On March 21, 2013, the Ninth Circuit issued its opinion in Tibble v. Edison International, affirming the district court’s decision in a case where participants alleged that 401(k) plan fiduciaries breached their duties of loyalty and prudence by including certain investment options in the plan, such as retail-class mutual funds, and engaging in revenue sharing. In its detailed decision, the court addresses a myriad of issues that are essential for plan fiduciaries in understanding how to limit and avoid liability under the Employee Retirement Income Security Act of 1974 ("ERISA") going forward. Highlights from this 50-page opinion are:
- Plan fiduciaries breached their duty of prudence by including retail-class shares of three mutual funds in the plan’s investment menu without first investigating the funds’ cheaper institutional-class alternatives.
- ERISA’s six-year statute of limitations starts to run from when the initial decision was made to include the challenged investments in the plan’s investment menu.
- The safe harbor provided under ERISA section 404(c), which protects fiduciaries from liability arising from losses that result from a participant’s exercise of control over his or her account, does not apply to a fiduciary’s selection of investment menu options.
- The Ninth Circuit rejected a bright line rule that plan fiduciaries should only offer wholesale or institutional shares of mutual funds.
- The abuse of discretion standard of review is not limited to benefits claims, but also applies to fiduciary duty claims.
- Defendants’ revenue sharing arrangement did not violate ERISA.
- Defendants did not violate their duty of prudence by including mutual funds, a short-term investment fund, and a unitized stock fund in the plan’s investment menu.
This lawsuit commenced on August 16, 2007, when the plaintiffs filed a putative class action in the Central District of California alleging that the defendants imprudently managed the Edison 401(k) Savings Plan ("Plan") by offering a unitized stock fund, money market-style investments, and retail-class mutual funds.Plaintiffs also alleged that the defendants violated the terms of the Plan document and committed a prohibited transaction under ERISA because the Plan’s mutual funds had revenue sharing.
The defendants consisted of numerous parties, including the parent company, the Plan administrator and other named fiduciaries. They are Edison International, Southern California Edison Company ("SCE"), SCE Benefits Committee, Edison International Trust Investment Committee, the secretary of the SCE Benefits Committee, SCE’s vice president of Human Resources, and the manager of SCE’s Human Resources Service Center. Edison International is the parent company of SCE and the Edison Mission Group, Inc. SCE is the Plan sponsor, and the SCE Benefits Committee serves as the Plan Administrator. Edison International Trust Investment Committee selects and monitors the Plan’s investment options under the authority delegated by SCE and the Edison International Board of Directors. The officer defendants were all named Plan fiduciaries during the relevant time period.
The plaintiffs were current and former employees of Midwest Generation, LLC, which is a subsidiary of Edison Mission Group, Inc.Through their employment, plaintiffs were participants in the Plan.
The Plan was created in 1982, and consisted of six investment options until it was amended following union negotiations in 1998. The amended plan contained numerous investment options, including ten institutional or commingled pools, an indirect investment in Edison known as a unitized fund, and approximately 40 mutual funds.With the inclusion of mutual funds as an investment option, the practice of revenue sharing was introduced into the Plan.Under this practice, some of the Plan’s mutual funds shared revenue with the Plan’s service provider, Hewitt Associates, who then allocated the received funds to pay for some of the Plan’s administrative costs.Consequently, Edison, who paid the cost for administering the Plan, received a credit on its invoices from Hewitt Associates.
Following discovery, the parties each filed a motion for summary judgment. The district court granted the defendants’ motion almost in its entirety.Thus, only the following two claims remained for trial:
- Whether the defendants violated their duty of prudence by selecting a money market fund that allegedly charged excessive management fees
- Whether the defendants violated their duty of loyalty and duty of prudence by offering the retail-class shares of certain mutual funds
The district court ruled in favor of the defendants on the first claim. With respect to the second claim, the district court held that the defendants did not breach their duty of loyalty, but instead breached their duty of prudence by failing to investigate the possibility of institutional-class alternatives before including retail-class shares of three specific mutual funds in the Plan’s investment menu. Accordingly, the district court awarded damages of $370,000.Plaintiffs appealed the district court’s partial grant of summary judgment to the defendants, and the defendants cross-appealed, mainly contesting the post-trial judgment.
Ninth Circuit’s Decision
The Ninth Circuit affirmed the district court’s decision on the defendants’ motion for summary judgment. The appellate court also affirmed the post-bench trial ruling that the defendants imprudently included retail-class shares of certain mutual funds in the Plan’s investment menu before investigating the institutional-class alternatives. This decision touches upon several key issues that can impact how plan fiduciaries carry out their duties and defend against future claims.
Fiduciary Duty When Selecting Retail-Class Mutual Funds
The Ninth Circuit upheld the lower court’s decision that the defendants acted imprudently by including retail-class shares of three mutual funds in the Plan’s investment menu without first investigating the possibility of similar, institutional-class alternatives.
The defendants argued that they had reasonably relied on Hewitt Financial Services for advice. However, the court rejected this argument, holding that Hewitt Financial Services was the defendants’ consultant, not a fiduciary, and that "independent expert advice is not a whitewash." The court further emphasized that "[j]ust as fiduciaries cannot blindly rely on counsel, or on credit rating agencies, a firm in Edison’s position cannot reflexively and uncritically adopt investment recommendations."
The court explained that an experienced investor would have reviewed all available share classes and the costs of each class before including a mutual fund in the Plan. Furthermore, the court provided several reasons why institutional-class shares, instead of retail-class shares, for the three mutual funds at issue would have been more appropriate. First, all three mutual funds offered institutional shares that were 24 to 40 basis points cheaper. Second, there were no major differences in the investment quality or management for these two classes of funds. Third, even if the Plan could not meet these three funds’ investment minimum, it could have obtained a waiver because funds regularly waive such requirements for 401(k) plans with assets over a billion dollars, such as the Plan.
Statute of Limitations
The Ninth Circuit agreed with the district court that the six-year prong of the ERISA statute of limitations for the breach of fiduciary duty applied to the plaintiffs’ claims and started to run from when the initial decision was made to include the challenged investments as options in the Plan. With this decision, the court rejected both parties’ arguments on the applicable statute of limitations.
Plaintiffs, and the Department of Labor ("DOL"), argued that all of plaintiffs’ claims were timely so long as the challenged investments were included in the Plan because there was a "continuing violation."The court refused to apply the "continuing violation theory" because it "would make hash out of ERISA’s limitation period and lead to an unworkable result."
The court also dismissed the defendants’ argument that a three-year statute of limitations applied because plaintiffs were provided with the information about the retail-class mutual funds by the Plan’s summary plan descriptions ("SPDs") and mutual fund prospectuses. It explained that the crux of the plaintiffs’ claim was that the defendants failed to investigate alternatives to certain retail-class mutual funds and, therefore, "mere notification that retail funds were in the Plan’s menu falls short of providing actual knowledge of the breach or violation."
Safe Harbor Section 404(c)
ERISA section 404(c) is a statutory safe harbor that protects plan fiduciaries from liability "for any loss or by reason of any breach, which results from [a] participant’s or beneficiary’s exercise of control" over plan investments. The defendants argued that their actions were within the scope of this safe harbor provision because the plaintiffs exercised control by selecting the challenged investments. However, the Ninth Circuit dismissed this argument and affirmed the lower court’s decision that section 404(c) does not apply to a fiduciary’s selection of investments funds as part of an investment menu.
In applying the administrative-law deference set forth in the U.S. Supreme Court’s decision in Chevron, U.S.A., Inc. v. Natural Resources Defense Counsel Inc., the court agreed with the DOL’s interpretation of section 404(c). The DOL explained in its amicus brief that section 404(c) could not protect the defendants from losses that resulted from their decision to include the challenged funds because "the selection of particular funds to include and retain as investment options in a retirement plan is the responsibility of the plan’s fiduciary, and logically precedes (and thus cannot result from) a participant’s decision to invest in any particular option." In concluding that the DOL’s interpretation was reasonable, the court stated that the fiduciary is in a better situation than the participant to prevent the losses that could arise from the inclusion of unsound investment options, and Chevron deference promotes "a coherent and uniform construction of federal law."
Standard of Review for Fiduciary Breach Claims
The Ninth Circuit next examined what is the appropriate standard of review by a court before resolving whether the defendants had violated the Plan document and whether the defendants had a conflict of interest in violation of ERISA section 406(b)(3). The court held that the framework for reviewing disputes over plan terms — as set forth in key Supreme Court cases, Firestone Tire & Rubber Co. v. Bruch, Metropolitan Life Insurance Co. v. Glenn, and Conkright v. Frommert — also applies to cases implicating fiduciary duties. The court explained that because ERISA is governed by trust law, the trust principle that "a deferential standard of review is appropriate when a trustee exercises discretionary powers" applies to all ERISA claims. It further stated that applying deference across the board helps control administrative and litigation expenses and, thus, would help prevent employers from being discouraged from offering ERISA plans. With this holding, the Ninth Circuit joins the Third and Sixth Circuits in refusing to limit the application of a deferential standard of review to only benefit claims.
The Ninth Circuit held that the defendants did not violate the Plan document or ERISA section 406(b)(3), which prohibits a fiduciary from receiving "any consideration for his own personal account from any party dealing with [a] plan in connection with a transaction involving the assets of the plan."
In determining whether the defendants violated the terms of the Plan document, the court applied the deferential standard of review because the Plan explicitly vested the Benefits Committee with the "full discretion to construe and interpret [its] terms and provisions." The Ninth Circuit held that there was no evidence of an abuse of discretion for several reasons. First, the revenue sharing practice did not explicitly conflict with the Plan’s plain language which stated that the "cost of the administration of the Plan will be paid by the Company" because a natural reading of "cost" meant the bills Hewitt Associates sent to Edison. Also, there was nothing within the Plan prohibiting a third party from paying Hewitt Associates for its recordkeeping services. Second, the inclusion of these revenue sharing mutual funds increased the number of mutual fund options in the Plan’s investment menu. Third, the union was aware of the revenue sharing funds because it had several discussions with Edison during the union negotiations on the use of these funds. Finally, during the relevant time period, participants were made aware on at least seventeen occasions that fees received by Hewitt Associates from the Plan’s mutual funds were used to pay for some of the Plan’s recordkeeping costs. For instance, the Plan’s SPD stated that "the fees received by Edison’s 401(k) plan recordkeeper are used to reduce the recordkeeping and communication expenses of the plan paid by the company."
As for the plaintiffs’ conflict of interest allegation under ERISA section 406(b)(3), the court also found in favor of the defendants. The plaintiffs argued that Edison received "consideration" from Hewitt Associates which was a "party dealing with the plan." The court rejected this argument because the DOL regulations under ERISA section 408(b)(2) exempt revenue sharing from the definition of consideration.
Inclusion of Mutual Funds, Short-Term Investment Fund and Unitized Stock Fund
The Ninth Circuit also rejected the plaintiffs’ claims that the defendants violated their duty of prudence by including mutual funds, a short-term investment fund (similar to a money market fund) rather than a stable value fund, and a unitized fund for participants’ investment in Edison stock in the Plan’s investment menu.
The court rebuffed the plaintiffs’ entire claim regarding the Plan’s mutual funds. The plaintiffs alleged that the inclusion of the retail-class mutual funds was categorically imprudent and that ERISA plan fiduciaries must instead offer only institutional investment alternatives, such as commingled pools or separate accounts. The plaintiffs also complained that the Plan’s mutual funds charged excessive fees. In rejecting the plaintiffs’ arguments, the court explained that commingled pools are not subject to the same reporting, governance, and transparency requirements as mutual funds. The Ninth Circuit, like the Seventh Circuit, refused to accept a bright line rule that fiduciaries should only offer wholesale or institutional shares, because there are several factors a fiduciary must consider in selecting a fund, such as whether the lower cost alternative may have lower returns, higher financial risk, or offer fewer services. The court also found that the expense ratio range for the Plan’s approximate forty mutual funds of 0.03 to 2% was not out of the ordinary. It further stated that, although the revenue sharing practice in this case did not violate the Plan’s terms, or ERISA, its decision assumes that the cost of revenue sharing did not drive up the selected fund’s overall expense ratio and that the defendants were not motivated to select the mutual funds because of the financial benefit of revenue sharing.
As for the short-term investment fund, the court held that the defendants were prudent because there was uncontroverted evidence showing that they had investigated the merits of this investment. This evidence included discussions on the pros and cons of a stable-value fund and how the short-duration bond fund already offered in the Plan filled the same niche as a stable value fund.
The court also held that the inclusion of the unitized stock fund was not imprudent because the evidence showed that the fiduciaries were vigilant in adjusting the fund when market conditions changed.
Lessons for Plan Fiduciaries to Take Away from the Ninth Circuit’s Decision
The Tibble appellate decision contains an abundance of points for ERISA plan fiduciaries to consider. The Ninth Circuit’s thorough discussions on issues ranging from revenue sharing to retail-class mutual funds provide valuable guidance. The following are lessons that we believe plan fiduciaries should take away from this decision:
- Before including any mutual fund investments in a plan, plan fiduciaries should ask about any alternative class shares and make reasoned determinations on what class share would be in the plan participants’ best interests. If the fiduciaries determine that there are no salient differences between the retail and institutional class shares, they should inquire whether the plan meets the minimum investment requirement for institutional shares. If the plan does not meet this requirement, the fiduciaries should request that this requirement be waived.
- Plan fiduciaries should not automatically exclude retail-class mutual funds from their plans’ investment options. Selection of retail-class mutual funds is not automatically deemed an imprudent decision in the Ninth and Seventh Circuits, but plan fiduciaries should inquire about the availability of alternative class shares and make reasoned determinations as to which share classes should be included.
- Plan fiduciaries should monitor their service providers, including investment consultants, to ensure that they are analyzing all aspects of the current and recommended investment options.
- Plan fiduciaries should document the reasons for all decisions related to investments, especially if they decide to choose a more costly class share. Note that the Ninth Circuit stated that expense ratios for mutual funds ranging from 0.03 to 2% were considered ordinary.
- Plan fiduciaries should review the mutual funds in their plans and determine whether to include or remove certain funds. This review should include determining which mutual funds have revenue sharing, the amount of the revenue sharing, and the costs associated with these funds.
- Plan documents should contain language granting the plan administrator, and perhaps other fiduciaries, full discretion to construe and interpret the terms of the plan. This is especially important for Plans in the Third, Sixth, and Ninth Circuits, because courts in these appellate circuits have applied a deferential standard of review to fiduciary duty claims as well as to benefit claims.
- Plan fiduciaries in the Sixth or Ninth Circuits should be aware that section 404(c) may not protect them from liability if a participant brings a claim alleging imprudent selection of investment funds.