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Compliance October 3, 2017
TDF Underlying Funds and Revenue-Sharing Disclosure Claims Dismissed in Lawsuit
The participant only prevailed in moving forward a claim that Verizon allowed an imprudent investment option to continue to be offered in its retirement plans.
Reported by Rebecca Moore
A federal court judge has dismissed claims against Verizon Communications retirement plan fiduciaries and Fidelity Investments over underlying investments in target-date funds (TDFs) and a lack of disclosures about revenue sharing in participant fee statements.
A participant in one of the Verizon retirement plans filed suit on her behalf as well as on behalf of participants in all of Verizon’s defined contribution (DC) plans, alleging Verizon created white label funds which include underlying funds and multiple layers of fess “that are nearly impossible for participant in Verizon’s plans to understand or evaluate.” The lawsuit specifically calls out target-date funds offered in the plans which include these white label funds as well as risky alternative investments.
The lawsuit alleges that all the TDFs underperformed low-fee, passively managed TDFs offered by Vanguard.
U.S. District Judge Paul G. Gardephe of the U.S. District Court for the Southern District of New York found the plaintiff’s claims to be insufficient. First, Gardephe noted that regarding TDFs, the Department of Labor (DOL) requires a plan to offer a “broad range of investment alternatives” that are “diversified” and have “materially different risk and return characteristics.” He also noted that a year after alternative investment funds were added to the TDFs, the rate of return for the TDF actually increased from 13.47% to 15.50%. According to Gardephe, asset allocations of TDFs are not required to take into account risk tolerances, investments or preferences of an individual participant.
In addition, according to the court opinion, while the plaintiff offered two charts labeled “Verizon vs. Vanguard Target Date Funds” and “Verizon vs. Custom Index Target Date Funds,” neither demonstrates Vanguard’s superior performance and none of the referenced Vanguard funds is a target-date fund.
Finally, Gardephe said, “Decisions in which courts have allowed allegations of imprudence to go forward rested on allegations that the defendants selected certain funds out of self-interest or demonstrated clear imcompetence.” Neither was alleged in the case, so the judge dismissed this claim.
Allegations Regarding Fee DisclosuresThe plaintiff in the case claimed Verizon defendants and Fidelity breached their fiduciaries duties when Fidelity failed to disclose its compensation and Verizon failed to correct the failure per the DOL’s 404(a)(5) participant fee disclosure rules.
Gardephe found that under the regulations, where an investment fund offered in a plan transfers to the recordkeeper some portion of its fees (revenue-sharing), plan administrators need not disclose the exact amounts remitted to the recorkeeper. Instead the regulations instructs plan administrators to provide an explanation that some of the plan’s administrative expenses are paid from the total annual operating expenses of one or more of the plans designated investment funds, either through revenue-sharing arrangements, 12b-1 fees or sub-transfer agent fees. Verizon’s participant fee disclosure include such an explanation.
The plaintiff also alleged that Fidelity breached its duties under the Employee Retirement Income Security Act (ERISA) by making misrepresentations of fees on the plans’ annual Form 5500 reports. Gardephe found lower courts have ruled that participants lack standing to assert a claim based on an alleged misrepresentation in a Form 5500.
He dismissed this claim and as the plaintiff had not alleged that Fidelity had any fiduciary duty of participant disclosure of fees or with respect to filing Form 5500, Gardephe dismissed Fidelity as a defendant in the lawsuit.
A Win on the Prudent Investment Claim
The plaintiff alleged that Verizon defendants breached their fiduciary duty with regard to the Global Opportunity Fund, which she says had “obvious and long-term underperformance over a ten-year period.”
Gardephe concluded that the plaintiff’s allegations were sufficient to state a claim. He noted that the complaints pleadings that the fund was a “core asset” of most of the Verizon plans’ investment options, that it wildly underperformed its benchmark over a ten-year period and barely surpassed the return of a money market investment, and that it charged an expense ratio higher than any other investment option available to participants were “sufficient to defeat a motion to dismiss.”