In our second blog in this series, we will dive deeper into the litigation surrounding managed accounts. When advisors and consultants work outside their ordinary functions, downside risks arise. Such risks can undermine long-term participant success and generate conflicts of interest, additional fees and expenses, and litigation risks to plan sponsors. One area where advisors reach beyond their ordinary scope is managed accounts. A managed account is a discretionary investment management service where someone else is making investment decisions on behalf of the participant. Advisors most commonly market managed account services as a service offering retirement account customization based on individualized participant factors such as age and risk tolerance.[I]
For a review of the roles involved under ERISA, read our first blog in this series.
Context for Litigation
The race to capture the significantly higher fees associated with managed accounts has escalated. Initially, nearly all managed account services were third-party and, while integrated from a technology perspective with the recordkeeper, were not captive to their environment. Recordkeeper-managed accounts came next as recordkeeping firms built managed account solutions native to their recordkeeping platform and collected the revenues associated with the services. Now advisor-managed accounts (also known as AMA) are becoming more prevalent. AMAs allow the advisors to build the underlying model portfolios used in the managed account service and add an asset-based fee for their portfolio construction responsibilities. AMAs are creating friction and conflicts in the market as some recordkeeping firms that do not allow for AMA’s are reporting being excluded from recordkeeping search opportunities. This raises questions of whether the client’s interest, or those of the advisor, are leading the way.
The growth opportunity is notable. While historically, managed accounts were nearly always available ala carte as a participant opt-in solution, more plans are considering using managed accounts as QDIA, increasing asset flows into these products.[ii]
The downside of these managed account services is that they are generally very costly; there is no commonly accepted benchmarking practice for this service; and there is generally a lack of data provided by the plan sponsor and participants to evaluate any purported value from these services. Looking behind the marketing reveals a service that resembles lower-cost target date funds. As a result, when provided by an advisor who charges an additional fee for making the recommendation to add the managed account service and also receives additional compensation. As a result, you can imagine the conflict. This conflict can increase plan sponsor exposure, as explored in this set of cases. With higher revenue comes greater scrutiny and many lawsuits testing the appropriateness of fees for managed accounts and the various relationships among recordkeepers, advisors, and managed account providers.
Guyes v. Nestle
In the instance of Guyes v. Nestle USA Inc. et al, 20-cv-1560 (E.D. Wisc.), Nestle is a plan sponsor that selected Voya Institutional Plan Services (Voya) as the plan’s recordkeeper, and Voya Retirement Advisors, LLC as the plan’s managed account service provider. In October 2020, the plan had over $4.2 billion in plan assets and nearly 40,000 participants.
The named plaintiff alleged breach of fiduciary duty based on
- excessive fees for recordkeeping and administration
- authorizing the plan to pay excessive fees for managed account services
- engaging in self-dealing relating to plan administration
In moving to dismiss Guyes’ claim based on excessive managed account fees, Nestle argued that Guyes lacked standing because she never enrolled nor paid fees for managed account services. Defendants submitted an uncontested declaration from a Nestle employee attesting that Guyes never enrolled in managed account services. Guyes countered that the court should consider the plan’s fees holistically; in other words, she could maintain standing by alleging that the overall fee structure was unfair, partly because of the excessive managed account fees. The court rejected that argument, noting that the Supreme Court has insisted that standing must be established on a claim-by-claim basis. The Magistrate Judge found this fact so significant it further recommended that Guyes not be allowed leave to amend this claim. The plaintiffs have objected to the Magistrate Judge’s opinion, which means the Article III judge will now decide whether to accept or reject the Magistrate’s recommendation.
Gosse v. Dover Corporation
Gosse v. Dover Corporation et al (22-cv-04254) (N.D. Ill.) is another putative class action challenging the use of managed account services. Much like Guyes, the Gosse plaintiffs allege that the marketing for managed account services does not withstand scrutiny. In the plaintiffs’ words, managed account services “merely mimic the asset allocation available through a target date fund while charging additional unnecessary fees for their services.” The defendants moved to dismiss the case on Dec. 15, 2022. The court will likely rule on that motion sometime in 2023.
Merit in Managed Account Litigation?
The Magistrate’s opinion in Guyes demonstrates potential defenses for managed account service providers, as the plaintiffs seeking to bring these claims (at least under the standard as articulated in Guyes) must plausibly allege their money was specifically invested in funds utilizing managed account services. Under this standard, bootstrapping a managed account services claim to a proposed class representative not using such services will not suffice. Bifurcating plan participants will provide pleading defenses and likely provide potential defenses to class certification if a Plaintiff survives a motion to dismiss.
However, plan sponsors considering managed account services should be aware of (at least) two important countervailing considerations. First, some courts may be persuaded to treat this particular issue as one of class representative adequacy to be addressed at the class certification stage and not on an initial pleadings challenge.
Second – and more immediately addressable by the plaintiffs’ lawyers – the standing issue can be solved by finding a plaintiff who used managed account services. Put differently, plan sponsors should note that Guyes does not speak to the substantive merit of managed account services. The decision instead hinges on a technical pleading problem that savvy plaintiffs’ attorneys may solve in subsequent suits.
Indeed, the decision in Guyes has not deterred further litigation targeting managed account services. A new proposed class case was filed in January against U.S. Bank, a company with a roughly $10 billion 401(k) plan. The suit alleges that U.S. Bank violated its fiduciary duties by overpaying for managed account services. That case is now pending in the District of Minnesota.[iii]
Until federal appellate courts weigh in, expect plan participants (and plaintiffs’ attorneys) to continue to challenge managed account services, especially where such services raise the specter of a conflict of interest and can be argued to offer marginal-to-little value over substantially cheaper traditional target date funds. And even beyond the litigation risk, plan sponsors should evaluate whether managed account services offer a benefit in the financial interest of plan participants. Recall that ERISA Section 404 requires the duty of loyalty and acting solely in the financial interest of plan participants and their beneficiaries. Further, the DOL has made clear that the selection and monitoring of service providers requires a determination of any conflicts of interest that may impact the service provider’s performance. Beyond litigation risk, plan sponsors should be concerned with whether the DOL may also take issue with the conflicts presented in these arrangements.
For more information on managed account litigation, download our complete guide to advisor independence here.
Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Multnomah Group does not provide legal or tax advice. Any views expressed herein are those of the author(s) and not necessarily those of Multnomah Group or Multnomah Group’s clients.
[i] See also, Independent Lost, available at: https://blog.multnomahgroup.com/forward-thinking/independence-lost.
[ii] As of 2020, according to a survey from Plan Sponsor Council of America, 85% of plans have a QDIA and of those plans, 4% used a managed account as the QDIA.
[iii] Dionico et al v. U.S. Bancorp, 23-cv-00026 (D. Minn.).