Compliance January 23, 2017

Schwab Faces Excessive Fee, Self-Dealing Lawsuit

The lawsuit calls out Schwab’s use of its own proprietary funds as well as the use of unallocated plan cash.
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A class action Employee Retirement Income Security Act (ERISA) lawsuit has been filed against Charles Schwab Corporation and its retirement plan fiduciaries alleging fiduciary breaches and prohibited transactions.

The lawsuit claims plan fiduciaries engaged in the imprudent and disloyal exercise of their discretionary fiduciary authority over the plan to include Schwab’s own affiliated investment products as investment options within the plan and sale of their own services to the plan. The complaint alleges that defendants “reaped significant fees and profits at the expense of the plan and its participants.”

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In a statement to PLANSPONSOR, Charles Schwab said, “It’s our practice not to comment on pending litigation. However, we intend to vigorously defend against this case, and believe it is totally without merit. We are committed to helping employees save for retirement by providing a 401(k) plan with low-cost investment products and independent personalized advice.”

At issue in the case are several types of Schwab Affiliated Products and Services, categorized as: the “Affiliated Funds,” the “Schwab Savings Account,” the “Self-Directed Brokerage,” and the “Interest Free Loan from Unallocated Plan Cash.”

The lawsuit accuses plan fiduciaries of making no meaningful investigation into whether these Schwab Affiliated Products and Services were prudent for the plan, or whether alternative funds offered by other providers would be more appropriate, cost effective or better performing. Instead, the complaint says they “imprudently and disloyally elected to provide the Schwab Affiliated Products and Services to the Plan in an effort to generate fees for the Schwab Entity Defendants at the expense of the Plan and its participants.” The lawsuit says the fees were excessive, unreasonable and far exceeded the real costs associated with administering the plan.

The compliant pointed out a 3 to 5 basis point difference in fees between the Schwab S&P 500 Index Fund and the other S&P 500 Index funds. It said while that “may seem small at first glance, the plan had more than $100 million invested in the Schwab S&P 500 Index Fund each year during the class period, meaning the plan paid hundreds of thousands of dollars in fees more to Schwab than it would have paid to other fund providers even when not compounded.”

The lawsuit noted that since 2011, the fees for Schwab’s S&P 500 Index Fund have remained the same, while the fees for many of its competitors’ S&P 500 index funds have declined. In addition, other new S&P 500 index funds are now offered with lower fees than charged by the Schwab S&P 500 Index Fund. “Thus by 2015, numerous S&P 500 index funds with lower costs and better performance than the Schwab S&P 500 Index Fund were available on the market,” the complaint says.

NEXT: TDFs and stable value fund called out

The lawsuit also says that during the class period, the defendants included seven other Schwab mutual funds, ten Schwab target-date funds, a Schwab stable value fund, a Schwab money market fund, and a Schwab savings account as investment options. It says that like the Schwab S&P 500 Index Fund, many of the other Schwab affiliated funds had higher fees and worse performance than comparable funds from other providers. By year-end 2015, more than $500 million in plan assets were invested in these Schwab affiliated funds.

The complaint specifically calls out the Schwab Managed Retirement Trust Funds or target-date funds, noting that the Vanguard Target Retirement Funds target-date series had fees more than 80% lower than the Schwab Managed Retirement Trust Funds, and materially outperformed the Schwab funds during the years leading up to the start of the class period.

In 2014, the Schwab defendants replaced the Stable Advantage Money Fund with a Schwab Bank Savings Cash account as an investment option in the plan. According to the lawsuit, the Schwab Savings Account is a demand deposit account at defendant CSBank that pays accountholders interest equivalent to money market rates. The lawsuit sites reports that show stable value funds are conservatively managed to preserve principal and provide a stable credit rate of interest, and because they hold longer-duration instruments, they generally outperform money market funds, which invest exclusively in short-term securities. The Schwab retirement plan fiduciaries are accused of making no meaningful investigation into the merits of including a higher yielding stable value fund offered by another company in lieu of or in addition to the Schwab Stable Value Fund, the Schwab Value Advantage Money Fund, or the Schwab Savings Account, either at the time those investment options were added or on an ongoing basis as part of periodic review of the plan’s portfolio.

NEXT: Self-Directed Brokerage Account fees and use of unallocated cash

According to the complaint, Schwab and its affiliates collected fees from several sources arising out of the plan’s participation in Schwab’s Self-Directed Brokerage Account, including transaction fees and commissions and other fees to individual plan participants who opened Self-Directed Brokerage accounts through the plan. The lawsuit also notes that the complexity and confusing fee schedule make this option non-optimal for less sophisticated investors, but Schwab offered it to all participants. Schwab is accused of not investigating whether a self-directed brokerage account offered by another company would have been a better option for the plan than Schwab’s own and of not investigating whether it would have been more appropriate to forgo offering any sort of self-directed brokerage account at all. The defendants are accused of including the account for no other reason than to generate fees for the Schwab defendants at the expense of the plan’s participants.

Finally, the lawsuit calls out Schwab for using unallocated plan cash from new contributions, other assets awaiting investment, and from pending distributions and rollovers for their own benefit. Defendant CSBank, as the plan’s trustee, held the unallocated plan cash in accounts in the plan’s name. The plan’s fiduciaries exercised their discretionary authority to give CSBank discretionary authority to invest the unallocated plan cash and retain as compensation for its services any credit, interest or other earnings it achieved on its investments. The lawsuit calls this an interest free loan to CSBank. Schwab is accused of not investigating whether the unallocated plan cash could be used in a different way that benefitted the plan or its participants.

The lawsuit asks that defendants make good to the plan the losses their fiduciary breaches, co-fiduciary breaches and/or prohibited transactions caused the plan; disgorge to the plan any and all property they hold as a result of the fiduciary breaches, co-fiduciary breaches and/or prohibited transactions that in good conscience belongs to the plan, the proceeds of such property to the extent it has been disposed of, and any profits defendants received as a result of holding such property; and provide a full accounting of all fees paid, directly or indirectly, by the plan to the defendants.

Compliance January 23, 2017

Peering Through the Fiduciary Rule Uncertainty

A direct order from President Trump regarding the fiduciary rule could be forthcoming imminently, and that is likely what it would take for the fiduciary rulemaking to truly be paused or killed outright at DOL.

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It is more or less standard practice that an incoming U.S. President will move to halt or delay a predecessor’s unfinished regulatory projects—particularly when there is a shift in the party controlling the executive branch.  

What is less clear is how much power a newly minted president has to overturn straggling regulations that already went through the full proposal/comment/finalization process under the previous POTUS—which are simply waiting on staggered implementation deadlines to fully take effect. Further complicating the picture will be the millions, if not billions, of dollars that the affected industry will have spent to meet the hurdles established by the fully finalized regulation.

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This is just the environment overhanging the Department of Labor’s (DOL) longstanding effort to strengthen the fiduciary standard as applied under the Employee Retirement Income Security Act (ERISA). The new fiduciary rule was finalized in June 2016, but it includes implementation deadlines stretching out into 2018, with the first roughly 10 weeks away. 

Since President Donald Trump finished his transition into power in the last week, many industry experts—attorneys, lobbyists and advisers—have opined that the fiduciary rule is most likely doomed. This is despite the fact that the advisory and investment industries have spent significant sums to bring business models, investing tools, sales practices and more into compliance.

The latest move in the more-than-decade-long fiduciary rule saga came Friday, when Politico published a copy of a White House memo issued January 20 by Reince Priebus, assistant to the President and chief of staff. The order has caused some conflicting interpretations among ERISA attorneys and others focused on the subject matter in that it clearly orders federal agencies to halt their work on rules that have not yet been made effective by being published in a finalized version in the Federal Register—at least until a Trump-appointed agency head grants a review and approval. It also seeks, “with respect to regulations that have been published [in final form] … but have not taken effect, as permitted by applicable law, to temporarily postpone their effective date for 60 days from the date of this memorandum.”

The order to executive agency heads continues: “Where appropriate and as permitted by applicable law, you should consider proposing for notice and comment a rule to delay the effective date for regulations beyond that 60-day period. In cases where the effective date has been delayed in order to review questions of fact, law, or policy, you should consider potentially proposing further notice-and-comment rulemaking.”

NEXT: Memo sees various interpretations 

Some have suggested this should be taken to include the DOL fiduciary rule, given the first compliance deadlines do not apply until April 2017. But as explained by David Levine, principal with Groom Law Group, it is important to note that the memorandum uses the term “effective,” not “applicable.”

“To me it is not at all obvious that this new memo would apply to the DOL fiduciary rule,” Levine tells PLANSPONSOR. “However, as you know, policy in our industry often circulates first as rumor or speculation, so I do agree that a delay in the rule’s implementation remains likely. But I don’t think this memo establishes that.”

Levine suggested it is likely that a direct order from President Trump regarding the fiduciary rule could be forthcoming imminently, and that this is likely what it would take for the fiduciary rulemaking to truly be paused or killed outright at DOL.

“Important to keep in mind is that under the Administrative Procedures Act, you can’t just say the rule is dead because you don't like it,” Levine observes. “The new administration needs a good reason and an effective process to do it. You can’t just get rid of the rulemaking without further rulemaking, in other words. Congress could do it outright, but given that it’s not a revenue item and it's not part of reconciliation, as far as I have heard, you would need 60 votes in the Senate, most likely.”

And so Levine puts a conservative bet on the likelihood that the Trump Administration will move directly, and soon, to re-propose a final rule that would substantially alter or even dismantle the rulemaking.

“The legal angle remains somewhat unclear, but there is also the business reality and the marketing angle of the fiduciary rule implementation,” Levine observes. “People have invested a lot of time and money in preparing for the rule and very few will want to just turn away from that. Some have already sold portions of their business or forged new partnerships to prepare. And so I still believe there will be a wide range of how people move forward. The vast majority will be in the middle, embracing some aspects of the fiduciary rule while resisting others.”

The full White House memo is available here on Politico’s website. 

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