Fiduciary Breach and Wells Fargo’s Lawsuit

Fiduciary Breach in the use of Proprietary Funds…

Since the Board of Governor’s of the federal Reserve System has been investigating, and uncovering, gross mis-deeds by Wells Fargo executives and the Board of Directors, perhaps they should also investigate the way they have been treating their employees 401(k) retirement savings plan as well….

The 401(k) industry took a major hit from a district court judge a last year when Minnesota district court judge David S. Doty granted Wells Fargo’s motion to dismiss in a  Fiduciary Breach case alleging the firm breached its fiduciary duty to the company 401(k) plan by offering proprietary target-date funds, and charging excessive fees.  There is no acceptable benchmark to determine suitability of these funds nor whether the fees are excessive, but historically, under the Investment Advisers Act of 1940 and ERISA regulations, the trading practice of providing conflicted advice was grounds for litigation, yet this judge went so far as to even disallow an amended compliant.

If district court judges continue to follow Doty’s methodology to not consider the rights of investors in their decision-making, our retirement system is certainly doomed for extinction.  If he had simply reviewed Section 206 of the Advisers Act, he would have had to acknowledge not only the possibility, but also the likelihood, that the fees were excessive and that the proprietary funds offered by Wells Fargo were conflicted investments.  Without allowing the case to move forward leaves his decision more than suspect.

The reality is that, as the complaint states,

…… since at least 2010, Defendants have engaged in a practice of self-dealing and imprudent investing of Plan assets by funneling billions of dollars of those assets into Wells Fargo’s own proprietary funds. Specifically, the Benefit Committee, with the knowledge and participation of Wells Fargo, the HR Committee, and the other fiduciary Defendants, selected as investments a class of mutual funds—known as target date funds—and designed and maintained a system to maximize the amount of Plan assets invested into those funds.”

“For the entire class period described herein, the Wells Fargo target date funds cost on average over 2.5 times more than comparable target date funds while, at the same time, substantially and consistently under-performing those comparable funds. The substantial cost inflation was due, in part, to the fact that, unlike the comparable funds, Wells Fargo double charged for its target date funds—charging fees for both (1) managing the target date funds themselves, and (2) managing the index funds underlying the target date funds.”

Summary Plan Description/Prospectus…

On January 1, 2011, Wells Fargo & Company published a “Summary Plan Description/Prospectus.”  In small print beneath the heading, the following disclosure is stated:
“This document constitutes part of a prospectus covering securities that have been registered under the Securities Act of 1933. Specifically, this Summary Plan Description is part of a prospectus covering shares of Wells Fargo & Company common stock issuable under the Wells Fargo & Company 401(k) Plan (“the 401(k) Plan”). Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of the securities offered under the 401(k) Plan or determined if this Summary Plan Description and Prospectus is truthful or complete. Any representation to the contrary is a criminal offense.”
 
This document also included a Quick enrollment feature:
“Quick enrollment is an enrollment feature that is available to any eligible team member who has not previously enrolled in the 401(k) Plan.   Quick enrollment provides a preset before-tax contribution rate of 2% of certified  compensation, with an automatic 1% increase to the contribution rate annually in March of each year up to 12% of certified compensation.  Contributions made using this feature are automatically invested in the Wells Fargo Advantage Dow Jones Target Date Fund closest to your normal retirement age (age 65) based on your date of birth…”
 
Historically, the years leading up to 2010 were a disaster for Wells Fargo Target Date investors… five funds that didn’t even exist in 2006 andWells Fargo 2007 were added in 2008, all of which averaged almost 30% in losses by years end in 2008.  Miraculously, in 2009, those same five funds experienced an average gain of over 27.5%.  This seemly unpredictable turn of events can be explained through the use of proprietary funds.  Wells Fargo “sold” their big losers in 2008 to the 401(k) Target Date Funds for exaggerated prices to shore up their own share prices during the 2008 meltdown when they had over-leveraged commercial loans to developers.  The so-called 2008 losses were unrealized, just as the gains in 2009 were unrealized.  Strictly speaking, this is a clear illustration of shadow banking and off-balance sheet accounting at work!
 
On January 5, 2016, Wells Fargo Institutional Retirement & Trust announced the introduction of a new Personalized Investment Product.  Wells Fargo Institutional Retirement & Trust, headquartered in Minneapolis, Minnesota, introduced Target My Retirement, “a personalized investment product for its 401(k) plan sponsors and participants. Target My Retirement takes its cue from the well-accepted target date approach to investment allocation, but the product’s innovation comes through the addition of more personal information about the investor, including an individual’s current financial and demographic information. Like a target date fund, Target My Retirement is cost-effective and can be used as a plan’s qualified default investment alternative (QDIA). Wells Fargo chose Morningstar Associates, a registered investment advisor and part of Morningstar’s Investment Management group, as the independent financial firm that will advise and construct the portfolios for those participants who choose or are defaulted into Target My Retirement in their 401(k) plan.”
 
Wells Fargo recognized the fact they were in violation of fiduciary requirements as defined by both the Security and Exchange Commission as well as ERISA, so they privatized their Target Date funds, moving away from proprietary funds.  I doubt very much that Morningstar’s Investment Management group will be investing in Wells Fargo proprietary funds at any time in the near or distant future.  Meanwhile, the ultimate losers are once again the investors, victimized by not only the individuals responsible to act prudently with the best interest of the investor as a priority, but also, as in the case with Wells Fargo retirees and 401(k) investors during the financial meltdown years, by our very own district court legal system.  I say shame on both Minnesota District Court Judge David Doty, as well as the Wells Fargo defendants, for their gross indiscretions while holding positions of fiduciary responsibility.
 
In case Judge Doty wants to review his decision in this ERISA related case…
PlanSponsor, an online newsletter for employers offering retirement plans for their employees, published an article in March, 2012, written by Stephan M. Saxon, a partner with the Washington-based Groom Law Group. Groom is one of the preeminent employee benefits firms in the country. I have attached a portion of Saxon’s article that perhaps Doty should have reviewed before handing down his final ruling, and one which the Board of  Directors with Wells Fargo should read as well, governing the use of proprietary funds for 401(k) investments:
  “Prohibited Transaction Exemption (PTE) 77-4 permits Principal to invest client plan assets into proprietary mutual funds through target-date funds or other insurance company pooled separate accounts.  In exchange for relief from ERISA section 406, fiduciaries relying on PTE 77-4 must abide by certain conditions imposed by the exemption: (1) the prohibition against payment of sales commissions by a plan in connection with the purchase or sale of mutual fund shares; (2) the prohibition against the receipt of “double” investment advisory fees by the fiduciary or its affiliates, with respect to the investment of shares for the period of the investment; (3) the limitation of redemption fees payable by the plan; (4) the requirement that certain disclosures are sent to a second fiduciary, named fiduciary or trustee of the plan that must approve the purchase or sale of the mutual fund shares; and (5) the approval, in writing, by the plan fiduciary of any change in the rate of fees to be applied to the plan.” (source:  Groom Law Group, Washington, DC)

 

 

 

 

 

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Author: Dennis Myhre

Mr. Myhre can be contacted at..... dmyhre@fiduciaryfactor.com