Putnam Wins Suit Over Proprietary Funds in 401(k)

A federal district court has entered judgment for Putnam Investments and its 401(k) plan’s committees in a case alleging self-dealing in its investment fund lineup for the plan and excessive fees for lack of monitoring and replacing investments.

Previously U.S. District Judge William G. Young of the U.S. District Court for the District of Massachusetts dismissed prohibited transactions claims saying they were time-barred under the Employee Retirement Income Security Act’s (ERISA)’s three-year statute of limitations. In his most recent decision, Young ruled for Putnam on all remaining claims.

In his decision, Young noted that from the beginning of the class period through January 31, 2016, all of the designated investment options available under the plan’s investment menu were affiliated with Putnam. With the exception of certain categories of funds, i.e., closed-end mutual funds, hedge funds, and tax-exempt funds, all Putnam open-end mutual funds were added to the plan lineup upon launch, as required by the plan document. Up until early 2016, non-affiliated investments were offered exclusively through the plan’s self-directed brokerage account option. Starting on February 1, 2016, the plan’s investment menu included six BNY Mellon collective investment trusts (CITs).

According to the decision, for a period of time, the plan investment committee reviewed reports compiled by the Advised Asset Group (AAG), a subsidiary of Great-West. The AAG Reports showed that a number of Putnam funds were given “fail” ratings, but after internal discussions, the committee determined that the AAG Reports did not provide an accurate indication of fund performance. Still, Putnam recommended the AAG Reports as a source of investment advice to plan participants on their account statements.

The investment committee regularly reviews the qualified default investment alternative (QDIA) funds for risk-adjusted returns, costs, asset allocation, and performance as compared to competitors. “It is undisputed that [committee] followed a prudent process in reviewing and monitoring the QDIA funds,” Young wrote in his decision.

However, for other investments, the investment committee appeared to rely entirely on the expertise of the investment division to determine whether a fund was failing and needed to be shut down. As a result, the committee did not seem to have independent standards or criteria for monitoring the plan investments. The decision notes that the committee never once removed a fund from the plan lineup, and there seems not to have been separate discussion within the investment division as to whether a particular fund was appropriate for the plan.

The plaintiffs argue that the defendants violated the duty of loyalty by “stuffing the Plan’s investment lineup with all of Putnam’s publicly-offered mutual funds, as well as other Putnam affiliated investments, without regard to their expenses, track record, or other objective criteria.” But, Young found the plaintiffs failed to point to specific circumstances in which the defendants have actually put their own interests ahead of the interests of plan participants. “The Plaintiffs’ duty of loyalty claims are reduced almost exclusively to identifying instances of self-dealing. However, pointing to self-dealing alone is insufficient for the Plaintiffs to meet their burden of persuasion to show by a preponderance of the evidence a breach of the fiduciary duty of loyalty, particularly where the practices are common within the industry,” Young found. “Evaluating the totality of the circumstances, the Court holds that the Defendants have not breached the duty of loyalty owed to the Plaintiffs’ class.”

The plaintiffs also argue that the defendants violated their fiduciary duty of prudence by failing to implement or follow a prudent objective process for investigating and monitoring the individual merits of each of the plan’s investments in terms of costs, redundancy, or performance. In support, they point to the committee’s failure to remove funds from the plan that had repeatedly received “fail” designations in AAG Reports. Young said the AAG Reports alone, however, are insufficient to carry the plaintiff’s burden of persuasion with respect to the claim of breach.

The defendants counter that they fulfilled their fiduciary obligations by having Putnam’s Investment Division, some senior members of which sat on the investment committee, monitor the performance of Putnam’s mutual funds, including those in which the plan is invested. Young noted that such care for its mutual funds, however, is not sufficient to rebut the plaintiff’s claims of breach of fiduciary duty with respect to the plan. “Although Putnam is a defendant in the present lawsuit, it is in fact [the investment committee] that is the named fiduciary of the Plan under ERISA,” he wrote.

Closely monitoring Putnam’s mutual funds is not the same as closely monitoring the plan’s lineup, Young said. “The fact that some of the incentives of Putnam’s Investment Division aligned with those of the Plan participants is not sufficient to remedy the situation. A direct contribution 401(k) retirement plan could well have specific interests and goals different from a given mutual fund. ERISA fiduciaries ought take into consideration those differences in managing and monitoring Plan assets,” he wrote in his decision.

However, because the defendants have not yet presented the entirety of their case, Young refrained from making conclusive findings and rulings on whether the defendants breached their duty of prudence.

“Where the evidence presented is insufficient to sustain either the plaintiff’s claim of breach of fiduciary duty or a prima facie case of loss to the plan, the plaintiff’s claim fails. Because the Court refrains from making any conclusive ruling about the alleged breach of fiduciary duty of prudence before the Defendants have had the opportunity to put forward all of their evidence, the question here becomes whether the Plaintiffs have made out a prima facie case of loss,” Young wrote.

Citing another case, he said “[A] fiduciary’s failure to investigate an investment decision alone is not sufficient to show that the decision was not reasonable. Instead, a plaintiff must show a causal link between the failure to investigate and the harm suffered by the plan.”

Young said the fundamental problem in the case is the broad sweep of the plaintiffs’ “procedural breach” theory. They argue that the alleged lack of an “objective process” by the investment committee to monitor the plan investments makes the entire investment lineup of the plan imprudent. He said this argument lacks legal support.

The plaintiffs must point to a specific imprudent investment decision or decisions to make a showing of loss due to a breach of fiduciary duty, according to Young. “The Plaintiffs’ theory that the procedural breach tainted all of the Defendants’ investment decisions for the Plan constitutes an unwarranted expansion of ERISA’s seemingly narrow focus on actual losses to a plan resulting from specific incidents of fiduciary breach,” he wrote.

Young found it is clear from the record before the court that Putnam employs sophisticated techniques to monitor its mutual funds. Even if these practices are not sufficient to meet the ERISA fiduciary duties to the plan, they are certainly sufficient to dispel the unsupported allegation that the entire plan investment lineup was per se imprudent.

“[The investment committee’s] review of the Plan lineup was no paragon of diligence. In light of the Plaintiffs’ failure to establish loss, the Court further declines to grant other declaratory or injunctive relief under ERISA,” Young wrote.