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.