Service Provider and Investment Due Diligence in the Retirement Plan Space: A Look at Recent Law Suits

An interesting development arose earlier this month in the qualified retirement plan space. Three law suits were recently filed against M.I.T., N.Y.U., and Yale. The universities, as fiduciaries, are being sued for allowing their employees to be charged excessive fees on their 403(b) and 401(k) plans. The suits are seeking class-action status.

The complaints generally allege, among other things, that the universities, as the plan sponsors, failed to address excessive fees paid to administer the plans and did not replace more expensive, poorly performing investments with cheaper ones. When the universities didn’t use their bargaining power to cut costs it collectively cost the participants tens of millions of dollars.  The suits also argue that even the cheapest funds offered could have been negotiated for less and the universities did not select a single low-cost record keeper for administrative tasks such as sending statements to employees.  Even when Yale consolidated to one provider and switched to some lower-cost investments, the suit alleges that the changes did not go far enough.

The suit against MIT also alleges that the university, due to its longstanding relationship with its plan provider, which has donated hundreds of thousands of dollars to the University and with its CEO serving as a member of M.I.T.’s board of trustees, did not conduct a thorough search for a plan provider.

Registered investment advisers providing advisory services to plan sponsors should document initial and periodic third party due diligence including a review of the cost structure of the service provider’s fees compared to similar services.  Advisers should clearly communicate recommendations to plan sponsor clients based on the due diligence conducted considering cost, performance and other key factors.  The best interest of the plan and plan participants should be the lynchpin of all recommendations to add or retain a service provider or investment option.

Advisers to qualified plans should be especially attuned to the potential conflicts of interest that may arise with an affiliated service provider, or a service provider who is associated in some other fiduciary capacity to their client. One such conflict may exist when a service provider pays fees either directly to the adviser or indirectly by paying for services that the adviser or the adviser’s affiliate would under other circumstances pay such expenses for themselves (e.g. legal, administrative or accounting fees, or office space).

Prior cases remind us of the following:

• Investment advisers, including large institutions, such as Franklin Templeton, American Century and New York Life, have been sued for putting their own investments (self-dealing) in their employees’ 401(k) plans.
• In a landmark case before the Supreme Court filed by the same attorney who filed the recent cases against the universities, the justices agreed that plan sponsors, as fiduciaries, had a “continuing duty to monitor investments and remove imprudent ones.”
• Financial professionals serving as a fiduciary must act in the customers’ best interest.

Doug Kamin is a Senior Consultant at NCS Regulatory Compliance and can be reached by calling 646-883-6500 or by e-mailing him at dkamin@ncsregcomp.com.

NCS Regulatory Compliance has been assisting broker-dealers and investment advisers with industry critical compliance responsibilities for over 25 years. We continue to provide products and services to thousands of firms in the financial services industry. If you have questions related to compliance obligations, compliance requirements, or other compliance topics, please contact us at 800-800-3204 or info@ncsregcomp.com.