Dismissal of Capital Group Self-Dealing ERISA Challenge Offers Fiduciary Insight

The U.S. District Court for the Central District of California has dismissed a self-dealing Employee Retirement Income Security Act (ERISA) lawsuit alleging fiduciary violations and prohibited transactions on the part of Capital Group and its subsidiaries.

The lawsuit alleged various violations in Capital Group’s selecting, retaining and failing to remove what plaintiffs called “expensive affiliated investment options in its retirement plan that generated significant revenue for Capital Group and its subsidiaries.” The fiduciary violations were alleged to have occurred through the present, with the proposed class period starting June 13, 2011.

Named as defendants in the lawsuit were The Capital Group Companies, Inc., the Board of Directors of Capital Group, the U.S. Retirement Benefits Committee of the plan, Capital Guardian Trust Company (CGTC), Capital Research and Management Company (CRMC) and Capital International, Inc. (CII).

With the new opinion, the district court seeks to make clear where the line is when it comes to pleading standards in ERISA lawsuits. As the decision states, “Federal Rule of Civil Procedure 8(a)(2) requires only a short and plain statement of the claim showing that the pleader is entitled to relief. Specific facts are not necessary; the statement need only give the defendant fair notice of what the claim is and the grounds upon which it rests, per Erickson v. Pardus. But Rule 8 requires more than labels and conclusions, and a formulaic recitation of the elements of a cause of action will not do, per Bell Atlantic Corp. v. Twombly.”

The court further points out that the Federal Rule of Civil Procedure 12(b)(6) “allows an attack on the pleadings for failure to state a claim upon which relief can be granted.”

“When ruling on a defendant’s motion to dismiss, a judge must accept as true all of the factual allegations contained in the complaint,” the court explains, again citing Erickson. “However, a court is not bound to accept as true a legal conclusion couched as a factual allegation, per Ashcroft v. Iqbal. Nor does a complaint suffice if it tenders naked assertions devoid of further factual enhancement.”

The real point here is that a complaint must state a claim for relief that is plausible on its face. This means that the complaint must plead factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged. Offering further context, the decision states the “plausibility standard is not akin to a ‘probability requirement,’ but it asks for more than a sheer possibility that a defendant has acted unlawfully.”

The clarification continues, citing Twombly: “Ruling on a motion to dismiss is a context-specific task that requires the reviewing court to draw on its judicial experience and common sense. But where the well-pleaded facts do not permit the court to infer more than the mere possibility of misconduct, the complaint has alleged—but it has not shown—that the pleader is entitled to relief.”

Considering the timeliness of the claims  

With this context set up, the decision pauses to consider precedence set by the groundbreaking case of Tibble vs. Edison, pulling in helpful guidance regarding the application of various statutes of limitation under ERISA.

“Plaintiff claims defendants were disloyal in selecting, retaining, and failing to remove unduly expensive Capital Group-affiliated investment options and permitting plan participants to invest in the more expensive R5 share class, despite the availability of the cheaper R6 share class, because R5 allegedly generated substantial revenue for defendants. Plaintiff’s imprudence claim relies on substantially similar reasoning,” the court notes. “Plaintiff also alleges she had no knowledge of all material facts necessary to understand that defendants engaged in unlawful conduct in violation of ERISA. Thus, plaintiff contends that ERISA §1113(a)(1) applies and her claims are timely.”

Defendants argued that plaintiff’s “blanket disavowal” here is “insufficient to demonstrate a lack of actual knowledge because she received regular fee disclosure statements that made her aware of the allegedly expensive fees.” However, in Tibble v. Edison, the United States Court of Appeals for the Ninth Circuit held that such disclosures were “evidence of the wrong type of knowledge” for a claim alleging the defendant made an imprudent investment. Rather, the “actual knowledge” standard requires “some knowledge of how the fiduciary selected” the allegedly imprudent investment.

The court then explains its finding that the complaint is, at least in part, timely: “Here, as in Tibble, plaintiff’s claims are based on allegations that defendants continuously made disloyal and imprudent decisions relating to the funds. Plaintiff did not have actual knowledge of defendants’ process for selecting and retaining the investment options. Accordingly, § 1113(1) applies and each new breach by defendants begins a new limitations period. And plaintiff alleges the plan did not switch to R6 share classes until 2014 and the fees charged were unduly expensive even after the switch. Accordingly, Plaintiff’s first and second claims are timely.”

The plaintiff’s third and fourth claims allege Capital Group violated ERISA’s prohibition against certain self-interested transactions by charging excessive fees on the Capital Group-affiliated investment options, leading to a windfall for defendants. But the court is more skeptical here: “Unlike her fiduciary duty claims, plaintiff had actual knowledge regarding her prohibited transaction claims. For her third and fourth claims, the underlying violation is the collection of fees from Capital Group-affiliated funds. Here, plaintiff knew defendants had caused the plan to engage in self-interested transactions when the plan included Capital Group-affiliated funds. Several of the investment options named in the first amended complaint are clearly affiliated with Capital Group. Plaintiff also knew that those investment options extract fees. With the exception of three funds, defendants’ selection of the investment options and initial collection of fees occurred outside of the three-year limitations period.”

The plaintiff argued that each new collection of fees started a new limitations period, making her third and fourth claims timely. But “when there is a series of ‘discrete but related breaches,’ the § 1113(2) limitations period does not begin anew with each related breach. Accordingly, plaintiff’s third and fourth claims are time-barred except as they relate to the CG Emerging Markets Growth Fund, the American Funds Developing World Growth and Income Fund, and the American Funds 2060 Target Date Retirement Fund.”

Heart of the decision

With the timeliness questions settled, the court states the real core of its choice to dismiss the lawsuit.

“Courts have routinely held that a fiduciary’s failure to offer the cheapest investment option is not enough by itself to state a claim for a breach of fiduciary duty,” the decision states. “The fact that it is possible that some other funds might have had even lower expense ratios is beside the point; nothing in ERISA requires every fiduciary to scour the market to find and offer the cheapest possible fund. … As the Ninth Circuit has stated, there are simply too many relevant considerations for a fiduciary, for that bright-line approach to prudence to be tenable. Rather, plaintiffs must plead some other grounds to plausibly suggest wrongdoing.”

Here, plaintiff’s claim for breach of the fiduciary duty is premised on high fees, including defendant’s failure to switch investment options from R5 to the cheaper R6 share classes, and the fact that the vast majority of the plan options were proprietary funds. Again the court is skeptical: “Plaintiff’s present allegations … are not sufficiently plausible to survive a motion to dismiss. It may not be necessary for plaintiff to allege that the challenged funds underperformed, but plaintiff must at least allege facts that plausibly suggest the fees were unjustified. That defendants ‘could’ have chosen funds with lower fees, that ‘similar’ Vanguard funds charged lower fees, and that all or most of the challenged funds were defendants’ own financial products are insufficient, when viewed in context, to create a plausible inference of wrongdoing. Although a motion to dismiss is not the place for the court to find fees reasonable (or excessive) as a matter of law, the fees alleged here are not so obviously excessive as to meet the plausibility test standing alone.”

According to the text of the decision, the plaintiff’s allegation that, for most of the challenged funds, defendants failed to switch the plan from the more expensive R5 share class to the less expensive R6 share class does not bolster her claim. In Braden, the United States Court of Appeals for the Eighth Circuit considered similar allegations with one key difference—the plaintiff in Braden alleged that both share classes had the same return on investment and differed only in price.

“Plaintiff here makes no such allegations,” the decision notes. “She alleges only that the R6 share class was cheaper and defendants could have switched share classes earlier.”

Also interesting, as explained above, the plaintiff’s third and fourth claims alleging that defendants engaged in prohibited transactions are time-barred except as to a small number of funds. But defendants also contend the claims should be dismissed because the transactions are exempt under the “prohibited transaction exemption 77-3.” The plaintiff countered that PTE 77-3 does not apply because her prohibited transaction claims concern the collection of fees, not the sale of the mutual funds at issue. The court on this point is “not persuaded” and again sides with defendants. 

Additional dismissed claims are discussed in detail in the full dismissal decision, available here.