Intel Lawsuit Questions Custom Target-Date Fund Construction

A participant in retirement plans sponsored by Intel Corporation has filed a lawsuit claiming custom-built investment portfolios within the plan are too heavily invested in imprudent investments.

The gravamen of the complaint is that the asset-allocation models adopted by the retirement plans’ investment committee departed dramatically from prevailing standards employed by professional investment managers and plan fiduciaries, and as a result, caused participants to suffer massive losses and excessive fees. However, the lawsuit more subtly hints that what some would call “best practices” in defined contribution retirement plans caused a great number of participants to be invested in these alleged improper investments.                       

Plaintiff Christopher M. Sulyma, on behalf of two proposed classes of participants in the Intel 401(k) Savings Plan and the Intel Retirement Contribution Plan, claims 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. According to the complaint, beginning in 2011, the investment committee dramatically altered the asset-allocation model for the Intel custom target-date portfolios (TDPs) by increasing Intel TDP investments in hedge funds from about $50 million to $680 million, an increase of 1,300%. Similarly, the investment committee increased exposure to hedge funds and private equity investments during 2009 through 2014 in a custom-built Intel Global Diversified Fund. During this period the Diversified Fund’s investment in hedge funds increased from about $582 million to $1.665 billion, an increase of approximately 286%; the fund’s investment in private equity increased from about $83 million to $810 million, an increase of 968%.

NEXT: Underperformance due to risky investments

The lawsuit says the Intel TDPs have underperformed peer TDFs by approximately 400 basis points annually. Although defendants failed to provide documents to participants disclosing the amount invested by the 401(k) plan via Intel TDPs, the amount was estimated in June 2015 to be approximately $3.63 billion. “Given the underperformance compared to peer TDFs, and the billions of dollars allocated to Intel TDPs, the plans have lost hundreds of millions of dollars that they would have otherwise earned had the Intel TDPs been prudently allocated since 2011,” the complaint states.

The lawsuit compared Intel’s 2030 TDP to what it calls “peer group” target-date funds, and asserted that the peer group funds do not allocate any assets to hedge funds and very few have even small commodity stakes. Further, peer funds allocate 70% of equity assets to U.S. stocks and 30% to foreign, whereas the Intel 2030 TDP allocates more than 50% of equity investments to foreign stocks. According to the complaint, an index fund-based suite of target-date funds offered by Fidelity Investments yielded, on average, more than 4.5 times the returns of the suite of Intel TDPs. The lawsuit says if the investment committee had selected index funds for the Intel TDPs, the 401(k) plan and its participants would be far better off.

Similarly, the lawsuit claims the Diversified Fund has underperformed peer balanced funds. From May 2007, when the Diversified Fund began investing in hedge funds and private equity, through May 2014, the fund underperformed a Vanguard balanced fund, the LifeStrategy Moderate Growth Fund, by approximately 50 basis points annually. As of June 2015, the Retirement Contribution Plan invested the vast majority of its assets in the Diversified Fund—$5.82 billion out of $6.66 billion. The lawsuit alleges the underperformance is largely due to the “massive allocations to hedge funds and private equity, almost $2.5 billion as of the end of 2014.”

Additionally, the complaint accused 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, and information in filings with the Department of Labor discloses only the name of the hedge fund or private equity investment, the costs and last year’s value. 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.

NEXT: “Best practices” put most participants in imprudent investments

The Intel plans offer nine “white-labeled” investment funds as a core menu for participants as well as for the underlying funds for its asset-allocation portfolios, as follows:

• Alternative Investments (aka Private Equity Fund), which invests in more than 50 private equity investment partnerships;
• Commodities Fund, investing in two commodities funds and a commodities hedge fund;
• Emerging Markets Fund, which invests in two emerging market funds and two emerging market private equity funds;
• Global Bond Fund, which invests largely in debt securities;
• Hedge Fund, investing in more than 20 hedge fund investment partnerships;
• International Stock Fund, investing in two international stock funds and equity securities;
• Small Cap Fund, which invests in three small cap funds and small cap equity securities;
• Stable Value Fund, which invests in several guaranteed investment contracts and pooled separate accounts; and
• U.S. Large Cap Fund, investing in four large cap equity funds.

The lawsuit notes that, since the TDPs and the Diversified Fund invest in these underlying funds in an amount determined by the investment committee, it is the investment committee that manages and dictates participants’ assets allocated to each fund, and not the participants’ choice. The lawsuit further alleges that participants were not given information about how much of their assets were allocated to private equity and hedge fund investments or information about how risky and more expensive these assets are.

Participants in the 401(k) plan were automatically enrolled into the plan at a 6% default deferral percentage which automatically increases 2% per year up to a maximum of 16%. Participants who fail to select their investment allocation are defaulted into the Intel TDP that corresponds with their age. However, the complaint notes that in 2011, Intel performed a reallocation, mapping existing participant accounts in the 401(k) plan into the customized Intel TDPs unless they opted out. According to a PIMCO DC Dialogue interview with Stuart Odell, in March/April 2014, as a result of this reallocation, approximately two-thirds of existing participants were mapped into the TDPs. The 401(k) plan had 62,838 participants with account balances and $7,895,030,553 in total assets as of December 31, 2014.

According to the complaint, the Retirement Contribution Plan also used automatic enrollment, but effective January 1, 2011, it was closed to new participants. It continues to cover eligible employees. Intel makes discretionary contributions to the plan, but employees do not. The plan document requires that participants younger than 50 are required to invest their accounts in the Diversified Fund. Between January 1, 2007, and March 31, 2009, participants older than 50 were given the chance to diversify their assets into an Intel TDP. As of April 1, 2009, participants older than 50 could elect to invest their accounts in an Intel TDP or in the Intel Stable Value Fund. Beginning January 1, 2015, participants in the Retirement Contribution Plan are allowed to elect to have their accounts in the plan invested in whatever funds or portfolios the investment committee made available as an option. According to the 2014 Form 5500 filed August 16, 2015, the Retirement Contribution Plan had 48,272 participants with account balances and $6,722,726,892 in total assets as of December 31, 2014.

NEXT: What’s wrong with investing in hedge and private equity funds?

The lawsuit 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. The complaint notes that before the investment committee changed the Intel TDP allocations in 2011, the fees for the Intel TDPs ranged from 65 basis points to 71 basis points—already higher than index-based target-date funds such as those offered by Fidelity. But, the increased allocation to hedge funds increased the expenses of the Intel TDPs to between 130 to 136 basis points. “This significant investment and allocation to high-fee hedge funds and private equity added no value. To the contrary, investing in high-fee hedge funds and private equity caused the Intel TDPs to consistently and substantially underperform index-based [target-date funds] since 2011,” the complaint says.  

The lawsuit argues that hedge funds have been traditionally limited to “accredited investors” who have more than $200,000 in annual income and/or more than $1,000,000 in net worth, restricting these investments to those who can afford to lose their invested principal. “Retirement accounts encompass all levels from the C-suite to those working in the shipping department. Managing a retirement plan therefore must focus always on the most vulnerable participant. Higher earning participants can choose to take more risk, but [target-date funds] are designed for everyone and need to be constructed to protect the average employee.”

Hedge funds lack the transparency of publicly traded funds such as mutual funds, the lawsuit alleges, and the desire of the hedge fund manager to keep an investment methodology private is in direct conflict with a plan fiduciary’s duty to monitor such a methodology. In addition, it is very difficult for retirement plan fiduciaries to evaluate the performance of hedge funds, because of the wide variety of hedge fund strategies; the substantial rate of turnover of funds opening and closing; the selection bias created when new funds choose not to report returns until after they have a run of good years; and the survivorship bias created when closed funds simply disappear from hedge fund indices, the lawsuit claims.

NEXT: What happens when transparency is lacking

The lawsuit also cites a Government Accountability Office (GAO) report that found retirement plans investing in hedge funds are also exposed to greater operational risks than presented by traditional investments. Hedge funds are not registered with the Securities and Exchange Commission (SEC), and are subject to few regulatory controls. In addition, hedge fund strategies can be exceedingly complex, and the lawsuit says, a prudent fiduciary must be capable of understanding the strategy in order to evaluate whether it is appropriate for investment of retirement plan assets. “Even if the plan fiduciary is able to gain visibility of a hedge fund’s investment strategy, the detailed holdings of a hedge fund portfolio are not disclosed to individual investors,” the complaint says.                    

In addition, the lawsuit claims private equity advisers have been criticized for their valuation practices, such as using a valuation methodology that is different from the one that has been disclosed to investors or changing the valuation methodology from period to period without additional disclosure. “Such valuation practices make it exceedingly difficult, if not impossible, to monitor manager performance and evaluate fees accurately where fees are tied to assets under management and therefore increase as valuations increase.” It adds that the high fees of private equity funds can have a significant negative impact on net investment returns.

The Intel fiduciaries are accused of not properly conducting a prudent investigation. “In addition to the Investment Committee’s personal experience with hedge fund underperformance in 2008, numerous studies and reports published in the years before and after the 2008 financial crisis questioned the value of hedge funds,” the lawsuit says, arguing that, because of these things, the investment committee knew or should have known hedge funds were an imprudent investment for the TDPs and Diversified Fund.

A spokesperson for Intel tells PLANADVISER the company has no comment about the lawsuit at this time.

The complaint in Sulyma v. Intel Corporation is here.