Introduction

Buoyed by their recent success in fee litigation cases against plan fiduciaries,[1] plaintiffs' counsel are bringing more lawsuits seeking to impose heightened fiduciary standards for 401(k) plans. In an unprecedented surge, plaintiffs filed at least a dozen fee litigation lawsuits between December 2015 and February 2016. These suits include challenges against: (i) 401(k) plans that offer Vanguard and Stable Value Funds (SVFs), which are typically regarded as low cost, conservative funds;[2] (ii) non-traditional investments offered in 401(k) plans, such as through target date funds, that did not perform well in hindsight; (iii) insurers offering what they believe are ERISA-exempt guaranteed benefit contracts;[3] and (iv) investments in target date funds.[4]

The U.S. Department of Labor's new fiduciary rule, could conceivably lead to even more fee litigations.[5] By expanding the scope of individuals and entities subject to ERISA's fiduciary requirements, the rule could likewise expand the potential targets for such lawsuits.

While these developments cause concern, they also can identify areas of potential exposure, and provide insights on best practices to mitigate the risk of what appear to be ever heightening fiduciary standards.

Overview of Fee Litigation Cases

As 401(k) plans supplemented the traditional defined benefit (pension) plan as the primary vehicle for funding employee retirement, beginning in 2006 plaintiffs' counsel commenced a wave of ERISA fiduciary lawsuits challenging the fees and expenses associated with 401(k) plans.[6] Initially, these fee litigation lawsuits challenged “revenue sharing" arrangements with plan service providers and claimed that the selection of various types of investment options, such as retail mutual funds and actively managed funds, charged plan participants excessive fees.[7]

Defendants prevailed in many of those cases;[8] however, several recent rulings resulted in substantial settlements and judgments. For example, three notable and long running fee litigation cases settled in 2015 for over $220 million, including the payment of over $80 million in attorney's fees.[9] Plaintiffs achieved these results despite losing on many of their claims. But fee litigation operates like hydraulic pressure, probing for any weak parts in plan management, even when the plan is overall well-managed. These recent developments have emboldened plaintiffs to push the envelope in fee litigation cases, including bringing claims against 401(k) plans that offer very low cost funds and against investment vehicles and providers previously considered exempt from ERISA, like insurers offering investment policies with guaranteed rates of return.

New Complaints Seeking to Impose Heighted Fiduciary Standards

In a significant new development, this past year plaintiffs' counsel have begun bringing claims against 401(k) plans that offer as investment options Vanguard and Stable Value Funds. These claims are surprising, since plaintiffs' counsel have previously argued that fiduciaries should use Vanguard funds in 401(k) plans because they often have relatively lower index-based fees as compared to other investment options.[10] Similarly, plaintiffs and courts alike have noted that SVFs offer stability over money market funds, based on their holdings of longer-duration instruments, and that through various "wrap contracts" with banks or insurance companies they "guarantee the fund's principal and shield it from interest-rate volatility."[11]

Vanguard Claims

Plaintiffs have brought two fee litigation cases against Anthem and Chevron based, in part, on their inclusion of Vanguard funds that plaintiffs claim charged excessive fees in relation to other share classes that were allegedly available.

  • In Bell v. Anthem Inc., plaintiffs alleged that Anthem's 401(k) plan, with assets worth over $5 billion,[12] failed to use its considerable bargaining power to demand lower cost investment options.[13] This type of claim is not new in fee litigation cases but what is new is that at least ten of the allegedly high cost investment options were Vanguard mutual funds;[14] one of the allegedly high-cost Vanguard funds[15] charged the Anthem plan a fee of 4bps, an extremely low fee compared to an industry where fees can average well over 25bps.[16] Nonetheless, plaintiffs alleged that the plan should have used its bargaining power to bargain for even lower cost share classes, in this case an identical lower-cost mutual fund that charged a fee of 2bps.[17] In total, plaintiffs alleged that Anthem's 401(k) suffered losses of $18 million as a result of the alleged higher-cost share classes for these funds.[18]
  • ​In claims very similar to the ones asserted against Anthem, plaintiffs alleged that fiduciaries of the Chevron 401(k) plan (with assets over $19 billion) breached their fiduciary duty by, among other things, offering lower-cost Vanguard funds and a Vanguard money market fund instead of a stable value fund.[19] Plaintiffs alleged that Chevron's decision to offer the Vanguard money market fund instead of a stable value fund cost plan participants $130 million in retirement savings.[20] Plaintiffs also challenged Chevron's inclusion of ten Vanguard mutual funds (some with fees as low as 5bp) because there were allegedly identical Vanguard funds with lower-cost share classes available.[21] Plaintiffs alleged that Chevron's use of the higher-cost Vanguard funds contributed to plan participants losing over $20 million through unnecessary expenses.[22]

Stable Value Fund Claims

  • Plaintiffs have sometimes demanded that SVFs be provided (as they did in the Chevron case above), but at other times they have claimed that SVFs are bad investments when they fail to perform as hoped because they allegedly deviated from the investment mix "typically" offered by SVFs.[23] These "Goldilocks" type claims are continuing:
    • In Ellis v. Fidelity Management, one of plaintiffs' central claims concerns a fund they claimed was a SVF offered by Fidelity as an investment option in the Barnes & Noble 401(k) plan.[24] Plaintiffs alleged that the fund performed poorly because Fidelity adopted an unduly conservative investment strategy by investing in shorter average duration securities, like money markets, instead of investing in longer duration bonds.[25] Plaintiffs claimed that Fidelity had previously engaged in an overly aggressive and imprudent investment strategy for this fund but over corrected with an overly conservative investment strategy.[26] Plaintiffs also alleged that Fidelity allowed wrap contract providers to charge excessive fees, and in turn Fidelity charged its own excessive fees.[27]
    • In Pledger v. Reliance, plaintiffs alleged that Reliance, the trustee of Insperity's $2 billion dollar 401(k) plan,[28] breached its fiduciary duty by offering money market funds that did not keep pace with inflation instead of SVFs that could have earned an additional $14 million.[29] Plaintiffs made this claim despite the fact that Reliance added a SVF to the list of available options to participants of the plan in 2014.[30] Plaintiffs claim that the SVF was not an established enough fund because it was in existence for less than a year and underperformed other SVFs.[31]

Claims against ERISA-Exempt Guaranteed Benefit Policies

In several slightly different cases, plaintiffs have challenged the ERISA-exempt status[32] of SVFs offered by insurers, including New York Life, Prudential and Great-West Life, which are ERISA-exempt to the extent that they are guaranteed benefit policies.[33] Plaintiffs' principal argument against ERISA exemption is that because the insurers can unilaterally set the rate of return on the investments, the investments are not truly guaranteed benefit policies.[34] If the investments are found to not offer guaranteed benefits then, according to plaintiffs' theories, the insurers that manage the funds are subject to ERISA fiduciary standards. In Teets v. Great-West Life, the district court certified a class of over 270,000 participants to resolve, in part, the issue of whether ERISA's fiduciary standard applies to Great-West's management of a guaranteed stable value fund and whether the fund falls under ERISA's guaranteed benefit policy exemption.[35]

In Great-West, the 270,000 plan participants came from 13,600 different retirement plans.[36] Plaintiffs have previously had mixed results when attempting to satisfy Rule 23's "commonality" and "typicality" requirements against service providers who offer multiple plans (sometimes thousands) with substantial variability in the services and structure offered from one plan to another.[37]

Claims Challenging Alternative Investments

  • Plaintiffs are also attempting to prove new theories of liability related to alternative investments offered in 401(k) plans. For example, in Johnson v. Fujitsu, plaintiffs are challenging investments in target date funds that allegedly included too many unique and non-traditional asset classes, such as natural resources and real estate limited partnerships.[38]

View from Proskauer

The cases discussed above are all in the early stages of litigation, and at least eight have pending motions to dismiss. Regardless of the outcomes in these cases, they illustrate the ever heightening scrutiny being applied to plan fiduciaries – e.g., even index funds with fees of 4bps can now be targets. The low interest rate environment after the Great Recession has also put substantial pressure on money market and stable value funds, which are delivering low returns in this environment. Low returns and poor market performance has also led to a search for alternative investments, which can also increase risk and hindsight-based second-guessing.

Plan fiduciaries can, however, engage in preventive measures that should help them defend against these newly minted claims.[39] One such measure is to periodically investigate share classes and fee options to ensure that the 401(k) plan is obtaining the lowest cost option for which it qualifies. This process should be well documented to defend against any later claims that a cheaper share class was readily available. Another is to consider and to document the fiduciary process that led to the selection even of what are considered low-risk investment options, such as money market, stable value, and target-date funds. This will help to defend against the risk of hindsight-based claims whenever any option fails to perform against benchmarks, or if plaintiffs want to challenge why certain investment options, such as SVFs, are not offered.