How To Manage 401(k) Lawsuit Risks In 4 Steps

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Nordstrom Inc. recently made headlines for breaching its fiduciary duty after failing to consider low-cost options and disclose specific amounts charged to participants. In November 2017, a California court ruled that the company was guilty of failing to reduce plan expenses by as much as &l;a href=&q;; target=&q;_blank&q;&g;&l;span&g;$3.6 million a year&l;/span&g;&l;/a&g;.

This is one of many ERISA lawsuits filed against plan providers. Even though offering a 401(k) plan remains one of the best ways to attract and retain talent, it is important to assess risks and design a plan that manages lawsuit risk.

Completely eliminating all litigation risks is not a realistic goal. However, it is possible to take steps towards reducing them and seek to improve your chances of defeating a claim in court.

&l;strong&g;Understand your role and identify risk areas&l;/strong&g;

The Employment Retirement Income Security Act of 1974 (ERISA) establishes standards of conduct for fiduciaries. ERISA explains what needs to be disclosed to plan participants and their beneficiaries and defines the primary purpose of a fiduciary as acting in the best interest of the plan participants at all times.

Reviewing recent ERISA cases shows that there is a pattern in the mistakes made by plan providers. Most of these cases suggest that plan providers are not entirely aware of their obligations as fiduciaries and do not plan accordingly to uphold these standards.

The first step toward reducing the risk to your organization from lawsuits is to &l;a href=&q;; target=&q;_blank&q;&g;&l;span&g;read the DOL&a;rsquo;s guidance for following ERISA&l;/span&g;&l;/a&g; and understand all your fiduciary obligations.

You should be able to properly identify risk areas by assessing previous ERISA lawsuits such as the Nordstrom Inc. case and a recent &l;a href=&q;; target=&q;_blank&q;&g;&l;span&g;lawsuit filed against Home Depot&l;/span&g;&l;/a&g;&l;span&g; which&l;/span&g; revealed that the employer consistently selected assets with poor performances and failed to replace them. Home Depot also failed to disclose how a financial advisor was compensated and didn&s;t take the necessary steps to reduce fees that were deemed unreasonable.

These lawsuits reveal four problematic areas: high fees, recordkeeping and administrative issues, a failure to follow due diligence processes to choose investments and evaluate their performance, and failure to disclose information to plan participants regarding fees, investment options or the services offered.

&l;strong&g;Establish due diligence processes&l;/strong&g;

Until you have established due diligence processes to manage your organizations 401(k) plan, you should not consider beginning to design or allocate assets for the plan itself.


It is important to create due diligence processes to cover these different areas:

&l;ul&g;&l;li&g;A methodology to select investments and manage risks.&l;/li&g;

&l;li&g;Reviewing asset performances and potentially replacing assets.&l;/li&g;

&l;li&g;Reviewing fees and comparing them with industry standards.&l;/li&g;

&l;li&g;Determining which fees are justifiable and which services bring value to the plan.&l;/li&g;

&l;li&g;Selecting third-party service providers such as financial advisors and verifying their compliance with the ERISA.&l;/li&g;

&l;li&g;What needs to be disclosed to plan beneficiaries and how this information will be shared with them.&l;/li&g;

&l;li&g;How plan participants will be informed and educated regarding different investment options.&l;/li&g;

&l;li&g;Monitoring communications between third-party service providers and plan beneficiaries to make sure they receive advice that is in their best interest.&l;/li&g;

&l;li&g;Keeping records of all communications and due diligence processes so you can strive to meet fiduciary duty standards in case of a lawsuit.&l;/li&g;

&l;/ul&g;&l;strong&g;Select an ERISA 3(38) fiduciary&l;/strong&g;

By selecting an ERISA fiduciary advisor (rather than a broker) a great deal of the liability and responsibility mentioned above is mitigated for the selection, performance and monitoring of the investment lineup.

Some advisors may also offer the assistance of other consulting services to help you keep your plan compliant

&l;strong&g;Create an investment committee&l;/strong&g;

One of the best ways to manage a 401(k) plan is to create an &l;a href=&q;; target=&q;_blank&q;&g;&l;span&g;investment committee&l;/span&g;&l;/a&g;. This committee (along with your financial advisor) will be responsible for developing the different due diligence processes and for implementing them.

Adopting a committee structure means that HR professionals would have the opportunity to work with their financial and legal counterparts. Responsibilities and duties will be shared between committee members, and each committee meeting presents an opportunity to assess how the plan is performing and confirm that fees are aligned with industry standards.

This approach prevents a single person from holding too much influence over how the retirement plan is managed. Additionally, it will facilitate the review of multiple assets and services when the time comes to compare products and fees.

You can begin to reduce your risks by scheduling a thorough review of current plan assets. If there are any due diligence processes in place, audit these processes and look into improving them so you can strive to meet and exceed fiduciary duty standards. You can then move on to creating an investment committee to work on establishing new due diligence processes and making any necessary changes to your 401(k) plan.

&l;em&g;Securities and Advisory services offered through LPL Financial, a registered investment advisor. Member&a;nbsp;&l;/em&g;&l;a href=&q;; target=&q;_blank&q;&g;FINRA&l;/a&g;&l;em&g;/&l;/em&g;&l;a href=&q;; target=&q;_blank&q;&g;SIPC&l;/a&g;&l;em&g;.&l;/em&g;

This information is not intended as authoritative guidance or tax or legal advice. Each plan has unique requirements, and you should consult your attorney or tax advisor for guidance on your specific situation. In no way does advisor assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations.


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