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Exclusive Interview: Jerry Schlichter Reveals 3 Ways 401k Plan Sponsors Can Avoid a Fiduciary Breach

October 21
00:02 2014

Jerry Schlichter has made a name for himself and his firm as lead attorney on numerous cases on behalf of employees and retirees involving claims of excessive fees and fiduciary breaches in large 401k plans. Widely quoted in articles concerning Jerry_Schlichter_Photo_8-2011_(01364769)_300401(k) fees and was recently featured in the New York Times article “A Lone Ranger of the 401(k)’s” and in the Investment News article “Public Enemy No. 1 for 401(k) Profiteers,” He has been listed as the third most influential person nationally in the 401(k) industry in the industry.  Mr. Schlichter has been praised by The AARP for his work benefitting workers and retirees by reducing fees in 401(k) plans.

More recently, the Supreme Court has decided to hear the Tibble v. Edison excessive fee case, with Mr. Schlichter working for the plaintiffs. Although the case involves a possible fiduciary breach based on excessive fees, the Supreme Court will rule on the issue of whether one’s fiduciary duty has a statute of limitations.

FN: Our readers are always interested in the background of our subjects. What got you interested in the field of law in general? When did you first become aware of the issues that you’ve exposed in the 401k market? What was the “critical” point or event that occurred that enabled you to pursue your first successful case?
Schlichter: I grew up in a small town in the Midwest and didn’t know any lawyers. My father was an aircraft mechanic and my mom a housewife. The reason I went to law school was because I didn’t know what I wanted to do and thought that knowing how the law worked would be helpful in whatever I did, especially in helping others. The combination of law school and the civil rights struggle in this country showed me that a lawyer can accomplish a lot for people and make a profound difference in their lives. The first major case I took on as a practicing lawyer was a class action for a group of African American and Hispanic workers at a railroad, who were kept in the lowest paying, hardest jobs. We were able to achieve a significant settlement which dramatically changed the employer’s policies and created opportunity for the minority employees. I have always represented individuals in matters ranging from civil rights to personal injuries to environmental matters and founded a firm to do that. I’ve also had the good fortune to work with a lot of colleagues in the firm who share my values and work tremendously hard for our clients.

Some years ago, we began getting more and more questions and hearing greater concerns from workers about their retirement as the 401k defined contribution model replaced the traditional pension plan in this country. Workers told us that they couldn’t tell what fees they were being charged and were worried about whether they would have enough money to retire. And when they asked their employers questions they weren’t getting answers. We spent a long time looking at industry practices, and came away convinced that there were some 401k plans that were not being run by fiduciaries in a way that was consistent with their legal obligation to work for the benefit of employees and retirees according to the federal ERISA statutes. The result is that we have brought cases to change those practices and compensate 401k plan participants who have suffered losses of retirement assets.

FN: There appears to be a common thread in the cases you’ve brought before the courts. Can you tell our readers what these commonalities are and why you think they existed? Given the new 401k Fee Disclosure Rules promulgated by the DOL, do you see these issues on the wane or do the disclosure rules still allow some wiggle room for conflicts-of-interest to occur?
Schlichter: We do see fiduciary actions that violate the clear and important duty that a fiduciary must act only in the exclusive interests of employees and retirees. Fiduciaries must be familiar with practices that adhere to the law and are in the best interests of plan participants. Fiduciaries must ensure that fees are reasonable relative to the size of the plan; too often fees are being charged that are excessive given plan asset size that could easily get participants lower fees. Fiduciaries must also monitor all fees in the plan, and avoid using employees’ retirement assets to benefit the employer. These really are very simple duties for fiduciaries to follow, yet some fail to do so.

The DOL Fee Disclosure rules are a good thing. Judges and commentators have reported that the cases we’ve brought were part of the reason why they were instituted. But many plan sponsors are still not coming into compliance. Even without these new disclosure regulations, the law does not permit fiduciaries to create or act on conflicts-of-interest, but unfortunately some of them do. An example of such an employer practice is an employer obtaining large discounts on employer services from the same service provider who is overcharging participants in the 401k plan.

FN: There seems to be a push by some leading lobbyists and politicians to add annuity options to 401k plans. Since these products are multi-layered, with each layer potentially containing a different fee, and since these products often represent potential conflicts-of-interest and it is often difficult to obtain apples-to-apples fee comparisons on these products, what are some potential fiduciary liabilities plan sponsors need to focus on when considering the possibility of including annuities in their 401k plans?
Schlichter: Fiduciaries must first determine what all the fees are that are being charged. As you point out, annuities have often been opaque when it comes to determining all in what fees are being charged. Next, fiduciaries must determine, as with all plan investments, that the fees are reasonable, and that the investments are sufficiently safe so as to be a meaningful long term retirement asset. If diversification of products in the annuity is limited, the product may result in a fiduciary breach because it exposes the employee to undue risk. Further, of course, there should absolutely be no conflict-of-interest or self-dealing. We’re aware of the growing interest in annuities and the potential for abuse.

FN: In terms of actual enforcement, it seems, as if you’re doing a lot of the work the DOL is required to perform. Why do you think this is so? What are the differences between the types of cases you pursue and the types of cases the DOL pursues?
Schlichter: I think we have to recognize that the DOL has a tough job. They have limited resources and an ever growing and changing industry to keep in compliance. I don’t think anyone realized when ERISA was instituted 40 years ago that the financial services industry would become as large and complex as it is today, let alone all the crises that have occurred on Wall Street that have had such a devastating impact on the average “Main Street” saver. You would have to ask the DOL to provide their views on what cases they have or have not taken. Certainly, they also have the ability to bring cases similar to what we have brought, and to make a major difference in the American retirement system. The DOL has also written briefs in support of our cases for which we are grateful. We’re pleased that multiple federal courts have noted that we have functioned as a “private attorney general” in pursing these cases, and the judges have also noted that our cases have had a major impact in bringing fees down across the board for Americans who participate in 401k plans.

FN: Some have said that DOL regulations have become too onerous for the “part-time” fiduciary that many corporate plan sponsors have become. They suggest plan sponsors might be better served if they could delegate as much of their fiduciary responsibility as possible. The idea is, if plan sponsors hire a professional fiduciary, the proper due diligence is more likely to be completed and plan participants would be better served. Do you agree with the concept behind this premise? In the cases you’ve brought, has the plan sponsor more often than not failed to hire a fiduciary to oversee plan investments? What is the difference in the nature of the issue between the cases where the plan sponsor didn’t hire a fiduciary and the cases where the plan sponsor did hire a fiduciary?
Schlichter: There are clear regulatory, management and administrative burdens for any employer who decides to provide a 401k plan. However, there are also benefits to both the employer and its employees. While an employer can benefit from hiring an experienced, ethical adviser, by sharing the burden of fiduciary responsibility, there is a danger that employers may place too much reliance on the adviser or fail to monitor the adviser’s actions. So, I don’t agree that employers should think of delegating as much fiduciary responsibility as possible. No matter what the level of delegation, the delegating plan sponsor still retains some fiduciary responsibility, including co-fiduciary duties, and there can be a temptation to believe that the employer’s duty is avoided.

FN: Can you briefly explain the differences between a 3(21) adviser, a 3(38) adviser, a 3(16) adviser? What are the types of firms that usually undertake these roles? How does the degree of plan sponsor fiduciary liability change with each of these roles?
Schlichter: Generally speaking when it comes to fiduciary status under ERISA, it is best to start with the fiduciary named in the documents governing the plan. The plan documents will set forth the responsibilities for the named fiduciary(ies), which often will include administrative responsibilities referred to in ERISA 3(16). In the absence of a named fiduciary, the responsibilities are assumed by the plan sponsor. Fiduciary status, however, is mostly a functional test under ERISA 3(21). While a named fiduciary cannot escape liability by delegating or ignoring his/her responsibilities, the functional test under ERISA 3(21) contemplates that others who possess or exercise authority or discretion over the plan or its assets are also fiduciaries. One example of a fiduciary under 3(21) would be an investment advisor or consultant that is hired by the named fiduciary to give recommendations regarding the plan’s investments. Certainly, when a registered investment advisor is contracted to invest plan assets, the advisor becomes a fiduciary both under ERISA 3(21) and 3(38).

FN: There is a fourth option, one which the IRS allows but the DOL has placed stringent restrictions upon, and that is the MEP. Under current DOL guidelines, an MEP is a group of businesses with a common association. They would all share the same plan with the association acting as a plan sponsor. In most cases, one or more professional fiduciaries are hired to oversee the plan. Given this, to what extent is fiduciary liability mitigated between a company that acts as its own plan sponsor and one that has delegated its plan to an MEP?
Schlichter: There are numerous factors involved in the administration of an MEP, but, again, the businesses must be careful not to assume that they have delegated away all fiduciary responsibility. It is not uncommon for a fiduciary to delegate responsibility to another person or entity, including, at times, third parties. The delegation of fiduciary responsibility, however, does not completely relieve the delegating fiduciary of responsibility. Both in the delegation and the continued oversight of the delegee, the original fiduciary must act according to ERISA – reasonably and prudently in the sole interests of the plan and its participants, avoiding all prohibited transactions.

FN: What would you advise plan sponsors to do in order to avoid being in the position of finding themselves in court? How can they best use professional fiduciaries? Recognize that, even when delegating certain fiduciary duties, the plan sponsor still retains significant fiduciary liability, what must a plan sponsor continue to do even when delegating fiduciary duties?
Schlichter: The sponsor first and foremost must always act with the strict guide that what it does must be based on the standard of one familiar with industry practices, investment management, and financial matters, while acting solely in the interests of plan participants. Following that principle answers many questions that arise. Clearly, sponsors must carefully monitor the performance of advisers and independently determine whether their advice is sound and based on prudent standards. They should never get so locked into a particular adviser, or into a broader business relationship with that adviser and its organization, that they don’t question his or her advice.

FN: Many of the cases you’ve been involved with represent the appearance of obvious and serious conflicts-of-interest. Your work has helped expose important issues all plan sponsors must monitor with extreme diligence. How worried are you that your success might attract copy-cats who are less discriminating? Do you ever see the legal industry taking aim at fiduciary liability within the retirement plan industry the same way it has targeted malpractice in the medical industry? Can you suggest any types of tort reform that might be advanced that would discourage lawyers interested only in a quick strike from entering into the retirement industry yet continue to allow honest cases like yours to move forward?
Schlichter: I’m not concerned about a run of litigation by lawyers copying what we are doing. There is a reason why private lawyers have historically not brought the kinds of cases we’ve taken on for plan participants. It requires a great deal of expertise and hard work to become familiar with what is going on in a 401k plan, to develop the infrastructure to do the in-depth research into a broad and diverse set of facts, and to bring in top notch expert witnesses. Then there’s expertise in the courtroom actually trying these complex cases, not to mention the appeal process and even Supreme Court experience, which we also have. It also requires having the capability and willingness to invest substantial time and resources, all at risk to the law firm, in order to pursue a case to the right outcome for the plan participants. We have cases that have gone on now for eight years, and we are committed to pursuing them to conclusion no matter what it takes because we believe those plans need to be reformed and the participants’ losses restored. The commitment needed to bring and pursue a case fully and to a positive result is much greater than that required for most other kinds of cases. I don’t see that becoming something many lawyers take on.

FN: Can you summarize the top three fiduciary liability concerns, as you see them, that all ERISA plan sponsors should be focused on?
Schlichter: 1) Putting participants’ interests first – this should be the beacon that fiduciaries follow; 2) Developing a fully informed understanding of industry practices and reasonableness of service providers’ fees – in other words becoming a knowledgeable industry expert; and, 3) Avoiding self-dealing – you simply cannot benefit yourself in any way.

FN: Do you have any other thoughts you’d like to share with our readers?
Schlichter: I’m really gratified that our firm has been able to help so many plan participants and that we’ve been able to have a positive impact on bringing plan sponsors into compliance with ERISA. In our settlements we work to ensure that there will be ongoing monitoring to ensure that compliance persists. I also think we’ve helped bring national attention to the core issues, which focus not just on adhering to the law but on the broader responsibility of doing what’s in the best interests of employees participating in the retirement plan. There are tens of millions of people in 401k plans and the numbers are growing. I think our work has helped those people, most of whom rely almost solely on these plans for their retirements. That’s a good feeling.

FN: Thank you very much Mr. Schlichter for taking time from your very busy schedule to tell our readers of your experiences and how they might reduce their fiduciary liability while helping retirement savers have the best chance to enjoy a comfortable retirement. We look forward to reading more of your activities, especially your upcoming appearance before the Supreme Court.

Interested in learning more about important topics confronting 401k fiduciaries? Explore Mr. Carosa’s book 401(k) Fiduciary Solutions and discover how to solve those hidden traps that often pop up in 401k plans.

Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada. His forthcoming book Hey! What’s My Number? – The One Thing Every Retirement Investor Wants and Needs to Know! Will be available later this year.

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About Author

Christopher Carosa, CTFA

Christopher Carosa, CTFA

7 Comments

  1. Ron Surz
    Ron Surz October 21, 13:42

    I wonder how Mr. Schlichter views the current common practice in selecting target date funds, namely choose your bundled service provider, with apparent disregard to risk, especially at the target date. In other words, whatever the bundled service provider offers is presumed to be OK, or perhaps it’s presumed that all TDFs are the same? Both views are certainly not enlightened.

  2. Christopher Carosa, CTFA
    Christopher Carosa, CTFA Author October 21, 14:17

    Ron: While not pertaining to Target Date Funds specifically, the issue of “poor fund choice” came up briefly at the CFDD Annual Conference last week. It came up in this context: “No plan sponsor has ever been sued for poor performance.” I believe the intention of that remark was to say there must be some clear fiduciary breach, rather than merely a process failure, to rise to an actionable concern – whether on the part of regulators or in the civil courts. Clearly, it relatively easy to see that conflicted fees pass this test. Ergo, the same would hold true for Target Date Funds. The twist, though, is that target date funds must be comprised of index products, not actively managed products. It’s easy to compare fees with index funds, not so easy to compare them for actively managed funds. That being said, the practice of bundling proprietary funds – whether indexed or not – may rise to the level of self-dealing. There are exemptions, so you are correct about the need to ask a lawyer the question.

  3. Ron Surz
    Ron Surz October 22, 09:54

    Hi Chris,

    It’s not about performance. It’s about the Duty of Care. Fiduciaries have a duty to (1) try to select the best (which doesn’t mean the best performance) and (2) to protect against foreseeable harm. Bundled service providers are not the best IMHO, and they certain;y aren’t protecting against loss, especially at the target date (they’re actually running a performance horse race that is betting on risk). Please see http://www.targetdatesolutions.com/articles/Fiduciary-Handbook-Chapter02.pdf

    Thanks

  4. Christopher Carosa, CTFA
    Christopher Carosa, CTFA Author October 22, 11:39

    Ron: I think you’re correct. Bundled service providers are at greater risk when it comes to embedded conflicts-of-interest. Ironically – and I think we’d have to ask an ERISA lawyer for sure – it’s possible to violate one’s fiduciary duty due to a conflict-of-interest (or self-dealing) transaction even if the performance is superior. That’s a tough nut to swallow, but, in the purest sense of “fiduciary” (now I’m going all the way back to the Magna Carta), that should be the case. But then that brings up an interesting question: Isn’t “superior performance” in the best interest of the client? Therefore, shouldn’t that trump a conflict-of-interest? I know in the real world that’s a rare find, but it’s an interesting philosophical (if not legal) point to ponder.

  5. Ron Surz
    Ron Surz October 22, 14:22

    Hi Chris.

    It’s not about performance, nor conflict-of-interest. It’s about laziness and apathy. And it’s not about bundled service providers, since they are not fiduciaries. It’s about plan sponsors & their advisors.

  6. Mike Sladky
    Mike Sladky October 23, 11:02

    Bundled service providers present the best choice of 401k retirement savings platforms for most small-mid size employers. This has been true since 1982!
    Give these firms credit (insurance companies, banks and investment management firms) for their product development over the years. Without their service models that they have offered, what would the USA retirement savings market look like today?

    Mike Sladky
    PS-Not sure these fee law suits that have settled have provided much financial benefits to participants-the math is not hard

  7. Ron Surz
    Ron Surz October 23, 16:19

    We have a different opinion Mike. Bundled service providers do NOT offer the best target date funds, at least not the Big 3. Not even close.

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