By Daniel Aronowitz
Key Points
(1) A complete and diligent fiduciary process can result in underperformance – fiduciary prudence is judged, even at the motion to dismiss stage, based on process and not results.
(2) This is the second court to dismiss (without prejudice) the dubious Miller Shah investment imprudence claims that BlackRock LifePath target-date funds are a “vastly inferior retirement solution.”
The most cynical of the recent lawyer-driven ERISA class action lawsuits involves claims that plan fiduciaries are guilty of fiduciary malpractice for choosing poorly performing investment options for the plan. These contrived lawsuits are suspect because most large plans in America are advised by sophisticated investment managers who are monitoring the challenged investments. At any given time, half of all investment options underperform the median investment, and significant research has shown that most active investments fail to match the return of a passive index fund over the long term. But that does not make active investments imprudent for a plan with a diversified portfolio. We also know that good investors should not chase top-performing funds, and that prudent investors should not change investments frequently just because of short-term underperformance. But none of this practical investment wisdom has stopped the plaintiffs’ bar from suing large plans for alleged investment underperformance.
Given how unfair it is to seek fiduciary liability for investment underperformance, any such fiduciary imprudence claim should be met by reviewing courts with extreme skepticism. And courts need to set a high pleadings bar to prevent frivolous imprudent investment claims.
The most dubious of the recent investment underperformance lawsuits is the twelve lawsuits filed in 2022 by the Miller Shaw law firm against plans invested in top-rated BlackRock LifePath target-date funds. In these lawsuits, Miller Shah compares LifePath performance to results from popular investments, notwithstanding that these other investments had different investment strategies and goals and thus are not fair comparisons. The first lawsuit, Locascio v. Fluor Corporation (No. 3:22-cv-00154-X Jan. 22, 2022 S.D. Tx), alleged that Fluor’s custom target date funds, which were invested in the BlackRock LifePath target-date funds, experienced “dramatic underperformance.” For perspective on their trademark hyperbole, the best the complaint could allege was a marginal range of .3 to 2.0% alleged underperformance in each quarter. On January 18, 2023, the court dismissed the investment underperformance claims. The case was dismissed without prejudice, giving plaintiffs with standing have the right to file an amended complaint, but the court expressed significant skepticism of the Miller Shah lawsuit.
The ruling is worth studying because the Fluor lawsuit is not much different than the eleven other pending lawsuits alleging underperformance of BlackRock LifePath target date funds. But more importantly, it provides four important fiduciary standards that should apply to all attempts by plaintiff law firms to assert unfair claims of investment underperformance over short time periods with misleading purported benchmarks. The court stated the obvious that a diligent and complete fiduciary process can result in underperformance. The key ruling is that the test for fiduciary liability is how the fiduciary acted, and not whether the investment succeeded or failed. Prudence is judged by process, not results – even at the pleadings stage of the case. These crucial themes are needed to restore the process-based fiduciary standard required under ERISA in order to stop the lawyer-driven abuse in fiduciary litigation.
The Fluor Underperformance Case
Like most plans that Miller Shah sues for alleged investment underperformance, the Fluor plan is a mega plan. As of December 31, 2020, the plan had 15,062 participants with account balances and assets totaling approximately $3.45 billion. In its initial complaint, Plaintiffs alleged both excessive recordkeeping fees and imprudent investment options. The initial complaint was misleading for two reasons. First, plaintiffs alleged that this mega plan was paying Voya an average of $96 per participant over the prior six years. We know of no mega plan with recordkeeping fees that high, so it had to be a false claim. Like most plaintiff law firms, they ignored their clients’ fee disclosures from the plan recordkeeper that would have provided the accurate amount of annual recordkeeping fees, and instead used Form 5500 data that is inflated by transaction fees that have nothing to do with the amount charged for recordkeeping. So the claim was knowingly false, and easily contradicted by the Voya fee disclosures that both plaintiffs would have received four times a year. When plaintiffs filed an amended complaint in April, plaintiffs withdrew their excess recordkeeping claim. We can only assume that the Morgan Lewis defense lawyers gave proof that the recordkeeping fee was nowhere close to $96 per participant. To Miller Shah’s credit, they withdrew the false claim. We have seen too many cases in which plaintiff lawyers purse false recordkeeping claims even when contradicted by undisputed evidence, like the recordkeeping contract, fee disclosures, or attorney affidavits.
The second misleading element of the initial complaint was the picture painted that Fluor plan fiduciaries were acting alone, without the advice of an investment manager. Nearly every large plan in America retains a high-quality investment advisor to help the plan fiduciaries select and monitor investments. The Fluor plan was no exception. But the Fluor fiduciaries went one critical step further: they retained the prominent, top-quality investment advisory firm Mercer in 2017 as a 3(38) discretionary investment advisor. Mercer was the responsible investment fiduciary under this contract. The original complaint made no mention of the decisive role played by Mercer.
The amended complaint thus focused solely on the claim that the plan was filled with “objectively imprudent investment options” – only this time both the Fluor plan committee and Mercer as the 3(38) fiduciary were the named as co-defendants. The primary investment focus in the amended complaint was the Fluor custom target-date funds that are managed by BlackRock, which plaintiffs alleged mirror the BlackRock LifePath index funds. Plaintiffs alleged that the Fluor TDFs are “significantly worse performing” than many of the mutual fund alternatives available in the market. The Miller Shah argument is that a prudent fiduciary must evaluate TDF returns “not only against an appropriate index or a group of peer TDFs, but also specific, readily investable alternatives to ensure that participants are benefitting from current TDF offering[s].” This is the unique argument in these cases: that investments are not to be judged solely by their investment objective, but rather against whether there are higher potential returns in the investment universe. The obvious fallacy of this argument is that every investment has a different risk profile, and higher return potential usually means a higher assumed risk. In other words, if you want a lower risk profile, which most investors in BlackRock TDFs desire, you are to be judged against investors who take higher risk and thus, in some markets, get a higher return. These cases are a blatant attack on institutional investors with a conservative investment goal or temperament.
Plaintiffs next alleged that the returns of the Fluor TDFs have been “dwarfed” across the board by the “off-the-shelf” TFDs available in the market offered by American Funds, Fidelity Freedom Index Funds, T. Rowe Price Retirement Funds and TIAA-CREDF Lifecycle Index Funds. Plaintiffs included nine charts with purported returns of the fourth quarter of 2018 to the second quarter of 2020 purporting to show Fluor TDF returns in last place in performance for eight of the nine quarters. Plaintiff also allege “dramatic underperformance” from 2016 to 2021: “Across the board, at all stages along the Fluor TDFs’ glide path from aggressive to conservative, the Fluor TDFs’ returns pale in comparison to those of the Off-the-Shelf TDFs.”
Plaintiff next alleged underperformance of three other custom investment options. First, plaintiffs allege that the custom Large-Cap Equity Fund was imprudent because it failed to demonstrate an ability to beat the Russell 1000 index benchmark over a 5- and 10-year time period. Plaintiff allege that the Fluor Large-Cap fund missed the purported index benchmark by .9 to 2.1% over a five-year time period and an even smaller .6 to 1.6% differential over a 10-year time period. Plaintiff allege that this underperformance failed to justify the 30 basis point (.30%) expense ratio of the large-cap equity fund.
Second, plaintiffs allege underperformance of the Custom Small/Mid Cap Equity Fund that allegedly failed to match the performance of the Russell 2500 Index over a trailing five- or ten-year time period. Plaintiffs allege that the .3 to 1.6% underperformance over a five-year time period, and .6 to 2.0% underperformance over a 10-year time period, failed to justify the .46% expense ratio.
Finally, plaintiffs alleged that the Custom Non-U.S. Equity Fund failed to beat the MSCI ACWI ex U.S. Index with .3 to .9% underperformance over five-years, and .9 to 2.0% over a ten-year time period, and thus failed to justify the .39% expense ratio.
EUCLID NOTE: Plaintiffs make little effort to evaluate what actual investments were in the popular TDFs used to benchmark performance other than citing some equity allocations. Nor do they explain how these purported comparisons match up to the actual investments in the BlackRock LifePath TDFs.
The Fluor Court Dismissed the Investment Imprudence Claims Without Prejudice
In a pleasant change from most courts reviewing excess fee and investment imprudent investment cases, Judge Brantley Starr was openly skeptical of the Fluor investment imprudence case and injected humor into the decision. He started the opinion sarcastically by stating the obvious that “[s]ometimes stock underperform,” citing in a footnote “E.g, the Year of Our Lord 2022.” In describing the BlackRock Life Index Funds, he notes that the glide paths become more conversative as the target date approaches. In a footnote, he notes that is “[f]iscally – not politically conservative. After all, it’s BlackRock we’re talking about here.” Super funny, especially in a court in Texas where the state legislature has been trying to pull money from BlackRock for pushing ESG investments that could harm Texas’s carbon-intensive natural gas and oil industries. He summarizes the motive of these lawyer-driven cases with appropriate skepticism that is missing in most cases: “When Plaintiffs recognized that the Plan was underperforming – at least according to their standards – they decided to sue.”
Plaintiffs objected to the Chamber of Commerce filing an amicus brief, and this is how Judge Starr amusingly responded:
“Speech is a beautiful thing. So beautiful that James Madison, who wrote that a bill of rights was unnecessary, later drafted a bill of rights and urged Congress to pass it. Sure, the Seventh Circuit disfavors amicus briefs, as the plaintiff suggests. But this Court is within the Fifth Circuit, which still views amici as friends. Accordingly, the Court grants the motion for leave to file an amicus brief from the Chamber of Commerce of the United States of America.”
Behind the light-hearted humor are serious findings. We highlight four key themes in the ruling that should be used in all investment underperformance cases: (1) participants lack standing for generalized injury and can only challenge investments in which they are personally invested; (2) appointing a 3(38) discretionary advisor creates a safe harbor for plan fiduciaries in which their duties decrease to just basic monitoring; (3) fiduciary imprudence is judged by conduct in choosing the investment and not the results of the investment; and (4) a meaningful benchmark requires more than a superficial label that the higher performing fund is “comparable.”
KEY RULING #1: Participants Lack Standing for Generalized Injury, and Can Only Challenge Investments in Which They Are Personally Invested.
The business plan for the ERISA plaintiffs’ bar is to find one or more disgruntled former employees who invested in one or more investment options in a large defined contribution plan at some point in time. Sometimes these former employees are no longer invested in the plan. And most times they are not invested in all of the investment options being challenged. Plaintiffs then extrapolate that these participants with marginal investments in the plan are entitled to seek generalized injury to the plan as a whole.
We get that a single participant cannot possibly invest in all age-related glide paths of the plan’s target-date funds, but we cannot understand the growing body of law that allows participants to sue on investment options in which they are not personally invested. The generalized injury argument makes sense for a defined benefit plan, but is illogical in a participant-directed defined contribution plan in which each participant has their own individual account and investments.
Contrary to the disturbing trend allowing standing for generalized injury, this court required participants to be invested in the investments they want to challenge. The court started with the premise that, in a defined contribution plan, “the performance and fees of the investments not selected by a participant had no effect on the value of the participant’s selected plan.” Article III standing requires personal and individualized injury by each challenged fund, and that generalized injury to the plan and its participants is not enough. In addition to requiring personal investment in any challenged fund, the court also stated that the burden of providing an injury “rests on the shoulders of Plaintiffs.” Based on this, the named plaintiff Deborah Locascio was dismissed from the case for lack of standing because she had invested in none of the twelve investment options being challenged. The second plaintiff David Summers was only allowed to challenge the three investment options in which he personally invested [the custom TDFs and two of the three other active custom funds].
KEY RULING #2: Appointing a 3(38) Discretionary Advisor Creates a Safe Harbor for Plan Fiduciaries in Which Their Duties Decrease to Just Basic Monitoring.
The smartest action that fiduciaries responsible for managing defined contribution plans can take is to delegate their fiduciary investment duties to a 3(38) discretionary investment advisor. This is the best practice in today’s litigious environment. The Fluor plan fiduciaries appointed Mercer on March 1, 2017 to assume fiduciary responsibility for monitoring and deciding whether to retain or replace the Fluor TDFs and other investments. The safe harbor provision of 29 U.S.C. section 1105(d) states that “[i]f an investment manager or managers have been appointed[,] . . . no trustee shall be liable for the acts or omissions of such investment manager or managers, or be under an obligation to invest or otherwise manage any asset of the plan which is subject to the management of such investment manager.”[i] Fluor alleged that it could only be responsible for Plaintiffs’ claims concerning events that occurred before the appointment of Mercer, and after that it retained a limited duty to monitor Mercer as its appointee. It argued that this “residual duty is much narrower than the primary fiduciary duty to select and monitor investments.” That residual duty, in practice, looks like “checking in with Mercer at reasonable intervals to ensure it was carrying out its fiduciary responsibilities as intended.”
In response, plaintiffs made two arguments. First they argued that there is an exception to Section 1105(d)’s safe harbor for those who knowingly participated in a breach of fiduciary duty. Second, they argued that Fluor failed to monitor Mercer. The court rejected both arguments for lack of alleged evidence. The court ruled that plaintiffs failed to plausibly allege knowing participation because all they have alleged is failure to correct Mercer’s decisions with respect to the funds – nothing more. The second argument was rejected for similar failure to identify any flaws in Fluor’s monitoring process. As the court aptly summarized, “[r]elative unsuccess (or even utter unsuccess) of the funds does not necessarily indicate to a failure to monitor.” (emphasis added by Euclid). This is the key point of the entire decision, and is discussed in the next pivotal ruling by the court.
But before we move on, we have to discuss what we consider to be the worst ERISA decision of last year: the December 8, 2022 decision denying the plan sponsor’s motion to dismiss in Mills v. Molina Healthcare, Inc., No. 2:22-cv-01813-SB-GJS (C.D. Ca.). The Fluor ruling absolving a plan committee from fiduciary liability because they appointed a 3(38) investment advisor should be unremarkable. It is just black letter law. But unfortunately, courts have not afforded the required protection of a 3(38) advisor in two recent cases. In Lauderdale v. NFP Retirement, Inc. (C.D. Ca. 11/17/2022) and the Molina cases filed by the Schlichter law firm alleging investment imprudence in the selection of NFP’s FlexPATH target-date funds, courts have failed to afford a safe harbor when both companies hired quality 3(38) discretionary investment advisors for monitoring the FlexPATH investments. The Lauderdale case was on a summary judgment motion (after losing the motion to dismiss), and the Molina case involved a motion to dismiss. The Lauderdale decision appears to have been decided on the court’s concern that it could not find process evidence in appointing the 3(38) investment manager. The Molina decision, however, is concerning because the court took the position that the reference to “trustee” in section 1105(d) means that the 3(38) safe harbor protection does not apply to plan fiduciaries. In other words, the court ruled that a plan “trustee” is somehow different than a plan “fiduciary.” We are dumbfounded by the Molina ruling. It is just plain wrong, and has materially prejudiced a company that engaged in the best practice of hiring a discretionary investment advisor to ensure that they were protected. The Molina court has undermined a key tenant of the ERISA statute. Fortunately, the Fluor court made no mention of the Molina court’s aberrant decision.
KEY RULING #3: Fiduciary Imprudence is Judged by Conduct in Choosing the Investment and Not the Results of the Investment.
The court summarized that the primary purpose of ERISA is to protect beneficiaries of employee benefit plans, which is why participants may sue to allege that a fiduciary breached the duty of prudence by failing to properly monitor investments and remove imprudent ones. But the court cited precedent that the “prudence standard normally focuses on the fiduciary’s conduct in making investment decisions, and not on the results.” That was the core of Fluor’s arguments in the motion to dismiss. First, plaintiffs improperly claimed imprudence based on the success of the investments rather than on how the fiduciary acted; and second, plaintiffs failed to allege facts from which the Court can reasonably infer that the process of offering or creating the custom options was flawed. The defendants argued that plaintiffs cannot compare one investment to another with the benefit of hindsight.
The court held that plaintiff failed to point to facts that infer imprudence, but rather relied on conclusory allegations. Like nearly every excess fee complaint, plaintiffs drafted paragraph after paragraph of conclusions of law to define the standard of conduct, but alleged no plausible facts about how the Flour defendants somehow did not engage in a prudent monitoring process. The court bluntly stated that the remaining plaintiff “is wrong” to argue that the mere decision to maintain the investments after the appointment of Mercer is sufficient to allege breach of fiduciary duty. “In order to demonstrate a lack of prudence,” the court ruled, “[plaintiff] must demonstrate ‘conduct, not results’ of the fiduciary actions towards the investments.” The court continued that “[t]he focus of the inquiry is ‘how the fiduciary acted,’ not ‘whether his investments succeeded or failed.’” To make this evaluation, a plaintiff must “point to information ‘at the time of the investment without the benefit of hindsight.’” The court held that the data from other investments that outperformed the Fluor investments “does little to aid the Court in evaluating the fiduciary process.” The court then made its key finding: “Put bluntly, a flawed fiduciary process can result in great returns while a diligent and complete fiduciary process can result in underperformance.” Because plaintiffs failed to allege anything showing a deficient fiduciary process, the court refused to infer that the fiduciary process was flawed.
KEY RULING #4: A meaningful benchmark requires more than a superficial label that the higher performing fund is “comparable.”
The court concluded with a short analysis as to whether plaintiffs had provided a “sound basis for comparison” or “a meaningful benchmark” to show that a prudent fiduciary in like circumstances would have acted differently. The court asked, “[s]o what is a meaningful benchmark.” Answering its rhetorical question, the court noted that the Fifth Circuit has yet to define it exactly, “but clues that guide the definition exist in different courts.” First, courts have reasoned that a meaningful benchmark distinguishes between actively and passively managed accounts; and second, a meaningful benchmark involves comparison of funds with a “similar investment strategy.” The court concluded that the “crux of [plaintiff’s] pleading issue lies in the fact that ‘simply labeling funds as ‘comparable’ or a ‘peer’ is insufficient to establish that those funds are meaningful benchmarks against which to compare the performance of’ the allegedly imprudent funds.’” Plaintiffs’ superficial label that popular plans are comparable to the LifePath TDFs was shot down by the court as insufficient.
The Euclid Perspective
The Fluor decision is the second district judge to dismiss Miller Shah cases alleging investment imprudence of BlackRock LifePath cases. The district court in the Northern District of Virginia similarly dismissed (without prejudice) cases with the same claims against Capital One and Booz Allen Hamilton. The Virginia district court dismissed both complaints after hearing argument on the motions to dismiss on December 1, 2022. Following oral argument, the court explained that the plaintiffs failed to adequately allege that the alleged comparator TDFs were “appropriate, meaningful benchmark comparators,” because the complaints “lack[ed] facts showing that the TDFs shared the same investment strategy, investment style, risk profile, or asset allocation.” The court further explained that the differences “between actively managed and passively managed, the time horizons of ‘to retirement’ versus ‘through retirement,’ and the different allocations of bond and equity mixes is fatally defective in plausibly stating a claim.” While the plaintiffs were granted leave to file amended complaints if there is “a good-faith basis for doing so,” the court cautioned that “plaintiffs should think carefully about whether or not there’s a way to move forward and whether that makes sense.”
Not surprisingly, Miller Shah filed an amended complaint in both cases. We have studied the amended complaints, and besides removing some of the performance charts that did not help their case, the only material difference that we can discern is that plaintiffs added a purported comparison to the S&P TDF indices, which is a generic comparison or compilation of TDF investments. This is not a meaningful benchmark of similar investments or strategic investment goals – just a comparison to the average TDF investment. It is no different than their original argument that you should compare LifePath funds to four of the five most popular TDFs available in the market. They have provided no comparisons to the actual makeup of the BlackRock Lifepath TDFS. There is some mention of the percentage of equity in the various funds and Sharpe Ratios [how well an equity investment performs in comparison to the rate of return on a risk-fee investment], but no mention of real estate, bonds, or any other investments in the funds. They are just recycling an argument that you can compare one TDF against the composite return of all TDFs or against other popular TDFs. This does not meet the judge’s requirement of a meaningful benchmark based on “the same investment strategy, investment style, risk profile, or asset allocation.”
We should expect an amended complaint in the Fluor case as well. But based on the amended complaints in the Northern Virginia cases, we believe that their quixotic quest to seek damages for the allege underperformance of the top-quality, highly rated BlackRock LifePath TDFs should meet the same dead-end. Their amended complaints in the Virginia cases continue with the same flaws of (1) failing to allege anything related to fiduciary process in selecting the investments, and (2) using superficial labels that popular plans are comparable when they have distinct investment objectives and goals. The Fluor decision thus provides helpful guidance for how courts should review unfair investment imprudence lawsuits in the BlackRock LifePath and many other cases.
_____________
[i] 29 U.S.C. § 1105(d); see also U.S.C. § 1105(c)(2) (“If a plan expressly provides for a procedure [that allocated fiduciary responsibility] . . . then such named fiduciary shall not be liable for an act or omission of such person in carrying out such responsibility[.]”).
