Challenges to 401(k) Plan Fees and Investments Continue—with a New Twist
The flow continues of new cases, decisions, and settlements in cases alleging fiduciary breaches through the overpayment of fees and the retention of underperforming investments in 401(k) plans. Good fiduciary processes also continue to prevail. The following is a sampling of this quarter’s developments, including a challenge to the fees on managed accounts.
Managed Account Fees—Nestle USA, Inc. has been sued in connection with its 401(k) plan. The case alleges overpayment for administrative and recordkeeping fees. It goes on to challenge the fees on a managed account service offered to plan participants. The challenge to managed accounts alleges that the asset allocations of participants using the managed account service are not materially different from the asset allocations of the plan’s target date funds. Managed accounts are more expensive than target date funds, which would be the natural alternative. The conclusion is that participants are being overcharged for the managed account service because it does not add value over a target date fund. Guyes v. Nestle USA, Inc. (E.D. WI filed 10-9-2020)
Money Market versus Stable Value Funds—American Airlines was sued in a lawsuit challenging its use of a credit union savings account option as the capital preservation option in its 401(k) plan rather than a stable value fund. The stable value fund would be expected to have a higher return. 401(k) plans are effectively required to offer at least one capital preservation option. This would typically be either a money market or stable value fund. The credit union savings account used in the American Airlines plan is similar in some respects to a money market fund, with the added advantage of being insured by the federal government for up to $250,000. A number of cases have unsuccessfully challenged fiduciaries’ use of money market funds rather than stable value funds.
About five months after the case was filed, the parties arrived at a proposed settlement of $8.8 million and presented it to the judge. After considering the settlement amount, the judge concluded that if the plaintiffs’ allegations were correct—the settlement was too low. He required the parties to produce additional information to justify the settlement. The judge was unsatisfied with the information provided and began actively managing the case. Eventually, motions for summary judgment were filed.
The judge concluded that the plan could reasonably offer the credit union savings accounts—it was not a breach to not offer a stable value fund. He noted that the credit union savings account and stable value funds have different characteristics, so a direct comparison of their returns was not meaningful. Also, to win, the plaintiffs were required to establish that no reasonable fiduciary would have included such a fund in the plan—which they failed to do. Judgment was entered for the plan fiduciaries, with the plaintiffs winning nothing. Ortiz v. American Airlines, Inc. (N.D. TX 2020)
Supreme Court Considering 403(b) Plan Fee Case—Following the format of a series of similar cases, Northwestern University was sued for alleged fiduciary breaches in the operation of its 403(b) retirement plans. Alleged breaches included retaining an underperforming fund, assessing participant fees on a pro rata rather than per capita basis, offering overpriced investments, and having multiple recordkeepers. The district court found that the facts alleged in the lawsuit did not support any of the claims, and the case was dismissed before trial. The U.S. Court of Appeals for the Seventh Circuit evaluated each claim and upheld complete dismissal of the case before trial. Divane v. Northwestern University (7th Cir. 2020)
The plaintiffs have now asked the U. S. Supreme Court to consider the case, noting that—unlike the Northwestern case—similar allegations in cases in other circuit courts have survived motions to dismiss. One basis for the Supreme Court to accept cases is to resolve differences among the federal courts of appeal around the country. The Court has asked the Solicitor General for the federal government’s views on this case, which is an indication of interest in the case. A decision by the Supreme Court on whether to hear the case is expected in coming months.
Other cases:
- Salesforce.com. Familiar allegations of using high-cost investments and not using index funds, collective trusts, or separate accounts were made. These claims were dismissed because the judge observed that: there is no obligation to use collective trusts or separate accounts, revenue sharing received from mutual funds was properly used to pay plan expenses, and actively managed funds cannot reasonably be compared with passively managed funds.
In a unique argument, the plan fiduciaries were alleged to have breached their duty of loyalty by having a conflict in offering investments and retaining the services of investment firms that invest in Salesforce.com—the plan sponsor. For instance, Fidelity is a significant investor and holder of Salesforce.com stock. Fidelity is also the plan’s recordkeeper, and one of the plan’s most used investments is the Fidelity Contrafund. Salesforce.com is one of its top holdings. The judge was not moved by this overlap in interests. He found that the loyalty breach allegations were entirely conclusory and lacked any details to support the claims. This claim was also dismissed. Davis v. Salesforce.com, Inc. (N.D. CA 2020)
- Trader Joe’s. This suit alleged the use of high-cost investments, not investigating lower-cost share classes, not monitoring recordkeeping fees, not putting recordkeeping out to bid, and depositing revenue sharing in a recapture account and then allocating it out to participants.
The case was dismissed because the lawsuit failed to allege specific facts to support the alleged breaches. The judge noted that fiduciaries have the latitude and the obligation to value investment features in addition to fees. The judge also pointed out that plaintiffs have to do more than allege the sheer possibility that fiduciaries have acted unlawfully. Kong v. Trader Joe’s Company (C.D. CA 2020)
Lawsuit Follows Significant Losses in COVID-19 Market Turmoil
During the extreme market volatility in February and March 2020, as markets anticipated the impact of COVID-19 prevention efforts, Allianz Global Investors U.S. had investment products that lost a significant percentage of their value—up to 90 percent in some cases. That investment and others from Allianz that suffered significant losses were held in the master trust for pension plans that participate in the National Retirement Program of the Blue Cross and Blue Shield Association. According to a lawsuit filed in September by the committee for the Blue Cross and Blue Shield master trust, the master trust had approximately $2.9 billion invested in these strategies and ultimately suffered a realized loss exceeding $2 billion.
The investments that suffered such losses are Allianz Structured Alpha strategies. These are options-based strategies designed to provide diversification benefits over long periods of time. They engage in the buying and selling of calls and puts in an effort to capitalize on investors’ historical willingness to overpay for protection against market selloffs.
The Blue Cross and Blue Shield lawsuit was filed against the investment manager and the committee’s investment advisor. It alleges that Allianz mismanaged the investments. It also alleges that following losses in these investments during the market decline in 2018, the committee sought and received incorrect assurances from the investment advisor that the investments were still recommended for the trust. Blue Cross and Blue Shield Association National Employee Benefits Committee v. Allianz Global Investors U.S. LLC (S.D. NY filed 9-16-2020)
It is important for fiduciary committees to understand the investments used in their portfolios. It is also important for plan fiduciaries to thoughtfully review the advice received from their advisors. Of course, committees that have delegated investment responsibility to an advisor will be focused on whether the advisor is operating within the bounds of the investment policy statement rather than the details of the investments.
Plaintiffs’ Lawyers Sanctioned Up to $1.5 Million for Reckless Litigation
Taking a different approach to challenging investment fees in retirement plans, plaintiffs’ lawyers filed a lawsuit against Great-West Capital Management for allegedly violating the Investment Company Act. To find plaintiffs, the lawyers who filed the suit used a newspaper advertisement. Participants in two different 401(k) plans that used Great-West investments were apparently located and the suit filed.
The main claim was that the fees charged on the Great-West investments were so high that they had no reasonable relationship to the services being provided. The plaintiffs’ case was dependent on an expert witness, and, at trial, the expert was completely discredited. Reflecting on the case, the judge observed that during final trial preparation the plaintiffs’ attorneys should have realized that the case was destined to fail and dismissed it. Instead they put the judge and defendants through an 11-day trial. At the end of the trial, the judge concluded that the expert’s testimony held no weight. There was no evidence the plan participant investors were harmed, and the case was decided against the plaintiffs.
After the trial, the defendants filed a motion for sanctions under a federal law allowing sanctions in federal court cases against lawyers who “multiply proceedings unreasonably and vexatiously.” The law was designed to compensate victims of abusive litigation and does not require bad faith for sanctions to be imposed. The judge noted that acting with an “empty head and a pure heart” was not enough to avoid sanctions. Citing the weakness in the plaintiffs’ expert witness and that in 50 years no one had won a case of this type, the judge concluded that it was reckless to proceed to trial. The judge also pointed out that the case was lawyer driven. No participant investor testified that they had been harmed. Individual participant investors stood to gain only a small amount if the case succeeded. However, the lawyers stood to gain millions. The defendants were awarded a refund of the fees and costs they incurred beginning on the first day of trial—in an amount not to exceed $1.5 million. Obelso v. Great-West Capital Management, LLC (D. CO 2020)
