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Issues Related to the University 403(b) Lawsuits

Robert J. Toth

The recent flurry of lawsuits against major universities on their (very large) 403(b) plans has raised significant concerns in the market related to what has been very common plan designs. It is not unusual, for example, for universities to establish a plan where the employer contributions are deposited into a typical TIAA contract, with a relatively small number of managed or monitored investment options, while employees are permitted to invest their elective deferrals into any fund of a particular fund family. This effectively acts like a self-directed brokerage account.

It appears that the plaintiffs are making the same mistake that many 401(k) vendors made when viewing 403(b) plans as just another 401(k) plan, ignoring the fundamental differences between these types of arrangements. What the litigators hopefully will stumble upon is that the foundational differences between 403(b) plans and 401(k) plans necessarily means that the application of the ERISA’s fiduciary rules to the investments should be substantially different.

What does this mean? Consider the following:

The SEC views the 403(b) plan participant as the shareholder of the plan’s investments. This is unlike the trust ownership structure of 401(k) plans. This means that the participant receives all manner of disclosures related to their investments:

  • participants receive full prospectus disclosure of the funds at the time of purchase, complete with management fees;

  • disclosure of distribution comp; and

  • full description of the management style and holdings of the funds.

The participants receive proxy disclosures and have fully voting rights related to the funds; receive annual reports on the funds’ performance; and the board of directors of the funds owe fiduciary duties directly to the 403(b) plan participant.

It seems curious that a plan participant which chooses a 403(b) investment after full disclosure as provided by securities laws can somehow claim damages on behalf of the plan against the sponsor under these circumstances-especially where low cost or high performing funds are also available as options.

There is also difficulty with the notion that a fiduciary or a court even can do anything about the investments in the plan, once selected by the plan participant. The vast majority of the 403(b) platforms upon which the suits are being brought reserve to the individual participant the right to control the investment of their funds.

So even should the courts demand the plans disgorge the higher-priced funds selected by the participant, the court has no authority to demand the participant move from their chosen fund-and the plan sponsor will have no right to do so, either.

One of the biggest concerns will be that the litigators and the courts will disregard the basis of 403(b) plans in the first place, and in particular the impact any decision will have on charities. The vast majority of 403(b) plans are run by charities manned by individuals who care deeply about their charity’s mission. Staff often have little expertise or resources to spend toward retirement plan issues. There is a reason that 403(b)s can only be invested in professionally managed funds.

Think about it: 403(b) funds can only be invested in accounts managed by insurance companies under an annuity contract or professional investment managers under a mutual fund. They are designed as individual pensions, which used to be easily “ported” from employer to employer. Any application of ERISA’s standards needs to take these type of concerns into account, or charities’ ability to maintain retirement plans will be severely compromised.

A finding against the universities may well spell the end of self-directed brokerage accounts. The participants’ ability to choose any mutual fund within a fund family is effectively the same structure as self-directed brokerage accounts (SDBAs). Shutting these 403(b) arrangements down as being imprudent may well affect SDBAs.

Finally, the plaintiffs in these cases have made a serious miscalculation.
Class action lawsuits have their own economics: these lawsuits are expensive to bring, and they need to be able to generate enough lawyer fees to pay for the investment the firm has made. Particularly in these complex 403(b) arrangements, discovery will be expensive. But there is something telling about the ability of these firms to cover their “nut”: the size of the legal fees is directly dependent upon the size of the damages.

What is unique about the high-priced mutual funds made available under these plans, and where the claim for damages is strongest, is that very few of the plan’s assets are actually in these funds. In fact, the large chunk of the investments are held in TIAA’s traditional funds, which guarantee interest rates far above what is generally available elsewhere in the market.

The question becomes how these firms will be able to establish that there are any significant damages, or at least enough to make the lawsuits worth their investment. It just looks like bad math.

Robert J. Toth, Jr. is principal in the Law Office of Robert J. Toth, Jr., LLC and is a member of the NTSA Communications Committee.

Opinions expressed are those of the author, and do not necessarily reflect the views of NTSA, or its members.

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