This is the tenth in a series of articles about Best Practices for Plan Sponsors.

To be clear, “best practices” are not the same as legal requirements. Instead, they are about better ways to manage retirement plans. In many cases, though, “best practices” also are good risk management tools because they should exceed legal standards, address areas of concern, or anticipate future developments as retirement plans and expectations evolve.

Plan sponsors should be aware of the latest trends in fiduciary litigation to help manage the risk of being sued and, if sued, the risk of being liable. In my past two plan sponsor posts, Best Practices for Plan Sponsors #8 and #9, I discussed the lessons learned from the conditions in the settlement agreements for the Anthem and Vanderbilt cases. This article—about the BB&T settlement agreement—is another example of the importance of using appropriate share classes and a good process for selecting investments and monitoring service providers.

BB&T sponsored a large 401(k) plan. The complaint alleged that the plan did not take advantage of its size to select lower-cost mutual funds and negotiate lower record keeping costs. In addition, it alleged that the fiduciaries imprudently selected and retained underperforming investment funds.

The case settled for $24 million. While that is a lot of money, the settlement agreement’s non-monetary conditions are the “lessons” for plan fiduciaries.

The participants were represented by the Schlichter, Bogart & Denton law firm. As is typical of that firm, the settlement didn’t end with the money. Instead, the agreement imposed a number of conditions on the plan and its fiduciaries. Here are some of the most interesting conditions, followed by my comments.

The first condition is that the fiduciaries must:

  • Engage an unaffiliated consulting firm with expertise in conducting requests for proposals (RFPs) for investment consulting services
  • Work with that firm to conduct an RFP for investment consulting firms that are not affiliated with BB&T; the RFP process must identify at least three qualified candidates for consideration by the plan committee
  • Interview the finalists
  • Select and engage an independent, qualified investment consulting firm.

Comment: It seems fairly obvious that the first step in developing a new process for the prudent oversight of a 401(k) plan’s investments would be to select a competent investment consultant. However, this goes even further. The committee must select an independent RFP consultant to help identify the investment consultant finalists for the committee to interview. The objective is to ensure both the independence and the expertise of the investment consultant. In that sense, it is a good lesson for all 401(k) plan fiduciaries─use an independent consultant with significant experience with plans that are similar to yours.

Then, the investment consultant must:

  • Evaluate the plan’s investment options and provide the committee with recommendations about the investment options, taking into consideration:
  • Whether the lowest-cost share class available for a mutual fund is being used in the plan
  • Include in the plan collective investment trusts or separately managed accounts with the same investment style and risk profile as that mutual fund when they also are offered by the manager of a mutual fund in the plan
  • Review the pros and cons of including an additional index fund in any asset class for which there is an actively managed investment
  • Examine the extent to which any 12b-1 fees, sub-transfer agency fees or other monetary compensation paid to the record keeper are rebated to the participants or, alternatively, maintained by the record keeper.
  • Present three choices for the committee to consider if the investment consultant recommends the replacement for an existing investment or a new investment to the plan; the presentation of the investment options must include the investment consultant’s analysis of the fees associated with each of the three options, including whether the lowest-cost investment class is being recommended.
  • The lawyers for the plan fiduciaries must provide the plaintiffs’ class action attorneys with a written summary of the investment consultant’s recommendations and the decisions of the committee.

Comment: The focus on costs, share classes and index funds should not surprise anyone who has followed 401(k) litigation in recent years. The concerns about costs and share class have merit—but can be overdone, while the preference for passive versus active has not been supported by court decisions. Let me explain.

The law says that fiduciaries must consider the costs incurred by the plan; plan assets cannot be squandered by overpaying for investments or services. But the law does not require that fiduciaries use the cheapest investments; instead, fiduciaries can pay reasonable amounts for investment services. So long as the costs are reasonable for the investments or services, the law is satisfied. But, as plans grow in size, they can buy lower-cost share classes of the same funds. It would likely be a waste of money to pay for a more costly share class when a lower-cost one is available. (Note, in some cases a more expensive share class can have a lower “net” cost, e.g., when 12b-1 fees are restored to the plan.)

In terms of active versus passive, ERISA does not distinguish between the two. Instead, fiduciaries are required to evaluate quantitative and qualitative information about the investments and determine whether the investments reasonably can be expected to perform well in the future, net of costs. It also is proper for fiduciaries to consider factors other than performance where those factors may be appropriate for the covered workforce. An obvious example is that fiduciaries may prudently select a more aggressive or more conservative series of target date funds based on consideration of the needs, circumstances and risk tolerance of the covered employees.

The settlement agreement requires that the consultant and the committee consider whether the managers of the plan’s mutual funds also offer collective investment trusts or separately managed accounts “with the same investment style and risk profile.” While no court has yet held that this is required, I am concerned that it may reflect the future direction of the law. An eye toward the future suggests that investment consultants and committee members should take that into account.

  • The committee must participate in a training session on ERISA’s fiduciary duties conducted by experienced ERISA counsel.

Comment: My view is that plan committees should receive fiduciary education from an experienced ERISA attorney once a year. That training should cover both “microscope and periscope” issues. To explain, microscope education is about the “known” issues; we can put those under the microscope and analyze the requirements, how committees have gotten into trouble and what committees should be doing now. But periscope education is for emerging risks. The ERISA attorney should scan the horizon of emerging issues and educate committee members on the most likely future threats. Remember that the general statute of limitations for ERISA claims is six years. That means that our conduct today can be reviewed for years to come.

  • The committee agrees to rebate to the plan participants any 12b-1 fees, sub-transfer agency fees, or monetary compensation that any mutual fund company (affiliated or unaffiliated) pays or extends to the record keeper … based on the plan’s investments.

Comment: This arrangement is sometimes referred to as equalization or leveling of “revenue sharing.” When revenue sharing is restored to the accounts of the participants who owned the investments that paid the revenue sharing, their accounts will have the benefit of a “net” expense ratio that could justify the higher nominal cost of mutual funds that pay revenue sharing. If a plan committee decides to use revenue sharing mutual funds, it should consider, for risk management, “equalizing” payments in that manner. However, from a legal perspective—at least based on current court decisions, the revenue sharing can be used to pay plan service providers, so long as the compensation, including those payments, of the service providers is not excessive.

  • If BB&T decides to charge a fee for the record keeping services it provides to the plan, the fiduciaries must conduct an RFP for record keeping and administrative services.

Comment: Plan sponsors don’t typically recordkeep their own plans, so this doesn’t directly apply to most plans and fiduciaries. However, there is a lesson to be learned. That is that fiduciaries, such as committee members, must regularly monitor the costs of their service providers. While RFPs are one way to do that, they are too expensive and burdensome to be used for regular monitoring of recordkeeping fees. Benchmarking is a good substitute for that.

Concluding Thoughts

As with the Anthem and Vanderbilt cases, the BB&T settlement teaches fiduciaries that they need to pay attention to the share classes of the mutual funds in their plans. A committee should devote at least part of one meeting a year to a report by its investment adviser on the share classes of the plan’s investments and compare those to the share classes that are available to the plan. While not yet required by any court decisions, advisers and committees also should consider whether comparable collective trusts and separately managed accounts are available at a lower cost. This is a high-risk area and should be treated accordingly, that is, with close attention and care.

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The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

Lessons Learned from Litigation (#2)—the Vanderbilt Case

This is the ninth of the series about Best Practices for Plan Sponsors.

Plan sponsors should be aware of the latest trends in fiduciary litigation in order to manage the risk of being sued and, if sued, of being liable. In my post, Best Practices for Plan Sponsors #8, I discussed the lessons from the settlement of the Anthem case. The Vanderbilt settlement is another example of the importance of using appropriate share classes and of a good process for selecting investments and monitoring service providers. This article discusses the Vanderbilt lawsuit and the conditions in the settlement agreement.

Vanderbilt sponsored a large 403(b) plan (about $3.4 billion in 2014). The complaint alleged that the plan did not take advantage of its size to use lower cost share classes of mutual funds and to negotiate lower costs for its recordkeeper.

The case settled for $14,500,000. While that is an eye-catching dollar amount, the conditions attached to the settlement offer more helpful lessons to plan fiduciaries.

The participants were represented by the Schlichter, Bogart & Denton law firm. As is typical of that firm, the settlement didn’t end with the money. Instead, the agreement imposed a number of conditions on the plan and its fiduciaries. Here are some of the most interesting, together with my comments. Keep in mind that this is for a 403(b) plan.

  • The participants must be given a disclosure of the fees and performance of their frozen annuity accounts, and the current investment options, and must be given contact information to facilitate transfers.

Comment: This is an issue unique to 403(b) plans. Where annuity accounts are frozen, they may no longer be supported by the plan, and the plan may have changed its investments from individual annuity contracts to a custodial platform or a group annuity contract, which may have lower investment and administrative costs. This will provide information and services to help participants transfer money from the frozen accounts to the investments offered on the plan’s new platform.

  • Vanderbilt must conduct a request for proposal (RFP) for recordkeeping and administrative services that includes at least three qualified providers; the recordkeeping fees must be expressed on a per-participant basis.

Comment: The condition is consistent with the claim that the recordkeeping services were too expensive. The monetary settlement is for losses suffered in the past. This condition is to correct that matter on a forward-looking basis. The law doesn’t require RFPs; instead, it requires that fiduciaries spend no more than reasonable amounts for services and investments. RFPs are one method for determining reasonableness; benchmarking is another.

  • The agreement with the recordkeeper selected by the RFP process must “contractually prohibit the recordkeeper form using information about Plan participants acquired in the course of providing recordkeeping services to the Plan to market or sell products or services unrelated to the Plan to Plan participants unless a request for such products or services is initiated by a Plan participant.”

Comment: The Schlichter law firm did not include this condition in earlier settlements and it may foretell the future. The Schlichter firm takes the position that participant information has value and should not be given to the recordkeeper unless the participants agree. This is a developing area and fiduciaries should discuss the implications with their legal counsel.

  • Vanderbilt must provide the Schlichter law firm with “the best and final bid amounts that were submitted in response to the RFP and a copy of the agreed-upon contract for record-keeping services.”

Comment: This allows the Schlichter firm to oversee the implementation of the conditions in the settlement agreement.

  • Vanderbilt must, when evaluating the plan’s investments, consider the cost of different share classes available to the plan.

Comment: This shouldn’t be a surprise. The failure to look at the lower cost share classes was a fundamental allegation in the complaint and the settlement imposes this “protection” on a going-forward basis. Every plan committee should consider the costs of investments and should investigate whether lower-cost share classes are available to the plan. As a practical matter, most plan committees will need help with this; as a result, committees should work with advisors to ensure that they are properly identifying and selecting the appropriate share classes.

  • Vanderbilt must either continue to use its current independent investment consultant, or engage another investment consultant, to provide investment services and information, and the Vanderbilt committee must consider the information provided by the consultants.

Comment: Plan committees need to engage in an informed and prudent process for vetting their plan investments and service providers, including the fees and costs for those products and services. A certain amount of investment industry knowledge is needed to identify and evaluate the right information. As a result, plan committees should work with knowledgeable and experienced advisors.

Concluding Thoughts

As with the Anthem case, the Vanderbilt settlement teaches fiduciaries that they need to pay attention to the share classes of the mutual funds they include in their plans, including private sector 403(b) plans. A committee should devote at least part of one meeting a year to a report by its investment advisor on the share classes of their plan’s investments and the share classes that are available to the plan. This is a high risk area and should be treated accordingly, that is, with close attention and care.

Similarly, plan fiduciaries should be attentive to how much the plan is paying its service providers and regularly benchmark those fees to comparable service providers for peer plans. A best practice, and good risk management, would be to dedicate part of at least one meeting a year to reviewing updated information on fees and benchmarks.