Compliance July 15, 2016

Court Finds Nothing Wrong with Fidelity's Use of Float Income

Float income are not retirement plan plan assets, a federal appellate court ruled.
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The 1st U.S. Circuit Court of Appeals has ruled that “float income” Fidelity retained in the process of making distributions to retirement plan participants is not a plan asset, so Fidelity did not violate its fiduciary duties under the Employee Retirement Income Security Act (ERISA).

The ruling was in line with a district court ruling in the case.

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In two lawsuits, both filed in the U.S. District Court for the District of Massachusetts, retirement plan participants and one plan administrator claimed Fidelity breached its fiduciary duties by not by failing to distribute float income solely for the interest of the plans. The float income was earned on assets Fidelity redeemed for participants requesting a distribution from the plan and placed into an interest-bearing account (called FICASH) until the distributions were made. The assets remained in FICASH for one day if participants were paid electronically, but if participants requested a check, the assets remained in the account until the check was cashed.

The appellate court noted that the participant plaintiffs in the lawsuit claim no direct stake in the plan assets they say are being improperly used. “They do not allege that they are or will be short so much as a penny of any benefit to which they are entitled under the terms of their plans,” the opinion says. Instead they bring claims on behalf of the plans themselves, contending that the plans are being cheated of certain plan assets. “Given this posture, it is notable that the participants are joined as plaintiffs by only one plan administrator. Thus, whatever mischief the participants see in defendants’ actions, the concern apparently is shared only halfheartedly by the plans themselves. That is likely because the behavior complained of is nothing other than what the plans expected,” the court notes.

NEXT: The arguments

The appellate court found the agreements between Fidelity and the plans, cited in the complaint and attached to the motion to dismiss, confirm that Fidelity's duty is to make a distribution by a route incapable of providing any benefit to the plan from temporary use of the cash. The court also cites a document that suggests the plans are not entitled to hold uninvested cash—"The Trust Fund shall be fully invested . . ."

The court said if the payout from the redemption were going to the plan itself, ordinary notions of property rights probably would dictate that the substitute cash becomes an asset of the plan upon the exchange. But, the payout from the redemption does not go, and is not intended to go, to the plan itself. “Plaintiffs allege no facts to support the proposition that the same cash becomes a plan asset simply because it moves, not directly from the fund to the participant, but from the fund through Fidelity on its way to the participant.     

The court did not consider arguments brought by the Department of Labor in an amicus curiae brief supporting plaintiffs. It said the Secretary of Labor contends that Fidelity's use of float violated ERISA fiduciary duties, not because float is a plan asset, but because Fidelity failed to seek and obtain the plans' permission to use float as it did. “Plaintiffs did not press a failure-to-obtain-agreement claim in the district court or in their opening brief here, and their reply brief's unsuccessful attempt to cast the Secretary's position as their own is, in any event, too little too late,” the opinion says.

In a final point in support of its decision, the court noted that in Tussey v. ABB, Inc., the 8th U.S. Circuit Court of Appeals reached the same conclusion on materially similar facts.

The 1st Circuit’s opinion is here.

Data & Research July 15, 2016

Evolution in Use of Institutional Multi-Asset-Class Solutions

Cerulli’s latest survey of institutional investor priorities and behaviors shows lasting momentum for multi-asset-class solutions, but also some challenges for the market segment. 
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Protecting portfolios from “debilitating large-scale losses” and adjusting for the likelihood of rising interest rates remain primary goals of large-scale institutional investors, according to new research from Cerulli Associates.

The other most frequently cited goals of institutional investors, including corporate and public retirement plans, will sound familiar to professional financial advisers, including “achieving lower asset volatility,” “capturing investments with low or no correlation in returns,” and “raising risk-adjusted returns.” Cerulli finds these factors are driving greater interest and demand for “multi-asset-class solutions strategies,” both on the equity and fixed-income sides of the portfolio.

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Especially among larger defined contribution (DC) plans, there is an ongoing push into this domain via custom target-date funds (TDFs), managed volatility overlay strategies, and a variety of other “sophisticated volatility or income-targeting and absolute return investments,” Cerulli finds.  Related to this is steady interest in outsourced chief-investment officer mandates.

“We believe institutional custom solutions represent a substantial and growing market for asset managers, investment consultants, and other financial firms,” Cerulli explains. “Assets in these categories stood at $1.1 trillion at year-end 2015, up from $506 billion in 2010. Assets are expected to grow 34.5% to $1.7 trillion by 2020, reflecting somewhat uneven near-term growth, but accelerating more fully in the medium to long term.”

Asset managers favor this growth, in fact, because “the focus on cost prevalent in the broader asset management industry is largely not present in institutional custom solutions … When it comes to complex custom solutions mandates, however, there is an understanding that managers will be expected to provide more technical and in-depth services beyond basic investment management.”

NEXT: The evolving scope of service 

Cerulli finds that the number of custom institutional multi-asset-class solutions added over the past year “has risen exponentially, even if growth of client assets under management is more uneven as of late.”

In terms of clients’ goals in utilizing these approaches, approximately 60% of strategies “continue to be judged on performance against a traditional market benchmark, as opposed to an objective such as real returns or volatility targets.”

Other findings suggest the present environment for pension de-risking represents “a pause in the long-term future growth of liability-driven investing (LDI) client assets.” As such, nearly half (49%) of LDI managers and others are “managing assets for corporate defined benefit (DB) plans that have frozen accruals in some form,” Cerulli explains. “Nearly two-thirds (63.5%) of corporate DB clients of LDI managers have a de-risking glide path in place. However, most plans are not hitting their de-risking glide path triggers as interest rates have remained low and funded status has stagnated, or, in some cases, deteriorated.”

With so much market complexity, Cerulli says it only makes sense that custom solutions mandates “tend to be complex and clients expect a greater amount of interaction with a manager than in traditional single-asset-class assignments.” A majority (68.4%) of firms overseeing these mandates report having a dedicated team to work with custom solutions clients.

“The most-cited roles serving institutional custom solutions mandates are portfolio manager and investment specialist (89% and 83%, respectively),” Cerulli concludes.

Information on obtaining Cerulli Associates research, including “U.S. Institutional Custom Solutions 2016: The Rising Demand for Outcome-Oriented Client Strategies,” is here. 

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