Cash allocations in stable value fund that exceeded industry mean did not establish imprudence
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Monday, July 23, 2018

Cash allocations in stable value fund that exceeded industry mean did not establish imprudence

Pension and Benefits Editorial Staff

The investment of the assets of stable value fund in cash equivalents did not establish a claim of imprudent management, despite being more conservative than the mean of cash-equivalent allocations by other funds in the industry, according to the U.S. Court of Appeals in Boston (CA-1). Although the fund's cash-focused strategy may have radically departed from the logic and practices of stable value funds, such evidence was not sufficient in itself to state a claim of imprudence under ERISA.

Stable value fund investment in low return cash options

CVS Health Group sponsored an employee stock ownership plan (ESOP) that was managed by Galliard Capital Management, Inc., pursuant to appointment by the plan's benefits committee. The ESOP offered participants 16 investment options, including a Stable Value Fund, which held nearly $1 billion in assets. The express intention of the Fund was to preserve capital while generating a steady rate of return higher than that provided by money market funds. In accordance with the plan's stated investment objectives, more than one-half of the Fund's assets were invested in an EB Temporary Investment Fund that invested primarily in cash and cash equivalents. The EB Fund was used by other investors as a short-term investment option and offered only a low rate of return.

Plan participants who were disappointed in the investment return realized under the Stable Value Fund brought suit, alleging that Galliard breached its fiduciary duty by causing the Fund to invest in securities with extremely low yield, low durations, and excessive liquidity compared to expectations of prudently managed stable value fund investments. The participants also charged that CVS breached its fiduciary duties by failing to monitor and supervise Galliard and forcing it to change its policy of concentrating investments in cash-equivalent accounts that produced “abysmal” investment returns.

The participants specifically, maintained that when compared to other stable value fund investment averages (as reflected in a Stable Value Investment Association survey indicating a mean cash equivalent allocation of 5-10 percent) the investment of 27-55 percent of the Fund's assets in cash or cash equivalents was a “severe outlier” and “categorically imprudent.” The large investment in cash was also alleged to have depressed the Fund's performance by acting as an “enormous drag” on the overall Stable Value Fund portfolio and necessitating the payment of an unnecessary liquidation premium.

The fiduciaries moved to dismiss the complaint, maintaining that the allegation that Galliard allocated a relatively high proportion of fund assets to short-term, cash equivalent investments could not alone support a claim of imprudence. In January 2017, a federal magistrate issued a Report and Recommendation (R&R), recommending that the participants' claim be dismissed for failure to provide sufficient facts to raise an inference of imprudent investment management on the part of Galliard. A federal trial court in Rhode Island, agreed ruling that the investment strategy did not constitute a fiduciary breach because the fund's portfolio conformed to the plan's stated investment objectives. The prudence of the plan's investment strategy, the court stressed, could not be measured in hindsight, but needed to be determined by the specific context in which the investments were made.

Radical disparity from standard allocation practices is not imprudent

On appeal, the participants maintained that their imprudence claim against Galliard was not based on hindsight, asserting that the imprudence of the company's cash-focused investment strategy could be reasonably inferred from the fact that it radically departed from the practices and logic governing the management of such funds. As framed by the court, the participants effectively charged that Galliard was imprudent in managing the stable value fund, despite meeting the fund's stated investment objective of outperforming money market funds, solely because the fund was managed too much like a money market fund.

The court rejected the foundation of the participants' claim, finding no case support for the suggestion that the investment of the assets of a stable value fund in cash or cash equivalents, by itself, states a claim for imprudence under ERISA, even if such a strategy departs radically from industry averages and the underlying logic of stable value management. Unlike the putative precedents, the participants did not allege flaws in Galliard's decision-making processes that would support a reasonable inference of self-dealing or indicate that the fiduciaries assumed more risk than had been disclosed to participants.

Industry data not sufficiently specific to establish imprudence

Even while acknowledging the theoretical merit of the participants' theory, the court stressed that the participants did not establish the context for the imprudence charge, beyond evidence of the extent to which Galliard's cash-equivalent allocations deviated from the allocation averages in the stable value fund industry and, allegedly, from the inherent logic of stable value funds. Moreover, the evidence offered by the participants did not establish the radical deviation from standard value fund management practices that was necessary, even under the participants' theory, to establish imprudence.

The survey data cited by the participants established the mean cash equivalent allocation by funds participating in the survey. However, the data was insufficient with respect to cash equivalent allocations from individual funds to indicate that Galliard was a severe outlier. In addition, the data did not even address certain years in which Galliard management of the funds was allegedly imprudent.

Cash allocation higher than industry mean does not establish imprudence

The court finally concluded that the participants did not provide a theory that would make plausible the idea that the cash-equivalent allocations of a stable value fund are imprudent simply because those allocations are larger for a certain number of years than the mean allocation of 5-10 percent derived from all funds participating in an industry survey. In order to state a claim for imprudence under ERISA, the court stressed, the participants needed to establish evidence beyond the fact that the CVS fund's cash equivalent allocations were higher than the mean of the surveyed funds' allocations.

Source: Barchock v. CVS Health Corp. (CA-1).

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