Compliance March 22, 2018

District Court Dismisses ERISA Lawsuit Targeting Aon Hewitt, Financial Engines

Plaintiffs suggested plan fiduciaries permitted excessive fees to be paid, leading to improper provider kickbacks; a district court judge has summarily dismissed the allegations for failing to state an actionable claim. 

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The United States District Court for the Northern District of Illinois, Eastern Division, has ruled for the defendants in an Employee Retirement Income Security Act (ERISA) lawsuit filed by participants in the Caterpillar 401(k) plan against Aon Hewitt.

A number of Aon Hewitt companies were named as defendants in the lawsuit, including Aon Hewitt Financial Advisors, Hewitt Financial Services and Hewitt Associates. Another provider, Financial Engines, was also named in the text of the suit but was not actually challenged as a defendant.

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The central claim in the proposed class action was that plaintiffs were forced to overpay significantly for advisory services provided by Financial Engines, with the excess payments essentially amounting to kickbacks returned to Hewitt defendants. As the text of the lawsuit laid out, for periods prior to 2014, Financial Engines provided services directly to plaintiffs and other Caterpillar plan participants and was paid directly from participants’ accounts. But the fee for those services was significantly higher than it should have been because the agreement between defendants and Financial Engines required Financial Engines to kick back to defendant Hewitt a significant percentage of the fees charged by Financial Engines, plaintiffs claimed, even though Hewitt and its sister company co-defendants did not perform any investment advisory or other material services in exchange for the payment they received.

Responding to these allegations, the defendants denied wrongdoing and argued that the plaintiffs failed to state any legally cognizable claims—and that the complaint should be summarily dismissed. Defendants argued they are not a fiduciary of the plan for the purposes in question here, and that they did not act as a fiduciary with respect to Hewitt’s receipt of fees from Financial Engines or the firms’ retention of Financial Engines as subadviser.

Beyond this, defendants argued that plaintiffs’ prohibited transaction and self-dealing claims should collectively fail because they “do not allege their essential elements.” Additionally, defendants asserted plaintiffs’ non-fiduciary liability claims should be dismissed because the plaintiffs “fail to allege a predicate prohibited transaction.”

The text of the decision includes detailed argumentation on all of these points, with the court broadly siding with defendants throughout.

For example, the decision states clearly that “nowhere in her complaint does [the lead plaintiff] allege that Hewitt is identified as a fiduciary in any plan documents, and [the plaintiff’s] conclusory allegations that Hewitt controlled Caterpillar’s decision to engage Financial Engines are contradicted by the Hewitt/Financial Engines Master Service Agreement.”

The decision goes on: “The language of the Hewitt/Financial Engines Master Service Agreement makes it clear that Caterpillar, and not Hewitt, retained the sole and final authority to decide whether to hire Financial Engines. [Plaintiff’s] allegations that (1) Hewitt gave Caterpillar no choice but to accept Financial Engines if Caterpillar wished to provide investment advisory services, and that (2) Hewitt hired Financial Engines on the Plan’s behalf are conclusory and not plausible in light of the parties’ agreement. In light of the language of the Hewitt/Financial Engines Master Service Agreement, and nothing to the contrary in the record except Scott’s bald allegations of ‘control,’ the court concludes Caterpillar had sole authority to select and hire Financial Engines, and it is not plausible on this record that Hewitt had any final authority or control over the selection and hiring of Financial Engines.”

As the court points out, similar claims have recently been rejected by other district courts.

“Even construing the facts in her favor, as the court must do at the motion to dismiss stage, nowhere in her complaint does [the lead plaintiff] allege any facts to support a claim that Hewitt provided individualized investment advice to the plan on a regular basis pursuant to a mutual agreement that its advice would serve as a primary basis for the plan’s investment decisions,” the decision further explains. “There is nothing to indicate, other than bare and conclusory allegations, that Hewitt exercised discretionary authority over the plan or its assets, and those bare and conclusory allegations are not enough to survive a motion to dismiss.”

Importantly, the dismissal was handed down “without prejudice,” and the plaintiff may, if she chooses to do so, file an amended complaint consistent with the court’s opinion and order. There is a 30-day deadline assigned for this purpose.

Another important caveat pointed out in the dismissal decision is that “it is not disputed that Aon Hewitt Financial Advisors [AFA] is a fiduciary to the plan for the purpose of providing investment advice to the plan participants, but that does not make AFA a fiduciary for all purposes.” This is important because the plaintiff here alleged that AFA breached its fiduciary duties by receiving an excessive fee from Caterpillar. “However, it is well-established that a service provider who negotiates its own compensation with a plan fiduciary at arm’s length is not a fiduciary for that purpose,” the decision concludes. “Courts have held that a fiduciary’s negotiation of its own compensation is a non-fiduciary act as a matter of law.”

The full text of the decision includes significantly more detail arguments as to why the plaintiff has broadly failed to state an actionable claim and is available in full here.

Products March 22, 2018

Personal Touch Matters in 3(38) Fiduciary Marketplace

The demand for 3(38) investment manager search support and monitoring has moved up market into the range of plans with billions of dollars in assets; smaller plans are seeking cost savings while larger plans are seeking deeper expertise and nimble capabilities.

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Phil Edwards is principal of Curcio Webb, a unique firm that helps both defined contribution (DC) and defined benefit (DB) plan sponsors identify the most appropriate service providers for 3(38) fiduciary investment management.

As PLANSPONSOR has previously reported, Edwards says the marketplace for 3(38) fiduciary investment management services is expanding for a variety of reasons—and it will very likely continue to do so as complex new market pressures emerge.

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“We have been serving in this role of 3(38) matchmaker for about 10 years and over the last three years alone have completed about 30 of these projects, involving about 45 providers,” Edwards explains. “Our clients range from plan sponsors with $100 million to $8 billion in assets across defined contribution, defined benefit and endowment/foundations.”

Use of Curcio Webb 3(38) provider search support has moved up market over time, Edwards adds. Initially the firm was serving plans in the $100 million to $300 million range pretty exclusively.

“Today the demand for 3(38) search support and monitoring has moved up market into the range of plans with billions of dollars in assets,” he notes. “The big emphasis from many of the smaller plan sponsors is pursuing cost savings. These clients have an understanding that working with an outsourced chief investment officer [OCIO], as we tend to describe the 3(38) relationship, can help them purchase investments with far greater economies of scale.”

Over time the average client has climbed up to probably $500 million, and recently the firm has worked with clients with assets north of $8 billion.

“I mention this less to boast about our success and more to highlight that larger and larger plan sponsors are resonating with the idea of getting 3(38) support,” Edwards says. “As you move up market the opportunity for cost savings is not as big a deal, because these sponsors can achieve pretty good leverage on their own to negotiate better pricing. So why are they pursuing 3(38) support? A lot of it is a resource and staffing issue on the part of the plan sponsor.”

Even though they might have the legacy of having the pension plan and/or a large DC plan in place, as the organization changes and personnel move out of the firm, there can be an emerging sense that expertise is being lost and that more support is needed. And as the competition and quality of the 3(38) marketplace has improved, even the largest plan sponsors see it as increasingly attractive and reasonable to pursue this course.

“We very commonly hear from the larger clients that managing the pension plan is just taking too much time and too much expertise—and it just one day starts to make a lot of sense to look for that outside support,” Edwards notes. “And the other trend as you move up market is that you find that the circumstances and goals facing each plan, especially on the DB side but also with DC plans to some extent, really start to become quite different from sponsor to sponsor. They can find it hard to maintain a strong direction and orientation for their plans.”

Looking across a pool of $100 million plan sponsors, the goals and challenges are often more homogeneous, Edwards explains, because the plans are still just getting started and they are likely focused on implementing all the best practices and features that one commonly hears about in the industry trade publications. But as the plans mature and become more sophisticated, the conditions will become less homogeneous, and the nature of the support the plan needs can really change.

“Against this background we have a crop of about 45 or 50 3(38) service providers that we have gotten to know quite well through our request for information and monitoring processes,” explains Uma Kolluri, a lead consultant with the Pennington, New Jersey-based firm. “It is important to highlight that these firms provide very different ranges and styles of services. Some are very high touch or very low touch and they can really bring different services and solutions to bear that can really benefit plan sponsors in quite different situations.”

This is where the real leg work comes in from firms like Curcio Webb: “We work to get to know the plan sponsor and its needs and goals, and then we look across our book of providers that we know, and we work together to reach a recommendation,” Kollure notes. For example there are some providers out there who might specialize in helping an underfunded pension plan at an employer with high cash flow more aggressively purse full funding through tactical risk-taking in the markets, whereas another provider that emphasizes liability-driven investing would be a better fit for a sponsor that has only a slight deficit and wants to ensure that they do not slide backwards on the funded status.

“We have done cases where we have helped plan sponsors specifically find a provider that is good at establishing pension plan hibernation, and others where we have connected providers and sponsors that are interested in moving down the road towards pension risk transfer,” Edwards observes. “I would point out that in many of the searches, it is just as much about the plan sponsor gaining back-office administrative support as it is about finding them new expertise in investment management. There is a lot that we can help plan sponsors do.”

Importantly, each new search starts with a formal kick-off meeting.

“The data that we collect in advance of that meeting is certainly informative, but it is also crucial to have that early meeting in person so that we can get to know the personality and history of the plan sponsor,” Kollure says. “As you know, in the retirement plan services field, yes it is about technical capabilities and the optimal alignment of resources—but successful projects are also very much about aligning the right philosophies and personalities. These cultural factors matter quite a bit when ultimately selecting and working with a 3(38) provider.”

The firm will do this first meeting with the plan sponsor and then go back and run its analysis to come up with a short list of between five and ten providers that might be a good fit. The firm strives to present a variety of providers and approaches that could fit the plan sponsor’s needs.

“We have come to see that it is not really helpful to present the plan sponsor with five or ten different flavors of vanilla, so to speak, and ask them to pick one,” Edwards says. “It’s the same idea as trying to present plan participants with a more rational and simplified choice architecture. Plan sponsors really value seeing the different approaches and comparing what the value of each might be.”

The final short list will generally contain some very large global firms, which take one approach to the outsourced chief investment officer business, and then some mid-sized regional providers with their own strengths—and then finally smaller independent firms that purposefully focus on very specific services or on serving a limited number of clients. All of these approaches have their relative merits, and it’s really up to the plan sponsor to decide what will be the best fit, based on both technical capabilities and culture. Beyond these basic factors, there are different service models that each provider can bring to the sponsor.

“In some service models you have the hub-and-spoke approach, for example, where a centralized portfolio management team is on one side doing its work and the sponsor is served by a distinct client support team,” Edwards concludes. “Other providers have a service model where the portfolio manager is very much directly involved in the client relationship. And of course you have very different investment philosophies out there, with some firms being more strategic and others more tactical. They all believe in diversification, but they all define and implement diversification in different ways. There are different definitions of liability driven investing and different philosophies about what it means to de-risk and how you should go about doing that. So it’s a very dynamic and active and evolving marketplace.”

More information about Curcio Webb and its services is available here.

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