California Federal Judge Upholds Plan Sponsor in TDF-Selection Case

The plan sponsor and its advisers proved they had conducted the appropriate due diligence in selecting funds and managing the retirement plan, the judge concluded. 

A California federal district court ruled in favor of a plan sponsor and its advisers in a case brought by 401(k) participants alleging that the sponsor and investment manager had breached their fiduciary duties by imprudently selecting and sticking with target-date funds affiliated with the 3(38) investment manager and plan adviser.

The case, Robert Lauderdale et al. v. NFP Retirement Inc. et al., was resolved on Friday by U.S. District Judge James V. Selna in the U.S. District Court for the Central District of California, Southern Division.

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The initial complaint was filed by the Schlichter Bogard & Denton law firm on behalf of the plaintiffs in February 2021, naming plan adviser NFP, the retirement plan committee of Wood Group U.S. Holdings and 3(38) investment manager flexPATH Strategies LLC, which at the time was an affiliate of NFP. In November 2022, the court dropped NFP from the complaint.

The 401(k) participants alleged that, rather than acting in the best interest of participants under the Employee Retirement Income Security Act, the plan sponsor and advisory NFP prioritized investing in collective investment trusts managed by NFP affiliate flexPath, as well as failing to use the plan’s size to bargain for lower fees. The result, the plaintiffs alleged, was “substantial losses to investments” in participants’ retirement accounts.

In his February 23 decision, Selna reviewed the allegations in a 70-page “Findings of Fact & Conclusions of Law.” Through the analysis of the various charges against evidence presented by the defense, he concluded that the plan sponsor and its advisers proved they had conducted the appropriate due diligence in selecting funds and managing the retirement plan.

Wood is an international consulting and engineering company in energy and materials, and the 401(k) plan had $2.66 billion in assets as of 2020, according to data from Beacon, which, like PLANSPONSOR, is owned by ISS STOXX.

The court had held a “nine-day bench trial” hearing the arguments of both sides from March 21, 2023, through March 29, 2023, and September 5, 2023, through September 6, 2023.

Thorough Analysis

In his findings, Selna examined the selection processes Wood’s retirement plan committee undertook in choosing NFP and the flexPATH investment options for plan participants; these included creating a finalist list of competitors and negotiating down fees.

“By the time flexPATH was hired in March 2016, [the Wood retirement plan committee] had already collected and analyzed a significant amount of information about the Wood Plan that informed its decision to select the flexPATH TDFs,” he wrote.

The judge went on to further describe the investment policy statement created by Wood’s committee, along with flexPATH’s ongoing review of its TDF offerings, which included BlackRock Inc.’s passive funds. The judge also considered how often the committee met and what was reviewed. The detail went as far as to note cancelled meetings, such as one intended for October 26, 2017, that did not happen due to the impact of Hurricane Harvey on the Houston area.

In going over the variety of allegations from the plaintiffs, Selna countered with evidence that the defendants had followed proper procedure under ERISA. Examples included:

  • The evidence showed that flexPATH did not receive additional compensation from the plan’s investment in the flexPATH TDFs;
  • The plaintiffs alleged that flexPATH selected the flexPATH TDFs because it needed seed money and to improve the marketability of the funds. However, the evidence showed that the flexPATH TDFs were fully seeded almost immediately after they were created;
  • The plaintiffs alleged that in December 2015, NFP formally announced a new program that incentivized NFP advisers to sell flexPATH by offering them bonus compensation whenever flexPATH TDFs were “implemented into” one of their retirement plan clients. But Selna found that the 3(38) management fee was not contingent on which funds were selected;
  • The plaintiffs alleged that there was no action taken on the underperformance of the flexPATH TDFs. But the flexPATH TDFs were performing as expected, given the inflation period. Selna ruled that the evidence showed that the Wood Committee appropriately considered and evaluated the reasoning behind the underperformance; and
  • The plaintiffs alleged that the Wood Committee never met with flexPATH. However, Selna noted, nothing in the law requires the Wood Committee to meet with its 3(38) investment manager; rather, it was compelled to monitor the TDFs’ performance.

Reasonable Decisions

Selna also noted at one point in the filing that a fiduciary’s duty, according to prior rulings, is not to “pick the best performing fund,” or the “cheapest possible fund available on the market,” but rather to show “a reasoned decision-making process” done through independent evaluation and with the appropriate methods “to investigate the merits of the investment.”

The plaintiffs were given seven days to file an appeal to the judgment, after which it will be filed in the Federal Rule of Civil Procedure 52(b), according to the filing.

Representatives for the plaintiffs did not immediately respond to request for comment. The Wood Group’s lead representation is Mayer Brown LLP, flexPATH’s is Seyfaqrth Shaw LLP, and NFP’s is Jenner and Block LLP, according to the court docket.

FlexPATH is no longer an affiliate of NFP, which itself is in an agreement to be acquired by Aon plc.

EBSA Expects to Finalize Voluntary Correction Update in ‘Next Few Months’

Ali Khawar, of the Employee Benefit Security Administration, indicated that the agency may be set to finalize amendments to the fiduciary correction program in the coming months.

The Department of Labor should be finalizing its proposed update to the Voluntary Fiduciary Correction Program in “the next few months,” according to a representative of the Employee Benefit Security Administration speaking at a conference on Tuesday.

Ali Khawar, the principal deputy assistant secretary for EBSA, at the Small Business Retirement Summit hosted by the U.S. Chamber of Commerce and Paychex Inc., spoke about the VFCP and other regulatory items, including the DOL’s retirement security proposal.

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The VFCP allows fiduciaries to document administrative errors and then submit a correction to EBSA in order to receive a no-action letter from the agency. Under current regulations, “certain transactions such as prohibited purchases, sales and exchanges; improper loans; delinquent participant contributions; and improper plan expenses” may be corrected using the VFCP.

The DOL proposed in November 2022 to permit certain errors to be self-corrected: A fiduciary could fix the error and inform EBSA after the fact, instead of seeking pre-approval. Eligible errors would include employee contributions that are invested or loan repayments that are deposited in an untimely manner, provided the cost of error does not exceed $1,000 and is not more than 180 days old. This is believed by EBSA to represent the majority of the fiduciary errors made in plan administration.

Khawar explained that many errors are made by small businesses that are not acting recklessly or in bad faith. He said that, in some cases, the plan’s bookkeeper simply took a vacation, and the backup bookkeeper needed more training.

He added that permitting plan fiduciaries to fix these issues without resorting to enforcement action is a “win-win,” and he anticipates final rules to be issued in the coming months.

Khawar also spoke briefly about the retirement security proposal. He noted that small businesses are not considered retail investors and are therefore not protected by the Securities and Exchange Commission’s Regulation Best Interest when paying for advice on investment menu design, which the retirement security proposal would address.

Tim Hauser, the deputy assistant secretary for program operations of the Employee Benefits Security Administration, also highlighted this element of the proposal, which would subject one-time investment menu sales to fiduciary standards under the Employee Retirement Income Security Act, in a recent interview with PLANSPONSOR. A comment letter from Morningstar to the DOL on the proposal estimated that small businesses often overpay on such fees, which could cost them as much as $55 billion per year in unnecessary fees.

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