Santomenno v. John Hancock: Does It Matter That the 401(k) Service Provider Is Not a Fiduciary?

I wanted to comment at least briefly, or more accurately thematically, on the Third Circuit’s decision last week in Santomenno v. John Hancock, in which the Court held that John Hancock’s role as an advisor and service provider for a company 401(k) plan, by which it helped select fund options and administer participant investments, did not render it a functional fiduciary under ERISA for purposes of an excessive fee claim. It’s a well-reasoned and interesting opinion on a number of fronts, but what struck me as important about it relates more to broader issues than to the narrow details on which the decision itself turns. Personally, I think the 30 page decision itself does a wonderful job of laying out the issues and explaining them, something which is not always true of appellate decisions concerning the technicalities and complexities of ERISA class action cases, making the source document here the best place to turn for a full understanding of the details of the decision. This is not always the case, as some decisions of this ilk are simply too dense or otherwise difficult to penetrate to go first to the opinion itself, rather than to secondary sources – such as blogs and client alerts – for a full understanding of the case.

If you want to skip reading the case itself and instead go to commentary on it that sums up the central facts, Thomas Clark, who has staked out a firm position in the blogging world as one of the more scholarly analysts of fiduciary duty litigation, recommends some summaries in his post on the case. His recommendation is good enough for me in that regard, so I would refer you to his post and the summaries about the opinion for which he provides links.

For me, I was struck, as I noted, by some thematic, big picture aspects of the decision, and I wanted to discuss three of them in a post. First, in speeches, articles, presentations and even in small group meetings with clients, I often make the point that service providers to 401(k) plans are very good at structuring their contracts and relationships to avoid incurring fiduciary status. Most recently, in providing an update on ERISA litigation to an ASPPA conference, I discussed this point in the context of explaining why it is such a smart strategy: because it is simply not possible to predict the next theories of ERISA liability that the class action bar will pursue (did anyone foresee the rise of church plan litigation? I didn’t think so), the best strategy open to plan service providers is to avoid assuming fiduciary status at all, thus defanging new theories of liability without even knowing what they will be. The opinion in Santomenno provides a very detailed explanation of the contractual structure by which John Hancock avoids fiduciary status despite its intimate involvement with the plan’s assets and investment options, and as such it does a beautiful job of making my point; the Court demonstrates exactly the subtle, intelligent, thoughtful and carefully planned structure that insulates the service provider from incurring fiduciary status.

Second, I have long been a critic of a habit some courts have of, in a nutshell, jumping the gun and deciding complex ERISA cases prematurely, without first allowing the facts to develop to a sufficient level. I understand the impulse – ERISA litigation, and class action litigation in general, can be very expensive as well as disruptive to plan sponsors, and courts can often be sympathetic to the desire to avoid unnecessary litigation in circumstances where the likely outcome of the case can be anticipated at an early stage. I recently listened to one well-regarded federal judge address a law school class after a motion session, when he commented – in a different context entirely – on the fact that we have created, in the federal court system, a Maserati, a beautiful machine but one that most people can’t afford. Early resolution, such as at the motion to dismiss stage, of lawsuits that are unlikely to end up any differently later on is an antidote to this problem.

That said, however, this mindset can often lead to cases being decided too early, with regard to the question of whether a court has enough information to really get the nuances right. All too often, judicial opinions in ERISA cases issued at the motion to dismiss stage – or on appeal from an order granting a motion to dismiss – end up reading more like a law review article than a judicial decision because, by being decided without much factual development having yet occurred, they end up being based more on hypothesis and assumptions about the world of service providers, investments, fees and the like than on the actual realities of those worlds. This is a problem with a simple solution, which is for courts to avoid making significant doctrinal rulings without first having a well-developed factual record. You can see this, but from the good side, in Santomenno, in which the Court had access to significant factual information, including the relevant contractual documents, and fashioned a ruling around – and dependent upon – those facts. It makes for a far more compelling and weighty decision than would otherwise be the case. It is for me, in any event, an approach that makes me give far more value to the Court’s reasoning and makes me far more likely to be persuaded by the Court’s reasoning.

Third, the case illustrates, and the Court even alludes to briefly, a point that I think is very important and which I often raise in a variety of contexts involving ERISA litigation. This is the question of whether systemically it matters whether John Hancock or a similarly situated service provider is or is not a fiduciary, and the answer is that, generally speaking, it does not matter. Sure, it may matter to the participants and their lawyers who are looking for a deep pocket, and it certainly may matter to the business model of the service provider, but it shouldn’t actually matter to the ERISA regulatory and enforcement regime itself. As I have written many times, including too often to count in this blog, ERISA is essentially a private attorney general regime, in which the idea is that private litigation and even just the threat of it enforces proper behavior within the relevant industry. That occurs here regardless of the fact that John Hancock and other such vendors are not considered, in this context, to be fiduciaries who can be held liable, as a breach of fiduciary duty, if the expenses and fees in a 401(k) plan are too high. And why is that? Because the system outlined in Santomenno is one in which the vendors may not be fiduciaries, but they are obligated to provide sufficient information and control to the actual fiduciaries – those appointed by the plan sponsor to run the plan – to allow the actual fiduciaries to make informed decisions about the investment options and the fees. Importantly, the system as viewed and approved of by the Santomenno court is one in which the actual plan fiduciaries bear financial liability if they don’t use the power granted to them by the vendor to police fees and expenses, thereby resulting in excessively high expenses. In that circumstance, the named fiduciary becomes liable for that problem. As a result, even without the service provider being deemed a fiduciary, the system still captures the risks of excessive fees and requires action – only by the plan sponsor and its appointees rather than by service providers such as John Hancock – to ensure that the problem is either avoided or remedied.