“Tipping Off” Potential ERISA Fiduciary Violations – Part 1

As a former catcher, I always enjoyed watching pitcher to see if he was “tipping off” his pitches so or team could gain an advantage. As an ERISA attorney, one of the services I provide to ERISA consulting clients is forensic analyses of plans to determine if they are “tipping off” potential breaches of their ERISA fiduciary duties. In far too many cases, I find that plans and plan sponsors are “tipping off” potential ERISA violations, exposing themselves to unnecessary fiduciary liability.

I bring this up because of the news that Jerome Schlichter has reportedly filed actions against M.I.T, N.Y.U. and Yale alleging various violations of ERISA. Having analyzed the 403(b) and 457(b) plans of several American universities and colleges, I figured that it would only be a matter of time before someone decided to address many of the same fiduciary issues that plague 401(k) plans, as many of the leading private colleges and universities have plans with assets in the trillions of dollars.

I expect private colleges and universities to draw most of the attention as to ERISA violations since state-run colleges and universities are not covered by ERISA. However, state-run colleges and universities are arguably subject to similar actions based on common law grounds such as agency, negligence and breach of contract, so state universities and colleges should not assume that they their 403(b) and 457(b) plans are safe from future litigation.

I have not read the actual complaints that Mr. Schlichter reportedly filed against the three schools. However, based on the stories that I read in both the Wall Street Journal and the New York Times, Mr. Schlichter has identified some of same potential violations that I often see with plans, violations that plans often unknowingly “tip-off” to plaintiff’s attorneys and regulators.

By far, the easiest “tip-off” has to do with the number of investment options that a plan offers. Plans often attempt to justify a large number of investment options within the plan by claiming that it benefits plan participants by proving more choices and allows them to reduce the overall investment risk of their plan account.

Such arguments fail to consider a number of factors. First, studies that the more investment options that investors are provided with, the higher the potential of investors suffering “paralysis by analysis,” with investors choosing to do nothing at all or opting for the simplest perceived option, e.g., the 50% S&P 500/50% Bond portfolio (which might actually be both the simplest and best option anyway.)

The articles I read on the Schlichter filings indicated that he cited that at least one of the plans has offered well over 300 investment options at one point in time. Schlichter reportedly argues that such a large number of investment options could impair a plan’s opportunity to negotiate lower investment related fees for the plan and its participants, thereby violating the plan sponsor’s fiduciary duty of prudence.

I would suggest that having so many options within a plan is a “tip-off” that the plan sponsor has not properly performed their fiduciary duty to conduct an independent and thorough investigation and analysis of the investment options within their plan. The legal decisions on this topic make it very clear that the failure of a plan sponsor or other plan fiduciary to properly conduct the required investigation is a blatant violation of the plan sponsor’s fiduciary duties. The sheer number of funds raises obvious questions as to whether the required investigation  was done properly, if at all. A good plaintiff’s attorney will obviously ask for documentation  verifying both the investigation and its findings.

Plans with a large number of investment options may also “tip-off” potential ERISA fiduciary violations based on the types of funds offered as investment options within a plan. According to the two stories referenced earlier, Schlichter reportedly cites similarities between many of the fund as a breach of the plans’ fiduciary duties.

The larger the number of available investment options within a plan. the greater the likelihood of overlap of funds with similar investment objectives, but with varying levels of fees and other costs. This overlap provides an opportunity to raise questions regarding  the fiduciary duty of prudence – why offer six funds with the stated investment objective of capital appreciation, but with varying fees, instead of the one or two with the best cost/benefit results? Again, other than possibly confusing plan participants, what benefit do plan participants receive from having to consider ten, fifteen or more funds with a similar investment objective? Plan sponsors should anticipate that question at deposition and at trial.

The number of investment alternatives offered by a plan also raises the issue regarding a fiduciary’s fiduciary duty to minimize the risk of large losses by properly diversifying a plan’s investment options. Some plan sponsors apparently mistakenly believe that proper diversification can be achieved by the sheer number of investment options that their plan offers. Anyone familiar with diversification knows that effective diversification depends not on the number of investment in a portfolio , but rather on how the various investments react under various economic and market conditions. In a perfect world, the investor could combine investment in such a way that the portfolio’s investments would react in such a way as to balance each other out, thereby preventing significant financial losses.

Unfortunately, the evidence has increasingly shown that the correlations of returns for equity-based investments, both domestic and international investments, have increased over the past decade or so. At the same time, 401(k) and 403(b) plans have shown a definite patterns of offering a high percentage of funds with similar investment objectives, e.g., large cap growth, and/or a menu of investment options that have a high correlation of returns. Either scenario raises obvious potential breach of fiduciary issues.

One final point with regard to “tipping off” potential ERISA fiduciary violations with regard to product selection. The two stories I read mentioned that Schlichter’s complaints included allegations involving annuities offered by the plans, both variable annuities and TIAA’s Traditional Annuity.

The high costs associated with many annuities, combined with the poor relative performance of many of the sub-accounts offered within variable annuities, make these an easy target for breach of fiduciary claims, both in ERISA related and non-ERISA related cases. Given the fact that the two of the three largest service providers for colleges and universities plans are known for their annuity products, the introduction of this new fiduciary issue may result in even more fiduciary litigation in the 403(b) and 457(b) arena, including state colleges and universities.

Tomorrow: “Tipping Off” Fee Related ERISA Fiduciary Violations.

© Copyright 2016 InvestSense, LLC. All rights reserved.

This article is for informational purposes only, and is not designed or intended to provide legal, investment, or other professional advice since such advice always requires consideration of individual circumstances. If legal, investment, or other professional assistance is needed, the services of an attorney or other professional advisor should be sought.



About jwatkins

I am a securities and ERISA attorney. I am a CFP Board Emeritus™ and an Accredited Wealth Management Advisor™. I am a 1977 graduate of Georgia State University and a 1981 graduate of the University of Notre Dame Law School. I am the author of "CommonSense InvestSense: The Power of the Informed Investor" and " The 401(k)/403(b) Investment Manual: What Plan Sponsors and Plan Participants REALLY Need To Know. " As a former compliance director, I have extensive experience in evaluating the legal prudence of various types of investments, including mutual funds and annuities. My goal is to combine my legal and compliance experience in order to help educate investors and investment fiduciaries on sound, proven investment strategies that will help them protect their financial security and/or avoid unnecessary fiduciary liability exposure.
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