By Daniel Aronowitz, Encore [formerly Euclid] Fiduciary
The formula for a fiduciary imprudence claim is the same in nearly every proprietary investment case: (1) find an investment company that includes one or more proprietary investments in the company-sponsored 401k plan; (2) allege that the proprietary investment(s) was excessively priced and underperformed non-proprietary investment options, even if the purported underperformance is for a short time period; and (3) assert that the company improperly used the 401k plan to launch or prop up an underperforming, expensive and uncompetitive investment product that the marketplace did not want. The disloyalty claim that plan fiduciaries favored the company’s investment products to the detriment of plan participants is the lynchpin of every proprietary investment case. The reason is that the excess fee trial bar knows that it is the golden ticket to survive a motion to dismiss. But the disloyalty claim is often brought on false pretenses with a prejudicial narrative of disloyalty that ultimately cannot be proven.
That is what happened in the Goldman Sachs proprietary investment case. In order to survive a motion to dismiss, plaintiff’s lawyers promised to prove at trial that the venerable Wall Street investment firm engaged in “unlawful self-dealing” by force-feeding participants in its 401k plan with underperforming proprietary funds that “saw large redemptions” from other investors, “allowing Goldman Sachs to stem the consequences of further depletion of fund assets.” Like most cases, the district court denied the motion to dismiss and gave plaintiff the benefit of the doubt to prove his claims. After losing the motion to dismiss, most investment companies settle proprietary investment cases well before a trial on the merits, because the cost of defense is so high, and plaintiffs can leverage the public embarrassment of proprietary investment claims with staggering damage models. But Goldman Sachs forced the Nichols Kaster law firm to prove its claims, and the disloyalty case fell apart for lack of proof. In fact, Marcia Wagner, plaintiff’s curious choice to serve as the fiduciary process expert, ended up as the most effective witness for the defense as she conceded that Goldman Sach’s fiduciary committee was filled with knowledgeable, conscientious, and engaged fiduciaries who followed a rigorous process that was the same for all investments in the plan.
In our analysis, the key significance of the Goldman Sachs decision is that it reveals that many fiduciary disloyalty claims are brought on false pretenses with a prejudicial narrative that the company uses its 401k plan to support failing investment products. It is way too easy to bring a claim of fiduciary disloyalty, as courts give the benefit of doubt to plan participants who bring these claims. But the Goldman Sachs case shows how a prudent process of engaged and diligent fiduciaries can be used to rebut the unfounded claims of disloyalty and fiduciary imprudence on a summary judgment record. The case hopefully will give support for district court judges to grant summary judgment in more performance cases even when proof of fiduciary prudence is inherently fact intensive.
The case has been labeled a “roadmap” for how to prove sound fiduciary process. And the case certainly shows what quality fiduciary due diligence looks like. But even more importantly, the way the Sullivan & Cromwell defense lawyers cast their summary judgment argument is a lesson for future cases that involve the same fabricated disloyalty claims. The defense lawyers reminded the judge that plaintiffs used false pretenses of serious disloyalty claims in the complaint to survive the motion to dismiss, but could not deliver the goods when it came time at summary judgment to “put up or shut up.” Given that many of the proliferating excess fee and performance cases are based on contrived claims designed to get past a motion to dismiss, it is useful to learn from the Goldman Sachs defense strategy, i.e., reminding the judge that plaintiffs sold the court a bill of goods that they could not deliver.
The Goldman Sachs Investment Performance Case
In the class action fiduciary imprudence lawsuit Falberg v. The Goldman Sachs Group, Inc., Case No. 19-CV-9910 (S.D.N.Y. 10/25/2019) filed in the Southern District of New York in 2019, the Nichols Kaster, PLLP law firm alleged, with just a single participant in the plan as the sole plaintiff, that the fiduciaries of the Goldman Sachs 401(k) Plan retained five underperforming mutual funds managed by Goldman Sachs Asset Management (GSAM) that an objective fiduciary would allegedly have removed. The disloyalty claim that the plan fiduciaries gave preferential treatment to the five GSAM investments was based on the assertion that “[w]hile underperforming proprietary funds saw large redemptions from other investors, Defendants retained these funds in the plan, allowing Goldman Sachs to stem the consequences of further depletion of fund assets.”
By the summary judgment stage, there was no proof of the disloyalty claim that Goldman Sachs had used the 401k plan to prop up the investments. In its summary judgment brief, Goldman Sachs noted that these claims had essentially been abandoned. The case devolved to second-guessing the process that Goldman Sachs fiduciaries used to monitor and ultimately remove the challenged investments. But it is a noteworthy reminder that this type of unfounded disloyalty claim is asserted in every proprietary investment case, even when there is no proof. It is why there needs to be a higher pleading standard to ferret out what we consider to be offensive and defamatory claims based on nothing but weak circumstantial evidence of alleged short-term underperformance.
Context and details are critical to understand this case. This is tedious, but if you want to understand the seriousness of purpose of the Goldman Sachs fiduciary committee, you have to see why the court called it “rigorous.” And if you dig into the rigor of the process, you will see how the plaintiff lawyers in this case filed a case based on false pretenses alleging serious disloyalty claims that were unfounded and defamatory to the Goldman Sachs plan committee members. Let’s dig in.
Context: The Proprietary Investments were just a small part of the overall investment options – five out of 30 options: Like many excess fee lawsuits, the complaint gives the misimpression that the Goldman Sachs 401k plan was filled exclusively with high-priced, poorly performing investment options sponsored by Goldman Sachs. But that is far from the truth. The Goldman Sachs 401k plan did not force its employees to choose only Goldman Sachs investments. Instead, the plan offered thirty investments, with only five investments managed by Goldman Sachs. Second, all five challenged investments had been removed from the plan two years before the case was filed. Nichols Kaster characterized this as an “act of self-preservation” that “arrived too late” to avoid the fate of other investment companies being sued in other proprietary investment cases, but this again shows how easy it is to cast dispersions without proof. Goldman Sach’s summary judgment brief noted that extensive discovery revealed no basis for the allegations that the investments were included to stem the supposed depletion of the funds’ assets caused by other investors’ large redemptions, and plaintiff stopped even mentioning it. Instead, the case evolved into “Plaintiff larging second guess[ing] the decision-making of experienced, well-informed, and attentive Plan fiduciaries about the timing of the removal of the five GSAM funds from the Plan more than two years before” the lawsuit was filed, with Plaintiff “arguing that the funds should have been removed sooner.”
A Highly Sophisticated Committee that was assisted by ERISA Counsel and an Investment Advisor: Plaintiff’s expert Marcia Wagner conceded that the Goldman Sachs fiduciary committee consisted of ten to twelve highly sophisticated professionals from Goldman Sachs: “consummate financial professionals” with “deep expertise in the markets,” some of whom are “famous” in the investment community. Plaintiff’s expert also acknowledged that the committee members’ experience “compares favorably” to that of members of other large-plan retirement committees, the “vast majority” of whom possess “limited investment knowledge.” The committee had a full-time secretary, who the district court described as “highly-qualified.” And the committee was advised by Goldman Sachs’ ERISA counsel, who the court described as “experienced” and “highly-qualified,” as well as outside ERISA counsel from the law firm of Steptoe & Johnson LLP.
Fiduciary Training: Each new committee member participated in one-on-one training with Goldman Sachs’ ERISA counsel that covered members’ fiduciary responsibilities, ERISA’s prohibited-transaction rules, and potential conflicts of interest. Throughout their tenure, committee members also received additional training at committee meetings. The district court noted that committee members were specifically trained to treat the GSAM funds offered by the plan “exactly the same, as equals [to the other] plan options.”
Rocaton as Investment Advisor: The committee hired Rocaton as a fiduciary advisor to provide impartial investment advice. Rocaton provided the committee with: (1) information about each of the plan’s investment options, including monthly and quarterly performance reports; (2) written reports summarizing Rocaton’s meetings with investment managers; (3) Rocaton’s commentary on different investment options and industry trends; and (4) other information periodically requested by the committee.
The Committee’s “Robust” Fiduciary Process: The committee met at least once per quarter to review the plan’s investments and held ad hoc meetings as needed. Rocaton attended every Committee meeting, providing committee members in advance of all quarterly meetings with detailed reports that included a quantitative and qualitative review of each investment option. Those reports gave the committee information about each option’s quarterly, year-to-date, one-year, three-year, five-year, seven-year, and ten-year performance compared to index benchmarks and peers. Committee members testified that they reviewed Rocaton’s reports before each meeting, with some reading them “multiple times.”
Each quarterly meeting began with Rocaton presenting detailed information to the committee about plan performance and fielding questions from committee members. The committee also heard presentations from managers of current or prospective plan investments. Plaintiff’s expert admitted that the committee’s direct access to these outside investment managers was “very, very atypical” for a retirement committee and “a very good thing.” Rocaton also regularly met with investment managers and provided the committee with reports on those meetings.
The committee regularly evaluated the fees charged by each plan investment option to ensure that the fees were reasonable and to reduce them whenever possible. Committee members received detailed analyses of the fees charged by each investment option, including comparisons to peer-group averages across different investment vehicle types. During the class period, the fees charged by the five challenged GSAM mutual funds were lower than the institutional mutual fund average.
The Performance of the Challenged Funds: The complaint alleged that Goldman Sachs foisted underperforming investments into the plan, and that the fiduciaries acted with self-interest. Both claims fell apart. To the contrary, the court noted that the committee members uniformly testified that they applied “no different standard for Goldman Sachs funds than for any other fund in the plan.” They applied the same format of evaluation to all investment options.
In November 2010 – three years before the start of the 2013-19 class period – the committee asked Rocaton to evaluate the performance of five GSAM funds, including three of the funds challenged in the case (the Mid Cap Value, High Yield, and Short-Duration Government Funds) by comparing their performance to that of their peer group and funds on Rocaton’s “Buy List.” That review showed that the three challenged GSAM funds performed at or above the median performance of their comparators over three-year and five-year periods.
Following Rocaton’s review, the committee voted in December 2011 to remove an underperforming GSAM real estate fund from the plan and replace it with a non-GSAM fund, but to retain the three challenged funds. The Committee also directed Rocaton to expand its prior analysis and evaluate “ALL [of] the GSAM funds in the Plan against their peer groups.” After this broader review, the Committee voted in January 2012 to remove two additional underperforming GSAM funds from the Plan (the Large Cap Growth and Mid Cap Growth Funds) and replace them with non-GSAM alternatives. The defense noted that the removal of GSAM funds contradicts the allegations in the complaint of “preferential treatment” of GSAM funds. Plaintiff’s argument of a poor and “rudderless” fiduciary process because the plan did not have a formal Investment Policy Statement, was limited to the fact that Rocaton had a “Not Broadly Recommended Rating” on the three GSAM funds, but this was not a recommendation to sell the investments.
Of the five challenged funds in the complaint, Rocaton’s quarterly reports to the committee show that each of the five challenged GSAM funds outperformed its benchmark in 2012 – the last full year before the start of the class period. Moreover, as of January 2014, the “long-run (ten-year) historical returns” of the Mid Cap Value, Large Cap Value, and High Yield Funds – the three GSAM funds that plaintiff says should have been removed from the plan at the beginning of 2014, instead of 2016-17 because of alleged poor performance – “were generally consistent with, or better than, those of their mutual fund peers (both on an absolute and a risk-adjusted basis).” The level of performance continued, with Rocaton monthly reports showing that none of the challenged GSAM funds underperformed its benchmark on a rolling twelve-month basis for three consecutive months (a full quarter) until December 2015, when the Mid Cap Value fund showed one standard deviation of underperformance for a quarter, which rose to two standard deviations in March 2016. The Large Cap Value and High Yield Funds did not show one standard deviation of underperformance on a rolling twelve-month basis for a quarter until March 2016 and May 2016 respectively. During the class period, the other two challenged GSAM funds never exhibited one standard deviation of underperformance for a full quarter. Consistent with these monthly reports, Morningstar and Lipper, two investment research firms, both rated the five challenged GSAM funds as average or above average from 2013 to 2015, further rebutting any claim of underperformance.
In response to Rocaton’s monthly reports showing that three of the five challenged funds had exhibited some underperformance for over a quarter beginning in 2016, the Committee acted later that same year. At its September 29, 2016 quarterly meeting, the committee discussed the performance of GSAM’s Mid Cap Value and Large Cap Value Funds. The committee received a presentation from those two funds’ managers and asked questions about the funds’ “investment performance,” “the team’s current outlook, and “adjustments made to the portfolios and investment theses.” The committee then convened an ad hoc meeting on October 25, 2016 to review the plans overall investment lineup, including all of the GSAM funds. Rocaton presented its views on the investment lineup and decided to further review the value funds at the next quarterly meeting in December 2016.
Before the December 2016 meeting, Rocaton provided the Committee with a 119-page presentation that included an evaluation of each of the five challenged GSAM funds as well as potential replacements. Before that meeting, Rocaton provided the Committee with a 119-page presentation that included an evaluation of each of the five challenged GSAM funds, as well as potential replacements. Following the investment presentation, the committee unanimously voted to remove from the plan four of the five challenged GSAM funds (the Mid Cap Value, large Cap Value, Core Fixed Income, and Short-Duration Government Funds). The committee asked for the managers of the fifth GSAM investment, the High Yield Fund, attend the next meeting. At that next meeting in April 2017, the committee heard presentations and then voted unanimously to remove GSAM’s High Yield Fund from the plan. This last of the challenged investment was removed from the Plan on June 6, 2017 – more than two years before the fiduciary imprudence lawsuit was filed on October 25, 2019.
This is a serious fiduciary committee that follows all fiduciary best practices. From our review, the only credible process critique was that the committee did not adopt an Investment Policy Statement or other formal criteria for monitoring investments. Plaintiff’s process expert Marcia Wagner testified that the lack of an IPS was not best practice and caused a “rudderless process,” but she does not appear to have been able to otherwise criticize how the plan fiduciaries evaluated the plan investments.
The District Court’s Summary Judgment Ruling: The District Court granted summary judgment by finding no triable issue on plaintiff’s claim that defendants breached their duty of loyalty by retaining the GSAM mutual funds among the plan’s many investment options. The evidence showed that defendants employed a robust process to manage any potential conflict of interest arising from including GSAM funds as Plan investment options. Members of the Retirement Committee received extensive training on conflicts, were advised by experience ERISA counsel, and retained an independent investment advisor – Rocaton Investment Advisors LLC – to assist them in evaluating and monitoring all plan investment options. Key to the decision was the uniform testimony of committee members that they held GSAM funds to the same standards as other plan investments. Consistent with that testimony, the Committee removed a total of ten GSAM funds from the plan both before and during the class period.
Second, the district court found no triable issue on the plaintiff’s claim that defendants breached their duty of prudence by failing to monitor the GSAM funds. The evidence showed that the Committee employed a rigorous process to monitor all plan investments, including the GSAM funds. The committee’s independent advisor Rocaton provided detailed monthly and quarterly reports on all plan investment options. Each of the committee’s regular quarterly meetings began with Rocaton leading a discussion of those options, and managers of plan investments frequently made presentations to the committee. The district court also disposed of both the prohibited transaction and duty to monitor claims.
The Second Circuit Affirms the Summary Judgment Ruling: The Second Circuit Court of Appeals affirmed the district court’s grant of summary judgment on February 14, 2024. The appellate court started with the premise that “[i]n assessing the prudence of a fiduciary, courts apply an objective standard and “must judge a fiduciary’s actions based upon information available to the fiduciary at the time of each investment decision and not from the vantage of hindsight.” Citing Sacerdote v. New York Univ., 9 F.4th 95, 107 (2d Cir. 2021).
The Court first dismissed the duty of loyalty claim because plaintiff failed to introduce evidence that the Goldman Sachs defendants retained the challenged funds “for the purpose of advancing their own interests.” The court held that there was evidence to the contrary, because the Goldman Sachs committee “employed a robust process to manage potential conflicts of interest: the Committee required its members to participate in fiduciary training sessions, which is not a standard market practice, and retained an investment consultant to act as an independent advisor and provide unbiased advice about the Plan’s fund offerings.” The court reiterated that plaintiff adduced no evidence to prove that committee members had “any personal incentive to favor the Challenged Funds.” The court noted that plaintiff took issue with the timing in removing the GSAM funds, but “a fiduciary does not breach its duty of loyalty by choosing to retain an investment that, in the fiduciary’s reasonable assessment, may perform well in the long term despite short-term underperformance.” The process for choosing the GSAM investments was the same as non-GSAM investments. That is how a prudent process disproves a claim of disloyalty.
On the duty of prudence claim, the court rejected plaintiff’s argument that the Goldman Sachs fiduciaries breached their duty of prudence because they did not establish formal criteria for selecting and monitoring plan investments. The court noted that prudence focuses on process and the conduct in arriving at the investment decisions – not results. The court affirmed the district court’s finding that plaintiff failed to introduce sufficient evidence that a prudent fiduciary in same position “would have acted differently.” Plaintiff’s only real argument that the plan did not have a formal investment policy statement, but the court held that an IPS is not required under ERISA, and it was “mere speculation” that it would have changed the committee’s conduct or investment decisions. “[E]ven without an IPS, the Committee followed a deliberative and rigorous process when selecting and monitoring investments.”
The Encore Perspective
Our perspective on the Goldman Sachs case is colored by what the trial bar promises to prove when it files a proprietary investment case. The lynchpin of every case is that the investment company acted in its own self-interest and harmed its plan participants by cramming lousy proprietary investments into the 401k plan. That is exactly what Goldman Sachs was alleged to have done. These are serious, inflammatory claims. And these disloyalty claims are what are used by plaintiffs to survive a motion to dismiss and cause the investment company to spend millions of dollars to defend their reputation.
Rather than settle like most investment companies, Goldman Sachs forced Nichols Kaster to prove its disloyalty claims. And by summary judgment, there was no proof to support the claims that Goldman Sachs used its 401k plan to prop up investments in which investors were fleeing. Instead, the case became a dispute over whether a plan committee is “rudderless” if they do not have a formal investment policy statement, and why Goldman Sachs chose investments that were rated by the committee’s investment advisor’s “not widely recommended list.” None of this is enough to support a claim of disloyalty, let alone to survive a motion to dismiss. To the contrary, the complaint was brought with false pretenses that Goldman Sachs fiduciaries were self-interested and engaged in self-dealing.
This case is yet another in a long line of excess fee and investment imprudence cases that attempts to second-guess a plan fiduciary committee. But when the evidence was revealed after discovery, it is yet another example of a plan committee with a rigorous and robust fiduciary process to manage potential conflicts of interest. The truth is that most large plan sponsors in America have excellent fiduciary committees and are advised, like the Goldman Sachs committee, by outside ERISA counsel, an independent investment advisor, and have periodic training. Goldman Sachs demonstrated that its fiduciary process was even better than most companies – as plaintiff’s expert Marcia Wagner conceded. But the trial bar narrative in most excess fee cases that America’s plan fiduciaries are “asleep at the wheel” – or in proprietary investment cases, engaged in “self-dealing” – is once again proven false.
The Goldman Sachs case shows that the current judicial system allows the trial bar to make wild accusations of fiduciary disloyalty and imprudence without proof. The trial bar files case after case second-guessing the fiduciary decisions of America’s quality plan sponsors not because these cases are legitimate, but because they can. There may be an aberrational situation in which a plan sponsor has acted improperly, but it certainly wasn’t this case involving fiduciaries with financial expertise. Given how many cases based on unfounded disloyalty claims implode at trial when real evidence is required – beyond the circumstantial claims in complaints of purported underperformance and customers leaving investments – the question we ask is when district courts will stop giving plaintiffs alleging disloyalty claims the benefit of the doubt at the pleading stage? It is not fair to force companies like Goldman Sachs to spend millions of dollars to defend against a case brought under false pretenses of fiduciary disloyalty. But that is what happened.
The Goldman Sachs case is a reminder that we must fight on for a pleading standard that does not allow the trial bar to second-guess the fiduciary decisions of quality plan sponsors without real proof of disloyalty or underperformance. And we must fight on for fiduciary law that honors the fiduciary discretion intended by ERISA, and for a presumption of good faith to eliminate meritless litigation.
