Savers’ Lawyers Spot Pitfalls in 401(k) Private Asset Proposal

Plaintiffs’ attorneys for 401(k) savers are scouring a new Department of Labor alternative asset proposal to spot litigation potential if more plans venture beyond typical public markets.

The Employee Benefits Security Administration’s rule, if finalized, creates a safe harbor for fiduciaries who follow a non-exhaustive list of six factors when considering whether to add assets like private equity and cryptocurrency to retirement plan menus.

While some benefits attorneys view the safe harbor as robust, others see legal landmines. The six-factor test doesn’t amount to a total liability shield for fiduciaries under the Employee Retirement Income Security Act, they said, and the final rule will need to stand up to post-Chevron scrutiny.

Jerry Schlichter, founding and managing partner of prominent ERISA plaintiffs firm Schlichter Bogard LLC, said future litigation would depend on the process a fiduciary follows to select and monitor investments.

“It certainly, though, is a situation where there is peril for a company which does this because of the need for a very different approach by the fiduciaries to the process,” Schlichter said. “And it is an onerous task that will be on them.”

The safe harbor is “very broad and process-driven,” and it will be critical for fiduciaries to document their work, said Karen Brandon, an attorney in the employee benefits and executive compensation group at Ogletree Deakins. Even so, there are some areas where plans could be vulnerable to suits, she said.

Fees have become a major source of ERISA litigation brought by plan participants, and managed investments like private equity largely charge more.

If fees aren’t reasonable and necessary on investments customized to a plan, it could create risk for sponsors, Brandon said.

Risk Factors

The March 30 proposal states a fiduciary can fulfill their duty of prudence if they select an alternative asset with higher fees if it has greater customer service or better risk-mitigation features. The fiduciary must also consider similar alternatives to demonstrate the fees are appropriate.

There are also liquidity risks, because alternative assets can be difficult to quickly convert to cash. Plaintiffs’ attorneys said lack of liquidity could cause headaches if an investment needs to be removed for poor performance, or a worker is trying to get money out quickly for an emergency, borrow against their 401(k), or if they change jobs.

“How do you provide that liquidity with what is by definition an illiquid investment?” Schlichter said. “The only way to do that is by setting aside a cash equivalent or cash in the fund in order to meet those liquidity needs.”

The proposal states fiduciaries have to determine if an investment alternative will have the liquidity to meet the plan’s needs and “must ensure that investments can deliver on any promises of liquidity.”

The complexity of alternative assets that are typically more opaque than stocks and bonds is frequently cited as an employer plan adoption risk. The proposal says if a fiduciary lacks expertise on an alternative investment, they must bring in an independent adviser to satisfy their duty of prudence.

“A fiduciary may decide he or she has the requisite knowledge and experience to select an investment such as crypto even though it is a new type of investment, and then select a plan investment that was not a prudent decision,” Brandon said.

Plaintiffs’ attorneys already have questions about what a useful benchmark would be to confirm plans are investing in a worker’s best interest when it comes to newer assets like cryptocurrency, or private equity funds, when it’s difficult for investors to know the make-up.

Post-Chevron Scrutiny

The DOL’s final rule must also withstand Administrative Procedure Act scrutiny after the US Supreme Court’s 2024 ruling that eliminated the Chevron doctrine, which required judges to defer to reasonable agency interpretations where the law was ambiguous or silent.

Mark Boyko, a partner at Bailey & Glasser LLP who represents plan participants, said post-Chevron courts are going to be “even less receptive to relying on DOL guidance, and even this rulemaking moving forward, when we have centuries of trust law that ERISA is built on to guide courts in evaluating that.”

DOL in its proposal argued its regulation “should carry persuasive weight to courts,” citing the Supreme Court’s Skidmore v. Swift ruling establishing deference to agency interpretations based on persuasiveness.

The proposal acknowledged that the Fifth Circuit has questioned the continuing role of Skidmore after the Loper Bright decision that overturned Chevron, but said the court has implied its precedent carries weight when the department has clear authority it has exercised consistently.

It said DOL has “promulgated safe harbors regarding a prudent process in the past” and the proposal is consistent with “past Departmental practice.”

Attorneys for plan participants and sponsors agreed the DOL took pains to be asset-neutral in the proposal, likely in an effort to rebuke administrative law challenges.

EBSA Chief Daniel Aronowitz has said he couldn’t predict that the proposal, once finalized, would decrease the number of lawsuits filed, but it could give fiduciaries another tool in getting cases dismissed.

“I believe plan fiduciaries have already adopted many of the principles set forth in the regulation,” said Erin Cho, who leads Mayer Brown’s ERISA fiduciary practice. “One of the goals of the proposal is that by creating clearer guidance on the factors fiduciaries should be considering when evaluating plan investments, it will help provide a framework for a successful defense in the event a fiduciary is sued.”

But Charles Field, co-vice chairman of Sanford Heisler McKnight LLP, which represents plaintiffs, cautioned fiduciaries against focusing so intently on the six-factor test itself that they fail to fully consider their broader duty to act solely in participants’ best interest.

“I just worry that they’re in a situation where they’ve done their homework, they’ve done their due diligence, they’ve missed something, and the riskiness of the enterprise shows itself and people lose money,” Field said.