Pension & Benefits News Concentration of affiliated funds in plan of investment management company did not state claim for fiduciary breach
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Tuesday, January 7, 2020

Concentration of affiliated funds in plan of investment management company did not state claim for fiduciary breach

By Pension and Benefits Editorial Staff

Claims by a participant in a 401(k) plan sponsored by an investment management company that plan fiduciaries breached their duties under ERISA by “stacking” the plan with underperforming high cost affiliated investment options, were dismissed by a federal trial court in Georgia. However, noting the concentration of affiliated funds in the plan and the restricted access of participants to non-affiliated options, the court allowed the participant leave to amend the complaint to state more specific claims of fiduciary breach.

Plan investment menu dominated by proprietary funds. Invesco Holding, an independent investment management company, sponsored a 401(k) plan for its employees. The plan is one of the largest in the United States, holding over $890 million in assets and covering over 3,700 participants in 2016.

Under the plan, participants could invest their contributions by: (1) selecting a set of investment funds designated by the plan’s investment managers (Invesco subsidiaries) or (2) opening a self-directed brokerage account with Charles Schwab & Company. The Schwab Account restricted participant choices to exchange traded funds (ETFs) affiliated with Invesco, effectively preluding investment in ETFs offered by competitors of Invesco.

The Invesco Benefit Plan Committee (IBPC) served as the named fiduciary of the plan. The IBPC was comprised of senior Invesco executives and empowered with “exclusive responsibility and complete discretionary authority to control the operation, management and administration of the plan.”

A plan participant brought a putative class action suit, alleging fiduciary breach by Invesco, IBPC, and related entities. Specifically, the participant charged that the fiduciaries failed to act prudently and in the exclusive interest of plan participants by “stacking” investment options with between 55 percent and 68 percent Invesco-affiliated options. In some categories, (e.g., high yield bond and diversified emerging markets), the participant further maintained, the options were limited to Invesco-affiliated products, despite the fact the affiliated options underperformed and charged higher fees than readily available alternatives. Highlighting the argument, the participant noted that, of the 25 total investment options offered in 2017, 15 were Invesco-affiliated. Of the 15 actively-managed options, only one was not affiliated with Invesco. Moreover, between 2012 and 2017, 9 investment categories provided only Invesco-affiliated options.

The participant also charged that Invesco and the benefit plan committee engaged in prohibited transactions with the Invesco-affiliated investment managers. According to the participant, the fiduciaries steered plan participants from the Invesco Emerging Market Equity Trust (with an operating expense of 0.21 percent) into the Invesco Developing Markets mutual fund (with an operating expense of 1.01 percent), even though the latter fund had a track record of underperformance.

Significantly, the participant did not allege that the mere selection of the Invesco-affiliated funds constituted a prohibited transaction. The alleged prohibited transaction arose from the fact the transactions allowed for an excess of reasonable compensation, were not selected solely in in the interest of plan participants, and were based on terms less favorable than could have been procured if the transaction was the product of arms-length negotiations with outside investors.

Finally, the participant alleged that Invesco and IBPC engaged in prohibited transactions because the Invesco executives on the committee received financial benefits, under the Invesco Executive Incentive Bonus Plan for increasing assets under management. According to the participant, the bonus plan provided a “strong personal incentive” for IBPC executives to steer participant contributions towards Invesco-affiliated investments. As a result of such incentives, the participant noted, by December 31, 2016, 81 percent of plan participant investments (representing nearly $570 million) were in Invesco-affiliated funds.

The fiduciaries moved to dismiss all the participant’s fiduciary breach claims for failure to state a claim. The fiduciaries further maintained that the prohibited transaction claims were time-barred.

Fiduciary breach requires more than allegation of fund underperformance. In moving to dismiss the fiduciary breach charge, the fiduciaries argued that general allegation regarding poorly performing funds or excessive fees are not sufficient to state a claim. Suggesting that the participants were merely alleging fiduciary breach from the underperformance of certain funds, the court found that the participant failed to “plausibly plead” underperformance. Specifically, the court noted that: (1) the participant did not provide benchmarks or plead the rankings of selected Invesco funds for each year in the class period; (2) the performance of the targeted funds over a 6-year period was mixed, with some Invesco funds actually outperforming alternative funds cited by the participants; and (3) the participant failed, with one exception, to “plead anything” regarding the fees or expense ratio of any of the funds. The fact that the participant alleged a single instance of a questionable decision by the fiduciaries in the last 6 years, the court advised, did not “in and of itself create an inference of wrongdoing.”

However, noting that 81 percent of investments by plan participants were in Invesco-affiliated funds, that the executive bonus plan incented committee members to increase assets under management, and the access of participants to non-Invesco-affiliated funds was restricted, the court granted the participant leave to amend the complaint. A “more carefully drafted complaint,” the court advised, could allow the participant to state a claim for fiduciary breach.

Prohibited transaction claims too generalized to state a claim. The fiduciaries also moved to dismiss the participant’s prohibited transaction claims regarding the selection of the affiliated funds under the reasonable compensation exemption set forth under ERISA Sec. 408(b). In addition, the fiduciaries stressed that the governing ERISA regulations and PTE 77-3 expressly allow mutual funds advisors and their affiliates to invest in affiliated mutual funds.

In satisfying its burden to prove application of the 408(b) exemption, the fiduciaries argued that the fees charged by the Invesco-affiliated funds were within ranges found by other courts to be reasonable as a matter of law. The court expressed reluctance to address the reasonableness of compensation issue on a motion to dismiss, as a matter of law, given a plaintiff’s generally limited access to information in support of a claim. However, the participant in the instant case did not cite a lack of access to the compensation paid to the parties in interest. The court found that the class representative satisfied the requirements for Article III standing, although he had not participated in every investment option or service under the plan. However, the court reserved ruling as to whether the participant had established standing to bring claims on behalf of the putative class members. Similarly, the participant’s charge that the exemption under PTE 77-3 was inapplicable was stated in a conclusory manner. The participant did not identify fund fees or expense ratios, compare them to similar non-Invesco-affiliated funds, indicate whether the investment managers charged the plan different fees from their standard fees, or claim that the information was not available to him.

The prohibited transaction claims, therefore, were dismissed for failure to state a claim. However, the participant was again allowed leave to amend the complaint to plead specific facts supporting the claim.

Source: Cervantes v. Invesco Holding Company (U.S.) (DC GA).

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