This is the second of two articles in this newsletter about the recent decision by the Ninth Circuit Court of Appeals in Tibble v. Edison International. This article addresses the only issue in that case on which the defendants did not prevail – the duty to consider institutional share classes of mutual funds.
Mutual funds may offer multiple share classes, including “institutional” share classes and “retail” share classes. As those names imply, institutional share classes are typically available to institutional investors – such as larger retirement plans. Institutional shares are less expensive than their retail share counterparts, which are often available to individual investors and small plans.
In Tibble, the plan offered retail shares, rather than institutional shares, of three mutual funds. The institutional share classes of the funds were in the range of 24 to 40 basis points (i.e., .24% to .40%) cheaper than their retail share class counterparts. According to the court, there were “no salient differences in the investment quality or management.” In other words, while in some cases there may be features associated with retail share classes that make them suitable for a particular plan, there was no evidence that was the case in Tibble. Plaintiffs alleged that, in failing to investigate and ultimately offer lower-priced institutional shares, the fiduciaries acted imprudently.
At trial, the defendants argued that the amounts invested in those funds fell below the minimum investment required for institutional shares. During the trial, however, expert witnesses for both sides testified that mutual fund companies can and often do waive or reduce the minimum investment requirement when requested to do so by investors like larger retirement plans.
On appeal, Edison argued that it relied on its investment adviser to determine which share classes to offer. Reliance on expert advice is helpful – but the reliance must be reasonable. In Tibble, the court noted that fiduciaries are required to (1) probe the expert’s qualifications, (2) furnish the expert with reliable and complete information and, importantly, (3) make certain that reliance on the expert’s advice is reasonably justified under the circumstances.
According to the court, the fiduciaries in this case fell short on this final point – reasonable reliance. Showing reasonable reliance requires fiduciaries to assess the advice they receive, and in the court’s words, “question the methods and assumptions that do not make sense.” Expert witnesses on both sides of the case testified that a reasonable investor would have reviewed all available share classes and the relative costs of each when selecting a mutual fund. This required Edison to show that its investment adviser engaged in a prudent process in considering share classes. The court noted that if Edison had presented evidence of the specific recommendations the adviser made to the fiduciaries, the scope of the investment adviser’s review, and whether the investment adviser considered both retail and institutional share classes, the outcome may have been different. But because no such evidence was presented, the court stated that it had “…little difficulty agreeing with the district court that Edison did not exercise the ‘care, skill, prudence, and diligence under the circumstances’ that ERISA demands in the selection of these retail mutual funds.”
While fiduciaries must engage in a reasonable process in evaluating the expense of their investments, the law does not require them to always select the least expensive investment option. Fiduciaries may take many factors into account in deciding which investments they will offer to their participants. Expense is just one of those factors. The issue comes down to whether fiduciaries perform a prudent analysis and are prepared to explain why a more expensive option was selected if a less expensive version of the same fund is available.
Ultimately, fiduciaries should ask relevant questions, get answers to those questions, and document the process throughout. Tibble, and many other cases, make clear that a fiduciary cannot simply “rubber stamp” a consultant’s conclusions or advice.