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Insights From Encore Fiduciary on Fiduciary Liability & Other Risk Exposures of Employee Benefit Plans

THE Fid Guru BLOG

Insights From Encore Fiduciary on Fiduciary Liability & Other Risk Exposures of Employee Benefit Plans

The Pleading Standard for Fiduciary Imprudence Cases: the Sixth and Seventh Circuits Disagree in Oral Arguments on What the Supreme Court Held in Hughes v. Northwestern.

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By Daniel Aronowitz

For the last decade, a collection of plaintiff law firms have been alleging fiduciary malpractice against large defined contribution retirement plans at a rate that is now up to one to three cases per week.  These cases ask the court to infer fiduciary malpractice based on limited circumstantial evidence of purported bad outcomes, like alleged high recordkeeping and investment fees or under-performance of plan investments.  But these hindsight claims mostly fail to allege anything about the fiduciary process that is relevant under fiduciary law – i.e., how the recordkeeper or investment options were chosen.  Instead, they are the same basic complaints every time, alleging malpractice by comparing active funds fees and performance to lower-cost index funds, and comparing recordkeeping fees of the challenged plan to five to seven plans in the entire retirement plan universe that allegedly paid less.

The Supreme Court in January 2022 held in Hughes v. Northwestern that the heightened circumstantial pleading standard of Iqbal and Twombly applies to ERISA imprudence cases, and that courts in a rule 12(b)(6) motion to dismiss must take into account “the range of reasonable judgments a fiduciary may make based on her experience and expertise.”  The Northwestern decision seemed clear that the Court was only rejecting a narrow participant choice rule that the Seventh Circuit had used in the decision below, namely that imprudent investments cannot be justified by the fact that participants had access to low-cost funds.  As the Court stated, “[t]he Seventh Circuit erred in relying on the participants’ ultimate choice over their investments to excuse allegedly imprudent decisions by respondents.”  Now the Northwestern case is back in the Seventh Circuit, and appellants [plaintiffs below] have filed their opening brief.  But before the Seventh Circuit can rule on the remanded Northwestern case, this month the Seventh Circuit heard oral argument in the  Albert v. Oshkosh Corporation excessive fee case, and the Sixth Circuit heard oral argument in the Smith v. CommonSpirit Health case.

The arguments in the Oshkosh and CommonSpirit cases are noteworthy because highly respected appellate judges appear to take radically different positions on the holding in Hughes v. Northwestern on nearly identical facts in the two cases.  Both cases alleged that the two large plans were imprudently invested in retail share class K of the Fidelity Freedom active funds at .45-.65%, which the complaints alleged was imprudent because these active target-date funds were more expensive and under-performed the index target-date funds also offered by Fidelity.  Both cases had been dismissed in the lower court for failure to state a claim under rule 12(b)(6) of the federal rules of civil procedure.  But Judge Easterbrook from the Seventh Circuit took the position in the beginning of oral argument that these type of imprudence allegations must be allowed to proceed to discovery and cannot be dismissed on a motion for summary judgment.  Judge Easterbrook stated that “I read a complaint like this cannot be dismissed on the pleadings.  It belongs at the summary judgment stage.  That is where the defendants’ justifications for their behavior can be heard, because they cannot be heard on [a] 12(b)(6) motion.”  Judge Easterbrook “thought [the Northwestern decision] was a perfectly clear opinion.”

In stark contrast, Chief Justice Sutton of the Sixth Circuit in the CommonSpirit appeal told the plaintiff/appellants “not to get too excited” or “carried away” about the Northwestern decision because the Court was just making the point that you should not give two “stupid options” to participants and argue that it was not imprudent because you offer other prudent ones.  As Judge Sutton explained, “it doesn’t flip things and say it is always imprudent to offer active funds.”  The Sixth Circuit panel immediately shot down any notion that all excessive fee lawsuits must be allowed to proceed to discovery, notwithstanding Judge Easterbrook’s belief that the Supreme Court had clearly ruled to that effect.

So here we are.  Six months after the Supreme Court decision in Northwestern, we have one highly respected appellate judge saying that the Supreme Court was “perfectly clear” that all excessive cases must be allowed to proceed to discovery, and that the only way for plan fiduciaries to justify their behavior is on a motion for summary judgment.  But another respected appellate judge takes the opposite position that the Northwestern decision was limited to just one issue and that the Court ruled that plaintiffs must allege sufficient facts about an imprudent process in order to proceed beyond the motion to dismiss stage.  What a mess:  plan fiduciaries sued in states in the Sixth Circuit get a higher level of legal protection than if you are sued in neighboring states in the Seventh Circuit.

Understanding that it takes millions of dollars to prove a case at summary judgment, having a clear and rigorous pleading standard remains a high priority for plan sponsors.  But unfortunately, most courts are reading the Northwestern decision incorrectly like Judge Easterbrook.  Given that the oral arguments showed how two appellate courts arrived at different interpretations of the Northwestern case, we think it is important to review the questions asked in the oral arguments.  The following are the key questions posed in the two oral arguments, and analysis as to how these questions should be answered.

 

Question 1:  Can a case alleging excessive investment fees or poor investment performance be dismissed on a motion to dismiss, or do plan fiduciaries need to justify their behavior at summary judgment?  We have to start with the question of what the Supreme Court actually ruled in the Northwestern decision.  On this point, Judge Easterbrook is dead wrong.  Nowhere in the opinion did the Supreme Court espouse any position that every excessive fee case must proceed to discovery and that the only pleading requirement is to allege a short and plain statement of fiduciary negligence.  To the contrary, the Supreme Court expressly stated that the higher pleading standard for circumstantial cases from antitrust law applies to ERISA fiduciary imprudence cases.  In Iqbal, an antitrust plaintiff was not allowed to just allege conscious parallelism, but rather was required to show evidence of an illegal agreement.  Applying this reasoning to fiduciary cases, because plan fiduciaries have a “range of reasonable judgments” in making decisions, plaintiffs must allege something beyond a mere inference showing a defective or imprudent plan process to meet the higher pleading standard.  The only specific ruling by the Supreme Court in Northwestern was that plan fiduciaries cannot justify their conduct on a motion to dismiss by relying on the fact that the participants had the choice of lower-cost funds to justify imprudent funds.  The Court’s ruling was very narrow.  How Justice Easterbrook finds a “perfectly clear” instruction to deny all motions to dismiss in excessive fee cases is as baffling as it is incorrect.  As Justice Sutton noted, there is nothing to get “carried away” with in the limited ruling.  But we still have two noted justices arriving at diametrically opposed decisions.  They both cannot be right as to what the Supreme Court intended, and we think Justice Easterbrook needs to re-read the short Northwestern decision before he issues a ruling that misconstrues the ERISA pleading standard.

 

Question 2:  What is necessary to establish standing for plan participants – can a plan participant who is not invested in all allegedly imprudent investments or for the entire alleged time period sue for relief in a plan-wide representative capacity?  Plaintiffs took the position in the CommonSpirit appeal that once you establish that one participant satisfies Article III standing – meaning one investment at any period of time – then you have plan-wide standing to sue as a representative to address injury on behalf of the entire plan.  Participant-counsel did not have any appellate authority to back up this assertion, but this is exactly what the District Court of Massachusetts held in Coviello v. BHS Management Services, Inc. in a June 9, 2022 decision denying the motion to dismiss.  The court held that “Plaintiffs have Article III standing because they allege Defendants caused them to suffer a redressable ‘injury in fact that is concrete, particularized and actual,’” even when the named plaintiff did not invest in the challenged investments.

To our knowledge, the only appellate court to address whether a plan participant has standing to sue on funds in which the participant did not invest is the June 1, 2022 decision by the Court of Appeals for the Third Circuit in Boley v. Universal Health Services, Inc.  The Third Circuit affirmed the district court’s holding that class representatives had standing even when they did not invest in each of a defined contribution retirement plan’s available investment options.  The reasoning was that “the class representatives had alleged actions or a course of conduct by ERISA fiduciaries that affected multiple funds in the same way.”  We have seen multiple articles and blogs discussing this case, mostly stating that the case stands for the proposition that participants can sue for plan-wide imprudence even if they are not invested in the challenged funds.  But the Universal Health Services case needs to be distinguished because it is a challenge to the much maligned Fidelity Freedom active target-date funds – the same target-date funds challenged in many cases, including the CommonSpirit and Oshkosh cases.  The named plaintiffs were not invested in every glide path of the target-date funds, but each one appears to have invested in the glide path for their projected retirement date, so they were invested in at least one Freedom target-date fund.  For example, Fidelity offered thirteen glide path options according to the opinion.  The fact that the participants only invested in one of the thirteen target-date options is not dispositive, because the choice by the plan fiduciaries of Fidelity Freedom funds is essentially one investment choice with multiple options for participants depending upon age.  From our perspective, the Third Circuit got the decision right.  It does not stand for the proposition that participants have standing if they are not invested in challenged plan investments.  To the contrary, it stands for the obvious proposition that investing in one target-date glide path gives you standing to sue on the entire target-date series chosen by plan fiduciaries.  This is a critical distinction.

Two other recent cases provide authority that standing requires investment by the class representatives in the challenged investments.  For example, in the Eastern District of Virginia, the court recently dismissed the Capital One purported excessive fee case because the sole participant attempting to represent 60,876 participants in the plan was never invested in the three allegedly imprudent investments, but rather was invested in the super low-cost BlackRock target-date funds which served as the plan’s low-cost QDIA.  Similarly, the District Court of Massachusetts in Brown v. MITRE Corp., D. Mass., No. 1:21-cv-11605 on April 28, 2022 dismissed the case because the plaintiff did not own any of the alleged imprudent investments, but rather was invested in a single fund that was in the lowest share class that paid no revenue sharing, because the excessive fee claim was premised on revenue sharing.  MITRE had further argued that Brown lacked standing because the administrative fees he paid were less than $5 per year, which were far lower than the fee level the suit had claimed was “reasonable.”  The Massachusetts court cautioned, however, that “the fact that he paid only a small absolute amount in administrative and recordkeeping fees does not establish he did not suffer an injury.”  By contrast, in Nohara v. Prevea Clinic, Inc. No. 2:20-cv-01079 against a $281 million 401(k) plan, a plan participant was allowed to file an amended complaint even though she may have lost only 22 cents by investing in the plan.  The Wisconsin judge held that an actual injury – no matter how small or de minimis – is enough to create standing.  The issue of standing is far from settled, but is another example of the muddled and convoluted current state of fiduciary imprudence law.

 

Question 3:  Is an allegation that the plan fiduciaries should have used lower-fee share classes automatically a factual dispute as to what is reasonable and prudent to do, and thus not appropriate to dismissal on a motion to dismiss?  This is the most difficult question for plan sponsors.  Many cases involving Fidelity investments have claims that a large plan was invested in retail or higher-fee share classes when lower fees were available for the same exact funds.  We would have expected the participant lawyers in both cases to have led with this argument, but they did not.  But both cases present problematic claims of excess investment fees in the Fidelity Freedom active funds at .45% to .65% when Fidelity offers lower-fee share classes to institutional investors with high-asset balances.  We continue to recommend that defense counsel refrain from motions to dismiss on claims of Fidelity K shares when large plans are eligible for lower fees in the same investments.  The reason is that once again, like in the Northwestern case, we have the risk that the Oshkosh court will rule that a motion to dismiss is not appropriate for a claim based on investing in retail share classes.  It is hard to justify investments in the wrong share class unless you can show that the revenue sharing was rebated to participants to the extent that the fees were the same or lower than the lower-fee share class.  Prior to the Northwestern decision, plans sometimes won dismissal, but we do not believe that a retail-share class claim can be dismissed at the pleadings stage any longer under the Northwestern decision.  It just leads to bad case law, which is what we should expect from both the remanded Northwestern and the Oshkosh cases.  Maybe the Sixth Circuit will rule in CommonSpirit’s favor because the complaint appears to focus mostly on the allegedly imprudent decision to choose the active Fidelity target-date funds over the alternative versions, but that does not change the fact that the large CommonSpirit plan was invested in the higher-fee K shares for no apparent reason other than to enrich Fidelity.

 

Question 4:  Where would participants get the facts to allege imprudence if they are required to allege fiduciary process, but cannot conduct factual discovery or were denied information in their rule 104 inquiry?  If plan sponsors are going to argue effectively that they should not be sued for alleged poor outcomes without proof of process, then they must come prepared to answer the fair question as to how participants can gain access to process evidence.  In Euclid’s amicus brief before the Supreme Court in the Northwestern case, we attempted to answer this critical question.  We pointed out that it is unfair to allege fiduciary malpractice in a law that is about process without alleging anything about process.  But we attempted to preempt the counterpoint from participant lawyers that they should not be required to allege actual process facts because they do not have access to the plan’s deliberative process.

First, we continue to recommend to plan sponsors that they provide any inquiring plaintiff firm under ERISA 104 with the plan minutes and any proof of the deliberative process in choosing the plan recordkeeper and plan investments, as well as reports from plan investment advisors and consultants.  Give participant lawyers proof of a good fiduciary process to eliminate the argument that they need discovery because the plan refused to provide information.  Second, we emphasized in our amicus brief that as insurance underwriters, we evaluate fiduciary best practice based on the significant fee and financial disclosures provided to the plan and participants under ERISA and DOL regulations.  Like plaintiff lawyers, we do not have access to plan minutes or other plan deliberations, but underwriters make informed judgments of fiduciary process based on fee disclosures.  Plaintiff lawyers should be required to plead based on the treasure trove of plan information in the DOL-mandated fee disclosures.  The rule 404a5 participant fee disclosure gives all plan fees, investment choices, and the relative performance of plan investments against a benchmark on a one-, five-, and ten-year basis.  We asked the court to act like fiduciary underwriters to make an informed judgment based on the significant information required under the regulatory regime.  As the Sixth Circuit summarized in the CommonSpirit argument, if the required ERISA disclosures are not enough, it is a problem for Congress to rectify, and not a basis upon which to sue plan fiduciaries.

 

Question 5:  Why treat Rule 8 Pleading Requirements different for fiduciary claims than employment or medical malpractice cases?  Judge Easterbrook explained that the General Rules of Pleading in Federal Rule of Civil Procedure 8 only require “a short and plain statement of the case,” and that employment discrimination and medical malpractice cases are allowed to proceed based on minimal allegations of being fired as a woman, or having suffered a botched medical procedure.  Another judge on the panel asked why plan fiduciaries should somehow be treated “special” so as to require a higher pleading standard.  As Oshkosh’s lawyer explained, it does not matter, because the Supreme Court ruled that the higher antitrust pleading standard applies to claims of fiduciary malpractice.  But with the benefit of more time to pose an answer, we would suggest that there are reasons to justify a higher standard.  The first is that unlike being fired or suffering a bad medical procedure, any purported injury to plan participants is subjective and speculative at best.  Whether a recordkeeping fee is too high, or a plan investment under-performed is an argument – something that needs substantiation.  A subjective argument is different than suffering a direct injury like being fired.  Second, unlike cases being filed by the person harmed – when the plaintiff has been fired or suffered a medical injury – these cases are generated by plaintiff lawyers who are pursuing a business model.  In most cases, these plaintiff lawyers are advertising to find disgruntled employees to file a case.  The plaintiff lawyers are manufacturing the fiduciary malpractice lawsuit.  Cases manufactured and invented by plaintiff lawyers based on circumstantial evidence should be required to meet a higher pleading standard.  We believe this is a crucial difference from cases filed by medical patients or fired employees who have suffered obvious, concrete injuries – far from the speculative, lawyer-manufactured claims of negligence in excessive fee cases.

 

Question 6:  Does it state a claim to allege active funds are imprudent compared to passive funds, i.e., is it enough to satisfy rule 12(b)(6) to allege that it is imprudent to offer an actively managed fund?  Even counsel for participants in the oral argument admitted that it is not enough to state a plausible claim by just alleging that it is imprudent to choose active funds for retirement participants.  But the claim that index funds are better than active funds is asserted in nearly every excessive case, and both the Oshkosh and CommonSpirit complaints allege that it was imprudent to choose the Fidelity Freedom active target-date funds because the index versions had better performance.  Judge Sutton emphasized that it is not enough to allege that active funds are per se imprudent.  And the Department of Labor in their amicus briefs in the Northwestern case have not taken this position.  We continue to believe that any claim declaring active funds are inherently imprudent must be legislated by Congress, or at a minimum by the Department of Labor as the designated regulator of employee benefit funds.  Even though DOL continues to allow plaintiff law firms to serve as de facto regulators of retirement plan fees and investments, it is a step too far to rule that active funds are per se imprudent unless it is done by affirmative regulation or legislation.

 

Question 7:  When is a sufficient time period in which to allege imprudent investment claims?  How many years before you can allege an investment imprudence case?  Is a red flag enough to allege performance?  Is five years enough?  On what basis can you allege a claim of imprudence – what is good enough to state a claim?  If plan fiduciaries are going to argue that you cannot claim investment imprudence in the short-term, they must have an answer to the question of what would be enough to state a plausible investment imprudence claim.  Stated differently, plan fiduciaries cannot credibly take the position that it is never possible to bring an imprudence claim. There has to be a reasonable balance.  Counsel for CommonSpirit gave a good answer that there needs to be substantial under-performance over a long period of time.  They suggested ten years, as plan fiduciaries are not “day-traders.”  We believe that plan fiduciaries should concede that a lesser time frame than a decade may be legitimate if there are valid red flags that fiduciaries should have taken into account.  But surely the weak, unsupported, and factually false claim in many lawsuits that retirement plan investors “have lost faith in Fidelity Freedom funds” is not enough.  Indeed, the Fidelity amicus brief in CommonSpirit case easily rebutted any assertion that plan sponsors have lost confidence in Fidelity Freedom funds.  In sum, we continue to stress that the pleading test in an excessive fee case must be egregious fees that are beyond the range of reasonable judgment; and the test for alleged investment under-performance must be substantial under-performance over a meaningful period of time.

 

Question 8:  What comparators do you need to allege fiduciary imprudence?  Do you need more than the industry average or fees paid by several low-fee plans?  Jeremy Blumenfeld of Morgan Lewis did a masterful job at oral argument in demonstrating how the typical comparator chart in excessive fee cases fails to prove that the Oshkosh plan or any other plan have paid excessive fees.  The first rebuttal is the obvious point that it is not indicative of an imprudent process simply because a few other plans paid less.  Statistics show that there are approximately 750 jumbo plans with assets over $1 billion, and excessive fee lawsuits repeatedly try to allege malpractice based on the fact that they found seven or so other large plans that allegedly paid less.  The comparison chart of seven plans is not even close to a legitimate average or median recordkeeping fee for large plans.  Again, obvious, but too many courts seem to be misled by this flimsy claim.  There is always some plan that paid less, and that cannot possibly be sufficient circumstantial evidence that fiduciaries committed malpractice.  The next rebuttal is that excessive fee complaints fixate on the purported cost of the plan’s fees without offering any allegation as to the scope or caliber of the services being provided in exchange for those fees.  What Morgan Lewis labels as a “narrowminded” fixation on cost fails to allege any facts about the breadth and level of services that Fidelity provided to the Plan’s participants for the challenged fee amounts.  Nearly every purported excessive recordkeeping lawsuit fails to allege any facts about the breadth and level of services that Fidelity provided to the Plan’s participants for the challenged fee amounts.  The simple assertion that the Plan was paying higher recordkeeping fees than its peers is insufficient, because there are always differences in the packages and levels of services that plans negotiate with their recordkeepers, based on individual considerations relevant to a particular plan and its participants.

The answer to the Court’s question as to what is necessary in a plausible excessive fee complaint is a comparator using legitimate industry data showing that a plan’s fees are egregious.  There is no discovery needed to provide this data, because it is not in control of the plans.  Plaintiff law firms do not provide legitimate comparator data because the only available industry data available shows that most large plans do not pay excessive recordkeeping fees.  To this point, plaintiff law firms previously cited the NEPC recordkeeping survey, but it proved that over $1B plans pay a median of $35-55 per participant for recordkeeping fees, and this disproves their claims that all large plans need to pay less than that amount.

 

The Euclid Perspective

Judge Easterbrook’s misreading of the Northwestern pleading standard for ERISA imprudence cases is disheartening.  The pleading standard has been diluted to a point in which plaintiffs purport to be plan representatives when they did not even invest in the allegedly imprudent shares.  The pleading standard, however, is still critical to weed out the implausible cases.  The reason is that it costs millions of dollars to defend the plan’s fiduciary process in the federal courts, and you are still at risk of liability based on litigation uncertainty even when you have good process defenses.  When Judge Easterbrook says that fiduciary decisions must be defended at the summary judgment stage, it misses the point that most cases do not even get to that stage because the financial burden and risk is often insurmountable.

Even though defense options are limited as the case law continues to develop unfavorably, we continue to recommend that plan sponsors should only file a motion to dismiss in cases with foolproof defenses of low recordkeeping and investment fees.  Motions to dismiss in cases with retail share classes or high fees lead to problematic decisions that can be misconstrued by the courts.  That is what is happening with the Northwestern decision, and likely in Oshkosh with Fidelity Freedom high-fee K shares.  Second, we continue to believe that it is time for the Department of Labor to insert some sanity into fiduciary prudence law.  The DOL has allowed plaintiff law firms to become the de facto regulators of ERISA.  If you listen to the difference in the quality of the arguments between the plaintiff law firms and the lawyers at Groom and Morgan Lewis in the two cases, you will see how plaintiff law firms are not qualified to serve as legitimate regulators of fiduciary malpractice law.  As an industry, we must work to ask the DOL to set a fair fiduciary standard that gives some protection from these strike lawsuits.  Finally, we will continue to advocate that the service provider contracts must change so that investment and service providers bear responsibility if a court rules that they have overcharged a plan fiduciary.

Disclaimer:  The Fid Guru Blog is intended to provide fiduciary thought leadership and advocacy for the plan sponsor community in areas of complex fiduciary litigation.   The views expressed on The Fid Guru Blog are exclusively those of the author, and all of the content has been created solely in the author’s individual capacity.  It is not affiliated with any other company, and is not intended to represent the views or positions of any policyholder of Encore Fiduciary, or any insurance company to which Encore Fiduciary is affiliated.  Quotations from this site should credit The Fid Guru Blog.  However, this site may not be quoted in any legal brief or any other document to be filed with any Court unless the author has given his written consent in advance.  This blog does not intend to provide legal advice.  You should consult your own attorney in connection with matters affecting your legal interests.

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