In recent years, target-date funds (TDFs) have gained popularity as a set-it-and-forget-it investment option for millions of Americans saving for retirement through their workplace 401(k) plans. However, these funds have now become the center of federal lawsuits, alleging underperformance and creating new risks for employer sponsors who rely on them.
TDFs are designed to automatically adjust investments over several decades to maximize returns as retirement approaches. However, employees at major companies have accused their employers of failing to prudently monitor these funds over shorter periods, typically three to five years.
The latest phase of litigation involves JPMorgan Chase & Co.’s SmartRetirement Funds, which were implicated in a lawsuit brought by participants in a plan administered by an Intermountain Healthcare Inc. subsidiary. Last year, nearly a dozen companies faced similar lawsuits, accusing them of sacrificing returns by prioritizing low fees offered in BlackRock Inc.’s suite of LifePath index Funds.
Employers commonly rely on TDFs due to their relative affordability and ease of use. According to The Vanguard Group Inc, these funds account for nearly one-third of total retirement savings in the United States and are found in almost 98% of defined-contribution plans. The involvement of TDFs in workplace retirement plan litigation could have far-reaching effects, shifting employers’ focus from fees to returns.
While fee-related lawsuits had previously driven employers toward the perceived safety of TDFs, the focus has now shifted to performance. This shift challenges the traditional notion that TDFs are long-term investments and raises questions about the importance of short-term performance metrics.
Plaintiffs in the Intermountain Healthcare suit allege that their employer, Sisters of Charity of Leavenworth Health System, mismanaged the group retirement plan by including an actively managed JPMorgan TDF suite on the investment menu, despite its alleged poor performance compared to industry-accepted benchmarks.
Similar lawsuits filed against Citigroup Inc., Marsh & McLennan Cos. Inc., and Cisco Systems Inc. in the previous year claimed that low-cost BlackRock funds underperformed their competitors over the past three to five years.
Determining the threshold for underperformance is a critical issue in these cases. Questions arise about the prudent timing for changing funds and the significance of a few years’ performance in the context of long-term investments.
Some companies, such as Condé Nast, successfully defended themselves against TDF lawsuits, while others are regrouping to pursue legal action. The potential for substantial settlements incentivizes law firms to identify TDFs that have underperformed their peers within a specific timeframe and then search for company 401(k) plans that invested in them during that period.
Differences in the management strategies of JPMorgan and BlackRock funds play a significant role in TDF litigation. BlackRock’s LifePath funds are passive index funds that follow a predetermined glidepath based on diversified portfolio performance. In contrast, JPMorgan’s suite is actively managed, with Wall Street managers attempting to outperform the market by introducing additional risk and reward.
Courts have been inclined to differentiate between these two management strategies, recognizing that active funds have different aims, risks, and potential rewards. However, whether courts will allow comparisons between active and passive funds or limit analyses to within the respective fund categories remains uncertain.
Retirement plan officials, held to a strict fiduciary standard, are responsible for selecting and monitoring investments. The U.S. Department of Labor emphasizes that plan fiduciaries must fulfill their duty to oversee the entirety of underlying investments in a TDF strategy. The department is cautious about absolving fiduciaries of their responsibility to make prudent investment choices.
As the litigation landscape evolves, employers and retirement plan officials must navigate the challenges TDF lawsuits pose. Vigilant monitoring of investment performance, prudent selection of funds, and understanding fiduciary responsibilities are crucial for protecting the retirement savings of employees and mitigating legal risks.
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