Fiduciary liability is often cited as a primary concern of Plan Sponsors, and rightfully so. Investment Committees must walk the fine line between excessive risk and inadequate returns when evaluating the suitability and overall performance of different investment options. Too far in either direction may jeopardize participants’ retirement security and expose Plan fiduciaries to participant grievances or even worse, litigation. One of the more recent examples occurred less than two months ago when the Investment Committee of Intel Corporation, one of the world’s largest semiconductor chipmakers, was sued. The lawsuit alleged that the Committee imprudently directed 401(k) participant money into excessively risky, expensive and non-transparent investment options resulting in significant losses for participants. Specifically, Intel’s custom built Global Diversified Fund and custom target date portfolios, whose allocations are determined by the Investment Committee, were called into question for their large allocations to hedge funds, private equity and commodities.
As detailed in DiMeo Schneider & Associates, L.L.C’s most recent third quarter Fiduciary Focus, custom funds are gaining traction in the industry due to their potential cost savings and flexibility. Furthermore, a diversified custom fund can provide participants incremental exposure to more alternative and often riskier asset classes perhaps not appropriate to offer as standalone options. While custom portfolios can be beneficial for participants, they must be diligently constructed, disclosed and monitored.
The Intel complaint stated that the hedge fund and private equity allocations “deviated greatly from prevailing asset allocation models adopted by investment professionals and plan fiduciaries.” To avoid extreme and potentially imprudent allocations or asset class exposures, we encourage the development and adoption of robust benchmarking that incorporates not only returns but also the underlying allocations of similar portfolios, such as other target date suites. For example, some third party target date indexes represent the average allocations of numerous target date products, offering a consensus glide path. Evaluating relevant benchmark comparisons for the returns, risk and allocations of the target date funds on an ongoing basis can help ensure your funds don’t fall on the extremes of the spectrum or wildly differ from industry norms.
Another critical component of the Intel case resides with expenses. The suit alleges that the investments in hedge funds and private equity were “unreasonably costly.” Expenses in employer-sponsored Plans must be both necessary and reasonable, which can be established through benchmarking. Total Plan fees are comprised of several layers which should each be isolated for benchmarking purposes. Investment management fees should appear competitive versus asset class and category averages while Plan recordkeeping and administration fees should be benchmarked against Plans of similar size and scope. All-in Plan fees (investment fees plus Plan administration fees) also serve as a helpful metric to benchmark against other Plans. Routinely comparing the fees associated with your Plan to industry averages is one of the best ways to confirm that they are “reasonable,” along with periodically conducting independent Requests for Proposal or Requests for Information.
The final key component of the suit against Intel centers around participant communication. The plaintiffs claim that not only were the custom funds excessively risky and expensive, but that these characteristics were not properly communicated to participants. Participants were given limited information about these investments and filings with the Department of Labor disclose the hedge fund and private equity investment in name only. The lawsuit alleges that participants should have received detailed information on the strategy, the risks, the fees and the underlying investments of these funds. While it is important to be as transparent as possible regarding the investment options available in your Plan, participant communication is often a challenging area to navigate. Too much information may lead to greater confusion among participants so a direct, concisely articulated message with links and resources to additional detailed information may serve as the appropriate communication approach. Partnering with a recordkeeper with robust communication capabilities, technological aptitude and firsthand experience with similar participant communications is essential. Discussing significant Plan changes and custom investments with your ERISA attorney is strongly encouraged.
Defined contribution litigation continues to grow each year and formal complaints can experience an uptick in frequency when markets become volatile. The best path to avoiding a similar fate as Intel is to regularly monitor all Plan investment options, Plan expenses and participant education and communication efforts. Moreover, Plan fiduciaries should make certain administrative procedures are established and followed but also documented with regularity along with all meaningful Committee decisions. These reviews and subsequent documentation become even more imperative when a Committee takes on the additional responsibility of directing the allocations of custom built funds. Although custom funds require increased oversight, we continue to believe that the widespread benefits to Plan participants are often compelling enough to warrant the extra effort.
Please contact any of the professionals at DiMeo Schneider & Associates, L.L.C. for assistance in reviewing your Plan’s investments, building custom core or target date funds or assessing existing fiduciary processes.
