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Prepare Clients for a Litigious 401(k) Environment


As an accounting professional, your business owner clients look to you for financial guidance. With their busy schedules, they may have blind spots that can open them up to potential vulnerabilities. One area of significant potential liability today is with 401(k)s and other retirement plans.

Aug 4th 2021
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Accountants are well-positioned to offer advice on 401(k)s and other retirement plan options for small business clients…especially before legal issues can set in. But how does this happen?

Well-meaning small business owners often take great care to set up retirement plans initially, carefully choosing the mutual fund lineup and plan policies. Then, they assume most of their work is done.

However, ongoing administration is not only needed and is considered a critical responsibility. In fact, the US Supreme Court ruled that plan sponsors have a continuing duty to monitor the plan and its funds.  

These ongoing requirements have caught many unsuspecting companies off guard, sometimes resulting in lawsuits against retirement plan sponsors. As of 2019, over $6.2 billion in settlements had been incurred, according to data by the Corporate Research Project of Good Jobs First. Since then, litigation activity has accelerated further.

Not Just Large Employers

The scope of these lawsuits has changed as well. Initially, legal efforts targeted large companies.  Recently, however, even smaller employer plans with less than 1,000 participants have been sued.  

Then, there’s an area of risk that smaller companies are especially prone to: cybersecurity issues.  The risk of cyber breaches can put the smallest of plans at risk. According to Jordan Mamorsky, an ERISA litigation attorney at Wagner Law Group, “Smaller plans have a harder time investing in more robust cybersecurity measures, just because of their resources.”

Significant Downside

Many small business owners don’t realize that by sponsoring a retirement plan, they become fiduciaries to that plan.  That means increased business liability and what most business owners know is that with liability comes the potential to have to defend a lawsuit. Even if the case has little merit, the cost to defend any legal action can be prohibitively expensive.

But it gets worse. In some cases, the business owners or their executives may even face personal liability. In Tibble v Edison International, a Vice President of Human Resources was found personally liable for a fiduciary duty breach along with the corporation.

On top of that, some attorneys have begun to specialize in retirement plan lawsuits and proactively seek employees who are unhappy with their 401(k) plans.  All of this has occurred during a generally stock rising market. As you can see, attention is warranted.

What Can Plan Sponsors Do to Reduce Liability?

The good news is that the increased litigation has helped provide more clarification on what the courts consider to be best practices.  As a firm that has helped plan sponsors stay compliant for three decades, here are our top tips to help clients minimize potential liability. 

1. Understand the responsibilities of a plan fiduciary

The first step is awareness.  Clients with retirement plans need to be educated about potential liability.  Then, they need to understand their day-to-day responsibilities to the plan and the participants. 

Why wouldn’t they know?  Frequently, small business clients may turn to local generalist financial advisors to help them manage the plan. It might be their personal wealth manager. 

Instead of being specialists, these firms tend to dabble in retirement plans, which is different from their core business. This can create dangerous blind spots for their clients. So, any company with a 401(k) plan should take the initiative to get educated, first and foremost. 

2. Keep written and detailed records

Court rulings tell us that missing any administrative task can mean a potential problem down the road.  That’s why it's critical to document everything done for the plan. 

Any dealing with the plan or participant questions should be formally documented. An extensive set of records can help prove the firm took its fiduciary responsibility seriously and executed its obligations. 

3. Pay close attention to plan fees and investments

Fees continue to be a flashpoint for litigation. As a fiduciary, the plan sponsor is responsible for keeping participant fees reasonable. That means gathering quotes to make sure participants are not overpaying compared to other similar size plans. 

It doesn’t always mean switching, either. Usually, you can go back to vendors and request fee adjustments on behalf of plan participants. 

Plan investments are also a frequent issue in lawsuits.  Courts have ruled that plan sponsors must continually monitor plan investments and replace any funds that are faltering relative to their peers. 

4. Hire a plan advisor with extreme care

As you can probably see, a lot of this is specialized work. Fortunately, the law allows plan sponsors to hire certain financial advisors who can serve as co-fiduciary. That means that along with advising on plan management, they can also share liability. 

Choosing a firm with proven experience managing plans is usually the most efficient way to prevent potential liability. But not all firms can share liability. Brokers, for example, are allowed to provide advice but may not serve as a co-fiduciary for the plan. 

Fortunately, certain financial advisors, accountants included, are permitted to act as co-fiduciaries: 

  • The 3(21) advisor.  They may act as advisor, but the client still retains most of the liability.
  • The 3(38) advisor.  This type of advisor has the discretion to make and implement investment decisions for the plan.  This lessens the client’s liability.  (However the firm is still responsible to hire that advisor very carefully.) 

There are far more 3(21) than 3(38) advisors out there, according to data from Ann Schleck & Co

The bottom line is that of your small business owner client has a retirement plan, ask them if they are properly managing their potential liability. If not, recommend they look into it and get educated.