Economic Analysis in ERISA Litigation over Fiduciary Duties

Transcription

1 1 September 2011 Economic Analysis in ERISA Litigation over Fiduciary Duties By Dr. John Montgomery 1 Published as a three-part series in The Employment Law Strategist, July-September 2011 In the past decade, numerous lawsuits have been brought under ERISA against the fiduciaries and sponsors of 401(k) and other defined contribution retirement plans. Many of these lawsuits have been pled as class actions on behalf of all or many participants of the plan. The most common lawsuits have involved declines in the value of employer stock offered in the plans and allegations that decisions to maintain employer stock in the plans were imprudent. There have also been some lawsuits over other investment options, as well as lawsuits over the management of collateral from securities lending programs run by plan trustees. Another substantial category of litigation has involved allegations of excessive fees. Many of these cases, both investments and fees, have also involved allegedly inadequate disclosure of information to plan participants. Economic analysis plays an important role in many of these cases. The purpose of this paper is to discuss some of the important economic issues that arise in ERISA litigation, both in establishing liability and in calculating damages. From an economic point of view, the question of liability involves three related questions. First, what should investors do? Second, what do they do? And third, what should fiduciaries do about these facts? In financial economics, as in other branches of economics, researchers study two related subjects: the normative question of what investors should do, and the positive question of what they actually do. Normative questions are typically structured around a model of how financial markets work, and ask what analyses and choices constitute the optimal approach for investors. Positive questions involve the examination of data on financial markets and investor actions to assess how investors actually make their investment choices and how far these choices differ from particular models of financial markets and optimal investor choices. 1 Dr. Montgomery is a Senior Vice President with NERA Economic Consulting. The author thanks David Tabak for his helpful comments.

2 I will argue that both the normative and positive branches of financial economics are relevant to such litigation. The prescription of ERISA Section 404(a)(1)(B), the prudent man standard, involves both. 2 Its requirements of care, skill, prudence, and diligence would appear to require that fiduciaries do the best possible job for participants, and the normative branch of financial economics addresses what constitutes the best possible job. However, the standard also involves a comparison to others acting in a like capacity, suggesting a positive analysis of the choices of others involved in similar financial decision-making. In this article, I will begin by discussing the basic structure of the theory of investment decisions within financial economics based on portfolio theory and the efficient markets hypothesis; this can be viewed as a theory about what investors should do. I will then discuss empirical challenges to this theory, constructed around work on behavioral finance, which introduces psychological insights on what investors actually do. I will discuss the implications of both of these approaches to litigation on fiduciary duties within defined contribution (DC) retirement plans. I will then review the implications of financial economics for the administration of DC plans, including issues related to litigation over allegations of excessive fees. The article will conclude with a discussion of damages issues in litigation related to price drops in employer stock within DC plans, addressing both the issue of the appropriate alternative investment return for calculating losses and the question of whether initial plan holdings of employer stock should be included in damage calculations. Efficient Markets and Portfolio Theory In considering fiduciary decisions related to investment options offered in defined-contribution plans, courts have shown a particular interest in two concepts from financial economics. One is Modern Portfolio Theory, which relates to the body of knowledge on how investors should construct an investment portfolio. 3 The other is the Efficient Market Hypothesis, which holds that securities prices reflect available information, such that it is not possible to obtain predictable, extraordinary profits from investing. 4 These concepts provide the basis for both normative approaches to financial economics and positive approaches, with empirical investigations focused on assessing the conformance of securities prices and investor behavior with these principles. Rational models of investment decision-making form part of the bedrock of financial economics. These models are based on the assumption that investors are risk-averse, such that they seek to make investments that minimize risk for any given level of expected return, or (equivalently) maximize expected return for any given level of risk. An investment portfolio that meets these conditions is known as an efficient portfolio. The specific portfolio that meets these conditions depends on the information used to assess risk and expected return, and also on the exact nature of an individual s risk aversion. It also depends on the statistical properties 2 a fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims. 29 U.S.C. 1104(a)(1) and 1104(a)(1)(B). 3 The 4th Circuit discussed Modern Portfolio Theory in DiFelice but concluded that it was not relevant in that case. DiFelice v. U.S. Airways, Incorporated, 497 F.3d 410, 423 (4th Cir., 2007). 4 See Summers v. State Street Bank & Trust Co., 453 F.3d 404, 408 (7th Cir. 2006). 2

3 of financial returns. A general implication of portfolio theory is that diversified portfolios are more efficient than concentrated portfolios. This is a key insight of Modern Portfolio Theory. Interpreted strictly, it is a normative description of what investors should do, but to the extent that one accepts the assumption that investors rationally pursue their self-interest, it forms the basis for positive analysis of what investors actually do. The Efficient Markets Hypothesis (EMH) holds that competition among investors drives expected returns on investments to a level such that expected returns are a function only of the systematic risk factors embodied in the value of the underlying investment. A simple model of these risk factors is that of the Capital Asset Pricing Model, which predicts that the expected return on any investment depends only on the risk-free interest rate, the expected return on the entire market for investments, the correlation in returns between the market and the specific investment, and the relative volatility of the market and the specific investment. 5 Financial economists have long distinguished between different forms of the EMH based on the types of information that market prices are assumed to reflect. The weak form implies that the market for an investment is efficient with respect to information about that investment s past prices; the semi-strong form implies that the market is efficient with respect to all publicly available information; and the strong form implies that the market is efficient with respect to all information, including private information. The general presumption among economists is that major financial markets are usually and approximately semi-strongform efficient. This presumption is based on the idea that any return exceeding the markets compensation for risk will quickly be competed away by investors. The EMH has several important implications for investment decision-making. Probably the most important is that the EMH generally implies that expected returns on a particular stock (or other asset) will reflect only the baseline, risk-free interest rate plus a compensation for the non-diversifiable, systematic component of the risk of the stock. Thus the stock price already reflects the market s assessment of any possible future drops or jumps in a stock price due to negative or positive information. In the case of a typical employer stock, this implies that the stock price already reflects any possibility of the stock s declining in value. Stocks of troubled companies, such as United Airlines following the 2001 terrorist attacks, already reflect bad news that has been publicly released. They do not have worse expected returns than other stocks. As the 7th Circuit noted in its opinion regarding United Airlines, however, it is possible that such a stock would embody greater risk than other stocks, because its previous decline in value diminished its equity value relative to its debt value, making that equity value more sensitive to any news about the company. 6 I will return to this issue below. 5 These last two factors determine beta, the familiar statistic summarizing the relationship between a stock return and market returns. 6 See Summers, 453 F.3d at

4 Another implication of the semi-strong form of the EMH is that diversified portfolios are superior to concentrated portfolios, at least in the absence of private information about the prospects of specific investments relative to the market. Since the EMH holds that extraordinary returns cannot be predicted, a diversified portfolio reduces risk without reducing expected returns. ERISA, of course, generally encourages diversification, 7 although the portfolio choices made by individuals in DC plans may sometimes be undiversified, particularly when undiversified options such as company stock are offered to participants. Despite the general presumption of efficiency in major securities markets, the efficiency of markets for particular securities is frequently subject to question. Courts in securities matters have recognized numerous tests for market efficiency. Cammer v. Bloom is undoubtedly the most influential decision. It mentions factors that might be considered as part of an analysis of market efficiency. One of these considers the reaction of a security s price to relevant news. 8 Other courts have recognized these factors and added some other considerations. In Polymedica, a court also recognized constraints on securities lending as a factor that could inhibit short-selling and therefore prevent efficiency. 9 Relevance of Behavioral Finance Despite the appeal of the semi-strong form of the EMH, several sources of doubt exist. The first is that various empirical anomalies have been documented that appear to represent departures from the EMH. These anomalies typically suggest the existence of predictable returns in excess of the market s compensation for systematic risk. A considerable debate exists over whether some of these anomalies represent departures from market efficiency or whether instead they might be due to different forms of systematic risk, such as a differential risk associated with stocks of smaller capitalization companies. The existence of anomalies representing uncompensated excess returns is difficult to square with the existence of informed investors intent on maximizing their investment returns. A general explanation is that the anomalies may be due to the limits of arbitrage, involving limitations placed on traders and investors attempting to take advantage of excess returns available in the market. 10 Arbitraging such excess returns involves the assumption of risk and may involve borrowing, or it may involve selling investments short. In either instance, there are limits to any trader s ability to undertake such activities. Aggregate limitations, such as limits on credit availability or on the availability of securities to borrow for short sales, may permit apparent market inefficiencies to persist. In the view of a seminal series of articles by DeLong et al., rational traders may unable to marshal the resources to prevent irrational, noise traders from driving securities prices away from fundamentals See 29 U.S.C. 1104(a)(1)(C). 8 The other four are a stock s average weekly trading volume, the number of securities analysts following a company, the company s eligibility to file SEC registration form S-3, and the number of market makers for the stock. Cammer v. Bloom, 711 F. Supp. 1264, (D.N.J. 1989). 9 In re Polymedica Corp. Sec. Litig., 453 F.Supp.2d 260 (D.Mass. 2006). 10 See Andrei Shleifer and Robert W. Vishny, The Limits of Arbitrage, Journal of Finance, 52:1, March 1997, pp See, for example, J.B. DeLong, A. Shleifer, L. Summers, and R. Waldmann, Noise Trader Risk in Financial Markets, Journal of Political Economy, 98, 1990, pp

5 Since the early 1990s, a substantial literature has developed in behavioral finance, some of which is devoted to linking apparently irrational trading behavior to psychological tendencies and biases. One of the best known of these tendencies is prospect theory, developed by Kahneman and Tversky. 12 In part this theory stresses the importance of a reference point for evaluating the risk of different outcomes. An application of this is the disposition effect, which holds that investors are reluctant to sell stocks on which they have a capital loss, because they are psychologically averse to recognizing the loss. 13 The direct relevance of behavioral finance for investment decision-making is unclear. It does not appear to change the basic goal of portfolio managers to aim for some combination of maximum expected return and minimum risk. It may, however, have implications for the dynamics of asset prices, and, to the extent that behavioral factors introduce market inefficiencies, it may also imply that optimal portfolios no longer track broad market indices. Behavioral finance is probably more relevant for the specific task of administering a 401(k) plan, because it has lessons for the behavior of individual investors when faced with a menu of investment options. I will return to this issue below. Implications for ERISA Litigation ERISA provides little guidance on the extent to which fiduciaries should consider the likely behavior of plan participants. ERISA 404(c) absolves plan administrators from liability for the consequences of participants investment choices, as long as a plan offers a broad range of investment alternatives and a plan fiduciary provides participants with information on the investment alternatives, among other requirements. 14 Yet among the possible portfolios that might be constructed from options offered by a plan, some portfolios are likely to be more prudent than others. It is unclear the extent to which administrators need to consider the poor choices that participants might make. Indeed, this may be an impossible task, as the prudence of different portfolios may depend on other investments participants may have outside their plan assets. In the case of eligible individual account plans, employer stock is an exception to the ERISA requirement that plan investments be diversified. 15 Courts have developed a doctrine of a rebuttable presumption that employer stock is a prudent investment in these situations. A Department of Labor bulletin suggested limited circumstances in which an employer stock might be imprudent, especially a situation of bankruptcy filing in which there is little likelihood of a stock obtaining any value. 16 But under the EMH, or even if markets are not efficient but still reasonably responsive to public information, it is highly unlikely that a stock could be liquidated with any substantial recovery in such a situation. 12 Daniel Kahneman and Amos Tversky, Prospect Theory: An Analysis of Decision under Risk, Econometrica, 47:2, March 1979, pp See Terrance Odean, Are Investors Reluctant to Realize Their Losses? Journal of Finance, 53:5, October 1998, pp See 29 C.F.R c See 29 U.S.C. 1104(a)(2). 16 US Department of Labor, Employee Benefits Security Administration, Fiduciary Responsibilities of Directed Trustees, Field Assistance Bulletin , December 17, 2004, p

6 Against this possibility, the 7th Circuit has suggested that as a stock declines in value, it also generally becomes riskier as the market value of a company s debt/equity ratio increases, and that there may be a point at which the stock becomes sufficiently risky for it to be imprudent. But at least in part because this issue was not specifically before the court, the court provided no guidance as to the level of risk that would trigger a finding of imprudence. 17 A separate issue arises in many cases involving drops in the value of employer stock. These cases, which generally piggyback on shareholder class action involving alleged securities fraud, are based on allegations that corporate officials possessed negative, non-public information about the company s business and therefore about the value of the company s stock. Plaintiffs assert that defendants are liable both for not having properly disclosed pertinent information and for not having removed the company stock as an investment option in the plan. The disclosure parts of these claims closely track claims in the shareholder class actions. In these situations, the lack of disclosure, assuming it is material to at least some investors (and assuming an efficient market), implies that the stock would have been trading at an inflated price. Investors who purchased at the inflated price are considered in securities cases to have relied on the fraudulent information because that information would be incorporated into the stock price in an efficient market. (For some stocks, courts reject a finding of an efficient market, leaving plaintiffs unable to use this fraud-on-the-market approach.) Participants in an ERISA plan who invested in employer stock would presumably suffer the same harm as other investors who are members of the class for the shareholder class action. A grey area is whether the plan would be a member of the securities class or whether each participant of the plan who bought stock at an inflated price and held past the corrective disclosure (or disclosures) would be a member of the class. Shareholder class actions generally presume that a loss due to revelation of previously misstated information was foreseeable to defendants. In an ERISA context, the existence of such a foreseeable loss obviously lowers the expected return on the stock below general market returns (adjusted for risk). An unresolved issue is the amount by which the expected return would have to decline for the investment to become imprudent. An insider who knows about the misstated information may know other, more favorable facts about the company that might suggest strong returns in the future. A plaintiff would presumably need to show that the balance of information available to the defendant indicated that the stock would have a below market return. If all information except the misstated information is public, then an efficient market implies that the misstated information will lead to a negative return on average. However, that negative return might be small relative to the overall variation in the stocks return. A typical measure is the Sharpe ratio, which is the ratio of an investment s expected return (in excess of a risk-free return) to its volatility. For volatile stocks, a small change in the expected return may result in little difference in the Sharpe ratio. 17 See Summers v. State Street Bank & Trust Co., 453 F.3d 404, (7th Cir. 2006). 6

7 ERISA stock-drop cases that piggyback on shareholder class actions also typically include a claim that defendants harmed plan participants by failing to correctly disclose the misstated information. In a shareholder class action, the misstated information would be tied to an inflated stock price. The only plan participants who could be harmed by inflation would be those who purchased more shares at an inflated price than they sold. Several types of analysis used in shareholder class action are also relevant in this context. First, an analysis of company disclosures, news, and analyst reports can shed light on whether the allegedly misstated information was in fact misstated, or whether it was provided to the market on a timely basis. Second, an event study can determine whether the corrective disclosure had a meaningful, statistically significant impact on the stock price. The economist using this statistical technique can filter out fluctuations in the stock price due to market or industry factors, and the economist can also determine whether the resultant excess return is statistically significant, that is, whether it is larger than the overwhelming share (generally defined as 95%) of typical, random movements in the stock price, and therefore likely the product of the release of information that was material to investors. Third, the analyst can perform a battery of tests related to the question of whether the stock trades in an efficient market, in which all information is rapidly incorporated into the stock price. If the market is efficient, then courts would typically support a finding that the misstated information resulted in an inflated stock price. Discussions of efficient markets often imply that there is only one correct price for a security. Under this view, investors, considering the same public information, all arrive at the same belief about the value of an investment. All investors, or at least all professional investors, would have the same expectations for an investment s return. A more nuanced approach, however, is that investors may have different beliefs about the value of an investment, even when in possession of the same information. The price of an investment, in this instance, represents a balance of opinions by different investors, some who might think it undervalued and others who might think it overvalued (and either don t hold the investment or hold a short position). Others may simply rely on the market price providing a fair estimate of the value of the investment, given all other opinions. The implication of this approach for fiduciary duty is that a range of actions may be equally reasonable. One prudent investor might invest in a risky asset, thinking it undervalued or at least fairly valued, while another might avoid the investment or sell it short, thinking it overvalued. Both may make their investment decisions carefully, but they may be shaped by different approaches or beliefs. The market price ends up at the point at which demand by the optimists absorbs the market float and any short interest created by the pessimists. 7

8 The 7th Circuit, at least, has held that it is not imprudent to rely on the market price. 18 This is consistent with the presumption that the market price represents a good approximation of the stock s true value, even if investors hold varying opinions. In at least one other instance, a circuit court has decided that a prudent fiduciary need not rely on the market price and may expend time and resources to develop its own opinion on the value of the stock. 19 The usefulness of such an exercise, at least for large capitalization, heavily traded stocks, is open to doubt. Provision of Financial Services with Choice A DC plan is a financial service to its participants. The primary service provided is a vehicle for saving for retirement. It can also provide a means to invest in one s own company, with that investment also providing a vehicle for savings. The provision of various ancillary services is also part of the package, including loans from plan balances and mechanisms for learning about and choosing among different investment options. The concept of a DC plan as a financial service is particular relevant in litigation over allegedly excessive fees in a 401(k) plan. The fees paid by a plan must be weighed against the services that those fees provide. These services are typically provided in a bundle, so there is often no information about the cost of particular services. A comparison of the costs of a 401(k) plan to other financial services used for retirement savings can therefore provide evidence on the reasonableness of fees for the 401(k) plan. A natural comparison is to mutual funds, since a set of mutual funds embodies the options normally found in a DC plan, excluding employer stock, and since mutual funds also provide investment information and accounting similar to that provided in a DC plan. The convenience of a 401(k) plan may justify a higher level of cost. When an individual undertakes investment, he or she has to search for appropriate financial firms and for appropriate investments. By offering these conveniently to employees, a 401(k) plan can help economize on participants time. Its availability and convenience also encourages savings, counteracting the typical psychological reluctance to delay gratification. Lessons from behavioral finance are particularly relevant here. First, the default option offered by a plan can have a substantial impact of participant investment choice. 20 This could be because participants perceive an endorsement of the investment option by their company s officials (acting as plan fiduciaries). It could also be due to the substantial inertia in investment decisions that has been documented among investors See Summers, 453 F.3d at See Bunch v. W.R. Grace & Co., 555 F. 3d 1 (1st Cir. 2009). 20 See, for example, Olivia S. Mitchell, Gary R. Mottola, Stephen P. Utkus, and Takeshi Yamaguchi, Default, Framing and Spillover Effects: The Case of Lifecycle Funds in 401(k) Plans, National Bureau of Economic Research Working Paper 15108, June See Olivia S. Mitchell and Stephen P. Utkus, Lessons from Behavioral Finance for Retirement Plan Design, chapter 1 in Pension Design and Structure: New Lessons from Behavioral Finance, Mitchell and Utkus eds., Oxford University Press, 2004, at p

9 Consumers of financial services have also been shown to have difficulty managing complex information. 22 Thus, more complex investment menus may not yield better investment decisions, and in fact may lead participants to adopt rules of thumb. Moreover, allegations in excessive fees cases that participants should have received more detailed disclosure of fee arrangements imply that participants should have received more complex information. It is not evident that participants would benefit from this type of disclosure, in that the need to understand all the information may lead them to avoid making active decisions to contribute to their 401(k) and choose suitable investments. Loss Calculations the Selection of But-for Returns ERISA gives participants the right to sue fiduciaries for plan losses. These losses are normally calculated as the difference between the actual plan value and the but-for value if the breach did not occur. In lawsuits over the selection of investment options (including company stock), the approach laid out in Donovan v. Bierwirth is often followed. 23 That approach involves a comparison between the actual investment returns and the returns on an alternative investment. This raises the question of what the alternative investment should be. Donovan says that of the plausible investment alternatives, the one with the returns most favorable to the plaintiffs should be chosen. If the litigation is about a 401(k) plan, then the plausibility test requires a coherent argument about what loss the breach might have caused: if the offending investment (usually employer stock) had not been offered by the plan, in what alternative would participants instead have invested? 24 Plaintiffs in such cases would obviously want to claim that the all investments are plausible, permitting them to choose the best performing investment in the plan, which would maximize the calculated loss. But this approach fails to pass the test of plausibility. It is not possible to choose the best-performing investment option in advance, and therefore it is not plausible to argue that participants would all have placed their money in this option. This argument is emphasized by the 7th Circuit in Leister v. Dovetail. 25 The 7th Circuit instead supported taking the overall investment return in the plan as the alternative investment. This approach makes sense if there is reason to think that the additional investment would be similar to existing investments. The Leister case involved a lawsuit over money that the defendant had failed to deposit in the plaintiff s 401(k) plan, and the 7th Circuit suggested the return on the plaintiff s actual investments would be a guide to the return she would have obtained on additional contributions. In other circumstances, however, this may not be plausible. 22 See Julie Agnew and Lisa R. Szykman, Asset Allocation and Information Overload: The Influence of Information Display, Asset Choice and Investor Experience, Journal of Behavioral Finance, 6:2, 2005, pp ; Gerry Gallery, Natalie Gallery, and Kerry Brown, Superannuation Choice: The Pivotal Role of the Default Option, Journal of Australian Political Economy, Special Issue June 2004, iss. 53, pp Nancy G. Ross and Steven W. Kasten, Calculating Damages in 401(k) Litigation Over Company Stock, Benefits Law Journal, 19:1, Spring 2006, pp Some of the issues in this section and the next are also discussed in Cathy M. Niden, Economic Analysis in ERISA Class Actions Involving Employee Investments in Company Stock, Benefits & Compensation Digest, 44:4, April Leister v. Dovetail, Inc., 546 F.3d 875, 880 (7th Cir. 2008). 9

10 In particular, for lawsuits alleging that an investment option should have been removed from a plan, we would expect that when an investment option is removed, participants would reallocate their portfolios to maintain a similar balance of risk and return to the balance they had before the removal of the investment option. Employer stock, for example, would plausibly be replaced by equity investments of similar volatility. Damages Calculations with Allegations of Misstatements or Omissions As I discussed above, many ERISA lawsuits over employer stock involve alleged misstatements or omissions by the employer or its officers. This implies that the price of the stock is allegedly inflated. In such cases, the but-for world might involve either investment in an alternative investment or investment in a hypothetical version of the employer stock without inflation. The latter, hypothetical option can be estimated based on estimates of the alleged stock price inflation. Approaches used in shareholder class actions, where inflation is estimated from stock price reactions to corrective disclosures, using event study techniques, could be applied to ERISA cases. 26 Plan participants may actually benefit from inflation, because they are able to sell their holdings of employer stock at a higher price than if the misstatements or omissions had been corrected. Such participants may not have a claim to a loss. Moreover, their presence may potentially result in the plan as a whole gaining from the misstatements, if in aggregate, the plan gained more from selling stock at an inflated price than it lost by purchasing stock at an inflated price. The alleged misstatements or omissions delayed a drop in the stock price that would otherwise have come earlier and caused a greater loss to the plan. A distinction between ERISA damages and damages in shareholder class actions is that in shareholder class actions, shares held at the start of the class period do not qualify for damages in the shareholder class action, because these class actions require a purchase of the security in question. In contrast, holders do potentially qualify for damages in an ERISA case. If the offending investment option had been removed from the plan, holders investments would have been switched to other, presumably prudent options, and they may have had better returns in those options. However, if the allegations involve misstatements or omissions, it is not reasonable to claim damages for holders in the ERISA case. If plan fiduciaries were aware of the misstatements or omissions and removed the employer stock as an option, they might run afoul of securities laws against insider trading. But if they instead corrected the information, the stock would have dropped to its true value, and holders of the stock would have lost anyway. So in such a case, holders should not be able to claim a loss, and may in fact have a benefit. Not only should they be excluded from damage calculations, but any gains they might have from sales at allegedly inflated prices should be offset against their losses from subsequent purchases. 26 Analysis in these cases is generally based on the assumption that the stock trades in an efficient market and therefore rapidly reflects any publically disclosed information. 10

11 A similar argument may be made for non-disclosure cases. The removal of employer stock as an option from a plan may by itself cause the price of the stock to drop. One possible reason is that the removal may be taken as an indication that the officers of the company are pessimistic about the company s prospects, and possibly that they have non-public information, which could cause other investors to lower their assessments of the stock s value. The other possible reason is that liquidation by a plan of its holdings of company stock implies downward pressure on the stock from the volume of sales as the holdings are liquidated. In either case, holders of employer stock would suffer a loss if the fiduciaries of the plan followed the allegedly prudent course and liquidated the stock. These issues may also give rise to serious conflicts between class members. If there is any ambiguity about the nature of the alleged misrepresentations or their timing, the class representative will have an incentive to maximize his or her own damages when resolving the ambiguities. That may not serve the interests of other class members or indeed of the class or plan in aggregate. For example, if the class representative first sold stock and then purchased additional shares, he or she would prefer that the class period begin after the sales and before the purchases, to maximize the alleged loss due to the misrepresentations. Other class members, or the plan in aggregate, may obtain larger losses with an earlier start date for the class period. Conclusion In this article, I have sketched out some important areas where financial economics can provide useful insights in ERISA litigation. Financial economists analyze both the question of what investors should do and what they actually do. Although these two concepts are distinct, they both provide important insights on how fiduciaries to defined contribution plans should act. I have also touched on some of the important issues financial economists confront when they calculate alleged damages in ERISA litigation. 11

12 About NERA NERA Economic Consulting ( is a global firm of experts dedicated to applying economic, finance, and quantitative principles to complex business and legal challenges. For half a century, NERA s economists have been creating strategies, studies, reports, expert testimony, and policy recommendations for government authorities and the world s leading law firms and corporations. We bring academic rigor, objectivity, and real world industry experience to bear on issues arising from competition, regulation, public policy, strategy, finance, and litigation. NERA s clients value our ability to apply and communicate state-of-the-art approaches clearly and convincingly, our commitment to deliver unbiased findings, and our reputation for quality and independence. Our clients rely on the integrity and skills of our unparalleled team of economists and other experts backed by the resources and reliability of one of the world s largest economic consultancies. With its main office in New York City, NERA serves clients from more than 20 offices across North America, Europe, and Asia Pacific. Contact For further information and questions, please contact the author: Dr. John Montgomery Senior Vice President john.montgomery@nera.com The opinions expressed herein do not necessarily represent the views of NERA Economic Consulting or any other NERA consultant. Please do not cite without explicit permission from the author.