Compliance January 11, 2016

Court Rejects Excessive Fee Claims Against Principal

Among other things, the 8th Circuit found Principal’s adherence to its agreement with a plan sponsor does not implicate any fiduciary duty.
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An appellate court has dismissed a plan sponsor’s lawsuit claiming its plan provider charged excessive fees to retirement plan participants.

Affirming a district court’s decision that McCaffree Financial Corp. failed to state a claim, the 8th U.S. Circuit Court of Appeals agreed that Principal Financial Group was not acting as a fiduciary under the Employee Retirement Income Security Act (ERISA) when it entered into a contract with McCaffree to offer separately managed accounts for McCaffree’s retirement plan for employees.

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The contract between McCaffree and Principal provided that plan participants could choose to invest their accounts among various separate accounts which invested in Principal mutual funds. Principal reserved the right to limit which separate amounts it made available to participants and McCaffree also had the ability to limit in which accounts employees could invest. Principal presented 63 accounts that could be included in the contract, and this was narrowed down to 29 accounts made available to plan participants.

The contract also provided that participants would pay both management fees and operating expenses to Principal. Principal assessed the management fees as a percentage of the assets invested in a separate account, and this percentage varied for each account according to its associated mutual fund. In addition, Principal could unilaterally adjust the management fee for any account, subject to a cap specified in the contract, and would have to provide participants with at least 30 days’ written notice of such change.

McCaffree entered into the contract in 2009. In 2014, it filed a lawsuit alleging that Principal charged participants invested in these separately managed accounts “grossly excessive management fees and other fees” in violation of its fiduciary duties under ERISA.

The appellate court said that to first state a claim of breach of fiduciary duty, a plaintiff must first plead facts demonstrating the defendant is a fiduciary. Principal was not a named fiduciary to the plan.

NEXT: Five arguments rejected

McCaffree argued that Principal’s selection of 63 separate accounts in the initial investment menu constituted both an exercise of discretionary authority over plan management and over plan administration, so it owed a fiduciary duty to make sure fees for the accounts were reasonable. However, the appellate court noted that the contract clearly identified each account’s management fee and authorized Principal to pass through expenses to participants. The court said sister circuits have held that a service provider’s adherence to its agreement with a plan sponsor does not implicate any fiduciary duty where the parties negotiated and agreed to the terms of the agreement in an arm’s-length bargaining process. Up until it signed the agreement with Principal, McCaffree remained free to reject its terms and contract with another service provider.                        

McCaffree argued that Principal acted as a fiduciary when it selected from the 63 accounts identified, the 29 accounts made available to plan participants. The company contends this winnowing process, after the parties entered into the contract, gave rise to a fiduciary duty to ensure the fees associated with the accounts were reasonable. The court found that McCaffree did not assert that only some of the 63 accounts had excessive fees or that during the winnowing process, Principal made sure participants only had access to the higher-fee accounts. The action subject to complaint is that excessive fees were charged for all the accounts in the contract, so McCaffree cannot base its excessive fee claims on any fiduciary duty Principal may have owed while selecting the 29 accounts, the court concluded.

The appellate court also rejected McCaffree’s argument that Principal’s discretion to increase fees and adjust amounts charged to participants supports its claim that Principal was a fiduciary. Again, the court said the company failed to plead any connection between this and its excessive fee allegations. McCaffree did not allege that Principal exercised this authority, resulting in excessive fees.

Similarly, the court found McCaffree’s allegation that Principal was a fiduciary because it provided participants with “investment advice” was unrelated to the context of the lawsuit. McCaffree also argued Principal inadequately disclosed the additional layer of management fee for the underlying Principal mutual funds in which the separate accounts were invested, but the court found the mutual fund fees were not subject to complaint, so this argument does not apply to the decision whether Principal was a fiduciary for actions relating to the complaint.

The decision in McCaffree Financial Corp. v. Principal Life Insurance Company is here.
Compliance January 11, 2016

JP Morgan Will Pay $150 Million Over Risk Disclosures

Retirement plans across the U.S. argued they were misled about the riskiness of funds exposed to the firm’s much-maligned “London Whale” trading losses in 2012. 
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It’s been several years since newspaper headlines railed again the “London Whale” trading difficulties at J.P. Morgan, but at least one related securities lawsuit involving retirement plans is still unfolding in the federal courts.

Documents filed over the past several weeks with the U.S. District Court for the Southern District of New York show J.P. Morgan Chase and Co. has tentatively agreed to pay $150 million to settle claims in a securities lawsuit brought by retirement plans who shared in billions of unexpected losses.

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By way of background, case documents explain the so-called “London Whale” is a former J.P. Morgan trader named Bruno Iksil, who turned out to be an influential trader at the bank making large and complex bets on U.S. corporate bonds. According to plaintiffs, Iksil eventually made errors and serious miscalculations in certain very large trades executed through exotic derivative products. Making matters worse, risk managers at the firm apparently bent the rules for investing as they were explained to clients with a lot of money at stake, allowing the risk-taking to grow. By the time others at the bank noticed and took corrective action the losses had already climbed to the billions.

More than a few pieces of litigation arose from the matter, including the case at hand, brought by a collective of mainly public retirement plans, including the Ohio Public Employees Retirement System (OPERS), the Arkansas Teacher Retirement System, and several public retirement plans in the State of Oregon. The plans all suffered unexpected investment losses and claim J.P. Morgan violated federal securities laws by making materially false and misleading statements concerning the risks and losses arising from “secret proprietary trading activities.”

A hearing on preliminary approval of the parties’ proposed $150 million class action settlement is scheduled for January 19. According to the plaintiffs’ written agreement to the settlement terms, the parties did not agree on the hard-won terms “until after the court’s [previous] decision on defendants’ motion to dismiss the lead plaintiffs’ claims; the completion of substantial discovery, including depositions; the court’s favorable decision to certify the class; and a lengthy mediation spanning several months.” The settlement, if approved by the district court, would “resolve and release the class’s claims against all defendants in this action in exchange for the immediate payment of $150,000,000, in cash, by defendants.”

NEXT: Settlement details hinge on risk monitoring 

Case documents contain some interesting details about the risk management processes of the firm and how plaintiffs felt they were mistreated by the bank, especially its representations of its risk management processes.

According to the plaintiffs, the firm’s “principal risk management unit,” was “responsible for making investments to hedge the structural risks of [the firm’s] balance sheet on a consolidated basis … in other words, to decrease the bank’s risks by hedging them.” The lead plaintiffs instead alleged that, “contrary to this public portrayal,” the most prominent activity carried out by the risk mitigation unit tasked with protecting their investments “was proprietary trading in an enormous portfolio of complex credit derivatives known as the Synthetic Credit Portfolio (SCP), which reflected over $150 billion in notional value by the time the class period began.”

Plaintiffs alleged that the size of the SCP’s positions “greatly increased during the first three months of 2012, triggering risk limit breaches that J.P. Morgan told investors it used to monitor and control risk, including the ‘value at risk’ or ‘VaR’ metric, which is a measure of how much money the company could lose on a given day.” Yet, rather than require the London Whale trader to reduce risky positions—which would have resulted in substantial short-term losses but mitigated the prospective overall risk of the portfolio—the bank “approved a temporary increase to its firm-wide VaR limit, and then authorized a change to the VaR model that instantaneously cut the VaR in half.”

Further, plaintiffs alleged that, beginning around February 2012, “hedge funds such as Saba Capital recognized that certain credit derivative index markets were being distorted by a single trader taking on outsized positions (i.e., the London Whale), and that by taking opposing positions they could reap profits when that trader was eventually forced to exit due to liquidity constraints and mounting mark-to-market losses.”

Regarding how the settlement money will be divided up, the proposed plan of allocation “is similar to plans of allocation that have been approved in numerous securities class actions asserting claims under Section 10(b) and Rule 10b-5 of the Exchange Act,” plaintiffs say. “The plan allocates the net settlement fund based on an estimate (determined by co-lead counsel and their experts) of the amounts by which the market prices of J.P. Morgan common stock trading on the New York Stock Exchange were artificially inflated at various points during the class period, and takes into consideration when an authorized claimant purchased and/or acquired J.P. Morgan common stock and when those shares were sold.”

Under the plan, no class member will receive a payment unless they held J.P. Morgan common stock through at least one alleged corrective disclosure date and the amount of their payment calculates to $10 or more.

Full details of the settlement of agreement are here.

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