The Walt Disney Co.'s defined contribution plan might not be the “happiest place on Earth” to adapt the marketing catchphrase of Disneyland.
Two lawsuits filed in U.S. District Court in Los Angeles by participants as class actions against Disney's investment and administrative committee accuse the committee and its members of a breach of fiduciary duty over lack of diversification in one of the plan's investment choices and seek damages for losses.
The Sequoia Fund, one of the investment choices in the $5.8 billion Disney Savings and Investment Plan, concentrated a large part of the portfolio's assets in a single stock, Valeant Pharmaceuticals International Inc., according to the lawsuits. The Sequoia prospectus states the fund “typically sells the equity security of a company when the company shows deteriorating fundamentals.”
But the fund “deviated from the sell strategy because it maintained a heavily concentrated position in Valeant,” states a suit filed May 19 on behalf of Jack Wilson and other participants.
In 2015, Valeant represented more than 30% of the Sequoia Fund's assets, said a second suit, filed June 28 on behalf of Patricia Du Vall. At the same time, the Sequoia Fund was the largest shareholder in Valeant, holding nearly 10% of its shares.
Plan managers should have recognized ample warning signs that the Sequoia Fund was an imprudent investment, the Du Vall suit states, claiming Valeant's “unconventional business model and non-traditional financial statements and metrics, was diametrically opposed to the fund's value policy.”
Even though Valeant's stock price fell significantly in mid-October 2015, the Sequoia Fund later in the month purchased more Valeant stock, leading to two of the fund's independent directors to resign, the Du Vall suit states.
Both lawsuits call the concentration in a single stock reckless.
A defined contribution plan should provide a way for participants to build assets for their retirement income savings without risk of an undiversified investment.
Fiduciaries must be held accountable for plan investment fund choices, and lawsuits often represent the only recourse participants have for doing so.
At the same time, participants must bear accountability for choosing to invest in a fund with a concentrated position, if they have sufficient information about the risk of such investments. Losses have a way of focusing attention. The lawsuits were filed only following the alleged losses. The cases should bring into focus education programs and details of investment choices provided to participants by plan sponsors.
The Sequoia prospectus states, “The fund is "non-diversified,' meaning that it invests its assets in a smaller number of companies than many other funds. As a result, your investment in the fund has the risk that changes in the value of a single security may have a significant effect, either negative or positive, on the fund's net asset value.”
As the Wilson suit states, the Disney executives should have provided “disclosures that would have warned and alerted plan participants about the material change in the fund's risk level and prudence as an investment.”
In such litigation, defendant plan sponsors face challenges to show that their investment committees acted in accord with their fiduciary duty to offer investment choices in the sole interest of participants and that participant education programs and fund disclosures were comprehensive so as to enable participants to understand risks and make informed asset allocation decisions.
They must also show that they, or their investment consultant, monitored the portfolios of the investment choices available to participants for unacceptable risk.
The more complex, sophisticated and higher risk a portfolio strategy is, the more challenging for a plan sponsor to meet its fiduciary duty, and the more risk it faces as becoming a touchstone for litigation.