In this Ropes & Gray podcast, litigation & enforcement partners Amy Roy and Dan Ward, and ERISA and benefits partner Josh Lichtenstein, discuss 401(k) litigation risk assessment and management. They review current trends in proprietary funds litigation, the key legal issues surrounding the statute of limitations for claims arising under ERISA, and the upcoming Intel case before the Supreme Court that could have significant ramifications for 401(k) plan sponsors and employers.
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Amy Roy: Hello, and thank you for joining us today on this Ropes & Gray podcast, during which we will be discussing 401(k) litigation risk assessment and management. I am Amy Roy, partner in Ropes & Gray’s litigation and enforcement practice group, based in Boston. Joining me for today’s discussion is Dan Ward, a partner in our Boston office and fellow member of Ropes’ litigation and enforcement practice group, as well as Josh Lichtenstein, an ERISA and benefits partner in our New York office. We’re here today to talk about class action litigation brought by employees against their own employers under ERISA for alleged mismanagement of retirement plans. More specifically, we’ll talk about current trends in proprietary funds litigation, meaning cases where the employer is an asset manager that selects its own funds for inclusion in a retirement plan for its employees. But before we get into the details, Josh, could you start with some background on the topic of defined contribution plans?
Josh Lichtenstein: Sure, Amy. Over the past 40 years, defined contribution plans, such as 401(k) plans, have displaced traditional defined benefit pension plans as the leading form of employer-sponsored retirement savings programs in the United States. ERISA governs the operations of these plans, and ERISA imposes fiduciary duties on those who manage and control plan assets, include fiduciaries who design 401(k) investment menu line-ups. ERISA’s fiduciary duties are generally regarded as “the highest known to the law” in the United States. The statute requires retirement plan providers to act prudently, and with the exclusive purpose of benefitting plan participants and their beneficiaries and defraying the reasonable expenses of administering the plan. This ERISA fiduciary duty is often described as a prudent expert standard, which is higher than the prudent person standard under many other laws. The courts have frequently described ERISA fiduciaries as needing to act with an eye single towards the best interest of plan participants.
Amy Roy: So today, we’re specifically talking about “proprietary funds” litigation. Dan, could you talk about what that means?
Dan Ward: Sure. In recent years, asset management companies have faced a wave of litigation in the proprietary funds or “prop funds” space. These cases involve claims under ERISA brought against large investment firms by current or former employees. Plaintiffs allege that their employers’ inclusion of their own proprietary investment products in the investment menus of employee retirement plans violates their duties under ERISA. The basic theory underlying these lawsuits is that the defendants decided to offer their own investment products in their 401(k) plans—rather than selecting cheaper or better-performing options from the market—with the goal of generating fees or other benefits for the company, at the expense of plan participants.
Amy Roy: And how do plaintiffs try to substantiate their allegations?
Dan Ward: Well, most prop fund cases center around allegations that the products that an employer has elected to offer to participants in their 401(k) plans have underperformed, or that they charged excessive fees. To support these allegations, plaintiffs often cite benchmark funds—that is, non-proprietary funds with similar structure and investment strategies as those offered by the defendant—and allege that the proprietary funds failed to match the benchmark performance and fees.
Amy Roy: What are the stakes?
Dan Ward: While some of these cases have been dismissed early in the proceedings, many employers faced with prop funds litigation have spent years embroiled in discovery, negotiating settlements in the millions, and in at least one case, have gone all the way to trial. So, it’s important for asset managers to understand the issues around including prop funds in their 401(k) plans, and to stay informed about developments in this hotly contested area of law.
Amy Roy: I understand there is a Supreme Court case coming up about the statute of limitations under ERISA. Josh, what is the statute of limitations for these types of cases?
Josh Lichtenstein: That’s right Amy. The statute of limitations for breach of fiduciary duties and related claims is set forth under ERISA § 413 (29 U.S.C. § 1113). It provides that no action may be brought after either a) six years following the date of the last act or omission constituting a part of the breach or violation; OR b) three years after the earliest date on which the plaintiff had “actual knowledge” of the same – whichever is earlier. Because ERISA defendants aim to have claims against them dismissed at the earliest stage possible, they often argue that a plaintiff had “actual knowledge” of the defendant’s fiduciary breach or violation more than three years before the claim was filed, which would therefore time bar the claim.
Amy Roy: What does “actual knowledge” mean in this context?
Josh Lichtenstein: That’s a great question. As is common under ERISA, there is no clear meaning for this term. Congress never defined the term “actual knowledge” under this statute, so it’s been left to the courts to determine what the phrase actually means in the context of ERISA litigation. Different circuit courts have applied very different standards in determining whether plaintiffs possess “actual knowledge” of an alleged fiduciary breach or related claim. Broadly speaking, the courts’ positions can be described as those that are favorable to plaintiffs; those that are favorable to defendants; or those that fall somewhere in a middle ground.
Amy Roy: Dan, Josh just mentioned courts having different views on this. Can you give us more details on the split between the circuits?
Dan Ward: Yes. First, there’s the Plaintiff-Friendly Approach. The Third and Fifth Circuits interpret “actual knowledge” narrowly, to the benefit of plaintiffs. Under this approach, defendants need to show that plaintiffs not only knew of the underlying conduct giving rise to the claim, but also that the conduct supported a claim under ERISA. This is known as the “claims” approach, due to its focus on when the plaintiff has enough knowledge to be aware that he or she has an actual legal claim against the defendant.
Now, the Sixth, Seventh, and Eleventh Circuits have taken a more defendant-friendly approach that requires them to show only that plaintiffs had sufficient knowledge of the “facts or transaction” that formed the basis of the alleged violation. In other words, they don’t need to understand that they have an actual legal claim, as long as it can be shown that they knew enough facts that could give rise to a claim. This interpretation has helped some defendants obtain early dismissal of cases because they’re not required to demonstrate that the plaintiff had “actual knowledge of facts that would establish a cognizable legal claim.”
Some other circuits have adopted a middle ground. For example, the Second Circuit has applied a hybrid view of “actual knowledge.” Under this interpretation, a plaintiff has “actual knowledge” when he knows of “all material facts necessary to understand that an ERISA fiduciary has breached his or her duty or otherwise violated the Act. While a plaintiff need not have knowledge of the relevant law, he must have knowledge of all facts necessary to constitute a claim.” The Ninth Circuit adopted a similar approach in a case called Sulyma v. Intel Corporation Investment Policy Committee. In that case, the court held that “actual knowledge” means “something between bare knowledge of the underlying transaction, which would trigger the limitations period before a plaintiff was aware he or she had reason to sue, and actual legal knowledge, which only a lawyer would normally possess.”
Amy Roy: So Josh, can you tell us about the case going to the Supreme Court, and about the issue being presented there?
Josh Lichtenstein: Yes. The Supreme Court has granted cert in the Intel case that Dan just mentioned, and the case will be argued in December of this year. The case has been closely watched by plan sponsors for years. The issue of when a plaintiff has had “actual knowledge” required to trigger the three-year statute of limitations for a breach of fiduciary duty claims under ERISA will be front and center next month at the Supreme Court. After the Ninth Circuit’s ruling in Intel that employees can only gain “actual knowledge” of an ERISA violation when they’ve read financial documents that would have alerted them to the existence of wrongdoing or have been told of such wrongdoing, Intel filed a petition for a writ of certiorari on the issue. As presented in their petition, the question for the Court is “whether the three-year limitations period under Section 413(2) of ERISA bars suit where all of the relevant information was disclosed to the plaintiff by the defendants more than three years before the plaintiff filed the complaint, but the plaintiff chose not to read or could not recall having read the information.” So this case could decide once and for all what “actual knowledge” means in the context of ERISA. It also has other implications for ERISA litigation and more broadly. This case arose based on Intel’s decision to incorporate alternative investments, such as hedge funds and private equity funds, as a component of investment options offered under there 401(k) plan and other defined contribution plans. If the Supreme Court decides that the statute of limitations has not expired and the case is therefore allowed to proceed at the district court level, it may ultimately have significant consequences for retirement plan sponsors who would like to adopt a similar plan design to Intel—including whether offering private funds (which are alleged to carry more risk) would constitute a breach of fiduciary duties in and of itself. A decision on the merits in Intel’s favor could lead to more 401(k) plans that include exposure to these types of private funds, which are currently broadly offered under defined benefit plans but not often seen in defined contribution plans. However, until the Intel decision comes down, plan sponsors should keep abreast of the different and evolving standards the different courts have used to define “actual knowledge.”
Amy Roy: Dan, Josh just discussed the broader implications the Intel case may have. Can you talk about what implications the Intel case might have specifically with regard to proprietary funds cases?
Dan Ward: Sure, the importance of the definition of “actual knowledge” is critical in the prop funds space—particularly where employers face risk based on their prior activities, even as they update their practices in response to the current litigation landscape. For example, most recent prop funds cases involve allegations that the funds in question underperformed or charged excessive fees. As a basis for their claims, plaintiffs often allege that the proprietary funds selected do not match comparable funds’ performance or fees. When a court applies the more stringent approach to “actual knowledge,” it will typically require defendants to show that the plaintiff had “actual knowledge” not only of the prop fund’s fees and performance, but also of the benchmark fund’s fees and performance. The statute of limitations defense will not be met under this interpretation unless it can be shown that all of these facts were known to the plaintiff. Depending on where the Supreme Court comes out in Intel, it could become much harder or easier for plaintiffs to make these allegations based on a comparison to benchmark funds and survive a motion to dismiss based on the statute of limitations.
Amy Roy: Thanks to you both, Dan and Josh, for joining me today for this discussion. And thank you to our listeners. For more information regarding the topics discussed today or other aspects of 401(k) litigation risk assessment and management, as well as links to our recent articles, please visit www.ropesgray.com. If we can help you to navigate this complex and rapidly developing area of the law, please do not hesitate to contact us. You can also subscribe and listen to this series wherever you regularly listen to podcasts, including on Apple, Google and Spotify. Thanks again for listening.