CenturyLink Faces ERISA Lawsuit on Custom Large Cap Fund Design

The latest Employee Retirement Income Security Act (ERISA) lawsuit, emerging from the U.S. District Court for the District of Colorado, targets CenturyLink for alleged mismanagement of an active large cap U.S. stock fund offered to defined contribution plan participants.

By way of background, in 2011, CenturyLink appointed its subsidiary CenturyLink Investment Management (CIM) as its retirement plan investment fiduciary. In 2012, CIM formed the CenturyLink, Inc. Defined Contribution Plan Master Trust and merged the assets of its two 401(k) plans into the master trust. According to the text of the complaint, through the master trust, CIM then reestablished the investment options for the plan considered here, including a number of custom funds designed by CIM.

The complaint seeks certification of a class consisting of the participants and beneficiaries of the CenturyLink Dollars & Sense 401(k) Plan invested in such a custom menu option, called the “Active Large Cap U.S. Stock Fund.”

In their compliant, plaintiffs suggest the objective of the large cap fund was to “exceed the return of a broad market index of the largest 1,000 companies using an actively managed multi-manager approach.” According to the complaint, CenturyLink hired six different investment firms to manage the large cap fund, and the fund has consistently underperformed its benchmark index, the Russell 1000 Stock Index. The underperformance, plaintiffs allege, exceeded two percentage points or more each year since the investment option was formed in 2012.

The complaint seeks to state a claim—without relying on hindsight—by arguing the underperformance of the large cap fund was “virtually guaranteed” because it contained a serious design flaw from inception.

“This design flaw was built-in by [CenturyLink] by using six different fund managers with the same mandate (five active and one passive),” the complaint states. “The odds of the five active managers outperforming the market in aggregate was highly remote due to the efficiency of the large cap domestic equity market and the difficulty of even one manager outperforming for more than a year … Because of the highly efficient nature of the large cap domestic equity market, companies are generally fairly valued and excess returns are hard to produce over time. Furthermore, the five active managers would inevitably take competing positions and cancel out each other’s strategy. Effectively, the fund managers will be trading stocks among themselves as one manager overweights a stock that another manager chooses to underweight.”

In such an efficient market, plaintiffs argue, it was unreasonable for plan fiduciaries to expect five active managers to outperform in aggregate.

“Indeed, even in an optimistic scenario, it would have only been reasonable to assume the strategy would effectively turn the actively managed large cap fund into an expensive large cap domestic index fund,” plaintiffs suggest. “This also would have been unreasonable given the existence of the ‘U.S. Stock Index Fund,’ a fund heavily weighted to large cap equities, as a plan option.”

The impact of the underperformance of the large cap fund, according to plaintiffs, was magnified by CIM’s other investment option choices. The large cap fund “was one of only three stock funds offered by the plan and the only large cap stock investment option. Moreover, the large cap fund comprised up to 16% of the underlying investments in each of the target-date funds offered by the plan, which reduced the performance of those funds as well.”

The complaint concludes, as an investment professional, “CIM knew or should have known that the large cap fund’s design was flawed and underperforming. The plan fiduciaries breached their duty of prudence by failing to replace or restructure the large cap fund for five years despite its poor design and performance.”