Index funds may not be the magic bullets many plan sponsors think they are. A wave of recent lawsuits alleging breach of fiduciary duty against smaller plans reveals why.
The largest plan facing a class action lawsuit from participants is from New York Life Insurance Co. The plaintiff’s case is based on one index fund available in two separate 401(k) plans available to plan participants, the MainStay S&P 500 Index Fund.
MainStay Funds happens to be the proprietary fund family of New York Life.
The lawyers pleading the class action case on behalf of plan participants maintain that New York Life is profiting from excessive fees charged by the MainStay index fund. This, the lawyers claim, is not in the best interest of participants and therefore constitutes a breach of fiduciary duty.
The MainStay S&P 500 Index Fund charges higher fees of 35 basis points to participants, according to the class action lawsuit, by contrast, S&P 500 Index funds from Vanguard and State Street charge much lower fees (in the single digits).
Despite the implied simplicity of the index fund platform, plan sponsors should remember that seeing “index” in a fund name doesn’t necessarily mean low cost. Especially in the current market climate of changing regulations and intense competition, fund providers continue to look for opportunities to innovate and differentiate, all in the name of capturing the flood of assets flowing into passive index options.
But much of this innovation may be just trying to improve upon the wheel. There are a lot of commonalities among index funds. Often what distinguishes similar index funds is the expense ratio.
Even the name “Vanguard” may not be enough to keep plan sponsors safe from participant lawsuits. Back in January, health insurer Anthem was targeted with a class action case based on several Vanguard index funds available to participants in the plan’s investment lineup.
This lawsuit alleged the Anthem plan didn’t use its large size to negotiate with Vanguard to get less expensive versions of the same index funds on the plan menu. This case has not been settled yet, and Anthem may yet prevail. But it’s an important lesson for other plan sponsors to learn from—words like “index fund” or a firm name like “Vanguard” aren’t enough by themselves to help fulfill a fiduciary duty to plan participants.
Plan sponsors need to adhere to a process of prudence when evaluating all funds being considered for a plan menu—index and otherwise. This process of prudence includes examining closely how different index funds are built, what different index fund providers have to offer and how their fees compare with similar funds following the same benchmark.
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