Principal Back on the Hook for GIC Challenge

A federal appellate court has revived a lawsuit accusing Principal Financial Group of violating the Employee Retirement Income Security Act (ERISA) by setting the crediting rate for a guaranteed investment contract (GIC) such that it can “retain unreasonably large and/or excessive profits.”

The 8th U.S. Circuit Court of Appeals reversed a lower court’s decision that Principal is not a fiduciary when it sets the composite crediting rate (CCR) for the GIC, and it is also not a party-in-interest engaging in prohibited transactions. The appellate court says outright, “Principal is a fiduciary when it sets the CCR.”

The court relies on a 10th U.S. Circuit Court of Appeals decision in Teets v. Great-West Life & Annuity Ins. Co., which the 8th Circuit says all parties agree is the decision that should guide the appeal. According to the opinion, Teets determines that a service provider acts as a fiduciary if it (1) “did not merely follow a specific contractual term set in an arm’s-length negotiation,” and (2) “took a unilateral action respecting plan management or assets without the plan or its participants having an opportunity to reject its decision.” In other words, if the provider’s actions (1) conform to specific contract terms or (2) a plan and participant can freely reject it, then the provider is not acting with “authority” or “control” respecting the “disposition of [the plan’s] assets,” per ERISA’s definition of a fiduciary.

For the Principal Fixed Income Option, Principal unilaterally calculates the CCR every six months. Before the CCR takes effect—typically a month in advance—Principal notifies plan sponsors, which alert the participants. If a plan sponsor wants to reject the proposed CCR, it must withdraw its funds, facing two options: (1) pay a surrender charge of 5% or (2) give notice and wait 12 months. If a plan participant wishes to exit, he or she faces an “equity wash.” They can immediately withdraw their funds, but not reinvest in contracts such as the Principal Fixed Income Option for three months.

The 8th Circuit found that Principal’s setting of the CCR does not conform to a specific term of its contract with the plan sponsors. Every six months, Principal sets the CCR with no specific contract terms controlling the rate. Principal calculates the CCR based on past rates in combination with a new rate that it unilaterally inputs.

Citing Teets, the appellate court also found the plan sponsors do not “have the unimpeded ability to reject the service provider’s action or terminate the relationship.” The opinion states, “Charging a 5% fee on a plan’s assets impedes termination. Likewise, holding a plan’s funds for 12 months after it wishes to exit impedes termination.”

Principal argues that the surrender penalty and delay are not impediments because they are in the plan contract, but the appellate court says this argument is misplaced. “Fiduciary status focuses on the act subject to complaint. … Here, Rozo complains about the setting of the CCR. Because plan sponsors do not have an opportunity to agree to the CCR until after it is proposed, the CCR is a new contract term. This court, therefore, must decide if plan sponsors can freely reject the term. … It does not matter that the barriers to rejecting the CCR are in the contract,” the opinion says.

The appellate court also rejected Principal’s argument that a participant’s ability to freely reject the CCR—regardless of the plan sponsor’s ability—negates fiduciary status for the service provider, saying Teets summarizes ERISA case law as finding fiduciary status if either a plan sponsor or a participant is impeded from rejecting the service provider’s act.