Pension & Benefits News Plan requirement restricting investment options to in-house funds did not allow for dismissal of fiduciary breach claims
Friday, November 9, 2018

Plan requirement restricting investment options to in-house funds did not allow for dismissal of fiduciary breach claims

By Pension and Benefits Editorial Staff

The requirement in a plan maintained by a financial services company that trustees invest exclusively in in-house mutual funds was not sufficient to warrant dismissal of plan participants' fiduciary breach claims, according to a federal trial court in Maryland. Accordingly, plan participants were allowed to proceed to discovery on claims that plan trustees imprudently continued investments in underperforming, expensive retail funds, in addition to fiduciary breach and prohibited transaction allegations.

Exclusive investment in underperforming in-house funds. T. Rowe Price, a large mutual fund and financial services organization sponsored a 401(k) plan for its employees. The company structured the plan so as to restrict plan investment options exclusively to T. Rowe Price funds.

Affiliates of T. Rowe Price provide investment advisory services to all of the company's in-house mutual funds and serve as the trustees and investment managers of the in-house funds in the plan. The trustees are named plan fiduciaries and are empowered to select, monitor, and remove or replace investments offered in the plan. Two T. Rowe Price management committees are further authorized to appoint and remove the trustees.

Plan participants, citing the underperformance and expenses of the plan investment options, brought suit under ERISA against the plan trustees and other fiduciaries, alleging breach of the duties of loyalty and prudence, failure to monitor the trustees, and prohibited transactions. Generally, the participants charged that the fiduciaries favored the economic interests of the company and its affiliates over the interests of the participants by restricting the plan to underperforming retail in-house funds and collecting windfall profits through excessive fees. T. Rowe Price moved to dismiss all of the participants' charges for failure to state a claim. The court denied the motion.

Fiduciary breach by trustees in selection and monitoring of plan investments. The centerpiece of the participants' action was the charge that the plan trustees breached their duties of loyalty and prudence in the selection and monitoring of the investments for the plan, resulting in significant losses to the plan and its participants. According to the participants, the trustees gave preferential treatment to the in-house funds, despite “chronic” underperformance, because those funds financially benefitted T. Rowe Price and its subsidiaries. Detailed expenses provided by the participants indicated that the expense ratios for the plan's funds were 16-2,500 percent higher than comparable funds.

The participants further charged that the trustees selected and/or failed to replace higher cost retail versions of the in-house funds, even though lower-cost institutional share class funds and collective trusts were available. The participants cited numerous examples in which plan participants were restricted to retail class versions of in-house funds, while the company offered less expensive versions of the same funds to its commercial customers.

Finally, the participants maintained that the company used plan assets to “seed” T. Rowe Price's newly created funds. Plan assets would not be moved to the less expensive, identical versions, the participants averred, until the new funds attained sufficient marketability to attract outside investors.

The trustees countered, in defense, that they were required by the plan to restrict the plan investment line-up to T. Rowe Price funds. In addition, the trustees argued, the decision of T. Rowe Price to structure the plan to contain the restriction was within its settlor function, and was not subject to ERISA's fiduciary rules.

The court initially acknowledged that ERISA allows financial services companies to offer employees proprietary funds under their 401(k) plans. However, the court cited precedent for the rule that fiduciaries are empowered with authority and responsibility to exclude company stock from a plan, regardless of plan dictates, if the stock proves to be an imprudent investment (In re: Polaroid ERISA Litigation, DC NY (2005), 362 F. Supp. 2d 461). Thus, regardless of the reasoning that T. Rowe Price may have relied on to restrict the trustees to investing only in in-house funds, the court stressed, “it does not provide a blanket defense” for the plan trustees. The court then concluded, the participants' factual allegations, taken in combination, allowed for a plausible inference that the trustees breached their duties of loyalty and prudence in the selection and monitoring of the plan investments

Self-dealing prohibited transactions.  The participants finally charged that the plan trustees and the T. Rowe Price investment affiliates were parties in interest who engaged in self-dealing by acting in concert to cause the plan to be invested in T. Rowe Price funds, knowing that the investments would result in the plan paying investment management and other fees to the investment affiliates on a monthly basis for more than reasonable compensation. The fiduciaries countered that the transactions were exempt under ERISA Sec. 408(b)(8). Moreover, they argued that the plan participants were required to establish that the transactions were not exempt (i.e., allowed for compensation in excess of a reasonable amount) because the investments in the in-house products was required by the plan.

Misplaced reliance on ERISA Sec. 408(b)(8). Initially, the court suggested that the fiduciaries' reliance on ERISA Sec. 408(b)(8) was misplaced. The parties were not challenging the investments, the court explained, but the reasonableness of the fees associated with those investments.

Continuing duty to monitor trust investments. The fiduciaries asserted that the participants’ prohibited transaction claims were time-barred under ERISA's statute of limitations. Arguing that the only transaction attributable to the trustees was the initial inclusion of funds in the plan, the fiduciaries asserted that funds initially offered to plan participants more than six years before the initial complaint was filed in February 2017 were time-barred.

The participants countered that plan fiduciaries have a continuing duty to monitor and remove imprudent trust investments (Tibble v. Edison, Int'l, U.S. Sup. Ct. (2015), 135 S. Ct 1823). While acknowledging that Tibble does not relate to ERISA Sec. 406 prohibited transactions, and that the decision to maintain certain investments cannot constitute a transaction for purposes of ERISA Sec. 406 (David v. Alphin, CA-4 (203), 704 F. 3d 327), the participants stressed that the prohibited transactions at issue were the monthly fees being paid by the trustees to the T. Rowe Price affiliates, and not the initial selection of the plan investments. Therefore, the participants reasoned, the alleged prohibited transactions did occur within the required six-year period.

In response, the fiduciaries stressed that the trustees were not causing the monthly fee transactions to be paid for by the plan. Rather, the fiduciaries explained, the investment affiliates were charging monthly fees to the assets of the mutual funds, so that there was no direct transaction between the plan or the trustees and the T. Rowe Price investment affiliates.

The court conceded the viability of the fiduciaries' alleged defense. However, the court concluded that those putative defenses did not warrant dismissal of what it viewed as plausible prohibited transaction claims that were not time-barred.

SOURCE: Feinberg v. T. Rowe Price Group, Inc. (DC MD).

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