Best Practices To Mitigate Potential Exposure for 401(k)

and 403(b) PlansBY:

ROBERT RACHAL AND AL HOLIFIELD

Holifield · Janich · Rachal & Associates, PLLCKnoxville, TNNew Orleans, LAChicago, IL

aholifield@holifieldlaw.comrrachal@holifieldlaw.com Phone: (865) 566-0115

Fax: (865) 566-0119

www.holifieldlaw.com

OverviewqConstantpressure/uptickinlawsuits:qSuitsstartedinmassin2006.qPlaintiffsachievesubstantialsuccessby2015– hundredofmillionsinrecoveriesandattorney’sfees.

qExpandingtheoriesandhydraulicpressureproblem– anyflawintheplan,nomatterhowwellrunotherwise,cancreateexposure.

qOriginallytargetinglarge$1billion+plans,butmoreplaintiffsfirmsenteringfieldalsotargetingmid-marketandsmallerplans,smallas$9millioninassets.

qCasesalsoteachwaystomakeyourplananunattractivetarget/limitexposures.Thatisthefocusofthispresentation.

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FeeLitigation– IssuesandRecentDevelopmentsqBy2015,Plaintiffs’firmshadachievedsubstantialfinancialsuccess:qAnAugust2015BNAarticlenotedthatthefirm(Schlichter)thatstartedbringingmanyoftheERISAfeelawsuitsin2006hascollected$70millioninfeestodate.

qInApril2015inHaddockv.Nationwidea$140millionsettlementwasapprovedthatincludedattorney’sfeesandexpensesofmorethan$50million.

qInJuly2015ontheeveoftrial,Abbottv.LockheedMartinesettledfora$62millionpaymentthatincluded$22.3millioninattorney’sfeesand$160,000inincentiveawardsfornamedplaintiffs.

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FeeLitigation– IssuesandRecentDevelopmentsqExperienceinthecaseshasshownthatERISAfeelitigationoperateslikehydraulicpressure,probingforliabilityfromanyweakaspectofplanmanagementandadministration,evenifthe401(k)or403(b)planisoverallcollectivelysoundandwellmanaged.qE.g.,plaintiffsmaybring10claims,loseon9,andyetwinsubstantialfeesandrecoveryontheoneclaiminwhichtheywon.

qDiscoveryisburdensomeandexpensive;plaintiffsalsousediscoverytoprobeforotherclaims.

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FeeLitigation– IssuesandRecentDevelopmentsqPlaintiffscontinuetofilefeesuitsatrecordpace– notunusualtoseetwotothreefeeclassactionsfiledaweek:qHavetargetedplansassmallas$9millioninplanassets.qIn2016startedsuingnon-profitinstitutionsoffering403(b)plan.15universitiessuedtodate.

qKeepexpandinganddevelopingtheoriesofpotentialliability,e.g.,evenchallengingtheofferingofVanguardindexfunds.

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FeeLitigation– IssuesandRecentDevelopmentsqExamplesofnewtheoriesandclaimsbrought- plaintiffswinorstillupintheair:q“Shareclass”claims– thatplancouldhavequalifiedfororreceivedacheaperinstitutionalshareclass.qClaimsbroughtevenonlowcostfundssuchasVanguardindexfunds.qLargerplansaresometimesgrantedlowercostshareclassesevenbeforeinvestmentsreachbreachpoints.Maybeprudenttocheck.

qOKifhighercostshareclassisusedtopayrevenuesharingtorecordkeeper,butneedtotrackanddocumentdecision.Alsomaytakediscoverytodefeattheclaim.

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FeeLitigation– IssuesandRecentDevelopmentsqExamplesofnewtheoriesandclaimsbrought- plaintiffswinorstillupintheair:qThatrecordkeeperpaidapercentagebasedontheassetsintheplanoverpaidasassetsgrewintheplan.

qIn403(b)area,thathavetoomanyfundsandmultiplerecordkeepers.Notachievingefficienciesandeconomiesofscale.

qThatguaranteedbenefitcontractsarenotERISA-exemptbecauseinsurerretainscontroloverreturns.

qSmallplansuingrecordkeeperNationwide,claimingchargingexcessivefeesof$625aparticipantversus$64average.qSeekstoformaclassof37,000planswith2.4millionparticipants.qEconomiesofscaleforlargerplans/somefeesfixedperplan.Notsurethat$625versus$64a

faircomparison.Alsorecordkeeperstypicallynotactingasfiduciarywhennegotiatingtheirfees.

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FeeLitigation– IssuesandRecentDevelopmentsExamplesofnewtheoriesandclaimsbroughtthatcourtshaverejectedsofar:

qStablevaluefundclaims:qThatshouldhaveofferedastablevaluefundinsteadofamoneymarketfund.q“Goldilocks”claims– thatstablevaluefundwasinvestedtooconservatively,ortooaggressively.

qPlaintiffslosingclaimstodate,e.g.,Fidelity,CVSHealth.

qThatshouldnothaveincludednon-traditionalinvestments,suchashedgefunds,commodityfunds,andrealestatefunds,intargetdateanddiversifiedfunds.

qThatrecordkeepersreceivingexcessivecompensationfromrobo-advisers.Voya won,notafiduciarywhennegotiatingitsfeeswiththeplan.

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FeeLitigation– IssuesandRecentDevelopmentsExamplesofnewtheoriesandclaimsbroughtthatcourtshaverejectedsofar:

qClaimsonactivemutualfunds:qThatshouldofferonlyindexandpassivelymanagedfunds.qThatactivemutualfundunderperformedagainstbenchmarks.qThatactivefundwastooconcentratedinariskystock,SequoiaandValeantPharmaceuticals.

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ProblemCasesandIssues

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Tibble:ExposureonShareClassesqForsixmutualfunds,planofferedretailshareclassesinsteadofinstitutionalshareclasses.

qPlan’sinitialinvestmentsinthesefundsdidnotqualifyforinstitutionalshareclass,butturnsoutfundshadpracticeofofferinglargeplanswaiversforinstitutionalshareclassiftheyasked.

qCourtheldaprudentfiduciarywouldhaveknownthisoratleastinvestigatedwhethercouldhavequalifiedforthecheapershareclass.

qCourtfound$400,000liabilityforthreefunds;ongoinglitigationonliabilityforotherthreefunds.Alsoappealscourtnotedshouldreconsiderfeerequest($2.5million)inlightofimportantERISAprincipalvindicated.

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ABB:ExposureonRecordkeepingFeesqCourtrejectedmultipleclaimsagainstplanandrecordkeeperFidelity.Butfoundfiduciariesbreacheddutiesbypayingrecordkeepertoomuchinfees.qRecordkeeperpaidrevenuesharingbasedonpercentageofassetsinvestedinthosefunds;courtfoundplandidnotmonitortotalfeespaid,evenafterexpertsaidrecordkeeperlikelywasoverpaid.

qPlan’soverpaymentmayhavebeensubsidizingworkFidelitydidfornon-qualifiedplans.

qPlaintiff’swinonthisoneclaimwasworth$13.4millioninliability,plusattorney’sfeestodateof$11million(caseisongoing).

q DoNOThavetogowithlowestcostprovider,butneedtomonitoranddocumentwhypayingfees.

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Kraft:ExposureonNon-DecisionqKraftoffereditsemployerstockinaunitizedfundinits401(k)plan.qUnitizedfund=stockandsomecashtofacilitatetrading.qPros=allowssamedaysettlementandreinvestment;canloweroveralltradingcostsbynettingbuysandsells.

qCons=someinvestmentdragifstockisrising.Frequenttraderscanimposetheirtradingcostsonotherfundinvestors.

qPlanfiduciariesinvestigatedfrequenttradinginthefund,alsoawareofinvestmentdragissue.Nochangeandnodocumenteddecision.

qCourthelditwaslikelyaprudentfiduciarywouldhavemadeadecisionhereandremandedcasetotrialcourt.

qCasesettledfor$9.5million.

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WaystoLimitExposuresAnd becomeanunattractivelitigationtarget

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Disney andChevron:CaseTeachingsonHowtoLimit ExposureWhitevChevron andInreDisneyERISALitigation casesweredismissedonthepleadings.Toughtodo,butshowhowgoodfactsandpracticescanhelpmakeplananunattractivetarget.

Chevron – Plaintiffsbroughtmultipleclaims.Eachonewasdismissedonthepleadings.

qClaimpaidrecordkeepertoomuchsincepaidapercentofassetsmanaged.qFactsshowedplanfiduciarieschangedtoflatfeewhenassetsgrew.Courtnotedthisshowedprudentmonitoringofthefees.

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Disney andChevron:CaseTeachingsonHowtoLimit ExposureChevron – Plaintiffsbroughtmultipleclaims.Eachonewasdismissedonthepleadings.

qClaimplandidnotofferlowestcostshareclasses.qFactsshowedplanfiduciariesweremonitoringandmovingtolowercostshareclasses.

qClaimshouldhaveofferedstablevaluefundinsteadofmoneymarketfunds.qCourtnotedclaimwasbasedonuseofhindsight,andnobasistoinferimprudentprocessbecausedidnotincludeastablevaluefund.

qClaimshouldhaveremovedanunderperformingsmallcapfund.qFactsshoweddidmonitorandremoveafteraperiodofunderperformance.

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Disney andChevron:CaseTeachingsonHowtoLimit ExposureDisney – PlaintiffschallengedinclusionofconcentratedSequoiaFundthatwasheavilyinvestedinValeantstock

qCourtnotedclaimwasbasedonuseofimproperhindsight.Plansnotrequiredtoattempttooutsmartthemarketanditsvaluations.

qConcentratedfundjustoneofmanyoptionsofferedparticipants.Highrisk,highpotentialreward.

qPlandisclosedthesefundcharacteristicstoparticipants.

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BestPracticestoLimitExposuresOverarchingbestpracticeI:Implementanddocumentprudentfiduciaryprocess.

qCritical– absentthis,fiduciariesaresubjecttosecond-guessingandhindsight.SeeKraft.

qMustdocumentprocessand thedecision.SeeKraft.

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BestPracticestoLimitExposuresOverarchingbestpracticeII:Provideadiversifiedmix(stylesandcosts)ofinvestmentoptions.

qDoNOThavetoofferjustlowcostindexfunds.Butsafetoincludetheseinmixofplaninvestmentoptions.

qChevron influencedbymanylowcostindexfundsoffered.

qPutschoiceinparticipants’hands.

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BestPracticestoLimitExposuresOverarchingbestpracticeIII:Providefulsomeplanandfunddisclosures

qDisneyillustrates– participantsnotifiedthattheywereinvestinginconcentrated,highriskfund.

q Properdisclosuresagainputschoiceinparticipants’hands.

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FeeLitigation– StatusofDOLFiduciaryRuleRuleaddresseswhoisafiduciaryregardingthosewhoprovideinvestmentadviceforafee.

qDOL’snew,broaderdefinitionoffiduciaryandimpartialconductstandardswentintoeffectonJune9,2017:qRecommendation=acommunicationthatisacalltotakesomeactionregardinginvestments.

qCompensation=directorindirect,suchasrevenuesharing.qImpartialconductstandards=advisormustactprudentlyandintheinterestsofinvestor/client.

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FeeLitigation– StatusofDOLFiduciaryRuleRuleaddresseswhoisafiduciaryregardingthosewhoprovideinvestmentadviceforafee.

qSincemoreadvisorswillbefiduciaries,planfiduciarieswillhavebroadermonitoringobligations.

qButfiduciaryobligationsoughttoalsogiveplanbroaderprotections.

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Questions?

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