A recent appeals court decision allowing Charles Schwab Corp. to force its employees to arbitrate disputes about the company's 401(k) plan could prove to be a negative development for 401(k) participants and their financial security in retirement.
The decision by the 9th U.S. Circuit Court of Appeals came in a
class-action lawsuit brought by a Schwab employee, Michael Dorman, in 2017, alleging that the company had enriched itself at the expense of plan participants by using poorly performing in-house investment funds in the company's 401(k) plan.
Schwab argued that the dispute should be dealt with in arbitration, given that the company had added a clause to its plan in 2014 that said participants had to settle disputes in binding arbitration and didn't have the right to pursue a class action.
A district court judge
dismissed Schwab's argument, citing a court ruling from 35 years ago that said claims under the Employment Retirement Income Security Act could not be arbitrated. But the appeals court overturned that decision, noting a Supreme Court decision in 2013 that said there's "nothing unfair" about arbitration on an individual basis.
Currently, the ruling applies only in the 9th Circuit, which covers California. But if other appeals courts follow the circuit court's lead, adding arbitration clauses to 401(k) plans could allow plan sponsors to protect themselves from potentially costly class-action litigation.
Plaintiff's attorneys have brought a
slew of suits against 401(k) plan sponsors over the past 12 years, generally alleging that plans' fees were too high or their investments were inappropriate. Some of the litigation resulted in companies having to pay big settlements to participants. Nationwide coughed up $140 million in 2014, Lockheed Martin paid $62 million in 2015 and Boeing paid $57 million, also in 2015.
While limiting participants' ability to file 401(k) class actions would benefit plan sponsors, it would be a step in the wrong direction for their employees. The 401(k) class-action lawsuits were among the factors contributing to investors' growing awareness about the costs of investing. Many industry participants
credit the lawsuits with playing a key role in the marked decline in costs borne by 401(k) participants, such as investment fees and administrative expenses, over the past 10 to 15 years.
For example, an Investment Company Institute study shows that 401(k) participants paid an average expense ratio of 41 basis points for equity mutual funds in 2018, down 47% from the average of 77 basis points in 2000.
Even if other appeals courts agree with the 9th Circuit, it's not clear that limiting 401(k) participants' disputes to arbitration would shield companies from all costs related to unhappy plan participants.
Jerry Schlichter, a St. Louis-based plaintiff's attorney who has been a driving force in the 401(k) litigation, told
InvestmentNews reporter Greg Iacurci that ERISA allows participants to bring an action on behalf of the entire 401(k) plan. Mr. Schlichter thinks that an arbitrator hearing a claim brought by one participant could award damages to all of the plan's participants.
In any case, ensuring that 401(k) plans provide decent investments at a reasonable cost should be of interest to all of us. Paying fees that are too high can put a serious dent in the nest egg an individual accumulates over 30 to 40 years of work.
At this point, 401(k)s are the main retirement savings vehicle for Americans, and we know that many don't have enough saved for a comfortable retirement. Class-action lawsuits against 401(k) plans and their sponsors have played a role in lowering plan fees, and as such they have value.
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