Participants Can Move Forward With Excessive Fee Claims Against Emory

A federal judge agreed with the 403(b) plan participants on many points, but agreed with Emory University that offering a wide range of investment options does not hurt participants.

A federal judge has denied in part and granted in part Emory University’s 403(b) excessive fee suit.

Among the claims for which U.S. District Judge Charles A. Pannell, Jr. of the U.S. District Court for the Northern District of Georgia granted dismissal, was the claim that the plan included too many funds in the investment lineup. The plaintiffs argue that having too many investment options is imprudent. They asserted that the plans offered 111 investment options, and that many of those options were duplicative. Instead, the plaintiffs allege that the plans should have offered fewer options and used more bargaining leverage with those investment options to obtain lower fees.  

Pannell said he does not agree with the plaintiffs’ theory. “Having too many options does not hurt the plans’ participants, but instead provides them opportunities to choose the investments that they prefer,” he wrote in his opinion

In the lawsuit, the plaintiffs’ primary allegations are that the plans’ fiduciaries did not use their bargaining power to negotiate for lower expenses and exercise proper judgment in deciding what investment options to include in the plans. In addition, they allege Emory fiduciaries allowed the recordkeepers to tie the plans to certain investment options, and collected “unlimited asset-based compensation from their own proprietary products.” 

The defendants’ first argument is that the plaintiffs’ prudence claims fail as a matter of law. They argue that the plaintiffs fail to state a plausible claim that the plans’ investment management fees were excessive. But, Pannell noted that the complaint sets out close to 100 mutual funds used by the plans with higher costs than identical mutual funds the plans could have attempted to negotiate for with lower costs. Parnell found the plaintiffs have properly stated a claim that choosing retail-class shares over institutional-class shares is imprudent.

NEXT: Active vs. passive funds

In addition, the defendants contend that the plaintiffs have not stated a claim that they acted imprudently by including actively managed funds instead of solely passively managed funds. The plaintiffs argue that the plans’ administrative and recordkeeping providers required the defendants to include their preferred investment lineup in the plan as investment options for participants. The plaintiffs contend that these fund options were not included in the plans based on the best interest of the participants, but instead to benefit the plans’ service providers. TIAA-CREF required the plans to “offer its flagship CREF Stock Account and Money Market Account, and to also use TIAA as recordkeeper for its proprietary products,” the plaintiffs say. The plaintiffs argue that the plans should have instead used an open architecture model. That would allow the plans’ fiduciaries to choose funds independently and in the best interest of the participants because the plans would not be subject to using only the provider’s investment products.

According to the complaint, the plaintiffs contend that the defendants failed to properly analyze the funds allowed in the plans, and that if they had analyzed the funds they would have learned that the actively managed funds (including the funds the recordkeepers required the plans to use) would not outperform similar passively managed funds. Even if an investment was no longer prudent, the plaintiffs argue that the defendants’ agreement with the plans’ providers would not allow many of the funds to be removed because the contract with the providers required the plans to retain the investment options.

The defendants argue generally that the plaintiffs’ claim fails because simply having an actively managed fund instead of a passive fund is not imprudent. However, Pannell said the plaintiffs’ claims are not that simplistic. The plaintiffs contend that the defendants acted imprudently because they did not properly analyze the funds used in the plans, were forced to use certain funds provided by the recordkeepers, and the plans’ fiduciaries were persuaded by certain recordkeepers to use their funds without researching or choosing other funds. He found the plaintiffs have sufficiently alleged that the defendants’ process for choosing and analyzing certain funds was flawed. 

NEXT: Fees and removing underperforming funds

The plaintiffs allege that two of the annuity accounts included in the plans charge unnecessary fees. They argue that the distribution expenses and mortality and expense risk charges are unnecessary for the plans. Additionally, they state that the mortality and expense risk charges assessed are not relevant to all participants, but benefit only those participants that elect to annuitize their holdings upon retirement. Finally, the plaintiffs allege that all five of the expenses aid the fund companies but not the plans’ participants.                

Pannell concluded that the fees charged by funds in a plan should benefit the participants, and the fund options chosen for a plan should not favor the fund provider or the fiduciary over the participants. “Thus, the plaintiffs’ allegations that the plans’ funds charged fees that were excessive and/or provided a benefit to TIAA but not to the benefit of the participants are sufficient to state a claim for relief,” he wrote.

Pannell also ruled that the plaintiffs have properly alleged that the defendants acted imprudently by retaining underperforming funds. “Therefore, the plaintiffs’ claim that the defendants acted imprudently by retaining the CREF Stock Account and TIAA Real Estate Account will not be dismissed.”

The plaintiffs also allege that the defendants should have used a stable value fund instead of the TIAA Traditional Annuity. The defendants argue that stable value funds have underperformed the TIAA Traditional Annuity over the last one, three, five, and ten years. Pannell said the defendants are improperly arguing questions of fact at this stage. Taking the plaintiffs’ allegations as true, a stable fund could have been an alternative option to the TIAA Traditional Annuity. Therefore, Pannell did not dismiss the plaintiffs’ claim related to an alternative investment option to the TIAA Traditional Annuity.

NEXT: Revenue sharing and recordkeeper consolidation

The complaint included allegations that the defendants’ “revenue sharing” method is improper and overcompensates the recorkeepers. Pannell said that at this point, the plaintiffs’ do not have the burden “to rule out every possible lawful explanation” for the allegedly overcharged recordkeepers’ fees used in the plan. “The defendants can be held accountable for failing to monitor and making sure that the recordkeepers charged appropriate fees and did not receive overpayments for their services. Therefore, the plaintiffs’ claim regarding “revenue sharing” will not be dismissed,” he wrote.

The plaintiffs’ complaint states “Despite the long-recognized benefits of a single recordkeeper for a defined contribution plan, defendants have continued to contract with three separate recordkeepers for the Plans: TIAA-CREF, Fidelity, and Vanguard. This inefficient and costly structure has caused plan participants to pay excessive and unreasonable fees for plan recordkeeping and administrative services.”

Pannell ruled that the plaintiffs’ allegation that a prudent fiduciary would have chosen one recordkeeper instead of three is sufficient to state a claim for relief. Also, he said the plaintiffs’ allegation of the absence of competitive bidding for the17 recordkeeping services was imprudent; therefore, the plaintiffs’ claim is sufficient to state a claim for relief.