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Circle Trust: A Problem Solved

Stable value funds are among the most sound and secure investments available to investors in 401(k) plans and other defined contribution plans. The funds invest principally in high-quality, intermediate-term bonds that are further protected by a wrap or investment contract issued by an insurance company or financial institution. Those contracts are designed to insure that investors in stable value funds will lose neither principal nor accrued interest.

With that said, how did a stable value fund find itself in bankruptcy and charged with violating ERISA by investing in imprudent and speculative investments by the Department of Labor (DOL)?

Beginning in 1998, the Trust Advisors Stable Value Plus Fund strayed from the fund’s investment guidelines, ultimately driving the fund into bankruptcy court last year. That’s the bad news. The good news? Thanks to the intervention of the Connecticut Department of Banking, the U.S. Department of Labor, and an independent third-party fiduciary, Fiduciary Counselors, the fund was shut down and the stable value promise of principal and accrued interest through the bankruptcy date was kept to investors.

The fund was established in 1998 pursuant to a declaration of trust by a Connecticut bank, Columbus Circle Trust Co., which was later renamed Circle Trust Co. In time, more than 1,500 retirement plans had more than $200 million invested in the fund. For a while, it posted exceptional returns. But by 2005, losses on inappropriate investments had driven the fund’s crediting rate so low that investors became concerned and regulatory authorities began to investigate its operations.

While regulators discovered that the bulk of the assets in the fund—about 75 percent of the total—were invested in a legitimate stable value fund operated by another financial institution, the remaining 25 percent of assets were steered into three investments that most stable value managers would not use in any amount. Addressing the SVIA’s annual forum in Washington, D.C., in October, attorney Michael Felsen, counsel for ERISA in the Department of Labor’s Office of the Solicitor in Boston, said those investments should have raised any number of red flags to anyone running a stable value fund. The questionable investments included:

• A hedge fund that invested in collateralized mortgage obligations and used inverse floaters to try to manage risk. It boasted of returns of 12 percent to 18 percent, which Felsen said “should have raised red flags all over the place.” It also warned that investors could lose some or all of their money and had vague investment guidelines that allowed the general partner to change investment strategy at any time.
  
  
• An investment company engaged in the sub-prime mortgage lending business that claimed a 17 percent return on a “safe” investment. It did not have a wrap contract, meaning it was not in compliance with accounting regulations for stable value funds. It was not liquid and, again, contrary to the tenets of stable value investing, was not benefit responsive, meaning it was not obliged to pay benefits at book value.
  
  
• Notes linked to an investment fund invested primarily in other hedge funds, which in turn invested primarily in stocks. These notes also were not wrapped, were not liquid, and were not benefit responsive.

According to the Department of Labor, the entities controlling Trust Advisors Stable Value Plus Fund, including the fund’s financial advisor, Trust Advisors LLC, breached their fiduciary duties by choosing imprudent investments not appropriate for a stable value fund, paying prohibited fees to interested parties, and self-dealing with plan assets. On October 3 of this year, the DOL announced a settlement with Circle Trust, Trust Advisors LLC, and certain other corporations and individuals, in which the defendants agreed to restore more than $8.8 million to 1,500 retirement plans that had invested in the fund and also pay a civil penalty of $886,364 to the federal government. Combined with money recovered through the liquidation of the fund by the independent fiduciary appointed in September 2005, Fiduciary Counselors of Washington, D.C., the settlement allowed all investors to walk away without any loss of principal and their accrued interest at the time of the bankruptcy.