Workplace retirement plans are facing a growing wave of class action lawsuits under the Employee Retirement Income Security Act (ERISA), pushing employers to evaluate the policies that dictate how 401(k)s are administered, according to a new report from law firm Duane Morris.
“If you look at the last three years compared to the 30 years beforehand, the amount of money that corporations have paid to settle class action lawsuits has exploded,” said Gerald Maatman Jr., co-author of the report and chair of the firm’s class action defense practice team.
Last year marked the third year in a row where the top 10 ERISA class action settlements totalled $400 million or more, according to the report.
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“What has occurred is you have two things going on: A migration of very skilled plaintiff’s lawyers into the space, because they’re seeing so much money being made, and you’re seeing plaintiff’s lawyers begin to assert novel theories, to say, ‘Let’s rethink these issues underlying the law or the statutes and bring novel causes of action,'” Maatman said.
A new challenge to 401(k) plans
One such novel theory concerns the way that employers use forfeited 401(k) funds in their plans.
Over the past year, numerous ERISA class action lawsuits have taken aim at how 401(k) plan sponsors use forfeited funds. In a typical 401(k) plan, employees contribute to their accounts, often with a matching contribution from their employer. While employees are usually immediately vested in their contributions, employer matches typically vest over time. If an employee departs before fully vesting, the unvested portion of the employer’s contributions is forfeited.
Many employers use these forfeited funds to offset their future plan contributions. However, in 2024, several class actions have argued that these funds should instead be directed toward covering administrative costs that are currently paid by plan participants. Federal district courts have found that these lawsuits present plausible claims under ERISA, according to the report.
The practice of using forfeited funds to offset future employer contributions is common practice across the country, according to Chris Tobe, chief investment officer at The Hackett Group in New Orleans. Despite the pervasiveness of the practice, Tobe said that using forfeited funds to cover administrative costs for employees would make little to no difference for individual workers.
“98% will never know the class action was even filed,” Tobe said. “99.9% will [not] even notice the few pennies added to their plans, if any.”
Experts say it’s difficult to determine how much of an impact the current practice has on employees, but some say it could be significant at certain companies.
“Forfeitures can be a significant sum, especially at companies with higher turnover,” said Carl Engstrom, a partner at Minneapolis, Minnesota-based law firm Engstrom Lee.
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The class actions challenging this practice have survived motions to dismiss, but they still need to receive class action certification before moving forward, Maatman said. Certification of a case is the “holy grail” for plaintiffs’ attorneys, as it generally results in a sizable settlement from a company, Maatman said.
Such cases, if they succeed, could have a “deterrence effect” on companies and the policies they use to administer their 401(k) plans, Maatman said. But Engstrom, who has experience representing employees in retirement plan malfeasance cases, says that these cases may not drive much large-scale change.
“In most of these cases, the issue about how to allocate forfeitures is arising because the plan documents in many of these cases give discretion to the employer as to how those funds will be used,” Engstrom said. “Well, under ERISA, anything that is discretionary is fiduciary in nature, to which a duty of loyalty and care applies. I think the most likely outcome from this litigation will be that employers will eliminate that discretion from their plan documents and instead instruct that forfeitures should be used to offset employer contributions to the plan. And that change won’t make any difference to retirees.”
Rather than altering the way that employers currently use forfeited 401(k) funds, litigation could, in fact, formalize that practice.
“Some plaintiffs have tried to argue that forfeitures are plan assets that must be used to benefit employees, regardless of what the plan document says,” Engstrom said. “If that argument prevails, that would be a meaningful victory for retirees. But based on the opinions that have come out thus far, that view seems unlikely to prevail.”
The Supreme Court sets a new standard
Still, even if this particular set of class actions doesn’t change employer 401(k) practices, a growing number of filings could. Earlier this month, the Supreme Court issued a 9-0 ruling that “substantially lowers the bar for plaintiffs alleging prohibited transactions,” Maatman said.
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The case centered on Cornell University employees who claimed that the university violated ERISA by causing its two retirement plans to engage in prohibited transactions. These transactions involved third-party service providers offering investment options, platform access and recordkeeping services for the retirement plans, all while allegedly charging excessive fees.
“Defendants in these cases can no longer point to a plaintiff’s failure to discuss statutory exceptions to secure a motion to dismiss. Rather, defendants must provide clear evidence that an exception applies in their responsive pleadings,” Maatman said.
The ruling “will likely lead to an uptick, if not an explosion, in filings,” he said.
For financial advisors and their clients, current cases involving ERISA are unlikely to significantly impact their decision to participate in workplace retirement plans, but they could help improve things like costs and disclosures over the long term, according to Cristina Guglielmetti, founder of Future Perfect Planning in Brooklyn, New York.
Such cases could help drive “very incremental” improvement in 401(k) plans over the long term, but for financial advisors working with clients today, deciding how to make use of workplace plan offerings is mostly dictated by cash flow, contributions and fees, she said.
