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403b lawsuit


In the last 3 years, the number of lawsuits filed against colleges for excessive fees and compliance issues related to their 403(b) plans has increased exponentially.  Here is a list of just some of the colleges that have had lawsuit brought against them by their 403(b) plan participants:


  • Yale
  • NYU
  • Duke
  • John Hopkins
  • MIT
  • Columbia
  • Emory
  • Cornell
  • Vanderbilt
  • Northeastern
  • USC


The fiduciary landscape has completely changed for organizations, like colleges, that sponsor ERISA 403(b) plans.  In 2009, new regulations were passed that brought 403(b) plans up to the compliance standards historically found in the 401(k) market.   Instead of slowly phasing in the new regulations, the 403(b) market basically went from zero to 60 mph in a blink of an eye.  While some of the basic elements of the new rules were taken care of by the current service providers such as the required written plan documents, contract exchange provisions, and new participant disclosures, we have found that colleges, due to a lack of understanding of what is required to fulfill their fiduciary role to the plan, have fallen very short of putting the policies and procedures in place to protect the college from liabilities that can arise from the 403(b) plan.


Top Violations


Based on the lawsuits that have been filled against the various colleges, here is a list of the most common claims that have been included in these lawsuits:


  • Excessive fees
  • Fees associated with multiple recordkeepers
  • Too many investment options
  • Improper mutual fund share class
  • Variable annuity products


Excessive Fees


This is by far number one on the list.  As you look at these lawsuits, most of them include a claim that the university breached their fiduciary duty under ERISA by allowing excessive fees to be charged to plan participants.


Here is the most common situation that we see when consulting with colleges that leads to this issue.  A college had been with the same 403(b) provider for 60 years.   Without naming names, they assume that their 403(b) plan has reasonable fees because all of the other colleges that they know of also use this same provider.   So their fees must be reasonable right?  Wrong!!


If you are member of the committee that oversees that 403(b) plan at your college, how do you answer this question?  How do you know that the fees for your plan are reasonable?  Can you show documented proof that you made a reasonable effort to determine whether or not the plan fees are reasonable versus other 403(b) providers?


The only way to answer this question is by going through an RFP process.  For colleges that we consult with we typically recommend that they put an RFP out every 3 to 5 years. That is really the only way to be able to adequately answer the question: “Are the plan fees reasonable?”   Now if you go through the RFP process and you find that another reputable provider is less expensive than your current provider, you are not required to change to that less expensive provider.  However, from a fiduciary standpoint, you should acknowledge at the end of the RFP process that there were lower fee alternatives but the current provider was selected because of reasons X, Y, and Z.  Document, document, document!!


Investment Fees / Underperformance / Investment Options


Liability is arising in these 403(b) plans due to


  • Revenue sharing fees buried in the mutual fund expense rations
  • Underperformance of the plan investments versus the benchmark / peer group
  • Too many investment options
  • Investment options concentrated all in one fund family
  • Restrictions associate with the plan investment
  • Investment Policy Statement violations or No IPS
  • Failure to document quarterly and annual investment reviews


Here is the issue.  Typically members of these committees that oversee the 403(b) plan are not investment experts and you need to basically be an investment expert to understand mutual fund share classes, investment revenue sharing, peer group comparisons, asset classes represented within the fund menu, etc.   To fill the void, colleges are beginning to hire investment firms to serve as third party consultants to the 403(b) committee.  In most cases these firms charge a flat dollar fee to:


  • Prepare quarterly investment reports
  • Investment benchmarking
  • Draft a custom Investment Policy Statement
  • Coordinate the RFP process
  • Negotiation plan fees with the current provider
  • Conduct quarterly and annual reviews with the 403(b) committee
  • Compliance guidance



Multiple Recordkeepers


While multiple recordkeepers is becoming more common for college 403(b) plans, it requires additional due diligence on the part of the college to verify that it’s in the best interest of the plan participants.   Multiple recordkeepers means that your 403(b) plan assets are split between two or more custodians.  For example, a college may use both TIAA CREF and Principal for their 403(b) platform.  Why two recordkeepers?  Most of the older 403(b) accounts are setup as individual annuity contracts.  As such, if the college decides to charge their 403(b) provider, unlike the 401(k) industry where all of the plan assets automatically move over to the new platform, each plan participant is required to voluntarily sign forms to move their account balance from the old 403(b) provider to the new 403(b) provider.  It’s almost impossible to get all of the employee to make the switch so you end up with two separate recordkeepers.


Why does this create additional liability for the college?  Even through the limitation set forth by these individual annuity contracts is out of the control of the college, by splitting the plan assets into two pieces you may be limiting the economies of scale of the total plan assets.  In most cases the asset based fees for a 403(b) plan decreases as the plan assets become larger with that 403(b) provider.  By splitting the assets between two 403(b) platforms, you are now creating two smaller plans which could result in larger all-in fees for the plan participants.


Now, it may very well be in the best interest of the plan participants to have two separate platforms but the college has to make sure that they have the appropriate documentation to verify that this due diligence is being conducts.  This usually happens as a result of an RFP process.  Here is an example.  A college has been using the same 403(b) provider for the last 50 years but to satisfy their fiduciary obligation to the plan they going through the RFP process to verify that their plan fees are reasonable.  Going into the RFP process they had no intention of change provides but as a result of the RFP process they realize that there are other 403(b) providers that offer better technology, more support for the plan sponsor, and lower fees than their current platform.  While they are handcuffed by the individual contracts in the current 403(b) plan, they still have control over where the future contributions of the plan will be allocated so they decide that it’s in both the plan participants and the college’s best interest to direct the future contributions to the new 403(b) platform.


Too Many Investment Options


More is not always better in the retirement plan world.  The 403(b) oversite committee, as a fiduciary, is responsible for selecting the investments that will be offered in accordance with the plan’s investment menu.  Some colleges unfortunately take that approach that if we offer 80+ different mutual funds for the investment that should “cover all of their bases” since plan participants have access to every asset class, mutual fund family, and ten different small cap funds.    The plaintiffs in these 403(b) lawsuits alleged that many of the plan’s investment options were duplicates, performed poorly, and featured high fees that are inappropriate for large 403(b) plans.


To make matters worse, if you have 80+ mutual funds on your 403(b) investment menu, you have to conduct regular and on-going due diligence on all 80+ mutual funds in your plan to make sure that they still meet the investment criteria set out in the plan’s IPS.  If you have mutual funds in your plan that fall outside of the IPS criteria and those issues have not been addressed and/or documented, if a lawsuit is brought against the college it will be very difficult to defend that the college was fulfilling its fiduciary obligation to the investment menu.



Improper Mutual Fund Share Classes



To piggyback on this issue, what many plan sponsors don’t realize is that by selecting a more limited menu of mutual funds it can lower the overall plan fees.  Mutual funds have different share classes and some share classes require a minimum initial investment to gain asset to that share class.  For example you may have Mutual Fund A retail share class with a 0.80% internal expense ratio but there is also a Mutual Fund A institutional share class with a 0.30% internal expense ratio.  However,  the institutional share class requires an initial investment of $100,000 to gain access.  If Mutual Fund A is a U.S. Large Cap Stock Fund and your plan offers 10 other U.S. Large Cap Stock Funds, your plan may not meet the institutional share requirement because the assets are spread between 10 different mutual funds within the same asset class.  If instead, the committee decided that it was prudent to offer just Mutual Fund A to represent the U.S. Large Cap Stock holding on the investment menu, the plan may be able to meet that $100,000 minimum initial investment and gain access to the lower cost institutional share class.


Variable Annuity Products


While variable annuity products have historically been a common investment option for 403(b) plans, they typically charge fees that are higher than the fees that are charged by most standard mutual funds.  In addition, variable annuities can place distribution restrictions on select investment investments which may not be in the plan participants best interest.


The most common issue we come across is with the TIAA Traditional investment.  While TIAA touts the investment for its 3% guarantee, we have found that very few plan participants are aware that there is a 10 year distribution restriction associated with that investment.  When you go to remove money from the TIAA Traditional fund, TIAA will inform you that you can only move 1/10th of your balance out of that investment each year over the course of the next ten years.  You can see how this could be a problem for a plan participant that may have 100% of their balance in the TIAA Traditional investment as they approach retirement.   Their intention may have been to retire at age 65 and rollover the balance to their own personal IRA.  If they have money in the TIAA Traditional investment that is no longer an option.  They would be limited to process a rollover equal  to 1/10th of their balance in the TIAA Tradition investment between the age of 65 and 74.  Only after age 74 would they completely free from this TIAA withdrawal restriction.


Consider Hiring A Consultant


While this may sound self-serving, colleges are really going to need help with the initial and on-going due diligence associate with keeping their 403(b) plan in compliance.  For a reasonable cost, colleges should be able to engage an investment firm that specialized in this type of work to serve as a third party consultant for the 403(b) investment committee.  Just make sure the fee is reasonable.  The consulting fee should be expressed as a flat dollar amount fee, not an asset based fee, because they are fulfilling that role as a “consultant”, not the “investment advisor” to the 403(b) plan assets.


Michael Ruger

About Michael………

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

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Investment advisory services offered through Greenbush Financial Group, LLC. Greenbush Financial Group, LLC is a Registered Investment Advisor. Securities offered through American Portfolio Financial Services, Inc (APFS). Member FINRA/SIPC. Greenbush Financial Group, LLC is not affiliated with APFS. APFS is not affiliated with any other named business entity. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not ensure against market risk. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.