Edward Jones Latest Target of Self-Dealing ERISA Suit

Plan officials are accused of steering participants into investments that charged improper amounts of revenue-sharing and other fees that benefitted the mutual fund partners of Edward Jones. 

Similar to other self-dealing suits recently filed against well-known retirement plan providers, Edward Jones is accused of favoring its own investments and those of its “preferred partners” in its 401(k) plan, at the expense of performance.

Defendants, which include the Edward Jones company and individual fiduciaries serving the plan, are also accused of causing the plan to pay excessive recordkeeping and plan administration fees to the recordkeeper, Mercer HR Services, Inc. According to paperwork filed by defendants on behalf of the plan, the plan’s payments to Mercer HR Services “increased by 314% between 2010 and 2014 even though market rates for recordkeeping services declined over that period and even though the number of plan participants only increased by 22%.”

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Plaintiffs are seeking class action certification for their suit, which calls out a number of investment options by name for being persistently poor performers that were allowed to remain on the investment menu due to their brand’s connection with Edward Jones.

According to the complaint, the lead plaintiff’s individual account in the plan was “invested in various investment options offered under the plan’s investment menu in the class period, including: American Funds Europacific Growth Fund, American Funds Growth Fund of America, and Washington Mutual Investors Fund, with allocations set by defendants according to plaintiff’s investment election for a Balanced Toward Growth portfolio. The plaintiff, like substantially all plan participants and beneficiaries, was not provided any information regarding the substance of deliberations, if any, of defendants concerning the plan’s menu of investment options or selection of service providers during the class period.”

The text of the complaint shows the Edward Jones plan is a straightforward 401(k) and profit sharing arrangement  where participants “have the opportunity to direct the investment of the assets allocated to their individual accounts into the investment options approved by the committee and offered by the plan, and the return on those investments are credited to each participant’s account.” During the class period the plan “has invested in at least 53 different investment options, of which three were managed by defendants and at least 40 more were managed by partners or preferred partners of Edward Jones.”

NEXT: Specific allegations 

According to the complaint, the mutual fund companies Edward Jones markets pay Edward Jones a portion of all fees they receive from the assets Edward Jones steers into their funds.

“These payments are called revenue-sharing and they include both ‘annual asset fees’ and ‘sales fees,’” the complaint states. “They are calculated based on the total contributions and/or assets made by Edward Jones clients. Edward Jones also receives hundreds of millions of dollars per year in ‘networking’ and ‘shareholder accounting’ fees from partner mutual fund companies, like those included in the plan.”

During the class period, plaintiffs suggest the asset fees have ranged from 2.4 basis points (bps) to 13 bps. According to plaintiffs, “the annual asset fees are based on the value of assets under management no matter when they were invested. Sales fees are one-time payments based on the amount of new money contributed to the funds by the plan and other Edward Jones customers in the year in which the contribution was made.

The text of the complaint goes on to suggest “certain of the funds marketed by Edward Jones, and most of the funds in the plan, are managed by ‘Preferred Product Partners’ of Edward Jones. As consideration for the asset fees and sales fees ‘shared’ with Edward Jones by the Preferred Product Partners, Edward Jones provides them with greater access to certain information about its business practices, frequent interactions with Edward Jones financial advisers, marketing support and educational presentations.”

Plaintiffs suggest the cozy nature of this relationship eventually led plan officials to start to consider these monetary and compensation issues above the best-interest of plan participants.

“The plan’s investments show a high correlation to mutual funds offered by mutual fund families that pay Edward Jones the most money,” the complaint continues. “Of the 12 mutual fund families listed in the 2015 Edward Jones revenue sharing disclosure, eight have fund offerings in the plan. The eight mutual fund family partners (or preferred partners) represented in the plan accounted for 92% of the revenue sharing paid by mutual fund families to Edward Jones in 2015. Every single partner or preferred partner that paid Edward Jones more than $10,000,000 in revenue sharing in 2015 was represented in the plan. Indeed, approximately 80% of plan assets were invested in mutual funds offered by partners or preferred partners of Edward Jones. And approximately 80% of funds offered in the plan in 2014 came from partners or preferred partners.”

The full text of the complaint is available online here, including more specific information about the funds being scrutinized and the damages being sought. 

PPA Reduced Lawsuits Against Cash Balance Plans

It also provided guidance about how to convert a traditional pension to a cash balance plan.

When cash balance plans were first developed in the 1980s, plan sponsors were immediately drawn to them, says Alan Glickstein, a senior retirement consultant with Willis Towers Watson in Dallas.

“As many as 30% of large plan sponsors gravitated to them,” he says. “The thing that makes cash balance plans attractive is their simplicity. It is hard for a young person to relate to an annuity in a traditional pension plan. For the same reason that 401(k) plans have become so popular, with a cash balance plan, everyone knows how much is in their account. For many companies and participants, that transparency is crucial, and if you leave the company, the cash balance plan account is portable.”

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Kevin Wagner, a senior retirement consultant with Willis Towers Watson in Detroit, adds: “If you go back 30 years, every defined benefit plan was a traditional pension plan.

However, nearly as soon as cash balance plans were developed, participants began suing them, with the majority of the cases based on age discrimination. With cash balance plans, plan sponsors set an interest crediting rate for accounts. “The plaintiffs said, if you look at the investment horizon of a 20-year-old and a 40-year-old, each of whom will retire at age 65, the 20-year-old has a 45-year trajectory for receiving interest, while the 40-year-old has only 25 years, so you are discriminating by age,” says David Godofsky, a partner and head of the employee benefits and executive compensation group at Alston & Bird in Washington, D.C.

When the Pension Protection Act (PPA) was passed in 2006, it specifically said that as long as the rate of interest you are delivering to the participants is not higher than the market rate, then you are not discriminating by age, Godofsky says. “If you had a guaranteed higher rate of interest, the degree to which it would be worth more for the 20-year-old than the 40-year-old is, in fact, age discrimination,” he says. “Shortly after the PPA was passed, appellate courts started saying that age discrimination doesn’t make any sense because the accounts are just receiving compound interest. If Congress had never passed the PPA, the courts would have eventually solved the age discrimination problem anyway, but the PPA came in with a clear solution.”

NEXT: Addressing other types of lawsuits

The second type of lawsuit that cash balance plans faced before the passing of the PPA was what is known as the “whipsaw” effect, which essentially had to do with how the beginning balance transferred from the traditional pension to the cash balance plan is calculated, says Daniel Schwatz, an employee benefits attorney and officer in the employee benefits practice group at Greeensfelder, Hemker & Gale, P.C. in St. Louis. He explains: “The PPA said that as long as the plan uses the market interest rate to calculate the balance, and not a higher interest rate, then the whipsaw effect is eliminated.”

Godofsky adds: “Shortly after cash balance plans came into existence 30 years ago, the Internal Revenue Service (IRS) issued guidance that said you may not be able to pay an individual in a cash balance plan a lump-sum equal to their account balance. Their logic was that there is a minimum lump-sum rule in the Employee Benefit Security Act (ERISA) and the Internal Revenue Code (IRC). The IRS said the lump-sum must be computed with a mortality and interest rate so that participants are not lured into taking a lump-sum that is lower than the annuity. The idea behind whipsaw is to take the balance and convert it into an annuity and then back to a balance, and if that number is greater than the original account balance, you have to pay them the larger amount.”

A third breed of lawsuits that cash balance plans faced regarded what is called “wear away,” which dealt with the transition from traditional pension plans to cash balance plans, says Jon Waite, chief actuary and director on the advisory team at SEI Institutional in Oaks, Pennsylvania. “The wear away happened when plans transitioned from a traditional pension plan to a cash balance plan,” Waite says. “Employers said, ‘We will give you and account balance to start off in your new cash balance plan, and it will be the better of the benefit in the frozen plan or the cash balance plan. Of course, the frozen pension plan would have a much higher balance, so you ended up with participants who, for several years, accrued no benefit because they were catching up to the old balance. The PPA came in to fix that anomaly by mandating that the frozen benefit be converted to an account balance plus new accruals so that everyone receives some accrual each year.”

Particularly by permitting cash balance plans to convert the hypothetical account balance into benefits other than a lump-sum, the PPA has successfully eradicated lawsuits against the plans, says Robin Schachter, a partner with Akin Gump Strauss Hauer & Feld LLP in Los Angeles. “That provision in the PPA resolved a lot of issues for both plan sponsors and participants and reduced a lot of litigation and uncertainty,” he says.

While the PPA essentially negated these three types of lawsuits against cash balance plans, there is a fourth type that these plans have faced that cannot be legislated, Schwartz says, and that is the failure to properly communicate to participants how their traditional pension plan is being converted to a cash balance plan. “It would be very difficult to legislate how you put this in your benefit materials,” he says. “While the other types of cash balance plan lawsuits—very technical cases dealing with age discrimination and conversion rights—have essentially disappeared since the passing of PPA, there could still be lawsuits alleging that a benefit was taken away without proper explanation,” and this is an area of which plan sponsors and their advisers need to be mindful.

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