How Does the Threat of Litigation Shape Trends in DC Plan Design?
By Keegan Brown and Angela Antonelli
At this year’s Center for Retirement Initiatives (CRI) Policy Innovation Forum, industry and legal experts gathered to consider how the threat of litigation affects innovation in DC plan design. How does such litigation shape the actions of plan providers, sponsors, and those who advise them, and where is the balance between protecting plan participants and allowing sponsors to innovate and improve outcomes?
Unfortunately, every aspect of the design and management of today’s retirement plans is subject to intense scrutiny. While lawsuits against plan sponsors can be a justifiable course of action for participants, there are certainly cases where litigation is not only frivolous but serves legal counsel’s monetary interest more than plaintiffs. The U.S. Chamber of Commerce has underscored this trend, noting in an amicus brief related to an ERISA excessive fee lawsuit against the American Red Cross that “converting subpar allegations into settlements has proven a lucrative endeavor — mostly for the lawyers bringing these lawsuits, though, rather than the plan participants they purport to represent.”
How Litigation Shapes Today’s Retirement Plans
Plan sponsors are no strangers to litigation and regulatory compliance risk. In 2020 alone, Callan reports that 73 ERISA litigation suits were filed against mid- to mega-sized DC plans. Increased litigation risk over the last decade has shaped the industry in several ways.
- Fiduciary advisors and chief investment officers’ roles are being outsourced
Many plans have outsourced their fiduciary advisors and chief investment officers to hedge against litigation risk, in part due to an erosion of fiduciary indemnifications that favor plan sponsors. Shifting fiduciary duty away from a shared responsibility (such as those in 3(21) style plans) to an outsourced version can be particularly helpful for organizations lacking the resources to provide adequate oversight of the plan. Pooled Employer Plans (PEPs) support many smaller businesses by reducing costs associated with plan administration, recordkeeping, and other vendors. The rise in 3(38) advisors, however, does not preclude a plan from liability related to the prudent selection of an investment manager or 3(38) advisor. In addition, not all 3(38) providers are created equal. Some solutions provided may not be as favorable to plan sponsors from a litigation perspective as others.
- Compliance burdens and client communication are becoming even more cumbersome
The compliance burden for plan sponsors has ballooned, particularly when it comes to client communication. Disclosures required for relatively basic client communication can be quite lengthy, and largely serve to protect against litigation rather than inform plan participants. Plans looking to be innovative in the options provided to their participants (e.g., strategies that consider assets outside of the plan itself, decumulation-focused strategies for individuals drawing on plan savings, etc.) must focus immense compliance resources on preempting litigation, even if the benefits of an innovation are clearly in client interest. Required research and compliance burdens associated with these requirements can be costly and time-consuming, and ultimately chill more effective and clear communications to plan participants.
- Small plans follow the lead of large plans
Large plans managing millions in assets almost view litigation as a potential cost of doing business and the risk of designing plans in the best interest of their participants. Their size and scope allow for more latitude and innovation. More resource constrained plans likely do not have the compliance resources to effectively prepare to introduce more innovative approaches and solutions. Smaller plans typically end up adopting innovation after it has seen success in larger plans.
Finding Ways to Innovate Is Possible
While some of these trends are not necessarily negative, others can hinder effective service to plan participants. There are ways to begin to create an environment for plan sponsors which can reduce the risk of litigation and encourage more innovation.
- Judges should use their discretion to assess the merits of a case earlier
Judges should intervene in cases where the merits of a suit are unlikely to lead to a finding in favor of the plaintiffs and thus may discourage the “sue to settle” strategy leveraged by some firms. This could effectively reduce compliance costs for plans that find settling frivolous cases less expensive than combating their merits at trial. While there is no room for discouraging lawsuits with legitimate claims, taking steps to evaluate suits’ merits before they are filed could help reduce regulatory burdens for plan sponsors.
- Policymakers and regulators should provide clear guidance for sponsors
Policymakers can significantly improve the legal landscape by providing legal and regulatory guidance that supports plan sponsors electing to innovate. For example, the ESG rules from the Trump administration — and their subsequent reversal in the Biden administration —is a common change that creates uncertainty until new guidance is provided. In this case, the DOL finally issued updated guidance in late November 2022. Clearly defined boundaries of governance and fiduciary obligation allow plan sponsors to act confidently toward long-term strategies.
- Sponsors should engage in more frequent review of fund offerings and service providers
Excessive fees are the most common source of litigation. Plan sponsors should frequently review their fund offerings and service providers to ensure both that they are providing competitive performance and expenses are in line with industry standards for the services rendered. Evidence of consistent fiduciary review of plan offerings is advisable, especially with the Supreme Court’s recent ruling in Hughes v. Northwestern University that participant choice between investment vehicles does not preclude a plan manager’s burden to furnish prudent investment options.
If reasonable steps can be taken to ameliorate the litigation risks to plan sponsors, it is possible we could have more innovation and better outcomes for plan participants. The fiduciary duty requirement remains the standard of care. Innovation that can improve outcomes for plan participants should be considered by plan sponsors and, if appropriate, adopted. But it is important that both the legal and regulatory environment allow plan sponsors the latitude to use their expertise to evaluate and execute on decisions in the best interest of plan participants
Angela M. Antonelli is a Research Professor and the Executive Director of the Georgetown University Center for Retirement Initiatives (CRI).
Keegan Brown is a graduate Research Assistant with the Center for Retirement Initiatives (CRI).
December 2022, 22-07
Callan, What DC Plan Sponsors Should Know About Recent Litigation Trends: Part 1, January 2022.
Cerulli Associates, Litigation in Defined Contribution Retirement Plans, March 2021