Compliance September 20, 2021

Plan Fiduciaries Can’t Escape Lawsuit Over Investment in Aon CITs

Duty of prudence and prohibited transaction claims will move forward against the Centerra Group plan fiduciaries and Aon Hewitt, which also has to face a duty of loyalty claim.

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A federal judge has denied motions to dismiss a lawsuit alleging fiduciaries of the Centerra Group 401(k) plan violated the Employee Retirement Income Security Act (ERISA) by selecting poorly performing collective investment trusts (CITs) for the plan and allowing for excessive recordkeeping fees.

According to the decision by Judge Sherri A. Lydon of the U.S. District Court for the District of South Carolina, Aon Hewitt Investment Consulting (now known as Aon Investments USA) was hired by Centerra’s benefits committee in January 2016 as the plan’s discretionary investment manager. That year, Aon Hewitt replaced 11 actively managed equity, fixed income and target-date funds (TDFs) with five CITs, called the Aon Trusts, that were managed by Aon Trust Co., a banking affiliate of Aon Hewitt. When the plan merged with another plan in January 2019, the new sponsor replaced the five Aon Trusts.

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The lawsuit, which was filed in December 2020, alleges that the Centerra defendants and Aon Hewitt breached their ERISA fiduciary duties when the plan invested in the Aon Trusts and that they engaged in prohibited transactions prohibited by ERISA. The plaintiffs also allege that the Centerra defendants breached their fiduciary duties by causing the plan to pay unreasonable recordkeeping fees. The Centerra defendants and Aon Hewitt filed separate motions to dismiss the claims related to them.

Aon Hewitt argued that the plaintiffs failed to plausibly allege it breached its duty of prudence under ERISA when selecting the Aon Trusts as investments for the plan. The firm says the plaintiffs rely on a hindsight-driven view of the poor performance of the investment selections instead of an allegation that Aon Hewitt’s process in selecting the investments was deficient.

However, Lydon noted that the plaintiffs also allege that Aon Hewitt benefited directly and indirectly when it chose to invest the plan in its affiliated Aon Trusts, creating a significant conflict of interest. The plaintiffs also say that, despite the conflict of interest, Aon Hewitt failed to undertake an independent investigation of investment options available in the market before deciding to use its own products; that Aon Hewitt hired an inexperienced manager without a meaningful track record; and that the Aon Trusts were newly created with insufficient performance history.

Citing prior case law, Lydon said even when a plaintiff does not directly address the process by which a plan is managed, “a claim alleging a breach of fiduciary duty may still survive a motion to dismiss if the court, based on circumstantial factual allegations, may reasonably infer from what is alleged that the process was flawed.” She decided the plaintiffs plausibly allege a flawed process, not just a flawed outcome.

On the duty of loyalty claim, Aon Hewitt argued that the complaint sets forth no plausible basis for claiming its decision to include the Aon Trusts in the plan’s lineup was motivated by anything other than the interests of the plan. Aon Hewitt argued it could not have breached the duty of loyalty because, under the terms of its service agreement with the plan, it was entitled to no more and no less than its negotiated fee for acting as the delegated fiduciary whether the plan invested in the Aon Trusts or some other funds.

Lydon noted that the plaintiffs do not dispute the terms of the service agreement but contend that, even if Aon Hewitt did not derive a direct increase in its compensation from choosing to include Aon Trusts in the plan’s lineup, other benefits drove the decision. She pointed out that Aon Hewitt acknowledges its banking affiliate receives a small amount of compensation for its service as the trustee for the Aon Trusts. In addition, the plaintiffs contend that Aon Hewitt chose to include Aon Trusts in the plan’s lineup because it bolstered the company’s investment management business, provided seed money it could use for its own benefit and enhanced the marketability of the new CITs. Lydon found these allegations to be sufficient to plausibly allege a breach of the duty of loyalty.

In their motion to dismiss the claims related to them, the Centerra defendants argued that the breach of duty of prudence claim should be dismissed against them because they delegated sole responsibility for selecting and retaining the Aon Trusts to Aon Hewitt.

Lydon noted that ERISA protects plan trustees against liability for an investment manager’s actions, but it does not protect plan trustees against liability for their own actions. For example, the plaintiffs allege the Centerra defendants agreed Aon Hewitt could exclusively consider its own funds rather than requiring it to consider all prudent investments available to the plan to objectively determine which options would best serve the interests of the plan participants. “This amounts to an allegation that the Centerra defendants’ imprudence enabled [Aon Hewitt] to commit a breach, conduct excluded from safe harbor,” Lydon wrote in her opinion.

In addition, the plaintiffs allege the Centerra defendants allowed an inexperienced investment manager to replace established and well-performing plan investments. “This amounts to an allegation that the Centerra defendants were imprudent in designating persons to carry out fiduciary responsibilities, conduct excluded from safe harbor,” Lydon wrote.

She found the allegations sufficient to state a claim against the Centerra defendants for breach of the duty of prudence. However, Lydon said the complaint fails to plausibly allege a breach of the duty of loyalty against the Centerra defendants.

Turning to the excessive recordkeeping fees claim, the opinion says the plaintiffs allege the Centerra defendants caused the plan to pay excessive recordkeeping and administrative fees because they failed to follow prudent practices used by similarly situated fiduciaries: They allegedly did not solicit competitive bids from other providers; failed to monitor the amount of the plan’s recordkeeping fees, including asset-based payments from the plan’s investments; allowed the recordkeeper’s total compensation to increase while services did not; and failed to leverage the plan’s size to obtain lower fees.

As a result, the plaintiffs allege, the plan vastly overpaid compared to what similarly sized plans paid for substantially identical recordkeeping services. Lydon found these allegations sufficient to state a claim for breach of the duty of prudence related to the recordkeeping fees. However, she found the plaintiffs do not state a claim that the Centerra defendants breached their duty of loyalty by paying allegedly excessive recordkeeping and administration fees. “The complaint is devoid of any specific allegations regarding the Centerra defendants’ self-serving motive as it relates to fees,” she wrote.

The plaintiffs allege Aon Hewitt engaged in prohibited transactions between a plan and a fiduciary in violation of ERISA. They also allege the Centerra defendants engaged in prohibited transactions between a plan and a party in interest.

Aon Hewitt argued that prohibited transaction claims against it must be dismissed because, as the investment manager, it was not the fiduciary responsible for approving its compensation, and its investment in the Aon Trusts is expressly permitted by the exemption in ERISA Section 1108(b)(8).

Lydon agreed that Aon Hewitt did not act as a fiduciary when negotiating its own fees as investment manager with the plan. However, she said she couldn’t dismiss the prohibited transaction claim on the basis of the prohibited transaction exemption at this stage in the litigation. She said the exemption is “an affirmative defense, for which [Aon Hewitt] bears the burden of proof.”

The Centerra defendants argued that prohibited transaction claims against them must be dismissed because Aon Hewitt was not yet a “party in interest” when Centerra engaged it as investment manager, and the Centerra defendants did not “cause” Aon Hewitt to invest in the Aon Trusts.

Lydon found that the complaint sufficiently alleges Aon Hewitt was a party in interest when the service agreement was executed. In addition, the plaintiffs show that Aon Hewitt provided investment consulting services to the plan before executing the service agreement. Therefore, Lydon said, according to the complaint, Aon Hewitt was not an “unrelated” party, as the Centerra defendants argue. Lydon ruled that the plaintiffs plausibly allege Aon Hewitt was a party in interest at the relevant time for purposes of their prohibited transaction claims.

However, she found that the plaintiffs failed to state a claim that the Centerra defendants “caused” the plan to invest in in the Aon Trusts.

Reader Responses September 20, 2021

SURVEY SAYS: Support for a Small Business Retirement Plan Mandate

PLANSPONSOR NewsDash readers share whether they support retirement plan requirements proposed in legislation drafted as part of the Congressional budget reconciliation process.

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Legislation drafted as part of the Congressional budget reconciliation process includes a broad mandate for employers to offer retirement plans, along with language promoting guaranteed retirement income investments.

Language in the draft bill would generally require small business employers to offer their employees a retirement plan. The language, which could be amended or deleted during the forthcoming debate, appears to permit a service/eligibility period of up to two consecutive 12-month periods. During that time, each of the to-be-enrolled employees would need to complete at least 500 hours of service to be eligible for the plan.

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The bill would also require that auto-enrollment retirement plans offer participants with account balances of $200,000 or more an option to take a distribution of at least 50% of their vested account balance in the form of a protected lifetime income solution.

Last week, I asked NewsDash readers, “Do you support requiring small businesses to offer a retirement plan for employees?” I also asked, “Do you support requiring a protected lifetime income solution to be offered to defined contribution plan participants?”

Forty percent of responding readers work in a plan sponsor role, 31% work for/are recordkeepers/TPAs/investment consultants, 23% are advisers/consultants, 3% are attorneys and 3% are CPAs.

More than half (54%) of responding reader do not support requiring small businesses to offer a retirement plan for employees. Twenty-three percent said they do support it, and the same percentage said they are not sure.

More than six in 10 (63%) of respondents do not support requiring a protected lifetime income solution to be offered to defined contribution plan participants. Twenty-three percent do support it, and 14% are unsure.

Among respondents who left verbatim comments, there was a strong feeling that the government should not tell small businesses what to do about benefit offerings. Several readers said they thought a retirement plan mandate and/or a mandate to offer a protected lifetime income solution would create a fiduciary and administrative burden for small businesses. There was also strong sentiment that the government should be focusing on fixing Social Security and making sure it is solvent. A couple of readers said incentives for small businesses to offer a retirement plan would be better than a mandate. One reader suggested more education to employees about saving for retirement. There is no Editor’s Choice this week.

A big thank you to all who participated in the survey!

Verbatim

WE HAVE TOO MUCH GOV INTERFERENCE AT THIS POINT. LEAVE THE GOV OUT OF BUSINESS DECISIONS FOR THIS ASPECT.

It’s time for Congress and the IRS to put all qualified plans under the same set of rules (401(a)). There is no reason to have different rules for 403(b), 457, governmental, church, etc. It only causes confusion, requires recordkeepers to build more complex systems and expect them to work correctly for each plan type and requires plan sponsors to know which set of rules applies to their plans. We consistently hear “simplify.” In order to do that, the plans should be simple, consisting of contributions, allowing for hardships and distributions are retirement/termination. No loans, no other withdrawals. Remember, it is a RETIREMENT plan, not a bank account.

The federal government has no authority to require any matter of this nature.

I believe it would be an administrative burden for small employers, with costs that cannot easily be passed on to customers.

I’m not sure offering a protected lifetime income solution to participants is the most efficient way of saving. However, I’m not sure all plan sponsors offer enough matching and support to enable their participants to successfully save for retirement, or that participants have the knowledge to do so themselves so maybe this is the best solution.

Mandating a protected lifetime income option for plan participants sounds like a pretty nice windfall for the insurance companies. If that’s going to be the case, then there should be limits on the fees or amounts insurance companies can charge for the lifetime income option and I’m curious if the PBGC or State guarantee insurance fund would need to be involved to guarantee a minimum lifetime benefit if the insurance company went belly-up. On the other hand, could an employer have the option to self-insure the guaranteed lifetime income option through some form of supplemental defined benefit plan? In such case, I imagine it would then be subject to minimum funding standards under ERISA, actuarial valuations and once again back to the point of what basically killed DB plans in the first place…fluctuating (non-predictable) annual funding requirements and the PBGC burdens.

Some small businesses can’t currently handle the cost of a retirement plan, let alone some of the responsibility that comes with one. I think the idea behind requiring them to offer a plan is good, but in reality, I think it puts a lot more pressure on all the parties involved. When a plan sponsor wants a retirement plan, but is not responsive or promoting the plan, can you imagine the plan sponsor’s interaction who was forced to implement one? Goodness!

I agree on the mandate to provide a plan. However, any participant that wishes to have protected income can do so at retirement outside of the plan with an option that makes sense for them. I don’t think this should be mandated with a one size fits all income option in the plan.

I think most small businesses have their hands full already just surviving without adding more burdens and costs. There are individual retirement account options (IRAs) already available in the marketplace as well as lifetime income annuities available. I’d believe in retirement education over retirement solution mandates.

The funniest part of this plan is that the staffers providing the analysis say that this can all be done for zero administrative costs for the owners. Everyone should have retirement savings, but government mandates are not helpful. If they want to help just fix Social Security! That is already a mandated retirement plan. It’s not the employer’s fault that Congress fails to manage/finance it correctly.

While it would personally benefit me to require all small businesses to offer a retirement plan, I do not approve of government overstepping its bounds. There are some great incentives to sponsor retirement plans already. But some small employers are not equipped to handle the complexity, responsibilities and costs which are inherent with the administration of retirement plans. With regard to the lifetime income solutions, I see how costly annuities are already for defined benefit plans and expect that a greater market will increase the demand and rates even higher. However, I find it inconsistent that a spouse has to consent to a lump sum of $5,000 from a defined benefit plan but a participant can take a multi-million-dollar distribution from a DC plan without their spouse’s consent.

If plans are mandated (meaning there is no ability for an employer to opt-out of offering a plan), then a lot of employers will be saddled with ERISA responsibilities for which the employers are not prepared to do. The goals of a mandated plan would be accomplished efficiently as an extension of Social Security retirement with contributions collected concurrently with other payroll taxes. A mandated protected lifetime income option is a mandated investment menu option. Selecting, monitoring performance and fees, and changing providers of lifetime income products will be an added plan fiduciary responsibility for which many employers are not prepared to do. Protected lifetime income options have a role in guaranteeing benefits last for a lifetime and the guarantee functionally is insurance. It works because of gains and losses attributable to mortality experience are an important component of the success of these products. Let the individual participant decide whether or what to buy annuity insurance policy.

I think that smaller businesses – under 35 people, would find administering a 401(k) plan a burden. Is their accounting outsourced and/or does their bookkeeper have the knowledge to ensure compliance? Who among their staff would have the interest/knowledge to serve on a committee? Do they have staff members who can draft RFP’s and go thru the process of finding the cost effective/right TPA’s and investment advisors? Or…are there service providers out there that can provide all this without costing the small company a lot of money.

Our government is becoming too intrusive, and never considers the unintended consequences of their actions. The “Secure Act II” is a better solution by providing employers with the tools to assist their employees in acquiring more secure retirement.

Mandating a small business depends on your definition of “small.” I would support it for businesses with 50 or more participants. I’m not sure about less than 50 participants. I would like to see a federal government offering available to participants not covered by an employer-based plan.

When I read the title of the survey “Survey Says: Support for a Small Business Retirement Plan Mandate”, I got the shivers. Mandate. To me, that is a bad word. I don’t believe that the government should require small businesses to provide a retirement plan. What types of benefits businesses offer their employees should be their choice. Same logic applies for protected lifetime income solutions. If a recordkeeper wants to offer lifetime income solutions as part of their services, then plan sponsors should have the choice whether or not they want to offer it. Did you notice what word I’m using? Choice. That is a good word.

If an employee doesn’t contribute much, or at all, to a retirement plan, a lifetime income option will not be worth the trouble of creating these options.

As a small business owner, I hate to see mandates being imposed. I would rather see more incentives for a small business to offer a plan.

It seems this would be a way to kill off small businesses.

I support encouraging people to take responsibility for their own lives. Every alternative to this leads to an anti-selection death spiral for the economy, then the society, and eventually the country.

Instead of this mandate, Congress should be working on fixing the Social Security program. They need to stop paying out money that was deposited by working people to people that never contributed a penny in their entire life. When I retire in 10 years, I expect to receive all the money that I paid into SS over the past 50 years. I am entitled to that money.

In order to keep small plans efficient and affordable we must be careful not to overregulate. Encouragement is a better strategy than requiring.

We need less government intrusion…not more.

The government already mandates a retirement plan for small businesses. It is called Social Security & it offers a lifetime income option. Another retirement plan mandate would be onerous on small employers.

 

NOTE: Responses reflect the opinions of individual readers and not necessarily the stance of Institutional Shareholder Services (ISS) or its affiliates.

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