The latest self-dealing lawsuit filed against a financial services provider by its own in-house retirement plan participants challenges the offering of proprietary products within the plan.
Plaintiffs filed their complaint in the U.S. District Court for the Northern District of California, seeking class action certification on behalf of all similarly situated participants in the Franklin Templeton 401(k) retirement plan. Named as defendants are both the Franklin Resources Inc. company and the retirement plan’s fiduciary investment committee—the members of which are called out by name.
The suit alleges that defendants “breached their fiduciary duties by causing the plan to invest in funds offered and managed by Franklin Templeton (Franklin funds), when better-performing and lower-cost funds were available.” The lead plaintiff further alleges that defendants were “motivated to cause the plan to invest in Franklin funds to benefit Franklin Templeton’s investment management business.” Further, the suit alleges that defendants “offered the plan inferior arrangements compared to that offered to non-captive plans, and, in so doing, engaged in prohibited transactions.”
Much of the text of the complaint looks familiar, as it mirrors similar suits filed in the last year against investment product providers. According to plaintiffs, the plan has some $750 million invested in mutual funds managed by Franklin Templeton and its subsidiaries. While use of proprietary products is a common practice among providers of mutual funds, plaintiffs argue in this case it is a violation of the fiduciary duty because “these investment options were chosen because they were managed by, paid fees to, and generated profits for Franklin Templeton and its subsidiaries.”
The complaint continues: “Over the relevant time period, over 40 mutual funds offered by the plan were, and continue to be, managed by Franklin Templeton or its subsidiaries. The plan also includes a company stock fund, which invests in common stock of Franklin Templeton, and a collective trust, managed by State Street Global Advisors, which is intended to track domestic large-capitalization stocks as represented in the S&P 500 Index. In 2015, the plan also added three other collective trusts, also managed by State Street Global Advisors, to offer index tracking for international stocks, domestic small and mid-capitalization stocks, and bonds.”
Plaintiffs suggest that, prior to 2015, the S&P 500 Index fund was the only passively managed, and only non-proprietary, option in the plan. The crux of the complaint is that, “at all times relevant herein, the proprietary funds charged and continue to charge plan participants and beneficiaries fees that were and are unreasonable for this plan. The fees charged were and are significantly higher than the median fees for comparable mutual funds in 401(k) plans as reported by the Investment Company Institute, in The Economics of Providing 401(k) Plans: Services, Fees and Expenses and by BrightScope, Inc., an independent provider of 401(k) ratings and data, based on its review of 1,667 large 401(k) plans reported in Real Facts about Target Date Funds.”
Participants challenge revenue sharing arrangement
The lawsuit also challenges certain revenue sharing practices engaged in by Franklin Templeton fiduciaries. According to plaintiffs, during the class period, because Franklin offered the plan lower shareholder service fees, the plan “both had to pay additional administrative fees to the plan’s recordkeeper and lost the opportunity to benefit from the reimbursement of fees to the plan for other purposes. At the same time, for other shareholders of the same Advisor share class of the proprietary funds, Franklin offers a 15 basis point beneficial owner servicing credit, which was also paid by Franklin Templeton Investors Services, LLC using fees collected from the Franklin mutual funds and reducing the value of the mutual funds for all shareholders, including the plan. The 15 basis point beneficial owner servicing credit was offered to Franklin-fund shareholders such as the Mercury General Corporation Profit Sharing Plan, but was not available to the [in-house] plan.”
The lawsuit continues: “Upon information and belief, other shareholders in the Advisor share class benefitted from the additional 15 basis points through payments to their advisers, including Franklin Templeton Institutional, LLC, the funds’ distributor, Franklin Templeton Distributors, Inc., or entities who had entered into selling agreements with Franklin Templeton Distributors, Inc.”
According to plaintiffs, had Franklin made this 15 basis points fee reduction available for the benefit of the in-house plan, as it did with other shareholders, the plan and Charles Schwab would have received beneficial owners servicing credits of approximately $1.1 million per year, an increase of $700,000 per year from the benefit offered by Franklin for its own plan.
“Conversely, had Franklin offered all shareholders the same arrangement as it had with Charles Schwab for the plan, the amount of the payments made from each fund would have been less, causing the value of the plan’s investments in the Franklin Funds to be higher,” plaintiffs argue.
Taking all the charges together, plaintiffs summarize what they see as the defendants’ motivation for taking the actions at issue here: “With an operating margin of over 37%, very high for the mutual fund industry, defendants made a fortune off of the plan’s investments in proprietary funds.”
Among various other points of content, the suit also calls out Franklin Templeton’s treatment of the plan’s qualified default investment alternative, suggesting the decision in 2014 to use newly created proprietary target-date funds was also made with the company’s, and not participant’s, best interest in mind. Plaintiffs also suggest the offering of a money market fund rather than a stable value fund has robbed participants of easily available returns.
In a statement to PLANSPONSOR, Franklin Templeton strongly denies the allegations: “This lawsuit, filed by the same law firm that filed the pending Cryer action against the company, names additional defendants and includes additional claims, but is premised on the same alleged set of facts and seeks duplicative relief. This second lawsuit follows the unsuccessful attempt by the plaintiff in Cryer to add these same additional claims and defendants. Franklin Templeton takes pride in its 401(k) plan, which offers a generous matching program and provides employees with a diversified line-up of investment choices, including proprietary and non-proprietary funds, and will defend against both lawsuits aggressively.”
The full text of the compliant is available here.