March 6, 2000
Mutual fund companies providing 401(k)'s or other types of defined contribution plans may be in for a rash of lawsuits foiled by unhappy 401(k) investors, say industry executives and consultants.
Such lawsuits may not appear in any great numbers until 2001 when the bulk of baby boomer investors who have relied on defined contribution retirement plans rather than the traditional defined benefit pension plans, begin to retire, said Gary Blank, a principal with William M. Mercer of New York. Based in Mercer's San Francisco office, Blank works with major plan sponsors nationwide on structuring retirement plans.
Such lawsuits will also be inevitable when the stock market ends its 107-month-long bull run, industry executives said.
A number of plan participants will file lawsuits against their employers or 401(k) providers, accusing them of inaccurate, inefficient or inadequate investment advice, said Kathleen Powers Dunlap, managing director of Barclays Global Investors of San Francisco. Whether they will file such suits against mutual fund companies or employers will depend on which is seen to have the most resources, Dunlap said.
"The reality is, if there is a downturn [in the market], there are some plan participants who will mistakenly believe their ERISA [the Employee Retirement Income Security Act of 1974] assets are protected and secure," said Ivan Strasfeld, director of exemptions for the Department of Labor in Washington. "Regulation 404c of ERISA, regarding information about options to participate, doesn't require [401(k) plan sponsors to provide] advice or education - just factual information about investments offered under the plan, so that the participant is capable of making an informed decision."
But 401(k) lawsuits will be inevitable, said Strasfeld. Defined contribution investors will increasingly come to expect their employer will provide investment advice, particularly now that more and more employers and mutual fund firms are offering such third-party investment advice, Strasfeld said.
And it is a potentially lucrative business that is prompting a growing number of companies - Morningstar and Ibbotson, both of Chicago, included - to vie for providing online advice to the 30 million-plus 401(k) investors in the U.S., Strasfeld said.
Twenty-nine percent of 401(k) plans currently offer investment advice to participants and 17 percent will begin doing so by year-end, according to Spectrem Group of San Francisco.
Some 401(k) advice vendors are assuming part, if not all, of the fiduciary responsibility for such advice, thereby relieving plan sponsors and mutual fund companies of responsibility, Strasfeld said. This is making it easy for these early vendors to land contracts with plan sponsors and fund firms, he said.
However, other vendors like Ibbotson, are following a different 401(k) advice business model, said Mike Henkel, president of Ibbotson. Ibbotson's 401(k) advice product will enable a mutual fund company to use its name more prominently than other 401(k) advice providers are, on the Ibbotson 401(k) online investment software, Henkel said. This shared visibility also means shared fiduciary responsiblity, he said.
However, applications for exemption from 401(k) fiduciary responsibilities being filed at the labor department are currently overwhelmingly for companies using separate 401(k) advice by third-party vendors willing to provide indemnification to plan sponsors and fund companies willing to sponsor their advice, Strasfeld said.
Regardless of how it is provided, 401(k) advice is increasingly being offered to investors and 401(k) participants are coming to expect it as an integral part of their plans, Strasfeld said. And, if future retiring 401(k) investors find themselves ill-prepared for their retirement, mutual fund companies will pay dearly with lawsuits, said Strasfeld, Dunlap and Blank.
It's a "damned if you do, damned if you don't" situation, said Henkel of Ibbotson.
"If you don't give advice, the plan sponsor has a fear that long-term they might be sued by plan participants short x-thousand of dollars when they retire," he said. "They could very easily say, You put it all on my shoulders, you did not help me, I am suing you.'"
Lawsuits are inevitable, said Blank of William M. Mercer.
"Investors could very rightly say they did not receive investment advice early enough, they did not receive enough investment advice, and even they were not told how to invest wisely," he said.
The best defense against potential suits is for a mutual fund company and a 401(k) plan sponsor to provide third-party investment advice, Blank said.
"How could a judge possibly say to Bill Sharpe, a Nobel laureate and founder of Financial Engines [another 401(k) investment advice vendor], You don't know what you are doing,'" Blank said.
Fund companies and their 401(k) plan sponsor partners should offer some kind of prepackaged, Internet-based 401(k) investment advice, said Blank, who works closely with plan sponsors.