A federal judge has recommended that a lawsuit against CenturyLink and its subsidiary CenturyLink Investment Management (CIM) over the design of an investment choice in CenturyLink’s non-union 401(k) plan be dismissed.
The lawsuit challenges the design and monitoring of the Large Cap Fund, an actively managed fund benchmarked against the Russell 1000 Stock Index. The fund has annual management fees of 0.41% of net assets, which is notably higher than an index fund. The fund allocated its assets between four investment firms, one actively managed mutual fund, and one large cap index fund.
The plaintiffs in the lawsuit argue that the use of so many active managers is a “design flaw” and the reason for the fund’s underperformance by an average of 2.11% relative to its benchmark since its inception in 2012.
However, U.S. Magistrate Judge Nina Y. Wang of the U.S. District Court for the District of Colorado concluded that the complaint “fails to sufficiently allege facts, taken as true, that would permit a factfinder to conclude that CIM breached its fiduciary duty under the applicable standards.”
Wang pointed out that the claims that CenturyLink breached its fiduciary duty by failing to properly monitor CIM and that it is also liable for CIM’s breach of fiduciary duty as a co-fiduciary depend on finding that CIM actually breached its fiduciary duty.
According to Wang, the plaintiffs make minimal factual allegations regarding any alleged flaws in CIM’s process in designing the fund. The complaint makes no factual allegations why, at the time the fund was designed, no prudent fiduciary would have diversified the fund across five different managers, except generic assertions regarding the use of multiple fund managers, she said, adding that she is “disinclined to accept Plaintiffs’ generic assertions.”
However, even accepting the plaintiffs’ assertions as true, Wang said the relevant standard acknowledges that fund managers are balancing multiple factors in their investment strategies, and there are no factual allegations to establish that CIM failed to reasonably balance risk and reward, short-term and long-term performance when diversifying the fund across five different managers. “In fact, the Second Amended Complaint does not make a single allegation regarding how a prudent fiduciary would have analyzed the available investments, and entirely ignores how the fund and its design fit into that analysis,” Wang wrote in her recommendation.
To the extent that the plaintiffs allege that the design of the fund is defective due, in part or whole, to its management fees, Wang said selecting a fund with “substantial fees” is not per se a breach of fiduciary duty; a modern portfolio may have any number of risky or high-cost investments if such investments are hedged and reasonable in context. And, citing Hecker v. Deere, she said there is no Employee Retirement Income Security Act (ERISA) requirement that a fiduciary “scour the market to find and offer the cheapest possible fund.”
Wang pointed out that courts find a plausible basis for a breach of fiduciary duty when the fiduciary could have selected an identical option with lower fees, but the plaintiffs make no such allegations, nor do they allege that an identical fund to the Large Cap Fund was available and had lower fees.
Wang also found that the plaintiffs failed to allege sufficient facts for a factfinder to conclude that CIM failed to properly monitor and replace the Large Cap Fund when it underperformed its benchmark by an average of 2.11% since 2012. She said the plaintiffs’ allegation that “[h]ad CIM replaced the Large Cap Fund with the T. Rowe Price Institutional Growth Fund, Plaintiff and other class members would have realized 5% higher returns on their investment,” improperly focuses on the outcome.
Reviewing a fund
Wang found that the plaintiffs failed to allege facts that indicate when a review of plan investments should have been conducted and/or that any review was deficient and what information and investment options were available to CIM at that time. Laying out what facts could have been argued, she said there are no allegations:
- that a particular event precipitated the need for CIM to review its plan investments;
- that CIM had a choice to replace the Large Cap Fund with any other fund year-to-year;
- what funds were available for replacing the Large Cap Fund, including but not limited to the T. Rowe Price Institutional Growth Fund;
- the opportunity costs of replacing the Large Cap Fund or CIM’s decision to remain with the Large Cap Fund was unreasonable weighing the opportunity costs of a switch, the comparative risk of the funds, the comparative short-term and long-term returns of the funds, and the balance of the overall portfolio, given information available to it at the time CIM would have been making year-to-year investment determinations.
Wang pointed out that the plaintiffs stated 89% of managers underperform their benchmarks, “and this court cannot accept that the mere fact of relative underperformance is sufficient to state a claim.” In addition, she noted that the fund had strong absolute performance—averaging over 11% return per year since inception—and that relative underperformance has been decreasing by the plaintiffs’ own admission.
If her recommendation to dismiss the suit is not accepted, Wang stated that she found the plaintiffs have sufficiently pleaded that CenturyLink is a functional fiduciary at this stage. She also rejected the defendants’ contention that the plaintiffs “have not pled any facts supporting their claim that CenturyLink ‘should have known’ continued investment in the Large Cap Fund was imprudent.” Wang also concluded that dismissal of plaintiff Birse’s claims on the basis of the statute of limitations is not appropriate at this juncture since there were no facts from which she could definitively discern the timing of Birse’s actual knowledge.
Dismissal with prejudiceWang explained that a dismissal with prejudice of a complaint that fails to state a claim under Rule 12(b)(6) is appropriate only when “granting leave to amend would be futile.” Futility has been found when a party has been previously granted leave to amend, but was unable to cure the deficiencies, and where a party has made no showing how it could cure the defects present in its current complaint. She noted that the plaintiffs do not seek leave to amend as an alternative to dismissal, and they have had multiple opportunities to amend. “Accordingly, this court respectfully recommends that dismissal of the Second Amended Complaint be with prejudice,” she wrote.