Recent trends in ERISA litigation

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1 RETIREMENT INSIGHTS SERIES A valuable resource for advisors looking to grow their retirement business. Recent trends in ERISA litigation At Groom Law Group, where he currently serves as the firm s Chairman, Stephen M. Saxon works on a wide variety of administrative, litigation, and legislative matters involving tax-exempt organizations and ERISA. He specializes in matters relating to Title I of ERISA, with respect to which he has obtained scores of advisory opinions and exemptions. Mr. Saxon also represents tax-exempt clients in IRS audits and appeals procedures, as well as in restructuring non-profit organizations to address unrelated business income tax and other issues. In addition, he has worked on numerous DOL audits of plans and financial institutions that service plans. He heads up the firm s special practice groups on pension plan investments and on 401(k) plan administrative and investment management matters. Among other things, these groups focus on the ERISA, securities, banking, and tax issues that arise in connection with the offering of products to employee benefit plans. He has his B.S. from Colgate University and his J.D. from Georgetown University Law Center. Executive summary Hardly a day goes by when we don t see a new class action lawsuit brought against plan sponsors and their advisors ( plan fiduciaries ) regarding the management and administration of retirement plans. Making things worse, plaintiff s theories upon which they are claiming that plan fiduciaries violated duties to the plan have become wide-ranging and complex. Given the frequency of such suits and the significant potential liability relating to claims made under the Employee Retirement Income Security Act of 1974, as amended ( ERISA ), plan fiduciaries should familiarize themselves with the types of claims being raised. While the majority of claims raised against plan fiduciaries are ultimately unsuccessful, the amount of resources needed to defend, settle, and otherwise resolve these kinds of disputes presents an ongoing concern for those of us in the retirement plan industry. In this piece, we describe the major allegations and cases that have shaped the delivery of retirement investments and services to plans and on how these services are paid for. This article describes these trends, with particular focus on recent litigation involving (1) plan fiduciaries, (2) plan service providers, and (3) company stock. Plan fiduciaries should understand the common allegations made by plaintiffs attorneys and the implications of the case outcomes for their retirement plans. As they say, an ounce of prevention is worth a pound of cure. FOR INSTITUTIONAL USE ONLY. NOT FOR DISTRIBUTION TO THE GENERAL PUBLIC.

2 I. Background ERISA is a comprehensive federal law governing employee benefit plans. Title I of ERISA imposes various fiduciary duties on those who manage and administer plans. Among other things, ERISA s fiduciary rules require that plan fiduciaries act prudently solely in the interest of plan participants, and that plan assets be held for the plan participants benefit and not be diverted for use by the plan sponsor or any other party. The ERISA fiduciary rules apply to a broad range of employer sponsored plans, including 401(k) plans and other defined contribution plans, defined benefit plans, and 403(b) plans. As fiduciaries to the plan, plan sponsors and their advisors must meet strict standards of conduct in fulfilling their responsibilities to the plan and plan participants. In general, plan fiduciaries are subject to the following rules: Fiduciaries must act solely in the best interests of, and with the exclusive purpose of providing benefits to, plan participants and their beneficiaries. Fiduciaries must avoid conflicts of interest and defray reasonable plan expenses. Fiduciaries must carry out their duties with the care, skill, prudence, and diligence that a person familiar with the matter at hand would use. Plan assets must be diversified to reduce the risk of large investment losses, unless, if under the circumstances, it is clearly prudent not to do so. Fiduciaries must follow the terms of the plan document insofar as they are consistent with ERISA. Fiduciaries must ensure that any plan expenses paid from plan assets, including investment-related expenses, are for services that are necessary to the administration of the plan and that such expenses are reasonable. Under ERISA, plan fiduciaries may be personally liable for plan losses caused by a breach of their fiduciary duties, whether or not intentional. ERISA also entitles participants to bring suit to recover damages for such losses and to otherwise enforce their rights under ERISA. Notable litigation against fiduciaries alleging a violation of these duties is discussed below. II. Recent Litigation Against Plan Fiduciaries The major types of claims brought against plan fiduciaries typically involve performance of the plan s investments or the cost of administering and managing the plan. For example, plaintiffs commonly allege that plan fiduciaries failed to leverage the size of their plans in offering participants retail class mutual fund shares rather than lower cost institutional share classes. Plaintiffs have also claimed that plan fiduciaries were imprudent for selecting more expensive, activelymanaged mutual funds rather than lower cost passivelymanaged alternatives. In addition, plaintiffs have claimed that fiduciaries failed to satisfy their duties of prudence and loyalty by investing in mutual funds as opposed to collective trusts or separately managed accounts. As would be expected, several court decisions considering these issues have focused on cost. Importantly, when describing the diligence that plan fiduciaries must perform when considering investment options for their plans, the court in Hecker v. Deere held that there is no duty to scour the market for investment options with the lowest fees. Courts have also decided that, not unexpectedly, ERISA does not preclude the inclusion of mutual funds on plan investment menus. Instead, both the courts and the Department of Labor have indicated that the fees of an investment option are but one factor to consider and that fiduciaries should engage in an objective process that is designed to elicit information necessary to assess the provider s qualifications, quality of services offered, and reasonableness of fees charged for the service. However, the landscape for plan fiduciaries is not altogether safe. For instance, the court in Tibble v. Edison found that plan fiduciaries breached their duties of prudence and loyalty when they invested the plan s assets in retail share classes and failed to inquire into the possibility of obtaining institutional shares. These decisions should help inform plan fiduciaries of the steps that they should be taking to avoid litigation involving their plan. For instance, plan fiduciaries should consider the fees and expenses of investment options when investing the assets of an ERISA-covered defined contribution plan; and Plan fiduciaries should regularly monitor both the performance of the investment options and the expenses paid by the plan to ensure the plan is competitive with similarly situated plans. 2

3 III. Recent Litigation Involving Plan Service Providers Plaintiffs have also raised a rash of claims against plan fiduciaries involving the plan s recordkeeping and related administrative fees. ERISA-covered defined contribution plans pay for recordkeeping services in a variety of ways, including on a per participant basis, through revenue-sharing arrangements, or based on the value of assets in a plan. The plaintiffs bar has focused special attention on service providers that are paid through revenue sharing arrangements and have argued that in approving revenue-sharing arrangements, plan fiduciaries failed to calculate the amounts paid to the service provider failed to determine whether the amounts paid to recordkeepers were reasonable, and failed to leverage the plan s size to negotiate a reduction in fees. Plaintiffs have also alleged that plan fiduciaries used the plan s assets to subsidize the cost of corporate services that the recordkeeper was providing to the plan sponsor. Although the case law is still developing in this area, 401(k) fee cases involving plan service providers have led to mixed results. For instance, in Renfro v. Unisys Corp., the court dismissed claims that paying for recordkeeping fees through revenue sharing was per se imprudent. On the other hand, the court in Tussey v. ABB held that plan fiduciaries should leverage plan size to negotiate reductions in recordkeeping fees. The Tussey court also held that that excessive recordkeeping fees were used to subsidize the cost of non-plan related, corporate services that the recordkeeper was providing. In addition to administrative service providers, lawsuits involving investment firms have been filed with increasing frequency. These cases typically involve allegations that the investment service provider maintained and acted on conflicts of interest while rendering investment advisory or management services. Allegations frequently include a claim that the service provider was a fiduciary to the plan by virtue of the provider s authority over the plan investment menu resulting in the service provider receiving prohibited compensation under ERISA. Plaintiffs have also filed claims that service providers engaged in conflicts of interest by receiving fees from partners or affiliates who were selected to provide investment and recordkeeping services to plans. Importantly, the court decisions in most of these cases have favored the defendants. As an example, the court in Hecker v. Deere, and many others, have held that a service provider s creation of an investment menu, in and of itself, does not result in fiduciary status under ERISA. Courts have also reaffirmed the longstanding principle that revenuesharing arrangements are permissible under ERISA provided that the details of the revenue sharing are adequately disclosed. However, litigation involving plan service providers has increased and the plaintiffs bar continues to develop new and threatening allegations focusing on plan administration and investments. It is most appropriate therefore that plan fiduciaries consider the potential implications of these cases during the onboarding process and throughout the terms of the service provider s relationship with the plan. These cases suggest that it is important that plan fiduciaries (1) understand the fees paid to recordkeepers and other plan service providers, (2) regularly benchmark fees with applicable peer-groups, (3) review fees paid to plan service providers on a regular basis, (4) revisit disclosures to ensure that compensation retained in connection with services provided to plans is accurately disclosed, and (5) review current practices and arrangements in light of the DOL s conflict of interest rule. 3

4 IV. Company Stock Lastly, there has been a significant uptick in stock drop litigation against plan fiduciaries. Stock drop cases involve situations where plan fiduciaries offer employer stock as an investment option and where the stock subsequently loses substantial value once held by the participants. The rise in these cases is largely driven by the Supreme Court s landmark decision in Fifth Third Bancorp v. Dudenhoeffer, in which it held that ERISA fiduciaries are no longer entitled to a presumption of prudence when investing in employer stock. Prior to Dudenhoeffer, nearly every Circuit Court adopted some form of a presumption of prudence in an effort to establish a standard that balanced the need to protect participants against imprudent investments with Congress s desire to encourage ESOPs. The Court s analysis in Dudenhoeffer of typical stock drop claims provides valuable insight to plan fiduciaries offering employer stock. In particular, the Court has said that, absent special circumstances, allegations that a fiduciary should have removed or stopped additional investments in company stock because the fiduciary should have recognized based on publicly available information that the stock was improperly valued are generally implausible. Class action litigation has had a profound effect on the delivery of retirement investments and services to plans. As described in this article, recent litigation trends provide several valuable lessons for plan fiduciaries. First, it is important for plan fiduciaries to monitor the costs of investing the assets of an ERISA-covered defined contribution plan. It is also important for plan fiduciaries to review and monitor the arrangements with plan service providers, including recordkeepers, to ensure that they understand the arrangements and their costs. Lastly, it is important for plan fiduciaries with company stock in their plans to engage in some level of monitoring to satisfy their obligations as articulated by the Supreme Court. The Court left open the possibility that plaintiffs could proceed with limited claims based on allegations that a fiduciary should have acted based on non-public information. However, the Court noted that plaintiffs must be able to (1) articulate what course of action the fiduciary legally could have taken to avoid incurring losses, and (2) show that a prudent fiduciary in like circumstances could not have believed that such an action would be more likely to harm rather than help the plan. 4

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