401k

Stable Value: The Good, the Bad and the Ugly-Avoiding Litigation

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By Christopher B. Tobe, CFA, CAIA    

I contend that the Good version of Stable Value is still the best low risk investment for 401(k) plans.  With an estimated $700 billion in assets, Stable value is typically 15% to 30% of assets in many DC plans.    Stable Value’s popularity with participants is well deserved.  It’s combination of principal protection like a money market and solid returns closer to an intermediate bond fund are unmatched among 401(k) choices.  Stable Value in recent years has had yields nearly triple that of Money Market. A recent Wharton study has confirmed the superior risk/return profile of stable value funds compared to money market and bond funds. [i]

There has already been litigation against firms that did not offer stable value at all and only offered money market.  Plans who want to avoid litigation need to get the Good versions of Stable value which are the diversified synthetic GIC based products.

All Stable Value funds use Guaranteed Investment Contracts (GIC’s) to provide them book value accounting, which allows for a smoothing of returns and no negative periods.  There are 3 basic categories of stable value:  1. the original General Account or Traditional GIC (Ugly) 2.  Insurance Company Separate Account GIC (Bad) 3. Synthetic GIC sometimes known as a wrap. (Good)

Mega ERISA 401(k) plans abandoned General account GIC’s almost 30 years ago after the Executive Life and Confederation Life defaults of 1992.   Large ERISA plans for the most part abandoned Insurance company Separate Account stable value 20 years ago and have almost all converted to Synthetic GIC’s.  Many mid-size and multi-employer plans access synthetic stable value via over 30 Stable Value Pooled Funds which are Bank Collective Trusts with well-known names such as Fidelity, Vanguard, T. Rowe Price, and others since stable value is not offered in mutual funds.    With synthetic GIC’s the plan owns the underlying bonds usually 95% to 100% of the total value, while with the insurance company separate account and general account the plan does not own any securities but owns a contract with the insurance company.    All the large independent consultants recommend synthetic stable value as evidenced in this recent February 2022 article in Plan Sponsor quoting Willis Towers Watson.[ii]

NAGDCA the association representing public DC plans in a September 2010 brochure had the following characterization of General Account stable value. Due to the fact that the plan sponsor does not own the underlying investments, the portfolio holdings, performance, risk, and management fees are generally not disclosed...[i]

Ben Bernanke spoke in 2008 in defending the AIG bailout saying, “Workers whose 401(k) plans had purchased $40 billion of insurance from AIG against the risk that their stable value funds would decline in value would have seen that insurance disappear.”  I contend that an ERISA plan should not take on the single entity credit risk and liquidity risk of an insurance Company especially in the aftermath of AIG and in the so-called end of too big to fail?  

The largest providers of the Bad and Ugly versions of Stable Value are Prudential, Principal, Lincoln, TIAA, MetLife, NYLife, MassMutual,John Hancock, Great West, Transamerica.   You tend to still find them in 403(b)s, smaller 401(k)s and of course 457 plans which are exempt from ERISA.  These bad and ugly versions of stable value are litigation magnets with their hidden fees many times in excess of 200 basis points (2%) along with high single entity credit risk.

Synthetic stable value options which are transparent, diversified and have low fees are widely available for any 401(k) plan over $50 million in size.  Using bad stable value or skipping stable value increases your litigation risk.   Even then with good stable value you still need to look at fees between options.   

Chris Tobe, CFA, CAIA is a leading expert on Stable Value http://www.christobe.com/stablevalue/    writing dozens of articles and the only book “The Consultants Guide to Stable Value” published this century.

[i] http://fic.wharton.upenn.edu/fic/papers/09/p0925.htm

[ii] https://www.plansponsor.com/in-depth/role-stable-value-funds-qdias-otherwise/

[i] http://www.nagdca.org/documents/StableValueFunds.pdf

NAGDCA 2010GADownload

The “Fiduciary Prudence Trinity”: ERISA Fiduciary Law After the Hughes/Northwestern Decision

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SCOTUS recently announced its much anticipated decision in the case of Hughes v. Northwestern University.1The significance of the decision cannot be overstated, as it dramatically changes the “rules of the game” for 401(k) and 403(b) retirement plans,

Hughes was the last piece of what I am referring to as the “Fiduciary Responsibility Trinity.” The trinity is composed of three key ERISA related decisions-Tibble v. Edison International2, Brotherston v. Putnam Investments, LLC3, and Hughes. Given the heavy reliance that the Supreme Court and the First Circuit Court of Appeals, as well as the Solicitor General, placed on the common law of trusts, an argument can be made that the logic set out in the trinity decisions is equally applicable to all investment fiduciaries.

So why are the trinity so important? Here are key quotes from each decision.

Tibble:

We have often noted that an ERISA fiduciary’s duty is ‘derived from the common law of trusts.’ In determining the contours of an ERISA fiduciary’s duty, courts often must look to the law of trusts.4

The Restatement (Third) of Trusts is a restatement of the common law of trusts. So, the Court is recognizing the Restatement as a legitimate resource in addressing fiduciary questions.

Under trust law, a trustee has a continuing duty to monitor trust investments and remove imprudent ones. This continuing duty exists separate and apart from the trustee’s duty to exercise prudence in selecting investments at the outset…. Rather, the trustee must ‘systematic[ally] conside[r] all the investments of the trust at regular intervals’ to ensure that they are appropriate….In short, under trust law, a fiduciary normally has a continuing duty of some kind to monitor investments and
remove imprudent ones.5

Brotherston:

Congress sought to offer beneficiaries, not fiduciaries, more protection than they had at common law.6

[A]ny fiduciary of a plan such as the Plan in this case can easily insulate itself by selecting well-established, low-fee and diversified market index funds. And any fiduciary that decides it can find funds that beat the market will be immune to liability unless a district court finds it imprudent in its method of selecting such funds, and finds that a loss occurred as a result. In short, these are not matters concerning which ERISA fiduciaries need cry “wolf.”7

[T]he Restatement specifically identifies as an appropriate comparator for loss calculation purposes ‘return rates of one or more. . . suitable index mutual funds or market indexes (with such adjustments as may be appropriate).’8

In Brotherston, the lower court had ruled that the plan participants’ expert could not calculate alleged damages by comparing actively managed funds within the plan with comparable index funds, the copurt ruling that that would constitute comparing “apples to oranges.” The First Circuit’s decision effectively discredits the “apples to oranges” argument.

Hughes:

The Seventh Circuit erred in relying on the participants’ ultimate choice over their investments to excuse allegedly imprudent decisions by respondents. In Tibble, this Court explained that, even in a defined-contribution plan where participants choose their investments, plan fiduciaries are required to conduct their own independent evaluation to determine which investments may be prudently included in the plan’s menu of options…. If the fiduciaries fail to remove an imprudent investment from the plan within a reasonable time, they breach their duty.9

The Seventh Circuit had dismissed the plan participants’ case on the basis of the “menu of options” argument, which said a mixture of both prudent and imprudent investment options within a plans was permissible, as it provided plan participants with more choices. SCOTUS effectively discredited the “menu of options” defens

Going Forward
Bottom line, the combined impact of the trinity decisions is that cases will now be decided based on their merits, not on legal fictions such as the “apples and oranges” and “menu of options” defenses. This should result in more protection for plan participants in the form of fewer dismissals of 401(k)/403(b) …as long as the attorneys for plan participants properly plead such cases to meet SCOTUS’ plausibility standard for pleading.

Notes
1. Hughes v. Northwestern University, 19-1401 (2022).
2. Tibble v. Edison International, 135 S. Ct. 1823 (2015).
3. Brotherston v. Putnam Investments, LLC, 907 F.3d 17 (2018).
4. Tibble, 1828.
5. Tibble, 1828-29.
6. Brotherston, 37.
7. Brotherston, 39.
8. Brotherston, 31.
9. Hughes, Ibid.

James W. Watkins, III, is a licensed attorney (41 years), specializing in securities and ERISA law, a Certified Financial Planner™ professional (32 years) and an Accredited Wealth Management Advisor.™ He has extensive experience in evaluating the legal prudence of various types of investments, including mutual funds, and advising 401(k)/403(b) pension plans on both designing and monitoring plans to ensure legal compliance.  

CIT’s (Collective Investment Trusts) in 401(k) – The Good and the Bad

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Collective Investment Trusts (CIT’s) can be helpful to a 401(k) plan and its participants, or it can cause harm.

There is a general assumption that CIT’s are regulated by the Federal Government Office of Comptroller of the Currency (OCC).  Some CIT’s are regulated by the OCC while many others are regulated by one of 50 state bank regulators.   This allows CITs to choose their own state regulator who may have the most lax oversight. 

Many of the most popular CITs in 401(k) have been shown to be superior to mutual fund versions as being identical in holdings but lower fees.   Some plans have been sued for using higher priced mutual funds when identical lower cost CIT’s were available.  The largest target date funds of Vanguard, Fidelity, and T.Rowe Price all have identical CIT funds to their SEC regulated Mutual funds which I believe are a better fiduciary choice. 

Stable Value Funds are currently not offered in mutual funds, so CIT’s have been the best avenue for many plans to deliver synthetic based stable value.   Most of the best Stable Value CIT’s are in the Heuler Pooled Universe, and include the SV CIT’s of Vanguard, Fidelity, T.Rowe Price, Invesco, Galliard.   Of course, even among this group fees vary. 

Most synthetic Stable Value CIT’s have been run adequately with one exception.  A JPM stable value CIT used a JPM broad bond CIT, which put in another JPM CIT with a Private Equity like structure technically private debt.  This Private debt blew up during the 2008 financial crisis and this has cost JP Morgan over $400 million in damages in 401(k) litigation.[i] [ii]   

However, I fear that CIT’s will be used to hide high fee high risk investments in the guise of improving return or risk.

In my previous paper “Private Equity in 401(k) -a Fiduciary Time bomb”[iii] I outline the excessive fees, massive risks and unproven performance in that asset class which also applies to private debt and other alternatives.

The other high fee high risk investment that has been and will continue to be hidden in CIT’s are annuities.   I touch on all the fiduciary flaws in annuities including general account stable value plus the 200 basis points in hidden fees[iv]   

This type of layering from JPM is what I expect to see in Target Date CIT’s with annuities, private equity, private debt and other alternatives especially in weakly state regulated CIT’s.   I fear state regulators will allow in risky high fee complex investments they do not even understand, to appease Wall Street managers.

Even a small allocation of alternatives ie Private Equity or annuities to a Target Date CIT or Stable Value CIT , with the excessive risk, lack of outperformance and excessive fees make it a Fiduciary Risk.

If you have underlying alternatives or annuities or are seriously considering it in a CIT, get an independent legal opinion that the actual underlying Annuity and Private Equity contracts pass ERIA fiduciary muster.   Make sure your fiduciary liability insurance cover Annuities and Private Equity- many do not.

CIT’s with a strong Federal regulator like the OCC are preferable.  However, some state regulated CIT’s which are exact clones of SEC registered mutual funds are probably OK.   Fiduciaries need to dig down to the security level of every CIT to make sure there are no hidden risks and fees.

[i] https://www.nytimes.com/2012/03/23/business/jpmorgan-discloses-it-lost-in-arbitration-to-american-century.html

[ii] https://casetext.com/brief/whitley-v-jp-morgan-chase-co-et-al_memorandum-of-law-in-opposition-re-49-motion-to-dismiss-first-amended

[iii] https://commonsense401kproject.com/2022/02/15/private-equity-in-401k-plans-a-ticking-time-bomb/

[iv] https://commonsense401kproject.com/2022/02/10/401k-lifetime-income-a-fiduciary-minefield/

Private Equity in 401(k) Plans: A Ticking Time Bomb

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Private Equity along with other illiquid contract investments like hedge funds, private debt, real estate are a potential Fiduciary Time Bomb for plans and their participants

Center for Economic and Policy Research’s Eileen Appelbaum recently said “Much as private equity firms may wish it were different, they have been mostly unable to worm their way into workers’ 401(k)s and abscond with their retirement savings,”[i] from a series of articles on how the new Trump DOL rules were connected to massive political donations by the Private Equity industry.[ii]  

A report by University of Oxford professor Ludovic Phalippou shows that in the last 15 years, private equity firms generally have not provided better returns to investors than low-fee stock index funds. Prof. Phalippou has shown excess mostly hidden fees and expenses to exceed 6% killing net returns. [iii]    

Noted founder of investment consulting firm Richard Ennis in quoting Beath & Flynn 2020 study says that private equity (as a class of investment) in fact ceased to be a source of value-added more than a decade ago. [iv] 

Jeff Hooke of Johns Hopkins book the “Myth of Private Equity” goes into great detail on an asset class and its numerous fiduciary flaws.  He documents that many performance claims are made up by the managers with no independent verification and are greatly exaggerated. [v]

The plan as I see it is to bury Private Equity into Target Date Funds where they can hide these Fiduciary Time bombs collect the massive fees and hope that they do not blow up.   Their main claim for inclusion is excessive performance which is dubious at best.

A Private Equity like structure technically private debt has cost JP Morgan over $400 million in damages in 401(k) litigation.  This private debt was put in a JP Morgan CIT, which was put in JPM broad bond CIT, with was put in a JPM stable value CIT.[vi] [vii] This type of layering is what I expect to see in Target Date CIT’s.

Former SEC Attorney Ted Siedle goes over the Fiduciary Breaches common in most Private Equity funds in his Forbes Column that should make any fiduciary nervous.  [viii]

1.   Private equity offering documents generally prominently state (in capital, bold letters) that an investment in a private equity fund is speculative, involves a high degree of risk, and is suitable only for persons who are willing and able to assume the risk of losing their entire investment.  

2. Largely “unconstrained” and may change investment strategies at any time.  Can engage in borrowing, or leverage, on a moderate or unlimited basis.  No assurance of diversification since funds generally reserve the right to invest 100 percent of their assets in one investment.  Heightened offshore legal, regulatory, operational and custody risk.

3. Myriad conflicts of interest, self-dealing practices. The investment manager determines the value of the securities held by the fund. Such valuation affects both reported fund performance as well as the calculation of the management fee and any performance fee payable to the manager. [ix] Naked Capitalism writes “The toothless and captured Institutional Limited Partners Association has proposed a fee disclosure template which has gone nowhere.”[x]  It is widely known there is a massive underreporting of fees.

4. Business practices that may violate ERISA. Private equity fund offering documents often disclose that investors agree to permit managers to withhold complete and timely disclosure of material information regarding assets in their funds. Further, the fund may have agreed to permit the investment manager to retain absolute discretion to provide certain mystery investors with greater information and the managers are not required to disclose such arrangements. As a result, the fund you invest in is at risk that other unknown investors are profiting at its expense—stealing from you. Finally, the offering documents often warn that the nondisclosure policies may violate applicable laws. That is, certain practices in which the fund’s managers engage may be acceptable to high-net-worth individuals (or unknown to them) but violate laws applicable to ERISA plans. [xi]

5.  Lack of disclosure has led to numerous violations some pointed out by the SEC, others pertaining to IRS like monitoring fees tax law violations and management fee waivers tax law violations.

These 5 points are a very abbreviated list of Former SEC Attorney Ted Siedle’s column on the Fiduciary Breaches in Private Equity funds in his 8/23/20 Forbes Column.  [xii]

Even a small allocation to a Target Date Fund, with the excessive risk, lack of outperformance and excessive fees seem to make it a Fiduciary Risk.

If you have underlying Private Equity or are seriously considering it, get an independent legal opinion (from a firm that does not represent PE firms) that the actual underlying Private Equity contract passes ERIA fiduciary muster.   Make sure your fiduciary liability insurance covers Private Equity many do not.

While the Trump DOL “get out of jail free card” letter may protect a plan from Department of Labor action on Private Equity, you are making a dangerous bet in litigation, that the judge will block transparency and discovery of these contracts. 

With no proven performance advantage, grossly excessive fees, and numerous fiduciary issues there seems to be nothing but harm in adding Private Equity into your 401(k) plan.

Chris Tobe, CFA, CAIA is an expert on Private Equity Corruption writing the book Kentucky Fried Pensions, and dozens of articles..  http://www.christobe.com/alternatives/

[i] https://www.dailyposter.com/biden-reversal-gives-wall-street-a-big-win/

[ii] https://www.dailyposter.com/news-trump-just-fulfilled-his-billionaire/

[iii] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3623820  an Inconvenient Fact Private Equity Returns U.of Oxford  Ludovic Phalippou

[iv] https://richardmennis.com/blog/how-to-improve-institutional-fund-performance

[v] https://cup.columbia.edu/book/the-myth-of-private-equity/9780231198820

[vi] https://www.nytimes.com/2012/03/23/business/jpmorgan-discloses-it-lost-in-arbitration-to-american-century.html

[vii] https://casetext.com/brief/whitley-v-jp-morgan-chase-co-et-al_memorandum-of-law-in-opposition-re-49-motion-to-dismiss-first-amended

[viii] https://www.forbes.com/sites/edwardsiedle/2020/08/23/trump-dolsec-fail-to-warn-401ks-about-massive-private-equity-dangers/?sh=62e7fb7eb808

[ix] https://www.forbes.com/sites/edwardsiedle/2020/08/23/trump-dolsec-fail-to-warn-401ks-about-massive-private-equity-dangers/?sh=62e7fb7eb808

[x] https://www.nakedcapitalism.com/2022/02/sec-set-to-lower-massive-boom-on-private-equity-industry.html?

[xi] https://www.forbes.com/sites/edwardsiedle/2020/08/23/trump-dolsec-fail-to-warn-401ks-about-massive-private-equity-dangers/?sh=62e7fb7eb808

[xii] https://www.forbes.com/sites/edwardsiedle/2020/08/23/trump-dolsec-fail-to-warn-401ks-about-massive-private-equity-dangers/?sh=62e7fb7eb808