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Categorized | Financial

Litigation prompts a shake-up in a sleepy pension world


Posted on November 24, 2016

More than 70m Americans suddenly have a pressing reason to check their pension statements. The US presidential election re­sult has unleashed wild swings in equity and bond prices, prompting the S&P 500 index to outperform 10-year Treasury bonds by more than 10 per cent in just 11 days. This could dent the fortunes of many of those who have a 401(k) — the most common form of employer-sponsored defined contribution plan — particularly if they hold those 10-year Treasury bonds.

There is another reason why 401(k) holders might want to scan their statements: litigation. And investors of all stripes should take note. In the past year there has been an explosion in class action lawsuits over alleged malpractice in these pension plans.

These suits have not yet garnered much public attention. That is partly because the legal action is fragmented, spread between different courts, and cases are often settled in private.

Moreover, the pension industry often looks dull and the sums involved (rarely above $100m) tend to be small compared with the multibillion-dollar dramas seen in banking since 2008.

While 401(k) tussles may not grab headlines, they do touch many household names. In the past six months, for example, Delta Air Lines employees have sued Fidelity over alleged mismanagement of a 401(k) plan; staff at Edward Jones, the financial advisory company, have sued their employer over the in-house pension plan. There have been similar suits at Franklin Templeton, New York Life Insurance, American Century and Neuberger Berman. And a $150m class action suit has been lodged against Morgan Stanley.

Details vary but all have a similar theme: plaintiffs claim that members of 401(k) schemes have been charged excessively high fees, sometimes because the asset managers used unnecessary third-party advisers. The salient point, in other words, is not fund performance but the investment process. As in other financial fields, litigants claim financiers have used an opaque web of transactions to scalp clients.

Is this charge justified? It is hard for outsiders to tell since the industry is so complex and fragmented. America is estimated to have about 600,000 different 401(k) funds, holding more than $4tn of assets, and the fine print is usually bewildering for a novice.

Lawyers working for asset managers insist the criticism is overdone. “401(k) schemes have been great for American workers,” says James Carroll of Skadden, Arps, Slate, Meagher & Flom, who is defending “numerous” clients against 401(k) suits. “All these lawsuits do is burden the employers with additional expenses — no one is going to benefit except lawyers.” Indeed, Mr Carroll and others argue the trend is driven by opportunism: a US Supreme Court decision last year made it easier for plaintiffs to launch complaints and triggered the boom. (Most notably, courts no longer presume asset managers are behaving prudently.) “Cases which are utterly without merit are now getting out of the starting block,” Mr Carroll says.

Lawyers representing the plaintiffs vehemently disagree, saying malpractice is widespread in the 401(k) world, partly because there is so little independent scrutiny. “So many plans have had excessive fees,” says Jerry Schlichter, a Missouri lawyer who has spearheaded the litigation wave. “The assets were in a dark closet with no transparency, and the employer had no real financial incentive to keep fees down.”

Mr Schlichter estimates that the suits have already clawed back $300m in excess fees and fines for members of 401(k) schemes, mostly in out-of-court settlements. That in turn is pushing fees down across the industry, he argues.

A cynic might say $300m is a modest sum, given the size of the 401(k) world — and that asset management fees would probably be falling anyway, given growing pressure on the investment industry to cut costs.

The one thing that almost everyone appears to agree on, however, is that the litigation genie will not go back into the bottle. “These cases will carry on [into 2017],” Mr Carroll says.

While that might dismay companies and 401(k) sponsors paying the legal bills, it does have a silver lining. Until now, most people have paid scant attention to how their schemes are run, partly because the fine print is complex and seemingly dull.

It would be nice to hope that this wave of litigation finally sparks more scrutiny and much needed transparency. If so, that is welcome indeed after a decade of paltry investment returns — and just as a spell of wild markets looms in a Trumpian world.

gillian.tett@ft.com