Compliance June 24, 2020

Costco’s Use of Actively Managed Funds in 401(k) Plan Lineup Called Out in Lawsuit

The warehouse club is also accused of breaching ERISA fiduciary duties by allowing the plan to pay ‘unreasonably high’ recordkeeping fees.

Reported by

A participant in the Costco 401(k) Retirement Plan has filed a lawsuit against the company, its board of directors and benefits committee alleging violations of the Employee Retirement Income Security Act (ERISA).

The lawsuit says the fiduciaries of the plan breached their ERISA duties by authorizing the plan to pay unreasonably high fees for recordkeeping; failing to objectively and adequately review the plan’s investment portfolio with due care to ensure that each investment option was prudent, in terms of cost; and maintaining certain funds in the plan despite the availability of identical or similar investment options with lower costs and/or better performance histories.

Get more!  Sign up for PLANSPONSOR newsletters.

“The plan generally chose more costly ‘actively managed funds’ rather than ‘index funds’ that offered equal or better performance at substantially lower cost. Additionally, the administrative fees charged to plan participants were consistently greater than the fees of most comparable 401(k) plans, when fees are calculated as cost per participant or when fees are calculated as a percent of total assets,” the complaint states.

Costco told PLANSPONSOR it has no comment on the lawsuit at this time.

At the end of 2018, the plan had approximately 174,403 participants and approximately $15,464,315,721 in assets. At different times, the plan offered about 42 different investment choices to its participants, the lawsuit notes.

The complaint alleges the defendants did not have a viable methodology for monitoring the expenses of the funds in the plan, failed to have an independent system of review in place to ensure that the plan participants were charged appropriate and reasonable fees for the plan’s investment options, and failed to leverage the size of the plan to negotiate lower expense ratios for certain investment options maintained and/or added to the plan during the class period.

The plan’s investment platform contained 16 active mutual funds, 14 collective trusts and 12 index mutual funds. In a chart, the complaint compares the plan’s funds to those from Vanguard, which the lawsuit says are comparable, to show fees exceed those of the Vanguard funds by up to 3,400%.

The lawsuit suggests that a “plan fiduciary must pay close attention to the recordkeeping fees being paid by the plan. A prudent fiduciary tracks the recordkeeper’s expenses by demanding documents that summarize and contextualize the recordkeeper’s compensation, such as fee transparencies, fee analyses, fee summaries, relationship pricing analyses, cost-competitiveness analyses, and multi-practice and standalone pricing reports.”

In addition, it suggests that “to make an informed evaluation as to whether a recordkeeper or other service provider is receiving no more than a reasonable fee for the services provided to a plan, a prudent fiduciary must identify all fees, including direct compensation and revenue sharing being paid to the plan’s recordkeeper. To the extent that a plan’s investments pay asset-based revenue sharing to the recordkeeper, prudent fiduciaries monitor the amount of the payments to ensure that the recordkeeper’s total compensation from all sources does not exceed reasonable levels and require that any revenue-sharing payments that exceed a reasonable level be returned to the plan and its participants.”

The defendants in the case are accused of failing to undertake any of these steps because, among other things, there is no evidence that they negotiated lower recordkeeping costs.

According to the complaint, the total amount of recordkeeping fees paid throughout the class period on a per participant basis was unreasonable. From 2014 to 2018, recordkeeping costs paid to T. Rowe Price, as disclosed on Forms 5500, rose 500% from around $1 million per year in 2014, to $6 million per year in 2018, while the number of participants only went up 21%. “Although these costs on the surface are already unreasonable, these costs could actually be higher due to revenue-sharing arrangements and indirect compensation,” the complaint states.

The plaintiff contends that the defendants did not use a competitive bid process for recordkeeping services for a substantial period of time. And, although T. Rowe Price is not a defendant in the lawsuit, it is accused of receiving multiple income streams for recordkeeping from the plan and for selecting mutual funds that paid excessive revenue-sharing fees.

Citing a study from S&P Dow Jones Indices, the complaint says, “While higher-cost mutual funds may outperform a less-expensive option, such as a passively managed index fund, over the short term, they rarely do so over a longer term.” The lawsuit cites another study that said, “long-term data suggests that actively managed funds lagged their passive counterparts across nearly all asset classes, especially over the 10-year period from 2004 to 2014.”

Plan fiduciaries are accused of retaining several actively managed funds as plan investment options despite the fact that these funds charged grossly excessive fees compared with comparable or superior alternatives, and despite ample evidence available to a reasonable fiduciary that these funds had become imprudent due to their higher costs relative to the same or similar investments available.

The lawsuit says this fiduciary failure decreased participant compounding returns and reduced the available amount participants will have at retirement. “During the class period, the plan lost millions of dollars by offering investment options that had similar or identical characteristics to other lower-priced investment options,” the complaint states. It contends that a “reasonable investigation would have revealed the existence of these lower-cost alternatives.” Again, a chart is provided to demonstrate that the expense ratios of the plan’s investment options were more expensive by significant multiples of comparable passively managed funds in the same investment style.

To avoid an argument by defendants that the plaintiff had actual knowledge that could lead to his claims being barred by ERISA statute of limitations, the lawsuit says the plaintiff had no knowledge of the defendants’ process for selecting investments and monitoring them to ensure they remained prudent or of how the fees charged to and paid by the plan participants compared to any other funds. Nor, the lawsuit says, did the plaintiff know about the availability of lower-cost and better-performing investment options that the defendants did not offer because they provided no comparative information to allow the plaintiff to evaluate and compare investment options.

Compliance June 24, 2020

DOL Seeks Stricter Limits on ESG Investing Under ERISA

The proposed regulation would “confirm that ERISA requires plan fiduciaries to select investments and investment courses of action based solely on financial considerations relevant to the risk-adjusted economic value of a particular investment.”

Reported by


The U.S. Department of Labor (DOL) has proposed a new rule that would, in the words of Secretary of Labor Eugene Scalia, “update and clarify” the Department of Labor’s set of investment duties and requirements enforced under the Employee Retirement Income Security Act (ERISA).

In a statement published alongside the new regulation, Scalia says the rule is intended to provide “clear regulatory guideposts” for plan fiduciaries in light of recent trends involving environmental, social and governance (ESG) investing. While it will take some time for industry experts to understand the proposed regulation, Scalia’s characterization is that this new ESG framework represents a tightening of what is permissible under ERISA.

Never miss a story — sign up for PLANSPONSOR newsletters to keep up on the latest retirement plan benefits news.

“Private employer-sponsored retirement plans are not vehicles for furthering social goals or policy objectives that are not in the financial interest of the plan,” Scalia says. “Rather, ERISA plans should be managed with unwavering focus on a single, very important social goal—providing for the retirement security of American workers.”

The full text of the proposed regulation stretches to 62 pages. The summary explains that it will modify Title I of ERISA “to confirm that ERISA requires plan fiduciaries to select investments and investment courses of action based solely on financial considerations relevant to the risk-adjusted economic value of a particular investment or investment course of action.”

According to the DOL leadership, the proposal is designed “to make clear that ERISA plan fiduciaries may not invest in ESG vehicles when they understand an underlying investment strategy of the vehicle is to subordinate return or increase risk for the purpose of non-financial objectives.”

They say the proposal would make five core additions to the regulation, as follows:

  • New regulatory text is created to codify the department’s position that ERISA requires plan fiduciaries to select investments and investment courses of action based on financial considerations relevant to the risk-adjusted economic value of a particular investment or investment course of action.
  • A new express regulatory provision states that compliance with the exclusive-purpose (i.e., loyalty) duty in ERISA section 404(a)(1)(A) prohibits fiduciaries from subordinating the interests of plan participants and beneficiaries in retirement income and financial benefits under the plan to non-pecuniary goals.
  • A new provision is created that requires fiduciaries to consider other available investments to meet their prudence and loyalty duties under ERISA.
  • The proposal acknowledges that ESG factors can be pecuniary factors, but only if they present economic risks or opportunities that qualified investment professionals would treat as material economic considerations under generally accepted investment theories. The proposal adds new regulatory text on required investment analysis and documentation requirements in the rare circumstances when fiduciaries are choosing among truly economically “indistinguishable” investments.
  • A new provision is created on selecting designated investment alternatives for 401(k)-type plans. The proposal reiterates the department’s view that the prudence and loyalty standards set forth in ERISA apply to a fiduciary’s selection of an investment alternative to be offered to plan participants and beneficiaries in an individual account plan (commonly referred to as a 401(k)-type plan). The proposal describes the requirements for selecting investment alternatives for such plans that purport to pursue one or more environmental, social, and corporate governance-oriented objectives in their investment mandates or that include such parameters in the fund name.

At this early stage, it should be emphasized that the proposal is subject to public comment and amendment, and there is also a potential time crunch facing the DOL to get such a rule fully implemented should President Donald Trump fail to win a second term.

Furthermore, while various ESG regulations and pieces of guidance have been published by concurrent administrations going back to the 1990s, market trends and organic demand among participants are an equally important factor driving plan sponsors’ and fiduciaries’ behavior when it comes to using ESG.

In early commentary shared with PLANSPONSOR, George Michael Gerstein, co-chair of the fiduciary governance group at Stradley Ronon, says the proposed regulation, if adopted as-is, would definitely make it more challenging for retirement plan sponsors to leverage ESG-themed investments.

“This proposal comes just two years after the DOL issued Field Assistance Bulletin 2018-01,” he notes. “It is also part of a continuum of ERISA-ESG guidance over the decades, across both Democrat and Republican administrations, that has sought to address how ERISA’s stringent fiduciary duties may be satisfied when one or more ESG factors are pursued, either because they are material to investment performance or because they further some public policy or similar goal.”

Gerstein says that, should the proposal be adopted as proposed, plan sponsors, other fiduciaries and the retirement plan industry generally will face a tall order in incorporating ESG factors, especially in furtherance of policy or other non-financial goals. Still, in his view, more sophisticated ESG strategies that expressly incorporate one or more ESG factors because of materiality to investment performance would still be considered consistent with ERISA’s fiduciary duties, provided that there is documentation as to the basis for the materiality determination.

Under both the existing and proposed regulatory framework, the weight given to the ESG factor in the materiality analysis must be accurate and appropriate—a point the DOL stressed in Field Assistance Bulletin 2018-01. It is also going to be even more important that an ESG investment is measured against other available alternative investments with respect to diversification, liquidity and potential risk/return of the plan portfolio.

“Because the DOL believes a fiduciary finding that an ESG investment is economically indistinguishable from a non-ESG investment to be a rare occurrence, it does not believe the aforementioned documentation requirements will be a significant cost to the industry,” Gerstein notes. He also points out that the DOL has cautioned that fiduciaries should be skeptical of ESG rating systems—or any other rating system that seeks to measure, in whole or in part, the potential of an investment to achieve non-pecuniary goals as a tool to select qualified default investment alternatives (QDIAs), or investments more generally.

Gerstein concludes that ESG funds and products that have short track records, low assets under management, and/or are somewhat more expensive than similar non-ESG funds, will be particularly vulnerable under this proposal.

«