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Law Firm Files Another Excessive Fee Suit Targeting TDFs

Litigation

Shepherd, Finkelman, Miller & Shah LLP has filed another suit on behalf of a plaintiff who takes issue with the choice of Fidelity’s Freedom Funds as a QDIA.

This time Yosaun Smith, a participant of the Catholic Health Initiatives 401(k) Plan, has filed suit against the plan’s employer sponsor and plan fiduciaries. The plan, which as of 12/31/18 had 105,590 participants, and some $3.2 billion in assets, among other options, offered a suite of 13 target date funds. 

The allegations regarding those target-date funds were direct and to the point. In the suit, filed in the U.S. District Court for the Eastern District of Kentucky (Smith v. CommonSpirit Health, E.D. Ky., No. 2:20-cv-00095, complaint docketed 7/6/20), the plaintiff essentially notes that Fidelity offers an “Active” suite of Freedom funds and what was described as the “substantially less costly and risky Freedom Index funds (the ‘Index suite’).” 

Earlier this month plaintiff Lawanda Lasha House Johnson, “individually and on behalf of all other similarly situated persons and the Profit Sharing Plan of Quest Diagnostics Incorporated,” filed suit against her employer, challenging the plan’s TDF fund selection—contrasting, as this suit does, Fidelity’s Freedom funds (the “Active suite”) and the “substantially less costly” Freedom Index funds (the “Index suite”). In that suit, the plaintiff was also represented by Shepherd, Finkelman, Miller & Shah LLP (and Law Offices of Sahag Majarian). In fact, the suit is one of at least five[i] potential class actions filed in the past two weeks challenging the use of the Fidelity Freedom funds in its retirement plan where the plaintiffs were represented by Shepherd, Finkelman, Miller & Shah LLP.

In recent months, the firm has also represented plaintiffs in litigation involving ADPSafeway and Gucci

‘Freedom’ Funds

The suit claims that the “defendants failed to compare the Active and Index suites and consider their respective merits and features,” and that “a simple weighing of the benefits of the two suites indicates that the Index suite is a far superior option, and, consequently, the more appropriate choice for the Plan.” Instead, he argues, “defendants failed to act in the sole interest of Plan participants, and breached their fiduciary duty by imprudently selecting and retaining the Active suite.”

The suit claims that these two fund families “have nearly identical names and share a management team,” but that “while the Active suite invests predominantly in actively managed Fidelity mutual funds, the Index suite places no assets under active management, electing instead to invest in Fidelity funds that simply track market indices.” It goes on to characterize the Active suite as “dramatically more expensive than the Index suite, and riskier in both its underlying holdings and its asset allocation strategy”—and impact made all the worse, it alleges, because that Active suite was chosen to be the plan’s Qualified Default Investment Alternative (QDIA)—and, as of 12/31/18, the suit claims that approximately 76% of the plan’s assets were invested in the Active suite.

Glide Paths

As for that additional risk the suit notes that while “at first glance, the equity glide paths of the two fund families (meaning the Active suite and Index suite) appear nearly identical, which would suggest both target date options have a similar risk profile.” That turns out not to be the case, according to the plaintiff—and “through multiple avenues.” Not surprisingly, the suit claims that the Active suite “primarily features funds with a manager deciding which securities to buy and sell, and in what quantities”—that’s what active management is all about, after all. The suit points out that the Active suite allocates approximately 1.5% more of its assets to riskier international equities than the Index suite, and “also has higher exposure to classes like emerging markets and high yield bonds.” 

That skillset comes with higher expenses—the plaintiff claims that “while the Institutional Premium share class for each target year of the Index suite charges a mere 8 basis points (0.08%), the K share class of the Active suite—which the Plan offered until 2018—has expense ratios ranging from 42 basis points (0.42%) to 65 basis points (0.65%),” and since then the plan has offered the K6 share class of the Active suite, which, “while less expensive than the K class funds, still bears expense ratios from 37 basis points (0.37%) to 49 basis points (0.49%).”

The plaintiff alleges that, even “considering just the gap in expense ratios from the plan’s current investment in the Active suite to the Institutional Premium share class of the Index suite, in 2018 alone, the Plan could have saved approximately $1.24 million in costs.”

Oh—and they allege that the funds underperformed relative to their benchmarks.

Not that the target-date fund suite was the only issue raised with plan investments, though it was the most extensive focus (and about half of the 38-page filing). Suffice it to say that two other options—the American Beacon Large Cap Value Fund and the AllianzGI NFJ Small Cap Value Fund were also criticized for underperformance.

All in all, the suit alleges that “participants were offered an exceedingly expensive menu of investment options, clearly demonstrating that Defendants neglected to benchmark the cost of the Plan lineup or consider ways in which to lessen the fee burden on participants during the Class Period.” The suit goes on the note that, even with a fee reduction that took place in 2018 with the shift to the K6 share class of the Fidelity Freedom funds, “the Plan investment menu was considerably more expensive than those of comparable plans.”

Recordkeeping Record

The suit alleges that Fidelity received a flat fee charged at between $30 and $34 per person for recordkeeping services, while “according to one industry publication” (the 401(k) Averages Book), “the average cost for recordkeeping and administration in 2017 for plans much smaller than the Plan (plans with 100 participants and $5 million in assets) was $35 per participant.” Leading the plaintiff here to allege that “given its size, and resulting negotiating power, with prudent management and administration, the Plan would have unquestionably been able to obtain a per-participant cost significantly lower than $30 per participant.”

“As such, it is clear that Defendants either engaged in virtually no examination, comparison, or benchmarking of the recordkeeping fees of the Plan to those of other similarly-sized 401(k) plans, or were complicit in paying grossly excessive fees,” the suit concludes. The suit goes on to state that “had Defendants conducted any examination, comparison, or benchmarking, Defendants would have known that the Plan was compensating Fidelity at levels inappropriate for its scale,” and that “plan participants bear this excessive fee burden and, accordingly, achieve considerably lower retirement savings, since the excessive fees, particularly when compounded, have a damaging impact upon the returns attained by participant retirement savings.”

The suit concludes by note that, “by failing to recognize that the Plan and its participants were being charged much higher fees than they should have been and/or failing to take effective remedial actions, Defendants breached their fiduciary duties to the Plan.”

NOTE: In litigation there are always (at least) two sides to every story. However factual it may turn out to be, the initial lawsuit in any action is only one side, and one generally crafted toward a particular result. In our coverage you'll see descriptions of events qualified with statements such as “the suit says,” or “the plaintiffs allege”—and qualifiers should serve as a reminder of that reality.


[i]Another suit filed by the same firm at nearly the same time (July 6) against the 25,010 participant, $1.8 billion MedStar Health, Inc. Retirement Savings Plan made essentially the same arguments (though a mere 58% of the plan’s assets were in the QDIA), and in fact did so using much of the same language.

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