Compliance July 7, 2020

Health Care Organization Faces 403(b) Excessive Fee Suit

Much of the complaint is dedicated to discounting the use of an actively managed TDF suite rather than a less costly index TDF suite.

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A former participant of the MedStar Health Inc. Retirement Savings Plan has filed a proposed class action lawsuit against MedStar, its 403(b) retirement plan committee and individual committee members for breaching their fiduciary duties under the Employee Retirement Income Security Act (ERISA).

The lawsuit says the defendants not only selected and retained high-cost and poorly performing investments, but also failed to fully disclose the expenses and risk of the plan’s investment options to participants.

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A significant amount of space in the complaint is dedicated to trying to discredit the use of the Fidelity Freedom Funds—a suite of 13 target-date funds (TDFs)—rather than “the substantially less costly and less risky” Freedom Index Funds or any other TDFs offered by Fidelity or any other provider. The participant alleges that the defendants failed to compare the actively managed Freedom Funds and index suite. “A simple weighing of the benefits of the two suites indicates that the index suite is a far superior option, and consequently the more appropriate choice for the plan,” the complaint states.

The lawsuit claims that designating the Freedom Funds as the plan’s qualified default investment alternative (QDIA) “exacerbat[es] defendants’ imprudent choice to add and retain the active suite.” It notes that approximately 58% of the plan’s assets were invested in the funds.

The lawsuit challenges the level of risk taken by the Freedom Funds’ portfolio managers across the glide path and delves into the underlying assets. “The active suite allocates approximately 1.5% more of its assets to riskier international equities than the index suite. The active suite also has higher exposure to classes like emerging markets and high-yield bonds,” the complaint says.

The Freedom Funds underwent a strategy overhaul in 2013 and 2014, giving managers the discretion to deviate from the glide path allocations by 10 percentage points in either direction, according to the court document. “Fidelity encouraged its portfolio managers to attempt to time market shifts in order to locate underpriced securities, which the firm dubs ‘active asset allocation,’” the complaint states, which it alleges “heaps further unnecessary risk on investors.”

The lawsuit alleges that since the strategy overhaul took effect, the index suite has outperformed the active suite in four out of six calendar years. In addition, it says the active suite “has substantially underperformed the index suite on a trailing three- and five-year basis.”

Finally, the complaint compares the fees for the Freedom Funds with those for the Freedom Index Funds. “While the Institutional Premium share class for each target year of the index suite charges a mere 8 basis points [bps] (0.08%), the K share class of the active suite—which the plan offers—has expense ratios ranging from 42 basis points (0.42%) to 65 basis points (0.65%),” it states.

Two other funds in the 403(b) plan’s investment lineup were mentioned in the lawsuit as being high-cost and low-performing, one of which had been removed in 2018. However, the lawsuit says, “Defendants’ failure to replace this underachieving investment option with better performing alternatives earlier than they ultimately did was a severe breach of fiduciary duty.”

The plaintiff alleges the defendants also failed to monitor the average expense ratios charged to similarly sized plans, saying “participants were offered an exceedingly expensive menu of investment options, clearly demonstrating that defendants neglected to benchmark the cost of the plan lineup or consider ways in which to lessen the fee burden on participants during the pertinent period.” According to the court document, from 2014 through 2018, the plan paid out investment management fees of 0.45% to 0.47% of its total assets, which it says is considerably more than those of comparable plans.

“The most recent Brightscope/ICI study published in June 2019 indicates that the average Total Plan Cost (TPC) for a plan with over $1 billion in assets [is] 0.28% of total assets as of 2016. Just the investment management fee component that the plan paid during the relevant period was 61%-68% higher than the average total cost for other large plans,” the complaint states.

The same law firm has recently filed similar lawsuits on behalf of 401(k) plan participants.
Compliance July 7, 2020

Judge Roundly Rejects CareerBuilder ERISA Lawsuit

The text of the dismissal ruling relies heavily on precedent set by the United States 7th Circuit Court of Appeals.

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The U.S. District Court for the Northern District of Illinois, Eastern Division, has ruled in favor of CareerBuilder’s motion to dismiss a lawsuit filed against it under the Employee Retirement Income Security Act (ERISA).

The court’s order explains that the complaint has failed to adequately state a claim, and it gives the plaintiffs until July 28 to attempt to remedy this and other failures. If the plaintiffs do not file an amended complaint by that deadline—or any extension of it granted by the court—then the court will convert the dismissal to “with prejudice” and enter a final judgment under Federal Rule of Civil Procedure 58.

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Plaintiffs filed the complaint in October, alleging that plan fiduciaries allowed the plan’s recordkeepers, ADP and Empower, and its investment adviser and/or trustee, Morgan Stanley Smith Barney, to receive excessive and unreasonable compensation.

According to the complaint, the providers received excessive compensation through direct “hard dollar” fees paid by the plan to ADP and/or Morgan Stanley; indirect “soft dollar” fees paid to ADP and/or Morgan Stanley by mutual funds added and maintained in the plan to generate fees to ADP and/or Morgan Stanley; fees collected directly by ADP and/or Morgan Stanley from mutual funds added and maintained in the plan to generate fees to ADP and/or Morgan Stanley; and float interest, access to a captive market for 401(k) rollover materials to plan participants and other forms of indirect compensation.

The text of the dismissal ruling relies heavily on precedent set by the United States 7th Circuit Court of Appeals.

“Defendant argues that these allegations are uncannily similar to those made in Divane v. Northwestern University, where the 7th Circuit recently affirmed dismissal of an ERISA case,” the ruling states. “According to defendant, Divane is one in a line of 7th Circuit cases preventing courts from paternalistically interfering with plans’ slates of funds so long as the fiduciaries don’t engage in self-dealing and offer a comprehensive-enough menu of options.”

The court states that the 7th Circuit has repeatedly cautioned that plaintiffs and courts “cannot use ERISA to paternalistically dictate what kinds of investments plan participants make where a range of investment options are on offer.”

“It has accordingly affirmed dismissal of ERISA complaints alleging that some combination of high fees and underperforming funds signaled imprudence, where the plans in question offered some cheaper alternatives, and the complaint did not include allegations speaking to flawed decisions or self-dealing,” the ruling states. “Here, defendants are correct that under binding 7th Circuit precedent, plaintiff has not adequately pled a breach of the duty of prudence. Preliminarily, Divane resolves most of this case. … The [plan] in Divane charged fees (partially through revenue sharing) that averaged between $153 and $213 per person, essentially the same as those at issue here (which range from $131.55 to $222.43). The 7th Circuit held that such fees were not inconsistent with prudent portfolio management, particularly when revenue sharing was used to keep mandatory per-capita costs down. … Likewise, Divane clarified that a fund’s failure to invest in institutional as opposed to retail funds does not give rise to an inference of imprudence when a plan offers cheaper alternatives.”

Importantly, the ruling has been issued without prejudice, a development that is explained as follows: “Defendants moved to dismiss with prejudice. That would be overkill. Although 7th Circuit precedent dictates that some of plaintiff’s allegations are insufficient to state a claim for breach of fiduciary duty on their own, Rule 15 and circuit precedent counsel in favor of allowing an amended pleading here, as it is by no means clear that amendment would be futile.”

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