Thanks to a well-documented and prudent process, American Century has beaten back an excessive fee suit brought by a participant in the firm’s 401(k) plan.
The trial – which ran for 11 days – consisted of a number of claims common to the dozen or so excessive fee suits brought by participants in the 401(k) plans sponsored by a number of investment management firms. However, Chief Judge Greg Kays in the U.S. District Court for the Western District of Missouri noted (Wildman v. Am. Century Servs., LLC, 2019 BL 21670, W.D. Mo., No. 4:16-cv-00737-DGK, 1/23/19) that all of the plaintiffs' claims – breach of fiduciary duty, failure to monitor fiduciaries, and an equitable disgorgement of ill-gotten proceeds – ultimately rested on the notion that the defendants committed a breach of fiduciary duty.
The suit had alleged that “at all stages, both in selecting the Plan’s designated investment alternatives and in monitoring those investments, Defendants only considered investments affiliated with American Century, in furtherance of their own financial interests, rather than the interests of Plan participants.”
The defendants here provided committee members with “training and information about their fiduciary duties, including a ‘Fiduciary Toolkit,’ which outlined their duties as fiduciaries, as well as a summary plan document, and articles regarding fiduciary duties in general.” Judge Kays noted that the materials also included a copy of the current Investment Policy Statement, and that “the Committee members read these materials and took their responsibilities as fiduciaries seriously.” The committee met regularly three times a year, and had “special meetings if something arose that needed to be discussed before the regularly scheduled meetings.” Moreover, the defendants testified that those meetings “were productive and lasted as long as was needed to fully address each issue on the agenda. On average, the meetings lasted an hour to an hour and a half.”
Too Many (Duplicative) Funds
With regard to allegations that they offered too many and duplicative funds, Judge Kays noted that “Committee members testified they purposefully offered a large number of investment options because the majority of American Century’s employees are sophisticated investors (holding various financial advisor certifications and financial industry regulatory licenses), who preferred the ability to invest their retirement savings more precisely.” How sophisticated? Judge Kays wrote that, by the end of 2016, 404 out of the approximately 1,300 plan participants were active employees of American Century who had passed exams allowing them to buy and sell securities.
As for charges that the plan consisted of only American Century funds, Judge Kays noted that “it contained a diverse array of asset classes and investment styles covering the entire risk/reward spectrum.”
“The evidence shows the Committee thoroughly discussed the composition of the Plan’s lineup to ensure it covered the entire risk/reward spectrum without duplication,” Kays wrote, going on to note that “while the Plan offered a large number of investment options to participants, it was certainly not imprudent to do so given the sophisticated investor base of the Plan participants.”
Active Versus Passive
Regarding the decision to provide active, rather than passive investment options, he noted that the Committee members testified they “preferred actively managed funds – the only type of fund American Century offered – because they believed actively managed funds were more responsive to market fluctuations,” and that while the committee members were not only “aware of the fee differential between passively and actively managed funds, they believed the benefits outweighed those costs,” they also “believed Plan participants preferred actively managed funds, given the employees’ enthusiasm in American Century, their investment in American Century products outside of the Plan, and the fact the Committee only once – after this lawsuit – received a question about the lack of passive options in the Plan.”
Citing Deere v. Hecker, Judge Kays observed that “ERISA does not require a retirement plan to offer an index fund or a stable value fund, and the failure to include either in the Plan, standing alone, does not violate the duty of prudence… Rather, the issue is whether the Defendants considered these options and came to a reasoned decision for omitting them from the Plan.”
On that point, Kays noted that the committee “…appropriately considered adding passive options to the Plan… but ultimately decided against it due to the instability in the marketplace.” Specifically it was noted that the committee “preferred active management coming out of the financial crisis because financial experts in an actively managed fund could review the actual prospects of the securities being held, and therefore, had a greater ability to manage risk and lessen the effect of downturns in the market.”
As for the differential in fees, Kays explained that the committee not only believed that active management’s added costs were justified by its performance, but that the human element of active management provided value. “In this case, the Committee monitored the expense ratios of each fund and verified whether their expenses were justified based on performance.”
More than that, Judge Kays noted that the Committee preferred American Century funds because the fund managers were readily accessible to the Committee, and that on several occasions, the Committee heard reports from American Century fund managers about new funds, strategies to combat changes in the market, or management changes in funds suffering from poor performance. “The Committee felt the closeness with the fund managers was advantageous because the Committee (and participants) had an ‘insiders’ view’ into the inner-workings of the fund’s investment management team,” he wrote.
Beyond that, he noted that “it is not disloyal as a matter of law to offer only proprietary funds.” Kays went on to explain that “a fiduciary of a plan sponsored by an asset manager is not required to consider competitors’ funds if the proprietary funds chosen in the Plan are prudent options,” and that “there was significant evidence that other investment management companies administering retirement plans have lineups consisting solely of proprietary funds.”
Investment Policy ‘Statements’
As for allegations that their actions with regard to fund selection and monitoring were imprudent, Judge Kays noted that the IPS guidelines did not require removal of a fund from the Plan for failure to attain certain metrics, but rather “…provided the Committee with broad discretion, which allowed them to use their investment expertise to determine whether a fund’s long-term performance goals could still be achieved despite its underperformance over a specified period.” Nor was this an accident. Kays explained that the committee members believed this was preferable because “an IPS that mandated removal of investments that underperformed their benchmarks would be undesirable in that it would always require removing a fund at its low point, incurring a loss, and preventing participants from taking advantage of any subsequent improved performance.”
On the other hand, the court gave “no weight to the testimony of Plaintiffs’ process expert, Roger Levy,” who the judge said “opined a fund that remained on the Watch List for more than five quarters should be removed absent a compelling, documented reason,” that “the Committee members should have conducted a winnowing process for each fund in the core lineup and should have taken more detailed minutes.” Now, the court noted that Levy himself acknowledged that “his approach has not won wide acceptance in the retirement plan industry, with only fourteen to sixteen retirement plans out of approximately 500,000 conforming to these standards.” And, “while the Court agrees with Mr. Levy that fiduciaries should strive to attain the standards he champions, they are not the standards ERISA requires,” the opinion concluded.
The Court also gave no weight to Plaintiffs’ expert on damages, Steve Pomerantz, Ph.D., described in the opinion as a mathematician with 30 years’ experience in the investment field, including working as a portfolio manager and providing investment management services to mutual funds as both an investment advisor and as a sub-advisor – who has “testified in numerous 401(k) cases in federal court, primarily for plaintiffs.” However, the court found “Dr. Pomerantz’s testimony regarding the propriety of the Committee’s process not credible,” that “many of Dr. Pomerantz’s opinions were not tethered to the law, and Dr. Pomerantz, a mathematician, has never had a role with respect to a 401(k) plan at any of his places of employment, has never been hired as a consultant to design a 401(k) plan, has never been hired to draft or review plan documents for a 401(k) plan, and has never been hired to design a watch list procedure for a 401(k) plan.”
That said, not all of Dr. Pomerantz’ calculations were deemed flawed. Pomerantz – who also provided expert testimony in the Brotherston v. Putnam Investments, LLC case, which is being petitioned for review by the U.S. Supreme Court – testified that delaying the conversion to a lower share class resulted in $472,193 in excess fees ($101,563 from the failure to convert the Short-Term Government Bond Fund and $370,630 in losses associated with the R6 share class). He also calculated losses related to the lack of revenue sharing in the amount of $2.4 million.
Ultimately, Judge Kays concluded that “the record and testimony demonstrates Committee members made careful investigations of investment decisions and acted in the best interests of the Plan participants. Plaintiffs presented no emails, documents, or testimony suggesting that Committee members placed American Century’s interests before Plan participants’. Not only did the Committee members truly believe in the quality of American Century’s funds, but the Committee members believed having American Century funds was more beneficial to Plan participants because the participants were familiar with the funds offered by American Century, had the ability to more closely monitor their investments, and received direct access to fund managers for consultation.” Moreover, he noted that “the Committee had no particular incentive to ‘push’ American Century’s funds” since the plan’s investments in American Century funds were only 0.35 percent of all American Century’s assets under management, which he described as “a drop in the ocean of assets under American Century’s management.” Nor had the plaintiffs presented any evidence that any of the Committee members benefited in their role as American Century employees based on the Plan’s lineup or performance.
Judge Kays noted that while the plaintiffs had an issue with the fact that certain funds remained on the Watch List for many quarters despite their poor performance compared to similar funds – but commented that “a fund’s rate of return is only relevant in so far as it suggests the Committee’s decision-making process was flawed.” To that end, he wrote that committee members explained that “removing funds from the Plan was very disruptive to Plan participants, and the Committee was hesitant to remove a fund simply because it had not performed well in the short term.”
There was a complaint about the inclusion of two specific sector funds, Global Gold and the Strategic Inflation Opportunities Fund – but Judge Kays noted that “…merely because sector funds carry with them an inherent risk does not mean that offering them in the lineup was imprudent.” With regard to the alleged lack of an established record of performance, Kays noted that “Plaintiffs cite no authority holding that the implementation of a fund without a long performance history is per se imprudent.”
Further, Judge Kays noted that although the plaintiffs have alleged the defendants acted imprudently by retaining funds with excessive fees in the plan, but cited precedent in cautioning that “[f]ees, like performance, cannot be analyzed in a vacuum.” Moreover, he noted that the Plan’s fees ranged from 4 to 158 basis points, similar to those approved of by other courts, “which suggests the fees were not excessive,” and that for “a majority of the time, the expense ratios for the funds were below the 50th percentile of the funds in their peer groups.” Moreover he explained that from 2014 on, the Committee received and reviewed a report containing each fund’s expense ratio compared to mutual funds in the same category, and that, from 2017 on, the Committee also received and reviewed information regarding the funds in the Plan with the median expense ratio of fund within the same Morningstar category. “None of this demonstrates an imprudent process,” he wrote.
The plaintiffs had complained about a year’s delay in converting 23 funds to a lower share class, but Judge Kays concluded that the committee converted the shares as soon as “practicable.” He wrote that the Committee members testified that at the time the R6 shares became available, they were juggling multiple items, including changing recordkeepers – and that they wanted to make all changes to the Plan – including changing recordkeepers, switching share classes, and adding new funds – at the same time so as to minimize the disruption to participants.
“It is clear the Committee thoroughly discussed when the change to the R6 shares would occur and took into account all reasonable information, including the other changes to the Plan at the time. Based on the totality of circumstances, the Court holds the delay in converting the funds to R6 shares did not breach the duty of prudence,” Kays wrote.
Another issue raised by plaintiffs was that the Plan did not offer revenue sharing rebates that were provided to other Plans with American Century funds – and had argued, citing the case of Tussey v. ABB, Inc. that it was imprudent per se to fail to negotiate a rebate back to the plan participants. “That is not so,” concluded Kays, noting that, “In this case, American Century paid the recordkeeping costs, and Plaintiffs produced no evidence that such rebates were available and would have been offered to the Plan prior to 2018.”
While Kays determined that since there was no breach of fiduciary duty, he did not need to determine the issue of losses to the plan – but outlined its reasoning if that had been an issue “to aid in any appellate review.” In essence, Judge Kays determined that the plaintiffs’ calculations “did not use suitable benchmarks and relied on unfounded assumptions.” Judge Kays explained that “In this case, where the Plan’s philosophy and investment strategy was so dissimilar to the indexes Dr. Pomerantz chose, his choice of indexes is fatal to his analysis, and by extension, Plaintiffs’ prima facie case of loss. Moreover, nothing in Brotherston supports that a loss may be shown by comparing alleged imprudent investments to funds that cannot be said to be prudent.”
He went on to note that “not only did Dr. Pomerantz perform only a one-to-one, rather than a range, comparison of funds,” he also:
- failed to isolate the effect of the alleged breach;
- failed to account for statistical significance between the performance of the at-issue fund and the alternative;
- failed to opine on the prudence of any of the alternatives that he used;
- mis-mapped risk profiles between the at-issue fund and the alternative;
- ignored the nonperformance attributes of funds; and
- ignored Plan participants’ preferences.
Consequently, he noted that the plaintiffs had “failed to meet their burden of proving a prima facie case of loss for the alleged breaches as calculated by Dr. Pomerantz’s four models.”
Summarizing the court’s findings, Kays noted that “After carefully considering all of the evidence presented at trial, the Court finds Plaintiffs failed to prove Defendants breached any fiduciary duty to the Plan participants. Accordingly, the Court finds in Defendants’ favor on all counts and claims.”
What This Means
The headline says it all – a prudent process prevails. Here many of the allegations that have been widely made in these excessive fee cases were refuted by testimony and documentation that revealed the kind of thoughtful, ongoing, due diligence process that plan fiduciaries are often counseled to undertake.
Many of these cases are still ongoing, or have been settled prior to trial – in fact, this is only the second case filed since 2015 to go to trial. Last year Putnam Investments LLC defeated similar claims at trial, only to see that ruling by the district court overturned on appeal. However, that decision has been appealed to the U.S. Supreme Court.