Has ERISA Class Action Litigation Made a Positive Difference for Plan Participants?

By Daniel Aronowitz

A recent article this month in Pension & Investments asked ERISA lawyers whether class action litigation has made a positive difference for plan participants.  The premise of the article was that while many critics issue harsh assessments about class action litigation, plan participants have nevertheless seen positive changes and fee reductions from the litigation.  We do not believe that plaintiff firms can take full credit for the fee reductions in a competitive market for plan services.  But if the goal of the Schlichter firm’s initial lawsuits was to lower plan fees, that objective has been satisfied.  Plan administration and investment fees are universally lower for nearly every plan, and large plans have adopted best fiduciary practices that include advice and monitoring of investments by sophisticated investment advisors.  The current slate of cases have an entirely different agenda.  These lawsuits are about changing ERISA into something Congress never intended:  (1) requiring plan sponsors to prove that they have the lowest fees in the entire market; and (2) guaranteeing a return on investments equal to the highes t performing funds, as judged in hindsight.

Instead of helping plan participants, the current out-of-control wave of class action litigation is harming participants by forcing plan sponsors into the defensive mode of limiting plan options and innovation.  The best example is the five recent plan forfeiture lawsuits alleging that it is a breach of fiduciary duty to apply plan forfeitures to the employer match – a legitimate practice that has the support of federal regulators.  Any rational plan sponsor would respond by eliminating the employer match.  How would that help plan participants?  Other cases challenge the actuarial equivalence of certain plan annuities in defined benefit plans.  All of these plan interest rates have been qualified and approved by the IRS.  These cases will only accelerate the exodus of plan sponsors from offering defined benefit plan solutions.  Another case challenges the ability of plan participants to access ESG funds in an open brokerage account – in a case in which the plaintiff participant did not even access the brokerage account.  Yet another case takes the position that it violates ERISA to charge a higher recordkeeping fee for retired employees.  Many other cases challenge managed accounts, which like brokerage windows are optional plan features that any risk-adverse plan sponsor would be wise to eliminate if it will attract nuisance litigation.  These lawsuits encourage plan sponsors to eliminate plan options to reduce liability.

We continue to operate in a strange legal environment in which we allow plaintiff lawyers with a profit motive to serve as the ERISA police, as the Department of Labor has largely abdicated the fiduciary liability enforcement agenda to plaintiff lawyers.  But plaintiff lawyers are not neutral regulators.  They have a profit motive and incentive to bring illegitimate lawsuits and push the boundaries of what is right and wrong.  Plaintiff lawyers are pursuing theories of liability that have no basis in ERISA.  They are biased prosecutors that are not acting in the best interests of plan sponsors or participants.  This is particularly true when lawsuits allege imprudence with claims that attempt to stretch or change ERISA fiduciary liability.  This includes lawsuits based on disfavored outcomes that ignore fiduciary process – the lynchpin of ERISA fiduciary liability.

Applying ERISA Plaintiff Lawyer Rules of Fiduciary Responsibility – Are America’s Workers Better Off With Plaintiff Lawyers Serving as the ERISA Police?

The best way to judge whether the litigation is helpful in the long-run for plan participants is to analyze the rules that plaintiff lawyers try to impose in their attempt to regulate fiduciary liability by litigation on a case-by-case basis.  In other words, if plaintiff lawyers were fully in charge of fiduciary liability in America, how would their rules affect plan participants?  Let’s apply some of their rules from recent litigation, and see how America’s workers are somehow better off.

1. No active funds – only passive investments allowed. A consistent theme of excess fee litigation is that active investments must be compared to passive investments.  The underlying premise is that it is imprudent to offer an active investment option with higher fees unless it outperforms a passive fund with lower fees.  We have seen the studies showing that the vast majority of active funds fail to outperform passive funds when fees are considered.  And we are sympathetic to the viewpoint that participants should have access to a low-cost S&P 500 or other index fund that is designed to track the market.  But there is nothing in ERISA that requires plans to eschew active management.  It is the province of Congress to legislate that retirement plans must only offer index funds.  But until ERISA is changed to legislate what investments can be offered, plan sponsors have legitimate reasons to offer a diverse mix of active and passive investment options.  This is especially true for actively managed investment strategies that attempt to preserve capital or hedge against volatility [but see below when plaintiff lawyers pursue claims asserting that all such strategies are imprudent].
    
2. No new investments in retirement plans ever. Another common theme of plaintiff lawyers is that it is per se imprudent for plan sponsors to choose a new investment offering.  There is no support for this in ERISA, which requires a sound fiduciary process in selecting investments, but that has not stopped plaintiff lawyers from alleging fiduciary imprudence for novel or new investment offerings.  In the Wood and Molina Healthcare imprudent investment cases, for example, the Schlichter law firm claims that any plan fiduciary, even with the advice of a 3(38) discretionary advisor, who chose the FlexPath target-date funds when they were first introduced in 2016 acted imprudently.  Taken to its logical conclusion, all of the initial FlexPath initial clients were imprudent, irrespective of their fiduciary process.  FlexPath funds were based on BlackRock target-date funds with the longest track record of any such funds.  Seven years later, these funds have demonstrated excellent returns over the long term, especially during the current period of high inflation.  They are now the twelfth most popular target-date funds in the country, and one of the few target-date funds with an innovative and creative investment approach.  But the Schlichter firm wants a categorical rule that plan fiduciaries can never try anything new.  This obviously reduces innovation and will constrain the available investment options for large plans.  But again, in the world of plaintiff lawyers serving as ERISA’s chief enforcement officers, plan fiduciaries would be limited to low-cost index funds.  This index-only rule would have one caveat:   the Miller Shah law firm wants to outlaw any low-cost index funds that – in hindsight – did not perform in the top ten percent of all index funds.  See the twelve lawsuits filed by Miller Shah against the Morningstar #1 rated BlackRock LifePath funds, which are compared to the highest performing funds of the last decade.
    
3. No value funds or any fund with hedge against inflation. Plaintiff lawyers have filed many cases against families of target-date funds alleging imprudence because of purported poor returns.  Challenged funds include target-date funds from Fidelity Freedom, Northern Trust, Wells Fargo, J.P. Morgan Smart Retirement, and NFP-FlexPath funds.  In nearly every case, plaintiffs assert that these target-date funds must be compared against the same three target-date funds:  Rowe Price Retirement; American Funds; and Vanguard index target-date funds.  The reason that plaintiff lawyers use the T. Rowe Price and American Fund target-date funds as purported comparators is that these two funds had the highest returns in the last 10-15 years.  The reason that these funds performed better than the challenged investments is that T. Rowe Price and American Funds used a higher allocation of equity in each glide path.  This aggressive strategy paid off in the long-term bull market of the decade from 2012-2022.  These funds did better because they took higher risk.  But it is not fiduciary malpractice to choose a more conservative target-date fund, yet that is what most of these cases are about.
    
   Many plan fiduciary committees with a more conservative temperament chose value funds – like plans that chose the Wells Fargo funds at issue in the pending UnitedHealth case.  Many conservative committees eschewed growth funds favored by plaintiff law firms and instead chose funds with inflation hedges or more conservative glide path with a lower allocation of stock.  But plaintiff lawyers have cynically filed dozens of investment imprudence cases taking the position that they get to pick the comparator funds once they prove negligence.  Not surprisingly, they always choose the highest performing funds from the last ten years.  This litigation is a shakedown of any plan committee that chose a value fund or any investment with a hedge against volatility.  It has nothing to do with helping plan participants, because it sends the message that plan fiduciaries face liability unless they chose the most aggressive stocks funds.
    
   Plaintiff lawyers in their litigation are requiring plan fiduciaries to take more risk than may be prudent.  Otherwise plan sponsors are exposed to capricious fiduciary imprudence litigation in which they have to act like an insurance policy guaranteeing the investment return compared to the highest performing funds in the market.  The push by litigation to take more risk is contrary to ERISA fiduciary law.  Under ERISA, it is inappropriate to criticize the objectives of fiduciaries as long as those objectives are reasonable.  29 C.F.R. section 2550.404a(1)(b)(4) (authorizing fiduciaries to choose investments “consistent with the plan’s investment objectives”).  We cannot speak for America’s retirement plan participants, but we can only assume that some participants want more conservative value funds.  If we apply plaintiff law firm fiduciary rules, however, only growth funds are prudent for America’s retirement plans.  We have been in a protracted time period in which value investing has not been rewarded, but there is nothing imprudent about offering and choosing value strategies.
    
4. You need to dump an investment that is underperforming after one year, but certainly after three years. Every smart investor knows that investing is a long-term proposition, and you cannot switch investments to chase the latest high-flying stock fund.  It is a seminal principle of investing to give investment strategy time to work.  And it may take ten years to judge whether an investment has met its objective.  But that is exactly the opposite of what plaintiff lawyers are advocating.  Look at the Verizon excess fee case.  The plaintiff expert testified in the Verizon case that you have to dump any investment before thirty-six months if it is underperforming the benchmark.  This type of testimony takes place in most of the cases.  In the pending Wood trial, the Schlichter’s law firm’s expert took the position that it was imprudent to hold an investment for just 28 months!  Plaintiff law firms are reducing investment theory to the absurd in which you have to replace any investment that underperforms the benchmark in as little as one year, or face liability with huge damages models.  This is perversion of fiduciary law, but more importantly, it is bad investment policy.  It defies all prudence to follow the “expert” testimony proffered by plaintiff lawyers in the investment imprudent cases to dump investments the instance that they underperform their benchmarks.These cases try to cash in on a hindsight-driven methodology.  Plaintiff lawyers want the ability to challenge any investment option against the most profitable alternatives in the marketplace.  If allowed to continue, retirement plan fiduciaries are responsible for picking the funds that generate the best returns in hindsight.  This obviously is not what ERISA was designed to allow, and certainly has nothing to do with helping plan participants.
    
5. No hedge funds or alternative investments. The Verizon and Intel cases raise the issue of whether it is prudent to offer alternative investments in defined contribution plans.  Plaintiffs in the Intel case label Intel’s 30% allocation of the custom target-date funds to non-traditional investments, and more than half of the global diversified fund to hedge funds and private equity as a “novel experiment” gone bad.  They disparage the “radical” and “novel asset-allocation approach” in which Intel plans paid higher fees in exchange for alleged higher risk and lower returns as a “market-defying strategy” that amounted to “institutional gambling” with employees’ assets.  The fiduciary malpractice claims were similar in the Verizon case.The Intel plaintiffs deride private equity as reckless gambling, but it is a naïve and uninformed viewpoint.  For perspective, there are approximately 4,850 public companies compared to over 52,000 private equity or venture-capital companies in America.  The investment strategy preferred by the plaintiff lawyers in the Intel case is to restrict participants in the company’s-sponsored plans to less than ten percent of the available investment opportunities in America.  Their hyperbolic rhetoric may sound convincing to someone with limited investment experience, but private equity exposure, with the advice of qualified and experienced investment consultants, increases diversification and adds potential for higher returns.  Sometimes it can provide hedges to protect against market volatility.  It can easily be argued that restricting defined contribution plans to just publicly traded companies potentially harms plan participants, especially when better returns and diversification might be available from the larger universe of privately-held companies.  Indeed, some investment experts take the position that only the worst private companies go public in initial public offerings, as private equity firms keep the companies with the most value.
    
6. No revenue sharing: We are not a fan of revenue sharing for larger plans.  We credit the initial lawsuits for the diminished use of revenue sharing.  But revenue sharing is a very common and legitimate strategy to pay for recordkeeping services of plans under $200m in assets.  Many lawsuits that allege that plan investments are in the wrong share class and/or that the plans have excess recordkeeping fees intentionally hide the revenue sharing rebates.  See the Barrick Gold, Trader Joe’s and Salesforce cases.  The failure of candor to the courts is a practice of deception and has nothing to do with helping plan participants.  The same goes with the many lawsuits that use Form 5500 data for alleged excess recordkeeping fees, when the lawyers filing these lawsuits know that the data is inflated with transaction fees.  These same complaints often compare large plans to the 401k Averages Book with manipulated data that excludes the revenue sharing used by the plans cited in the book.  Again, deception and dishonest claims are not in the interests of America’s retirement system.
    
7. Switch Recordkeepers every three years if you can get even a nominally lower price. Plaintiff lawyers want plan fiduciaries to conduct expensive RFPs for recordkeeping services at least every three years.  This is overkill, because plan advisors can help plans ensure that they have competitive recordkeeping.  The RFP requirement also misses the critical point that changing recordkeepers is disruptive and represents a potential administrative nightmare.  We are all for ensuring that large plans have low recordkeeping fees, but plaintiff law firms routinely compare challenged plans to five to ten large plans that have the lowest recordkeeping fees in the market.  The duty under ERISA is not to have the lowest fee, but that has not stopped the lawsuits to this effect.
    
8. Investment fees for each individual investment have to be below the average of all investments in the same category. Many lawsuits allege that investment fees are too high.  But because there is no proof for these claims, they try to compare the active fees to passive fees.  Knowing that courts reject this comparison, plaintiff lawyers then compare the investment fees of an active fund to the median or average fees for all retirement plan fees.  This means that most active funds would be above average and allegedly imprudent.  This is not evidence of anything, but plaintiff lawyers claim this is evidence of fiduciary malpractice.
    
9. If you work for an investment advisor, you cannot have your own company’s investments in the plan. The highest settlements continue to involve proprietary investments.  Many financial institutions have been sued for offering company-sponsored investment options in their retirement plans.  Plaintiff lawyers have attacked these plans with claims of breach of loyalty and accuse the companies of acting in the corporate self-interest.  Unless you understand that these cases are lawyer driven, you would find it puzzling why Citibank employees do not want to invest in their own company’s investment products.  It is like Walmart employees being forced to shop at Target.  But in the world in which plaintiff lawyers enforce ERISA, Fidelity must offer Vanguard investments in the Fidelity plan, and Vanguard must offer Fidelity investments.
    
10. All ESOP transaction are overvalued and can be challenged in court by plaintiff law firms. A significant percentage of new ESOPs are challenged on the ground that the valuation was too high.  This is one area in which the DOL is active in litigation, but plaintiff lawyers file most of the cases.  A court in Hawaii ruled this month that DOL’s case “crumbled” based on weak expert testimony.  Far from helping plan participants, the valuation challenges have limited the number of new ESOPs.  ESOPs are one of the best ways for employees to gain ownership stakes in companies.  But this avenue to ownership is severely diminished because most ESOPs never get started – all because of the litigation threat.  The reduced number of ESOPs in America is the best proof that the epidemic of ERISA class action litigation is not helping America’s workers.
     

This is not an exhaustive list of the plaintiff lawyers attempts to change ERISA by litigation.  Many cases attempt to chip away at ERISA preemption.  Plaintiffs in the AT&T case attempt to label routine transactions as a prohibited transaction, and require all exemptions to be proven in court.  As noted above, a new set of serial filings alleges that plan forfeitures need to go to participants.  And the imprudence case against American Airlines asserts standing for a participant to challenge a brokerage account when the participant did not even invest in any stock from the brokerage account.  The current slate of cases are not about helping plan participants, but are intended to change ERISA into a statute that allows plaintiff lawyers to challenge any fee or investment for any plan in which they can find a disgruntled employee.    

The Euclid Perspective

When Plaintiff’s lawyers serve as the ERISA police, they turn fiduciary law into a liability trap for plan sponsors.  Plaintiff lawyers want to eliminate all discretion and flexibility from the ERISA fiduciary process.  Instead, they want plan sponsors to guarantee a certain level of fees and a certain level of investment performance.  They want to turn defined contribution plans into defined benefit plans.  But even worse, they want a defined benefit from a defined contribution plan that is measured in hindsight based on the best-performing funds in the market that took the highest risk to achieve those results.

To date, we know of no plan sponsors that have stopped offering retirement plans.  But give it time and let’s see what happens in the next protracted recession.  Nevertheless, the cumulative effect of the current litigation risk is that plan sponsors have no incentive to innovate or try anything creative.  It is certainly a more lucrative environment for both plaintiff and defense attorneys.  But is it better for plan participants?  We do not think so.