In In re Regions Morgan Keegan ERISA Litig., Case No. 08-2192 (W.D. Tenn. Mar. 9, 2010), the U.S. District Court for the Western District of Tennessee denied a motion to dismiss ERISA breach of fiduciary duty claims involving a bank’s inclusion of affiliated mutual funds and a company stock fund in its retirement plan.
Plaintiffs, current and former employee participants in 401(k) plans sponsored and administered by a consumer and commercial banking firm, filed a class action suit alleging that plan fiduciaries breached duties owed under ERISA by (1) including mutual funds advised and distributed by affiliates in the plans for the improper purpose of generating income for defendants; (2) selecting proprietary bond funds for inclusion in the plans that were overexposed to high-risk assets such as subprime mortgage-backed securities; and (3) offering the plan sponsor’s stock as an investment option when the stock was an imprudent selection due to the bank’s “improper and extremely risky business activities” in the subprime mortgage market. The complaint named as defendants the plan sponsor, its affiliated broker-dealer and mutual fund investment adviser, as well as several individuals who performed functions with respect to the plans.
Use of Proprietary Funds. Plaintiffs in their complaint alleged that defendants breached fiduciary duties and engaged in prohibited transactions by selecting for the plans mutual funds affiliated with the bank for the purpose of generating a profit to the bank and its related entities. With respect to their prudence claim, plaintiffs asserted that the funds charged excessive fees and that plan fiduciaries had failed to use the plans’ bargaining power to secure lower costs. The court held that plaintiffs had adequately pleaded these claims by pleading, among other allegations, that defendants selected retail share classes over investor share classes, and that the expense ratios for selected funds were in some instances six times the expense ratio for “readily available comparable funds.” With respect to the prohibited transaction claims, plaintiffs alleged that defendants engaged in self‑dealing at the expense of the plans by including mutual funds that paid “revenue sharing and other kickback payments” to defendants. Defendants argued in their motion to dismiss that the DOL’s Prohibited Transaction Exemption 77-3 (“PTE 77-3”) precludes liability insofar as the exemption permits, under certain conditions, the acquisition or sale of shares of mutual funds by a plan covering employees of the mutual fund’s manager or principal underwriter and its affiliates (i.e., “in-house plans”). (For a discussion of PTE 77‑3 and related Department of Labor Advisory Opinion 2006-06A, see the August 8, 2006 Alert.) The court declined to address on the pleadings whether the exemption applied, noting that favorable decisions cited by defendants regarding when PTE 77-3 should apply address motions for summary judgment, brought after discovery had been taken. Accordingly, the court denied defendants’ motion to dismiss on this ground.
Inclusion of Bond Funds. Plaintiffs alleged that defendants violated ERISA by offering proprietary bond funds that, while described as holding low to moderate risk portfolios, were heavily exposed to high risk assets. In moving to dismiss, defendants argued that, under principles of modern portfolio theory, the plans should include investments with low risk/return characteristics, as well as other investments with high risk/return characteristics, and that no particular investment option should be viewed in isolation in determining fiduciary prudence. Citing plaintiffs’ allegations that defendants knew or should have known that investments in the bond funds were imprudent because the funds were advised by an affiliate of the sponsor, the court concluded that plaintiffs had adequately stated claims with respect to those funds.
Employer Stock Claims. Plaintiffs also alleged that it was a breach of ERISA fiduciary duty to include the employer’s own stock as an investment option in the 401(k) plans given the decline in the stock price due to sub-prime related exposures. Defendants moved to dismiss these claims on the ground that plan fiduciaries were entitled to the “presumption of prudence” that attaches to the selection of employer stock for inclusion in retirement plans. Defendants cited ERISA § 404(a)(2), which provides that ERISA’s duties of diversification and prudence are not violated by a plan’s acquisition or holding of qualifying employer securities, and ERISA § 407(b)(1), which exempts plans from limits placed on ownership of employer securities. The district court declined to decide on a motion to dismiss whether the presumption of prudence should apply to the facts of the case, citing a recent amicus brief filed by the Department of Labor (“DOL”) in a case pending before the Second Circuit in which the DOL argues that it is improper to apply the presumption of prudence at the pleadings stage. (The DOL position will be discussed in greater detail in the forthcoming edition of the ERISA Litigation Update, expected later this week.) The court also held that plaintiffs had adequately pleaded that defendants breached their ERISA disclosure obligations by allegedly failing to accurately disclose the plan sponsor’s financial condition.Disposition. The court granted dismissal of one count of co-fiduciary liability against the affiliated broker-dealer and investment adviser defendants relating to the company stock fund on the ground that those parties were not alleged to have been involved in the relevant challenged conduct. Plaintiffs’ claims were otherwise sustained.