Plan sponsors and consultants have no doubt been watching with interest the latest round of target date fund lawsuits based on BlackRock’s LifePath Index target date series. Over the past month, a growing number of current and former defined contribution plan participants have sued their respective employers, alleging violations due to the poor results of the incumbent target date provider. The defendants in the cases include well-known names like Citigroup, Capital One and Microsoft.1
Plaintiffs claim the defendants selected, retained and/or otherwise ratified poorly performing target date investments instead of offering more prudent alternative target date funds that were readily available, including the American Funds Target Date Retirement Series®. Suits assert that “… as is currently in vogue, Defendants appear to have chased the low fees … without any consideration of their ability to generate return.”2
Similar cases have been filed before. A suit against Berkshire Hathaway’s Marmon Holdings, Inc., claimed that underperforming target date funds in the company’s retirement plan were “left languishing.”3 And last year, in a case against UnitedHealth Group, the judge found it plausible that plan sponsors could be acting imprudently, in violation of the Employee Retirement Income Security Act (ERISA), by continuing to offer lagging target date funds on their investment menus.4 But the new cases are a major wake-up call, given the prominence of the defendants and the sheer number of lawsuits.
Collectively, this could mark a major shift in the theme of ERISA litigation, away from excessive fees to a focus on results. Expense ratios certainly still matter, but a more balanced approach that evaluates both fees and the net-of-fee results that ultimately determine retirement success may better serve participants and sponsors.
This is far from a simple task for target date funds. Nuances abound, from the selection of an appropriate peer group to the isolation of “to” versus “through” glide paths (i.e., paths managed until the retirement target date versus paths that continue to be managed into retirement, respectively) and active versus passive strategies. In the latest cases involving Citigroup and Microsoft, among others, the results of the incumbent provider’s “to” glide path are being compared to the superior results of “through” glide path peers.5,6
It’s arguable that comparisons between target date types such as “to” versus “through” are like comparing apples to oranges. And several recent court decisions have rejected plaintiffs’ claims that active and passive target date strategies are comparable, noting that active strategies have “different aims, different risk and different potential rewards”7 than passive strategies and empower participants “to take on more risk and pay higher fees in the hope of beating the market.”8 It will be interesting to see how the court decides on the “to” versus “through” comparison at stake now.
Moreover, appropriate success metrics evolve over time. For younger investors in further-dated vintages, returns usually matter most, whereas investors in retirement tend to be primarily concerned about volatility and drawdown risk. Risk-adjusted return metrics (such as the Sharpe ratio9) offer a short-hand solution to comparing across vintages, but a more sophisticated multi-factor model that more accurately tracks the evolution of participant needs over time would be best.
While the validity and merit of these new cases have yet to be fully decided, ERISA case law continues to focus on a thoughtful and thorough investment selection process. For example, in July a three-judge panel of the Sixth Circuit of the U.S. Court of Appeals rejected a class action brought against CommonSpirit Health based, in part, on claims of lagging five-year results. They noted that “[m]erely pointing to another investment that has performed better in a five-year snapshot of the lifespan of a fund that is supposed to grow for fifty years does not suffice to plausibly plead an imprudent decision — largely a process-based inquiry — that breaches a fiduciary duty.”10
So, while process remains the touchstone, the recent surge of performance-related litigation serves as an important reminder that good outcomes, as quantified by solid relative results as well as return and risk-adjusted return ranks, may help mitigate the risks of a lawsuit.
Defendants in the latest cases are likely to file a motion to dismiss to avoid discovery (the fact-finding process that precedes going to trial). It’s common for plans to settle if they can’t get the case dismissed before this stage. Few plan sponsors want to fight all the way to a verdict on the merits of the case. It’s an open question whether the plaintiffs can convince a judge that there’s a legitimate question at stake: Would prudent fiduciaries have made a change to a better-performing target date series?
For additional context on this topic, please read "Active management plays an important role in 401(k) plans" from Groom Law Group.
1Steyer, Robert. “2 more firms sued over offering of BlackRock index target-date funds,” Pensions & Investments, August 4, 2022.
2Tullgren v. Booz Allen Hamilton Inc. et al, No. 1:22-CV-00856 (E.D. Va., August 1, 2022).
3Lard v. Marmon Holdings, Inc. et al, No. 1:22-CV-04332 (N.D. Ill., August 16, 2022).
4Snyder v. UnitedHealth Group, Inc. et al, No. 21-1049-JRT-BRT (D. Minn, December 2, 2021).
5Motz v. Citigroup Inc. et al, No. 3:22-CV-00965 (D. Conn., July 29, 2022).
6Beldock et al v. Microsoft Corporation et al, No: 2:22-CV-01082-JLR (W.D. Wash, August 2, 2022).
7Davis v. Washington University in St. Louis, 960 F.3d 478 (8th Cir., 2020).
8Smith v. CommonSpirit Health, No. 20-95-DLB-EBA (E.D. Ky., Sept. 8, 2021). See also Davis v. Salesforce.com, Inc., No. 20-CV-01753-MMC (N.D. Cal., October 5, 2020), which notes that “actively and passively managed funds have, for example, different management approaches” and that active management can provide an opportunity to earn superior returns and take advantage of alternative investment strategies.
9Sharpe ratio uses standard deviation (a measure of volatility) and returns to determine the reward per unit of risk. The higher the ratio, the better the portfolio’s historical risk-adjusted performance.
10Smith v. CommonSpirit Health, No. 21-5964 (6th Cir., June 21, 2022).
Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.
Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing.
Although the target date portfolios are managed for investors on a projected retirement date time frame, the allocation strategy does not guarantee that investors' retirement goals will be met. Investment professionals manage the portfolio, moving it from a more growth-oriented strategy to a more income-oriented focus as the target date gets closer. The target date is the year that corresponds roughly to the year in which an investor is assumed to retire and begin taking withdrawals. Investment professionals continue to manage each portfolio for approximately 30 years after it reaches its target date.
Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and should not be considered advice, an endorsement or a recommendation.
All Capital Group trademarks mentioned are owned by The Capital Group Companies, Inc., an affiliated company or fund. All other company and product names mentioned are the property of their respective companies.
Use of this website is intended for U.S. residents only. Use of this website and materials is also subject to approval by your home office.
American Funds Distributors, Inc.
This content, developed by Capital Group, home of American Funds, should not be used as a primary basis for investment decisions and is not intended to serve as impartial investment or fiduciary advice.