401(k) Plan Administrator Sues VALIC Over Surrender Fees Charged to Plan

The administrator of the D.L. Markham, DDS, MSD, INC. 401(k) Plan has filed a lawsuit against the Variable Annuity Life Insurance Co. (VALIC) over fees he says were improperly withheld from plan assets.

“Fundamentally, this class action seeks to right defendants’ wrongs of targeting and exploiting unsophisticated small employers seeking to provide benefits to their employees,” the complaint states.

Effective May 18, 2018, David Markham hired VALIC to maintain the plan on VALIC’s retirement platform by entering into an agreement with VALIC whereby it would provide administration, individual services and investment products.

The annuity contract selected by Markham for the plan was the Portfolio Director Group Fixed and Variable Deferred Annuity Contract, a fully allocated group fixed and variable deferred annuity contract for which VALIC serves as the issuer and contract recordkeeper of the assets invested under the contract.

In or around January 2020, Markham determined that the investment returns and quality of services provided were insufficient to justify the high fees imposed by VALIC through the investment funds it made available to plan participants. Markham informed VALIC that he intended to terminate the plan’s contract with VALIC and select a successor plan service provider.

In an email to Luminita Markham, David Markham’s wife and co-owner of the dental practice, on April 30, providing information relating to the plan’s deconversion from the VALIC system, a VALIC representative pointed out that the annuity contract provided for a 5% surrender charge on transfers out of the contract on amounts contributed in the previous 60 months, which would effectively cover all assets to be transferred by the plan. Only VALIC is expressly authorized to waive the surrender charge.

According to the lawsuit, David Markham did not have actual knowledge of the surrender fee until communications with VALIC last year. “Moreover, plan administrators would not have understood that VALIC applies the surrender charge to the termination of a plan’s relationship with VALIC because its disclosures state only that the surrender fee provision would be imposed on participants who chose to withdraw funds from their account,” the complaint states.

Markham’s firm delayed implementing its decision to terminate VALIC’s services while it retained counsel. He then requested a waiver of the surrender fee. Markham’s counsel sent VALIC a letter on June 23, alerting VALIC to the prohibition on penalty charges imposed by service providers under the necessary services prohibited transaction exemption set forth in the Employee Retirement Income Security Act (ERISA). On August 7, after a review by VALIC’s Executive Review Committee, a consultant in AIG’s Retirement Services division informed Markham that the committee had decided to impose the surrender fee upon the transfer of plan assets. AIG is the parent company of VALIC.

On or about August 19, all plan assets were transferred from the VALIC platform to the successor service provider’s platform. A surrender fee of $20,703 was retained by VALIC, representing approximately 4.5% of the pre-fee account balances.

The complaint points out that under ERISA, a contract for services is exempt from the prohibited transaction rules if the contract is for services is necessary for the operation of the plan and no more than reasonable compensation is paid by the plan. A contract for services is not reasonable unless it permits the plan to terminate the contract without penalty on reasonably short notice. “An early surrender fee does not reasonably compensate for loss if it provides for payment in excess of actual loss. VALIC’s early surrender fee, which provides for payment in excess of any actual loss, is prohibited by ERISA,” the complaint states.

The suit was filed on behalf of all ERISA covered plan administrators and plans that entered an agreement with VALIC in which VALIC had discretion to impose a surrender charge on outgoing transfers and which paid VALIC a fee of any kind since January 4, 2018. It was also filed on behalf of a “self-dealing subclass,” defined as: “All ERISA covered plan administrators/plans that entered an agreement with VALIC in which VALIC imposed the surrender charge on outgoing transfers since January 4, 2018.”

According to the complaint, VALIC’s audited statutory financial statements ending on December 31, 2019, show that it held $3.945 billion in group annuities that include a surrender charge of 5% or more. “Based on that amount there would be well over 8,000 class members if they are all comparably sized to the plaintiff plan,” the complaint says.

The lawsuit requests the court issue an order requiring VALIC to provide an accounting for, and to disgorge, all losses caused to class members’ plans—including all fees retained—as a result of its knowing participation in a prohibited transaction as a nonfiduciary. In addition, it asks that the court order require VALIC to restore all losses caused to the subclass members’ plans as a result of its self-dealing prohibited transaction as a fiduciary in imposing the surrender fee.

VALIC and AIG have declined to comment about the lawsuit.

In November 2019, AIG confirmed that the Securities and Exchange Commission (SEC) was investigating the 403(b) annuity sales practices of VALIC. In July, the SEC charged Houston-based VALIC Financial Advisors Inc. (VFA) in a pair of actions for failing to disclose to teachers and other investors practices that generated millions of dollars in fees and other financial benefits for VFA.