Avoid ERISA litigation with attention to common red flags
Any size retirement plan can run into serious trouble when sponsors aren’t careful. With some planning, though, your qualified retirement plan doesn’t have to be the target of ERISA litigation. Awareness of some of the most common red flags leading to litigation might be helpful.
Of course, you can’t assure consistently strong investment performance. But plan sponsors can — and must — ensure that expenses are reasonable.
When your plan’s investment portfolios are performing well, it’s easy to pay less attention to the recordkeeping costs and investment management fees. But when performance is subpar, out-of-line expenses stick out like the proverbial sore thumb. Make sure you schedule regular, independent reviews of your plan expenses and fees every three to five years as part of your due diligence.
Opaque fee structures
In the past, complex and opaque fee structures such as revenue-sharing arrangements between asset managers and third-party administrators made it harder to get a handle on cost. But with the U.S. Department of Labor’s fee disclosure regulations now in their fourth year, pleading ignorance is no excuse. In fact, it never really was.
Mutual fund shares with built-in revenue sharing features still exist but, with required disclosure statements, it’s easier for you (and plan participants) to understand what they are. Although these built-in revenue sharing features aren’t inherently bad, they tend to be associated with funds that have higher expense charges.
In some plan fee litigation, courts have deemed fee-sharing arrangements a payoff to an administrator to recommend those funds, subordinating its assessment of the funds’ merits as sound investments.
Another expense-related red flag that could trigger litigation is exclusive use of a bundled plan provider’s investment funds. This also can raise questions about the effort that you put into investment performance evaluation.
So if you use only a bundled provider’s funds, you could give the appearance of not performing your fiduciary duty to seek out the most appropriate and competitively priced funds. And in fact, the odds are slim that one bundled provider has best-of-class funds in all of your desired investment strategy categories and asset classes. When retaining a bundled provider, question whether the recommendation of primarily proprietary funds could result in a conflict of interest if better performing and lower cost funds are available on their platform.
Even when your plan’s investment lineup features funds from multiple asset management companies, you could be inadvertently flying a red flag if the funds in your investment menu are in an expensive share class. Individual investors, unless they have very deep pockets, generally have access to only retail-priced share classes. In contrast, retirement plans, even small ones, typically can use more competitively priced institutional share classes. The failure to use institutionally priced share classes has been at the heart of many class actions against plan sponsors.
Different share classes of the same mutual fund have different ticker symbols; that’s one easy way to determine what’s in the portfolio. Fund companies that offer shares with sales loads typically offer more variations, with “A,” “B” and “C” categories of retail shares, and an institutionally priced “I” share class without embedded sales charges.
Having some high-cost investments in your fund lineup isn’t in itself a reason that you’ll be deemed to have breached your fiduciary duties. There may indeed be good reasons to include them, notwithstanding the higher costs.
Investment policy statements
The concept of “procedural prudence” is embedded in ERISA and case law. This means plan sponsors must establish — and follow — policies and procedures to safeguard participants’ interests and set the criteria used to evaluate vendors, including asset managers.
Create an investment policy statement (IPS) to articulate your vision for plan investments overall, and the investment options you want to make available to participants. The IPS should clearly state:
- What kind of assets you’ll include in investment options,
- The degree of investment risk and volatility that’s acceptable,
- How you’ll assess investment performance, and
- When you’ll change managers.
Although having an IPS isn’t obligatory, doing so can show that you’re exercising procedural prudence — provided you can document your compliance with it. Merely signaling prudence won’t get you off the hook; following carefully crafted procedures and policies will go a long way toward preventing missteps that could lead to litigation in the first place. If you already have an IPS, be sure to follow it.
Avoiding ERISA litigation is on every plan sponsor’s wish list. Reviewing expenses, fee structures and bundled services, and creating and following an IPS, can help you achieve this. Start by making periodic review of these areas the norm, in good times and bad.
Our advice is: Don’t go it alone. Contact George Pickard, CPA, Ciuni & Panichi, Inc. Accounting and Audit Senior Manager, at 216-831-7171 or firstname.lastname@example.org for help with your plan. His expertise includes performing your plan audit, advising you on compliance issues and helping to avoid litigation.
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