Class Action Sought Against TDF Provider

Three participants in two different 401(k) plans are seeking class action status in a breach of fiduciary claim against a major target-date fund provider.

The suit (Nelsen v. Principal Glob. Inv’rs Tr. Co., S.D. Iowa, No. 4:18-cv-00115-SMR-SBJ, complaint filed 4/16/18) charges Principal Global Investors Trust Co. with “disloyal and imprudent management of the Principal LifeTime Hybrid Collective Investment Funds (‘Principal CITs’) in violation of ERISA, to the detriment of participant investors.”

Specifically, plaintiff Ashley Nelsen (a current participant in the Starkey Laboratories, Inc. Employee Retirement Plan) and plaintiffs Roody Jasmin and Joellyn Williams (current participants in the Fleetcor Technologies, Inc. 401(k) Savings Plan) allege a number of violations in the composition and design of the target-date funds in question.

According to the suit, filed April 16 in the U.S. District Court for the Southern District of Iowa, as of the end of 2017, the Principal CITs consisted of 12 trusts: 11 options with a target date ranging from 2010 to 2060 (2010, 2015, 2020, etc.), and the Principal LifeTime Hybrid Income Fund designed for investors “who have reached their investment time horizon.” Regarding fees, the suit notes that Principal CIT consisted of four components: (a) a trustee fee of .04%; (b) operating expenses, which are deducted from the trust; (c) the service fee, which varies based upon the share class selected in the participation agreement, and ranges from 0 bps to 110 bps; and (d) the “fees charged by the underlying investments in the [Principal CIT].” The plaintiffs go on to explain that the first, second, and fourth fee components were the same for all investors in a particular Principal CIT, while the service fee varied depending upon the share class selected by the participating plan.

They go on to explain that the defendants:

  • determined which asset classes would make up the CITs;
  • determined the percentage allocations to each of these asset classes throughout the investor’s investment lifespan (the glide path), and
  • constructed each Principal CIT’s investment portfolio, which involved “the selection and monitoring of the Target Date Funds’ underlying investment options and investment managers.”

Index ‘Calls’

It is this last step to which the plaintiffs attributed the fiduciary breaches: the selection and monitoring of the Principal CITs’ underlying investment options. Specifically, the suit notes that the defendants “…determined that four asset classes should be represented through passively-managed investment portfolios,” that during the relevant period represented 60% to 70% of the total assets of each of the Principal CITs. That, of course is not the issue – rather, the plaintiffs note that it’s not the “decision to use passive investments for these four asset classes or the index used to represent each asset class” that’s at issue here. Rather, the suit claims that “defendants’ fiduciary breaches relate to which index funds they utilized to track each of these four indices, a determination that fell squarely within the scope of their fiduciary duties.”

The suit notes that, “for most major market indices, one or more companies offer an index fund product that can track the index with a high degree of accuracy, while charging very low fees,” and that this is “particularly true for large investors such as the Principal CITs (which at all relevant times had over two billion dollars invested in index fund investments), that can leverage their billions in investable assets to negotiate lower fees than what is available to the vast majority of investors.”

However, the plaintiffs allege that the defendants here “…did not invest in any of the competitive index fund offerings in the marketplace, choosing instead to profit themselves and their affiliates by investing exclusively in Principal’s proprietary index funds, despite fees that were 5 to 15 times higher than marketplace alternatives that tracked the exact same index.” And if that were not enough, the plaintiffs further allege that the Principal index fund products were “far more expensive,” and “also of significantly lower quality,” 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.”

‘High Fees and History’

Ultimately, the plaintiffs allege that, “given the high fees and history of poor performance of Principal’s index funds, a prudent fiduciary of a multi-billion dollar suite of target date funds acting in the best interest of the trust beneficiaries would have removed these proprietary index funds from the Principal CITs at the beginning of the relevant period and replaced them with more competitive marketplace alternatives,” and that failing to do so has “cost participants millions in investment losses compared to what they would have earned had Defendants acted in accordance with their fiduciary duties.”

Not that the breaches were limited to the index fund selection. Rather, the plaintiffs allege that the defendants also “intentionally selected higher-fee versions of proprietary actively-managed funds to increase fee revenue, at the expense of trust participants and beneficiaries.”

The suit goes on to state that the “imprudent investment decisions were not the result of mere negligence or oversight,” but that the defendants “consistently invested the assets of the Principal CITs in costly and underperforming index funds, vehicles, and share classes, and failed to timely remove those funds long after a reasonable investigation would have revealed the availability of lower cost, better performing options.” Those decisions resulted in “additional investment management fees and provided a larger asset base to make Principal’s index fund and mutual fund products more competitive in the marketplace,” according to the plaintiffs.

Material ‘Witnessed’?

Perhaps laying the groundwork to refute statute of limitation arguments, the suit states that “plaintiffs did not have knowledge of all material facts (including, among other things, availability of less expensive and better performing alternative investments, the availability of lower-cost investment vehicles and share classes, the relatively greater experience, expertise, and asset base of Principal’s competitors in the index fund marketplace, and the investment performance of underlying Principal CIT investments versus other specific alternatives) necessary to understand that Defendants breached their fiduciary duties in violation of ERISA, until shortly before this suit was filed,” and that they do “not have actual knowledge of the specifics of Defendants’ decision-making processes with respect to the selection and monitoring of investment options within the Principal CITs (including Defendants’ processes and motivations for selecting, monitoring, evaluating, and removing investments), because this information is solely within Defendants’ possession prior to discovery.”

As of the end of 2016, over 9,000 retirement plans had one or more participants invested in the Principal CITs, and that while the plaintiffs “do not currently know the number of participants that have invested in the Principal CITs during the relevant period,” they believe it is in the “hundreds of thousands.”

In a response to Bloomberg Law, a company spokeswoman at Principal said the firm disagrees with the allegations in the lawsuit and will vigorously contest them.

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