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Another TDF Targeted With Fiduciary Suit

Litigation

Another set of plaintiffs have filed suit about the target-date fund choices on their former employer’s investment menu.

The suit, filed in the U.S. District Court for the Middle District of Tennessee, was brought by Becky Kirk, Perry Ayoob and Dawn Karzenoski on behalf of the CHS/Community Health Systems, Inc. Retirement Savings Plan, which, as of Dec. 31, 2017, had $3.2 billion in assets and about 112,700 active participants. 

Kirk, a New Mexico resident, Ayoob, a West Virginia resident, and Karzenoski, a resident of Pennsylvania, are all former participants in the plan who invested in the Principal Retirement Target 2025 separate account (Kirk) or the Principal Retirement Target 2045 separate account (Ayoob and Karzenoski). According to the suit, each claims that they have “been injured by Defendants’ unlawful conduct,” and that “had Defendants prudently and loyally managed the Plan’s investments and the Principal separate accounts,” each “would have had more assets” in their plan account at the time it was distributed. Moreover, that “Principal has been unjustly enriched as a result” of the investment in the Principal separate accounts.

Allegations

The suit – which names as defendants not only the CHS plan fiduciaries, but also Principal Life Insurance Company, Principal Management Corporation, and Principal Global Investors, LLC – specifically alleges that the CHS fiduciaries “did not give any serious consideration to these competitive index fund offerings in the marketplace, and instead used Principal’s proprietary index funds, despite fees that were several times higher than marketplace alternatives that tracked the exact same index.” While claims of available, identical funds with lower fees are the “norm” in this litigation, this suit raises the issue of tracking error, claiming that “compared to marketplace alternatives, Principal’s index funds deviated further from the benchmark index, and consistently had the worst performance even on a pre-fee basis. 

“Given the high fees and history of poor performance of Principal’s index funds, a prudent fiduciary acting in the best interests of the Plan’s participants would have removed these index funds from the Plan and replaced them with more competitive marketplace alternatives” – and that their failure to do so “has cost participants millions of dollars in excessive fees and lost investment returns.”

The plaintiffs alleged that Principal retained higher-fee versions of other underlying proprietary investments in the TDF separate accounts to increase its own fee revenue, at the expense of Plan participants. The complaint claims that Principal:

  • consistently used Institutional shares for the mutual funds held by the TDF separate accounts despite the availability of less expensive R6 shares;
  • utilized the mutual fund version of the MidCap Growth III, SmallCap Value II, and SmallCap Growth I funds as underlying investments in the TDF separate accounts, “even though identical annuity subaccount versions of these funds were available with fees that were 20 to 30 percent lower”; and
  • used the mutual fund version of the Diversified Real Asset fund, “even though a CIT versions of this fund with lower fees was available, and was used by Principal as an underlying investment in other target-date products it managed.”

They also took issue with the CHS Retirement Committee’s decision to retain the Principal Large Cap S&P 500 Index to track the S&P 500 Index at a cost of 6 basis points – “while numerous other investment managers offered funds tracking the exact same index for only 1 bps.” (Those aren’t typos.) Aside from alleging that the plan used funds with higher fees and poorer performance, the suit repeatedly questions the tracking error associated with those funds.

Conflicts of Interests?

The plaintiffs argue that, “given Principal’s conflicts of interest, the CHS Defendants should have closely scrutinized Principal’s choice of investments for the TDF separate accounts and its management of those accounts. Moreover, the CHS Defendants should have been especially cognizant of the problems associated with the Principal index funds in the TDF separate accounts, given that the CHS Defendants included those index funds as standalone funds in that Plan.” 

The plaintiffs claim that the CHS Defendants “took no action to address Principal’s mismanagement of the TDF separate accounts and left those separate accounts undisturbed in the Plan,” and that, they allege, “…was imprudent and improperly placed Principal’s interests ahead of Plan participants.”

Doubtless laying out a marker against future statute of limitations claims, the suit alleges that the plaintiffs “did not have knowledge of all material facts (including, among other things, the CHS Defendants’ process for managing the Plan, Principal’s process for managing its separate account TDF investments in the Plan, the availability of less expensive and better performing alternative investments, the availability of lower-cost investment vehicles and share classes, and the relatively greater experience, expertise, and asset base of Principal’s competitors in the index fund marketplace) necessary to understand that Defendants breached their fiduciary duties in violation of ERISA, until shortly before this suit was filed.”

“Indeed,” they go on to note, “much of this information (including the CHS Defendants’ process for managing the Plan, and Principal’s investment processes and motivations for selecting, monitoring, and retaining underlying investments in the TDF separate accounts), is solely within Defendants’ possession prior to discovery.” 

The suit concludes that, “based on this conduct, Plaintiffs assert a claim against all Defendants for breach of their fiduciary duties of loyalty and prudence (Count 1), and assert a claim against the CHS Defendants for failing to properly monitor other fiduciaries (Count 2).”

The plaintiffs are represented by Nichols Kaster, PLLP (who is no stranger to this type of litigation) and Nashville, Tennessee-based Barrett Johnston Martin & Garrison, LLC.

TDF ‘Targets’

This is not the first suit to specifically “target” target-date fund choices, though the fund families, criteria, and specific missteps alleged are hardly monolithic. About a year ago, three participants in two different 401(k) plans filed suit alleging a breach of fiduciary claim against Principal with regard to its target-date funds. Earlier this year, Safeway (as well as its TDF provider, and eventually its advisor)  was sued for its TDF selection, but even more recently, Walgreen’s $10 billion 401(k) was sued for allegedly selecting and retaining “a suite of poorly performing funds” called the “Northern Trust Focus Target Retirement Trusts,” while Intel, which had built its own set of custom target-date funds, is currently fending off two separate suits. About a year ago, Wells Fargo successfully defended against a suit brought by a participant in its 401(k) regarding its use of proprietary target-date funds.  

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