Compliance March 4, 2020

Evonik Chemical Corp. Faces ERISA Excessive Fee Challenge

Retirement plan fiduciaries at the specialty chemical company are accused of failing to take advantage of the lowest cost share class for many of the mutual funds offered within the plan, among other issues. 

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A new Employee Retirement Income Security Act (ERISA) lawsuit has been filed in the U.S. District Court for the District of New Jersey, alleging that the Evonik Corp. permitted excessive fees to be charged to its defined contribution (DC) retirement plan.

Also named as defendants in the lawsuit, which seeks class action status, are the company’s president, the board of directors, the retirement plan investment committee and 30 “John Does.”

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Similar to the plethora of ERISA excessive fee fiduciary breach lawsuits that have been filed in recent years, this one suggests the plan failed to use its bargaining power to negotiate lower fees. According to the text of the suit, the DC plan held more than $1 billion as of 2017.

“Defendants, however, did not try to reduce the plan’s expenses or exercise appropriate judgement to scrutinize each investment option that was offered in the plan to ensure it was prudent,” the lawsuit states. “Instead, defendants abdicated their fiduciary oversight, allowing Prudential Bank and Trust to lard the plan with funds managed by the trustee and/or its affiliates. These plan funds charged excessive fees.”

Notably, the lawsuit does not accuse Prudential of fiduciary breaches. Instead, it focuses on the conduct of the plan’s fiduciaries, who are also accused of failing to take advantage of the lowest cost share class for many of the mutual funds offered within the plan. The plaintiffs also accuse the fiduciary defendants of failing to consider collective trusts, comingled accounts or separate accounts as alternatives to the mutual funds in the plan.

Based on this alleged conduct, the plaintiffs assert claims against the defendants for breach of the fiduciary duties of loyalty and prudence (organized under count one) and failure to monitor fiduciaries (count two).

Turning to the ever-important topic of timeliness, the complaint states that plaintiffs “did not have knowledge of all material facts (including, among other things, the investment alternatives that are comparable to the investments offered within the plan, comparisons of the costs and investment performance of plan investments versus available alternatives within similarly-sized plans, total cost comparisons to similarly-sized plans, information regarding other available share classes, and information regarding the availability and pricing of separate accounts and collective trusts) necessary to understand that defendants breached their fiduciary duties and engaged in other unlawful conduct in violation of ERISA until shortly before this suit was filed.”

The text of the complaint goes into significant detail while describing the duties of prudence and loyalty under ERISA before turning to the specific allegations at hand. It also discusses the broad debate about the use of active management funds within retirement plans.

“The funds in the plan have stayed relatively unchanged since 2013,” the complaint states. “Taking 2018 as an example year, the majority of funds in the plan (at least 10 out of 16) were much more expensive than comparable funds found in similarly-sized plans (plans having between $500 million and $1 billion in assets). The expense ratios for funds in the plan in some cases were up to 54% above the median expense ratios in the same category.”

The complaint then suggests that, in several instances, “defendants failed to prudently monitor the plan to determine whether the plan was invested in the lowest-cost share class available for the plan’s mutual funds, which are identical to the mutual funds in the plan in every way except for their lower cost.”

“A prudent fiduciary conducting an impartial review of the plan’s investments would have identified the cheaper share classes available and transferred the plan’s investments in the above-referenced funds into the lower share classes at the earliest opportunity,” the complaint alleges. “There is no good-faith explanation for utilizing high-cost share classes when lower-cost share classes are available for the exact same investment. The plan did not receive any additional services or benefits based on its use of more expensive share classes; the only consequence was higher costs for plan participants.”

The complaint goes through similar arguments with respect to the defendants’ alleged permission of excessive recordkeeping fees and their offering of poorly performing and expensive actively managed funds.

The Evonik Corp. has not yet responded to a request for comment about the litigation.

The Markets March 4, 2020

When Target-Risk Makes More Sense Than Target-Date

The reason why target-risk funds gave way to target-date funds is the perceived simplicity of just using one’s retirement date to set the portfolio's investment risk tolerance—but this approach doesn’t work optimally for all participants.

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Invesco has released findings from its new study, “The Forgotten Participant,” examining defined contribution (DC) participant investing behaviors and decisions regarding the core investment menu.

The research finds that DC plan providers have made significant progress in helping participants address the challenges of reaching a financially secure retirement through automatic enrollment, automatic escalation and auto-default into target-date funds (TDFs). At the same time, the retirement plan industry has overlooked a “significant segment” of participants that are actively making investment decisions—often ineffectively—across the core DC plan menu in an effort to diversify and fine tune their risk profile.

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John Galateria, managing director and head of North America Institutional for Invesco, tells PLANADVISER the best way to explain this new research is to make one thing abundantly clear.

“By no means are we advocating that target-risk strategies should come in and automatically replace target-date strategies,” Galateria says. “Target-date strategies have done a lot to provide diversified and professionally managed portfolios to participants that are relatively straightforward to understand and use. They give many people a much more stable and rationale way to approach their retirement investing.”

Instead, what the new analysis is about is looking again at the core menu and understanding some of the potential unintended consequences that have come about due to the radical simplification of core menus that has occurred in the last decade since the passage of the Pension Protection Act (PPA), which helped to normalize and popularize TDFs as default investments.

“We are asking whether we can see a world where target-date and target-risk go together on the same plan menu,” Galateria says. “What would that mean for these overlooked or forgotten participants who are trying to direct their own portfolios?”

Stepping back, Galateria says, the main reason why target-risk gave way to target-date is not that target-risk strategies are inherently inferior. Instead, target-date funds have benefited from the added perceived simplicity.

“The fund you pick is simply based on your age, versus something more complex like your risk tolerance,” Galateria says. “We know that, for many people, their understanding of risk is somewhat challenged, but that’s not universally true. We did a series of focus groups as part of this research project, and we saw clearly that there is an informed population out there that is thinking deeply about risk, their time horizon, and more. These people are not asleep at the wheel and they don’t just want to invest in TDFs.”

Invesco’s survey finds 65% of all participants felt that a risk-based solution would be a good fit for them, personally, while 80% of higher income participants would invest in risk-based strategies. At the same time, 64% of plan sponsors are interested in adding risk-based strategies to the investment menu as they allow participants to take the amount of investment risk that meets their needs.

“The survey data and focus groups have proven to be really important in understanding what is going on here,” says Greg Jenkins, Invesco’s head of institutional defined contribution. “We observed a sizable group of people that didn’t want a TDF but weren’t 100% confident in investing on their own. They want more control and to be engaged more than a set-it-and-forget-it investor. They are great candidates for target-risk strategies.”

According to Jenkins and Galateria, older and wealthier participants voiced stronger support for target-risk strategies, as did participants who have multiple investment accounts within their household—say a pension, an individual retirement account (IRA) or even other 401(k) plans.

“They wanted to be able to dial in a particular level of risk for their current DC plan investments,” Jenkins explains. “We also saw a group of younger participants who really didn’t resonate with the whole concept of having a pre-defined, one-time retirement date. They don’t think about retirement as a single date, at all. So TDFs are confusing to some younger participants. Also, we heard from quite a few people that they actually wanted to be able to dial up risk beyond what is offered in the default TDF.”

Galateria says the industry has learned a lot from behavioral finance researchers since the passage of the PPA.

“This is starting to change, but until recently, there was a challenge associated with asking people to accurately assess their own risk tolerance,” Galateria says. “The old-fashioned quizzes could only go so far. But now, with all the tools of behavioral finance and with researchers being able to use digital tools to analyze the real behaviors and goals of participants, we are realizing that risk tolerance is not contained in the responses to a questionnaire. Risk tolerance is actually much more emotional and aspirational than logical, and we have come to understand this a lot better.”

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