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. 

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.

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.