Peppered with claims unique to 403(b) plans, lawsuits in the higher education marketplace have become prevalent as plaintiffs’ attorneys have followed a litigation recipe tested in the corporate 401(k) marketplace. In August 2016, Schlichter, Bogard & Denton, the plaintiffs’ firm responsible for much of the 401(k) litigation, reset the litigation table to include prominent private universities and filed eight lawsuits alleging breach of fiduciary responsibilities.
Other law firms quickly added to the mix, and as of March 15, 2019, at least 19 such lawsuits have been filed against universities. These lawsuits primarily focus on three areas: inappropriate or imprudent investment choices, excessive fees, and self-dealing.
- Inappropriate or imprudent investment choices. Plaintiffs allege that too many investment choices resulted in participant confusion. Plaintiffs also identify investments that habitually underperform both their benchmarks and available alternatives as well as pinpoint the liquidity restrictions of a popular fixed annuity as being problematic. Plaintiffs allege that retaining these poor performing options substantially reduced participants’ retirement assets.
- Excessive fees. Plaintiffs allege that too many investment choices diluted the plan fiduciaries’ ability to leverage scale to negotiate lower administrative and investment fees. In addition, using multiple recordkeepers resulted in duplicative, excessive, and unreasonable fees. Further, plaintiffs assert a fiduciary breach, as the plan fiduciaries failed to conduct a periodic, competitive bidding process to ensure that participants faced reasonable recordkeeping fees.
- Self-dealing. Several lawsuits allege self-dealing by plan fiduciaries. Specifically, plaintiffs allege the fees paid by participants were used for the university’s own benefit.
Evolution of 403(b) Landscape
In 1958, Congress added Section 403(b) to the Internal Revenue Code. At that time investments were limited to annuity contracts. With the passage of the Employee Retirement Income Security Act of 1974 (ERISA), Code Section 403(b) was amended to permit custodial accounts that could invest in mutual funds.
Department of Labor regulations that became effective in 1975 specified that the purchase of annuity contracts or establishment of custodial accounts were not subject to ERISA if participation by a 403(b) plan participant is completely voluntary, and all rights under the contracts or accounts are enforceable solely by the participant. Additionally, employer involvement must be limited to allowing vendors to publicize their contracts/accounts, collecting employee contributions, and limiting funding products to afford employees reasonable choice in light of all relevant circumstances. At that time many 403(b) plan sponsors interpreted the regulations to mean that multiple recordkeepers and investment lineups were preferred. The Internal Revenue Service issued new 403(b) regulations in July 2007 that imposed a written plan document requirement and various employer responsibilities. Since these regulations there has been a renewed focus on overall compliance, including adherence to the requirements of ERISA.
Unfortunately, the ability for 403(b) plan fiduciaries to effect change remains encumbered. Individually owned contracts, which are typically a staple in many 403(b) plans, require that certain proprietary investment options be maintained and open for ongoing deposits. Additionally, individually owned contracts limit the plan fiduciaries’ ability to map assets when an investment becomes imprudent. Plan fiduciaries may only make changes with respect to future contributions. Today, more than 40 years after the passage of ERISA, 403(b) plans are still precluded from investing in low-cost collective investment trusts.
Current Litigation Setting
Where do the 403(b) lawsuits stand as of March 15, 2019? Some cases have been fully dismissed. A majority are still pending, in whole or in part, with the primary focus on investment choices and fees. Finally, some cases have been settled or have been agreed to be settled with no admission of liability. Some of the interesting case notes, from our point of view, include:
- One university petitioned the Supreme Court to compel participants to accept arbitration rather than file ERISA class-action lawsuits. The Supreme Court denied this request.
- At least one case was voluntarily withdrawn by the plaintiff, with both parties agreeing to bear their own attorney fees and costs of litigation.
- In one pending settlement, the proposed agreement requires the plan sponsor to:
- Hire an independent adviser to conduct an RFP
- Ease the ability of participants to transfer investments out of frozen annuity accounts
- Avoid the use of plan assets to pay salaries of employees who work on the plan
- Use reasonable efforts to further reduce recordkeeping fees
- Notify participants if fees increase and why
We predict that more lawsuits will be filed against colleges and universities that sponsor 403(b) retirement plans. As a result, we encourage 403(b) plan sponsors and fiduciaries to consider adopting sustainable practices in executing their oversight responsibilities. These include regular reviews of investment options and completing operational compliance and service reviews.