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Defined Contribution

401(k) suits point to need for litigation risk prevention

James P. McElligott Jr. said the lawsuits are driving investment changes.

A series of recent settlements in ERISA lawsuits illustrates to defined contribution sponsors why an ounce of prevention is worth a pound of cure.

These settlements cover financial institutions that have filled their 401(k) plans with proprietary investments, provoking allegations of self-dealing that violate their fiduciary responsibilities under the Employee Retirement Income Security Act.

Although defendants admitted no wrongdoing and agreed to pay money, many settlements include non-monetary remedies for plan management practices that could have reduced litigation risk in the first place.

These requirements "are not onerous to a great extent," said James P. McElligott Jr., the Richmond, Va.-based counsel for McGuireWoods LLP, who represents sponsors in ERISA cases. "There's no excuse for people not looking seriously at this issue." Mr. McElligott, like other attorneys interviewed, declined to comment on specific cases.

Some settlements have been strictly financial ones, but the non-monetary requirements appear to ERISA attorneys as reflecting common sense for fiduciaries.

"Some of these things you should think of at the base knowledge level" of plan management, said Stephen Rosenberg, a Boston-based partner for The Wagner Law Group.

In recent settlements, for example, defendants have agreed to remedies ranging from hiring independent fiduciaries to monitor plans' investment selections to taking ERISA training.

Jerome Schlichter, the St. Louis attorney who has been lead plaintiffs' counsel in many ERISA cases, said he insists on non-monetary requirements as part of settlements.

"It will determine benefits in the future," said Mr. Schlichter, founder and managing partner of Schlichter Bogard & Denton LLP, St. Louis. "The value of non-monetary compensation in the future can dwarf the monetary compensation of the past."

In one of Mr. Schlichter's cases, BB&T Corp., Winston-Salem, N.C., agreed on Dec. 4 to pay $24 million to settle self-dealing allegations by participants in the company's 401(k) plan, pending court approval.

Among the non-monetary features is a requirement that BB&T plan fiduciaries hire a consulting firm that will issue an RFP for an unaffiliated investment consultant who will provide independent consulting services. This consultant would make "an objective evaluation of the options of the plan," the document said. BB&T plan fiduciaries also must participate in a training session regarding fiduciary duties under ERISA.

Other settlements

BB&T joins a host of other financial institutions in settling ERISA self-dealing cases. Just before Thanksgiving, Waddell & Reed Financial Inc., Overland Park, Kan., agreed to a preliminary settlement of $4.875 million. In early November, Jackson National Life Insurance Co., Lansing, Mich., agreed to pay $4.5 million.

In August, Deutsche Bank Americas Holding Corp., New York ($21.9 million), and Citigroup Inc. ($6.9 million) settled claims that they — like other fiduciaries in these cases — had violated their ERISA duties by offering proprietary investment products in their 401(k) plans without adequately examining other choices. Deutsche Bank agreed to have an independent fiduciary rule on any plan action regarding a proprietary fund.

And more settlements are on the way. On Dec. 6, Franklin Resources Inc., San Mateo, Calif., agreed to settle self-dealing allegations against the Franklin Templeton (BEN) 401(k) Retirement Plan. The terms will be announced within 60 days of the ruling.

Many of the self-dealing lawsuits have been filed within the last three years, although some were filed during the previous decade. The flurry of settlements in 2018 as well as those in 2017 indicate that sponsors have decided it's better to reach an agreement than pursue a case to trial. As such, there have been no self-dealing case verdicts favoring plaintiffs.

Some financial firms have dodged the litigation bullet, at least at the U.S. District Court level, by winning dismissals. One example is Wells Fargo & Co., which prevailed in 2017 in a federal District Court as well as in a federal appeals court in August 2018.

A May report by the Center for Retirement Research at Boston College, citing data from Bloomberg BNA, counted 46 self-dealing lawsuits having been filed against financial services companies between 2007 and January 2018, covering proprietary products as well as deals with affiliates or partners.

Most cases were identified as pending.

Numerous complaints

The litany of complaints in these lawsuits include allegations that sponsors paid excessive fees, kept poor-performing investments and failed to monitor funds' performance. Other complaints blame sponsors for paying high administrative fees via revenue sharing with affiliated firms and failing to consider cheaper, similar funds from non-proprietary sources.

"They look like fat targets right off the bat" for ERISA lawsuits, said Wagner Law Group's Mr. Rosenberg, referring to financial firms using proprietary products in their own 401(k) plans. "However, that alone doesn't mean per se that there is something wrong."

Mr. Schlichter agreed that financial firms offering proprietary products in their 401(k) plans isn't automatically improper, warning that sponsors must show they didn't restrict their search.

"When you have proprietary investments or in-house record keepers, it raises red flags about whether this is a prudent process," said Mr. Schlichter, referring to the prudent investor rule that guides ERISA fiduciaries. "The process has to be objective and thorough, and it cannot favor proprietary funds or in-house record keepers."

Attorneys representing DC sponsors said companies can reduce litigation risk by documenting their procedures and by showing they reviewed the investment landscape before selecting proprietary products. "The biggest issue in all of this is not to miss the point," said Andrew Oringer, a New York-based partner at Dechert LLP, referring to the need for detailed proof of a comprehensive process.

Lawsuits have caused sponsors "to be more detailed in their processes and to validate using their own products in their investment menus," he said.

Mr. Oringer counsels clients to compare their proprietary funds to other investment managers' funds. "You don't want to be accused of not having looked at the issues," he said.

Still, some recent settlements demonstrate that financial companies needed to make significant changes. In May 2017, TIAA-CREF, New York, settled a self-dealing lawsuit involving two DC plans with a $5 million payment as well as six non-monetary remedies.

Among the requirements, TIAA had to add at least 10 non-proprietary investment options, including five options that would have investment management fees of 15 basis points or less. TIAA said it would hire an independent consultant to advise fiduciaries on investment option performance and costs "relative to the appropriate peer groups."

Allianz Asset Management of America, Newport Beach, Calif., paid $12 million in December 2017 to settle a self-dealing lawsuit against its 401(k) plan. The settlement agreement said that for three years an independent investment consultant will annually evaluate the plan's investment lineup and review the plan's investment policy statement.

Commonplace

Financial firms using proprietary products in their 401(k) plans is common as a proxy-marketing device, said Mr. McElligott of McGuireWoods. "Many do this routinely," he said. "They say, 'We want to tell our customers that we invest in these products.' "

However, as suits have proliferated and as many DC plans move away from relying heavily or solely on their record keepers' products, financial firms have started to get the message. In the past, "there was a lack of sensitivity to ERISA requirements" among plan fiduciaries at some financial firms, he said.

He predicted that "in another year or two," the volume of self-dealing lawsuits — at least those that could lead to settlements — will "certainly diminish" as fiduciaries do a better job of employing best practices.

Until then, settlements remind defendants what they should have done and sponsors as a whole what needs to be done. "It's always great to learn from other peoples' mistakes," Mr. McElligott said. "Some folks are quicker learners than others."