Christopher M. Sulyma filed a lawsuit on behalf of two proposed classes of participants in the Intel 401(k) Savings Plan and the Intel Retirement Contribution Plan, claiming that the defendants breached their fiduciary duties by investing a significant portion of the plans’ assets in risky and high-cost hedge fund and private equity investments through custom-built target-date funds.

The lawsuit says the Intel custom-built funds have underperformed peer funds by approximately 400 basis points annually. The lawsuit claims automatic enrollment and a reenrollment of existing participants resulted in more than two-thirds of participants being allocated to custom-built investments. It goes into great detail about why the plaintiffs believe hedge funds and private equity funds are inappropriate investments for Employee Retirement Income Security Act (ERISA) retirement plans.

PLANADVISER reached out to Marcia Wagner, principle with Wagner Law Group in Boston, for comments about the case.

PLANADVISER: Do you see the Intel case as opening the door to other cases about the construction of custom target-date funds or TDFs, just as the number of cases about excessive fees in retirement plans grew?

Wagner: While the Intel case is an offshoot of the excess fee and stock drop cases and utilizes many of the same legal theories, I doubt the new complaint will open up new opportunities for the plaintiffs’ bar, since its underlying facts are fairly unique, specifically that an individual account plan offered alternative investments. 

My sense is that it is still mainly defined benefit pension plans that are interested in hedge funds and private equity, which are the focus of the Intel case. This is not to deny that interest in these alternative investments on the part of defined contribution plans has grown in recent years. In fact, despite the added risks and work they entail, many see alternative investments as the perfect antidote to the anemic returns forecast for the broad-based equity and bond markets. A 2011 report by the ERISA Advisory Council to the Secretary of Labor attests to this fact. 

PLANADVISER: Do you think the case has a chance of surviving a motion to dismiss?

Wagner: While it is never safe to make a prediction, the complaint itself has a number of conceptual and technical problems that make me wonder whether it can survive a motion to dismiss.

First is the issue of establishing proper Bbenchmarks or the issue of how damages were measured. My reading of the complaint is that accounts in the two Intel plans did not incur losses in the conventional sense. Rather, the Intel plans, on average, did not make as much as money during the class period as a certain benchmark selected by plaintiff’s attorney Cohen Milstein Sellers & Toll. I do not want to suggest that this result is not actionable if it was caused by a fiduciary breach. However, it is an unusual circumstance and could influence a court’s view as to whether a fiduciary breach occurred or has been properly alleged in the complaint.

The benchmark the complaint uses to measure the difference between actual returns under the Intel plans and what the complaint contends these returns should have been is a series of indexed Fidelity funds. If only the Intel Investment Committee had had the sense to invest in these Fidelity funds, the complaint argues, the plan’s rate of return would have been 400 additional basis points annually. Of course, this translates to an additional 4% return, a significant figure to be sure, but perhaps not enough to convince me that there has been a fiduciary breach.

Another problematic benchmarking-type of issue is how the complaint attempts to establish that the Intel plan’s level of investment in hedge funds was too high. The complaint regularly refers to “prevailing asset allocation models,” “prevailing standards” and “peer TDF’s.” What this means in the end  (as reflected in paragraph 118 and Exhibit I of the complaint) is that eight commercially available target-date funds either did not utilize alternative investments or failed to break them out in their reports on investment allocation.

The correct fiduciary decision-making process for selecting an investment under the Employee Retirement Income Security Act, or ERISA, is to investigate the particular investment in question so as to fully understand it and, based on the facts gathered, make a rationale decision as to whether it fits the role prescribed for it in the plan’s investment portfolio. This process should include an evaluation of whether the specific investment’s potential for gain is commensurate with its risk of loss. The actions of peers and competitors represent only one strand in this reasoning process. 

PLANADVISER: So, do you see a problem in the lawsuit’s argument that hedge funds and private equity investments are inappropriate for defined contribution retirement plans?

Wagner: The use of a passively invested index funds to measure damages is a signal of what the Intel case is really all about. At bottom, the complaint is an attack on the design of the Intel plan’s target-date funds, for which the underlying investments are actively managed funds subject to higher fees in the hopes of obtaining better returns. This is expressed most directly in paragraph 156 of the complaint which argues that a “two percent annual flat fee on assets under management [as charged by an actively managed hedge fund seeking superior returns] … is not justified in the defined contribution plan context.”

Addressing the issue of risk in a similar vein, paragraph 139 of the complaint asserts a corollary to its position on fees: “Managing a retirement plan therefore must focus always on the most vulnerable participant” by which it seems to mean a non-highly compensated employee working in the shipping department. As a general rule, in all investment matters the greater the potential for gain, the higher the level of risk. The Intel complaint seeks to establish the proposition that ERISA prohibits target-date funds in a retirement plan from investing in anything with an unusual level of risk or that is actively managed and has high fees.  In other words, ERISA retirement plans need to be dumbed down.

The goals asserted by the Intel complaint are debatable as a matter of policy.  However, I do not see that they are reflected in DOL regulations or other guidance relating to target-date funds, much less in ERISA’s statutory provisions. 

PLANADVISER: But, the Intel custom-built funds underperformed peer investments, according to the lawsuit; does that not add validity to the complaint?

Under the pleadings standard set forth by the Supreme Court in Ashcroft v. Iqbal, a complaint must contain sufficient factual matter, which if accepted as true, states a “claim to relief that is plausible on its face.” In my opinion, the Intel complaint does not do a very good job in linking the asserted underperformance of the plan’s target date portfolios (TDPs) to specific hedge fund and private equity positions taken by the plan. There is no need to prove anything at this stage, but it is necessary to do more than cite press reports and various studies claiming that hedge funds, as a group, are risky and have underperformed.

Paragraph 181 of the complaint does note that the Intel plans’ hedge fund portfolio lost 17% during the 2008 financial crisis. I would not consider that a major indictment, since many funds lost money in 2008, and reasonable investors could well have anticipated a rebound. The complaint contrasts the 2008 loss with a 5.2% gain in a Barclay’s bond index. This comparison is an apples and oranges type of comparison, and it is hard to understand the point being made. After 2008, the supporting factual evidence cited by the complaint rests largely on generalized predictions regarding hedge funds that appeared in magazine articles and certain studies. Since these reports have no connection to the Intel plan’s actual investments, I would say that the complaint runs the risk of failing to meet the Supreme Court’s pleading standard.  

PLANADVISER: The complaint accuses the plans’ administrative committee of failing to adequately disclose to participants the risks, fees and expenses associated with investment in hedge funds and private equity. Participants were given virtually no information about these investments other than that there were some hedge fund and private equity investments made by the plan. Virtually nothing about the strategy, the risks, the fees or anything about underlying investments was disclosed in anything that defendants provided to or made available to participants. Does this allegation have a chance of moving forward?

Wagner: As is common in excess fee and stock drop cases, the Intel complaint asserts a cause of action for failing to disclose certain particulars (e.g., investment performance over specified periods) regarding three of the plan’s nine “Investment Funds”, specifically, the “Hedge Fund,” “Private Equity Fund” and “Commodities Fund.” There appears to have been an assumption that this disclosure is required, because these funds constitute “Designated Investment Alternatives,” a term defined by the applicable disclosure regulations as “an investment alternative designated by the plan into which participants and beneficiaries may direct the investment of assets held in, or contributed to, their individual accounts.” 

I am not sure how the Intel plan works, and whether or not participants can choose to invest their account assets directly into one or more of these investment funds or whether a participant must choose one or more of the so-called TDPs. Each TDP allocates a different percentage of its assets across the Intel plan’s various Investment Funds with each TDP becoming more conservative as it nears its maturity date.  If the only way to invest in the Intel Hedge Fund or Private Equity Fund is through one of the TDPs, then it would seem that the TDPs, not the Investment Funds, are the plan’s Designated Investment Alternatives.  (This analysis is consistent with Question 28 of DOL Field Advisory Opinion 2012-012R.) The consequence of this would be that the disclosure obligation would relate to each TDP, not to a TDP’s underlying investment funds.

Another possible misfire relates to the fact that the earliest possible effective date for the then new disclosure requirement was August 2012, just as the plaintiff’s two-year tenure with Intel was ending. If the plaintiff had cashed out his plan account, he would not have been entitled to any disclosure under the new regulations. Even if disclosure were required to the plaintiff as a continuing plan beneficiary, it would only be for periods after the effective date of the new rule. Thus, for at least half of the class period, there was no requirement to make the disclosures demanded by the plaintiff.

PLANADVISER: If the lawsuit does survive a motion to dismiss, do you think it will get class action approval?

Wagner: Cohen Milstein has obviously attempted to construct the broadest possible group of Intel employees as participants in the plaintiff class in order to ensure a large damages award. In this, it may have overreached, as is often typical in this type of case. As already noted, the sole plaintiff who seeks to represent the class had a relatively brief tenure with Intel. This makes it more likely that the circumstances of his plan dealings differ from those of other plan participants so that he has less in common with them and may even have interests that are adverse to them.

The Intel Plan appears to have offered at least 12 TDPs with maturity dates set five years apart, each of which was allocated differently among the plan’s nine investment funds. As previously noted, the allocations of target-date funds, such as the TDPs, grow more conservative as the funds approach maturity. Thus, participants in each TDP would have experienced different rates of return or loss in a given period. Even if the plaintiff is successful in asserting that his TDP experienced a 400 basis point loss, he could be sacrificing the interest of participants in another TDP who experienced a more favorable result. This type of analysis has served as the basis for denying class certification in other cases, because it demonstrates the lack of commonality among putative class members.

PLANADVISER: Any other comments about the case?

Wagner: The Intel case provides a lot to think about, and the issues are not limited to those we’ve discussed. This is a preliminary analysis of the complaint.