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Pru Prevails in Pay-to-Play Suit

A federal judge has dismissed a series of charges against Prudential, an employer, and the plan’s advisor regarding the plan’s use of revenue-sharing, allegedly excessive fees and pay-to-play arrangement.

In Rosen v. Prudential Ret. Ins. & Annuity Co. (2016 BL 436738, D. Conn., No. 3:15-cv-01839-VAB, 12/30/16), plaintiff Richard A. Rosen brought suit on behalf of the Ferguson Enterprises, Inc. 401(k) Retirement Savings Plan in which he participates, as well as on behalf of other similarly situated participants.

The suit took issue both with the composition of the plan’s investment options as well as Prudential’s revenue-sharing arrangements with mutual funds. Specifically, the plaintiffs challenged:

  • the concentration of actively managed mutual funds offered as part of the plan’s menu;

  • Prudential’s alleged “self-dealing” through its receipt of revenue sharing payments in exchange for investing plan assets in mutual funds; and

  • the inclusion of Prudential's GoalMaker product in the plan, which they claimed steers participants into high-cost investment options to the benefit of Prudential and against the best interests of plan participants.

Motion to Dismiss

Noting that in considering a motion to dismiss it must accept as true all factual allegations in the complaint and draw all possible inferences from those allegations in favor of the plaintiff, Judge Victor A. Bolden of the U.S. District Court for the District of Connecticut noted that this requirement “is inapplicable to legal conclusions,” that the complaint must offer more than “labels and conclusions,” “a formulaic recitation of the elements of a cause of action” or “naked assertion[s]” devoid of “further factual enhancement.” Additionally, Judge Bolden noted that to survive a motion to dismiss, the complaint must state a plausible claim for relief.

The court noted that while the amended complaint brings claims against all three named defendants, the majority of its factual allegations focus only on Prudential and that, in bringing this lawsuit, plaintiffs seek to establish that service providers like Prudential violate ERISA when their compensation includes revenue sharing with mutual funds. “In Plaintiffs’ view,” the court explained, “Prudential’s participation in the alleged revenue-sharing model is, at its core, a violation of the fundamental ERISA principle of ‘prudence.’”

But, the court noted, Prudential never addressed the prudence or imprudence of its decision to engage in revenue sharing with mutual funds and similar investment instruments, but rather argued that it cannot be liable for a breach of fiduciary duty under ERISA because it was not acting as a fiduciary with respect to any of the alleged conduct. “According to Prudential, it lacked the authority and control required to act as a fiduciary, as Ferguson, not Prudential, was contractually responsible for any relevant decisions regarding the Plan and its assets.” Indeed, Prudential argued that Ferguson, as the primary fiduciary with respect to the plan, and CapFinancial, as the investment advisor, were ultimately responsible for directing investment decisions in connection with the plan.

Trust Agreement Controls

In support of its contention that it was not a fiduciary with respect to plan assets, Prudential relied on the terms of the Trust Agreement, which the court acknowledged required Prudential Trust, as a directed trustee of Ferguson, to act only in accordance with Ferguson's instructions when making decisions regarding plan assets. “Prudential, therefore, cannot be considered a fiduciary based on its initial selection of the available investment options for the Plan,” the court said, “because this action was taken before the parties entered into a contractual relationship, and it was ultimately up to the plan sponsor — in this case, Ferguson — whether or not to engage the plan on the stated terms.” Moreover, with regard to the selection of the funds on the menu, the court noted that “Prudential did not have the contractual authority to delete or substitute mutual funds from its menu without first notifying Ferguson and ensuring its consent.”

The court noted that as an alternative approach, plaintiffs argue that Prudential retained discretionary authority to determine its own compensation, and thus Prudential has fiduciary status in connection with the revenue-sharing arrangements, but the court noted that “this allegation, too, is contradicted by the clear language of the governing contractual agreements.” The court felt that the Trust Agreement “strips Prudential of its discretionary authority over its own compensation” because it limited Prudential’s compensation to “the fee schedule provided to the Employer,” requiring advance notice to Ferguson of any changes to the agreed-upon schedule.

GoalMaker Gauged

As for the inclusion of the GoalMaker product, the court noted that “the documents referenced in the Amended Complaint demonstrate that Prudential disclosed relevant details with respect to its GoalMaker program, and the contractual agreement in place regarding the GoalMaker program confirms that Ferguson, not Prudential, was ultimately responsible for the investment selections with respect to this program.”

Ultimately, the court held that the trust agreement “demonstrates that Prudential did not possess the authority to be considered a fiduciary under ERISA,” and thus the firm “cannot be held liable under ERISA for breach of fiduciary duties or prohibited transactions with respect to its selection of investment options, determination of compensation, administration of the GoalMaker program, or alleged securities lending activities. Plaintiffs have failed to plausibly plead any ERISA violations with respect to these activities, and any related claims are dismissed for failure to state a claim.”

Plaintiffs had also argued that Prudential had fiduciary status through its ownership and management of Separate Accounts — group variable annuities owned by PRIAC that contain some assets contributed by plan participants. The court noted that, “Taken as true, these allegations suggest that Prudential both possessed and exercised discretionary authority over Separate Accounts sufficient to support a finding of fiduciary status at this stage.” Ah but, it then said that “the documentation submitted in connection with Prudential’s Motion to Dismiss, however, suggests that Plaintiffs’ allegations regarding the Separate Accounts are not plausible,” basically because Prudential successfully argued that since it did “not invest any Plan assets in mutual funds through these accounts, thus its authority over the Separate Accounts is immaterial.”

Citing a standard articulated in one of the first excessive fee cases, Hecker v. Deere & Company (556 F.3d 575, 586 (7th Cir. 2009)), the court noted that Prudential was not required to maximize returns to plan participants, or to “scour the market to find and offer the cheapest possible fund.” The court said that “even if Plaintiffs are correct in their assertion that Plan participants would have earned more returns had Prudential not engaged in revenue-sharing through its management of Separate Accounts, according to the law in this Circuit, a service provider who adheres to the agreed-upon terms of an employee retirement plan is not bound to deviate from those terms against its own interests simply because doing so could result in more gains to plan participants.”

Separate Accounts

“Rather," the court held, “in order to determine whether Prudential, as a fiduciary with respect to the Separate Accounts, exercised its fiduciary duties imprudently, the relevant inquiry is straightforward: under the circumstances then prevailing, what would a prudent fiduciary have done.” Moreover, the court noted that “Plaintiffs’ allegations that Prudential engaged in revenue sharing, without more, do not state a claim for a violation of ERISA,” and that the amended complaint “contains no factual allegations suggesting that similarly situated service providers would have engaged in revenue-sharing any differently than Prudential was alleged to have done during the relevant time frame.”

Judge Borden concluded that even “viewing the factual allegations in the Amended Complaint as true, Plaintiffs have failed to establish that Prudential had fiduciary status with respect to the vast majority of Plan assets,” and “to the extent that Prudential acted as a fiduciary with respect to Separate Accounts and Collective Trusts, Plaintiffs have failed to allege facts suggesting a breach of fiduciary duty or engagement in prohibited transactions in connection with those accounts,” dismissing Count 1 of the complaint.

With regard to count two of the complaint, which included a claim for “co-fiduciary breach,” since “only a fiduciary can be held liable as a co-fiduciary,” and since, in the court’s assessment, Prudential was “only a fiduciary with respect to its ownership and control over the Separate Account assets, and it did not breach its fiduciary duties in connection with those accounts,” the complaint was dismissed regarding Prudential.

Ferguson, CapFinancial Focus

Judge Borden also discussed — and dismissed — the fiduciary claims against Ferguson and CapFinancial, though the court noted that those claims were “narrower and fewer in number than those brought against Prudential, and focused “exclusively on (1) the concentration of high-cost mutual funds among the investment options in the Plan, (2) the inclusion of Prudential's ‘GoalMaker’ product within the Plan offerings without making full disclosures regarding the nature of that program, and (3) the failure to monitor Prudential’s investments of Plan assets in mutual funds and other instruments in exchange for revenue-sharing payments.”

Judge Borden noted that the plaintiffs’ allegations against CapFinancial and Ferguson are “brief, limited to only 5 paragraphs out of the 151 paragraphs in the Amended Complaint,” and that they “are also rather general, and the two entities are consistently referenced together as ‘Ferguson Defendants.’” Borden was not willing to dismiss the claims against CapFinancial based on the suit’s failure to provide them with reasonable notice, nor on grounds that they lacked standing to sue (the specific plaintiff had neve used GoalMaker), but noted that plaintiffs “have not made any allegations directly addressing the methods used by Ferguson and CapFinancial to select investment options for the Plan,” and instead focused on detailed allegations regarding the size of the plan, the layers of fees and the revenue sharing arrangements involved with the mutual funds selected, as well as general allegations regarding the higher costs associated with actively managed mutual funds as opposed to passive funds or index funds. While plaintiffs argued that these allegations supported the notion that “a reasonable fiduciary would have known that the investment options were imprudent,” the court was not persuaded. “Based on the case law in this Circuit and other Circuits, the alleged concentration of high-cost mutual funds here, without more, is not sufficient to state a claim against Ferguson and CapFinancial for breach of fiduciary duty.”

In dismissing all claims, the judge noted that the lawsuits were part of a series of cases aimed at moving the entire 401(k) industry away from certain compensation structures that are frequently challenged in court. The judge said that while the lawsuits “seek to transform the market itself,” ERISA protects investors’ “reasonable expectations in the context of the market that exists.”