Will 2023 be another banner year for 401(k) fee litigation?

Both stocks and bonds suffered bear markets in 2022, dragging down performance in employee retirement plans. There was, however, a bull market in excessive-fee lawsuits against plan sponsors and advisors.

Daniel Aronowitz, managing principal of Euclid Fiduciary, a fiduciary liability insurance underwriting company for employee benefit plans, believes plaintiff's lawyers will once again be busy filing cases in 2023. Plus, he expects the courts to continue to struggle with a heavy volume of cases, often brought by new players attempting to establish themselves.  

InvestmentNews caught up with Aronowitz to get his outlook on retirement plan litigation in the coming year, as well as his views on whether the recently passed SECURE Act 2.0 and changes in the make-up of the Supreme Court will alter the environment.  

InvestmentNews: There were 88 fee lawsuits against retirement plans last year, the second most ever. What is your expectation for such lawsuits in 2023?

Daniel Aronowitz: We are predicting 50 to 75 excess fee lawsuits in 2023 based on the continued high frequency of filings by the most prolific law firms like Capozzi Adler and Walcheske & Luzi, and the high rate of filings by new entrants like the Wenzel Fenton Cabassa law firm. The total cases filed may end up being lower than 2022 but would still represent a high number of projected filings. 

In addition to new law firms filing cases, our prediction of a continued high frequency is influenced by the fact that, for the first time, more cases are being dismissed. Plaintiff law firms have learned that they will need to keep the pipeline full in order to achieve their settlement fee targets. We predict more cases focusing solely on alleged excessive record-keeping fees, as these cases avoid investment standing issues and have proven more resilient to being dismissed at the pleadings stage. We would point to the recent filing by the Walcheske law firm against U.S. Bancorp as part of this trend. 

We also believe there will be a continued trend of investment imprudence cases alleging that plan fiduciaries improperly allowed underperforming investments to remain in the plan. We would point to the most recent case against Nebraska Health Systems filed by the Capozzi law firm as part of the growing trend of imprudent investment cases.

IN: Which do you expect to be the most frequent targets of litigation? Large or small plans?

DA: The operating theory of excess fee cases is that large plan fiduciaries have failed to leverage their size to negotiate lower fees, but that has not stopped plaintiff firms from suing both large and small plans indiscriminately. In 2022, 60% of the cases were filed against plans with over $1 billion in assets, but 20% of the cases were against plans under $500 million in assets, and five cases were filed against plans under $250 million in assets. 

We predict that while most cases will be filed against the mega-sized plans, over $1 billion, and larger plans between $500 million and $1 billion, we believe that more and more cases will continue to be filed against smaller plans. Plaintiff firms continue to move downstream in suing smaller plans, as evidenced by the Jan. 24 filing against Nebraska Methodist Health System and the Jan. 20 filing against LHC Group, Inc. Both of these lawsuits involve plans with less than $500 million in assets.

IN: What about record keepers? Will they be targeted and for what offenses?

DA: Plaintiff law firms do not typically sue service providers like record keepers because they are not acting in a fiduciary capacity and thus it is difficult to establish liability. Plaintiff firms, however, have sued investment advisors more frequently as additional defendants in the lawsuits against the plan sponsor. Even then, the investment advisors have had significant success in being dismissed from cases or absolved from liability in many of the cases. This is why most of the lawsuits are filed against the plan sponsor irrespective of whether they received services or advice from third-party advisors. 

IN: Last year target-date funds were the focus of a number of lawsuits, especially BlackRock’s TDFs. Will TDFs once again be a popular target?

DA: Target-date funds are the qualified default investment options for well over 80% of plans, and that is where a higher percentage of assets are invested in most large plans — up to 50% or more in many plans. Given that TDFs are the most common investment vehicle with significant assets, they will continue to be the most prominent target of excessive fee and imprudence claims. This trend will continue, as plaintiffs continue to sue actively managed target-date funds with claims that active management is imprudent to the extent that performance cannot justify the higher fees, and that revenue-sharing share classes contain excess fees. 

The 12 cases against BlackRock LifePath TDFs — if you include the Fluor case involving custom TDFs managed by BlackRock — were distinctive in that this was the first time that a plaintiff law firm reversed the script and alleged that it was imprudent to chase low fees but ignore performance. We believe that courts will dismiss the cases against these low-cost index target-date funds because they lack merit. The BlackRock LifePath funds are high-quality investments with low fees and good performance, and are being improperly compared to other popular TDFs with different and distinct investment objectives. We believe courts will dismiss these cases against BlackRock LifePath funds as frivolous, and plaintiff firms will learn that this new type of claim is a dead-end.

IN: Will the recently passed SECURE Act 2.0 have any effect on the step-up in legal actions?

DA: We think that SECURE 2.0 is positive legislation, but does not establish any new liability theories for plaintiffs to exploit. At the same time, we are disappointed that Congress did not take the opportunity to add legislation that reduced the high level of frivolous ERISA class action litigation, including the excessive fee cases. In the past, Congress has passed reform legislation to reduce securities class action litigation, but unfortunately has yet to help plan sponsors reduce the burden of lawyer-driven, meritless litigation. 

IN: Where is the current Supreme Court when it comes to retirement fee litigation?  

DA: The Supreme Court had the opportunity to rein in abusive ERISA class-action litigation in the Hughes v. Northwestern case last year. It essentially punted in its January 2022 decision in which it ruled on the narrowest issue and avoided the larger issue of whether plaintiff lawyers have the right to file dubious excess fee and investment imprudence claims based on circumstantial evidence and without proof that plan fiduciaries had imprudent processes. As time passes, however, more courts are recognizing that the Supreme Court did take the position that the higher plausibility pleading standard applies in ERISA class actions, and plaintiffs must do more than just infer imprudence based on circumstantial claims that fees are too high. 

The Hughes decision shows that the court will largely avoid providing significant guidance in this arena. They recently had the opportunity to weigh in on the arbitrability of ERISA claims in the Cintas case, but declined to review the case. We are thus a far cry from the Fifth Third Bancorp v. Dudenhoeffer court in 2014 that helped shut down most frivolous ERISA stock-drop cases. We can only hope that the Department of Labor will step into the void and instill some discipline on the runaway litigation, as plan sponsors deserve a uniform and predictable national standard of fiduciary responsibility. Plaintiff lawyers should not be allowed to be the unofficial fiduciary regulators in America, but that is what is currently happening.