KEY POINTS: (1) Milliman was falsely accused of acting in the company’s financial self-interest and violating fiduciary prudence and loyalty duties to its retirement plan participants by offering a hedging strategy in target-risk funds. Its Managed Risk Hedging Strategy, which was designed to reduce downside market risk and volatility, was vindicated in a trial verdict because plan fiduciaries and the company’s board followed the “highest level of fiduciary prudence” with advice from its independent investment advisor. The target-risk funds were otherwise objectively prudent in a plan with diversified investment options because conservative investment strategies that hedge against market downturns are appropriate for retirement plans.
(2) The challenge to Milliman’s hedging strategy is yet another in a growing list of breach-of-fiduciary duty performance cases filed by the trial bar challenging conservative investment strategies as imprudent. These illogical challenges are premised on a theory that conservative investment strategies are flawed if they somehow do not match the returns of more aggressive and higher-risk strategies. If allowed to continue, plan fiduciaries will be forced to offer higher risk, aggressive investment strategies to avoid fiduciary litigation and liability – a perverse incentive that is not consistent with ERISA fiduciary law under which preservation of investment capital is a legitimate investment goal.
Is it fiduciary malpractice to offer conservative investment strategies in a company-sponsored defined contribution plan? That was the key question in the fiduciary imprudence case that went to trial against Milliman, and will be the same question in the upcoming trial against UnitedHealth. Both cases were brought by the Sanford Heisler law firm. Milliman was accused of imprudence for hedging market volatility in target-risk funds. And UnitedHealth is accused of selecting underperforming Wells Fargo target-date funds that were conservatively invested to avoid volatile technology stocks. In hindsight, UnitedHealth’s conservatism in choosing Wells Fargo funds with a lower-volatility strategy did not pay off, because technology stocks have been leading the market for years. But was it fiduciary malpractice to offer a conservative investment strategy if your goal was to minimize downside risk?
The investment imprudence theory against conservative investment strategies is similar to what the Schlichter law firm alleged in the recent trials against Molina Healthcare and the Wood Group. These two cases alleged that plan fiduciaries committed fiduciary malpractice for choosing the FlexPATH target-date funds [offered by a 3(38) discretionary advisor, we would add], because these funds represented a supposedly novel strategy [despite using Blackrock target-date funds with a long-term investment track record] that allegedly underperformed by hedging against inflation. The inflation hedge turned out – in hindsight – to be unnecessary because we had a decade before 2023 of benign inflation. Both companies had to spend millions of dollars to defend against fiduciary malpractice lawsuits. After trials, two separate judges ruled for the defense because the fiduciary breach theories were based on misleading expert testimony that improperly compared FlexPATH results to the highest performing funds of the last decade which had more aggressive investment strategies. Beyond these trials, other performance challenges are pending against Intel because it used a risk-mitigation strategy, and against the Motion Picture Industry multiemployer plan because the plan trustees had the temerity to implement a conservative investment strategy to limit plan investment losses. Similarly, a conservative hedge-fund strategy was the dispositive issue in the Verizon case that led to a substantial settlement after summary judgment was denied.
Given the historic bull-market run in stocks, driven primarily by a few high-flying technology stocks, any investment strategy – active or passive – that hedged against a market downturn, inflation, or even market volatility will have underperformed the S&P 500 index over the last decade. If you were a conservative investor over the last ten years, when measured in hindsight, you got it wrong. You didn’t need to hedge, because the market kept going up, or rebounded quickly when it did go down. If you were concerned about the federal deficit leading to a recession, you were wrong. If you were concerned about inflation, except for a short time period, you were wrong. Any fears of a sustained market correction and recession, like what happened in 2008, were not justified. If measured only in hindsight, you were wrong. But were you imprudent to be conservative?
If you were a fiduciary with responsibility to choose investment options for your company’s 401k plan, are you now guilty of fiduciary malpractice because you were too conservative and wrong to worry about market risks? Are you personally liable for the differential in the performance compared to the S&P 500, which has been heavily influenced by outsized performance of just seven companies, or compared to the leading target-date funds that loaded up more aggressively on a higher percentage of equities in the glidepath? That is the issue in most of these cases. Whether it is Wells Fargo target-date funds in the UnitedHealth case that eschewed tech stocks, Flexpath target-date funds in the Wood and Molina cases with an inflation hedge, or JP Morgan Smart Retirement or Fidelity Freedom target-date funds with lower stock allocations in many other cases, it is all the same basic question.
Are you liable for fiduciary malpractice if you chose a conservative strategy that ends up being unnecessary or wrong?
From this perspective, the current slate of fiduciary performance malpractice cases are asserting a dangerous precedent. The cases are forcing plan fiduciaries to choose aggressive investment strategies, because fiduciaries will be punished if they chose anything other than the most popular, high-performing investments. It is weaponizing ERISA to impose liability for investing conservatively. By allowing the trial bar to regulate ERISA fiduciary liability, we are imposing a fiduciary imperative to choose the most aggressive stock investments for 401k plans. Because if you chose a conservative investment that underperformed, heaven help you. You will be accused of conflicts of interests and dereliction of duty by failing to match the soaring results of an unprecedented stock market.
When did it become a breach of fiduciary duty to adopt a conservative investment strategy?
Only in the crazy and unfair world of ERISA class action breach-of-fiduciary duty litigation. Even when you win after trial, like Milliman, Molina HealthCare, or the Wood Group, you have to stare down huge liability risks from inflated damage models and spend millions of dollars to defend your fiduciary process. You have to risk huge liability to take a case to trial. And even if your fiduciary process was best-in-class like Milliman, you are placed on the defensive and unfairly second-guessed for every decision, even when you have been 100% conscientious and diligent.
Under this important perspective, we believe it is imperative to learn from the Milliman case. It is crucial to compare what the plaintiff law firm said they would prove when they filed the case to what the evidence actually showed on the record in a trial before a federal court judge. Only then can we properly and convincingly evaluate whether the current system is fair to plan sponsors (and obviously, it is not). And only then can we validate the need for a higher pleading standard for class action ERISA breach of fiduciary duty lawsuits to weed out cases based on inflammatory and false claims of fiduciary imprudence or disloyalty. The Milliman case exposes the con game of the excess fee and performance lawsuit genre. It is another in a long list of conscientious plan sponsors accused of self-interested actions that violate fiduciary duties, when the reality is that the company, with the help of qualified outside advisors, was conscientious and diligently focused on ensuring that its employees received a quality retirement that was not eroded by a severe market decline.
There have been nine deep and sustained market declines, which is defined as a 20% or more decrease in the S&P 500 lasting six months or more, since the mid-1950s. On average, a deep and sustained market decline occurs every 8 to 10 years. Just because it hasn’t happened since 2008 should not justify the fake damage models and imprudence lawsuits that the trial bar brings against companies that offer conservative investment strategies. The is especially true when the plaintiff damage models are based on investment theories choosing unlimited risk profiles – a reckless and dangerous precedent.
It is too easy in America for the trial bar to file a lawsuit that turns out to be defamatory and offensive. It is too easy to assert breach of fiduciary duty and claim outsize damages that are based on speculation and junk investment models. The rules need to change to require courts to throw out meritless cases that lack real proof of wrongdoing, and the Milliman case demonstrates why.
The Imprudence Claims against Milliman’s Hedging Strategy
In January 2022, the Sanford Heisler law firm filed a breach of fiduciary duty and loyalty lawsuit against the Milliman 401k plan. With the characteristic hyperbole of excessive fee and imprudent performance lawsuits, the law firm promised to prove at trial that the venerable Milliman professional firm had lost $56 million of its participant retirement funds in a failed “experiment” to benefit its own bottom line in promoting its investment services. The trial brief promised to show “troubling” evidence that Milliman’s board and fiduciaries followed an “untested” and unproven investment strategy, and breached their ERISA’s duties of prudence and loyalty to its 401k plan participants when it failed to remove the hedged investment options after purported significant underperformance. That lawsuit alleged that Milliman’s motive was its concern that removing the target-risk funds would negatively affect the business prospects of the Milliman FRM subsidiary that served as the subadvisor for the funds.
The lawsuit was untrue, and filled with false and defamatory claims. The federal court granted a trial verdict in favor of Milliman, ruling that that the Milliman fiduciary committee “engaged in hard, careful, and thorough work” and that the “Committee’s diligent, persistent, and efficient efforts demonstrated the highest level of performance.” The court held that the disloyalty claims lacked evidence that Milliman acted in its own interest, but instead Milliman legitimately wanted to offer an investment option that protected against downside risk in a diversified plan of fifteen other investment options. The court rejected the duty of loyalty claim because plaintiff failed to prove that Milliman “acted with anything other than the best interests of Plan participants in mind.” The court also held that the investments were objectively prudent on their own merits, and that a hypothetical prudent plan fiduciary would not have acted differently in offering the same investment lineup to Milliman plan participants. On damages, the court found that there was no proof that the WPS funds caused the plan to suffer losses.
After explaining the Milliman plan investments, we identify the key issues addressed by the Milliman trial verdict.
The Milliman Plan
Like most excessive fee and performance cases, the complaint alleging breach of fiduciary duty distorts perspective and the actual investments offered in the Milliman Inc. Profit Sharing and Retirement Plan. The plan committee was advised by Cook Street Consulting, Inc., which began servicing in that role in December 2013. The plan committee met quarterly and had a track record of an active and engaged fiduciary committee. The fiduciary committee included serious professionals like Milliman’s CEO and the head of the FRM investment subsidiary.
The plan offered a diversified mix of 18 investment options, including target risk and target date funds across four categories, including active and passive investment option tiers. Specifically, the plan offered nine active funds; five passive funds; the three WPS target-risk funds (with conservative, moderate, and growth options); and “InvestMap” funds, which are similar to target-date funds. The WPS moderate fund was initially chosen as the qualified default investment option, but the QDIA was later switched to the InvestMap funds when they were added to the plan.
The lawsuit was obviously lawyer driven by a sophisticated plaintiff law firm who specializes in investment performance lawsuits. But it is important to understand who they used to file the lawsuit. They filed the case with just a single participant who had already left the plan years before the 2022 filing. The solo participant worked at Milliman a decade earlier for just two years. She had transferred some funds from a prior company into the plan, yet only had $63,000 invested in one of the target-risk funds, as she had diversified some of her plan assets into index funds. To be clear, the entire case was prosecuted by a former employee who was a former participant in the plan with a marginal plan balance. [We note that it is a fiction to pretend that the plan participants are the actual litigants in lawyer-driven cases, but courts follow this fictional narrative in all of the class action ERISA fiduciary-breach cases. The point is how easy it is to gain standing to file a serious fiduciary malpractice case in America, whereas the securities law require a higher threshold of invested assets in a company before a trial firm can serve as counsel to the class representative]. The former participant who served as the purported representative for close to 3,000 Milliman plan members was not invested in the WPS funds or even the plan for vast majority of the 2016-2022 time period in which her trial lawyers sought $56 million in damages against Milliman fiduciaries.
The lawsuit challenged just the three related Unified Trust Wealth Preservation Funds (WPS Funds), which totaled approximately $241m or less than 20% of the total $1.7B plan when Milliman was sued in 2022. Belying the claims that Milliman used its retirement plan to promote its FRM hedging business, the WPS funds represented a tiny fraction of the $70 billion in assets under FRM management, including a $10 billion family of funds that implemented MMRS hedging strategies as of July 31, 2015. The amended complaint left out this key perspective.
The WPS funds are a suite of investment funds that seek to preserve capital and guarantee investors specified levels of risk through the application of a hedging strategy – the Milliman Managed Risk Strategy (MMRS) – which was also called the “overlay.” The hedging strategy was designed to manage risk in a method similar to what is used by major financial institutions. The purpose of the WPS funds was to implement hedges designed to limit the expected volatility of each portfolio and preserve capital during sustained market declines. The goal of the WPS funds was to achieve 75% of the potential market upside, but experience only 25-30% of a sustained downside.
The WPS funds are managed by Unified Trust Company, and the Milliman Financial Risk Management (FRM) subsidiary served as a subadvisor to Unified trust. FRM manages the overlay or hedging strategy for the WPS funds, determining when and by how much to hedge the WPS Funds’ equity exposures. Plaintiff’s claim was that the overlay or hedge is what caused the target-risk funds to underperform.
Contrary to the premise of the lawsuit that the Milliman hedging strategy was novel and untested, the MMRS or overlay hedging strategy has been successfully used in variable annuity sub-accounts. Hedging is one of several ways to protect against a decline in the value of assets invested in the stock market. Hedging reduces an investment’s risk by protecting against the downside, but at a cost and a potential decrease in returns, i.e., lower upside capture or participation. It was not a novel or untested strategy. The court noted that these type of “hedging programs saved the life insurance industry about $40 billion in September and October 2008.” It worked again in 2016 when investors started dumping stocks, and was valuable in the 2020 and 2022 market declines, although none of these time periods had a sustained market decline.
The Milliman fiduciary committee recognized from the outset that FRM’s role created the appearance of a conflict of interest, and thus prepared disclosures and waived its fees. The leader of FRM, who was on the fiduciary committee, recused himself from the committee’s vote to add the WPS funds. And to cure any potential conflict of interest, the Committee directed that language disclosing Milliman’s relationship with FRM be included in plan communications. The plan communication disclosing the potential conflict disclosed that FRM and Milliman were waiving all normal sub-advisory fees.
There is one final housekeeping issue before we turn to the key issues in the Milliman case, and that is Sanford Heisler’s argument that the Milliman board was negligent by delegating the day-to-day monitoring of the plan to the plan committee. The plaintiff lawyers argued that the “Board’s delegation to the committee of monitoring responsibilities, while retaining for itself decision-making authority for the Plan, was imprudent.” Plaintiff’s expert Arthur Laffer argued that “delegating monitoring but not decision-making authority creates a risk that no one will take responsibility.” Plaintiff argued that “no one took responsibility,” and that the Board was unaware of the problems with the WPS funds. [Plaintiff also argued that Milliman committee had poor training, which the Court rejected based on evidence of actual training. Again, this shows how the trial bar will argue anything that makes a plan sponsor look bad, even when they have contrary evidence on point.]
Court rejected this board delegation argument “as contrary to ERISA jurisprudence, which is replete with instances in which a corporate board of directors retained decision-making authority, but delegated monitoring responsibility to a committee.” You have to remember that Milliman’s CEO was on the fiduciary committee. The court concluded that Milliman employed a prudent process in deciding to keep the WPS funds in the plan, with the plan committee handling the key monitoring function with reports to the company’s board. Contrary to plaintiff’s suggestion, separating the responsibility for monitoring the plan from the authority to make decisions for the plan was not improper. It was designed to reduce “groupthink” and created a “check and balance” to separate the responsibility for monitoring the plan from the authority to make decisions for the plan. In sum, the entire delegation argument shows how the trial bar will create and pursue fiduciary malpractice claims even in the face of serious due diligence and fiduciary best practice. Class-action litigation is not a truth-finding process for the prosecuting lawyers. The entire delegation argument was a misdirection that had no valid legal basis, but the plaintiff firm pursued it tirelessly.
ISSUE #1: Is it acceptable to offer conservative investment strategies in a defined contribution retirement plan?
The long introduction to this article addresses this key point. The Milliman WPS target-risk funds were conservative investment options designed to hedge against a once-a-decade long and sustained market decline. They were intended to be conservative. That meant not capturing the full market upside potential, but attempting to avoid most of a sustained market downturn. The wealth preservation funds were vilified as a self-interested and failed “experiment” that harmed plan participants. The investments had temporary periods of underperformance, but the ten-year return was adequate. And most importantly, the investments performed as they were intended: to mitigate the risk of a market downturn. It is a legitimate investment strategy to include in a diversified investment lineup that offered active and passive investments to give a participant full exposure to the market in different ways. Participants could choose normal investments with full exposure to equities, or the wealth preservation funds with a market hedge, or a mixture of the diversified investment strategies.
Like the Milliman case, the current slate of performance cases have the same common theme. The trial bar is attacking conservative investment strategies, and alleging fiduciary malpractice by comparing conservative strategies to the most popular funds that achieved higher returns by taking a higher level of market risk. The cases against Wood Group, Molina Health, UnitedHealth, Milliman, Intel, Verizon, and the Motion Picture multiemployer plan are all liability theories challenging legitimate and prudent investment strategies that conservatively attempted to hedge against downside market risk. The damage model is comparing a risk-mitigation strategy to an investment model with an unlimited or higher risk strategy.
These investment performance lawsuits are perversely alleging fiduciary imprudence for choosing conservative investment strategies or philosophies. What used to be considered prudence – investing conservatively – is now being flipped as fiduciary malpractice. The key problem is that it is too easy to allege an imprudence claim that a court will consider plausible, and then plan sponsors have to spend millions of dollars and face huge liability risks to vindicate their fiduciary processes. Most plan sponsors settle to avoid the litigation and liability risk. Most plan sponsors, unlike Milliman, lack the fortitude its takes to go to trial to disprove unfair liability theories.
The risk is that plan sponsors will be forced to offer high-risk investment strategies in order to avoid litigation. That is bad public policy. We realize that the stock market has gone up for over a decade. But that is rare. At some point, the aggressive investment options that the trial bar espouses as “prudent” will turn out to be imprudent because these strategies assume too much market risk. Yet it will then be too late for plan participants.
We need courts or the DOL to understand what is happening, and stop this madness. We cannot allow the trial bar to seek liability for prudent, conservative investment options.
ISSUE #2: What does proper fiduciary process look like?
Milliman was accused of fiduciary breaches, but the Court held that the Milliman fiduciary committee and board was “persistently armed with [a high] level of detail and generally favorable statistics.” It found that that investment advisor “Cook Street’s and the Committee’s diligent, persistent, and efficient efforts demonstrated the highest level of prudence.” The Committee, assisted by Cook Street, “engaged in hard, careful, and thorough work.”
The court held that Milliman fiduciaries followed the “hallmarks of prudent processes.” This opinion cites the key fiduciary process case decisions over the last several years, and should be used as a training guide for plan fiduciary committees. The court listed the following “hallmarks” of prudent fiduciary practices:
- (1) Meeting regularly to review and evaluate a plan’s investment options: Before and at each meeting, does the committee thoroughly monitor the independent merits of each fund in relation to funds from other asset management companies to determine whether it was a prudent investment and should remain in the lineup?;
- (2) Evaluating the reasons for any periods of underperformance: During quarters when the challenged investment options did not meet all of the performance standards, did the plan’s independent consultant explain the reasons for all underperformance?
- (3) Retaining an independent investment advisor, such as Cook Street: The fact that the plan committee sought independent, expert advice is evidence of a thorough investigation by a fiduciary, and provides evidence of a thorough investigation and of procedural prudence and proper monitoring.
- (4) Reviewing the investment advisor’s reports and recommendations: Did the committee’s independent advisor continually monitor and evaluate the plan’s investment options, providing the committee with detailed information, including monthly and quarterly performance reports, writing reports summarizing meetings with investments managers?; did the advisor provide commentary and other information requested by the committee on a periodic basis?
- (5) Questioning and probing the investment advisor on why it is making a particular recommendation: Did the committee engage critically with the investment advisor; asking questions, expressing concerns about methodologies for evaluating investments?
- (6) Considering the quantitative and qualitative factors in the plan’s investment policy statement and the mix of options available in the plan. We discuss this issue in a separate section below. The court found Milliman’s process was prudent because the fiduciary committee considered the disputed funds in the context of the entire plan investment lineup. Specifically, “they considered not only the WPS Funds’ performance, but also how these target-risk options fit within the mix of other Investment Alternatives and whether they continued to meet the purpose for which they were added to the Plan.”
Milliman’s fiduciary committee followed all of these best practices. An unbiased observer would have to conclude that Milliman was unfairly sued, and they would be correct. The case shows how the current judicial system allows the trial bar to file complaints filled with inflammatory claims of fiduciary imprudence and disloyalty based on pure conjecture. We need a judicial system that requires real proof of deficient fiduciary process. Instead, courts are allowing claims as “plausible” that are based purely on circumstantial evidence of a supposedly poor investment result anytime an investment has any relationship to the plan sponsor, or when the trial bar claims a high, but inflated, damages model. The Milliman case demonstrates that fiduciary-breach complaints based solely on circumstantial evidence must be treated with judicial cynicism.
ISSUE #3: When are investments objectively prudent?
While it is always best to follow a prudent fiduciary process like Milliman, the trial bar specializes in accusing plan fiduciaries of following an imprudent process. Like it did to Milliman, it will allege that you followed a deficient process, even if they have no actual proof when they file the case. They will try to create a factual issue so that the case is not dismissed, and force you to defend your fiduciary process. They will then use discovery to attempt to embarrass plan fiduciaries and try to make the process look deficient. They will second-guess everything that you did. It takes millions of dollars to mount this type of defense, including hiring expensive experts.
Given the unfair ability of the trial bar to allege fiduciary procedural imprudence, it is important to remember that there is a second off-ramp in fiduciary breach litigation, and that is what the Milliman court called “substantive prudence.” We call this objective prudence, but we are talking about the same thing. The reason we call it “objective” prudence is that the test should be whether the investment is a legitimate investment in a 401k plan even if the process was deficient. In other words, does the investment stand on its own as prudent for plan participants? The key perspective is that many investments are objectively prudent and are appropriate for inclusion in 401k plans. That is why you have a decision like the recent trial verdict in Molina Healthcare in which the procedural prudence of the plan committee was less than optimal, but the plan fiduciaries still prevailed because the FlexPATH investments are legitimate target-date funds for the defined contribution plans sponsored by many companies. The Wood Group trial involved the same finding that the FlexPATH funds were objectively prudent. We would further note that the Wood fiduciaries also followed a best-in-class procedurally prudent process like the Milliman fiduciaries.
We note that there is an unresolved dispute as to how to define the test for an objectively prudent investment. The Milliman court stated that the “requisite inquiry is whether ‘a hypothetical prudent fiduciary would have made the same decision.’” (emphasis added). We have written about the pending Yale appeal in which there is serious dispute as to whether the test for objective prudence should be “could have” a prudent fiduciary made the same decision versus “would have” a prudent fiduciary made the same decision. There is a big difference in how this could play out, because the “would have” connotation would mean that there is only one right investment decision for every plan, and that cannot be right. If plan sponsors are afforded legitimate discretion to make sound fiduciary decisions, the causation standard must recognize that there are many possible investment decisions that are prudent. Thus, there are real consequences for plan sponsors on this issue in the Yale appeal.
Nevertheless, the would-have versus could-have debate was not an issue in the Milliman case. In addition to finding procedural prudence, the court also held that Milliman had met the standard for substantive prudence. As the court held, “[a] fiduciary acts in an objectively prudent manner even when not selecting funds expected to provide higher returns if such alternative funds ‘would have resulted in taking on more risk, subjecting participants to higher volatility and a higher likelihood of losses as their retirement dates approached.’”
This is the key point in our core question as to whether it is imprudent to offer investments with low-risk strategies. Lower-risk strategies will offer lower returns, but the tradeoff can be appropriate and prudent for retirement plans. To this end, the court held that the committee came to a “reasoned decision” to keep the WPS funds in the plan despite short-term underperformance. This decision was consistent with the plan committee’s long-term investment strategies designed to limit volatility and provide protection against losses in down markets. The committee’s actions were substantively prudent even though the WPS funds under-performed their one-year and three-year benchmarks.
ISSUE #4: What are the proper benchmarks to judge investment fund performance? The need for a meaningful benchmark to judge performance.
Milliman used its investment advisor to track and benchmark the performance of the funds on a quarterly basis. Cook Street offered data on a hypothetical unprotected portfolio that would not have the hedge. It also compared the WPS funds to Morningstar Peer Groups.
Sanford Heisler nevertheless argued that the Morningstar Peers Groups are inapt comparators because they have lower equity allocations than the WPS funds. The court was not persuaded, because the Morningstar peer groups assigned to each WPS fund contains assets with equity allocations in the range in which the WPS Funds equity allocation fluctuates over times as a result of the overlay.
The main argument advanced by plaintiff’s law firm was that the Milliman hedge was what caused the WPS investments to perform, and thus their damage model they advanced was the WPS funds without the overlay or hedging strategy. In other words, Plaintiff wanted damages for a stock fund with no hedge. This hypothetical investment did not exist, but more importantly, Milliman fiduciaries wanted the hedge. It was the purpose of the investment option. Without the hedge, they would not have offered the investment in the plan. In other words, Plaintiff wanted a damage model for an investment strategy that does not exist.
The con game of fiduciary-breach performance cases is to file a complaint alleging a huge damages model, hoping to create sympathy for plan participants and convince a judge to allow the case to proceed. Many of these cases have contrived and inflated damage models that are based on junk models. The damage models advanced by the trial bar are reckless and violate all standards of prudence, because they are calculated by assuming an unlimited amount of risk. The Milliman decision underscores the serious prejudice of the trial bar’s imprudent performance models that are based on misleading comparators. The need for a meaningful benchmark that is based on the same investment strategy is crucial, and remains the key to performance cases.
Other cases, like in the two FlexPATH trials, attempt to compare conservative investment strategies to the highest performing investments, as judged in hindsight. The trial continues to argue that once they prove a fiduciary breach, they are then entitled to a damage model that compares to the performance of the highest-grossing investment available in the market. This is seriously prejudicial to plan sponsors, and should have no bearing on calculating damages in a fiduciary breach case.
ISSUE #5: When do you need to remove underperforming funds on the watchlist?
After the need for a meaningful benchmark to judge performance, the next key issue is when does a fiduciary committee need to remove an underperforming investment. The evolving trend of the trial bar, including the frequently used plaintiff’s expert David Witz, is to argue that plan fiduciaries have to remove any underperforming investment in increasingly shorter time frames. Investments designed for the long-term are judged by the trial bar in quarterly and one-year time frames. Investments like the WPS funds that are designed to minimize losses from twenty-plus percent market declines that occur once a decade cannot be fairly judged in one, two, or three-year time frames. But that was the plaintiff theory in the Milliman case – that the funds should have been removed immediately after short-term underperformance.
For perspective, the ten-year track record of the WPS funds were reasonable, if not very good:
10-year returns:
WPS Conservative Versus Peer Group Return: 65.1% versus 41.4%
WPS Moderate Cumulative Return 77.6% versus Peer Group Return 19.9%
WPS Growth Fund Cumulative Return 74.6% versus Peer Group Return 89.8%
The court summarized that, with respect to the ten-year period ending on December 31, 2022, which contains seven of the almost eight years of the Class Period, these figures indicate:
- The WPS Conservative Fund consistently outperformed its Morningstar Peer Group;
- The WPS Moderate Fund kept pace with its Morningstar Peer Group; and
- Although the WPS Growth Fund did not produce as much in returns, it also did not experience as much volatility as its Morningstar Peer Group, and thereby offered a “smoother ride” for its investors.
The WPS funds had a one-to-two-year time period in which the funds underperformed benchmarks, and the funds were placed on the investment watchlist at Cook Street’s recommendation. Milliman fiduciaries followed their investment advisor’s recommendation and requested heightened monitoring of the funds. This included debates as to whether the funds were meeting the risk-mitigation and whether the strategy could be achieved with different investment options. The Milliman committee could not be accused of rubber-stamping anything Cook Street recommended, as the committee was actively engaged, requested additional information, debated alternatives, and kept the WPS funds on the watchlist even after Cook Street had recommended a status change based on good performance.
Nevertheless, plaintiff’s argument was that the plan fiduciaries should have removed the WPS funds given the short-term underperformance. This argument is advanced by plaintiffs in every performance lawsuits. The significance of the Milliman decision is that the court rejected the notion that plan fiduciaries are imprudent if they maintain investments despite short-term under-performance. This should be an obvious principle, but it is not.
The court held that “[c]ontrary to Mattson’s argument, the WPS Funds’ underperformance with respect to certain benchmarks during a three-year (or even five-year) period is insufficient to prove substantive imprudence.” The court quoted from the Sixth Circuit’s seminal decision in Smith v. CommonSpirit Health, 37 F.4th 1160, 1166 (6th Cir. 2022): “Precipitously selling a well-constructed portfolio in response to disappointing short-term losses, as it happens, is one of the surest ways to frustrate the long-term growth of a retirement plan. Any . . . rule [requiring such sales] would mean that every actively managed fund with below-average results over the most recent five-year period would create a plausible ERISA violation . . . [and likely] lead to the disappearance of this option in ERISA plans.” The court held that removing the WPS funds from the plan based on only three (or even as much as five) years of underperformance would have been inconsistent with the plans Investment Policy Statement and the WPS funds’ long-term focus. Moreover, the plan made mid-2017 changes to the hedge overlay. And in the 2020 and 2022 market downturns, the WPS funds proved that they “serve[d] the purposes” for which they were added to the plan, protecting investors from experiencing large losses during periods of high volatility, while outpacing or closely tracking the performance of peer group funds.
The court’s decision was influenced by the high-quality monitoring by the Milliman fiduciary committee: “Almost immediately after the returns of the WPS funds became concerning, Milliman began to take action.” Cook Street intensified its monitoring during the first period of temporary underperformance in 2014, and then again when the funds were placed on the watchlist in 2016. Cook Street also validated that the overlay hedge was at all times was “performing in line with how we would expect it to perform.”
The court’s opinion summarizes the debate over how long you measure an investment’s performance. Milliman suggested that a “full market cycle” is the appropriate time frame for evaluating an investment, especially an investment with risk-mitigation strategy. Milliman’s expert Jennifer Conrad described a “full market cycle” as a period during which the market goes from trough to peak to trough, or from peak to trough to peak. According to Conrad, when measuring the performance of an investment, a long sampling period involving different economic conditions or market states is desired. Nevertheless, the court noted that Milliman was provided with, and took action on the basis of, performance data for a range of timeframes other than a “full market cycle,” namely quarterly, one-year and three-year returns, which were routinely reviewed, and five-year and ten-year results, which were considered as they became available.
The issue of when plan fiduciaries can be held liable for failing to remove an underperforming investment remains a pivotal issue. The Milliman decision provides helpful analysis for plan sponsors to avoid unfair liability when an investment remains on a watchlist under careful monitoring.
ISSUE #6: Challenges to Investments Must be Evaluated in the Context of the Entire Fund Lineup.
We continue to see fiduciary-breach performance and fee cases that attack isolated investments out of context of the entire plan lineup. Two recent examples are the cases filed Hormel and Cape Cod Healthcare. Both companies sponsor plans with low-cost Vanguard index funds as the plan’s QDIA. The choice of low-cost, high-performing index funds should be considered as prima facie evidence of a diligent plan fiduciary process, especially when the trial bar challenges one or two active fund options in the plan as imprudent.
Consider the recently filed case against Hormel. Hormel sponsors a retirement plan with a really low recordkeeping fee – so low it is not challenged in the fiduciary-breach lawsuit – and a QDIA anchored by super low-cost Vanguard target-date funds. But you wouldn’t know any of that from the breach of fiduciary duty lawsuit that alleges two isolated active funds have excessive fees and that the stable-value fund has a deficient crediting rate. The fiduciary-breach lawsuit against Cape Cod Healthcare follows the same misleading template. You wouldn’t know that participants have the chose of low-cost Vanguard index funds, and the plan offers investment balance and diversity of choices with a few active funds that the trial bar claims are imprudent. The prudence of these active investment alternatives must be evaluated in the context of the entire lineup of passive and active investment options.
The Milliman decision is rare to the extent the court’s ruling that the WPS funds were objectively prudent was evaluated in the context of the plan’s entire investment lineup. The court considered the prudence of the risk-mitigation investment options in the context of a thoughtful plan that already offered full exposure to the equity stock market with passive and active investment strategies. We have always maintained that you cannot judge the prudence and performance of an investment option in isolation. It has to be judged in the context and perspective of the diversified investment lineup that includes passive, active and fixed income options. A conservative investment option makes sense in the context of a plan that offers other investment options that have more aggressive investment strategies. Courts must be more discerning to question why the plan offered different types of investment options.
We have found defense lawyers reluctant to make this critical argument, as they are worried of being accused by the trial bar of ignoring the Tibble Supreme Court decision that all investment options must be monitored and all investment options must be prudent on their own merits. The Supreme Court in the Northwestern decision similarly rejected that Seventh Circuit’s prior law that a higher-fee active fund can be considered prudent if the plan offers low-cost index funds. But there is an important nuance. A plan that offers active funds usually does so in the context of already offer passive options. Fiduciaries do not choose investment options in isolation. They choose individual funds in the context of the entire plan lineup. And therefore, any prudence challenge must be judged in the context of how the particular investment options fits into a diversified plan lineup.
Think of it another way. What is the plaintiff law firm hiding when they intentionally hide from the judge that the plan has low recordkeeping fees and/or a low-cost index target-date funds as a QDIA? They hide this evidence in cases like Hormel and Cape Cod Healthcare because they are using misleading circumstantial evidence to get past a motion to dismiss. They don’t want the judge to get the full context of the plan investment options, because that critical context would deflate their misleading fiduciary-breach claims. It is all about getting into discovery in order to leverage the high cost of defense into a favorable settlement for the plaintiff lawyers. Truth is not part of the trial bar’s litigation strategy.
ISSUE #7: Retaining proprietary investments – even if they underperform – without more, is not evidence of disloyalty.
The most defamatory claim in the Milliman lawsuit was that Milliman offered the WPS funds to serve its own interest. There never was any proof for these disloyalty claims. The trial bar knows that proprietary claims are an automatic ticket past a motion to dismiss, and even summary judgment in the Milliman case. But that does not make the claims fair or proper. Milliman never accepted any compensation for its sub-advisory services. And most importantly, Milliman wanted to offer a risk-mitigation strategy to protect its employees’ retirement funds from a 2008 catastrophe. Milliman employees wanted the conservative strategy. Why? Because Milliman employees had seen how the company had served the insurance annuity industry so effectively in the 2008 market meltdown. The plaintiff lawyers in the case knew all of these facts, but nonetheless pursued the disloyalty theory despite no real evidence to back up these serious claims.
The trial court completely vindicated Milliman. The court held that Milliman’s board and fiduciary committee kept WPS funds in the plan because they genuinely believed that continuing to offer the WPS funds served the best interests of plan participants as opposed to those of FRM or Milliman. Milliman took efforts to mitigate any apparent conflict of interest by disclosure and waived fees. It even moved the QDIA to a different investment options. “Mattson’s breach-of-loyalty claim is based on nothing more than inclusion in the Plan of an investment option as to which Milliman’s subsidiary (FRM) serves as a subadvisor. This fact does not a breach-of-loyalty claim make.” Finally, the court ruled that plaintiff’s contention that the designation of the WPS Moderate Fund as the QDIA was motivated by a desire to “seed” or “incubate” the WPS Funds, and thereby ensure they would endure, is “unsupported by the evidence.”
The trial bar has filed too many cases of alleged proprietary fund disloyalty without evidence. We saw the Goldman Sachs decision recently. And now we have the Milliman trial verdict. The Milliman case should never have gone to trial. It should have been dismissed when it was filed based on pure conjecture and inflammatory claims without proof. We continue to need a higher pleading standard in the federal courts in which the trial bar has to allege real participant losses before allowing a class action challenges. And we need a higher and consistent pleading standard to weed out meritless cases in which the trial bar alleges fiduciary breaches based on hyperbolic rhetoric and contrived damage models.
