Compliance December 15, 2014

Nationwide Settles 13-Year-Old Revenue Sharing Suit

After 13 years and a number of court opinions, all granting relief in the plaintiff’s favor, Nationwide has presented a motion to settle a lawsuit over its revenue-sharing practices.
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Nationwide Financial Services has filed a motion for preliminary approval of a settlement of a lawsuit filed by trustees of five qualified retirement plans alleging that the provider’s revenue-sharing arrangement with mutual funds constituted transactions prohibited by the Employee Retirement Income Security Act (ERISA).

In its motion, Nationwide says the settlement secures a number of significant changes to its business practices that will result in different investment options and enhanced disclosures for the plans and for future purchasers of Nationwide’s annuity contracts and trust platform products. Nationwide will also pay $140,000,000 to the class identified in the lawsuit.

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The suit, Haddock v. Nationwide, alleges that Nationwide violated ERISA when it kept fees that it received from nonproprietary mutual funds that it offers through its defined contribution platform. Nationwide is the third-largest writer of 401(k) contracts in the nation, the company says in its press releases.

The lead plaintiff in the action is the deferred compensation plan of Flyte Tool & Die, a plastic molding company in Bridgeport, Connecticut. The plaintiffs claim that the refunds of management fees that Nationwide received from nonproprietary mutual funds were plan assets that should have been returned to the plans. Furthermore, they allege that, in not revealing these “kickbacks,” Nationwide misrepresented the level of fees it was receiving.

By retaining the fees and not disclosing them, the plaintiffs claim Nationwide violated ERISA’s prohibited transaction and fiduciary duty rules. They say the provider purposefully chose to include outside mutual funds with high management fees in order to maximize the “undisclosed kickbacks” it received. The plaintiffs are asking for a return of these fees along with damages plus all profits that Nationwide earned on them.

In 2006, the U.S. District Court for the District of Connecticut denied Nationwide’s motion to dismiss the case, saying a reasonable jury could find that Nationwide Financial Services Inc. and Nationwide Life Insurance Co. were plan fiduciaries under ERISA, and the trustees deserved a chance to present further evidence against the Nationwide companies. Nationwide argued it was not subject to ERISA's prohibited transaction rules because it was not a fiduciary to the plans and because the revenue-sharing payments were not plan assets.

Nationwide offered the plans various investment options, including insurance products such as variable annuities. The variable annuity contracts allowed the plans and plan participants to invest in a variety of mutual funds selected by Nationwide. The court said, “A rational factfinder… could find that Nationwide's ability to select, remove, and replace the mutual funds available for the Plans' investment constituted discretionary authority or discretionary control respecting disposition of plan assets, and thus that Nationwide is an ERISA fiduciary.” The court also said, "The Trustees have also raised triable issues concerning whether the challenged payments constitute plan assets under a functional approach and whether, even if the revenue-sharing payments do not constitute plan assets, Nationwide's service contracts constitute prohibited transactions."

The following year, U.S. District Judge Stefan R. Underhill again turned away an attempt by Nationwide to have certain claims dismissed because they were not brought up in previous versions of the complaint. In 2008, Underhill said Nationwide’s attempt to countersue the trustees because they had the ultimate responsibility for purchasing annuity contracts and making changes to investments options, they knew of the revenue sharing payments, and they received cost-savings from those revenue sharing payments should be allowed, but warned the provider that the counterclaims would ultimately be unsuccessful.

The settlement agreement calls for substantial changes to Nationwide’s disclosure and fund selection practices, including disclosures of all fees and revenue-sharing payments, notices of fund changes, and the opportunity to transfer from certain investment products to products for which payments are credited to the plan in the form of reduced asset fees.

More details of the settlement agreement can be found in the motion for preliminary approval.

The Markets December 15, 2014

Institutional Investors Face a Complicated 2015

While institutional investors are optimistic about equities in 2015, their outlook is tempered by market risks that are difficult to predict and control.
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Pension funds and other institutional investors believe they will meet their long-term return objectives, a new Natixis Global Asset Management survey shows, but most are worried about increasing market correlations and the challenge of earning stable short-term returns in the current environment.

The findings are from the Natixis 2014 Institutional Investors Survey, which suggests institutions are struggling to generate sufficient and reliable short-term returns within traditional asset-allocation strategies. Fully 87% of the institutional investors polled by Natixis—which included public and corporate retirement plans—expect to meet their long-term liabilities, yet more than half of respondents believe most other organizations will fail to do so.

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Underscoring this sentiment, six in 10 institutions say the financial advisory and investment management industries have not been innovative enough in developing liability-driven investing (LDI) solutions that help organizations map and meet future costs—especially those related to pension fund contributions and benefit liabilities.   

On average, investors polled by Natixis expect to achieve yearly returns of 6.9% after inflation during the years ahead. Despite their need for continued asset growth, institutional investors are twice as likely to reduce portfolio risk as to increase it in the next 12 months. Survey respondents pointed to geopolitical events, European economic problems, slower growth in China, and rising interest rates as potential drags on performance next year that could lead to a lower-risk approach.

One Natixis leader who discussed the survey results with PLANADVISER says this is the first in six editions of the survey where the theme of environment, social and governance (ESG) investing has jumped to the forefront.

“And it’s not just the survey results that are showing us the increased attention for ESG,” notes Robert Hussey, executive vice president, institutional services, Natixis Global Asset Management. “We have an ESG manager in Europe that we’ve been bringing to the U.S. quite a bit in recent months to meet with some of our institutional clients. They’ve really shown an increased interest in ESG solutions moving into 2015.”

According to Hussey, pension funds and other institutional investors are looking to ESG in more sophisticated ways than they have in the past.

“It’s encouraging that clients aren’t asking for hard overlays that say things like, ‘no tobacco’ companies or ‘no defense industry investments in our portfolio,’” Hussey explains. “That’s not what the next generation of ESG investing is going to be about. Valuable ESG investing is going to involve doing some real fundamental research to try and achieve alpha.” (See “Looking Ahead Responsibly.”)

To this end, Hussey anticipates institutional investors will increasingly look to green bond funds, as well as water and agriculture infrastructure projects. Others may decide to apply portfolio screens and avoid companies with uncompensated exposure to fuel cost risk, environmental safety risk, water scarcity risk, and other factors that are important to business success in a more populous and environmentally strained future.

ESG investing executed this way serves not only the philosophical and ethical objectives of the client, Hussey says: It can also be a real source of alpha in increasingly correlated and efficient global markets. The survey results find 54% of institutions think ESG investing has long-term growth and alpha benefits, and 55% agree that ESG investing mitigates risks such as loss of assets due to lawsuits, social discord or environmental disasters/scarcity challenges.

Other results from the survey show more than half (55%) of institutional investors agree that traditional assets are too highly correlated to provide distinctive sources of return. Hussey says this is in part a result of global markets growing more efficient through technology and emerging market maturation—a sentiment shared by 75% of survey respondents.

“Information barriers continue to break down and the interconnectedness of markets can only be expected to increase in the future,” Hussey continues. “As the survey found, this is leading most institutions to turn away in some measure from traditional asset allocation and towards a greater use of alternative strategies.”

In fact, 81% of institutions agree that alternatives are suitable for their portfolios, and 60% feel alternatives are a good potential source of return that can help an investor beat the wider markets. On the other hand, more than seven in 10 (71%) believe that alternatives are already a necessary portfolio component that helps manage risk and asset correlation.

As they look ahead to 2015, 67% of survey respondents expect difficulties over the next three years linked to rising interest rates, and 81% say it will be challenging to manage volatility in that time. As rates rise, the top three ways institutional investors plan to reposition their portfolios are to move from long to shorter-duration bonds (cited by 61%), reduce exposure to fixed income (46%), and increase use of alternative strategies (36%).

The Natixis Global Institutional Investor 2014 study is based on fieldwork carried out in 27 countries. Interviews were conducted in October and November with 642 senior decision makers working in institutional investment. Respondents were leaders of corporate, public and government pension funds; sovereign wealth funds; insurance companies; endowments and foundations; and other institutions.

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