Judge Deals Blow to Vanguard Fund Comparison in Self-Dealing Case

Ultimately, Putnam Investments prevailed in a lawsuit claiming it and its retirement plan fiduciaries engaged in prohibited transactions by offering proprietary funds in its plan.

By Rebecca Moore | April 07, 2017

U.S. District Judge William Young of the U.S. District Court for the District of Massachusetts, ultimately agreed with Putnam Investments that prohibited transactions claims against its retirement plan fiduciaries are time-barred under the Employee Retirement Income Security Act’s (ERISA)’s three-year statute of limitations, saying the plaintiffs “were well aware that the parties involved were all Putnam entities.”

However, Young’s discussion on two points could impress findings of other court’s addressing pending ERISA excessive-fee or self-dealing cases.

John Brotherston and Joan Glancy brought suit against Putnam Investments and plan fiduciaries of the Putnam retirement plan accusing them of self-dealing to promote that firm’s mutual fund business and maximize profits at the expense of the plan and its participants. The complaint says Putnam loaded the plan exclusively with its own mutual funds, without investigating whether plan participants would be better served by investments managed by unaffiliated companies.

Previously, Young denied a motion to dismiss the lawsuit against Putnam, saying the plaintiffs allege facts sufficient to state plausible claims.

According to Young’s current judgement, between 2009 and 2015, more than 85% of the plan’s assets were invested in Putnam mutual funds, which pay management fees to Putnam. By the end of 2015 Putnam had converted its investments in 25 Putnam mutual funds from Y shares to R6 shares, which are cheaper.

The plaintiffs claim the payment of fees by Putnam mutual funds to Putnam is a prohibited transaction under ERISA. But, the defendants note that fees are paid out of mutual fund assets rather than plan assets, and argue that cash held in mutual funds are not assets of the plan.

The plaintiffs contend that ERISA’s intent to protect participants mandates a broad definition of "plan assets." But the judge noted the 1st U.S. Circuit Court of Appeals decision in a Fidelity float income case adopted a narrow approach to identifying plan assets for the purposes of ERISA’s prohibited transactions provisions. “The Plaintiffs’ argument that the management fees paid from the value of the mutual fund shares owned by the plan (which are plan assets) is, therefore, precluded by First Circuit case law,” Young wrote. The judge ruled the prohibited transaction claim fails as a matter of law.

The court opinion also noted that net expense ratios of Putnam plan’s investments ranged from 0% to 1.65%. The plaintiffs argue these fees were materially higher than investment fees paid by other funds. They relied on an expert that compared the Putnam mutual funds’ average fees to Vanguard passively managed index funds’ average fees. Young found this comparison flawed. Vanguard is a low-cost mutual fund provider operating index funds “at-cost.” Putnam mutual funds operate for profit and include both index and actively managed investments. Young said the expert’s analysis “thus compares apples and oranges.” Young ruled that the Putnam mutual funds pay reasonable management fees to Putnam.

In light of Young’s ruling, it is interesting to note that several pending excessive-fee or self-dealing suits also compare a plan’s proprietary investments to Vanguard investments.