Putnam Partially Prevails in Proprietary Fund Suit

Putnam Investments took to trial and won several key counts in a suit brought by participants in its own 401(k) plan.

Specifically, the court published the results of its determinations on a hearing conducted on Feb. 28, 2017 as to counts II and III of the complaint.

In this case (Brotherston v. Putnam Invs., LLC, 2017 BL 103953, D. Mass., No. 1:15-cv-13825-WGY, 3/30/17), the participant plaintiffs had alleged (as have a number of recent suits brought by participants against their provider-employer plans) that the defendants “have loaded the Plan exclusively with Putnam’s mutual funds, without investigating whether Plan participants would be better served by investments managed by unaffiliated companies.”

Case History

The suit claimed that that the defendant’s actions cost “Plan participants millions of dollars in excess fees every year,” going on to claim that in 2013 “the Plan’s total expenses were 66% higher than the average retirement plan, with between $500 million and $1 billion in assets (the Plan had $589 million in assets as of the end of 2013), costing Plan participants at least $1.72 million in excess fees in 2013 alone.” The suit also claimed that the plan fiduciaries “have failed to remove poorly performing investments from the Plan, in breach of their fiduciary duties,” and “have no process for selecting mutual funds for the Plan, indiscriminately adding every mutual fund that Putnam offers into the Plan.”

Specifically, the suit notes that between 2009 and 2015, more than 85% of the plan’s assets were invested in Putnam mutual funds, in two share classes; Y shares and R6 shares. At the end of 2009, the Plan owned Y shares in nearly 60 Putnam mutual funds, but following the introduction of R6 shares in July 2012, the plan converted these 20 funds from class Y to class R6 shares effective April 1, 2013, and by the end of 2015, the plan had converted its investments in 25 Putnam mutual funds from Y shares to R6 shares, the lower cost option of the two classes of shares.

The Rulings

In the ruling, Judge William G. Young of the U.S. District Court for the District of Massachusetts cited three particular counterarguments by defendants to the claims made by plaintiffs:

1. The challenged transactions do not involve “assets of the plan,” and therefore are not prohibited under ERISA.

Putnam argued that the management and servicing were paid out of mutual fund assets rather than plan assets and, according to the Judge Young, “the Plaintiffs do not contend otherwise.” Rather, Putnam successfully argued that “only the shares of the mutual funds owned by the plan are plan assets,” and the court, “finding that the management fees are not paid out of plan assets, rules that the Plaintiffs’ prohibited transaction claim fails as matter of law.”

2. Code Section 1108 and Prohibited Transaction Exemption (PTE) 77-3 specifically exempt these transactions from Section 1106’s restrictions.

While the plaintiffs had argued that the management fees Putnam mutual funds paid to Putnam were “materially higher on average than the investment fees paid by other funds,” the court found that the comparison to Vanguard passively managed index funds’ average fees was “flawed.” Judge Young noted that “Vanguard is a low-cost mutual fund provider operating index funds ‘at-cost,’” while “Putnam mutual funds operate for profit and include both index and actively managed investment.” As a result, the court held that the plaintiffs’ analysis “compares apples and oranges.” Moreover, Judge Young noted that, “even if the Court were to accept the Plaintiffs’ account of the range of Putnam mutual fund expense ratios or average management fees, the Plaintiffs cite no relevant case law holding that such ranges or averages are unreasonable as matter of law.” And so, he ruled that “Putnam mutual funds pay reasonable management fees to Putnam,” that the defendants had carried their burden, and that the plaintiffs’ prohibited transaction claim fails as matter of law.

3. The plaintiffs’ prohibited transaction claims based on 72 investment options are barred by ERISA’s three-year statute of limitations.

The plaintiffs also argued that the requirements of PTE 77-3 are not satisfied because Putnam introduced a lower cost R6 class of shares for 20 Putnam funds on July 2, 2012, but did not convert the Plan’s investments in Putnam mutual funds from R6 to Y shares until April 1, 2013. The defendants argued that ERISA’s statute of limitations bars this aspect of the plaintiffs’ prohibited transaction claims as to 72 investment funds. ERISA’s statutes of limitations apply either:

  • six years after the date of the last action which constituted a part of the breach or violation, or in the case of an omission, the latest date on which the fiduciary could have cured the breach or violation; or
  • three years after the earliest date on which the plaintiff had actual knowledge of the breach or violation, except that in the case of fraud or concealment, such action may be commenced no later than six years after the date of discovery of such breach or violation.

The plaintiffs argued that they did not have “actual knowledge” of the claimed breaches more than three years prior to filing suit and that Putnam had fraudulently concealed its breaches by claiming that its transactions were exempted.

But Judge Young noted that a plaintiff has “actual knowledge” when he or she knows “the essential facts of the transaction or conduct constituting the violation,” and that while the plaintiffs “argue that they lacked knowledge of many ‘essential facts,’ including knowledge regarding the Defendants’ decision-making processes with respect to the Plan, as well as knowledge of facts negating possible exemptions, the defendants respond that all of the relevant information was clearly disclosed in the Plan’s enrollment kit…” Judge Young noted that the plaintiffs were “well aware that the parties involved were all Putnam entities,” and that, as a result, “the actual knowledge requirement is satisfied, and the three-year statute of limitations bars the plaintiffs’ prohibited transactions claims based on 72 investment funds.”

As for counts I, V, and VI, and the defendants’ fifth affirmative defense, on March 3, 2017, the court issued an order denying summary judgment on those specific counts. On those points, the jury – or more accurately, the judgement – is still “out.”

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