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6 Ways Advisors Can Protect Against 401(k) Lawsuits

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The proliferation of lawsuits against 401(k) and 403(b) plan sponsors and their advisors alleging breach of fiduciary duties poses challenges for financial advisors, even those who are fiduciaries.

“Advisors are scared,” says Brian Hamburger, president and CEO of  MarketCounsel, a compliance and consulting firm. “They’re scared about the liability … [which is] not exactly consistent with the businesses they’re building.”

Hamburger says these lawsuits mark “the beginning of a trend” that starts with suits against large plan sponsors and large financial services firms — which, in the case of New York Life and Morgan Stanley, are one and the same — then spreads to smaller sponsors and smaller financial firms.

“When there’s success at one of the large financial services firms or large plan sponsors, the plaintiffs’ bar will utilize that settlement or judgment to obtain a very rapid resolution with others,” says Hamburger. 

Most of the suits to date charge retirement plan sponsors with excessive fees and/or poor performing investment options, which cost participants thousands of dollars that they allegedly would have otherwise saved for their retirement. These include suits against some of the country’s top universities (Columbia, Yale, MIT, Duke, Johns Hopkins, NYU), accused of having too many investment options offered by multiple firms, which increase costs, and/or poorly performing funds.

There are also multiple suits brought by the employees of financial firms, such as Morgan Stanley, Neuberger Berman, Franklin Templeton, New York Life and American Century, which are charged with self-dealing, including their own funds among their firms’ 401(k) investment choices. In addition, Cetera Advisor Networks has been charged as a co-fiduciary, along with CheckSmart, for “grossly excessive fees” in a 401(k) plan having poorly performing investment options.

The suits “starts with the fact that the options were not the lower cost investment, which begs the question why they were selected,” says Hamburger.

He has several recommendations for advisors that can help protect them against such lawsuits or at least mitigate the impact:

Don't work with retirement plans if you're not doing it regularly

1. Don’t work with retirement plans if you’re not doing it on a regular basis. Servicing retirement plans is “not something to do on a one-off basis,” says Hamburger. Providing such services is complicated, and firms that work on retirement plans only occasionally can’t do it as well as firms that offer such services regularly with systems in place.

2. Avoid all conflicts of interest. If you can’t, then “mitigate those conflicts as best as you can.”

This doesn’t mean only avoiding or limiting those investment products that provide a direct benefit to a financial advisor, such as funds with 12b-1 fees, but also abstaining from having product manufacturers help develop an offering for a retirement plan prospect. Running investment scenarios, for example, “is a benefit for the advisor, support they wouldn’t otherwise get,” says Hamburger.

“The best way to deal with a conflict of interest is to get rid of it,” says Hamburger. “Develop your own proposal, run your own screen etc. … to insure that the work you do is unbiased.”

Document your research

3. Disclose any potential conflicts.

Under current laws and regulations, it’s “clear what is a prohibited transaction and what is not,” says Hamburger. But that clarity is now blurring because of the upcoming Department of Labor fiduciary rule.

“The area we’re going to enter into is a very significant gray area … [including what is] not prohibited but has to be disclosed. There will be liability if a plan sponsor doesn’t understand the disclosure…[and] a lot more disputes in this area. “

4. Document your research.

It’s important that an advisor “substantiate” his or her research if the lowest cost investment is not selected and make the case why another mutual fund, ETF or other type of investment was chosen instead.

“That’s where the value is for an advisor,” Hamburger said, adding that if a plan sponsor only needed to select the lowest cost investment they wouldn’t need advisors.

“Advisors have taught me over that the years that there are many reasons not to take the lowest cost product,” says Hamburger. “That’s fine, but document your reason. It’s incumbent upon you to document the rationale for your decision regardless … Anytime you’re leaving this safe harbor of low-cost investments, you should do so with the expectation that you’ll have to answer for that. “

Never say never

5. Never say never.

Never make quantitative promises about an investment, says Hamburger. He cautions advisors to never say that a particular allocation will never comprise more than 20% of a portfolio, for example. It could jump to 22% or some other percentage that’s higher than the stated one.

6. Realize potential divergent interests with your firm.

If your firm is being sued for its role as sponsor of a 401(k) plan or named as a recordkeeper in another suit, know that you and your firm have “a divergent set of interests” that can result in a settlement detrimental to advisors. “Don’t think that the firm is cover,” says Hamburger. “You may find you’re not on the same side of the table as the [firm’s] lawyers.” Advisors who are employees of a firm that’s being sued “don’t have any control” in those suits, says Hamburger.

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