DC Plan Investment Prudence -- How About Your Own Funds?

I think we may have the first fiduciary litigation of a slightly new style. Barbara Fuller, a former 38-year employee of SunTrust Banks, has filed suit against the company, its president, members of the Board who served on the Compensation Committee, and the bank's investment and capital management subsidiaries.

Here is the new twist: the suit alleges that SunTrust monitored non-SunTrust funds carefully, and terminated those managers who underperformed or whose fees were unreasonable, except for one. That one was funds that were managed by SunTrust or a subsidiary. In other words, according to the complaint, when a SunTrust fund underperformed or charged excessive fees, it was not terminated. Ms. Fuller asserts that this mismanagement resulted in losses in the tens of millions of dollars due to excessive fees and poor investment performance. A spokesman for SunTrust said that "[W]e believe the suit to be without merit and we will vigorously defend ourselves."

Let's step back for a second and consider, without attempting to consider the merits of this particular litigation, the issue here. I suspect that all large banks and other investment management firms in the US face this particular dilemma. Probably all of these companies sponsor a 401(k) plan. Further, I believe that all of these companies, or certainly most of them, have funds which they seek to have chosen as investment options in defined contribution plans. The plan Committee is under a fiduciary obligation to monitor all of the plan's investment options, and presumably, to monitor all of them in the same fashion.

We are about to go into a hypothetical. While some of these hypothetical facts and circumstances may resemble those in the SunTrust plan  in question, such resemblance is purely accidental. As such, this is not intended to place blame on the SunTrust Committee, nor is it intended to absolve them of such blame.

Now, let's put you, dear reader, in the shoes of one of the Committee members. You are looking at your most recent quarterly reports for all of the funds offered in your plan. Let's say that there are 25 of them. Of the 25, let's assume that 15 offer no good reason for removal; that is, they have consistently been top or second quartile performers, net of fees, and there are no red flags (such as manager change or style change) that suggest that there is reason for new concern. That leaves 10 funds that deserve some scrutiny.

For sake of identity, we're going to call your company Really Big Investment Management People, or RBIMP. As you are performing your Committee function, you notice that of the 10 funds on your 'I need to look at this group of funds really carefully' list, 6 are RBIMP funds. Ouch!

If the RBIMP 401(k) Plan fires its own funds, word will probably get out. And if that happens, those funds may lose other mandates, and if that happens, RBIMP's profits may go down, and if that happens, your bonus is going to be smaller, and those stock options that you already have are going to be worth less.

Uh oh.What are you going to do?

Now, I know that if you are one of my readers that you will take the high road and look at RBIMP's funds exactly as you look at all the rest of the funds. So, at the next meeting, you vote (on the record, of course) to terminate two of those six RBIMP funds and to put three of the other four on a watch list. You argue that the remaining fund has changed managers as a result of poor performance and that it deserves a few quarters to see if it will turn things around (yes, maybe it should go on a watch list as well, but that's not your vote). But, the vote comes down and a few of your Committee colleagues do not hold themselves to quite as high a standard as you do, and the votes are to not even put any of the six on a watch list. Next quarter, when you reconvene, the five funds that concern you have underperformed again, and the Committee still decides to take no action with regard to them.

Is this outside the realm of possibility? I don't think so. Do I think this is happening for real? I don't know, I've never done a study to see whether this practice actually occurs. Do I think this could happen? Absolutely!

This case was just filed on March 11, so there are as of yet no interesting twists and turns, but as this appears to be the first of a genre, I thought you should read about it here.