Currently pending before the Third Circuit Court of Appeals is plaintiffs’ appeal of the district court’s decision in Renfro v. Unisys, No. 07-2098, 2010 WL 1688540 (E.D. Pa. Apr. 26, 2010).[2] Renfro is one of over a dozen nearly identical putative class actions that were commenced in 2006 by the same law firm against some of the nation’s largest employers, their 401(k) plans, and the fiduciaries of those plans. As in the other actions, plaintiffs in Renfro assert that Unisys Corporation and Fidelity Management Trust Company breached their fiduciary duties under ERISA by offering investment options with allegedly excessive fees in participant-directed 401(k) plans. As with many of the other suits, plaintiffs complain that defendants did not take advantage of the plan’s large size to obtain lower fees or increased services for plan participants.

On April 29, 2010, United States District Judge Berle M. Schiller of the United States District Court for the Eastern District of Pennsylvania dismissed the putative class action complaint, holding that Unisys did not breach its fiduciary duties and that Fidelity was not a fiduciary under ERISA. As suggested by the seven amicus curiae filings, including briefs submitted by the Department of Labor (DOL), the Chamber of Commerce of the United States, the Investment Company Institute, and the Securities Industry and Financial Markets Association, the Third Circuit’s decision could have far-reaching implications, in terms of both the types of investment vehicles that plan sponsors will be able to offer in participant-directed 401(k) plans, and the scope and application of the defense afforded to plan fiduciaries under ERISA Section 404(c).[3]

Background

Plaintiffs were participants in the Unisys Corporation Savings Plan (Plan), which provides individual accounts for each Plan participant. As is typically the case with 401(k) plans, a participant’s benefits under the Plan are determined by the amounts contributed to his or her account and any income, gains, and losses that may be allocated to the account as a result of the participant’s investments. Plan participants decide how to allocate their money among the different investment options in the Plan after receiving detailed information about the investments’ historical performance, the managers’ investment strategies, and the associated fees and expenses. During the period in question, the Plan offered over 70 investment options with varying fees, risks, and potential rewards, including commingled pools, index funds, bond funds, funds representing parts of the global economy, and a money market fund. The funds offered had fees ranging from as little as 0.10% to as high as 1.21%. From 2000 to 2007, the total assets in the Plan exceeded $2 billion, with the total number of Plan participants exceeding 30,000.

Pursuant to the agreement entered into with Fidelity Management Trust Company (FMTC), FMTC agreed to provide a wide variety of services, including recordkeeping, participant education and communication, reviews with plan sponsors, and trustee services such as facilitating the monetary inflows and outflows of the Plan. FMTC delegated certain of these tasks to its affiliate, Fidelity Investments Institutional Operations Company, Inc. The trust agreement stipulated that the only mutual funds that could be offered to Plan participants were those advised by Fidelity Management & Research Company; however, Unisys could add additional investment options with FMTC’s consent.

The Renfro Litigation

Plaintiffs filed a putative class action complaint against Unisys and its Plan fiduciaries (collectively, the Unisys Defendants) and FMTC and affiliated entities (collectively, the Fidelity Defendants). The complaint alleged that defendants breached their fiduciary duties by including retail mutual funds as investment options in the Plan. Plaintiffs contended that participants and beneficiaries were forced to pay excessive administrative and investment management fees, and complained that Defendants did not take advantage of the Plan’s large size to negotiate lower fees or increased services for Plan participants and beneficiaries.

Both the Unisys and Fidelity Defendants moved to dismiss the complaint. Unisys also moved in the alternative for summary judgment. The district court granted all motions in Defendants’ favor.

In their motion to dismiss, the Unisys Defendants argued that the Complaint failed to state a plausible claim for relief under Ashcroft v. Iqbal, 129 S. Ct. 1937 (2009), and Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555 (2007), for purportedly forcing participants to pay excessive fees by offering retail mutual funds in the Plan. Relying in part on the Seventh Circuit’s decision in Hecker v. Deere & Co., 556 F.3d 575, 586 (7th Cir. 2009), the district court concluded that because the Plan “offered a sufficient mix of investments,” no rational trier of fact could find that the Unisys Defendants breached their fiduciary duties. Agreeing with the Seventh Circuit’s opinion in Hecker, the court held that, because Unisys negotiated a trust agreement that provided Plan participants with investment options that were not unreasonable on their face, the complaint failed to state a plausible claim that the Unisys Defendants breached their fiduciary duties under ERISA. In so ruling, the court determined, like Hecker, that prudence did not require a plan fiduciary to select the cheapest fund available. The court noted that by offering more than 70 funds, the Plan provided participants with “a number of investment options with varying fees, risks and potential rewards,” and that the fees charged by the funds in the plan were “disclosed to investors who could choose from among the investment options to create a portfolio tailored to meet their investment objectives.”

As in Hecker, the court found that, because the funds offered in the Plan were also offered to investors in the general public, “the expense ratios necessarily were set against the backdrop of market competition.” The court observed that “plan sponsors, when negotiating with potential trustees, would seek out the best deal possible for plan participants and would negotiate lower investment fees or administrative fees based on their market power if possible” and that “labor market forces are better positioned than courts to determine if plan sponsors can use the size of their plan as a bargaining chip to elicit lower prices or better services for plan participants.” The court inferred from these circumstances that the Plan’s fee agreement “was an arm’s-length bargain and therefore needs less judicial oversight to ensure fairness to plan participants and beneficiaries.”

The district court also granted the Unisys Defendants’ alternative motion for summary judgment, which contended that any losses allegedly suffered by Plaintiffs were the result of their individual investment decisions and that ERISA Section 404(c) shielded Defendants from any liability. The court held that the Unisys Defendants met their burden of demonstrating compliance with Section 404(c), in that the plan provided participants and beneficiaries (1) an opportunity to exercise control over the assets in their individual accounts, and (2) an opportunity to choose from a broad range of investment alternatives. Relying on the Third Circuit’s decision in In re Unisys Savings Plan, 74 F.3d 420, 445 (3d Cir. 1996), the court rejected Plaintiffs’ contention that Section 404(c) does not insulate fiduciaries from liability in connection with the selection and monitoring of investment options. Plaintiffs argued that Unisys Savings Plan is no longer good law because that case dealt with conduct that predated the effective date of the DOL’s Section 404(c) regulations and that the court should defer to the agency’s interpretation of the statute pursuant to Chevron U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837, 842-43 (1984). The court rejected this argument, holding that the DOL’s regulations are not entitled to Chevron deference because the Third Circuit’s decision in Unisys Savings Plan was based on the “plain language” of the statute. The court in Unisys Savings Plan stated that ERISA’s “unqualified instruction that a fiduciary is excused from liability for ‘any loss’ which ‘results from [a] participant’s or [a] beneficiary’s exercise of control’ clearly indicates that a fiduciary may call upon section [404(c)’s] protection where a causal nexus between a participant’s or a beneficiary’s exercise of control and the claimed loss is demonstrated.” The district court concluded that since Congress had issued such a clear directive and the statutory language is not ambiguous, full blown Chevron-deference was not applicable.

The court also dismissed the claims against the Fidelity Defendants, holding that they were not fiduciaries with respect to the selection of plan investment options, and thus could not be liable for breach of fiduciary duty. In so ruling, the court rejected Plaintiffs’ argument that Fidelity was a fiduciary by virtue of its “veto power” over the selection of any non-Fidelity funds as investment options, noting that the trust agreement did not limit Unisys’s ability to establish another trust to offer Plan participants the opportunity to invest in non-Fidelity mutual funds.

The Pending Appeal

In their appeal to the Third Circuit, Plaintiffs argue again that the district court incorrectly held that retail mutual funds are reasonable Plan investment alternatives “on their face.” Plaintiffs reassert that because mutual funds are more expensive than other institutional investment alternatives, Defendants breached their fiduciary duties of loyalty and prudence by limiting the Plan to only Fidelity investment vehicles, the majority of which were retail mutual funds. Plaintiffs contend that the court’s reliance on Hecker’s “backdrop of market competition” theory to make mutual fund fees reasonable for large 401(k) plans was undermined by the Supreme Court’s ruling in Jones v. Harris Assoc. L.P., 130 S. Ct. 1418 (2010), which, Plaintiffs argue, rejected the Seventh Circuit’s reliance on the “market” to ensure mutual funds comply with the Investment Company Act of 1940. Plaintiffs also contend that the district court erred in entering summary judgment based on ERISA Section 404(c). Relying on the DOL’s interpretation of Section 404(c) as set forth in a footnote in the preamble to the 404(c) regulations,[4] Plaintiffs argue that Section 404(c)’s safe harbor applies only to breaches of fiduciary duty that are the direct and necessary result of participant control over their individual accounts and should not shield fiduciaries from liability for imprudently and disloyally selecting the investments available under the Plan. Plaintiffs also reassert their arguments that FMTC was a fiduciary and that the other Fidelity Defendants are liable in restitution to disgorge the purportedly excessive fees they received as a result of Defendants’ alleged breaches of fiduciary duty.

In response, the Unisys Defendants contend that it is undisputed that Unisys complied with Section 404(c)’s requirements and that Defendants are therefore shielded from liability for the supposedly excessive fees. Defendants contend that the participants themselves determined those fees by their individual investment decisions and that any alleged losses were necessarily determined by the participants’ control. The Unisys Defendants contend that the Third Circuit’s decision in Unisys Savings Plan, which held that the “plain” terms of the statute excuse a breaching fiduciary from liability where the claimed loss stemmed from the participants’ investment allocations, is controlling and mandates dismissal of Plaintiffs’ claims.

The Unisys Defendants argue, in the alternative, that even if Section 404(c) does not shield Defendants from liability, Plaintiffs failed to state a plausible claim that retail mutual funds are imprudent. The Unisys Defendants contend that Jones v. Harris has no relevance because it involved claims under the Investment Company Act, not ERISA, and did not involve funds competing for business from 401(k) plans.

The Fidelity Defendants argue that FMTC is not a fiduciary for purposes of selecting the investments offered in the Plan, as the trust agreement makes clear that the Unisys fiduciaries have exclusive authority over investment selections. The fact that FMTC must consent to the addition of investment options to the trust agreement does not give FMTC control over the addition of options to the Plan as Unisys is free to add options to the Plan, administered by another trustee, if FMTC does not consent to add options to the trust agreement.

Amicus Filings

In an amicus brief submitted in support of Plaintiffs, the DOL argues that Section 404(c) does not immunize fiduciaries from losses caused by their own imprudence in the selection and monitoring of investment options available under a plan.[5] The DOL contends that Unisys Savings Plan is not binding because that court’s statements were dicta and, in any event, when properly read, that decision is consistent with the Secretary’s regulatory interpretation of Section 404(c). The DOL further argues that the district court erred in holding that deference to the Secretary’s regulatory interpretation was inappropriate under Chevron.

The DOL also argues that the complaint adequately states a claim that the fees charged by many of the Plan’s investments were excessive compared to the services provided and that the investments were imprudently selected. In this regard, the DOL contends that the complaint is akin to the complaint that the Eighth Circuit held sufficient to state a fiduciary breach claim in Braden v. Wal-Mart Stores, Inc., 588 F.3d 585 (8th Cir. 2009), and is distinguishable from the complaint that was dismissed by the Seventh Circuit in Hecker.

The Chamber of Commerce, in the amicus brief it submitted in support of Defendants, takes the opposite view, arguing that the district court’s ruling is correct on the law based on the plain language of the statute and controlling precedent.[6] The Chamber further argues that the court’s decision should be affirmed in all respects “because it provides protection against unfettered litigation over liability for a participant’s investment decision, squarely places the responsibility for such investment decision-making on the participant, and advances one of the ERISA purposes highlighted by the Supreme Court in Conkright v. Frommert, 130 S. Ct. 1640, 1648-49 (2010): To encourage employers to create and maintain ERISA plans.” The Chamber warned that the costs associated with this type of litigation, if allowed to proceed, would have a chilling effect on the establishment and maintenance of 401(k) plans.

Proskauer’s Perspective

The decision in Renfro is potentially important in a number of respects. First, it will be the first decision in the Third Circuit to address squarely the scope of Section 404(c) since the effective date of the Section 404(c) regulations. As noted, the Third Circuit previously ruled in Unisys Savings Plan that Section 404(c), if properly complied with, could relieve plan fiduciaries of liability for the selection of investment options. The Fifth Circuit reached the same conclusion in Langbecker v. Elec. Data Sys. Corp., 467 F.3d 299, 309 (5th Cir. 2007). However, the Fourth Circuit, consistent with the position advanced by the DOL, has held that Section 404(c) does not shield fiduciaries from liability for imprudent selection of investment options. DiFelice v. U.S. Airways, Inc., 497 F.3d 410 (4th Cir. 2007). Until recently, the Seventh Circuit, in Hecker, appeared to side with the position of the Third and Fifth Circuits, but a more recent decision in Howell v. Motorola, Inc., Nos. 07-3837, 09-2796, 2011 U.S. App. LEXIS 1193 (7th Cir. Jan. 21, 2011),[7] decided by a panel that included two of the three judges who decided Hecker, explicitly adopted the DOL’s view that Section 404(c) does not apply to the selection of investment options. As we previously reported, this issue is also currently on appeal to the Sixth Circuit in Tullis v. UMB, N.A, No. 09-CV-4370 (6th Cir.). Thus, the Third Circuit will have an opportunity to render a ruling on an issue on which the circuit courts appear to be greatly divided.

Renfro also presents an opportunity for the Third Circuit to consider the viability of claims attacking the offering of retail mutual funds in 401(k) plans, and specifically whether these claims should be rejected outright where the fees charged for these funds are bargained for at arm’s-length and are consistent with the fees charged to other investors. With respect to the claims against Fidelity, the Court also will have the opportunity to opine on the boundaries between what is and is not a fiduciary role in servicing an ERISA plan.