Giving plan participants a wide range of investment options is a good thing — but only to a point. That’s one of multiple allegations in recent class action lawsuits filed against several prominent universities. The litigation, in the early stages as of this writing, offers a cautionary note for plan sponsors who offer a high number of investment options. While 401(k) plan sponsors are more than familiar with these types of claims, this is the first time nonprofit organizations have been targeted.
Targeting seven universities, including New York University, Duke, Yale and MIT, the lawsuits suggest there are at least two problems when offering too many fund choices:
- Overwhelming participants, and
- Incurring excessive costs.
Another possible problem: Fiduciaries may not have the ability to monitor the performance of so many funds.
“Defendant provided a dizzying array of duplicative funds,” according to the complaint in Sacerdote v. New York University. According to the complaint, NYU offered more than 70 investment options for participants.
To put that number into perspective, the complaint cited a survey that determined the average number of funds in defined contribution plans, excluding target date options, is 15. The plaintiffs contend that this lower number of options “provides choice of investment style while maintaining a larger pool of assets in each investment style and avoiding confusion.”
According to the suit, studies indicate that people have less confidence and end up making no decision when presented with too many choices. Thus, according to the plaintiffs, plan fiduciaries aren’t serving the best interests of plan participants as required under ERISA by offering a large number of options.
Be aware, however, that the complaint didn’t offer any statistical evidence that participants had made inappropriate investment choices. The organizational culture at many universities gives great deference to employees’ confidence in their ability to make complex decisions.
Whether that confidence is appropriate under ERISA is to be determined. Each plan sponsor will need to provide evidence that it took the demographics of its own employee population into account in determining whether the number of plan investments is overwhelming.
As for the cost issue, the evidence may be easier to assess. The suit faults NYU on two fronts: using three record keepers and too many funds. The complaints allege that these failures cost tens of millions of dollars in retirement funds. As is not uncommon with nonprofit organizations that sponsor 403(b) plans, their retirement programs consist of multiple recordkeepers with different investment options. Employees can choose among all offered recordkeepers to invest their funds.
The plaintiffs contend that using a single recordkeeper provides clear benefits. For example, using a single recordkeeper can enhance purchasing power and allow sponsors to negotiate lower, transparent participant investment fees.
The complaint makes the same argument with respect to the number of investment options: The plaintiffs assert that plan sponsors can “dramatically reduce participant-borne costs while improving employees’ retirement readiness by reducing the number of investment options, utilizing an ‘open architecture’ investment menu, and packaging the options within a tiered structure.”
The plaintiffs also criticized the plan’s inclusion of many actively managed stock funds, whose costs are typically much higher than passive index funds. “To the extent managers show any sustained ability to beat the market, the outperformance is nearly always dwarfed by mutual fund expenses,” states the complaint.
These cases are in the early stages. However, take notice: No matter how well you’ve chosen your investment options, if your plan includes dozens of options, this could signal a breach of your fiduciary duty. Review your investment options now to avoid the possibility of dealing with this issue later in court.
BPM is one of the largest California-based accounting and consulting firms, ranking in the top 50 in the country. It has served the San Francisco Bay Area's emerging and mid-cap businesses, as well as high-net-worth individuals, since 1986. Our Employee Benefits team consists of professionals with extensive knowledge of ERISA guidelines and deep expertise performing employee benefit plan audits. We can help you craft a smooth-running plan that serves your employees while mitigating associated risk. For more information or for a free expert consultation, Jenise Gaskin at (925) 296-1016 or visit us at www.bpmcpa.com/ebp.