On January 8, 2022, the United States District Court for the Northern District of California granted defendant plan fiduciaries’ motion to dismiss in Anderson v. Intel, a case involving a challenge to Intel’s inclusion of non-traditional assets (including hedge funds, private equity, and commodities) in Intel’s 401(k) plan default target date fund (TDF). Plaintiffs argued that the inclusion of non-traditional assets in the TDF resulted in the TDF’s “underperformance” and was therefore imprudent.
The case is interesting in (at least) two respects. First, the court’s analysis of what is the proper comparator/benchmark to judge whether a TDF has “underperformed” focuses on the critical issue of the similarity (between the proposed benchmark and the challenged TDF) of aims, risks, and potential rewards And, second, in view of the Department of Labor’s recent “Supplemental Statement” on the inclusion of private equity investments as a “component” of, e.g., a target date fund, the case presents a real world test of the prudence, under ERISA, of that strategy.
Intel maintains (1) a 401(k) plan that includes a TDF as a default and a “Global Diversified Fund” (GDF) as an optional investment and (2) an employer-funded Retirement Contribution Plan in which the (GDF) is the default and the TDF is an option. Both of these funds include a substantial allocation to “non-traditional investments” (hedge funds, private equity, and commodities), as part of a “risk-mitigation strategy.”
Plaintiffs filed suit claiming, among other things, that these funds (the TDF and the GDF) “performed poorly,” and that that poor performance “can be attributed largely to the Funds’ ‘substantial allocations to hedge funds.’ [citation omitted] According to Plaintiffs, the Funds ‘gave up the long-term benefit of investing in equity, which delivers superior returns’ to hedge funds.”
The case has a complicated history, including a Supreme Court decision on the application of ERISA’s statute of limitations, which plaintiffs won. On January 2, 2021, the district court granted defendants’ motion to dismiss but allowed plaintiffs to amend their complaint. This most recent decision is on the subsequently amended complaint.
We recently posted an article discussing the issues presented under ERISA’s fiduciary prudence standard by participant claims that a fund in a 401(k) plan fund menu underperformed (and that its retention in the fund menu was therefore imprudent). Generally, and as reaffirmed in Intel, to survive a motion to dismiss such a claim plaintiffs must show both (1) actual underperformance vs. a benchmark and (2) some additional facts that indirectly show an imprudent process.
In this context, a critical issue is, what is an appropriate comparator/benchmark to be used to determine whether the fund actually “underperformed?” That issue is especially complicated with respect to target date funds, which involve a diverse set of asset classes, investment styles, and glide path strategies. Any one of those factors may account for the difference in performance of two TDFs. For instance, in the context of a bull market, a TDF with a more conservative glide path (e.g., a higher allocation to bonds at age 65 than a less conservative TDF) is likely to “underperform” a less conservative TDF. That isn’t because the conservative TDF is “poorly managed” – it is because it employs a more conservative TDF glide path.
Courts on benchmarks
Many of the courts that have dealt with this issue have taken an approach that disregards these complexities. For instance, in the Home Depot litigation, which involved a BlackRock LifePath TDF, the court accepted as comparators TDFs provided by State Street, Vanguard, T. Rowe Price, and Voya and (as a benchmark) the Dow Jones Global Target Index, without an inquiry into the issues of asset allocation, investment style, and glidepath.
In In Re Linkedin ERISA Litigation, discussed in our more recent article, the court accepted as a comparator to the plan’s actively managed Fidelity TDF (the “Active Suite”) Fidelity’s (so-called) Index Suite, notwithstanding defendants’ argument that a number of courts have rejected this sort of comparison between actively managed funds and index/passively managed funds. In doing so, the court found persuasive plaintiffs’ arguments that “all TDFs are actually inherently actively managed” (presumably because they use a manager-chosen glidepath) and that “the Index Suite is a ‘perfect comparator’ for the Active Suite because the two share the same investment management firm, management team, and a nearly identical glide path.” The court did not, however, inquire into differences in asset allocation and investment style with respect to the two funds being compared.
Decision in Intel – comparator/benchmark must have similar aims, risks, and potential rewards
By contrast, the court in Intel did address these critical issues, holding that “[a] fund that is a ‘meaningful benchmark’ must … have similar aims, risks, and potential rewards to a challenged fund.”
Based on this standard, the court rejected the comparators/benchmarks that plaintiff offered in its complaint as “common benchmarks” – “(1) published indices such as the S&P 500; (2) peer groups such as the categories established by Morningstar, Inc., a leading provider of investment data, and (3) specific peer alternatives within a given asset class.” The court found that plaintiffs had “fail[ed] to provide factual allegations explaining why their chosen benchmarks are ‘meaningful’ benchmarks that have similar aims, risks, and rewards as the Intel TDFs. … Plaintiffs only conclude that these comparators are ‘common.’” [Emphasis added.]
Given that non-traditional assets were included in the TDF (and the GDF) as a (somewhat novel for 401(k) plans) risk mitigation strategy, the court’s emphasis on the similarity (or difference) in aims (and, in effect, similarity/difference in style) between the “typical” TDF and Intel’s funds was critical to the court’s rejection of plaintiffs’ (more general) allegations:
In short, Plaintiffs argue that Defendants never should have pursued a risk mitigation strategy at all and that Defendants should have been looking for ways to change their risk mitigation strategy to a riskier strategy that could provide more returns for employees. However, Plaintiffs’ new theory fails to state a claim under current case law. ERISA fiduciaries are not required to adopt a riskier strategy simply because that strategy may increase returns.
To elaborate just a little on this point: If the alleged “underperformance” is the result of a risk mitigation strategy, and that strategy is not itself imprudent, then the “underperformance,” relative to the fund that took more risk (reflecting different aims, risks, and potential rewards), does not indicate imprudence.
The significance of Intel’s custom benchmark
Finally, we note that one persuasive element of Intel’s argument against the use of plaintiffs’ proposed (more generic) benchmarks was Intel’s explicit adoption of a custom benchmark for the challenged funds. It’s worth quoting the court at length on this issue:
[A]s Defendants point out, the document on which Plaintiffs rely, which is incorporated by reference into the [first amended complaint], unambiguously shows that the Intel TDFs are not benchmarked against the Morningstar “peer group category” but against a customized benchmark. … Plaintiffs do not allege that the Intel TDFs performed worse than the customized benchmark. Instead Plaintiffs rely on the Intel TDFs’ performance against the Morningstar “peer group category,” which Intel did not designate as a benchmark.
Connecting the dots: adoption of a custom benchmark (that realistically reflects a TDF’s aims, risks, and potential rewards) may at least help against attempts by plaintiffs to compare a challenged TDF’s performance against a more generic benchmark (without similar aims, risks, and potential rewards).
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Without an adequate comparator to show underperformance, therefore, the court dismissed plaintiffs’ claims that retention of non-traditional assets in the TDF and the GDF was imprudent.
The viability of alternative asset/private equity strategies in 401(k) plan TDFs
As noted at the top, the Department of Labor recently issued a “Supplemental Statement” on the inclusion of private equity investments as a “component” of, e.g., a target date fund. In that context, the decision in Intel, dismissing an ERISA prudence challenge to such a strategy, has gotten a lot of attention.
As we discussed in our earlier article, DOL in the Supplemental Statement reaffirmed that the inclusion of private equity in a participant directed DC plan TDF is not per se prohibited by ERISA. The Supplemental Statement did, however, raise certain issues about the appropriateness of such a strategy, e.g., with respect to the ability of participants to understand PE disclosures and the assumption that certain participants can tolerate the (sometimes problematic) issues presented by PE investments because they have longer “investment horizons.” And it explicitly questioned whether PE investments could be appropriate for smaller participant directed DC plans or (indeed) where plan fiduciaries do not have the sort of investment sophistication that a DB investment fiduciary has.
In Intel, plaintiffs did claim that the defendants had “fail[ed] to prepare Summary Plan Descriptions (‘SPDs/) that adequately disclosed and explained the risks associated with the Intel Funds’ investments in hedge funds and private equity.” The court dismissed this claim, finding that plaintiffs did not have standing to sue because they could not prove that they had been injured:
Plaintiffs needed to provide some factual allegation to show that they faced a risk of harm because of the procedural violations of that informational entitlement. Here, Plaintiffs have, for the second time, failed to allege that they [had read or] relied at all upon the disclosures and summary plan descriptions provided by the Administrative Committee. It is therefore difficult to see how the information contained or not contained in the disclosures and summary plan descriptions could have had relevance to Plaintiffs’ purported injury in this case.
Plaintiffs in this case did not challenge the adequacy of the Intel fiduciaries’ investment sophistication, nor is it likely that they realistically could have.
None of the foregoing means that the issues that DOL raised in its Supplemental Statement could not, on different facts and with a different defendant, be an element of an ERISA prudence challenge to the use of PE as part of a TDF.
Takeaways for plan sponsors
To repeat what we have said in prior articles, we are seeing a number of cases involving claims by 401(k) participants that fiduciaries violated their ERISA fiduciary duty of prudence because they chose or retained an underperforming fund/funds. Especially (as in Intel) underperforming target date funds.
In these cases, a critical issue (perhaps the critical issue) is, how should the challenged fund’s performance be benchmarked. That is an issue that is especially complicated for TDFs, because TDF performance may be affected by a number of factors (as the Intel court described them, “aims, risks, and potential rewards”) having nothing to do with imprudence, that may nevertheless generate lower returns than, e.g., more generic TDFs with different aims, risks, and potential rewards.
Winning this argument (over what is the right benchmark) may be a key to winning a motion to dismiss, and sponsors/sponsor fiduciaries will want to take care to adopt a benchmark for a plan’s TDF (and indeed for other funds in the menu) that accurately reflects that TDF’s aims, risks, and potential rewards.
Finally, with respect to the issue of the use of PE in TDFs and DOL’s recent Supplemental Statement on the issue of participant disclosures – at least in this real world test, plaintiffs were unable, with this court, to survive a motion to dismiss. Certainly, in the next case on this issue, the plaintiffs’ lawyers will try to find clients who have read relevant disclosures, and we may get a more substantive read on what courts think of the issues raised by DOL.