Fidelity Freedom Funds: ‘Unsuitable’ in One Fee Lawsuit, ‘Excellent’ in Another

Walcheske Alleges WEC Energy Fiduciaries Imprudently Chose Fidelity Freedom Target Date Funds, But One Day Later Capozzi Sues Illinois Tool Works for Not Choosing the Same “Excellent” Fidelity Freedom Funds

By Daniel Aronowitz

If you thought there was any merit to the surge of lawsuits alleging fiduciary malpractice by the fiduciaries of America’s large defined contribution plans, the two filings in the second week of May will disabuse you of that notion.   On May 10, the Walcheske law firm sued WEC Energy Group Inc. alleging that the defined contribution plan fiduciaries imprudently chose the “high risk and unsuitable” Fidelity Freedom active target-date funds for their plan participants.  But on May 11, the Capozzi law firm sued Illinois Tool Works, Inc. for offering company-created target date funds, which was purportedly “baffling given the number of excellent target date suites available on the market.”  The “excellent” alternatives that Illinois Tool Works fiduciaries should have chosen?  The target-date funds offered by T. Rowe Price, American Funds, and Fidelity.  Yes, the same Fidelity Freedom active target-date funds that Walcheske says are evidence of malpractice in the WEC Energy case.

But wait, there’s more.  These are the same exact Fidelity Freedom target-date funds that the Capozzi law firm has claimed in numerous lawsuits constitute evidence of fiduciary malpractice because of “miserable” performance.  We cannot make this stuff up.  The Capozzi law firm has contradicted its claims against Illinois Tool Works in many lawsuits.  In 2022, the Capozzi law firm has filed seven fiduciary malpractice lawsuits against plans with Fidelity Freedom target date funds:  (1) Boston Children’s Hospital; (2) DISH Network; (3) Beth Israel Deaconess Medical Center; (4) L3 Harris; (5) 99 Cents Store; (6) Rush University Medical Center; and (7) Univar.  This is on top of many other lawsuits alleging imprudence in selecting the Fidelity Freedom active target-date funds, including cases against LinkedIn, MedStar Health Inc., Zachry Holdings, Inc., Prime Healthcare Services Inc., Quest Diagnostics, Omnicom, and CommonSpirit.  This is not even a complete list, but enough to make our point.

The Fidelity Freedom Funds cannot be “unsuitable” and “excellent” choices for fiduciaries at the same time.  Every one of these lawsuits should be thrown out and the plaintiff law firms should be sanctioned, to reimburse every defendant and fiduciary insurer that has had to fund the defense of these irresponsible lawsuits.  But let us take the opportunity to prove why the Fidelity Freedom Funds are prudent choices by the fiduciaries of any defined contribution plan.  We will use the allegations of the Capozzi law firm in the Illinois Tool Works case, and the work of the excellent O’Melveny attorneys in the amicus brief they filed in the CommonSpirit appeal before the Sixth Circuit Court of Appeals.  We will also quote from a recent investment report by Morningstar, which is an authority on mutual fund investments.

1. Capozzi’s Proof that Fidelity Freedom Funds are High Performing, Suitable Investments: In Illinois Tool Works (ITW), the Capozzi complaint alleges that ITW fiduciaries acted imprudently by failing to provide different glide paths in its target date funds:  “the performance of the ITW target date funds were identical from 2040 to 2065 and failed to change to become less risky as the funds grew closer to an expected retirement date.”  The complaint then offers “alternate[]” target-date funds in charts for each glide path.  Here is the 2040 glide path comparison of the ITW target-date funds to the “excellent” alternatives [we are assuming that the complaint is using one-year, five-year, and ten-year returns]:

Capozzi has filed numerous lawsuits claiming that (1) the Fidelity Freedom active funds have under-performed other purportedly comparable alternatives; and the (2) Fidelity Freedom active funds are imprudent for any fiduciary to choose over Fidelity’s index funds, because the Fidelity index funds have out-performed the active funds.  In many lawsuits, for example, Capozzi alleges in cookie-cutter fashion that “[t]he active suite is high-risk and unsuitable for plan participants.”  Capozzi further alleges that no prudent fiduciary would have selected the “dramatically more expensive” active suite because it is “riskier in both its underlying holdings and its asset strategy.”  Using a chart of purported returns against alternative funds from other companies, Capozzi alleges that the active suites has experienced “miserable performance” and “inferior returns” when measured against any of the other most widely utilized TDF offerings from American Funds, T. Rowe Price, Vanguard, and J.P. Morgan.  Capozzi further alleges that the plan fiduciaries selected the “riskier and costly Freedom funds (the “Active Suite”)” instead of the “substantially less costly and less risky Freedom Index funds.”  According to the complaints, the choice of the Fidelity Freedom active funds and failure to remove them “constitutes a glaring breach of their fiduciary duties.”

The investment return chart filed by Capozzi in the ITW case undermines all of these fiduciary malpractice lawsuits and hyperbolic claims of imprudence, because it shows just the opposite:

• First, it shows that the Fidelity Freedom active funds have comparable returns to quality competitors like T. Rowe Price and American Funds.
• Second, it shows that the Fidelity Freedom active funds have not lagged the performance of Fidelity’s index target-date funds, and remain a prudent choice – with good returns, even adjusted for the higher active fees. The Fidelity Freedom active funds had a slight dip in relative performance after five years, but outperformed in the last year, and has outperformed the index funds on a more appropriate ten-year investment horizon.  Importantly, every single fiduciary malpractice case against Fidelity Freedom funds are based on a slight dip in performance on the five-year track record that has been reversed with good long-term performance.  There is no statistical evidence that Fidelity Freedom funds have any performance issues.

2. Fidelity Proved that the Fidelity Freedom Funds Have an Excellent Performance Track Record in the CommonSpirit Case: As we have previously reported, Fidelity finally responded to the attack on the company’s Fidelity Freedom funds by filing an amicus brief in the CommonSpirit Health case before the United States Court of Appeals for the Sixth Circuit.  The amicus brief demonstrated with investment statistics that the Freedom Funds have delivered strong performance, net of fees, over the relevant time period.  According to Fidelity, with the more appropriate longer term perspective of a ten-year horizon, “the Freedom Funds [] delivered higher returns than their Fidelity Index Fund counterparts over the trailing one-year, three-year, five-year, and ten-year period across every target-date vintage.”  Over the full ten-year horizon, according to Fidelity’s amicus brief, the Freedom Funds have outperformed their Freedom Index Fund counterparts net of fees by an average of more than 50 basis points annually.

The O’Melveny brief is a masterful defense of active investing and the Fidelity Freedom active funds.  It proves conclusively that the numerous complaints filed by the Capozzi law firm alleging inferior returns by the Fidelity Freedom active funds are just plain wrong and should be rejected by courts.

3. Morningstar Validates that Fidelity Freedom Funds are Prudent Investments: On January 20, 2022, Adam Millson of Morningstar did a full investment report of Fidelity Freedom target-date funds and labeled them “A Solid Choice Among Target-Date Series.”  Morningstar gave the funds an analyst rating of four out of five stars in the silver category [with the higher-fee K share class earning a still high-quality Bronze rating].  The report summarizes that the “robust asset-allocation team, research-intensive approach, and strong underlying funds makes the Fidelity Freedom target-date series a compelling option for retirement savers.”  (emphasis added by Euclid).  The report highlighted that Fidelity Freedom funds have “a solid long-term record. Over the past decade through December 2021, only three of the funds in the series (K6 share class) failed to outperform their respective S&P Target Date Index benchmarks. On a risk-adjusted basis, results were more in line with the bogy and fell near the 37th percentile on average relative to category peers.”  Morningstar attributed the “outperformance” of the Freedom Funds based on the “strong active managers”:  “Over the past five calendar years, the underlying managers have positively contributed to performance in all but one year.  Over the entire period, half of the 24 funds with a five-year record landed in the top quintile relative to their respective category peers.”

We are not claiming that Fidelity Freedom funds received a perfect report from Morningstar, but only that the report validates that the funds represent a prudent choice by a plan fiduciary.  Stated differently, there is nothing in the comprehensive report that should allow a plaintiff firm to allege fiduciary malpractice and seek millions of dollars in damages on behalf of plan participants.

The Euclid Perspective:  The contradiction between the WEC and ITW lawsuits is breathtaking.  One purported “excessive” fee lawsuit claims that Fidelity Freedom funds are unsuitable investments and evidence of malpractice, and the other uses the Fidelity Freedom funds as evidence of an excellent alternative investment choice.  Capozzi alleges the same Fidelity Freedom funds have excellent performance in ITW, but asserts with typical Capozzi hyperbole that the same exact funds have “miserable” performance in many other cases.

It demonstrates that plaintiff law firms are not qualified to serve as the regulators of fiduciary prudence.  The courts need to shut down these purported investment imprudence cases.  But if the courts cannot see through the hypocrisy and lack of credibility, then the Department of Labor regulators need to step in and restore justice and fairness.

Finally, the main purpose of this blogpost is to expose the lack of credibility of investment imprudence cases.  But we continue to have concerns when Fidelity or other investment providers allow large plans to be invested in the wrong share class.  If a large $1.66b plan like WEC Energy is invested in the higher-fee K shares as Walcheske alleges, this is problematic.  We are the first to defend Fidelity when plaintiff firms improperly allege investment underperformance of the Fidelity Freedom funds, but we will not defend Fidelity if they are overcharging fiduciaries by using the K or other higher-fee share class when these plans are eligible for lower fees.  Fidelity and other investment providers should be accountable to reimburse any alleged overpayment based on share classes.  If this will not happen under existing fiduciary law, then plan sponsors need to demand accountability with indemnification in the investment contracts.  We will continue to push hard on the need for this change.