Krueger v. Ameriprise Financial: DC fiduciary litigation

August 22, 2013

Krueger v. Ameriprise Financial (November 2012) involves a decision by the United States District Court District of Minnesota in a suit by three current and four former Ameriprise employees. Plaintiffs claimed (among other things) that Ameriprise and plan fiduciaries breached their fiduciary duty under ERISA with respect to the Ameriprise 401(k) plan by using Ameriprise-affiliated funds in the fund menu. Plaintiffs alleged that many of the Ameriprise-affiliated funds charged excessive fees or underperformed relevant benchmarks.

The case involves a number of issues that are unique to the use by ‘in-house’ plans of financial services companies of ‘in-house’ funds. We will not be discussing those issues in this article. Instead we are going to focus solely on the more general issue of the application of ERISA's prudence standard to the selection and monitoring of funds in a 401(k) plan fund menu, and the application of the rules laid out in [Hecker v. Deere & Co.] in that regard.

Background

The case comes up on a motion by defendants to dismiss. Generally, under such a motion, plaintiffs' claims can only be dismissed if, assuming all facts alleged by plaintiffs are true, there is no legal claim. We note that the facts as described in the court's opinion are somewhat sketchy. We would expect a clearer picture to emerge in further proceedings.

Ameriprise maintains a 401(k) plan that allows participants to choose among different investment options. During the period the Krueger case relates to, the plan primarily (although not exclusively) used Amerprise-affiliated funds in its fund menu.

The plan maintained a 3-tier fund structure:

Tier 1 consists of several "target maturity funds" that are designed for participants who do not wish to put together their own individualized mix of investment options and who have a likely retirement date. ... Tier 2 comprises "core investments," including an Ameriprise stock fund, an income fund, and other mutual fund and collective trust options. ... Tier 3 is the Plan's Self-Managed Brokerage Account ("SMBA"), through which Plan participants can individually invest in funds offered by a variety of investment managers. [Citations omitted.]

We note that this structure – target date/core/brokerage window – is a common fund menu design for large corporate plans and is considered by some to be emerging as a best practice.

With respect to Tier 1 (target maturity) funds, plaintiffs claimed that:

Ameriprise used newly created Ameriprise-affiliated funds that had no performance history and in which the "Plan was the first investor."

These Ameriprise-affiliated funds underperformed their benchmarks each year and were rated (significantly) lower than comparable funds.

These funds paid excessive fees. Plaintiffs claimed both that these funds charged two levels of fees (at the target maturity level and at the underlying fund level) and that "the fees were higher than the median fees for comparable or better performing mutual funds, as reported by the Investment Company Institute and BrightScope, Inc." (It's not clear whether this claim applied to Tier 1 or 2 funds or both.)

With respect to Tier 2 (core) funds, plaintiffs claimed that:

The core funds were predominantly Ameriprise-affiliated funds.

These funds had expense ratios that were significantly higher than the funds of other providers. They further claimed that plan fiduciaries used more expensive share classes when less expensive ones were available.

With respect to Tier 3 (the brokerage window), plaintiffs claimed that:

The plan put procedural obstacles in the way of making brokerage window investments.

The brokerage window options "charged fees higher than those available to institutional investors, such as the Plan, in addition to charging annual account maintenance fees and transfer fees."

The 900 funds in the brokerage window "were selected not because of their inherent reasonableness and prudence for the Plan, but because those funds paid kickbacks or other compensation to one or more Defendants." (Presumably, "kickbacks or other compensation" refers to revenue sharing of some sort.)

Based on these allegations, plaintiffs claimed that Ameriprise, certain affiliates and plan fiduciaries were liable under ERISA for (among other things) breaches of their duty of prudence in selecting Ameriprise-affiliated funds (and certain other funds) for the fund menu and failing to prudently monitor those funds.

The court's decision

Generally the court found that plaintiffs had made sufficient allegations to get past a motion to dismiss. The most interesting aspect of the case (for plan sponsors that are not affiliated with any mutual fund) involved the court's discussion of the ‘Hecker defense.’ As a preliminary matter, we note that Hecker was decided by the Seventh Circuit, and the Krueger court is in the Eighth Circuit -- so Hecker is not directly controlling on the Krueger court.

The Hecker defense

Defendants asserted that plaintiffs had not stated a viable claim because even if, for instance, the Ameriprise-affiliated target maturity funds were overpriced and underperformed, the plan offered "a broad and diverse menu of investment options at market prices." In Hecker v. Deere & Co. the Seventh Circuit held that, where there is such a broad range of investment options (the Deere plan included a brokerage window with about 2,500 fund options), the fact that some of them might charge excessive fees was not an ERISA violation. The decision is worth quoting at some length:

In our view, the undisputed facts leave no room for doubt that the Deere Plans offered a sufficient mix of investments for their participants. Thus, even if, as plaintiffs urge, there is a fiduciary duty on the part of a company offering a plan to furnish an acceptable array of investment vehicles, no rational trier of fact could find, on the basis of the facts alleged in this Complaint, that Deere failed to satisfy that duty. As the district court pointed out, there was a wide range of expense ratios among the twenty Fidelity mutual funds and the 2,500 other funds available through BrokerageLink. At the low end, the expense ratio was .07%; at the high end, it was just over 1%. Importantly, all of these funds were also offered to investors in the general public, and so the expense ratios necessarily were set against the backdrop of market competition. The fact that it is possible that some other funds might have had even lower ratios is beside the point; nothing in ERISA requires every fiduciary to scour the market to find and offer the cheapest possible fund (which might, of course, be plagued by other problems).

Defendants' argument in Krueger, following Hecker, might be characterized as: the Ameriprise plan offers over 900 fund choices; the fact that some of them are overpriced or underperform is not a violation as long as there are others – e.g., funds available through the brokerage window – that are fairly priced and perform adequately.

Limits to the Hecker defense

The Krueger court rejected this defense. It noted that the Seventh Circuit, in denying a petition by the Secretary of Labor for a re-hearing en banc of the Hecker case, clarified that:

[The Seventh Circuit's decision] was not intended to give a "green light" to recklessness or imprudence in the selection of investments. ... Rather, [it] "was tethered closely to the facts before the court." ... The court noted that "[p]laintiffs never alleged that any of the 26 investment alternatives that Deere made available to its 401(k) participants was unsound or reckless, nor did they attack the BrokerageLink facility on that theory." ... The court stated that its holding was based on the plaintiffs' allegations that Deere decided to "accept 'retail' fees and did not negotiate presumptively lower 'wholesale' fees."

Further, the Krueger court found that "the Sixth, Fourth, and Seventh Circuits have found that merely including a sufficient mix of prudent investments along with imprudent options does not satisfy a fiduciary's obligations under ERISA." It also emphasized that this case, unlike the Hecker case, involves an allegation "that the Defendants selected Ameriprise affiliated funds to benefit themselves at the expense of Plan participants."

Takeaway

This is a preliminary decision, and the court's description of the facts and of its reasoning are (in places at least) sketchy. So we don't want to overstate our conclusion. Moreover, in reviewing this decision it is, at times, hard to separate out the conflict of interest issues – which are unique to financial services companies that use affiliated funds in their own plan – from the more general requirements of a prudent evaluation and monitoring of a fund menu. But we believe the reasoning of this court may indicate that Hecker defense – that where you have a "broad and diverse menu of investment options" the fact that some underperform or are overpriced is not an ERISA prudence issue – may not be available with respect to the "basic options" in a fund menu, e.g., target date or "core" funds.

A final point: we have said in the past that proving that an actively managed investment fund's fees are ‘too high’ is a challenge for plaintiffs in fee cases, because each fund manager can simply say that his or her or its fund management expertise is unique. But the Krueger plaintiffs got past a motion to dismiss with an allegation of above-median fees plus weak performance (in this case, given that the funds are new, weak performance with no prior history of strong performance). Whether that formula will work at trial (if this case gets to trial) or in other cases remains to be seen.

Litigation exposure for fund menu selection and monitoring is one of the major risks 401(k) plan sponsors face. We will continue to follow this case (if there are further proceedings) and fund menu litigation generally.

October Three, LLC is a full service actuarial, consulting and technology firm that is a leading force behind the reemergence of defined benefit plans across the country. A primary focus of the consultants at October Three is the design and administration of comprehensive retirement benefits to employees that minimize the financial risks and volatility concerns employers face.

Through effective plan design strategies October Three believes successful financial outcomes are achievable for employers and employees alike. A critical element of those strategies is the ReDB® plan design. The ReDefined Benefit Plan® represents an entirely new, design-based approach to retirement and to the management of both the employer’s and the employee’s financial risk, focusing on maximizing financial efficiency and employee value.

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