Recent lawsuit raises questions about a company providing its own products and services to its own employees in its own qualified retirement plans.
W. Scott Simon is a principal at Prudent Investor Advisors, a registered investment advisory firm. He also provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. Simon is the recipient of the 2012 Tamar Frankel Fiduciary of the Year Award.
Early last month, six current and one former employee of the Massachusetts Mutual Life Insurance Company (MassMutual) filed a class action lawsuit for breach of fiduciary duty against MassMutual in the United States District Court, District of Massachusetts. The plaintiffs also sued relevant operating divisions, subsidiaries, and affiliates of MassMutual, the current as well as the two immediately preceding chief executive officers of MassMutual, the Investment Fiduciary Committee and Plan Administrative Committee of the MassMutual Thrift Plan (Thrift Plan), as well as eight current officials at MassMutual who are alleged to be members of the two committees or are otherwise alleged to be fiduciaries of the Thrift Plan.
The Thrift Plan is a defined contribution plan with nearly 15,000 participants and almost $1.5 billion in assets (please see paragraphs 107.A and 140.B of the plaintiffs' 70-page complaint), and is offered to eligible MassMutual employees.
The plaintiffs' complaint sets forth seven counts, including the selection of unreasonably priced and imprudent investment options, entering into prohibited transactions, the failure to administer the plan in accordance with the governing plan documents, and the failure to monitor fiduciaries. This month's column will center on the first of these counts. Before looking at that, however, let's focus briefly on the allegations of Count V of the complaint: the failure to administer the plan in accordance with the governing plan documents.
Allegation of Failure to Administer the Thrift Plan in Accordance With the Plan Document
Section 404(a)(1)(D) of the Employee Retirement Income Security Act of 1974 (ERISA), which governs the Plan, requires a fiduciary (as relevant) to discharge its duties in accordance with the terms of a qualified retirement plan, but only to the extent that such terms don't conflict with ERISA.
Plaintiffs allege in paragraph 51 of their complaint that the plan document of the Thrift Plan states that "all expenses of establishing and administering the plan including expenses with respect to the group annuity contract and fixed income account agreement shall be borne by the employer [i.e., MassMutual] as a further contribution to the plan." In paragraph 53 they allege that "Contrary to the Plan document, however, Defendants caused the Plan [i.e., plan participants and their beneficiaries] to pay, among other items, investment, administrative, and recordkeeping expenses to each investment option and to MassMutual."
The preceding allegation would seem to be pretty cut-and-dried. It's alleged that MassMutual promised in the plan document to pick up the check for the Thrift Plan's administrative expenses including those related to the group annuity contract and fixed-income account agreement, and broke that promise. This issue doesn't appear to be one where reasonable minds may differ about whether or not a given fee or charge is "reasonable." (It's always possible, of course, that MassMutual could answer that it never made that promise or it could answer that, in fact, it is--and always has been--picking up that check.)
But if MassMutual should come to admit that it did promise in the plan document (no doubt drafted by MassMutual's own ERISA legal counsel) to pick up the check for the Thrift Plan's administrative expenses (including those for the group annuity contract and fixed-income account agreement), and it outright failed to do so, then that would obviously be a flagrant fiduciary breach.
Indeed, it's alleged that in 2010 alone "MassMutual was paid well over $5 million for providing services to the Plan" (paragraph 61)--which presumably included amounts paid to MassMutual for administrative expenses.
This raises the issue of some plan sponsors that live in a Fantasyland in which the administrative expenses in their retirement plans are "free." The administrative costs in a plan are never free. Despite this obvious fact, many sponsors are more than willing to work with plan service providers that say with a straight face that plan administration expenses are free (or negligible).
The reality, though, is that the investment-related expenses (both "explicit" annual expense ratios and "implicit" market impact costs, for example) pay for/subsidize the administration expenses. In the case of stable value funds, not only the annual expense ratio but also the (very rich) "spread" (i.e., profit) subsidizes the real administration expenses of a plan. This all-too-common sleight of hand practiced by many service providers in the retirement plan marketplace illustrates once again the critical need for transparency so that sponsors can know what services they are receiving at what cost.
Allegation of Selection of Unreasonably Priced and Imprudent Investment Options
Plaintiffs allege that MassMutual provides 38 investment options in which participants in the Thrift Plan may invest. 36 or 37 of these options are MassMutual-owned separate accounts and mutual funds. 22 of the 38 funds in the Thrift Plan are managed by MassMutual's subsidiaries, affiliates, or business units, while the remaining funds are subadvised by a third party (paragraphs 66 and 67). Plaintiffs also allege that MassMutual added an additional layer of fees on top of the subadvisory fee that sometimes were double or triple the fee charged by the investment manager of the fund; they include a chart depicting a few examples of this in the Thrift Plan (paragraph 68).
Plaintiffs allege that all investment options made available to participants in the Thrift Plan are offered through a "Group Annuity Contract" (a contract between "Massachusetts Mutual Life Insurance Company of Springfield, Massachusetts and Massachusetts Mutual Life Insurance Company") (paragraph 4). If true, that's called "negotiating with yourself," which means that you always win.
Plaintiffs allege further that one of the Thrift Plan's investment options is something called the Fixed Interest Account. "The Fixed Interest Account" is made available to participants in the Thrift Plan through the Group Annuity Contract (paragraph 86), and under that contract the assets of the Fixed Interest Account are invested in MassMutual's general account (paragraph 66). The Fixed Interest Account appears to be a stable value fund (SVF). I wrote about SVFs in October and December of last year.
Plaintiffs also allege that MassMutual's "general account" is a pool of assets composed of various investments including commercial mortgages, publicly issued bonds, asset-backed securities, and privately issued debt securities. They assert that MassMutual uses the assets in its general account to pay claims on its insurance policies and annuity contracts (paragraph 83).
Plaintiffs allege that the CEO of MassMutual sets the terms of the Group Annuity Contract (which includes setting the interest crediting rate for the Fixed Interest Account at six-month intervals for any amounts deposited in the Fixed Interest Account) (paragraph 55), mandates that the Fixed Interest Account be invested in the MassMutual general account, sets the fees charged to the Thrift Plan, and selects the other investment options to be made available to the participants in the Thrift Plan (paragraph 10).
The idea that the CEO of a company that provides its own products and services to its own employees for the company's own qualified retirement plan--where the plan document is alleged to appoint the CEO as the "primary fiduciary" of the Thrift Plan--seems to suggest the appearance of a fixed fight, an inside job. In effect, the plaintiffs are alleging that MassMutual is setting its own compensation and setting the return to be received by participants in the Thrift Plan. I wonder if a court would consider that to be a breach of fiduciary duty, since the CEO (the alleged primary fiduciary of the Thrift Plan) is alleged to be setting his own compensation with no submission to an independent third party to determine whether that is reasonable.
Plaintiffs allege further that the Fixed Interest Account investment option caused the Thrift Plan to be exposed to imprudent and undiversified risk, for which the Plan was not compensated (paragraph 84). This concentrated risk/lack of compensation allegation is a very interesting one. Investing in a stable value fund is often akin to investing in a single stock or bond, in my view. That's particularly risky in this case because the plaintiffs allege that the Fixed Interest Account is the largest investment option in the Thrift Plan, representing as much as 40% of its assets (paragraph 82). In my view, this would be like investing 40% (or about $600 million) of the Thrift Plan's assets in one investment. That percentage may sound high, but our registered investment advisory firm has run across this kind of percentage (or even greater) in some instances.
Next month's column will delve more into this fascinating case.