant pushback, Ms. Credico said.
Several complaints that Mr. Schlichter uses against 401(k) plans are found in his 403(b) plan litigation — allegations of excessive record-keeping fees and high investment product fees, as well as plans' failures to offer lower-priced shares instead of retail-priced shares of mutual funds. His 403(b) lawsuits also criticize sponsors for having too many record keepers and too many complex, cumbersome and expensive annuities.
All 403(b) plans — higher education, health care, K-12 — “are wasting nearly $10 billion annually,” said a January report by Aon Hewitt. Among the culprits: too many investment options, too many record keepers, too many record keepers' proprietary investments and too great an emphasis on annuity products.
Didn't follow best practices
DC plan consultants and other DC industry members acknowledge that 403(b) plan executives have often shot themselves in the foot by failing to always follow best practices. However, they say sponsors have been thwarted in some cases by laws, customs and contracts that have made it difficult to quickly simplify plans and reduce costs.
There are “concerns with contractual structures underlying 403(b) plans that prevent fiduciaries from exercising their fiduciary duty,” said Aaron Friedman, national tax-exempt practice leader at Principal Financial Group, Des Moines, Iowa. Like others interviewed for this article, he didn't comment on specific lawsuits.
“Many contracts still contain archaic provisions that assign all contractual rights to participants, even in ERISA plans where the fiduciary is supposed to control actions on behalf of participants and beneficiaries,” Mr. Friedman said. “It is these limitations that need to be solved prior to being able to look at finding cost efficiencies.”
Still, sponsors can take — or should have taken — steps to improve their plans regardless of certain constraints, consultants say.
“They should make changes before the lawsuits force them to do so,” said Barbara Healy, a Scottsdale, Ariz.-based consultant for SST Benefits Consulting. “They could have used the least-expensive shares. They could have reduced the number of investment options. They could have reduced the number of record keepers.”
Ms. Credico said plan executives should review their governance structure; re-examine investment options “to make sure they are reasonable and effective;” get a better idea of expenses in general and annuities in particular; and regularly benchmark and document fees.
“Consolidate record keepers and investments, and document why you did it or didn't do it,” Ms. Credico said.
Among the Schlichter firm lawsuits, for example, Johns Hopkins University, Baltimore, had five record keepers during the time period cited in the participants' complaint; Duke University, Durham, N.C., had four; and Vanderbilt University, Nashville, Tenn., had four.
The Schlichter law firm also sued on behalf of participants in 403(b) plans offered by Northwestern University, Evanston, Ill.; Yale University, New Haven, Conn.; New York University; Emory University, Atlanta; University of Pennsylvania, Philadelphia; Columbia University, New York; Cornell University, Ithaca, N.Y.; and University of Southern California, Los Angeles.
The law firm Sanford Heisler LLP has also filed a recent lawsuit against two 403(b) plans at Columbia University, New York.
“We are reviewing the complaint and intend to defend the university vigorously,” Beth Fortune, vice chancellor for public affairs at Vanderbilt University, wrote in an e-mail. Her comments echoed many universities' representatives who vowed to fight the lawsuits.
“The university employs a rigorous process to review all aspects of the investment options offered to its faculty and staff to ensure they are administered with the highest degree of care and prudence,” wrote Ron Ozio, director of media relations for University of Pennsylvania.
Several other university representatives defended their practices without commenting on their legal response. “Johns Hopkins University offers its employees a generous and carefully managed program of benefits, including for retirement,” wrote spokesman Dennis O'Shea. “We are in the process of reviewing the lawsuits that were filed against Johns Hopkins and other universities.”
Push to consolidate
All 403(b) plans were prodded to become more efficient by IRS regulations that took effect in 2009. The IRS didn't order record-keeping consolidation, but some plan executives decided consolidation was the best way to obey the IRS rules, which require preparing more comprehensive plan documents and devoting greater attention to loan and hardship withdrawal practices.
“Multiple record keepers do make administration very difficult, creating compliance vulnerability,” said Principal Financial's Mr. Friedman. “A significant vulnerability is with plan sponsors that tend to keep adding new investment options and rarely — if ever — eliminate anything.”
Among universities cited in the Schlichter firm lawsuits, Duke University had more than 400 investment options; Johns Hopkins, 440; Vanderbilt, 340; and Emory University had 177, during the time periods cited in the respective complaints.
Opportunities for cost cutting and menu simplification are more limited in most 403(b) plans than for 401(k) plans, said William Ryan, a Chicago-based associate partner for Aon Hewitt Investment Consulting Inc. For example, higher education 403(b) plans cannot use collective investment trusts, “thus limiting their ability to fully leverage their plan size to negotiate even lower investment fee levels,” Mr. Ryan said.
Citing a Spectrem Group 2014 study, Mr. Ryan noted that mutual funds represented 24% of investment assets of all 403(b) plans, while variable annuities accounted for 33% and fixed annuities represented 43%.
Even if a 403(b) plan created a new investment lineup, plan executives could only map the mutual fund components to new investments, Mr. Ryan said. “Plan sponsors normally don't have the authority to move an individual insurance/annuity contract” to another investment.
The Aon Hewitt report also advocated greater use of open architecture in 403(b) plans, moving away from high percentages of proprietary investments offered by record keepers.
Reforming a 403(b) plan can take years, Mr. Ryan said. Plan executives must hire consultants to review administration and investment lineups, and executives must issue RFPs, implement changes, streamline investment lineups and consolidate vendors.
“The industry is in the process of reforming, but it will take many years to undo legacy contracts and legacy issues,” Mr. Ryan said.
A recent survey of all types of 403(b) plans illustrated some executives' willingness to improve. Twenty-six percent of plan executives said they re-evaluated how plan expenses should be allocated last year vs. 16.8% in 2014. The survey results were issued Aug. 18 by the Plan Sponsor Council of America, Chicago, and Principal Financial Group.
This article originally appeared in the August 22, 2016 print issue as, "New target for fiduciary lawsuits".