What the 403(b) Excessive Fee Lawsuits Do Not Consider

In the past two weeks, eight lawsuits have been filed against large universities concerning excessive investment and recordkeeping fees for their 403(b) plans. One has been filed against excessive fees in a university’s 401(k) plan.

The lawsuits attack the 403(b) plan design model of offering an extensive amount of investment options, including individual annuities, and using multiple recordkeepers. Before new 403(b) regulations were passed in 2007, there was little plan sponsor oversight of 403(b)s. Often annuity providers were allowed to meet with employees and set up individual annuities for them, which resulted in many plans having hundreds of investments. In addition, before the regulations, it was much easier for 403(b) plans to be exempt from the Employee Retirement Income Security Act (ERISA), as long as they did not include employer contributions.

“I’m surprised the plaintiffs’ bar has turned to 403(b)s,” says David Levine, a principal with Groom Law Group, Chartered in Washington, D.C. “These lawsuits are in a lot of ways clones of 401(k) lawsuits, completing disregarding some of the distinctions between the two plan types.”

It was only in 2009 that 403(b) plans were required for the first time to have a written plan document, notes Joseph K. Urwitz, partner with McDermott Will & Emery LLP in Boston. “If someone is not in [the 403(b)] field, they may think 403(b) plans are still really different from 401(k) plans, when in fact the differences between the two have decreased over the years,” he says.

Todd Solomon, partner with McDermott Will & Emery LLP in Chicago, adds that he thinks the lawsuits are based on the outdated notion that 403(b) plans in general are part of a wild, wild west of retirement plans. “With respect to large institutions that have good governance, this notion is outdated. Plan sponsors are taking great care to manage their plans and do all they need to do,” he says.

Levine notes that 403(b) plans have different funding vehicles, custodial accounts or annuities. And there are different views plan sponsors and participants take: move to a single vendor, or offer different types of solutions. “Plan participants may have grown up with a traditional annuity product and prefer that, and many plan sponsors have a multi-vendor model because there are some products they can’t get rid of,” he says.

For example, a lot of legacy annuity product relationships are not between the plan fiduciary and vendor. They are between the vendor and participants. Levine points out that plan sponsors can discontinue future contributions to these annuities, but they cannot force employees out. Also, plan sponsors may not necessarily be able to remove underperforming investment options; they may only be able to freeze them.

In addition, Levine contends recordkeeping pricing needs to account for how plan sponsors have to service 403(b)s, considering the different vendors or investment solutions.

“Academic institutions sponsoring 403(b)s are known for having generous benefits. They have lots of engagement with faculty and staff about what benefits should be offered,” Levine says. “These institutions have given a lot of thought to their plan design, and what they need for participants.”

He adds that cookie-cutter retirement plans do not even mesh with the Department of Labor’s (DOL’s) own guidance. And, he says these lawsuits are an “egregious example of how fees are the only thing that matter; it’s not about services.”

Urwitz says that just like the 401(k) lawsuits, the 403(b) lawsuits offer clues for plan sponsors about how to protect themselves. “Plan sponsors may not be able to completely protect themselves—for example, it may not make sense to have just one recordkeeper—but the type of things lawyers are looking for—having too many investment choices and revenue sharing, for example—can be addressed by plan sponsors in their investment committee meetings,” he says.

Urwitz says, to the extent 403(b) plan sponsors can renegotiate with fund providers and recordkeepers to eliminate revenue sharing and 12b-1 fees, they will be putting themselves in a better position.

Solomon adds, “I would tell anyone seeing this in the news to take steps to look at their processes. When is the last time they did a fee review or benchmarking of investment options? Do they use a consultant or adviser to help the investment committee? Are they in the most favorable share class of funds?”

While it is not known where this litigation will go, Urwitz says it is no surprise that the first batch is targeted to larger universities. He warns that if plaintiffs’ lawyers have success in winning a case or getting a settlement, lawsuits will trickle down to smaller universities.

“My gut is some academic institutions may fight it out because they have genuinely tried to create the best plan for participants. These institutions have a different story to tell,” says Levine. “But settlements can happen if institutions decide if it’s more cost-effective to move on, even if they think they are right.”