Company Stock in Retirement Plans: Where Lies the Line Between Prudent and Imprudent Conduct?
Chris Carosa at Fiduciary News highlighted this New York Times article in his twitter feed the other day, in which the author argued that there is no reason, from the point of view of a participant/employee, to hold large amounts of company stock in a retirement portfolio (as opposed to, say, as part of a bonus plan or other compensation supplement that is external to a 401(k) plan or other retirement account). The author of the article makes a very persuasive case that, as a participant, holding company stock of their employer is a mistake, and violates basic, elementary rules of diversification and investment philosophy that any competent financial advisor would insist their clients live by. So, the author asks, how can it possibly make any sense to have company stock holdings in a 401(k) plan or to have company matches to retirement savings be in the form of company stock? The author’s answer, as you can tell from the summary above, is it doesn’t.
But if it doesn’t make any sense from the perspective of a participant, then how can it ever be a prudent decision for a fiduciary to offer it in the first place? A fiduciary is supposed to be acting as a knowledgeable expert and in the best interest of the participants, so if one accepts the premise that someone knowledgeable about retirement investing would not hold company stock in a 401(k) plan, then it would seem to never be in the interest of participants – and therefore compliant with a fiduciary’s obligations – to offer company stock in a retirement plan. Note that this question concerns general retirement savings of employee participants, and not ESOP holdings, which we know are deliberately and intentionally overweighted to holding company stock.
Now, this analysis needs one qualification. We all know that some companies do so well that employees and participants would be ill-served by not holding employer stock, and the returns on their retirement accounts would be severely reduced absent large holdings of company stock. All have heard the story of Microsoft millionaires (or Apple, or Facebook, or Google, or fill in the name of the tech company) but we also know that sometimes this has been true of employers in less glamorous industries as well (even if not to the same extent with regard to the appreciation of their stock). But these events are outliers in a bell curve, and are not the experience of most participants or of most employers offering company stock, just as the instances of company stock holdings going south, i.e., a stock drop, are outliers as well. For most participants in most plans in most companies, the potential gain certainly doesn’t outweigh the general risk, accepted in investment theory, of the accompanying excessive concentration of stock of any one company, which in this instance is the employer.
So, if this is the case, how can it ever be prudent to offer company stock in a 401(k) plan, and, if the stock falls in value, not have it be a fiduciary breach? Such an analysis would suggest that even holding or offering the company stock as an option is a fiduciary breach, as it is not prudent to offer it at all. But this is where ERISA meets the real world. The statute was not enacted in a vacuum, but was instead created by balancing competing interests. And the answer to the question, and the reason why such an argument would not succeed in a stock drop case, is that ERISA allows, to a certain extent, such holdings, so their very existence alone, without more, cannot constitute a fiduciary breach. The statute allows for it, so doing it can’t breach the statute.
And this, to a certain extent, is what Dudenhoeffer was about – the idea that a plan sponsor gets the protection of being allowed to do, without being accused of imprudent conduct, what the statute specifically allows, but is not insulated anymore than that from scrutiny of its conduct. So here, with regard to company stock, despite the idea that it is probably never prudent, as an individual retirement investor, to hold an excessive concentration of one company’s stock and in particular that of one’s employer, that alone cannot support a breach of fiduciary duty claim against a plan sponsor; instead, to impose fiduciary liability, that plan sponsor must have done something more than just offering that stock to employee participants.
Back to the Future: Learning from the Past and Looking into the Future of 401(k) Advisor Fees
So, my past two Mondays have been bookended by being quoted in a pair of excellent articles concerning the operation of 401(k) plans, one in Pensions & Investments and the other in Fiduciary News. The interesting thing about them is that one is about looking backwards, and the other about looking forwards. In the Pensions & Investments article (you can find the link here, but subscription is required; sometime copyright litigator that I am, I don’t do work arounds on these things), author Robert Steyer asks – and looks to answer – whether, and what, plans and their lawyers learn from settlements of major disputes involving other company’s benefit plans. The answer he finds, with help from me and a number of other lawyers who often look closely at settlements entered into by other lawyers’ clients, is that lawyers who represent plans see such settlements as a free look at what went wrong and how to plan future actions to avoid ending up sued for the same things.
In the second article, Chris Carosa of Fiduciary News looks into the future of plan advising, and at the type of compensation schemes that might work best in the brave new world of advising 401(k) plans. Chris points out that changes in the industry present an opportunity to adjust the compensation model for advisors to plans but I, wet blanket that I can sometimes be, point out in the article that such changes may raise questions of both liability and responsibility for a plan’s investments under ERISA.
Comparing and contrasting the two articles is worth doing, particularly if it provokes you to think a little bit about the inevitable process of dragging plan operations and advisor compensation into the future. As Don Draper once said, “Change is neither good or bad, it simply is.”
Me, Tibble, Pensions & Investments and Don Draper
With the Supreme Court hearing argument this month in Tibble, I thought I would pass along a link to this article in Pensions & Investments (registration may be required) on the case. Leaving aside (for the moment) the fact that I am quoted in the article, it is worth reading as a primer on the issues before the Court that are raised by the case. As the article makes plain, the case is not simply about the six year statute of limitations under ERISA, or about – as someone else quoted in the article notes – retail versus institutional share classes. Instead, it is a vehicle that could allow the Court to discuss many aspects of fiduciary duty in this context, and how they fit together with the statute of limitations. As such, the Court, if it uses the case in that way, could easily overturn a lot of apple carts, in much the same way that its discussion a few years ago in Amara, arguably in dicta and on an issue that was not expressly before the Court, upset a lot of assumptions about the scope of equitable relief under ERISA.
For my contribution to the article, I noted that:
“We need to clarify how the six-year statute runs,” said Stephen D. Rosenberg, of counsel at the Wagner Law Group, Boston. “The linchpin issue is whether a sponsor has a continuing duty. Do you have a continuing duty after six years?”
If the Supreme Court supports arguments by Edison 401(k) plan participants that fiduciaries can be held responsible beyond the six-year time limit, the ruling could encourage more fiduciary breach lawsuits, he said.
From a practical perspective, the answer to that question will impact plans in a number of ways, running from whether we will see a trickling off of class actions filed over excessive fees, to the costs of running such plans, to the level of diligence that plan sponsors and administrators will need to apply. All of these may vary depending on how the Court answers the question of when does the six year period start and end, and, perhaps more importantly, what events can start the six year period running again.
In some ways, to steal a line from an in-house benefits lawyer I know at a company with plans in place holding very large assets, it is almost like asking if you can sue Don Draper today for sexual harassment thirty years ago at Sterling Cooper. ERISA is no different than any other area of the law: there has to be a starting point and an ending point for the time period during which conduct can give rise to a suit. The multi-million dollar question posed by Tibble for the numerous plans out there is how do you determine those points in the context of investment decisions made by plans, where those investments may be held for many, many years.
What Does Spano v. Boeing Foretell About the Future of Excessive Fee Litigation (and about the Future Ruling in Tibble As Well)?
Tom Clark, who writes the excellent Fiduciary Matters Blog, gave me either a late Christmas or an early New Year's present when he forwarded me, last week, the district court's December 30th decision in Spano v. Boeing, which addressed numerous issues related to excessive fee litigation but, in particular, discussed the relationship of ERISA's six year statute of limitations to those types of claims. Tom has now done both you and me an additional favor in this regard, writing up an excellent post summarizing the decision, sparing me the ordeal of writing my own synopsis and you the time consuming - but rewarding - act of reading the opinion itself. You can find Tom's summary and analysis here.
From my perspective, the most interesting aspects of the decision relate to the impact on the theory of liability and on the defendants' theories of the plaintiffs' precision, at this point, in presenting their case. Tom references the same idea in his post, but I will discuss it in more detail here. For years, one thing that has jumped out from many of the district court and appeals court decisions that have run in favor of defendant fiduciaries and plan vendors has been the extent to which the plaintiffs' allegations and theories were of the blunderbuss variety, in which they broadly alleged conflicts of interest and the existence of both high fees and undisclosed revenue sharing. In many of those cases, the plaintiffs essentially never boiled their claims down to narrow, specific allegations (at the motion to dismiss stage) or evidence backed theories (at the summary judgment stage) supporting the existence of a particular fiduciary breach. As a result, the plaintiffs' theories often had holes large enough to drive a truck through, or, at a minimum, the statute of limitations or failure to prove imprudent conduct or whatever other theory was being pressed by the defendants. In many of those decisions, it was clear that a more narrowly and precisely tailored theory of fiduciary breach could have avoided the defenses raised by the plan fiduciaries, sponsors and vendors, forcing, at a minimum, a trial to resolve the claims (and thus likely a settlement of some nature, given the amounts at stake in many of the cases and corporate America's risk adverse nature and resulting preference for avoiding trials). I could walk you through many of those decisions and show you exactly how a more properly and precisely pled theory of fiduciary breach could have survived the motion to dismiss or for summary judgment that instead sunk the case.
Here, though, in Spano, you see a much more focused theory, which is not based simply on the premise that the fiduciaries had broadly erred by retaining and never dispensing with high cost funds, and did not essentially allege simply that certain types of investment or operational decisions are essentially wrong per se. Instead, what you see is a narrow focus on specific decisions and activities by which the fiduciary duty was breached, forcing the defendants - and in turn the Court - to address not whether the type of conduct in general violates fiduciary norms, but instead whether the particular fiduciaries acted imprudently under the specific circumstances that confronted them; that is a much harder claim to get tossed out by means of motion practice, and the Spano decision reflects that.
This is telling, in many ways, for the future, as the plaintiffs' bar gets better and better at framing fiduciary breach claims. As they get better at identifying, isolating and targeting specific alleged misconduct, their win rate is going to go up, and it won't be as common as it has been for prominent appellate rulings or major trial court rulings to go against them.
One other aspect of Spano that is worth highlighting is the Court's detailed treatment of ERISA's six year statute of limitations, given that some of the funds at issue where first selected more than six years before suit was filed, leading the defendants to seek to bar many of the claims related to those funds on the basis that they were time barred. This is, of course, essentially the issue pending before the Supreme Court in Tibble at the moment, and the Spano Court addressed Tibble and the Supreme Court history of that case in reaching its own determination on the statute of limitations issues. Essentially, the Court concluded that it was not enough to defeat the fiduciary breach claims that the original decisions to offer the funds in question occurred more than six years before suit was filed, so long as the plaintiffs could set forth an actionable fiduciary breach that took place within the six years before suit was filed that concerned the funds, above and beyond simply the preceding, and time barred, decision to offer the funds in the first place. Consistent with the theme of this post, the Court found that the plaintiffs had done so by showing, on the law and the facts, how the defendants had committed fiduciary breaches that post-dated the decision to offer the funds in question and within the relevant six year period; once again, the plaintiffs avoided barriers to recovery that had sunk earlier plaintiffs by focusing on the precise facts needed to keep their claims alive, rather than simply making broad and often un-nuanced allegations that could more easily be found to be time barred. And that, incidentally, is exactly what I think the Supreme Court will do in Tibble, finding that, first, the six year statute of limitations does not forever bar claims if the initial offering of the investment option, or selection of it, occurred more than six years before suit was filed, and, second, that instead the six year period is satisfied in those instances where the plaintiff can show a legally actionable breach within the six year period that is independent of the original decision to offer the investment option.
An Overview of 401(k) Litigation, Courtesy of Chris Carosa's Excellent Interview with Jerry Schlichter
Chris Carosa of Fiduciary News has a tremendous interview with Jerry Schlichter, who has carved out an important niche litigating class action cases against 401(k) plans. Schlichter has litigated nearly all of the key excessive fee cases of the past few years, and currently has one pending before the Supreme Court. I discussed the case he currently has pending before the Supreme Court, Tibble v. Edison, in an article way back after it was decided by the trial court, where I contrasted the trial court’s analysis of the excessive fee issues to that provided around the same time by the Seventh Circuit. You can find that article here.
Chris’ interview with Schlichter is important and valuable reading. The opposite of a puff piece or personality profile, it contains some real thought provoking comments on 401(k) plans and the risks of fiduciary liability, and I highly recommend reading it.
Interestingly, I am speaking next week at ACI’s ERISA Litigation Conference in New York on conflicts of interest and other ethical issues arising with regard to ERISA litigation. Chris, in his interview with Schlichter, goes right to the heart of the question, when he turns the conversation to the “obvious and serious conflicts-of-interest” that can exist in 401(k) plans given their structure, compensation schemes, and the sometimes contradictory interests of fiduciaries, participants and service providers. In the interview, Schlichter provides a nice window for approaching the issue, when he presents three key rules that he believes fiduciaries should follow, which are:
1) Putting participants’ interests first – this should be the beacon that fiduciaries follow; 2) Developing a fully informed understanding of industry practices and reasonableness of service providers’ fees – in other words becoming a knowledgeable industry expert; and, 3) Avoiding self-dealing – you simply cannot benefit yourself in any way.
A great deal of conflicts of interest in this area of the law can be avoided simply by keeping those three principles first and foremost. Indeed, many of the conflict of interest issues that I will be discussing next week on a granular level are violations, on a macro level, of one or the other of those three ideas.
Tatum v. RJR Pension Investment Committee: What it Teaches About Fiduciary Obligations
Somehow, RJR Nabisco has always been fascinating, from beginning to now. There must be something about combining tobacco and Oreos that gets the imagination flowing; maybe its the combination of the country’s most regulated consumer product with the wonders of possibly the world’s favorite cookie. Heck, its birth even birthed a book and then, in turn, a movie starring James Garner, whose mannerisms, in the guise of Jim Rockford, are imbedded to at least a slight degree in the personality of every male my age. Ever watch a late forties/early fiftyish lawyer try a case in front of a jury? Watch closely, and you will see at least a little Rockford in the persona.
Now, in the guise of a Fourth Circuit decision over breaches of fiduciary duty involving company stock funds, RJR Nabisco has become a touchstone for ERISA litigators as well. There are a number of takeaways and points of interest in the decision, which you can find here, and the decision has generated no small number of thoughtful commentaries over the past few weeks, some of which you can find here, here, here and here. Without repeating the yeoman’s work that others have already done summing up the case, I am going to run a couple of posts with my thoughts on two key aspects of the case.
Today, I wanted to address the question of the finding of a breach of fiduciary obligations, and I will, lord wiling and the creek don’t rise, follow that up with a post on the question of proving loss as a result of the breach. These are two interrelated issues in fiduciary duty litigation, and Tatum v. RJR has some interesting things to say, and to teach, about both.
Initially, as everyone knows, you cannot have a breach of fiduciary duty recovery without a breach of fiduciary duty. Here, the Court found a breach of fiduciary duty on the basis of the defendants’ quick and informal decision concerning whether to continue to offer company stock that was based as much as anything on myths and legends about holding company stock in a plan as it was on any type of a reasoned approach to the question. Concerned about the possible liability exposure under ERISA for holding an undiversified single company stock fund in a plan, a working group decided to eliminate the fund without actual investigation into the legal, factual, potential liability or other aspects of holding the fund. Further, they did so in a short meeting, without ever gathering any of the detailed information that would be relevant to making such a determination.
There is a real and important lesson here with regard to the manner of making any decisions with regard to plan investment options, and an additional one that is of particular significance with regard to a decision to eliminate an investment option, which was the event in RJR Nabisco that triggered potential liability. The general lesson is that the days of fly by the seat of your pants management of plan investment options are over (if they ever existed; people may have been doing it that way, but it was probably never legally appropriate to do so). Instead, a failure to properly investigate investment options, including using outside expertise to do so, has reached the point where it can essentially be considered a per se breach of fiduciary duty. It may not have that posture in the law, in the sense of pleading and proving it simply establishing the existence of a breach, but that fact pattern, at this point in time (and not simply because of the holding in RJR Nabisco, but because of a number of cases and legal developments leading up to the time of that ruling), will consistently lead to a finding of a breach.
The more specific lesson to think carefully about here is something very interesting, and to some extent ironic. The working group felt obliged to eliminate the investment option because of questions related to the liability issues of holding a non-diversified single company stock fund, but that is not the same question as whether it was in the best interests of the plan participants to hold, or to instead eliminate, that fund. It is the latter question, and not the former question which is primarily one that concerns the risks to the plan sponsor and those charged with running the plan, that is supposed to be at the heart of the decision making process when it comes to these types of issues. Fiduciaries must run a plan – subject to many limitations on that general principal – in the best interest of the plan participants, without regard to their own interests. That, in all areas of the law, is the basic premise and obligation of being a fiduciary. Here, the defendants’ fiduciary breach occurred because they failed to do that: they did not investigate or analyze the issue from the perspective of what was best for the participants but instead from the perspective of the risks to the plan sponsor and its designees (i.e., the fiduciaries).
When thought about that way, the irony becomes apparent. By being overly concerned about the liability risks of keeping the investment option, the defendants created liability exposure by getting rid of the investment option.
How to Trigger Insurance Coverage for an ERISA Claim
Well, how can I not comment on this, given the focus of both this blog and my practice? The Second Circuit was just presented with the question of whether an insurer has to provide a defense to a company and its officer, under the employee benefits liability portion of a policy, for an ERISA claim related to a retaliatory discharge/reclassification claim brought by an employee of the insured. The employee claimed, in essence, that she had been retaliated against for complaining of sexual harassment.
Now, coverage by insurers for complaints alleging sexual harassment or similar claims under standard CGL policies have their own complicated backstory, revolving around the question of whether, no matter what is actually alleged in the complaint by the employee, the acts in question are intentional, dishonest or otherwise harmful in a manner that precludes coverage. Some of this history goes back to at least the 1980s, and, having been involved with a client’s rollout of the coverage, it played a role to some degree in the creation and eventual acceptance of EPLI – or employment practices liability insurance – coverage.
The insurer here took the same tack with regard to the ERISA claim at issue, and, given the history noted above and the nature of the claim, understandably so. The issue, though, as the Second Circuit found, is that the ERISA claim itself did not require any type of intentional misconduct, which is basically true across the board with most types of ERISA claims, and held that the insurer therefore could not deny coverage for the ERISA claim based on an exclusion for dishonest or malicious acts. The Court found that the ERISA claim could, in essence, simply be a claim for negligent conduct – at least as pled in the complaint – and thus the insurer could not deny a defense to the insured based on such an exclusion, which would not reach a claim of negligence.
There are a number of lessons here for both insured companies (and their officers) who are sued in ERISA cases and for their insurers. First, don’t assume that principles related to coverage of employment related claims will transfer to an ERISA claim; they may very well not do so. Second, you have to pay close attention to the true nature of an ERISA claim (including its key legal elements) before deciding whether or not there is coverage, and not simply to the surrounding factual allegations relating to the insured’s conduct (which in most harassment and similar claims are usually pretty egregious, at least as alleged by the plaintiff).
Anyway, here is the decision, which is Euchner-USA, Inc. v. Hartford Casualty Insurance Company, and here is an article providing a nice summary, for those of you who don’t want to read the full decision.
More on the Golf Course RFP
Susan Mangiero, one of my favorite experts on financial deals and transactions, was kind enough to post on my presentation to the Boston Regional Office of the Department of Labor, where I spoke on common mistakes by plan sponsors. I spoke as part of a day long training program that Susan presented at as well, even if she was too modest to mention it in her post, and I was very pleased and impressed by the audience, their participation and their questions. I have written before that I generally hold a high opinion of the Department’s staff, and the audience participation at the training session did nothing to lessen that opinion. Both in my primary talk, on plan sponsor mistakes, and during a subsequent panel that I participated in on litigation issues, fee disputes, and fiduciary governance of plans, the audience raised great points and asked pointed questions. One member of the audience shared with me an additional important mistake plan sponsors make, that I had not previously thought of as a significant problem, primarily because it is not one that arises in litigation but is instead more of a day to day compliance issue. There is nothing better as a speaker than having walked away having learned something from the audience that you did not know the day before.
Susan’s reference to the “Golf Course RFP,” which actually is a slide in my PowerPoint deck, concerns one of my chief cautions to smaller and mid-size companies, where benefit plans, particularly 401(k)/mutual fund programs, may be chosen by a company owner simply based on the vendors that are already in the owner’s social circle, such as, yes, those at his or her country club. If it turns out down the road that employees were paying too much for or getting too little from the plan, in comparison to what could have been located in the marketplace as a whole at that time, picking a plan’s vendor in that manner will most certainly come back to bite the company owner. Indeed, from a trial lawyer’s perspective, such a selection process would, in a fiduciary duty lawsuit over that plan, be a smoking gun used to show poor processes and a corresponding breach of a fiduciary duty. At the end of the day, RFPs aren’t normally conducted on a golf course, and this is one area of business life where it is especially important to remember that.
What if Trust Law Cannot Support the Moench Presumption?
The “stock drop” presumption of Moench, now before the Supreme Court in Fifth Third Bancorp, is best understood as a judicial attempt to balance the sometimes conflicting demands placed on corporate insiders by, on the one hand, the securities laws and, on the other, ERISA, when it comes to employee stock plans in publicly traded companies. It’s not an unreasonable tack to take, even if those perceived conflicts could be easily handled and avoided simply by the use of an outside independent fiduciary, as W.R. Grace did years ago in the situation that became the First Circuit case of Bunch v. W.R. Grace, which I discussed here, rather than using a corporate insider in that role.
The problem though, for those who believe that it is appropriate for the courts to find a way to balance those obligations, is how to get to that result. The terms of the ERISA statute itself don’t easily lend themselves to the creation, justification and imposition of the presumption, leaving the importation of, and reliance upon, doctrines developed under trust law to provide a basis for the creation of the presumption. But what if trust law, properly understood, cannot support the creation of a presumption of that much benefit to plan fiduciaries? Can the presumption stand if that is the case? The extent, nature and degree to which the Supreme Court grapples with these two issues – whether either the terms of the statute or the scope of trust law can support the presumption – will tell a very interesting tale, by illustrating whether the presumption’s status is actually driven by the legal foundation crafted by the statute and trust law or, instead, by an outcome driven need to balance the securities law regime with the dictates of ERISA. If the presumption is found valid, one will need to look closely at whether the Court was able to properly base that conclusion in the historical intricacies of trust law or in the statute’s language. If so, then the presumption can be understood to follow naturally from existing law; if not, then the presumption must be seen, as many have argued it is, as simply a convenient judicial fiction, one not properly founded on either trust law or statutory language, used to balance conflicting legal obligations imposed by distinct statutes.
Into this question rides Professor Peter Weidenbeck, in this absolutely fascinating article, “Trust Variation and ERISA’s ‘Presumption of Prudence’,” in which he details the history of the trust law basis on which the Moench presumption is said to rest, and finds that the trust doctrines relied upon by the courts that have created and applied the presumption do not support the presumption. In a nutshell, Weidenbeck argues "that prevailing state law standards governing trust variation do not impose the extremely restrictive (well-nigh insuperable) barriers that the federal courts following Moench mistakenly assume” and that deciding how to handle stock drop cases requires a more nuanced and comprehensive analysis of statutory history.
You can download his article here, and I highly recommend reading it. Even though it discusses tax issues and trust law, it is very readable, and only 24 pages in any event. At a minimum, the Supreme Court’s eventual opinion in Fifth Third Bancorp will make a lot more sense if you read the article first.
Ayres is Wrong, and Hecker is Wrong: Establishing a Fiduciary Breach Through Excessive Fees
A further thought on Ayres’ focus on what he calls dominated funds, namely funds with higher than necessary fees that nonetheless contain a disproportionate amount of a 401k plan’s assets, and whether their inclusion by a plan sponsor should be seen as a fiduciary breach. As I discussed in a recent post, it’s a viable theory, and a welcome antidote to the very low bar set by the Seventh Circuit in Hecker on the question of fees when it found that simply including lots of funds with fees set by the market as a whole represented a sufficient effort by fiduciaries when it came to protecting participants against unnecessarily high fees. However, as I also pointed out in my recent post, the Eighth Circuit, in Tussey, cabined that mistake by the Seventh Circuit, without needing to take the broader step urged by Ayres, which is to treat the excessive use in a plan of one fund with higher fees, in and of itself and without anything more, as a breach (as Ayres and a co-author argue for here). It is probably a bit much to say that this later circumstance, without more (such as the circumstance being caused by a mapping strategy that benefits a plan sponsor by driving down operational costs), should be enough to impose liability for breach of a fiduciary duty.
And why is that? Probably because such an approach applies a very paternalistic view to 401k plans, employees, and their employers (in the guise of plan sponsor and/or plan fiduciary). Ayres’ thesis presumes the existence of low cost – presumably index – funds within a plan, along with higher cost funds, and assumes that it is effectively a breach to allow funds to flow into the latter. It seems to me, though, that it places too low a burden on participants, and gives them too little credit. If there are a range of funds available in a plan, and mapping or other decisions are not driving employee withholdings into the higher priced funds, then it seems to me participants should be free to make their own call on what funds to hold. Further, unless one accepts the premise that no knowledgeable investor would ever use any fund other than the lowest cost funds (which requires living under a presumption that only index funds or similar passive investing funds can ever be an appropriate investment), then it is not legitimate to say that a prudent person in the position of the plan fiduciary could not make available higher cost funds along with lower costs funds. If that is the case, then it cannot be a breach of fiduciary duty to include such a range of funds in a plan – even if it results in some participants over investing in the higher cost funds.
In essence, while the Seventh Circuit – as I have often said and written – was wrong to believe that the inclusion of many funds is enough to preclude a breach of fiduciary duty by the inclusion of investment options with excessive fees, so too is the premise that simply having an excessive amount of assets invested in a higher price product that is included among many funds with varying fee structures is enough to constitute a breach. The truth, as with most things, lies somewhere in between – you need more than simply excessive investing in a higher priced fund, and less than simply inclusion of many fund choices, to have a fiduciary breach based on the costs of the investment options in a 401k plan.
Tussey v. ABB - Opening Up New Avenues for Excessive Fee Litigation and Putting the Final Nail in the Coffin of Hecker v. Deere
This Forbes opinion piece by Yale Professor Ian Ayres is interesting for two things, one of broader relevance and one of interest perhaps to me alone. In it, he argues that our analysis of excessive fees as a potential fiduciary breach should not be based solely on fees in general, but also on an analysis of whether excessive amounts of plan assets are being placed into the one or two investment options in a plan that have particularly high fees, rather than in the many other investment options in a plan that have lower fees; those lower fee options give a plan the image of having reasonable fees, by balancing out the fees charged in the more expensive options. He suggests that Tussey v. ABB should be thought of and analyzed as a case concerning this type of a fiduciary breach, where the problem with the fiduciary’s conduct was the decision to map plan assets into higher fee funds for the benefit, in the longer run, of the plan sponsor. This broader argument for rethinking how we analyze fiduciary prudence in the context of fees opens up new avenues for prosecuting fee claims, but also raises a red flag that prudent and conscientious plan sponsors need to pay attention to; namely, is the overall structure of plan choices optimal for the participants, rather than just whether there are some low cost choices open to the participants who are sophisticated enough to want to avoid the higher cost options. In essence, it is an argument that plan sponsors who want to do a good job for their participants need to see the forest, not just the trees, in structuring a plan.
And this is important because, jaded and cynical as I may be after litigating ERISA disputes for decades, I still think most plan sponsors are truly motivated to put together a strong plan for their employees, and are not motivated – at least not knowingly and consciously – by nefarious purposes. (Before people start bombarding me with emails and comments about their own experiences or particular cases they have been involved with that are to the opposite, note that I said “most,” not “all,” and that I made the word choice deliberately). Diligent plan sponsors who want to create the best possible plan would do well to keep Professor Ayres’ thesis in mind in formulating a plan structure and selecting its investment options.
I also said that the article was interesting to me, as well, on another level, one that may be of interest only to me. A few years back, right after the Seventh Circuit had decided Hecker v. Deere, I took the decision to task in an article,”Retreat from the High Water Mark: Breach of Fiduciary Duty Claims Involving Excessive Fees after Tibble v. Edison International.” In it, I argued that the Court was wrong to believe that having a range of fee options spread among many investment options was enough to defeat an excessive fee claim. Ayres likewise takes exception to the Seventh Circuit’s analysis in this regard, finding that it was not consistent with plan reality. To me, one of the most important parts of the holding in Tussey v ABB was not the float issue, heavily focused on by most reports, but the Eighth Circuit’s ringing rejection of the thesis, pressed by the Seventh Circuit in Hecker, that it was enough to defeat an excessive fee claim that a plan provided a range of investment options with a range of fees; the Eighth Circuit, in my thinking, put a well-deserved end to that line of argument, when the Court explained:
The ABB fiduciaries contend the fact the Plan offered a wide “range of investment options from which participants could select low-priced funds bars the claim of unreasonable recordkeeping fees.” In support, the ABB fiduciaries rely on Hecker v. Deere & Co. (Hecker I ), 556 F.3d 575, 586 (7th Cir.2009), Loomis v. Exelon Corp., 658 F.3d 667 (7th Cir.2011), and Renfro v. Unisys Corp., 671 F.3d 314, 327 (3d Cir.2011), which the ABB fiduciaries propose “collectively hold that plan fiduciaries cannot be liable for excessive fees where, as here, participants in a self-directed 401(k) retirement savings plan that offers many different investment options with a broad array of fees can direct their contributions across different cost options as they see fit.” The ABB fiduciaries' reliance on Hecker I and its progeny is misplaced. Such cases are inevitably fact intensive, and the courts in the cited cases carefully limited their decisions to the facts presented.
I have always thought that Hecker was wrongly decided with regard to this issue, and that one of the reasons for the mistake was that the Court did not fully develop and analyze the factual context before reaching a decision. As a result, I don’t necessarily agree with the Eighth Circuit that Hecker is limited to its own circumstances by its own facts; I think it is limited to its own circumstances by its poor reasoning in this regard. Nonetheless, I can live with the Eighth Circuit approach, which I think all other courts are likely to follow as well, that Hecker’s erroneous analysis in this regard cannot control other cases because of the fact-intensive nature of the inquiry.
The International Paper Settlement and the Continued Vitality of Excessive Fee Claims
One of the first long articles I wrote on ERISA (I had already penned some opuses on patent infringement litigation and insurance coverage disputes) was on excessive fee litigation, and was based, at heart, on the Seventh Circuit’s then recent decision in Hecker v. Deere. Titled “Retreat from the High Water Mark: Breach of Fiduciary Duty Claims Involving Excessive Fees After Tibble v. Edison International,” the article set forth my view that, in Civil War parlance, the decision in Hecker, which was being highly trumpeted by the defense bar at the time as a major victory, was, in fact, little more than the high water mark for plan sponsors and vendors in defending against excessive fee class actions. My thesis was that, when the decision was broken down and analyzed in its constituent parts (and particularly with a focus on the Court’s reasoning), it was unlikely that the decision would be replicated, and more likely that other courts would come to different conclusions in the future that would validate excessive fee claims and invigorate the theory as a basis for class action litigation.
From where I sit, four years of court decisions, settlements and courtroom results appear to have borne out my prognosis. Humble scribe that I am, I don’t believe I have ever pointed out before that I was right in this regard, but, as Thomas Clark pointed out earlier this week in an excellent post on the FRA PlanTools Blog, the recent $30 million settlement entered into by International Paper is solid evidence that I was right.
My real purpose for writing today, though, was to pass along his post on the settlement, which does an excellent job of breaking down the issues, the claims, the alleged breaches, and the settlement of the International Paper case. It comprehensively covers everything any outsider to the litigation would want to or need to know about the case.
CalPERS and Passive Investing: A Couple of Thoughts
I have had a couple of interesting conversations recently about CalPERS considering going to index/passive investing. As I have noted in the past, if a major and highly influential pension fund goes that route, how long will it be until others follow, seeking both safety in numbers and the potential defense to breach of fiduciary duty claims of pointing to CalPERS’ decision as reflecting an industry-wide standard of reasonableness?
Two questions have come up in that event, however, in recent conversations I have had. First, how long will it be until fiduciaries who switch their plans to index and passive funds are sued by participants claiming they would have done better under actively managed funds, and that, given the make up of the particular participant base for that plan and their investment objectives, active investing was the prudent course? Second, and more fun/theoretical, is this: what happens when everyone follows along and goes index only? Who do you trade with on the other side of the deal, and what – if everyone is just moving along with the market index – drives the price one way or the other, when there is no one out there buying and selling in the hope of beating that index?
Both are simply theoretical concerns to a certain extent, and mostly entertaining thought experiments. But still, one has to wonder whether index investing can really be the answer to everything, in all circumstances. Seems to me that once upon a time all the funds in my 401k all held internet stocks at the same time to boost their returns, even when their stated investment objectives wouldn’t have called for those holdings, and that uniformity of approach didn’t work out too well for anyone. Maybe let a thousand flowers bloom in investment choices and approaches, anyone? Isn’t that what diversification is supposed to be – holding different categories of investments, selected in different approaches, rather than all holding the same portions of an index, all moving in lock step? One has to wonder.
The Lessons of First Data Corp's Suspension of 401(k) Contributions
There is a fascinating story in today’s Wall Street Journal, about First Data Corp. abandoning the practice of making cash contributions to employee 401(k) accounts, as part of cost cutting clearly designed to make the company more profitable (or at least profitable enough) to hold an IPO, which would allow an exit for the leveraged buyout group that had acquired First Data but has so far failed to improve the company’s prospects. As the article explains, First Data is instead going to make stock awards to all employees, but apparently outside of the retirement plan format. As best as one can tell from the article, the stock grants to employees won’t be made as part of an ESOP or some other type of retirement plan account, although the article is not entirely clear on this point.
We have seen for years the abandonment of pensions in favor of 401(k)s and similar plans that remove long term funding and investment risks from the sponsor/employer, and transfer those obligations and risks to employees. That is old news. What is new, however, and both interesting and troubling about the First Data story, is that it takes that transitioning of retirement risk from a company to its employees one step further, by replacing the cash contribution by the plan sponsor with the entirely speculative and risky grant of private stock, for which there is not even a current public market. In so doing, First Data has gone one step beyond simply the transitioning of employee retirement risk to employees by means of 401(k) plans, by removing the certainty – and cost to the company – of cash contributions in favor of paper awards that do not increase the employees’ current retirement assets. There are multiple problems with this step, viewed from the prism of retirement policy. First, we have all long counseled employees against excessive reliance on company stock in retirement planning, and in fact, it is a common refrain in defending against ERISA stock drop cases that employees in many cases could have and should have diversified out of company stock, but did not do so. This change by First Data effectively forces employees to have less cash to use for diverse investments in their 401(k) plans in favor of holding, apparently outside of the retirement plan, a concentrated amount of company stock. Second, and related to this, the company is reducing the cash in employee 401(k) accounts at the same time that the market is doing well as a whole (generally speaking), reducing the employees’ ability to invest broadly and keep up with the market; instead, they get company stock which, according to the article, is becoming less and less valuable each day.
A related and to me, fascinating, note on this is the fact that the stock grants, as noted above, may not be made as part of an ESOP or otherwise within the context and confines of an ERISA governed plan. If this is so, then the plan sponsors will avoid the obligations and potential liabilities that come with fiduciary status, when it comes to the granting of the stock and company decisions that impact the value of the employees’ stock holdings down the line. This is a very interesting and subtle point that should not be overlooked, particularly since the company is basically a creature, at this point, of the leveraged buyout industry and the real purpose of the changes in question are clearly directed at future transactions that would allow the current major investors to cash out. If they keep the employee stock obligations out of any ERISA governed plan, including an ESOP, the fiduciary obligations imposed by ERISA will not be implicated in or by any future transactions designed to unwind the stakes of current ownership. If those stock grants are instead placed in ERISA protected plans, in contrast, ERISA’s fiduciary obligations will serve as a check on any future complex transaction involving the company’s stock that might negatively impact the value of stock held by employees, in circumstances where those same events might positively impact those with control over the company and the majority of its stock. Those of you who recall the tortured history of theChicago Tribune’s ESOP and its role in a complex corporate transaction will recognize this point, and the risks and benefits incumbent in the decision to keep, or not, the stock grants within an ERISA governed plan.
My Journal of Pension Benefits Article on Operational Competence after Amara
For years, in speeches and articles, I have preached the gospel of what I have come to call “defensive plan building,” which is the process of systemically building out plan documents, procedures and operations in manners that will limit the likelihood of a plan sponsor or fiduciary being sued while increasing the likelihood that, if sued, they will win the case in the end. Over the past couple of years, doctrinal shifts related to remedies available to participants under ERISA have made defensive plan building even more important, for at least two reasons. First, these shifts have expanded the range of potential liabilities and exposure in offering, and running, a benefit plan. Second, these developments have, to a significant degree, given rise to an increased focus in ERISA litigation on the actual facts concerning the plan’s activities, as the lynchpin of the liability determination. The combination of expanding liability risks with an increased focus on plan actions makes it more important than ever to focus on the steps of defensive plan building, including by focusing on operational competence in running a benefit plan.
I discussed this concept in much greater detail in my recent article in the Journal of Pension Benefits, “Looking Closely at Operational Competence: ERISA Litigation Moves Away from Doctrine and Towards a Careful Review of Plan Performance.” The article discusses how the last several years of ERISA litigation, including in particular the Supreme Court’s recent activism in this realm, has created this phenomenon. You can find a much more fully realized presentation of these points in the article.
And a Third Post on Tibble: Thoughts on Revenue Sharing and the Small Recovery for the Class
A few more thoughts to round out my run of posts (you can find them here and here) on the Ninth Circuit’s opinion in Tibble. First of all, where does revenue sharing go as a theory of liability at this point? The Ninth Circuit essentially eviscerated that theory, and I doubt it has much staying power anymore, at least as a central claim in class action litigation. Revenue sharing hasn’t, generally speaking, had much traction in court, and I think it is because, at some level, judges understand that someone has to pay for the plan’s operations. That said, you should still expect to see it as a claim in cases against DC plans and their vendors, even if only as a tag along, with liability only likely to follow in cases where someone comes up with a smoking gun showing that the plan sponsor acted in ways harmful to participants specifically because of a desire to save money for the plan sponsor through its revenue sharing decisions. But revenue sharing in and of itself as an improper act or a fiduciary breach that can warrant damages? Probably not much of a future for such claims.
Second, there is a lot of talk about the expansion of litigation against DC plans and their providers, and has been for sometime now. How does that fit with the minimal recovery by the class in Tibble? To some extent, Tibble, although affirming a trial court award to the class, is not much of a victory, given that the class only recovered a few hundred thousand dollars. In fact, to call it a victory for the plaintiffs, while correct , reminds me of nothing so much as the comment of British General Henry Clinton after the Battle of Bunker Hill, when he noted, given the extent of British casualties, that “"a few more such victories would have surely put an end to British dominion in America." Likewise, a few more victories similar to this one for class plaintiffs in excessive fee cases will put an end to this area of litigation quicker than anything else could, as these types of cases simply would no longer be worth the costs and risks to the class action plaintiffs’ bar. However, it is important to remember that the dollar value of the recovery in Tibble was likely driven down substantially by the statute of limitations ruling, which took much of the time period of potential overcharging out of the case and with it, presumably much of the recovery. If participants bring suit over fees closer to the time that the investment menu that included the excessive fees was created, they will not face that barrier to recovery and the likely recovery could easily be high enough to justify the risks and costs of suit. This, interestingly, is where fee disclosure should come into play – participants, and thus the plaintiffs’ bar, should have enough information about fees to bring suit early enough to avoid the statute of limitations problem that impacted the plaintiffs in Tibble. As a result, there should be more than enough potential recovery in many possible excessive fee cases to motivate plaintiffs’ lawyers to pursue the claims.
Tibble, the Ninth Circuit and the Scope of the 404(c) Defense
Do they still teach administrative law in law school? I don’t know if they need to bother anymore, because the Ninth Circuit’s exposition of Chevron deference in Tibble, when discussing the 404(c) defense, pretty much sums up everything a practicing litigator needs to know about the subject. It is a first class explanation of the law of administrative deference, as well as a pitch perfect explanation of how one analyzes the issue.
Of import to ERISA, however, is a much narrower and more specific point, which is the Court’s cabining of the scope of the 404(c) defense so as to only encompass participant decisions that take place after the selection of the investment menu, on the basis that this reading matches the Department of Labor’s interpretation of 404(c). Based on this reasoning, the Ninth Circuit concluded that a fiduciary’s selection of investment options is not protected by 404(c). This is, at the end of the day, perhaps the most important aspect of the Court’s opinion, although in the immediate aftermath of the ruling it may well not be the aspect that garners the most comment and attention. However, it is really the one key part of the ruling that expands the scope of fiduciary liability and that adds to the arsenal for lawyers who represent plan participants, in that it clearly demarcates the selection of plan investments as an issue that falls outside of a 404(c) defense. Not only that, but the opinion does so in an articulate, well-reasoned manner, making it likely to have significant persuasive force when the issue is considered by other courts.
And the Ninth Circuit Swings Away at Tibble v. Edison . . .
Well, the United States Court of Appeals for the Ninth Circuit has affirmed the District Court’s well-crafted opinion in Tibble v. Edison. I discussed the District Court’s opinion in detail in my article on excessive fee claims, Retreat From the High Water Mark. From a precedential perspective, as well as from the point of view of what the opinion foretells about the future course of breach of fiduciary duty litigation in the defined contribution context, there is a lot to consider in the opinion. There is too much, in fact, for a single blog post to cover, or at least without the post turning into the length of a published paper. I try to avoid that with blog posts because otherwise, to misquote a poet, what’s a journal or law review for?
I plan instead, however, to run a series of posts, each tackling, in turn, a separate point that is worth taking away from the Ninth Circuit’s opinion. The first one, which I will discuss today, concerns ERISA’s six year statute of limitations for breach of fiduciary duty claims. The Court held that, in this context, ERISA’s six year statute of limitations starts running when a fiduciary breach is committed by choosing and including a particular imprudent plan investment. The Court held that the fact that it stayed in the investment mix did not mean that the breach continued, and the statute of limitations therefore did not start running, for so long as the investment remained in the plan.
Beware future arguments over this holding. You can expect defendants to regularly argue that this case stands for the proposition that the six years always runs from the day an investment option was first introduced, and that any breach of fiduciary duty claims involving that investment that are filed later than six years after that date are untimely. You can also expect defendants to argue to expand this idea into other contexts, and to ask courts to rule that anytime the first part of a breach began more then six years before suit was filed, the statute of limitations has passed. This would not be correct. The opinion only finds this to be the case where there were no further, later in time events that, as a factual matter, should have caused the fiduciaries to act, or which, under the circumstances of those events, constituted a breach of fiduciary duty in its own right; if there were, then those are independent breaches of fiduciary duty from which an additional six year period will run. Those independent, later in time breaches would presumably be their own piece of litigation, evaluated independent (to some extent) of the original breach.
Cut the Deficit, Not 401(k)s
I was somewhat stunned – and frankly, to some extent angered - by this article yesterday in Slate, in which a business school professor asserts that, if research from Holland does not support the idea that tax breaks motivate savings, one should do away with the 401(k). This completely misses the point that, in a country where the 401(k) is now effectively the only private sector retirement plan available to most employees, the tax break in question is a necessary element of increasing employees’ retirement assets, and is thus a retirement subsidy, not a savings incentive. As a result, the proper frame of reference for debating whether or not to maintain the 401(k) tax preference is that of retirement policy, in terms of considering whether or not it is the proper approach to creating retirement income for the American public; the proper frame of reference for debate is not the tax code, and the preference’s relationship to the deficit.
Amnesty and the Fee Disclosure Regulations
I like this piece here on the question of whether investment and financial advisors who foul up their initial efforts to comply with the fee disclosure regulations should be given a mulligan, and allowed to effectively self-report and correct without penalty. The proposal is to have the Department of Labor essentially run yet another type of voluntary correction procedure, which would then insulate advisors who have erred in complying with the new rules. While I am not in favor of a complete free pass for mistakes, certainly the middle ground on the idea staked out by one commentator, Craig Watanabe of California’s Penniall & Associates, who favors amnesty for honest mistakes but not for those that rise (or – I guess more accurately – fall) to the level of negligence, has merit.. Why? Because its not the easiest thing to implement and comply with a new regulatory regime of this nature, and it seems fair to allow the regulated a chance to fix early, honest mistakes that occur in trying to properly comply; the same can’t be said for efforts to comply that are so lax, so without real intent to satisfy the new rules, and so poorly executed that they should be deemed negligent. I would also note that, since the justification given for the idea is the difficulty of early compliance, that the amnesty program, if created, ought to vanish after a year or so. If someone cannot get it right by then, they shouldn’t be trusted with all of the other complexities involved in handling and protecting workers’ retirements.
Small Employers and the Problem of Plan Compliance
I often think of the story of the cobbler’s kids having no shoes when I read about problems in a law firm’s benefit plan; lawyers spend their time fixing other people’s business problems, often to the exclusion of paying attention to their own business issues. Festering problems in a law firm’s 401(k) or other benefit plans fit this rubric well. This story, about a small Philadelphia law firm sued by the Department of Labor for operational problems in its 401(k) plan, illustrates the point nicely. As the story makes clear, the law firm does not seem to have engaged in any nefarious conduct, but to instead have dropped the ball on various technical, operational aspects of running a defined contribution plan, such as segregation of assets, timing of deposits, and the like. I have represented smaller and mid-sized law firms in disputes over their defined contribution plans, and I can tell you that, as this story likewise reflects, smaller law firms face the same burdens and problems in running profit sharing and 401(k) plans as do most other mid-sized and small businesses: the technicalities, the time demands and the complexity of doing it correctly are often beyond their internal capacities, and certainly outside of their core competencies. I have preached many times that the key to not getting sued, whether by the Department of Labor or plan participants, is an obsessive focus on compliance in plan operations; for many smaller businesses, as this story about the Philadelphia law firm reflects, this can only be accomplished by outsourcing to a competent vendor.
The Zeitgeist of Chris Carosa
I used to be a fan, back in the old days when The New Republic was actually meaningful and influential, of its zeitgeist table, as it really did, in a glance, sum up what people were thinking and talking about, albeit in a humorous way. I couldn’t help but think of that this morning when I read Chris Carosa’s “FiduciaryNews Trending Topics for ERISA Plan Sponsors: Week Ending 7/27/12.” Its like a college survey course on one page of what everyone in the retirement industry either is or should be thinking about right now, from the costs of plans to fee disclosure to the coming tax wallop you are going to suffer to fix the public pension system to the misinformation, non-disclosure and outright confusion rampant in the knowledge base of plan sponsors and participants.
A Bunch of Cliches About Scary Things (Or a Few Words on Why Fee Disclosure Isn't Scary)
Here’s a very nice piece on fee disclosure, as mandated by the Department of Labor, and the idea that it is to everyone’s benefit. I have long maintained that fee disclosure of the type at issue falls squarely in the ballpark of the old saying that sunshine is the best disinfectant, and that running from fee disclosure – whether as a plan sponsor or a service provider – is the intellectual equivalent of running from the bogeyman; there is, in fact, nothing to fear from it, for well-run plans and above-board advisors, and for those who aren’t yet those but aspire to be.
Why is that? Well, let’s run through the list of players in the 401(k) rubric. Plan participants obviously benefit from knowing what their funds costs, and from the opportunity to use that information to demand proper attention to fees from their plan’s sponsors, administrators and fiduciaries. Where is the downside to them? I can’t see one. And then there are plan fiduciaries. Plan fiduciaries should be avoiding fees that are higher than needed, both to protect themselves from fiduciary liability and to best serve participants. Now this doesn’t mean they are required to, and nothing in fee disclosure or the law governing fees requires them to, chase the lowest possible cost investment options. What it does mean, though, and which cases like Tibble make clear, is that they have to investigate and follow a prudent process directed at using the right investment option at the right price. The more information they have, the better they are able to do this; likewise, the more they are pressed by participants to do this, the more likely they are to install a good process to review these aspects of their plans and, correspondingly, the less likely they are to fall below their fiduciary duties in this regard. This all make them less likely to be sued for, or found liable for, excessive fee claims, and thus protects them from financial risk in running the plan. These outcomes flow naturally from the public disclosure of the fees inherent in a plan. And finally there are the investment advisors and other service providers. More than one such provider has told me that they already make this information available or have changed their business models to build around the open disclosure of this information, and that they believe their ability to compete both on transparency of and attention to controlling expenses is a competitive advantage for them. I have long believed that transparency works to the business advantage of the best players in this area, and aren’t those the ones who should be winning business? Just another side benefit of fee disclosure, and one more reason why, when it comes to fee disclosure, there is, to quote a former president who knew a thing or two about creating a retirement plan, nothing to fear but fear itself.
Plan Administrators and the Risk of Personal Liability: A Primer
Often when I chat with middle and upper level managers of mid-size and larger companies who have been assigned the job of administering their employer’s 401(k), ESOP or other benefit plans, I wonder if they are fully cognizant of the risks of personal liability they are taking on, and whether they have made sure that, through insurance or otherwise, they are protected against breach of fiduciary duty lawsuits. I particularly wonder this in those cases in which it appears that, while they are taking on the role, they are simultaneously not high enough up the corporate food chain to clearly have enough power to control for and avoid potential problems in the plans they have been charged with administering. This leaves those administrators in the situation of being exposed as fiduciaries to personal liability for problems in the plan, while not having enough power to avoid or cure the problems. As fiduciaries, of course, they risk personal liability for the plan’s losses, and, as this excellent piece here explains in detail, it’s a liability they will have trouble ever shaking, even if their employer goes belly up and leaves them sitting there holding the bag.
On the Other Hand, There May Not Be Any Structural Impediments to Breach of Fiduciary Duty Class Actions in the Sixth Circuit
An astute and clearly knowledgeable reader passed along the point that the recent Sixth Circuit decision in Pfeil v. State Street Bank implicitly rejected the structural barriers to bringing class actions over fiduciary breaches that had been created by the developing case law in other circuits and which were discussed in my recent article, Structural Impediments to Breach of Fiduciary Duty Claims. The Pfeil decision, in allowing the putative class action to proceed past the stage of motion practice, refused to allow a stock drop type case to be ended, prior to the full development of the facts needed for the plaintiffs’ case, by the early application of lowered – or merely altered and fact specific, depending on your point of view - fiduciary standards with regard to employer stock holdings in defined contribution plans, in circumstances in which the plaintiffs could not have, at the outset of the case, full and complete information about the fiduciary breaches at issue. In this way, the Sixth Circuit, deliberately or not, mitigated the difficulties for plaintiffs, identified in my article, that are caused by the intersection of the Iqbal and Twombly pleading standards with the limited information available to plaintiffs at the outset of the case.
Pfeil is interesting for a couple of other reasons as well. One is that, in some ways, it is not a pure stock drop claim, because the plan documents imposed an obligation on the fiduciary to divest under certain circumstances, and the question is whether the fiduciaries failed to comply with those plan terms, rather than simply being the question of whether the holding of the stock under the stock drop scenario in and of itself constituted a breach. Second, I have always felt that the stock drop case law reflected an attempt, implicitly at least and perhaps even subconsciously, to balance the obligations of a company under the securities laws and under ERISA when it comes to stock held in employee plans; Pfeil, by focusing on the liability of an outside fiduciary, does not have that dynamic. Three, I have written before about the evolutionary nature of plaintiffs’ class actions in ERISA, with the idea being that, over time and in response to early defeats – such as Hecker or the stock drop cases – the plaintiffs’ bar will craft more sophisticated and carefully targeted theories of liability, that will eventually pass muster. You see that here in Pfeil, in which a more nuanced approach to a fiduciary breach involving employer stock is able to leap a hurdle – a motion to dismiss – that earlier, less nuanced stock drop theories were not able to clear.
The Dam Breaks: Tussey v. ABB
Tussey v ABB, Inc., an excessive fee and revenue sharing case decided on the last day of March after a full trial before the United States District Court for the District of Western Missouri, is a remarkable decision, imposing extensive liability for acts involving the costs of and revenue sharing for a major plan, on the basis of extensive and detailed fact finding. It is hard to sum up in a quick blurb, and I recommend reading it in full. However, Mark Griffith of Asset Strategy Consultants has a terrific write up of its its import here on his blog, and here is a nice case summary from Dorsey. Beyond that, I would highlight a few key points about the case, viewed from 30,000 feet (the case itself is going to provide grist for tree level, finding by finding analysis for some time to come).
First, and to me most interesting, is that it confirms several conclusions about excessive fee litigation that I have come to in the past and written on extensively, including my insistence that the pro-defense ruling in Hecker was not the last word on this issue (despite the desire of much of the defense bar to believe it was) but was instead the high water mark in defending against such claims. I argued in the past, with regard to the Seventh Circuit’s handling of this issue in Hecker, that the entire issue of fees and revenue sharing would look different than it did to the court in Hecker once courts began hearing evidence and conducting trials on the issues in question, rather than making decisions on the papers, and this ruling bears that out. Like the trial court decision in Tibble, another key early excessive fee case to actually reach trial, the taking of evidence by the court on how fees were set and revenue shared has, in Tussey, resulted in a finding of fiduciary breach in this regard. Tibble and Tussey reflect a central truth: when courts start hearing evidence on what really went on, it becomes apparent to them that plan participants were not fully protected when it comes to the setting and sharing of fees in the design and operation of the plans in question. To deliberately mix my metaphors, what Tussey reflects is that when courts start looking under the hood of how plans are run, they are not liking how the sausage was made. They quickly (relatively speaking, of course, since it takes a long time to get a case from filing through to a trial verdict) conclude that the fees were set and shared in ways that did not properly benefit the participants.
This particular aspect of Tussey is very important. Tussey involved a major plan and a market making investment manager and recordkeeper, applying what the court characterized as standard industry practices in some instances. It is therefore unlikely that the scenarios found by the court in Tussey to be problematic are unique to that case. Other excessive fee and revenue sharing cases that, like Tibble and Tussey, get past motions to dismiss and into the merits are therefore likely to uncover factual scenarios and problems similar to those identified by the court in Tussey.
What also jumps out at me about Tussey is the extent to which revenue sharing, which has often been characterized in the professional literature as harmless in theory, is strongly depicted as problematic as practiced with regard to the particular plan and by the sponsor and service providers at issue. I would have real question, going forward as a plan sponsor, as to whether it makes any sense at all to continue with revenue sharing. Better to just pay a fixed cost, than to risk extensive liability for engaging in revenue sharing. Absent that choice, the treatment of revenue sharing in Tussey makes clear the need for extensive, on-going, documented analysis by the plan’s fiduciaries of whether the level of compensation generated by the revenue sharing was, and remained at all times, appropriate.
Other aspects of Tussey worth noting include these two. First, the opinion provides as good an explanation, in detail, of what revenue sharing really is and how it works as you are going to find. If you want to understand what all the hullabaloo about revenue sharing is about, this opinion is as good a place to start as any.
Second, the opinion contains a nice analysis of one of the most misunderstood issues in ERISA breach of fiduciary duty litigation, namely the six year statute of limitations and how it applies to the implementation of a fiduciary’s decisions related to plan investments. A decision to change a plan investment takes time, starting with an analysis of whether to do so, followed by the steps needed to effectuate it, and eventually resulting in the final steps needed to permanently conclude the change. As the court explained in Tussey, the statute of limitations in that scenario does not start to run – for any of the losses related to that event – until the last act in that run of conduct occurred.
Structural Impediments to Breach of Fiduciary Duty Claims
As many of you know, I write a regular column on ERISA litigation for Aspen’s Journal of Pension Benefits, usually focused on whatever issue has my attention at the moment, although I try to balance that against what readers might have an interest in as well. When it came time to write my article for the publication’s winter issue, I was musing on what seemed to me to be a contradiction in a webinar I had listened in on, in which two prominent experts – who shall remain nameless to protect the innocent – discussed liabilities arising out of the operation of defined benefit and defined contribution plans. The contradiction resided in the fact that they discussed the range of problems and difficulties facing such plans, and the seemingly incongruous fact that, nonetheless, plan sponsors and fiduciaries were unlikely to face liability in a courtroom for their handling of such problems and difficulties. How could that be, I wondered? So I fleshed out an answer, which became this article, titled Structural Impediments to Breach of Fiduciary Duty Claims.
Although I didn’t spell it out explicitly, the article focuses on the barriers to prosecuting such claims as class actions, because that is the forum in which these issues and impediments really manifest themselves, although the issues apply as well to breach of fiduciary duty claims brought by individuals solely on their own behalf. I also used ESOP class actions as an exemplar, for several reasons, running from my own experience with litigation over them to my somewhat morbid fascination – as a lover of newspapers - with the legal morass that the ESOP of the Chicago Tribune (and other affiliated papers) tumbled into.
A Perfect Storm, ERISA Style
This is not, at this point, a novel idea, but I do take credit for being one of the first to blog regularly on the thesis that we are approaching, if haven’t by now already hit, a perfect storm when it comes to retirement benefits and ERISA. The perfect storm consists of a series of elements all coming together in the same place and time, which in this instance consists of the following. First, a move from pensions to 401(k) plans, with the corresponding shift of two key risks – investment performance and capital accumulation – from plan sponsors to participants, a change which most people paid little attention to for a long time, because pensioners were still the majority of people accessing retirement benefits, while the vast numbers who would have to instead rely on defined contribution accounts to fund retirements were still working; this kept both the impact of, and the fear of the impact of, that change relatively hidden for quite some time. Second, the impending boom (pun intended) in retirements of a generation whose retirements will be funded – or, actually, more often than not won’t be funded, if you believe the numbers – solely by 401(k) plans. Third, the swooning of the stock market contemporaneously with these events. Add it all up and you end up with a retirement crisis.
For ERISA litigation, you are already seeing some of the changes that this storm is rendering, and will continue to render, as legal rulings and regulatory initiatives occur that are making it and will continue to make it, roughly speaking, easier to sue for breach of fiduciary duty under ERISA and to recover under ERISA if you are a plan participant. Doctrinal development of case law does not happen in a vacuum, and the easing of the restrictions against suing and recovering in ERISA cases is not happening in a vacuum either, but is instead being firmly influenced by the changes in the retirement industry and environment that are causing this perfect storm.
This occurs in a number of influential but indirect ways, which includes more cases being filed, often by more sophisticated lawyers, providing more opportunities for the legal principles at issue to evolve. One manner in which you see this is the shifting, sometimes almost glacially, of principles created in the case law during the days of pensions, when – in my view – courts paid less analytical attention to certain issues because most disputes concerned problems between sponsors and outsiders to the system, such as vendors or lenders, and did not directly affect the ability of participants to be paid their pensions; this is because, absent outright collapse of the sponsor, the obligation remained to pay those benefits regardless of the dispute at issue. The same, of course, cannot be said with regard to defined contribution plans, and thus courts are looking more closely at disputes in this environment than they did when confronted with similar, pension based cases 20 years ago. Indeed, we have clear direction from the Supreme Court that lower courts should reconsider doctrines established back in the long ago days of pensions when they arise in the context of defined contribution plans. Another manner in which this occurs is regulatory change – clearly, the Department of Labor’s flurry of regulatory initiatives related to fee disclosure and fiduciary status concern the need to tighten up the legal structure with regard to defined contribution plans in a manner that was not needed back when pensions walked the earth, as they increasingly no longer do. Each of these regulatory changes, in turn, opens up greater avenues for litigation and fiduciary liability, further changing the legal environment concerning 401(k) plans and ERISA itself. In this way, the perfect storm comes to affect ERISA litigation and liabilities.
Now here is a new wrinkle to add to the perfect storm, one that if true will just add to the impetus towards change described above: the possibility that the impending boom in 401(k) funded retirements will in and of itself depress stock prices. This will in turn simply accelerate the cycle, described above, by increasing the investment risk and capital accumulation risks that the systemic changeover from pensions to defined contribution plans has transferred to participants. The more risk of this nature passed to participants, and the more they suffer as a result of the outcome of those risks running against them, the more litigation, the more recoveries, and the more doctrinal changes you will see.
Put this one in a blog time capsule, and come back and see me in 20 years. I bet I will be right on this one.
On ERISA and the Potential Liability of Senior Executives
Susan Mangiero of FTI Consulting, who blogs at Pension Risk Matters (as well as at Good Risk Governance Pays) and is one of my favorite sources of information concerning the investment and risk management realities that lie behind the façade of ERISA governed plans, is, along with a few other worthies, presenting a webinar on Wednesday, March 7, on “The ERISA and Securities Litigation Snapshot: Things You Can Do Now to Minimize CFO and Board Liability.”
The webinar is scheduled to cover:
•Why ERISA litigation claims against top executives and board members continue to grow
•How securities litigation and ERISA filings are related and what it means for corporate directors and officers
•What ERISA liability insurance underwriters want clients to demonstrate in terms of best practices
•What steps the Board and top executives can take to minimize their liability
•When to Get the CFO and board members involved
My quick thoughts on each of these topics, and why they mean this webinar is worth a listen if you have any responsibility for the financial and liability risks generated by ERISA governed plans? Lets go in order.
Why do ERISA litigation claims against top executives and board members continue to grow? There a number of reasons, but here are three quick ones in a nutshell. First, the market losses suffered over the past few years by participants has highlighted the investment risks faced by participants, and made them look closely at others’ possible responsibility for those losses. Second, decisions such as LaRue and Amara, while not opening a floodgate, have nonetheless created an environment in which it is easier to structure and prosecute claims against fiduciaries on behalf of participants. Three, plans are where the money is; there is more potential damages sitting in a company stock plan than you can shake a stick at. Remember what Willie Sutton said about banks? None of this is changing anytime soon, and ERISA litigation claims against senior officers will continue to be a growth stock as a result.
How are securities litigation and ERISA filings related and what does it mean for corporate directors and officers? Short answer: over the past several years, court decisions and congressional action have made it harder to recover in securities cases, while the same is not true for ERISA cases. In many instances, ERISA theories allow another way to target stock losses without having to jump through the hoops that exist in a securities case. For directors and officers, this means they will face more ERISA suits down the road, including against them personally. They need to have the right business structures in place to protect them against such claims, and the right insurance in place if they are found liable.
What do ERISA liability insurance underwriters want clients to demonstrate in terms of best practices? Underwriting needs in this area in many ways overlap with the same steps that should be put in place to protect the fiduciaries against suits, to reduce the risk of a judgment, and to minimize the likelihood of a suit being brought in the first place, regardless of the insurance issues. These steps are what I have often called defensive plan building, which is the need for due diligence, active understanding of the plan, accurate communications with participants, developing expertise and/or hiring it as needed, and following the same level of sophistication and investigation that would be applied to any other crucial part of a company’s operations.
What steps can the Board and top executives take to minimize their liability? This pretty much concerns taking the same steps, mentioned above, that the company’s insurance underwriters will appreciate. Interestingly, this is an area of the law and of insurance where all of the incentives line up well. The same steps reduce the risk of liability, reduce the risk of getting sued, and likely reduce premium dollars all at the same time. There is one other key step that should be looked at closely though, when considering how to protect senior executives and Board members against liability under ERISA, which is to carefully think about who will be involved in the plans and in what manner; the selected ones will be at risk for ERISA breach of fiduciary duty claims, while the others can be carefully and deliberately kept out of harms way. This means, though, that this has to be considered in advance and the proper structures put in place to accomplish it; if you do this after the fact, you are bound to end up with a lot more potentially liable fiduciaries among the executives and board members than anyone at the defendant company ever expected would be the case, due to ERISA’s concept, embedded in statute, of the functional, or deemed, fiduciary.
When should you get the CFO and board members involved? Yesterday, if possible, and right now, if not, for all the reasons noted above.
Fiduciary Prudence? 9.5 Million Reasons to Care.
Here’s something very interesting, which I thought I would pass along with a couple of comments. It is the Court’s order concerning the proposed settlement of the class action at issue in George v. Kraft Food. George, which I discussed here, involved a particularly minute attack on the stock fund structure in a company 401(k) plan and on the decision making process by which the recordkeeper’s fees were determined. A panel of the Seventh Circuit found those claims viable as presented at the summary judgment stage, and allowed them to move forward. I discussed at the time of the Seventh Circuit’s ruling the fact that the decision ran counter to a wide spread sentiment that the Seventh Circuit’s earlier decision in Hecker v. Deere, which threw out an excessive fee and revenue sharing case with great vim and vigor, effectively foreclosed breach of fiduciary duty claims premised on the expenses of running a plan. What George showed, however, is that all Hecker precluded were broad, sweeping attacks on the fee structure and design of a plan; precisely targeted criticisms, with factual support for them, addressed to specific issues concerning the fiduciary’s conduct regarding the plan’s pricing and structure, can still move forward, as it did in George. And to what end? The settlement order in George indicates a settlement fund being paid out to the plan participants of $9.5 million.
So what to make of that? Here’s a good start. First, carefully targeted and supported breach of fiduciary duty claims targeting plan expenses, fees and structures are not guaranteed to go away through motion practice, as though a motion to dismiss or for summary judgment is akin to a wand at Hogwarts. Many, many, many fiduciaries – or at least their lawyers - have become convinced in recent years of the opposite, in my view. Second, if they don’t go away, their settlement value becomes significant, because of the sheer amounts at risk in a breach of fiduciary duty case involving a plan of any meaningful size. Third, breach of fiduciary duty cases, especially class actions, targeting the design and expense structures of plans are going to continue, no matter what lesson anyone hoped to take from the outcome in what was one of the earliest cases, Hecker. They are simply going to have to be better targeted and designed, and more carefully grounded in facts, than were the earliest cases, for this line of litigation to continue.
Fee Disclosure, the Wall Street Journal, and the Value of Regulation
Well, its 2012 and its time to pay close attention to fee disclosure involving 401(k) plans, for those of you who weren’t thinking about it already. The Wall Street Journal caught the bug yesterday, in this article that got wide play. I will tell you what about it caught my attention, which was the quote that the prospect of fee disclosure alone is already "putting downward pressure on fees." I have written on many occasions that the point of the fee disclosure regulations is to create marketplace pressure, driven by sponsors who are worried about the liability risk of failing to target fees and by participants challenging the amount of fees, that will reduce the costs inherent in plans. As I have written before, this approach will affect fees and benefit participants to a far greater degree than the hit or miss excessive fee litigation that has been targeting these issues to date. If the Wall Street Journal says this is already having this effect, then how much more proof do we need?
An Entertaining Little Primer on Cash Balance Plans
All right, I am getting back in the saddle after a couple weeks off from blogging to recharge my batteries and tie up some key end of the year issues in a few cases. Not wanting to do too much heavy lifting on my first day back on the blog beat, I thought I would pass along, with minimal comment from me, this nice little piece on cash balance plans, and particularly how they might fit in alongside 401(k) plans in a particular business’ benefit plan structure. Anyone who follows the field knows that the rise of cash balance plans and their implementation, especially in instances where they have supplanted traditional pensions, has been rife with problems, both real, imagined, and litigatory (I may have just made up that last word, but still). Amara, of course, jumps to mind, but so do many other examples. The story I am passing along today, though, does a nice job of showing how, properly used, cash balance plans can be a force for good, not evil, to borrow a cliché.
The Realities of Plan Fees - Or Why They Are Not Excessive Just Because They Exist
Amidst all the commentary and lawsuits over excessive fees – or allegedly excessive fees – on 401(k) investment options comes this article pointing out all that advisors do to earn that money, and raising questions, at least implicitly, as to whether courts and critics are asking the wrong question when they inquire into the reasonableness of fees; perhaps the better question, suggests the author, is whether the administration of the plan involves more than enough effort to justify the fees that are being paid. I like the article, and found it both entertaining and thought provoking.
I thought I would point out three things that the article brings to my mind. First, the author points out that determining whether fees are reasonable by comparison to industry benchmarks isn’t really a good test, because all it is showing you is that everyone of similar size and shape looks the same. As the author points out, if everyone in the industry suddenly raised their fees substantially, would all their fees still be reasonable? They would be if the relevant test was to benchmark against the industry as a whole, since their fees would all still be reasonable in comparison to each other. This harkens back to a problem with the Seventh Circuit’s analysis in Hecker, in which the Court indicated that fees in a particular plan are reasonable if they are consistent with the retail market as a whole. As the author of the commentary suggests, doesn’t this just beg the question, which is whether the fees charged across the overall market as a whole are reasonable? I know that the Seventh Circuit answered that question in Hecker by concluding that the omniscient power of the marketplace will guarantee that the answer to the question that is begged is yes, but I can’t say that the panel, in its ruling in that case, provided much empirical support for that assumption. The tribal myth of marketplace discipline, divorced from empirical support establishing that market forces actually force the fees to a level that would be found reasonable if the fees were independently analyzed without regard to the existence or not of those marketplace forces, really should not be enough support for the creation of a legal rule.
Second, the author’s point makes clear why that sort of benchmarking is not the test, or should not be, and that instead the proper test of the reasonableness of fees should be more of a two step test, of whether the fees are realistic in relation to the marketplace as a whole and whether the process of establishing the fees was prudent; this is essentially what occurred in Tibble, and circumvents the problem the author identifies with relying on benchmarking to determine whether or not fees are reasonable and, in turn, whether a fiduciary breach has occurred with regard to charging those fees.
And third and finally, the author brings us back to a fundamental issue when it comes to fees, and also to revenue sharing claims, which is that administration of a plan costs money, and someone has to pay for it. You can’t avoid it, and liability theories premised on excessive fees or on the existence of revenue sharing have to account for this fact; fees have to be paid somewhere in the system, and at a level that pays for the work needed to run a plan.
How Much Employer Stock is Too Much? Anything More than a Little
Here is a well-done article, with data spoon fed by BrightScope, on the issue of having large employer stock holdings in defined contribution plans. The article points out the extent to which some plans have very large employer stock holdings in them, as well as the efforts being taken by some employers to educate participants on the risk of failing to diversify out of the employer stock holdings. That said, though, the real answer to the question posed by the article’s title – how much company stock is too much – is that, at this point, anything more than a small exposure is too much, if you are a participant looking to protect yourself. After the Second Circuit’s recent ringing endorsement of the Moench presumption, fiduciaries face relatively minimal legal risk from - or potential financial liability for – any significant decline in the value of the company stock held by the participants, at least under ERISA. This puts the onus further on participants to protect themselves proactively, by minimizing employer stock holdings in their defined contribution plans through intelligent investment decisions. If they don’t, when - note I leave out the word if in this day and age – the stock drops precipitously, the participants will end up stuck with the loss, as the wide spread adoption of the Moench presumption means that courts are not going to let the plaintiffs’ bar ride in on a white horse to recoup those losses by means of breach of fiduciary duty lawsuits.
Some Notes From the Real World on the Practical Realities of Fee Disclosure
I have worked over the years, formally or informally, with a number of third party administrators, investment advisors, and similar service providers to plans, and have always preferred those who bring to the table a real understanding of, and ability to communicate, the substantive issues that impact plan operation and performance. If you think of it in the framework of my rubric of defensive plan building (which is how I view most everything in representing plan sponsors and fiduciaries), hiring advisors who fit that description goes far towards protecting plan sponsors and fiduciaries from liability, because fiduciaries satisfy – in essence – their duty of prudence when they hire the expertise that they lack internally. By way of contrast to hiring people who know what they are doing – i.e., who can walk the walk – rather than those who can just talk the talk, there is the contrary option of just hiring the guy who takes you golfing, which probably isn’t going to satisfy the duty of prudence.
I have always liked Mark Griffith’s work for this reason and he shares his expertise on his (relatively) new blog, Fiduciary Advisor. In the first two parts of a three part series, Mark gives a thorough and thoughtful insider’s perspective on the impact of the fee disclosure regulations. They are worth a read, particularly for those of you who are ready for something above and beyond simply descriptions of what the regulations themselves require to be done.
Citigroup, McGraw-Hill, and Moench
Not unexpectedly, the Second Circuit has just adopted the Moench presumption, in this ruling here and this one here involving stock drop cases. For those with less time on your hands, here is an excellent news media summary of these stock drop rulings out of the Second Circuit yesterday. I have long posited that, given the trend in the case law, such an adoption of this approach by the Second Circuit would essentially spell the death knell for this theory of liability; I have essentially always been of the view that, should the Second Circuit apply the Moench presumption approach to these types of cases, the stock drop theory vanishes. It’s a strange legal structure, in a way, that an area of plan management involving vast sums of employee wealth can essentially be subject to no court oversight whatsoever, even to the minimal extent of the actions getting past the motion stage and into a court review of whether, on the actual facts, the fiduciaries’ conduct was prudent, simply because the company wasn’t on the precipice of outright collapse (which is the layman’s language version of what the Moench presumption requires for a stock drop case to get past the motion to dismiss stage). Now, this isn’t the same as saying the outcome at the end of the day in stock drop cases should be different, and that the fiduciaries shouldn’t walk under these fact patterns; it may well be a fair statement, given the ups and downs of the market and the potentially conflicting duties imposed by the securities laws, that the exact conduct made not actionable at the pleading stage by means of the Moench presumption should also pass muster on their actual facts after a review of whether the behavior was prudent under all the circumstances. But the Moench presumption is essentially a get out of jail free card that insulates the conduct without such review, simply on the basis that the plaintiffs cannot plead that the company was in near fatal financial distress; as a result, the propriety or lack thereof of holding employer stock in the stock drop scenario becomes free of any review – and of the healthy discipline imposed by the risk of court review – under pretty much all other circumstances. That’s a weird little outcome, really, if you think about it. It essentially consists of the courts making a decision to divest themselves of any jurisdiction to oversee the propriety of fiduciary conduct in the circumstances presented by stock drop cases.
Defensive Plan Building After Loomis
Many of you may remember the race among law firms, after the trial court ruling in Tibble, to issue client alerts advising plan sponsors to make sure they were not holding retail share classes in their 401(k) plan investment options. Now, of course, we have the Seventh Circuit holding that it is just plain fine to have retail shares in the investment mix. So which is it? Well, of course, as I alluded to in my last post, it is really both.
In my article on Tibble, Hecker and excessive fee claims in the Journal of Pension Benefits, I took exception to the idea that Tibble effectively barred holding retail share offerings and explained that, under the detailed fact based approach applied by the court in Tibble, holding retail share classes instead of institutional share classes would not be actionable, even if the former were more expensive than the latter, if there are legitimate “issues with performance, availability of information, investment minimums, or other concerns about an institutional share class in a particular plan that would justify a deviation from including them as investment options” in favor instead of more expensive investment options, such as retail share classes. The Seventh Circuit took this exact same approach in Loomis, allowing the holding of the retail share classes in part because other possible investment selections that the plaintiffs asserted would have been preferable were not realistic, feasible, cost effective or practical alternatives to the retail shares. Thus, as was not the case in Tibble, in Loomis there was a finding that there was a legitimate basis for holding the retail share classes instead of other, proffered alternatives.
Now one can quibble with the Seventh Circuit’s preemptive determination that there were legitimate reasons for holding the retail shares and no compelling reasons not to on two potential grounds: the first that the court is substantively wrong on them (I haven’t formulated a full opinion on that yet), and the second that it is too early in the litigation process to determine that (in Tibble, for instance, it was clear that it was only on the actual facts learned in discovery that one could properly evaluate that issue, and one of the places that the Eighth Circuit, in Braden, broke from the Seventh Circuit was in allowing the plaintiffs to move forward with trying to prove the existence of issues beyond simply the holding of expensive shares). But it is fair to say that Loomis, like Tibble, rightly recognized the need to review whether there were proper alternatives to the retail share classes before determining whether or not holding them can constitute a fiduciary breach.
This means that, from a practical, boots on the ground perspective for those who build and run plans, the focus on diligent effort and investigation remains; what I always call defensive plan building, which is simply a catchy way of saying building a plan structure that will protect the fiduciaries against suit, continues to require putting in the effort of considering the propriety of different types of investment choices, and documenting that this was done. Do this, and it won’t – other than in terms of the amount of defense costs incurred before a case ends – matter one whit whether a suit is filed in the Seventh Circuit, in the Eighth Circuit, or before the same District Court judge who ruled in Tibble.
Loomis, Hecker, Tibble and the Evolution of Excessive Fee Claims
Well, well, well. Here is the story – well-presented by two lawyers from Williams Mullen – of the Seventh Circuit deciding this month, in the case of Loomis v Exelon Corporation, that holding retail class mutual fund shares, rather than cheaper institutional share classes, in a defined contribution plan was not sufficient to establish fiduciary liability. Here is the decision itself.
Reading them together raises more than a few thoughts about the decision and the Court’s reasoning. I wanted to focus today on one particular point, which is that, as the authors of the article point out, the Seventh Circuit, in the opinion, continues its heavy reliance in rejecting excessive fee claims on the idea that marketplace competition is sufficient, in and of itself, to police the expense levels of retail class shares offered to plan participants. This idea is, in many ways, the theoretical foundation of the Seventh Circuit’s seemingly categorical rejection of excessive fee claims, with the Court reasoning that, if market forces have set those fee levels, it is appropriate for plan sponsors to offer them.
However, it is important to recognize what the Court is really saying in Loomis, which is that the mere holding of retail shares – without more - under circumstances in which their pricing is subject to market discipline is not a fiduciary breach; the Seventh Circuit’s rulings in this regard, including in Loomis, are best understood as meaning that something more than that must be shown to make out a fiduciary breach. The Court, in fact, seemed to recognize this when it claimed for its own the Eighth Circuit’s decision in Braden, asserting that it was consistent with the Seventh Circuit’s approach in Hecker (and thus by extension in Loomis) because “the plaintiffs in Braden alleged that the plan sponsor limited participants’ options to ten funds as a result of kickbacks; while adopting the approach of Hecker, the eighth circuit held this allegation sufficient to state a fiduciary claim under ERISA.” The Seventh Circuit then went on in its decision in Loomis to explain why none of the additional assertions of potential fiduciary misconduct, above and beyond simply holding retail class shares, alleged in Loomis was sufficient to demonstrate the existence of the type of additional conduct that constitutes a fiduciary breach, such as existed on the allegations in Braden.
Loomis is therefore not properly read as meaning that excessive fee claims are futile, although it certainly means, in the Seventh Circuit anyway, that alleging excessive fee claims based solely on the decision to hold retail share classes without more is futile. The authority is instead properly read as meaning that something more than that has to be attributed to the fiduciaries to sustain an excessive fee claim, and that this something more must add up on its own to a fiduciary breach. This means that one should put little stock in news flashes, articles and client alerts that claim that Loomis means that excessive fee claims are futile or that holding retail share classes is per se fine; rather, what Loomis means is that excessive fee claims are futile and that holding retail share classes is fine only if participants can find no additional aspect of the fee related decisions that falls below a fiduciary’s standard of care. This is a subtle but clear, and important, difference, one that can cost a plan sponsor a lot of money if that sponsor turns out to be the one that left retail funds in place under circumstances where that additional lack of diligence can be shown.
Further, as many readers know, the federal district court’s decision after trial in Tibble, now up on appeal to the Ninth Circuit, is seen by many as contrary to Hecker and as finding a fiduciary breach in a plan’s holding of retail, rather than institutional, shares. The trial court’s opinion in Tibble, however, did not really find a breach just for that reason, but instead found a breach due to the lack of prudence and diligent investigation by the fiduciaries that led to holding retail share classes. Understanding both Loomis and Tibble in their proper light suggests that they are more in harmony than would appear on first glance; both require something more than just the holding of the retail class shares alone to demonstrate an excessive fee claim and a corresponding breach of fiduciary duty.
The New York Times on BrightScope
I don’t have much to say about this, but I would be remiss if I didn’t pass along this article from the New York Times the other day on BrightScope and its founders. The article, rightly, notes that BrightScope has its critics, but there is no denying that their work is adding to the knowledge of, and information available to, plan participants. Ignorance is not bliss, probably ever and certainly not for plan participants when it comes to their investments; as I noted in my most recent post (oddly, also provoked by a Times article), this same idea underlies the Department of Labor’s fee disclosure regulations as well.
The New York Times, Fees, Regulation and Wrap Fees
This is an interesting article from the New York Times, directed at plan participants who may want to increase the returns in their 401(k)s by decreasing the costs in their plans and of their investments. It is not interesting so much for what it says - nothing in it is likely to be very surprising, or even new, to most regular readers of this blog – but more for two points that it illustrates, both of which line up well with themes that have developed on this blog.
The first is the article’s discussion of the need for plan participants to focus on fees and the need to reduce fees in plans to increase returns; the article operates from the central premise that the plan participants reading the article may not be aware of the fees and expenses in their plans. Both recent litigation – the excessive fee cases – and Department of Labor regulatory initiatives have focused on fee disclosure and the effect of expenses on returns, and a focus on this issue is clearly trickling down – or up, depending on your point of view – into mainstream conversation at the participant level, as the article demonstrates. I have frequently mentioned in posts that the fee disclosure regulations may have more of an indirect impact on sponsors and fee structures than a direct one, in the manner in which sunshine is said to be the great disinfectant, in the classic formulation: bringing the issue out into the open is likely to provoke plan participants to press sponsors to reduce fees and the fear of being sued over fees once the information is more readily available is likely to motivate fiduciaries to focus on the issue. It is a safe bet that this indirect response is likely to have at least some downward impact on fees and expenses in plans, and it is my view that the point of the Department of Labor regulatory initiatives is to have this exact indirect effect, whereby disclosure improves performance rather than the Department having to focus its own resources or enforcement efforts directly at the issue. If they are right and it works – which, as noted, I think it will – they will have accomplished exactly what promulgating regulations should do, which is alter behavior in the intended manner solely through the process of enacting regulation. It is a much cheaper solution, and often more effective because it is prospective rather than backwards looking, then the use of litigation to change conduct.
The second relates to my recent post on Ary Rosenbaum’s article providing a short tutorial on fees and expenses in plans. In this article on excessive fee litigation, I pointed out that the use of shorthand in this area of the law can obfuscate what is really at issue with regard to the fee structure of plans, explaining that:
Certainly the starting point for any discussion of this issue should be an understanding of the nature of excessive fee claims. ERISA lawyers, like other specialists, tend to use shorthand to which only they are privy, and this type of claim is no exception. Pithy references to excessive fee claims, however, shortchange the depth and complexity of what is at issue. Teasing out the phrase’s full meaning gives a much more nuanced picture of what is at stake, and how it impacts fiduciary liability.
The New York Times article is a perfect example of this phenomenon, with the author writing that “plans sold by insurance agents (particularly with onerous “wrap” fees) and by stockbrokers tend to be the most expensive,” without ever explaining what a wrap fee is (leaving aside the question of whether this general statement is always true, only true on the outliers, sometimes true, or maybe true, etc.). This is not unique to the author of this article; the entire industry tends to throw around phrases like “wrap fees” as though everyone in the world knows what they mean, which is not the case. This is particularly not going to be the case at the participant level, which is the target audience of the story. One of the things I particularly liked about Ary’s article, which I referenced in this post here, is his excellent explanation of “wrap fees” for anyone who doesn’t already know what it means.
Fee and Expense Disclosure: No Such Thing as a Free Lunch
I have commented before, including here, on the fact that there is some inherent tension between the fact that the administration of 401(k) plans costs something and the obligation of sponsors to, nonetheless, keep those costs down. One of the hoped for goals of the Department of Labor’s effort to shed light on fees, expenses, costs and revenue sharing is to make sure that plan sponsors and fiduciaries have an accurate understanding of the expenses paid to run their plans, with the implicit assumption that they will then act on that knowledge (which they will, if they don’t want to end up a defendant in a future excessive fee/costs claim, likely filed as a class action in many cases).
Ary Rosenbaum does a beautiful job in this piece here of explaining the costs of administration, where they are buried, the belief of some – particularly smaller – plan sponsors that they are not paying for plan administration, and the impact on this system that the new disclosure regulations are likely to have. Ary writes regularly on 401(k) management issues, most of which I read, and I think this is his best piece yet. I highly recommend it, particularly for anyone looking for a nice, short yet comprehensive, introduction to the subject (it also has great pictures, if you like alligators).
401(k)s, Spousal Waiver and Beneficiary Forms
I don’t have much to add to this Wall Street Journal story on the interplay of spousal consent rules, ERISA and beneficiary forms in 401(k) plans, but I did want to pass it along. There may be no more common fact pattern in either my years of practice or in the case law than that of the deceased employee who meant to leave the assets of his 401(k) plan to his children from an earlier marriage – and filled out a beneficiary form so saying – but whose assets instead ended up paid out by the plan to the employee’s second wife, who was not named a beneficiary but, at the same time, never waived her right to the 401(k) assets. In most of these instances, the employee never knew that spousal consent/waiver rules would result in the widow receiving the benefits, no matter what the employee intended while alive or what he wrote in the beneficiary form.
For many people, the terms of their plans are a riddle wrapped up in an enigma, and without outside guidance, they are unlikely to get it right if they try to leave the assets in their 401(k) plans to anyone other than their current spouse.
Retreat From the High Water Mark: Excessive Fee Litigation After Tibble
By the way, I never did make available a full copy of the article I referenced in this blog post here, which I wrote for the Spring 2011 edition of the Journal of Pension Benefits. The article analyzes excessive fee litigation in light of the trial rulings in Tibble, against the backdrop of the motion to dismiss ruling in Hecker, and essentially concludes – as you might expect a trial lawyer to conclude – that the world (including that of fiduciary decision making with regard to investment selections in plans) tends to look a lot different after discovery and with evidence in hand, than it does when a complaint is drafted. You can find the article here.
The Lessons of Unisys
Here is a very nicely written opinion out of the Third Circuit in Renfro v Unisys rejecting a breach of fiduciary duty claim alleging excessive fees in the mutual fund options in a company’s 401(k) plan. A few particular points are noteworthy. The first is the detailed explanation in the opinion of the reason that the directed trustee, Fidelity, was immune to suit for those decisions. The opinion lays out the written structure used by Fidelity to avoid being exposed to claims of this nature and, quite frankly, it is really well done. Pats on the back all the way around to the Fidelity legal department, or at least that part that over the years has formulated this structure and its documentation. While I mean that sincerely, I mean something more serious as well: somebody over there invested significant resources to get this right, and you see the value of that in this opinion. Investments in ERISA compliance and liability prevention can pay off down the road in spades, and this is a perfect example of it.
A second nice aspect of the opinion is the Court’s nice synthesis of Hecker and Braden, which otherwise can be seen as standing in conflict with each other. However, this leads to the third point, which is that the opinion reasonably and quite intelligently explains that the allegations concerning the mix of investments are not enough to show a breach, even though some of the fund choices were of the retail class in circumstances in which one can assume the sponsor had sufficient negotiating power to avoid that class of investments. As I discussed in this article here, one of the wrong lessons many people took from the District Court opinion in Tibble, which followed a trial of an excessive fee case, was the idea that having retail share classes as investment vehicles is a per se problem and needs to be avoided. That, however, was not really the case in that litigation; what was the problem there was not the use of the retail share classes, but the manner in which they ended up in the investment mix. The Third Circuit’s opinion is essentially driven by the absence of allegations that would match the evidence in Tibble showing that there were errors by the fiduciaries that caused the plan to unnecessarily and improperly carry retail share class investments. Rather, the Third Circuit’s opinion simply rejects the idea that the inclusion of retail share classes alone shows, without more, flaws in fiduciary decision making.
Talking About Fees
Summer time and the living is easy. Well no, not really – which is fine, because nothing makes a lawyer (at least this lawyer) more nervous than having time on his hands. Time demands have, though, cut down on my posting since the 4th. Still, I have had time over the past few weeks to think a little bit about this educational seminar I spoke at that was hosted by Asset Strategy Consultants on the role of fees and revenue sharing in designing 401k plans. My talk focused on defensive plan building, or defensive lawyering in other words, which I define as the process of building out the investment options in a manner that will reduce the risk of getting sued on the theory that fees and expenses in a plan were excessive, or, if sued, of being found liable.
This particular seminar was very interactive, with a lot of give and take with the audience, which is something I like, not least of all because I inevitably learn something. What did I learn this time around? A few things, but the following stuck with me. First, it is important to remember that there are a lot of plans out there, and many of them are staffed by committed professionals working hard to provide participants with the best plans possible. One can lose sight of this in litigation, or even in reading about the various lawsuits, settlements and judgments involving 401(k) plans, because the contentiousness of those cases, along with the real and often significant breaches of fiduciary duty that occurred in them, can obscure that reality. However, there are many more plans – some of them represented at the seminar – where people are doing the work of really diving into the plan’s investment structure, and making sure it is optimal, from both the perspective of fees and the perspective of returns. As I discussed in my talk, fiduciary prudence requires weighing both of those aspects – as well as a whole host of others – in choosing investment options.
Second, when it comes to fees and expenses in investment options, there is a lot of expertise out there, and there really is no reason not to tackle this issue prospectively. Looking backwards, the issue was not on many sponsors’ front burners, and thus I have little doubt that there may be plans out there that never put resources into controlling fees and expenses. However, at this point in time, there is no reason for any plan sponsor to be ignorant on this issue and of the risk of liability it imposes going forward, and there is more than enough expertise out there that can be brought to bear to address such concerns. I would hope that, down the road, excessive fee and expense cases will eventually go the way of the Pterodactyl, now that plan sponsors have learned to pay attention to this issue and to address it.
Third, while I am not a skeptic of excessive fee claims (the math on the impact on participants of a lack of diligence on this front is undeniable), I am of revenue sharing claims, as a general rule. Unless and until revenue sharing in a particular plan is shown to actually impact the investment choices or returns of the plan participants, it seems to be a “no harm, no foul” type of problem. If, as I discussed at the seminar in response to an excellent question, the participants can get a strong return at low fees while at the same time plan costs are driven down by revenue sharing, I don’t see a basis for finding a fiduciary breach, even if the revenue sharing was not disclosed or poorly disclosed. Obviously, this is a best case scenario, but that is my general view of that subject. I did get a good dose of reality on this issue, though, from the presentation of Mark Griffith of Asset Strategy Consultants, who illustrated the extent to which certain revenue sharing arrangements can, over time, result in too much money being paid for administration, relative to the actual costs; at the same time, Mark did a nice job of emphasizing a fact which often gets overlooked when the lawyers start yelling at each other in court about revenue sharing, which is that the costs of administering a plan are significant and have to be paid for one way or the other, a reality check that should not be overlooked when regulators, courts and lawyers are considering the propriety, or instead lack thereof, of various revenue sharing arrangements.
Extrapolating From Employer Stock Drop Cases to Other Types of Investment Losses
Susan Mangiero, who brings expertise in finance and investments to the discussion over the propriety of various investments in defined contribution plans and whether their presence in a plan can support a claim for breach of fiduciary duty, has written this interesting post on the issue I discussed here, namely the role of CFOs in running plans and different approaches to reducing the fiduciary liability risks of including employer stock as investment options. What she points out is something we litigators, with our backwards looking focus – what is litigation, after all, but a fight over something that already happened? – may not have noticed: namely, that the fights over employer stock are likely laying the ground work for future fights over other investment choices. This idea is interesting, in that breach of fiduciary duty litigation is, in fact, much like the old saying about people who accomplish something who are standing on the shoulders of the people who came before and tilled the ground. Fiduciary duty suits involve the courts confronting a new situation, such as employer stock drops, and creating rules to deal with them, and then later suits involving other similar fiduciary acts build upon, flow from, or distinguish the rules created in those earlier cases. In future cases involving other types of investments, such as the bond losses Susan references, one key factual distinction is going to come into play, which is that stock is unique to a certain extent in this context, because of the competing obligations imposed on company officers by the securities laws and ERISA, which has driven much of the development of the law of stock drop claims in the ERISA context (along with a concern that the class action bar should not be allowed to easily reframe securities class actions as ERISA breach of fiduciary duty cases, a concern that either flows directly from or fits very easily with the recognition that corporate officers are in a position of having to serve different masters with differing agendas, in the form of the securities laws and ERISA, when employer stock is held in a plan). The question for the next round of cases, such as disputes over bond losses, is how comparable those scenarios are to that conflict, as it only makes sense to extend the breach of fiduciary duty rules developed in the employer stock drop context to other types of losses to the extent that similar concerns are as present in those cases as they were in the employer stock drop context.
Live Blogging from Bentley College . . .
Live blogging is usually used to mean that someone is attending a seminar and putting up posts about it while there. I mean it differently, that I will be talking live, about the topics I regularly address in my blog posts, at this seminar on May 10 hosted by Asset Strategy Consultants-Boston. The seminar is open to plan sponsors and their advisors, and I will be opening the event by speaking on "Hot Topics in Fiduciary Governance: Limiting the Risks Inherent in Selecting Plan Investment Options.”
Other speakers include Mary Rosen from the Department of Labor, as well as Todd Mann of AllianceBernstein Investments and Mark Griffith of the host, Asset Strategy Consultants-Boston. Mary and I spoke together on a panel awhile back in Boston, and her comments on the current focus of the DOL alone tend to be worth the price of admission.
Information on registering for the seminar can be found on this invitation, if you would like to attend. I hope to see many of you there next week.
Playing Hot Potato With Employer Stock
This is an interesting piece on one of the most loaded issues in ERISA litigation, namely the potential personal liability of corporate officers who run a company’s benefit plans, in particular their defined contribution plans, such as 401(k)s or ESOPs. The article drives home the fact that when CFOs or other officers are named as the fiduciaries, as is often the case with company plans, they are thereby opened up to liability for any problems in the operation of the plans that can be characterized as breaches of fiduciary duty. Importantly, however, and on a topic that the article skips over (it’s a short article, and a point likely deliberately beyond its scope), corporate officers who get intimately involved with the operations of such plans are likely to be targeted as fiduciaries in litigation, and may well be found to be fiduciaries, even if the plan at issue avoids naming them as fiduciaries; their involvement is bound to render them so-called deemed or functional fiduciaries, which opens them up to much the same liability risk.
The article focuses on the problems for those corporate officers, and in particular CFOs, that stem from holding employer stock in plans, which are acute as a result of the inherent conflict between the business needs of the company with regard to its publicly traded stock and the potentially distinct risks to plan participants of financial loss from holding that stock in a plan. When problems with a stock arise, a corporate officer’s actions in response in one direction may benefit one side of that equation at the expense of the other, at the same time that different actions by that same officer could reverse that calculus. When the resolution of that problem results in losses to the company stock held by the plan or its participants, the fiduciaries enter the cross-hairs for litigation and potential resulting liability based on the possibility they have breached their fiduciary duties to the plan participants by those actions.
The article poses as one solution the creation of a data driven system that preordains decision making with regard to company stock holdings, based on such issues as changes in stock price, etc., thereby taking the day in, day out discretion over what to do with the stock holdings out of the hands of the fiduciaries. There are many benefits to such an approach when it comes to defending possible breach of fiduciary duty claims down the road involving those stock holdings, but it is far from a get out of jail free card. At a minimum, the corporate officers who have been serving as plan fiduciaries, whether in name or by operation of law, are likely to be accused of having breached their fiduciary duties by erring in creating, selecting and putting the automatic system into place in the first place, and by failing to monitor or adjust the system along the way in response to any changing dynamics in the marketplace. As the Seventh Circuit’s decision this month in Kraft Foods reflects, there is no doubt that good class action lawyers and good financial experts can identify and target financial anomalies in any system designed to process employer stock holdings, and they will do that with this approach as well. It doesn’t mean the author’s proposal doesn’t have merit, and I can see many ways in which it would strongly aid in the defense of a breach of fiduciary duty claim against corporate officers.
However, it doesn’t change the fact that the best approach to the defense of such corporate officers is either to keep employer stock out of the plan itself or, in a move court tested and approved by at least one circuit, move the entire management and decision making on whether to hold company stock or not, and if so when to buy and sell it, out of the company and onto very qualified outside advisors. This will still, just like the case as noted above with regard to the author’s proposal for creating an automated system, not completely exempt the corporate officers who are fiduciaries from the risk of liability, but will make it very, very hard to recover from them; they can still be sued for alleged errors in selecting and then failing to monitor that outside advisor, but if the outside experts are well-chosen, that’s going to be a hard row to hoe to recover from them.
What Exactly is the Investment Drag of Macaroni and Cheese?
This is interesting – it’s the story, in abbreviated form, of the Seventh Circuit breathing new life into an excessive fee class action case, by finding that there is a factual question of whether the fiduciaries properly evaluated their options and that the defendants cannot insulate themselves easily from their obligation to properly monitor and test fee levels. Its also an interesting case on the question of the fiduciaries’ obligations with regard to structuring an employer stock fund and on the effect of such choices on returns net of expenses. The case itself is George v Kraft Foods Global, and you can find the opinion itself here.
The case jumped out at me for three reasons. The first is that it runs counter to the assumption, expressed in many quarters, that the Seventh Circuit’s prior and highly publicized ruling in Hecker created a significant barrier, and possibly spelled the death knell, for claims built around excessive fees and costs for plan investment options. Many, including me, thought the Seventh Circuit went too far in that regard at that time, and that excessive fee claims needed to be evaluated on the micro-level of the actual facts of the fiduciary’s conduct to decide whether a claim was viable, which was not the approach taken in Hecker. This latest case out of the Seventh Circuit seems to move in that direction, as it is clearly a fact specific investigation of the issue, one that found that the plaintiffs were free to make out such a case on the actual facts of the fiduciaries’ conduct.
The second is that this ruling thereby fit perfectly with the thesis of my article on excessive fee claims after Hecker, referenced here, which posited that subsequent judicial and regulatory developments would move the case law away from the approach of the court in Hecker and toward the approach taken in this most recent Seventh Circuit case. Time seems to be bearing out my forecast.
The third is the nature of this claim involving breach of fiduciary duty involving employer stock holdings. We all know that the traditional form for such claims is the stock drop case, in which the complaint is that the plan should not have been holding employer stock which then dropped significantly in value. In many jurisdictions, this is no longer a promising approach (although not in all, and for good reason, an issue for another day). Here, however, we see a revamping of the traditional approach to such claims, one that makes the stock holdings aspect of an investment plan a possibly significant basis for a breach of fiduciary duty claim under ERISA. Those plaintiffs’ class action lawyers – what will they think of next?
Excessive Fee Claims After Tibble and Hecker
I thought I would pass along that my article on the law of excessive fee claims under ERISA is coming out this week in the Spring 2011 edition of the Journal of Pension Benefits. Titled “Retreat from the High Water Mark: Breach of Fiduciary Duty Claims Involving Excessive Fees After Tibble v. Edison International,” the article explores the interplay of the Seventh Circuit’s reasoning in Hecker (a case I have discussed often on this blog), the detailed fact finding of the trial judge in Tibble, and the regulatory changes related to fees and fiduciary status being enacted by the DOL. The article’s takeaway – since as many of you already know, I tend to think that legal writing that doesn’t tie things up with a lesson or a conclusion that will help practitioners or clients is wasted ink – concerns how to structure plans to reduce potential liability in light of these developments.
Here is a link to the abstract for the article, which will also give you the full cite if you want to track it down.
What Can We Learn From a List of the Best 401(k) Plans?
Funny, this chart from Bloomberg on the top rated 401(k) plans in the country, taken from the BrightScope data. When I first discovered BrightScope’s beta site and blogged on it, I was struck by the fact that if you want a good retirement, you should go to work for the Saudi Arabian oil company. This chart highlights that this advice, cheap and useless though it is, is still sound. But what’s not a throwaway comment about this chart is this: take a look a this list of the best 401(k) plans, and then look at the companies. It’s a cross sample of some of the most successful companies in America. So what comes first? Does the success breed large account balances? Or do employees who feel the company has their back on benefit plans, such as 401(k) plans, build a better company? My gut instinct from a lifetime of work and a professional career working on benefit and plan disputes is that the answer to both is yes, in that it is a self-reinforcing cycle. Properly treated employees build a better and wealthier company, which in turns leads to larger account balances in 401(k) plans (because of employer matching, because employees have more income to invest, and because employees think they will be there long enough for it to be a worthwhile undertaking), which in turn leads to more highly motivated employees, which in turn leads to a more successful company, which in turn . . . Well, you get the picture.
Fiduciary Definitions Change Hand in Hand with the Real World
One underlying theme of much commentary about 401(k) plans is the idea that their replacement of pensions as the primary retirement vehicle for most private sector workers was not intended, and is the walking, talking example of the law of unintended consequences. Seen as it was in its origin myth – as a supplemental retirement investment vehicle – its flaws become less significant; for instance, questions of the appropriate levels of fees, or whether and under what circumstances to include employer stock, are less important when the risks of reduced return from those issues impact not the participant’s primary retirement investment, but rather a supplement to it. In some ways, that is the revolution of BrightScope. I have spoken with lawyers and industry people who quibble (and sometimes outright quarrel) with its math, but the reality is that, regardless, it is the first public forum (that I know of, anyway) to really treat 401(k)s as what they truly are: the primary retirement vehicle for a vast swath of the public. Viewed in that light, every piece of information that impacts or reduces performance, which BrightScope tries to capture and communicate to the participants, is of the utmost importance, something that would not be the case if 401(k)s played a less central role in employee retirement planning.
I was thinking of this today because of two stories on issues involving the use of ESOPs and 401(k) plans for purposes other than retirement income accumulation; in both cases, for the more traditional purpose – in my mind anyway – of motivating employees and managing tax exposures. As tools for these purposes, they have more value and less risk than they do as primary retirement vehicles. Both though are subject to distortion depending on the nature of the management of them: the ESOP by misuse, as I have written before, as a tempting tool for corporate transactions and the 401(k) by mismanagement of its investment selection and cost. Each risk is countered, or supposed to be, by the fiduciary obligations of those operating the plans, and at heart this is what the Department of Labor initiatives to expand the scope of fiduciaries is targeted at: making sure that all those who play a management or similar key role in the operation of these types of plans become fiduciaries and are subject to the discipline imposed by that status, in terms of potential liability exposure, behavioral demands and expectations, and litigation risks.
Pozek on Werewolves
I have mentioned to people in the past that I am reasonably confident that I am the only author of legal information who has managed to link Walker Percy, denied benefit claims and ERISA in the same publication, which I did here in this post. I think that’s a pretty good stupid human trick myself. Adam Pozek’s linking of Warren Zevon, Werewolves of London, 401(k) plans and the 404(c) defense, although a little less obscure in its references, is pretty good too. It also has the benefit – pun intended – of being accurate and informative, and a nice little walk through the realities of the 404(c) defense, all at the same time.
Me, Behavioral Finance and PlanSponsor Magazine
Alert reader Tom Obara of Cassidy Retirement Group here in Massachusetts - or as I have taken to calling it during this perpetually snowy winter, East Dakota - passed along to me an article on behavioral finance in January’s issue of PlanSponsor in which I am quoted on the need for plan sponsors to adequately educate and inform plan participants about investment options and the risks they pose. You can find the article, called “Misbehavioral Finance,” here, and this is what I had to say on the matter:
Not delivering a reality check: Some of the wave of participant lawsuits since the 2008 crash could have been prevented if sponsors had delivered the message more clearly throughout to DC participants that they bear ultimate responsibility for their retirement security, believes Stephen Rosenberg, a Boston-based Partner at law firm The McCormack Firm, LLC, who works primarily with employers. “There are some lawsuits that suggest they do not want to rock the boat in telling people who are already concerned about their declining house value anything else that could worry them,” he says.
Employers should have been delivering that reality check all along, Rosenberg thinks. “There is little doubt that years and years of significant asset growth meant that many people did not pay attention to the risks and the fees. It has left people with very unrealistic beliefs and expectations,” he says. “I do not think that they were educated enough in advance. It is easier for plan sponsors, as well as for their vendors, to not really point out the risks or exposures and just let everybody be happy.” Employees need to get the clear message that “you cannot just rely on the company to get you there,” he says of retirement security. They need to know, he says, that a 401(k) “is something different from what your parents had, or what you wish you had.”
Now lets be clear. No amount of information, education and disclosure is going to insulate a plan against class actions if there is a problem in a plan that the class action bar thinks can be targeted (and let’s make sure we are fair: sometimes the class action bar is right and a plan does have legitimate problems that call for class wide relief). They will always be able to find some plan participants who are unhappy enough to serve as class representatives, no matter how much information the plan sponsor had imparted to those individuals. But it is my view and my experience that many individual complaints and individual participant lawsuits can be avoided by educating participants properly about their investments; many suits arise because participants feel blindsided and misled, and that is a dynamic that disclosure and education can defuse. Beyond that, there is little doubt in my mind that an educated workforce that, even when 401(k) balances decline, is knowledgeable enough to understand that risk and even to have foreseen that possibility, is a happier workforce, and one that suffers less damage to its morale in a downturn. Isn’t that a good enough reason right there to expand disclosure and education to plan participants?
On Spano and Certifying Classes in Defined Contribution Cases
Here is a nice article from Planadviser.com that sums up the recent opinion out of the Seventh Circuit that I discussed the other day in this post, on the propriety of certifying classes of plan participants in excessive fee cases. The article does a nice job of summing up the findings on that issue, if you don’t want to read the court’s fairly long, but well written analysis of the issue.
One of the impressions you may get from the article is that, in some manner, certifying a class in such a case may be difficult, but I don’t think that is a fair reading of the case or of the events in the litigation itself that gave rise to the ruling. If you think about it, there is little question that each plan participant’s account rises and falls on its own, independent of those of other plan participants to a certain extent, and that harm to one may not be harm to all. However, there is also little question that if there is an overarching problem with the plan that runs across all or many participants’ accounts - such as fees that are too high with certain investment options - that many participants may be injured in the same way and to a similar extent. What the Seventh Circuit’s ruling in Spano suggests, rightfully I think, is that, under these circumstances, one has to think carefully about how a class should be defined and of whom it should consist. There is no reason to draft a broad class definition that simply includes all plan participants, and instead a class should be constructed that is limited to those plan participants who actually invested in the specified investment options that are shown to have had excessive fees or other fiduciary breaches during the time period that the problems existed. That is not a lot to ask to make sure that class action litigation actually serves it purposes and satisfies the procedural and other legal limitations that exist to ensure that it does so, and doesn’t run off the tracks. It certainly requires more thinking, study and analysis of the actual scope of the investment problems at the class certification stage, rather than simply certifying the class and waiting to figure that out during the merits portion of the case, but isn’t that, after all, what class certification discovery exists for?
Just idle musings for a Monday morning.
Class Actions, the Diamond Hypothetical and the Seventh Circuit
I have written before about the various implications of the Supreme Court broadening fiduciary duty claims in LaRue to allow individual participants to sue for losses only to their own accounts, rather than just for harms suffered by all participants, or in other words, by the plan as a whole; among other aspects, I have discussed its interplay with the class action rules, and the importance for the development of the law of ERISA of the Court’s distinction in that case between defined benefit plans and defined contribution plans.
On the first point, I have noted that the famous - to a small group of interested observers otherwise known as ERISA lawyers and scholars - role played in LaRue by the so-called (by me, anyway) diamond hypothetical may have a wide range of implications for the development of the law, not all of them either intended or even foreseeable. Under the diamond hypothetical, each participant’s account in a defined contribution plan can be understood to contain its own specific bunch of diamonds, which all together add up to make up the totality of the diamonds held by the plan; this is different than a defined benefit plan, in which the diamonds are not subdivided in that manner, but instead are merely held in their entirety as the plan’s assets. I have blogged before about the question of whether this meant that an individual plan participant who suffered no harm to his particular account - i.e., his diamonds didn’t vanish - could proceed as a class representative where other plan participants did suffer harm in their accounts - i.e, their diamonds did vanish - or could seek relief on a plan wide basis. Judge Gertner of the United States District Court for the District of Massachusetts has a nice discussion of the diamond hypothetical in the footnotes of her opinion that is discussed in this post.
In a decision interesting on a number of fronts, the Seventh Circuit has now addressed this same issue in detail, in the context of deciding whether class certification orders in excessive fee cases involving defined contribution plans were appropriate. In Spano v. Boeing, the Court focused on the implication of the diamond hypothetical structure of defined contribution plans (without mentioning the diamond hypothetical), finding that class certification can be proper, despite the fact that each plan participant has his or her own individual account and possible loss, after LaRue, but that the particular injury to the different participants’ accounts had to be examined to determine whether class certification was appropriate with regard to the particular theory being pursued by the class and the representative plaintiffs. In essence, class certification may not be appropriate if there is too much variance in the impact on different participants’ accounts of the challenged conduct. The opinion is a fascinating read on this question, and you can find it here.
The opinion is notable for a number of other reasons as well, some of which I may return to in further posts, but one of which I will mention here. I have posted in the past that the Supreme Court’s opinion in LaRue invited courts to revisit the rules in place with regard to defined benefit plans when instead evaluating claims concerning defined contribution plans, and emphasized that the rules applicable to the former may not properly fit the latter. I have pointed out as well that figuring out where or how the rules should diverge in the two contexts should open up avenues for participants’ lawyers to try to advance their cases when pressing claims involving defined contribution plans. The Seventh Circuit drives home both this point and this new reality in Spano, recognizing this dynamic put into play by the Supreme Court in LaRue.
The Ever Evolving Risks of Fiduciaries
Well, I am not sure I could have said this better myself, although in post after post, I have spoken of the increasing litigation risk for fiduciaries, and of the need to respond by emphasizing compliance and diligence in designing and running 401(k) plans. At the end of the day, ERISA has become a fertile ground for litigation, and the inherent conflicts and difficulties in running 401(k) plans are exposing fiduciaries to lawsuits and the potential of personal liability. Susan Mangiero, in this post on her blog Good Risk Governance Pays, surveys this landscape and explains what is putting fiduciaries ever more at risk. Two particular aspects of her post are worth highlighting. The first is her reference to a leveling off of fees, and her attribution of that event to litigation risk; we are coming through a storm of lawsuits over investment fees and expenses in 401(k) plans, all alleging - in one way or another - that sponsors and fiduciaries should have used their market power to obtain lower fees. It is often remarked that litigation is a terribly blunt instrument to effect change (its also expensive and not terribly efficient), but it may have done so here and, if so, those of us who labor in the vineyards of the court system should be pleased by the system’s ability to effect change. The second is her discussion of the series of changes that are affecting fiduciaries, each of which in one way or the other has the potential to expand fiduciary liability, if manipulated well by counsel for participants. I have written many times that we are in an era of evolution of fiduciary liability under ERISA, driven by the old Marx line that at the end of the day, everything is economics. As I have written before, the simple fact is that 401(k) plans - and worse yet losses - have become the fundamental reality of retirement for most employees, and with that change in the economic environment is going to come change in the risks, obligations, demands and legal exposure of the fiduciaries of such plans; we see that here in Susan’s post as well.
On Disclosure and Conflicts of Interest
In my life as a trial lawyer, I have found myself in a recurrent situation, in which a judge or an arbitrator eventually looks at me in an argument over discovery and asks if I really want the information I am after, as it could run against me. I always answer the same way, to the effect that I am comfortable with facts, believe that more information is more likely to lead to the just result in the case, that I will trust the facts to show us which way to go, and that I am more than willing to let the facts come out in the open and drive the case. Now, the truth is that, before ever seeking the discovery that is at issue, I will have long since thought through the subject and become convinced that the evidence in question, once brought out, is far more likely to help my case than to harm it; the reality, from a tactical perspective is that, otherwise, I would not have pressed the point in the first place, with me going so far as to ask a court or arbitration panel to order production of the witness, or documents, or whatever else is in question. That said though, my response - to the effect that I favor the facts coming to light - is a true sentiment. Facts are stubborn things, in the classic formulation, and they decide cases; I am more than happy to have them see the light of day. Heck, I would certainly like to know of them while I can do something about them, even if they are bad for my case, than have them just show up for the first time out of some witness’ mouth on the stand in the middle of a trial.
I thought of this when I read this investment manager’s discussion of the Department of Labor’s expansion of the term fiduciary, which I discussed in my last post, and of the Department’s various initiatives related to fee disclosure, in particular his discussion of lobbying against those actions. Like facts in a lawsuit, the facts of revenue sharing, fees, and the like belong in the open, and can do nothing at the end of the day but improve outcomes for participants, plan sponsors, fiduciaries and the better advisors. What’s wrong with a little sunshine, a little transparency, and a lot of disclosure in this context? Frankly speaking, probably nothing. Participants will eventually end up with better outcomes, while plan sponsors and fiduciaries will have the information needed to best do their jobs, which will - if they use the information right - make them far less likely to get sued or, if sued, be held liable for fiduciary breaches. Meanwhile, we all know that advisors get paid fees, as of course they should; the only change is that everyone involved in the decision making will know who is getting paid what and for what exact services. Under that - possibly excessively rosy - view of the world, the end result should just be that the better advisors, who are providing better products and services at better prices, will get more of the business. What’s wrong with that, from a forest eye view?
Talking About Compliance is Cheap - Taking Action On Compliance Is What Matters
I talk regularly, of course, about the importance of compliance in the operation of ERISA plans - just take a look at my immediately preceding post for instance - but that is just a fancy way of restating the old saw that an ounce of prevention (in the form of a well run plan) is worth a pound of cure. As an ERISA litigator, the cure - litigation - is better business for me than the ounce of prevention ever could be, but that doesn’t change the basic fact that the only real precaution against litigation costs and liability is a well run plan, and the best defense against a lawsuit that arises anyway is the same thing -a well run plan.
But how do you get to a well run plan? While there are a number of ways to get there, here are a couple. Ary Rosenbaum, in this piece, explains why one step towards a well run plan is to bring in expert legal advice on the compliance aspects of the plan right from the get go. A true ounce of prevention strategy if I have ever heard one. Another is to constantly increase the knowledge base of a plan’s decision makers. On that front, Pozek on Pension’s Adam Pozek and ERISA lawyer Ilene Ferenczy have created a really useful little engine for accomplishing that, in the form of a series of webinars offered by Pension Pundits LLC. Their next one, coming up shortly after the first of the year, is on non-discrimination testing, and you can sign up for it here. At the end of the day, litigation costs too much money, even if a plan’s sponsor and its fiduciaries prevail, to not take advantage of these type of opportunities to avoid getting sued.
Fees, Fees and More Fees - Once Again
I wanted to say that much ink has been spilled over the Department of Labor’s regulatory initiatives concerning fee disclosure, but no one really uses ink anymore, and we all just post on the internet, in either blogs or in intermediary sites that publish law firm client advisories. Either way, though, there is no getting around the tsunami of reporting on the fee initiatives, much of which is quite good. That said, for those of you who don’t feel overwhelmed by the amount of information out there on this subject or, on the other end of the spectrum, are not yet comfortable with the impact of the regulations, I liked this publication here for an easy to digest summary on the issue. Beyond that, Josh Itzoe, author of Fixing the 401(k), is offering this webinar on the subject on a few occasions over the next several weeks.
Does LaRue Alter the Rules for Class Actions?
As a general rule, I don’t write blog posts about cases I am handling. For the most part, nothing good can come of it. I do make an exception once and awhile, but only to the extent of passing along a particular ruling, without commentary, that may be of broader relevance and interest. Today is one of those days, in which I am posting this recent federal district court decision from one of my cases which concerns class certification related to a 401(k) dispute, and I post it only because the Court provides a nice synopsis of one particular wrinkle raised by the Supreme Court’s ruling in LaRue, namely its impact, if any, on the propriety of certifying a class in a dispute involving a defined contribution plan. In the words of the Court:
There is a question whether the Supreme Court’s decision in LaRue v. DeWolff,
Boberg & Assoc., Inc., 552 U.S. 248 (2008), bars class certification of fiduciary breach claims by participants in defined contribution plans because participants as a result of LaRue’s holding may now pursue individual ERISA actions against plan fiduciaries. Although some courts have so held, see, e.g., In re First Am. Corp. ERISA Litig., 622 (C.D.Cal. 2009), other courts, including this one, have not been persuaded that so radical a revision of Rule 23 was intended by the Supreme Court. See Hochstadt v. Boston Scientific Corp., 2010 WL 1704003 at *12 n.12 (D. Mass. Apr. 27, 2010); see also Stanford v. Foamex L.P., 263 F.R.D. 156, 174 (E.D. Pa. 2009) (“The availability of an individual account claim under § 502(a)(2) [of ERISA] does not alleviate the concerns cited by numerous courts that have certified ERISA class actions pursuant to Rule 23(b)(1)(B) in situations where claims on behalf of the Plan are identical to those on behalf of an individual account.”).
You can find the discussion at footnote 4.
Fees, Fees, and More Fees
Investment option fees are the current bête noire of 401(k) plans, but to date the government response to them has not been a direct attack on the amount of fees themselves, in the form of regulatory or legislative establishment of appropriate ranges of fees. This differs, for instance, from the manner in which the government has effectuated health care reform, where the new regulatory structure is built around establishing and dictating exact manners of compliance. In contrast, with 401(k) fees, the government response, as formulated through regulatory initiatives, is to increase transparency, as Ryan Alfred of BrightScope discusses in this insightful post, presumably in the belief that greater transparency will lead to greater pressure to reduce fees. At a minimum, one would expect broad knowledge of the fees that are part of different investment options to increase competition, as plan participants and fiduciaries seek lower fees for their own reasons when confronted with this information, and the providers respond to that pressure by competing more on price. That, in any event, would seem to be the theory.
Will it work? Probably, would be my guess, although obviously if we give it a little time, someone will be able to give us quantitative evidence at some point as to whether or not this approach succeeded in bringing down fees. But looking prospectively, rather than in hindsight, it only makes logical sense that it would. That relatively small subset of participants who understand the impact of fees on their 401(k) plans can be expected to press for lower fee options, and fiduciaries can in turn be expected to respond by seeking such options, if for no other reason than to reduce the risk of getting sued down the road by disgruntled participants; in this way, the self-interest of the key set of players on the buy side ought to reduce plan fees, as providers respond to this pressure by competing on price. Maybe that’s a little too “invisible hand of the market” for some people, and that may not be the answer to all problems everywhere, but it seems a nice logical outcome in this instance.
Moreover, it is likely to work here because the use of transparency to bring about lower fees is not occurring in a vacuum, but instead is reinforced by the private attorney general aspect of ERISA litigation, in which participant classes and individual participant plaintiffs simultaneously pressure fiduciaries to reduce fees or risk paying out a small fortune in defense costs and settlement money if they don’t, as this story about a recent settlement over fee disputes entered into by Bechtel reflects. Greater transparency combined with increased risks of liability for failing to act on fees seems like a pretty potent combination, and a sensible way to try to bring down fees without simultaneously hemming in fiduciaries and their vendors by dictating exact fee ranges.
In the More Things Change Department . . .
I mentioned in a prior post that I was speaking on a panel with David Webber of Boston University Law School. David’s blog, Labor Capital, has a nice post on the financial weakness of public pension plans, and the questionable financial transactions that have led to it; you can find it here. I have commented in various posts on the same phenomenon at different times, but what was interesting to me about David’s post is how much it sounds like the gamesmanship with pension funding that eventually brought about the enaction of ERISA itself. One wonders whether the problems of state pension funds will eventually lead to some sort of broader national reform effort of a similar nature targeted at those funds.
This in turn leads to another thought, which again links to the seminar I presented last week, which concerned the legal implications of the shift from pensions to 401(k) plans. ERISA was enacted, as noted, in response to pension problems and to create some uniform rules and regulations to govern them. One can argue that, in hindsight, the system that was created - a mix of regulation, insurance and private enforcement - did a pretty good job controlling pension issues. Now, however, we have, in essence, moved out of the pension world and, for all intents and purposes, into the defined contribution world, and ERISA in all its forms - litigation theories, judicial doctrines, regulatory provisions, etc. - have not yet caught up, resulting in ERISA not currently being as well suited to govern defined contribution plans as it was for governing pension plans. From this perspective, one can see the new fee disclosure regulations, for instance, as steps towards grafting on the type of regulatory and other controls that are appropriate for the defined contribution world, and that were not needed before, when pensions roamed the earth.
I think it is important to realize this, as we watch both the DOL develop new rules and the courts develop doctrines to govern employer stock drop, excessive fee, and other hot topics related to defined contribution plans, so that we are aware of exactly what we are watching proceed, which is - from a very broad and macro perspective - the creation of a framework for applying ERISA, and its fiduciary duty obligations in particular, to the defined contribution world which we now inhabit. In hindsight, in terms of jurisprudential philosophy, that is what the Supreme Court’s decision in LaRue was about: the recognition that the fiduciary liability rules applicable to defined benefit plans may have to change to match the reality of the defined contribution world.
The Ninth Circuit Adopts Moench and Why It Matters
Now here’s an interesting tale, namely the story of the Ninth Circuit’s adoption of the Moench presumption with regard to breach of fiduciary duty claims alleging that fiduciaries erred by allowing a plan to hold too much employer stock or otherwise failing to act to protect participants from the risk of holding that stock as an investment option. As I discussed in this post, the Moench presumption essentially shields the fiduciaries from such claims where the plan expressly authorizes employer stock as an investment unless the company and/or its stock value had been placed at extreme risk. As the blog post on the Ninth Circuit’s decision notes, and as I have commented elsewhere, courts vary in how they frame the circumstances in which the presumption can be overcome and a breach of fiduciary duty claim maintained, but in all circumstances it can fairly be described as requiring a significant risk to the investment, beyond just a major stock decline. The Ninth Circuit, in its opinion, notes the variance in formulating the standard, and then formulates a pretty high bar for overcoming the presumption.
As I discussed in this post, the Department of Labor is in the process of arguing to the Second Circuit that this presumption should not exist, and the outcome of this at the Second Circuit becomes key, I think, for the future of this theory of liability against fiduciaries. If the Second Circuit joins the Ninth and a few other circuits in adopting this presumption, this becomes a very unattractive potential theory of liability for the class action bar or anyone else to pursue; large scale breach of fiduciary duty cases against large, well run and sophisticated plans are tough cases to win in the first place, before adding in the significant defense at the motion practice stage that this presumption grants to plan fiduciaries. If, on the other hand, the Second Circuit agrees with the Department of Labor and rejects the Moench presumption, it doesn’t take a soothsayer to suspect the issue goes from there to the Supreme Court, given the obvious circuit split on a significant issue of federal law that such a decision would create. On that front, with regard to the question of what the Second Circuit may do in response to the Department of Labor's arguments, it is worth noting that the Ninth Circuit's opinion in many ways anticipates and provides the rejoinder to much of the Department of Labor's argument in its briefing to the Second Circuit, on whether the presumption is compatible with ERISA; the opinion actually presents a well reasoned framework for viewing the presumption as consistent with the statutory framework.
The Ninth Circuit decision, in Quan v. Computer Sciences Corporation, adopting the presumption, is interesting for another reason. I will confess - and frequently do, to anyone who will listen - to a preference for issues being decided on their merits and, preferably, at trial, after thorough investigation and vetting. As discussed in this interview I did awhile back with Tom Gies, right after he argued the LaRue case before the Supreme Court, I believe the jurisprudence develops better, and we get more accurate results, when key issues are decided after an evidentiary record is developed that will shed light on the propriety, or lack thereof, of challenged conduct, than is the case when such issues are decided based upon the legal arguments, hypotheses and assumptions that checker any decision made in advance of factual development, such as at the motion to dismiss stage. My experience as a trial lawyer has taught me to put my trust in facts, and to believe that they are more likely than not to lead one to the right result. They are, as the saying goes, stubborn things, far less manipulable than legal doctrine and argument.
That said, though, the Ninth Circuit case adopting the presumption presents a perfect justification for the presumption. As detailed in this blog post, the stock drop at issue in the case, and on which the claim of breach of fiduciary duty rested, was a 12% single day decline, which was recovered in a reasonable length of time. Given the variability and the volatility of the market in general, it is extremely hard to think of a convincing rationale for imposing fiduciary liability simply because of a moderate, but not company threatening, short term decline in the value of the company stock, or for allowing expensive, time consuming litigation over that stock drop. In that particular case, the presumption resolves this, by establishing that the stock drop alone isn’t enough, and much more must be shown to justify the suit going forward.
ERISA and the 401(k) turn 30
I mentioned in a previous post that I am speaking on ERISA issues in a seminar for the Professional Liability Underwriting Society. The presentation is “I Have to Retire on THIS? ERISA and the 401(k) turn 30,” and its tomorrow, Thursday, October 7th, at 2 pm. You can find registration information here if you would like to attend. I am joined on the panel by David Webber, a law professor at Boston University School of Law whose research interests run to securities law and regulation, and Mary Rosen, the Associate Regional Director of the Employee Benefits Security Administration, U.S. Department of Labor.
Moench, the DOL and the Future of Stock Drop Litigation
I had the pleasure yesterday of presenting the September Advisor Success Webinar for BrightScope, in which I discussed the law and practice of fiduciary liability and exposure in detail. Its for subscribers only and not publicly available, but for those of you in the Boston area who are in the insurance industry, I will be touching on some of the same points when I speak as a member of a panel next month at a meeting of the Professional Liability Underwriting Society; more details on that to follow.
For now, though, I thought I would comment on one particular issue that seemed to strike a chord yesterday, which is the current status and likely future direction of stock drop litigation under ERISA. To date, stock drop litigation has not, as a general statement, been terribly successful, as least not from the perspective of those seeking to represent classes of participants; its been pretty darn successful for those representing plan sponsors and fiduciaries. The reason, as many readers already know, is the famous - or infamous, depending on which side of the “v.” you sit on - Moench presumption, which in essence imposes a powerful presumption that allowing substantial amounts of employer stock to be held in a defined contribution plan cannot constitute a breach of fiduciary duty unless the company was in severe financial distress, with severe meaning something more than just a significant decline in the stock price (courts' exact phrasing on this point can vary).
What was of interest in the webinar was the question of whether this presumption will remain effective, or will instead fall by the wayside, which would open the door to more suits and likely as well to greater liability as a result of electing to offer employer stock as an investment option. The answer is that it will fall by the wayside, resulting in an increase of these types of suits and a rebirth of interest in this theory among the class action bar, if the Department of Labor has its way. In an amicus brief filed before the Second Circuit in the case of Gearren v. McGraw-Hill, the Department has outlined its position in this regard, which is, in a nutshell, that the presumption is inconsistent with ERISA’s mandates, and that, with regard to employer stock, the only exception to the generally high duties of care imposed on fiduciaries is the removal of any duties related to diversification of investment options. A Second Circuit ruling adopting this viewpoint will unquestionably expand stock drop exposure and increase lawsuits based on stock drop claims, by allowing the participants to focus on proving as a factual matter through discovery that it was not prudent to include employer stock, rather than being forced to prove that the company was under the level of severe financial distress needed to trump the Moench presumption before ever being able to investigate and prove that thesis. You can find a copy of the Department’s brief on this issue here.
Private Attorney Generals and ERISA
Here’s an interesting, although at a minimum somewhat overstated, diatribe against 401(k) plans from Forbes, in which the author complains about four specific risks to participants: greater investment risk than would exist investing outside of such a plan; problems with employer or vendor record keeping and management; the possibility of employer failure; and a lack of regulatory oversight, at least in comparison to the extent of regulation applicable to other investments. The author overstates some of his points - for instance, some of his complaints about regulatory oversight are more accurately seen as complaints about sponsor capabilities, such as with regard to publishing and timely distributing summary plan descriptions or making timely distributions.
What’s more interesting to note, though, than quibbling about the details of the author’s complaints, is the extent to which they primarily concern the fact that the 401(k) world, much more than being a regulatory driven regime, is governed more on a private attorney general model, in which breach of fiduciary duty lawsuits and denial of benefit claims are the tools that address and remedy the problems the author identifies. For instance, in his discussion of increased investment risk, he references the fact that, outside of 401(k)s, an investor can pick from the universe of funds, while within the 401(k), the investor is limited to the several funds included in the plan, which may not be the best performers or the cheapest (or, if neither, at least the funds with the optimum combination of performance and cost). This, though, is at heart what all breach of fiduciary duty claims related to excessive fees or other complaints about fund selection are directed at, namely whether the fiduciaries included the right mix of funds. In theory, fiduciaries will do that, if for no other reason than out of fear of being sued if they don’t. Anecdotally, there seems to be, for instance, greater attention being paid now by plans to fees and fund selection in the wake of the class action litigation that has been pursed over excessive fees and alleged non-disclosure of fees. This is a perfect example of a private attorney general mindset, in which the issues of concern - here, the operation of 401(k) plans - are expected to be avoided by the threat of liability and, if they are not, are remedied by private litigation; this is, theoretically anyway, the counter to the type of more regulated regime to which the author compares the 401(k) world.
Pay Now and Later: High Plan Fees Pose an Increasing Risk of Fiduciary Exposure
Chip, chip, chip. No, that’s not the sound of the polar ice caps shedding ice, although I suppose it could well be. It’s the sound of the Fortress Europa that some of the more optimistic lawyers for 401(k) plans thought was being enacted against excessive fee claims - in the wake of cases such as Hecker - slowly being whittled away. Cases such as this, in which the fiduciaries were found to have fallen down on the job by accepting retail class fees, are going to open the door to more of these cases, and to more settlements to resolve them, than seemed possible when the first wave of excessive fee type cases were being ruled on; indeed, as this client advisory points out, it is no longer possible for plan fiduciaries to simply ignore the question of the propriety of retail fees in their plans. I have long believed that it will take only a couple of district courts who are willing to allow excessive fee cases to proceed into discovery and to adjudication on their merits to turn excessive fee cases into a potentially significant risk for fiduciaries, and I feel comfortable predicting that this is the start of that trend. To add a Civil War metaphor to my earlier climate change and World War II metaphors, these types of cases are going to bear out my prior prediction that Hecker was likely to be the high water mark in the defense of excessive fee cases.
Can the Deepwater Horizon Spill Sink the Fiduciaries of BP's 401(k) Plan as Well?
Well, someone thinks so. You can count me, though, as monstrously skeptical that you could tag the fiduciaries of the BP 401(k) plan with breach of fiduciary duty for overexposure to company stock because they failed to expect the Deepwater Horizon explosion and account for it by greater diversification. On the other hand are two notes: (1) perhaps there is a circuit, somewhere out there, with fiduciary liability standards for company stock investment that are so loose that including BP stock ahead of such an event could be deemed an actionable breach; and (2) the decline in the value of the plan’s assets may be so large that, if a class gets certified, even a minor settlement to avoid a potential ruling against the fiduciaries could easily run into the tens of millions.
On Named and Functional Fiduciaries
I have been a fan of Scott Simon’s Morningstar articles on the various fiduciary relationships among those who run plans and those who advise them. This one here is a good, practical, business oriented view of the different forms of fiduciaries - named and functional (or deemed) - in 401(k) and other plans. It is written more from the business perspective, of who are the different players and what fiduciary niches do they occupy, in the structuring and operation of a plan. This is somewhat different than how we lawyers, particularly litigators, tend to look at these issues, because it is forward facing and addresses the deliberate structuring of the plan and of these roles. We litigators in particular tend to look at things from a different vantage, more in hindsight, and say did this person or that entity, looking at what they actually did, acquire the status of a fiduciary for purposes of liability exposure, whether they were intended to be put in that position or not at the outset of the plan’s establishment. And from that perspective, one of the most useful comments in his most current article is his explanation of one type of functional fiduciary, namely the party that assumed control over plan assets to some extent unintentionally, but that nonetheless then became a fiduciary with fiduciary responsibility for any acts taken in that regard. As he points out, that party assumes fiduciary liability in that situation, even if it did not knowingly cross the line into that role. As Simon Says:
A more serious scenario is where a person unilaterally exercises discretionary control or authority over a plan without express authorization. Such a person can become a "functional" 3(21) limited scope/non-named fiduciary--without a written contract--through its mere conduct of providing unauthorized advice or exercising unauthorized control or discretion. Given that no contract is present in this situation, the entity obviously doesn't intend to become a 3(21) limited scope/non-named fiduciary but becomes so anyway through its inadvertent conduct.
From a litigation perspective, this is a far more common circumstance than one might assume, and is a central point in much breach of fiduciary litigation, where a key question is often whether a particular defendant became a fiduciary by its actions concerning the plan and its assets, where it was not intended by the plan’s authors and founders to be a fiduciary.
Over the past week or so, several interesting items have crossed my desk, none of which have appeared while I have had time to do them justice with a full blown post. We will do three for Wednesday today - even though there is no alliteration at all to that title, as opposed to five for Friday or twofer Tuesday - and run them down here.
First is this interesting article on the 403(b) regulations, and the intersection of the tax code and ERISA. It’s a good starting point for understanding the current regulatory status of such plans.
Second, in a perfect intersection (well, almost, since surety bonds aren’t exactly insurance) of the two topics included in the title of this blog, is an excellent post summarizing ERISA’s surety bond requirements. From fiduciary liability insurance to surety bonds to the personal liability of fiduciaries, ERISA in theory, structure and operation, is built around a framework that is intended to surround retirement plan management with pockets of funds that can be used to reimburse plan participants against losses.
Third, here is a nice squib on the question of when ERISA applies to, and governs, severance package programs as part of company reductions in force. Most such programs will fall within ERISA’s ambit, and, as the article points out, it is beneficial to the employer to structure the program to bring it within the confines of ERISA.
Harris, Hecker, Excessive Fees and Marketplace Discipline
Yesterday, the Supreme Court effectively rejected the idea that mutual fund fees, in the non-ERISA context, are not actionable if consistent with the market as a whole, in response to a Seventh Circuit decision finding that a fund did not pay excessive fees to its investment advisor in light of marketplace discipline (I am oversimplifying the Supreme Court ruling a little bit, as this is not actually a blog on the Investment Company Act of 1940). Shrewd observers of ERISA excessive fee case law, or even most casual ones, will likely quickly note that, in the ERISA context, the Seventh Circuit essentially applied the exact same thesis to an ERISA excessive fee claim in its highly influential decision in Hecker, finding, in part, that fees were not excessive if consistent with the market as a whole. In the new Supreme Court decision, the court instead applied a different test - albeit in a different context than ERISA excessive fee claims - to determine whether the fees were excessive, asking instead whether a fee is being charged “that is so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm’s-length bargaining.”
Is this a what is good for the goose is good for the gander situation? Is the same market based approach to testing fees that the Supreme Court has now rejected in the investment advisor scenario also, by implication, unwarranted in the context of a fiduciary’s obligations to protect participants against excessive fees in ERISA governed plans? Isn’t the test that the Supreme Court references for the investment advisor context equally a good fit for ERISA excessive fee cases, by asking not whether the fees were consistent with the market as a whole but instead whether the fees are disproportionate to the services provided and whether the evidence reflects them to be the product of an arms length negotiation? In many ways, this is what critics of the Hecker test - at least in my case - have complained about: not that the fees being paid by the defendant company in that case were necessarily too high, but rather that the court didn’t adequately test and vet them before deciding that the excessive fee claim had no merit. The Supreme Court’s new (well, actually a restatement of an old) test for fees in a different context would fit the situation very well, much better than the Hecker approach. The standard would still give a great deal of deference to plan administrators, sponsors and fiduciaries, allowing a wide range of fees to pass muster. The standard, though, would require that there be a reasonable linkage between the fees being charged and the value received by the plan, and that the evidence support the conclusion that the fees came about as a result of arm’s length, business like negotiating by the fiduciaries. In essence, this would bring the test back to the prudence required of the fiduciary, by asking not whether the fees were per se too high, but rather whether the evidence reflects that the fiduciary engaged in the basic business activity of seeking appropriate fees.
Here is the new decision from the Supreme Court, in Jones v. Harris Associates, and here, pat on the back to me, is a post I did last November suggesting that the opinion in Jones may well impact the Hecker line of thinking on ERISA excessive fee cases.
The Fiduciary Status of Investment Advisors
I often explain to people that as a litigator, I am typically presented with a knotty, tied up problem, consisting of all the decisions and plan choices that have been made in the past that eventually resulted in litigation, and that I then have to unravel the knot into its constituent pieces, which can then be used to defend the decisions that led to the knotty problem (if I am defending the case) or to attack the decisions that created the knot (if I am instead representing a plaintiff, whether a plan participant or a plan sponsor or other fiduciary). This is a much different perspective on plans and their design and development than that of those who assemble plans, who look at things in a more prospective manner, from the vantage point of the one developing the world from scratch. In essence, their view is the mirror image of mine, as they look at all the independent strands of a plan and assemble them into what, eventually, will become the knot that I get charged with unraveling in litigation.
That more prospective view comes through in Adam Pozek’s excellent post yesterday on the difference between different types of fiduciary advisors to plans, and how to select them, as well as in the excellent source article on section 3(38) and section 3(21) advisors he references. Adam presents a typical scenario of a plan sponsor trying to work through the issues of how to use such advisors, when to use each kind, and the factors to be considered in making such a decision. To someone like me who normally only sees those types of transactions in the rear view mirror, as they are recounted for purposes of litigation (such as in a deposition), it is very interesting to read a presentation of the decision making and the transaction back at the start of the whole process.
A Parable About the Cable Man
For reasons too obscure and uninteresting to mention, I have had almost nothing to do with the cable tv industry since, well, it was invented. What’s a DVR, anyway, and why would I want one? But yesterday, I had to obtain digital cable from my local cable company, and called them, braced to be gouged. Instead, I was offered a special deal for a year, much less than I was expecting to pay, with stuff I would never pay for thrown in. A few hours later, of course, the reason occurred to me. The cable monopoly I recall from my youth is not what I was dealing with, and I was instead talking to a cable company that had competition from dishes - Dish.com, I guess? - and the local telephone/internet/cable company, so instead of gouging me, they had to offer me a deal they figured would keep me as a customer. Classic economic, legal and antitrust theory holds that there are really just two ways to police pricing - competition or, in its absence, regulation. Competition, of course, is why I got my sweet deal on cable yesterday.
So what does this have to do with the topics of this blog? Seems like plenty, in that it is the absence of above board open competition that is at the root of much of the problems discussed in these pages concerning ERISA governed plans. I have discussed in many posts that the problem with health insurance coverage through employers has much less to do with the question of whether employers want to provide it than it has to do with the ever escalating cost of health insurance and the fact that providing health insurance is a punishing cost. Employers, in my view, are unfairly demonized as trying to avoid providing health insurance, but it is the cost that is driving their increasing balkiness about being, as I have described it in other posts, unofficially deputized as the providers of health insurance in this country. From where I sit, one of the fundamental problems with acts mandating health insurance provision or payments by employers is that they don’t account for this, either by reducing health insurance costs or by recognizing the business costs imposed by these types of statutes. Does anybody really think that the restaurants targeted by the San Francisco statute are swimming in profits? This article here, profiled on the Workplace Prof blog, describes this exact concern about costs as the driving force behind employer, and particularly small employer, health insurance decisions.
And perhaps one solution to the problem of the cost of providing health insurance - perhaps the most important one - is that what is good for the cable industry should also be sauce for the gander, i.e., much greater competition among, and significantly less market control by, health insurers, as pointed out in this op-ed piece here by Robert Reich (when even the archetype liberals are arguing that market competition is the answer to all evils, you know the world has turned upside down).
And the same thought continues across to 401(k) plans, and the ongoing issue of fees and costs in investment options, and how they are disclosed. What if, instead of arguing after the fact about whether the fees in a particular plan were too high, prudent fiduciary practices were deemed to require a competitive process for selecting investment options, in a manner forcing putative vendors to put their lowest cost options forward to win the business? Isn’t that what all the complaining about large asset plans that don’t use their size to win better pricing is about, after all? Instead of just complaining in the abstract that plan sponsors should have acted that way, or engaging in after the fact litigation to try to police how much should have been charged in fees, wouldn’t it make more sense to just require a fully competitive process among vendors for selecting investment options, conducted by fiduciaries - or their delegates - who have the knowledge base to understand the pricing structure of the proposed options?
In that version of the world, it would be a fiduciary obligation to impose a fully competitive, open call for investment options, and to select the best - including on fees, costs, disclosure and performance - from among them, with it being a fiduciary breach for failing to pursue this process (rather than it being a fiduciary breach for ending up with fees that are too high). The focus would return in this way to fiduciary practice, both in terms of judging conduct as meeting or failing to meet the standards of a fiduciary and in terms of whether to impose liability, rather than on an after the fact, necessarily subjective evaluation of the amount of fees, costs, or disclosure in a particular plan that resulted from the fiduciary’s decisions.
Open competition would certainly drive down the fees and costs in plans, while simultaneously giving fiduciaries a clear standard - namely their obligation to decide on the basis of such competition - against which to work. I can’t help but think that, like the cable customer, plan participants will end up with better and cheaper products to pick from, while plans - and their insurers - will spend substantially less on litigation costs.
On Plan Fees, Wal-Mart and the Costs of Bad Publicity
Ouch. Here’s a story bashing Wal-Mart for having very high plan fees in its 401(k) plan, and wanting to know why in the world it doesn’t negotiate lower fees when it has some ten billion dollars in assets to use as leverage. I am sure the plaintiffs’ class action bar has the same question. A quick cross reference to BrightScope, by the way, bears out the allegation.
Here’s the original Forbes story on the issue.
In this day and age, whether to avoid bad publicity or to avoid the costs of litigation, there is no reason for plan sponsors not to put in the effort to seek below market, rather than market - or worse - fees, particularly when they have substantial plan assets to use as a cudgel. Even if a court might eventually find that the higher than necessary fees do not add up to a fiduciary breach, why incur the costs of defending against a major lawsuit alleging that plan fees were too high? It has to be cheaper, in terms of both dollars and corporate resources, to invest the time and effort to obtain lower fees on a plan’s investment options. It’s the same old same old, that I talked about here most recently - an obsession on compliance is the best way of avoiding litigation costs and potential legal exposure. From the point of view of a plan sponsor, it may not legally be necessary to drive down plan fees - the law on excessive fee issues is still developing - but an effort to do so can only be beneficial in the long run, by avoiding potential legal costs on the one hand and improving employee morale on the other.
On Attorneys Fees and Hecker
Honestly, I have spent a week scratching my head, off and on, over the Supreme Court granting cert to consider the standards governing when attorneys fees can be awarded in an ERISA case, particularly when they denied cert shortly thereafter in Hecker, which presented the opportunity to address the much more substantive issue of the scope of fiduciary responsibility for the amount - and corresponding degree of disclosure - of 401(k) fees. In my mind, there is already a conflict among the circuits over that issue, with the Seventh Circuit finding outright that there was no viable theory against fiduciaries of large plans with market standard fees, and the Eighth finding this same theory worthy of factual inquiry. However, as I thought more on it, the denial of cert for Hecker makes some jurisprudential sense. Hecker itself was decided on a motion to dismiss, leaving essentially no factual record for evaluating these types of claims (critics will say, of course, that this didn’t stop the Seventh Circuit from deciding the theory had no merit) and forcing any Supreme Court ruling to turn solely on the allegations in the pleadings. This is a complicated issue, one I have said before would have been more properly evaluated by the Seventh Circuit after factual development, and I suppose it is likewise fair to say that a Supreme Court review of the issues posed by Hecker by means of reviewing Hecker itself would have suffered from the same flaw; Supreme Court review of the fee issues raised by the Hecker line of cases is probably better suited to a case that has played out sufficiently to allow all of the factual and legal fault lines to develop prior to Supreme Court review.
But the attorneys fee case itself still doesn’t make a whole lot of sense to me, as a practicing litigator who spends plenty of time with cases pending in the federal courts that are governed by that fee statute. The reality is that such attorney fee awards are either subsumed within settlements, or the courts award them under current standards only, typically, where there is significant merit to a party’s position and the party obtains significant relief; the district court judges, in my experience, do a good job of utilizing the current standards and understanding of the fee shifting provision of the statute to bring about that result, such as in this case here. And at the end of the day, no matter certain peculiarities that exist in the wording of the statute, this is really the only standard for awarding or not awarding fees that makes practical sense in the real world. After all, do we really want attorneys fees awarded for less than obtaining at least a significant portion of the relief sought by a plan participant?
I understand that the Fourth Circuit, in the case under review, applied a somewhat more stringent test than what I am discussing here, but, from a courtroom level view, courts get this issue right often enough that it doesn’t seem to warrant Supreme Court intervention. But the Court seems to have a thing for ERISA cases these days, for whatever reason.
Is There A Disjunct Between Excessive Fee Cases and the Real World?
Here’s a very interesting article from the Financial Times on the Deere/Wal-Mart line of 401(k) suits, in which class actions are being brought on behalf of plan participants alleging that fees in the plans at issue were too high and insufficiently disclosed. I have discussed in other blog posts the essentially diametrically opposed results in Hecker and in Wal-Mart, with one circuit essentially finding no merit to the underlying legal theory, and the other deeming it viable and worthy of further fact finding to determine whether fiduciary breaches had in fact occurred. Me, personally, I think the theory, independent of actual facts of any given case, is viable and has merit. I don’t think, though, that the fiduciary obligations require the particular plans to have the lowest possible fees, but rather require reasonable fees under all the circumstances, along with a realistic and reasonably aggressive process to obtain lower fees than smaller companies or the consumer off the street would have ended up with, this later point being something which the opinion in Hecker did not require.
Factually, though, I thought it would be fun to combine two of my favorite hobby horses - the Hecker theory of fiduciary liability and BrightScope ratings - in light of the Financial Times article, and see what we learn. Interestingly, it is in Wal-Mart that the Eighth Circuit let this line of attack on 401(k) fees proceed, but we learn from the BrightScope ratings on Wal-Mart’s 401(k) plan that it has low fees in comparison to other companies. John Deere’s plan, at issue in the Hecker case, isn’t rated yet on the BrightScope site. Two other large companies identified in the Financial Times article as being the target of such suits, Lockheed Martin and Boeing, are both rated as likewise having low total fees. The same can be said of Caterpillar, which just settled such a suit. ABB Inc., which the article identifies as proceeding to trial as we write on just such a claim, doesn’t score as well as those other companies in this regard, but is rated as having low fees.
Now, long time readers know that I am quick to quote (especially when the other side on one of my cases has a statistician for an expert witness) the old line that there are three kinds of lies - lies, damn lies and statistics - and certainly there are subtle points to be made about the comparison between what the plaintiffs are claiming against those various companies and what the BrightScope ratings on fees tell us. This, though, isn’t the place to fully vet those points. What is clear, though, is that easily accessible data - for us, anyway, but surely not for the folks at BrightScope when they went through the work of getting it - suggests there is a pretty good disjunct on a macro level between the theories being crafted by participants’ lawyers in this particular area and the factual reality of the operation of many of the plans that are being targeted.
BusinessWeek on BrightScope
I have posted frequently on BrightScope and their work in rating 401k plans, and in particular about their decision to rate them in a Zillow like manner that can be quickly understood by employees. Here’s a terrific article out of BusinessWeek on the site, and on the people behind it. Its an excellent way to wile away the end of a workweek.
A Nice Explanation of the DOL Advisory Opinion on Target-Date Funds
I like this (relatively) new blog here, the Benefits and Employment Observer, by the lawyers at the small - only in numbers - Washington D.C. shop of Bailey & Ehrenberg. This is the cleanest, most easily understood presentation of the findings of the DOL’s recent advisory opinion “addressing the issue of whether the assets of ‘target-date’ or ‘lifecycle’ mutual funds constitute ‘plan assets’ of employee benefit plans which invest in the funds” that I have come across over the couple of weeks since the opinion’s issuance.
Marx on 401(k) Litigation
I have a stack of substantive ERISA matters that I have been trying to post on for the last week or two, and I am going to try to work through them over the next few weeks. The thing about a blog, though, is the world keeps on spinning, and each day you find something new you want to post on, which keeps shunting those older items further into the background. That’s happened again today.
Regular readers know I am fond of the saying that Marx was wrong about a lot of things, but he was right that everything is economics. It is economic reality that is driving the increase in ERISA litigation, both at the big ticket class action level and at the micro level of individual participant claims; as I often say, the same compliance errors or high plan fees that participants ignored while their account balances were just going up, up, up, are being sued over, now that account balances have spent a year or more going down, down, down (yes, I know, I am not accounting for recent upticks, but you get my drift). Along this line, fiduciary liability insurance expert and fellow blogger, Joe Curley of U.S. Reinsurance, and I were discussing a couple days ago the ticking time bomb posed by the impending retirement - for the first time - of a generation of employees devoid of pensions and forced to rely instead on their 401(k) plans. It is conventional wisdom and common knowledge that these retirees are not, as a class, financially prepared for retirement by the assets in those accounts, particularly after the recent market downturn. Those people are not going to go quietly into decades of financial struggle in retirement, if there is a target for complaints about the operation, returns, or anything else concerning their 401(k) plans who can be sued; they make for a nice big pool of potential class action representatives, a huge pool of potential class members, and gazillions of potential individual claimants, for the latter of whom even a relatively small recovery will be significant relative to the values of their accounts. On a practical, day in and day out level, this means two things for plan sponsors, named fiduciaries or functional (who are often simply accidental) fiduciaries. One is to make sure there is sufficient fiduciary liability insurance in place; as Joe noted when we spoke, some service providers and others who may become functional fiduciaries by their roles in company 401(k) plans are not aware of that risk, and are not necessarily prepared for it. The second is an old hobby horse of this blog - compliance, compliance, compliance. ERISA litigation, particularly breach of fiduciary duty litigation, is an area of the law where a good defense is always the best offense - watch the fees, watch the operational compliance, document a sound practice for selecting investment options, etc. A fiduciary who does that severely decreases the likelihood of being sued, and strongly increases the likelihood of not being found liable if suit is filed.
This is on my mind today particularly because of this article from the Wall Street Journal about unemployed workers in the age 55 to 64 bracket who cannot find work and are, for all intents and purposes, being forced to retire, long before they intended to and long before they are financially prepared to do so. These people - or at least the lawyers they go to - are not going to overlook problems in their retirement accounts, even if they are just arguable or comparably minor or, as is often the case, were things that no one paid attention to years ago, like fees and costs. And this is where we loop back around to the Marx quote - there may be nothing different about the operational aspects of these 401(k) plans then there ever were, but the economic forces that are driving these people into retirement are going to likewise drive them to pursue any opportunity to bolster the returns on their accounts, even if that is by suing those who ran the plans.
Three for Thursday
I am going to catch up on a number of items I have meant to blog on this week, all in one fell swoop. So here goes:
• I posted before about my appearance in an article in the Boston Business Journal, but one that was only available on-line to subscribers. Here it is in another forum, openly available.
• I, and a cast of thousands, have been saying for some time now that the plaintiffs’ class action bar has wisely latched onto ERISA breach of fiduciary duty theories as an excellent replacement for bringing pure securities actions. As I have discussed in other posts, there are a variety of reasons for this, including easier discovery and possibly easier avenues to recovery. In addition, securities law in the area of what we in ERISA would call “stock drop” type litigation is much more well developed than it is under ERISA, leaving more room for tactical and theoretical maneuvering. Beyond that, the sort of backlash in public opinion, in Congress and in court decisions that existed - at least prior to the most recent market meltdown - with regard to securities class action litigation was non-existent with regard to framing the same types of cases under ERISA. Here’s a dog bites man story out of Business Insurance reporting on this phenomenon. Anyone who has been reading this blog or similar sources over the past few years already knows what the article is reporting, but it is still a nicely done introduction to the topic.
•And speaking of using ERISA for class action litigation, one of the central questions with regard to the increasing use of that statute to press stock drop litigation and its cousin, excessive fee litigation, has long been whether it is a successful tactic. The successful defense of the excessive fee claims in Hecker v. John Deere, in the Seventh Circuit, at an early procedural stage and prior to detailed discovery into the facts of the plans and the fees at issue, strongly suggested that ERISA claims of this nature may be no more likely to get past the procedural stage and into expensive litigation of the merits than a pure securities theory would be. The Supreme Court’s subsequent pronouncements in Iqbal seemed to confirm the approach taken by the Seventh Circuit in Hecker, of testing the legal viability of the underlying ERISA based theories before allowing the plaintiffs to conduct discovery that might more strongly establish the legitimacy of their claims (or lack thereof, for that matter). As many have been reporting, the Eighth Circuit has just essentially taken the opposite tack, in a putative class action case against Wal-Mart, Braden v. Wal-Mart Stores. Braden can be understood, in part, as rejecting the approach taken by the Hecker court and finding that discovery is necessary before the merits of a complex excessive fees type claim can be decided. For more detail on Braden, here is Paul Secunda’s take on the matter over at the Workplace Prof (including a link to the case itself) and Roy Harmon’s take on the matter (which focuses nicely on the Rule 8 pleading requirements) at his always illuminating Health Plan Law blog. I have said before that with the increased focus on fees, the increased focus on the lack of retirement savings of most Americans, and the economic impact of high fees on returns in 401(k) plans, Hecker may turn out, in hindsight a few years down the road, to have been the high water mark for the corporate bar in defending against such claims. I am not sure whether that’s a good or a bad thing (I suspect, actually, that it’s a mix of both, but addressing that in depth here would make for an awfully long post), but it may well be the case either way.
On Fiduciary Liability Insurance
I have written before that one of the things that makes insurance coverage law interesting is the fact that almost every trend in liability or litigation eventually shows back up in insurance disputes, in a sort of fun house mirror sort of way. Whether it is corporate exposure for asbestos liabilities, or the sudden invention of Superfund liability, those liability risks eventually end up in insurance coverage litigation over the question of whether insurers have to cover them. I cannot think of one major doctrinal development in tort liability or one trend in liability exposure in the last 20 to 30 years that has not, eventually, resulted in litigation to determine whether insurance policies cover the new exposures flowing from those developments and trends.
Anyone who reads this blog knows that ERISA governed plans, and in particular pension and 401(k) plans, have become a huge target for large dollar claims over the past several years. Just a click through the posts on this blog detail many of the claims, such as stock drop and excessive fee litigation, that are working their way through the legal system. And with this, hand in hand, has come a new focus on whether plan fiduciaries have appropriate insurance coverage in place for those risks. Some do, some don’t, and others - consistent with insurance coverage litigation trends in the past when relatively new theories of liability have had to be analyzed under policies written before the theories themselves were developed in depth - won’t know unless and until courts pass on the meaning and scope of their policies. But here, though, is a good initial primer on the question and here, likewise, is a webinar that looks likely to provide much greater detail on the subject. One thing that is for sure is that this is an area of the law that anyone involved with the representation of plan fiduciaries needs to have more than a passing familiarity with at this point.
Hecker, Fees and A Broad Public Market
To me, intellectually, all roads lead to Hecker right now, as the sort of touchstone around which all thinking about fiduciary obligations and the amounts of fees charged in 401(k) plans must revolve. Hecker, of course, found not only that a broad range of offering meant that marketplace discipline guaranteed appropriate fees, but also that this could be determined at the motion to dismiss stage. This whole question of whether a broad marketplace for mutual fund offerings can be counted on to guarantee appropriate fees is at issue before the Supreme Court in a different context in an upcoming case, as commented on here: once again, you see that the question is the propriety of the assumption that market discipline is all that is needed to protect against overcharging of this type, and thus whether there is a legitimate basis for the assertion that the existence of a broad market is all that is needed to ascertain that fees were not so high that a fiduciary breach has occurred. It would take many more pages, and an analysis much more suited to a different forum, such as a law review article, to break down the potential flaws in the base premise of that assumption, but for this venue, at least one comment is warranted, and that has to do with the Supreme Court’s relatively recent conclusion that the same thesis - that marketplace discipline would prevent the problem from actually coming into existence - was not an acceptable answer to the problems potentially posed by structural conflicts of interest with regard to ERISA benefit claims. There, the Court rejected the view of many circuits that the risk of the marketplace punishing companies that misbehave did not represent a legitimate basis for assuming that administrators who both decided and funded benefit decisions could not be acting out of a conflict. There is independent evidence for the argument that fees are, in fact, too high with regard to 401(k) plans, as discussed in this report here (and thanks are due to the ever vigilant eyes of the folks at BrightScope for passing that along) and other places too numerous too detail in a few minutes this morning, causing one to ask whether, much like the Court decided with regard to structural conflict claims related to benefit decisions, it is a realistic economic assumption to believe that a large public market alone is a guarantor of appropriate fees, as the Seventh Circuit assumed in Hecker.
Time to Retire the 401(k)?
Many years ago, I remember hearing the comment that you knew Nixon was done for when Johnny Carson turned against him in his monologue, because Carson was a perfect proxy - some hip writer today (or maybe just some writer today trying to be hip) would instead call him an avatar - for the thinking of mainstream America at the time. I immediately thought of this when I saw this story on the cover of Time magazine entitled “Why its Time to Retire the 401(k).” When this bastion of middle of the road, middle class, mainstream American thinking has signed on to the 401(k)s are bad campaign, you have to wonder if the tide has turned for this investment instrument, its primacy, and the massive amounts of income it generates for the investment community. If it has, then Hecker and similar cases that have gone very well for the defense bar when it comes to cost and performance issues in these plans, are going to start to look, in hindsight, like little more than the last gasps of a dying regime. Not sure that is the case, but this little window into the Zeitgeist has to make you wonder.
You Say Securities, I Say ERISA
I have to admit I have found the Workplace Prof blog tough sledding since the site’s founding blogger, Paul Secunda, took retirement from the site, apparently to spend more time in the snow in Wisconsin. Without Paul, the blog has trended heavily towards labor law and lacks the type of frequent, insightful commentary about ERISA that was a hallmark of the Secunda regime.
I mention this today because the blog has a guest/drop in post from Paul, commenting on a Wall Street Journal law blog story about the decline in securities class action litigation. Paul comments that one reason for this that was overlooked in the story may well be the discovery of the class action plaintiffs’ bar over the past few years of ERISA as a better tool for prosecuting such claims and as an excellent stand-in in many cases for securities suits. This is something I have discussed frequently over the years on this blog, but I have to admit, until Paul, the law professor formerly known as the Workplace Prof, mentioned it in his post, it had not jumped out at me as something relevant to the Wall Street Journal piece. But there you have it - more anecdotal evidence for the idea that ERISA is displacing securities actions in many circumstances.
Excessive Fee Litigation and the Small Plan
It has become a given in any talk on 401(k) plans and fiduciary liability that I give these days - my comment that, when the market was always going up, up, up, no one cared that they might have made 15% instead of 14% but for some unresolved problem with a plan’s structure, but with the market going down, down, down, anything and everything even allegedly wrong with a plan is going to get sued over. The point is always the same: it is doubly important now to always dot all the eyes and cross all the tees, which translates into watch your investment selection mix, watch your fees, watch your level of disclosure, watch the process by which you select your vendors, and so on. It all adds up to the idea that in this market, someone is going to come after you if you are a fiduciary or a plan vendor, so be prepared to defend everything you do.
That is why I liked this post here, from the folks at the Float, about excessive fee litigation trickling down to the level where suits based on fees are being filed against plans with as little as $2 million is assets, and their advisors. There’s nowhere to hide anymore, folks. Get it right in the first place, and then defend yourself; being the small fish isn’t going to keep you out of the churn.
Thoughts on Costs and Fees in 401(k) Plans
In my last post, I mentioned a seminar I gave recently on insurance coverage issues and commented on one of the themes of my presentation. Another theme I emphasized in that talk was the fact that modern insurance coverage law is basically 20 years old, with its fountainhead being the development of the law of insurance coverage to account for the complexities and size of the asbestos exposures that confronted much of American industry at that point; from that development of the case law would come further refinement and expansion of the relevant doctrines as the courts, insurance companies and industry subsequently struggled to allocate financial responsibility for the surge in environmental clean up actions. Insurance coverage law before then was essentially a backwater of random, not necessarily sophisticated decisional authority; since then, it has become a complex weave of interdependent theories and doctrines.
I mention this because I am reminded of it by the current state of the law concerning fee and cost issues in 401(k) plans. To some, it may be a weird correlation, but not to me. I have written before about how the Seventh Circuit’s decision in Hecker provides a broad range of issues that warrant review and thought, some of which I have touched on in my posts and others of which I have not. I suspect there will come a time in which we will think of the law on this particular subject as being divided into two eras: before Hecker and after Hecker. And by that, I do not necessarily mean that the case law will start to follow Hecker and reform or solidify the landscape on this issue as a result. That might happen, but I am skeptical, at least in the longer or middle term. There are many issues in Hecker that were not played out fully in that decision or in the record underlying it in my view, and I suspect they will be in later cases, or by legislation or regulation, in ways that will change how we think about this type of issue, both from what existed before Hecker and from what Hecker itself suggests.
I am thinking in particular today of the court’s treatment of the amount and lack of transparency of the fees and costs in the plan before it as essentially not important, for all intents and purposes, either to participants, or, seemingly, to the court’s analysis of the plan’s obligations. A deeper look at the role of costs and fees, along with their impact, I suspect, might suggest an entirely different outcome to excessive fee cases such as Hecker, and it would not surprise me if at least some other courts in the future engage in such a closer examination and come to a different conclusion as a result. What has me thinking about this today? It is this excellent post by Ryan Alfred of BrightScope on the range of fees and costs in funds, a fiduciary’s obligations to understand all of them, and the lack of transparency as to exactly what plans are actually paying in fees and costs. Moreover, he points out the systemic differences among how different knowledgeable parties - experts may be a fair statement - calculate such fees and costs. This analysis suggests that fees and costs are nowhere near as simple to interpret and analyze as the Hecker court’s analysis assumes them to be, given that the court analyzed them on a motion to dismiss without detailed factual development of the evidence on the fees and costs in question. My educated guess, using Ryan’s analysis as a backdrop, is that a court may reach an entirely different understanding of fiduciary obligations in this regard if it first engages in a thorough factual development of the record on this issue before ruling, which the Hecker court did not.
Hecker, InsideCounsel and Defensive Plan Building
Hecker is the gift that keeps on giving, for either an academic or a blogger (or perhaps a blogger with an academic frame of mind). It presents a wealth of issues warranting further consideration, running from those commented on in my prior posts on the Seventh Circuit’s decision, to one I haven’t even passed on yet, namely the propriety from a jurisprudential perspective of using every trick in the trade, as the Seventh Circuit did, to go outside the complaint for extensive evidence that would allow the case to be decided on a motion to dismiss. It is fair to say that the circuit’s heavy reliance on those maneuvers (and I don’t criticize those tactics in general, as they are a litigator’s stock in trade in presenting motions to dismiss and I am one of those who thinks that, used properly, they provide an opportunity to focus a court on issues that should be decided in a lawsuit at the earliest stage possible) renders the opinion more akin to a law review article that now has the force of law - at least in the Seventh Circuit - than the type of factually based analysis that we normally think of with regard to a binding judicial opinion.
But that’s a topic for another day. What I wanted to pass along today was this excellent article - quoting yours truly extensively, although that’s not what makes it excellent - in InsideCounsel magazine this month on the Hecker decision. It is a well written, interesting report on the case, but I wanted to focus on what I am quoted on at the closing of the article, in which the author writes:
"Hecker is almost a quintessential law and economics opinion. It assumes the 401(k) plan included funds that charged the same [fees] as the market as a whole, and that’s all we need to know," Rosenberg says. "I would be surprised if many other courts are willing to just stop their analysis at that point."
Although Hecker provides a lot of protection for companies, he advises general counsel to assume the decision is just a baseline for ERISA compliance.
"Hecker didn’t impose a very high standard," he says. "Far and below Hecker is going to get you in a lot of trouble in a lot of different jurisdictions."
The defense bar, of which 80% of the time I am one, is very pleased with the decision and thinks it protects and/or validates much of what plans have done when it comes to fees in 401(k) plans. I am not so sure, and I think that prospectively at least it warrants more vigilance from plan sponsors, not less. To my mind, everything follows economics, whether its fashion, car design, house sizes (think McMansions), the social propriety of using company jets and, yes indeed, legal regimes. I have little doubt that with the baby boomer generation looking at becoming the first cohort to both lack pensions and have battered 401(k)s, the economic impact will eventually increase the level of performance and fiduciary expertise demanded of plan sponsors and those they select to run their 401(k) plans. It might take one year, it might take ten years, and I don’t know if it will come about by new regulation, statutory enaction or the development of case law, but it will happen.
Prospectively, as a result, plan sponsors and other fiduciaries can and should assume that, down the road, there will be much tougher looks taken at their 401(k) plans on issues such as fees than the very deferential approach taken by the Seventh Circuit in Hecker; when that comes to pass, they will have been much better off having understood Hecker as presenting only the base minimum standard for the plans they operated, and having targeted a much higher level of participant protection in building their plans than Hecker seemed to them, today, to have required. After all, if you think about it, what really is so hard about looking closely at fees as part of putting together a 401(k) plan’s investment options from here forward, and documenting that this was undertaken, as an additional step in defensive lawyering and plan building, rather than just stopping at the Hecker level of analysis and conduct? It doesn’t take all that much - there are independent fiduciaries out there right now who will try to do it for you - but the legal protection in the long run, and the participant goodwill in the short run, that it will buy far outweighs the costs.
Looking at Fiduciary Performance from the Vantage Point of a Plan Participant
I had dinner recently with the brothers Alfred, Mike and Ryan, two of the co-founders of BrightScope, and much of the conversation centered around the question of transitioning the management and analysis of 401(k) plans from a practice oriented perspective to a plan participant oriented one. Translated into practical terms, this encompasses the idea that fiduciary standards for plan sponsors currently take the approach of considering whether the fiduciary’s practices in operating the plan, for instance with regard to deciding which vendors to use or funds to offer, were prudent and reasonable; this is particularly evident in the case law that is developing concerning the current bete noir in this area of the law, the amount of fees and costs in a 401(k) plan and their impact on plan participants. In the context of fiduciary liability, this plays out in cases like Kanawi and Hecker as courts finding that fiduciaries did not breach their obligations because the evidence showed that the means and methods by which those plans were built was reasonable, rather than by looking at whether the fiduciaries built a strong plan in terms of the fees and costs and performance of the investment options; in Kanawi, the court was swayed by the fact that the sponsors had followed a reasonable course in selecting the plan options, and in Hecker the court was persuaded by the simple fact that the plan sponsors included funds that were publicly available at the same cost structure.
Case law routinely takes the approach that fiduciary obligations when it comes to fees charged in a plan or other aspects of the operation of a plan relate to the nature and manner in which the plan is built or operated, rather than the actual returns or costs structures of the plan itself. As a result, the focus of plan sponsors who are trying to be proactive in protecting themselves and of lawyers counseling them on how to do so has long been on pursuing a “best practices” approach: solicit multiple bids, have them compare themselves against benchmarks they use, bring in outside advice if needed to evaluate them, and then pick the best one. The end result of this process isn’t necessarily going to be a plan with the best ultimate outcome (something driven heavily in a 401(k) plan for instance by the plan’s fee and cost structure) for plan participants, but will instead be a plan that looks best from among the range of options considered. This is an approach that most ERISA lawyers recognize is defensible if the plan sponsor is sued, because it allows for the argument that, regardless of what problems there might have been in the plan, the approach used to put the plan together - and to run it - was prudent and reasonable. To a large extent, courts have accepted this idea, that the manner in which the plan was built and, for instance, fees settled on is the central issue to be tested, with the fiduciaries having lived up to their obligations if the approach to building the plan and selecting the funds (and accompanying potential fee structure) was reasonable.
This approach to the issue by courts is understandable, in that it is almost the only approach that practical reality leaves open to them on many difficult issues, such as the amount of fees and costs in a 401(k) plan. There is no uniform, consistent, hard data driven, accepted benchmark for what such fees and costs should be, or how one particular plan’s fees and costs compare to those across the industry. Courts are, quite understandably, therefore devoid of an appetite for allowing disputes over the cost and fee structure in a plan to devolve into a simple battle of experts, with each side putting up an expert saying the objective amount of fees and costs in a plan are, according to one expert, too high, and according to the other, just right. It would quickly turn into the Goldilocks school of ERISA litigation - these fees are too high, these costs are too low, these are just right. Beyond that, there would be tremendous practical barriers to such an approach due to the general absence of uniform, broadly accessible industry wide data on many of these points, which results in serious questions as to whether, and if so with what credibility, experts could even testify to an opinion as to whether fees in a particular plan are too high or too low; the difficulty of accessing industry wide data that would allow for a detailed and defensible opinion in this regard would undercut both admissibility and credibility of any such expert testimony. Courts, to a certain extent, have thus to date been better served by a practice oriented analysis of fiduciary conduct in areas such as 401(k) fees because of the difficulty of effectively testing fiduciary conduct against any other standard.
But what if you could test fiduciary obligations against a more definitive standard, particularly with regard, for instance, to the fees and costs built into a 401(k) plan? You could then rightfully have a standard for determining whether fiduciary breaches have occurred that is based on the outcome to the plan participants, such as whether the fees were too high and drove down returns. If you could do that, because a true benchmark for testing the performance and management of a plan existed, there would be no reason to base a decision about the propriety of fiduciary conduct in running a plan on an analysis of how the plan was run, but instead one could base the analysis on how the operation of the plan impacted outcomes for the plan participants. Such an approach to fiduciary liability would be entirely different than the one currently employed, and would instead ask whether the fees, costs or other challenged operational aspects of the plan negatively impacted - and if so to what extent - the plan participants. You would then be focusing the question of whether fiduciaries have lived up to their obligations on whether the optimal results were achieved for the plan participants, rather than simply on the question of whether the fiduciaries followed industry wide practices in operating the plan, practices which may or may not create the optimal results for plan participants. The latter approach always threatens to be a race to the bottom, moderated only to whatever extent some sponsors are driven to provide good returns to motivate their own workforces, which can keep the bottom from falling too low. In contrast, the former is a race to the top, or at least near enough to the top that fiduciaries can be said to have lived up to their obligations to the participants by shooting for the best results possible; it goes without saying that everyone cannot be at the top unless everyone simply buys the same products from the same vendors, which basic economics tells you is antithetical to driving down fees and thereby increasing returns, so something short of the very pinnacle of performance as against a legitimate independent benchmark would have to be sufficient to satisfy a fiduciary’s obligations. Isn’t that approach far more consistent with fiduciary obligations than the current practice oriented focus, given the oft used cliche about ERISA, that the fiduciary obligations are the highest known to the law?
And that is the idea behind BrightScope: to collect independently verifiable data on fees, costs and performance variables behind the 401(k) statements given to participants, and use that data to create a defensible, industry wide benchmark allowing fees, costs and performance to be compared across plans. When you reach that goal, done to a level of mathematical sophistication and defensible data sufficient to allow its use as evidence in a courtroom or as a foundational piece for expert testimony on how a particular plan’s fees, costs or performance compare to the broader universe, you have the linchpin on which you can turn analysis and the standards for fiduciary conduct in this area from the practices by which a 401(k) plan was run to the outcomes for the participants. And that, in a nutshell (though an admittedly long one) is what I meant in the first paragraph in this post when I referred to the question of transforming fiduciary obligations from a practice oriented perspective to a participant outcome oriented perspective.
Hecker and the Development of the Law on the 404(c) Defense
One of the Seventh Circuit’s most interesting tricks in its recent decision in Hecker was the extraordinary breadth it gave to the 404(c) defense. This was an aspect of the decision that raised a lot of hackles, and I noted in my own post on the case that I doubted this was the last word on the subject and that it would be interesting to see how the case law developed as other courts tackled this question. Well, here’s a decision from a week or so ago out of the United States District Court for the District of New Hampshire taking a much narrower approach in interpreting the amount of protection granted to fiduciaries by section 404(c), finding that the defense does not apply to “a fiduciary's designation of the investment options that are available to plan participants.” The court reached this conclusion because:
First, section 404(c) is unclear as to whether it can be used to bar a claim based on a fiduciary's designation of investment options. Second, section 404(c) requires the DOL to adopt regulations explaining when a participant or beneficiary has sufficient control over his assets to be subject to a section 404(c)defense. 29 U.S.C. § 1104(c)(1)(A). Third, the DOL's implementing regulations are themselves unclear as to whether section 404(c) applies to a fiduciary's decision to designate investment options. Fourth, the DOL reasonably determined in the preamble to its regulations that losses which result from a fiduciary's designation decision are neither a "direct" nor a "necessary" result of a participant's exercise of control over plan assets. Finally, both the Supreme Court and the First Circuit have recognized in similar circumstances that an agency's reasonable interpretation of its own regulations in a regulatory preamble is entitled to deference.
Frankly, I am inclined to think that a close review of the actual statutory text and regulations suggest that this judge is closer on the mark on this issue than was the Seventh Circuit in Hecker, leading to what I think is the real takeaway from the continued development of the case law on this issue: namely, that plan sponsors should not overly rely on Hecker in evaluating their potential exposure and their obligations. Rather, as I have said in other forums, Hecker should be understood by plan sponsors and their vendors as setting forth the base minimum in terms of how a plan should be structured with regard to investment option fees, and should not be seen as a get out of jail free card by a sponsor who does no more than build a plan consistent with the reasoning in that case.
Surprisingly, the Stock Market Decline is Leading to Litigation . . .
You know what a dog bites man story is, right? Well, here’s one, though a well-written one. This piece on CFO.com surveys the collateral damage from the Wall Street collapse, with a focus on its severe impact on 401(k) plans and the corresponding increase in fiduciary duty litigation. It is a well done piece that is worth a read, though nothing in it will come as a surprise to anyone familiar with the subject. The take away? The collapse in 401(k) values, combined with the extinction of pensions, will lead to "lawsuits, new regulations, and the specter of an aging workforce that, like a bad party guest, shows no inclination to leave." I have to admit, I do like that last analogy.
Pension Fiduciaries in the Hot Seat - What to Avoid and How to React if Sued
I and a cast of thousands will be speaking at a webinar on April 14th on “Pension Fiduciaries in the Hot Seat - What to Avoid and How to React if Sued,” put on by Pension Governance, Inc. Well, its not really a cast of thousands, just me and four very experienced worthies, who know so much about the subject that they seem like a cast of thousands.
I have to say that, long before ever being invited to participate in one of Pension Governance’s webinars, I attended as a member of the audience, and not only found them informative but enjoyable as well.
How Much Information Is Enough to Decide A Breach of Fiduciary Duty Lawsuit?
Is a motion to dismiss a good tool for disposing of major breach of fiduciary duty lawsuits? In essence, should it be treated as a mini-summary judgment proceeding, that tests the sufficiency of the case’s theories against, not the detailed facts of a specific case, but instead against the world as a whole as understood by the court? Or are these cases instead ones that are better decided by - and both litigants and the development of the case law better served by - a decision on the actual factual merits of a case, after drilling down into the conduct in question?
The former scenario is, in essence, the route taken by the court in Hecker, and Kevin LaCroix provides another example in his post yesterday, on the dismissal of the breach of fiduciary duty lawsuit in the Huntington Bancshares ERISA litigation. What happened in both cases is, in a nutshell, the court comparing the allegations of fiduciary errors to the market as a whole, finding that what took place was not inconsistent with what was occurring in the broader market (in the case of Hecker, that being the pricing on mutual funds in a plan, and in the case of Huntington, that being the stock losses in the plan), and that therefore, essentially by definition, the plan fiduciaries could not have fallen below the standard of care imposed on them. I can understood the arguments on both sides, and particularly those in support of this approach. A fiduciary is charged with acting with the skill and care of a prudent person in that position, and one can argue that this standard was not breached if the plan losses were consistent with what occurred across the market and with regard to others similarly situated; after all, if all the other investment managers took the same beating, then the plan’s fiduciaries, by definition, were acting like all others with expertise in the area when they likewise took the same pummeling. Plus, of course, conducting extensive class action litigation to further analyze what the market itself seems to be telling us - that the fiduciaries were acting like all other prudent investors since all got clobbered to the same extent - is a tremendous drain on the defendant’s resources. Then you add on top of that the realpolitik of the situations, which is that we know that most cases of these types settle after expensive litigation if they survive the motion to dismiss stage and possibly the summary judgment stage, so in many ways these procedural stages dictate the outcome, and there will never actually be a trial to allow a full drilling down into the actual facts of fiduciary conduct which can serve as the basis for a decision; delaying the day of reckoning from the motion to dismiss stage to the summary judgment stage, in this way of thinking, doesn’t really change that, as there will undoubtedly be factual disputes at the summary judgment stage that will preclude a fact based decision and instead any decision at that stage will, like the motion to dismiss rulings, likewise be based on the types of broader legal theories addressed by the courts in the motions to dismiss in these types of cases.
But on the other hand, is it really safe or fair to just assume that fiduciaries have lived up to their obligations, simply from the existence of broader market indicia? I am thinking in particular of two sets of data that crossed my desk recently, the first courtesy of 401(k) blogger Josh Itzoe and the second courtesy of the guys at BrightScope, who slice and dice the data on this field for fun and profit. In this post, Josh points out survey results showing that a large number of plan sponsors don’t really have a structure in place for operating 401(k) plans at a high level, while this chart here, passed along by BrightScope and based on its data, shows the wide range of fees that plans assume in their 401(k)s. This information reflects the tremendous diversity one can find in operating talent, execution, fees and other aspects of a plan that can seriously impact performance. Under those circumstances, is it really appropriate to stop the analysis of fiduciary conduct at the motion to dismiss stage, before investigating the aspects of a particular plan, just because the market as a whole lines up in a reasonably consistent manner with the performance of or fees in a particular plan? Market performance may be down, or fees across the market may line up with those in a plan, but this doesn’t by definition mean that a plan sponsor is living up to its obligations without further analysis. Behind those market numbers and the relationship of a particular plan’s performance to those numbers, may very well be a fiduciary whose operational structures and/or charges to plan participants fall below what other fiduciaries are doing; I am not sure it is fair to allow the muck of a bad market to provide cover for that.
Asking the Seventh Circuit to Revisit Hecker
I was going to post on something else today - namely the scope of contractual obligation clauses in insurance policies - but my Google Alert pulled in something else that I wanted to pass along first instead, namely, this post by Paul Secunda at Marquette on an amicus brief filed by several law professors asking the Seventh Circuit to reconsider Hecker v. Deere en banc. The brief asks the Seventh Circuit to consider the exact issues that I noted in my post on Hecker as being the debatable parts of the decision, namely the panel’s decision to link a very narrow interpretation of fiduciary obligations with a very broad interpretation of the 404(c) safe harbor. I am very curious to watch how the panel’s analysis of those issues gets played out as the case law develops on excessive fee issues, 401(k) plans, and the application to them of the safe harbor and of breach of fiduciary duty claims, whether that takes place in the courts of other circuits who are confronted by the Hecker decision, or in an en banc revisiting of the issues by the Seventh Circuit.
Fun stuff, either way.
Notes on Hecker v Deere
The Seventh Circuit’s opinion in Hecker v Deere is interesting in a number of ways, and on a number of levels. I won’t detail the facts of the case in depth here, but the case turns on the question of the plan sponsor’s and service providers’ potential fiduciary liability for allegedly high fees in the mutual funds offered in a 401(k) plan and the limited degree of disclosure provided to participants about the fees. You can find the case itself here, and for those of you who don’t have an interest - or possibly the time - in reading the entire 33 page opinion, a readers digest overview of the case itself right here. It is, though, a well-written, fluid, almost elegant opinion, an easy read if you care to take the time.
Perhaps most notable, from an overview perspective, is the fact that the Seventh Circuit simultaneously gave the scope of protection granted to fiduciaries by Section 404(c) pretty much as broad an interpretation as possible, and the scope of fiduciary obligations with regard to investment selection and fee disclosure as narrow a one as possible. Its an interesting double whammy. I am not saying its right or wrong (although Ryan Alfred at BrightScope has made a detailed argument that the court is off base in reading the protections of section 404(c) so broadly), but it is certainly a very interesting framework. If you think of it as a Ven diagram, with one circle the world of problems that can arise with mutual funds and 401(k) plans, and the other the extent of fiduciary obligations in the view of the Seventh Circuit, the overlap is smaller than one would have anticipated.
Then there is the question of the court’s view of the fiduciaries’ obligations of disclosure with regard to fees in the plan, finding that the statute and the regulations did not require more disclosure than was made, and thus there was no breach in failing to disclose more information about the fee structure. Paul Secunda in his piece on the intersection of preemption and the statute’s limited remedies (in which he emphasizes how those two aspects of ERISA can result in harms that cannot be remedied) discusses what he views as two competing ideological camps with regard to the interpretation of ERISA, literalists and remedialists. I don’t fully agree with this particular bicameral division of the world, but it offers a handy frame of reference for understanding the Seventh Circuit’s ruling: the panel took a truly literalist approach to the question of disclosure, finding that what the statute and regulations don’t expressly require, is not required. This seems, I have to say, hard to square with the idea that a fiduciary’s obligations run to a high level of care, which would seem to raise the question of whether a fiduciary has more obligations than simply those that are required by express mandates, but the panel does not squarely address that question.
This leads into a central point that animates the case, in my opinion, and which can be summed up in two famous words: caveat emptor, at least if you are the plan participant. The court finds that the mutual funds in the plan are numerous and also sold to the public as a whole, and therefore the fees are, in some broad sense, fair and appropriate, as they are what the public marketplace as a whole is willing to bear. But is the public pricing as a whole a fair determination of whether fees charged within a 401(k) plan are excessive or not? Isn’t this just using the lowest common denominator to make this call? After all, a public buyer does not have the leverage or the expertise - at least in theory - that a plan sponsor brings to negotiating investment options and their fees. Part of the problem in analyzing this question is that the district court, and now the appeals court, resolved the case on a motion to dismiss, where argument and supposition play too much of a role and factual development of these types of questions have not occurred. Deciding whether the fees are excessive on an actual factual record may suggest an entirely different answer than just the assumption that the market as a whole has acquiesced in the pricing, so therefore it was not excessive when a plan sponsor signed off on it. But for a plan participant, the ruling clearly means one thing: it is your responsibility to engage in the same full due diligence that you would have to pursue if you just purchased the mutual fund from a 1-800 number, and you are not entitled to rely on the plan’s fiduciaries to have done that for you.
Shining a BrightScope on Heckler v. John Deere
Still parceling out items of interest that have stacked up on my desk in the last week or so. Among the things I still haven’t gotten to, I have to admit, is a careful reading of the Seventh Circuit’s recent decision in Heckler v John Deere, but I will, shortly. In the meantime, though, the bright guys over at BrightScope have, and their’s is a very interesting take. You can find it right here. Its clear, when you read the post, that they don’t just have the analytics down when it comes to 401(k) plans, but also their structure and the manner in which they operate.
Do People Who Are Told the Truth Sue?
I love this story. A couple of weeks ago I blogged about BrightScope’s launch, and pointed out my view that more information generally means less litigation. I learned thereafter that some think that is a counter-intuitive thought; presumably, people who believe that think that if you cover up problems and don’t let people know what’s going on, they may not find out and thus may not sue you. The oldest saying in the book, of course, is that the cover up is worse than the crime. Rather, people who are legitimately wronged will sue no matter what, as they should; but people on the margins are more likely to sue if they feel they were not told the truth, than they would be if they feel they were given a fair shake, even if it worked out badly for them. More technically as well, many breach of fiduciary duty claims are based on allegations of non-disclosure - that the sponsors did not disclose problems with the company stock, or backdating, or cdos. etc., that would have changed the participants’ investment strategies had they known. Obviously, something that is disclosed, rather than kept under wraps, cannot be the basis for a breach of fiduciary duty claim based on the failure to disclose.
This thesis, which I maintain is hardly counter-intuitive, but just plan common sense, is borne out beautifully by this story about a long time Merrill Lynch broker who has lost millions of dollars in company stock held in an ESOP. He points out that had he been told the truth and given the opportunity, he would have divested and diversified along the way, but did not, and that he was regularly told things by management that were not true. Now, in the close of the article, he points out that what he needs now are “the services of a sharp labor and ERISA attorney." Had he been told the truth and given the opportunity to move his retirement savings out of company stock in light of information given to him at that time, he may be worse off today than he was before the Wall Street meltdown, but he is likely well enough off still that he isn’t looking for a lawyer to file suit for him.
Bunch v. W.R. Grace: What a Breach of Fiduciary Duty Doesn't Look Like
I cannot do better by anybody interested in fiduciary obligations under ERISA than to recommend to you the First Circuit’s decision the other day in Bunch v. W.R. Grace & Co.. For those of you not familiar with the lower court proceedings in that case, what was at issue is whether it was a breach of fiduciary duty to sell company stock, rather than maintain it as an investment option, after retaining outside advisors to investigate the stock’s value, potential and appropriateness as an investment option. At the District Court level, and again now on appeal, the courts have found the fiduciaries’ conduct to be almost literally above reproach with regard to the handling of this issue. The First Circuit’s brief is notable for two points. The first is its synopsis of the duties of a fiduciary with regard to investment options, including company stock, and the court’s emphasis on the fact that it is the appropriateness of the fiduciaries’ conduct in the face of uncertainty that must be judged, not the dollar value outcome of any particular investment decision in isolation. As the First Circuit opinion noted:
what ERISA calls for from a fiduciary is that it use the "care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims." 29 U.S.C. § 1104(a)(1)(B). As the district court aptly stated, "in common parlance, [what] ERISA fiduciaries owe participants [are] duties of prudence and loyalty," Bunch, 532 F. Supp. 2d at 288 (citing Moench v. Robertson, 62 F.3d 553, 561 (3d Cir. 1995)). The district court noted that other courts faced with allegations similar to those of appellants in this case had looked at the totality of the circumstances involved in the particular transaction. Id. Among the key decisions relied upon by the district court for reaching this conclusion was DiFelice v. U.S. Airways, Inc., in which that court stated: [W]e examine the totality of the circumstances, including, but not limited to: the plan structure and aims, the disclosures made to participants regarding the general and specific risks associated with investment in company stock, and the nature and extent of challenges facing the company that would have an effect on stock price and viability.
And second, if you want to read an outline of what a thorough and, once in court, easily defensible, course of conduct by a fiduciary looks like when it comes to investment options, it’s the underlying course of action by the fiduciaries that is described in the First Circuit’s opinion.
BrightScope and 401(k)s
Holy Transparency, Batman! If you like Zillow, and you have a 401(k) plan, have I got a website for you. BrightScope has now publicly launched its rating website, in which you plug in a particular company’s name and the site then provides you with a colorful, graphic presentation of that particular plan’s performance and structure in comparison to certain benchmarks and comparable companies. Its simply a lot of fun, and, moreover, allows an easy, quick overview of a particular plan, without having to wade through all of the paper information for a particular plan. This facet alone makes it worthwhile, in a world in which plan participants really do need an understanding of the details of their companies’ 401(k) plans but may not have the time or expertise to parse the documents themselves. I certainly am not advocating limiting participant education to checking BrightScope, but every piece of information - the more accessible and transparent the better - helps. At the end of the day, its been my experience that, in all areas of the law, the more information, the less litigation, and I think that is clearly the case with regard to retirement funding. Remember that piece of folksy wisdom the next time you see someone pause in the face of government moves to increase 401(k) plan disclosure and transparency.
I have actually been playing with their site for awhile, while it was in testing, but its now been publicly unveiled, so you can go there yourself and see what I am talking about. I could say more about the site, what it does and how it runs, but I don’t have to, because Josh Itzoe has done it for us, right here, and you can go test run it yourself now, right here.
The Trend Lines in ERISA Litigation
I like when you sort of hit the zeitgeist in things you write and talk about. I mentioned in a post last week that I would be presenting a seminar to the ASPPA Benefits Council of New England on current trends in ERISA litigation, and I presented the seminar yesterday. As I gave the talk, a theme unfolded: namely, that the confluence of economic problems and the unsettling of many apple carts when it comes to the rules governing ERISA related litigation (a perfect case in point being the majority’s suggestion in LaRue that litigants and lower courts should feel free to reconsider precedents established in defined benefit cases when confronting disputes over defined contribution plans such as 401(k) plans) means we are looking at an expansion of litigation, perhaps in the overall number of suits and, if not, at least in the complexity, dollar value and expense of the suits that are brought. I noted this to be a particular issue with regard to stock drop and excessive fee cases, particularly in the current stock market meltdown.
Well, lo and behold, today here comes this report, from Seyfarth Shaw by means of Global Pension:
The Seyfarth Shaw Workplace Class Action Litigation Report showed last year, the top ten settlements for Employee Retirement Income Security Act-related (ERISA) class action cases topped US$17.7bn, a dramatic increase from the $1.8bn paid out in 2007 . . .“There is an explosion in class action and collective action litigation involving workplace issues. The present downturn in the economic climate is likely to fuel even more lawsuits, and the financial risks in this type of employment litigation can be enormous . . .” The firm said this trend was likely to continue, with particular reference to cases being brought over “stock drop” complaints – in which ERISA plan members brought action over the availability of employer’s equities as an investment option and “plan administration” cases, whereby participants brought action over ‘excessive’ advisory fees and other elements of plan administration.
Itzoe and Reish on the Fee Disclosure Regulations
By the way, I really like Josh Itzoe’s post here on the new DOL investment fee disclosure rules, which consists of a well-done interview by e-mail with Los Angeles lawyer Fred Reish. I have noted before that the interview style blog post is the most difficult to do well, and Josh pulls it off with panache. Not only that, but he and the interviewee still manage at the same time to educate the reader on the meaning and significance of these new regs. It’s a nice five minute investment of time in continuing education, for those of you interested in the subject.
The Perfect 401(k) Plan?
What would a 401(k) plan look like if you could create the fantasy football version (fantasy 401(k)?) for your company? Well, thanks to the good folks at Brightscope (I have only the vaguest idea at this point who they are and what they do, but I am already enjoying their new blog), you don’t have to wonder anymore - it would look something like this one right here, offered by the Saudi Arabian Oil Company. Low fees, great company contributions, high participation, high dollar values in individual participants’ accounts. The description of the plan reminds me of something I have often discussed on this blog, which is the idea that there is an inverse correlation between ERISA litigation brought by participants and the extent of retirement risk that particular plans impose on the participants; for instance, pension plans generated only a relatively low level of participant driven litigation because most of the financial risk related to pensions rested with the sponsor, but defined contribution plans will generate more participant driven litigation, because such plans transfer the risk (and thus the corresponding motivation to remedy the risk and eliminate losses by means of litigation) onto participants. A plan such as the one highlighted here by Brightscope, I suspect, would generate almost no participant driven litigation.
Talkin' ERISA Litigation Trends
I will be presenting a seminar next week, on Wednesday January 14th, to the ASPPA Benefits Council of New England, entitled “ERISA Litigation: An Update from the Front Lines.” After three full days of outlining my talk, I now actually have a pretty good idea of what I am going to say; the talk will blend the latest developments nationally and at the Supreme Court in ERISA law with ERISA litigation trends and realities in the First Circuit. If you are interested in attending, its not too late to register. The brochure and registration form for the talk is here.
Disclosure of Information: Where Securities Law and ERISA Diverge
Cool, what a nice treat to me for the first real workday of the New Year. I have always wanted a reason to link to the Harvard Law School Corporate Governance blog because, well, it just sounds so impressive (that plus it’s a really good read on all things corporate), and one of their contributors handed me the opportunity over the weekend. In a post addressing SEC requirements for online posting of public company proxy materials, the author - a Gibson Dunn partner and visiting professor at Georgetown - points out how these requirements differ from the notice requirements under ERISA:
Compliance with notice and access [rules under the SEC requirements] is not likely to satisfy the requirements for electronic delivery of materials under the U.S. Department of Labor standards for participants in ERISA-covered defined contribution plans, such as 401(k) plans and employee stock ownership plans. Section 404(c) of ERISA permits electronic delivery only if a participating employee has the ability to effectively access documents furnished in electronic form at any location where the participant is reasonably expected to perform his or her duties as an employee and for whom access to the employer’s information system is an integral part of the employee’s duties (e.g., a networked desktop computer at work), or if the employee provides written consent accepting delivery of information electronically. As a result, although an issuer may rely on notice and access for permitted employees and consenting employees, other employee participants should receive paper delivery of proxy materials.
You know what’s interesting about this? The focus on procedural aspects of providing information to plan participants (and others, with regard to the SEC rules). We could use an equal level of attention and agreement when it comes to the amount, type and transparency of the information provided to plan participants in particular, something more important than just the formal procedures by which it is provided.
More Evidence that Including Company Stock in a Retirement Plan May Not Be Worth the Litigation Risk
A few months back, I discussed the broad conception of damages in stock drop type cases articulated in the case of Bendaoud, which essentially found that damages exist if the participant could have done better in an alternative investment option. This concept makes it fairly easy to construct a damages theory in 401(k) and ESOP cases that will survive the scrutiny of a motion to dismiss, and that can support a significant award of damages. A prerequisite to getting to the damages analysis, however, is a basis for attributing an actionable error in the plan to the fiduciaries; the fact that a participant could do better in a different investment is irrelevant if there was no mistake in offering the original investment option in the first place.
That, however, is not too hard to show either. The bar, for instance, is low when showing that offering company stock as an option is an actionable error. For instance, "a stock can be imprudently risky for an employee savings plan even in the absence of fraud or imminent collapse,” according to a federal judge sustaining an ERISA case against Ford alleging that the offering of company stock as an investment option was a breach of fiduciary duty, given the extensive problems in the industry at the time and the lack of broad disclosure of how those problems may affect the investment.
With numerous major industries heavily roiled, and a stock market that has tanked, I can’t say that it should really tax the imagination of any good lawyer to come up with both damages to participants and errors by plan fiduciaries in any case involving the inclusion of company stock in a retirement plan or ESOP.
Blogging on Fixing the 401(k)
Sometimes the Zeitgeist is hard to read, other times it hits you smack in the face with a two by four. As we move towards the end of the year (the business year anyway, as we all know how much work actually gets done between Christmas eve and New Year’s day), the constant drumbeat of news drives home one unassailable fact, which is that ignorance cannot possibly be bliss when it comes to investing, particularly with regard to pension and 401(k) funds. From Madoff (hey, what an amazing long term track record; lets put our money there without further analysis) to pension plan fiduciaries buying CDOS they know nothing about based solely on the recommendation of the seller, it has become obvious that a little - or more - knowledge would actually be a wonderful thing. Josh Itzoe, author of “Fixing the 401(k): What Fiduciaries Must Know (And Do) To Help Employees Retire Successfully,” thinks so too, and has elected to step into the breach, launching a new blog, not coincidentally also titled Fixing the 401(k), intended to provide commentary and information related to the business of retirement investing.
As anyone who has read Josh’s work knows, he firmly believes that problems ranging from a lack of transparency to excessive fees to a host of other problems bedevil the industry, and certainly the past year has done little to undercut his thesis. It should be helpful to have his voice added to the commentary already out there.
Back Again at the Crossroads of Securities Law and ERISA
Here is a case from a week or so ago that I haven’t had time to post on yet, but which warranted a little more discussion than suited inclusion in Monday’s Thanksgiving Week potpourri post. In his latest ruling in In re Boston Scientific Corporation ERISA Litigation, Judge Tauro of the United States District Court for the District of Massachusetts delves in depth into the question of whether and when putative class representatives satisfy the requirements to represent a class in an ERISA breach of fiduciary duty case involving alleged securities law violations by the defendants. Building on the work of Judge Gertner, of the same bench, in her opinion in Bendaoud, issued two months ago, Judge Tauro analyzes the question of whether the requirements of both ERISA and constitutional standing, including injury in fact by the putative class representatives, are satisfied, finding that the requirements were not satisfied. The case provides a good tutorial on these issues. Beyond that, however, of perhaps even more interest, given the ongoing development of the law with regard to the intersection of securities violations and ERISA, is that the court’s analysis is heavily influenced by certain defenses to standing and injury in fact that are borrowed from securities law. Normally, in most instances, we are seeing ERISA used as a broader forum for attacking these types of violations, as compared to relying on the securities laws to do so, but in this case, doctrines developed as part of securities litigation serve to blunt a related ERISA case.
A Thanksgiving Week Feast
Some of the more prolific bloggers manage to be prolific by posting short notes on various topics of interest written by others, which isn’t my usual style. But over the past week or so I have managed to back up a good stack of things that I have wanted to talk about in detail, but haven’t had the time to comment on. So in the spirit of a Thanksgiving host laying out a big spread, here’s a whole bunch of things at once:
First, here is a good follow up story providing more detail on Wal-Mart’s success in defending itself against excessive fee litigation, a topic I first discussed in this post here. This particular story, in PlanAdvisor, does a nice job of illustrating the point I made in my earlier post, which is that the court, in ruling in favor of Wal-Mart, did not focus on or analyze the propriety of the particular fees themselves, but rather focused on the method used by the fiduciary to select the investment options in question and whether that was prudent. Interestingly, the article describes the Wal-Mart investment menu, and it reads like one you would find in just about any 401(k) plan. Does this suggest that most plans are actually fine on this front? Or might it suggest that fiduciaries as a whole accept fees that are too high, and that perhaps comparing a particular plan’s investment choices, such as Wal-Mart’s, against industry benchmarks is not really the right focus for deciding whether the fees in a particular plan were too high? Just asking.
Second, here’s one court’s answer to an oft asked question: is a plan participant seeking benefits entitled to attorney’s fees for the administrative appeal portion of his claim?
Third, here’s an interesting webinar rounding up the Supreme Court’s treatment of ERISA issues during the 2008 term. The Court’s fascination with ERISA during the past year has been well documented and the biggest item of discussion in ERISA related media, and pretty much everything about those developments has been chronicled on this blog and a million other places. But if you haven’t seen it all enough by now, the webinar may be for you. Interestingly, one of the topics noted in the webinar is the Court’s involvement in a case, still pending and not yet decided, concerning waivers by divorcing spouses of plan benefits. This is the quickly becoming infamous Kennedy case, which to date has caught the eye for two reasons: first, many people have some question as to why the Court took on this case and whether it merited the Court’s involvement, and second, because of the Court’s decision to seek supplemental, post-argument briefing on the very basic issue of the extent to which plan administrators are bound - barring an effective QDRO - to the express written terms of a plan. As a very experienced benefits consultant recently commented to me, the Court is going to upturn an awful lot of apple carts if, intentionally or even (probably by accident) implicitly, they indicate that administrators are not strictly controlled by the actual written terms of the plan instrument. As a result, a case that started out as perhaps the least substantively significant of the ERISA cases taken up by the Court in the past year threatens to become one of the more disruptive to settled practices, in a manner similar to how the Court reopened much settled thinking on fiduciary duty issues by indicating in LaRue that rules long established in the defined benefit context may not hold true for all other situations.
Okay, that clears some of the backlog.
You Say Securities Law, I Say ERISA
Stop me if I am beating a dead horse, but this press release/short story on a class action law firm’s investigation into a stock drop involving Hartford’s stock reads exactly like one that, a few years ago, would have been issued prior to pursuing a securities class action; now its written in advance of pursuing an ERISA breach of fiduciary duty claim, with the class consisting of the company’s 401(k) participants. There is no better or more succinct illustration of the movement away from using the securities laws to pursue these types of claims and towards instead using ERISA to pursue these types of claims than this brief story. The facts at issue haven’t changed; they just replaced the words “securities act” with the word “ERISA.”
More grist for the mill for those who believe that the merging of the two areas by plaintiffs’ firms needs to be met by integrating the obligations under both areas of law so that fiduciaries are not operating under two separate and sometimes contradictory legal regimes.
Revenue Sharing, Fees, Indemnity and Contribution: A Potpourri of Hot Button Issues Confronting Fiduciaries
So you’re an amateur fiduciary, nominally in charge of a company’s pension plan or 401(k) plan but generally relying on your outside vendors and service providers for substantive advice and decision making, and you get sued for breach of fiduciary duty because of losses resulting from the investment advice you received from them. So what’s the first thing you do? File third party actions for contribution or indemnity against the outside vendors on the theory they were fiduciaries as well and must reimburse you for any loss you are held responsible for because of your role as a fiduciary? Well, not necessarily in Massachusetts, where at least one judge has now concluded, on an issue that has been treated differently in different courts, that ERISA did not expressly incorporate such rights as against other fiduciaries, and so therefore they do not exist. The case is Charters v. John Hancock, and here is a nice article on it, here is nice post elsewhere on it, and here is the decision itself.
The central issue of the case and of the court’s reasoning is presented well in the article, where the court’s reasoning is explained as follows:
Under the indemnification and contribution principle, when one person is subject to liability because of another person's action, the second person has to make good the loss, and contribution requires the loss to be distributed among several liable fiduciaries. In his ruling, Groton noted that federal appellate courts are divided on the issue of whether ERISA permits indemnification and contribution, but said Groton was siding with those courts that have found that courts should not imply statutory remedies, which are not allowed under ERISA.
"Here neither party disputes that ERISA does not explicitly provide for claims of contribution and indemnification among co-fiduciaries. Allowing fiduciaries who have breached their duty to resort to contribution and indemnification to recover from co-fiduciaries is not 'of central concern' to ERISA," Groton asserted.
There is a lot of room for argument on both sides of this issue, as to whether a fiduciary should have or does have such a claim against another fiduciary, and I can certainly see both sides of it, or argue either side of it. It is more of a policy issue as to how ERISA should be applied, than it is a jurisprudence question of understanding and interpreting the statute, and is one that the entire system would benefit from a simple declaration one way or the other, by Congress or the Supreme Court, as to what the rule shall be on this going forward.
In the Charters case itself, it is worth noting, and important to practitioners to recognize, that the court was confronted by this issue in a case where the defendant was using indemnification as a counterclaim to ward off a breach of fiduciary duty claim against it by a trustee by trying to pass the liability back to the trustee; it may well be that the court would have reached a different conclusion if presented with a more traditional contribution/indemnification scenario, where the defendant fiduciary was not trying to use the doctrines offensively, but instead simply to spread the liability owed to the plaintiff as a result of fiduciary breaches among all fiduciaries who may have participated in the breach.
Finally, although it seems to be the court’s rejection of the contribution and indemnity doctrines as applicable under ERISA that has caught the attention of observers, of at least equal interest is the court’s further discussion of a particularly timely issue, which is the defendant’s status as a fiduciary and possible breach of fiduciary duty based on failure to disclose fees fully and on receiving “revenue sharing payments in the form of 12b-1 and sub-transfer agency fees from
the funds in which it invested on the Plan’s behalf.” The court provides a nice analysis of these issues, making the case a good starting point for analyzing them with regard to the ever growing number of such cases being filed.
Between a Rock and a Hard Place: Pity the Poor Fiduciary, Trapped Between the Securities Laws and ERISA
One continuing theme in the posts on this blog is the replacement by plaintiffs’ class action firms of securities actions with ERISA breach of fiduciary duty actions in stock drop and similar type cases; the large class actions are brought on behalf of plan participants who hold company stock, often in an ESOP, against the plan fiduciaries. Such claims, for all intents and purposes, serve as independent securities type lawsuits against the company involved, through the guise of a breach of fiduciary duty lawsuit against the company’s designated fiduciaries, without having to meet all the rigmarole of a traditional class action securities fraud suit. I have posted often about this developing trend pretty much since launching this blog, and it has become a commonplace among other commentators as well.
Well, Georgetown law student Clovis Trevino Bravo has taken this line of thinking one step farther, authoring a detailed look at the advantages of prosecuting these types of cases under ERISA instead of under the securities laws, with a particular focus on the procedural and discovery advantages that accrue to the litigator who files such cases under ERISA rather than under the securities laws. Beyond that, she does an admirable job of synthesizing the often conflicting case law as to the intersection of the two legal regimes, providing an understanding of an evolving consensus - which is still a bit of a moving target, though, as she notes - as to the obligations of an ERISA fiduciary trapped between two separate lines of legal duty, that provided by the law of ERISA and that provided under the securities acts.
You can read her article in full right here, and you should - it will be worth your while.
LaRue, The Postscript
Remember the grave concern in different quarters about whether the Supreme Court’s ruling in LaRue would lead to a flood of litigation? Turns out it didn’t even do so in the LaRue case itself, which, now on remand at the trial court level, has been voluntarily dismissed by the plaintiff to avoid the expense of litigating the case. There’s your real check on excessive litigation: the costs of pursuing them. While ERISA grants a prevailing party the right to recover attorney’s fees, it is not a given that they will be awarded, particularly in a case, such as LaRue, where - as the multiplicity of opinions at the Supreme Court make clear - the law governing the issues in dispute is unsettled. Moreover, they are only awarded if you win; litigating a questionable case at significant expense risks large attorney’s fees that may never be recouped.
Of course, I guess all of this is just a back door argument for the outcome suggested by the opinion in Bendaoud discussed here: that the LaRue type cases are better structured as class actions than individual actions, for a variety of reasons, apparently including that litigating one small case is just plain not cost effective.
TARP and ERISA Litigation
Here’s an interesting looking and timely webinar from West next week on the stock market meltdown, the bank bailout, and their effect on ERISA governed plans. The short version of their pitch for the webinar, which ought to be in 20 point type spread across a banner headline, is “here come the breach of fiduciary duty lawsuits.” Overhyped? I doubt it. If the markets are down 40%, so are gazillions of dollars in 401(k) assets. If an individual financial company’s stocks are being battered, then so to are megamillions of dollars in that company’s stock likely held by its own employees in esops and other vehicles. Who are all of these plan participants going to be looking at? Who can they actually make out a claim against, and have standing to sue? To ask these questions is to answer them: the applicable plan’s fiduciaries.
Now the interesting question, more so than whether such lawsuits are coming (the answer to that question falls in the dog bites man category) is the structure of the defenses that will be raised by the fiduciaries. You can expect some consistencies across the positions raised by the defendants, not the least of which - and the best of which may well be - that prudent investment processes were followed, so no breach occurred, and proper levels of disclosure to the plan participants were maintained, so again no breach occurred, but the fiduciaries got blindsided, with the underlying theme of, one, so did everybody else (supposedly, anyway) and, two, no one could have anticipated and avoided these losses. What do I think of these likely defenses? Well, it would take a book length piece to address the ins and outs of these defenses, their holes, their strengths, and their weaknesses. But I do know this - any fiduciary relying on such defenses better have a squeaky clean documented trail of disclosures to participants, investigation into investment options and vendors, and informed decision making to back it up, or they are going to be writing very big checks when all is said and done.
To Be or Not to Be (a Fiduciary, That Is)
I talked about a case last week that addressed the damages aspect of making out a breach of fiduciary duty claim related to stock drop type issues, and pointed out the broad, ambiguous and easy to manipulate nature of a damages claim in that scenario. Another case last week, also out of the United States District Court for the District of Massachusetts, points out that other aspects of making out a breach of fiduciary duty case on a class action basis based on the administration of 401(k) plans provide a real check on such cases. The issue in that case? Namely that not everyone involved in operating a 401(k) plan is a fiduciary, and that while deep pockets involved in allegedly inappropriate behavior with regard to such a plan may make tempting targets, they cannot be sued successfully for breach of fiduciary duty if the prerequisite of having acted as a fiduciary is not satisfied.
As Judge O’Toole’s opinion in Columbia Air Services v. Fidelity Management Trust Company illustrates, an administrator of a plan - and who is not a named fiduciary of the plan - is only a functional fiduciary with regard to those specific limited areas in which it exercised discretionary, decision making authority; alleged wrongdoing by it with regard to other areas of its work for the plan do not subject it to fiduciary liability because the administrator is not deemed to have been serving as a fiduciary in those other contexts, regardless of the fact that it served as a fiduciary for other purposes. Thus, in that case, claims that improper fees were paid to the administrator as part of the structure of the 401(k) plan it was administering could not be the basis for a breach of fiduciary duty class action, because that did not occur as part of the activity where the administrator was, in fact, a fiduciary. As a result, ERISA granted no avenue for redressing those allegations of improper fees being paid to the administrator as part of its work for the 401(k) plan in question.
Although, as I have discussed in the past and as is discussed as well in this interesting article here, ERISA is becoming a favored structure for bringing securities related class actions, as this case shows, there are hurdles to these types of claims as well, ones that should dissuade anyone who thinks that bringing a stock manipulation class action under ERISA rather than the securities laws themselves equates with shooting fish in a barrel.
Joshua Itzoe on Fixing the 401(k)
In an odd coincidence, at the same time Wall Street has been imploding, laying bare valuation and other problems with investments in retirement plans and elsewhere, I happen to have been reading independent fiduciary/401(k) advisor Joshua Itzoe’s book, Fixing the 401(k), which is premised on the idea that 401(k) plans are compromised by inherent, systemic problems, ranging from issues in plan design to the significant impact of fees charged against plan assets (Susan Mangiero, who knows as much as anyone around about valuation, fee, and other issues impacting pension investments, has a valuable review of Joshua’s book here). I hope to return to some specific chapters in the book and discuss them in detail and in the context of the types of cases that I see and that appear on the court dockets, but for now what struck me most was the extent to which the problem that Joshua identifies as needing to be fixed is really one of fiduciary talent and application; excessive fees that decrease performance, poor investment choice selection, and controlling plan costs - all items that he identifies as systemic problems at this point in the 401(k) regime - are all issues that are or should be right in the wheelhouse of plan sponsors and fiduciaries. They alone, either on their own or by exercise of their authority to bring in outside expertise, are in the position and have the authority to protect plan participants against essentially every one of these problems; further, by operation of the liability imposed on them for failing to do so, they are the one and only players in the system who both have the power to address these issues and the legal incentives to do so. Plan participants have neither the power, responsibility nor authority to do so, and outside vendors - particularly ones who do not rise to the level of a fiduciary or who will at least argue that they do not - likewise may lack, at a minimum, the incentives to address these problems. The Wall Street implosion just drives these points home further; fiduciaries alone are in a position to protect plan participants from the pressures and potentially explosive risks in retirement investing by means of company plans such as 401(k)s, and there really isn’t anyone else with the authority, power or interest in doing so. Indeed, at heart, isn’t this really what a breach of fiduciary duty lawsuit really is - a claim that the only party in a position to put the participants’ needs first, didn’t?
Using Up My Fifteen Seconds of Fame
Permalink | There were a lot of things on my desk I could post about today, but I am going to take the easy - and self-promoting - way out, and pass along this article from Massachusetts Lawyers Weekly on the W.R. Grace decision out of the First Circuit on the question of standing in ERISA cases, which I blogged about last week. I am quoted extensively in the article.
Notes for a Friday
Permalink | I thought I would pass along a couple of things of interest that I read this week, before next week starts up with its own events. Taking up where my comments on the status of extra-administrative record discovery in the aftermath of MetLife v. Glenn left off, Roy Harmon has this post on a Ninth Circuit decision pointing out that MetLife v. Glenn in fact expands the availability of such discovery. Meanwhile, Michael Fox (no, not that Michael Fox; see e.g. Reilly, “Hey, what's-your-name! I love you”), really one of the founding fathers of employment law blogging, has nice things to say about the Boston ERISA and Insurance Litigation blog, along with a useful list of blogs worth reading that cover the employment law field. And finally for today, the WorkPlace Prof passes along an entertaining essay on the three competing decisions in the LaRue case, which provides a humorous take on an issue that I talked about here, concerning the differing approaches of each opinion to the problems raised by the LaRue case.
That’s plenty to read on Friday.
The First Circuit on ERISA Standing
Permalink | Very interesting case out of the First Circuit the other day on the question of whether former employees satisfy ERISA standing requirements with regard to defined contribution plans. Short answer is they do, but the Court’s analysis and discussion is an interesting open field run across a range of issues that are both explicit and implicit to any consideration of this question. One particular point, basically noted in a footnote, was of particular interest to me. I have discussed frequently in past posts my thesis that much of the evolution in ERISA law is and will continue to be driven by the economic effect on employees of the replacement of the pension system by 401(k) plans; this is partly because employees have become the persons at risk from investment mistakes, which they generally were not - barring complete failure of the employer and its pension plan - when employees were instead covered by pensions. In an interesting footnote, the Court addresses the distinction between the two types of benefits, and hints at the impact of that difference on employees:
Under a defined benefit plan, participants are typically promised a fixed level of retirement income, computed on the basis of a formula contained in the plan documents. See 29 U.S.C. §1002(35). The formula generally accounts for an employee's years of service and compensation level at retirement. Graden, 496 F.3d at 297 n.10. In contrast with a defined contribution plan, where the amount of benefits is directly related to the investment income earned in an individual account, the investment performance of the portfolio held by a defined benefit plan has no effect on the level of benefits to which a participant is entitled, provided that the plan remains solvent. See LaRue,128 S. Ct. at 1025 ("Misconduct by the administrators of a defined benefit plan will not affect an individual's entitlement to a defined benefit unless it creates or enhances the risk of default by the entire plan.").
The case is Kerr et al. v. W.R. Grace, et al.
A Middle of the Road Supreme Court?
Permalink | Here is an interesting article in which a former Solicitor General argues that the popular - and perhaps a little bit intellectually lazy - characterization of the current Supreme Court as “pro-business” may, at a minimum, be overstating the case a bit. Certainly, the ERISA rulings out of the Court this past term were hardly pro-employer or pro-business community, as both LaRue and MetLife v. Glenn weakened the defenses of plan sponsors and administrators and, at least in the case of LaRue, opened up new lines of potential liability. It is hard to argue that these rulings were pro-business at all, except perhaps from the perspective of those critics who felt that the Court actually didn’t go far enough in favor of claimants in its opinion in MetLife and should have instead drastically altered the nature of the standard of review applicable to cases presenting the circumstances at issue in that case, something the Court certainly did not do in its opinion. In that sense, with regard to the ERISA rulings, it would be much fairer to characterize the Court rulings as moderate and middle of the road, than as anything else.
Follow the Numbers: the Evolution in ERISA Law
Permalink | I have noted two things - well, many things, only two of which are relevant to this post - in the past, one the line that Marx was wrong about a lot of things, but he was right that everything is economics, and the second that we are beginning to see an incremental evolution in the law of ERISA to account for the reality that pensions - predominant at the time of many of the earlier, key court rulings on ERISA - have been supplanted by defined contribution plans. We saw the latter, for instance, in dramatic fashion in the Supreme Court’s ruling in LaRue, with the justices’ discussion of how rules applicable to pensions may not be equally applicable to 401(k) plans. The two ideas - that everything is at base driven by economic reality and the evolution of ERISA law - are linked, in a way driven home by this column in the Washington Post yesterday arguing for a new retirement structure based on the belief that the defined contribution approach simply is not going to work for most employees. The author noted “that when ERISA went on the books in 1974, employers were contributing 89 percent of the funds in pension plans, but by 2000, the employers' share of contributions had dropped to 49 percent.” With that change, as I have argued before, we are going to see a real shift in court rulings on ERISA as applied to defined contribution plans, with rulings providing more protection - or at least more recourse - to plan participants when the conduct of plan fiduciaries, particularly in the realm of investment choices, is challenged. When ERISA was only concerned with a world in which almost all retirement benefits were in the form of a pension, investment mistakes were, speaking generally and in sweepingly broad terms, the problem of the sponsor, as the employee was still promised his or her benefits; defined contribution plans invert this paradigm, making investment mistakes by fiduciaries the employees’ problem, and the law of ERISA will continue to shift to give those employees more redress than they have traditionally had in that situation under ERISA.
There's A Public/Private Sector Distinction For a Reason
Permalink | Two of my favorite bloggers ended up at the same place on a topic of interest over the past week, although from different directions and apparently unwittingly. The WorkPlace Prof posted last week on the idea being floated in a number of state legislatures that the states or their pension plans manage private sector 401(k) (or equivalent) plans and funds, and noted that this simply didn’t sound like a good idea. I nodded my head in agreement at the time, but didn’t think much more of it till today, when Susan Mangiero, who blogs at the cleverly named Pension Risk Matters, posted this piece on financially dubious plans in Massachusetts to increase public sector pension payouts, raising questions about both the financially irresponsible nature of the plan and the “smoke filled room” nature of the decision making. Implicitly, the post leads you to the place where the Workplace Prof’s recent post left off, with the idea that state pension plans aren’t necessarily the place to put private sector 401(k) money.
Millions for Defense, Billions for Damages: State Street's Exposure
Permalink | Backdating. It’s a scandal. No, not that backdating. I mean when bloggers can’t get to something when it first comes up, and then go back in time to talk about it. That’s what I mean by backdating, and that’s what I am going to do today. Last week, I read, but didn’t have a chance to discuss here, this article from Bloomberg on the State Street Bank subprime losses and potential ERISA related exposure. The article was particularly interesting because it takes a tack someone different than most articles that, like this one, rely on lawyers to evaluate the litigation against State Street arising out of those events; most such articles focus on liability issues, the procedural defenses available to State Street under ERISA, and the defensive position that the company can assert. This article, though, asks and attempts to answer the million dollar - or in this case, more like the billion dollar - question of how much losing these cases will cost State Street. The numbers bandied about by well informed lawyers are staggering, even to the jaded eye.
The article rounds up the usual band of worthies to comment, including the Workplace Prof’s mild mannered alter ego, Paul Secunda, who tacks the eye popping number of “hundreds of millions to the billions” on State Street’s potential liability, and Boston ERISA lawyer Marcia Wagner, who noted that the plan administrators filing suit against State Street may have had no other options but to sue. To quote the article:
Wagner said fund managers hurt by the drop may have an obligation to sue as the existing plaintiffs have. “To the extent plans were misled into purchasing something they were not authorized to purchase, they may have a fiduciary obligation to sue,'' said the lawyer, who isn't representing the investment manager or plaintiffs. ``It's sue or be sued,'' she said. ``They allowed bad investments, so they should be attempting to make the plans whole.”
This echoes something I said in my last post on the State Street mess, in which I raised concerns about the fact that pension fund managers invested in the State Street products without properly understanding what they were buying. As I suggested in that post, administrators fall down on their own fiduciary obligations in such circumstances. As Wagner’s comment suggests, it may well be that the administrators’ fiduciary duties under those circumstances require them to then try to remedy their initial mistakes by suing to recover the losses, rather than compounding their own fiduciary breaches by simply absorbing the loss; that latter course of action would likely just make the administrators themselves targets for breach of fiduciary duty lawsuits based on their own mistakes in investing in the State Street funds.
LaRue, Auditing, and 401(k) Plans
Permalink | On various occasions on this blog I have tried to turn away from its understandable focus on legal issues and onto the real world consequences of the legal rulings that govern ERISA plans. In particular, I have a particular interest, because of the manner in which it impacts my clients, on what practices companies should follow to best protect themselves from potential exposure in the current - and in the ERISA world these days, ever changing - legal environment.
As a result, I took particular interest in this piece out of Legal Times today by an experienced accountant and employee benefit plan auditor on the practical auditing steps that should be taken to ensure proper operation of a 401(k) plan and to limit potential liability in the operation of such a plan. The author’s hook into this topic? The Supreme Court’s decision in LaRue, and the manner in which the opening of liability, at least in theory, by the case is best met by that hoary chestnut, best practices. More than that, though, the author details exactly what, on an operations level, should be part of those best practices.
Big Questions From A Small Story on a (Relatively) Small Loss
Permalink | Here’s a short newspaper story of a local municipal pension plan that suffered a $2.4 million loss to its pension fund, which is only about a $53 million fund, as a result of investments in subprime mortgage backed assets made either by State Street or in State Street funds (the article isn’t clear on the relationship between the pension plan and State Street, the current poster boy for breaching fiduciary duty by subprime investments). As the article points out, the pension plan has retained counsel to pursue State Street over the loss, on the theory that State Street did not adequately disclose the nature of the investments and the risk; this is pretty much par for the course for the various State Street subprime lawsuits being brought by pension and 401(k) plans, which essentially allege that volatile subprime related exposures were not disclosed but were instead contained within investment products sold as safe, conservative bond investments. Although dressed up to suit ERISA and breach of fiduciary duty issues, they can essentially be understand as highly gussied up bait and switch claims, in which retirement plan administrators and fiduciaries allege that they thought they were buying one thing from State Street - a conservative investment vehicle to balance out riskier investment allocations - but instead were sold something else, namely a highly volatile and risky exposure. State Street, of course, as the article reflects, views the cases otherwise, as instances in which the proper disclosure was made, but market downturns harmed the investments.
This whole scenario raises an interesting question, aside from whether it is the plaintiff administrators or instead State Street that is right, because no matter which one is correct in their interpretation of the events at issue, you still end up in the same place, which is that the plans signing off on these investments just plain didn’t know what they were buying. This is certainly the case if, as the plaintiff fund fiduciaries claim, they weren’t told the truth, but it is likely also the case if, as State Street claims, plan sponsors were told the truth and are now simply complaining about market outcomes; if it’s the later case, one can only assume that the sponsors didn’t understand the risk being taken when they signed up for the investment.
And this goes right back to the most important question of all here, which is what were the plan sponsors and fiduciaries doing when they were offering these investment options or making these investments themselves? This scenario speaks of poor investigation and over reliance on the investment provider, namely State Street, and suggests the plans themselves did not have proper processes, including independent administrators with the sophistication to analyze the investment choices and risks, in place for choosing investment options, prior to offering them to plan participants or investing the plans' funds directly. In this day and age, I think we are moving past the point of debating whether those types of processes are part of the fiduciary obligations of those running retirement plans.
And by the way, for the record, I am not buying the article’s spin that the loss was not that damaging to the pension plan discussed in the article, because it was only about $2.4 million. Against total plan assets of approximately $53 million, and with the taxpayers on the hook to fund the pensions because it is a municipal plan, that’s an important hit, both financially and to the public pocketbook.
Excessive Fee Litigation: A Real Problem or An Imaginary One?
Permalink | Here's a piece passed along by the Workplace Prof, noting the rise in excessive fee litigation under ERISA. I have noted before that the combination of demographic and economic factors with the ruling in LaRue is going to create more of these types of actions over the years, not less, and thus I share the skepticism the Prof expresses over whether, as a defense lawyer quoted in the piece suggests, these cases don't pose a significant problem for plan administrators. Moreover, I don't necessarily buy the sentiment suggested by defense counsel quoted in the article, to the effect that these cases are about a battle of the experts over whether any particular plan's fees were too high relative to the market or not. I think of them more as due diligence and best practices cases, as really revolving around whether the administrator followed a proper process to pick providers and funds, and to make sure the fees involved remained appropriate as measured against appropriate benchmarks.
Does Employer Stock Even Belong In Retirement Plans?
Permalink | Should there even be employer securities in a 401(k) plan or other retirement vehicle? That’s the million dollar question (or more like the hundred million dollar question) that cases like those arising out of the Bear Stearns collapse raise. Moreover, it goes right to the underlying tension between ERISA and the securities laws that plays out in the concept of fiduciary duty: namely, the extent to which it is appropriate for a fiduciary to continue to allow employer stock holdings in a retirement vehicle when the company is simultaneously facing market pressure on its stock price and an obligation to comply with the securities laws in dealing with the marketplace as a whole. The legal and philosophical issues of this inquiry go on and on, spinning on like a fall into the rabbit hole; this is manifest in cases such as the Seventh Circuit’s ruling in Baxter, discussed here, in which these types of issues are merely raised, but not resolved. It’s a good topic for a law review article, but since blog posts traditionally don’t run to the hundreds of pages, I am not going to get very far into answering those issues here, but rather want only to raise the topic, which I think will be played out in a fundamental manner in the case law as the subprime mess lurches its way through the legal system. And on a practical level, what raised this thought this morning was this story here in the New York Times about pension funds moving out of equities, because, while there is a certain apples and oranges aspect to any comparison between that issue and employee holdings of employer stock in defined contribution plans (in that pension funds are moving in this direction because of future liabilities related to pension plan payouts and not necessarily for the same reasons that an employee might not want to be invested in his or her own employer’s equities), that fact does raise an interesting question. Simply put, if the professionals who run pension funds are moving out of the stock market for, in part, volatility reasons, should comparatively unsophisticated 401(k) investors be allowed to, even in some instances encouraged to, overload with one particular company’s equities?
Passing Along Some Reading on Excessive Fee Cases and Other Timely ERISA Topics
Permalink | What would this blog be if it was done as a newsletter instead? Well, probably something like this new ERISA newsletter out of Proskauer Rose, with its detailed but readable length discussions of current events in the field, such as the Supreme Court’s recent decision in LaRue and the Supreme Court’s consideration of whether to hear a case that will allow it to return again to the problem of defining the available scope of equitable relief under ERISA. For me personally, I particularly liked the discussion of the latest trends at the trial level in the federal court system with regard to lawsuits filed over allegedly excessive fees charged on mutual fund investment options, as it takes an approach that I like to pursue whenever possible in my own posts here on this blog: it discusses the early decisions on the issue at the motions stage in the trial courts, and looks ahead to what this may mean for the industry as a whole and service providers. Its worth a read, and if you enjoy this blog, you will almost certainly enjoy this newsletter as well.
What LaRue Wrought
Permalink | Suzanne Wynn has the story of the day when it comes to ERISA litigation, as she posts on the Seventh Circuit’s application of LaRue to exactly the type of case that, had the Supreme Court ruled otherwise, would have gone away without any potential liability on the part of the fiduciaries or, for that matter, recovery by the plan participant. The case, as Suzanne explains, concerns a single plan participant who charges plan fiduciaries with breaches of fiduciary duty related to the amount of company stock held in that particular participant’s account; the plaintiff’s theory holds that the fiduciaries breached their duties because they “allowed participants to invest in [company] stock despite knowing that the stock was overpriced and therefore was a ‘bad deal’.” The Seventh Circuit recognized that, after LaRue, a plan participant can move forward with such a claim, at least in terms of having standing to pursue relief that is not plan wide.
The Seventh Circuit’s decision touches on a number of themes that are not fully addressed in the opinion, but which really rest at the crossroads that the law of ERISA finds itself at today. The first has to do with the extent to which LaRue will or will not increase litigation. I have previously discussed that, in my view, the real impact of LaRue is that the types of cases, such as stock drop cases of the kind considered by the Seventh Circuit in this case, that in the past would only be brought if the scale was sufficient to attract the interest of the organized plaintiffs’ class action bar, will now be brought in many instances even if the scale is insufficient to give rise to class or plan wide litigation. Rather, as this case illustrates perfectly, these types of theories will be pressed now if even only one participant has enough loss to warrant the action, as LaRue expressly authorizes and as occurred in this case. This is where you will see the impact of LaRue with regard to expanding litigation, not necessarily in terms of a massive increase in numbers of suits, but rather in an incremental increase in the types and natures of suits brought against fiduciaries. And don’t kid yourself - as the baby boomer generation moves towards retirement, there are going to be a huge number of plan participants in 401(k) and ESOP plans and the like who have large enough accounts and holdings (for instance of company stock) for it to be worth their while to bring these types of suits if their accounts take a significant hit.
The second that I wanted to mention relates to something that is certainly not going to be news to any long time reader of this blog, and its certainly not an idea unique to me, namely, the fact that, in the aftermath of judicial and political responses to the growth - and some would say overuse - of class action securities litigation, the plaintiffs’ bar has begun using ERISA to prosecute what are in essence securities fraud claims of the kind that, in the past, would have been simply litigated under the securities laws. The plaintiffs’ bar has found that, given the evolution of the securities laws and of ERISA, ERISA may well be the better theory to prosecute in stock drop type cases. The swarm of litigation already being filed over the collapse of the Bear Stearns stock is a perfect example of the type of event that we have long been conditioned to expect to be litigated under the securities laws, but which is instead generating putative class actions under ERISA related to the company’s ESOP and other retirement vehicles. Among the many issues that this evolution in securities related litigation raises is how to integrate the securities laws and ERISA under these types of scenarios, to prevent ERISA from being distorted from its original purpose and transformed instead into simply some type of alternative securities law regime; Judge Easterbrook, writing for the Seventh Circuit, raises exactly these points, but doesn’t resolve them, noting instead that they will have to be developed in the future.
The case is Rogers v. Baxter International, and thanks to Suzanne for bringing it to my attention.
The Meaning of Justice Roberts' Concurrence in LaRue
Permalink | There’s nothing really new in this piece for those who have already closely followed and studied the LaRue decision (how’s that for opening with a bang?), but this column on the decision in the April 2008 issue of Metropolitan Corporate Counsel magazine by two Proskauer attorneys is interesting. They focus on playing out the meaning of Justice Roberts’ concurrence concerning whether such claims need to be pursued as denial of benefits claims, rather than as breach of fiduciary duty claims, and just what that means practically if the lower courts take him up on that suggestion.
A Blog to Pass Along, and Some Thoughts About the Supreme Court's Interest in ERISA
Permalink | Lots going on, lots to talk about. Let’s start with this one, which, coincidentally, allows me to kill two birds with one stone. You may recall that some time back I mentioned that I had come across two interesting blogs that I wanted to pass along, one of which was The Float, covering primarily investment related issues and their intersection with ERISA. I mentioned I would pass along the other blog in a subsequent post, which, almost inevitably since I had promised to do so, I never did, as breaking news and a pending trial shunted it to the side. Well, that other blog is this one, Benefits Biz blog, by the benefits and executive compensation lawyers at Baker & Daniels, which I have found to be a consistently interesting read. Moreover, I return to it today to pass that link along because of a very interesting post they have concerning a case that the Supreme Court has now elected not to add to its docket, concerning the relationship of age discrimination laws and employer provided health insurance benefits. As many already know and as I have discussed in the past here on this blog, the Supreme Court has shown a continuing interest in all things ERISA, with three cases either already decided or added recently to its docket. The Supreme Court’s lack of interest in this particular case perhaps hints - I am reading tea leaves here now, in the august tradition of Kremlinologists and other students of secretive institutions - at the outer limits of the Court’s interest in the subject of ERISA. The cases accepted for review to date by the Court emphasize litigation issues and, in particular, the effect of the evolution of retirement benefits from pensions to 401(k) plans on the litigation environment. This is not a fair reading of the case passed on by the Court that the Baker & Daniels’ lawyers discuss in their post; we may be able to infer that if you want to attract the Court’s interest in an ERISA case right now, you better make it about litigation and defined contribution type plans.
Back to the Well: Fiduciaries and Subprime Assets
Permalink | I guess this is the flip side of all the grief that is starting to come down on fiduciaries for excessive - or at least what seems to plaintiffs’ lawyers to be excessive in hindsight - exposure to the subprime mortgage mess in pension and 401(k) holdings: pension plan fiduciaries now adding such exposure to their funds in the hope of goosing returns by buying these beaten down assets at fire sale prices (kind of like they are playing at being Jamie Dimon). Here’s the story, and thanks to my colleague Eric Brodie for bringing this development to my attention.
Back From Trial, But the World Kept Spinning In the Interim
Permalink | My trial finally concluded late yesterday after two weeks, with the jury returning a verdict in favor of my client (pause here for self-congratulatory pat on the back). While I was able to get some posts up last week, during the first week of trial, events during trial this past week left me with no time to post. A lot went on during that week that would be of interest to readers of this blog, running from the almost certain ERISA litigation that will follow from the Bear Stearns collapse, to further Department of Labor attempts to mandate transparency, to the Commonwealth of Massachusetts’ continuing efforts to single handedly prove that state regulation of employer provided health insurance benefits should, in fact, be preempted. We’ll return to these themes, and other topics, next week, now that we have time to get the printing press rolling again here.
Want to Learn More About the Post-LaRue World?
Permalink | I am trying to kick the LaRue habit, but couldn’t resist going back to the well one more time (how’s that for mixing my metaphors?). I know from readers of this blog and from talking to other lawyers that people are very interested in LaRue and the Supreme Court’s current interest in ERISA cases - in fact, one lawyer told me that right after LaRue was decided he was at a meeting on an entirely different topic but LaRue is all anyone wanted to talk about that day- so I wanted to pass along this very interesting looking teleconference next month on individual 401(k) suits post-LaRue. The faculty includes Tom Gies, who represented the plan and its sponsor in LaRue, and Karen L. Handorf, an attorney currently in private practice who previously worked for the Office of the Solicitor of Labor, background that may make her ideally suited to comment on one of the biggest mysteries of all raised by LaRue and the Supreme Court’s selection for its docket of two more ERISA cases, namely what’s with the Supreme Court’s sudden fascination with ERISA litigation.
Passing Along an Interesting Blog: Number One
Permalink | One interesting thing about the LaRue case is the amount of blog commentary it inspired. For me personally, the best aspect of that wasn’t so much what other bloggers had to say about the subject, but more the fact that the discussions brought some blogs to my attention that I had not previously been aware of. I thought I would pass along two of the more interesting ones to you, as they may be of interest to people who come here to read up on the ERISA and retirement benefit issues discussed in this blog.
The first is The Float, published by Interlake Capital Management. The Float is mostly focused on financial news related to 401(k) plans and the like, but is somewhat unique in that it blends discussion of those economic issues - as well as just plain old fashioned business media bashing - with intelligent comments on breaking legal issues affecting such plans, such as the LaRue decision. It’s a lot of fun to read, not the least of which is because you don’t need a Wall Street background to enjoy their financial commentary, just some interest in and experience with the subject.
I’ll pass the second blog along in my next post.
More on LaRue: Lawyers USA Weighs In
Permalink | Thought I would pass this along right now, while the article is still available to non-subscribers - I suspect if you read this post tomorrow, you will have to subscribe to get access to the article by then. Either way, here’s an interesting article available on Lawyers USA today on the LaRue decision, and on the broader topic of what impact it will have. I am quoted in it on the issue of whether it will spawn more litigation; to quote the article:
Some see the ruling as spawning multiple lawsuits by individual 401(k) account holders.
"It will open the door to a lot more litigation. I don't think it will be an avalanche, but plan sponsors are definitely looking at death by a thousand cuts," said Stephen Rosenberg, an attorney with The McCormack Firm in Boston, who blogs on ERISA issues.
This is pretty consistent with what I said in my post last Friday, in which I discussed my views about how much litigation will result from this case. It is hard, as I said then, to quantify, but it is clear that the case paves the way for sponsors to face a steady stream of smaller cases, whereas in the past they really - or at least predominately - only had to worry about whether they were in a position to be targeted for a large dollar value, class wide type suit.
Choice Architecture, 401(k) Plans and the Argument for Restricting Choice
The topic of this article from yesterday’s Boston Globe, concerning behavioral economics and the idea that most people simply get it wrong when making investment choices with regard to retirement if they are left to their own devices, will be familiar to any long time reader of this blog, but it did catch my eye because its suggestion that employees need to be guided towards the right retirement choices echoes George Chimento’s point, which I discussed the other day, that perhaps 401(k) plans should actually be set up to take those choices away from employees and place them in the hands of someone with more knowledge about the subject. It’s a provocative idea, one that runs counter to the general Zeitgeist that we are all now responsible for funding our own retirements rather than passively relying on our employers to provide that as well, but the question of how best to generate appropriate returns for employees invested in such plans is, and should be, more widely discussed, including with regard to how much say individual employees should have in the matter. The Globe article is a nice survey of the theory behind the idea of just how much choice should be granted to employees in that context, and how structuring the choices available to them may affect the outcome for their retirements.
Fair warning, though: you may have to register (its free, but still annoying) to access the Globe article.
Will LaRue Actually Lead to An Increase in Litigation?
Permalink | I thought I would pass along today this article from Business Insurance in which I am interviewed about LaRue, and its impact on plan sponsors. The point of the article is that the decision opens them up to more potential liability, and they need to be aware of that. I am actually a little bit agnostic as to how much this ruling will increase litigation over these types of cases, given the expense and difficulty of litigating these types of cases if you are a participant. Probably for practical reasons - because I could, and probably did in the interview, go on at length about this topic - the article doesn’t contain all of my comments on this point. The gist of my thoughts on the issue, however, is that, as a practical matter, LaRue lowers the financial bar for suits over problems in 401(k) plans and makes it more likely that smaller company plans may be sued for the types of errors - such as excessive fees, company stock, and the like - that big plans get sued over. This is because these types of claims have predominately been brought so far on a class wide basis by class action plaintiff firms. As a result, only larger sponsors with large possible exposures were really in the cross hairs for these types of defects in 401(k) plans, because that is who the class action bar targets; LaRue, by at least establishing the right of participants to bring suits over these same issues only on their own behalf lowers the bar and provides an avenue for much smaller suits over these types of issues. This puts smaller company plans in the line of fire for suits over these issues, because while they may not have sufficient assets to attract the interest of the class action bar, they still have enough assets to attract lawsuits from their own participants.
Fiduciary Obligations - and Common Sense - Support Hiring Outside Expertise for 401(k) Plans
Permalink | One of the common themes of many of my posts, as well as of many of the judicial opinions, concerning fiduciary obligations of companies sponsoring 401(k) plans is the need to bring in outside expertise to manage the plans, particularly for the purpose of insuring that investment selections are appropriate and priced right. As I have discussed both in numerous posts and in a range of articles in which I have been quoted, smaller and mid-sized companies generally lack the expertise to properly handle all of the aspects of 401(k) plans and can best discharge their fiduciary duties - and best protect themselves against litigation - by retaining outside experts to manage a plan. There is an entire industry that exists to service such companies and their plans. Here is a story out of New Hampshire that illustrates this point brilliantly; it concerns a small company that believed it could operate its own 401(k) plan without an outside vendor, and ended up, without any intention to defraud, being pursued by the Department of Labor for $33,000 in employee contributions that were never paid into the plan. By all accounts, the company was not engaged in anything underhanded; it just was wrong in thinking it could handle the logistics itself.
And not to beat the LaRue drum too much, but obviously the establishment in that case of the right of plan participants to sue fiduciaries for mistakes affecting their 401(k) accounts (whatever may be the exact parameters of that right, an issue up for some debate in light of some of the vagaries of the three opinions from the Supreme Court), just drives home the importance of making sure that a 401(k) plan is run absolutely as well as possible.
A Couple of Other Perspectives on LaRue
Permalink | There’s a lot out there on the Supreme Court’s ruling in LaRue, and I thought I would pass along today a couple of articles and blog posts that approach the issues raised by the case from a slightly different perspective than simply the technical legal issues raised by the case. Employee benefits lawyer George Chimento discusses the LaRue decision in this client advisory here, with a focus on a particular question, namely, whether in light of the problems posed by LaRue type cases, it makes any sense to sponsor a 401(K) plan that allows participants to pick and choose among investments. He makes a compelling argument that it just may not make any sense to do this, given the liability risks, amply illustrated by the LaRue case, and the investment skills of the average participant. He sums that issue up in this paragraph from his article:
With all this additional liability, is it wise to sponsor self-directed plans, with the extra expenses associated with open-end mutual funds and daily investment switching? Are participants really better off self-managing their retirement assets, doing something they were not educated to do? Perhaps it's safer, and better for all parties, just to have an "old fashioned" managed fund, without participant direction, and to employ properly certified investment managers who can be delegated fiduciary liability under ERISA. A dividend of LaRue is that it may cause employers to step back and reconsider the current, expensive, and dangerous fad of self-direction.
And Kevin LaCroix, a lawyer/expert insurance intermediary, tackles LaRue in this interesting blog post on his well-regarded D&O Diary blog, in which he focuses on the issues for fiduciary liability insurance raised by the case. One interesting point he makes is that the availability of coverage may be affected by exactly that split between the Justice Roberts’ concurrence and the other two opinions, related to whether or not claims of this nature should actually be prosecuted only as denial of benefits claims, or instead as breach of fiduciary duty claims. Anyone interested in the insurance implications of LaRue should find it a useful and informative post.
Permalink | Some follow up thoughts on the Supreme Court’s opinion in LaRue, after having some time to digest it. First, the court’s three opinions make for an interesting assortment of analyses of the issue, but what is most important on the front lines, down at the trial level where these issues play out in court, is the unanimous agreement that an individual 401(k) participant can sue for losses to just his or her account. This resolves a key dispute that, I know from my own practice, has become a key issue in the question of when and how participants can seek legal redress with regard to their 401(k) accounts.
Second, the three opinions set forth almost radically different answers to the question of how and why such an individual participant can sue for losses just to his or her account in a 401(k) plan. The majority opinion posits that this is the appropriate reading of ERISA in the context of defined contribution plans, which may be different from what the rule should be with regard to defined benefit plans. The second opinion, by Justice Roberts, poses the extremely thorny argument that, while a plan participant can sue for such losses, he or she should do so under the denial of benefits portion of ERISA, rather than under the breach of fiduciary duty portion of ERISA. The third opinion, by Justice Thomas, finds that the plain language of the statute warrants individual participants being allowed to bring such claims, and holds no truck with the idea, relied on by the majority, that there is some underlying principle distinct to defined contribution plans that either justifies - or is necessary to justify - this conclusion.
The competing opinions present some interesting issues. First off, Justice Roberts’ suggestion that the law governing denied benefits, rather than the law of breach of fiduciary duty, should apply to the circumstances of the LaRue case appears unworkable in the context of that particular type of claim, for a variety of practical and legal reasons; there is a certain extent to which it seems to me that even suggesting that is to work mischief, particularly for the judges and litigants who, going forward, are going to have to work out the myriad issues that claims like that brought by the participant in LaRue raise, none of which were preemptively resolved by the Supreme Court. Second, there is something telling in the contrast between Justice Thomas’ approach and that of the majority, something that may well be a clash of philosophy, not just with regard to statutory construction for purposes of the instant case, but also perhaps as well with regard to the road that lays ahead for the law of ERISA. Justice Thomas is correct in his opinion that the issue can be resolved, in the participant’s favor, simply off of the plain language of the statute, without relying on any special considerations raised by the fact that the case involves a defined contribution account rather than a defined benefit plan, which is the issue animating the majority’s opinion. Does the majority’s heavy emphasis on the fact that LaRue concerned a defined contribution plan hint at a belief among the majority that, in fact, ERISA needs to be treated as an organic, evolving body of law that needs to shift from its past precedents to account for the rise of defined contribution plans? And if so, is the emphasis on this point in the majority’s opinion a subtle suggestion to lower courts to approach new issues brought before them concerning defined contribution plans - or even old issues never before resolved under defined contribution plans - with an eye to how ERISA should develop to fit those types of plans? At a minimum, it is hard not to see lawyers for participants arguing exactly that to district courts and circuit courts of appeal in the aftermath of the ruling in LaRue.
The Supreme Court Decides LaRue, In Probably Predictable Fashion
Permalink | As a practicing litigator, I often can’t delve too deeply into a particular issue right when it arises, and instead have to return to it that night to analyze it for further discussion the next day. With a trial set to start in one of my cases and a court appearance this afternoon, this is one of those instances, but I did want to pass along the Supreme Court’s opinion in LaRue, just issued today. I will give it a more in-depth read tonight and may post more on it tomorrow, but in the interim, here is the opinion itself, along with two initial, superficial thoughts. First, as I - and others - expected, the opinion goes in favor of the plan participant, and expands the right of individual plan participants to sue for breach of fiduciary duties. Second, on first glance, the opinion seems animated by the need to account for the particular risks of defined contribution plans such as 401(k)s, and to recognize the need for the law of ERISA to develop in a manner that accounts for the transition to those types of benefit plans. In a weird bit of precognition, that’s something I just talked about in my post earlier this morning, on the Supreme Court accepting cert on still another ERISA case.
The Benefits of Relying On Investment Managers
Permalink | We all know that in reality, most companies that sponsor retirement plans, including 401(k)s, for their employees bring in outside advisors to manage the plan. There are at least two primary reasons for this, the first being that most companies don’t have the expertise to select investments and otherwise run plans themselves, and hope to get better retirement plan performance by relying on outside expertise. The second is the hope that fiduciary exposures will be reduced by bringing in, and relying upon, an outside advisor who has superior expertise with regard to retirement investing. These two factors ideally work in conjunction to improve retirement accounts for plan participants; the fear of legal liability inspires a desire to bring in experts, who in turn can do a better job in selecting investments than the company could on its own. In this way, we see the operation of a perfectly selected legal rule, and we see the important role that fiduciary liability rules play in the ERISA scheme; the exposure does not simply exist to support litigation after the fact, but also as a motivating force that improves plan performance on a day in, day out basis, by driving plan sponsors towards reliance on expertise that will both protect them and improve performance. It is possible, to some extent, to view almost all breach of fiduciary duty litigation as examples of failures in this dynamic. For instance, what are claims that companies breached their fiduciary obligations by excessively including company stock in a plan but instances in which a company, insufficiently afraid of its potential liability for breach of fiduciary duties, failed to either diversify investments on its own or bring in sufficient outside expertise to allow it to do so?
A good example of this dynamic at work can be seen in Judge Young’s just released ruling out of the United States District Court for the District of Massachusetts in Bunch v. W.R. Grace, in which the court found that the company was insulated from breach of fiduciary duty claims with regard to the retention and sale of company stock in one of its retirement funds by the company’s retention of and reliance on an outside investment manager to make those decisions. The court found that the investment manager had properly acquitted itself with regard to those issues, and therefore the company could not be liable on claims that it had breached its fiduciary duties by selecting and relying upon that advisor. The court explained that If the investment manager “did not commit a breach, then [the company] did not fail in the discharge of its duty to select and monitor” the manager.
But you can take that analysis one step further. The interesting aspect in this regard of the ruling in Bunch is that the company was absolved of liability by its reliance on an outside expert because the outside expert did not itself breach any fiduciary obligations by the actions it took and decisions it made in that role. But what if the advisor had violated fiduciary obligations in its handling of its delegated duties? What then of the company’s attempt to protect itself by retaining and relying upon an outside expert? The answer in general is that the company can probably still successfully defend itself against claims for breach of fiduciary duty, so long as it can show that its own steps in selecting and monitoring the outside advisor were prudent, even if the chosen advisor turned out, in hindsight, to be the wrong choice of advisor or investment manager. And in that lies the two real teachings of Bunch. First, that companies can protect themselves from fiduciary liability by selecting and delegating to an outside expert and, second, companies have to pursue that old cliche - best practices - in making that delegation if they really want to avail themselves of the protection that bringing in outside expertise can provide. By abiding by the second teaching, they should be protected even if the advisor they selected thereafter, unlike the advisors relied upon by W.R. Grace in the Bunch case, falls down on the job.
LaRue is Decided . . . Well, Sort of
Permalink | In an opinion it issued on Monday, the United States Court of Appeals for the Sixth Circuit confronted essentially the exact same facts and issues as are at play in the LaRue case currently pending before the Supreme Court, and effectively entered its own prediction as to how the Supreme Court will rule in LaRue. Tackling the same arguments that were presented to the Supreme Court in LaRue, the Sixth Circuit concluded that individual participants could recover on their own behalf for losses solely to their accounts in the plan, and that breach of fiduciary duty claims under ERISA are not limited to actions brought on behalf of the plan as a whole or for recovery benefiting the entire class of plan participants as a whole. This, of course, is the primary issue presented to the Supreme Court by the LaRue case.
Interestingly, the Sixth Circuit even borrowed and relied upon Justice Breyer’s diamond hypothetical that he posed to the plan's counsel in LaRue in reaching its ruling in favor of the participants, a hypothetical that clearly caught many lawyers’ fancy after it was offered up by the justice during oral argument.
The decision is Tullis v. UMB Bank, N.A.
The Recent History of Subprime Litigation
Permalink | Kevin LaCroix, at his D&O Diary blog, has a tremendous history of the recent filing of subprime litigation, including class actions, many filed under ERISA. While I don’t necessarily agree with each of his interpretations of that history, it’s as good an overview of the subject as a whole that I have seen in any media. Perhaps my primary point of departure from his presentation would concern his view that these cases are very different from other types of class action litigation, such as the stock drop cases, that are often criticized as lawyer-driven suits warranting reform, because these are cases instead being brought by “very large institutions [who are] suing other very large institutions.” Perhaps, and certainly to some extent, but there is also an aspect to at least some of these cases that reflect that the class action bar has, for reasons of legal developments, public sentiment, and the winds of politics, moved towards using ERISA in circumstances where they would have previously used the securities laws, as well as towards the representation of large retirement plans, rather than individuals, as plaintiffs.
SmartMoney on the Practicalities of Complying With ERISA
Permalink | This is a law oriented blog, obviously, and one of the things that is always worth remembering is that the complicated legal issues played out in the cases discussed here have real world implications for plan participants and for businesses trying to provide benefits to their employees. A nice reminder of that is here, in this article on SmartMoney.com, in which I and others are quoted on the question of how business owners should operate 401(k) plans in light of the potential for fiduciary liability being imposed under ERISA.
On Regulation of Fiduciaries and Pension Plan Vendors
Permalink | I was interviewed by a reporter recently concerning the subprime mess and its implications for pension plan fiduciaries, and the issue came up as to whether further regulation was the answer, as she had heard from a number of others. To me, the ongoing problem we are seeing with fiduciary breaches - or at least allegations of them - arising from plan investments involve one type of flawed plan investment being replaced by another; first it was too much company stock in the plan, then when that problem worked its way out of the system, it was excessive fees being paid for investment options, with that quickly followed by the latest flaw du jour in investment selection, namely excessive exposure to subprime risk. Regulation can’t predict and thereby prevent whatever may turn out to be the next problematic interaction between the investment community and the obligations of pension plan fiduciaries to act prudently in selecting investments. Rather, regulation will inevitably target the last problem that popped up, not the next one that is coming down the pike. At best, one could improve things at the margins through further regulation by targeting not the fiduciaries themselves, but the vendors who provide investment products to them, and even then only by imposing more transparency, which may at least give pension fiduciaries a fighting chance at understanding the investments they are selecting and the risks or flaws inherent in them.
This news yesterday out of the Department of Labor, that it is proposing a regulation requiring further disclosure to plans by vendors of their compensation, fits this to a tee. The proposed regulation will require that “all compensation, direct and indirect, to be received by the service provider be disclosed in writing.” Well, excessive fees charged by mutual fund companies and others for the investments held by pension plans and 401(k) plans is last year’s litigation problem for fiduciaries, and the world has already moved on to the next problem. Indeed, I would speculate that many fiduciaries have already accepted the need to engage in due diligence as to all aspects of their vendors’ compensation arrangements, both hidden and not, simply out of awareness of the past lawsuits that focused on the issue. It’s a perfect example that regulation can’t predict and protect fiduciaries and the plans they serve from the next particular investment problem, but can instead only identify and prevent a reoccurrence of a past investment problem for retirement plans. At the same time, though, the regulation is focused on the transparency problem, and on obliging vendors to provide information openly to fiduciaries and plans; that’s the best avenue for using regulation to aid fiduciaries pro-actively, by adding to the information they have access to in evaluating vendors and proposed investment choices.
Talkin' With Tom Gies, Counsel for the Respondents in LaRue
I promised awhile back that I would run more interviews at some point on this blog, and we return today to our - granted, somewhat sporadic - series of interviews with movers and shakers in the worlds of ERISA and insurance. What provoked me to get back into the interviewing business, which I noted before are among the most difficult of posts to do well? The chance to provide more insight on the oral argument before the Supreme Court in LaRue v. DeWolff, Boberg, which was argued right after the Thanksgiving weekend. And with that lead in, here’s the blog’s interview with Tom Gies, a partner at Crowell & Moring in Washington, D.C., who was lead counsel for the respondents. Tom was gracious enough to provide some real thought provoking commentary on both the issues raised by the case and some aspects of the argument before the court:
Blog: How did you end up representing the respondents?
Tom Gies: We have represented the employer, and the plan, in a variety of employment, benefits, corporate and commercial litigation matters for years. They are longstanding valued clients of our firm. When this case was initially filed in the district court in South Carolina, we were retained to defend against the claim.
Blog: Many ERISA cases, particularly in the area of pensions and 401(k)s, never reach the merits, and instead are resolved by procedural motions addressed to whether there is even a cause of action or remedy available to the plaintiff. That’s what happened here. Would the law of ERISA be better developed, or the parties themselves better served, if courts were resolving questions such as those presented by LaRue after development of the facts of a particular case? On the merits, as it were, rather than on procedural issues?
Tom Gies: An interesting question. The case was pled and litigated in the district court solely as a Section 502(a)(3) claim. We moved for judgment on the pleadings because it was pretty obvious plaintiff sought compensatory damages that are not available under Section 502(a)(3), following the Supreme Court's "rather emphatic guidance" in Mertens, Great-West and Sereboff. Every court that has looked at this question so far agrees with us on this point. And, not to get too much into the prediction game, I think it is unlikely that the Supreme Court will use this case to reverse field on the question of what's appropriate equitable relief under Section 502(a)(3). Had plaintiff pled the 502(a)(2) claim in the district court, the litigation may well have proceeded differently. For instance, there may have been a more fully developed record after discovery, so that the case could be resolved on a motion for summary judgment. The Fourth Circuit was correct in observing that the 502(a)(2) claim was waived, having not been litigated in the district court. As with other types of litigation, the parties to ERISA actions are better served when the basic rules of engagement are followed and parties are not permitted to raise new issues for the first time on appeal. In our judgment, a more complete record in this case would have made it even easier for a reviewing court to understand that this is not a good vehicle for expanding the scope of Section 502(a)(2). A court looking at this fact pattern in response to a motion for summary judgment would readily conclude that this case does not present a triable claim for “losses to the plan” resulting from a fiduciary breach. More generally, I don’t think it’s wise to have some sort of special, more lenient, pleading rules in ERISA cases. The Supreme Court’s recent decision in Twombly recognizes the negative consequences, both to parties and the civil justice system, of the substantial costs imposed on defendants in having to go through discovery in complex litigation involving putative class claims. Those litigation costs are obvious in the 401k plan “stock drop” cases. The excessive fee claims present the same kinds of costs for employers and plan sponsors. The Court’s decision in Twombly wisely recognizes that bare allegations of a statutory violation, without more, should not subject a defendant to the tremendous cost of full-bore class action litigation. It shouldn’t make any difference whether such claims are brought by antitrust plaintiffs, Title VII claimants, or by lawyers representing ERISA participants.
Blog: Any particularly surprising questions or lines of inquiry at the oral argument directed at either you or LaRue’s counsel? What’s particularly interesting or surprising about it?
Tom Gies: Although the questioning of Mr. Stris regarding Section 502(a)(1)(B) was not a surprise (we mentioned it in our brief, and one of our amici devoted considerable time to the issue), I was intrigued with the implications in some of the questions asked by three of the Justices about the potential interplay between 502(a)(1)(B) and 502(a)(2). These questions suggest the Court will provide a careful analysis of the inter-relations of the various subdivisions of Section 502. The Court’s subsequent denial of certiorari in Eichorn v. AT&T may be another indication of the Court’s approach to this corner of ERISA law.
Blog: Any answers you’d like to have back? Any questions you’d like another shot at?
Tom Gies: I would have liked the opportunity to engage Justice Breyer more fully, perhaps in response to his second diamond theft hypothetical, on his question of "why" 502(a)(2) should not be read to extend to a situation like this. A decision to expand the remedies available under Section 502 has significant consequences because it is contrary to ERISA’s goal of encouraging plan formation. Permitting such lawsuits would inevitably require someone to make judgments as to a variety of issues, including: should there be a limit on damages, whether there should be jury trials for such claims, whether there should be an obligation on the part of the plaintiff to do some due diligence before bringing a damages action years after the alleged mistake, whether employers and plan sponsors can require arbitration of these kinds of claims, what should be done about the consequences of such litigation to the fiduciary insurance industry, and how would such claims be fit into the current rules for certification of class actions under Rule 23. There are surely others. These kinds of policy judgments seem best left to Congress.
Blog: Play it out for us. What’s the negatives for the industry if the Court reverses the Fourth Circuit and allows these types of claims to go forward?
Tom Gies: Imagine you have a new employee who joins your law firm, which, we assume, sponsors a 401k plan. Four years after you hire her, you get a lawsuit seeking compensatory damages for a violation of ERISA’s fiduciary duty rules. Her lawyer claims she was not given enrollment forms when she was hired, because of a mistake made by your HR director, and, as a result, employee contributions into the 401k plan were not made. The complaint goes on to assert that, had the contributions been made, she would have invested in Google the day after its IPO, and that the plan fiduciaries are personally liable for more than $500,000 in lost profits. When you look into it, your HR manager has a vague recollection that the employee took the paperwork and said she’d “think about” whether she wanted to join the plan. Should that case go to trial? Before a jury? Justice Scalia’s comment during oral argument in LaRue seemed to appreciate our point – there would be no end to the type of damages claims that plan participants could devise if these types of claims are permitted to go forward.
Imagine another situation. One of your employees who participates in your 401k plan had 75% of her account balance invested in mutual funds heavily concentrated in real estate. Now that those investments have lost considerable value, she seeks counsel. You get a complaint for compensatory damages that includes the allegation that someone in HR told the employee to “stay with” the real estate investments because that sector of the market would be sure to turn around soon.
The considerable costs of defending against such lawsuits will be born ultimately by employer plan sponsors. Fiduciary insurance will become even more expensive. Permitting these kinds of claims would undercut one of the fundamental assumptions made by employers in deciding to offer DC plans, rather than DB plans – the ability to shift investment risk to employees. All in all, a bad idea if you believe, as we do, that it’s critical not to take steps that would discourage employers, particularly small employers, from continuing to offer DC plan.
Blog: Paul Secunda, at the Workplace Prof blog, and I have been going around and around for a bit about whether ERISA is properly understood as having been intentionally enacted by Congress with only limited rights of recovery and remedy for plan participants. Clearly, that idea underlies DeWolff’s arguments to a substantial degree and, in fact, the lower courts’ rejection of LaRue’s claims can be understood as a recognition of this principle and of the fact that, as a result, LaRue simply has no recourse at this point. What’s your view on this? Are those of us who treat ERISA as specifically and intentionally limited in this way right about that?
Tom Gies: I start with Pilot Life and Mertens where the Court is clear in stating that ERISA represents a series of political compromises, not all of which were in favor of plan participants. ERISA is thus fundamentally different from other employee protection statutes. Encouraging plan formation, through the tax laws and otherwise, seems to me to be a cornerstone of the statute. And, of course, it’s not accurate to say that people like Mr. LaRue have “no recourse” in a situation like this. From what we know from the record, this is a case that could have been avoided by a telephone call. If you want to sell 100 shares of stock, you probably call your broker and place the trade. If you don’t get a confirmation order pretty quickly, you’ll call back, and if you don’t get a satisfactory answer, you’ll call her boss. If the boss won’t help you, you’ll escalate the situation until you get your trade executed. People like Mr. LaRue who want to trade securities in their 401k plan accounts have a variety of remedies available to them; they just don’t have a cause of action for compensatory damages based on a lost profits theory.
Blog: I shouldn’t put you on the spot, but I will - want to hazard a guess as to the outcome of the LaRue case?
Tom Gies: The Fourth Circuit will be affirmed 5-4, with the majority concluding that it is up to Congress to decide whether to extend the remedies currently set forth in Section 502.
Protecting Corporate Officers from Fiduciary Exposure
Permalink | Here’s an interesting article on one particular aspect of ERISA breach of fiduciary duty cases, namely the targeting as defendants of executive officers of the company sponsoring a pension or 401(k) plan; the gist of the article is that there are tactical and psychological benefits that accrue to counsel representing plan participants when they name officers of a company as defendants in such actions and allege that they are plan fiduciaries. Discretionary authority of any nature, of course, can render someone a fiduciary under a company’s pension or 401(k) plan, and those individuals can thereafter be rightfully targeted as defendants in a breach of fiduciary duty action related to that plan. As the article points out, allowing senior officers or directors of the company to engage in such activities can leave them open to suit, a bad idea because of the distraction and injury to company reputation of having senior management named as defendants in any major piece of litigation. The article’s suggestion to solve this problem? The old ounce of prevention is worth a pound of cure approach. The authors recommend that, well in advance of any litigation and even with none hovering off, threateningly, on the horizon, companies return to the plan documents and make sure they are structured to keep senior management out of the operation and decision making of the company’s pension plans. In essence, delegate that job downward in the company, as far away from senior management as day to day operational concerns - as opposed to concerns of preventive lawyering - allow. In a company retirement plan structured in that manner, the ability to credibly assert that any member of senior management exercised discretionary authority over the company’s retirement plan - and to therefore charge them as fiduciaries - is very limited and possibly non-existent.
Roundup at the LaRue Corral
Permalink | More on LaRue in the wake of Monday’s oral argument, and the inevitable commentary from all sides - including this one - on Tuesday:
• My last two posts on the LaRue case, here on the briefing and here on the oral argument, assumed a certain prior level of understanding on the part of the reader as to the issues and statutory provisions involved in the case. Workplace Prof has a more soup to nuts review of those, in the wake of the argument, here, which is also cross-posted here.
• Susan Mangiero was taken by the discussion in the oral argument of what powers may or may not have been identified in the summary plan description appended to LaRue’s complaint. I took this discussion by the Justices to be part of an inquiry into what are the constraining parameters of a claim such as the one brought by LaRue. As I have discussed before, I think the Court will allow this type of claim to be actionable, primarily because the law of ERISA is going to have to evolve to fit the brave new retirement world in which defined contribution plans, rather than defined benefit plans, rule, and establishing a right of remedy for the type of error alleged by LaRue is a necessary part of that evolution. However, I don’t expect, both for reasons related to the historically limited remedial reach of ERISA and the philosophy of various justices, that theory of liability and right of recovery to be unconstrained or left as simple as error by fiduciary plus loss to one account =s liability. Rather, although the Court may leave the parameters of the theory of liability to future cases for development, I expect the Court to at least indicate in dicta certain restraints and constraints on such claims. In this way, I think the eventual opinion will essentially walk the line between the concern of the respondent and its supporting amici that allowing claims of this nature will excessively increase the cost of providing plans to employees and the concern voiced by LaRue’s counsel that employees must be allowed a remedy for this kind of error.
• And here’s the New York Times’ highly readable account of the oral argument, by the excellent Linda Greenhouse.
• Finally for today, on a lighter and less substantive note, here’s the WSJ Law Blog’s post on the case, with a nice little profile of Tom Gies, who represented the respondent.
Thoughts on the Oral Argument in LaRue v. DeWolf, Boberg
Permalink | Just read the transcript of Monday’s oral argument in LaRue, which you too can read right here. Interesting argument, and interesting lines of questions from the court, although I am skeptical as to how much guidance as to the court’s thinking one can draw from the Justice’s questions themselves. In many ways, the lines of inquiry seemed to parallel my earlier post here on the arguments made by both sides. I had mentioned in my earlier post that the respondent focused heavily in its briefing on two points, the first being that prior jurisprudence of the Court concerning ERISA cases suggest that the narrow framework of ERISA remedies should not extend to encompass this type of claim, and the second that LaRue’s case itself was pled with holes that did not suggest it as a good vehicle for authorizing these types of claims. With regard to the first line of argument, questioning right off the bat of the respondent’s counsel targeted the fact that the prior jurisprudence relied upon by the respondent did not concern defined contribution or other retirement benefits and was based on a starkly different fact pattern; I mentioned in my earlier post on the parties’ briefing that I thought the earlier jurisprudence was too different in nature to provide much support for either side in the circumstances presented in the LaRue case, and after reading the argument, I think that remains the case. With regard to the second issue, LaRue’s counsel was peppered with questions concerning possible holes in the way he sought to recover for the alleged mistakes at issue, questioning that I thought was consistent with my earlier view that while the Court may well allow the type of claim at issue here to be actionable, the Court may well find that LaRue himself hasn’t placed himself in a position that he qualifies to go forward with such a claim. Perhaps the most interesting nugget to me in the transcript is that, with regard to the question of whether such a claim should be allowed at all - i.e., found to be authorized by the statute - the questioning seemed to consistently focus on one simple issue, namely that the only intelligible and consistently intellectually defensible position is that the plain language of the applicable statutory section would allow a loss to only one or a few plan participants’ accounts to be actionable, and would not require, as the respondent asserts, a loss to most or all of the plan’s participants before a claim for breach of fiduciary duty could exist.
Interestingly as well, the issue of whether a claim could proceed in the LaRue case as an equitable claim for relief under the Sereboff line of cases was discussed in only the most cursory terms by all involved, including the Justices. For various reasons, not the least of which is that the Court’s prior treatment of this issue has painted the Court into a bit of a corner from which it cannot back out without either repudiating prior holdings or engaging in intellectual gymnastics, I don’t see the Court advancing the ball on this issue in its opinion in this case.
LaRue v DeWolff, Broberg and the Concept of Administration Risk in ERISA Plans
Permalink | Oral argument at the Supreme Court is scheduled for Monday in LaRue v DeWolff, Broberg & Associates, which presents the technical question of whether a loss to only one participant’s 401(k) plan is actionable as a breach of fiduciary duty causing a loss to the plan, but which on a broader level concerns the question of who should bear the administration risk (defined as the problems of mistakes or malfeasance in the operation of a benefit plan) inherent in the operation of a 401(k) plan. Is it the participant or instead the plan fiduciaries who should bear that risk? To LaRue, who focuses his arguments around this idea, mistakes attributable to the administrators that harm the account balances of a particular plan participant represent a risk that should be borne by the erring administrator, and should therefore be actionable under ERISA even if the only losses in the entire plan from the mistake were suffered by one particular plan participant. The respondents reply, quite correctly, that ERISA provides limited remedies and some losses are simply - and quite intentionally under the terms of the statute - not actionable; to the respondents, LaRue’s loss, which stemmed from the administrator not following his specific investment instructions related to his specific account, is exactly such a non-remediable event under ERISA.
While the respondents are right that ERISA, presumably intentionally and certainly consistently with the general understanding of the statute and its history, provides only limited rights of recourse and leaves some losses to be borne by the affected plan participant, the statutory language itself at issue in the case - concerning whether an individual’s loss of the type described by LaRue qualifies as an actionable loss to the plan when only the individual was harmed - does not specifically leave in or leave out the circumstances of LaRue’s particular loss from the category of losses that are actionable under ERISA. And that is really where the Supreme Court’s involvement here comes into play, on the question of whether the type of administration risk described by LaRue belongs within or without the statute’s remedies; how the Court interprets the specific statutory language at issue will decide that question.
Personally, I’m of the view that the Court will find that the statutory language allows for the type of claim that LaRue is presenting. The language in question is capable, without any stretching of the language, of including the kind of claim at issue, and past jurisprudence doesn’t bar - or even present a significant impediment - to such an interpretation of the particular statutory language at issue. Moreover, and interestingly given the respondents’ - quite appropriate - tactical reliance on the general theme underlying past Court opinions on ERISA cases that suggest a claim such as LaRue’s is not actionable, the body of law that bears on this issue really was not created in response to one of the primary economic developments in American life over the last handful of years, namely the transition over to a regime of individual responsibility for retirement by means of defined contribution plans such as 401(k) plans and the accompanying transfer to individuals of the risks of retirement investing, and the corresponding disappearance of a defined benefit regime in which all such risks were borne not by individuals, but instead by their employers. Questions like the one presented by the petitioner in LaRue haven’t really been addressed at the high court level in the context of this new economic reality, and I am not convinced of the utility of past ERISA decisions concerning other contexts in resolving the statute’s application in the defined contribution context. I suspect that LaRue will present an early example of the Court accepting that the statutory language in ERISA that remains open to differing interpretations should be understood as transferring at least some of the administration risk inherent in the world of 401(k) plans from the individual saver and onto the party in the best position to avoid the risk, namely the administrator.
At the same time, I am not convinced that this is going to do much good for LaRue himself. The respondents take the tactical approach in their briefing of focusing on the particular flaws in LaRue’s presentation of himself as the poster boy for plan participants confronted by erring administrators, in an attempt to show that the particular claim he presented to the courts below does not justify interpreting the statutory language in a manner that would allow his claim to proceed. It’s a pretty good argument, and I wouldn’t be surprised to see a final opinion that opens up the type of claim he is arguing for, but puts him outside of its scope.
Is Subprime the New Stock Drops?
Permalink | The consensus in the legal community, and I don’t think it is just because they are looking hopefully for a new flow of work, has for awhile now been that fund investment losses resulting from exposure to the subprime mortgage mess will eventually generate substantial ERISA related litigation. There are plenty of avenues for these cases, not the least of which is plans and their fiduciaries bringing suit against investment advisors or investment funds for losses suffered by the plans on the theory that the advisors and funds improperly exposed the plan to such losses. This article here, out of the Boston Globe, provides a good example of exactly this line of litigation, detailing extensive losses to pension plans from investing in what were supposed to be conservatively managed bond funds at State Street. Here’s the overview provided by the article:
Institutional money manager State Street Corp. now faces three lawsuits over its management of bond funds that were touted for their conservative investment strategies, yet posted losses over the summer because of risky holdings tied to the subprime mortgage industry . . .The latest lawsuit was filed last week in federal court in Boston by Nashua Corp., a Nashua, N.H.-based maker of paper and imaging products, against State Street's investment arm, State Street Global Advisors. . . Nashua lost $5.6 million by investing company pension funds in State Street's Bond Market Fund, due to the fund's ’overexposure in mortgage-related securities,’ according to the lawsuit. Nashua's complaint seeks class-action certification, which could allow other companies that invested in certain State Street funds to join the case.
Perhaps of even more interest on this front is the complaint that was filed a few weeks ago in the Southern District of New York by Unisystems, Inc. Employees Profit Sharing Plan, an ERISA governed plan, alleging substantial breaches of fiduciary duties under ERISA by State Street related to the bond funds it managed that the Unisystems plan and other plans invested in. The complaint seeks to be certified as a class action, and was brought by the Keller Rohrback firm, which looks to be on its way to becoming the Milberg Weiss (sans the indictments) of ERISA class action litigation. The complaint itself in that case, which you can find right here, is a terrifically detailed, step by step overview of the subprime mortgage problem, how it impacts ERISA governed plans, and the fiduciary exposures which that credit crisis has created - at least in theory so far - for investment managers and other ERISA plan fiduciaries. If nothing else, it gives you the whole story of this line of potential liability for ERISA fiduciaries.
And the scope of this area of liability and potential litigation involving ERISA plans is as big as you would expect. State Street notes that:
the problematic [State Street] funds [at issue in these lawsuits] amounted to a small fraction of the $244 billion in fixed-income funds it manages. About $36 billion of that total is actively managed -- as opposed to passive funds that track indexes. The proportion exposed to subprime mortgages amounted to $7.8 billion as of June 30, and just $2.6 billion as of Sept. 30.
Well, you know what? That’s still billions of dollars of investments at issue, and that’s only involving one potential defendant in these cases. As the old saying in politics goes, a billion here, a billion there, and pretty soon you are talking about real money.
ERISA, Investment Strategies and the Duty to Investigate
Permalink | ERISA litigation, particularly in the area of retirement benefits, is one of those areas of the law that can be particularly complicated because both the governing body of law and the underlying fact pattern to which it is applied can be tremendously complex. Take, for instance, the example of disputes over whether the fiduciaries of a retirement plan erred in selecting investments for the fund. This example, as you have probably guessed, is not chosen at random, but instead because Susan Mangiero has this interesting post here on a particular equity investment strategy involving short selling, and on the question of whether such an investment strategy by a retirement fund would be prudent or instead a breach of fiduciary obligations. The strategy itself is relatively complicated, at least to anyone approaching it from outside the investment world, and so too is the question of how it compares to other investment tools the fund could have selected. Fortunately for those of us who litigate such questions, the rules of evidence allow those questions to be answered in court by the use of experts who actually know these points inside and out and can comment on them in depth. These underlying factual details are ones that must be considered in passing on whether a fiduciary breach has occurred before even getting to the question of how a particular investment strategy fits within the fiduciary obligations imposed by ERISA.
After mastering the details of the investment strategy at issue, one then still has to evaluate whether its use was a breach of fiduciary duty under the law of ERISA. I am quoted in Susan’s post on the fact that this in turn depends heavily not so much on whether the investment strategy itself was sound, but more on whether the approach taken by the fiduciaries to selecting that investment strategy was sound. As Susan discusses in her post, this in turn depends very much on whether the fiduciaries sought sufficient outside expertise on the particular type of investment strategy at issue to allow a third party looking in on the decision making after the fact - such as a judge or a jury - to say that the fiduciaries fully considered the merits of the particular type of investment in question before investing and thus did not breach their fiduciary obligations, even if the investment went south.
What struck me about this duty to investigate, for lack of a better phrasing, is that the obligations of the fiduciaries in this regard in many ways mimic the approach of the ERISA litigator handed a case after the fact involving the particular investment strategy and the question of whether its use was a breach of fiduciary duties: the ERISA litigator at that point brings in independent experts to advise on the appropriateness relative to the market of using that particular investment strategy, and bases a defense to a large extent on testimony from such experts that the investment strategy was sound. The fiduciaries themselves, however, could have effectively deflected claims of breach of fiduciary obligation in selecting the investment strategy in the first place by doing the same thing before ever making the investment; retaining outside experts to render this opinion prior to making the investment provides a strong defense against claims that the fiduciaries breached their obligations by making the investment. Indeed, contemporaneous reliance on outside, independent expertise to evaluate investment strategies is perhaps the best steps a retirement plan can make to head off potential claims of breach of fiduciary duty involving the selection of investments.
In this way, the question for fiduciaries and the plans they serve becomes as much as anything one of pay me now, or pay me later. They can avoid problems by paying for independent advice and investigation before making investments, or they can pay for the same advice later in defending themselves if they are sued. As a litigator, obviously, I am happy to retain experts and resolve the problem after the fact; as a counselor, though, I would always recommend the preemptive approach of obtaining such expertise before selecting a particular investment strategy.
Sex, Lies and 401(k) Plans?
Permalink | Well, that is probably overselling this post, but we couldn’t resist the play on the title of the much hyped, much overrated 1989 movie. Regardless, here is an interesting story, out of the soap opera meets 401(k) genre, concerning questions that have arisen over the administration of a prominent law firm’s 401(k) plan as a result of a particularly contentious divorce. At a minimum, it seems to be about just plain bad management of a plan, and at most about something a little worse. Either way, it illustrates the importance of scrupulous and professional management of company benefit plans, something that self-managed smaller plans often struggle to achieve.
Number of Suits + Questionable Practices = X
Permalink | I have talked, certainly more than once, about the fact that the law governing fiduciary obligations in the realm of retirement plans is evolving, and most recently I commented on how it looks as though the Supreme Court is poised to weigh in on the direction of this evolution in the case law. Some of the evolution of the law in this area, it seems, is being driven simply by numbers. Susan Mangiero, author of the blog Pension Risk Matters, pointed out in a recent interview that we are seeing somewhere around 250 to 300 new lawsuits filed per quarter involving the liabilities of pension fiduciaries, mostly involving private company plans. As numbers of suits go up, simple experience tells us the courts will face new issues, or old issues under new fact patterns, and will issue rulings that advance the ball on what the shape of the law should look like in this area as a result. But the evolution is also driven, I think, by another issue I have commented on before, which is that, with pensions being replaced by 401(k) plans in which the employee bears all the risk, plan participants are motivated by that change to protect themselves against poor practices and oversights by those in charge of their retirement investments. And experts on the subject of pension governance suggest that they have good reason to concern themselves with these issues: Susan Mangiero points out in the same interview that pension governance practices quite simply leave a lot to be desired.
If there has ever been a roadmap to the evolution of a particular body of law, its right here in this scenario: more suits plus questionable practices by the targets of the suits.
More on Whether Socially Conscious Investing Is a Breach of Fiduciary Duty
I have raised before the question of whether so-called socially conscious investing would be a breach of fiduciary duty if undertaken by a pension plan or 401(k) fiduciary. The National Law Journal has a neat opinion piece by law professor Edward Zelinsky right now to the effect that it would be. Here’s a link, although you may have to be a subscriber to access it. Either way, I think I am going to exercise my fair use rights under copyright law, and quote the professor’s conclusion on this particular point:
Inconvenient truth no. 3: Social investment dilutes fiduciary standards. Divestment for worthy causes, like other forms of social investing, opens the door to less noble uses of public pension funds by diluting the fiduciary standards governing pension trustees' investment decisions. Suppose that a group seeks to use public retirement assets to support the Hamas-dominated regime in Gaza. There are, of course, persuasive distinctions between an anti-Sudan investment policy and a pro-Hamas policy. However, politicizing public pension investments for good causes will invariably turn such pensions into battlegrounds as others seek support for their causes, not all of which will be attractive.
Instructive in this context are the traditional standards of fiduciary conduct including, in Benjamin N. Cardozo's famous formulation, "the duty of undivided loyalty." The insight animating this formulation is convincing: It does not matter if a fiduciary (like a public pension trustee) dilutes his loyalty to beneficiaries' welfare for a commendable cause. Once fiduciaries weaken that loyalty by considering any objective other than the well-being of their beneficiaries, the door is opened to causes that may not be meritorious. Even if trustees only pursue estimable objectives, they pursue such objectives with others' money, i.e., retiree's retirement resources.
I discussed in an earlier post an academic paper by a different professor arguing to the contrary, and you can find that here. So now you have both sides of the coin, and can make your own call. For me, though, I will return to my own roots - and initial instincts - as a litigator, and repeat something I have said before: if representing a client sued for breach of fiduciary duty, I’d rather be in the position of defending an investment strategy that called for maximum possible returns than one calling for only the maximum possible returns available by investing in good doobie companies.
Reinsurance and LaRue, All in the Same Post
Permalink | Instead of posting twice in the same morning, I am going to try to address two distinct substantive issues, one involving reinsurance and the other ERISA, all in the same post, hopefully without turning this post into some sort of Frankenstein monster combination of topics that instead should have been kept entirely separate.
On the first, ever wonder why so many reinsurance companies are domiciled in Bermuda? I thought so. The New York Times has an excellent article today explaining why, and as one might have guessed, it has to do with taxes. As the New York Times sums up the matter:
At issue are federal rules that allow insurance premiums to be shifted from the United States to offshore affiliates — which reduces taxes — and allow the proceeds to be invested tax free, increasing the profit to parent companies. . . .The core of the dispute is an unusual tax treaty with Bermuda. It allows insurance companies based on the island to deduct from their American taxes premiums that their subsidiaries in the United States collect from American customers and send back to the headquarters abroad. In Bermuda and other tax havens, the money is invested tax free. This money is moved, under the law, through the purchase of reinsurance by the affiliates from their parent companies.
Personally, I really like Bermuda and have long wanted to have reinsurance clients there that would justify my opening an office in Bermuda, which I suspect influences my views on this issue, and so I will therefore keep them to myself.
The second is an ERISA issue, involving the Supreme Court’s decision to hear LaRue v. DeWolfe, Boberg and Associates. This case, which I discussed here and here, involves whether a plan participant can sue under ERISA to recover losses suffered only in that participant’s account, and not across the plan as a whole. As I discussed here, it makes sense that a participant can do so and I expect the Supreme Court to rule to that effect. The defendants, in an attempt to avoid the Supreme Court ever reaching this issue, moved to dismiss the appeal as moot on the ground that the plaintiff had cashed out of the plan and therefore cannot proceed with a claim against the plan for losses incurred in the plaintiff’s now cashed out account; whether such cashed out participants can proceed with such cases is something of a hot topic that has been decided in differing ways by trial level judges in the federal system, including by judges sitting in the same federal district court, as I discussed here. Well, Workplace Prof and SCOTUSBLOG are reporting that the Supreme Court has denied the motion to dismiss on that ground and the Supreme Court will go ahead and hear the case.
There, I did it - two items on two different issues, all for the price of one admission.
Some Thoughts on Behavioral Economics, 401(k) Plan Architecture and the Potential Liabilities of Fiduciaries
Permalink | I have blogged before about behavioral economics, and the question of whether how we structure retirement investment choices will affect whether plan participants successfully save for retirement. Two recent articles really drive home this point. In the first one, “Choice Architecture and Retirement Savings Plans,” the authors posit that the design of 401(k) plans will in fact affect retirement savings and investment choices. Here is the abstract, which lays out their thinking:
In this paper, we apply basic principles from the domain of design and architecture to choices made by employees saving for retirement. Three of the basic principles of design we apply are: (1) there is no neutral design, (2) design does matter, and (3) many of the seemingly minor design elements could matter as well. Applying these principles to the domain of retirement savings, we show that the design of retirement saving vehicles has a large effect on saving rates and investment elections, and that some of the minor details involved in the architecture of retirement plans could have dramatic effects on savings behavior. We conclude our paper by discussing how lessons learned from the design of objects could be applied to help people make better decisions, which we refer to as “choice architecture.”
In the second, "Individual Account Investment Options and Portfolio Choice:
Behavioral Lessons from 401(K) Plans," the authors present the honestly fascinating finding that as 401(k) plans disproportionately add higher cost actively managed funds to their menu selections, plan participants move disproportionately into those funds instead of into less expensive alternatives that are also present in the menu of investment choices available to them in their plans, with the result that plan costs increase and participants’ returns on investments decrease. Here is the abstract from their paper, more extensively describing the authors’ findings:
This paper examines how the menu of investment options made available to workers in defined contribution plans influences portfolio choice. Using unique panel data of 401(k) plans in the U.S., we present three principle findings. First, we show that the share of investment options in a particular asset class (i.e., company stock, equities, fixed income, and balanced funds) has a significant effect on aggregate participant portfolio allocations across these asset classes. Second, we document that the vast majority of the new funds added to 401(k) plans are high-cost actively managed equity funds, as opposed to lower-cost equity index funds. Third, because the average share of assets invested in low-cost equity index funds declines with an increase in the number of options, average portfolio expenses increase and average portfolio performance is thus depressed. All of these findings are obtained from a panel data set, enabling us to control for heterogeneity in the investment preferences of workers across firms and across time.
In other words, the architecture - or layout of investment choices - in a given 401(k) plan actively affects how participants invest, with the result that adding too much of the wrong kind of choices - in the view of these papers, actively managed high cost funds - negatively affects performance, even though the plans do not preclude participants from investing in better choices that are available to them in the plan and which would reduce expenses to them and increase the return in their portfolios.
The first question that jumps out at me from all of this concerns why such higher cost funds are added to menu choices more often than are lower cost, less actively managed choices. Is it because, given the fee structure, the fund companies have a greater incentive to sell those funds, and to convince the administrators and sponsors of 401(k) plans to include those funds in their roster of choices? And the second question that pops up is, if adding such funds is known to decrease returns even if the administrators also include less expensive choices in the investment menu, then is it a breach of fiduciary duty to overload the menu selections with higher cost choices? In essence, if the design of the plan itself will subtly affect the returns in this way, then don’t sponsors, advisors and administrators -at least those who rise to the level of a fiduciary, functional or otherwise, for purposes of ERISA - commit a breach of fiduciary duty if they don’t push back against fund companies’ pitches to include a disproportionate number of costly investment choices and don’t prevent the architecture of their plans from becoming distorted in this manner?
These questions raise a multitude of issues, including how far plan fiduciaries should really have to go to protect plan participants from themselves. For instance, if the plan gives the participants the choice to invest in lower cost funds, isn’t that enough? Should the plan’s fiduciaries really be responsible for decisions by participants to allocate their investments into other, higher cost options? But at the same time, one can certainly argue that it is proper for the fiduciaries to bear the responsibility of making sure that menu selections will not lead to reduced performance because they include a disproportionate amount of high cost options, when: (1) it is a given that most participants will not be sophisticated enough to effectively allocate across both low cost and high cost choices in the most effective manner possible; (2) it is known that inclusion of too many high cost investment choices in a menu will drive down returns; and (3) it is the fiduciary who is in the best position to avoid overloading menus with higher cost products, and who has the ability to bring in advisors to prevent this type of overloading of the investment selection menu to the detriment of participants and their return on investments.
More Education is Always Better than Less: American Conference Institute's Upcoming Seminar on 401(k) Risks
I mentioned in yesterday’s post that my goal for the week was to move rapidly through several items that had caught my attention over the last week or so, and that I wanted to pass on to readers of this blog. I thought the next one I would mention is this conference in New York in December, sponsored by the American Conference Institute, on litigation and regulatory issues related to 401(k) plans. The subject matter of the conference ranges across the hottest topics in litigation and potential exposures for sponsors and fiduciaries of 401(k) plans, including stock drop litigation, excessive fee issues, and in a topic that hits both primary subjects of this blog, insurance coverage for fiduciary liability risks. Here’s the brochure for the conference.
401(k) Plans and Increasing Liability Risks for Fiduciaries
Permalink | Coming off the holiday weekend, I have a long list of items I want to pass on or talk about. I will try to put up as many as I can over the next few posts, to work through the backlog. I thought I would start with this one, because it ties two of the items together. Susan Mangiero of Pension Governance and the Pension Risk Matters blog, passed along this article on last week’s decision by Judge Tauro that I blogged about here, holding that cashed out participants in a 401(k) plan could sustain breach of fiduciary duty claims, a finding contrary to that of some courts - including at least one by another judge sitting in the same district as Judge Tauro - but supported by the holdings of some other courts.
What I liked about the article, aside from the fact that it adds some further discussion about the case and the issues it presents to that contained in my earlier blog post on the case, is the article’s comment that the case is likely part of “a trend that will result in most courts following suit.” An animating theme of my posts and thinking on ERISA litigation concerning defined contribution plans such as 401(k) plans is that we are in the process of watching the case law evolve to hand more protections to plan participants, with a corresponding growth in the potential liability exposure of plan fiduciaries. As the world shifts from a defined benefit world - read pensions - to 401(k) plans, the law of ERISA is going to shift with it to better protect investors in those latter types of plans. For the first thirty years or so of the development of ERISA jurisprudence, defined contribution plans were simply not that important and the unique concerns of those plans - such as what becomes of the rights of cashed out plan participants, the issue addressed by Judge Tauro last week - played a relatively peripheral role in the development of ERISA jurisprudence. That is all changing and changing quick. Moreover, we can expect that evolution in the law to proceed with real force for some time, given the expected exponential growth in assets held in 401(k) plans. On this last point, three economist authors have done the heavy lifting, and document this point in this paper, as summarized in the abstract of their article:
Over the past two and a half decades there has been a fundamental change in saving for retirement in the United States, with a rapid shift from employer-managed defined benefit pensions to defined contribution saving plans that are largely controlled by employees. To understand how this change will affect the well-being of future retirees, we project the future growth of assets in self-directed personal retirement plans. We project the 401(k) assets at age 65 for cohorts attaining age 65 between 2000 and 2040. We also project the total value of assets in 401(k) accounts in each year through 2040 and we project the value of 401(k) assets as a percent of GDP over this period. We conclude that cohorts that attain age 65 in future decades will have accumulated much greater retirement saving (in real dollars) than the retirement saving of current retirees.
Follow the money is always a safe bet. As the majority of Americans’ individual savings move into 401(k) plans, the law governing those plans is going to shift with it.
Another View on Whether a Cashed Out 401(k) Participant Has Standing to Sue for Losses Under ERISA
Permalink | Judge Tauro, of the United States District Court for the District of Massachusetts, has weighed in lately on some of the more cutting edge and currently unsettled issues in ERISA litigation, such as the impact of ERISA preemption on the powers of a state agency. This week, he ventured into the now hot topic of whether a plan participant who has cashed out of a 401(k) plan has standing to sue for breach of fiduciary duty, in this instance for imprudently investing in allegedly inflated company stock. In the decision, involving a putative class action against Boston Scientific, the judge surveyed case law from other jurisdictions on the issue and broke from the opinion of another judge of the circuit, who had found that such a participant, once cashed out, lacked standing to bring a claim for benefits. Judge Tauro reviewed case law from other circuits to the contrary, and elected to follow those rulings.
The cases relied upon by the judge are an instructive lot, and almost a road map for briefing this issue when arguing in favor of standing for such a cashed out participant:
More persuasive is the reasoning of the Seventh Circuit, which recently reached an opposite outcome and found that a plan participant did have standing, despite having cashed out of the plan. [The Seventh Circuit found that] "[b]enefits are benefits; in a defined-contribution plan they are the value of the retirement account when the employee retires, and a breach of fiduciary duty that diminishes that value gives rise to a claim for benefits measured by the difference between what the retirement account was worth when the employee retired and cashed it out and what it would have been worth then had it not been for the breach of fiduciary duty." The Third and Sixth Circuits have adopted this line of reasoning as well. Also instructive is the analysis by Judge Hall in the District of Connecticut: “[T]he court is puzzled by the . . . assertion that a claim for benefits lost due to imprudent fiduciary investment becomes a claim for damages once the plaintiff accepts a lump sum payment constituting the balance of her account with the relevant plan. . . . Regardless of whether [the participant] accepted or refused the balance of her account, her underlying claim would still be for the money lost by the Plan as a result of the defendants' imprudent investments. The court sees no logical reason why such a claim seeks an ascertainable benefit when the plaintiff refuses a lump sum, but the very same claim seeks an unascertainable damage award once the plaintiff accepts a lump sum.”
I Got Them Low Down No Good Pension Blues
Permalink | On the first Monday morning in August I expect things to lighten up with lots of people on vacation and the like, so I scheduled a breakfast meeting this morning right in the middle of one of Massachusetts’ most congested highways (well, not really in the middle of the highway, more like at a restaurant off an exit off of one of the most congested highways), on the theory traffic would be lighter than usual. It wasn’t. But I still think August should be a lighter month, so today’s blog posting is musical. Here is a link to the song “Pension Tension Blues,” courtesy of Pension Governance. What is “Pension Tension Blues”? Pension Governance describes it thusly:
Inspired by those who bring attention to serious issues through humor, Dr. Susan M. Mangiero, [Pension Governance] president and founder, and Mr. Steve Zelin, the Singing CPA have co-created a (hopefully) memorable ballad about the state of affairs in pension land. Mangiero adds "Pension Governance, LLC is committed to helping fiduciaries do a better job of identifying, measuring and managing financial risk. We hope the song is a friendly reminder of the hard work ahead."
Why You Can Never Generalize When Considering Whether Brokers Are Plan Fiduciaries
Permalink | A couple of loyal blog readers have commented that I have veered off a good bit on digressions this past couple weeks, and I can’t deny it - maybe it’s a lawyer’s version of a summer fling. Anyway, today I return to a central focus of this blog, ERISA and, in particular today, investment advisors and their potential liability as fiduciaries. This law firm newsletter, passed on by the Workplace Prof, has a nice discussion of the question of when a broker or other investment advisor to a defined contribution plan (and I suppose a defined benefit plan as well) crosses the line, by rendering professional services to the plan, into the dangerous realm of being deemed a fiduciary. The Prof highlights the following discussion from the newsletter:
[T]here are lawsuits and NASD arbitrations claiming that brokers have become ERISA fiduciaries. They are, in the main, based on allegations that the brokers gave investment advice. The cases are usually filed by the plan sponsor or its fiduciaries (e.g., the responsible officers, the committee or the trustee) to recover investment losses. Some of those cases are won by the plans and others are won by the brokers. The legal issue is whether the broker made investment recommendations that rose to the level of ERISA-defined “investment advice,” which is different than either the securities law definition or the conversational meaning of those words. Stated slightly differently, ERISA did not make every broker a fiduciary, nor did it turn every investment recommendation into fiduciary advice. Instead, ERISA and the DOL regulations crafted a specific and limited definition of fiduciary investment advice.
This is a nice summary of the point addressed in the newsletter, but as one of my law school professors liked to say whenever someone stopped after the first part of a holding, you need to read on. When you go the newsletter itself, you find that the summary really reflects simply the holding under a particular, and detailed, set of facts from one particular case. And that is exactly as it should be. The determination of whether a particular broker or other financial advisor to a plan became a fiduciary as a result of investment advice rendered to the plan is highly fact specific, and should turn on exactly what events occurred in any one particular case. As a result, one neither can nor should jump to any particular conclusion about the fiduciary status - and accompanying potential exposure - of any particular broker or advisor (or of brokers or advisors as a class) from the newsletter, the case discussed in the newsletter, or the Prof’s post. Instead, it is important to analyze the status of a particular broker on the basis of the exact role played by that particular broker or advisor with regard to a particular plan.
Me and LaRue, and Business Insurance Too
Permalink | There is an article in Business Insurance magazine this week, the June 25th issue, on the Supreme Court accepting review of the LaRue decision, in which I am quoted. The article is here - subscription required - and if you read it, you will note that it ends on my comment that I expect the Supreme Court to overturn the Fourth Circuit. A short article intended really just as a little news blurb on the subject for the benefit of the magazine’s business management oriented readership, the reporter did not have the space to go into why I think the Court will overturn the lower court decision, but I, obviously, have the space to do so here. So to the extent anyone is interested in the question, here’s my thinking.
First, I don’t really expect the Court to do much, if anything, with the question of the scope of equitable remedies issue. If anything, given the language of the statute, despite the fact that many people want the Court to expand individual remedies and available damages under ERISA - including, I have found in my litigation practice, many District Court judges who are displeased with the limitations of the statute but nonetheless consider themselves duty bound to enforce its restrictions on recovery - the Court has probably read the range of equitable relief that can be pursued in as broad and pro-plaintiff a manner as the language allows, with its test of whether the relief sought would be equitable or not way back in the days of the divided bench. There simply isn’t much more you can do with the statute’s restriction of recovery in certain circumstances to equitable relief unless you are simply going to ignore the actual language of the statute and rewrite it by judicial fiat, which this Court certainly isn’t going to do and arguably, the thinking of Ronald Dworkin and his heirs aside, no court should do.
In a way, this issue is a perfect parallel to a long running and common problem in the insurance coverage field, in which there was an oft litigated dispute over whether insurance policies, because they only cover claims for damages, cover lawsuits seeking equitable relief, the issue being that the policies only cover damages and equitable relief is something different than damages. In both insurance coverage and ERISA cases - such as LaRue - the simple fact of the matter is that equitable relief does mean something particular, something that is different than a claim for damages, and the question is what is the impact of that difference.
Second, with regard to the more fundamental question of whether the individual plan participant could recover just for losses to his account in the plan, yes, I do think the Court will overrule the Fourth Circuit and find that such an individual plan participant can bring such an action. I can never recall whether the saying is that the Court follows the election returns, or is that the Court doesn’t follow the election returns, so I looked it up, and in fact the saying is that they follow the returns, although every author who writes this then adds qualifiers to the comment, such as in this piece here. Either way, the kind of relief sought by the plaintiff in the LaRue case, to be able to enforce his investment instructions in his own retirement savings account, clearly fits with the current Zeitgeist and, more interestingly, is of a piece - and a natural fit with - the changes to retirement savings plans put into place by the Pension Protection Act. Beyond that, the statutory language that is at issue in this part of the case is completely open to either the interpretation selected by the Fourth Circuit, or that sought by the plaintiff, and thus the Court can realign this part of ERISA without doing any violence to the statutory language. Combine these things, and I get a reversal.
Common Misperceptions and The Obligations of Plan Sponsors
Permalink | I wrote, it seems to me, an awful lot over the last couple of weeks on the question of the fiduciary obligations of plan sponsors and others with regard to the investment selections made by pension funds and the investment choices offered in 401(k) plans. Susan Mangiero has a lot more to say about this in her series of posts - here, here, here and (most recently) here - on the due diligence obligations of fiduciaries when investing plan assets.
One particular issue that constantly comes up in this area is the belief of many employers and plan sponsors that they have satisfied any obligations they may have and have immunized themselves, for all intents and purposes, from liability for breach of fiduciary duty, by hiring an outside company to administer the plan and make investment decisions. Whenever I speak to people who offer investment and other assistance to plan fiduciaries, their need to disabuse fiduciaries, and particularly plan sponsors, of this belief is a constant topic of discussion. Quoting Rick Slavin, an attorney and former regulator, Susan nails down in three sentences why this is not the case:
In his overview of case precedent and enforcement actions, Slavin offered that sloppy, obtuse or incomplete paperwork is usually the beginning of trouble. He reiterated that the use of outside parties does not absolve plan sponsors of their fiduciary duties. Oversight obligations remain.
You know, the simple fact of the matter is that, in all the areas I have litigated cases in over the years, plan sponsors have the easiest ability to preemptively and pro-actively position themselves to defeat an action against them - due diligence, due diligence and more due diligence throughout the life of the pension fund or defined contribution plan will come as close to serving as a silver bullet to protect plan sponsors as exists anywhere in the world of litigation. But plan sponsors who forget that they still have to engage in due diligence in the form of oversight and instead elect to rely simply on the fact that they retained an outside manager effectively forfeit this safe harbor.
An Evolution in Fiduciary Standards Means an Increase in Litigation Risk
Permalink | My email inbox is often inundated with seminar pitches, book offers, and informational material, much of which, even if it looks valuable, I could never get to unless I decide to give up the practice of law and just read all this stuff full time. Fortunately, though, I can cut through the junk pretty quick and spot the diamond in it within minutes of sitting down at my desk in the morning (or, more often than not, while remotely surfing my inbox in the middle of the night).
And here is one such diamond, a really terrific paper on the rapidly evolving nature of the fiduciary standards affecting plan sponsors of defined contribution - most commonly 401(k) - plans and the steps they should be taking as a result. The paper, authored by Laurence Cranch and Daniel Notto of AllianceBernstein, is Evolving Fiduciary Standards for Defined Contribution Plan Sponsors - The Impact of New Thinking About Employee Participation and Investment Selection, and you can find it here.
In short, the authors argue, correctly I believe, that we are not only in an era of rapid change in the standards of care expected of fiduciaries, driven to a large extent by advances in knowledge in the area of retirement investing and the transition from pensions to defined contribution plans, but also in a time of vastly increased litigation threats to such fiduciaries. Perhaps the most interesting part of the paper concerns using the tools provided by the Pension Protection Act, in conjunction with the investment selection thinking that underlies the statute and its enabling regulations, to simultaneously demonstrate prudence on the part of the fiduciary and decrease the likelihood of litigation.
Just a terrific paper, and well worth the time to read it.
Divestment and Fiduciary Duties
Apparently there is something in the air these days about socially responsible investing and the fiduciary obligations of pension fiduciaries. I discussed here, just the other day, the argument that it is not a fiduciary breach to utilize a particular social agenda in investing and the litigation implications of that approach. Susan Mangiero has more to say on the same subject at her blog, Pension Risk Matters, here. I don't know about this one, frankly. I know, as I discussed in my last post on this issue, that the more defensible position, if sued as a fiduciary, is to have stayed out of socially responsible investment in preference for a focus on maximum return investing. But geez, who wants to be the one who says fiduciary obligations preclude avoiding, in the scenario Susan discusses, investments in so-called terrorist countries?
Criminals and terrorists in my last two posts. I don't know, maybe I better get off the ERISA beat and over to the digressions section of this blog, to write about intellectual property for a bit, a subject where, I don't think, I can find any reason to write about such things.
Criminal Restitution, Alienation of Retirement Benefits and the Supreme Court
Permalink | We return, as promised, to America today, to two particular, but certainly not unique, American obsessions, the Supreme Court and criminals. As discussed here and here, the Supreme Court has refused to hear an appeal presenting the question of whether pension and retirement benefits governed by ERISA can be attached in the criminal context. As I discussed in this post, in at least some instances courts are finding that retirement funds can be attached as part of the penalty for criminal conduct, including to pay criminal restitution.
It is interesting - although there is probably nothing more to read into it other than that the Court agreed with the Solicitor General’s office that there was no circuit split warranting review of the precise issue presented by the particular case at issue - that the Supreme Court passed on this one, as they have taken on a fair number of ERISA cases, most recently accepting the LaRue case, which I discussed here and here, and which presents questions as to whether or not a single plan participant can sue for breach of fiduciary duty. And just a short time ago the Court reached out to address questions related to mergers and terminations of pension plans, as discussed here.
But I guess the question of whether or not criminals lose any protection provided by ERISA to their retirement benefits as a result of conviction doesn’t rate as high as those other issues on the Court’s agenda. And perhaps it shouldn’t. That’s an issue for another day, and one I will not voyage into today. But it is important to remember, however, that, as I discussed in a National Law Journal article a few months ago concerning one circuit that does allow attachment of a felon’s retirement benefits, alienating retirement benefits doesn’t necessarily punish only the wrongdoer, but may well seriously impoverish possibly innocent spouses, who may have expected to rely on those funds in retirement, and adult children, who may end up with no choice but to subsidize the so-called golden years of that innocent spouse. Of course, it is also fair to say that victims who have suffered financial losses as a result of the criminal conduct may have an equal, or even superior, claim to the funds. Either way, what is clear is that there is plenty of collateral damage to go around in the situation presented by this type of case, enough that it would certainly be worthwhile to at least have an authoritative decision out of the Supreme Court as to whether those courts that do allow attachment of those funds to pay criminal restitution or other similar sums are correct about it or, for that matter, that those jurisdictions who don’t allow it are correct.
More on Amaranth and Fiduciaries' Due Diligence Obligations
Permalink | In a post on Friday, I discussed how a large pension fund’s large losses from a hedge fund investment had given rise to litigation between the pension and the hedge fund, as discussed in this post in the WSJ Law Blog, and how it further raised the question of whether the pension plan’s fiduciaries might be liable to plan participants for their failure to properly vet and monitor that investment prior to the large loss. In essence, the question raised by the loss is whether the pension plan simply blindly - or at least half-blindly - invested the plan’s assets in the hedge fund without really understanding why or what they were doing, and was instead simply seeking to goose the pension plan’s returns without sufficient analysis of the risks, in much the same way individual mutual fund investors are often said to simply follow the latest investing trend without really knowing much about it or whether it is right for them.
Interestingly, I am clearly not the only one concerned whether pension fund fiduciaries and others charged with the management of pension assets are sufficiently knowledgeable about hedge fund investing and the ins and outs of any particular hedge fund, as the good folks at Pension Governance have now rolled out a series of webinars intended to educate retirement plan decision makers about hedge fund investing. Information about the series, called the Hedge Fund toolbox, can be found here.
A Thought About Litigation Against Fiduciaries For Hedge Fund Losses
Permalink | We’ve talked a lot on this blog about the due diligence obligations of fiduciaries and other advisors to pensions, 401(k) plans and the like when it comes to investment choices. A story yesterday offers the opportunity for a little thought experiment demonstrating why it matters, and why anything less than stringent oversight and investigation of investment choices will put fiduciary advisors front and center as potential targets of lawsuits.
The WSJ Blog yesterday had this description of litigation by a public employee pension fund against a hedge fund in which it had invested that managed to lose literally billions of dollars, in spectacular and newsworthy fashion:
Amaranth, the hedge fund that lost $6.4 billion in a few days last fall in the worst debacle in the industry’s history, responded today to a lawsuit filed against it in March by the San Diego County Employees Retirement Association, or SDCERA. SDCERA is the only investor to have filed suit against the hedge fund. . . At the time it filed the lawsuit, SDCERA said Amaranth’s collapse resulted from “excessive and unbridled speculation in natural gas futures that was directly contrary to statements made to SDCERA that Amaranth would be diversified and risk controlled.”
Amaranth says SDCERA knew exactly what it was getting into. In its motion, it quotes the funds private-placement memorandum, which read in big bold letters: THE FUND IS A SPECULATIVE INVESTMENT THAT INVOLVES RISK, INCLUDING THE RISK OF LOSING ALL OR SUBSTANTIALLY ALL OF THE AMOUNT INVESTED.
[A lawyer for Amaranth] said in a statement that he hopes “SDCERA will now withdraw its suit and stop wasting the resources of its 33,000 county employees and pensioners on this misguided and ill-fated litigation.”
So here’s the thought experiment to play out, the line of dots to connect. We know we are currently watching the rise of a pension/401(k) investment plaintiffs bar, clearly modeled after the securities litigation class action bar, ready and waiting to sue pension advisors and anyone else in the line of fire for excessive fees, poor investment choices, and anything else that affects returns in the plans. We see here as well in this blog post from the WSJ Blog that Amaranth’s defense to litigation by a pension plan is that the plan and its advisors knew exactly what they were getting into and should take responsibility themselves for the risks they took. Now here is where we connect the dots - if the hedge fund’s lawyers are right, then aren’t the plan’s fiduciaries and other advisors potentially liable for breaching their own obligations to the plan and its participants to properly select and monitor plan investments? And if so, then their best defense should the newly forming class action bar come after them for this mess would be that, contrary to what the hedge fund’s lawyers say, they actually did full and complete due diligence, and therefore lived up to their obligations and cannot themselves be liable for the fact that the investment went south.
And at the risk of sounding like a scold, that, I suppose, is what I would like fiduciaries to take away from the story of the Amaranth collapse, that hedge fund issues can come back on them, and they need to take steps in advance to insulate themselves. Just something to muse over on an early summer weekend at the beach, right?
Excessive Fee Litigation, 401(k) Plans and LaRue
Permalink | The current issue of the National Law Journal has an article providing an excellent overview of litigation over allegedly excessive fees charged on investments in 401(k) plans. The article notes the variations in the theories, and discusses what are likely to be large, class wide actions in the near future. There are those who think these types of claims are going away but, as this article suggests, that doesn’t actually look to be the case.
Now connect the dots between that story and the LaRue case, which I discussed here and about which more can be learned here, in which the Supreme Court is being asked to determine whether a single participant in a 401(k) plan can bring a breach of fiduciary duty claim for breaches that harmed only his account. Right now, with regard to the excessive fee issue, we are seeing, as the National Law Journal article reflects, the development of essentially plan wide suits. But if developments in the LaRue case establish that any individual plan participant can sue for breaches of fiduciary duty affecting that participant’s account, that will change. We will instead have a universe of individual participants, all with the capacity to sue over their own account balance and over any complaints they have that excessive fees drove down the balance of their own accounts over the course of years, and I suspect we will see plenty of lawyers appear who are ready and willing to represent individual account holders in such lawsuits. This will create a different litigation world for fiduciaries, plan sponsors, plan administrators and the like, then the current one in which the real risk is large plan wide actions by specialist plaintiff firms. In its place will be more of a death by a thousand cuts type of litigation regime that will confront plan fiduciaries and their allies.
I am not saying this is necessarily a bad thing, or a good thing. It is what it is. But in at least one way it may well be a good thing. We are all bombarded with the mantra that, in this defined contribution plan world we now inhabit, individuals are now responsible for their own retirement, as opposed to when companies provided it by means of guaranteed pensions. Well, I suppose if we are going to make individual plan participants the risk bearers and care takers of their own retirement funding, the least we can do is provide them with the legal tools to protect their investments.
LaRue v. DeWolff, Losses to the Plan and the Supreme Court
Permalink | SCOTUSBLOG is the NY Times, or maybe - given its focus on one particular field - the Wall Street Journal, of the legal blog world. With the backing of a major international law firm, it brings tremendous resources to its in-depth coverage of all things goings on at the Supreme Court. Cripes, the blog even has its own reporter, to supplement the work of the actual bloggers.
And of course that’s also why I read it, because you know you are not going to miss anything of importance to your own practice area that happens at the Supreme Court. And here, of interest, is their post on the United States Solicitor General’s brief recommending that the Supreme Court hear an appeal from the Fourth Circuit’s decision in LaRue v. DeWolff, Boberg & Associates, which presents the question of whether an individual participant in a 401(k) plan can sue to recover losses from errors by fiduciaries that affected only his or her account in the plan, rather than the accounts of all or most participants in the plan. In dispute is the question of whether it qualifies, first, as a loss to the plan, such that the participant can sue for breach of fiduciary duty, and/or second as equitable relief as the Supreme Court has interpreted that phrase for purposes of ERISA, such that the participant can recover on a separate equitable relief theory.
One thing’s for sure. If the Supreme Court puts its imprimatur on this theory, and makes clear that individual plan participants can sue for their own individual losses in their defined contribution accounts, there will be a whole range of new potential plaintiffs out there, and I am sure plenty of lawyers ready and willing to represent them. At the same time, to be fair, in a world of Enrons and the like, maybe there should be.
The Workplace Prof reads SCOTUSBLOG too, and here’s the prof’s take on these events.
Documenting the Death of Pensions
Permalink | I have written before about the question of whether we are creating a more litigious environment by switching employees from defined benefit plans to defined contribution plans, and we all generally know that companies are overwhelmingly shifting employees from the former to the latter. Those of you in the retirement industry certainly already are aware of studies actually documenting that change and establishing that, in fact and not just anecdotally, pensions are going by the wayside and 401(k) plans are replacing them across the board. For the rest of us, Suzanne Wynn has this study, from Watson Wyatt, documenting that this change has, in fact, occurred over the past twenty years.
Pension Performance, 401(k) Plans and Breach of Fiduciary Duty Litigation
Permalink | This is an interesting paper, that comes to us via Workplace Prof, and which provokes further thought on the issue of the litigation boom involving 401(k) plans. The paper finds that pension plans outperform mutual funds, and attributes that differential to costs buried within mutual funds, as well as to the size of pension funds, which allows them to negotiate better deals on cost and related issues than would otherwise be the case. If you think about it, exactly that type of action is likewise what is expected of the fiduciaries of 401(k) plans, that they will assert themselves so as to avoid performance being affected by unreasonable fees or by other asset management decisions (such as overloading with company stock). One can think of lawsuits by participants against company 401(k) plans as being, at heart, driven by the failure of plans and their fiduciaries to live up to that high standard. Lawsuits involving excessive fees paid by 401(k) plans are in essence claims for failing to do what this article shows pension plans routinely doing: protecting participants against excessive costs impacting the plans’ returns.
Behavioral Economics and a Disincentive to Retire
Permalink | We have talked a fair amount on this blog about “choice architecture” and how the new structure of the retirement system, with its move from pensions to 401(k) plans, may be affecting behavior in unintended ways, such as by encouraging litigation. At his blog, the RiskProf has an excellent post on another negative behavioral change that the transition to defined contribution plans, such as 401(k)s, may be inadvertently creating: namely, a disincentive for older workers to retire, driven by the uncertainty in these types of retirement plans as to whether the worker actually can fund a decades long retirement. In the RiskProf’s personal case, involving the graying of university faculties, he presents the argument in his post that combining this dynamic with tenure is likely to lead to an aging university faculty population hanging on well past its prime. I suspect I made enough faculty members angry with my post on the increasing irrelevance of law review articles, so I won’t stick my two cents in on this issue and will instead let the RiskProf’s post speak for itself.
401(k) Plans and Breach of Fiduciary Duty Lawsuits
Permalink | I have written before, and frequently (such as here and here), about the coming boom in litigation against plan sponsors and fiduciaries over alleged excessive fees and other alleged malfeasance in the administration of 401(k) plans. One point I have tried to drive home in my posts, including here and here, is that the best defense to this litigation boomlet, possibly soon to be a boom, is a good offense, in the form of careful, regularly scheduled due diligence with regard to the funds offered in a plan and the fees charged for those funds.
This article, making the same points, by the lawyers at Littler Mendelson, crossed my inbox today. It provides a nice easy to digest overview of the issue, and recommends the same preemptive course of conduct, in the form of these recommendations for due diligence:
Sound advice in my book, and one I - and others - have been recommending for awhile.
What to Do? We believe that there are some actions that employers and plan fiduciaries can take to protect themselves:
•Continually monitor all plan and fund expenses and assure that they have negotiated the best deal for participants, but keeping in mind that fees are only one piece of the fiduciary puzzle; the others include risk, rate of return, and historical performance.
•Periodically review all aspects of the fund selection and monitoring, and document these efforts.
•Be sure that all plan expenses can be determined from documentation provided or made available to participants, and consider providing participants with a separate summary of those expenses.
•Review your service provider agreements, make sure you get legal counsel involved in negotiating those agreements. It is recommended that all 401(k) plan service provider agreements prohibit any undisclosed revenue sharing.
•Ask your plan service providers to provide you with a detailed written description of all plan fees – hard dollar and soft dollar.
•If you believe you may be vulnerable, consider having a legal audit performed on your 401(k) plan.
Behavioral Economics, the Pension Protection Act and 401(k) Litigation
Permalink | I have written before about my thesis that 401(k) litigation, and the tendency of individuals to pursue such suits, may be driven in part by the psychology of retirement benefits and the uncertainty for employees as to whether they will be able to fund their retirement that these types of retirement savings vehicles create, particularly as opposed to pensions, which, on anecdotal evidence, seem to generate far less litigation than 401(k) plans. Along these lines, this article out of today’s New York Times about behavioral economics and the impact of consumer choice on 401(k) contributions caught my eye. The article compares retirement savings to research into the strange behavioral distortions that appear to underlie overeating, and discusses how the Pension Protection Act is written in a manner intended to remove certain behavioral distortions from the decision to make 401(k) contributions. Is there a linkage between the security of retirement and the tendency to sue over retirement benefits, and if so, can restructuring the benefit programs, such as in the manner pursued by the Pension Protection Act, reduce the extent of litigation over such benefits?
I certainly don’t pretend to know the answer, and I suspect academic research doesn’t provide an answer to this question at this point either. But the article sums up the research into consumer behavior as follows: “[w]hether it’s 401(k)’s or food, the way choices are presented to people — what the economist Richard Thaler calls ‘choice architecture’ — has a huge effect on the decisions they make.” If we are presenting 401(k)s to employees in a way that makes for retirement uncertainty and for doubt (or at least fears, founded or unfounded) as to the abilities and fidelity of those managing them, the question becomes whether we are creating a “choice architecture” that points people towards litigation, rather than away from it. If, on the other hand, we can create an environment of greater trust in the operation of those types of retirement vehicles, perhaps employees will tend away from trying to resolve concerns over retirement funding through the blunt instrument of litigation.
Defined Benefit, Defined Contribution, and The Psychological Effect on Litigants
Permalink | Here is a very neat and interesting paper contrasting defined benefit plans - i.e. pensions - with defined contribution plans - i.e. 401(k) plans - and addressing, in particular: (1) the decline in the former in the workplace and replacement by the latter; and (2) the problems engendered by that change. In essence, the authors argue that the defined contribution plans, as they currently are regulated and operated, simply are not satisfactory replacements for the vanishing pension system, and cannot be counted on to provide an appropriate stream of retirement income for most retired workers. The authors provide suggested changes for both types of plans that, they hope, will make pensions more palatable to employers and 401(k) plans more beneficial to employees.
I have spent a couple days musing on the paper, which was first brought to my attention in this post last week on Workplace Prof, and have a few thoughts to offer, mostly about how the facts and arguments in this paper fit in with the litigation climate involving, in particular, 401(k) plans. What jumps out at me is the central theme of the paper, that pensions are overly regulated and employee contribution plans like 401(k) plans insufficiently regulated, with the result that the latter plans are unlikely to meet the needs of the prototypical employee. And this leads to two thoughts about excessive fee, breach of fiduciary duty and other types of lawsuits against companies sponsoring 401(k) plans and the advisors they retain. First, are the suits driven, at core, by the defined contribution plans' absence of overarching regulation and government protection, placing the onus for policing them on employees and their lawyers, who can be seen to have been forced into serving almost in a “private attorney general” role with regard to such plans? And would this be the case if, like pensions, they were more heavily regulated and backstopped by the government, much like pensions are by the Pension Benefit Guaranty Corporation? And second, echoing a theme I have commented on in the past, to what extent is the litigation driven by the exact problem emphasized in the article, namely that workers cannot confidently assume an appropriate retirement income by relying on 401(k) plans and therefore may rightfully be afraid for their long term economic security? If they didn’t have that fear, and instead were confident in their retirement income, much as - sometimes wrongly - they generally are in pensions, would they be so quick to authorize lawyers to sue in their names?
Introducing Pension Governance LLC
Permalink | I have talked before about my tendency to veer from my appointed rounds when something more interesting appears on the horizon than that which I had planned to work or post on, and today is another one of those days. I came in full of grand hopes to discuss insurance coverage for intellectual property risks and discovery issues in insurance bad faith cases, using two upcoming seminars on those topics as a foundation from which to riff. Those can wait for another day, and I will return to them, either over the weekend or next week, but something more interesting appeared on the horizon this morning that I wanted to post on, and that is likely to be of interest to those of you who read this blog out of a professional interest in ERISA and how it applies to 401(k) plans and pensions, namely, the launching of Pension Governance LLC, a subscriber website providing independent advice and information for pension investment fiduciaries. Among other features, the website, http://www.pensiongovernance.com/home.php, provides analysis, research and commentary on issues affecting defined contribution and defined benefit plans; interviews with industry leaders; annotated online articles from a variety of news sources; access to research team members; original content from expert practitioners; and educational webinars.
Readers of this blog who have been curious enough to peruse either the “About Stephen Rosenberg” part of this blog or the what’s new section of my firm’s website already know that I am a member of the website’s editorial board; I have already submitted one article for the site, and am looking forward to contributing still more to it.
While I am excited about the launch of the website, that’s not the only reason I write about it today. The more urgent reason for writing about it today, and to introduce Pension Governance to you right on the heels of its launch, is that the site is currently offering a free two week trial subscription, and I think the information that it makes available will be of interest to many who read this blog.
Novak and the National Law Journal
Permalink | I guess this is me and the media week here at the blog. There is an excellent story in the National Law Journal this week on the Novak decision out of the Ninth Circuit, which I talked about here, in which the court allowed attachment of ERISA governed retirement benefits as part of criminal restitution. I am interviewed in the article, which, unfortunately, is only available online to subscribers, so I cannot provide a link here to the actual article, and my fear of the copyright laws dissuades me from uploading the whole article here for you to read.
I think, though, that the fair use exception to the copyright act allows me to quote myself from the article, in which I mention that the ruling in Novak is kind of draconian, and in particular that “it almost goes to the level of 19th century debtor’s prison issues: do we bankrupt the spouse of a white collar criminal?” Beyond that, I am quoted in the article on the decision’s ramifications for future cases, and I note that there are issues raised in the court’s decision that will need to be resolved in future cases. I also point out, as do others quoted in the article, that it is important, going forward, to try to separate out pension benefits from the restitution amounts when negotiating resolution of criminal charges.
Insurance Coverage for Pension Plan Fiduciaries
Permalink | There is an interesting interrelationship between the two primary subjects of this blog, ERISA litigation and insurance coverage, and one that I had not really thought much about until Rick Shoff, who works with Mike Pratico over at CapTrust Financial Advisors, raised it in a conversation recently. As I have mentioned in the past, Mike and his colleagues at CapTrust serve as fiduciary advisors to retirement plans and their sponsors, and he and Rick commented to me about the issue of errors and omissions insurance and the necessary amount of coverage for fiduciary advisors.
Two points came out of our conversation that I thought I would pass along. First, what is the appropriate amount of coverage for a fiduciary advisor under its E&O insurance? What should the relationship be between the limits selected and the amount of assets in the plans that the advisor works with? Obviously, the limits can’t match the asset amounts, as any good advisor is likely advising on plans with assets far higher than the amount the advisor could purchase in E&O insurance, at least not without paying every penny the advisor earns over to the insurance company as premiums (and even then, I doubt limits that high could be obtained). It also would not be necessary, since an advisor’s potential exposure to a lawsuit undoubtedly would never equal the total amount of the assets in a particular plan, but instead would equal only some portion of it that was supposedly affected by an error by the advisor. My own take is that the proper policy limit is somewhere around the amount that would make a plaintiff in a hypothetical claim consider settlement within the policy limits, without trying to obtain an excess verdict that the advisor itself would have to pay.
The second issue that popped up is the range of actors out there who are involved in providing advice to retirement plans, participants and the like. It may well be that not all such companies and consultants, even if they have professional liability or general liability insurance coverage, are actually covered for claims arising out of their role in providing such advice. Many policies, unless they are specifically underwritten to cover a professional engaged in ERISA related activities, contain exclusions for ERISA related claims that would preclude coverage of claims involving ERISA governed plans. As a result, a plan sponsor cannot assume that all advisors to a plan actually have coverage for claims arising out of their activities, and the sponsor must instead actually examine their advisors’ insurance coverage to know whether or not this is the case.
Congressional Hearings on 401(k) Plan Fees and What They Mean for Plan Fiduciaries
Permalink | Wow. Don’t think the heat is on for company 401(k) sponsors and other fiduciaries of employee retirement benefit plans who may not have done enough benchmarking and due diligence to make sure that mutual fund and advisor fees are as low as possible? Then take a look at this article out of the Washington Post about congressional hearings into the issue. The gist of the testimony is to the effect that fees are too high, are not disclosed fully or understood by plan participants, and have a significant impact on returns in the plans. While the mutual fund industry disputes this characterization, anecdotal evidence certainly suggests that at least some significant portion of company sponsored plans suffer from these problems. It would certainly be nice if the sponsors of plans investigated right away whether or not their plans suffer from these defects and, if so, promptly remedied the problems. But for reasons I have discussed before in other posts, doing so would not only be good business and the right thing to do for company employees who participate in such plans, but is also necessary to protect the plan’s fiduciaries from legal exposure. It clearly appears at this point that conducting due diligence to root out these problems and then remedy them - or even better, to find out that the particular plan in question does not suffer from these problems and that there is nothing to remedy - is an essential element of satisfying a fiduciary’s obligations in the operation of these plans, and that the failure to do so is an open invitation for a breach of fiduciary duty lawsuit.
What Happens When Reimbursement of Overpaid Benefits Is Equitable for Purposes of ERISA, but Nonetheless Inequitable?
Permalink | Here is an interesting little twist on the common scenario of a plan overpaying retirement benefits and then seeking reimbursement, as allowed under the plan’s terms, of the overpayment from the plan beneficiary. Normally, these cases are focused on whether the reimbursement qualifies as equitable relief that the fiduciary is allowed to pursue. In this case out of the District Court for the District of New Hampshire, however, the court simply assumed the plan fiduciary could legally obtain that recovery as equitable relief under ERISA, even though the judge commented in the opinion that “the scope of this court’s equitable authority in an ERISA context is not well-defined.”
However, the court then went on to let the beneficiary off the hook (or at least to find a question of fact that precluded an award of summary judgment to the plan), on the theory that the beneficiary could have reasonably believed that he was entitled to receive the overpayments, even though they amounted to many thousands of dollars a month for a number of months beyond the one time lump sum he had elected to receive as his pension benefit, and had changed his position, by spending those funds, in reliance on that belief. The court found that ordering reimbursement from the beneficiary, under those circumstances, could be inequitable, and that the plan could not recoup the overpayments if that were the case.
Of interest, there was one factual quirk that made the case somewhat different than the usual recoupment case where the overpaid beneficiary argues that he or she already spent the money and it would be inequitable to order repayment as a result. There was actually evidence showing that the beneficiary, prior to the time of the request for reimbursement, had performed rough calculations that showed him entitled to a sum significantly larger than he was actually entitled to receive. Although the math was grossly incorrect, the court found that even if his “calculations are inaccurate, the mere fact that he prepared the estimate suggests that he may have reasonably believed that he was entitled to the erroneous payments.” Most of the published decisions where beneficiaries claim they didn’t know they were receiving large payments in error and thus should not have to repay them involve fact patterns where that assertion is simply hard to believe; the court here, rightly or wrongly, was clearly swayed by evidence that placed this case outside of that mainstream.
The case is Laborer’s District Council Pension Fund for Baltimore v. Regan.
Restitution, Anti-Alienation and ERISA
Permalink | Although I am diligent about covering in this blog ERISA decisions coming out of the courts in the First Circuit, I also keep an eye on ERISA decisions elsewhere in the country and discuss them when there is something particularly interesting about them that catches my eye. The Ninth Circuit has just done exactly that, luring me into the realm of the intersection of criminal law and ERISA by its en banc decision in USA v. Novak, and giving me an opportunity to use this blog to make my pitch to any readers in Hollywood for my proposal for a new and thrilling television show, CSI:ERISA. Can’t you just see it? Ripped from the headlines, a husband and wife resell stolen telephone equipment, fail to report the millions of dollars they earn from that to the government on their tax returns, and are caught (these are the real underlying facts of Novak, and that gave rise to the ERISA issue before the court); in tonight’s exciting episode, what happens to their retirement benefits after the conviction? Well, I don’t know, maybe that’s going a bit far, but the Novak decision is pretty interesting, on a few levels.
In Novak, the Ninth Circuit addressed the impact of ERISA’s anti-alienation provision on a federal criminal restitution order that attempted to attach the garnishee’s retirement benefits. Recognizing that ERISA itself contains an anti-alienation provision that would appear to bar such attachment, the Ninth Circuit held that the federal Mandatory Victims Restitution Act of 1996 (“MVRA”) overrode the prohibition and allowed attachment of the retirement benefits for purposes of satisfying criminal restitution orders. There is much that could be said about this opinion, but I’ll limit myself today to a few points.
First, as the court recognized, the two statutes themselves - ERISA and the MVRA - do not expressly resolve the issue of whether, despite the anti-alienation provision in ERISA, retirement benefits can be attached to pay restitution. The court presents a very persuasive and well reasoned exercise in statutory construction to reconcile the two statutes and conclude that the MVRA controls the issue and allows such attachment. To a certain extent, the court provides really a mini-tutorial on the rules underlying statutory interpretation, and the opinion is useful reading for anyone who ever has to argue a case involving construction of a previously unaddressed statutory provision. At the same time, though, the analysis reflects a real problem with trying to reach a final decision over rights and obligations by means of statutory construction, in that there is no real definitive basis in the legislative history or statutory language relied upon by the court that mandates reaching the particular conclusion accepted by the court, and instead one can argue that the opposite result could just as credibly be reached in the case.
Second, and building off of the point that the statutory language itself is not determinative of the proper result here, the court’s analysis and approach rings true, even if the result might be arguable. Conceptually and intellectually, the court’s opinion reminded me of nothing so much as Ronald Dworkin’s mythical Judge Hercules, who, when presented with a particular statute whose meaning is open to debate, sees himself as the next of a series of authors - a series that began with the legislature - and who tries to interpret the statute by adding the necessary additional layers of meaning to it that are needed to effectuate its purposes. The Ninth Circuit’s analysis reads exactly like that, with the court taking a complicated statutory text - two of them, actually, ERISA and the MVRA - and adding more meaning to the statutory text to allow it to deal with this particular fact pattern, one not addressed by the congressional drafters of the statutes.
And third, on a more prosaic basis, it is interesting how the court resolved the question of exactly what could be attached - all the assets of the retirement plan itself that are attributable to the garnishee, or only the payments due to the garnishee as they come due. The court resolved this in a quite sensible manner, concluding that what can be garnished are only those assets the garnishee himself has a current right to receive.
Fiduciary Advisors, Due Diligence, and Avoiding Fiduciary Liability
Michael Pratico, a fiduciary advisor to retirement plans throughout New England for Captrust Financial Advisors, and one of my favorite touchstones for real world - i.e. non-lawyer - information about the actual operation of retirement benefit plans, pointed out an interesting conundrum to me the other day concerning the operations of retirement plans and the fiduciary obligations of those who operate them. As I have discussed in other posts, the fiduciary obligations of those who sponsor or administer such plans clearly require, at this point in time and in light of current developments in the law, a certain level of due diligence, requiring at a minimum a regular comparison of fees and other aspects of a 401(k) or other retirement plan to the broader market as a whole.
Michael points out an interesting side effect of this, however, which is that once a plan sponsor or other fiduciary undertakes such due diligence, the plan becomes obliged, for all intents and purposes, to act on any bad news uncovered by the due diligence. What this means is that, yes, the plan sponsor is obligated to do the due diligence, and it seems to me is a sitting duck for a stock drop or excessive fees type suit if it fails to do so based simply on that failure. But that is certainly not the end of it. Instead, it means as well that once the sponsor has done that, if the due diligence shows a disjunct between better results or costs in the market as a whole and what the particular plan is earning or paying in expenses, the plan sponsor or other fiduciary becomes obligated to act on that information and change the plan to address those problems, with the failure to take that step likewise then becoming a legitimate basis for a breach of fiduciary duty lawsuit.
This is what Michael and other fiduciary advisors of his ilk do, take the existing plan, see where it is off base relative to the mutual fund world as a whole, and then recommend how to fix it. Taking both steps, and not either playing ostrich and skipping the due diligence entirely or else doing the due diligence but skipping the action it points out is needed, is really the best way to avoid incurring liability from excessive fee and similar types of claims.
The Effect of the Savings Rate on 401(k) Fee and Other Retirement Benefit Litigation
Permalink | Now here’s a curious little article from the New York Times on the question of whether mutual fund companies, including in their retirement calculators, deliberately overestimate the amount that people must save and invest to be able to afford to retire. The article notes that a number of respected economists find this to be the case, and the article notes that the mutual fund companies themselves obviously have much to gain if employees believe they must increase their retirement savings. As the article bluntly puts it, “financial firms have a pointed interest in persuading people to save much more than they need because the companies earn fees on managing that money.” Specifically - although without analyzing the data behind these conclusions, one can’t be sure whether these numbers fall into the old saw that the three types of lies are lies, damn lies and statistics - one of the economists claims that “Fidelity’s online calculators typically set the target of assets needed to cover spending in retirement 36.4 percent too high. Vanguard’s was 53.1 percent too high. A calculator offered by TIAA-CREF, one of the largest managers of retirement savings, was 78 [percent] higher.”
The article engenders a couple of thoughts. For one, would 401(k) fee and other breach of fiduciary litigation related to retirement savings be quite as wide spread if the working/retirement saving public believed they were saving enough already for retirement, rather than having been taught that they are behind the eight ball in accumulating enough money for retirement? This raises something of a behavioral question, or maybe a chicken and the egg question. Would people care enough to sue over these types of issues if they thought they were safely prepared for retirement, and to what extent does the fear that they are not drive decisions regarding litigation? Or are these suits really driven by the imagination of plaintiffs’ lawyers, and thus it really wouldn’t make any difference at all what the actual world view is of employees as a whole with regard to whether they are on track for a secure retirement or should instead be very, very afraid of what the future will bring?
And finally, would it be a breach of fiduciary duty if plan administrators overstated the amount that employees should save for retirement when they educate employees? And if it was, what would the damages be, particularly if the oversavings produced significant investment gains for the plan participant?
Excessive Fees, ERISA and 401(k) Plans
Here is an excellent article, by way of workplace prof, on the fees charged in 401(k) plans, their impact on performance, and the difficulty of even learning about them. We have talked before about how challenges to excessive fees charged to 401(k) plans is the new growth stock in ERISA litigation, and many people are always skeptical, often with good reason, when the plaintiffs’ bar moves into a new area and starts pressing a particular theory of liability against numerous companies and in many different jurisdictions. Yet articles like this one make clear that the underlying issue, of whether fees are appropriate and how they are arrived at, is a legitimate one with serious implications for the financial well being of the average investor, and for the retirement they can expect to afford. And at the same time, to the extent that excessive fees are a problem or the growth in this type of litigation is worrisome, it is clear that proper management by fiduciaries can eliminate both the problem of excessive fees and the potential liability of fiduciaries for allowing excessive fees.
More on 401(k) Fees and ERISA
Permalink | For those of you readers who are interested in the issue of fiduciary liability for excessive 401(k) fees - and who isn't? - here is more on the subject. I posted before about ways to avoid exposure to these types of claims, and Susan Mangiero has more on that topic here. Meanwhile, Workplace Prof has this to say on the upcoming wave of litigation over this issue, and about Congress weighing in on this issue now as well.
401(k) Plan Fees and Breaches of Fiduciary Duty
Some of you hopefully saw my recommendation the other day concerning this morning's webinar on 401(k) plan fees and the attendant obligations of fiduciaries. The webinar discussed in detail the obligations of plan sponsors and other fiduciaries with regard to 401(k) plans and their accompanying fees. On the key issue of how to avoid incurring liability for breach of fiduciary duty as a result of the fees incurred by 401(k) plans and their impact on plan performance, the speakers emphasized a commitment to due diligence. In particular, the speakers favor a systemic and periodic review of the entire issue of the fees affecting the plan, and proper investigation and selection of funds and advisors with the issue of fees firmly in mind. In other words, don’t put the plan together without thinking about the issues of fees and ensuring that the applicable fees are consistent with industry benchmarks, and even after you do that, don’t just forget about the issue, but instead return to the topic regularly and make sure fees and performance remain appropriate. There is no magic wand to protect against liability exposures of this nature, but a documented consistent course of conduct that makes certain that fees remain consistent with relevant benchmarks will go far towards insulating fiduciaries from liability on the basis of excessive plan fees.
In some ways, the entire issue reminds me of a story a well-seasoned money manager told me about his firm’s selection many years ago to manage a portion of the funds of a municipal pension plan. The plan selected multiple advisors, each charged with a different portion of the assets, and each was assigned an appropriate benchmark against which its performance would be measured. Each was also told that after a set period of time, the plan would review all of the managers’ performances as against the applicable benchmarks, and the trailing performers would be replaced, and the others would continue to manage their portions, at least until the next scheduled review, at which point the trailers at that point would be replaced.
Isn’t this exactly what we mean by diligent, reasonable conduct by fiduciaries - a consistent, regular effort to ensure that fund assets are being managed to the advantage of participants, based on a comparison to appropriate benchmarks?
Investment Management Fees, and Contract Geeks
Two things to chew on over the holiday, other than the turducken (I have always wanted to use that word in a sentence), one to know about before it occurs, the other to note before it disappears. I guess I could take that dichotomy a little further, and note that one concerns the first half of the blog’s title, and the other, the other half.
The first: Susan Mangiero, who writes the excellent blog Pension Risk Matters, is hosting a webinar on November 28 covering issues related to investment fees, the management of 401(k) plans, and fiduciary obligations. The webinar, covering “401(k) plan fees - what they are, how they can affect reported performance and the fiduciary practices that address investment management fees” is driven by the fact that:
In the aftermath of the Pension Protection Act of 2006, 401(k) plan sponsors are required to carefully select "fiduciary advisors", identify appropriate default investment choices for participants and comply with more rigorous federal reporting procedures. All of this could spell trouble for retirement plan fiduciaries who fail to realize that regulation, public awareness and employee angst put them in the spotlight as never before. This is especially apropos with respect to plan fees.
You can find more information on the webinar here.
The second: Insurance coverage lawyers, almost by definition, have to be contracts geeks. At the end of the day, what they are really doing is fighting over the language in contracts, a particular type of contract certainly, but contracts nonetheless. And here, before it vanishes from the internet, is the story of how much money there is in not being a contracts geek.
401(k) Plans and Pensions: Are They Enough?
I wanted to pass along today a fascinating law review article by one of the better ERISA scholars, Susan Stabile, on the retirement benefit system. In the article, "Is It Time to Admit the Failure of an Employer-Based Pension System," to be published in the Lewis & Clark Law Review, Professor Stabile raises the question of whether, given recent developments concerning pensions and 401(k) plans, it is time to give up on the current system for funding employee retirement and instead create a new paradigm for it. She starts from the premise that incremental changes to the system are not sufficient to achieve retirement security, which is interesting to me because, at a minimum, it is fair to say that the stock drop and other ERISA and pension benefit litigation chronicled on this blog, and the judicial responses to them, really are exactly that - incremental changes to how 401(k) plans and pension benefits are governed and provided. She proposes that a much more radical response to the problem of providing Americans with retirement security is needed, such as the provision of a government pension for everyone or mandatory employer pensions with more stringent regulation than currently exists.
These are obviously radical departures from what currently exists, and from the ERISA governed system I discuss regularly in this blog, which is why the article is particularly interesting. But as a side benefit to those of you who are interested in the ERISA issues regularly chronicled here, Professor Stabile provides a nice presentation of the impact of ERISA's fiduciary duty and other obligations on the problem addressed in her article.
401(k) Plans and ERISA Class Actions
Jerry Kalish has a terrific post, drawing on a law firm white paper, about the potential ERISA liabilities of financial advisors and others who manage or otherwise help to run company 401(k) plans. As he discusses, class action lawsuits are being filed alleging ERISA violations in the operation of such plans; the suits stem from the decisions made by plan advisors and others concerning plan investments and the effect of those decisions on plan expenses.
Substantively, these types of suits raise interesting questions as to exactly how much discretion in making investment decisions should be extended to administrators, sponsors and advisors of such plans before second guessing becomes appropriate. On a broader note, these suits also point out the extent to which the simultaneously high and somewhat amorphous standards that govern the actions of fiduciaries under ERISA make the responsibilities and potential liabilities of 401(k) administrators, sponsors and advisors a fertile field for imaginative plaintiffs' lawyers.
And finally, given the number of different advisors and other players involved in the operations of these types of retirement vehicles, there are bound to be plenty of fiduciaries - as that term is understood in the context of ERISA - involved in almost any 401(k) plan, making for plenty of targets for such suits.
ERISA and Retirement Benefits
I guess one could say that I have taken issue with some recent legal scholarship concerning the standard of review that should apply to judicial review of benefit denials, such as in this post and in this one. Perhaps part of that is that at the end of the day, I think standard of review is a litigation issue, and one that is best understood in the context of the day to day progression of benefit litigation; I am not sure it is well considered outside of that context and from outside of the courtroom.
But that is not to say that there aren't many, many ERISA issues that are far more complicated than that one, and which could certainly benefit from a deeper and more thorough analysis than that which the litigation prism can provide. The Spring issue of the John Marshall Law Review is a benefits symposium, with a series of papers on exactly those issues that are on the front burner and can use a thorough review, such as, in particular, pension and stock issues in the aftermath of the stock manipulation scandals (which I have talked about here, for instance), and the shaky status of retiree medical benefits (talked about here and again here).
I know I will be reading the whole thing, and I will likely toss out on this blog highlights and comments about the articles over the next few months, so once again, if you have better uses of your time than reading law review articles, you can just skip reading this law review issue as well and just check back here later.
Freddie Mac's Stock Drops, then Settles
The mortgage giant Freddie Mac has now agreed to a settlement of claims against it stemming from the effect of questionable accounting on the stock holdings of employees enrolled in its 401(k) plan. As Stephen Taub nicely sums it up:
Freddie Mac agreed to pay $4.65 million to settle a class-action lawsuit brought under the Employee Retirement Income Security Act. The charges stemmed from the company's restatement for the years 2000 through 2002.
The mortgage giant had been accused of fraudulently overstating its earnings, thus inflating the value of its shares, according to published reports. Part of the affected stock was held in employee retirement plans.
The lawsuit was "brought on behalf of past and present employees who held Freddie stock through their 401(k) retirement plans when the company disclosed billions of dollars of accounting errors and its share price sank." The Freddie Mac action is of a type with other lawsuits claiming that ERISA was violated under these circumstances "because the people running the [401(k)] savings plan failed to give complete and accurate information to participants in the program and failed to manage the fund properly."
Of particular note may be the applicable numbers, as the settlement calls for only a $4.65 million payment, which doesn't seem like that high a number, given that "[a]t the end of 2002, $76.5 million of the retirement plan's holdings -- 19 percent of the total -- was invested in" Freddie Mac stock, according to the plaintiffs. This may be more evidence for the idea, addressed here, that this theory of liability is increasingly no longer the road to riches for plan participants and their lawyers.
Nice informative story out of the National Law Journal on the so-called stock-drop suits, which allege breaches of fiduciary duty under ERISA by trustees charged with managing company 401(k) plans. The lawsuits in question were "filed on behalf of employees who lost money in their 401(k) and other retirement plans because of the declining price of their employer's stock." In those cases, the "[p]laintiffs allege that companies and trustees they hire to manage their retirement plans had a fiduciary duty to shift employee investments out of their stock after learning of an impending decline in the share price." The law may be turning against such theories. As the article summarizes:
The so-called "stock-drop" suits, which were filed under the Employee Retirement Income Security Act of 1974, or ERISA, were brought alongside hundreds of shareholder class actions following the demise of Enron Corp.
In the past year, several rulings -- coupled with an action by the U.S. Department of Labor -- have put limits on the liability of directed trustees, who are hired by an employer to manage employee retirement plans.
The article does allow, however, that plaintiffs' lawyers will respond by shifting their targets, and possibly their theories, rather than abandon this line of litigation.
401(k)s and ERISA
A terrific paper on the application of ERISA and its fiduciary duty standards to 401(k) plans and to the people who run them is available free right now from the ABA. As employee benefit plans, these retirement plans are within ERISA's ambit and the companies and individuals who operate them are subject to the fiduciary obligations imposed by ERISA. The paper provides a nice overview of the application of ERISA to these types of employee benefit plans. The fiduciary duties and the manners in which they can be breached that are detailed in the paper carry over to the operations of other employee benefit plans as well, and do not apply only to the operators of 401(k) plans. As a result, it is worthwhile reading for fiduciaries of other types of benefit plans as well.
A nod of thanks to BenefitsBlog for noting the availability of this paper. BenefitsBlog discusses tax and other issues related to benefits that are beyond the ambit of this blog, which focuses more on litigation under ERISA.