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Small(er) Plan Targeted with Excessive Fee Suit


Another 401(k) has been charged with falling short of its fiduciary obligations—and of failing to leverage its “tremendous bargaining power”—though it’s a smaller plan than most caught in those crosshairs.

The plan in this case is 99 Cents Only Stores, LLC (also branded as “The 99 Store”), an American deep-discount retailer operating primarily in California and the Southwest—a plan that, as of Dec. 31, 2020, had (just) 2,715 participants with account balances and $69,907,378 in assets.

The suit (Aquino v. 99 Cents Only Stores LLC, C.D. Cal., No. 2:22-cv-01966, complaint 3/25/22) was filed in the U.S. District Court for the Central District of California by a group of participant-plaintiffs (Salvador Aquino, Susan Ford, Monicalayle Garcia, Barbara Kraus, Martha Lopez, Francisco Martinez, Megan Sargent)—and yes, despite the relatively modest size of the plan (in comparison to the norms in this vein of litigation, which nearly always exceed $1 billion), the suit contends that “the Plan has tremendous bargaining power to demand low-cost administrative and investment management services and well-performing, low-cost investment funds.”

Indeed, ultimately the allegations here were identical to those made in this class of litigation, specifically that the “plaintiffs suffered an injury in fact by investing in the higher cost mutual fund shares when lower cost shares of the same fund were available to the Plan; by paying excessive fees to Covered Service Providers and investing in the most expensive share class of Fidelity’s conflicted target date funds.”

The plaintiffs here do make a statement that, though not without precedent, the “Defendants chose to accept the benefits of federal and state tax deferrals for their employees via a 401(k) plan, and the owners and executives of Defendant organizations have benefitted financially for years from the same tax benefits.” They go on to contend, however, that “Defendants have not followed ERISA’s standard of care. This lawsuit is filed after careful consultation with experts and publicly available documents to return benefits taken from Plan participants by Defendants.”

Specifically, the suit claims that “99 CENTS and its individual members breached their fiduciary duties of prudence and loyalty to the Plan” by:

  1. offering and maintaining higher cost share classes when otherwise identical lower cost class shares were available, resulting in the participants paying additional unnecessary operating expenses that not only failed to add value to the participants but resulted in an unjustifiable loss of compounded returns;
  2. overpaying for Covered Service Providers by paying variable direct and indirect compensation fees through revenue sharing arrangements with the funds offered as investment options under the Plan;
  3. failing to engage in a competitive bidding process by submitting a Request for Proposal to multiple service providers including recordkeepers, shareholder service and financial advisers;
  4. imprudently choosing and retaining expensive funds that consistently failed to meet or exceed industry benchmarks;
  5. utilizing the recordkeeper’s own proprietary target-date funds, which also served as the plan’s qualified default investment alternative (QDIA); and
  6. failing to offer passively managed index funds as opposed to actively managed funds.

While most suits in this genre criticize revenue-sharing practices (but acknowledge that there is noting illegal per se in employing them), this suit claims that “revenue sharing burdens on mutual fund investors are always more costly to participants than the fee the revenue sharing is intended to pay.” They continue that, “since costs are inversely correlated to a fund investor’s returns, when comparing share classes of the same SEC-registered mutual fund, the Defendants’ actions were even more erosive to the trust’s growth (and in turn the participants/beneficiaries account values) because of the loss of additional compounded growth.” Based on that premise, and “given the ample options available to pay service providers, Defendants should have investigated and prudently entered a flat fee or capped arrangement with Fidelity that did not result in fees that reduced participants’ cumulative returns.”

The suit also claims that, “because revenue sharing payments are asset based, they bear no relation to the actual cost to provide services or the number of plan participants and can result in payment of unreasonable recordkeeping fees. To put it another way, recordkeepers (or any other CSP) receiving unchecked revenue sharing compensation accrue significant ongoing pay increases simply because of participants putting money aside biweekly for retirement”—and that every contribution dollar “triggered additional revenue sharing revenue without the requisite additional labor.”

By way of further making their case, the suit cites that “Defendants have included the Eaton Vance Atlanta Capital SMID-Cap Fund Class A shares (‘Eaton Fund’) as an investment option available to participants in 2016,” while the information provided in the 2016 annual prospectuses “clearly shows a significant difference in fees and investment returns between the Class A and Institutional Share Class,” specifically that the Eaton Fund had an R6 share class available for 88 basis points per year or 0.88%, but the Defendants selected the “A” share classes that cost 122 basis points or 1.22%. 

As if that were not enough, the suit notes that “while the difference in annual expenses is 0.34% ... the cumulative return difference is more than twice as much.” The plaintiffs here also assert that “an analysis of each attribute of the different share classes reveals that there is no difference between the share classes other than costs and performance returns, all borne by the participants,” more specifically that the share classes all “shared the same manager, manager start date, manager tenure, allocations in stocks, bonds, cash, same percentage of holdings, number of holdings, turnover rate, average price/earnings ratios, price/book ratios, and average market cap.”

And while it is not unusual for litigation to challenge the use of actively managed funds over passive alternatives, the plaintiffs here note that while “It is commonly stated by defendants in 401(k) lawsuits that ERISA does not require fiduciaries to choose index funds and they have argued that it is improper to pare actively managed funds against passively managed funds because it is an ‘apples and oranges comparison.’ While the former is true, the latter is not.” These plaintiffs argue that an active manager may have varying degrees of flexibility with respect to the investment decisions they make—“such as whether to buy or sell a stock (or bond), portfolio weighting and length of holding time, but, they are pulling from the same pool of stocks (or bonds).” Moreover, they allege that while a retail investor can consider the merits of both active and passive funds, “plan fiduciaries held to a prudent expert standard do not have the luxury of opting for actively managed funds to the exclusion of their passive counterparts.” Instead they claim that in order to select an actively managed fund “a trustee must answer, and continually answer, what benefit is derived from the greater costs of an active manager.”

And finally, the plaintiffs argue that a conflict of interest is “laid bare” in this case where the recordkeeper utilized its own proprietary target-date funds, which also served as the plan’s qualified default investment alternative (QDIA). “The conflict was exacerbated by Fidelity’s utilization of its higher-cost mutual funds with more expensive share classes, which returned more value to Fidelity.” In fact, the suit asserts that “there appears to be no reasonable justification for the millions of dollars collected from Plan participants that ended up in Fidelity’s coffers.”

Oh—the plaintiffs in this case are represented by Tower Legal Group and Christina Humphrey Law PC, two small California firms focused on employment law.

Will these arguments be persuasive to the court? We shall see.