Sponsor Faces Class Action Challenge Alleging Self-Dealing

In another example of class action litigation spearheaded by the law firm of Schlichter, Bogard and Denton, participants in the Northrop Grumman Savings Plan accuse their plan sponsors and fiduciaries of paying excessive fees and using the benefit plan for purposes beyond exclusively promoting the financial well-being of employees.  

The proposed class was filed in the United States District Court for the Central District of California, Western Division, and cites 29 U.S.C. §1132(a)(2) and (3). Defendants named include “Northrop Grumman, the Northrop Grumman Savings Plan Administrative Committee, the Northrop Grumman Savings Plan Investment Committee, and the individual members of both committees and known delegees thereof for breach of fiduciary duties.”

According to the complaint, rather than complying with their strict fiduciary obligations, defendants “acted to benefit themselves and Northrop by paying Plan assets to Northrop purportedly for administrative services Northrop provided to the Plan, which were not necessary for administration of the Plan or worth the amounts paid. Defendants also caused the Plan to pay unreasonable recordkeeping fees to the Plan’s recordkeeper and mismanaged the Plan’s Emerging Markets Equity Fund.”

The complaint cites portions of key Northrop Grumman plan documents, challenging the process by which the company assembled and monitored both the administrative and investment committees. According to plaintiffs, failures to train and supervise members of the plan committees allowed the plan to fall into the habit of paying excessive fees and of otherwise breaching the demands of fiduciary oversight and prudence.  

“The predominant administrative expense for a defined contribution retirement plan is recordkeeping,” plaintiffs suggest. “Recordkeeping for the Plan was provided by a third party for millions of dollars … No additional services were necessary to administer the Plan, or, if any additional services were necessary, they were limited and could have been provided by a third party. Defendants, however, caused the Plan to hire Northrop—that is, for Northrop to hire itself—to provide purported administrative services, which served as a scheme to direct Plan assets to Northrop that were not payments reasonably related to any service the Plan needed or was provided.”

NEXT: Further conflicts of interest alleged 

According to plaintiffs, the plan’s administrative and investment committees entered into administrative services agreements (ASAs) “by which they arranged for paying Plan assets to Northrop purportedly in return for Northrop providing certain administrative and investment-related services to the Plan.”

“Northrop provided these purported services to the Plan through various Northrop corporate departments,” the complaint states. “The only departments that the ASAs authorized to perform services to the Plan or to receive reimbursement of expenses were: Benefits Administration and Services; Benefits Accounting and Analysis; Benefits Compliance; and Investments and Trust Management.

“The ASAs required the administrative committee to approve the reimbursement of expenses to Northrop’s Benefits Administration and Services, Benefits Accounting and Analysis, and Benefits Compliance departments,” the compliant continues. “The ASAs required the Investment Committee to approve the reimbursement of expenses to Northrop’s Investments and Trust Management department. Although the ASAs contain detailed requirements by which Northrop’s services and payments had to be approved before any services were provided and again after the service were provided but before payment was made, the Administrative Committee and Investment Committee failed to follow those requirements.

“They failed to follow the requirements of, among others, obtaining the opinion of an independent consultant that these services were necessary for administration of the Plan and that the charges therefore were reasonable and that the quality of the services and amount of the charges were equivalent to what an independent third party would charge,” plaintiffs allege. “Instead, in violation of the fiduciary duty to operate the plan solely in the interest of plan participants, on Northrop’s instruction, the Administrative Committee and Investment Committee allowed the heads of the very departments that were to be paid from Plan assets the authority to authorize payment of Plan assets to those departments.”

The complaint doesn’t stop there: “Moreover, Northrop sought to maximize the amounts charged to the Plan for expenses incurred by Northrop’s corporate departments regardless of whether those expenses were reasonable and necessary for the services provided or directly incurred in the operation and administration of the Plan. Northrop employees were motivated to, and did, charge time and expenses to the Plan which were impermissible in nature, unreasonable, and unnecessary.”

NEXT: Other issues called out 

According to the complaint, from January 1, 2007, to April 1, 2016, Hewitt Associates LLC has been the plan’s recordkeeper. Effective April 1, 2016, Fidelity Investments replaced Hewitt.

“From 2010 to 2016, Hewitt was compensated for recordkeeping services at a fixed rate of $500,000 per month plus transaction-specific payments, or a rate of $39.47 per participant per year on the basis of 152,000 participants in all Northrop defined contribution plans, with that rate reduced to $37 per participant per year when the plans had over 152,000 participants. At the same time, Hewitt provided recordkeeping services to Northrop’s health and welfare plans, defined benefit plans, and non-qualified plans for highly compensated executives,” plaintiffs explain.

However, the payment set forth above was not the only payment made to Hewitt, according to the compliant. Beginning in 2012, Hewitt also received indirect compensation from another plan service provider—Financial Engines.

“Financial Engines provides individualized investment advice to Plan participants to assist them with investing their retirement assets in the Plan. Financial Engines receives a fee based on the percentage of assets in the participant’s 401(k) account. Financial Engines shares or kicks back to Hewitt 25% of the asset-based advice fee and 35% of the asset-based professional management fees that Plan participants pay to Financial Engines for advice, yet Hewitt provides no advice,” the complaint states. “Hewitt provides no service to Financial Engines or the Plan participant to justify this payment to Hewitt from participants’ Plan assets.” (Also see Fleming v. Fidelity Management Trust Company.)

Thus, according to plaintiffs, “since Financial Engines provided its advice services for less than the fee that was being charged to participants who paid it, participants paid Financial Engines excessive fees for the services Financial Engines provided to them … Defendants failed to properly monitor Hewitt’s total compensation from all sources in light of the services Hewitt provided and thus caused the Plan to pay unreasonable administrative expenses to Hewitt.

“From 2009 through 2015, the number of participants, and in turn 401(k) accounts, Hewitt was required to recordkeep declined by over 31,000 (23%), from 134,000 to 103,000,” the complaint continues. “However, Hewitt’s flat compensation was not reduced … This caused Hewitt’s total recordkeeping compensation to increase by over 54% on a per-participant basis to $73 per participant per year, even though Hewitt’s recordkeeping services remained the same or declined. The amount of asset-based compensation Hewitt received from Financial Engines skyrocketed nearly ten-fold, increasing from approximately $258,120 in 2013 to over $2.3 million in 2015,1 even though the recordkeeping services provided by Hewitt to the Plan remained the same or declined.”

The full text of the compliant, which also includes arguments alleging the plan fiduciaries improperly accepted poor performance and high active management fees in an emerging markets equity fund,  is available here.