Another 401(k) Self-Dealing Lawsuit Filed

A participant in the Franklin Templeton 401(k) plan has sued Franklin Resources and the plan’s investment committee alleging that defendants breached their fiduciary duties by causing the plan to invest in funds offered and managed by Franklin Templeton, when better-performing and lower-cost funds were available.

In addition, the lawsuit claims the defendants were motivated to cause the plan to invest in Franklin Funds to benefit Franklin Templeton’s investment management business.

Franklin Templeton tells PLANADVISER it is reviewing the complaint and does not have a comment at this time.

According to the complaint, all 40 mutual funds offered by the plan are managed by Franklin Templeton or its subsidiaries. The plan also includes a company stock fund, which invests in common stock of Franklin Templeton, and a collective trust, managed by State Street Global Advisors, which is intended to track domestic large-capitalization stocks as represented in the S&P 500 Index. Prior to 2015, the S&P 500 Index Fund was the only passively managed, and only non-proprietary, option in the plan.

The lawsuit says the funds’ fees are and were significantly higher than the fees available from alternative mutual funds, including Vanguard Institutional Funds with similar investment styles that were readily available as plan investment options throughout the relevant time. According to the complaint, fees charged for funds in Franklin Templeton’s plan ranged from 57% higher to 1,275% higher than comparable Vanguard funds.

In addition, the lawsuit says that difference was even larger at the time most of these investments were selected, as current and cheaper R6 share classes of the proprietary funds were not offered in the plan prior to May 2013.

The participant argues that many of the proprietary funds had and continue to have poor performance histories compared to prudent alternatives defendants could have chosen for inclusion in the plan. Specifically, the lawsuit says from the beginning of the relevant time period until at least September, 2013, the plan included three Asset Allocation Funds—the Conservative Allocation Fund, Moderate Allocation Fund, and Growth Allocation Fund—and all three trailed their Morningstar peer median returns in 2011 and 2012, with only the Conservative Allocation Fund beating its peers in 2013.

The defendants decided to replace the Asset Allocation Funds with target-date funds shortly before or during 2014. The complaint alleges that at the time, there was no shortage of established, cheaper target-date fund families in the marketplace, but instead of selecting one of those, the defendants chose for the plan “the untested, expensive proprietary target-date funds, despite the poor performance of its managers managing similar Asset Allocation Funds.”

The lawsuit says the target-date funds have subsequently underperformed the cheaper, established alternative funds “which, upon information and belief, were not even considered by defendants when they decided to invest plan assets in the target-date funds.” All eight target-date funds are rated in the bottom 10% of their peer groups for the most recent period, January 1 to June 30, 2016, according to the complaint.

The lawsuit notes that many of the proprietary funds were and are poorly rated by Morningstar, the independent rating service, compared to prudent alternatives the committee could have chosen for inclusion in the plan. For example, not a single proprietary fund is rated 5-stars (out of 5), the highest rating, by Morningstar, and none was rated 5-stars at any point during the statutory period. To the contrary, the Templeton World Fund, Templeton Frontier Markets Fund, and Franklin High Income Fund are all rated 1-star, the lowest rating. Ten other proprietary funds have 2-star ratings and most of the rest have 3-star ratings.

Despite the poor performance, high fees, and low Morningstar ratings, the only proprietary funds removed from the plan during the entire class period were the three Asset Allocation Funds, which were replaced with eight proprietary target-date funds using the same managers as the Asset Allocation Funds, according to the lawsuit. Three other proprietary funds were added to the plan lineup during the class period—the International Growth Fund, for which Franklin Templeton charges 102 bps; the Templeton Frontier Markets Fund, for which Franklin Templeton charges 165 bps; and the Real Return Fund, for which Franklin Templeton charges 50 bps. The lawsuit alleges the plan lost in excess of $64 million during the class period as a result of losses sustained by the proprietary funds “compared to prudent alternatives such as comparable Vanguard Funds.”

The lawsuit calls out the plan for not offering a stable value fund. Instead, the plan offered the Franklin Funds Money Market Fund, a fund managed by Franklin and paying Franklin up to 47 bps per year. “In real terms, investors in this most-conservative option have lost over 12% of their buying power over the class period. Had defendants used a comparable stable value fund, the plan participants would have seen their assets grow by over 22% during that period,” the complaint asserts.  

The participant also alleges the total plan cost, including investment and administrative fees, was nearly double the cost of comparable plans—almost entirely the result of the mutual fund fees paid to Franklin Templeton. In the six-year period from 2010 to 2015, the plan paid approximately $15 million more at the 57 basis points fee rate than did a plan at the 31 basis points fee rate, the complaint says.  

The lawsuit seeks a declaration that the defendants breached their fiduciary duties under section 404 of the Employee Retirement Income Security Act (ERISA); an order compelling the disgorgement of all fees paid and incurred, directly or indirectly, to Franklin Templeton and its subsidiaries by the plan or by proprietary mutual funds as a result of the plan’s investments in their funds, including disgorgement of profits thereon; and an order compelling the defendant to restore all losses to the plan arising from their violations of ERISA, including lost opportunity costs, among other things. In addition, the participant is asking for class certification of the lawsuit.  

There has been a spate of self-dealing lawsuits against fund companies this year.  

The complaint in Cryer v. Franklin Resources Inc., et. al. is here.