proprietary funds in 401(k) and retirement plans: a view from...

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The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10. Presenting a live 90-minute webinar with interactive Q&A Proprietary Funds in 401(k) and Retirement Plans: A View From the Trenches Navigating Prohibited Transaction Rules, Fiduciary Duties, and the Recent Surge in DOL Investigations and Civil Litigation Today’s faculty features: 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific WEDNESDAY, AUGUST 9, 2017 Jeremy P. Blumenfeld, Partner, Morgan Lewis & Bockius, Philadelphia Brian T. Ortelere, Partner, Morgan Lewis & Bockius, Philadelphia

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Page 1: Proprietary Funds in 401(k) and Retirement Plans: A View From …media.straffordpub.com/products/proprietary-funds-in-401... · 2017. 8. 7. · –PTE 77-3 (mutual funds/ETFs) –

The audio portion of the conference may be accessed via the telephone or by using your computer's

speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10.

Presenting a live 90-minute webinar with interactive Q&A

Proprietary Funds in 401(k) and Retirement

Plans: A View From the Trenches Navigating Prohibited Transaction Rules, Fiduciary Duties,

and the Recent Surge in DOL Investigations and Civil Litigation

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

WEDNESDAY, AUGUST 9, 2017

Jeremy P. Blumenfeld, Partner, Morgan Lewis & Bockius, Philadelphia

Brian T. Ortelere, Partner, Morgan Lewis & Bockius, Philadelphia

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For additional information about continuing education, call us at 1-800-926-7926

ext. 35.

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Program Materials

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PROPRIETARY FUNDS IN 401(K) AND RETIREMENT PLANS: A VIEW FROM THE TRENCHES Jeremy P. Blumenfeld

Brian T. Ortelere

August 9, 2017

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THE USE OF PROPRIETARY OR AFFILIATED FUNDS OR SERVICES

• A recent dramatic upswing in number of putative class actions filed challenging the offering, typically by financial services companies, of those companies’ investment products to their employee/participants.

• Schlichter, Bogard and Nichols Kaster among other firms leading the charge. Here comes Schneider Wallace.

• The litigations appear to be piggybacking a Department of Labor investigatory initiative.

• Plans are large, stakes are high, complaints seek tens of millions of dollars and settlements are quite large.

• Very peculiar threat to plan sponsor’s reputation – cannot have court deem the offering of own funds a breach of fiduciary duty.

• Equally problematic is the possibility, after application of prudent process, determining own fund is not suitable for employees’ plan.

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THE USE OF PROPRIETARY OR AFFILIATED FUNDS OR SERVICES

• Affiliated Service Providers

– Trustee/Custodian

– Broker

– Investment Manager

– Adviser/Consultant

– Recordkeeper

• Affiliated products, such as registered funds, CITs, private funds, and insurance products

• Participant Level Advice Programs

• Employee IRAs

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NEW ENTRANT INTO THE MARKET

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FIRST SHOT ACROSS BOW

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USE OF FACEBOOK

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DOL INVESTIGATORY BACKDROP

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THE LITIGATION MILIEU

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STATUS OF RECENT CHALLENGES TO PROPRIETARY 401(k) INVESTMENTS

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THE LEGAL BACKDROP

• ERISA Section 406(a) prohibits plan fiduciary causing plan to engage in transaction with a “party in interest” to plan, including any sale or exchange, extension of credit, transfer or other use of plan assets.

– Party in interest includes employer, union, service providers and some affiliates of those entities.

• Section 406(b) prohibits fiduciary from conflicts of interest when using plan assets and prohibits other acts of self-dealing.

• Problem with proprietary products – may involve a purchase or sale between plan and party in interest (e.g., financial service company employer); the use of plan assets for benefit of party in interest; and/or the indirect provision of services by a party in interest to the plan. 406(a).

• Also raises possibility of self-dealing and/or kickbacks, 406(b).

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COMMON ALLEGATIONS

• Prudence/Loyalty

– Selection of proprietary funds is based on generating revenue for the service provider “at the expense of” participants’ best interests and for the benefit of the plan sponsor, violating ERISA’s duties of prudence and loyalty.

• Prohibited Transaction Claims

– Party in interest/conflict/self-dealing claims under Section 406.

• “Seed” allegations

– New service providers that are created to manage plan assets and then sold for a profit used the plan to “boost” sale price; the plan should be compensated for sale of business

– New funds whose first or primary investors are the service provider’s plan participants “seeded” the establishment of the funds.

• Plaintiffs’ bar has been actively filing new proprietary fund complaints in recent years, including several this past year.

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PROHIBITED TRANSACTION EXEMPTIONS

• Affiliated Mutual Funds.

• PTE 77-3 provides that “the restrictions of section[] 406 . . . shall not apply to the acquisition or sale of shares of an open-end investment company registered under the Investment Company of Act of 1940”—i.e., a mutual fund—“by an employee benefit plan covering only employees of such investment company.” PTE 77-3, 42 Fed. Reg. 18,734 (1977).

• For the exemption to apply, four additional conditions must be met: – Plan must pay no “investment management, investment advisory or similar fee” to

the mutual fund, although the mutual fund itself may pay such fees to its managers;

– Plan must not pay “a redemption fee” when selling its shares;

– Plan must not pay a sales commission in connection with the sale or acquisition; and

– All other dealings between the Plan and the affiliated fund must be “on a basis no less favorable to the plan than such dealings are with other shareholders.”

• But prudence and loyalty standards of ERISA section 404(a) still apply. The exemption “does not relieve a fiduciary . . . From section 404 of the Act.”

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PROHIBITED TRANSACTION EXEMPTIONS

• Affiliated Insurance Company Pooled Separate Accounts and Bank Collective Investment Trusts. ERISA section 408(b)(8).

• Affiliated Group Annuity and Insurance Contracts. 408(b)(5).

• Affiliated Bank Deposits. 408(b)(4).

• As the Department of Labor has recognized, it would be “contrary to normal business practice for a company whose business is financial management to seek financial management services from a competitor.” Notice of Proposed Rulemaking, Participant Directed Individual Account Plans, 56 Fed.Reg. 10724 (Mar. 13, 1991).

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COMMON DEFENSES

• Prudence/Loyalty

– Hecker/Renfro/Loomis reasonable range of fees

– Reasonable process in evaluating fees

– Substantive prudence

• Prohibited Transaction Claims

– Reasonableness of fees under ERISA Sections 408(b)(2) and 408(c)

– PTE 77-3 (mutual funds/ETFs) – dealings with investment company must not be on terms that are less favorable than between the investment company and any other shareholder.

• Charging of direct costs can be permitted.

• Statute of limitations – though post-Tibble, focus is on three-year “actual knowledge” limitations period.

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MEHLING V. NY LIFE (E.D. PA. 2001)

• Plaintiffs alleged that over $400 million of pension and 401(k) plan assets transferred to “seed, sustain, and grow” NY Life’s line of institutional mutual funds.

• Court refused 12(b)(6) motion as to the company, citing duty, based upon appointing authority, to monitor the fiduciaries’ investments.

• Dismissed prohibited transaction claims because complaint failed to allege a failure to comply with PTE 77-3.

• Nevertheless, lawsuit proceeded on basis of 404(a), i.e., that defendants failed to act in a prudent manner and breached duty of loyalty by selecting proprietary investment products.

• Does/can objective prudence play a role in the proper disposition of this type of lawsuit?

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DUPREE v. PRUDENTIAL (S.D. FL.)

• Plaintiffs alleged that fiduciaries violated ERISA by causing in-house pension plan to annuitize retirement benefits under a group annuity contract and by investing in Prudential separate accounts.

• Following bench trial, court issued 40 page set of findings of fact and conclusions of law, and opinion is useful roadmap to how to handle issues that arise when dealing with proprietary products. Note discussion regarding access to investment managers.

– Transactions fell within exemptions of 408(b)(2), 408(b)(5) and 408(b)(8).

– As to duty of loyalty – where fiduciary acts to benefit of both plan and non-plan interests, “incidental benefit to other interests is permissible . . . As long as primary purpose and effect . . . Is to benefit the plan.”

– Prudence – applies hypothetical prudent fiduciary analysis as well as procedural prudence inquiry. Responsible person is “knowledgeable and experienced.”

– Investment management fees were at all times reasonable, and were monitored at regular intervals.”

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DAVID V. ALPHIN (4TH CIR.)

• Participants challenged BOA defined benefit plan and 401(k) plan investment in BOA-affiliated mutual funds.

• As to DB plan, court says no Article III standing:

– Trust law principles don’t extend to an over-funded plan.

– Plaintiffs’ interest was only in future benefit, not the plan’s assets. The risk that benefits would someday not be paid was too speculative.

– (Unclear how recent ruling in Spokeo affects this decision.)

• Court also ruled plaintiffs’ 401(k) plan claims were time-barred by six-year SOL.

– This aspect of ruling as to prudence claims no longer viable in light of Tibble, but still applicable to PT claims.

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KRUEGER v. AMERIPRISE FINANCIAL (D. MINN.)

• Complaint alleged that Ameriprise invested some $500 million in affiliated mutual funds and commingled trusts.

• “Ameriprise used the retirement assets of [its] employees to seed new and untested mutual funds, which made those funds more marketable to outside investors, thus increasing profits for . . . Ameriprise.”

• Also, recordkeeping and trustee fees paid to affiliated service provider, and cheaper share classes allegedly available.

• Court denied motion to dismiss –

– Cites problem with “non-existent performance histories.”

– Process allegedly flawed, and cheaper share classes available.

– Braden v. Wal-Mart, duty of loyalty paramount.

– Rejects Unisys and Renfro. 408(b)(2) and 77-3 no help, again given duty of loyalty.

• Do the kickback allegations doom a motion to dismiss?

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SHIRK v. FIFTH THIRD BANCORP (S.D. OHIO)

• In proposed second amended complaint, plaintiffs sought to add proprietary fund claims to stock drop claims.

• Distinguishing Mehling, district court holds that whether “Defendants actually complied with PTE 77-3 is a factual question that cannot be resolved on a motion to dismiss.”

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FULLER v. SUNTRUST BANKS, INC. (N.D. GA.)

• “The Court cannot conclude, based on a review of the Amended Complaint and the documents attached to the Motion to Dismiss that these transactions fall within the requirements of PTE 77-3.”

• Court dismissed certain claims as time barred under six year statute of limitations because last action constituting the breach “must be more than a failure to remove funds that were improper when selected.”

– Contra Supreme Court in Tibble v. Edison.

• Prohibited transaction claim dismissed as to one proprietary fund into which the named plaintiff had not invested.

– “Plaintiff is correct that, once the requirements of Article III standing are established, she may pursue claims which bring relief to a broader class than herself. This does not eliminate the necessity of making a showing of the requirements of an Article III case or controversy, including injury in fact and redressibility.”

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LEBER v. CITIGROUP, INC. (S.D.N.Y.)

• Statute of limitations arguments premature on motion to dismiss.

• “While the question of whether ERISA’s statutory and administrative exemptions are affirmative defenses to be established by defendants or pleading requirements to be overcome by plaintiffs is not free from dispute . . . The Court finds plaintiffs’ pleadings insufficient to state a plausible claim to relief.”

– “The complaint alleges the very type of activity that the exemption expressly allows to occur – the investment by a plan in its affiliated mutual funds on the terms generally available to other investors.”

– PT claims related to affiliated service provider similarly wanting.

• “[A]bsent any allegation that defendants’ conduct falls beyond the reach of the statutory exemption – and thus might plausibly be actionable under section 406 – plaintiffs fail to state a valid claim.”

• But certain 404 prudence claims are “sufficiently concrete.”

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IN RE REGIONS MORGAN KEEGAN (W.D. TENN.)

• Application of 77-3 a fact question not to be decided on 12(b)(6).

• Refusal to dismiss prohibited transaction claims precludes dismissal of prudence claims.

• 404(c) argument premature.

• “Section 404(c) defenses require fact-intensive inquiries into whether the plan meets all of the relevant DOL regulatory requirements.”

• Again, query whether 12(b)(6) motions useful in this context, denial comes with the prospect of unfavorable law of the case, necessitating settlement.

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MEINERS v. WELLS FARGO & COMPANY (D. MINN.)

• Plaintiff alleged that Wells Fargo breached its fiduciary duty by continuing to invest in its own target date funds when better-performing funds were available at a lower cost.

• Court dismissed underperformance and excessive fees claims, because plaintiff failed to provide a meaningful benchmark for comparison.

– Plaintiff did not allege that its comparable funds (Vanguard and Fidelity) were sufficiently similar to the Wells Fargo proprietary funds.

• Plaintiff also alleged that Wells Fargo breached its fiduciary duty by setting its own proprietary funds as the default for participants in order to seed its own funds.

• Court dismissed this claim because plaintiff failed to “plead additional facts showing that the fiduciary’s decision was based on financial interest rather than a legitimate consideration.”

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BROTHERSTON v. PUTNAM INVESTMENTS (D. MASS.)

• Complaint alleged that Putnam violated their 404(a) duties of loyalty and prudence and engaged in 406 prohibited transactions by investing in Putnam affiliated funds.

• Court granted summary judgment to Defendants on plaintiffs’ prohibited transactions claims, because:

– Fees were not paid out of plan assets, thus 406(a)(1)(D) and (b)(1) did not apply;

– Putnam’s management fees were reasonable under 408; and

– Putnam complied with PTE 77-3 by making substantial discretionary contributions to the plan, and thus Putnam's dealings with Plan participants were on a “basis no less favorable to the plan” than dealings with its other shareholders.

• After Plaintiffs’ presentation at trial, Court granted Defendants’ motion for Rule 52(c) judgment on partial findings, because: – Defendants did not breach their duty of loyalty, as “Plaintiffs have failed to point to

specific circumstances in which the Defendants have actually put their own interests ahead of the interests of Plan participants” and that “pointing to self-dealing alone is insufficient for the plaintiffs to meet their burden of persuasion.”

– Plaintiffs failed to make out a prima facie case of loss, because they could not point to a specific imprudent investment decision or decisions.

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CRYER v. FRANKLIN TEMPLETON (N.D. CAL.)

• Complaint alleged that the Franklin Templeton breached its fiduciary duty by offering its own proprietary mutual funds that underperformed and charged excessive fees to the Plan, as well as offered a proprietary Franklin Templeton money market fund instead of a stable value fund.

• Court denied defendant’s motion to dismiss, rejecting defendant’s 408(b)(8) defense at this stage, because plaintiff alleged that:

– Defendant offered only its own products; and

– Decisions were made to allow defendant to collect excessive fees.

• Court recently certified a 23(b)(1) class of all plan participants from July 28, 2010 (six years prior to the filing of the complaint) to the date of judgment.

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SETTLEMENTS

• Mehling v. N.Y. Life Ins. Co. (E.D. Pa. 2007) approving a $14 million settlement in a case involving allegations that in-house plan assets were imprudently used as seed money for new mutual fund products affiliated with the plan sponsor.

• Franklin v. First Union Corp. (E.D. Va.) $26 million settlement of claims that in-house plan assets were used as seed money and that participants were charged excessive fees by the plan sponsor.

• Nolte v. CIGNA.

• Krueger v. Ameriprise Financial (D. Minn.) $27.5 million Ameriprise agreed to conduct a request for proposal competitive bidding process for recordkeeping and investment consulting services; will pay flat fees to the plan recordkeeper or on a per participant basis; and limits in compensation for administrative services provided to the plan and other reimbursement of expenses from the plan.

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THE FIDUCIARY EXCEPTION APPLIED

Leber v. Citigroup 401(k) Plan Inv. Comm., 2015 WL 6437475 (S.D.N.Y. Oct. 16, 2015)

• Granted motion to compel production of outside counsel’s memo providing legal advice re: investment committee responsibilities, avoiding conflicts of interest, and investment recommendations

– Material was subject to the fiduciary exception because it “relates not to the settlor functions of plan amendment or design … but rather to the core fiduciary functions of asset management and avoidance of conflicts of interest”

– Rejected argument that fiduciary exception did not apply because the materials were addressed to the plan sponsor as it was clear such advice was intended for the plan’s fiduciaries and the documents were ultimately made available to them

• Denied motion to compel production of Citigroup executive’s email seeking legal advice re: selection and monitoring of plan investments because the executive had limited fiduciary authority relating only to appointment of committee members rather than asset investment

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THE FIDUCIARY EXCEPTION APPLIED

David v. Alphin, 2010 WL 3719899 (W.D.N.C. Sept. 17, 2010)

• Granted motion to compel production of letters from in-house benefits counsel to plan participant explaining the reasoning behind offering proprietary mutual funds and positing that such action was consistent with fiduciary obligations

• Found that in-house counsel’s letters “concern[ed] plan

administration and investment of plan assets” and thus fell within the fiduciary exception

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AVOIDING LITIGATION AND REGULATORY HEADACHES

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© 2017 Morgan, Lewis & Bockius LLP © 2017 Morgan Lewis Stamford LLC © 2017 Morgan, Lewis & Bockius UK LLP

Morgan, Lewis & Bockius UK LLP is a limited liability partnership registered in England and Wales under number OC378797 and is a law firm authorised and regulated by the Solicitors Regulation Authority. The SRA authorisation number is 615176.

THANK YOU

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Jeremy P. Blumenfeld

[email protected]

Brian T. Ortelere

[email protected]