Compliance August 29, 2017

Morningstar and Prudential Deny Racketeering Claims

The complaint suggests the companies engaged in “Tammany-like” collusion to steer assets into more favorable investments; both providers have issued strong denials and requests for summary judgement. 
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Another ERISA lawsuit has emerged in federal court, this one naming both Morningstar and various Prudential companies as defendants in the U.S. District Court for the Northern District of Illinois.

The case is unique because it cites both the Employee Retirement Income Security Act (ERISA) and the Racketeer Influenced and Corrupt Organizations Law of 1970, known as RICO. The lead plaintiff in the would-be class action suit is an employee of Rollins Inc. and a participant in the Rollins retirement plan. The Rollins plan is a defined contribution retirement plan with assets of roughly $500 million and more than 10,000 participants and beneficiaries, case documents show. Defendants are investment analysts, investment-related software developers, investment consultants, recordkeepers and investment managers with respect to the Rollins Plan and other 401(k) retirement plans across the country.

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Specifically, the suit is focused on the various groups that manage the plan participant-level automated investment advice program marketed under the tradename GoalMaker.

“Plaintiff and the other participants in the plans used and were injured by this innocuous-sounding investment advice program,” the suit contends, “which in reality was a predatory racketeering enterprise developed, maintained and marketed by defendants. Defendants’ so-called investment advice program gets retirement plan investors to turn over the investment management of their plan accounts to defendant PRIAC. PRIAC, along with its corporate siblings who facilitated the instant racketeering scheme, is a core part of the RICO racketeering enterprise at issue here.”

It should be noted straightaway that both Prudential and Morningstar have filed extensive responses to the suit denying the charges here described and requesting summary judgement against the plaintiff. And it is also relevant to observe that the GoalMaker product has been challenged unsuccessfully in a federal district court before by a disgruntled participant. In that case, which is not exactly parallel but has some important similarities, U.S. District Judge Victor A. Bolden of the U.S. District Court for the District of Connecticut found plan participants were provided with sufficiently detailed information regarding the exact investments included within GoalMaker along with information pertaining to the fees involved with each of these investments. In addition, he noted it is undisputed that the GoalMaker program was optional for plan participants, and it did not offer any investment selections that were not already included in the broader menu of investment options.

At oral argument in the Connecticut case, plaintiffs suggested their complaint should be seen as part of a series of cases intended to move the entire retirement planning industry to zero revenue sharing, based on the notion that zero revenue sharing is much less expensive and transparent for plans and for participants. Bolden said these goals, however worthwhile they may be, are not compatible with the strict purposes of ERISA. Bolden added in his opinion that, in light of the legal insufficiencies discussed in connection with the plaintiff’s claims, further amendment of the amended complaint would be futile.

NEXT: Examining the new complaint 

Background information in the new complaint regarding the Rollins plans shows the plan sponsor, typical of a defined contribution plan, designates a number of mutual funds or other collective investment funds as the plan’s core investment options. Currently there are 17 separate choices, plaintiffs claim, including a Rollins stock fund. The complaint acknowledges that this gives individual Rollins plan investors the ability to choose how their accounts will be invested by allocating their accounts among those designated investments. True to form, the Rollins plan purports to transfer the entire responsibility and liability for investment decisions to the plan investors, plaintiffs explain.

Within this framework resides the GoalMaker overlay product, described by plaintiffs as “a computer-based asset allocation program that automatically allocates a plan investor’s account among various plan investment options based on the investor’s age, income, savings rate and other data.” Plaintiffs argue the GoalMaker solution is built “based on the goal of advancing the interests of the enterprise,” rather than for the best financial interest of the clients. To be clear, the complaint adds Morningstar as a defendant because “GoalMaker uses Morningstar’s technology to allocate retirement investing assets,” and it compensates Morningstar as a result.

The crux of the charges leveled by the lead plaintiff is that “both the Prudential defendants and Morningstar, through concerted racketeering action, including but not limited to consulting meetings and joint GoalMaker-related asset allocation computer modeling work, arranged for GoalMaker to influence plan investors including plaintiff to invest in high-cost retirement funds that kick back unwarranted fees to the Prudential defendants by limiting the investment choices otherwise available to participants in the plans that would be included in the GoalMaker asset allocation program.”

The suit argues that “what plan investors really get is an off-the-shelf asset allocation model from Morningstar. Morningstar provides their services to Prudential Retirement, as the plan recordkeeper, and the allocations are presented to the participants through Prudential’s GoalMaker service offering as GoalMaker Funds … When the plans use GoalMaker, GoalMaker does not take into consideration each plan’s entire menu of designated investment alternatives. For example, with respect to the Rollins plan, of the 16 designated investment alternatives (not including the Rollins Stock Fund), only seven are utilized by the GoalMaker program. In other words, instead of steering Plan participants into the best and most cost effective investment options available to them, GoalMaker sent plaintiff and other class member investors into high-cost retirement funds because doing so benefited defendants.”

One specific example of bias claimed by the plaintiff goes as follows: “As concerns the Rollins plan, for the so-called mid cap equity asset class, GoalMaker includes the Goldman Sachs Mid Cap Value Fund, Class A shares, with a total expense ratio of 1.16%. But it excludes the generally comparable but much less expensive Vanguard Mid Cap Index Fund Admiral share class, which has a total expense ratio of only 0.08%. The Vanguard fund pays no revenue sharing kickbacks to PRIAC, whereas the Goldman Sachs fund makes revenue sharing payments to PRIAC in the amount of 25-40 basis points of the investment in the fund.”

Both the Morningstar motion to dismiss and the Prudential motion to dismiss deny step-by-step the charges leveled above. Broadly speaking Morningstar’s approach is to argue that the complaint is mischaracterizing its relationship with Prudential to the effect that the two are nefarious collaborators, while Prudential denies the characterization of GoalMaker as grossly inaccurate. Both providers stress that the plan participants have full access to fee information and full control of how they would like to see their assets invested across the core menu.

The full text of the complaint is available here.

The Markets August 29, 2017

A Decade After PPA and the QDIA Debate Continues

The transition period, from five years before retirement to five years after, is the most critical phase of lifecycle investing—and potentially the most difficult to manage with a standard TDF glide path. 
Reported by

Ron Surz, president and CEO of Target Date Solutions, is among the retirement industry professionals who commonly offers his own independent analysis in response to PLANADVISER articles and big news from other trade publications. 

Regular readers may know Surz as something of an outspoken and unabashed critic of a lot of the thinking behind proprietary and bundled target-date funds. His website suggests that target-date funds (TDFs) are “a reasonably good idea” but with poor execution, “at least so far.” So it was no surprise to see him offer commentary in response to our recent articles speaking to the virtues (and some of the drawbacks) of bundled approaches to recordkeeping and target-date fund investing.

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Recently Surz has been focused on the theme of “combining TDFs with managed accounts to create personalized target-date accounts, or PTDAs.” Leveraging the open-architecture approach, he says PTDAs are customized to each participant’s circumstances and goals while also striving to get around the natural limitations of one-size-fits-all glide paths associated with big proprietary TDF products.

“Managed account providers can help participants identify appropriate risks and offer input on customizing risk exposures along the best TDF glide path,” Surz explains. “Recordkeepers have their role to play in managing the allocations to personalized age-and-risk appropriate models.”

Speaking frankly, Surz says the best managed account is delivered in tandem with face-to-face individual consulting, “but this is expensive, so true one-on-one managed accounts are generally limited to the executives of companies.” However, increasingly there are effective managed accounts available for the rank and file through so-called “robo-advisers,” which provide computerized automated guidance.

“The Department of Labor recommends the incorporation of workforce demographics into TDF design,” Surz adds. “This can only be accomplished with individualized choices. Some participants will have savings outside the DC pension plan, so they don’t need to generate high returns, arguing for conservatism. Others might not have saved enough, so they require higher investment returns associated with aggressiveness.”

NEXT: Related arguments from the biggest fund providers 

Surz’s firm is far from the only provider in the retirement investing industry to speak about expanding and improving the lifecycle investing conversation. Way back in 2013, Russell Investments introduced its Adaptive Retirement Accounts to provide a way for defined contribution (DC) plan sponsors to further enhance their plans’ default option. The solution leverages existing investment options and draws on participant information that can be made available from the recordkeepers (e.g., age, savings deferral rate, current account balance, salary and defined benefit pension benefit) to determine the appropriate asset allocation for each participant based on how “on-target” they are toward meeting their specific retirement income goal.

Importantly, this can all be done without requiring a great degree of direct participant involvement, since the necessary information to create the customization already resides with the recordkeeper or on the plan sponsor’s human resources system.

In 2014, Charles Schwab introduced an open-architecture approach to the qualified default investment alternative aimed at getting sponsors to “consider the opportunities presented by combining a 401(k) plan based on exchange-traded funds (ETFs) with an independent managed account service from a trusted plan adviser.” Building plan defaults in this style can significantly reduce expenses for participants and brings more transparency to sponsors and other fiduciaries, the firm contends.

Whereas TDFs are typically built to suit wide swaths of investors—based heavily on the single metric of participant age—the ETF/managed account approach allows each workplace investor to create a portfolio that’s directly relevant to his or  her personal financial outlook, according to Schwab research. Extensive salary data, outside assets and specific risk tolerance considerations can be factored into the asset-allocation strategy. For plan sponsors, there is the added benefit of cutting out share class considerations that come along with mutual funds, he adds. Unlike mutual funds, which come in different share classes (i.e., with different expense ratios) depending on the size of the investment, ETF shares are generally priced equally.

NEXT: Importance of the recordkeeper 

Surz, even while he remains skeptical of bundled TDF approaches, agrees that “a skillful and competent recordkeeper will be the glue that effectively cements TDFs with managed accounts … The recordkeeper applies a proprietary process to manage to each participant’s risk preference and age.”

“Some may say that the removal of standardization is a problem,” for example for benchmarking and fee comparison purposes, “but it is a natural consequence of personalized solutions, including managed accounts,” Surz concludes. “In addition to reducing costs and meeting the risk preferences of individual participants, managed accounts more accurately manage to each participant’s age.”

Interestingly, some major providers, such as Empower Retirement, have started to implement approaches “designed to help plan participants whose retirement planning needs change over time.”

For Empower, this is embodied by the Dynamic Retirement Manager solution, “which takes into account the driving roles of participant inertia and engagement.” Given the fact that engagement with the plan tends to increase dramatically over time, the solution allows plan sponsors to direct their employees’ retirement deferrals first into target-date funds during the early portion of their working years. Later on, when a pre-determined set of criteria having to do with the level of assets and the employee’s engagement are triggered, the assets will automatically shift into a managed account.

Empower says the later-career transition to a managed account affords participants who have had success in the plan an opportunity to receive advice on a personalized retirement income strategy once they are ready for it. Of course, given the challenge in general of getting young people focused on retirement savings, it stands to reason the solution will be most effective when paired with such progressive plan design features as auto-enrollment and auto-deferral escalations.

“In an ideal world everyone in their first job would make all the correct and necessary decisions about investing for the future and would continue to do so throughout their careers,” observes Edmund Murphy III, president of Empower Retirement. "The reality is that retirement isn’t top-of-mind for many workers until later in life and by then their needs and goals are more acute and likely in need of customization.”

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