Parts of Schwab Self-Dealing ERISA Lawsuit Will Proceed

The U.S. District Court for the Northern district of California has issued a new ruling in an Employee Retirement Income Security Act (ERISA) self-dealing lawsuit filed against Schwab Retirement Plan Services and other Charles Schwab corporate entities.

The ruling comes after the Schwab defendants moved to dismiss in part the plaintiff’s second amended complaint. Defendants also filed a request for judicial notice in support of their motion. The plaintiff opposed the motion to dismiss but did not oppose the request for judicial notice. Having considered the arguments and evidence presented, the court has denied in part and granted in part the Schwab defendants’ motion to dismiss, without leave to amend. The court has also granted the defendants’ request for judicial notice.

The second amended complaint names three groups of defendants, including various parts of the larger Schwab organization, individual fiduciary defendants from the retirement plan committee, and the Schwab board of directors. The plaintiff was a participant in a Schwab employee retirement plan from 2009 to 2015. During his participation, according to case documents, the plaintiff invested in both affiliated and unaffiliated options.

Previously, in September 2018, the court granted in part and denied in part defendants’ first motion to dismiss, addressing the plaintiffs first amended complaint. At that stage, the court granted the plaintiff leave to amend counts I, III and IV, except as to elements relating to a self-directed brokerage fund, which the court dismissed without leave to amend. At that time, the court denied defendants’ motion to dismiss counts II and V.

The plaintiff subsequently filed a second amended complaint alleging the same five counts. That led the defendants to move to dismiss counts I, III and IV. The plaintiff’s second amended complaint included new allegations to support his breach of fiduciary duty claim (count I). Furthermore, he argues that his failure to monitor claim (count III) and breach of co-fiduciary duty claim (count IV) should survive court scrutiny to the extent count I survived.

In the new ruling, the court first turns to the Schwab defendants’ motion for judicial notice of 17 documents. The first 13 are documents consisting of the plan’s summary plan description, the plan’s 2016 Form 5500, various notices to plan participants regarding the plan’s investment options and a prospectus filed with the Securities Exchange Commission. As stated in the text of the ruling, defendants had requested the court take judicial notice of these documents in support of their first motion to dismiss. The court says they are judicially noticeable. The other four documents are excerpted reports specifying how various funds in the plan performed. The four reports contain figures which the plaintiff relied upon, although he did not cite them in his second amended complaint. Here, the court rules that these four reports are judicially noticeable for purposes of a Rule 12(b)(6) dismissal motion, “because the documents are incorporated by reference” into the second amended complaint.

Even with these documents admitted into the court’s consideration, the ruling sides in a few places with the plaintiffs.

“Plaintiff has pleaded sufficient facts to give rise to an inference of a breach of fiduciary duty,” the new ruling states. “Plaintiff argues that a deficient process can be inferred based on meeting minutes produced in discovery. Specifically, the second amended complaint alleges that meeting minutes show it had delegated its role in selecting a Schwab stable value fund replacement to an independent consultant, Mercer, because the plan committee had a conflict, and Mercer was to prepare a recommendation as to how the committee should proceed in replacing the terminated stable value fund. However, because no such report was produced in discovery, despite the production of other minutes and Mercer reports, and because defendants maintain that all non-privileged and responsive committee documents have been produced, the plaintiff argues the court should infer that no such report exists or that the committee ignored the recommendation from Mercer.”

The Schwab defendants here maintain that this Mercer report was not produced because it was outside the scope of claims the plaintiff could bring in arbitration in that he never invested in the Schwab stable value fund or Schwab money market fund. The court “does not find this persuasive” because defendants have produced thousands of pages of discovery materials.

“The court finds that, viewing the allegations in the light most favorable to plaintiff, the absence of such a Mercer report or meeting minutes showing Mercer’s recommendation gives rise to an inference that the committee either never received or disregarded Mercer’s recommendation,” the decision states. “This sufficiently alleges that fiduciary defendants breached their fiduciary duties because the committee failed to follow its own process to prudently and loyally investigate options before selecting alternatives for Schwab’s stable value fund.”

The decision then turns in favor of the defendants, ruling that the plaintiff’s other allegations as to a deficient process fail.

“To the extent plaintiff argues again that replacing Schwab’s stable value fund with another stable value fund, as opposed to the Schwab money market fund, would have been the prudent action, this fails as it did the first time because defendants are not required to provide a stable value fund,” the decision states. Plaintiff also argues that the committee’s process was deficient because it ignored years of data showing the SMRT Funds were underperforming. However, SMRT Funds were not part of the stable value fund replacement funds. Moreover, assuming this was to show the committee’s deficient selection process separate from the stable value fund replacements, this still fails. The only factual allegations to support this conclusion was the purported underperformance of the SMRT Funds themselves. Plaintiff cannot use the funds’ purported underperformance as factual support of a deficient process when the funds’ underperformance, as discussed later, is insufficient to infer imprudence and must be supported by facts alleging a deficient process.”

The plaintiff lastly argued that committee’s process was deficient because transferring the stable value fund to the unaffiliated replacements did not guarantee against a loss and the unaffiliated funds were not a comparable replacement as capital preservation options. However, the court has ruled, the plaintiff has pleaded no facts to support this conclusory allegation.

Ultimately, while the plaintiff’s other allegations as to a deficient process fail, because the lack of any Mercer report or minutes stating the independent consultant Mercer’s recommendation does give rise to an inference of imprudence and disloyalty in the committee’s process, the court denies defendants’ motion to dismiss count I to the extent it relies on this theory.

The ruling then goes on to explain that, apart from certain matters involving the Schwab money market fund and Schwab savings account, none of the plaintiff’s new allegations in the second amended complaint as to his affiliated funds theory sufficiently alleges facts to infer a breach of fiduciary defendants’ fiduciary duties pertaining to count I.

Reviewing all these matters together, the court concludes that the plaintiff has sufficiently alleged facts giving rise to an inference of imprudence and disloyalty as to his theory of defendants’ deficient process in selecting the Schwab stable value fund replacements based on the lack of a report or meeting minutes, along with the allegations of excessive fees and underperformance of these stable value fund replacements. Thus, to the extent plaintiff’s breach of fiduciary duty claim relies on these theories, the Court denies defendants’ motion to dismiss count I. However, because the plaintiff has failed to cure the deficiencies as to his other theories despite an opportunity to do so, the court grants defendants’ motion to dismiss count I as to the other theories, without leave to amend.

“Defendants’ motion is denied to the extent that counts I, III and IV are based on the theories of a deficient process in selecting a replacement for the stable value fund and of excessive fees and underperformance of such stable value fund replacements,” the decision states. “The motion is otherwise granted without leave to amend.”

The full text of the ruling is available here.