Compliance January 23, 2020

Excessive Fee Cases Continue With Lawsuit Against Cerner Corporation

The ERISA complaint includes familiar allegations that retirement plan fiduciaries failed to manage or monitor plan recordkeeping and investment fees.

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An excessive fee lawsuit has been filed against Cerner Corporation, its Foundations Retirement Plan, several committees and various other alleged fiduciaries.

Repeating a number of excessive fee lawsuits filed, the complaint says the plan, which has more than $2 billion dollars in assets, qualifies as a large plan in the defined contribution (DC) plan marketplace, and, therefore, has substantial bargaining power regarding the fees and expenses charged. The lawsuit says the defendants did not try to “reduce the plan’s expenses or exercise appropriate judgment to scrutinize each investment option that was offered in the plan to ensure it was prudent.”

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The plaintiffs allege that from January 21, 2014, to the present, the defendants breached their Employee Retirement Income Security Act (ERISA) fiduciary duties by failing to objectively and adequately review the plan’s investment portfolio with due care to ensure that each investment option was prudent, in terms of cost; and maintaining certain funds in the plan despite the availability of identical or similar investment options with lower costs and/or better performance histories.

In an effort to avoid the timing or standing issues that have hindered other such suits from going forward, the complaint states that the plaintiffs did not have knowledge of all material facts necessary to understand that the defendants breached their fiduciary duties and engaged in other unlawful conduct in violation of ERISA until shortly before the suit was filed. In addition, it says the plaintiffs did not have and do not have actual knowledge of the specifics of the defendants’ decision-making process with respect to the plan “because this information is solely within the possession of defendants prior to discovery.”

“Having never managed a large 401(k) plan such as the Plan, Plaintiffs lacked actual knowledge of reasonable fee levels and prudent alternatives available to such plans. Plaintiffs did not and could not review the Committee meeting minutes or other evidence of Defendants’ fiduciary decision making, or the lack thereof,” the complaint adds.

In the complaint, the plaintiffs argued that passively managed funds cost less than actively managed funds, institutional share classes cost less than investor share classes, and collective trusts and separate accounts cost less than their “virtually identical” mutual fund counterparts. They claim that the defendants knew or should have known of the existence of cheaper share classes and/or collective trusts, and should have immediately identified the prudence of transferring the plan’s funds into these alternative investments.

The complaint states that as a large plan, it had sufficient assets under management at all times during the class period to qualify for lower share classes which often have a million dollars as the minimum for a particular fund. “Investment minimums for [collective trusts] are often $10 million, but will vary,” the complaint notes.

It also accuses the defendants of failing to monitor or control the plan’s recordkeeping expenses. The lawsuit alleges the plan fiduciaries failed to track the recordkeeper’s expenses by demanding documents that summarize and contextualize the recordkeeper’s compensation, such as fee transparencies, fee analyses, fee summaries, relationship pricing analyses, cost-competitiveness analyses, and multi-practice and standalone pricing reports.

It accuses the defendants of failing to identify all fees, including direct compensation and revenue sharing being paid to the plan’s recordkeeper. “To the extent that a plan’s investments pay asset-based revenue sharing to the recordkeeper, prudent fiduciaries monitor the amount of the payments to ensure that the recordkeeper’s total compensation from all sources does not exceed reasonable levels, and require that any revenue sharing payments that exceed a reasonable level be returned to the plan and its participants,” the plaintiffs claim.

The suit alleges the defendants failed to remain informed about overall trends in the marketplace regarding the fees being paid by other plans, as well as the recordkeeping rates that are available by not conducting a request for proposals (RFP) process at reasonable intervals, and immediately if the plan’s recordkeeping expenses have grown significantly or appear high in relation to the general marketplace.

“As a direct and proximate result of the breaches of fiduciary duties alleged herein, the Plan suffered millions of dollars of losses due to excessive costs and lower net investment returns,” the complaint says.

Investing January 23, 2020

The Case for TDFs That Mix Active and Passive Management

PIMCO says a mix of the two makes sense, especially assigning the fixed income portion of the portfolio to active management due to outperformance.

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It used to be that retirement plan sponsors only primarily considered active target-date funds (TDFs) for the lineups of qualified default investment alternatives (QDIAs), as these funds captured 90% of the market in the early 2000s, according to a white paper from PIMCO. However, because of concerns about fees and litigation risk, three years ago, passive TDFs surpassed active TDFs in market share.

Erin Browne, managing director at PIMCO, tells PLANSPONSOR that there is a third option that to consider, particularly because this option “is, by and large, what plan sponsors and consultants are looking for.”

The option? “Blend” TDFs that combine both active and passive management. “We poll the largest plan sponsors and consultants each year,” Browne says. “By and large, mid-size and large plans are looking for a blended strategy.”

A PIMCO survey found that 60% of plans with $1 billion or more in assets are looking for custom TDFs, which typically use a mix of active and passive investments. Only 25% of plans in this size range are looking for off-the-shelf blend TDFs.

What becomes interesting is that most plans below that size are looking for blend TDFs, probably because their assets are not large enough to command a custom TDF. Forty-seven percent of plans in the $500 million to less than $1 billion space are looking for blend TDFs, and this is true for 50% of those in the $200 million to less than $500 million bracket, for 47% of those in the $50 million to less than $200 million bracket, and 44% of those with less than $50 million in assets. Clearly, sponsors are looking for blend TDFs.

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While the amount of TDF assets that are in blend TDFs now is small, Morningstar data shows that blend TDF assets have grown 485% since 2013. “While it is a small segment of the market today, we think it will be the largest growth opportunity in the TDF market,” Browne says.

The reason sponsors are looking for a blended strategy is because “selecting active management on equity is not the best decision,” Browne says. “The percentage of active equity funds that outperform their benchmark is only 20%, whereas 70% of fixed income active managers are able to outperform their benchmark.”

As PIMCO says in its white paper, “In our view, the pendulum has swung too far from active to passive, and a compromise that incorporates investment considerations may be warranted. … A blend TDF typically carries lower fees than fully active options. In addition, blend TDFs offer alpha potential from active management, which over the long term may translate into higher income-replacement ratios or improved longevity of assets in retirement versus a fully passive TDF, typically for only a modest fee premium.”

The reason actively managed fixed income funds are able to outperform their benchmarks so much more often than actively managed equity funds is there are only about 1,000 equities on the market but tens and even hundreds of thousands of fixed income options traded over the counter, Browne says. This creates inefficiencies that active fixed income managers can exploit.

Additionally, “within fixed income, you have non-economic buyers: sovereign wealth funds, treasury managers, pension managers, currency managers, central banks,” she adds. “This creates additional alpha opportunities and is a big component” of why actively managed fixed income makes more sense than actively managed equities.

On top of this, according to PIMCO, actively managed equities cost an average of 61 basis points, versus only 33 basis points for actively managed fixed income.

PIMCO’s mantra, Browne says, is, “Go active where it matters [fixed income] and passive where it saves [equity].”

Finally, PIMCO notes that as investors approach or enter retirement, a greater portion of their TDF glide path is allocated to fixed income. Since actively managed fixed income has borne out to be superior to equities, doesn’t a blend TDF make even more sense?

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