Under Armor

There has been nothing short of a furious pace in the filing of new lawsuits under the Employee Retirement Income Security Act (ERISA) recently. Some of the latest suits take novel approaches, calling into question the most basic assumptions that service providers have relied on when assessing questions of fair client costs and value.

Many of the lawsuits’ claims evoke an image of a retirement planning industry wholly at odds with the client-centric persona broadcast to plan sponsors and participants every day. If you believe folks like Jerry Schlichter, a well-known 401(k) industry litigator with a self-described “crusade against conflicts of interest” in the retirement planning industry, providers are much more concerned about sales and profits than promoting successful outcomes for average Americans.

And yet, as Department of Labor (DOL) Secretary Thomas Perez has frequently stressed during the media blitz surrounding the rollout of the DOL’s final fiduciary rule, the vast majority of people working in the financial services industry are “caring individuals” looking to “make an honest living and to serve their clients as best they can.”

Even long-time ERISA attorneys experience moments of exasperation when considering the way plaintiffs are bringing more and more suits against retirement plans—raising challenges that scrutinize all areas of running a plan and question the most common business practices.

“I have clearly seen an increasing number of suits filed over the last year by a wider range of plaintiffs’ firms,” says Jamie Fleckner, a partner in Goodwin Procter’s litigation department and chair of its ERISA litigation practice, in Boston. These include law firms that have little experience filing ERISA fee suits, that think about ERISA issues in an entirely different way than the usual players do, he adds.

“These firms are continuing their marketing and outreach efforts [directly to the public], looking for additional plan participants to come forward to join new litigation. So I don’t see the pace slowing in the near future, unfortunately,” Fleckner says.

Why the rash of suits? Like others, Fleckner feels the significant amount of attention paid to the U.S. Supreme Court (SCOTUS) decision last year in Tibble v. Edison has played at least a small part in emboldening these firms to pick up the pace in bringing these lawsuits. While that case seemed to modestly strengthen sponsors’ distinct and ongoing “duty to monitor” retirement plan investments, even more important was the basic fact that the case made it to the Supreme Court and covered such a large class of plaintiffs—inspiring plaintiffs’ attorneys to consider opportunities to file suit in the potentially lucrative 401(k) industry.

Also, much more attention is being paid to retirement plan fees and conflicts of interest following steps by regulators to boost transparency—think 404(a)5 and 408(b)2—coupled with stubborn anti-financial industry sentiment hanging over from the credit crisis of 2008.

Beyond this intersection of factors, the litigators’ own personal motivations play a big role, given the huge fees that potentially can be collected after a large defined contribution (DC) plan settlement. For example, attorneys for plaintiffs in another recently settled big-ticket case (Tussey v. ABB) were reported, early this year, to have collected some $14 million, in total, in fees and other cost recoupments related to the long-running case.

Given the fervor, Fleckner warns there is “a good amount of unpredictability as to who will be subject to these suits. There is no panacea in terms of plan design that I have seen that would prevent all potential litigation,” he observes. “Even plans with fees that would appear to be objectively very low and that utilize a large amount of passive funds have found themselves subject to suit.”

This scenario has, in fact, already played out with the filing, earlier this year, of Bell v. Anthem. Similar to related lawsuits that have recently emerged targeting Oracle Corp., Empower, Prudential and Reliance Trust Co.—to name a few—the plan sponsor in this case, Anthem Health, is accused of failing to leverage its tremendous bargaining power to “obtain highquality investment management and administrative services at very low costs.”

Page 15 of the Bell v. Anthem complaint provides an exhibit of the “imprudent” funds called into question. Most cited by name come from Vanguard, a firm known for transparency and affordability, and are actually quite cheap from an industrywide perspective, charging less than 25 basis points (bps) in annual fees. One has just a 4-bps annual fee, but the complaint says an otherwise identical 2-bps version could have been obtained by an investor with the size and sophistication of the Anthem plan.

“As for advisers, if they are acting in a fiduciary capacity, they need to be mindful of their fiduciary obligations,” Fleckner says. “One court has held that a fiduciary that removed an investment option for fear of being sued if that option remained in the plan was, by that act, breaching its fiduciary duties and potentially liable for damages when the investment achieved outsized returns after it was removed.”

This was the case, for example, in RJR Pension Investment Committee v. Tatum et. al. The “reverse stock drop” case was rejected by the Supreme Court, leaving in place a decision by the 4th U.S. Circuit Court of Appeals that determined the plan fiduciaries for R.J. Reynolds Tobacco Co. had breached their duty of prudence by failing to put in place an effective process to evaluate forward-looking investment menu decisions. In this case, the fiduciaries essentially dropped the employer stock as an investment from the plan without thoroughly investigating whether it was prudent to do so at that time—especially given forthcoming events that could have (and subsequently did) significantly boosted the stock price.

The circuit court held that fiduciaries who manage a plan to minimize their own litigation risk are acting in their own interests and not in those of plan participants. “So, advisers who act as fiduciaries need to be sure they are properly discharging their duties to plan participants, rather than trying to minimize their own exposure,” Fleckner says.

Still, “the message I would give to plan sponsors is to try to remain calm and not act rashly,” Fleckner says. Keep in mind that the fiduciary fundamentals will go a long way toward keeping a plan safe from litigation, he says. Especially important is promptly fielding and responding to participants’ concerns—it is only after a participant feels spurned in some way that he will be receptive to the uncomfortable prospect of suing his own plan sponsor.

Learning From Others’ Mistakes

One interesting feature of today’s retirement plan litigation landscape is that claims often rely just as much on what plan officials failed to do as what they actually did.

Take, for example, a suit filed earlier this year against Chevron, which claims that “by providing participants the Vanguard Prime Money Market Fund instead of a stable value fund, as represented by the Hueler index, from February 2010 through September 30, 2015, Chevron Corporation caused its 401(k) plan, participants and retirees to lose more than $130 million in retirement savings.”

The implication of the allegations is that Chevron’s plan sponsors and advisers failed to use the company’s massive buying power to get a great deal on retirement plan investments. Further, Chevron is challenged for its failure to utilize collective trusts or separate accounts— somewhat exclusive investment vehicles that could have been obtained by an investor of the size and sophistication of Chevron’s retirement plans. Also on the list of alleged failures is the now-common claim that Chevron failed to monitor and proactively control recordkeeping fees, effectively allowing participants to subsidize other services provided by the recordkeeper to the employer by overpaying for plan administration.

Particularly telling in this case is that Chevron had, in recent years, taken at least one costcutting step considered to be an industry best practice regarding the capital preservation section of the investment menu, but this was not enough to avoid litigation. Background in case documents shows that since at least February 2010, Chevron had “provided plan participants as their sole capital-preservation, conservative investment option the Vanguard Prime Money Market Fund, initially in the higher-cost Investor class, and as of April 1, 2012, in the lower-cost Institutional class.”

Plaintiffs feel this step to reduce share-class derived fees was not substantial enough, mainly because the “microscopically small return [of the Vanguard fund] did not even beat the rate of inflation during that time period.” In the complaint, data from the Hueler Analytics Pooled Fund Comparative Universe is used to show that the returns of the funds in that index have “far exceeded the returns of the Vanguard Prime Money Market Fund in the plan … up to 67 times the return of the Vanguard Prime Money Market Fund.”

The primary lesson for plan advisers and sponsors is that plan participants feel they have a right to a quality retirement plan—and plaintiffs’ lawyers are helping them pursue just that. In addition, efforts such as the ongoing fiduciary rule reform and the demonstrated willingness of the Department of Labor to file and collect on its own ERISA challenges via the Employee Benefits Security Administration (EBSA) will only keep stoking the fire.

Moreover, in case after case, U.S. district court judges seem to agree with plaintiffs’ attorneys that retirement plan participants who feel they have been seriously wronged deserve their day in court. As explained by U.S. District Judge William Young of the U.S. District Court for the District of Massachusetts, “In factually complex ERISA cases, dismissal is often inappropriate.” Therefore, Young denied motions to dismiss the excessive fee lawsuits against Fidelity Management Trust and Putnam Investments.

In a combined order allowing the suits to move ahead, Young further stated that “even when the court must draw all reasonable inferences in favor of the non-moving party, the plaintiffs’ complaints in these two actions allege facts sufficient to state plausible claims.” The particular claims against Fidelity will be familiar and involve a stable value fund, the Fidelity Group Employee Benefit Plan Managed Income Portfolio Commingled Pool (MIP), which, the complaint says, “at all relevant times had such low investment returns and high fees that it was an imprudent retirement investment.” Putnam, on the other hand, is accused of selfdealing in its own retirement plan for employees to promote the firm’s mutual fund business and maximize profits at the expense of the plan and its participants.

Ways to Be Proactive

While it may seem impossible to take productive steps to effectively prevent ERISA litigation, experts stress better benefits education and communication are a must for preventing lawsuits. As Fleckner and others observe, participants are far more inclined to file a lawsuit when they are hit with some kind of sticker-shock event or if they feel disrespected or ignored by their employer.

Adding to the challenge is that “most Americans believe they pay nothing for their financial products or have no idea what they pay,” according to a recent study by Hearts & Wallets, “Wants & Pricing: What Investors Buy & Competitive Ratings.” Even less encouraging is that awareness of fees and the way pricing works in the retirement planning industry actually appears to be getting worse.

The Hearts & Wallets study found that about one-third (31%) of investors are unaware what they pay for their financial products, an increase of 4 percentage points in one year. Less than one-third (28%) said they are certain they are charged a fee by a retail financial “store,” which Hearts & Wallets defines as retail and defined contribution providers that work directly with investors. Of the 41% who said they pay their financial store “nothing” and instead pay through actual products, 72% said they pay nothing for the product.

“Everyone knows nothing in life is free,” says Laura Varas, founder and CEO of Hearts & Wallets in New York. “When you add together the Americans who say they don’t know what they pay for their financial products, and the high number of people who say they pay nothing for products they obtain through their retail financial stores, we have a major problem. Consumers should know what they pay.”

Echoing many of the ERISA complaints playing out in district and appellate courts, Varas adds that the industry “has a responsibility to price clearly and lay out the different choices available to consumers.” Understanding how a firm earns money is the No. 1 trust driver within the control of a financial services firm, Hearts & Wallets says. Yet, only one in five consumers has a clear understanding of the incentives of his provider, a figure that remains stagnant.

“Competition will force traditional financial services firms to confront the pricing issue,” Varas says. “Robo-advisers and other new fin-tech entrants are explaining pricing clearly and pushing others in the marketplace to do the same.”

The study also ranked U.S. households’ top 10 “wants” in their financial services provider and found that all income groups and life stages are becoming more demanding. The top three most important attributes are “has clear and understandable fees” (56%), “is unbiased, puts my interests first” (54%) and “explains things in understandable terms” (54%). About half of investors are highly price-sensitive and want providers to have “low fees” (54%) or at least “fees that are reasonable for the service provided” (53%).

The Shifting Landscape

Beyond Tibble, another recent decision by the U.S. Supreme Court directly affects ERISA retirement and health plans, and, according to Nancy Ross, a prominent ERISA litigator and partner in Mayer Brown’s Chicago office, plan advisers have not taken enough time to consider the potential impact of this second case.

She is referring to the SCOTUS decision in Montanile v. Board of Trustees, which has been interpreted to “limit the ability of ERISA plans to seek equitable relief or reimbursement of payments from a third-party recovery by a participant,” especially in cases where the money is not quickly and formally pursued by plan officials.

In Montanile, a participant in an ERISA-covered health plan was hit by a drunk driver and subsequently recovered, from said driver, the cost of his related medical care—expenses initially paid upfront by the ERISA health plan. As is often the case with such health and retirement plans, a subrogation clause was in place that would normally have required the participant to repay the plan for his emergency medical expenses from the recovered assets.

The plan waited too long to ask the participant to repay the money; he had already apparently distributed the assets in question when the plan sued to enforce a lien on them—thereby pushing the recovery sought by the employer outside the realm of equitable relief and into the realm of legal damages, which ERISA does not provide for.

“Frankly, the industry’s reaction so far has been somewhat blasé about this case, but I think that’s a real mistake,” Ross says. “There’s a lot to think about, coming out of this decision, from potential changes to summary plan descriptions [SPDs] and other formal plan documents, to reassessment of monitoring processes around third-party legal actions in which plan participants are involved and in which recoverable plan assets may be at stake.”

Ross believes the SCOTUS decision here is very consistent with the high court’s previous efforts to contain the definition of equitable relief under ERISA. “If you peel away the circumstances in this case and just take the legal issues at hand—it’s really about whether going after a dissipated trust or lien falls into the camp of legal damages, which ERISA does not allow,” she explains.

“What I surmise from all this is that, behind closed doors, the conservative justices agreed with the fact that, should they allow the plan to go after the assets in this case, then they would also actually be setting the stage for dilution of plan sponsors’ and plan fiduciaries’ ability to protect themselves from parties seeking damages under ERISA,” Ross says. “The majority of the conservative and liberal judges agreed this is not what ERISA is about, in other words.”

According to Ross, SCOTUS seems to firmly believe “there must have been a reason that Congress, in writing ERISA, limited the relief one can seek under this particular law to equitable relief.” Part of what the Supreme Court was wading into here was, did Congress use the word “equitable” as in the traditional courts of equity, or did it use the term in a more benign sense, as a synonym for “fair”?

“This is of critical importance for ERISA plans,” Ross adds. “The implications are broad.”

One of the most important is that, in regard to the subrogation provisions in place within many plans—especially large, well-run plans—sponsors will have to be vigilant and proactive in understanding where they may have the right or even the obligation to pursue recovery of plan assets under the subrogation clause, and where they do not.

“The plan needs to monitor situations like this closely,” Ross concludes. “It’s just what plan sponsors are looking for, I’m sure: more monitoring and litigation. It’s a little unfortunate from that perspective, yes. You could even imagine a runaway situation in which, if the plan is not vigilant in recouping money owed to it under plan terms, that in itself could be construed as a fiduciary breach.”

A Few Points of Conclusion

Given all the facets of the regulatory and litigation challenges facing the retirement planning industry, it is hard to draw any wide-reaching conclusions, beyond that it apparently is getting riskier, from the employer’s perspective, to deliver a retirement plan.

Drew Carrington, senior vice president and leader of Franklin Templeton Investments’ defined contribution business for the U.S. institutional large market, in Chicago, says that for an increasing number of clients, litigation risk has seemingly become the sole driver of decisionmaking.

“I always point out to people that, in the last several months, we have seen more suits filed than ever before regarding the capital preservation segment of the investment menu,” Carrington says. “This includes three suits targeting stable value funds. One employer is being sued for not offering stable value; another is being sued for offering stable value that was too conservative and lagged inflation; and the last one is being sued for offering a stable value fund that was too aggressive. What kind of a message does that send to employers who are just trying to do the right thing?”

Art by Chris Buzelli