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Pension Plan Sponsors Take Freewheeling Fund Companies to Court

Lawsuits raise the question of whether sponsors have a handle on risk.

Do fund companies have too much control over the risk they take on behalf of pension plan participants? When the typical 2010 target-date fund fell 24 percent in 2008, more than two thirds of defined contribution plans felt the shock. If a flurry of lawsuits is any sign, many plan sponsors have decided that their fund managers were reckless with what should have been low-risk portfolios.

Experts disagree on whether sponsors are in the driver’s seat. “They should not feel they’re on the receiving end of anything,” says Chris Lyon, a consultant with Norwalk, Connecticut–based Rocaton Investment Advisors. Given the variety of target-date funds, Lyon adds, if a provider offers just one, the plan sponsor can always move to another provider. Besides, he notes, 2010 target-date funds still did better in 2008 than the Standard & Poor’s 500 index, which fell 37 percent.

Sponsors can follow postcrisis guidelines drawn up by the Securities and Exchange Commission and the U.S. Department of Labor, Lyon says. Last May, in their first joint effort, the two federal agencies sought to ensure that sponsors of and participants in target-date funds were better informed about asset allocation, risks and potential losses. Also, the Government Accountability Office told the DoL to make providers share more information on plan choices, expectations for retirement payouts, the consequences of different savings plans and management of target-date fund assets.

Some think such oversight is long overdue. “It’s a shame on everyone for not explaining [the plans] better,” says C. Frederick Reish, a partner at Los Angeles law firm Reish & Reicher who specializes in employee benefits law. Plan sponsors “have to be more diligent and knowledgeable,” Reish adds. In his experience participants sometimes have the false impression that their target-date plan will deliver a set amount on the date in question.

Then there’s unintended risk. Andrew Oringer, a New  York–based partner in the tax and benefits department of law firm Ropes & Gray, points to a recent class-action suit against Boston’s State Street Corp. filed by the sponsors of some 200 pension plans, including defined contribution schemes. In its October 2009 decision, the U.S. District Court for the Southern District of New York awarded $89.8 million to the plaintiffs, who believed the fixed-income funds they chose were conservative, says their lead attorney, William Fredericks. Instead, State Street moved the plans to much riskier funds with significant exposure to mortgage- and asset-backed securities, Fredericks explains. “Two or more asset funds may appear identical on the surface but have dramatically different risk profiles,” warns Susan Mangiero, a Trumbull, Connecticut–based risk management and valuation consultant.

Investment program designer Ronald Surz, president of  Target Date Solutions in San Clemente, California, is an outspoken critic of target-date fund marketing. Dismissing much of it as “gimmickry,” Surz warns sponsors to make sure they’re in control.

Recent lawsuits have charged money managers with flouting plan investment guidelines, notes Dennis Logue, a management professor emeritus at Dartmouth College and chairman of Hanover, New Hampshire–based Ledyard National Bank. Such breaches take control away from plan sponsors and put portfolios at risk, Logue says. One suit alleged it was inappropriate for a fund to use the S&P 500 index as a benchmark because it had bought securities whose risks were incompatible with large-cap investing. Logue sees some managers declaring their funds multicap and multistyle to protect themselves, after the fact, from accusations of violating mandates.

Pension funds routinely lend securities to brokerages for use in short sales. But Logue cites a case in which the plan manager kept up that arrangement with Lehman Brothers Holdings long after the doomed bank’s financial problems were common knowledge. “The plan sponsors are suing,” he says.

In a similar case filed last year, the California Winery Workers Pension Plan accused San Francisco–based Union Bank of investing $5 million in a Lehman corporate obligation bond. The cash came from the Fresno-based pension plan’s securities lending program, whose assets were designated for low-risk purposes. “If you’re told the primary objective of the fund is to earn reasonable return with no risk of principal and then you’re hanging out with Lehman in the summer of ’08, you’re a candidate for a suit,” Logue says.

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