Insights From Encore Fiduciary on Fiduciary Liability & Other Risk Exposures of Employee Benefit Plans


Insights From Encore Fiduciary on Fiduciary Liability & Other Risk Exposures of Employee Benefit Plans

A Special Report from Euclid Fiduciary: Insights from the First Twenty-Five Excessive Fee and Investment Imprudence Cases of 2022

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By Daniel Aronowitz, Euclid Fiduciary

The immediate aftermath of the Supreme Court’s Hughes v. Northwestern excessive fee decision has not been helpful to plan sponsors.  We are experiencing an increase in case frequency, with a surge of cases filed by the Capozzi Adler law firm; courts have denied most motions to dismiss, using a minimal threshold to evaluate the plausibility of excessive fee and underperformance claims; and settlements continue at a high pace in the cases not dismissed.

The most common excess fee claim filed this year is against plans that allegedly have high recordkeeping fees and investments in high-fee retail share classes, led by a concerted attack against plans in the active Fidelity Freedom target-date funds.  From our perspective, the most concerning development is that plaintiffs have been filing cases challenging isolated actively managed investments in plans with otherwise overall low fees.

The following are insights from the first twenty-five excessive fee and imprudence cases filed against defined contribution plans in 2022.

  1. The Frequency is High — Comparable to the record 2020 rate, with 60% of cases filed by the Capozzi Adler law firm

With at least twenty-five cases filed in the first four months of the year, we are projected to have seventy-five to one hundred cases filed this year.  That is comparable to the approximately ninety-nine cases filed in 2020 when frequency spiked.  The number of cases dipped to at least forty-nine last year, depending on what you consider an excessive fee case [Euclid includes class actions that target only investment underperformance of a defined contribution investment option as an excessive fee case, even if the case does not allege excess fees].  We have seen some speculation that the rate of cases declined in 2021 as plaintiff firms waited on the Supreme Court to decide the Northwestern case.  But the real difference was that the Capozzi law firm filed over forty cases in 2020, but filed only eleven cases in 2021.  The firm appears to be back with a vengeance in 2022, however, filing sixteen of the twenty-five cases this year.  This tiny law firm with only seven ERISA lawyers – and only $3.9 million in their own sponsored defined contribution plan – has terrorized corporate America by continuing to file the majority of recent excessive fee cases.

The more important perspective is the size of plans being sued.  The lynchpin of an excess fee case is that the plan fiduciaries failed to leverage their plan asset size.  Given our analysis that at least twenty percent of the approximately 750 jumbo plans with over one billion in asset size have already been sued, most cases are now being filed against plans under one billion in assets, and ten percent of all cases are filed against plans under $500 million in size.  Finally, at least one plan under $100 million in assets has been sued so far this year [99 Cents Store with $69.9 million in assets and 2,718 participants].  This shows that plaintiff firms are increasingly targeting smaller plans that arguably do not have sufficient bargaining leverage to achieve the same low fees as mega plans.  And as shown below, we are most alarmed at the high-quality plans with low overall fees that are being unfairly sued.

  1. The Motion to Dismiss Defense Tactic is DOA as the Pleadings Standard is Diluted

Before the Supreme Court ruled in January in the Northwestern case, approximately three out of ten cases were dismissed at the pleadings stage.  Following the January 26th decision, however, we have seen only three cases in which a motion to dismiss has been granted, and two of those were temporary victories given that the court granted leave to amend.  Less than ten to fifteen percent of all cases are now being dismissed.  The Supreme Court held that the higher circumstantial evidence pleading standard applies to ERISA cases, but courts are ignoring this higher standard and requiring defendant plan sponsors to prove their defenses in court.

The worst decision of the year so far, in our opinion, is the North Carolina court in the Shoe Show case holding that it is an issue of fact whether a $40 million plan has sufficient bargaining leverage to negotiate lower fees.  Not far behind was the Humana case greenlighting a challenge to a $37 recordkeeping fee negotiated following a formal request-for-proposal, which was later reduced to $23-27 per participant after another RFP, notwithstanding that the plan fiduciaries had conducted two separate and periodic requests for proposals to ensure that the plan administration fees were reasonable.  We now have a court allowing an excessive fee case against fees that were based on competitive bidding.  In other words, plaintiffs are being allowed to challenge the results of RFPs.  We have reached rock bottom.

Our favorite decision so far is the dismissal of the Mitre purported excessive fee case filed by the Capozzi law firm.  The court granted the motion to dismiss for lack of standing authored by the Morgan Lewis law firm.  The court dismissed the case because the plaintiff did not own any of the alleged imprudent investments, but rather was invested in a single fund that was in the lowest share class that paid no revenue sharing.  The defense had also shown that the named plaintiff had paid only $5 in plan fees, but the court opined that even that could constitute actionable damages.  So we do not want to take too much solace from this minor, and likely temporary, victory.

A Diluted Pleadings StandardAs we have watched the trend in which courts have diluted the pleadings standard over the last two years, we have been imploring the ERISA defense firms to be more judicious in filing a motion to dismiss.  A major firm seems to finally acknowledge that a motion to dismiss should not be filed in every case, because the tactic is not working.  In the April 27, 2022 Law360 article 2 Rulings Highlight the Need for Different Defense Tactics, the Proskauer ERISA litigators argue that the Ninth Circuit reversals of the Trader Joe’s and Salesforce decisions call for consideration of waiting until the plan can file a more potent summary judgment motion.  Both of those cases attempted to justify the use of retail share classes by arguing that the higher-fee share classes were justified by revenue sharing to offset plan recordkeeping costs.  As we have already analyzed, we believe the Trader Joe’s lawyers at O’Melveny put on a more powerful defense by providing specific evidence that the revenue sharing was rebated to plan participants, but the case was nevertheless treated as if their defense was hypothetical and needed to be proven in expensive discovery.

The use of a motion to dismiss is like fighting malpractice claims with two hands tied behind your back.  This is because the plan fiduciaries are stuck with defending with a limited record that includes just the allegations in the complaint, which are slanted towards the plaintiffs’ biased view of the case and often contain unreliable and incorrect fees and improper benchmarks.  We have been frustrated when motions to dismiss are decided based on improper and inaccurate estimates of recordkeeping and investment fees, when courts should be relying on Department of Labor (DOL) mandated fee rule 408b2 plan and 404a5 participant fee disclosures that have the actual numbers.

We agree with Proskauer that it is “insanity” to keep filing a motion to dismiss in every case.  But our reasoning is broader than their argument that it is not working, because every case does not present the same facts with respect to plan fees.  Even though the Supreme Court confirmed that the higher circumstantial evidence standard of Iqbal and Twombly applies to ERISA cases, we believe the key reason that the effectiveness of the motion to dismiss has declined is that defense lawyers have not distinguished between high- and low-fee cases.  Defense lawyers filed a motion to dismiss in every high-fee case filed against Northwestern and the other twenty-plus universities.  This has meant that most published decisions have involved cases with high fee plans, including at the Supreme Court.  So when the plaintiffs sue a low fee plan like Humana, AT&T [$20 recordkeeping fee, but alleged initially and incorrectly to be $65], or Kroger [$30 recordkeeping fee, but evidence shows that the plan subsidizes most of the fees] with super low recordkeeping or investment fees, the courts are applying case law from high-fee cases like Northwestern [recordkeeping fees of $150-210+ with uncapped revenue sharing; and 129 investment options in higher-fee retail share classes] and Washington University [alleged $8.4 million in indirect revenue sharing to TIAA; multiple recordkeepers; and numerous Vanguard investments in higher-fee retail share classes] in which the courts were justifiably suspect of dismissing what might be a legitimate case.

Defense lawyers should not be filing a motion to dismiss to justify a retail share class unless they can prove with good evidence on the record that the actual all-in plan administration fees were low – by proving that any purported excessive amount was rebated to participants.  At a minimum, the defense needs to give the actual plan costs after revenue sharing is applied, not just arguing that it is justified without proof.  This is what the Trader Joe’s defense did, but they got lumped in with Salesforce and the many other cases that offered a more generic defense, without actual numbers, that revenue sharing somehow justified the higher share classes without proof.  To date, most motions to dismiss that we have read just generically say that revenue sharing justifies the higher class without any actual proof backed by specific numbers.  Courts have rejected this weaker argument that does not substantiate the argument, and it has harmed the cases in which the argument has been made better, like in Trader Joe’s.

As we have urged before, the onslaught of unfavorable decisions underscores that defense lawyers can no longer categorically argue that all excessive fee cases are unfair.  Threshold motions must be limited to cases with low fees, and should not be filed in cases that legitimately allege high fees.  This has confused the courts, who are now suspect of any attempt to dismiss the case before discovery.  Finally, any motions seeking to dismiss a case need to use the Department of Labor mandated disclosures to give full context of the all-in fees of the plan.  Stated differently, if the plan has low fees, then the court needs to take that into context.  But we have seen so many motions that rely only on the biased and often misrepresented facts of the plaintiffs’ complaint.  That has not worked, and will continue to lead to more losses for plan sponsors.

  1. Most Cases are Settled and Not Litigated to Conclusion, with Settlements Averaging 30-40% of the Alleged Damages Model

In denying the motion to dismiss recently, the judge in the Juniper Networks excessive fee case stated that “Juniper will have ample opportunity at trial or other merits proceedings to make its case.”  But that is now how it works in real practice.  Given that only a handful of cases have been litigated to summary judgment or the trial stage, a loss of the motion to dismiss has portended expensive settlements in most cases.  We have chronicled how plans like Walgreens with low-cost funds, or Costco with low recordkeeping fees, have settled after losing the motion to dismiss, seemingly to eliminate the litigation risk – certainly not because they were conceding that the plan fiduciaries had committed fiduciary malpractice.  But this has only buttressed the plaintiff business model to second-guess plan fiduciaries by alleging fiduciary malpractice, because they can cash in when the case proceeds past the pleadings stage.

A sample of the 2022 settlements show how plan sponsors are prejudiced by the litigation uncertainty and high damage models:

Costco:  $5.1 million [plan size $15.5b/174,403]

Washington University:  $7.5m [$3.8 billion/24,000]

Walgreen’s:  $13.75 million [$4.6 million in attorneys’ fees]

Zachry Holdings:  $1,875,000 [plan size $919 million/12,000] [Fidelity Freedom Funds]

Bronson Healthcare:  $3 million [$737 million/21,528]

Wells Fargo:  $32.5 million [$40 billion/344,287]

Our analysis of the settlements is that plans under $1b settle for approximately 30-40% of the damages model, whereas plans over $1b settle closer to 10% of the alleged damages model, or 1-5 basis points of plan assets.  Proprietary cases involving investments from the plan sponsors, like the Wells Fargo case, generate the highest settlements.  Indeed, most of the settlements over $10 million involve proprietary investments from the plan sponsor, representing 5-10 basis points of plan assets.  The exceptions are the settlements in many of the university cases.

In a world in which courts are allowing the vast majority of cases to proceed to discovery, without any distinction between legitimate and illegitimate cases, we will have to spend more time disputing the damages model.  The alleged damages in these cases can be staggering, particularly for alleged investment under-performance cases in which plaintiffs are benchmarking against the highest performance funds in every category.  This is where defense lawyers will need to focus their efforts to provide value to plan sponsors.

  1. Plaintiffs are Alleging Imprudence of Isolated Investments, Even When the Overall Fees of the Plan are Low and Contain Low-Cost Index Funds

The Supreme Court held in Northwestern that plan fiduciaries need to remove all imprudent investments, and that participant choice of low-cost index funds does not insulate against liability for imprudent investments.  This mirrored the Department of Labor’s position in their amicus brief.  No one disputes that plan fiduciaries should remove imprudent funds – the question is how you judge whether an investment option is imprudent, but that was not addressed.  The ruling nevertheless created an immediate risk that plaintiff firms would use the ruling as license to sue against isolated investments in the plan, and this is exactly what has happened.   At least four of the cases filed this year challenge a few actively managed investment options without giving the court context of the all-in low fees of the plan, or that the active investments were prudent when considered in the context of the other, mostly index, investment options in the plans.

As noted, it is noteworthy that neither the Supreme Court, nor the Department of Labor, offered any guidance as to how to measure whether an investment is somehow imprudent – just that you need to remove imprudent investments.  This has led to blatant misrepresentations of alleged fiduciary malpractice.  At least four of the first twenty-five cases this year are alleging investment imprudence in plans with overall low investment fees and sound fiduciary investment processes:

  • Mattson v. Milliman: The $1.7 billion Milliman plan was sued over three plan target-risk investments out of twenty available investments, representing less than 15% of overall invested assets and invested in by less than 10% of plan participants.  The case appears to be a purely under-performance case with no claim of excessive fees.  That is likely because the three target-risk funds charge only 17 basis points – lower than just about every active fund available in the entire market.  The three funds are named “wealth preservation” funds that appear to be designed to be invested conservatively, but plaintiffs attempt to benchmark these conservatively invested funds against aggressively managed funds.  In a fairer judicial system, aggressively invested funds would not be a plausible benchmark compared to aggressive funds with a different investment intent.
  • Lourdes M. Teodosio v. Davita, Inc.: Plaintiffs ask the court to infer imprudent investment options based on three actively-managed investments when in fact the plan is dominated by low-cost index funds and the all-in fees for the plan are less than .15% — well below any valid benchmark.  The plan QDIA in which more than one-half of the plan is invested is the JP Morgan Smart Retirement Passive Blend Index Fund in the CF-B institutional share class that carry low investment fees of .14% — below the .19% retail share class.  Five of the twelve remaining fund options are index-based, and over 75% of the plan is invested in these low-cost index funds.  Plaintiffs purport to challenge less than 5% of the plan’s investment options without transparently disclosing the actual investment lineup.
  • Adams v. Dartmouth-Hitchcock Clinic: Plaintiffs allege excessive investment fees based on the plan offering four active funds with fees above the ICI 2021 median of .30% for domestic equity and .50% for international equity.  But the all-in fee for the plan is super low at .16% – approximately one-half of the ICI median cited in the complaint.  The reason the investment fees are so low is that the QDIA is the .09% State Street target-date funds in the lowest K institutional share class.  The plan also has eight Vanguard index funds priced at .05% to .12%.
  • Kruzell v. Clean Harbors Environmental Services, Inc.: Plaintiffs allege imprudence of eight investment options averaging .59% with minimal .02% revenue sharing, arguing that the plan fiduciaries should have paid a higher 1.02% investment fee with higher .54% revenue sharing, for a total investment fee of .48% – a modest .11% investment fee differential, but an increase in revenue sharing of .52%.  In this case, the argument is that the plan should have used revenue sharing, which is the opposite of most cases.  Plaintiffs do not inform the court how much is invested in these eight investment options, but they are not the primary investments in the plan.  To this point, plaintiffs fail to disclose that nearly $400 million of the $814 million plan is invested in the low-cost Vanguard index and indexed target-date with fees between .04% and .09%.

These four cases show that the Northwestern case has emboldened plaintiff law firms to challenge isolated investments, even if the investments make sense in the context of the entire plan.  This type of lawsuit that takes a few investments out of context is becoming increasingly common, and the two-page decision denying the motion to dismiss in Reichert v. Juniper Networks, Case 3:21-cv-06213 (N.D. Calif.) shows that this misleading tactic can work.  Plaintiffs complain about two isolated investments in the Juniper plan – the AB Discovery Value Z Fund and the Fidelity Total Bond Fund are imprudent, but fail to disclose what the Form 5500 filing reveals, which is that the plan offered forty-four investments of 10 basis points (.10%) or lower, and fourteen of these low-cost investments are just two basis points (.02%).  But the court’s short opinion states that the amended complaint “provides a wealth of factual allegations about mismanagement of the plan . . . [and t]hese facts are more than enough to plausibly allege violations of Juniper’s duty of prudence.”  (citing Hughes v. Northwestern with no explanation of the context-specific plausibility standard required).  The court cites to the reversals of the Trader Joe’s and Salesforce cases in the 9th Circuit as purportedly following the Hughes case, rationalizing that “Juniper will have ample opportunity at trial or other merits proceedings to make its case.”  But as we have shown above, the loss of the motion to dismiss immediately prejudices the plan sponsor defendant because they face high defense costs and huge liability, which is leveraged into a settlement in most cases.  The cost to prove your innocence of fiduciary malpractice is too high, but this has not stopped courts from lowering the threshold bar to claim malpractice in the first instance.

Finally, given that ERISA imposes a duty of diversification, we continue to believe that the only way to judge whether an individual investment is imprudent is by looking in context at the total investment lineup [i.e., an active fund makes sense when combined with low-cost index options].  Unless Congress is going to amend ERISA to restrict defined contribution plans to index-only investments, then we must urge all courts to understand that fiduciaries properly judge the prudence of active funds in the context of the entire investment lineup.  In all four cases cited above, the challenged investments make sense in the context-specific overall lineup of the plans.

  1. One out of Every Three Cases is Against Active Target-Date Funds in the Allegedly Wrong Share Class, with Fidelity Freedom Funds Under Attack

If the number one target of excessive fee cases is funds in a retail share class when lower-fee share classes are available, the close and related number two target is using active target-date funds.  Nine of the initial set of 2022 cases are filed against plans with active target funds.  The key target by the Capozzi law firm is against the Fidelity Freedom funds.  Last year, a number of cases were filed alleging imprudence in selecting the Fidelity Freedom active target-date funds, including cases against LinkedIn, MedStar Health Inc., Zachry Holdings, Inc., Prime Healthcare Services Inc., Quest Diagnostics, Omnicom, and CommonSpirit.  In 2022, the Capozzi law firm has doubled down, filing seven lawsuits to date against plans with Fidelity Freedom target date funds:  (1) Boston Children’s Hospital; (2) DISH Network; (3) Beth Israel Deaconess Medical Center; (4) L3 Harris; (5) 99 Cents Store; (6) Rush University Medical Center; and (7) Univar.  To complete the picture, the Schlichter law firm filed a case against PPL Corporation alleging that the plan fiduciaries imprudently switched from Fidelity Freedom active funds to Northern Trust Focus funds at a more expensive L share class at 9 bps when 2 or 5 bps lower-share classes were available.  Two other cases – against Taylor and BDO – allege the same type of imprudence claim against these plans for offering T. Rowe Price active target-date funds at an improper share class with higher than necessary fees [for example, BDO had a .43% fee for the TRP funds when .37% or lower were allegedly available for large plans].

The claims against plans with Fidelity Freedom active target-date funds follow the same template every time.  We use the DISH Network complaint to demonstrate, but the complaints are almost verbatim copycat lawsuits.  First, Capozzi alleges that the plan fiduciaries selected the “riskier and costly Freedom funds (the “Active Suite”)” instead of the “substantially less costly and less risky Freedom Index funds.”  According to the complaints, “[t]he active suite is high-risk and unsuitable for plan participants.”  Second, Capozzi alleges that no prudent fiduciary would have selected the “dramatically more expensive” active suite because it is “riskier in both its underlying holdings and its asset strategy.”  To Capozzi, the choice of the Fidelity Freedom active funds and failure to remove them “constitutes a glaring breach of their fiduciary duties.”  Third, Capozzi next alleges that “investors have lost faith in the active suite from Fidelity,” with nearly $16 billion withdrawn from the fund family in recent years.  And finally, Capozzi alleges, with a chart of purported returns against alternative funds from other companies, that the active suites has experienced “miserable performance” and “inferior returns” when measured against any of the other most widely utilized TDF offerings from American Funds, T. Rowe Price, Vanguard, and J.P. Morgan.

Fidelity finally responded to this attack on the company’s Fidelity Freedom funds by filing an amicus brief in the Commonspirit Health case before the United States Court of Appeals for the Sixth Circuit.  Fidelity characterizes the complaint as a “broadside attack on the wisdom of active management,” notwithstanding that “a majority of assets in large 401(k) plans continue to be allocated to active strategies.”  Fidelity stated that the complaint is asking the court “to do the opposite of what Supreme Court has instructed [to give due regard to the range of reasonable judgments a fiduciary may make based on her experience and expertise], effectively arguing that no prudent fiduciary could have chosen the Freedom Funds in their plan, instead of the Freedom Index Funds.”  To the contrary, Fidelity argues that Freedom Funds are among the most popular target-date fund suites available, with thousands of retirement plan fiduciaries offering them to plan participants.  Fidelity cites that the active Freedom Funds held vastly more assets than the Freedom Index Funds:  $167 billion vs. $27 billion.  According to Fidelity, it is not plausible to ask the court to infer that “these thousands of plan fiduciaries breached their duties under ERISA by not adopting her personal preference for passively-managed funds.”  The amicus brief further demonstrated that the Freedom Funds have delivered strong performance, net of fees, over the relevant time period.  According to Fidelity, with the more appropriate longer term perspective of a ten-year horizon, the Freedom Funds have outperformed their Freedom Index Fund counterparts net of fees by an average of more than 50 basis points annually.  Finally, the amicus brief concludes that the Capozzi “one-size-fits-all solution is unsupportable,” as “there is no single asset allocation or risk/reward profile that is the ‘best’ for every retirement plan or investor.”

The O’Melveny brief is a masterful defense of active investing and the Fidelity Freedom active funds.  It proves conclusively that the numerous complaints filed by the Capozzi law firm alleging inferior returns by the Fidelity Freedom active funds are just plain wrong and should be rejected by courts.  It casts doubt on the investment returns that Capozzi has inserted in their complaints as false and intentionally misleading – certainly not worthy of a court to assume as “true” and correct under the pleading’s standard as plausible.  We note, however, that it does nothing to defend the fees charged, and whether Fidelity is charging higher fees in higher-fee share classes to large plans when it offers lower-fee share classes to other investors.  But it demonstrates that the investment imprudence and performance claims are improper in the Fidelity Freedom cases, and how many excessive fee complaints are strike suits without proper evidentiary support.

  1. Nearly Every Case Alleges Excessive Recordkeeping Fees Based on Misleading and Inappropriate Benchmarks

We have written a recent white paper to document how plaintiff firms are misrepresenting whether plans have excessive recordkeeping fees based on misleading claims and improper benchmark.    We continue to decry the use of inaccurate estimates of recordkeeping fees when plaintiffs have accurate fee disclosures mandated by the DOL.  In addition, the most common current tactic is to list four to ten other purportedly comparable plans, and claim that the plan being sued has excessive fees in comparison.  Plaintiffs characterize recordkeeping as commodity services that are the same for every plan.  In response, defendants argue in every motion to dismiss that plaintiffs have failed to compare the level and quality of recordkeeping services.  But courts reject most of these defenses in a threshold motion.  In our view, the plan sponsors dismissal motions have failed to articulate exactly how plan administration servicers can vary, and how it can affect the cost.

Until now.  The best motion to dismiss we have read to defend recordkeeping fees is in the Cunningham v. USI Insurance Services, LLC case filed by the Simpson Thacher firm.  The USI case asserted that the plan recordkeeping fees averaged $109 per participant based on estimates from the Form 5500 – ignoring that USI, which handled the recordkeeping for its own plan, issued a DOL-mandated fee disclosure to the plan and participants with the exact recordkeeping fee every quarter.  Like most current excess fee complaints, plaintiffs alleged this amount was imprudent because it exceeded the amounts of ten other “comparable plans” in a chart in the complaint.  Rather than take the usual defense approach of claiming that the services between the USI and the “comparator” plans were not the same, the Simpson Thacher lawyers actually tried to prove it.  They showed the court that “[w]hile the Complaint lists ten other purportedly ‘comparable’ plans in which participants receive ‘materially identical’ services (citations omitted), none of those ten plans offer participants the pension consulting or valuation services USICG offers to USI plan participants.”  The defense showed the court that the Form 5500 lists the service codes for plan administration in Schedule C, including recordkeeping and information management (computing, tabulating, data processing, etc.); investment advisory (participants); investment advisory (plan); participant loan processing; direct payment from the plan; and investment management fees paid directly by the plan.  The defense demonstrated that the plaintiff comparator chart of purportedly lower recordkeeping fees were based on more limited services to those plans.

This novel defense strategy of showing that USI performed additional services to justify higher fees worked, as the court rejected the claim (without prejudice) because the plaintiff failed to allege how she calculated the plan’s direct and indirect fees, and how the sum of those fees was excessive in relation to the specific services provided to the plan as compared to alleged “comparable plans.”  Like the more rigorous proof in the Trader Joe’s case to justify the revenue sharing with participant rebates, the USI lawyers went beyond a generic argument that the services are not the same between plans.  The defense gave the court a tangible reason to dismiss the case, and it worked (so far).  This is the model going forward for any attempt to dismiss the case at the initial stage, or how to prove the case later on at the summary judgment stage.

The Euclid Perspective – Who is Accountable When a Plan is Not in the Lowest-Fee Share Class

We think these insights give better perspective into what is happening currently in excessive fee litigation:  (1) frequency is up; (2) dismissal rates are way down; (3) settlements are up; and (4) more cases are being filed against smaller plans and plans with good overall fees.  We also find it noteworthy how many cases are being filed against Fidelity Freedom active target-date funds.  We hope this review of trends is useful to plan sponsors as they continue to work to de-risk their plans.  But we want to end with some thoughts about the frequent claims that plans are invested in funds in the wrong share class.

As we have shown, the most common claim in an excessive fee case that survives a motion to dismiss is that one or more investments is in a high-fee share class when a materially identical investment is available at a lower price.  We look at plan fees every day, and see this issue in most plans, including plans with overall low fees and good fiduciary processes.  The most common example we see is a large plan in which Fidelity is the recordkeeper, and the plan has more than $50 million invested in a popular fund like the Fidelity Contra Fund at the .81%  retail share price, or the .74% class K shares, when the K6 shares offer the same fund at .45% or between .35-43% in CIT share classes.  In the Fidelity Pricing Options for Retirement Plans updated as of February 28, 2022, the minimum for the .43% CIT share class is $50m invested in the fund.

The question we have is who is at fault when the plan is in the wrong share class.  Plaintiff law firms cannot sue Fidelity directly because Fidelity is not a plan fiduciary, so they allege fiduciary malpractice against the plan fiduciaries for what is paid to Fidelity.  But we find fault with Fidelity – or any other investment provider – when they do not inform their clients that they are eligible for lower fees.  Fidelity knows they are dealing with plan fiduciaries who are held to a high liability standard, and we have not seen Fidelity or any other recordkeeper or investment provider try to protect their clients from these lawsuits.  Most of these plans have plan consultants, and we think they bear responsibility as well.  Plan providers do not have to tell you that they are over-charging you, but they should.

There is a solution:  demand accountability from the service providers.  If the Department of Labor is not going to step in and protect plan fiduciaries from these lawsuits by articulating a fair standard, or impose the liability on plan providers, then we cannot rely on protection from the legal standard.  And we have seen that we cannot rely on courts to side with plan fiduciaries.  So the solution has to be in the contracts with recordkeepers and investment providers.  Plan sponsors must demand that outside vendors will indemnify the plan fiduciaries for any claim that they are in the wrong share class.  The damage model is the alleged overpayment of money to Fidelity, T. Rowe Price and other recordkeepers and investment providers.  If the providers are not going to protect their clients from this liability, then the contracts need to change.

Plan sponsors need to demand accountability from their providers.  Simply put, if you want to do business with my plan, then you need to indemnify my plan if we are held liable for overpaying plan recordkeeping and investment fees to your firms.  If you do not want to stand behind the value of your product, then hopefully there is another quality company that will.  It is time to change the paradigm.

We are not done with this issue, and we will continue to develop this argument to propose better ways to protect sponsors from unfair and capricious litigation.

Disclaimer:  The Fid Guru Blog is intended to provide fiduciary thought leadership and advocacy for the plan sponsor community in areas of complex fiduciary litigation.   The views expressed on The Fid Guru Blog are exclusively those of the author, and all of the content has been created solely in the author’s individual capacity.  It is not affiliated with any other company, and is not intended to represent the views or positions of any policyholder of Encore Fiduciary, or any insurance company to which Encore Fiduciary is affiliated.  Quotations from this site should credit The Fid Guru Blog.  However, this site may not be quoted in any legal brief or any other document to be filed with any Court unless the author has given his written consent in advance.  This blog does not intend to provide legal advice.  You should consult your own attorney in connection with matters affecting your legal interests.

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