A large money manager and recordkeeper is pushing back on allegations of self-dealing with regard to the investments and administration of its own 401(k) plan.
This time it’s Prudential’s $8 billion plan (and approximately 45,000 participants as of 2018) who were sued last November by former participant Young Cho.
That suit accused the Prudential defendants of, among other things, “overpopulating the Plan with proprietary mutual funds offered by Prudential and its affiliates, failing to monitor the performance of those funds, and failing to adequately disclose the amount of recordkeeping fees received by Prudential, resulting in the payment of grossly excessive fees to Prudential and significant losses to the Plan and its participants.”
The suit went on to charge the plan’s Investment Oversight Committee with not only picking those funds “because they were familiar and generated substantial revenues for Prudential,” but that the use of these “affiliated funds ensured that Prudential’s employees, many of whom may sell others on the benefits of owning Prudential funds, would themselves own Prudential funds, thereby building loyalty, product knowledge, and a built-in sales pitch touting the employees’ personal investment in the pitched products.”
Prudential Response
Prudential has already filed its response (Cho v. Prudential Ins. Co. of Am., D.N.J., No. 2:19-cv-19886, motion to dismiss 1/24/20), which could perhaps be summed up most briefly as “just because you say it’s so doesn’t mean it’s so.” Or, as the response more artfully says, “At the heart of Plaintiff’s complaint is his belief that the mere fact that Prudential offers its 401(k) plan participants investment fund options managed by its affiliates is in and of itself sufficient to allege that Prudential violated the Employee Retirement Income Security Act of 1974 (‘ERISA’). It is not.”
Moreover, since those same Prudential funds are “typically offered in large United States and global retirement plans, it would be troublesome if Prudential’s own plan did not offer such options to its employees.” More plainly they state that the selection was the result of “careful arms-length decision-making designed to benefit plan participants that resulted in the inclusion of a selected group of affiliate funds in Prudential’s 401(k) investment menu, alongside a variety of non-affiliated funds – and not some nefarious motive.”
Ultimately, they argue that “because Plaintiff has failed to adduce factual allegations that could support an inference of fiduciary breach, and for the other reasons described in this memorandum, the Court should dismiss Plaintiff’s Complaint, in its entirety, with prejudice.”
The Particulars
The response notes that the Prudential plan offers 21 investment options (11 of which are managed by Prudential), including mutual funds, pooled insurance company separate accounts, separately managed accounts, company stock, collective investment trusts, guaranteed retirement income products, and a fixed rate fund. And, despite the allegations in the suit, Prudential claims that the fees charged by those funds are “low-cost,” going on to explain that those funds carry expense ratios that range from 0.02% for the QMA U.S. Broad Market Index Fund (a passively managed index fund), to 1.01%6 for the PESP IncomeFlex Target Balanced Fund (a retirement income fund with guaranteed income), but that “the majority of the funds have expense ratios of 0.32% or less.” Indeed, it notes that, outside of the four IncomeFlex Funds and the PESP Fixed Rate Fund, “which all provide certain guarantees and have fees that reflect those additional features, Prudential-affiliated funds have an average expense ratio of 0.248%.”
The response also refutes the allegations of performance relative to benchmarks, noting that, “as of June 30, 2019, over 85% of the Plan’s available investment options with mandated benchmarks, including Prudential-affiliated funds, outperformed their benchmarks on a one five, or ten year basis,” going on to explain that, “of these, instances of funds underperforming their benchmarks have been short-lived, with the majority showing consistent outperformance on a long-term five or ten year basis.”
The Prudential defendants state that the plaintiff didn’t “plead facts showing Prudential had an imprudent process for managing the PESP investment lineup, and instead pleads facts about the PESP’s reasonable mix and range of investment options that actually demonstrate Prudential’s prudent management.” They also claim that the allegation that Prudential breached its duty of loyalty “fails because he does not allege facts suggesting Prudential acted to further its own interests.”
Moreover, they note that plaintiff Cho “only invested in four of these nine funds, only one of which is a Prudential-affiliated fund,” and that he therefore lacks standing to bring claims related to the other funds in the plan.
They go on to assert that the prohibited transactions claims are “inadequate because he does not allege any facts supporting an inference that, by offering affiliated funds, Prudential intended to benefit itself at the expense of Plan participants,” and that the claims are barred by the statute of limitations, “because he had actual knowledge of the facts he alleges more than three years before he filed suit.” Ultimately, they note that the allegations regarding the duty to monitor and knowing breach of trust claims “fail because they are derivative of his other failed claims and are inadequately pled.” In essence, “his insufficiently pled, time-barred claims should be dismissed, with prejudice.”
As for the specifics:
“The Vanguard fund alternatives Cho references are not comparable to the PESP funds – the Vanguard funds are index funds, whereas the PESP funds are actively managed,” and that “index funds are not an appropriate comparator for actively managed funds, because they do not employ similar operations or investment strategies.”
The claims of underperformance “are based on cherry-picked rolling return metrics designed to exaggerate brief periods of underperformance compared to inappropriate benchmarks; Cho has selected time periods that paint a bleak picture.”
Of the seven he chose, only four are alleged to have been the subject of fiduciary breaches: (1) Jennison Opportunistic Equity CIT, (2) Wellington Trust Company CIF II International Opportunities Portfolio, (3) Alliance Bernstein Core Opportunities Fund, and (4) Delaware Small Cap Core Equities Fund – but plaintiff Cho, they note, “has not alleged that he personally suffered any injury regarding the other three investment funds he utilized, and the fact that he purports to allege injuries to the Plan that did not and cannot affect him personally is not sufficient to give him standing.” Moreover, as a former participant, “Cho is at no risk of future losses because he cannot invest in other Plan funds in the future. Therefore, Cho lacks standing to sue for fiduciary breach regarding any fund other than the four he utilized, and all of his claims regarding other funds should be dismissed with prejudice.”
As for claims that Prudential’s role as the recordkeeper for the Plan provides Prudential with “a further stream of revenue” in the “form of direct participant fees” – and that Prudential “fail[ed] to adequately disclose the amount of recordkeeping fees – well, explaining elsewhere that, “since 2016, the Plan’s administrative expenses, including recordkeeping fees, are not paid by the Plan,” they note that the plaintiff “fails to provide any facts at all to support these statements, despite having access to Prudential 404(a) notices and Form 5500s.” The conclude that “his allegation is based on his disbelief of the actual information he admits to having.
“Conclusory assertions about defendants’ intent cannot substitute for factual allegations.”
What it Means
We noted last year that It seems likely that proprietary fund suits will continue to emerge, and sure enough here’s another. Most have, sooner or later – and often on the date of trial – settled. There have, however, been exceptions.
It’s worth remembering one of these cases that did prevail at trial; a big victory by the American Century plan fiduciaries where 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.
This particular suit was arguably “lighter” on its allegations than most; light on specifics, certainly in comparison with other suits in this genre have been. While such things can vary depending on the perspectives of individual judges, this one might well be rejected at summary judgment.
But then, such things are never certain – until they are.
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