Will target date funds (TDFs) be the next subject of the next wave of 401k lawsuits? An expert predicts that the combination of the new DOL conflict of interest rule, which raises the bar on fiduciary standards and opens up the door for more class action suits, plus the next big market correction where TDFs that take a lot of risk plummet like in 2008, will create a rich environment for lawsuits. And assets in TDFs have quadrupled to almost $800 billion since the last correction in 2008 making them even more attractive.
Though most 401k lawsuits have focused on overall excessive fees embedded within the expense ratio of the funds, more suits are focused on individual investments like stable value/fixed income and most recently managed accounts. TDFs are different than most other funds because they include a basket of investments requiring a different type of benchmarking and have become wildly popular as the default option or QDIA since the 2006 Pension Protection Act made it safe for plans to use them as the default. According to a recent SHRM survey, 44% of defined contribution plans offer a TDF and 38% offer auto enrollment which requires a default option.
The leading TDF providers with over 70% market share, Vanguard, Fidelity and T. Rowe Price have one thing in common – they offer record keeping services which is how they accumulated a majority of their TDF options. Because, until recently, most record keepers did not offer multiple TDF options, still common with smaller plans, which means prudent due diligence on these funds is difficult if not impossible leading some experts to recommend to pick the TDF before selecting a record keeper.
And the DOL has gone on record with their 2013 guidance which basically stated that selecting the TDF of a plan’s record keeper without proper due diligence is not acceptable. So what happens when there is no other option?
Regardless of the risk of lawsuit, DC plans should pay special attention to the selection and monitoring of their TDF because they are receiving over 60% of new contributions and will have the most dramatic effect on retirement outcomes than any other investment class.
