Proprietary Funds Prompt Another Participant Suit

Another 401(k) participant has filed suit against his employer for having “made a fortune off of the Plan’s investments in Proprietary Funds.”

This one, brought by a single plan participant, but seeking class action status, claims that the plan invested in funds offered and managed by Franklin Templeton, when “better-performing and lower-cost funds were available.” As has been the custom in such cases, the plaintiff alleges that the defendants were motivated to cause the plan to invest in Franklin Funds to benefit Franklin Templeton’s investment management business.

Basis ‘Points’

The suit claims that the plan paid $6.5 million per year in investment management and administrative fees, which it says, given the plan size, meant that the average total plan cost was over 57 bps in 2014 and 2015. However, it cites a BrightScope/ICI report that they claims shows that in 2013 the average 401(k) defined contribution plan with more than $1 billion in assets bore a total plan cost as a percentage of assets of 31 basis points – and it claims that the difference between those two figures is “almost entirely the result of the mutual fund fees paid to Franklin Templeton,” and that in the six-year period 2010–2015, the plan paid approximately $15 million more at the 57 basis points fee rate than did a plan at the 31 basis points fee rate.

The suit claims that the plan’s investment in the proprietary funds averaged approximately $750 million per year from 2010 to the present, and that the fees charged “are and were significantly higher than the fees available from alternative mutual funds.” The suit not only draws a negative comparison to the fees and those charged by passively managed institutional class funds, but also comparable separately managed accounts – which, it goes on to note, quoting the Department of Labor, could reduce investment management expenses to “one-fourth of the expenses incurred through retail mutual funds.”

The suit claims that all 40 mutual funds offered by the plan are managed by Franklin Templeton or its subsidiaries, though it also includes a company stock fund that invests in common stock of Franklin Templeton, and a collective trust managed by State Street Global Advisors that is intended to track domestic large-capitalization stocks as represented in the S&P 500 Index. In 2015, it notes that the plan also added three other collective trusts, also managed by State Street Global Advisors, to offer index tracking for international stocks, domestic small and mid-capitalization stocks, and bonds. That said, the suit alleges that prior to 2015, the S&P 500 Index Fund was the only passively managed, and only non-proprietary, option in the plan.

Proprietary TDFs

The suit claims that the plan fiduciaries decided to replace allocation funds of the plan with target date funds shortly before or during 2014, at which time they chose the “untested, expensive Proprietary Target Date Funds, despite the poor performance of its managers managing similar Asset Allocation Funds.” The plaintiff alleges that a “prudent, un-conflicted fiduciary would not have chosen untested, more expensive funds, particularly in light of the individual manager’s inability to succeed managing similar funds in the recent past.” The suit further claims that the plan “lost in excess of $64 million during the class period as a result of losses sustained by the Proprietary Funds compared to prudent alternatives such as comparable Vanguard Funds.”

The suit also criticized the plan for offering a proprietary money market fund, rather than a stable value fund (“paying Franklin up to 47 bps per year, while paying nothing at all to the Plan and its participants”), and lost in excess of $9 million during the class period as a result of losses sustained by the money market fund compared with stable value alternatives.

In addition to paying the “bloated expense ratios charged by Franklin Templeton on the Proprietary Funds,” the suit takes the fiduciaries to task for paying “a separate administrative fee, charged to each participant at a rate of $12.00 per quarter, or $48 per year.”

Similar suits have been filed against M&T Bank, American Century, MassMutual and PIMCO, to name just a few. That’s why offering proprietary funds is just one of the things on this list of things that means your plan might be an excessive fee litigation target.

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