low-cost index funds in the crosshairs of new 401(k) lawsuits | Knowledge
Since late July, at least 10 lawsuits have been filed against major 401(k) plan sponsors who offer certain target date funds (TDFs) from BlackRock Inc. among their investment options. In an unexpected turn away from the excessive 401(k) fee litigation that has become increasingly common in recent years, plaintiffs in each lawsuit allege that by selecting BlackRock’s low-cost TDFs, 401(k) plan sponsors (k) breached their fiduciary duties when such funds underperformed. The plaintiffs in each lawsuit are seeking class action status.
A TDF is an investment option that automatically shifts their asset allocation from higher risk to lower risk as the investor approaches their expected retirement year. The sliding trajectory of a TDF’s asset allocation begins with the majority of the fund invested in equities, and as the retirement date approaches, this allocation to equities decreases and the allocation to income investments fixed increases. TDFs are generally considered safe investments and are often used by 401(k) plans as the default investment option. A “until retirement” TDF reaches its lowest risk asset allocation in the year the investor retires, and a “until retirement” TDF continues to reduce its risk after reaching the lowest risk asset allocation. year of retirement.
Each of the 401(k) plans involved in the lawsuits offered the BlackRock LifePath target-date index funds, which received the highest rating in the Morningstar 2022 Target-Date Landscape report. Despite this rating and the fact that TDFs are not supposed to have the best performance of the investment options in a 401(k) plan, the plaintiffs argue that the plan’s trustees failed to consider the potential return BlackRock TDFs and instead only “chased low fees”. billed by the funds.
To illustrate the alleged underperformance of the BlackRock TDFs, the plaintiffs compared the returns of the BlackRock TDFs with the returns of the TDFs offered by Vanguard, T. Rowe Price and American Funds. These funds are not comparable to BlackRock TDFs for two reasons:
- Descent path. The comparator TDFs selected by applicants are ‘until retirement’ funds, while the BlackRock TDFs are ‘until retirement’ funds. Because comparator TDFs have a higher equity-to-fixed-income allocation ratio for most of the fund’s lifetime, these funds are expected to outperform “until retirement” funds such as TDFs. BlackRock in rising markets, as the United States has seen for most of the fund’s life. the last decade.
- Management. Comparator TDFs are also actively managed, but BlackRock TDFs are passively managed through investments in index funds. An actively managed fund is able to invest more in higher yielding stocks when the market is doing well. The objective of a passive fund, on the other hand, is more conservative. It does not aim to seize every opportunity to increase its return and rather aims to offer an investment option that is more resistant to market fluctuations. Passively managed TDFs generally charge lower fees than actively managed TDFs.
Take away food
While this series of lawsuits demonstrates that the selection of any fund by plan trustees can be exposed to claims of fiduciary breach, having a strong system of plan governance in place can make the plan 401( k) makes a company a less attractive target for plaintiffs’ attorneys and provides necessary defenses in the event of litigation. It is also very likely that compliance with Section 404(c) of the Employees Retirement Income Security Act (ERISA) will be an important defense in these cases.
If you’re a 401(k) plan sponsor and want help evaluating your plan’s investment selection and governance practices, ensuring your plan is 404(c) compliant. ERISA or to determine how these lawsuits might impact your plan, contact the authors, another member of Holland & Knight’s compensation and benefits team, or your Holland & Knight lead attorney.
The information in this alert is intended for the general education and knowledge of our readers. It is not intended to be and should not be relied upon as the sole source of information when analyzing and resolving a legal issue, and it should not substitute for legal advice, which is based on a specific factual analysis. In addition, the laws of each jurisdiction are different and constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular factual situation, you are encouraged to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.