Compliance January 3, 2020

Revenue Sharing, Recordkeeping Fees at Issue in Trader Joe’s Lawsuit

Employees of the grocery chain accuse their employer of acting imprudently in the selection of retirement plan investment options and of failing to monitor the services and fees paid.

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The Trader Joe’s Company has been named as the defendant in a new Employee Retirement Income Security Act (ERISA) lawsuit filed in the U.S. District Court for the Central District of California.

The proposed class action names several individual participants as well as the whole plan as plaintiffs. It alleges two primary breaches of ERISA—imprudence in the selection of investment options and a lack of care given to monitoring the services and fees paid by the $1.6 billion defined contribution plan.

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According to the complaint, Trader Joe’s chose Capital Research to serve as the plan recordkeeper and investment platform. Capital Research, in turn, is the investment adviser to the American Funds family of mutual funds. The complaint states the firm’s fees are generally based on a percentage of assets invested in the American Funds. Capital Research’s fees, plaintiffs suggest, are paid by the American Funds to Capital Research based on the previous month’s daily net asset levels.

The complaint says Capital Research—which is not a defendant—also receives fees directly from the plan for recordkeeping. For example, in 2018, it received a reported $183,075 in direct compensation for recordkeeping services.

“Trader Joe’s has not disclosed to plan participants the precise amount of fees and/or income Capital Research collects from the plan,” the complaint states. “However, Trader Joe’s has disclosed that Capital Research receives ‘direct’ and ‘indirect’ fees and compensation. Discovery is need to identify exactly how much Capital Research is collecting, however, even with the limited information available to plan participants it is apparent that Capital Research’s fees and compensation is excessive.”

The complaint goes on to argue that, as a general matter, asset-based recordkeeping fees do not meet ERISA’s requirement that fees be paid on a rational basis: “The cost of recordkeeping services depends on the number of participants, not on the amount of assets in the participant’s account. Thus, the cost of providing recordkeeping services to a participant with a $100,000 account balance is the same for a participant with $1,000 in her retirement account.”

The complaint suggests Trader Joe’s chose to pay Capital Research asset-based recordkeeping fees, via three pathways. Capital Research “received direct payments from the plan for recordkeeping; Capital Research received revenue sharing payments from the mutual funds offered as past or present plan choices; Capital Research received the difference between the higher operating cost of investor class shares of mutual funds on the plan menu and the lower operating cost of institutional share classes of the same funds on the plan menu.”

The plaintiffs argue that, because revenue sharing payments are asset based, they “bear no relation to a reasonable recordkeeping fee and can provide excessive compensation.”

“It is important to emphasize that fees obtained through revenue sharing are tethered not to any actual services provided to the plan; but rather, to a percentage of assets in the plan and/or investments in mutual funds in the plan,” the complaint states. “As the assets in the plan increase, so too increases the recordkeeping fees that Capital Research pockets from the plan and its participants. One commentator likened this fee arrangement to hiring a plumber to fix a leaky gasket, but paying the plumber not on actual work provided but based on the amount of water that flows through the pipe. If asset-based fees are not monitored, the fees skyrocket as more money flows into the plan.”

Plaintiffs argue that prudent fiduciaries monitor the total amount of revenue sharing a recordkeeper receives to ensure that the recordkeeper is not receiving unreasonable compensation.

“A prudent fiduciary ensures that the recordkeeper rebates to the plan all revenue sharing payments that exceed a reasonable per participant recordkeeping fee that can be obtained from the recordkeeping market through competitive bids,” the complaint states.

The complaint goes on to suggest that Trader Joe’s retirement plan committee failed to seek competitive bids for recordkeeping, and that Capital Research is investing the plan’s assets for its own benefit.

Trader Joe’s has not yet returned a request for comment.

Products January 2, 2020

Investment Products and Service Launches

Franklin Templeton adds first alternative ETF; Innovator launches four power buffer ETFs; Vanguard announces lowered expense ratios on several ETFs; and more.

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Art by Jackson Epstein

Art by Jackson Epstein

Franklin Templeton Adds First Alternative ETF

Franklin Templeton has expanded its active exchange-traded fund (ETF) lineup with the addition of its first alternative ETF, Franklin Liberty Systematic Style Premia ETF (FLSP). 

The fund seeks to deliver absolute return (positive returns in rising or falling markets) by employing a multi-asset, long/short strategy. FLSP is actively risk-managed, seeking a target annualized volatility of 8%, and targets four style factors: quality, value, momentum and carry.

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“We are thrilled to bring our first alternative ETF to the market,” says Patrick O’Connor, global head of ETFs for Franklin Templeton. “FLSP is unique due to our intentional focus on building an alternative investment while seeking to minimize any correlation to traditional equity and fixed income asset classes. We find investors need tools to help mute or dampen volatility and to find more consistent returns across market cycles or in times of market stress. FLSP looks to address those challenges­—and many others—in a low-cost, liquid ETF.”

This new ETF leverages the team’s focus on factor-based research, which is the same team behind its LibertyQ smart beta ETFs. FLSP will be managed by Dr. Chandra Seethamraju, senior vice president, head of quantitative strategies for Franklin Templeton Multi-Asset Solutions. This actively managed ETF does not seek to replicate the performance of a specified index and is listed on the NYSE Arca.

Innovator Launches Four Power Buffer ETFs

Innovator Capital Management, LLC has added four new Innovator Power Buffer ETFs based on the Nasdaq 100, Russell 2000, MSCI EAFE, and MSCI Emerging Markets.

“Today’s listings expand our category-creating Defined Outcome ETF suite with four new Power Buffer ETFs based on the Nasdaq 100, Russell 2000, MSCI EAFE, and MSCI Emerging Markets Indexes that provide exposure to major market segments with built-in downside buffers of 15% to mitigate market risks,” says Bruce Bond, CEO of Innovator ETFs. “Innovator is committed to building out a full range of Defined Outcome ETFs, based on broad equity benchmarks, that provide advisers tools to construct globally diversified equity portfolios with known upside potential and downside buffers against loss.”

Each Innovator Defined Outcome ETF seeks to provide a defined exposure to a broad market index (such as the S&P 500, Nasdaq 100, Russell 2000, MSCI EAFE, and MSCI EM) where the downside buffer level, upside growth potential to a Cap, and Outcome Period are all known, prior to investing.

Investors can purchase shares of a previously listed defined outcome ETF throughout the entire outcome period.

Each fund will hold a portfolio of custom exchange-traded FLEX Options that have varying strike prices (the price at which the option purchaser may buy or sell the security, at the expiration date), and the same expiration date of one year. The layering of these FLEX Options with varying strike prices provides the mechanism for producing a fund’s desired outcome (i.e. Cap or buffer). Each fund intends to roll options components annually, on the last business day of the month associated with each fund.

Vanguard Announces Lowered Expense Ratios on Several ETFs

Vanguard has announced that nine of its stock and bond ETFs have reported lower expense ratios.

Some of the lowered expense ratios include the $24.3 billion Vanguard Total International Bond ETF, the $17.3 billion Vanguard Total International Stock ETF, and the $63.2 billion Vanguard Emerging Markets Stock ETF. Vanguard also reported lower expenses on two active funds: Vanguard Global Minimum Volatility Fund and Vanguard International Value Fund.

All ETFs and funds saw changes of either one or two basis points. The Emerging Markets Stock ETF decreased by two basis points, while the International Stock ETF and the International Bond ETF lowered by one basis point. The Total Work Stock ETF, FTSE Europe ETF, FTSE Pacific ETF, FTSE All-World ex-US ETF, FTSE All-World ex-US Small-Cap ETF, Global Minimum Volatility Fund Admiral and International Value Fund Investor all changed by one basis point. The Tax-Exempt Bond ETF and the Global Minimum Volatility Fund Investor fell by two basis points.

Vanguard Creates Commission-Free Platform

Vanguard has extended commission-free online trading for stocks and options to all Vanguard Brokerage clients, effective immediately. 

This expands Vanguard Brokerage’s commission-free platform that has included all Vanguard mutual funds since 1977, all Vanguard ETFs since 2010, and nearly every ETF in the industry since 2018. Additionally, more than 3,000 non-Vanguard mutual funds have no transaction fee when traded online.

“Lowering the cost of investing is business as usual for Vanguard,” says Karin Risi, managing director of Vanguard’s Retail Investor Group. “For 45 years, we’ve been dedicated to lowering the cost of index and active funds, ETFs, advice, and brokerage services to help investors achieve better outcomes. The expansion of our commission-free platform marks the latest demonstration of this unwavering commitment to our clients.”

The platform is said to benefit Vanguard Brokerage’s clients via lower costs for stock purchases and other strategies, including rebalancing, dollar-cost averaging, and tax-loss harvesting. 

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