Wells Fargo 401(k) Suit Challenges Use of Proprietary TDFs

With barely a month left in 2016, predictions that the rapid pace of retirement plan fee litigation would only accelerate during the year have largely proven true.

The latest lawsuit filed targets sponsors and fiduciaries of the Wells Fargo and Company 401(k) plan—calling out by name the Employee Benefit Review Committee and its members, as well as the Human Resources Committee of the Wells Fargo Board of Directors. Defendants are accused of violating their duties of loyalty and prudence in investing plan assets; plaintiffs are seeking class action status for a significant portion of the 350,000 invested in the defined contribution (DC) plan.

“Specifically, since at least 2010, defendants have engaged in a practice of self-dealing and imprudent investing of plan assets by funneling billions of dollars of those assets into Wells Fargo’s own proprietary funds,” the suit claims.

The complaint further suggests the benefit committee, with the knowledge and participation of Wells Fargo, the HR committee, and the other fiduciary defendants, selected as investments a class of mutual fund target-date funds (TDFs) and designed and maintained a system to maximize the amount of plan assets invested into those funds.

“Defendants did so by, among other things, defaulting certain participant contributions into the Wells Fargo target-date funds, and encouraging participants to purchase the funds through an ‘easy’ and ‘quick’ enrollment feature, where participants would, with a check of a box, dedicate all their future contributions into the Wells Fargo target-date funds,” the complaint suggests.

Whether or not the practice should be deemed problematic on its face under the Employee Retirement Income Security Act (ERISA), defendants go on to suggest the Wells Fargo TDFs “cost on average over 2.5 times more than comparable target-date funds while, at the same time, substantially and consistently underperforming those comparable funds.” The substantial cost inflation was due, according to the complaint, to the fact that Wells Fargo “double charged for its target-date funds—charging fees for both managing the target-date funds themselves, and managing the index funds underlying the target-date funds.”

NEXT: Details from the complaint 

The complaint suggests “this intentional funneling of participants into the target-date funds not only generated substantial revenues for Wells Fargo, but, with plan assets constituting more than one-quarter of total assets in the funds, it provided critical seed money that kept the funds afloat by boosting market share … Thus, defendants have, among other things, violated their fiduciary duties of loyalty and prudence and/or knowingly participated in such breaches to the detriment of the plan, and are liable to the plan for damages, equitable relief, and all other remedies available under ERISA.”

Like many of the recent ERISA complaints, this one will likely turn on whether or not the plaintiffs can prove there were alternative actions that their plan fiduciaries would have taken had they truly held participant’s best interest in mind—rather than the financial wellbeing of their employer.

To make the case, plaintiffs describe the plan’s investment menu: “At all relevant times, the plan offered a limited menu of 26 to 27 investment options to plan participants, approximately 16 of which were proprietary funds managed by Wells Fargo or its subsidiaries. Twelve of these Wells Fargo funds are the funds at issue here—a family of funds called Wells Fargo Dow Jones Target Date Funds (“Wells Fargo TDFs”) managed by a wholly-owned Wells Fargo subsidiary.”

The TDFs, known within the company as “lifecycle funds,” are offered in a suite with projected retirement dates spanning from 2010 to 2060 in five year increments, in addition to a fund with a target-date of current day. According to the complaint, the Wells Fargo TDFs employ what is known as a passive index-based strategy. The stated objective of the funds is to approximate the holdings and weightings of the Dow Jones Target Date indices for each corresponding target year. The Dow Jones Target Date indices are proprietary indices developed by S&P Dow Jones Indices, LLC, which provide benchmarks for target-date funds. Each Dow Jones Target Date index is a composite of subindices representing three major asset classes—stocks, bonds, and cash.

The text of the complaint suggests the Wells Fargo TDFs “approximate the holdings and weightings of the Dow Jones Target Date indices by investing exclusively in three proprietary Wells Fargo index funds: (1) the Wells Fargo Diversified Stock Portfolio, (2) the Wells Fargo Diversified Fixed Income Portfolio, and (3) the Wells Fargo Short Term Investment Portfolio … The underlying strategy of the Wells Fargo TDFs, which is to approximate indexes developed by others, is a passive investment strategy.”

Plaintiffs go on to suggest the expenses associated with the Wells Fargo TDFs “include a management fee component and an administrative fee component. There is also a charge related to the management of the underlying Wells Fargo index funds comprising the Wells Fargo TDFs. Therefore, Wells Fargo effectively double charges for the Wells Fargo TDFs—once for the services for the target-date fund, and once for the services associated with the underlying index funds.”

Plaintiffs feel a prudent and loyal fiduciary would not be satisfied with the fee arrangement as described.

“During the entirety of the class period, the benefit committee, with the full knowledge and participation of the other defendants, selected Wells Fargo TDFs for the plan and failed to eliminate them … In so doing, the benefit committee and other defendants knew or should have known that the Wells Fargo TDFs were substantially more expensive and worse performing than comparable funds.”

NEXT: Concluding arguments question easy enrollment 

The complaint goes on to suggest that a prudent fiduciary would have gone with one of many other TDF choices available to the plan, especially as the plan's default option. 

“The comparable funds include, for example, the Vanguard Target Retirement Funds managed by the Vanguard Group, Inc., and the Fidelity Freedom Index Funds managed by Fidelity Investments. Like the Wells Fargo TDFs, these funds are target-date retirement index funds which employ a passive management strategy based on indexes. For the entire class period, the net expense ratios of the Wells Fargo TDFs were at least 2.5 times more than the net expense ratios of the Vanguard and Fidelity Funds for comparable share classes,” the complaint concludes. “Vanguard and Fidelity charged no fees for managing the target-date funds themselves, and only charged fees for managing the index funds underlying the target-date funds.”

The complaint goes on to question the practices the plan has in place for defaulting participants into the Wells Fargo TDFs. According to plaintiffs, the plan offered an “Easy Enroll” and “Quick Enroll” feature, which was prominently offered in the summary plan documents provided to the plan participants throughout the class period.

“Under the current Easy Enroll feature, participants may, with the check of a box, automatically commit 6% of their pre-tax salary to the Wells Fargo TDF that matches their estimated retirement year based on age, with automatic one percent increases each year thereafter until their contribution reaches 12%,” the complaint suggests. “This system of funneling members into the Wells Fargo TDFs has helped put over $3 billion in plan assets into the Wells Fargo TDFs, which has been an important source of seed money for the funds. Indeed, investments from plan participants constitute approximately 28% of the total assets in the Wells Fargo TDFs.

“Further, an additional 29% of the assets in the Wells Fargo TDFs come from other Wells Fargo-directed activity, including third-party 401(k) plans where Wells Fargo serves as a third-party administrator,” the complaint concludes. “Thus, Wells Fargo-directed activity accounts for approximately 59% of the assets in the Wells Fargo TDFs.”

The full text of the complaint is available here.