The educational community was rocked by the recent filing of class action complaints against Massachusetts Institute of Technology, New York University, Yale University, Duke University, Vanderbilt University and Johns Hopkins University. These suits generally allege the retirement plans sponsored by these institutions paid unreasonable and excessive fees for record keeping, administrative and investment services. They also allege the investment options offered to plan participants underperformed benchmarks and charged excessive fees. All of these allegations remain to be proven at trial.
I'm going to focus on the allegations in the complaint against Yale University (which I obtained from Pacer), because of the prominence of David Swensen, who is the Chief Investment Officer of Yale's $22 billion in Endowment assets. I could find no indication that Mr. Swensen is involved in any way with the retirement plan that is the subject of the lawsuit.
Mr. Swensen's achievements in managing Yale's endowment are the stuff of legend. During the past 30 years under his stewardship, the Yale Endowment generated returns of 14.1 percent per annum.
Swensen's investing advice
Swensen is a strong advocate for index-based investing. His advice to individual investors is unequivocal: "There are two sensible approaches to investing -- either 100 percent active or 100 percent passive, he noted. Unless an investor has access to "incredibly high-qualified professionals," they "should be 100 percent passive -- that includes almost all individual investors and most institutional investors," he stated.
Swensen takes a dim view of actively managed mutual funds. He has observed that most active mutual funds are more interested in collecting fees than in boosting returns for investors.
According to the Complaint, Swensen's sage advice has not been followed, to the detriment of the 16,487 participants in its $3.6 billion retirement plan.
Allegations of breach of fiduciary duty
It wouldn't be difficult for the sponsors of Yale's retirement plan to follow the recommendations of its Chief Investment Officer. All it would have to do is limit the investment options in its Plan (other than annuities that must be included in the Plan) to risk-adjusted portfolios of low management fee index funds. The portfolios would range in risk from conservative to aggressive. It would take no more that five portfolios, each consisting of three to five index funds, to give participants all the options they require. These funds are readily available from prominent fund families like Vanguard and Fidelity, among others.
According to the complaint, the Plan has 115 investment options, including retail and institutional share class mutual funds, insurance separate accounts, variable annuity options and fixed annuity options. It would be hard to defend the inclusion of retail share classes in the investment options of a plan this size, since it would qualify for lower cost institutional shares that are identical in all other respects.
All these choices are overwhelming to participants. The complaint alleges: "Numerous studies have demonstrated that when people are given too many choices of anything, they lose confidence or make no decision."
The complaint notes that the Plan continues to offer higher cost share classes of identical mutual funds available at a much lower cost. It alleges this conduct "demonstrates that Defendants failed to consider the size and purchasing power of this Plan when selecting share classes."
The combination of duplicative index funds and the inclusion of actively managed funds, allegedly serve to prejudice Plan participants. The complaint states: "As generally understood in the investment community, passively managed investment options should be used or, at a minimum, thoroughly analyzed and considered in efficient markets such as large capitalization U.S. stocks. This is because it is unheard of, or extremely unlikely, to find actively managed mutual funds that outperform a passive index, net of fees, particularly on a persistent basis..."
Retirement plans will continue to face scrutiny as the number of class action complaints increase. It's surprisingly easy to protect a plan from these lawsuits. Here are my suggestions:
1. Retain an advisor who accepts " ERISA 3(38)" fiduciary responsibility for selection and monitoring of investment options in the Plan. Such an advisor has full legal responsibility to select and monitor investments in the Plan.
2. Limit plan investment options (if permitted to do so) to globally diversified portfolios of low management fee index funds, passively managed funds or exchange-traded-funds, at different levels of risk. Don't include any actively managed funds as investment options.
3. Monitor plan expenses to insure they are as low as possible based on current market data.
4. Never include more expensive institutional share classes of a fund when lower cost share classes are available;
5. Don't permit "revenue sharing" payments by providers of investment options in the plan.
6. Engage in a continuous monitoring process to insure that investment options are the best available for plan participants.
If you are a participant in a plan, you have the right to insist your plan is operated solely in your best interest. A plan that deviates from these recommendations is arguably not doing so.
Dan Solin is a New York Times bestselling author of the Smartest series of books, including The Smartest Investment Book You'll Ever Read, The Smartest Retirement Book You'll Ever Read and his latest, The Smartest Sales Book You'll Ever Read.
The views of the author are his alone. He is not affiliated with any broker or advisory firm. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.