A new excessive fee suit—one with some familiar themes, but also some unique arguments—claims that plan fiduciaries used participants as a “captive investor base to effectuate…self-serving business strategies that ran counter to the Participants’ interests.”
In a Nutshell
(Another) group of participants in (another) multibillion-dollar 401(k) plan have sued plan fiduciaries for their decision to rely (nearly) exclusively on fund options managed by their employer. They make similar arguments to that made in other excessive fee cases—that those decisions benefited the fund company, not participants, and that they were made despite better performing, less expensive options being available. There are, however, some new arguments. And a “new” law firm representing the participant-plaintiffs.
The suit—brought by eight participant-plaintiffs, it involves a plan with nearly $5 billion in assets, with about 23,000 participants—claims that the fiduciaries of the State Street 401(k) plan “selected for the Plan and repeatedly failed to remove or replace imprudent proprietary investment funds managed and offered by Defendant State Street Corporation and/or its subsidiaries or affiliates.” The funds, they claim, “were not selected and retained as the result of an impartial or prudent process, but were instead selected and retained because Defendants benefited financially from their inclusion in the Plan to the detriment of the Participants.”
The allegations here (Gomes v. State Street Corp., D. Mass., No. 1:21-cv-10863, complaint 5/25/21) are largely consistent with those made in other proprietary fund suits—here that the State Street Funds “underperformed their benchmarks and generated unreasonable fees, resulting in Plan losses and/or unjust profits for the Company.” Moreover that there was not only an imprudent selection, but an ongoing “failure to monitor the continued prudence of retaining State Street’s proprietary funds in the Plan,” and in this case that it was “…all the more egregious in light of the availability of other non-affiliated investment alternatives with the same investment objectives, that were less risky, less costly, and able to showcase a consistently superior performance record at all relevant times. There were even less costly shares available of the proprietary funds at issue that other State Street investors were able to invest in, but not the Plan.”
The plaintiffs also took issue with the applicable performance track record of the funds—not just that it lagged, but that “a prudent fiduciary, among other things, would have removed any State Street Target Retirement Fund after four consecutive calendar quarters of underperformance,” though there’s no reference point for that statement/conclusion. The suit does comment that “Leading money managers advise that decision makers should consider ten-year periods prior to investing” (again, without citation) while claiming that State Street “did not require so much as a one-year track record when it came to investing the Plan’s retirement monies in proprietary State Street funds.”
The suit sets aside (for a minute) the options of a non-proprietary money market fund and a so-called “brokerage window,” noting that by restricting choices to State Street Funds, the participants were used as “captive investors to prop up the Company’s investment management business, while other investors were exiting or decreasing their positions in these funds (more on that in a minute), and the Company was thereby losing the revenue from non-Plan investment sources.”
Indeed, the suit argues that, “No one investment management firm is good at everything. Some investment management firms excel at providing fixed-income investment products, others at equity investment products, and still others at international and emerging market investment products. Prudent fiduciaries for large plans understand this fact and accordingly take a ‘best of breed’ approach in assembling menus of retirement plan investment options for their retirement plan investors, carefully and diligently searching among the various vendors in the retirement plan investment product market to construct a suitable and appropriately low-cost and diversified array of investment options.”
As has been alleged in other suits, “there is no indication that Defendants conducted a proper bidding process or engaged in appropriate negotiations to lower the administrative costs during the Relevant Period.” The suit claims that. “pursuant to the Plan’s 2021 Participant Disclosure Notice, the recordkeeping and other administrative fees amount to $66 per participant”—contrasting that with a figure that is increasingly cited by the plaintiffs’ bar—drawn from litigation involving Fidelity’s (the recordkeeper here) own participant-litigation where they cited/stipulated a figure of $14-$21 per participant. And then turned to the 401k Averages Book (which arguably doesn’t offer data comparable to this plan) as citing a $5 per participant fee for plans much smaller (2,000 participants and $200 million in assets).
Acknowledging an important point, the plaintiffs note that, “There is no indication that the Plan receives any administrative services, including recordkeeping services, beyond those that are typically provided by Fidelity and other 401(k) service providers to comparable retirement plans,” and “no indication that the value of the administrative services provided to the Plan is any different than the value of such services provided to any other plan of comparable size.” Of course, that doesn’t mean that they aren’t.
All that said, the plaintiffs allege that “this directly resulted in over $615 million of fees and other revenue for State Street and improperly low investment returns for the Plan.”
The plaintiffs here claim that, based on the allegations presented, it was “not plausible” that “defendants faithfully followed a suitable Investment Policy Statement (‘IPS’), outlining the process of diversifying the Plan investments, so as to minimize the risk of large investment losses by the Plan and its Participants,” nor that “each and every one of the approximately 17 State Street Funds in the Plan was chosen and retained pursuant to a rigorous evaluation, screening, and monitoring process involving, for instance, an appropriately detailed comparison to similar funds offered by competitor investment fund vendors to see how State Street Funds compared to other vendors’ funds with respect to costs, fees, performance history, and other relevant metrics.”
If many of the arguments made and allegations presented were familiar—there were some unique twists. By way of supporting their claim of a lack of a prudent monitoring process “the Plan’s inaccurate financial reporting” regarding an investment option on the firm’s 2015 Form 5500. They also take particular issue with the use of the proprietary funds as the qualified default investment alternative (QDIA), as well as that the “vast majority of the underlying State Street Funds in which the State Street Target Retirement Funds invest” are actively managed funds, and thus “…not consistent with the ostensible index-oriented model upon which the Target Retirement Funds are based.”
The allegations also note that “…at least one of Defendants’ major fund family competitors outsources its retirement plan’s fund selection process to avoid the conflicts of interest that are the gravamen of this case,” they attempt to at least imply that a decision not to do so is, in fact, a conflict.
Another slightly different twist in their arguments—by way of contrasting the choices of the defendants with a peer group, that “Schwab, JPMorgan, and Great-West, just to name a few—offer their own workers target date funds as designated investment alternatives in their ERISA-covered company 401(k) plans that feature non-proprietary index funds as the underlying asset base of those target date funds…”
Another different argument—at least in terms of its specificity—is the plaintiffs’ tracking of other plans that had dropped those particular funds from their lineups, pointing to those decisions (and the lack of similar response by these fiduciaries) as being illustrative of their not acting prudently.
Now, as for that money market fund—and while these type claims have been made in other litigation, this one again takes a different tact. The suit says that while it was “the only non-proprietary retirement investment option Defendants offered,” it wasn’t “suitable” because of “its continuously poor track record,” citing issues with its one-, five- and ten-year numbers. But then the suit does take a different tack, arguing that “…in the wake of certain reforms implemented by the Securities and Exchange Commission in October of 2016 with regard to money market funds (‘Money Market Reform of 2016’), institutional investors, such as the Plan, were faced with increased risks or lower yields on their short-term money offerings”—and thus, “many retirement plans have removed the money market fund offerings from their investment menus and replaced them with stable value options.”
Here, of course, they point out that State Street did not do so and that “despite the availability of such other better performing and low-cost investment options to the Plan, and despite the implementation of the Money Market Reform of 2016, Defendants failed even to consider or evaluate the continued prudence of maintaining the Money Market Fund in the Plan during the Relevant Period, wholly disregarding the fund’s repeated failure to meet its designated benchmark, or other risks and deficiencies posed to the Plan by this investment.” Oh, and because they didn’t go with a stable value alternative, the plaintiffs claim that it cost participants “almost $8 million in lost earnings during the Relevant Period,” and that if they had chosen a collective investment trust version, “participants would have gained over $13 million in their retirement accounts.”
In essence, the plaintiffs argue that, “instead of acting in the Participants’ best interests, Defendants’ conduct and decisions were driven by their desire to drive revenues and profits to State Street and to generally promote State Street’s business interests to the detriment of the Plan and its Participants,” that they “accomplished this by loading the Plan with State Street Funds, despite the fact that Participants would have been better served by being able to choose less expensive and better performing investment options managed by unaffiliated companies, that were readily available to the Plan, with its significant bargaining power, at all relevant times.” Moreover, that in addition to the “exorbitant multi-million-dollar fees, Defendants’ self-serving conduct enabled the Company to build up its investment management business, thereby increasing its visibility and improving its prospects in the asset management marketplace, ultimately bolstering the Company’s bottom-line, market value, and business opportunities at the expense and to the detriment of the Plan.”
“Participants (and their hard-earned retirement investments) were used as a captive investor base to effectuate State Street’s self-serving business strategies that ran counter to the Participants’ interests,” the plaintiffs write. “As a result of Defendants’ blatant self-dealing, the Plan-related investment decisions undertaken by Defendants during the Relevant Period, or their failure to act to protect the Plan, were imprudent and disloyal, and furthermore resulted in prohibited transactions under ERISA.”
The plaintiffs here are represented by Scott & Scott LLP and Peiffer Wolf Carr Kane & Conway LLP—the former positions itself as a technology law firm. Apparently, they’re “branching out.”
NOTE: In litigation there are always (at least) two sides to every story. However factual it may turn out to be, the initial lawsuit in any action is only one side, and one generally crafted toward a particular result. In our coverage you’ll see descriptions of events qualified with statements such as “the suit says,” or “the plaintiffs allege”—and qualifiers should serve as a reminder of that reality.