Investing January 16, 2015

PIMCO Faces Excessive Compensation Lawsuit

A PIMCO Total Return Fund investor lawsuit calls into question compensation paid to former co-chief investment officers and co-chief executive officers Mohamed El-Erian and Bill Gross.
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Investor Robert Kenny is suing Pacific Investment Management Company LLC (PIMCO) and PIMCO Investments LLC, alleging the company received excessive compensation that had no relationship to the services rendered. 

The lawsuit claims the excessive compensation received by the investment company through the PIMCO Total Return Fund, Kenny and the other fund shareholders is so disproportionately large that it could not have been the product of arm’s-length negotiations. 

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Kenny seeks to rescind the investment advisory agreements, the supervisory and administration agreements, and the distribution and servicing agreements the fund has entered into with PIMCO, and to recover the amounts charged by PIMCO or, alternatively, recover any improper compensation retained by PIMCO in an alleged breach of its fiduciary duty under Section 36(b) of the Investment Company Act of 1940 (ICA). The complaint states that because the excessive compensation is continuing in nature, Kenny seeks recovery for a period commencing at the earliest date in light of any applicable statute of limitations through the date of final judgment after trial. 

The lawsuit calls into question compensation paid to former co-chief investment officers and co-chief executive officers Mohamed El-Erian and William H. Gross. Gross is PIMCO’s founder and started the PIMCO Total Return Fund in May 1987.

The complaint notes that the fund was until recently the largest mutual fund in the world. At the close of the fiscal year 2013 (i.e. March 31, 2014), the PIMCO Total Return Fund held more than $230 billion in assets under management. 

However, according to the complaint, as the increase in assets in the fund led to larger and larger amounts of compensation being paid to the PIMCO, the fund’s performance suffered. In 2012, the fund failed to outperform its benchmark, and 60% of the fund’s peers outperformed the fund. In 2013, the fund lost 1.92% and trailed 70% of its peers in its worst performance since 1994. In calendar year 2013, for example, shareholders in Class A of the Fund saw returns of -5.97% before taxes, while shareholders of Class B shares saw returns of -6.36% before taxes.

The complaint argues that the fund’s poor performance has shaken up management at PIMCO. In early 2014, El-Erian announced his departure after purportedly butting heads with Gross over management of the fund. In a move that shocked investors, Gross also left the firm in September 2014, leaving to join competitor Janus Capital Group. News of both El-Erian’s and Gross’s departures compounded the poor results of the fund and led to billions of dollars in redemptions, the complaint notes. As of September 2014, the fund had seen outflows of investors for 16 months, totaling more than $60 billion in redemptions.

The lawsuit alleges that despite this poor performance, the compensation PIMCO has received for its work for the fund and fund complex has remained excessive and has led to extraordinary payments to its executives. Last year alone, PIMCO paid more than $1.5 billion in bonuses and compensation to Gross and El-Erian. According to the complaint, PIMCO claims that the compensation it pays “is designed to pay competitive compensation and reward performance, integrity and teamwork consistent with the firm’s mission statement,” but no other executive officer of a peer publicly-traded financial company came close to either of these bonuses on an individual level. It notes that one must aggregate the compensation of the CEOs of 20 publicly-held peer finance companies to come close to the amount of money Gross took home last year.

The lawsuit cites hearings before the Subcommittee on Commerce and Finance of the U.S. House Committee on Interstate and Foreign Commerce, in which one participant said the essence of a claim for unfair fees is “whether or not under all the circumstances the transaction carries the earmarks of an arm’s length bargain.” The participant also noted that a breach of fiduciary duty occurs “when a fiduciary permits an unreasonable or excessive fee to be levied on the fund,” or “when compensation to the adviser for his services is excessive, in view of the services rendered—where the fund pays what is an unfair fee under the circumstances.”

The complaint charts the fees charged by PIMCO for both institutional and retail class shares. It says for the fiscal year 2013, PIMCO received $641,047,097 in investment adviser fees and $608,321,040 in supervisory and administrative fees from the PIMCO Total Return Fund, for a total received of more than $1.2 billion. The complaint alleges various analysts criticized these fees, including one who said: “Pimco’s expense ratios for Total Return are no better than average, which seems ridiculous for a fund so large, and its prospects are worse.”

The lawsuit accuses PIMCO of raising fees over the years and not using the fund’s economy of scale to lower fees. The complaint explains that economies of scale are created when (as with the Total Return Fund) assets under management increase more quickly than the cost of advising and managing those assets. It notes that the work required to operate a mutual fund does not increase proportionately with the assets under management.

In a statement to PLANSPONSOR, PIMCO said, "PIMCO believes this lawsuit is without merit and intends to vigorously defend itself."

Compliance January 16, 2015

FedEx Pension Plan Faces DOMA-Related Challenge

The surviving spouse of a fully vested participant in a FedEx pension plan claims she is being unlawfully denied a survivor annuity benefit owed to her by the plan.
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A complaint filed in a federal district court by Stacey Schuett claims FedEx has refused to pay a mandatory survivor benefit she should receive as the surviving spouse of a fully vested FedEx pension plan participant. 

The complaint argues Schuett was legally married to Lesly Taboada-Hall at the time of Taboada-Hall’s death from cancer in June 2013. At the time of her death, according to the complaint, Taboada-Hall had been an employee of FedEx Corporation for more than 26 years and was fully vested in the FedEx Corporation Employees’ Pension Plan. As Taboada-Hall’s surviving spouse, Schuett says she is entitled to a survivor annuity beginning on the date that Ms. Taboada-Hall passed away.

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The complaint, filed in the U.S. District Court Northern District California San Francisco/Oakland Division, cites the U.S. Supreme Court’s June 2013 ruling in the case of United States v. Windsor as grounds that the FedEx plan is inappropriately withholding benefits due to Schuett. That landmark ruling found Section 3 of the Defense of Marriage Act (DOMA), which legally defined the term “spouse” as marriage between a man and woman, was unconstitutional (“Benefit Changes Ahead After DOMA Ruling”).

After the DOMA ruling, industry compliance professionals said the decision was a big step towards legal recognition of same-sex spouses for benefits purposes, at least in some states, and would likely lead to Employee Retirement Income Security Act (ERISA) litigation.

“In light of Windsor, same-sex spouses are entitled—on the same basis as opposite-sex spouses—to the protections of ERISA’s mandatory benefits provisions,” the complaint alleges. “Although Ms. Schuett submitted a claim for the survivor benefit after Windsor, FedEx has improperly insisted that it must continue to apply the Plan’s definition of spouse incorporating the now-unconstitutional law, rather than current law, in determining eligibility for benefits. In denying Ms. Schuett the survivor benefit to which she is entitled, and in providing misleading and incomplete information to Ms. Taboada-Hall about her benefits under the Plan before her death, Defendants have violated ERISA.”

Schuett’s complaint suggests the FedEx plan denied her a survivor annuity on the basis that the plan document defines “spouse” by explicitly incorporating Section 3 of DOMA, part of the law struck down as unconstitutional in Windsor. Court filings show Schuett is seeking declaratory, injunctive, and monetary relief pursuant to § 502(a)(1)(B) and § 502(a)(3) of ERISA; and 29 U.S.C. §§ 1132(a)(1)(B) and 1132(a)(3).

The complaint adds that the California federal trial court has subject matter jurisdiction over Schuett’s claims because the ERISA-governed plan at issue was administered in part in the district. “The venue is also proper pursuant to 28 U.S.C. § 1391(b) because some of the administrative events or omissions giving rise to Ms. Schuett’s claim occurred within this District, and Ms. Schuett resides in this District,” the complaint continues.

According to the complaint, the FedEx plan at issue is a defined benefit plan established and qualified under Section 401 of the Internal Revenue Code/26 U.S.C. § 401. The plan has two benefit accrual formulas: a traditional pension benefit formula, and a portable pension account formula.

The traditional pension benefit formula promises the participant a specified monthly benefit at retirement based on the participant’s age, salary, and years of service, according to Schuett’s complaint. The traditional pension benefit formula is only available to participants who were hired by FedEx prior to June 1, 2003. Benefits accrued under the traditional pension benefit formula were capped as of May 31, 2008.

After June 1, 2008, participants accrued benefits under the portable pension account benefit formula, in which the participant earns compensation credits (based on compensation and the participant’s combined age and years of service) and interest credits during each year of employment. The complaint defines the portable pension account benefit as a “cash balance” formula, meaning it defines the promised benefit in terms of a stated account balance, which is the sum of all compensation credits and interest credits.

Participants cannot accrue benefits under both formulas at the same time for a particular year of service at FedEx, the complaint explains. Rather, longtime employees such as Taboada-Hall initially accrued benefits under the traditional pension benefit formula, and then began accruing benefits under the portable pension account formula when the plan changed. As a result, when she died, Taboada-Hall had earned plan benefits under both formulas. Only Taboada-Hall’s traditional pension benefit is at issue in Schuett’s lawsuit. FedEx also has a 401(k) plan that is not at issue in the suit, according to the complaint.

As a defined benefit plan, Schuett says the plan is required by ERISA to provide a qualified preretirement survivor annuity to all married participants who are vested and die before the annuity starting date, unless the participant has waived the benefit and the spouse consented to the waiver, per 29 U.S.C. § 1055(a)(2).

“Section 5.02 of the Plan requires that, for the Traditional Pension Benefit, a ‘Qualified Joint and Survivor Annuity’ must be paid to the surviving spouse of a fully vested Plan participant who dies before retiring,” the complaint argues. “Section 1.66 of the Plan defines ‘Spouse’ to ‘have the same meaning as set forth in 1 U.S.C.A. § 7 (a person of the opposite sex who is a husband or wife), and shall be deemed to refer solely to the persons who have entered into a marriage, as defined in 1 U.S.C.A. § 7 (a legal union between one man and one woman as husband and wife).’”

The complaint says Schuett and Taboada-Hall became a couple in 1983, and “at all relevant times they lived together in Sebastopol, California.” Schuett and Taboada-Hall entered into a California registered domestic partnership in July 2003. In February 2010, Taboada-Hall was diagnosed with cancer, and by 2013 Taboada-Hall had to take a medical leave of absence because she could no longer safely operate a vehicle. Although she was on a medical leave, she remained employed by FedEx until her death. Before their marriage and Taboada-Hall's death, the complaint suggests the couple struggled to receive confirmation from FedEx plan officials about whether Schuett would be able to collect a survivor annuity from the plan—only getting a negative answer about a week before Taboada-Hall's death.

The complaint shows Taboada-Hall and Schuett were married one day before the former’s death, on June 19, 2013, in a ceremony officiated by a Sonoma County supervisor. This was one week before the Supreme Court handed down its decision in Windsor, but on September 18, 2013, Schuett says she obtained an order from the Sonoma County Superior Court stating that the couple’s marriage was legally valid, and the court issued a marriage certificate listing the date of the marriage as June 19, 2013. “Thus, Ms. Schuett and Ms. Taboada-Hall were legally married under California law at the time of Ms. Taboada-Hall’s death on June 20, 2013,” the complaint concludes.

FedEx responded with the following statement to PLANSPONSOR: “Lesly Taboada-Hall was a valued, long-term FedEx Express employee for 26 years, and we are saddened by her passing. Ms. Schuett’s claim has been carefully reviewed, and while we are sympathetic to her situation, we are required by federal law to apply the pension plan rules equally to all participants.”

The full text of the lawsuit is here.

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