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How to avoid 401(k) plan lawsuits

Published by Summit Marketing Team on Mar 8, 2021 8:00:00 AM

The 401(k) Audit CPA Success Show: Episode 15

While the topic of lawsuits may not be the most "fun" of topics, it is relevant and important for companies who offer 401(k) plans. Lawsuits are a lot of work. They take time, cost you money and can be very stressful. Today, Jamie Nau sits down with Kim Moore, Summit's Director of Auditing, to talk about lawsuits as it relates to 401(k) plans.

This episode will help 401(k) plan sponsors avoid lawsuits, and tell you where to look, and what to watch out for.




Jamie Nau: Hello and welcome to today's podcast. Once again I am joined by Kim Moore, Director of Audit at Summit CPA. Today we're going to talk about a not so fun topic, but I think one that's pretty, pretty hot right now and pretty relevant. We're going to talk about lawsuits as it relates to the 401(k) plan. So welcome to the show, Kim. 

Kim Moore: Thanks, Jamie. Glad to be here. As you mentioned, not a topic that probably everybody wants to hear about, but very important and can be very costly to your plan. If someone does bring a lawsuit against you, where you get caught up in, you know, maybe a class action type of lawsuit, those can happen as well. So we thought we would talk about it today. One of the reasons I wanted to bring this up today, you know, where we're sitting in 2021, the market's been doing fairly, fairly decent and fairly stable. But if we look back in 2020, of course, during the pandemic, the market was pretty volatile and we had some pretty big downturns at different times. Research shows that one of the big times that lawsuits can occur against plans is right after there's been a major downturn in the market. There was a study done recently, and there's these studies come out fairly frequently, but as they looked over time, if you go back, for example, in 2006, which was a fairly stable investment period, there were only eight lawsuits brought against 401(k) plans. But by 2008, that number had jumped to 107. And if you remember, 2008, 2009 was the huge market downturn related to all of the mortgage situations that were going on. Companies were going out of business, and there were all kinds of problems which caused the market to take a huge downturn. Now, the two don't necessarily go together. I mean, just because the mortgage business was having difficulties, you know, you'd say well, what does that have to do with my 401(k) plan? But what these studies have shown is that participants that maybe aren't paying that much attention to their overall plan investments and how they're tracking or maybe don't watch the market on a regular basis, they may get a statement in their mail, or maybe in their e-mail, and they're expecting to see a certain number because it's been historically around that number. Then all of a sudden they see a 50 percent drop and it just shocks them. Although they may and probably did choose the investments for their particular accounts and they could change those investments at any time. Obviously, it's not the plans fault that the market goes up or down. What the studies have shown is that participants get nervous, and they feel like that it its somebody's fault. So they will try and sue the plan over that. So we thought it's a timely topic because we did just go through a downturn. People may be nervous. We don't know exactly what's going to happen with the pandemic either. So people may have lost jobs or lost some of their income, that is another thing that might set them off to want to file a lawsuit. So anyways, we thought this would be a relevant topic because what's been happening.

Jamie Nau: I get my statement in the mail for my 401(k) all the time. You know, the rational person says, okay. The market's down 20 percent at the timing of my statement. So the amount on my statement is  going to be down a little bit, unless you have a really good investment mix. It’s not uncommon for the market for 401(k)’s statement to be going up and down with the market. I think a lot of people see that and understand that. But a lot of people, like you said, are just looking for looking for someone to blame or looking for a reason behind that, especially the closer you get to retirement. I have a little while away before I get to retirement. I know there's time to recoup those gains. But if you're getting closer to retirement and forgot to change your investment mix, those dips can really hurt.

Kim Moore: Right. It could definitely throw off your retirement plans if you're real close to retirement and there's a downturn. It’s not uncommon for any type of investment that you might have to postpone your retirement a couple of years or longer if the market does take a huge downturn. I wanted to just give everybody a sense of that. There was a study done in 2020 by Boston College. They have something called the Center for Retirement Research, and this is the kind of stuff that they that they get excited about. They took a look at past lawsuits and what happens with them, because obviously, just because someone files a lawsuit doesn't mean you're automatically going to be losing a lot of money if you're the company. They found 20 percent of them was dismissed. So, a good chunk. 16 percent of them were settled. So there was probably something going on by the company, but they were able to settle four percent on 16 percent. Then 4 percent on appeal. So that would mean you lost the case, or somebody lost on the other side and they're appealing it. The bad news is that 60 percent of them are still pending, So more than half had not been settled and they had been going for a while when they took the study. So that's another kind of negative factor for you. If you're running a 401(k) plan and you're worried about this, that they're they may be frivolous lawsuits or maybe not, but that doesn't mean that they automatically just go away. They can take time to work through the system. Depending on what it is, the courts may hear it sooner or later. Obviously, in this case, it sounds like later, probably more often than not. So, you know, it can take up a lot of your time. Obviously, it's a lawsuit. It's a legal action. You still have to address it, even if you believe there's totally no basis for it. That doesn't mean you can just ignore it. So you do have to work through it.

Jamie Nau: So the study was done in 2020. Do you know how far back they looked? Because that number really surprised me when you showed me that. 60 percent pending.

Kim Moore: I don't have the exact data, but I know it was several years. 

Jamie Nau: Then I guess the question is, during that time a lawsuit is pending for two years, how much of your time is spent on it? I mean, occasionally a question will come through or someone's digging into something, but it's not a ton of time. It's just the stress of having that outstanding case pending I'm guessing.

Kim Moore: Right. Depending on the size of your company, you know, you may have in-house attorneys or not. You could have in-house attorneys that don't have any experience in this area. It’s quite common with this kind of litigation that you would go get outside counsel, which, of course, you have to pay for. We all know attorneys are not cheap. So it's time, it's money, it's stress because you just don't know when it's even going to come up. Maybe it is resolved quickly once it comes up, but it takes a long time just to get to that point. So not a path you want to go down. If you can, avoid it. So we wanted to bring this up today and make sure it's on your radar and talk about okay. So I'm a plan sponsor. I don't think I'm doing anything wrong. But you just told me I still might have to worry about litigation. So what can I do to avoid it? That's what we wanted to talk about and where we want to focus the meat of today's discussion on.

Jamie Nau: So let's start there. Do you have a couple of topics, or a list of the main reasons are for these lawsuits?

Kim Moore: Yeah, the first thing we kind of alluded to at the beginning, is poor investment returns. Which, as a plan sponsor, you can control the fund line-up so you can control how many different options a person has, but you can't control the selections that they make. You can't obviously control the market. So there's limited things that you can do here. But first off, make sure that the options are participant directed, which the vast majority of 401(k) plans are. But that's not always the case, and it's not required that they be participant directed. So if for some reason yours are not, or maybe the employer contributions you are selecting the investment option there, I would take a look at that because that is, you know, something you might not come out so well in a lawsuit if the market heads downward and the investments you selected happens to be one of the ones that's, you know, not doing so well. Also, a lot of plans have a default investment option. So especially if you have auto enroll in your plan. So once a participant hits a certain eligibility set of requirements, which may be just that they join your company, so it might be upon hire, they're automatically enrolled in the plan unless they take action to decline enrollment. It’s more of a passive enrollment versus a lot of plans where you had to fill out form or go online and sign up. With auto enrollment you're automatically enrolled unless you take action to not enroll. In those types of plans they will always have a default investment option because if the person's not taking any action to enroll, then they may not also be taking action to select investment options. But their money has to go somewhere. So they'll have a default investment option. Most of the time those things are either target date retirement accounts. So they're going to select a default account that matches your anticipated target retirement date. So if it's a long way away they'll have more equity investments. If it's closer to retirement, obviously, they would have less risky. So the investments in those funds are targeted based on how long you have till retirement. Or it may be a kind of a balanced fund, or something called a stable value fund, which is really seeking to just maintain the investment and get a little bit of income, usually something like interest. Usually those types of investments, which tend to be less risky, but they wouldn't necessarily have to be. So, again, that's an area you would want to check out if your plan has a default investment option take a look at it periodically. Which you should be reviewing investment options anyways. But pay particular attention to this one, because it's an investment that subject to a lot of fluctuation. Again that could be, you know, lawsuit material for somebody and it would be difficult to defend yourself. We kind of mentioned this already, but a good thing to do to help defend yourself if someone brings one of these lawsuits is make sure that you're reviewing the investments on a regular basis. We recommend quarterly. You could do it more often or less frequently if you feel that you're comfortable with that. But often enough so that you are watching the investment options you have if they're not tracking close to their peers. So that doesn't mean every fund has to be making tons of money. It just has to be tracking to its peer because you want to have a good diversified mix of options. So maybe the bond funds right now are not doing well. That doesn't mean you get rid of all your bond funds. It just means that you want your bond fund to be tracking to its peers. So make sure you're doing those evaluations. Make sure you document those. What we've seen if these cases do go to court and the plan sponsor is able to show that, hey, I offered a diversified mix. We did evaluate the investments. We replaced investments if they were not performing as well as they should to their peers and their participant directed. So if someone chose a fund and that particular sector was not doing really well and they left their money in there, the courts will usually find in favor of the plan or the plan sponsor. Any of those pieces missing then that can be problematic. Documentation is going to be key. 

Jamie Nau: Can we talk about the documentation a little bit? I know I've seen companies have investment boards or people on that board where they just take minutes. Meeting minutes saying okay, we're starting to review at 8:50 a.m. we're going to talk about each investment, and have meeting minutes of notes each quarter. Do you recommend that?

Kim Moore: We recommend recording minutes. Usually if you have an investment adviser they'll put together a packet, and that packet is what you're going to review in the meeting. The packet will outline a criteria that you want to look at for all your investment options. And so, you know, just because it goes down a little bit, that's not alarm bells going off. But if it starts tracking downward and again, you're tracing it to its peers, if it starts tracking downward, you might put it on a watch list and then you'll say, well, next quarter or the next review, whenever it is, we're going to see if that's improved. You know, if it hasn't, then we're going to consider for replacement. Then obviously you would want to see in the next set of meeting minutes you addressed appropriately depending on what happened to it. Usually the investment advisors will also talk to you about funds where maybe the fund manager has changed. They've left or they're changing the strategy for that particular fund. That doesn't necessarily mean you want to change it, but those are things you'd want to talk about on this committee. So yeah, you want to make sure that you document all of that in either meeting minutes. I would keep that packet all together. So if you ever had to show somebody what was talked about. What you were looking at, you would have that kind of documentation. The other thing that's really important here, it's good if you have these meetings and you're going through the analysis, but it doesn't do you the best if you're not communicating to your employees that you're doing that. So you want to let your employees know at the very least that you have a committee. That they meet whenever that is, monthly, quarterly, annually and what you take a look at. What you talked about and what you found. If you're talking about replacing an investment, you want to give the employees plenty of heads up so that they know they can move their money around if they want to. Maybe they don't like what you're going to replace it with. Communication is important so that they know that you're monitoring things that may lessen their likelihood, you know, to get all freaked out if things suddenly do take a downturn, at least they know you're looking at it, you're kind of looking out for them. That communication will also help them if there is a huge downturn. They're not going to be surprised when they get their next statement. They might be a little surprised when they open it up, but hopefully they'll remember, oh yeah. They told me that they market took a downturn. So my next statement might look like this. So that kind of communication helps anticipate the surprise element.

Jamie Nau: So it sounds like I mean, as with anything in business, documentation and communication is key here. So you want to make sure you're hitting those two things. I'm guessing based on the other areas of lawsuits those words are going to come up again. So let's jump into the next one that is common to see a lawsuit in,

Kim Moore: The next area, and this one is totally under your control. If a problem occurs in the administration of the plan. So someone asked you to withhold 10 percent of their pay. It got missed. You find out two or three payrolls down the line oh. We forgot to do that or we just didn't implement it. That might be an example. The match doesn't get applied properly or the match doesn't get put into accounts. There's timeliness issues. So, you know, we did everything okay dollar wise, we just didn't put it into the account on time. So all those kind of things; distributions aren't handled properly. So if you think about every area that you're handling in terms of the plan administration, you make a mistake. Obviously, you should have procedures in place and controls to catch the mistake. But as soon as you know about it, you want to correct it. But the big thing here is communicate with the employee. Don't just do it and say nothing. Actually sit down with the person, explain what happened or explain what you did, why you did what you did, because there are regulations usually around mistakes and how you have to correct them, what you're required to do, what you're not required to do. But I think it really helps if you communicate to the employees so that they know. Most people know you just made an honest mistake. There was no intent there. As soon as you knew about it, you fixed it. You made them whole, if you will. Most people know this is complicated. There's a lot to it. Mistakes happen. We're all human and they'll just go on and they won't even think any more about it. But if you don't tell them, don't explain. They maybe find out about it on their own. Then they have to tell you, that kind of sets up a thought pattern inside these folks, that maybe they're really not doing what they should be doing and maybe I'm getting cheated or they're not, you know, not using my money well and putting it in my plan right away. That can set them off. One other thing we see a lot. We've had plans that are our clients that will get, especially DOL audits, there are also IRS audits, but the DOL ones are the ones that are most concerning here. I always ask the folks, you know, did they tell you why you got selected for audit? Or maybe an investigation, might not be at full audit just an investigation. Very rarely will they tell you. What the answer that the DOL will give you is that they randomly select plans for audit, just because they do audits to make sure things are going well. But they also, and I think this is probably what happens more often, is that they will investigate something if they hear from a participant. So if they get into the investigation and they start looking at individual accounts, that's usually a clue that a participant or maybe more than one participant complained, and they're looking at those particular accounts. Quite often the person that's complaining is not upset about the 401(k) plan. They're upset about something else. Maybe they felt like they didn't get a raise when they should have. They should have got promotion and they didn't get it. Maybe there was some termination type situation. So it might have nothing to do with their participation in the 401(k) plan. But an easy way to get back at a company is go and complain to the Department of Labor that, hey. These people did something with my money that they shouldn't have done. Which may totally not be true, but the Department of Labor will almost always, unless they really believe that it's not true, but in most cases, they will investigate and they do that through an investigation or an audit. So, again, another reason why communication is really important, and that's all kinds of communication, because as long as your employees know what you're doing and why, they may not like it, but at least if they understand why, that tends to not, you know, start up this chain where they'll end up thinking, what can I do to get back? And, oh, well, here's an avenue. Participants get information quite often about their plan. And at the bottom of those communications, it's always going to say, you know, if you're unhappy with this, you know, communicate with the Department of Labor, blah, blah, blah, you know, give them the avenue to communicate so they'll see that. And if they are unhappy, that can lead you down a path. It may not be a lawsuit, but it can end up being just as costly and certainly worrisome and wasteful of a lot of time.

Jamie Nau: I always tell my kids that. Fess up and let's get it fixed instead of trying to hide it and make it worse.

Kim Moore: Yeah, and we always tell people, you may think that they'll never know or they'll never notice the fix, but you would be surprised. Just one other area I wanted to mention is corrective distributions. So we've talked about in previous podcast about the discrimination testing that a plan has to go through. Unless it's a safe harbor plan. Those tests can quite often lead to what is called corrective distributions, which actually ends up being a return of the contributions. Especially if you're a highly paid individual at the company and you're contributing the 401(k) plan. If it fails the testing, you know, you may have contributed twenty thousand dollars to your account during the year. By March of the following year if it fails, one of the ways to fix it is to give you back that money. And of course, then you probably did that pretax. So there's going to be tax implications. That's another problem that can set off people. They may have already filed their tax return. Now they've got a 1099 showing that they owe tax. So now they got to go back and file an amended return. Now they're really unhappy. So again, communication here is the key. Let people know, especially if they're highly compensated, that this can happen. Try and test for it ahead of time, because there's ways that you can have them do their contributions so that this doesn't come into play. So there's other things you can do. Tal to your service provider, but another area that can cause upset. People can complain and that can potentially cause problems. 

Jamie Nau: I think this is a really good summary. Just to drop back to the beginning here when you mentioned the 2006 and 2008 numbers, you know, it's not like you mentioned numbers in the thousands. I think you mentioned 107 in 2008. So these are far few and far between. It's like they happen all the time, but good practices just to have is communication and documentation. I think, you know, the more you do that the easier the lawsuits are going to be if it does happen.

Kim Moore: Yeah, it does not happen often. It’s a pain on the individual to file a lawsuit or make a complaint. So it's not easy to do. So yeah, it's not going to happen all the time. But when it does happen, it's not a pleasant situation. So we like to bring it up. The things that we are recommending are best practices anyways. You should be doing all those things we talked about not to avoid a lawsuit, but just because it's the right thing to do. You should care about your employees and helping them save for retirement. So those are the things you should be doing anyways. Sometimes we get so busy and so wrapped up in our day to day that and you just don’t want to take the time to take minutes in that meeting about it. So just a reminder, stick with the program. Do all the things that you need to do and you will come out much better in the long run.

Jamie Nau: And those are the things you can't get back. You can't go back and re-have a meeting. You can't go back and re-communicate that now the lawsuits is coming. You want to make you're timely and you're thorough with communication and documentation because you can't go back and fix those after the fact. 

Kim Moore: That that's absolutely.

Jamie Nau: Well Kim, I thought this was a great topic. I appreciate you bringing this up. I look forward to talking to you again soon.



What Plan Sponsors Can do to Avoid 401(k) Plan Lawsuits

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