Proprietary Fund Suit Survives Dismissal Motion

Another financial services provider has failed to win dismissal of a suit brought by participants in its plan challenging the use of proprietary funds.

The most recent action, following on a suit brought last summer in the U.S. District Court for the Western District of Missouri Western Division by a current and former participant of the American Century plan, alleged that “at all stages, both in selecting the Plan’s designated investment alternatives and in monitoring those investments, Defendants only considered investments affiliated with American Century, in furtherance of their own financial interests, rather than the interests of Plan participants.”

The American Century defendants had moved to dismiss the suit on two primary grounds; that the claims were barred by a three-year statute of limitations, and that the suit failed to state a claim for relief. However, in Wildman v. Am. Century Servs., LLC (W.D. Mo., No. 4:16-cv-00737-DGK, 2/27/17), Chief Judge Greg Kays denied the motions.

The Allegations

In outlining his decision, Judge Kays noted that the plaintiffs in the case allege since 2010 the plan’s investment options were “a limited selection of American Century mutual funds, American Century collective investment trusts, and shares of American Century Companies, Inc. Class C common stock.” Plaintiffs estimate the plan costs were 0.73% in 2010 and 0.65% in 2013, and that the total plan cost was “extremely high for a defined-contribution plan with a similar amount of assets,” which they claimed would be 0.53% in 2009 (the only data available comparable to 2010), and 0.44% in 2013.

The suit alleged that the plan fiduciaries improperly managed plan assets for their own benefit, specifically by:

  • using a disloyal and imprudent process to manage the plan;
  • retaining high-cost proprietary funds in their own self-interest and to the detriment to plan participants;
  • failing to procure the least expensive available share class for numerous funds;
  • causing the plan to pay excessive recordkeeping costs; and
  • failing to adequately monitor investments and remove poor performing investments.

Plaintiffs also allege American Century Services, LLC (ACS) failed to monitor the performance of the Committee and American Century Investment Management, Inc. (ACIM), including monitoring the process used to select, evaluate and retain the plan’s investment lineup.

Plaintiffs further allege that the plan fiduciaries caused the plan to engage in prohibited transactions with ACS and ACIM through a revenue sharing agreement between ACS, ACIM and the plan, that the revenue sharing agreement allowed ACIM to deduct fees from plan assets for services it provided and paid a portion of those fees to ACS in what amounted to “…more than reasonable compensation” that “resulted in significant losses to the Plan participants.” Moreover, the plaintiffs alleged that they did not have knowledge of the material facts to support their claims until “shortly before this suit was filed.”

Statute of Limitations

American Century first argued that the plaintiffs had actual knowledge of the underlying alleged violation through publicly available records more than three years before bringing this suit. However, Judge Kays noted that the shorter, three-year statute of limitations requires “a plaintiff have actual knowledge of all material facts necessary to understand that some claim exists,” that, citing Caputo v. Pfizer, Inc., it was “not enough that [the plaintiffs] had notice that something was awry; [the plaintiffs] must have had specific knowledge of the actual breach of duty upon which [they sued].” And then determined that the defendants hadn’t (yet) established that the plaintiffs had that actual knowledge “of the material facts underlying the allegations of breach of fiduciary duties and engaging in prohibited transactions more than three years prior to commencing this action,” even though they had been provided disclosures because it was not proved that they had access to benchmarking information that established the excessive nature of the fees charged.

Failure to State a Claim

Defendants also pressed that the case should be dismissed for failure to state a claim, specifically that they had not adequately alleged a deficient process for selecting investments.

Even when the complaint does not allege facts showing specifically how the fiduciaries breached their duty through improper decision-making, a claim can survive a motion to dismiss if the court may reasonably infer from what was alleged that the fiduciaries followed a flawed process.

The court noted that American Century challenged the plaintiffs’ allegations on six grounds:

The plan’s use of American Century Funds is not improper.

Judge Kays said this challenge mischaracterized the limiting of options to American Century funds in order to benefit the firm, and that the availability of a self-directed brokerage option was “irrelevant to determining whether Defendants used a disloyal and imprudent process to select the other investment options.” The judge also pushed aside an argument that the “generous contributions” to the plan by American Century established that the firm wasn’t acting in its own self-interest, noting that the factual dispute couldn’t be resolved at this stage.

Fiduciaries are not required to select lowest-cost investments.

Here Judge Kays said this wasn’t the issue – that the issue was the process they used to select the proprietary options, not that they weren’t the cheapest, though he said that the “specific allegations regarding the excessive fees support an inference that the Plan’s fiduciaries’ process was deficient.” Similarly he found issues of the applicability of the comparisons a factual issue that couldn’t be resolved as part of a motion to dismiss.

Plaintiffs do not adequately plead the recordkeeping costs were excessive.

Judge Kays found that the allegations alleging the amounts paid to the recordkeeper and reasonable recordkeeping fees were sufficient, and that, “importantly, Plaintiffs plead facts that state Defendants failed to seek alternative recordkeeping providers,” which he felt were sufficient to “raise an inference of a deficient decision-making process for recordkeeping services.”

The delay in moving assets to a lower-cost share class is not a breach.

Offering a money market fund instead of a stable value fund is not a breach.

The existence of some underperforming funds is not a breach.

Judge Kays noted that while the “defendants attack these allegations individually,” viewed “collectively in conjunction with Plaintiffs’ allegations that Defendants’ decisions were motivated by self-interest and reflected a failure to act as a prudent investor, these allegations sufficiently support a claim for breach of fiduciary duty.”

In sum, Judge Kays determined that the plaintiffs “…plausibly stated a claim for breach of the duty of loyalty and prudence,” and that the amended complaint, read as a whole, “supports an inference that Defendants managed the Plan with a flawed decision-making process.” Moreover, he determined that the amended complaint “supports an inference Defendants did not employ the appropriate methods to investigate the merits of the funds within the Plan’s investment lineup, thereby failing to act as a prudent investor.”

And dismissed the motion to dismiss for failure to state a claim, noting also that the amended complaint states a claim for equitable relief.

Bloomberg BNA notes that the ruling marks the seventh time in less than a year that federal judges have refused to dismiss lawsuits targeting financial companies that put their own investment products in their own 401(k) plans (BB&T Corp., Allianz Asset Management of America, Putnam Investments LLC, Deutsche Bank, Franklin Resources Inc. and Edward D. Jones & Co.). In February, New York Life Insurance Co. said it would pay $3 million to settle similar claims over its 401(k) plan.

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