NEW YORK - The lawsuit brought by New York Life Insurance Co. employees over how the firm manages its pension plans hasn't been settled, but already the litigation might be causing some industry experts to recommend changes in how plan investment options are chosen.
The class-action suit's contention that New York Life created a conflict of interests by using its own mutual funds as the only investments in its defined benefit and defined contribution plans isn't the sole concern. Consultants and attorneys are warning plan sponsors that they run the threat of participant lawsuits when they decline to drop high-cost, low-performing funds, or decide to add funds requested by participants without conducting a full search.
In the New York Life case, the employees who brought the suit argued the company "broke faith" with its employees and agents by investing its $4 billion in defined benefit and $2.8 billion in defined contribution assets only in the company's own line of mutual funds, the Eclipse Funds.
The employees contend New York Life used the assets to prop up the Eclipse Funds, a new line of mutual funds. The suit also contends New York Life charged its plans retail fees, which are too high for plans of their size.
Out of Eclipse
On April 1, New York Life transferred the defined benefit plan money out of Eclipse Funds and into separate accounts managed by the same money managers who run the Eclipse Funds, said George Trapp, the insurer's executive vice president.
Company executives intend to keep the defined contribution assets invested in Eclipse Funds. "Most plan participants like mutual funds and want daily valuation," Mr. Trapp said. "That type of investment structure fits very much on the defined contribution side." Currently, the two 401(k) plans offer a guaranteed investment contract, managed by New York Life Investment Management, and seven Eclipse funds, he said.
Meanwhile, plaintiffs in the case are asking the court to add anti-racketeering charges to their complaint. They argue that moving the defined benefit into separate accounts is an "admission by conduct ... that none of the pension plans' assets should have been invested in mutual funds in the first place," explained Eli Gottesdiener, who filed the suit. He is an attorney with Gottesdiener Law Office, Washington.
Executives administering New York Life's plans did not investigate outside investments for their plans, Mr. Trapp said.
"We did not feel the need to do that," Mr. Trapp said. "We felt the investment options were available within New York Life. There is a specific (regulatory) exemption for financial services companies that recognizes that it would be foolhardy (for financial service companies) to be forced to go outside to invest their own money."
New York Life moved the defined benefit assets out of mutual funds as a result of an asset allocation study begun in 1999 by outside consultant DeMarche Associates Inc., Overland Park, Kan., explained Mr. Trapp, who chairs the board of trustees for New York Life's pension plans.
"Out of that study, the consultant recommended different types of asset classes and allocations we might consider," Mr. Trapp said. "We could not do everything we wanted to do within mutual funds. We're using the same managers but have more flexibility by doing it within separate accounts."
As a result of the DeMarche study, New York Life executives moved the overall asset allocation of the defined benefit plans to 60% equities and 40% fixed income from 50% equities and 50% fixed income.
Executives added private equity and both growth and value small-cap equities, Mr. Trapp said. They eliminated convertible securities and real estate. "We wanted to (make changes) in a rational way over a period of time. There is some savings on some of the fees, but that was not the primary issue or the only issue. Performance was the important factor."
However, New York Life shouldn't have used mutual funds, even institutional ones, for its large defined contribution plans because of costs, Mr. Gottesdiener said. "The fact that the funds throughout their existence have been dependent on the captive plans for one-half of their asset base demonstrates that the marketplace found Mainstay (the former name of the Eclipse Funds) undesirable, further indicating their unsuitability for the plans," he said.
Mutual funds uncommon
It is not common for defined benefit plans the size of New York Life's plans to use mutual funds, which include charges for services defined benefit plans do not need, like daily valuation, explained Michael Weddell, an attorney who works as a consultant for Watson Wyatt Worldwide, Bethesda, Md.
Nevertheless, the practice of using proprietary investment options in a financial service company's own defined contribution plan is fairly widespread, he said.
"I would recommend to a financial service client if they are using their own mutual funds or their own affiliate funds in a qualified plan that you have legal counsel review the plan and have an investment committee meeting to document why they believe that's a prudent decision despite the conflict of interest," Mr. Weddell said.
The New York Life case raises questions about how all plan sponsors - not just those in financial services - should select and monitor their investment options.
Many plan sponsors are hesitant to remove funds, even high-cost, underperforming ones, from their defined contribution plans because they fear participants will second-guess their actions if the funds rebound later, he said.
Sometimes the problem is not that an investment option cost 20 or 30 basis points more, but that the menu of options is not adequately diversified, is redundant, is accompanied by inconsistent education materials and lacks an oversight mechanism, said Ron Eisen, president, Investment Management Consultants Inc., Portland, Ore.
"Other companies may have a low-cost menu but participants use it foolishly," he said.
As for fees, Fred Reish, an attorney who specializes in retirement plan issues and partner in Reish Luftman McDaniel & Reicher, Los Angeles, said: "Most people in the benefits world would say buying retail for a very large defined benefit plan would generally be overpaying, and that would be a fiduciary breach. That's one of the issues that fiduciaries have to pay attention to. It may be difficult (for a lawyer) to argue mutual fund investment returns. It is not difficult to argue that a plan sponsor paid too much for a mutual fund. It's more dangerous for plan sponsors because it is much easier (for attorneys and courts) to calculate damages."