Litigation that involved a multiple employer plan (MEP), merging plans, a 3(38) investment advisor, a plan sponsor—and at one point an advisor (NFP)—has been resolved in favor of the fiduciary defendants, while reminding us of the value and importance of a prudent process in target-date fund selection.
The plaintiffs were former participants of the Wood 401(k) Plan (Robert Lauderdale, Joshua Carrell, Ting Sheng Wang, Leonard Dickhaut, Robert Crow, Aubin Ntela and Rodney Aaron Riggins). All were represented by the law firm of Schlichter Bogard & Denton LLP.
They claimed that rather than acting in the exclusive best interest of participants, “the Wood Defendants and NFP caused the Plan to invest in NFP’s collective investment trusts managed by its affiliate flexPATH Strategies, which benefitted the NFP Defendants at the expense of Plan participants’ retirement savings. The Wood Defendants and NFP also failed to use their Plan’s bargaining power to obtain reasonable investment management fees, which caused unreasonable expenses to be charged to the Plan.”
That said, the charges against NFP were rejected by the court back in November 2022 (that it acted “under a profound conflict of interest in recommending the use of its affiliated investments in the Plan”). But that left to be resolved claims that, “Based on conflicted advice, Defendants added NFP’s affiliated collective investment trusts to the Plan that were managed by an untested investment manager (flexPATH Strategies)….”
In a “findings of fact & conclusions of law” filing, United States District Judge James V. Selna walked the parties (and us) through a remarkably comprehensive (70 page) analysis of target-date fund history and policy, examined the genesis and structure of fiduciary reviews, and concluded that the flexPATH defendants provided a solid case for the selection of their funds by the plan in question.
More specifically, “The objective facts support the decision to use flexPATH’s own funds.”
TDF ‘Targets’
Judge Selna began his analysis (Robert Lauderdale et al. v. NFP Retirement Inc. et al., case number 8:21-cv-00301, in U.S. District Court for the Central District of California) by acknowledging a little-referenced aspect of the Labor Department’s counsel regarding the selection of target-date funds (TDFs); that an important criterion in selecting a TDF for a defined contribution plan is attempting to match a TDF to the participants’ risk profiles and adopting an appropriate philosophy for evaluating the given risk profile.”
Judge Selna further noted that the plaintiffs’ experts agreed that it was appropriate to consider participant investment behaviors and demographics in selecting a target-date fund, and that that focus was highlighted by the Department of Labor’s 2013 guidance concerning TDFs. It would not be the only time in this decision that he would reference the acknowledgement by the plaintiffs’ experts.
With regard to the process of evaluating TDFs under that criteria, Judge Selna commented that NFP had been performing the Fit Analysis since approximately 2010—an analysis that he said “generally draws on data such as deferral rates, account balances, and other information relevant to participant behavior and characteristics to determine the appropriate glidepath risk level for plan participants.
He further explained that NFP[i] (flexPATH was then part of NFP) would first determine an appropriate glidepath/asset allocation risk level for the plan, and then compare that against NFP’s “focus list” of investment managers and a glidepath “risk index”—and then, “Based on their review of TDF options in the market and experience using the Fit Analysis, Giovinazzo, co-founder of flexPATH and co-President of NFP and flexPATH, Della Vedova, co-founder of flexPATH and co-President of NFP and flexPATH, and Elvander, CIO of NFP and flexPATH, determined that available TDFs were not tailored to the needs of all retirement plan participants.”
Judge Selna further noted that they determined that “All the existing, ‘off-the-shelf’ TDFs had a single glidepath, which assumes all participants on a particular plan are homogeneous and have the same risk tolerance,” and that the three “also found that many plans included participants with different risk profiles and characteristics.”
In those cases, he noted that “selecting a glidepath that was a good fit for the average participant would result in many participants being invested in a fund that was a poor fit for them given their risk tolerances and retirement goals,” and that “because TDFs generally do not identify their risk levels in their names, these participants had no real way of adjusting their investments to match their risk tolerance, or even of knowing that the fund they were invested in was a poor fit.”
Beyond that, Judge Selna commented that NFP found that the TDFs offered in the market were “often populated by underlying funds that could not be unbundled to replace any underlying fund that was underperforming,” that “TDF providers would populate their asset allocations with their own proprietary underlying funds, even if those funds were not best-in-class,” and that “participants who invested in these TDFs had no way of investing in better underlying funds unless the plan changed to a completely different TDF, which could be costly and disruptive for the plan.”
flexPATH’s ‘Path’
Judge Selna noted that flexPATH created its TDFs in 2015, and that at that time was the only such family to offer risk-based “vintages” of the age-based portfolios, used a “fund of funds” structure, and used BlackRock for its passively managed set, articulating several reasons[ii] for that selection, “having a less aggressive approach to glidepath management, the versatility of its glidepath in a variety of market conditions (including high inflation), its focus on broader market exposure, and its competitive pricing.” flexPATH served as the investment “subadvisor” of the flexPATH TDFs and was appointed to select and monitor both the glidepath manager and underlying funds within the TDFs.
In considering the benefits of that structure, Judge Selna noted that flexPATH’s analysis showed that there was a diverse participant pool across the merging Plans, including “substantial differences in deferral rates among the plans.”[iii]
RFP ‘Process’
Following an RFP process, Wood unanimously chose NFP, which scored highest in their review, “because of its ability[iv] to create ‘custom risk tolerance funds similar to the custom funds currently offered in the Mustang Plan,’ and the fact that it would ‘act as a 3(38) fiduciary for the custom funds.’”
Judge Selna noted that “in making this assessment, Wood did not differentiate between NFP and its affiliated company, flexPATH.” Indeed, he noted that Wood hired NFP in part “because of its ability to offer the flexPATH TDFs through flexPATH.”
While the plaintiffs had raised concerns regarding an advisory firm’s selection of a fund managed by a firm with which it had organizational ties (and using a platform designed by that firm to derive that result), Judge Selna was persuaded by “the testimony of Defendants’ process expert, Steven C. Case, who explained that ‘[i]t is more efficient from a time and cost perspective for a committee to retain a 3(38) investment manager familiar with the funds they are hired to manage than it is to retain a third party 3(38) fiduciary who may be less familiar with the funds to be managed.’”
Judge Selna went on to cite Case’s testimony that “[t]here is no reason to believe that an RFP would have yielded a candidate better suited to monitor those TDFs than the individuals who created them.”
He then proceeded to outline a very detailed analysis of the qualifications and process utilized by the flexPATH investment committee, and noted that the investment policy statement (IPS) adopted by Wood in August 2016 “expressly incorporated NFP’s Scorecard System,” which was “a way of measuring the relative performance, characteristics, behavior and overall appropriateness of a fund for inclusion into a plan as an investment option.”
Track ‘Meat?’
As for concerns about the funds’ relatively short track record, Judge Selna commented that “the flexPATH TDFs should not have been rejected from consideration in 2016 solely because of their relatively shorter track record as distinct investment vehicles,” citing both the DOL’s recommendation “that plan fiduciaries consider using plan-specific custom TDFs, which by definition have no performance history,” and the acknowledgement by expert witnesses for the plaintiff that “custom funds do not have a track record as distinct investment vehicles before they are added to a plan, but they are commonly and appropriately offered in large defined contribution plans.”
That said, Judge Selna noted that “flexPATH also regularly compiled and analyzed information comparing returns, risk, glidepaths, asset allocations, investment styles, and numerous other investment characteristics of the flexPATH TDFs with other TDF offerings in the market,” that “flexPATH IC regularly examined each passive fund to ensure that it was closely tracking its benchmark each quarter, in addition to examining qualitative factors such as ‘people, process and philosophy,’” and that “flexPATH periodically negotiated additional fee reductions.”
Judge Selna noted that flexPATH’s only compensation was the fee that it earned as a 3(38) delegated fiduciary to the Plan—flexPATH earned no additional fees in connection with the Plan’s investment in the flexPATH TDFs, and thus “flexPATH’s decision to include flexPATH TDFs in the Plan had no impact on flexPATH’s compensation.” Further, “to address concerns raised by the Wood Committee about fees associated with the flexPATH TDFs, flexPATH sought and obtained fee reductions from BlackRock for the flexPATH TDFs in December 2015.”
Acquisition ‘Mode’
In December 2018, following Wood’s acquisition of Amec Foster Wheeler (“AFW”), the Plan merged with the AFW 401(k) Plan. Prior to that merger, the two plans offered different investment options to participants, including different TDFs (Wood provided flexPATH TDFs, and AFW provided Vanguard TDFs).
Judge Selna noted that the Wood Committee asked NFP to propose a new lineup that would combine the best of both plans and continue to provide a best-in-class retirement savings option—the Wood Committee decided not to continue using the flexPATH TDFs as a result of its review for the AFW Plan merger, and in late 2018, the Wood Committee decided to replace the flexPATH TDFs with Vanguard TDFs, terminating flexPATH as investment manager. It’s a decision the plaintiffs would later use as an indication that the flexPATH fund choice was imprudent.
Conclusions of Law
Having provided what seems to be an extraordinarily detailed assessment of the process and considerations, Judge Selna turned to his conclusions of law. He explained that “when assessing whether a fiduciary has complied with ERISA’s duty of loyalty, “what matters is why the defendant acted as he did.”
He noted that flexPATH argued that it “genuinely and reasonably believed” that the flexPATH Index TDFs were in the best interests of the Wood participants, that those TDFs were chosen “because of the participant data of the merging Plans; the participant demographics and investor preferences of the Wood Plan; an evaluation of the existing QDIA options of the merging Plans; consideration of TDF options available in the market that match the needs of the merged Plan, including an assessment of performance and fees; and input from the Wood Committee, including its preference for a multi-glidepath solution.”
Judge Selna also noted that flexPATH did not financially benefit from the selection of those TDFs—that “flexPATH’s only compensation from the Plan was its asset-based delegated-fiduciary fee, which it was entitled to regardless of what funds it ultimately selected as the Plan’s QDIA.”
Judge Selna commented that “Plaintiffs argue that flexPATH selected the flexPATH TDFs because it needed seed money and to improve the marketability of the funds.
However, the evidence shows that the flexPATH TDFs were fully seeded almost immediately after they were created.” He also noted that the evidence showed that flexPATH did not use the Wood plan’s investment to either market or attract additional investments (finding “unpersuasive” the argument made by plaintiffs that more assets under management may be used to attract other investments).
Conflict ‘Ed’
As for the potential for a conflict of interest (Elvander being part of the team at NFP that recommended the flexPATH TDFs, which he had a hand in creating, as well as the Scorecard system, an ownership stake in flexPATH, chaired the flexPATH IC and was CIO for both NFP and flexPATH), Judge Selna found that “this potential conflict was addressed because flexPATH’s only compensation from the Plan was its asset-based delegated-fiduciary fee, which it was entitled to regardless of what funds flexPATH ultimately selected as the Plan’s QDIA.”
“The objective facts support the decision to use flexPATH’s own funds,” Judge Selna concluded. “Where a business has competed fairly and ethically, it cannot be faulted for succeeding.”
As for arguments that the flexPATH TDFs should have been removed because they underperformed a style benchmark for several quarters, Judge Selna noted that “the evidence showed that the underperformance was due to the fact that the style benchmark did not have certain asset classes, such as inflation-protected securities, that the flexPATH TDFs contained and that impacted performance.”
He continued by explaining that the plaintiffs’ own experts “conceded that a fiduciary should wait at least two years in most circumstances before removing a fund based on performance issues.” And therefore, “based on the foregoing, the Court finds that flexPATH satisfied its duty of prudence in selecting and retaining the flexPATH TDFs.”
Other Claims
Judge Selna also discarded claims[v] regarding alleged prohibited transactions, and a failure to monitor the actions of plan fiduciaries. With regard to the former, he explained that “plaintiffs did not present evidence that flexPATH relied on the increase in assets from the Plan for seed money or to market the flexPATH TDFs.” As for the latter, despite arguments that the committee had cancelled two meetings during the time period in question, Judge Selna found that the reasons for doing so were justified.
“Moreover,” he concluded, “Wood’s cancellation of two meetings did not violate the Wood IPS,” since during that period Wood continued to receive and review the extensive information provided in the Fiduciary Investment Reviews and other materials.
He also dismissed claims that the Wood Committee never met with flexPATH, noting that “nothing in the law requires the Wood Committee to meet with its 3(38) investment manager but rather to monitor their performance. Nor does any evidence show that such in-person meetings were necessary. Moreover, the evidence showed that Elvander, CIO of NFP and flexPATH, did attend many Wood Committee meetings.”
Judge Selna concluded that “for the reasons stated above, the Court enters its findings of fact and conclusions of law as stated herein.” He commented that the defendants “shall file a proposed judgment forthwith,” and that the plaintiffs “shall file any objections thereto within 7 days of defendants’ filing,” and that—if no objections are received within 7 days, the judgement will be entered immediately.”
What This Means
This is not the first time that a party perceived to have a conflicted interest has been sued for allegedly abusing that position. However, it is also not the first time that a documented, prudent process has been sufficient to prevail in litigation, and as such, serves as a potent reminder of the value of having that in place.
It’s rare that a judgement provides such a thorough and descriptive analysis of that process as that utilized by the flexPath defendants, as well as its applicability to divergent participant populations.
The case also provides a good reminder of the Labor Department’s 2013 guidance on target-date fund selection, and how fiduciaries should take into account the plan demographics and needs in selecting and evaluating a target-date fund—something that we don’t hear nearly enough about, and which bears remembering with the expansion of managed account platforms that purport to do so.
[i] flexPATH is affiliated with NFP, another registered investment advisor, which has been providing services to retirement sponsors and plans since 2000. According to the ruling, both are registered investment advisors, both companies operate out of the same office in Aliso Viejo, California. Vincent Giovinazzo and other partners formed NFP in 2000, while Giovinazzo and Nicholas Della Vedova founded flexPATH in February 2014.
[ii] BlackRock was an industry leader in TDFs, having acquired the company that launched the first TDFs in the market. BlackRock also differentiated itself from other providers by having a less aggressive approach to glidepath management, the versatility of its glidepath in a variety of market conditions (including high inflation), its focus on broader market exposure, and its competitive pricing.”
[iii] For example, about 77% of the Elkhorn Plan was deferring less than 6% of their salary to retirement savings, whereas about 80% of participants of the PSN Plan were saving well-above that rate. flexPATH also reviewed how participants of the Mustang Plan were using that Plan’s custom risk-based models, which had conservative, moderate, and aggressive options. flexPATH’s review of the data reflected the presence of participants on all three glidepaths of the Mustang custom models.
[iv] Judge Selna noted that flexPATH’s process “involved, among other things, analyzing participant data of the merging plans; conducting the Fit Analysis to determine an appropriate glidepath risk level for the QDIA; evaluating the existing QDIA options and certain custom models across the merging Plans; and considering TDF options available in the market that match the needs of the merged Plan. He also explained that by the time flexPATH was hired in March 2016, it had already collected and analyzed a significant amount of information about the Wood Plan that informed its decision to select the flexPATH TDFs.
[v]As an interesting side note, even though Judge Selna noted that he “need not reach the issue of Wood’s duty of prudence, the Court would have found that Wood satisfied its duty of prudence when selecting flexPATH as the Plan’s 3(38) investment manager, that it had a process for selecting flexPATH as the 3(38) investment manager (the same RFP process used to screen NFP). He further noted that the Wood Committee’s preference for the flexPATH TDFs as its multiple glidepath solution was “reasonable,” in that it provided “broad exposure to low-cost, BlackRock Index funds, their diversified holdings helped mitigate risk in fluctuating market conditions over a long period of time, and they had naming conventions that were easy for Plan participants to understand.” Judge Selna concluded that “having determined that the flexPATH TDFs were uniquely suited to meet the Plan’s needs, the Wood Committee determined that flexPATH, as the creator of the flexPATH TDFs, would be best suited to serve as a 3(38) investment manager over the flexPATH TDFs.” He also commented that “the evidence presented shows that 3(38) investment managers routinely utilize their own products,” and noted that “ERISA does not require plan fiduciaries to conduct an RFP process before hiring a service provider. Nor did the evidence at trial show that 401(k) plan fiduciaries must conduct an RFP process to retain 3(38) investment managers.” He concluded that “having already conducted an RFP process exploring both 3(21) and 3(38) services, having learned how flexPATH and its competitors would approach the task of being a 3(38) and their philosophies toward selecting a QDIA, and having learned more about flexPATH through in-person meetings with NFP, the Wood Committee did not need to conduct another RFP process. Nor does the law require a separate RFP process for a 3(38) investment manager and 3(21) investment advisor.”