Fall 2007 issue of Horizons

GENERAL TOPICS

401(K) Lawsuits What You Don’t Know Can Hurt You A St. Louis law firm launched a surprise attack on 9/11 of last year. The firm filed a series of class action lawsuits, alleging that 401(k) plan sponsors had breached their fiduciary duties. The common thread among the suits is that plan sponsors failed to make sure certain expenses incurred by their plans were reasonable and appropriate. The first lawsuits involved large Fortune 500 companies – Lockheed Martin, General Dynamics, International Paper, Bechtel, Caterpiller, Exelon and United Technologies. Soon thereafter, similar suits were filed against Northrup Grumman, Kraft Foods and Boeing. In addition to the sponsoring employers, the defendants typically include plan committees, committee members and various company officers. 1. Fees paid by the plan are excessive. 2. Disclosures to participants regarding the fees are inadequate. 3. Plan sponsors failed to investigate, understand and monitor the fees adequately. A number of the suits allege that plan sponsors did not fully understand all fees being charged to the plan, overtly and otherwise. In particular, the complaints target Though the specifics of each case vary, the general themes are:

revenue-sharing arrangements that are commonplace in the 401(k) industry. On a broad basis, revenue sharing means the transfer of asset-based compensation from investment management providers (mutual funds, collective trust funds, insurance companies, etc.) to service providers such as plan record keepers, administrators and trustees. The transfers help offset the actual costs of providing recordkeeping and other services to 401(k) plans. Revenue-sharing arrangements, if not fully disclosed, make it difficult for plan sponsors to quantify a plan’s total expenses. The complaints allege that the defendants did not understand, monitor and control all hard dollar costs plus all revenue-sharing payments made directly or indirectly by the plans to their service providers. In addition, the suits allege that the defendants did not determine that the expenses were reasonable for services and incurred solely for the benefit of plan participants. Some of the complaints target lack of fund suitability and inappropriate benchmarks for fund review. Some complaints assert that fiduciaries selected inappropriate “retail” mutual fund share classes for the plan when they should have selected institutional share classes with lower expense ratios. Large plans often qualify as institutional investors, so the selection of retail funds for their portfolios raise the question of appropriate selection. Another complaint alleges that a plan offered “shadow” or “closet” funds – funds that claimed to be actively managed but behaved like passively managed index funds. The charges for active fund management are deemed excessive since it is alleged that similar returns could be obtained from a less expensive index fund. Some of the complaints targeted employer stock funds. One allegation is that management fees for the stock fund are excessive. Another allegation is that certain unitized stock funds composed of cash and employer stock included too much cash, thus diluting rates of return on the fund. Another allegation appearing in certain suits is that the performance benchmarks used to monitor certain funds are inappropriate. In some cases, the benchmark used for fund oversight is deemed inappropriate because the fund’s manager is guilty of “style drift” or investing portions of a fund in underlying investments that are not in line with the target benchmark for the portfolio.

17 u winter 2007 issue