Brotherston v. CommonSpirit Health: An Opportunity, and a Need, to Shift the 401(k) Litigation Paradigm

In the midst of chaos, there is also opportunity – Sun Tzu

As an ERISA attorney, the Sixth Circuit’s recent CommonSpirit Health (CommonSpirit) decision1 concerns me. First, the Court completely ignored the First Circuit’s Brotherston decision2, the Restatement (Third) of Trusts (Restatement), and SCOTUS’ subsequent denial of Putnam’s appeal of that decision.

Second, the fact that the CommonSpirit decision has revived the meritless “apples and oranges” argument regarding fiduciary prudence, even though both the Brotherston decision and SCOTUS’ denial of cert discredited such an argument. As a result, the Sixth Circuit has arguably created an unnecessary divide within the circuits.

Upon a recent re-reading of the CommonSpirit decision, I realized that the Sixth Circuit may have actually provided a valuable opportunity to provide more certainty for plan sponsors and to clarify the guidelines going forward for 401(k)/403(b) administration and litigation.

Brotherston v. Putnam Investments, LLC

The Restatement calls “for determining whether and in what amount the breach has caused a `loss’ . . . by reference to what the results `would have been if the portion of the trust affected by the breach had been properly administered.'”3 

Finally, the Restatement specifically identifies as an appropriate comparator for loss calculation purposes “return rates of one or more. . . suitable index mutual funds or market indexes (with such adjustments as may be appropriate).”4 (citing § 100 cmt. b(1)

ERISA itself is not so specific. Rather, it states that a breaching fiduciary shall be liable to the plan for “any losses to the plan resulting from each such breach.” Certainly this text is broad enough to accommodate the total return principle recognized in the Restatement. Behind the text, too, stands Congress’s clear intent “to provide the courts with broad remedies for redressing the interests of participants and beneficiaries when they have been adversely affected by breaches of fiduciary duty.”5 (cjtes omitted)

And as the Supreme Court has instructed, when we confront a lack of explicit direction in the text of ERISA, we often find answers in the common law of trusts. (citing Varity Corp. v. Howe, 516 U.S. 489, 496-97, 502, 506-07 (1996) (relying on “ordinary trust law principles” to fill gaps created by ERISA’s lack of definition regarding the scope of fiduciary conduct and duties).6 @32

[T]he burden of showing that a loss would have occurred even had the fiduciary acted prudently falls on the imprudent fiduciary. By allowing its analysis on loss to be driven by its concern regarding the objective prudence of the Putnam funds, the district court in essence required plaintiffs to show causation as part of its case on loss-even as it correctly sought to reserve that requirement to defendants.7

So to determine whether there was a loss, it is reasonable to compare the actual returns on that portfolio to the returns that would have been generated by a portfolio of benchmark funds or indexes comparable but for the fact that they do not claim to be able to pick winners and losers, or charge for doing so. Restatement (Third) of Trusts, § 100 cmt. b(1) (loss determinations can be based on returns of suitable index mutual funds or market indexes).8

In concluding, Judge Kayatta made two significant points:

The Supreme Court has time and again adopted ordinary trust law principles to construe ERISA in the absence of explicit textual direction.9

[T]he Supreme Court has made clear that whatever the overall balance the common law might have struck between the protection of beneficiaries and the protection of fiduciaries, ERISA’s adoption reflected “Congress'[s] desire to offer employees enhanced protection for their benefits…. In other words, Congress sought to offer beneficiaries, not fiduciaries, more protection than they had at common law, albeit while still paying heed to the counterproductive effects of complexity and litigation risk.10

CommonSpirit Health

Trust law informs the duty of prudence, as “an ERISA fiduciary’s duty is derived from the common law of trusts.”11

[The federal pleading] rules require the plaintiff to provide sufficient “facts to state a claim to relief that is plausible on its face.” Plausibility requires the plaintiff to plead sufficient facts and law to allow “the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.”  “The plausibility of an inference depends on a host of considerations, including common sense and the strength of competing explanations for the defendant’s conduct.”12

Even if CommonSpirit did not violate a fiduciary duty by offering actively managed plans in general, it is true, the company still could violate ERISA by imprudently offering specific actively managed funds. ERISA, in other words, does not allow fiduciaries merely to offer a broad range of options and call it a day. While plan participants retain the right to choose which fund is appropriate for them, the plan must ensure that all fund options remain prudent options.13

Nor does a showing of imprudence come down to simply pointing to a fund with better performance. We accept that pointing to an alternative course of action, say another fund the plan might have invested in, will often be necessary to show a fund acted imprudently (and to prove damages). But that factual allegation is not by itself sufficient. In addition, these claims require evidence that an investment was imprudent from the moment the administrator selected it, that the investment became imprudent over time, or that the investment was otherwise clearly unsuitable for the goals of the fund based on ongoing performance.14

That is why disappointing performance by itself does not conclusively point towards deficient decision-making, especially when we account for “competing explanations” and other “common sense” aspects of long-term investments. In context, such allegations standing alone do not move the claim from possible and conceivable to plausible and cognizable.15 

We would need significantly more serious signs of distress to allow an imprudence claim to proceed….publicly available performance information about an investment may show sufficiently dismal performance that this reality, when combined with ‘allegations about methods,’ will successfully allege that a prudent fiduciary would have acted differently.16

An Opportunity Out of Chaos?
Most 401(k) litigation focuses on the nominal returns of the investment options within a plan. Both the First Circuit and the Sixth Circuit agree on the importance of trust law in interpreting ERISA. As the Brotherston decision points out, the Restatement explicitly authorizes the use of index funds as comparators, discrediting the “apples and oranges” argument.

However, the Restatement provides other valuable guidelines in determining fiduciary prudence. Section 90 of the Restatement sets out several relevant cost-efficiency standards in determining whether a fiduciary has fulfilled its fiduciary duty of prudence, including

  • A fiduciary has a duty to be cost-conscious.17
  • A fiduciary has a duty to select mutual funds that offer the highest return for a given level of cost and risk; or, conversely, funds that offer the lowest level of costs and risk for a given level of return.18
  • Actively managed mutual funds that are not cost-efficient, that cannot be “justified by realistically evaluated expectations” to provide a commensurate return for the additional costs abd risks typically associated with active management are imprudent.19

Given these guidelines, the research on the cost-efficiency of actively managed mutual funds suggest that plan sponsors face a dauting challenge in trying to justify the inclusion of actively managed mutual funds in a 401(k) plan:

  • 99% of actively managed funds do not beat their index fund alternatives over the long-term net of fees.20
  • Increasing numbers of clients will realize that in toe-to-toe competition versus near–equal competitors, most active managers will not and cannot recover the costs and fees they charge.21
  • [T]here is strong evidence that the vast majority of active managers are unable to produce excess returns that cover their costs.22
  • [T]he investment costs of expense ratios, transaction costs and load fees all have a direct, negative impact on performance….[The study’s findings] suggest that mutual funds, on average, do not recoup their investment costs through higher returns.23

However, the Sixth Circuit insisted on “more serious signs of distress” and the use of publicly available performance information to show “sufficiently dismal performance” to establish that a plan sponsor breached their fiducairy duties

The Active Management Value Ratio™
I have suggested for some time that the Active Management Value Ratio (AMVR) is a valuable tool in analyzing the prudence of plan sponsors and other investment fiduciaries. The CommonSpirit decision seems to be the perfect opportunity to prove my assertions.

As I have noted in previous posts on this site, the AMVR is based on the investment research of investment notables such as Nobel Laureate Dr. William F. Sharpe, Charles D. Ellis, Burton L. Malkiel, and Ross Miller. The fundamental premise behind the AMVR is cost-efficiency, a criticial factor in assessing fiducairy prudence under the Restatement.

As Ellis has consistently suggested,

So, the incremental fees for an actively managed mutual fund relative to its incremental returns should always be compared to the fees for a comparable index fund relative to its returns. When you do this, you’ll quickly see that that the incremental fees for active management are really, really high—on average, over 100% of incremental returns!24

A sample of an AMVR analysis supports Ellis’ position.

When I perform an AMVR analysis, I provide two sets of numbers, one set being based on the funds’ nominal, or publicly reported, numbers, the other set being based on the funds’ correlation-adjusted costs and risk-adjusted returns. Experience has shown that the investment and 401(k) industries typically prefer the nominal numbers, while ERISA plaintiff attorneys prefer the adjusted numbers.

The AMVR is simple and straightforward, requiring only the ability to compare the data between an actively managed fund and a comparable index fund by simple subtraction. A plan sponsor, or any other investment fiduciary, then just has to answer two simple questions:

  1. Did the actively managed funds provide a positive incremental return?
  2. If so, did the actively managed fund’s incremental return exceed the fund’s incremental costs?

If the answer to either question is “no,” then the actively managed fund is cost-inefficient/imprudent relative to the comparable index fund.

The AMVR slides speak for themselves. Situations where an investment’s incremental costs exceed its incremental returns is never a desirable, or prudent, investment scenario. Cost-inefficient investment alternatives within a 401(k) plan are not legally valid “choices.” Additional details on the calculation and interpretation of the AMVR are available on this website.

In CommonSpirit, the primary issue was the alleged imprudence/ cost-ineffficiency of Fidelity’s Freedom Funds (Active Suite) compared to Fidelity’s Freedom Funds Index Funds. I performed an AMVR analysis on several of the funds to determine the merits of the plaintiffs’ case.

The results of an AMVR analysis on several of the other Freedom funds provide similar results.

The AMVR analyses clearly show that in most cases the Active Suite not only underperformed the comparable index shares, but such opportunity cost/loss was further compounded by the fact that an investor incurred additional incremental costs in connection with such funds, while receiving actually nothing in return for such costs. This is the antithesis of fiduciary prudence.

The situation becomes even worse if the costs are adjusted for the correlation between the active suite funds and the comparable index funds, shown here based on Miller’s Active Expense Ratio (AER). Miller described the importance of the AER:

Mutual funds appear to provide investment services for relatively low fees because they bundle passive and active funds management together in a way that understates the true cost of active management. In particular, funds engaging in ‘closet’ or ‘shadow’ indexing charge their investors for active management while providing them with little more than an indexed investment. Even the average mutual fund, which ostensibly provides only active management, will have over 90% of the variance in its returns explained by its benchmark index.25
Ross Miller, “Evaluating the True Cost of Active Management by Mutual Funds,” Journal of Investment Management, Vol. 5, No. 1, 29-49

The second slide shows just how much of an impact the combination of a fund with high incremental costs and a high correlation of returns can have on the effective costs that an investor pays for a active management, further reducing the cost-efficiency of an investment and overall prudence.

Going Forward: An Opportunity Amidst Chaos
The Sixth Circuit has created a division between itself and the First Circuit on the issue of whether index funds are valid comparators, “meaningful benchmarks,” in 401(k) actions. The two circuits do agree with SCOTUS that the common law of trusts provides insight on fiduciary law issues, including on questions involving fiduciary prudence.

The Restatement is just that, a restatement of the common law of trusts. In Tibble26, SCOTUS specifically noted that the courts often turn to the Restatement for guidance in resolving questions involving fiduciary law, including questions involving ERISA.

As the First Circuit noted, Section 100 the Restatement expressly approves of the use of index funds as comparators in 401(k) litigation. The AMVR can be used by plan sponsors and attorneys to easily prove that in the overwhelming majority of cases, the inclusion of actively managed mutual funds in a 401(k) plan cannot satisfy the Restatement’s requirement that the use of actively managed funds/strategies be justifiable by “realistically evaluated return expectations” of providing a commensurate return for the additional costs and risks associated with active management, are imprudent.

“Wilful blindness” is a legal term often defined as “a conscious avoidance, a judicially-made doctrine that expands the definition of knowledge to include closing one’s eyes to the high probability a fact exists.” Despite acknowledging the importance of the common law of trusts, the Sixth Circuit has seemingly decided to ignore the Restatement’s positions with regard to both index funds as acceptable benchmarks in 401(k) litigation and the concerns over a fiduciary’s use of active management strategies and/or products. However, “facts do not cease exist because they are ignored.”

The Sixth Circuit states asserts that plaintiffs must do more than simply pleading the underperformance of an actively managed fund. Under the federal pleading rules, the Sixth Circuit says that in order to satisfy federal pleading rules, plan participants must plead facts the plausibility, not just the possibility, that a plan sponsor breached of their fiduciary.

The AMVR provides plan plaintiffs and their attorneys with a simple means to provide the “more” that both the Sixth Circuit and the plausibility pleading standard demand. By combining the AMVR with the overwhelming research establishing the cost-efficiency of actively managed, plan participants can establish both the underperformance of actively managed funds, and the resulting cost-efficiency of such funds due to the fact that such funds’ incremental costs exceeding incremental returns, if any, provided by such funds.

The AMVR also eliminates the need for courts and plan sponsors to consider immaterial collateral issues such as a fund’s classification (active, passive, large cap, small cap) and/or investment strategy (growth, income), as the use of cost-efficiency as the comparator cuts across such factors to provide an evaluation based on the stated purpose of ERISA, that being the best interests of the plan participants and their beneficiaries.

The plaintiffs have not announced whether they intend the to appeal the Sixth Circuit’s CommonSpirit decision. I hope that the decision is appealed in order to shift the paradigm in connection with 401(k) plans and to clarify the applicable standards in 401(k) and 403(b) litigation.  Such a final resolution would provide much needed clarity for both plan sponsors and the courts as to the applicable guidelines for plan administration and allow plan sponsors to design win-win 401(k)/403(b) plans that actually promote the best interests of both plan participants and plan sponsors.

Copyright InvestSense, LLC 2022. All rights reserved.

This article is for informational purposes only, and is neither designed nor intended to provide legal, investment, or other professional advice since such advice always requires consideration of individual circumstances.  If legal, investment, or other professional assistance is needed, the services of an attorney or other professional advisor should be sought.

Notes
1. Smith v. CommonSpirit Health, No. 21-5964, June 21, 2022 (6th Cir. 2022). (CommonSpirit)
2. Brotherston v. Putnam Investments, LLC, 907 F.3d 17 (2018) (Brotherston)
3. Restatement (Third) Trusts, American Law Institute. All rights reserved. (Restatement)
4. Brotherston, 31.
5. Brotherston, 31.
6. Brotherston, 31.
7. Brotherston, 33.
8. Brotherston, 34.
9. Brotherston, 36.
10. Brotherston, 36.
11. Brotherston, 37.
12. CommonSpirit, Section II.A.
13. CommonSpirit, Section II.A.
14. CommonSpirit, Section II.A.
15. CommonSpirit, Section II.A.
16. CommonSpirit, Section II.A.
17. Restatement, Section 90, Introductory Comment. All rights reserved.
18. Restatement, Section 90 cmt. f. All rights reserved.
19. Restatement, Section 90 cmt. h(2). All rights reserved.
20. Laurent Barras, Olivier Scaillet and Russ Wermers, False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas, 65 J. FINANCE 179, 181 (2010).
21. Charles D. Ellis, The Death of Active Investing, Financial Times, January 20, 2017, available online at https://www.ft.com/content/6b2d5490-d9bb-11e6-944b-eb37a6aa8e. 
22. Philip Meyer-Braun, Mutual Fund Performance Through a Five-Factor Lens, Dimensional Fund Advisors, L.P., August 2016.
23. Mark Carhart, On Persistence in Mutual Fund Performance,  52 J. FINANCE, 52, 57-8 (1997). 24. Ellis
25. Ross Miller, “Evaluating the True Cost of Active Management by Mutual Funds,” Journal of Investment Management, Vol. 5, No. 1, 29-4.
26. Tibble v. Edison International, 135 S. Ct 1823 (2015).
27. Restatement, Section 100 cmt. b(1).
28. Restatement, Section 90 cmt. h(2).

Posted in 401k, 401k compliance, 401k investments, 403b, Active Management Value Ratio, AMVR, cost consciousness, cost-efficiency, Cost_Efficiency, ERISA, ERISA litigation, fiduciary compliance, fiduciary duty, fiduciary law, fiduciary liability, fiduciary liability, Fiduciary prudence, fiduciary prudence, fiduciary responsibility, fiduciary risk management, fiduciary standard, Mutual funds, pension plans, plan sponsors, prudence, risk management, SEC, wealth management, wealth preservation | Tagged , , , , , , , , , , , , , | Leave a comment

The Conversation Every 401(k) and 403(b) Plan Needs to Have: The Plan Sponsor Liability Circle™

James W. Watkins, III, J.D., CFP®, AWMA®

Whenever plan sponsors and plan advisers talk about 401(k) litigation, they always point the finger at those bad ‘ol ERISA plaintiff attorneys. Since I am one of those bad folks, I respectfully disagree with such sentiments. I respectfully suggest that plan sponsors should look in the mirror to see the real party for such litigation. As the famous comic strip, “Pogo,” once said, “we have met the enemy and he is us.”

Whenever I talk with a CEO and/or a 401(k) investment committee, this is the first graphic I show them.

Most plan advisers insist on plan sponsors agreeing to an advisory contract that contains a fiduciary disclaimer clause. Many plan sponsors are not aware that they have agreed to such a provision since the clauses are usually set out in legalese. But they are usually there.

When a plan sponsor agrees to such a clause, it waives important protections for both itself and the plan participants. With a fiduciary disclaimer clause, securities licensed advisers can claim to be subject to Regulation “Best Interest” (Reg BI) rather than the more demanding duties of loyalty and prudence required under a true fiduciary standard.

Reg BI claims that it requires brokers to always put a customer’s best interests first, including considering the costs associated with any and all recommendations. Then Reg BI turns around and allows brokers to only consider “readily available alternatives,” which the SEC considers to include the cost-inefficient and consistently underperforming actively managed mutual funds and various annuity products that brokers and broker-dealers generally recommend. So, in whose best interests?

Unless a plan sponsor properly performs the investigation and evaluation required under ERISA, this usually results in 401(k) litigation and the plan sponsor settling for a significant amount. As we discussed in a previous post, when you consider that all of this can be easily avoided by a plan sponsor by performing a cost-efficiency analysis using our free Active Management Value Ratio, you have to wonder why plan sponsors do not better protect themselves by simplifying their plans and ensuring that they are ERISA-compliant.

My experience has been that most plan sponsors create unnecessary liability exposure for themselves due to a mistaken understanding of their true fiduciary duties. “The CommonSense 401(k) Plan”™ provides a simple solution that reduces both administration costs and potential liability exposure, resulting in a win-win situation for both plan participants and plan sponsors.

So, for plan sponsors and plan advisers, the next time you point a finger at ERISA plaintiff’s attorney and blame us for the number of 401(k) litigation cases, remember the words of my good friend, Charles Nichols, when you point at us, three of your remaining fingers point back at you.

Copyright InvestSense, LLC 2022. All rights reserved.

This article is for informational purposes only, and is neither designed nor intended to provide legal, investment, or other professional advice since such advice always requires consideration of individual circumstances.  If legal, investment, or other professional assistance is needed, the services of an attorney or other professional advisor should be sought.

Posted in 401k, 401k compliance, 401k investments, 403b, Active Management Value Ratio, best interest, compliance, consumer protection, cost consciousness, cost efficient, cost-efficiency, ERISA, ERISA litigation, fiduciary compliance, fiduciary duty, fiduciary law, fiduciary liability, fiduciary liability, Fiduciary prudence, fiduciary prudence, fiduciary responsibility, fiduciary risk management, fiduciary standard, investment advisers, Mutual funds, pension plans, plan sponsors, prudence, Reg BI, retirement planning, retirement plans, risk management, securities compliance | Tagged , , , , , , , , , , , , , , , | Leave a comment

An Inconvenient Truth: Cost-Inefficiency and Closet Indexing in 401(k) Plans

“Facts do not cease to exist because they are ignored” – Aldous Huxley

The Sixth Circuit Court of Appeals’ recent decision in the CommonSpirit Health (CommonSpirit)1 401(k) action has brought renewed attention to several key 401(k) compliance and fiduciary liability issues. While many in the financial services and 401(k) industry have suggested that the decision signifies a new approach to 401(k) litigation, I would argue that that decision is premature.

I have over 27 years of combined experience in securities/RIA/ERISA compliance, I am a firm believer in the value of the black letter law, the actual statutes and regulations that govern an area of the law, as opposed to legal decisions interpreting such laws.

A prime example of that was SCOTUS’ recent decision in the Northwestern University case.2 As the Court pointed out, ERISA’s own language clearly indicated that the Seventh Circuit’s “menu of options” defense had no merit, to the point that Justice Kagan even asked the school’s attorney whether he actually believed his own argument. His answer – “no.”

We now have the same situation presenting itself as a result of the CommonSpirit decision, with the court renewing the anti-index funds “meaningful benchmarks” and “apples and oranges” argument. Both of these arguments were discredited in the First Circuit’s Brotherston decision3, and SCOTUS’ subsequent refusal to hear the case on appeal.

As a result of the CommonSpirit decision, we once again have two federal appellate courts with inconsistent and irreconcilable decisions that threaten the rights and protections guaranteed under ERISA. Fortunately, I would argue that the First Circuit has already provided the answer, stating that

[T]he Restatement specifically identifies as an appropriate comparator for loss calculation purposes’ return rates of one or more…suitable index mutual funds or market indexes….’

ERISA itself is not so specific. Rather, it states that a breaching fiduciary shall be liable to the plan for ’any losses to the plan resulting from each such breach.’ Certainly this text is broad enough to accommodate the total return principle recognized in the Restatement….And as the Supreme Court has instructed, when we confront a lack of explicit direction in the text of ERISA, we often find answers in the common law of trusts.4

ERISA is essentially a codification of the common law of trusts. The Restatement of Trusts essentially reflects the common of trusts. The First Circuit’s points perhaps explain the fact that the Sixth Circuit mentioned neither the Brotherston decision nor the Restatement of Trusts in its CommonSpirit decision.

Nevertheless, the CommonSpirit decision invites a deeper examination of the “why” regarding the current 401(k) litigation trend in general. While the amount of 401(k) litigation is a much-discussed topic, far too often the argument is disingenuous, as it ignores two key facts – most 401(k) plans are non-ERISA compliant due to the amount of cost-efficient and/or “closet index” funds offered within modern 401(k) and 403(b) plans.

Cost-Inefficiency Within Plans
Plan sponsors are co-fiduciaries with any plan adviser the plan hires. However, in many cases, the plan adviser will insert a clause in their advisory contract with the plan disclaiming any fiduciary duties in connection with their services to the plan.

I maintain that by agreeing to an advisory contract with such a fiduciary disclaimer clause, the plan sponsor violates their fiduciary duties. My argument is based on the fact that by agreeing to release a plan adviser from their co-fiduciary status and duties, a plan sponsors arguably allows a plan adviser to legally provide a lower quality of advice under the SEC’s Regulation Best Interest (Reg BI) than the adviser would have been required to provide as a fiduciary.

While a true fiduciary standard requires an ERISA fiduciary to always act in the best interest of a plan’s plan participants and their beneficiaries, Reg BI provides advisers with a loophole, the “readily available alternatives” language, which effectively allows an adviser to put the best interest of their broker-dealer and themselves ahead of plan participants and their beneficiaries. This creates an obvious problem, especially when the evidence suggests that many plan sponsors blindly follow their plan adviser’s advice without performing their own legally required investigation and evaluation of a plan’s investment options.

Does a plan sponsor’s agreeing to a fiduciary disclaimer clause allow a plan adviser to recommend imprudent investments for a plan under Reg BI? Does a fiduciary disclaimer clause allow an adviser to deny a plan access to prudent investment alternatives that the adviser actually has available, but simply chooses not to offer to a plan for financial reasons?

Plan advisers typically recommend actively managed investment options because that is how they and their broker-dealers make money. Research has consistently shown that the overwhelming majority of actively maanged mutual funds are cost-inefficient when compared to comparable passively managed index funds.

  • 99% of actively managed funds do not beat their index fund alternatives over the long-term net of fees.5
  • [I]ncreasing numbers of clients will realize that in toe-to-toe competition versus near-equal competitors, most active managers will not and cannot recover the costs and fees they charge6
  • [T]he investment costs of expense ratios, transaction costs and load fees all have a direct, negative impact on performance….[The study’s findings] suggest that mutual funds, on average, do not recoup their investment costs through higher returns.7
  • [T]here is strong evidence that the vast majority of active managers are unable to produce excess returns that cover their costs.8

In an earlier post, I noted that when the Securities and Exchange Commission (SEC) announced and implemented Regulation “Best Interest” (Reg BI), then SEC chairman Jay Clayton acknowledged the importance of cost-efficiency of investments:

rational investor seeks out investment strategies that are efficient in the sense that they provide the investor with the highest possible expected net benefit, in light of the investor’s investment objective that maximizes utility.9 

[A]n efficient investment strategy may depend on the investor’s utility from consumption, including…(4) the cost to the investor of implementing the strategy.10

And yet, as previously mentioned in my last post, the “readily available alternatives” language in Reg BI effectively allows brokers to ignore the cost efficiency issue and promote their own “best interests.”

SCOTUS has consistently recognized the Restatement (Third) of Trusts (Restatement) as a valuable resource in resolving fiduciary questions. The two dominant themes throughout the Restatement are cost-consciousness/cost-efficiency and risk-management through effective diversification.

Section 90 of the Restatement, more commonly known as the Prudent Investor Rule, is often cited in connection with the fiduciary duties of prudence and loyalty. Comment h(2) of Section 90 states that active management funds or strategies are only prudent when it can be objectively predicted that the fund/strategy will an investor with a commensurate return for the additional costs and risks typically associated with active management.

The obviousness and importance of cost-inefficiency within 401(k) plans can be illustrated with two forensic analyses using my Active Management Value Ratio™ (AMVR). The AMVR is based on the research of investment experts such as Charles D. Ellis, Burton L. Malkiel, Nobel Laureate Dr. William D. Sharpe and Ross Miller.

The basic premise is to assess the cost-efficiency of an actively managed mutual fund by comparing the fund’s incremental costs and incremental returns relative to a comparable index fund. Index funds, rather than market indices, are used for comparison purposes since market indices do not allow for cost-efficiency comparisons.

Each year, the retirement shares of Fidelity’s Contrafund Fund (FCNKX) and American Fund’s Growth Fund of America (RGAGX) are rated as within the top funds used in U.S. defined contribution plans. AMVR forensic analysis of both funds is shown below (based on the 5-year period ending on June 30, 2022).

When I perform an AMVR analysis, I report two sets of numbers, one set being based on the funds’ nominal, or publicly reported numbers, the other set being being based on the funds’ correlation-adjusted costs and risk-adjusted returns. Experience has shown that the investment and 401(k) industries typically prefer the nominal numbers, while ERISA plaintiff attorneys prefer the adjusted numbers.

The AMVR slides speak for themselves. Situations where an investment’s incremental costs exceed its incremental returns is never a desirable, or prudent, investment scenario. Cost-inefficient investment alternatives within a 401(k) plan are not legally valid “choices.” Additional details on the calculation and interpretation are available on this website.

The CommonSpirit case provided users of the AMVR with a unique opportunity – the opportunity to compare the cost-efficiency and respective prudence of two competing products offered by the same fund company, in this case Fidelity Investments. The products in this case involved the Fidelity Freedom suite of actively managed target date funds (TDFs) and the Fidelity Freedom Index TDFs.

The AMVR analysis slide comparing the two Fidelity 2035 TDFs is shown below.

Each quarter InvestSense prepares a “cheat sheet” on some of the top non-index funds within U.S defined contribution plans. The “cheat sheet” comparing the remaining Fidelity Freedom active and Index funds is shown below.

In an earlier AMVR analysis, Fidelity Contrafund K shares were compared to Vanguard Large Cap Growth Index shares. An AMVR forensic analysis comparing Contrafund to Fidelity’s Large Cap Growth Index shares is shown below.

So, the AMVR forensic analysis clearly shows that the Fidelity Large Cap Growth Index Fund shares are a more prudent investment option for a 401(k) plan. However, Fidelity does not offer the Large Cap Growth Index Fund to 401(k) plans. Contrafund is obviously more financially lucrative to Fidelity.

Unless Fidelity is in a fiduciary relationship with a plan sponsor, it has no legal obligation to offer their entire product line to 401(k) plans. If Fidelity is in a fiduciary relationship with a plan, an argument can be made that they do have a fiduciary obligation to offer their most prudent investment alternatives to a 401(k) plan.

At the same time, the Contrafund/Large Cap Growth Index fund AMVR analysis puts a plan sponsor in a predicament given the significantly better performance and cost-efficiency of the index fund. Simply because Fidelity refuses to make the better investment alternative available to a plan does not legally justify selecting the inferior investment alternative and causing the plan participants unnecessary losses. That would obviously constitute a breach of the plan sponsor’s fiduciary duties.

Closet Indexing


[A] large number of funds that purport to offer active management and charge fees accordingly, in fact persistently hold portfolios that substantially overlap with market indices….Investors in a closet index fund are harmed by paying fees for active management that they do not receive or receive only partially….11

Closet indexing raises important legal issues. Such funds are not just poor investments; they promise investors a service that they fail to provide. As such, some closet index funds may also run afoul of federal securities laws.12

Closet indexing is an international issue. As set out above, the issue is simple – are investors in actively managed mutual funds getting what they were promised, active management, or simply overpaying for the same performance they could receive from less costly index funds.

Professor Ross Miller did a study on the impact of closet indexing, focusing primarily on the relationship between an actively managed mutual fund’s r-squared number, “closet index” status, and the resulting overall financial impact of the two. “Closet index” funds are actively managed funds whose returns are essentially the same as a comparable index fund, but who charge much higher fees than the index fund. The higher an actively managed fund’s r-squared number, the greater the likelihood that the actively managed fund can be classified as a closet index fund.

An r-squared rating of 98 would indicate that 98 percent of an actively managed mutual fund’s returns could be attributed to the performance of a comparable index fund, rather than the active fund’s management team.

There is no universally agreed upon level of r-squared that designates an actively managed mutual fund as a closet index fund. I use an r-squared correlation number of 90 as my threshold indicator for closet index status. Others, including Morningstar, use much lower r-squared numbers.

Miller’s findings were extremely interesting.

Mutual funds appear to provide investment services for relatively low fees because they bundle passive and active funds management together in a way that understates the true cost of active management. In particular, funds engaging in ‘closet’ or ‘shadow’ indexing charge their investors for active management while providing them with little more than an indexed investment. Even the average mutual fund, which ostensibly provides only active management, will have over 90% of the variance in its returns explained by its benchmark index.13

As the AMVR and “cheat sheet” slides provided herein show, once correlations of returns is factored into the cost-efficiency equation, the effective expense ratios investors pay increase substantially, resulting in significantly lower overall cost-efficiency.

Going Forward
As a risk management consultant, I advise plan sponsors and other investment fiduciaries on compliance and “best practices” issues. I constantly stress to them the importance of exposing and eliminating cost-inefficiency and closet indexing within a 401(k) plan.

I often explain the relationship between cost-efficiency and fiduciary prudence/risk management with the following illustration.

As plan sponsors and investment fiduciaries increase the cost-efficiency within their plan, the level of fiduciary prudence increases, reducing their potential fiduciary liability exposure.

I believe that the CommonSpirit decision will eventually be vacated for exactly the reasons that the First Circuit set out in the Brotherston decision – SCOTUS’ advice regarding using the Restatement to resolve fiduciary disputes. The Restatement endorses the use of index funds as acceptable and “meaningful” benchmarks in calculating losses and addressing fiduciary breach questions. “Facts do not cease to exist because they are ignored.”

The Active Management Value Ratio™ provides plan sponsors and other investment fiduciaries with a fundamentally sound and simple means of accomplishing these goals using index funds. In so doing, plan sponsors can create and maintain a win-win plan, one that provides genuine benefits for plan participants and protects plan sponsors against unnecessary and unwanted exposure to fiduciary liability.

Notes
1. Smith v. CommonSpirit Health, No. 21-5964, June 21, 2022 (6th Cir. 2022). (CommonSpirit)
2. Hughes v. Northwestern University, 142 S.Ct. 737 (2022).
3. Brotherston v. Putnam Investments, LLC, 907 F.3d 17, 39 (1st Circuit 2018). (Brotherston)
4. Brotherston, 39.
5. Laurent Barras, Oliver Scaillet, and Russ Wermers, False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas, 65 J. FINANCE 179, 181 (2010).
6. Charles D. Ellis, The Death of Active Investing, Financial Times, January 20, 2017, https://www.ft.com/content/6b2d5490-d9bb-eb37a6aa8e
7. Mark Carhart, On Persistence in Mutual Fund Performance, 52 J. FINANCE 57-58 (1997).
8. Philip Meyer-Braun, Mutual Fund Performance Through a Five-Factor Lens, Dimensional Funds Advisors, L.P., August 2016.
9. SEC Release 34-86031, Regulation Best Interest: The Broker-Dealer Standard of Conduct (Reg BI), 279.
10. Reg BI, 279.
11. Martijn Cremers and Quinn Curtis, Do Mutual Fund Investors Get What they Pay For?:The Legal Consequences of Closet Index Fundshttps://papers.ssrn.com/sol/papers.cfm?abstract_id=2695133 (Cremers), 5, 42.
12. Cremers, 5, 42.
13. Ross Miller, “Evaluating the True Cost of Active Management by Mutual Funds,” Journal of Investment Management, Vol. 5, No. 1, 29-4.

Copyright InvestSense, LLC 2022. All rights reserved.

This article is for informational purposes only, and is neither designed nor intended to provide legal, investment, or other professional advice since such advice always requires consideration of individual circumstances.  If legal, investment, or other professional assistance is needed, the services of an attorney or other professional advisor should be sought

Posted in 401k, 401k compliance, 401k investments, 403b, Active Management Value Ratio, AMVR, best interest, closet index funds, compliance, consumer protection, cost consciousness, cost efficient, cost-efficiency, ERISA, ERISA litigation, fiduciary compliance, fiduciary duty, fiduciary law, fiduciary liability, fiduciary liability, Fiduciary prudence, fiduciary prudence, fiduciary responsibility, investments, Mutual funds, pension plans, plan sponsors, prudence, Reg BI, retirement plans, risk management, wealth management, wealth preservation | Tagged , , , , , , , , , , , , , , | 2 Comments

The CommonSpirit Health Decision: Fiduciary Risk Management Lessons for Plan Sponsors

Having read the CommonSpirit Health (CommonSpirit) decision1 and the related briefs several times, three key fiduciary risk management issues stand out to me with regard to plan sponsors

1. SCOTUS needs to expressly resolve this ongoing “apples and oranges” debate once and for all, to expressly rule on the propriety of using index funds for benchmarking purposes. I believe the Court may legitimately feel that they addressed and resolved the issue by refusing to grant certiorari in the Brotherston decision.2 The Sixth Circuit obviously feels differently, as it resurrected the “apples and oranges” argument in upholding the district court’s dismissal of the case.

In the CommonSpirit decision, neither the circuit court nor the Sixth Circuit acknowledged the First Circuit’s Brotherston decision and/or the court’s reliance on the Restatement (Third) of Trusts’3(Restatement) position on the propriety of using index funds for benchmarking purposes.

“So to determine whether there was a loss, it is reasonable to compare the actual returns on that portfolio to the returns that would have been generated by a portfolio of benchmark funds or indexes comparable but for the fact that they do not claim to be able to pick winners and losers, or charge for doing so. Restatement (Third) of Trusts, § 100, cmt. b(1) (loss determinations can be based on returns of suitable index mutual funds or market indexes)”4

Neither court acknowledged SCOTUS’ denial of Putnam’s application for certiorari, which many would interpret as the court’s indication that both the First Circuit’s decision and underlying rationale were correct.

One circuit is not obligated to follow the decisions of another circuit, and laws are obviously open to differing opinions. However, the fact that neither court acknowledged Brotherston nor tried to distinguish the two cases is arguably noteworthy given the First Circuit’s reliance on the Restatement, a resource recognized by SCOTUS as a legitimate resource in resolving fiduciary questions in its Tibble decision.5

Hopefully, the Sixth Circuit’s decision will be appealed. The fact that the case involves the prudence of two competing products from the same mutual fund company makes the case even more appealing for review. As the Solicitor General’s amicus brief in Brotherston argued, the rights and protections guaranteed to employees by ERISA are too important to vary based upon in which jurisdiction employees may reside.

2.  The whole “fiduciary disclaimer clause” issue needs to be addressed. More specifically, the question of whether a plan sponsor breaches his fiduciary duties of prudence and loyalty to the plan participants by agreeing to an advisory contract that contains a fiduciary disclaimer clause. Again, I think the CommonSpirit case brings this issue into focus since the case involved similar, yet competing, products offered by the plan adviser, Fidelity Investments.

I think several issues need to be explored and addressed with regard to the use of fiduciary disclaimer clauses in 401(k) plan advisory contracts. It can be argued that removing a plan adviser’s fiduciary obligations allows firms to argue that their advice and recommendations are to evaluated under Regulation Best Interest (Reg BI)6, not a true fiduciary standard.

The resulting quality of advice issues are obvious:

  • The fiduciary standard requires that an adviser consider the prudence of their actions/recommendations in terms of an “open architecture” platform, or the entire universe of investment options, to ensure that the best interests of the plan participants are genuinely protected.

  • Reg BI, and its “readily available alternatives” loophole, allows plan advisers to “carve out” a portion of the universe of investment options and essentially put the best interests of the broker-dealer and the plan adviser ahead of those of the plan and its participants.

This result is totally inconsistent with ERISA’s stated purpose and mission, to protect plan participants and retirement plans against any form of inequitable or abusive activity.

In analyzing cases involving fiduciary disclaimer clauses, my initial response is to ask (1) why a plan adviser would even request such a provision, and (2) why would a plan sponsor agree to such a provision.

Releasing a plan adviser from any fiduciary duties or obligations to a plan does not provide any benefits at all to plan participants. Not only does it allow a plan adviser to provide a lesser quality of advice and products pursuant to Reg BI, it also arguably allows them to avoid offering their company’s entire line of financial products to the plan participants, potentially denying the plan participants the opportunity to maximize their potential return by investing in cost-efficient investments. Therefore, agreeing to any plan advisory contract that contains a fiduciary disclaimer clause violates a plan sponsor’s fiduciary duties of loyalty and prudence.

I would argue that prior to agreeing to any fiduciary disclaimer clause, a plan sponsor should consider the fact that the financial services industry has historically opposed any attempt to impose a true fiduciary standard on its members. Could it be because the industry knows that their advice and products typically fall far short of complying with a true fiduciary standard, while Reg BI arguably protects them when providing imprudent advice and/or products?

Section 90, comment h(2), of the Restatement states that that due to the higher costs and risks associated with actively managed funds and active strategies, both are imprudent unless it can be objectively estimated that the funds and/or strategies will provide a commensurate return for the additional costs and risks incurred, i.e., are cost-efficient.7

The financial services industry does not like to discuss cost-efficiency, as studies have consistently shown that the overwhelming majority of actively managed mutual funds are cost-inefficient.

  • 99% of actively managed funds do not beat their index fund alternatives over the long term net of fees.8  
  • Increasing numbers of clients will realize that in toe-to-toe competition versus near–equal competitors, most active managers will not and cannot recover the costs and fees they charge.9
  • [T]here is strong evidence that the vast majority of active managers are unable to produce excess returns that cover their costs.10
  • [T]he investment costs of expense ratios, transaction costs and load fees all have a direct, negative impact on performance….[The study’s findings] suggest that mutual funds, on average, do not recoup their investment costs through higher returns.11

The CommonSpirit case presents a perfect example of this scenario in connection with the comparison between the Fidelity Freedom active suite of target-date funds and the Fidelity Freedom Index target date funds. A forensic analysis comparing the 2035 version of both funds using the Active Management Value Ratio™ clearly shows that the 2035 active version of the funds is cost-inefficient relative to the passive index version.

An AMVR analysis comparing the other Fidelity Freedom active/Freedom Index funds provided similar results

Had the CommonSpirit plan adviser remained subject to a fiduciary standard, it can be argued that the adviser would have been equally legally liable, along with the plan sponsor, for not recommending and selecting the cost-inefficient, i.e., imprudent, funds to the plan. The inability of the plan participants to include the plan adviser in any litigation could also impact their ability to achieve a full and complete recovery for any and damages suffered.

From a strategic standpoint, the inclusion of a claim based on the fiduciary disclaimer theory could also benefit ERISA plaintiff attorneys in preventing dismissal of their cases by creating a genuine and material issue of fact. On ruling on motions to dismiss, judges are required to accept plaintiff’s allegations of fact as true and to base their decisions involving such motions only on questions of law. A basic tenet of the law is that decisions of fact are to be made solely by a jury.

Furthermore, given the fact that the plaintiff will rarely have pre-trial access to the advisory contract between the plan and the adviser, the Leber v. Citigroup 401(k) Investment Committee decision12 should be cited as authority for granting plaintiff’s attorney restricted discovery on the issue of the advisory contract prior to the court deciding a motion to dismiss.

3. When I read the Sixth Circuit’s CommonSpirit decision, two other 401(k) decisions immediately came to mind, Brotherston and Hughes v. Northwestern University.13 The reasons these cases came to mind is that they support my advice to plan sponsors and other investment fiduciaries to follow the actual law, not the interpretations of the law by the courts.

My advice is not meant as disrespect for the courts. My advice is simply meant as a risk reduction reminder to plan sponsors and other investment fiduciaries that courts can, and sometimes do, legitimately interpret the application of the law differently due to a difference in the facts involved in a case.

Courts are also not infallible. As Justice Benjamin Carozo pointed out,

There is in each of us a stream of tendency, whether you choose to call it philosophy or not, which gives coherence and direction to thought and action. Judges cannot escape that current any more than other mortals.

The great tides and currents which engulf the rest of men do not turn aside in their course and pass the judges by.

The law, however, should remain constant. And in interpreting and applying the law, I agree with Justice Cardozo that in many cases, “[t]he risk to be perceived defines the duty to be obeyed.”

In the Northwestern University case, we saw SCOTUS reject the Seventh Circuit’s “menu of options” argument based solely on the wording of ERISA itself. In Brotherston, we saw the First Circuit reject the lower court’s “apples and oranges” argument solely on the wording of Section 100, comment b(1), of the Restatement (Third) of Trusts.

In the CommonSpirit case, we have two Courts of Appeal that have issued two diametrically opposed and irreconcilable decisions involving the same law and the same issue, the propriety of using index funds for benchmarking purposes in determining damages in 401(k) litigation cases.

Only time will tell what the eventual outcome of the case will be. In the meantime, I believe the case provides a valuable lesson as to why plan sponsors and other investment fiduciaries should always focus primarily on the actual laws, not judicial interpretations of such laws

As the Solicitor General pointed out in the amicus briefs filed with SCOTUS in both the Brotherston and Northwestern University cases, inconsistencies between the federal Courts of Appeal is simply one that cannot be allowed to stand, especially in ERISA cases where the financial security of employees and their families are involved.  

Notes
1. Smith v. CommonSpirit Health, No. 21-5964, June 21, 2022 (6th Cir. 2022). (CommonSpirit)
2. Brotherston v. Putnam Investments, LLC, 907 F.3d 17, 39 (1st Circuit 2018). (Brotherston)
3. RESTATEMENT (THIRD) TRUSTS, (American Law Institute). (All rights reserved).
4. Brotherston, 39.
5. Tibble v. Edison International, 135 S. Ct 1823 (2015).
6. SEC Release 34-86031, Regulation Best Interest: The Broker-Dealer Standard of Conduct (Reg BI), 279.
7. RESTATEMENT (THIRD) TRUSTS, (American Law Institute), Section 90, cmt h(2). (All rights reserved).
8. Laurent Barras, Oliver Scaillet, and Russ Wermers, False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas, 65 J. FINANE 179, 181 (2010).
9. Charles D. Ellis, The Death of Active Investing, Financial Times, January 20, 2017, https://www.ft.com/content/6b2d5490-d9bb-eb37a6aa8e
10. Mark Carhart, On Persistence in Mutual Fund Performance, 52 J. FINANCE 57-58 (1997).
11. Philip Meyer-Braun, Mutual Fund Performance Through a Five-Factor Lens, Dimensional Funds Advisors, L.P., August 2016.
12. Leber v. Citigroup 401(k) Plan Inv. Committee, 2014 WL 4851816.
13. Hughes v. Northwestern University, 142 S.Ct. 737 (2022).

Copyright InvestSense, LLC 2022. All rights reserved.

This article is for informational purposes only, and is neither designed nor intended to provide legal, investment, or other professional advice since such advice always requires consideration of individual circumstances.  If legal, investment, or other professional assistance is needed, the services of an attorney or other professional advisor should be sought

Posted in 401k, 401k compliance, 401k investments, Active Management Value Ratio, AMVR, best interest, compliance, consumer protection, cost-efficiency | Tagged , , , , , , , | 1 Comment

2Q 2022 AMVR “Cheat Sheets”

At the end of each calendar quarter, I perform a forensic AMVR fiduciary prudence analysis on the non-index mutual funds within the top 10 funds in U.S. defined contribution plans, as ranked by “Pensions & Investments.” InvestSense provides both a 5-year and a 10-year analysis, using both a fund’s incremental nominal costs/returns and a fund’s incremental AER/correlation-adjusted costs and incremental risk-adjusted returns.

Studies have consistently shown that the overwhelming majority of actively managed mutual funds are cost-inefficient. A cost-inefficient mutual funds is never in an investor’s “best interest.” Therefore, a fiduciary that selects cost-inefficient fund would violate his/her fiduciary duty of prudence.

Past AMVR analyses have generally confirmed the studies that have found the majority of actively managed funds to be cost-inefficient. InvestSense uses a fund’s incremental AER/correlation-adjusted costs and incremental risk-adjusted return in assessing a fund’s Fiduciary Prudence Rating.

None of the funds qualified as prudent using the 5-year analysis. The Dodge & Cox Stock fund’s nominal nominal numbers would have qualified as prudent. However, the fund failed to produce a positive incrmental return using the fund’s risk-adjusted return.

The 10-year analyses did produce one fund, the Vanguard PRIMECAP Fund (Admiral shares), that qualified as a prudent performance using the fund’s adjusted costs and returns.

The results of the analyses continue to show the harmful effects of a combination of high incremental costs and high r-squared correlation numbers. A prime example of this is the T. Rowe Price Blue Chip Growth fund, where the combination of high incremental nominal costs (1.17) and a high r-squared number (98) resulted in the fund’s incremental correlation adjusted cost increased to 9.31. Very few actively managed will ever provide incremetnsl returns to cover such a deficit.

Posted in 401k, 401k investments, Active Management Value Ratio, AMVR, asset allocation, best interest, consumer protection, cost consciousness, cost efficient, cost-efficiency, Cost_Efficiency, ERISA, ERISA litigation, fiduciary compliance, fiduciary duty, fiduciary law, fiduciary liability, fiduciary liability, Fiduciary prudence, fiduciary prudence, fiduciary responsibility, fiduciary standard, investment advisers, investments, Mutual funds, pension plans, plan sponsors, prudence, risk management, wealth management, wealth preservation | Tagged , , , , , , , , | Leave a comment

“Meaningful Choices”: Cost-Efficiency, the CommonSpirit Health decision, and the Future of 401(k) Litigation

Recently, the Sixth Circuit handed down its decision in the Smith v. CommonSpirit Health (“CommonSpirit) 401(k) action.1 My immediate reaction was “hello again SCOTUS,” as once again we have inconsistent and irreconcilable rulings between two circuits involving ERISA litigation

The decision raises a number of issues, including the Court’s suggestion that the alleged popularity of a fund has any relevance whatsoever in connection with the legal prudence of such fund. However I want to focus on what I consider to be the primary reason for the increase in 401(k) litigation and the simple solution that would provide a win-win situation for both plan sponsors and  plan participants going forward, reducing litigation and its associated costs.

As the Solicitor General pointed out in the amicus brief it filed in connection with Brotherston v. Putnam Investments, LLC,2 (Brotherston) case, the rights and protections guaranteed under ERISA are simply too important to be determined on the basis of the jurisdiction in which a plan participant resides. And yet, just as in the Northwestern University 401(k) case3, that is exactly the situation we now face as a result of the CommonSpirit decision

SCOTUS denied Putnam’s request for certiorari, thereby arguably implicitly, if not expressly, agreeing with the First Circuit’s decision and the reasoning behind the decision. The Brotherston decision clearly discredited the lower court’s reliance on the “apples and oranges” defense, the suggestion that the use of index funds for benchmarking purposes is legally inappropriate due to inherent differences between active and index funds.

SCOTUS has made it clear that whatever the overall balance the common law might have struck between the protection of beneficiaries and the protection of fiduciaries, ERISA’s adoption reflected “Congress'[s] desire to offer employees enhanced protection for their benefits.”4   

So to determine whether there was a loss, it is reasonable to compare the actual returns on that portfolio to the returns that would have been generated by a portfolio of benchmark funds or indexes comparable but for the fact that they do not claim to be able to pick winners and losers, or charge for doing so. Restatement (Third) of Trusts, § 100 cmt. b(1) (loss determinations can be based on returns of suitable index mutual funds or market indexes)”5

The First Circuit stated that while courts may determine questions of law, the lower court had effectively decided questions of fact, which is the exclusively the responsibility of a jury.   

The Court then went on to suggest a way that 401(k) plans might avoid such litigation going forward:

Moreover, any fiduciary of a plan such as the Plan in this case can easily insulate itself by selecting well-established, low-fee and diversified market index funds. And any fiduciary that decides it can find funds that beat the market will be immune to liability unless a district court finds it imprudent in its method of selecting such funds, and finds that a loss occurred as a result. In short, these are not matters concerning which ERISA fiduciaries need cry “wolf.”6  

In the CommonSpirit decision, the Sixth Circuit ignored both the Brotherston decision and the Restatement  (Third) of Trusts, a resource that SCOTUS has acknowledged as a resource in resolving questions involving fiduciary prudence. The Sixth Circuit’s primary basis for dismissing the action was its position that index funds are not a “meaningful benchmark” for determining the fiduciary prudence of an actively managed mutual funds.

We accept that pointing to an alternative course of action, say another fund the plan might have invested in, will often be necessary to show a fund acted imprudently (and to prove damages). But that factual allegation is not by itself sufficient.7

That court explained that the two general investment options “have different aims, different risks, and different potential rewards that cater to different investors. Comparing apples and oranges is not a way to show that one is better or worse than the other.”8

That a fund’s underperformance, as compared to a “meaningful benchmark,” may offer a building block for a claim of imprudence is one thing. But it is quite another to say that it suffices alone, especially if the different performance rates between the funds may be explained by a “different investment strategy….”We would need significantly more serious signs of distress to allow an imprudence claim to proceed.9

The Sixth Circuit then went on to suggest that the alleged popularity of a fund and/or its Morningstar rating may be relevant in determining the prudence of a fund. This suggestion is clearly in conflict with other courts, which have consistently stated that the alleged popularity of a fund and/or third-party ratings are totally irrelevant in determining the fiduciary prudence of mutual funds. 

The Court then stated that

publicly available performance information about an investment may show sufficiently dismal performance that this reality, when combined with “allegations about methods,” will successfully allege that a prudent fiduciary would have acted differently.10

The Court credited CommonSpirit with removing the AllianzGI Fund as an investment option in 2018, stating that is served as evidence “that CommonSpirit fulfilled its ‘continuing duty to monitor trust investments and remove imprudent ones’.11The Court apparently was unaware that the AllianzGI Fund was apparently closed in 2018, so it is possible that CommonSpirit had a choice in removing the fund from the plan’s menu of  investment options

Building a Better, and Fairer, Mousetrap
While most 401(k) decisions address costs and returns, I have never seen any court take the next, and to me the obvious, step of combining the two to address the cost-efficiency of an actively managed fund relative to a comparable index fund.

Interestingly enough, the Sixth Circuit referenced Charles D. Ellis’s classic book, “Winning the Loser’s Game.” Unfortunately, the Court failed to reference arguably Ellis’ most important contribution to wealth management:

So, the incremental fees for an actively managed mutual fund relative to its incremental returns should always be compared to the fees for a comparable index fund relative to its returns.

When you do this, you’ll quickly see that that the incremental fees for active management are really, really high—on average, over 100% of incremental returns!12

Add to that the contributions of both Nobel Laurerate Dr. William D. Sharpe and investment icon Burton L. Malkiel:

[T]he best way to measure a manager’s performance is to compare his or her return with that of a comparable passive alternative.13

Past performance is not helpful in predicting future returns. The two variables that do the best job in predicting future performance [of mutual funds] are expense ratios and turnover.14 

Based upon the Restatement and the studies of Ellis, Sharpe, and Malkiel, I created a simple metric, the Active Management Value Ratio™ (AMVR), that allows investors, investment fiduciaries and attorneys to quickly determine the cost-efficiency of an actively managed mutual fund relative to a comparable index fund. For more information about the AMVR, including the calculation process, click here (iainsight.wordpress.com).

Once the AMVR is calculated for an actively managed fund, the investor or investment fiduciary only needs to answer two simple questions:

(1) Does the actively managed mutual fund provide a positive incremental return relative to the benchmark being used?
(2) If so, does the actively managed fund’s positive incremental return exceed the fund’s incremental costs relative to the benchmark?

If the answer to either of these questions is “no,” the actively managed fund is both cost-inefficient and unsuitable/imprudent according the the Restatement’s prudence standards, and should be avoided. The goal for an actively managed fund is an AMVR number greater than “0” (indicating that the fund did provide a positive incremental return), but equal or less than “1” (indicating that the fund’s incremental costs did not exceed the fund’s incremental return).

The AMVR metric provides extremely useful information regarding the cost-efficiency of an actively managed mutual fund using just a fund’s nominal, or publicly reported, costs and returns. However, a cost-efficiency analysis should not end there if one wants a truly accurate cost-efficiency analysis of an actively managed mutual fund.

Professor Ross Miller did a study on the impact of closet indexing, focusing primarily on the relationship between an actively managed mutual fund’s r-squared number, “closet index” status, and the resulting overall financial impact of the two. “Closet index” funds are actively managed funds whose returns are essentially the same as a comparable index fund, but who charge much higher fees than the index fund. The higher an actively managed fund’s r-squared number, the greater the likelihood that the actively managed fund can be classified as a closet index fund.

An r-squared rating of 98 would indicate that 98 percent of an actively managed mutual fund’s returns could be attributed to the performance of a comparable index fund, rather than the active fund’s management team.

There is no universally agreed upon level of r-squared that designates an actively managed mutual fund as a closet index fund. I use an r-squared correlation number of 90 as my threshold indicator for closet index status. Others, including Morningstar, use much lower r-squared numbers.

Miller’s findings were extremely interesting, namely that

Mutual funds appear to provide investment services for relatively low fees because they bundle passive and active funds management together in a way that understates the true cost of active management. In particular, funds engaging in ‘closet’ or ‘shadow’ indexing charge their investors for active management while providing them with little more than an indexed investment. Even the average mutual fund, which ostensibly provides only active management, will have over 90% of the variance in its returns explained by its benchmark index.15

As a result of his study, Ross Miller, created the Active Expense Ratio (AER) metric. What Miller discovered was that once a fund’s r-squared correlation number is factored in, an active fund’s AER, the fund’s implicit, or effective, expense ratio is significantly higher than the fund’s stated expense, often as much as 400-500 percent higher. Investors and investment fiduciaries should remember John Bogle’s advice on investment costs, “you get what you don’t pay for,” as well as the fact that simple mathematics proves that each one percent in fees and expenses reduces an investor’s or fiduciary’s end-return by approximately seventeen percent over a twenty-year time period.16

The AMVR and the CommonSpirit Health Decision
The Plaintiffs in the CommonSpirit case did not include a cost-inefficiency argument in their complaint.  While the AMVR has gained increasing recognition and support among investment fiduciaries and some plaintiff’s attorneys, many attorney still refuse to even consider the metric. Attorneys often cite the simplicity of the AMVR and the fact that many judges still dislike the use of index funds, particularly Vanguard index funds, as comparators due to their inherent advantages over comparable actively managed funds

First, I believe that the simplicity of the AMVR is one of its main advantages. The AMVR requires very little time to learn and use effectively. The calculations are based primarily on online data from free sites such as morningstar.com and yahoo.finance.com and marketwatch.com. Once one becomes familiar with the AMVR calculation process and downloads the relevant data, the calculations themselves usually take less than a minute or two.

Second, with regard to judges’ resistance to the use of index funds as comparators, I believe that the Brotherston decision and the Restatement (Third) of Trusts clearly establish that index funds, including Vanguard index funds, are “meaningful benchmarks” under the law. The First Circuit and the U.S. District Court for the Southern District of New York17, aka Wall Street’s federal court, have recognized the propriety of benchmarking in connection with 401(k) actions. As a result, I have suggested to attorneys that they should always include a cost-inefficiency claim in their 401(k) actions cases, if for no other reason than to preserve the issue on appeal.  

The CommonSpirit decision validates the AMVR and the processes and fiduciary principles upon which it is based. This opinion is based on the Court’s dacknowledgement of the importance of investment costs:

“One feature of the active/passive management debate deserves focus. It is easy for investors at a given time to preoccupy themselves with the present-day or year-to-year value of their portfolio—the part of a financial statement usually placed most squarely in view. But just as compounding can dramatically increase the value of a mutual-fund investment over time, so the costs of that investment can dramatically eat into that investment over time…. Over time, management fees, like taxes, are not trivial features of investment performance.”17

The Sixth Circuit’s acknowledgment of  the importance of investment fees and others costs, including the fact that the impact of such fees, like returns, compound over time, cannot be overemphasized. The costs associated with underperformance are obvious and often discussed, both in terms of the financial loss and opportunity costs.

Costs and cost-efficiency generally do not receive the same amount of attention that returns receive. When the Securities and Exchange Commission (SEC) announced and implemented Regulation “Best Interest” (Reg BI), then SEC chairman Jay Clayton acknowledged the importance of cost-efficiency of investments:

rational investor seeks out investment strategies that are efficient in the sense that they provide the investor with the highest possible expected net benefit, in light of the investor’s investment objective that maximizes utility.18 

[A]n efficient investment strategy may depend on the investor’s utility from consumption, including…(4) the cost to the investor of implementing the strategy.19

The financial services industry quickly announced its opposition to Reg BI. The financial services industry opposition was based largely on the regulation’s requirement that costs must be factored into any investment recommendation provided my brokers.

Section 90, comment h(2) of the Restatement states that that due to higher costs and risks associated with actively managed funds, actively managed funds are imprudent unless it can be objectively estimated that the funds will provide a commensurate return for the additional costs and risks incurred, i.e., are cost-efficient.20

The financial services industry does not like to discuss cost-efficiency, as studies have consistently shown that the overwhelming majority of actively managed mutual funds are cost-inefficient.

99% of actively managed funds do not beat their index fund alternatives over the long term net of fees.21  

Increasing numbers of clients will realize that in toe-to-toe competition versus near–equal competitors, most active managers will not and cannot recover the costs and fees they charge.22

[T]here is strong evidence that the vast majority of active managers are unable to produce excess returns that cover their costs.23

[T]he investment costs of expense ratios, transaction costs and load fees all have a direct, negative impact on performance….[The study’s findings] suggest that mutual funds, on average, do not recoup their investment costs through higher returns.24

Critics of the AMVR often claim that it is simply a way to promote Vanguard funds. The CommonSpirit decision provided me with an opportunity to discredit that allegation by performing an AMVR forensic fiduciary prudence analysis comparing some of the the Fidelity Freedom active funds to comparable Fidelity Freedom Index funds.

I decided to also perform a similar AMVR fiduciary prudence analysis comparing some of the Fidelity Freedom active funds to comparable Vanguard TDF funds.

In the Fidelity Freedom active/inedx analysis, the active funds failed to provide a positive incremental return. So, arguably, the Fredom Active/Freedom Index AMVR analysis would have helped the plaintiff in the CommonSpirit case establish the cost-inefficiency of the active suite of funds, the “more” that courts keep demanding in meeting the required plausibility pleading standard. Conversely, the Fidelity Freedom active/Vanguard TDF AMVR analysis shows the importance of selecting the appropriate comparator index funds, as using Vanguard’s comparable index funds would have undermined the plaintiff’s case.

Going Forward
I would argue that there are several issues with the Sixth Circuit’s CommonSpirit decision. However, I believe the bigger issue in connection with 401(k) litigation and fiduciary in general is the opportunity it provides to divert attention from the active/passive debate and place the attention to a much more meaningful issue, the value of cost-efficiency and the AMVR in assessing fiduciary prudence/ liability and determining damages and in 401(k)/fiduciary actions. The simplicity and straightforward nature of the AMVR, combined with the fact that it is consistent with the fiduciary standards established by the Restatement, suggest that it is a “meaningful benchmark” that so many courts require to meet the federal pleading standards.

The AMVR exposes the irrelevancy of the defenses courts and the financial services industry often cite in 401(k) actions in defense of active management, e.g., differences in strategies, methodolgy, goals. The AMVR counters such arguments and tangential issues, essentially saying “ I do not care HOW you allegedly provided me with a benefit, but whether you actually DID provide me with a benefit at all.”

Businesses uses cost-benefit analysis every day. The AMVR is simply the cost/benefit equation using incremental cost and incremental returns as the imputs.

The Brotherston and Leber25 decisions, along with the Restatement effectively rebut any suggestions that index funds, including Vanguard index funds, are not “meaningful benchmarks.” The focus of the courts should be determining whether 401(k) plans provided plan participants with “meaningful choices” within their plans, cost-efficienct investment options that provided genuine benefits to the plan participants and their benefits as required by ERISA.  

In closing, I think the validity and the value of the AMVR can be summed up in two relevant quotes. In a 2007 speech at the University of Pennsylvania Law School, Brian G. Cartwright, then general counsel of the SEC, asked his audience to think of an investment in a mutual fund as a combination of two investments: a position in an “virtual” index fund designed to track the S&P 500 at a very low cost, and a position in a “virtual” hedge fund, taking long and short positions in various stocks. Added, together, the two virtual funds would yield the mutual fund’s real holdings. Cartwright told the students,

The presence of the virtual hedge fund is, of course, why you chose active management. If there were zero holdings in the virtual hedge fund — no overweightings or underweightings — then you would have only an index fund. Indications from the academic literature suggest in many cases the virtual hedge fund is far smaller than the virtual index fund. Which means…investors in some of these … are paying the costs of active management but getting instead something that looks a lot like an overpriced index fund. So don’t we need to be asking how to provide investors who choose active management with the information they need, in a form they can use, to determine whether or not they’re getting the desired bang for their buck?26

The second quote is from John Langbein, who served as the Reporter on the committee that wrote the Restatement (Second) of Trusts over fifty years ago. Shortly after the release of the revised Restatement, Langbein wrote a law review article on the new Restatement. At the end of the article, he made a bold prediction:

When market index funds have become available in sufficient variety and their experience bears out their prospects, courts may one day conclude that it is imprudent for trustees to fail to use such accounts. Their advantages seem decisive: at any given risk/return level, diversification is maximized and investment costs minimized. A trustee who declines to procure such advantage for the beneficiaries of his trust may in the future find his conduct difficult to justify.27   

I would suggest that that day has arrived and that the AMVR will be an indispensable tool in making both speaker’s predictions become reality for the benefit of both investors and investment fiduciaries.

Notes
1. Smith v. CommonSpirit Health, No. 21-5964, June 21, 2022 (6th Cir. 2022).(CommonSpirit)
2. Brotherston v. Putnam Investments, LLC, 907 F.3d 17, 39 (1st Circuit 2018)(Brotherston)
3. Hughes v. Northwestern University, 142 S.Ct. 737 (2022)
4. Brotherston, 37
5. Brotherston, 34
6. Brotherston, 39
7. CommonSpirit, II.A
8. CommonSpirit, II.A
9. CommonSpirit, II.A
10. CommonSpirit, II.A
11. CommonSpirit, II.A
12. Charles D. Ellis, “Letter to the Grandkids: 12 Essential Investing Guidelines,” available online at https://www.forbes.com/sites/investor/2014/03/13/letter-to-the-grandkids-12-essential-investing-guidelines/#cd420613736c
13. William F. Sharpe, “The Arithmetic of Active Investing,” available online at https://web.stanford.edu/~wfsharpe/art/active/active.htm
14. Burton G. Malkiel, “A Random Walk Down Wall Street,” 11th Ed., (W.W. Norton & Co., 2016), 460.
15. Ross Miller, “Evaluating the True Cost of Active Management by Mutual Funds,” Journal of Investment Management, Vol. 5, No. 1, 29-49 (2007) https://papers.ssrn.com/sol3/papers.cfm?abstract_id=746926
16. Private Pensions: Changes needed to Provide 401(k) Plan Participants and the Department of Labor Better Information on Fees,” (GAO Study”), http://www.gao.gov/new.item/d0721.pdf
17. CommonSpirit, I.A
18. SEC Speech: The Future of Securities Regulation: Philadelphia, Pennsylvania: October 24, 2007 (Brian G.Cartwright).(SEC Speech) http://www.sec.gov/news/speech/2007/spch102407bgc.htm
19. SEC Speech
20. RESTATEMENT (THIRD) TRUSTS, (American Law Institute), Section 90, cmt h(2).
21. Laurent Barras, Oliver Scaillet, and Russ Wermers, False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas, 65 J. FINANE 179, 181 (2010)
22. Charles D. Ellis, The Death of Active Investing, Financial Times, January 20, 2017, https://www.ft.com/content/6b2d5490-d9bb-eb37a6aa8e
23. Mark Carhart, On Persistence in Mutual Fund Performance, 52 J. FINANCE 57-58 (1997)
24. Philip Meyer-Braun, Mutual Fund Performance Through a Five-Factor Lens, Dimensional Funds Advisors, L.P., August 2016
25. Leber v. Citigroup 401(k) Plan Inv. Committee, 2014 WL 4851816
26. SEC Speech: The Future of Securities Regulation: Philadelphia, Pennsylvania: October 24, 2007 (Brian G. Cartwright). http://www.sec.gov/news/speech/2007/spch102407bgc.htm
27. John H. Langbein and Richard A. Posner, Measuring the True Cost of Active Management by Mutual Funds, Journal of Investment Management, Vol 5, No. 1, First Quarter 2007 http://digitalcommons.law.yale.edu/fss_papers/498

Copyright InvestSense, LLC 2022. All rights reserved.

This article is for informational purposes only, and is neither designed nor intended to provide legal, investment, or other professional advice since such advice always requires consideration of individual circumstances.  If legal, investment, or other professional assistance is needed, the services of an attorney or other professional advisor should be sought

Posted in 401k, 401k compliance, 401k investments, 403b, Active Management Value Ratio, AMVR, best interest, closet index funds, cost consciousness, cost efficient, cost-efficiency, ERISA, ERISA litigation, fiduciary compliance, fiduciary duty, fiduciary law, fiduciary liability, fiduciary liability, Fiduciary prudence, fiduciary prudence, fiduciary responsibility, fiduciary standard, investment advisers, investments, Mutual funds, pension plans, plan sponsors, prudence, Reg BI, wealth management, wealth preservation | Tagged , , , , , , , , , , , , , , | 1 Comment

Caveat Fiduciarius: The Reg BI “Reasonably Available Alternatives”/ERISA “Fiduciary Prudence” Liability Trap

I am on record as saying that (a) ERISA plaintiff’s attorneys should never lose a properly vetted 401(k)/403(b) action, and (b) the amount of 401(k)/403(b) litigation is going to continue to increase. Those opinions are based on three trends within those industries.

1. Many plan sponsors do not even realize that they are fiduciaries.
A J.P. Morgan survey found that 43% of plan sponsors surveyed were not aware that they are plan fiduciaries. Subsequent studies suggest that the problem still persists. It is highly unlikely that plan sponsors who do not even realize that they are fiduciaries realize what their fiduciary duties are in compliance with same.1            

1. Why do you offer so many investment options within the plan?
2. Why do you offer these specific investment options?

Far too often, the response is either “that’s what our plan adviser told us to do” or a simple shrug of the shoulders. My response – “What you are actually doing is unnecessarily exposing yourself to potential fiduciary liability. Simplicity is the new sophistication.”

Most plans try to qualify for ERISA 404(c) status in order to reduce their liability exposure. There are approximately 20-25 requirements that a plan must satisfy in order to qualify for 404(c) status. Fred Reish, one of the nation’s leading ERISA attorneys, has stated that many plans mistakenly believe that they have satisfied 404(c)’s requirements.

One thing has always fascinated me about the language in 404(c)’s requirements:

(3) Broad range of investment alternatives.

(i) A plan offers a broad range of investment alternatives only if the available investment alternatives are sufficient to provide the participant or beneficiary with a reasonable opportunity to:

(A) Materially affect the potential return on amounts in his individual account with respect to which he is permitted to exercise control and the degree of risk to which such amounts are subject;

(B) Choose from at least three investment alternatives:

(1) Each of which is diversified;

(2) Each of which has materially different risk and return characteristics;

(3) Which in the aggregate enable the participant or beneficiary by choosing among them to achieve a portfolio with aggregate risk and return characteristics at any point within the range normally appropriate for the participant or beneficiary; and

(4) Each of which when combined with investments in the other alternatives tends to minimize through diversification the overall risk of a participant’s or beneficiary’s portfolio…. (emphasis added)2

A valid argument can be made that a plan could comply with the three investment alternatives requirement simply with a plan consisting broad-based equity index fund, a broad-based fixed income index fund, and a money market fund. I would suggest that a plan at least add a broad-based international index fund to this three-investment plan.

Many plan advisers have told me that this type of simplified is absurd and will expose plan sponsors to liability, that their 15-20 investment options plans are absolutely. To that, I respond with my friend Rick Ferri’s quote–“Complexity is just job security.”

When it comes to designing 401(k)/403(b) plans, the adage “less is more” definitely holds true as far as exposing plan sponsors to unnecessary liability. As the Supreme Court recently pointed out, each individual investment must be prudent. The more investment options a plan offers, the greater the chances of a breach of the plan sponsor’s fiduciary duties.

Another issue I often see is plan sponsors mistakenly believing that they have a duty to ensure the ultimate performance of the investment options chosen for a plan. A plan sponsor’s fiduciary duties only involve the prudent selection of the plan’s investment options, not the eventual performance of such investments. Again, another example of plan sponsors making compliance with ERISA more difficult than it actually is, which provides a nice transition into my third point.

3. The Reg BI “reasonably available alternatives” vs. ERISA “fiduciary prudence” liability trap.
401(k) and 403(b) plans often hire third-parties to help them in administering the plan. These consultants are often what are known as 3(21) or 3(38) fiduciaries. While a lengthy discussion of the differences between the two is beyond the scope of this post, a simplified explanation is that a 3(21) adviser provides investment advice, while a 3(38) adviser provides investment management.

These consultants are often stockbrokers or dually registered stockbrokers/ investment adviser representatives. Under Regulation “Best Interest” (Reg BI), the SEC’s new standard of conduct for stockbrokers, the stockbroker is required to always put a customer’s best interest first and to consider various factors, including the cost associated with any product recommendations.

In deciding on investment recommendations, a stockbroker is required to consider and compare “reasonably available alternatives.”However, as the saying goes, “the devil is in the details.”

In the Proposing Release, we provided guidance on what types of recommendations would or would not be in the best interest of a particular retail customer. In particular, the Proposing Release stated that where a broker-dealer is choosing among identical securities available to the broker-dealer, it would be inconsistent with the Care Obligation to recommend the more expensive alternative for the customer. Similarly, in the Proposing Release, we noted our belief that it would be inconsistent with the Care Obligation if the broker-dealer made a recommendation to a retail customer in order to: maximize the broker-dealer’s compensation, further the broker-dealer’s business relationships,…”3

We also stated that under the Care Obligation a broker-dealer generally should consider reasonable alternatives, if any, offered by the broker-dealer in determining whether it has a reasonable basis for making the recommendation….4

Further, the Proposing Release indicated that under the Care Obligation, when a broker-dealer recommends a more expensive security or investment strategy over another reasonably available alternative offered by the broker-dealer,….(emphasis added)5

In particular, we are not requiring a natural person who is an associated person of the broker-dealer to be familiar with every product on a broker-dealer’s platform, particularly where a broker-dealer operates in an open architecture framework or otherwise operates a platform with a large number of products or options….Furthermore, such a requirement could encourage broker-dealers to limit their product menus or otherwise restrict access to products and services currently available to retail customers, which is contrary to the purpose and goals of Regulation Best Interest.6

And yet, I would argue that that is exactly what is happening by allowing plan advisers to artificially restrict their recommendations that benefit the plan adviser’s broker-dealer’s preferred providers.

“Open architecture” refers to an investment platform where a stockbroker can offer a wide variety of investment products, including no-load and index funds. Most of the major broker-dealers do not operate on an open architecture platform. Most broker-dealers usually restrict investment recommendations to the products offered by their “preferred providers,” mutual fund companies and other product vendors who have either paid for or arranged special deals for the privilege of accessing the broker-dealer’s stockbrokers.

The problem with this arrangement and Reg BI’s qualifying language, “reasonably available alternatives offered by the broker-dealer,” is that the investment products offered by preferred providers are often overpriced, consistently underperforming, i.e., cost-inefficient, products, the antithesis of both ERISA’s fiduciary prudence and loyalty requirements, as well as Reg BI’s goals.

Further complicating the situation is that plan sponsors often blindly rely on their plan adviser’s recommendations, even though the courts have consistently ruled that such blind reliance is a breach of a plan sponsor’s fiduciary duties, especially when stockbrokers and commissioned salespeople are involved.

It is by now black-letter ERISA law that ‘the most basic of ERISA’s investment fiduciary duties [is] the duty to conduct an independent investigation into the merits of a particular investment.’ The failure to make any independent investigation and evaluation of a potential plan investment’ has repeatedly been held to constitute a breach of fiduciary obligations.7

A determination whether a fiduciary’s reliance on an expert advisor is justified is informed by many factors, including the expert’s reputation and experience, the extensiveness and thoroughness of the expert’s investigation, whether the expert’s opinion is supported by relevant material, and whether the expert’s methods and assumptions are appropriate to the decision at hand. One extremely important factor is whether the expert advisor truly offers independent and impartial advice.

Defendants relied on FPA, however, and FPA served as a broker, not an impartial analyst. As a broker, FPA and its employees have an incentive to close deals, not to investigate which of several policies might serve the union best. A business in FPA’s position must consider both what plan it can convince the union to accept and the size of the potential commission associated with each alternative.   FPA is not an objective analyst any more than the same real estate broker can simultaneously protect the interests of “can simultaneously protect the interests of both buyer and seller or the same attorney can represent both husband and wife in a divorce.8 

A 3(21) adviser is technically a co-fiduciary with the plan sponsor. However, 3(21) advisers routinely insert fiduciary disclaimer clauses in their advisory contracts in attempt to avoid any fiduciary liability exposure, perhaps knowing the quality of the advice they are going to provide to a plan.

Addressing the Reg BI/ERISA Fiduciary Duties “Trap”
Perhaps the best advice on how plan sponsors should address the reasonably available alternatives/fiduciary prudence liability gap was offered by Judge Kayatta in the Brotherston decision.

Moreover, any fiduciary of a plan such as the Plan in this case can easily insulate itself by selecting well-established, low-fee and diversified market index funds. And any fiduciary that decides it can find funds that beat the market will be immune to liability unless a district court finds it imprudent in its method of selecting such funds, and finds that a loss incurred as a result.9

The Brotherston decision and the Solicitor General’s amicus brief in connection with Putnam Investment’s application for review by the Supreme Court provide an excellent overview of a plan sponsor’s fiduciary duties. I also wrote a post on fiduciary prudence in a post-Brotherston 401(k) world.10

Further support for this position can be found in the studies which have consistently concluded that the overwhelming majority of actively managed funds are not cost-efficient.

  • 99% of actively managed funds do not beat their index fund alternatives over the long-term net of fees.11
  • [I]ncreasing numbers of clients will realize that in toe-to-toe competition versus near-equal competitors, most active managers will not and cannot recover the costs and fees they charge.12
  • [T]he investment costs of expense ratios, transaction costs and load fees all  have a direct, negative impact on performance….[The study’s findings] suggest that mutual funds, on average, do not recoup their investment costs through higher returns.13
  • [T]here is strong evidence that the vast majority of active managers are unable to produce excess returns that cover their costs.14

One of the key points in Reg BI was the requirement that stockbrokers would be required to factor in the costs associated with any investment product recommendations. The release announcing the adoption of Reg BI supported the importance of cost-efficiency, stating that

A rational investor seeks out investment strategies that are efficient in the sense that they provide the investor with the highest expected net benefit in light of the investor’s investment objective that maximizes expected utility.15

This simply reiterates the previously referenced comments from Section 90 of the Restatement.

Nevertheless, the fact is that actively managed mutual funds still dominate 401(k) and 403(b), largely because, as the Gregg quote noted, those are the investment products stockbrokers recommend, primarily from their broker-dealer’s preferred provider list.

Fortunately, there are some simple steps that plan sponsors can take to protect themselves and their plan participants. First, do not sign any advisory contract that includes a fiduciary disclaimer clause. These clauses are often subtle and buried within the advisory contract. If a plan sponsor has any questions, they should consult with an experienced ERISA plaintiff’s attorney.

Second, the Active Management Value Ratio (AMVR) metric provides a free tool that plan sponsors can use to detect cost-inefficient recommendations. Plan sponsors should assess the cost-efficiency of any recommended investment option using a universal “reasonably available alternatives” menu, not Reg BI’s unduly restricted “reasonably available alternatives” standard.

The AMVR is simple and straightforward, requiring only the ability to compare the data between an actively managed fund and a comparable index fund by simple subtraction. A plan sponsor, or any other investment fiduciary, then just has to answer two simple questions:

  1. Did the actively managed funds provide a positive incremental return?
  2. If so, did the actively managed fund’s incremental return exceed the fund’s incremental costs?

If the answer to either question is “no,” then the actively managed fund is cost-inefficient, i.e., imprudent, relative to the comparable index fund and should be avoided.

That has always been my advice to plan sponsors. However, a reader of our “The Prudent Investment Adviser Rules” blog and a member of his plan’s investment committee recently sent me an email asking me whether I thought a plan adviser should provide an AMVR analysis for every recommendation they make. I believe that would be a reasonable request to better protect the plan, but that it is highly unlikely that they would do so using the exact AMVR format, especially using the correlation-adjusted costs. The AMVR quickly exposes cost-inefficient investments.

In his case, the plan adviser actually did provide an AMVR analysis based on the nominal numbers, but substituted some strange analysis in lieu of a correlation-adjusted analysis based on the Active Expense Ratio. The AMVR, as constructed, is the investment industry’s worst nightmare, as it forces a plan adviser to provide greater transparency, which is the financial services’ kryptonite.  

Going Forward
As I mentioned at the start of this post, I am on record as saying that (a) ERISA plaintiff’s attorneys should never lose a properly vetted 401(k)/403(b) action, and (b) the amount of 401(k)/403(b) litigation is going to continue to increase. My job as a fiduciary compliance counsel is to alert my clients to such trends and teach them how to minimize their exposure to liability and litigation.

A key to accomplishing these goals is to make sure that plan sponsors truly understanding what their fiduciary duties do, and do not, require. Fortunately, compliance with ERISA is just not that complicated if a proper system of policies and procedures is created and properly maintained.

Not much has been written about the fiduciary liability trap created by the disconnect between Reg BI’s “reasonably available alternatives offered by the broker-dealer” language and ERISA’s fiduciary prudence and loyalty requirements. The seriousness of this gap in compliance language and its potential consequences cannot be overstated, especially with the Department of Labor reportedly considering implementing its own fiduciary guidelines, including incorporating the provisions of Reg BI.

Far too often regulators have “dropped the ball” when it comes to protecting investors and employees against the very abuses that the securities regulations and ERISA were created to prevent. While many may have overlooked the potential implications of Reg BI’s cleverly drafted “reasonably available alternatives” language, it is imperative that plan sponsors recognize the issues discussed herein in order to protect both themselves and their plan participants.

Caveat fiduciarius

Notes
1. https://www.prnewswire.com/news-releases/jp-morgan-defined-contribution-survey-shows-plan-sponsors-aiming-to-strengthen-plans-finds-fiduciary-misperceptions-remain-300495423.html.
2. 29 CFR §2550.404c-1 – ERISA Section 404(c) Plans
3. SEC Release 34-86031, Regulation Best Interest: The Broker-Dealer Standard of Conduct (Reg BI), 278
4. Reg BI, 279.
5. Reg BI, 279.
6. Reg BI, 285.
7. Liss v. Smith, 991 F. Supp. 278, 291 (S.D.N.Y. 1988).
8. Gregg v. Transportation Workers of America Int’l, 343 F.3d 833, 841-42.
9. Brotherston v. Putnam Investments, LLC, 907 F.3d 17, 39 (1st Cir. 2018)
10. “Plan Sponsor Special Report: 401(k) Fiduciary Liability Risk Management in a Post-Brotherston World” https://bit.ly/3Q3MEkK
11. Laurent Barras, Olivier Scaillet and Russ Wermers, False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas, 65 J. FINANCE 179, 181 (2010).
12. Charles D. Ellis, The Death of Active Investing, Financial Times, January 20, 2017, available online at https://www.ft.com/content/6b2d5490-d9bb-11e6-944b-eb37a6aa8e. 
13. Mark Carhart, On Persistence in Mutual Fund Performance,  52 J. FINANCE, 52, 57-8 (1997).
14. Philip Meyer-Braun, Mutual Fund Performance Through a Five-Factor Lens, Dimensional Fund Advisors, L.P., August 2016.
15. Reg BI, 378.

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“The Lie of the Pie”: Mutual Fund Marketing “Trickeration”

by James W. Watkins, III

The financial services industry likes to use charts…a lot of charts. Attorneys do not like charts. Charts can be confusing and misleading, sometimes deliberately so. One judge told me that after I had argued the connection between charts and “weaseleze,” in a trial, he always grinned when an attorney tried to introduce a chart.

I tend to use the terms “weasel words” and “weaseleze” a lot. The terms come from Scott Adams’ book, “Dilbert and the Way of the Weasel.” Adams defines weaseleze as

Words that make perfect sense when individually, but when artfully arranged, they become misleading or impenetrable. Weaseleze is often used in advertising, legal work, employee performance reviews, and dating.1

One of the services I provide is fiduciary oversight services. Part of those services includes a forensic fiduciary audit. I tend to see a lot of weaseleze during such audits, often in connection with charts and diagrams. Lee Munson, author of “Rigged Money,” best described the use of weaseleze in connection with charts and diagrams with his phrase “the lie of the pie,”2

During a recent fiduciary audit of a 401(k) plan, the chairman of the investment committee politely questioned my findings, stating that they had followed the recommendations of their plan adviser.

I asked to see the documentation that the plan adviser had provided to the plan. I immediately recognized an ad that the adviser had provided in support of his recommendations. The ad is one used by a major mutual fund company claiming that their funds have beaten S&P 500 Index funds over an extended period of time.

I reminded the investment committee that they have a fiduciary duty to conduct their own objective investigation and evaluation of the funds chosen for their plan. Then I explained why mutual fund companies choose ads comparing their funds to market indices, rather than comparable index funds, knowing that they are arguably misleading.

First, the S&P 500 Index is technically classified as a large cap blend index. Prior to the Hughes v. Northwestern University (Northwestern) decision, the 401(k) industry, the investment industry, and even some courts objected to any comparison between actively managed funds and index funds, claiming that such comparisons were improperly comparing “apples and oranges.”

The Northwestern finally discredited such arguments. However, the use of the S&P 500 Index, or any other market index, to benchmark funds that are inconsistent with a fund’s classification is obviously comparing “apples and oranges.” This often results in misleading comparisons and potential liability exposure for plan sponsors and other investment fiduciaries.

Second, I have seen ads where the mutual fund company’s ads compare their funds to the S&P 500 Index’s returns without including the reinvestment of the Index’s dividends. Historically, over 40 percent of the Index’s returns can be attributed to the reinvestment of its dividends.

Excluding dividends in performance illustrations obviously creates misleading comparisons.

  • Over the ten-year period 2012-2021, the total return of the S&P 500 Index without the reinvestment of dividends was 251.67 percent (13.40 percent annualized) versus 325.33 percent with reinvestment of dividends (15.57 percent annualized).
  • Over the twenty-year period 2002-2021, the total return of the S&P 500 Index without the reinvestment of dividends was 301.13 percent (7.193 percent annualized) versus 488.87 percent with reinvestment of dividends (9.27 percent)

One mutual fund company is known for consistently engaging in this practice. Fortunately, their charts immediately raise red flags for attorneys and fiduciaries to investigate.

Finally, the decision to benchmark against market indices rather than comparable market indices suggests that the fund company is trying to prevent plan sponsors and other investment fiduciaries from performing a cost-efficiency evaluation of their funds.

Section 90 of the Restatement sets out several relevant cost-efficiency standards in determining whether a fiduciary has fulfilled its fiduciary duty of prudence, including

  • A fiduciary has a duty to be cost-conscious.3
  • In selecting investments, a fiduciary has a duty to seek either the highest level of a return for a given level of cost and risk or, inversely, the lowest level of cost and risk for a given level of return.4
  • Due to the impact of costs on returns, fiduciaries must carefully compare funds’ costs, especially between similar products.5
  • Due to the higher costs and risks typically associated with actively managed mutual funds, a fiduciary’s selection of such funds is imprudent unless it can be shown that the fund is cost-efficient.6

The fact that mutual fund companies and plan advisers would attempt to avoid cost-efficiency comparisons is not surprising. Studies have consistently concluded that the overwhelming majority of actively managed mutual funds are not cost-efficient.

99% of actively managed funds do not beat their index fund alternatives over the long term net of fees.7

Increasing numbers of clients will realize that in toe-to-toe competition versus near–equal competitors, most active managers will not and cannot recover the costs and fees they charge.8

[T]here is strong evidence that the vast majority of active managers are unable to produce excess returns that cover their costs.9

[T]he investment costs of expense ratios, transaction costs and load fees all have a direct, negative impact on performance….[The study’s findings] suggest that mutual funds, on average, do not recoup their investment costs through higher returns.10

What is troubling from a legal standpoint is that a plan adviser would knowingly try to expose their client, the plan, to unnecessary fiduciary liability exposure. While they typically feign surprise when they are confronted with this evidence, they known exactly what they are doing.

More often than not, their advisory contract with the plan also includes a fiduciary disclaimer clause. Fortunately for plans, the Supreme Court has ruled that such clauses do not prevent plans from suing plan advisers.

The Active Management Value Ratio™3.0
For all the foregoing reasons, I advise my fiduciary compliance clients to simply ignore any and all mutual fund ads and perform their own fiduciary compliance analyses using the Active Management Value Ratio (AMVR).

Based upon the Restatement and the studies of investment icons such as Nobel laureate Dr. William F. Sharpe and Charles D. Ellis, I created a simple metric, the Active Management Value Ratio™ (AMVR), that allows investors, investment fiduciaries and attorneys to quickly determine the cost-efficiency of an actively managed mutual fund.

In analyzing an investment option, Nobel laureate William F. Sharpe has noted that

[t]he best way to measure a manager’s performance is to compare his or her return with that of a comparable passive alternative.11

Building on Sharpe’s theory, investment icon Charles D. Ellis has provided further advice on the process used in evaluating the cost-efficiency of an actively managed mutual fund.

So, the incremental fees for an actively managed mutual fund relative to its incremental returns should always be compared to the fees for a comparable index fund relative to its returns.

When you do this, you’ll quickly see that that the incremental fees for active management are really, really high—on average, over 100% of incremental returns!12

The AMVR metric provides extremely useful information regarding the cost-efficiency of an actively managed mutual fund using just a fund’s nominal, or publicly reported, costs and returns. However, an investor’s analysis should not end there if they want a truly accurate cost-efficiency analysis of an actively managed mutual fund.

There is a direct, negative relationship between a fund’s r-squared correlation number, a fund’s incremental costs, and the fund’s cost-efficiency. Morningstar states that “r-squared reflects the percentage of a fund’s movements that are explained by movements in its benchmark index, [rather than any contribution by the fund’s management team.]”13

Professor Ross Miller did a study on the impact of closet indexing, focusing primarily on the relationship between an actively managed mutual fund’s R-squared number, “closet index” status, and the resulting overall financial impact of the two. “Closet index” funds are actively managed funds whose returns are essentially the same as a comparable index fund, but who charge much higher fees than the index fund. The higher an actively managed fund’s r-squared number, the greater the likelihood that the actively managed fund can be classified as a closet index fund.

An r-squared rating of 98 would indicate that 98 percent of an actively managed mutual fund’s returns could be attributed to the performance of a comparable index fund rather than the active fund’s management team.

In fairness, Professor Miller has noted that there is not a one-to-one correlation between an actively managed fund’s r-squared number and the percentage of the active management provided.

There is no universally agreed upon level of r-squared that designates an actively managed mutual fund as a closet index fund. I use an R-squared correlation number of 90 as my threshold indicator for closet index status.

Miller’s findings were extremely interesting, namely that

Mutual funds appear to provide investment services for relatively low fees because they bundle passive and active funds management together in a way that understates the true cost of active management. In particular, funds engaging in ‘closet’ or ‘shadow’ indexing charge their investors for active management while providing them with little more than an indexed investment. Even the average mutual fund, which ostensibly provides only active management, will have over 90% of the variance in its returns explained by its benchmark index.11

As a result of his study, Ross Miller, created the Active Expense Ratio (AER) metric. A fund’s AER number is based on a fund’s r-squared number.

Since many investors are unfamiliar with the AER metric, a frequent question I receive is why even calculate an AER-adjusted AMVR. One of the benefits of calculating an actively managed fund’s AER number is that the calculation process results in calculating the actual percentage of active management provided by the actively managed fund in question. Miller refers to this measurement as a fund’s “active weight.14

Deriving a fund’s “active weight” number provides valuable insight into the amount of active management provided by a fund purporting to provide active management, especially since such funds higher fees are based on the purported benefits of active management. However, Miller claims the primary benefit of calculating a fund’s AER number is that the AER provides investors with a quantitative analysis of the implicit cost of the fund’s active management component. The AER accomplishes this by simply dividing an actively managed fund’s incremental cost by the fund’s active weight number.

In many cases, once a fund’s r-squared correlation number is factored in, the fund’s AER is significantly higher than the fund’s stated expense, often as much as 400-500 percent higher. Investors and investment fiduciaries should remember John Bogle’s advice on investment costs, “you get what you don’t pay for,” as well as the fact that simple mathematics proves that each one percent in fees and expenses reduces an investor’s or fiduciary’s end-return by approximately seventeen percent over a twenty-year time period.

Once AMVR is calculated for an actively managed fund, the investor or fiduciary only needs to answer two simple questions:

(1) Does the actively managed mutual fund provide a positive incremental return relative to the benchmark being used?

(2) If so, does the actively managed fund’s positive incremental return exceed the fund’s incremental costs relative to the benchmark?

If the answer to either of these questions is “no,” the actively managed fund is both cost-inefficient and unsuitable/imprudent according the the Restatement’s prudence standards and should be avoided. The goal for an actively managed fund is an AMVR number greater than “0” (indicating that the fund did provide a positive incremental return), but equal or less than “1” (indicating that the fund’s incremental costs did not exceed the fund’s incremental return).

Prudent plan sponsors and other investment fiduciaries do not knowingly waste money by offering and/or investing in cost-inefficient investments. It may require a little more work, but by using the AMVR metric, alone or in combination with Miller’s AER metric, investors can better protect their financial security and investment fiduciaries can hopefully avoid unnecessary personal liability exposure.

Going Forward

Facts do not cease to exist because they are ignored.
Aldoux Huxley

As one commentator noted in 1976 after the Restatement (Second) Trusts was released made the following observation:

When market index funds have become available in sufficient variety and their experience bears out their prospects, courts may one day conclude that it is imprudent for trustees to fail to use such accounts. Their advantages seem decisive: at any given risk/return level, diversification is maximized and investment costs minimized. A trustee who declines to procure such advantage for the beneficiaries of his trust may in the future find his conduct difficult to justify.15

Over forty years later, the First Circuit echoed such sentiments in the Brotherston decision, when it offered the following advice:

Moreover, any fiduciary of a plan such as the plan in this case can easily insulate itself by selecting well-established, low-fee and diversified market index funds. And any fiduciary that decides it can find funds that beat the market will be immune to liability unless a district court finds it imprudent in its method of selecting such funds, and finds that a loss occurred as a result. In short, these are not matters concerning which ERISA fiduciaries need cry “wolf.”16

One of the rewarding things about my posts is receiving constructive feedback from readers. A member of a plan investment committee recently wrote me a very nice email, including the following questions and comment:

In your opinion, should our advisor provide [AMVR] calculations as part of their service?

[The AMVR] should be THE comparison that every investor uses to evaluate a fund.

My response as to requiring plan advisors to provide AMVR analyses on their recommendations has, and always be, yes. Why would any plan adviser refuse to provide such simple analyses unless they are not committed to putting a client’s best interests first?

However, insist that they follow the AMVR format used by InvestSense, including risk-adjusted returns and correlation-adjusted costs, using the Active Expense Ratio. In most cases they will provide the calculations based on nominal returns and costs, but they refuse to provide the adjusted data.

As for the AMVR being THE leading metric for complying with one’s fiduciary prudence duty, let’s just say I’m obviously biased. For what it is worth, more fiduciaries and attorneys are reportedly using the metric.

Copyright InvestSense, LLC 2022. All rights reserved.

This article is for informational purposes only, and is neither designed nor intended to provide legal, investment, or other professional advice since such advice always requires consideration of individual circumstances.  If legal, investment, or other professional assistance is needed, the services of an attorney or other professional advisor should be sought

Posted in 401k, 401k compliance, 401k investments, Active Management Value Ratio, AMVR, asset allocation, closet index funds, clsoet index funds, compliance, consumer protection, cost consciousness, cost efficient, cost-efficiency, Cost_Efficiency, ERISA, evidence based investing, fiduciary compliance, fiduciary duty, fiduciary law, fiduciary liability, fiduciary liability, Fiduciary prudence, fiduciary prudence, fiduciary responsibility, fiduciary standard, investment advisers, investments, Mutual funds, pension plans, plan sponsors, prudence, wealth management, wealth preservation | Tagged , , , , , , , , , , | Leave a comment

Redefining Fiduciary Prudence for 401(k) Plan Sponsors

by James W. Watkins, III, J.D., CFP®, AWMA®

The legal requirement for prudence, as defined in ERISA Section 404(a)(1)(B), is for a fiduciary to discharge his or her duties with:

“the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.”

But what does that really mean?

[R]ather than explicitly enumerating all of the powers and duties of trustees and other fiduciaries, Congress invoked the common law of trusts to define the general scope of their authority and responsibility.”1

Thus, a federal common law based on the traditional common law of has developed and is applied to define the powers and duties of ERISA plan fiduciaries….2

OK, getting closer.

The two consistent themes throughout the Restatement are cost-consciousness/cost-efficiency and risk management through effective diversification. Section 90 of the Restatement, more commonly known as the Prudent Investor Rule, contains three comments that could, and should, define prudence in future ERISA excessive fees/breach of fiduciary duty actions.

  • A fiduciary has a duty to be cost-conscious. (Introductory Section to Section 90)
  • A fiduciary has a duty to select mutual funds that offer the highest return for a given level of cost and risk; or, conversely, funds that offer the lowest level of costs and risk for a given level of return. (cmt. f)
  • Actively managed mutual funds that are not cost-efficient, that cannot objectively be projected to provide a commensurate return for the additional costs and risks associated with active management, are imprudent. (cmt. h(2)).

I collectively refer to these three comments as the “fiduciary prudence trinity.”

It is by now black-letter ERISA law that ‘the most basic of ERISA’s investment fiduciary duties [is] the duty to conduct an independent investigation into the merits of a particular investment.’ The failure to make any independent investigation and evaluation of a potential plan investment’ has repeatedly been held to constitute a breach of fiduciary obligations.3

Nobel laureate Dr. William Sharpe has offered the following advice for analyzing the prudence of mutual funds:

Properly measured, the average actively managed dollar must underperform the average passively managed dollar, net of costs…. The best way to measure a manager’s performance is to compare his or her return with that of a comparable passive alternative”4

Noted wealth management expert, Charles D. Ellis, goes further, stating that

So, the incremental fees for an actively managed mutual fund relative to its incremental returns should always be compared to the fees for a comparable index fund relative to its returns. When you do this, you’ll quickly see that that the incremental fees for active management are really, really high—on average, over 100% of incremental returns!5

Cumulatively, I submit that these comments and quotes suggest that the best way to prove compliance with one’s fiduciary duties is to quantify such duties. The Active Management Value Ratio™ (AMVR) metric provides a simple way of proving compliance with these fiduciary prudence standards.

The AMVR analysis shows that the actively managed fund produced a positive incremental return of five basis points at an incremental cost of 72 basis points. As we all learned in our basis economics classes, any situation where costs exceed benefits is not a prudent is not a prudent choice.

I am often asked why the AMVR uses adjusted returns. As the Restatement pointed out, an actively managed fund or a strategy that employs active management is only prudent if an investor receives a commensurate return for the additional risks and costs typically associated with active management.

Another questions I often receive is what is the purpose of the “AER” column. AER stands for Active Expense Ratio, the metric created by Ross Miller. The AER factors the correlation of returns between an actively managed fund and a comparable index fund to determine the effective expense ratio of an actively managed fund.

So why calculate an actively managed fund’s correlation-adjusted expense ratio? As Miller explains,

Mutual funds appear to provide investment services for relatively low fees because they bundle passive and active fund management together in a way that understates the true cost of active management. In particular, funds engaging in closet or shadow indexing charge their investors for active management while providing them with little more than an indexed investment. Even the average mutual fund, which ostensibly provides only active management, will have over 90% of the variance in its returns explained by its benchmark index.6

While the calculation methodology for the AER can be intimidating, the AER essentially divides an actively managed fund’s incremental costs by its “active weight.” The active weight is a metric created by Miller to determine the true amount of active management provided by an allegedly actively managed fund.

Based upon my experience, formerly as a securities/RIA compliance officer and now as a securities/ERISA attorney and fiduciary compliance consultant, financial advisers and plan advisers rarely discuss or provide AER numbers in connection with their recommendations. That is exactly why InvestSense includes AER data in its forensic fiduciary analyses, to help fiduciaries aware of potential fiduciary liability issues and the need for additional risk management.

In this example, the r-squared, or correlation of returns, number was 98, which translates into an AW of 0.1250, or 12.50 percent of active management within the actively managed fund. The AER is therefore 5.76 (0.72/.1250), resulting in an incremental CAC (correlation-adjusted cost) of 5.59, which makes the actively managed fund’s cost-efficiency even worse.

Going Forward
I believe that the combination of the “fiduciary responsibility trinity,” (Tibble v. Edison International, Brotherston v. Putnam Investments, LLC, and Hughes v. Northwestern University), and the “fiduciary prudence trinity,” will combine to increase the level of fiduciary litigation and eventual settlements, Investment fiduciaries can use the AMVR metric to proactively manage such liability risk exposure by identifying potential liability issues and adopting the necessary changes to bring their plans/accounts into compliance with ERISA and the Restatement.

Notes
1. In re Enron Corp. Securities, Derivatives, and ERISA Litigation, 284 F. Supp. 2d 511, 546 (N.D. Tex 2003)
2. Ibid.
3. Liss v. Smith, 991, F. Supp. 278, 297 (S.D.N.Y. 1988)3
4. William F. Sharpe, “The Arithmetic of Active Investing,” available online at https://web.stanford.edu/~wfsharpe/art/active/active.htm.
5. Charles D. Ellis, “Letter to the Grandkids: 12 Essential Investing Guidelines,” available online at https://www.forbes.com/sites/investor/2014/03/13/letter-to-the-grandkids-12-essential-investing-guidelines/#cd420613736c.Sharpe
6. Ross Miller, “Evaluating the True Cost of Active Management by Mutual Funds,” Journal of Investment Management, Vol. 5, No. 1, 29-4.

© Copyright 2022 InvestSense, LLC. All rights reserved.

“InvestSense,” the “InvestSense” logo, “Active Management Value Ratio. and the “Active Management Value Ratio” logo ” are trademarks of InvestSense, LLC.

This article is for informational purposes only and is neither designed nor intended to provide legal, investment, or other professional advice since such advice always requires consideration of individual circumstances. If legal, investment, or other professional assistance is needed, the services of an attorney or other professional advisor should be sought.

Posted in 401k, 401k compliance, 401k investments, 403b, Active Management Value Ratio, AMVR, closet index funds, compliance, consumer protection, cost consciousness, cost efficient, cost-efficiency, DOL fiduciary rule, ERISA, ERISA litigation, fiduciary compliance, fiduciary duty, fiduciary law, fiduciary liability, fiduciary liability, Fiduciary prudence, fiduciary prudence, fiduciary responsibility, investment advisers, investments, pension plans, plan sponsors, prudence, retirement plans, risk management | Tagged , , , , , , , , , , , , , , | Leave a comment

At What Cost?: Annuities, Cryptocurrency, and Fiduciary Law

A [fiduciary] is held to something stricter than the morals of the market place.  Not honesty alone, but the punctilio of an honor the most sensitive, is the standard of behavior….1

Fiduciary law is a combination of three types of law–trust, agency and equity. The basic concept of fiduciary law is fundamental fairness.

SCOTUS has consistently recognized the fiduciary principles set out in the Restatement (Third) of Trusts (Restatement) as guidelines for fiduciary responsibility, especially for plan sponsors.

ERISA is essentially a codification of the Restatement (Third) of Trusts (Restatement). SCOTUS has recognized that the Restatement is a legitimate resource for the courts in resolving fiduciary questions, especially those involving ERISA.2

Under the Restatement, loyalty and prudence are two of the primary duties of a fiduciary. A fiduciary’s duty of loyalty requires that a plan sponsor act solely in the best interests of the plan participants and their beneficiaries. A fiduciary’s duty of prudence requires that a plan sponsor exercise reasonable care, skill, and caution in managing a plan, specifically with regard to controlling unnecessary costs and risks.

Against that backdrop, plan sponsors are now confronted with the potential issues of including annuities and crypto currencies within a 401(k) plan. I believe that both assets are inappropriate for 401(k) and are fiduciary liability traps.

Annuities
While an exhaustive analysis of annuities is beyond the scope of this post, I want to address three of the most common types of annuities and the fiduciary issues involved with each. One of the fiduciary issues involved with annuities is their complexity. The analyses herein will be based on the simple, garden variety of each of the three annuities.

1. Immediate Annuities (aka Income Annuities)
These annuities are often recommended to provide supplemental income in retirement. In most cases, immediate annuities can be used to provide income for life or for a certain period of time, e.g., 5, 10, 15 or 20 years.

The key question in evaluating annuities, or any other investment, should always be “at what cost?” With annuities, you generally have annual costs as well as additional optional costs for various “bells and whistles.” While costs vary, a basic average annual cost for immediate annuities seems to be 0.7 percent. The average costs for various additional options with all annuities seems to be an additional 1.0 percent. However, it is a plan sponsor’s duty to always ascertain the exact costs.

Plan sponsors need to always remember this mantra – “Costs matter.” Costs do matter, a lot. The General Accounting Office has stated that each additional 1 percent in costs/fees reduces an investor’s end-return by approximately 17 percent over a twenty year period. 3

Peter Katt was an honest and objective insurance adviser. During my compliance career, he was my trusted go-to resource. While he passed away in 2015, the lessons I learned from him will always be invaluable. I strongly recommend to investors and investment fiduciaries that they Google his name and read his articles, especially those he wrote for the AAII Journal.

Katt’s thought on immediate annuities include:

The immediate annuity is for people who want the absolute security that they can’t outlive their nest egg. The problem is that there is nothing left over for your heirs.4

While annuities often offer options to address this issue, such options often result in reduced monthly payments and/or additional costs.

Katt always said to get the annuity salesmen to provide a written analysis providing the breakeven analysis for an annuity, the estimated time that would be required for an annuity owner to recover their original investment in the annuity. He told me that breakeven periods of twenty years or more are common, making it unlikely that the annuity owner will ever recover their original investment. And remember, with a life-only immediate annuity, once the annuity owner dies, the balance in the annuity goes to the annuity issuer, not the annuity owner’s heirs.

He also told me to always ask the annuity salesman for the APR that was used in calculating the breakeven point. The APR is the interest rate that annuity issuers typically use in determining an annuity’s payments.

One of the drawbacks with immediate annuities is that once an interest rate is set, that will be the applicable interest rate for the period of the annuity. Again, some annuities may offer options to avoid this inflexibility…at an additional cost.

The inflexibility of an annuity’s interest rate results in purchasing power risk for an annuity owner. This risk increases as the period of the annuity increases. Purchasing power risk refers to the risk that the annuity’s payments will lose their buying power over the years due to inflation. Some annuities provide for “step-ups” in rates…at an additional cost.

Katt’s advice-anyone considering an immediate annuity should first build a balanced portfolio consisting of stocks and bonds to ensure flexibility, and then invest augment that portfolio with a reasonable am0unt in the immediate annuity. While some annuity salesmen will argue for an “all or nothing” approach in order to maximize their commission. Prudent investors will follow Katt’s advice.

Perhaps the strongest argument against including immediate in 401(k) and other pension plans comes from a study by three well-respected experts on the subject.# In analyzing when a Single Premium Immediate Annuities (SPIAs), probably the most popular type of immediate annuity, would make sense, the three experts stated that

Results suggest that only when the possibility of outliving 70 percent or more of a cohort exists, and then only at elderly ages. For ages younger than 80, assets are best kept within the family, because both inflation and possible future market returns have time to do better than SPIA lifetime sums.5

Based upon my experience, very few 401(k) plans have plan participants aged 80 or older. I predict that plan sponsors who decide to offer immediate annuities, in any form, in their plans can expect to see that quote again, especially if I am involved in the litigation.

2. Fixed Indexed Annuities (fka Equity Indexed Annuities)
From what I have read and heard, the annuity industry’s plan to focus on including annuity options within 401(k) plans by imbedding fixed indexed annuities options within target data funds.

Target date funds are controversial investments that attempt to create investment portfolios that are appropriate based on the investor’s estimated retirement, or target, date. Target date funds have typically designed portfolios consisting of equity and fixed income investments.

From the reports I have read, the annuity industry plans to imbed a fixed income annuity aspect into target date fund, and then gradually increasing the percentage of the allocation to the annuity sector within the target date fund. When the target date is met, the annuity issuer would reportedly offer the plan participant the option to actually purchase the fixed indexed annuity.

So what would be wrong with that? Dr. William Reichenstein, finance professor emeritus at Baylor University sums the primary issue perfectly.

The designs of equity index annuities (EIAs) and bond indexed annuities ensure that they must offer below-market risk-adjusted returns compared with those available on portfolios of Treasurys and index funds. Therefore, this research implies that indexed annuity salesmen have not satisfied and cannot satisfy SEC requirements that they perform due diligence to ensure that the indexed annuity provides competitive returns before selling them to any client.6

While EIAs/FIAs are technically insurance products, not securities, Dr. Reichenstein’s analysis is still applicable with regard to a fiduciary’s duties of loyalty and prudence. If the design of these products ensures that they cannot offer competitive returns to those of alternative investments, then how does a plan sponsor, or any fiduciary for that matter, plan to meet their fiduciary duty of loyalty and prudence?

As regulators emphasize, before an insurance agent can sell an annuity, he or she must perform due diligence to ensure that the investment offered ex ante competitive returns. Therefore, it is appropriate to compare the net returns available in an equity-indexed annuity to those available on similar-risk investments held outside an annuity.7

[By] design, indexed annuities cannot add value through security selection ….[T]he hedging strategies [used by equity-indexed annuities] ensure that the individuals buying equity-indexed annuities will bear essentially all the risks. Conseqently, all (ital) indexed annuities must (ital) produce risk-adjusted returns that trail those offered by readily available marketable securities by their spread, that is, by their expenses including transaction costs.8

The reference to design refers to the fact that managers of indexed annuities buy Treasury securities and index options, but do not engage in individual security selection. Furthermore, indexed annuities typically impose restrictions on the amount of return that an investor can actually receive. Therefore, the combination of the design of these products and the restrictions on returns typically imposed by EIAs/FIAs ensure a fiduciary breach.

So, even though the annuity industry markets these indexed annuities by emphasizing stock market returns, the majority of fixed indexed annuity owners are guaranteed to never receive the actual returns of the stock market. While some annuity firms are marketing so-called “uncapped” fixed indexed annuities, they may still impose restrictions, and such “uncapped” returns…come with additional costs.

The restrictions and conditions that fixed indexed annuities naturally vary. During my time as a compliance director, the fixed indexed annuities I saw imposed a 8-10 percent cap and an participation rate of 80 percent. What that meant was that regardless of the applicable market index, with a cap of 10 percent, the most the annuity owner could receive was 10 percent of the index’s return.

As if that was not unfair enough, that 10 percent return was then further reduced by the annuity’s participation rate. So, with a participation rate of 80 percent, the maximum return an investor could receive in our example was 8 percent.

Reichenstein points out even more inequities, noting that  

Because interest rates and options’ implied volatilities change, the insurance firm almost always retains the right to set at its discretion at least one of the following: participation rate, spread, and cap rate.9

The one question that I always asked of fixed indexed annuity wholesalers, but still remains unanswered, was what happened to the excess return generated from the index options after the caps and participation rates were applied. Still waiting for an answer 

And finally, a simple explanation of how fixed indexed annuity companies further manipulate returns to ensure that they protect their interests first.

From AmerUS Group financial statements, ‘Product spread is a key driver of our business as it measures the difference between the income earned on our invested assets and the rate which we credit to policy owners, with the difference reflected as segment operating income. We actively manage product spreads in response to changes in our investment portfolio yields by adjusting liability crediting rates while considering our competitive strategies….’ This spread ensures that the annuity will offers noncompetitive risk-adjusted returns.10

Equity-indexed annuities generally do not credit owners with the dividends paid on the index used in calculating equity returns. Many indexed owners are not aware of this fact, or its significance. For example, historically over 40 percent of the S&P 500 Index’s compounded returns has come from dividends paid on its underlying stocks.

I could go on to discuss additional issues as single entity credit risk and illiquidity risks, but I think investment fiduciaries get the picture. The evidence against fixed index annuities establishes that they are a fiduciary breach simply waiting to happen. I strongly recommend that plan sponsors and other investment fiduciaries read Reichenstein’s analysis before deciding to offer fixed indexed annuities, in any shape or form, in their plans or to clients.

3. Variable Annuities
Any fiduciary that sells, uses, or recommends a variable annuity has breached their fiduciary duty…period. Katt summed it up perfectly:

Variable annuities (VAs) are flawed because they covert capital gains into ordinary income and have considerably higher expenses compared with comparable mutual funds. For this reason they are quite unsuitable for most investors.11

Exhibit A
Benefit – VAs provide a death benefit to limit a VA owner’s downside risk.

[T]he fee [for the death benefit] is included in the so-called Mortality and Expense (M&E) risk charge. The M&E risk charge is a perpetual fee that is deducted from the underlying assets in the VA, above and beyond any fund expenses that would normally be paid for the services of managed money.12

[T]he authors conclude that a simple return of premium death benefit is worth between one to ten basis points, depending on purchase age. In contrast to this number, the insurance industry is charging a median Mortality and Expense risk charge of 115 basis points, although the numbers do vary widely for different companies and policies.13

The authors conclude that a typical 50-year-old male (female) who purchases a variable annuity—with a simple return of premium guaranty—should be charged no more than 3.5 (2.0) basis points per year in exchange for this stochastic-maturity put option. In the event of a 5 percent rising-floor guaranty, the fair premium rises to 20 (11) basis points. However, Morningstar indicates that the insurance industry is charging a median M&E risk fee of 115 basis points per year, which is approximately five to ten times the most optimistic estimate of the economic value of the guaranty.14

Excessive and unnecessary costs violate the fiduciary duty of prudence. The value of a VA’s death benefit is even more questionable given the historic performance of the stock market. As a result, it is unlikely that a VA owner would ever need the death benefit. These two points have resulted in some critics of VAs to claim that a VA owner needs the death benefit like a duck needs a paddle.”

Exhibit B
Benefit – VAs provide a death benefit to limit a VA owner’s downside risk.

At what cost? VAs often calculate a VAs annual M&E charge/death benefit based on the accumulated value within the VA, even though contractually limit their legal liability under the death benefit to the VA owner’s actual investment in the VA.

As a result, over time, it is reasonable to expect that the accumulated value within the VA will significantly exceed the VA owner’s actual investment in the VA. This method of calculating the annual M&E, known as inverse pricing, results in a VA issuer receiving a windfall equal to the difference in the fee collected and the VA issuer’s actual costs of covering their legal liability under the death benefit guarantee.

As mentioned earlier, fiduciary law is a combination of trust, agency and equity law. A basic principle of fiduciary law is that “equity abhors a windfall.” The fact that VA issuers knowingly use the inequitable inverse pricing method to benefit themselves at the VA owner’s expense results in a fiduciary breach for fiduciaries who recommend, sell or use VAs in their practices or in their pension plans.

The industry is well aware of this inequitable situation. John D. Johns, a CEO of an insurance company, addressed these issues in an article entitled “The Case for Change.”

Another issue is that the cost of these protection features is generally not based on the protection provided by the feature at any given time, but rather linked to the VA’s account value. This means the cost of the feature will increase along with the account value. So over time, as equities appreciate, these asset-based benefit charges may offer declining protection at an increasing cost. This inverse pricing phenomenon seems illogical, and arguably, benefit features structured in this fashion aren’t the most efficient way to provide desired protection to long-term VA holders. When measured in basis points, such fees may not seem to matter much. But over the long term, these charges may have a meaningful impact on an annuity’s performance.15

In other words, inverse pricing is always a breach of a fiduciary’s duties of both loyalty and prudence, as it results in a windfall for the annuity issuer at the annuity owner’s expense, a cost without any commensurate return, which also violates Section 205 of the Restatement of Contracts.

Exhibit C
Benefit – VAs allow their owners the opportunity to invest in the stock market and increase their returns.

VAs offer their owners an opportunity to invest in equity-based subaccounts. Subaccounts are essentially mutual funds, usually similar to the same mutual funds that investors can purchase from mutual fund companies in the retail market.

While there has been a trend for VAs to offer cost-efficient index funds as investment options, many VA subaccounts are essentially same overpriced, consistently underperforming, i.e., cost-inefficient, actively managed mutual funds offered in the retail market. As a result, VA owners’ investment returns are typically significantly lower than they would have been when compared to returns of comparable index funds.

Exhibit D
Benefit – VAs provide tax-deferral for owners.

So do IRAs. So do any brokerage account as long as the account is not actively traded. However, dividends and/or capital gain distributions are taxed when they occur.

The key point here is that IRAs and brokerage accounts usually do not impose the high costs and fees associated with annuities. This is especially true of VAs, where annual fees of 3 percent or more are common, even higher when riders and/or other options are added.

Remember the earlier 1/17 note? Multiply 3 by 17 to see the obvious fiduciary issues regarding the fiduciary duties of loyalty and prudence. 

Although not an issue for plan sponsors, another “at what cost” fiduciary issue has to do with the adverse tax implications of investing in non-qualified variable annuities (NQVA). Non-qualified variable annuities are essentially those that are not purchased within a tax-deferred account, e.g., a 401(k)/403(b) account, an IRA account.

When investors invest in equity investments, they typically are not taxed on the capital appreciation until such gains are actually realized, such as when they sell the investment or, in the case of mutual funds, when the fund makes a capital gains distribution.

In many cases, investors can reduce any tax liability by taking advantage of the special reduced tax rate for capital gains. However, withdrawals from a NQVA do not qualify for the lower capital gains tax. All withdrawals from a NQVA are considered ordinary income, and thus taxed at a higher rate than capital gains. An investment that increases its owner’s tax liability by converting capital gains into ordinary income is hardly prudent or in an investor’s “best interest.”

Bottom line – there are other less costly investment alternatives available that provide the benefit of tax deferral. While they may not offer the same guaranteed income, they provide other significant benefits, while avoiding some of the risks associated with VAs, e.g., reduced flexibility, purchasing power risk, higher taxes.

Exhibit E
Benefit: Annuity owners do not pay a sales charge, so more of their money goes to work for them.

The statement that variable annuity owners pay no sales charges, while technically correct, is misleading. Variable annuity salesmen do receive a commission for each variable annuity they sell, such commission usually being in the range of 6-7 percent of the total amount invested in the variable annuity.

While a purchaser of a variable annuity is not directly assessed a front-end sales charge or a brokerage commission, the variable annuity owner does reimburse the insurance company for the commission that was paid. The primary source of such reimbursement is through a variable annuity’s various fees and charges, particularly the M&E charge.

To ensure that the cost of commissions paid is recovered, the insurance company typically imposes surrender charges on a variable annuity owner who tries to cash out of the variable annuity before the expiration of a certain period of time. The terms of these surrender charges vary, but a typical surrender charge schedule might provide for an initial surrender charge of 7 percent for withdrawals during the first year, decreasing 1 percent each year thereafter until the eighth year, when the surrender charges would end. There are some surrender charge schedules that charge a flat rate, such as 7 percent, over the entire surrender charge period.

Cryptocurrency
Fidelity Investments recently announced that it would begin offering a new fund that would allow 401(k) plans to offer a cryptocurrency option within the plan. The reaction was immediate and divided. And now news that Bitcoin and other cryptocurrencies have suffered a cumulative $200 billion dollar loss.

Since there are still a number of issues that need to be address ed, especially the concerns raised by regulators, including the Department of Labor16 and the Securities & Exchange Commission17, I will simply suggest that plan sponsors and other investment fiduciaries should wait until the regulators have issued guidelines on this topic.

One thing I will address is the notion that because investors may want to invest in cryptocurrency is no reason for a plan sponsor or other investment fiduciary to do so. First, a plan sponsor has no obligation, legal or otherwise, to include an investment option in a plan simply because one or more plan participant wants to invest in such an option. A plan sponsor, a trustee, or any other investment fiduciary has two primary duties, the duty of loyalty and the duty of prudence.

With all the acknowledged concerns about cryptocurrency, from susceptibility to hacked accounts resulting in significant losses, the volatility of such investments, and questions regarding the concept/ structure of such investments, prudence is the best course for all fiduciaries at this point. For plan participants that want to invest in cryptocurrencies, they are free to open up retail brokerage accounts and trade in such investments.

Going Forward
Ever since Fidelity made its announcement regarding cryptocurrency, I have been asked by clients and the media for my opinion on what I see for fiduciary law and 401(k) litigation. My answer-an increase in litigation.

What too many investment fiduciaries fail to recognize and appreciate is the fact that those recommending investment products generally are not doing so in a fiduciary capacity and, therefore, arguably have no potential fiduciary liability. Plan sponsors, trustees and other investment fiduciaries that follow such advice will typically have unlimited personal liability exposure.

Plan sponsors and other investment fiduciaries have a duty to independently investigate, evaluate, select and monitor the investment options they select or recommend.

  • Over and above its duty to make prudent investments, the fiduciary has a duty to conduct an independent investigation of the merits of a particular investment….A fiduciary’s independent investigation of the merits of a particular investment is at the heart of the prudent person standard.18 
  • The failure to make any independent investigation and evaluation of a potential plan investment” has repeatedly been held to constitute a breach of fiduciary obligations.19 
  • A determination whether a fiduciary’s reliance on an expert advisor is justified is informed by many factors, including the expert’s reputation and experience, the extensiveness and thoroughness of the expert’s investigation, whether the expert’s opinion is supported by relevant material, and whether the expert’s methods and assumptions are appropriate to the decision at hand. One extremely important factor is whether the expert advisor truly offers independent and impartial advice.

Defendants relied on FPA, however, and FPA served as a broker, not an impartial analyst. As a broker, FPA and its employees have an incentive to close deals, not to investigate which of several policies might serve the union best. A business in FPA’s position must consider both what plan it can convince the union to accept and the size of the potential commission associated with each alternative.   FPA is not an objective analyst any more than the same real estate broker can simultaneously protect the interests of “can simultaneously protect the interests of both buyer and seller or the same attorney can represent both husband and wife in a divorce.20 

These fiduciaries duties are inviolate. There are no “mulligans” or “do overs” in fiduciary law. As the courts have repeatedly pointed out, “A pure heart and an empty head’ are no defense to allegations of the breach of one’s fiduciary duties.21

If anything positive comes out of the current debate over the inclusion of annuities and/or cryptocurrencies in 401(k) plans, hopefully it will be a greater recognition and appreciation of the importance of one’s fiduciary duties by plan sponsors and other investment fiduciaries.

Resources
There are a number of resources available online that can be used to analyze annuities in terms of breakeven analysis. Google “annuity breakeven analysis” to find them. In my practice, I often use the Annuity Break-Even Calculator — VisualCalc program, which compares an annuity with an alternative equity investment. The graphic makes the results easier to understand.

The article by Frank, Mitchell, and Pfau provides detailed instructions on how to perform annuity breakeven analyses using Microsoft Excel.

Notes
1. Meinhard v. Salmon, 249 N.Y. 458, 464 (1928).
2. Tibble v. Edison International, 135 S. Ct 1823 (2015).
3. Pension and Welfare Benefits Administration, “Study of 401(k) Plan Feess abd Expenses,” (“DOL Study”). http://www.DepartmentofLabor.gov/ebsa/pdf; “Private Pensions: Changes needed to Provide 401(k) Plan Participants and the Department of Labor Better Information on Fees,” (GAO Study”), http://www.gao.gov/new.item/d0721.pdf
4. Peter C. Katt, “The Good, Bad, and Ugly of Annuities,” AAII Journal, November 2006, 34-39
5. Larry R. Frank, Sr., John B. Mitchell, and Wade Pfau, “Lifetime Expected Income Breakeven Comparison Between SPIAs and Managed Portfolios,” Journal of Financial Planning, April 2014, 38-47. 8. Reichenstein, 302.
9. Reichenstein, 303.
10. Reichenstein, 309.
11. Katt, 35.
12. Moshe Miklevsky and Steven E. Posner, “The Titanic Option: Valuation of the Guaranteed Minimum Death Benefit in Variable Annuities and Mutual Funds,” Journal of Risk and Insurance, Vol. 68, No. 1 (2009), 91-126, 92.
13. Milevsky and Posner, 94.
14. Milevsky and Posner, 122.
15. John D. Johns, “The Case for Change,” Financial Planning, September 2004, 158-168.
16. Department of Labor, “Compliance Assistance Release No. 2022-01”
17. https://www.sec.gov/speech/gensler-remarks-crypto-marketds-040422.
18. Fink v. National Saving & Loan, 772 F.2d 951 (D.C. Cir. 1985); Donovan v. Cunningham, 716 F.2d 1455, 1467; Donovan v. Bierwirth, 538 F.Supp. 463, 470 (E.D.N.Y.1981).
19. Liss v. Smith, 991F.Supp. 278 (S.D.N.Y. 1998).
20. Gregg v. Transportation Workers of Am. Intern, 343 F.3d 833, 841-842 (6th Cir. 2003)
21. Cunningham, 1461.

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This article is for informational purposes only and is neither designed nor intended to provide legal, investment, or other professional advice since such advice always requires consideration of individual circumstances. If legal, investment, or other professional assistance is needed, the services of an attorney or other professional advisor should be sought.

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