Target Date Funds Platform Investment Options

Transcription

1 Target Date Funds Platform Investment Options The Evolving Tension Between Property Rights and Union Access Rights The California Experience By: Ted Scott and Sara B. Kalis, Littler Mendelson Kim Zeldin, Liner Grode Stein Yankelevitz Sunshine Regenstreif & Taylor LLP (Plaintiff/Employee) Debbie Davidson -- Morgan Lewis & Bockius LLP (Management) Bernard T. King -- Blitman & King LLP (Union) 1

2 Section 404(c)(1) of ERISA allows fiduciaries of participantdirected plans to be shielded from liability for the participants investment choices if conditions are met When the regulations were passed in 1992, many fiduciaries used low-risk money market or stable value funds as default investments In 2006, the Pension Protection Act permitted automatic enrollment into plans, which led to a major infusion of contributions DOL regulations passed in 2008 under Section 404(c)(5) of ERISA provided a safe harbor for fiduciaries when participants default on choosing their investments if the fiduciaries invest the funds in a qualified default investment alternative ( QDIA ), which may be one of three types of funds Target Date Funds ( TDFs ) are the most used QDIA 2

3 Target Date Funds ( TDFs ) A TDF is an investment product that takes into account the participant s age or retirement date and invests in a mix of investments that become more conservative as the participant approaches that date. From GAO Report on Target Date Funds, available at 3

4 Target Date Funds ( TDFs ) TDFs are often established as mutual funds in a fund-of-funds structure, with equity and fixed income components that invest in underlying funds. From GAO Report on Target Date Funds, available at 4

5 However, TDFs are not without controversy The GAO found that, during financial crisis in 2008, some TDFs designed for participants retiring in 2010 lost considerable value, while many participants were not aware that large losses were possible so close to the retirement date Additionally, many participants in TDFs pay higher fees than investors who select their own mutual funds, due to the fund-of-funds structure and the fact that many TDFs are actively managed 5

6 Controversy involving TDFs Different TDFs with the same target date can vary substantially Equity holdings between 26%-72% Performance varies Different glide paths Varying fees Range between.19% and 1.82% with half over 1.00% 10%-25% more expensive than other mutual funds on the platform Assumptions about participant behavior may not be accurate: studies show that 54% take a lump sum on retirement, while only 20% use systematic withdrawals over time 6

7 As a result of the controversy, the DOL and the SEC held a joint June 2009 hearing on TDFs The SEC then proposed a rule regulating the way in which investment companies can advertise TDFs In a separate proceeding, the DOL has proposed a rule outlining notice requirements for Plans with respect to participants whose contributions are invested in a TDF as the Plan s qualified default investment alternative 7

8 The proposed DOL rule, published at 75 FR (Nov. 30, 2010), would require that certain information be disclosed concerning default plan investments in TDFs, including: An explanation of the asset allocation, how the asset allocation will change over time, and the point in time when the investment will reach its most conservative allocation; An explanation of the age group for whom the investment is designed, the relevance of the date, and assumptions about the participant s or beneficiary s contribution and withdrawal intentions; A statement that the participant or beneficiary may lose money in the TDF, including losses near or following retirement; and An explanation where further information can be received According to the DOL s most-recent regulatory agenda, a final rule is expected to be published in November

9 Also known as gatekeeper cases Brought against insurance companies or other service providers that offer a platform of investments to trustees and plan sponsors of 401(k) plans In exchange for putting a mutual fund company s funds on its platform, the provider receives a share of the revenue attributed to investments in the fund The revenue share amount may or may not be credited back to the plan to offset expenses, depending on the case 9

10 $ Contributions Insurance Company s Separate Accounts Insurance Company fiduciary? ( any authority or control over plan assets) $ Plan Funds $ Revenue Sharing Payments Mutual Fund Complex 10

11 ERISA Platform Investment Cases Claim Asserted Breach of fiduciary duty under 404 Service provider has breached its duty of loyalty and prudence by taking revenue sharing payments in exchange for offering mutual funds on its investment option platform; also possible failure to disclose claims and failure to defray reasonable expenses of the plan if offset not given Prohibited Transactions under 406(b)(1) Service provider is self dealing in plan assets by accepting revenue sharing payments to include mutual funds on investment platform Prohibited Transactions under 406(b)(3) Service provider receives consideration for its own personal account in connection with a transaction involving plan assets Prerequisite for all counts: Service Provider s fiduciary status 11

12 Lack of fiduciary status Even if a fiduciary for a limited purpose, not one for purposes of revenue sharing payments Even if a fiduciary for this purpose, no breach because fees used to offset plan expenses Lack of plan assets Prohibited transaction exemptions Statute of limitations 12

13 Contribution, indemnity counterclaims sometimes asserted by service provider Circuit split on issue, e.g.: No: 8 th Circuit, 9 th Circuit Yes: 7 th Circuit, 2 nd Circuit 13

14 408(b)(2): Reasonable arrangement with parties in interest for necessary services for reasonable compensation 408(b)(5): An insurance company can sell insurance contracts to its own plan provided that the plan pays no more than adequate consideration 408(c)(2): Compensation to fiduciaries for services rendered 14

15 Does the provider have authority to add or delete funds from the line-up? Haddock v. Nationwide Financial Services Inc., 419 F. Supp 2d 156, (D. Conn. 2006) Ability to add or delete funds is enough discretion and control for fiduciary status: [a]n entity need not have absolute discretion with respect to a benefit plan in order to be considered a fiduciary. 15

16 Does the provider have authority to add or delete funds from the line-up? Healthcare Strategies v. ING Life Insurance & Annuity Co., 2012 U.S. Dist. LEXIS (D. Conn Sept. 26, 2012) Suggests in Rule 23 context that contractual right to delete and substitute mutual funds from menu gave provider discretion with respect to the administration of the plan sufficient to make it a fiduciary. Leimkuehler v. American United Insurance Co., 2012 WL 28608, at *7 (S.D. Ind. Jan. 5, 2012) (appeal pending) Ability to eliminate funds is a fiduciary function, but here was not exercised in the context of revenue sharing funds or within the appropriate statute of limitations. Zang v. Paychex, Inc., 728 F. Supp. 2d 261, (W.D.N.Y. 2010) Ability to substitute or delete funds subject to the rejection of the plan fiduciary, no fiduciary status. 16

17 Does the provider have authority or control over plan assets? Haddock v. Nationwide Financial Services, Inc., 419 F. Supp. 2d 156 (D. Conn. 2006). Revenue sharing payments can be considered plan assets if: (1) they are received by a fiduciary and (2) made at the expense of the plan participants. Compare Leimkuehler v. American United Life Insurance Company, 2010 WL (S.D. Ind. Oct. 22, 2010): Revenue sharing payments are mutual fund assets, not plan assets. 17

18 Healthcare Strategies Inc. v. ING Life Ins.& Annuity Co., C.A. No. 3:11-CV-282, January 18, 2012 (D. Conn. 2012): Accounts not plan assets, applying guaranteed benefit exclusion under ERISA section 401(b)(2). Court rejected HSI s claim that ING s right to make unilateral changes to the funding agreement rendered the exemption inapplicable, finding that because ING did not retain power to change contractually guaranteed benefits the change of contract provision did not convert excludable benefits into plan assets. 18

19 Frost Letter DOL Opinion Letter 97-15A A bank serving as a trustee of ERISA plans may have discretionary authority or control over plan assets if it has the right to add or remove families of mutual funds that it makes available to plans. Aetna Letter DOL Opinion Letter 97-16A Not a fiduciary if you just offer a menu of options. If a company provides ministerial services to a plan and retains the right to delete or substitute available investments, that company is not a fiduciary so long as the plan fiduciary makes the decision to accept or reject the change. 19

20 DOL argued platform provider is a fiduciary because it was given broad authority to manage the Plan s separate accounts, and make all of the accounts investments pursuant to governing documents that gave it broad discretionary authority to unilaterally alter the Plans investments, eliminate securities, transfer investments to other accounts, and choose the particular share classes in which the Plans invested Thus, DOL alleged violation of Section 406(b)(3) of ERISA for using such control to enhance its compensation by choosing mutual fund share classes with higher expenses 20

21 In the DOL s view, if the Service Provider retains discretion to unilaterally add, delete, or substitute the investment options without the prior consent of the Plan s fiduciaries, the Service Provider is more likely to be acting as a fiduciary to the Plan. The DOL s view is that this will hold true whether the Service Provider has such discretion in connection with the mutual funds included in the Plan s lineup or in merely the selection of the share classes of such mutual funds offered. Key questions: does the decision involve fees paid by the Plan, and is the decision made by the Service Provider without prior approval of the Plan? 21

22 Ruppert v. Principal Life Insurance & Annuity Company, 252 F.R.D. 488 (S.D. Iowa 2008) Class certification denied. Determining fiduciary status of Principal as to 24,000- plus plans required plan-by-plan analysis as would determining any breach of that status. Appeal dismissed by the 8 th Circuit for lack of jurisdiction due to settlement. 22

23 Haddock v. Nationwide Financial Services, 262 F.R.D. 97 (D. Conn. 2009) -- Citing 6 th Circuit Fallick decision, finds trustees of one plan have standing to pursue class action on behalf of other plans; class certified under b(2). Second Circuit vacates the decision, holding that individualized monetary claims belong in 23(b)(3) under Dukes v. Wal-Mart. Nationwide Life Insurance Company v. Haddock, 460 Fed. Appx. 26 (2d Cir. 2012). On remand, plaintiff renews motion for class certification. Oral argument heard before the district court December 18,

24 Healthcare Strategies, Inc. v. ING, No, 11cv-282, 2012 U.S. Dist. LEXIS (Sept. 27, 2012). Court says plan-by-plan inquiry into fiduciary status is not a basis for denying class certification. Court goes extra step and says that ING s unexercised contractual right to substitute and delete mutual funds from its menus made it a fiduciary for purposes of class certification. Statute of limitations arguments rejected. 24

25 Golden Star, Inc. v. Mass Mutual Life Ins. Co., No. 11- cv (D. Mass) filed October 19, 2011 Standard allegations Additional allegations challenging two funds that did not have plan assets one a guaranteed benefit fund policy, and one in which Golden Star never invested. Plaintiffs agreed to dismiss both claims in light of similar claims being dismissed in ING. Docket 27. Class briefing currently scheduled to be complete in March 2013 (Motion to Certify Class filed under seal) 25

26 Butler National Corp. v. Union Central Life, No. 12-cv-177 (S.D. Ohio) filed March 1, Allegations similar to the rest of the cases (almost identical to those in ING) No activity yet; defense has asked for an extension of time to answer 26

27 Plaintiffs generally* ask for some combination of the following relief: Declaratory judgment holding that the acts of the Service Provider violate ERISA; Permanent injunction against the Service Provider prohibiting practices at issue; Disgorgement or restitution of all revenue sharing payments and other compensation improperly received by the Service Provider; Disgorgement or restitution of all profits earned by the Service Provider in connection with its receipt of revenue sharing payments and other unlawful compensation; Compensatory damages; and Attorneys fees, costs, and other expenses of litigation (pursuant to Section 502(g)(1) of ERISA). *See Complaint, Golden Star, Inc. v. Mass Mutual Life Ins. Co., 3:11-cv (D. Mass, Oct. 19, 2011). 27

28 If Service Provider is held to be a fiduciary, it may argue that the Plan suffered no cognizable damages to the extent the total compensation received by the Service Provider was nonetheless reasonable under Sections 408(b)(2) and 408(c)(2) of ERISA, even including any alleged kick-backs. Argument would note that because the Plan paid no more than a market rate for the services it received, there was no loss resulting in damages owed by the Service Provider. Or, similarly, the Service Provider could argue that it should be liable only for any excess above what would be considered reasonable if there was a slight loss due to the alleged kick-backs. 28

29 Plaintiffs may point to National Security Systems, Inc. v. Iola, 700 F.3d 65, (3d Cir. 2012), where The Third Circuit rejected a similar argument in a different context. The court held that the prohibited transaction exemptions in Sections 408(b)(2) and (c)(3) of ERISA do not shield actions that otherwise violate Section 406(b). Therefore, to the extent the Service Provider is found to have violated Section 406(b) of ERISA, the Service Provider may be required to return any profit or revenue obtained on account of the violations, regardless of whether the total compensation received was otherwise reasonable. 29

30 Cash payment Structural Changes/Injunctive Relief Additional Fee Disclosures 30