Taking advantage of a stranger is bad enough, but what happens when a large financial firm knowingly takes advantage of its employees?
And to make matters worse, what happens when the employees are disadvantaged by their employers in their 401(k) plans?
You would think this is a rare event, but unfortunately, it happens more often than people think. And when it happens, it is also a great indicator that if a financial firm (specifically a broker-dealer or mutual fund company) is taking advantage of their workers, they are certainly doing it to their non-employee customers.
Here are some of the investment firms that have been sued for putting their interests above those of their employees:
- Ameriprise (They were sued twice, settled one case in 2015, and had the most recent one dismissed, which is expected to be appealed.)
- Fidelity Investments
- New York Life
- Edward Jones
- Raymond James
- Morgan Stanley
- American Century
- Franklin Templeton
- TIAA-CREF
- Capital Group (American Funds). This case was dismissed earlier this year on a bad decision, but the plaintiff is expected to appeal.)
- MFS Investment Management
- Waddell & Reed
- Principal Financial
The investment industry has seen a significant shift from active to passive investing, a practice that fundamentally impacts investment expenses. The rise of ETFs and index funds, compared to the often lower net returns of actively managed mutual funds, has contributed to the noticeable differences in investment performance between the menu of offerings in 401(k) plans. This has also attracted the attention of investors. (For more about the impact of fund fees on returns, see the book How 401(k) Fees Destroy Wealth.)
Broker-dealers and mutual fund companies are familiar with ERISA laws, but as these lawsuits show, they may not change their practices fast enough. 
One possible reason is that fund companies have a massive investment in the active management infrastructure. From portfolio managers to fund accounting to compensation of large sales forces, these firms are going quickly down the highway by looking in the rearview mirror. This may explain why fund companies find themselves on the legal defensive.
The Legal Issues
“If the courts follow the Supreme Court’s lead, then most 401(k) excessive fees and breach of fiduciary duty cases should easily survive any motion to dismiss, followed by a settlement. I base my opinion on a three-step litigation process: Restatement of Trusts as an authority on fiduciary duties (Tibble decision), the fiduciary duty of cost-consciousness/cost-efficiency (Restatement Sections 88 and 90, especially comments b and h(2), SPIVA and my metric, the Active Management Value Ratio to establish that most actively managed funds are not cost-efficient.
“I also assume that in many of these cases that are pending appeal, the court’s expressed rationale is not consistent with the Restatement (Third) of Trusts, which the Supreme Court has endorsed as the authority for fiduciary issues in ERISA-related cases,” according to James Watkins, III, JD and CEO at InvestSense, LLC.
“As a result, it is easy to prove that most actively managed funds are not prudent under applicable legal standards and most 401(k) plans are not ERISA compliant since most 401(k) plan investment options include actively managed funds.”
Watkins said he is “seeing some change to more passive options but actively managed funds are still the primary investment options. I recently wrote on one of my blogs, iainsight.wordpress.com, that I expect to see even more of an increase in such cases. The evidence, including large settlements, is clear in this matter, but sponsors refuse to heed the warnings.”
Yet, for investors who rely on the expert advice of investment specialists, being sued for a fiduciary breach should be cause for concern.
Here are two specific cases that illustrate the problem.
Edward Jones vs. Its Employees
In a March 27, 2018 decision, U.S. District Judge John A. Ross refused for a second time to dismiss a lawsuit charging that Edward Jones violated ERISA, the pension protection statute, when it administered the company’s own 401(k) plan that overcharged participants for services.
It is alleged that Jones victimized its 401(k) plan participants “to benefit Edward Jones and its corporate partners, rather than in the interests of participants and beneficiaries.” Investment options available within the plan included three managed by Edward Jones and over 40 managed by “Partners” or “Preferred Product Partners,” according to the article in the 401k Specialist (March 30, 2018.)
How much did this cost Jones 401(k) participants? The suit charges Jones paid “excessive fees to the tune of tens of millions of dollars were paid to the plan’s record keeper (Mercer HR Services, Inc.) despite the availability of nearly identical, lower-cost options.”
When a lower-cost service or investment product is available, and the plan sponsor knowingly avoids using the lower-cost and equal-quality alternative, the plan sponsor violates its fiduciary obligations.
With over seven million clients and more than $1 trillion in assets, Edward Jones certainly knows critical ERISA law. Sweetheart deals are common in any industry, and Jones certainly knew what it was doing and had a reason not to comply, but they probably will never say what it is in open court.
Principal Financial
While Jones is the latest to be in the news, other major investment firms have violated their fiduciary duties by offering their employees higher prices and underperforming mutual funds.
Principal Financial, the largest employer in Iowa and a firm that holds itself out as a trusted advisor to individual investors, was involved in a lawsuit that said ERISA violations spanned from 2008 through 2015 and involved violated ERISA “by failing to comply with their responsibilities under ERISA to the Plans and participants of the Plans in the management of the Plans.”
In the case of Krystal M. Anderson and All Others vs. Principal Life Insurance Company, a lawsuit filed in the United States District Court for the Southern District of Iowa (Civil Action No. 4:15-cv-00119-JAJ-HCA), a settlement was reached in a little over two months for a case that involved fiduciary severe violations about selling proprietary funds to employees in company benefit plans that were both too expensive and underperforming.
The case, filed on 04/17/2015 and settled on 06/30/2015, was “most likely the shortest court case ever filed against Principal,” according to Dennis Myhre. And while this settlement admittedly is old news, it still contains a powerful message:
“For good reason: Principal could not afford to have the case endure scrutiny; the fewer of their clients that knew about it, the better. A key element in this case is that the class of plaintiffs filing this case is all employed by Principal Financial Services, with insider information, and involved the Principal Select Savings Plan for Employees or the Principal Select Savings Plan for Individual Field.”
“The Plaintiff claimed that the Defendants (Principal) acted improperly by selecting and maintaining proprietary Principal Life investment options in the Plans and charging excessive fees, paid to Principal Life, for the Plans’ administrative services. As a result, Plaintiff claims, participants of the Plans paid higher fees and obtained less return on their investment.”
As a former employee of Principal and one who wrote about these proprietary funds for marketing purposes, many of us knew Principal’s funds were chronic underperformers and that the choice of funds in Principal’s 401(k) plans was limited to their in-house stable of fund managers managed them.
These funds were widely sold to 401(k) plans subject to the Principal’s recordkeeping services. To add extra revenues, the Principal bundled their lackluster funds into the menu of choices offered to unsuspecting plan participants. All too often, 401(k) plan sponsors, aka the company offering the 401(k) plan, looked the other way or failed in their oversight capacity to their employees. In any case, the victims here were the workers who naively thought their employer and investment manager were looking out for their best interests.
There are many more similar cases, but the moral is that employees in a 401(k) should double-check all claims made by the plan’s administration. When there is a lot of money at stake, and the revenue stream can be hidden in many ways, suspect the worst until proven otherwise. That is also called employee risk management.
