By Daniel Aronowitz
KEY POINTS: Participants label Intel’s use of hedge funds and alternative investments to hedge volatility as “institutional gambling,” but compare the results to funds with higher-equity allocations that ironically are higher-risk investments. Just because the higher-risk funds did better in a long bull-market is not evidence of fiduciary imprudence, but rather the classic deficiency of ERISA malpractice lawsuits that use outcomes as a proxy for fiduciary imprudence.
The fiduciaries of two Intel-sponsored retirement plans developed a customized and innovative strategy to hedge against downside market risk for their plan participants. Despite their diligent fiduciary process, participants filed investment imprudence claims in three separate lawsuits in a several-year odyssey that included a trip to the Supreme Court. The consolidated proceeding is now on appeal and fully briefed in the Ninth Circuit Court of Appeals in Anderson v. Intel Corporation Investment Policy Committee, No. 3:19-cv-04618. If you read the appellate briefs to learn about the case, prepare for whiplash. It is like the same events on January 6, 2021 being called an “insurrection” on MSNBC and a “peaceful protest” on Fox News. In the Intel case, Intel’s hedge fund strategy is depicted by plaintiffs as “institutional gambling” and defended by Intel as a prudent “risk-mitigation” strategy.
Plaintiffs label Intel’s 30% allocation of the custom target-date funds to non-traditional investments, and more than half of the global diversified fund to hedge funds and private equity as a “novel experiment” gone bad. The “radical” and “novel asset-allocation approach” in which Intel plans paid higher fees in exchange for alleged higher risk and lower returns is disparaged as a “market-defying strategy” that amounted to “institutional gambling” with employees’ assets.
Intel fiduciaries, by contrast, tell a story of developing a thoughtful investment strategy born out of the 2008 market crash in which equity-laden funds lost half their value. To avoid a similar fate in company-sponsored defined contribution plans, the fiduciaries for two Intel company retirement plans implemented a risk-mitigation strategy, seeking to reduce volatility and earn stable risk-adjusted returns that would better cushion participants against the risk of precipitous market drops. The strategy involved customized, broadly diversified portfolios that included not only stocks and bonds, but also hedge fund and private equity investments that are commonly used in defined benefit plans, college endowments and institutional investment products. They recognized and disclosed that their risk-mitigation strategy would deliver lower returns during a bull market than equity-laden funds, and would carry the higher fees typically charged for actively-managed investments. The Intel fiduciaries argue that the strategy advocated by plaintiffs is actually higher risk: it would yield a home run in bull-markets, but retirees would suffer large losses in their retirement portfolios in market crashes.
Stripped of the plaintiff-lawyer hyperbole of reckless gambling, the Intel case raises three key principles that apply in investment imprudence cases, particularly when the complaint challenges a novel or innovative investment strategy:
- ERISA does not allow per se attacks on novel investment strategies, because ERISA prioritizes flexibility and discretion in making investment decisions.
- A meaningful benchmark is necessary to prevent hindsight attacks or Monday-morning quarterbacking of investment decisions, because outcomes cannot be used as a proxy for imprudence. Courts have a critical gatekeeping role to apply the plausibility pleading standard to prevent hindsight attacks based on results and not process.
- Investment imprudence lawsuits cannot be based on look-back comparisons to the highest-performing investments from the prior decade that achieved these results by increasing equity risk.
All of these points are well explained in Intel’s appellate brief and the Chamber of Commerce’s Amicus Curiae brief filed in support of the Intel defendants, but we highlight these key principles below.
(1) ERISA does not allow per se attacks on novel investment strategies, because ERISA prioritizes flexibility and discretion in making investment decisions.
When we hear politicians telling us what “Americans want,” we know to be wary. The same is true when plaintiff lawyers tell you what ERISA intended. ERISA was not designed to allow participants to challenge or police every investment decision made by plan fiduciaries. And ERISA did not intend for federal courts to serve as the referees of plan investment choices. Plaintiffs in the Intel case are wrong in asserting that the purpose of ERISA is to allow attacks on disfavored investment results, particularly when the complaint is either a per-se attack on certain types of investments – like hedge funds – or require the court to infer investment imprudence based on a disappointing outcome without evidence of a defective fiduciary process. It is worth investigating the true legislative purpose of ERISA, because most investment imprudence cases are falsely premised on the notion that ERISA was designed to allow participants to sue without any guardrails or evidence of defects in the fiduciary investment process.
As the Chamber’s amicus brief explains, ERISA’s legislative history demonstrates that ERISA “represents an effort to strike an appropriate balance between the interests of employers and labor organizations in maintaining flexibility in the design and operation of their pension programs, and the need of the workers for a level of protection which will adequately protect their rights and just expectations.”1 The key word is “flexibility.” Congress also knew that plan sponsors and fiduciaries must make a range of decisions and accommodate “competing considerations,” often during periods of considerable market uncertainty.2 As a result, Congress designed a statutory scheme that prioritizes flexibility and discretion for plan sponsors and fiduciaries. The Department of Labor has characterized ERISA as providing “greater flexibility” in the “making of investment decisions . . . than might have been provided under pre-ERISA common and statutory law in many jurisdictions.”3 And courts have recognized that broad discretion is the “sine qua non of fiduciary duty.”4
As the Chamber summarized, broad discretion is critical to the entire fiduciary framework because “there virtually is never a single ‘right’ answer to the questions fiduciaries must answer given the almost innumerable options available to them.” Fiduciaries, not the courts, are best positioned to weigh the pros and cons of various investment choices, which are often made with the assistance from consultants and other investment professionals. “Subjecting a fiduciary to constant Monday-morning quarterbacking over his decisions, with the benefit of 20/20 hindsight, would eviscerate the discretion that is at the core of the statutory framework.” But that is exactly what investment imprudence cases like the Intel complaint represent: hindsight-based attacks on disfavored investment results.
The Intel lawsuit demonizes hedge funds as inappropriate or imprudent to use in ERISA plans, at least when used in a meaningful amount, such as the 30% allocation to alternative investments in the Intel custom target-date funds. But the fundamental premise of ERISA, as the Supreme Court described in the Hughes v. Northwestern case, is the “range of reasonable judgments a fiduciary may make.”5 Neither Congress nor DOL provides a list of required or forbidden investment options or investment strategies because fiduciaries have broad discretion in directing investment strategy. In fact, when Congress considered requiring all plans to offer at least one index funds, the proposal failed.6 DOL has declined to provide even examples of appropriate investment options, because doing so would “limit . . . flexibility in plan design.” Likewise, DOL has expressly declined to weigh in on whether “a particular fund or investment alternative” is permitted or forbidden for a plan, because the appropriateness of any given investment option for a particular plan “is an inherently factual question” that depends on numerous “relevant facts and circumstances” that must be considered by a fiduciary through “an objective, thorough, and analytical process.”7
ERISA Focuses on Process, Not Results: ERISA was not intended to allow participants to police investment outcomes, but rather focuses on a sound fiduciary process. Claims for fiduciary breach must focus on a fiduciary’s conduct in arriving at an investment decision, not on its results. The proper question is not whether the investment results were unfavorable, but whether the fiduciary used appropriate methods to investigate the merits of the transaction. In other words, fiduciaries are judged not for the outcome of their decisions, but for the process by which those decisions were made.
The consistent guidance from the Department of Labor has been that the decision to offer a particular investment fund must involve “an objective, thorough, and analytical process that considers all relevant facts and circumstances.”8 This even applies to the type of alternative or private equity investments that the Intel plaintiffs challenge. So long as a fiduciary engages in this reasoned decision-making process, DOL has noted, “[t]here may be many reasons why a fiduciary may properly select an asset allocation fund with a private equity component as a designated investment alternative for a participant directed individual account plan.”9 This allows plan fiduciaries to consider any type of investment options as a part of diligent investment process. A contrary rule would turn ERISA’s process-based focus on its head, allowing entirely permissible choices to serve as a proxy for a deficient process.
Whereas ERISA’s fiduciary standards focus entirely on process, however, ERISA complaints asserting claims for fiduciary breach rarely include any allegations about process. Instead, they try one of two approaches. The first approach is a per se attack against particular fiduciary decisions, with no allegations that fiduciaries failed to consider the relevant factors or weigh relevant considerations. More often, in a pleading-by-inference approach, plaintiffs ask courts to infer an imprudent process based on circumstantial, outcome-focused allegations comparing the fees or performance of the plan fiduciaries’ decision against the fees or performance of a different option available on the market. Unless we want every retirement plan to offer only generic index funds, we must restore the flexibility and discretion to plan fiduciaries. But that means we must reduce the threat of litigation that is stifling innovation in plan design.
(2) A meaningful benchmark – rather than a purely results-based metric – is necessary to prevent hindsight attacks, because outcomes cannot be used as a proxy for imprudence. Courts have a critical gatekeeping role to apply the plausibility standard to prevent hindsight attacks based on results and not process.
Plaintiffs argued in the district court that they met the requirement of comparing the Intel investment strategy to a meaningful benchmark that is required by most courts. But the lower court made two findings. First, the Global Diversified Fund outperformed 80% of other comparable funds – in other words, the claims of investment underperformance were plain wrong. Second, the district court held that comparisons to commonly held investments were not meaningful benchmarks because they failed to compare the challenged investments to funds with similar investment objectives and strategies [i.e. similar to Intel’s risk-mitigation objective].
Plaintiffs thus changed tack on appeal and now argue that there is no need for a meaningful benchmark at all under ERISA. Plaintiffs argue that Intel’s allocation model was so imprudent that no similar fund adopted any analogous approach. When a plan employs a strategy that is uniquely unreasonable, plaintiffs argue that the investment is effectively immunized from any claims of imprudence if plaintiffs are required to compare it to a benchmark with a similar investment strategy. Plaintiffs argue that they are caught in a “Catch-22” under Intel’s “atextual pleading barrier” that has no basis in ERISA’s text or case law.
There may be situations in which the investment strategy is so unreasonable that it is impossible to benchmark, but this is not it. In the recent investment imprudence litigation involving DST Systems Inc., the allegations were that the plan fiduciaries were negligent in allowing the investment advisor Ruane, Cunniff & Goldbard to invest forty-five percent of the company-sponsored retirement plan in the stock of a single pharmaceutical stock. We would agree that outrageous investment strategies – like restricting one-half of a plan’s investment options to one volatile stock – do not have a reasonable benchmark. But risk mitigation is a reasonable and permitted strategy under ERISA. It is reasonable for fiduciaries to decide to protect against downside risk in bear markets, with the intentional decision to give up some upside risk. It is not hard – or unreasonable – for plaintiffs seeking breach of fiduciary duty damages to be required to compare a risk-mitigation strategy to another risk mitigation strategy. It does not require them to find another plan with a thirty percent allocation to private equity, but it does require them to compare the Intel plan to other plans with a similar risk mitigation investment strategy. If they can find a lower-cost, more effective risk mitigation strategy that does not involve alternative investments they find so offensive, they might have the right to assert a claim. But there should be no right to compare a strategy seeking higher returns with higher risk to Intel’s intentional strategy of reducing volatility.
Courts play a crucial gatekeeping role in preventing plaintiff lawyers from using outcomes as a proxy for imprudence. The whole point of ERISA’s fiduciary standards is that they do not compel any particular outcome; and fiduciary’s decisions cannot be judged in hindsight if another strategy with different aims and goals yields better results. When a complaint attempts to infer malpractice by circumstantial evidence, courts must require the alternatives cited by ERISA plaintiffs to be apt comparators. The Intel complaint attempts to peg its malpractice claims to purely results-based metrics without any consideration of the fiduciary process. But outcome is not a proxy for process.
With the benefit of hindsight, it is always possible for plaintiffs to identify a cheaper or better performing alternative investment. But this allows plaintiffs to assert that any investment decision was an imprudent one. The plausibility pleading rule is thus necessary to ensure that ERISA fiduciaries are not targeted for class-action litigation whenever they fail to follow a particular plaintiff’s preferred investment approach.
(3) Investment imprudence lawsuits cannot be based on look-back comparisons to the highest-performing investments from the prior decade that achieved these results by increasing equity risk.
The irony of the Intel lawsuit is that the damages model is comparing a hedging strategy designed to reduce volatility and risk to a higher-risk strategy with a higher allocation to publicly traded stocks. Investment imprudence cases based on using the highest performing investments in a hindsight analysis must be shut down as inconsistent with ERISA’s fiduciary process standard. But nearly every recent fiduciary imprudence lawsuit is using the same Vanguard, T. Rowe Price and American Funds target-date funds as the benchmarks to seek millions of dollars in damages. There is a reason why these same funds are used as purported benchmarks in most cases. It is because these funds are among the top ten percent in performance in the last ten years. But – and it is the most critical point – these funds achieved these results in large part because they have a higher allocation to equities than the normal target-date fund. They took higher risk, and achieved higher returns.
The irony of the Intel case is that, under the guise of mischaracterizing Intel’s risk mitigation strategy as high-risk gambling, plaintiffs are advocating that plan fiduciaries must take the highest possible investment risk or face liability. Plaintiffs characterize the hedge fund allocation in the Intel investments as radical and risky, but the purpose of the hedge fund strategy was to mitigate risk. The purpose was to reduce risk with the intentional strategy of giving up some of the upside in bull markets, but reducing investment loss in bear markets. Plaintiffs’ entire case is to complain that the result of the Intel hedging strategy lowered the investment results compared to Vanguard target-date funds or a Morningstar composite with a higher allocation to public equity after a ten-year bull market. The purported comparator funds did better because they took higher risk. The irony of the Intel case is that plaintiffs are seeking damages because the Intel plan took less risk to protect investors, but in hindsight there was no need to hedge against market volatility in a ten-year bull market that no rational investor or fiduciary could foresee.
Nevertheless, this is the model in many investment imprudent cases: plaintiffs file case after case comparing investment results of the challenged plan to the highest performing funds in the market. For example, the Wells Fargo target-date funds have been demonized by the Schlichter law firm in various cases and the Sanford Heisler Sharp law firm in the pending case against UnitedHealth for allegedly poor investment results. But the Wells Fargo funds had slightly lower investment returns compared to the leading target-date funds in the last decade because the TDFs had a different investment strategy to reduce market volatility than investment funds that loaded up on a higher equity allocation. The Wells Fargo funds were designed differently to hedge against market losses, and only underperformed in hindsight because of an unexpected ten-year bull market. Similarly, the Schlichter law firm has sued NFP and two different plan sponsors for early adoption of the FlexPATH target-date funds that had a higher allocation to hedge against inflation than other popular target-date funds, but – in hindsight – there was no inflation in 2016-2020. Nevertheless, Schlichter lawyers use the same flawed benchmark of commonly held target-date funds that have a higher allocation to stock instead of hedges against inflation. If you look in hindsight now after two years of inflation, the NFP FlexPATH funds were an excellent long-term investment strategy, even if the inflation hedge reduced return slightly in the years before inflation increased. In sum, the current litigation encourages investments with lower fees, but higher investment risk.
The Intel plaintiffs claim that they are stuck in a Catch-22 in which the lower court’s opinion prevents them from suing on any investment strategy that they claim is an outlier or inherently imprudent. But they have it backwards. The Catch-22 is experienced by plan fiduciaries. In the current litigation environment, plan fiduciaries can be sued for any investment outcome that is below the average of the most popular funds, even if these same popular funds take on more investment risk. Given this outsized litigation risk, fiduciaries cannot make any investment that is different than the herd of other plans – even if they follow a prudent fiduciary process with the help of investment advisors. The litigation risk encourages plan fiduciaries to follow the safest path of conformity to index funds, avoiding any customization or doing anything different. No innovation is allowed. Ironically, in the Intel case, that means taking on a higher risk of investment loss because the highest performing funds in the last ten years achieved this result by increasing the allocation to equities. Employing a risk-mitigation strategy will get you sued if it somehow underperforms in an unpredictable sustained bull market.
The Intel plaintiffs deride private equity as reckless gambling, but it is a naïve and uninformed viewpoint. For perspective, there are approximately 4,850 public companies compared to over 52,000 private equity or venture-capital companies in America. The investment strategy preferred by the plaintiff lawyers in the Intel case is to restrict participants in the company’s-sponsored plans to less than ten percent of the available investment opportunities in America. Their hyperbolic rhetoric may sound convincing to someone with limited investment experience, but private equity exposure, with the advice of qualified and experienced investment consultants, increases diversification and adds potential for higher returns. Sometimes it can provide hedges to protect against market volatility. It can easily be argued that restricting defined contribution plans to just publicly traded companies potentially harms plan participants, especially when better returns and diversification might be available from the larger universe of privately-held companies.
Final Thoughts On the Intel Appeal
In final analysis, most investment imprudence cases in the last five years are cynical attempts to challenge investments that had a more conservative strategy. The strategy in investment imprudence cases like the Intel case is to allege that something – here it is hedge funds – is super risky and imprudent, and then compare it to something labeled as less risky, but which in many instances is actually more risky. Then plaintiffs argue that plan fiduciaries did not switch out of the poorly performing investments quickly enough, even if it takes a long-term horizon to judge the viability of sophisticated investment strategies. If you end up being wrong, plaintiff lawyers are there to collect huge fees. Plaintiff lawyers policing investment results will tell you that this is what Congress intended in enacting ERISA. But plaintiff lawyers are not reliable sources of ERISA’s statutory intent.
_____________
