This month, we examine two recent circuit court opinions. First, we highlight the Seventh Circuit's decision in Loomis v. Exelon, Nos. 09-4081 and 10-1755, 2011 WL 3890453 (7th Cir. Sept. 6, 2011), and evaluate more closely that circuit's treatment of the issues raised in the 401(k) excessive fees cases, which will likely guide the adjudication of future claims in the Seventh Circuit, and possibly elsewhere.
Second, we discuss the Tenth Circuit's opinion in Tomlinson v. El Paso Corp., No. 10-1385, 2011 U.S. App. LEXIS 16525 (10th Cir. Aug. 11, 2011), which addressed important disclosure issues under ERISA Sections 102 and 204(h) that arise when employers convert traditional defined benefit plans to cash balance plans. The Tenth Circuit's opinion also addresses whether, post-Amara, a plaintiff asserting an ERISA Section 502(a)(3) claim based on a summary plan description (SPD) disclosure violation must prove that he detrimentally relied upon the defective SPD or that he suffered actual harm caused by the ERISA violation.
As always, be sure to review the section on Rulings, Filings, and Settlements of Interest.
Déjà Vu – the Seventh Circuit Again Rules in an Excessive Fee Case, Expanding on Hecker v. Deere, and Taking a Leading Role in the Field
There has been no shortage of so-called "excessive fee" cases: cases that address breaches of fiduciary duties related to the fees and expenses charged by investment funds in defined contribution plans. In fact, since the fall of 2006, more than 30 class action complaints claiming breaches of fiduciary duties under ERISA related to fees and expenses have been filed. The rulings rendered, both at the district court and circuit level, have diverged, and it is often difficult to determine the extent to which the divergent results are driven by different facts or different views on the applicable legal standards. With the Seventh Circuit's recent decision in Loomis v. Exelon, Nos. 09-4081 and 10-1755, 2011 WL 3890453 (7th Cir. Sept. 6, 2011), we have the opportunity to evaluate more closely that Circuit's treatment of the issues and to reach some tentative conclusions as to the overriding principles impacting that Circuit's rulings. Only time will tell whether in light of the dominant role that this Circuit has played – having rendered the majority of Circuit Court decisions on this subject – the law in the Seventh Circuit will become the state of the law elsewhere.
Circuit Court Rulings Prior to Loomis
The Loomis decision follows the prior Seventh Circuit ruling in Hecker v. Deere, the first of the leading rulings on the subject. In Hecker, the Seventh Circuit dismissed claims that defendants breached their fiduciary duties by offering funds that required excessive fees. In so ruling, the Court held that the claim was implausible because the funds at issue totaled 25 out of a total of 2500 funds offered by the plan with fees varying between .07 and 1 percent, the funds at issue were offered to the general public, and nothing in ERISA required the fiduciaries to offer only the cheapest fund options.
Since Hecker, other Circuit Courts have addressed excessive fee claims. In Braden v. Wal-Mart Stores, Inc., 588 F.3d 585 (8th Cir. 2009), the Eighth Circuit held plaintiffs' allegations of expensive fees were sufficient to state a claim that the process for selecting the funds was flawed and that overpriced funds were selected despite the availability of better options. More recently, the Third Circuit in Renfro v. Unisys, No. 10–2447, --- F.3d ----, 2011 WL 3630121 (3d Cir. August 11, 2011), affirmed the district court's dismissal of plaintiffs' class action complaint alleging that Unisys and the 401(k) plan's directed trustee breached their fiduciary duties under ERISA by failing to adequately investigate the investment options offered under the plan and, more specifically, by offering as investment options retail mutual funds whose fees allegedly were excessive in comparison to the fees of other mutual funds. The Third Circuit reasoned that the range of investment options offered by the plan, which included 73 investment choices, was reasonable because the options included a multitude of risk profiles, investment strategies, and associated fees.
The Decision in Loomis
The issues in Loomis were similar to those presented in Hecker. Exelon sponsored a defined-contribution pension plan (the "Exelon Plan") that allowed participants to choose how their retirement funds would be invested. Out of the 32 options, the Exelon Plan offered 24 "retail" funds -- mutual funds that were also open to the public. The "retail" funds were "no-load" funds. They did not charge investors a fee to buy or sell shares, but covered their expenses by deducting them from the assets under management and had expense ratios ranging from .03% to 96%. The "retail" funds on the low expense side were passively managed and had certain features that discouraged turnover, such as not allowing new investments for a certain period of time after withdrawal. The "retail" funds on the higher expense side were actively managed where the fund's investment advisors buy underpriced securities and sell overvalued securities, and placed no restrictions on turnover. The Plan also had at least 8 options other than the "retail" mutual funds. Loomis, at *1.
Plaintiffs' claims were directed exclusively at the 24 "retail" funds. Plaintiffs argued that the Exelon Plan Administrator breached its fiduciary duties by making these funds available because plan participants were offered the same terms and bore the same expenses as the general public, and by requiring the participants to bear the cost of those expenses rather than having the Plan cover the fees. Plaintiffs contended that the Plan should have instead arranged access to "wholesale" or "institutional" investment vehicles and that the Plan should have participated in trusts and investment pools that were not available to the general public. Essentially, plaintiffs argued the participants should not have had any opportunity to invest in "retail" funds.
The Seventh Circuit upheld the district court's dismissal of plaintiffs' claims. In so doing, it explicitly approved giving multiple choices to participants in defined contribution plans, even if the choices include high-priced, actively managed, retail mutual funds. It described as "paternalistic" the plaintiffs' theory that participants should not have a choice of retail funds.
Lessons Learned from Loomis
The decision in Loomis, coupled with the Court's prior ruling in Hecker, contain several components that should help guide the adjudication of future claims in the Seventh Circuit, and possibly elsewhere.
Institutional Funds Are Not Always Superior
The Court rejected plaintiffs' paternalistic notion that institutional funds are always better. In so ruling, the Court reinforced the ruling in Hecker, which had rejected the same argument on the grounds that the costs of publicly available "retail" funds are kept reasonable by the competition of the open market. Expanding on Hecker, the Loomis Court rejected the argument for institutional funds for the following additional reasons: First, privately held and commingled trusts' assets are hard to value when a participant wants to withdraw the funds and any type of valuation error could hurt other participant investors. Second, privately held trusts and commingled pools lack the benchmarks available for retail mutual funds; therefore, it can be hard to tell whether these types of investments are doing well or whether the fees are excessive in relation to the benefits they provide. Third, the information provided to the Court, including an amicus brief from the Investment Company Institute, demonstrated that it was not the case that retail fund fees were necessarily higher than the fees for institutional funds. Finally, the Court noted that the lack of liquidity was a big drawback to the institutional funds, one that might outweigh the benefit of lower fees. Loomis, at *2-4.
The Plan's Asset Base Does Not Necessarily Translate Into Lower Fees
Plaintiffs argued that because the Plan had total assets worth over $1 billion dollars, it could exercise buying power by negotiating lower fees in exchange for a promise to place more money with a given investment manager and also could demand the same retail services for which mutual funds charge their normal expenses. Plaintiffs also contended that Exelon could use its buying power to negotiate an annual flat fee per investor versus the current fees that are a percentage of the assets being managed. Loomis, at *4-5.
The Court rejected both of these theories. First, the Court noted that the fact that the Plan had $1 billion to spend did not mean the Plan would obtain lower fees because Exelon could not commit any portion of that sum to any one fund without undermining its guarantee that participants could freely make their investment choices and violating the Plan terms.
The Court also questioned whether a participant would view a flat-fee as an advantage. A flat-fee structure might benefit participants with large balances, but individuals with small investment accounts would end up paying more, per dollar under management, than a fee between .03% and .96%.
Paternalistic Concerns Should Not Prohibit Plan Sponsors From Offering A Choice Of Funds That Includes Higher Cost "Retail" Funds
The Court rejected plaintiffs' arguments that the Plan fiduciaries should have removed the more expensive actively-managed retail mutual funds from the Plan because they were overpriced and because the lower-cost passively managed funds were preferable, and that participants tended to be influenced by advertising that caused them to like the retail funds for "the wrong reasons." The Court found that these paternalistic arguments did not amount to a basis for finding a breach of fiduciary duties. Loomis, at *5-7.
In rejecting these arguments, the Court was influenced by the fact that ERISA encourages plan sponsors to give participants choice and control with respect to their investments. In fact, as the Court observed, the safe harbor from fiduciary exposure that ERISA § 404(c) offers to 401(k) plan administrators is expressly conditioned on the availability of multiple investment vehicles for participants to choose from. In light of these strong federal policies, the Loomis Court held that ERISA plan fiduciaries do not breach their fiduciary duties by giving participants the ability and responsibility to choose from among a diverse selection of investment options, even if those options include relatively high-priced, actively-managed retail mutual funds. The Loomis Court upheld the participant's right to choose under ERISA and refused to rule that the participants' choice should be taken away. Id.
The ruling in Loomis, like the ruling in Hecker, appears to be motivated, not merely by a finding that the facts alleged in these cases were insufficient to sustain a claim, but by the Seventh Circuit's disdain for the legal theories that are at the heart of the excessive fee cases. In writing for the three-judge panel of the Seventh Circuit in Loomis, Judge Easterbrook summed up the "damned if you do, damned if you don't" philosophy of these types of cases: "Many defined-contribution pension plans offer participants an opportunity to select investments from a portfolio, which often includes mutual funds. In recent years participants in pension plans have contended that the sponsor offers too few funds (not enough choice), too many funds (producing confusion), or too expensive funds (meaning that the funds' ratios of expenses to assets are needlessly high). See, e.g., Hecker v. Deere & Co., 556 F.3d 575, rehearing denied, 569 F.3d 708 (7th Cir. 2009); Howell v. Motorola, Inc., 633 F.3d 552 (7th Cir. 2011); Spano v. Boeing Co., 633 F.3d 574 (7th Cir. 2011); George v. Kraft Foods Global, Inc., 641 F.3d 786 (7th Cir. 2011)."
In summarily rejecting these claims, the Seventh Circuit appears to be recognizing — and preserving — the fundamental distinction that ERISA draws between the operation of defined benefit plans and defined contribution plans. In the former, the fiduciaries or the employer plan sponsor assume responsibility for all decisions about the investments (how much to invest, what asset classes to invest in, whether to use active or passive management, and what manager to hire, etc.), while in the latter, these decisions are left up to the participants, who are empowered to decide whether to invest at all, how much to invest, what asset classes to invest in, and which funds to use. The excessive fee claims threaten to undermine this distinction by shifting responsibility for investment choices back to the plan fiduciaries. The Seventh Circuit's decisions have responded to this threat by affirmatively establishing that in a defined contribution plan that offers a reasonable choice of investments, it is the participants – "the people who have the most interest in the outcome" – who are responsible for the choice of investments.