All rise! 401(k) legal battles set to surge in second half of year

The wheels of justice may turn slowly, but the action in retirement plan lawsuits should ramp up in the second half of 2022 after a pair of big court decisions.

There have been 42 Employee Retirement Income Security Act class-action suits filed since the start of this year that allege the mismanagement of 401(k) and 403(b) defined-contribution retirement plans, according to Euclid Fiduciary, a Vienna, Virginia-based employee benefits plan insurer. If the rate ticks up slightly, the industry may eclipse 100 lawsuits in 2022, making it the highest year ever. In 2021 there were 54 cases, a nearly 45% drop from 2020’s record tally of 97. 

The majority of these so-called “excessive fee and imprudence” lawsuits not only include claims of unlawfully exorbitant investment management fees, but allege that plan record-keeping and administrative fees are too high.

One reason behind the drop in cases last year was that plaintiff firms were waiting on the Supreme Court to decide the Hughes v. Northwestern case, which it did this past January, much to the chagrin of plan sponsors. In the Northwestern case, the Supreme Court found that a large menu of mutual funds and other investment choices does not protect a sponsor who includes a so-called “imprudent” investment in their plan.

“The increased frequency of cases in 2022 reflects that plaintiff firms see the Hughes v. Northwestern case as providing a green light to file more cases against actively managed investments in the plan investment lineup, investments that are allegedly in retail share classes with higher fees than institutional share classes, and alleged excessive record-keeping fees based on their interpretation that courts will allow more cases to proceed to discovery,” said Daniel Aronowitz, Euclid’s managing principal.

Another reason behind the spike in retirement plan litigation this year is the resurgence of lawsuits from Harrisburg, Pennsylvania-based law firm Capozzi Adler. Capozzi only filed 11 cases in 2021 after filing 40 in 2020. It has already filed at least 17 cases this year, according to Euclid. 

Apparently Capozzi’s strategy is to churn out cases with the goal of getting past the motion to dismiss. Once that legal bar is breached, they can push for damages in a settlement within fiduciary insurance limits. 

“This tiny law firm with less than 10 ERISA lawyers — and only $3.9 million in their own sponsored defined-contribution plan — has terrorized corporate America by continuing to file the majority of recent excessive fee cases,” said Euclid’s Aronowitz, a frequent Capozzi rival.

Capozzi did not respond to a request for comment.

Capozzi’s high-volume approach, however, could see stiffer resistance in the second half of 2022. Aronowitz believes large plan sponsors and advisers sued unfairly (in his view) are tired of being placed in the legal cross hairs. He predicts they will litigate more vigorously going forward and force cases to summary judgment and eventually to trial in order to vindicate the plan’s fiduciary process — to use poker parlance, calling the plaintiff’s bluff.

An additional reason why defendants are feeling emboldened to combat excessive fee allegations is the June decision by the 6th Circuit Court of Appeals in favor of the defendants in an ERISA lawsuit targeting CommonSpirit Health, a large not-for-profit corporation that provides hospital services across the United States.

The CommonSpirit Health complaint alleged that Fidelity’s Freedom Funds, a suite of 13 funds actively managed by Fidelity managers, had higher operating costs than Fidelity’s passively managed index funds, to the detriment of the plan’s investors.

The District Court dismissed the claim, stating the plaintiff had failed to “allege facts showing that the record keeping fees exceeded those of comparable plans or were excessive in relation to the service provided.” The court also ruled the plaintiff had “failed to identify another recordkeeper that would have been willing to conduct the same service as Fidelity” at a fair rate.

Aronowitz described the CommonSpirit decision as a “breath of fresh air” in excessive fee jurisprudence.

“A court finally got it right on all accounts," he said. "The court correctly rules that ERISA is a law of process and does not allow second-guessing of fiduciary decisions without proof of a process-based defect.”

For its part, Fidelity was more than thrilled with the court’s decision, especially considering that more than 20 cases have been filed in the last three years alleging its Freedom target-date funds are imprudent for retirement plans because the fees are too high and the performance is not up to par with its target-date index alternative. 

“The court recognized that Fidelity is a market leader, and that the Fidelity Freedom Funds and Fidelity Freedom Index Funds offer ‘distinct strategies,’ either of which may serve as a prudent choice for a retirement plan. Fidelity has an unwavering commitment to providing exceptional outcomes and a superior experience for shareholders in all of our target date strategies, and we are pleased the court recognized that the Plaintiff’s claims lack merit,” Fidelity said in a statement following the ruling.

Still, while the CommonSpirit decision may have been bracing for Fidelity and other excessive fee lawsuit targets, most experts don't think it will truly quell the rush of cases streaming into the judicial system.    

“In the 6th Circuit, it should give them pause, but so far the lawyers I’m dealing with on the other side in cases in the 6th Circuit have refused to amend their complaints based on the decision,” said Rene Thorne, an attorney at New Orleans-based Jackson Lewis.

For his part, Aronowitz believes defense lawyers will cite the CommonSpirit decision in most dismissal motions going forward, but doesn't think it will have much impact on the high-volume strategies of the likes of Capozzi, due to a string of plaintiff victories in the wake of Hughes v. Northwestern.

“We will need more circuits to follow CommonSpirit before we can turn the tide of the plaintiff’s momentum in the excessive fee cases,” Aronowitz said. “This is likely a speed bump in their continued excessive fee business model.”

In other words, everybody better buckle up. We could see some disorder in the courts from here on in.