By Pension and Benefits Editorial Staff
Allegations of high fees, chronic underperformance against benchmarks and comparable funds, and specific legal and financial warning signs supported a plausible claim that a plan sponsor breached its fiduciary duty of prudence by utilizing an imprudent decision-making process in managing the plan’s investment funds, according to a federal trial court in Georgia. However, claims that the plan’s investment advisors breached their duties of loyalty and prudence in providing services, or committed a self-dealing prohibited transaction by engaging in a “reverse churning” scheme, in which asset-based fees were charged for low maintenance accounts, were dismissed.
Underperforming and costly investment options. Home Depot sponsored and administered a 401(k) plan for its employees. Alight Financial Advisors (AFA) and Financial Engines Advisors (FEA) were retained by Home Depot to provide investment services for the plan.
Plan participants brought suit under ERISA, charging that Home Depot imprudently selected and retained investment options for the plan that poorly performed and charged high asset-based fees. The participants further charged that the selection and retention of FEA and AFA as investment advice service providers by Home Depot was imprudent because the advisors (in violation of their own fiduciary duties of prudence and loyalty) charged high asset-based fees, provided poor customer service, and furnished substandard advisement services. Finally, the participants maintained that the investment advisors engaged in prohibited self-dealing by engaging in a “reverse churning” scheme, under which the advisors, by charging expensive asset-based fees for investments with low trading activity and no need for ongoing monitoring or advice, were able to limit the time they spent on customer service and investment advice, allowing them to focus on recruiting additional customers and, thereby increase profits.
Plan sponsor’s duty to prudently manage plan. The participants charged that Home Depot utilized a “faulty investment process” that was tainted by imprudence because it allowed the retention of investment funds that had a long history of underperformance relative to their benchmarks. In moving to dismiss the claim, Home Depot argued that: (1) the allegations of poor investment fund performance, without specific allegations of actual imprudent conduct by Home Depot did not sufficiently state plausible prudence claims, and (2) the participants did not plausibly allege that the performance of any investment fund required removal from the plan.
The court initially conceded that the plan participants did not identify specific flaws in Home Depot’s decision-making process. However, the court advised that, at the motion to dismiss stage of litigation, plaintiffs are generally allowed to rely on circumstantial factual allegations to illustrate a flawed process with respect to the alleged mismanagement of underperforming investments.
Circumstantial evidence introduced by the participants indicated that the plan’s investment funds consistently underperformed other comparative funds relative to their benchmarks, while imposing higher management fees. In addition, the participants cited legal and financial issues that, they charged, should have alerted a prudent fiduciary to deficiencies in the plan’s investment options.
Relying on Meiners v. Wells Fargo & Co. (CA-8 (2018), 898 F.3d 820), Home Depot argued that the participants’ allegations did not state a claim because they did not cite actual performance data or present meaningful benchmarks. The court, however, was “unconvinced” that the participants’ factual allegations of performance date and benchmarks could not lead to a reasonable inference of imprudence in Home Depot’s decision-making process. Noting that the participants did not yet have access to Home Depot’s specific methods or other knowledge, the court found that the allegations of high fees, chronic underperformance against benchmarks and comparable funds, and specific legal and financial warning signs were sufficient circumstantial evidence of Home Depot’s imprudent management of the plan. The allegations further supported a reasonable inference that Home Depot utilized an imprudent decision-making process in managing the plan’s investment funds.
Failure of plan sponsor to monitor investment advisors. The court next noted that allegations of a failure to monitor investments and investment advisors, and to remove imprudent selections, must be supported by factual, even if circumstantial, allegations allowing for a reasonable inference of a flawed process by the fiduciary. The participants charged that: (1) comparable investment firms charged lower fees; (2) lower fees were offered to participants in other compatible plans; (3) Home Depot failed to conduct competitive bidding; (4) the plan’s investment options imposed duplicative advisory fees; (5) the plan’s recordkeeper received kick-backs that unreasonably increased the advisory fees that were charged to plan participants; and (6) Home Depot allowed the investment advisors to engage in the self-dealing reverse-churning scheme. Taking into consideration all of the circumstantial factual allegations regarding Home Depot’s retention of the investment advisors, the court determined that the participants had alleged sufficient facts to support an inference of an imprudent decision-making process.
Breach of duty of loyalty by investment advisors. The participants further contended that FEA and AFA breached their duties of loyalty and prudence in providing investment advice by: improperly charging excessive fees, making no effort to determine whether the asset-based fee arrangement was in the best interest of plan participants, failing to perform ongoing assessment of the plan participants’ lifestyles or financial situations to determine if the current investment strategies remained in their best interest, and failing to respond to attempted communications or otherwise make themselves available to plan participants. The investment advisors maintained that they could not be liable for any fiduciary breach with respect to their fees because they did not act as fiduciaries with respect to negotiating or collecting the fees.
The court agreed with the advisors that the participants’ allegation of fiduciary breach arising out of FEA’s and AFA’s negotiation and collection of its fees were not sufficient to state a fiduciary breach claim. A service provider, the court explained, does not become a fiduciary simply by negotiating its compensation in an arm’s-length bargaining process, especially where the provider does not have the ability to control the actual amount of its compensation. Accordingly, FEA and AFA did not function as fiduciaries with respect to the issue of fees.
Reverse-churning prohibited transaction. In charging the investment advisors with operating a reverse-churning scheme, the participants suggested that FEA and AFA, by charging asset-based fees for low maintenance accounts, engaged self-dealing prohibited under ERISA Sec. 406(b). However, the court found that the participants failed to identify any transaction violating ERISA Sec. 406(b), concluding that FEA’s and AFA’ collection of previously negotiated and agreed upon fees did not constitute self-dealing.
Source: Pizarro v. The Home Depot, Inc. (DC GA).
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