THE BLOG
08/03/2010 09:04 pm ET Updated Dec 06, 2017

Nationwide Tosses Its 401(k) Clients Under the Bus

I really thought there was nothing about the securities industry that would surprise me. Let's look at its track record.

Who can forget the Orange County bankruptcy in 1994? Merrill Lynch agreed to pay $30 million to settle a criminal investigation into that firm's role in underwriting bond offerings for the county.

The crash of technology stocks in 2000, fueled by irresponsible recommendations of brokers, cost investors billions of dollars.

There was the analyst scandal in 2002, where major brokerage firms sold out their retail clients for the benefit of their underwriting clients.

All this pales in comparison to the 2008 market crash, caused by shameless greed, arrogance and incompetence of brokers. This walk on the wild side brought the global economy to the brink of a worldwide depression.

For outright greed and deception, it's hard to top the 401(k) system. It's rife with conflicts of interest, exorbitant and often hidden fees, poor investment choices, little participant education and deception about the legal obligations of the brokers and insurance industry to the clueless plan sponsors who retain them. The opposition of the securities industry to the pathetic "interim final regulation" of the Department of Labor is telling. All the new regulation does is require fee disclosure so that employers and plan participants can figure out what they're paying for their 401(k) plan. Would you buy a car from a dealer who refused to reveal his price?

Nevertheless, the position of Nationwide in its defense of a class action lawsuit is so shocking that I was caught completely off guard.

Here's the background:

In Haddock v. Nationwide (No. 3:01 cv 1552), filed in the United States District Court for the District of Connecticut, Haddock, a trustee of a retirement plan advised by Nationwide, charges it with accepting "revenue sharing payments" from mutual funds it offered to its annuity contract holders in its retirement plans. Haddock claims the receipt of these payments violates Nationwide 's "fiduciary duty," which Haddock alleges is the duty to act solely in the best interest of the plan participants. The trustee plaintiffs seek to certify a class of all trustees of all 401(k) plans that had variable annuity agreements with Nationwide from the first date Nationwide began receiving payments from mutual funds based on a percentage of the assets invested in the funds by Nationwide. If they succeed, the liability would be enormous.

Nationwide denied any wrongdoing and further denied that it was a fiduciary to the plan. In a preliminary ruling issued Nov. 6, 2009, the Court found Nationwide "may be a fiduciary", noting that "...by accepting the revenue sharing payments from mutual funds that it selects to be investment options for the Plans and its participants, Nationwide is allegedly placing its interests in collecting revenue sharing payments ahead of selecting the best investment options for the Plans and participants. The revenue sharing payments are an incentive for Nationwide to offer those mutual funds to the Plans as investment options."

Stung by its efforts to get this massive case thrown out, Nationwide took a legal position which is the equivalent to tossing its clients under the bus. It sought to bring its own class action against all the trustees for the plans that were in the alleged class. It argued that, to the extent the plans were harmed by its revenue sharing arrangement, the trustees (its clients!) were responsible to reimburse them because of their "...failure to exercise reasonable prudence and care."

Translation: If our conduct caused harm to the plan participants, it was our clients' fault for not being smart enough to put a stop to it.

In a decision dated July 23, 2010, the Court dismissed this counterclaim.

The fact that Nationwide would seek to blame its clients for its own wrongdoing raises the bar for arrogance and lack of accountability in an industry known for its callous disregard for the interest of its clients. The reality is that trustees of 401(k) plans typically accept the recommendations of advisers without question. Their "ratification" is a mere formality. The ratification requirement is slipped into the plan documents so that advisers can avoid taking legal responsibility for the investment decisions they make. Few employers (or their lawyers), understand the legal significance of this sleight of hand. Hopefully, Nationwide's effort to avoid fiduciary responsibility and transfer liability to its clients will be a much needed wake-up call.

Employers can avoid these legal issues by insisting their advisers accept in writing full 3(38) ERISA responsibility for investments in the plan. This means the adviser is 100% liable for the selection and monitoring of these investments.

No need to wonder whose side Nationwide is on. Its own.

The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein. Furthermore, the information on this blog should not be construed as an offer of advisory services. Please note that the author does not recommend specific securities nor is he responsible for comments made by persons posting on this blog.

Here is the trailer for my new book, Timeless Investment Advice.