The filing of excessive fee litigation against plan fiduciaries is nothing new. However, according to a recent white paper, this type of litigation has entered a dangerous new phase, characterized by both heightened frequency and severity and affecting companies of all sizes. In this new phase, the risk of litigation has, according to the report, reached “unprecedented levels.” A copy of the report, written by Allison Barrett and Joel Townsend of AIG and entitled “Fiduciary Liability Insurance: Understanding the Rapid Rise of Excessive Fee Claims,” can be found here.
According to the report, the current round of excessive fee litigation is the third wave for these types of suits. The first round took place in the mid-2000s, as a single plaintiffs’ firm sued fiduciaries at 18 of the largest employer-sponsored 401(k) plans with billions of dollars in plan assets and thousands of plan participants. The average settlement during this period was over $10 million and at least three settlements exceeding $30 million.
The success of the first wave “spawned a cottage industry of copycat plaintiff’s firms” that filed even more lawsuits against a broader range of targets. Between 2015 and 2020, hundreds of excessive fee cases were filed, with more than 30 claims settling for more than $10 million.
In the current third wave, a growing number of plaintiff’s law firm have entered the fray, “bringing a flood of similar claims against retirement plan sponsors, fiduciaries and service providers.” According to the report, there were more than 100 excessive fee cases in 2020 alone, representing a more than five-fold increase over the number of filings in 2019. One of the distinct features of the third wave is the size of the litigation targets – more than a third of the cases have been filed against much smaller retirement plans, having plan assets under $1 billion. The average settlement remains “outsized”; according to the report, the average settlement exceeds $10 million.
The basic theory of these lawsuits is that plan sponsors and fiduciaries are liable under ERISA for failing to adequately negotiate and/or monitor the fees charge by plan service providers (fund managers, administrators, and record-keepers) or selecting imprudent investment options for plan participants and/or failing to monitor performance and reassess more options, consistent with their fiduciary obligations under ERISA.
The report identifies four factors that are contributing to the recent rapid rise in the number of excessive fee cases. First, some courts, applying the common law of trusts, have held that the defendants have the burden of showing that the alleged loss has not caused by a breach of fiduciary duty. That makes it much easier for plaintiffs to survive the initial pleading stages, as the burden is on the defendants to show why their choices were appropriate, prudent, and within the bounds of reasonableness. The cost of making this case is high as it is a highly technical and highly fact-bound defense. Plaintiffs’ counsel, on the other hand, can score a fee award of they merely show “some degree of success on the merits,” providing the plaintiffs’ bar with a “powerful incentive to file the cases.”
Second, because the cases are being filed by highly specialized, boutique law firms who file carefully crafted cases, the defense of the suits requires the involvement of attorneys who also have specialized ERISA litigation expertise and who can command hourly rates commensurate with those charged by securities litigation attorneys. The costs of defense create their dynamics and settlement incentives.
A third factor driving the litigation is that in many circumstances the statutes of limitations and repose provide little protection. The Supreme Court has held that plan fiduciaries have a duty to constantly monitor retirement plan investments, which as a practical matter has eliminated what had been a six year statute of repose, instead making the six-year lookback period a rolling target with the clock continually being reset. A more recent ruling held that “actual knowledge” of fiduciary breaches is necessary to trigger ERISA’s three year statute of limitations and cannot be established merely by making disclosures available to plan participants.
The fourth and final factor is that it is very difficult for defendants to get excessive fee cases dismissed. As noted above, the burden of proof is on the defendants to show compliance. Many of the arguments defendants seek to rely upon are inherently factual, and unsuited for resolution at the dismissal motion stage. The report cites research showing that in excessive fee cases filed between 2015 and June 2020, defendants were successful on a motion to dismiss in only about one-third of cases (by comparison to securities class action lawsuits, where the dismissal rate approaches 50%). Again, by contrast to securities lawsuits, there is no mandatory discover stay at the dismissal motion stage, subjecting the defendants to costly discovery at the outset, putting further pressure on the defendants to settle.
The upshot of all of this is a “surge in frequency and severity of these cases” with total settlements during the period 2015 and 2020 “totaling more than $1 billion.” With dozens of cases currently pending, the total cost of projected settlements is “likely to increase by hundreds of millions, if not more, over the next several years.” Legal defense costs associated with these lawsuit will even further increase the burden.
With the number of lawsuits increasing and the range of kinds of companies getting targeted expanding, well-advised companies will take steps to try to put themselves in a better position in order to mitigate and manage the risk. The report provides a detailed list of measure companies can put in place. This risk mitigation program “starts with strong governance practices, including establishing a committee to oversee the plan’s financial responsibilities and develop, adopt, and periodically review an investment policy statement.” Fiduciaries should also “keep close tabs on the third parties they engage.” There are a number of other steps companies can take that are detailed in the report, including ensuring that the average cost per participant is not excessive; benchmarking fees and negotiating financial arrangements with record keepers on a regular cycle; and replacing underperforming or expensive investment options.
Unfortunately, the report notes, in the current environment “even the most well run plans can still fall victim to excessive fee claims.” That is why it is “imperative” that fiduciaries of plans of all sizes always deepen their understanding of potential excessive fee allegations and act prudently, including when engaging third-party service providers.
The report concludes by noting that the threat of excessive fee litigation is not, in and of itself, new. However, with the frequency and severity of excessive fee litigation increasing, and the threat of litigation involving smaller firms growing is rising, as is the cost to defend and settle the cases once they are filed. The cost of fiduciary liability insurance is going up as well. That is why the “most forward-thinking companies are constantly assessing their risk tolerance and taking steps to ensure that both they and their insured retirement plan fiduciaries are doing everything they can to anticipate or prepare for the next wave of litigation.”
An infographic summarizing the report’s findings can be found here.