Nearing a Tipping Point

In a Twitter post recently, I quipped about the state of the retirement plan industry. For many years, mergers and acquisitions have continued to narrow the number of companies providing recordkeeping and administration services to the market. At the same time, the number of plaintiffs’ law firms “entering” the class action Employee Retirement Income Security Act of 1974 (ERISA) litigation space is increasing.

The Supreme Court decision in Hughes v. Northwestern seems to have made the dismissal of fiduciary breach cases more complex, and the further these cases progress, the more likely settlement becomes. It is not clear whether these settlements reflect real breaches or whether a settlement is merely the least expensive way to move on to bigger issues.

In the recently agreed-to settlement in the fiduciary case against Costco, the gross settlement was $5.1 million, which isn’t a small sum. Still, it is only $25 for each participant in the plan at the time of settlement. Reduce that $5.1 million by attorney’s fees, and the materiality of settlements becomes nearly comical. The firm representing the plaintiffs in the case is likely entitled to at least a third of the settlement amount. The website of the plaintiff’s firm lists five attorneys. Using the same per capita model, each of them would be receiving $300,000. The motivations to litigate and motivations to settle are clear and will repeat.

Post Northwestern, the rate of cases being filed is likely to remain heavy and the percentage that advances to the discovery phase may also stay high. Cases will focus on recordkeeping fees, share classes for funds in the menu, revenue sharing, fund cost, and investment performance.

ERISA has a relatively narrow set of responsibilities:

  • Acting solely in the interest of plan participants and beneficiaries and with the exclusive purpose of providing benefits to them;
  • Carrying out duties prudently;
  • Following the plan documents (unless inconsistent with ERISA);
  • Diversifying plan investments; and
  • Paying only reasonable plan expenses

Consolidation and litigation seem to be focused almost exclusively on the last, reasonable expenses. To adapt, providers have been aggressive in reducing expenses but equally aggressive in using the plan to sell other products and services. Recordkeeping retirement plans is a thankless business. Having access to hundreds of thousands of participant accounts and the ability to sell them products and services is highly lucrative. The concern becomes at what point in pursuit of lower expenses have / will the industry lose sight of the primary obligation to act solely in the interest of plan participants and beneficiaries?

The potential conflict between large financial service companies and participants has been known for some time. However, it looks like the real danger may be coming from inside the house.

For years, plan sponsors have been retaining fiduciary consulting firms to help manage the fiduciary risks, operational requirements, and improve the participant outcomes in the plan. The last five years have seen an unprecedented wave of consolidation among retirement plan consulting firms funded by private equity and public markets. The consolidation isn’t focused on greater efficiencies from scale; there aren’t many, but instead on trading on trusted relationships with plan sponsors to sell other products and services.

Consulting firms have begun developing their own proprietary investment products and promoting their use within the plans they monitor. This eliminates their independence to evaluate the performance of those proprietary investments. Consultants are increasingly providing a preference, not to the best recordkeepers, but the recordkeepers willing to allow them to use recordkeeping technology to generate revenues for the consultant. This severely calls into question their independence from the very recordkeepers they should be monitoring. Consultants have also been quick to insert themselves into the education of participants, allowing them to be the beneficiary of rollovers and other cross-sell opportunities.

When a recordkeeper pushes to sell products and services, they do so not as a fiduciary to the plan; contracts and agreements can be modified to ensure an appropriate balance with limits is struck. When consultants, charged with ensuring the fiduciary health of the plan and protection of the participants is the one trading on their access to do things that question their obligation to act in the sole interest of plan participants, the risks change fundamentally.

In July, we had our first in-person firm-wide meeting since the pandemic outbreak. It was a joy to be able to meet together with a group of colleagues I admire, learn from, and appreciate. During the two days, we did trainings on how to communicate with clients more effectively, the state of play for ESG in qualified retirement plans, participant saving adequacy and tools to improve retirement outcomes for participants, and rolled out enhanced recordkeeping vendor search and evaluation services for clients. Our time was focused on how we can be more helpful to our clients, not how our clients can be more valuable to us.

We recommitted, together, to our future as an independent fiduciary to our clients. There are signs that many in our industry are moving in the wrong direction, and we are committed to being an anchor toward running a firm that can support our clients in ensuring that their primary obligation toward acting solely in the interest of plan participants and beneficiaries is met.

Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Multnomah Group does not provide legal or tax advice.

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