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A federal court has rejected an argument that it was imprudent to use mutual funds rather than collective trust funds or separate accounts in a 401(k) plan.
For the very most part, defendant American Airlines failed to win dismissal of charges in Main v. Am. Airlines Inc. (N.D. Tex., No. 4:16-cv-00473-O, 3/31/17) that it acted imprudently in forcing its employees into what were allegedly expensive, poorly performing mutual funds offered by American Beacon Funds, an affiliated investment company.
However, one of the issues alleged here was that they “breached their duty of prudence by failing to consider low-cost separate accounts and collective trusts as alternatives to mutual funds.” This is an issue that has been raised in a number of the more recent litigations. Here Judge Reed O’Connor of the U.S. District Court for the Northern District of Texas noted that the 7th Circuit in Loomis v. Exelon Corp. held that offering mutual funds instead of other lower cost alternatives is not imprudent. And that while it did not appear that the 5th Circuit has addressed this question, “the Court agrees with the reasoning of the 7th Circuit,” and finding that defendants had not breached their duty of prudence by offering mutual funds and failing to consider alternatives, dismissed that part of the claim.
The core of the plaintiffs’ claims relate to the use of American Beacon Funds in American Airlines 401(k) plan. AMR Corp., American Airlines’ parent company, created a line of mutual funds that were managed by another subsidiary of AMR Corp. This fund manager was later renamed American Beacon Advisors, Inc. in 2005, which was sold to Lighthouse Holdings, Inc. in 2008, for which AMR Corp. received an equity stake in Lighthouse Holdings, Inc. Plaintiffs contend that this sale was premised on American Airlines’ continued use of American Beacon Funds in the plan. Although American Airlines employed an independent third party to approve the continued use of American Beacon Funds in the plan, the plaintiffs alleged that this was done merely to “whitewash” American Airlines’ actions.
The plaintiffs alleged that a prudent fiduciary would not retain the American Beacon Funds because their funds:
- were more expensive than similar alternatives;
- underperformed compared to other similar investments; and
- were not included in other 401(k) plans.
To defeat a motion to dismiss, the court noted that a plaintiff must plead “enough facts to state a claim to relief that is plausible on its face,” and that a claim “has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged” – and that amounting to “…more than a sheer possibility that a defendant has acted unlawfully.” Moreover, the court must accept all well-pleaded facts in the complaint as true and view them in the light most favorable to the plaintiff.
Defendants argue that Plaintiffs have failed to set forth a valid theory of disloyalty because:
(1) An independent third party reviewed and approved the continued use of American Beacon Funds after American Beacon Advisors was sold to Lighthouse Holdings, Inc.
To which the court noted that “to say at this stage in the litigation that engaging a third party fiduciary establishes that Defendants acted loyally during the entire period of time that Plaintiffs complain of would require the Court to draw an impermissible inference against Plaintiffs.”
(2) Department of Labor regulations allow plan investments managed by the plan sponsor itself.
To which the court noted that “although federal regulations allow these exemptions, it does not relieve Defendants of their fiduciary duties.” Moreover it having been alleged that that those investment options either charged higher fees than similar options or that those options were underperforming and that Defendants failed to investigate the availability of cheaper alternatives, the court determined that dismissal was not warranted at this stage.
(3) The Plan did not include all American Beacon Funds and, in fact, not all American Beacon Funds were sold after Lighthouse Holdings, Inc. sold American Beacon Advisors.
To which the court said that agreeing with Defendants “would require the Court to draw inferences against Plaintiffs which is not permitted at this stage.”
Duty of Prudence
As for arguments for dismissal based on a duty of prudence, the court first noted that regarding an argument that defendants were imprudent by including American Beacon index funds that were more expensive than nearly identical index fund alternatives, and “drawing all reasonable inferences in favor of Plaintiffs,” concluded that they had “plausibly stated a claim.”
A second argument – that defendants were imprudent by retaining poor-performing actively managed funds, specifically the American Beacon Short-Term Bond Fund, the American Beacon Large-Cap Growth Fund, and the American Beacon Treasury Inflation Protected Securities Fund – was something the court noted that while it could take judicial notice of refutations by the defendants, “it may not rely on the parties’ opinion about what the proper inferences should be drawn from them,” and that the plaintiffs were not required to “plead facts tending to rebut all possible lawful explanations for a defendant’s conduct.”
Judge O’Connor also refused to dismiss claims based on:
- A failure to allege fiduciary status (“It is typically premature to determine a defendant’s fiduciary status at the motion to dismiss stage of the proceedings”).
- A failure to monitor (as in, the 5th Circuit had never acknowledged a fiduciary duty to monitor – “Even so, other circuits have recognized the claim,” and the court held that plaintiffs had “adequately alleged sufficient facts to support a duty to monitor claim…”).