Exelon Sued Over Alleged Excessive Fees in Proprietary TDFs
The lawsuit also includes claims of excessive recordkeeping fees and unreasonable fees for managed account services.
A group of participants in the Exelon Corp. Employee Savings Plan have filed a lawsuit alleging the company, its investment oversight committee, its board of directors, its corporate investment committee, a current and former benefits manager, and various Jane and John Does violated their Employee Retirement Income Security Act (ERISA) fiduciary duties.
In sum, the complaint alleges that the plan’s fiduciaries breached their duties of prudence and loyalty to the plan and its participants by, among other things, selecting and maintaining investment options that were materially more expensive and performed materially worse than alternatives that were available in the marketplace; causing the plan to pay excessive fees for recordkeeping and administrative (RK&A) services; and allowing a third-party consultant to charge the plan unreasonably high fees for participant advisory services, which the consultant kept for itself or shared with another plan service provider.
The complaint notes that the target-date funds (TDFs) and three of the core funds—the U.S. equity fund, the international equity fund and the fixed-income fund—offered in the plan are not registered investment products but instead daily-priced funds with investments that are managed by multiple underlying investment managers. The selection of these managers and the allocation of assets among those managers for the core funds are the responsibility of Exelon, acting through the Exelon Investment Office (EIO). The EIO also selected the managers for the TDFs and, even though Exelon selected J.P. Morgan Investment Management Inc. to provide the allocation of assets, the suit alleges the allocation was constrained by the EIO’s selection of the managers of the underlying portfolios.
In addition, according to the complaint, during the class period, the plan was dominated by actively managed funds. Of the 36 investment options in the plan, 21 were actively managed. Of the remaining options, one is a money market account, which is run by an affiliate of the plan’s trustee, and another is the Exelon Corp. Stock Fund.
The plan does include some “Expanded Choice” investments, but the complaint says many plan participants are unable to invest in them, because they are not shown as options when participants log into their accounts. Prior to 2018, these “Expanded Choice” investments were not even shown on the quarterly statements, which displayed all other investment options in the plan whether a participant had invested in them or not. To view these “Expanded Choice” investment options and possibly select them, plan participants have to actively seek them out, and some are even required to sign paperwork to get access to those options. The lawsuit says this has the effect of steering participants’ investments to the Exelon proprietary funds.
According to the plaintiffs, the economies of scale dictate that lower-cost investment options will be available to plans with assets under management (AUM) approaching and exceeding $1 billion, like the Exelon plan. When large plans, particularly those with more than $1 billion in assets, have options that approach the retail cost of fund shares for individual investors or are simply more expensive than the average institutional fund shares for that type of investment, a careful review of the plan and each option is needed for the fiduciaries to fulfill their obligations to the plan participants, the complaint says.
Excessive Fees for Proprietary Funds
In 2014, the defendants replaced the Vanguard Target Date Retirement funds in the plan with the proprietary TDFs. Vanguard Target Date Retirement funds are well-performing and among the lowest-cost funds on the market, and there are many other options with similar performance and low expense ratios, including options from BlackRock, State Street, Charles Schwab and Fidelity, to name a few, the lawsuit contends.
Similarly, the defendants replaced other options in the plan with actively managed proprietary funds in the fixed income, U.S. equity and international equity categories. The complaint pointed out again that “providers abound in the marketplace that offer lower-costing alternatives, including Vanguard, BlackRock, State Street and Fidelity, among others.”
The lawsuit claims the expense ratios of the proprietary funds are significantly higher than comparators, and that the performance of the proprietary funds is not better than the comparators, which have substantially similar investment strategies and underlying assets.
In addition, the complaint notes, investment managers are receptive to negotiating rates lower than their public rates with plans whose assets exceed $1 billion, especially as those plans grow into multibillion-dollar plans. “As such, the defendants were in a position to command the best rates to secure some of the best-performing options in the marketplace,” the lawsuit says.
However, the plaintiffs accuse the defendants of instead directing or allowing Exelon, through the EIO, to construct the proprietary funds, 15 unregistered investment options that mirror the investment strategies of actively managed funds available in the marketplace, despite actively managed investment options rarely outperforming passively managed ones over time. The complaint also says the fees charged for the proprietary funds were significantly higher than those for actively managed funds available in the marketplace.
“As a result of including and maintaining the proprietary funds, the defendants caused plan participants to lose millions of dollars, both to expensive investment management fees and poorer performance,” the complaint states.
Excessive Recordkeeping Fees
The plaintiffs say that during the class period, the defendants did not have a process in place to ensure that the plan paid no more than a competitive reasonable fee for RK&A services. Or, to the extent there was a process in place that the defendants followed, the plaintiffs say, they acted ineffectively.
The complaint uses a table to show that for the years 2015 through 2019, the plan had on average 37,804 participants and paid an average RK&A fee of at least approximately $3,772,212 per year, which equates to an average of at least approximately $99.78 per participant. The plaintiffs argue that it was possible for the plan to negotiate RK&A fees for not more than between $20 and $35 per participant.
“Had the defendants engaged in any regular and/or reasonable examination and competitive comparison of the RK&A fees the plan paid, they would have realized that the plan was compensating the recordkeepers unreasonably and inappropriately for the plan’s size and scale, passing these objectively unreasonable and excessive fee burdens to the plaintiffs and plan participants,” the complaint states.
Unreasonable Fees for Managed Account Services
The lawsuit notes that managed account services have historically been expensive compared with other alternatives, such as TDFS, but, in recent years, a number of managed account service providers, such as Fidelity and Morningstar, have emerged that are capable of providing a high level of managed account services at competitive rates. The plaintiffs contend that expenses have declined and competition has increased over the past decade, resulting in declining fees for managed account services.
According to the complaint, around the same time that the defendants replaced certain investment options with proprietary funds, they also switched from Aon as the plan’s recordkeeper to Northwest Plan Services. Since at least 2016, Northwest, in partnership with Edelman Financial Engines, formerly known as Financial Engines, has provided managed account services to plan participants.
The lawsuit explains that there were two managed account services made available to participants: the Management program and the Personal Advisor program.
For the Management program, Edelman Financial Engines manages the retirement account on behalf of the participant. The provider uses a proprietary algorithm which mimics the investment pattern of a TDF, using a participant’s birthday to select a target date for retirement and adjusting the mix of equity and other assets to lower the risk profile of the participant’s portfolio as the retirement date nears. According to the lawsuit, the defendants have allowed plan participants to be charged an annual fee of 0.45% on the first $100,000, 0.40% on the next $150,000, and 0.30% on assets over $250,000. The lawsuit points out that this service is not dissimilar from a previous service offered by the plan in 2014 for online advice, which was provided without cost to participants.
For the Personal Advisor program, participants work with a dedicated adviser on their entire financial portfolios, including other retirement accounts. The plaintiffs say the defendants have allowed participants to be charged an annual fee of 0.95% on the first $100,000, 0.90% on the next $150,000, and 0.85% on assets over $250,000 for these services.
The lawsuit contends that there are a number of other managed account providers—e.g., Betterment, Vanguard and Charles Schwab—whose services are virtually identical to the services provided to Exelon’s plan participants through the management program service and whose fees range from 0.25% to 0.30% on all assets for plans much smaller than the Exelon plan. “Thus, the fee rates paid by the plan participants for the Management program were excessive and unreasonable given the plan’s size and negotiating power,” the complaint states.
In addition, the plaintiffs argue that the Management program service added no material value to participants to warrant the additional fees. The asset allocation created by the service was not materially different than the asset allocation of the age-appropriate target-date option made available to the participants at a lower fee. “As a result, based on the value provided, the reasonable fee for the plan’s Management program service was zero or very close to zero,” the complaint states.
“Based on the excessive amounts paid by the plan for managed account services, it is reasonable to infer that the defendants failed to prudently monitor and manage the plan’s managed account services,” the lawsuit adds. “The defendants’ failure to properly monitor or control fees for the plan’s managed account service cost resulted in plan participants paying excessive and unreasonable fees.”
The lawsuit also noted that Edelman Financial Engines often shares with a plan’s recordkeeper half or more of the revenue collected from a plan, and, as such, its standard fees are set to take that revenue-sharing into account. However, the defendants have not indicated in any Form 5500 that Northwest receives any indirect compensation at all. The plaintiffs say this leads to the conclusion that either the defendants have failed to disclose to whom the managed account provider is remitting half or more of its charges, or Edelman Financial Engines is keeping for itself all of the excessive fees it charges participants.
If the managed account provider has been remitting half or more of its charges to the recordkeeper, the lawsuit says, that means the recordkeeper’s compensation is even more excessive than described previously in the complaint, and the defendants have failed to bargain material reductions in the recordkeeper’s direct compensation on the basis of the indirect compensation they knew or should have known the recordkeeper has been receiving. If Edelman Financial Engines has been keeping for itself all or virtually all of its charges, the plaintiffs say, then the fees for the services it has performed are grossly excessive.
The lawsuit also includes a claim for failure to monitor other fiduciaries and provide them with accurate information.
Exelon has not yet responded to a request for comment about the lawsuit.
« 2022 Plan Sponsor of the Year Award Nominations Are Open