By Daniel Aronowitz
A federal district court has imposed $1.5 million in sanctions against the Schlichter Bogard & Denton LLP law firm and its co-counsel for “recklessly” prosecuting an excessive fee case under section 36(b) of the Investment Company Act of 1940 without credible factual or legal support against Great-West Capital Management. Sanctions are a rarely utilized tool to combat abusive litigation. This is because most high-profile defense firms rarely seek sanctions, as well as the fact that modern courts tolerate even the most outlandish lawsuits. But if you apply the sanctions standard of the Great-West court – when plaintiff attorneys pursue objectively unreasonable claims – to many of the skyrocketing number of ERISA class actions being filed today, it is clear that sanctions should be imposed in many of the recently filed cases. The most obvious example is the ten coordinated lawsuits claiming that choosing Morningstar’s number-one rated BlackRock target-date funds constitutes fiduciary malpractice. These attorney-driven cases are just as reckless and irresponsible as the manufactured claim that Great-West imposed excessive fees on its investor clients. The following is an analysis of the grounds for why sanctions were granted in the Great-West case. We then analyze three types of ERISA excessive fee and underperformance cases that deserve sanctions to stop the rampant litigation abuse against high-quality retirement plans, many of which are following the expert advice from professional investment advisors.
The Sanctions in the Great-West Case
Obeslo v. Great-West Capital Management, LLC was a consolidated shareholder derivative action filed in the District Court of Colorado under section § 36(b) of the Investment Company Act (ICA) by the Schlichter law firm. Plaintiffs were individual investors in Great West investment products [either through their IRA accounts or as participants of a government-sponsored defined contribution plan] who alleged that the fees charged by Great-West Capital Management, LLC and Great-West Life & Annuity Insurance Co. violated § 36(b) of the ICA, which prohibits fees that are “so disproportionately large that [they] bear[] no reasonable relationship to the services rendered and could not have been the product of arm’s length bargaining.” (emphasis added). The court had previously denied both a motion for summary judgment and a motion to strike the plaintiff’s damages expert, but ruled for Great-West at trial. Following the trial verdict, both parties filed cross-motions for sanctions. The court had ruled two years ago that plaintiffs’ counsel was liable for sanctions up to $1.5 million. In the current decision finalizing the sanctions award, the court decided that the entire $1.5m amount was to be paid jointly by the Schlichter law firm as lead counsel and its local counsel, who had tried to pin all of the fault on the Schlichter firm.
The Court determined that plaintiffs’ counsel was liable for sanctions because they “recklessly proceeded to trial in violation of their duty to objectively analyze their case,” ignoring “red flags” of weaknesses in their case along the way. Specifically, plaintiffs went to trial based on a sole expert to calculate the amount of damages allegedly suffered, even though the court had warned in response to the motion to strike that the expert report was “factually inaccurate.” At trial, the court said that the expert “was thoroughly discredited.”
The Court then analyzed whether plaintiffs’ lawyers were liable for sanctions under 28 U.S. Code § 1927, which is entitled “Counsel’s liability for excessive costs.” Whereas the more common Rule 11 sanctions is available under the Federal Rules of Civil Procedure, section 1927 sanctions are provided under federal statute. The sanctions statute provides that:
“Any attorney or other person admitted to conduct cases in any court of the United States or any Territory thereof who so multiplies the proceedings in any case unreasonably and vexatiously may be required by the court to satisfy personally the excess costs, expenses, and attorneys’ fees reasonably incurred because of such conduct.”
The purpose of section 1927 sanctions is to “compensate victims of abusive litigation.” The legal standard “does not require a finding of bad faith.” To the contrary, attorneys can be sanctioned if they (1) fail to “exhibit some judgment” and (2) pursue “objectively unreasonable” claims:
“When dealing with a lawyer, the courts ‘are entitled to demand that an attorney exhibit some judgment.’ To excuse objectively unreasonable conduct by an attorney would be to state that one who acts with an empty head and a pure heart is not responsible for the consequences.” (citation omitted). Therefore, ‘any conduct that, viewed objectively, manifests either intentional or reckless disregard of the attorney’s duties to the court, is sanctionable.”
The Court further explained that “[a]n attorney must ‘regularly re-evaluate the merits’ of claims and ‘avoid prolonging meritless claims.’”
Under this legal standard, the Court ruled that proceeding to trial was “objectively reckless”: “That reckless choice cost Defendants millions of dollars litigating this case and wasted valuable judicial resources which could have otherwise been allocated to the resolution of meritorious claims brought by deserving litigants.” The Court even noted in a footnote that “[i]f Plaintiffs had accurately represented the limitations of [the expert witness’s] opinions, it is highly likely that this case would not have survived Defendants’ Motion for Summary Judgment.” In addition to the failure of the plaintiff attorneys to use critical judgment, two additional key factors were influential in the Court’s sanctions ruling.
First, plaintiffs brought a manufactured case that was attorney driven. As the Court explained: “To make matters worse, Defendants accurately point out that Plaintiffs’ decision to continue through trial was inherently lawyer driven. Plaintiffs’ counsel manufactured this case by placing an advertisement in the newspaper seeking individuals to join the suit.” (emphasis added by Euclid). The manufactured nature of the case was evidenced at trial when the named plaintiff testified that when she reviewed her retirement account during the relevant period, it “was making money every time. It kept going up, which is what I wanted.” Moreover, individual plaintiffs testified that they were generally satisfied with investment results. In contrast, plaintiff’s counsel stood to gain tens of millions of dollars. “Thus, it is reasonable to deduce that Plaintiffs’ attorneys had a strong incentive to continue to litigate, even when it became clear that they should not.”
Second, plaintiffs’ counsel was left unchecked: The Court agreed with the sanctions brief of defense counsel that “when counsel is left unchecked by a client, their independent duty to objectively evaluate their claims should only be greater.” Unlike a normal case, a lawyer-driven and manufactured case lacks a sophisticated client with a legitimate stake in the case to rein in the excesses of its lawyer, and thus the incentives for attorney fees is left unchecked.
Based on these factors, the court sanctioned the Schlichter law firm and local counsel because they did not satisfy the duty to objectively analyze their weak case. The Court further explained that they “were undeterred by the signs that their case was fatally flawed,” and “they recklessly proceeded to trial in violation of their duty to objectively analyze their case.”
Applying the Sanctions Standard to Abusive Litigation Filed Under ERISA – Types of Objectively Unreasonable Excessive Fee and Underperformance Claims
For credibility purposes, it is important to start with the crucial distinction that the Obeslo v. Great-West Capital Management, LLC lawsuit is not an ERISA class action and thus the legal standard to prove excessive fees is codified by statute. The Great-West plaintiffs alleged excessive fees under section § 36(b) of the Investment Company Act. In response to Great-West’s motion for sanctions, plaintiffs admitted that “no plaintiff who has pursued a claim under § 36(b) of the Investment Company Act has ever won in the 50 years of that section’s existence.” It was persuasive to the court that the ICA creates a high bar to claim excessive fees, and that no claim had ever prevailed under the ICA legal standard.
Euclid has always believed that courts in ERISA fiduciary cases should borrow from the ICA’s “so disproportionately large” standard in order to evaluate whether investment or recordkeeping fees are truly “excessive,” or purported investment underperformance is truly egregious. An excessive fee case should require just that: excessive fees. In other words, an excessive fee claim under ERISA should be viable or plausible only if the fees are highly excessive or underperformance truly egregious, similar to the “so disproportionately large” ICA standard. To this point, many of the ERISA lawsuits are suing over tiny underperformance margins – often less than one percent per year behind the purported comparator fund. We have not seen any attempt to draw from the ICA disproportionately large standard, and the Department of Labor distinguished the ICA standard in a footnote of its amicus brief filed in the Supreme Court in the Hughes v. Northwestern excessive fee case. We are not persuaded by the DOL’s cursory analysis, and continue to believe ICA case law is relevant to excessive fee claims under ERISA. Indeed, some of the plaintiffs in the Great-West case were participants in a governmental plan. It makes no sense to have a higher standard for claiming the investment manager charged excessive fees, but a lower standard to claim that plan fiduciaries paid excessive fees to the same investment manager for the same exact investments. But at this point, it is important to understand that it is an “uphill battle,” as the Great West court called it, to win a § 36 ICA case, and that was influential in the decision to impose sanctions.
It will thus be more difficult to argue that excessive fee and underperformance cases deserve sanctions against plaintiff law firms in an ERISA case because ERISA lacks a clear standard like the Investment Company Act. Indeed, in the New York University case, a rare example of defense lawyers seeking sanctions in an ERISA class action case, the motion for sanctions against the Schlichter law firm was rejected by the trial court when it filed a second case against the university hospital system. This was not a strong sanctions motion, however, because the court found that the hospital was run separately from the university. Nevertheless, there are important commonalities discussed by the Great-West court that should apply to recent ERISA class actions, which have pushed the boundaries of legitimate claims of fiduciary imprudence.
Many of the recent ERISA purported fiduciary imprudence cases are contrived claims of excessive fees or investment underperformance that are factually wrong, and are just as reckless as the Great-West case. The reason they are being filed is because plaintiff firms have learned that they can leverage distorted damages models and litigation risk against plan fiduciaries with personal liability to drive high settlements. They know that most cases are too expensive to try, so even meritless claims can lead to settlements. Plaintiffs firms are banking on the fact that they will not have to try the cases before a federal district judge and actually prove their flawed damages model – the situation in which the Schlichter firm in the Great-West case was embarrassed by the federal court after a trial in which their weak damages model was discredited. Most of these cases are fishing expeditions that have no process evidence against plan fiduciaries, and increasingly assert more outlandish theories of excessive fees or purported investment underperformance.
EXAMPLE #1: ALLEGED UNDERPERFORMANCE OF HIGHLY-RATED BLACKROCK FUNDS: The prime example of an objectively unreasonable set of lawsuits is the coordinated ambush of ten high-quality plans for alleged underperformance of Morningstar’s number-one rated BlackRock target-date funds. It is objectively unreasonable to claim fiduciary malpractice for choosing Morningstar’s highest rated target-date funds. As recently as March 14, 2022, Morningstar reviewed the BlackRock LifePath Index Target-Date series and concluded that it “remains a first-class target-date series.” That should be enough to demonstrate that ten coordinated lawsuits constitute abusive use of litigation. Even though ERISA is a law of process and not results, none of these cases even attempt to allege how the plan fiduciaries selected the BlackRock investments, or even if the fiduciaries had the advice and counsel of quality investment advisors. Plan fiduciaries at Citigroup, Microsoft and the other eight companies did not wake up one day and come to the plan committee meeting advocating for BlackRock funds to hedge against inflation. That is not how it works. All of these sophisticated companies hired top-quality investment advisors who likely served in a co-fiduciary capacity and helped the plan fiduciaries make prudent selections. These top-notch investment advisors usually cite directly to the Department of Labor’s advice for selecting target-date funds as the plan’s QDIA, and diligently follow that process. But the imprudence cases do not even mention whether investment advisors helped the plan fiduciaries choose the top-rated BlackRock funds, even though it is the key factor in the investment process. Without any evidence of a deficient process, these cases are objectively unreasonable on their face.
Just like the Great-West case, these are lawyer-driven cases with manufactured claims. Every plan with BlackRock investments has experienced good long-term returns – indeed, there are no investment losses, just purportedly less investment gain than other funds with different strategies and investment management styles. The key differentiator of the BlackRock TDFs is that they have hedges against inflation. Because of this, they are outperforming many target-date funds since inflation started last year. But they are being compared to two active target-date funds with the highest return rates in the prior five years when inflation was at historic lows, because the Federal Reserve maintained rates at near zero – something that could not have been expected by any rationale plan fiduciary or plan investment advisor. A plaintiff law firm filing ten cases at the same time, with no process allegations and a far-fetched legal theory, is banking on the fact that it costs millions of dollars to defend these cases, and hoping that one or more of the courts will allow them to proceed to discovery on even one of the ten cases in order to cash in on the jackpot of high settlements and attorney fees. Just like the Great-West case, there is no rational or normal client to check the plaintiff lawyers against abusing the litigation process. In fact, it is direct evidence of litigation abuse to sue ten plans in a coordinated attack with far-fetched claims that the number-one rated target-date series is somehow imprudent.
EXAMPLE #2: ALLEGED EXCESSIVE RECORDKEEPING FEES BASED ON INACURRATE DATA AND FLAWED COMPARISONS: The second example of objectively unreasonable ERISA class actions that are lawyer-driven with manufactured claims is the many cases alleging excessive recordkeeping fees. Most of these cases allege an inaccurate and distorted recordkeeping fee amount that is based on inaccurate Form 5500 data that ignores the fee disclosures provided to participants and the plan that contain the actual, truthful recordkeeping fees. Euclid has fully documented this litigation abuse, including our whitepaper debunking the common tactics of the plaintiff law firms. New Euclid Fiduciary Whitepaper – Debunking Recordkeeping Fee Theories in “Excessive” Fee Cases – Euclid Fiduciary (euclidspecialty.com) These lawsuits take the recordkeeping number in Schedule C of the Form 5500 and divide it by the number of participants. But the plaintiff lawyers know that the Form 5500 recordkeeping number usually includes substantial transaction costs paid to the recordkeeper, such as loan and QDRO fees that are not recordkeeping expenses, and thus the Form 5500 number is not an accurate recordkeeping amount. It also ignores possible revenue sharing or indirect compensation, including whether the indirect compensation is credited back to participants. Every plaintiff recruited by the plaintiff law firms has received a quarterly plan fee disclosure from the recordkeeper that includes an accurate recordkeeping amount. There might be some revenue sharing that has to be accounted for, but it is a more accurate number than the distorted and inflated number from the Form 5500. After deriving an inflated recordkeeping fee, plaintiff lawyers then attempt to compare the plan to five to ten plans in which the transaction fees have been stripped out. There is no attempt at using a national benchmark, nor is there any attempt to compare the actual scope of recordkeeping services so that the comparison is fair. That is the whole point – it is a manufactured comparison designed to con a federal judge with an impressive looking chart into believing that the plan fiduciaries failed to negotiate low fees. The plans are not being compared to a true benchmark of what a similarly sized plan actually pays, let alone a comparison based on a similar set of services. But plaintiff law firms keep filing lawsuits with this misleading charade, and will keep doing it until courts shut down this deceptive practice.
You do not have to take just our word for it. The Sidley Austin law firm has fully documented the excessive recordkeeping con game in its recently filed motion to dismiss in Probst v. Eli Lilly and Company. The Sidley Austin motion proves how intentionally dishonest the claims of excess recordkeeping fees are in many of these lawsuits. The motion to dismiss first points out the Walcheske & Luzi law firm is using a document that is labeled “Kroger Amended Complaint.” This is not an isolated copycat example by this law firm. We have seen at least five other complaints that show that they were copied from the Kroger case, which itself is an exaggerated claim that a $30 recordkeeping fee is somehow unreasonable – a case in which the complaint was amended and refiled despite being shown proof that the company subsidizes part of the recordkeeping fee, making it even lower for plan participants. But again, the plaintiff law firm was undeterred by the facts.
The Eli Lilly motion to dismiss further demonstrates that the recordkeeping fees alleged in the complaint were “demonstrably false.” Plaintiffs in the Eli Lilly case alleged that the Plan had paid an average of $108 per participant over a five-year period, whereas purported similar plans paid an average of $23 and $39 during that same time period. Plaintiffs alleged the $108 average by taking the direct compensation from the annual Form 5500 filings and dividing it by the number of participants. The motion to dismiss redacts the actual recordkeeping fees paid by Eli Lilly, but the brief states that there is no need to consult the Form 5500s to determine actual recordkeeping fees, because the plan recordkeeping contracts with Alight give the exact amounts. The motion states that the plan’s recordkeeping fee was established in 2010; reduced in 2014; and then reduced again in 2019 when the contract was renegotiated. The actual amounts are redacted, but it appears that the fee was just higher than $39 from 2014 to 2019, but below that amount when renegotiated in 2019. Either way, it is clear that the plan committee took periodic action to reduce plan fees – direct evidence of sound fiduciary management.
The Eli Lilly motion to dismiss next demonstrates how plaintiffs’ lawyers incorrectly calculated the Alight recordkeeping fee by “misusing” the direct compensation listed in the Form 5500. The motion characterizes the Form 5500 into three parts: (1) part A is the direct compensation; (2) part B is the indirect compensation (revenue sharing); and (3) part C is the reference to whether the plan sponsor pays any of the recordkeeping fees so that they are not charged to the participant. The motion further points out that each plan has one or more service codes to indicate what types of recordkeeping services are provided.
The first key error by Walcheske is that the “A” piece – direct compensation – includes fees other than recordkeeping [what Euclid refers to as transaction fees]. Depending on the service codes listed, the recordkeeper receives fees for services other than recordkeeping (which is service code 15). Second, the dollar amount for the “B” piece – indirect compensation – is typically not shown, which means that any analysis of total recordkeeping fees is incomplete and cannot be fully calculated by using the Form 5500. Third, the reported compensation only includes amounts paid by the plan or its participants, which means if an employer pays some of the fees, those amounts are not shown. The motion thus sums it up by stating that “[t]he combination of these issues makes it virtually impossible to tell from a Form 5500 how much in recordkeeping fees were paid by any given plan.” The same flaws apply to the Walcheske comparison chart of purported comparison plans that is used in Eli Lilly and uses in many lawsuits to allege excessive recordkeeping fees. Plaintiffs understated the actual fees of the comparator plans, including the Michelin plan, because they all checked the indirect compensation box, and revenue sharing was not included in their fee total. In addition, nearly half of the comparator plans had plan sponsors that paid at least some of the plan’s administrative expenses. This means that many of the plans to which the Eli Lilly plan was being compared were meaningless comparisons because they had incorrect part A data, and ignored parts B and C completely.
The key takeaway from the Eli Lilly case is that the Walcheske law firm continues to file false claims of excessive recordkeeping fees even after a federal district court has called out their practices as fraudulent. As recently as May 27, 2022, the Eastern District of Wisconsin in Woznicki v. Aurora Health Care Inc. found that the standard Walcheske chart that is used repeatedly in many lawsuits – the same chart debunked by Sidley lawyers in the Eli Lilly case – has “serious defects.” The court continued that the comparison chart “does nothing to plausibly allege an ERISA violation” because it uses calculations that are “facially and demonstrably wrong.”[i] The purported comparisons in the Walcheske chart contained “botched math” that left no basis to infer imprudence. As the Sidley lawyers aptly state, Eli Lilly and the plan fiduciaries were “sued for no good reason” and should not have to bear the costly burden of defending illegitimate cases. We would take it one step further, and take the position that filing case after case based on an illegitimate methodology that has been called defective by a federal district court is an intentional and reckless pattern and practice of abusive use of federal litigation. The remedy to stop this abusive litigation is for plaintiff lawyers to be sanctioned for filing objectively unreasonable lawsuits.
EXAMPLE #3: CLAIMS WITHOUT PROOF THAT PLAN FIDUCIARIES FAILED TO ASK FOR LOWER FEES
A third example of objectively unreasonable and abusive litigation is the classic Schlichter claim that plan fiduciaries have failed to ask for lower fees without any proof. Plaintiff law firms know that the golden ticket to discovery and then settlements in excessive fee cases is to claim that plan fiduciaries are in the wrong share class and overpaid for investment fees. Some of these claims are legitimate. But many times the claims are based on pure conjecture without any proof. Investment providers have minimums to become eligible for lower institutional fees. Most lawsuits fail to allege the amount of assets needed for lower institutional share classes. Instead, for example, the Schlichter law firm claimed in the Northwestern case that Vanguard and other vendors will give lower fees than the investment minimums simply if large plans ask for them. There is never any proof to back up these claims. It is just a naked allegation to get passed a motion to dismiss and then leverage a high damages model in a mediation to pressure a large settlement. We are involved in a case in which the plan fiduciaries have provided evidence that they asked for and secured a lower fee than the scheduled investment minimum from an investment firm, but the Schlichter law firm still claims – again, without proof from a representative of that investment manager – that plan fiduciaries are still liable for not securing an even lower fee. This type of unsupported claim is meritless and lacks the judgment that the Great West court demands from an attorney’s duty of candor.
When faced with contrary evidence that discredits a claim, the claim must be withdrawn. But that is not what happens in these cases. In the AT&T case, the plaintiff firm continued to file multiple amended complaints alleging a false recordkeeping fee, and now a meritless appeal, even after being shown that the plan had a $20 recordkeeping fee and a contractual guarantee for the lowest rate that the recordkeeper charges any other similarly sized client. It crosses the line from ruthless to vexatious in which the plaintiff lawyers are pursuing objectively unreasonable claims. That is when sanctions are an appropriate remedy.
Conclusion
Finally, we readily admit that the legal standard to prove an excessive fee case under the Investment Company Act is unfortunately higher than how courts treat the same type of case under ERISA. But as copycat plaintiff lawyers push the boundaries of excessive fee and investment underperformance litigation, it is time for sanctions to be considered against lawyer-driven cases involving manufactured claims with no proof of a defective fiduciary process. When the claims of imprudence are only designed to leverage litigation uncertainty, such as filing ten objectively unreasonable cases with the same far-fetched legal theory in a coordinated attack, it constitutes an abuse of the federal court system. That is when the seldom used defense tactic of sanctions for abusive litigation is appropriate. The Great West legal standard for sanctions is thus a helpful reminder that many ERISA class action cases qualify as meritless and deserve sanctions.
[i] Woznicki v. Aurora Health Care Inc., No. 20-v-1246, 2022 WL 1720093, at *3 (E.D. Wis. May 27, 2022)
