Can your employer be trusted to manage your retirement fund exclusively for your own benefit? That's the question raised by a lawsuit recently brought against General Electric Co., stating that the answer is a resounding no.
The case, filed Sept. 26 in San Diego federal court, concerns GE's 401(k) plan, one of those defined-contribution plans that have increasingly supplanted traditional pensions for American workers. It alleges that GE managed the plan for its own benefit by loading it with mutual funds owned by its own subsidiary. The funds charged high fees while also underperforming the investment markets, a double-barreled drawback that cost employees millions in potential gains.
The lawsuit seeks class-action status to represent about 250,000 employees who were members of the 401(k) from 2011 through mid-2016, when GE sold the investment subsidiary that ran the mutual funds.
Of the retirement plan's $28.5 billion in assets as of the end of 2015, the lawsuit asserts, about half was invested in mutual funds. Of the mutual fund assets, about 56% were invested in five GE-owned funds — all but one of which underperformed its benchmark investment index.
GE profited from this arrangement in two ways, according to the lawsuit. The company pocketed the investment management fees paid by its own employees, and it exploited its employees as a customer base for the funds — the 401(k) plan accounted for more than 70% of the ownership of all five funds and 90% of one, an international equity fund. The value that ownership gave the funds contributed to the $485 million GE pocketed when it sold its investment subsidiary, GE Asset Management, to State Street in mid-2016, the lawsuit implies.
These factors presented an inevitable conflict of interest in GE's management of the retirement program. "GE selected its proprietary funds not based on their merits as investments," the lawsuit states, "but because these products provided significant revenues and profits to GE."
"The employer is a fiduciary to the plan and every man, woman and child in that plan," says Charles Field, the San Diego lawyer who brought the suit. "Fiduciary duty is the highest duty known in the law, and it's a duty of prudence, loyalty and of the highest good faith."
Field also is representing members of a retirement plan at the investment firm Morgan Stanley in a lawsuit filed in federal court in New York. Morgan Stanley has moved to dismiss the case. GE hasn't responded formally in court to the lawsuit. A spokeswoman says the company has no comment on the lawsuit, but added, "We intend to fully defend the case."
The GE lawsuit underscores a fundamental flaw in the 401(k) system, which offers employees the option to contribute a percentage of their wages into a retirement fund, tax free — but leaves the investment options in the hands of employers.
Since their introduction in 1979, 401(k) plans and other such defined-contribution arrangements have grown to become the most important source of retirement income for Americans outside of Social Security. Their rise has given employers a rationale to scrap traditional defined-benefit pensions, in which payouts are based on the worker's longevity and wage record with an employer. They may be more suitable for workers in an economy in which job-hopping is more common than before, but they also impose market risk on the workers and give them the complicated responsibility of managing large nest eggs without much professional help.
The old corporate habit of steering employees to invest in their own stock has faded, but too many 401(k) plans still offer unduly limited options. (There's a converse problem: Too many choices may confuse participants, discouraging some from investing at all and leading others to make imprudent choices. This is a consequence of asking workers without professional training to manage the risk in their own retirement accounts.)
The GE case is one of a string of lawsuits in recent years targeting corporate management of 401(k) plans. Most commonly, the lawsuits allege that companies have allowed excessive fees to be charged to their employees' accounts by their hand-picked investment managers, or have loaded the 401(k) choices with self-interested options such as their own proprietary mutual funds or funds owned by crony investment companies.
The consequences for employees can be immense. From 2011 through mid-2016, the lawsuit says, a $1-billion investment in Fidelity's Overseas fund would have grown to $1.57 billion. The same investment in GE's International Fund, 90% of which was owned by GE's 401(k), grew to only $1.22 billion, a relative shortfall of more than $300 million. Fidelity's fund wasn't offered to GE workers.
This area of employment law was turbocharged by two events in 2015. The first was Lockheed Martin's landmark $62-million settlement of allegations that its fund choices imposed excessive fees and that too much of the workers' investments were held in low-yielding money market funds operated by State Street Bank & Trust, with which Lockheed had a business relationship. The settlement covered more than 100,000 beneficiaries of the company's $28-billion 401(k) fund.
The second event was a ruling by the Supreme Court in a case involving Edison International, the parent of Southern California Edison. The court ruled that a plan sponsor's fiduciary responsibility to its workers was ongoing. It wasn't enough to choose investment options once and forget about them; the company had to keep an eye on the options continually and remove those that were underperforming or inappropriate.
The decision not only spelled out a company's fiduciary duties under the Employee Retirement Income Security Act in greater detail than before, but effectively eliminated the six-year statute of limitations on filing objections to a plan's management.
The litigation generally has resulted in improved behavior by companies, Field says. "It looks like there's been a change in behavior," he told me. More plans offer a broader combination of actively managed investments and passive investments such as index funds, for example. "But there still are some outliers."
Litigation dockets suggest that companies that own investment management subsidiaries tend to be a trouble spot. Field says that it's not always the case that a company's proprietary investment funds or funds with relatively high fees are bad investments, but when they also underperform the market, there are grounds to ask why they're on the menu.
The GE lawsuit alleges that was manifestly the case with its 401(k) offerings. Its international equity fund, of which 90% was owned by the 401(k) plan, consistently performed worse than more than 70% of competing international stock funds, the lawsuit says. The GE fund suffered "massive redemptions" from outside investors during these years, according to the lawsuit.
"GE would likely have had to scour the market to find an offering as poor-performing as the International Fund," it says. "However, GE had business and financial incentives to select and maintain the International Fund in the [401(k)] plan."
Another underperformer was the GE Strategic Fund, which invested in a balanced mix of stock, bonds and cash. About 75% of the fund's assets belonged to GE 401(k) members. The fund returned a cumulative 36.29% gain from 2011 through mid-2016, while its rival Vanguard/Wellington Fund returned 57.71%. Despite that, the GE fund's fees were twice those of the Wellington Fund.
"A prudent fiduciary … would not have offered the plan's participants the Strategic Fund," the lawsuits says. "But GE did just that."
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