The plaintiffs' bar for many years has filed lawsuits around the country against ERISA plan fiduciaries challenging the appropriateness of investment options in defined contribution plans, both with respect to the fees charged by such investments and their performance compared to other available investments. Over the past few years, there have been dozens of district court decisions addressing the sufficiency of—or lack thereof—those allegations.
This article focuses on three decisions, all of which are on appeal to their respective Circuits and are on track to be fully briefed in the coming months. The cases are Brotherston v. Putnam Invs., LLC, Case No. 17-1711 (1st Cir.); Sweda v. Univ. of Pennsylvania, Case No. 17-03244 (3d Cir.); and White v. Chevron, Case No. 17-16208 (9th Cir.). In White and Sweda, the plaintiffs attacked investment options that were not affiliated with the defendants; while, in Brotherston, the plaintiffs challenged affiliated investment options.
Non-Affiliated Fund Claims Retail Share Class v. Institutional Share Class Claims
Plaintiffs often challenge the prudence of including in plan investment lineups retail share classes of mutual funds over less expensive institutional share classes. In both White v. Chevron, (N.D. Cal. May 31, 2017) and Sweda v. Univ. of Pennsylvania, (E.D. Pa. Sept. 21, 2017), the defendants persuaded the district courts to dismiss those claims.
In White, plaintiffs alleged in their complaint that participants lost more than $20 million through unnecessary investment fees associated with certain Vanguard funds (including some with fees as low as 5 bps) because there allegedly were identical Vanguard funds available with lower-cost share classes. The court explained that plaintiffs' complaint failed to create a plausible inference of disloyal conduct because it was devoid of any allegations of self-dealing or conflicts of interest. The court also determined that an imprudence claim could not stand merely by providing comparisons between funds in the plan and funds that were purportedly less expensive. In so ruling, the court explained that, even if it improperly shifted the burden to defendants to provide an explanation for their decisions, as plaintiffs desired, defendants had an "obvious" rationale for being in the retail-class shares, i.e., the revenue sharing fees associated with these higher-cost share classes paid the plan's recordkeeping expenses.
In Sweda, the court dismissed a similar claim, observing that nearly half of the plan investment options were in the institutional share class, and that there were reasons why a plan fiduciary would not, or could not, move the other investments into institutional share classes, such as high minimum investment requirements. The court explained that fiduciaries cannot discharge their duties with a "myopic focus on the singular goal of lower fees." Rather, ERISA requires a more nuanced balancing act, obligating fiduciaries to provide a diverse range of investment options while simultaneously defraying expenses where possible.
Claims alleging that plan fiduciaries breached their duties by failing to remove underperforming investment options sometimes survive motions to dismiss when plaintiffs allege that the investment option had a history of underperformance. District courts, however, have become more skeptical of these claims, particularly when plaintiffs' allegations offer only a hindsight evaluation of an otherwise prudent decision. In White, for example, plaintiffs asserted that the fiduciaries breached their duties by offering and retaining a small-cap value fund that significantly underperformed its benchmark, peer funds, and comparable lower-cost investments. The court determined that plaintiffs' hindsight analysis was insufficient to state a claim. In Sweda, the court applied the same reasoning, even though just under half of the investment options outperformed their benchmark.
Stable Value Fund Claims
Plaintiffs have challenged a plan fiduciary's decision to include a money market fund, as opposed to a stable value fund, as a plan investment option because plaintiffs view stable value funds to be "safer" investments. The White plaintiffs argued that stable value funds outperformed money market funds during the putative class period, and that the decision to maintain a money market fund caused plan participants to lose over $130 million in retirement savings. Observing that ERISA does not have a per se rule requiring a 401(k) plan to offer a stable value fund as the plan's low-risk capital conservation option, the White court concluded that plaintiffs' attempt to infer an imprudent process from the inclusion of a money market fund instead of a stable value fund was implausible.
Administrative Fee and Revenue Sharing Agreement Claims
Plaintiffs have taken issue with revenue sharing agreements and arrangements with recordkeepers that they claim are not in the best interest of participants. In White, plaintiffs argued that the asset-based revenue sharing arrangement (in lieu of a fixed per-participant fee) was imprudent because, as the plan's assets increased, the fees paid to the plan's recordkeeper increased, even though there were no additional services provided. The court found plaintiffs' allegations were insufficient to state a claim because they did not allege the amount paid by the plan under the revenue sharing agreement and instead merely provided unsubstantiated estimates. The court also observed that ERISA imposes no obligation on fiduciaries to forecast future asset levels and proactively renegotiate asset-based fee arrangements.
The White plaintiffs also alleged that self-interest motivated Chevron to maintain the high-paying assets-based revenue sharing agreement with Vanguard, because Vanguard held a significant amount of Chevron shares in its mutual funds and allegedly had a practice of submitting proxy votes that favored Chevron's management. The court rejected that argument as well because plaintiffs failed to allege facts establishing that the plan fiduciaries were aware of Vanguard's voting practices or that Vanguard took a uniquely pro-management position with respect to Chevron.
The Sweda court rejected a similar claim, finding that it was within the plan fiduciary's discretion to determine a prudent arrangement. The court noted that in the asset-based model participants with higher account balances pay more, but under the flat per-participant model each participant pays the same amount regardless of account balance, meaning that participants with very small accounts pay as much as those with large accounts. Given that reality, the court stated that it would not infer it was imprudent for the fiduciary to choose an asset-based model.
Plaintiffs also alleged that the plan fiduciaries breached their duties by "locking" the plan into agreements with the plan's recordkeepers that required the plan to include certain investment options and by using two recordkeepers instead of one. The court found the locking-in claim implausible given that it is a common practice that allows parties to obtain better terms in exchange for agreeing to longer contractual periods. The court similarly determined that using multiple recordkeepers, each of whom had their own bundled investment options, was not imprudent, since it is common to bundle services to obtain the best possible terms from a recordkeeper.
Prohibited Transaction Claims
In addition to fiduciary breach claims, plaintiffs sometimes bring prohibited transaction claims, alleging that the plan provided a benefit to a party-in-interest. In general, fees paid to service providers are exempt from the party-in-interest prohibitions if the payments are found to be reasonable. In both White and Sweda, plaintiffs alleged that the plan paid excessive fees to recordkeepers, thereby precluding application of the prohibited transaction exemption for reasonable service provider fees. The White court dismissed the claim as time-barred under ERISA's six-year statute of limitations because the agreement between the plan and its recordkeeper dated back fourteen years before the complaint was filed. The Sweda court reached the merits of the claim and found that the mere act of paying a recordkeeper for its services, in the absence of additional allegations that the agreement would benefit plan fiduciaries at the expense of the plan participants and beneficiaries, could not establish a prohibited transaction.
Affiliated Fund Claims
In contrast to the claims discussed above, the plaintiffs' bar has been more successful in surviving a motion to dismiss where, as in Brotherston v. Putnam Invs., LLC, (D. Mass. June 19, 2017), they bring fiduciary breach claims challenging the inclusion of affiliated funds in a plan's investment lineup. In fact, some of the claims against Putnam Investments went to trial. But the claims ultimately were dismissed.
The plan participants alleged that defendants breached their fiduciary duties of loyalty and prudence and engaged in prohibited transactions by including affiliated mutual funds as investment options and by failing to offer the cheaper share class of those funds for a significant part of the putative class period. The court initially denied defendants' motion to dismiss, finding plausible plaintiffs' allegation that the plan fiduciary's decision to include affiliated funds was made to benefit the employer/investment company. The court subsequently denied defendants' motion for summary judgment on plaintiffs' fiduciary breach claims, finding that genuine issues of material fact precluded judgment on those claims. After a "case stated hearing," the court dismissed plaintiffs' prohibited transaction claims as time-barred or falling within an exemption to ERISA's prohibited transaction rules.
Following a bench trial, the court granted judgment for defendants on the remaining claims. It determined that, based on the totality of the circumstances, plaintiffs had failed to show that defendants' decision to include affiliated funds in the plan investment lineup amounted to a breach of loyalty where defendants also made substantial discretionary contributions to the plan (more than $40 million during the putative class period), provided additional services to plan participants, and paid for recordkeeping expenses. While the court declined to enter conclusive findings on whether defendants acted imprudently, the court determined that plaintiffs failed to establish a prima facie case of loss. In so ruling, the court rejected plaintiffs' theory that the entire investment lineup was imprudent because the plan relied on the expertise of Putnam's own investment division (and therefore lacked an independent monitoring process), finding that it was too sweeping and failed to pinpoint specific investment decisions that caused the participants to lose money. The court considered plaintiffs' theory an "unwarranted expansion of ERISA's seemingly narrow focus on actual losses to a plan resulting from specific incidents of fiduciary breach."
The decisions in White and Sweda, on the one hand, and Brotherston, on the other hand, reflect the tendency at the district court level to distinguish viable from nonviable claims based on whether they include plausible allegations of self-dealing. It remains to be seen whether the appellate courts will draw the same distinctions. Regardless of the outcome of the forthcoming appeals, we anticipate that the appellate decisions will offer useful guidance to plan sponsors and fiduciaries.