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Can 401(k) Lawsuits Help?

Recent legal actions have not targeted the worst offenders, but are an (inefficient) step in the right direction. 

John Rekenthaler, 08/16/2016

Serving Notice
Are there any 401(k) plans left to sue?

I left for vacation two and a half weeks ago. During my absence, lawsuits were filed against the sponsors of defined-contribution retirement plans at Franklin Templeton, Neuberger Berman, Duke, MIT, Yale, and New York University. Apparently, it's better for plan sponsors if I remain in the country.

Then again, in the month before, American Century and New York Life were served. So, it's not as if this rash of 401(k) lawsuits is a new thing. It has accelerated recently, but this has been an ongoing trend for several years now. There has been a whole lot of moving and shaking going on with 401(k) plans. (I use 401(k) generically, as a substitute for the less wieldy term of defined-contribution. Technically, universities offer 403(b) plans, but close enough.)

The alleged culprits are an unlikely group, consisting of four investment managers and four large private universities. Thus, the lawsuits have targeted arguably the two most knowledgeable segments of 401(k) plan sponsors. Investment firms, of course, run money for a living, while the large universities have in-house professionals that run their pension funds. Both types of organizations are much better positioned to establish and monitor 401(k)s than is the typical plan sponsor.

Those institutions haven't been notably bad actors with their regular businesses, either. If you were to form a list of the worst mutual fund managers, the four defendants would not be near the top. Nor are the four universities in bad grace. Quite the contrary; they are universally regarded as being among the nation's elite.

Only the Good Die Young
It's not surprising, then, that these plans look to be better than most. An independent rater of 401(k) plans, BrightScope, judges seven of the eight targeted plans as being superior to their peer-group average, with only Duke falling slightly below the norm. On the critical issue of costs, the plans fare better yet. Six earn BrightScope's top cost score of "Lowest Fees," with the other two having "Low Fees." Thus, all eight plans are cheaper than the average for their peer groups.

(By now, you are probably wondering about the alleged infractions. Most are that the plan's relatively low costs could be even lower, if the plan sponsor had been sufficiently diligent. Perhaps the sponsor could have trimmed the number of plan options; or used additional investment providers; or offered more index funds; or opted for collective investment trusts rather than registered mutual funds.)

Which brings us to the problem with how 401(k) plans are policed. Plans are penalized not by the severity of their crimes, but instead by the likelihood that they will pay a large fine. That is, in practical terms, the enforcement of 401(k) regulations does not come from the legal authorities. It comes instead from the possibility of a lawsuit--a lawsuit that is fruitless to its creators unless it leads to a sizable cash payment.

is vice president of research for Morningstar.

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