As an Employee Retirement Income Security Act (ERISA) litigator specializing in the defense of plan sponsors and fiduciaries, Rick Nowak, partner at Mayer Brown in Chicago, spends a lot of time thinking about why employers and their officers find themselves entangled in fiduciary breach lawsuits.
As recounted in the Q&A dialogue below, hundreds of ERISA lawsuits have been filed across the United States over the past 10 years or so, and Mayer Brown has been directly involved in more than a dozen of the biggest cases. The underlying claims of the suits have varied, but the central themes have related to allegations about the payment of excessive fees—whether for recordkeeping or investments—and disloyalty and imprudence on the part of the plan sponsor.
The issue of customization has also come up, particularly pertaining to the provision of novel asset classes within customized target-date funds (TDFs) being offered to participants as a plan’s qualified default investment alternative (QDIA). At a high level, Nowak says, customization is perfectly acceptable, including in a TDF being used as a QDIA. However, he adds, caution and diligence are certainly warranted, as demonstrated by the lawsuit known as Intel v. Sulyma.
PLANADVISER: Before we discuss the topic of customization, can you comment on the general flow of ERISA lawsuits? We continue to see substantial activity by the plaintiffs’ bar in this space.
Rick Nowak: That’s right. We are seeing new types of claims filed all the time, and the same types of claims that have been around for a decade or longer are not slowing down. They have almost picked up, in some ways, during 2020 and 2021. On the one hand, we have more and more case law emerging on the merits of these issues, which is helpful, but most courts still do not know how to immediately address ERISA claims.
We represent a number of plan fiduciaries in Wisconsin, as an example. There is a new plaintiffs’ firm there that is getting increasingly active, and the main argument in its cases is to present data suggesting a firm is paying higher fees than the average of its peers. We know, from working in this space, that such apples-to-oranges fee comparisons aren’t really appropriate or telling. We know that plaintiffs have to address and identify actual benchmarks in order to state a claim. However, the courts don’t yet feel confident making those judgments at the motion-to-dismiss stage, and so it leads to what we, from the defense side, view as potentially expensive and one-sided discovery. The whole dynamic gives a real incentive to plaintiffs’ firms to file these suits—as long as they have a viable way to get past the motion-to-dismiss stage, they will continue to do so.
The Sulyma case is important to distinguish. It is challenging the composition of the target-date fund, rather than the fee paid. In Sulyma, the plaintiffs suggested the inclusion of private equity [PE] in the customized fund was in itself risky and imprudent, and that by including it, the sponsor breached its fiduciary duty. The inclusion of the custom private equity component represented the breach, to the plaintiffs.
PLANADVISER: Common sense would suggest that this environment has provided little clarity for plan sponsors in terms of feeling confident about customization or other plan design or investing matters.
Nowak: The way I view this is to remember that, at a high level, there have been very few of these cases that have gone to trial and that have resulted in a successful outcome for the plaintiffs. Take the New York University (NYU) case. That case went to trial, and the defendants prevailed on all counts. Banner Health went to trial in Colorado more recently. There was a judgment for plaintiffs, yes, but it was a judgment that awarded a small fraction of what the plaintiffs were asking for—something in the range of $2.5 million, when they were asking for over $100 million.
These cases help to show that this litigation will continue until enough circuit courts can actually weigh in on the merits of these issues. The 7th U.S. Circuit Court of Appeals is a good example. It has had more opportunities to weigh in on the merits of fiduciary breach claims, which is why you have recently seen fewer cases filed in that circuit.
The circuit courts have the power to create sea change here. For example, if the 2nd U.S. Circuit Court of Appeals reverses the judgment in favor of NYU, it would almost certainly open the door further to lawsuits. But, if it affirms the lower ruling and backs NYU, it would be a strong sign to fiduciaries across the country.
Getting back to the issue of customization: Investments are always evolving and service providers and plan sponsors will always try to do new and innovative things. Every time there is development in terms of products and services, we can expect the plaintiffs’ bar will attempt to use ERISA to target them. It is a similar dynamic to what you see in the public securities litigation context. The sophistication of the plaintiffs’ bar, combined with the complexity of the issues at hand, means there is always room on the plaintiffs’ side to at least attempt to state a claim.
PLANADVISER: Assuming the trend of courts backing plan sponsors in actual decisions continues, how long would it take for this circuit court authority to develop? This is a mid-term conversation we are having, at least?
Nowak: Yeah, I think that’s right. For example, the NYU case in the 2nd Circuit is important, but it is also about specific issues relating to a trial about a university’s 403(b) plan. Those plans have unique aspects that differ from corporate 401(k) plans, in particular, which again leaves open the opportunity for plaintiffs’ firms to say that a given precedent is distinguishable from the new case they are making.
So I think it will be at least a number of years before we get enough circuit rulings to really create that sea change I’m referring to. Of course, I represent the defendants in these cases, but I will say that my clients all believe they go to great lengths to make sure they are acting in the best interest of their participants. They so often feel constrained, because on the one hand they are feeling pressure to use the lowest cost and simpler, conservative approaches. Yet the plaintiffs also say, ‘You should have been more aggressive or more adaptive.’ It’s a very trying environment for them to operate in.
PLANADVISER: Let’s dig into that. Intel, for example, is viewed publicly as a high-quality employer. It presumably wanted to include private equity in its custom TDF and made that happen. In hindsight, there might have been a lack of performance, but is that a fiduciary breach? Was the decision imprudent? It’s very hard to know what to make of a lot of these cases as an outside observer.
Nowak: I know what you mean. When I speak to clients about similar things, I tell them you certainly have to know about the best practices, but you don’t want to be only focused on the question of whether we are going to get sued. You want to be focused on your process and implementing the best practices that you believe will serve the best interest of your participants.
This work includes relying on your internal expertise and relying on your partners and vendors to deliver a high-quality program. That may not entirely insulate you from being sued, because the plaintiffs’ firms aren’t always interested in looking at this process. However, proof of that process will help you prevail. You need to be able to show you had a reasoned decisionmaking process and that you didn’t just pick investments out of a hat.
PLANADVISER: As an attorney, how do you think about the broad topic of ‘the pros and cons of customization’? Specifically, there is no requirement or even any significant expectation that an employer includes private equity investments in a custom-designed TDF it is going to deliver to its people. It is worth it putting yourself at risk?
Nowak: It’s a good question, definitely, and it’s one we are constantly dealing with. What I think the Intel v. Sulyma case has done, in conjunction with the Department of Labor (DOL) guidance letter published last year about this topic, is to emphasize the importance of deliberation. If you engage in the right deliberation and the right process, you can do it.
When we advise clients on this, we focus on the level of complexity that is going to go into any investment analysis. With custom TDFs and private equity, there is a different level of sophistication involved that goes beyond what you deal with when evaluating most other types of funds. You need to make sure that, internally and externally, you have the expertise to be able to evaluate these investments appropriately. It’s not enough to just say, ‘This is just one part of our diversified fund and so we are safe.’ If you are a plan fiduciary, you need to understand what components are in your default investment, and what goes into tracking performance and understanding the potential restrictions and how it all works.
If you don’t have that expertise, you can open yourself up to an argument that you acted imprudently because you didn’t understand what you were including. For an employer such as Intel, it probably feels comfortable with its ability to say it had the internal expertise and the vendor relationships to appropriately evaluate the inclusion of private equity, with the goals of lowering volatility and lowering risk over the long term.
Long story short, employers should not turn a blind eye to custom TDFs or private equity, but they need to make sure to evaluate the landscape and their own capabilities. Right now, sophisticated employers with the expertise may want to explore this area, while others may feel they have less sophistication and that it’s better to not go down this path. It’s an employer-by-employer evaluation.