Compliance March 4, 2020

Class Action ERISA Fiduciary Breach Lawsuit Targets Evonik

Similar to the plethora of ERISA excessive fee fiduciary breach lawsuits that have been filed in recent years, this one suggests the plan failed to use its bargaining power to negotiate lower fees.

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A new Employee Retirement Income Security Act (ERISA) lawsuit has been filed in the U.S. District Court for the District of New Jersey, alleging that the Evonik Corp. permitted excessive fees to be charged to its defined contribution (DC) retirement plan.

Also named as defendants in the lawsuit, which seeks class action status, are the company’s president, the board of directors, the retirement plan investment committee and 30 “John Does.”

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Similar to the plethora of ERISA excessive fee fiduciary breach lawsuits that have been filed in recent years, this one suggests the plan failed to use its bargaining power to negotiate lower fees. According to the text of the suit, the DC plan held more than $1 billion as of 2017.

“Defendants, however, did not try to reduce the plan’s expenses or exercise appropriate judgement to scrutinize each investment option that was offered in the plan to ensure it was prudent,” the lawsuit states. “Instead, defendants abdicated their fiduciary oversight, allowing Prudential Bank and Trust to lard the plan with funds managed by the trustee and/or its affiliates. These plan funds charged excessive fees.”

Notably, the lawsuit does not accuse Prudential of fiduciary breaches. Instead, it focuses on the conduct of the plan’s fiduciaries, who are also accused of failing to take advantage of the lowest cost share class for many of the mutual funds offered within the plan. The plaintiffs also accuse the fiduciary defendants of failing to consider collective trusts, comingled accounts or separate accounts as alternatives to the mutual funds in the plan.

Based on this alleged conduct, the plaintiffs assert claims against the defendants for breach of the fiduciary duties of loyalty and prudence (organized under count one) and failure to monitor fiduciaries (count two).

Turning to the ever-important topic of timeliness, the complaint states that plaintiffs “did not have knowledge of all material facts (including, among other things, the investment alternatives that are comparable to the investments offered within the plan, comparisons of the costs and investment performance of plan investments versus available alternatives within similarly-sized plans, total cost comparisons to similarly-sized plans, information regarding other available share classes, and information regarding the availability and pricing of separate accounts and collective trusts) necessary to understand that defendants breached their fiduciary duties and engaged in other unlawful conduct in violation of ERISA until shortly before this suit was filed.”

The text of the complaint goes into significant detail while describing the duties of prudence and loyalty under ERISA before turning to the specific allegations at hand. It also discusses the broad debate about the use of active management funds within retirement plans.

“The funds in the plan have stayed relatively unchanged since 2013,” the complaint states. “Taking 2018 as an example year, the majority of funds in the plan (at least 10 out of 16) were much more expensive than comparable funds found in similarly-sized plans (plans having between $500 million and $1 billion in assets). The expense ratios for funds in the plan in some cases were up to 54% above the median expense ratios in the same category.”

The complaint then suggests that, in several instances, “defendants failed to prudently monitor the plan to determine whether the plan was invested in the lowest-cost share class available for the plan’s mutual funds, which are identical to the mutual funds in the plan in every way except for their lower cost.”

“A prudent fiduciary conducting an impartial review of the plan’s investments would have identified the cheaper share classes available and transferred the plan’s investments in the above-referenced funds into the lower share classes at the earliest opportunity,” the complaint alleges. “There is no good-faith explanation for utilizing high-cost share classes when lower-cost share classes are available for the exact same investment. The plan did not receive any additional services or benefits based on its use of more expensive share classes; the only consequence was higher costs for plan participants.”

The complaint goes through similar arguments with respect to the defendants’ alleged permission of excessive recordkeeping fees and their offering of poorly performing and expensive actively managed funds.

The Evonik Corp. has not yet responded to a request for comment about the litigation.

Opinions March 4, 2020

Solving the Cash Balance Investment Problem

John Lowell, with October Three Consulting, discusses how a market-based cash balance plan design provides for a less complicated way to hedge liabilities.

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We’ve read a number of articles recently that focus on the investment issues inherent in traditional cash balance pension plans. While they’re not all identical, as a group, they highlight that it is essentially impossible to come up with an asset portfolio that effectively hedges the cash balance liabilities. In an era in which chief financial officers increasingly seek both stability and predictability in benefit costs, this really does create a problem.

The reasons behind it are fairly technical, but if we examine any cash balance plan whose interest credits are set at either a fixed rate or a long-term bond yield, no financial instrument that we know can perfectly track traditional cash balance plan liabilities.

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However, a cash balance plan gives employees a key combination of two elements they desire—a benefit they can understand and the ability to derive lifetime income at a fair price—that in combination are typically not available to them in either a traditional pension or in a defined contribution (DC) plan such as a 401(k). So, reframing the problem, it would be desirable to have a plan that still provides that key combination while allowing the employer to hedge the liabilities in the plan.

Such a structure exists. But we cannot start with the liabilities and find an investment portfolio to do the work for them.

Instead, let’s start with an investment portfolio and force the liabilities to behave like that portfolio. Rather than liability-driven investment (LDI) that we have heard so much about for the past 15 years or so, we can refer to this as investment-driven liabilities (IDL).

The plan design that allows us to use IDL as a hedging device is the market-based cash balance plan. It may be new terminology to many, but these designs were formally sanctioned by the Pension Protection Act in 2006 and were in place to a lesser extent before then.

To understand what a market-based cash balance plan is, let’s first explain what it’s not: It’s not a traditional cash balance plan. In a traditional cash balance plan, a participant gets pay credits (think of them as a contribution to a notional account balance) and those credits grow with interest credits. In the traditional plan, those interest credits are either a fixed rate of return or a rate of return tied to some bond index such as 30-Year Treasury Bonds or 1-Year Treasury Bills plus 1 percentage point.

In the market-based plan, on the other hand, interest credits are derived from a pool of real or hypothetical investments. As examples, they could be based on the actual return on plan assets or on a 50/50 mix of an S&P 500 Index Fund and a Bloomberg Barclays U.S. Aggregate Bond Index Fund. In the first case, the investment portfolio naturally tracks the growth in plan liabilities. In the second, by investing plan assets in that same 50/50 mix, plan assets also automatically track growth in liabilities. In fact, in both cases, we might even say that plan liabilities are tracking plan assets.

These plans are not for every company. Nothing is. However, if providing lifetime income opportunities for employees while still affording portability is desired and being able to predict and control an employer’s cash commitments to the plan through an automatic near perfect hedge are important, then this sort of design may be worth investigating. At the very least, it’s one more potentially very useful tool for an employer to have in its benefits tool kit.

 

John Lowell is an Atlanta-based actuary and partner with October Three Consulting LLC. He has more than 30 years of experience consulting on corporate retirement plans ranging in size from just a few participants to hundreds of thousands. John was also president of the Conference of Consulting Actuaries in 2018. He can be reached at jlowell@octoberthree.com.

This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of Institutional Shareholder Services or its affiliates.

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