Compliance July 19, 2021

Judge Allows Claims in ERISA Suit Against Prime Healthcare to Proceed

The lawsuit challenges the company's use of an active TDF suite in its 401(k) plan, among other things.

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A federal district court judge has denied dismissal of two claims in a lawsuit against Prime Healthcare Services.

Current and former participants of the Prime Healthcare Services Inc. 401(k) Plan filed a proposed class action lawsuit last year against the company and its 401(k) plan committee alleging they failed to fully disclose the expenses and risk of the plan’s investment options to participants; selected and retained high-cost, poorly performing investment options; and allowed unreasonable expenses for recordkeeping.

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A considerable amount of space in the complaint is dedicated to challenging the plan’s offering of the Fidelity Freedom Funds target-date fund (TDF) suite. The lawsuit alleges that the defendants failed to compare the actively managed Fidelity Freedom Funds to the passively managed Freedom Index Funds TDF suite and consider their respective merits and features. The complaint says the actively managed TDF suite was riskier and more expensive than the index suite.

In her discussion regarding her reasoning for allowing the breach of Employee Retirement Income Security Act (ERISA) fiduciary duties claim to move forward, Judge Josephine L. Staton of the U.S. District Court for the Central District of California noted that of the 29 Fidelity funds in the active TDF suite, 17 of them trailed their respective benchmarks over their respective lifetimes as of September 2020.

According to the court document, the active suite also had a significantly higher expense ratio than the index suite, despite consistently underperforming the index suite based on three- and five-year annualized returns. The active suite further underwent a “strategy overhaul” in 2013 and 2014 that gave its managers discretion to deviate from glide path allocations to time market shifts to locate underpriced securities. As a result of this “history of underperformance, frequent strategy changes and rising risk,” investors began to lose confidence in the active suite, as indicated by significant capital outflow; in 2018, the series experienced approximately $5.4 billion in net outflows, and the plaintiffs allege that nearly $16 billion has been withdrawn from the fund family over four years prior to 2018. The defendants continued to use the active suite as the plan’s qualified default investment alternative (QDIA) for as long as it was an option in the plan’s investment menu.

Staton found these allegations sufficient to plausibly allege that the defendants failed to act “‘with the care, skill, prudence and diligence’ that a prudent person ‘acting in a like capacity and familiar with such matters’ would use.”

The defendants argued that the complaint does not include any allegations about the process plan fiduciaries used to select the Freedom Fund TDFs as opposed to the index TDFs or other types of investments. But Staton agreed with the plaintiffs that “to state a claim for breach of fiduciary duty [under ERISA], a complaint does not need to contain factual allegations that refer directly to the fiduciary’s knowledge, methods or investigations at the relevant times.” She found the allegations sufficient to allow a reasonable inference of a flawed process.

The defendants also argued that the plan fiduciaries removed the active suite from the plan in 2019 and that the plaintiffs do not allege any facts showing the defendants acted imprudently with regard to the active suite during the period the plan actually held those funds. For example, the defendants point out that the three- and five-year performance analysis in the complaint is based on data as of September 20, 2020, which would include a period of time during which the plan did not offer the active suite. Staton said that at the pleading stage, this data is sufficient to support an inference that the active suite was consistently underperforming the index suite during the relevant time period. In addition, she found that the plaintiffs did allege additional facts supporting an inference of imprudence preceding the plan’s removal of the active suite.

Lastly, regarding the breach of fiduciary duties claim, the defendants argued that “courts routinely reject attempts to create an inference of an imprudent process through comparisons of the performance and fees of actively managed funds to those of passively managed funds.” Staton agreed that, where plaintiffs allege “‘a prudent fiduciary in like circumstances would have selected a different fund based on the cost or performance of the selected fund,’ they must provide a sound basis for comparison—a meaningful benchmark.” However, citing prior case law, she said, “Courts have specifically held that the determination of the appropriate benchmark for a fund is not a question properly resolved at the motion to dismiss stage.”

Regarding the plaintiffs’ failure to monitor co-fiduciaries claim, Staton noted that the defendants argued that this claim is derivative of the plaintiffs’ first claim and must be dismissed if they cannot adequately plead an underlying breach of fiduciary duty. However, because Staton found that the plaintiffs did adequately plead their first claim, she declined to dismiss the failure to monitor claim on this basis.

Staton did, however, grant the defendants’ motion to dismiss the plaintiffs’ third claim which alleged that “in the alternative, to the extent that any of the defendants are not deemed a fiduciary or co-fiduciary under ERISA,” they are liable for participating “in a knowing breach of trust.”

Staton gave the plaintiffs 21 days to amend their complaint to address the deficiencies she identified in her discussion.

The Markets July 16, 2021

Expect More ESG Investment Options Next Year

The move by the Thrift Savings Plan to add sustainable funds into its lineup next summer will likely cause private companies to follow suit, experts say.

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The financial services industry is likely to see a surge of environmental, social and governance (ESG) investing options in the next year, experts say.

That potential surge is expected as news made rounds that the largest U.S. defined contribution (DC) retirement savings program, the Thrift Savings Plan (TSP), will make ESG funds available in a new mutual fund window for the plan, starting in the summer of 2022. Participants will have access to more than 5,000 mutual funds through that window. 

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The TSP is a DC plan for U.S. civil service employees and retirees and for members of the uniformed services. It currently has 6.3 million participants and about $760 billion in assets.

“The opportunities to invest in funds focusing on ESG criteria will be attractive to investors generally and in many cases will motivate participation in retirement plans,” says Steven Skancke, chief economic adviser at Keel Point.

Unlike the Trump-era ESG rule that might have curbed sustainable investing in DC plans, the current administration has been more open to ESG investing. President Joe Biden’s administration even asked the Department of Labor (DOL) to consider rescinding the Trump-era final rule, though that rule took a softer stance than the original proposal, which drew intense criticism. The DOL had previously announced it would not enforce the ESG rule, or a rule on proxy voting, until it published further guidance.

“It signals a want and need from the American public to have investment options available to them,” says Jason Field, financial adviser at Van Leeuwen & Co. “As the [Biden] administration focuses on it, it continues that momentum that, in the future, ESG investing will be an everyday conversation.”

As a result of both the current administration’s approach and the move by the TSP, Field anticipates private organizations and the same companies that have avoided adding the funds due to confusion or uncertainty will be more likely to consider ESG investments. He says he expects to see popularity rise as plan sponsors realize they can fulfill their fiduciary duty by adding ESG funds, too.

“It’s removing barriers by this being a more general, broad inclusion into the TSP,” he adds. “This is just going to be a growing concept.”

F. Michael Zovistoski, partner at UHY LLP and managing director for UHY Advisors, agrees, saying the size and scale of the TSP will encourage employers and investors to consider adding the funds to their lineups, too. “The federal TSP is huge, so to be allowed on that platform will really escalate the exposure of ESGs and what investments are there,” Zovistoski says.

Because of this potential increase, Field says he also foresees a shift in how participants will think about their investing impact. For example, workers who didn’t have much knowledge ESG investing before might feel a social responsibility to invest in the funds if they are offered in their plan. Additionally, this move will likely prompt younger generations to invest, as these groups are more likely to care about the effect on their spending, Field says.

“There’s a generational gap where, in some cases, younger generations care more about the impact of their investment than just making as much money as possible,” he explains. “As the older generation’s wealth transfers to younger generations, that will be a big catalyst for ESG investing.”

This isn’t to say that investing in ESG funds will bring investors fewer dollars, though. While fees for ESG funds may be slightly higher than low-index or passive funds, studies have shown that ESG investing can perform just as well, or even better, than other funds. In February, for example, the Morgan Stanley Institute for Sustainable Investing released a study that found ESG funds performed better than non-ESG portfolios in 2020.

“This has been a heated debate over the past five to 10 years when it comes to retirement accounts and their possible inclusion, and it’s been even more relevant in recent years due to the growth of ESG fund flows in ETFs [exchange-traded funds] and non-retirement accounts,” says Craig Borkovec, financial adviser at Miracle Mile Advisors. “The flows have significantly increased in market share in just 2020 alone. ETFs that utilize ESG screens now take up nearly half the assets across the retail and institutional marketplaces.”

Field says he expects to see more investors and retirement plans avoid low-index funds that invest in fossil fuels, oils and tobacco. Along with that, he adds, there could be a shift toward renewable energy and solar wind, which, in turn, would drive up performance for ESG investing.

“This is just going to be a growing concept,” he says. “Inside of retirement accounts, outside of retirement accounts, it’s a conversation that we have been hearing, but now we’re hearing it more.”

However, just because there is more exposure does not mean additional guidance isn’t necessary. Zovistoski points to individual securities as one concern he sees with the TSP’s move. Within a fund could be anywhere between 35 to 60 individual securities, he explains.

“The question is: Is one individual company inside that ESG fund compliant or are all of them?” he asks. “My fear is that investors, in what’s touted as an ESG-compliant fund, may or may not realize that every investment inside that fund is not super compliant.”

Zovistoski says this is likely why the change won’t be incorporated until next summer.

“That may be the reason as to why the federal government put that off for another year, to get some regulation on that as well,” he says.” People are looking for a lot more guidance, and hopefully we’ll get there in the next year.”

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