Compliance August 29, 2016

Safeway Faces Lawsuit Over TDF Fees

The lawsuit also calls out excessive revenue-sharing and recordkeeping fees.
Reported by

A participant in Safeway Inc.’s 401(k) plan is suing the plan sponsor, its benefits committee and its recordkeeper, now Empower Retirement, for breaching their fiduciary duties and/or engaging in transactions prohibited by the Employee Retirement Income Security Act (ERISA) in connection with target-date funds (TDFs) managed by JP Morgan Asset Management (JPM) and offered as investment options in the plan.

In a statement to PLANSPONSOR, Empower said, “We won’t comment on pending litigation; however, we will say that we believe this suit and the claims it makes are without merit, and we will defend the matter vigorously.”

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According to the complaint, the defendants breached their fiduciary duties to plan participants by selecting JPM target-date funds as investment options for the plan that charged excessive fees as compared to readily-available alternatives.

In addition, in connection with selecting the JPM target-date funds as investment options for the plan, the Safeway defendants also agreed to a “revenue-sharing” arrangement whereby a large portion of the fees charged by the JPM target-date funds and paid by participants was kicked back to the recordkeeper. The complaint says the revenue-sharing was to compensate the recordkeeper for recordkeeping services, but the amount of the fees was far in excess of the reasonable value of such services and thus defendants engaged in transactions prohibited by ERISA.   

The lawsuit alleges that during the relevant times, the JPM Smartretire Passiveblend Funds charged participants in the Plan who invested in such funds between 47 and 50 basis points of the amount invested as a management fee. By comparison, the Blackrock Lifepath Index funds which were replaced by the JPM Smartretire Passiveblend Funds in 2011 charged only a 13 basis point fee.

In addition, the lawsuit says alternatives to the JPM Smartretire Passiveblend Funds that were readily available as of 2011 also charged substantially lower fees. It notes that target-date funds offered by Vanguard, for example, charge about a 15 basis point fee. Also, net of management fees, the Vanguard target-date funds substantially outperformed the comparable JPM Smartretire Passiveblend Funds.

NEXT: Recordkeeping fees were too high

According to the complaint, the management fee charged to participants for investing in the JPM Smartretire Passiveblend Funds included a 20 basis point revenue-sharing payment to the recordkeeper. During the relevant time period, the number of participants with account balances in the three 401(k) plans invested through the Safeway Inc. Defined Contribution Plans Master Trust steadily declined. “In other words, [the recordkeeper] received greater and greater revenue for providing the same services to a smaller number of participants,” the complaint says.

The lawsuit also alleges the revenue-sharing payments generated from the JPM Smartretire Passiveblend Funds were far from the sole source of the recordkeeper’s compensation for services. “These companies also received revenue sharing payment from other investments offered through the Plan and direct payments from the Plan for recordkeeping services,” it says.

According to the complaint, the Safeway defendants could have obtained recordkeeping services at a much lower rate, had they negotiated a per-participant payment for recordkeeping rather than an asset-based charge or negotiated a lower asset-based charge when it became clear that the amounts invested in the JPM Smartretire Passiveblend Funds were growing so quickly so as to generate a windfall for the recordkeeper. “The Safeway Defendants breached the duty of prudence in connection with agreeing to the revenue-sharing arrangement for the JPM Smartretire Passiveblend Funds because a reasonable investigation would have found that a per-participant fee for recordkeeping services as opposed to an asset-based revenue-sharing arrangement would have resulted in lower fees,” the complaint says.

The lawsuit is seeking declaration that the defendants breached ERISA fiduciary duties and an order compelling the Safeway defendants to reimburse participants for all losses resulting from their breaches of fiduciary duty, as well as an order awarding damages to participants, with interest as provided by law.

The complaint in Lorenz v. Safeway Inc. et. al. is here.

Data and Research August 29, 2016

Sponsor Demand Dramatically Shapes Fund Fees

Institutional asset owners are increasingly skeptical of revenue sharing and are relentlessly pursuing lower fees within defined contribution plan investment menus. 

Reported by

Strategic Insight (SI), an Asset International company providing authenticated business intelligence and actionable insight for the asset management community, published a new study focused on implications of the Department of Labor (DOL) fiduciary rule, slated to take effect in 2017 and 2018.

According to SI, much of the recent growth in institutional pricing demand has come from fee-based advisory programs which have seen demand shift rapidly toward funds’ lowest-cost available share classes, in anticipation of the new fiduciary paradigm. 

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“No Load shares with zero 12b-1 fees accounted for 66% of total mutual fund sales within fee-based advisory programs during 2015, rising significantly from just 36% in 2009,” Dennis Bowden, Strategic Insight managing director of U.S. research, tells PLANSPONSOR. “At the same time, A-shares sold with the load waived but carrying typically 25 basis points of 12b-1 fees declined from 51% of total fee-based sales in 2009 to 27% in 2015.”

The findings come from SI’s new report, “Fund Sales Benchmarking: 2016 Perspectives on Intermediary Sales by Share Class and Distribution Channel.” Bowden explains the study is based on SI’s proprietary survey of 35 fund firms that distribute primarily through financial advisers. Survey participants managed in aggregate $5.2 trillion in U.S. open-end stock and bond fund assets as of the end of 2015, and reported over $1 trillion in overall fund sales during the year.

“A noteworthy impact of the DOL fiduciary rule will be an acceleration of the existing movement toward lowest-cost share classes,” Bowden adds. “We have already seen this trend increasingly eliminate the use of 12b-1 fees within fee-based accounts, but looking ahead, the potential for further ‘institutionalization’ of pricing demand is an important area to monitor.”

NEXT: Implications for DC sponsors and their advisers 

SI measures some additional implications from the DOL rulemaking that may be less intuitive, but which will have crucial implications for product offerings in the coming years. For example, at a high level margins are being squeezed, but the trend of sponsors pushing for access to lowest-cost institutional pricing also implies they will rely on advisers to find great deals, to keep on top of the fee monitoring, etc.

“Looking at complying with the DOL rulemaking, distributors need to equalize payment streams which they receive from funds across their platform,” Bowden says. “This may be a more powerful impetus driving further externalization of fees outside of the fund expense ratio, including payments for asset servicing. Such evolution in pricing demand would impact not only the types of share classes that mutual fund managers need to offer but also carry potential profitability implications.”

For plan sponsors, the big consideration will be: “How will costs such as those for asset servicing now be paid, and who would pay them?"

“For investors, paying for certain services outside of fund expenses does not always equate to cost savings,” Bowden warns. “And for fund managers, different potential scenarios around 'out of pocket' payment demands by distributors can carry an important profitability impact.”

The SI report goes on to suggest share classes carrying point-of-sales commissions (commissionable A-and B-shares) continue to encompass a diminishing share of overall fund activity. Such classes accounted for just 11% of aggregate sales during 2015 and only 6% of sales for the median firm in SI's study.

“At a broad level, I would say that the key pricing consideration in the context of the DOL rule is the need for price equalization up and down the value chain—between investors and advisers, funds and advisers, funds and distributor home offices, etc.,” Bowden adds. “This would definitely favor fee-based advisers from a compensation structure perspective, versus those still relying variable point-of-sale commissions, although the Best-Interest Contract Exemption would obviously allow for this, when executed properly. So the movement from brokerage to fee-based advisory will definitely be accelerated by the DOL rule.”

The Strategic Insight Fund Sales Benchmarking: 2016 Perspectives on Intermediary Sales by Share Class and Distribution Channel study was recently published as part of the new Strategic Insight In-Depth Research report series. Additional research findings and information on SI are at online at www.sionline.com. 

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