In recent years, over 150 lawsuits have emerged alleging violations of ERISA [1] fiduciary obligations, primarily centered around “excessive fees” charged to participants in defined contribution retirement plans. A notable trend has also surfaced, focusing on the investment performance of target date funds. This article delves into this litigation trend and offers practical advice for employer investment committees and other plan fiduciaries.
Existing Fee-Based Lawsuits
Most existing lawsuits have concentrated on plan recordkeeping fees. Since recordkeeping is a generic service, these fees are easy targets for litigation. Fee comparisons can be easily translated into annual dollar amounts, allowing plaintiffs to make straightforward comparisons.
Other lawsuits have targeted the fees associated with investment option “share classes.” These fees are also appealing to plaintiffs because the underlying investment options can be identical, yet expenses and fees may vary, leading to different returns. If a plan fails to offer a less expensive “share class,” it opens itself up to legal challenges.
Target Date Fund Cases
Recently, a wave of lawsuits has emerged concerning the “target date” retirement funds offered in various plans. Some of these lawsuits allege excessive fees, while others, like the case against United Healthcare, argue that fiduciary violations have occurred due to poor investment performance of the plan’s target date funds.
The basis for this claim often involves comparing the average returns of the target date funds in question against certain indices and peer funds. For instance, the complaint scrutinizes the “2040” target retirement date funds from various providers, analyzing their performance over a five-year period.
Plaintiffs argue that the United Healthcare target date funds should have been removed from the plan due to their poor performance, as a prudent fiduciary would consider removing options that consistently underperform their benchmarks over rolling three- or five-year periods. This approach mirrors successful strategies in previous cases regarding recordkeeping fees and share classes—essentially, it’s about the numbers.
However, when evaluating target date fund performance, this quantitative analysis alone is insufficient.
Assessing Target Date Fund Performance
Evaluating the investment performance of target date funds is more complex than it appears. Making “apples to apples” comparisons is challenging. For example, some funds manage assets “to” a retirement date, while others manage “through” that date, affecting their asset allocation strategies.
Additionally, target date funds typically employ “glide paths” for de-risking investments as participants age. A more conservative approach may yield lower overall returns compared to a more aggressive strategy. However, lower returns do not necessarily indicate mismanagement; they must be evaluated in the context of risk.
Thus, simple comparisons of investment returns between different target date funds fail to capture the full picture.
Other Fiduciary Considerations
The aforementioned points highlight a critical aspect of fiduciary law often overlooked when allegations are based solely on investment results. Investing is inherently complex, and there is rarely a clear-cut solution. The law requires fiduciaries to engage in a thorough decision-making process before making investment choices. If this process is followed, a fiduciary may not be deemed to have violated their duty, even if the outcomes are less than ideal [5].
Some Practical Advice
Here are some practical recommendations for employer investment committees or plan fiduciaries:
First, when selecting target date retirement funds, carefully evaluate the glide paths and asset allocation strategies employed. Document the review process and the rationale behind selecting specific funds.
When assessing the performance of target date funds over time, consider their glide paths, asset allocations, and risk tolerances. Robust documentation of these ongoing reviews is essential.
If the committee lacks the expertise to make these decisions, consider hiring a professional investment advisor. Reasonable advisor expenses can be charged to the plan’s assets.
While it’s impossible to prevent lawsuits alleging poor investment performance, following these steps can demonstrate a thorough decision-making process, enhancing the committee’s defense against such claims.
Additionally, employers sponsoring retirement plans should consider obtaining fiduciary liability insurance coverage. Such policies can defend against claims and, if “nonrecourse,” protect the employer from liability up to policy limits. However, note that retirement plan assets cannot be used to purchase nonrecourse coverage; the employer must cover these costs from general assets.
