A Better Mousetrap?: A New Format for Plaintiffs’ Complaints in ERISA Fiduciary Breach/Excessive Fee Cases?

My two most recent posts on this blog have dealt with recent decisions involving ERISA fiduciary breach cases alleging excessive fees in 401(k) plans. To avoid a possible false sense of security within the investment industry, the posts also discussed provisions within the Restatement (Third) Trusts (Restatement) that might provide a means for plaintiffs counsel to prevent such adverse decisions going forward.

Lo and behold, plaintiff’s counsel in a recently filed ERISA fiduciary breach/excessive fees action have included several quotes from the Restatement in their complaint.(MFS Complaint)(1) The complaint cites both a fiduciary’s general duty to be cost-conscious, as well as specific quotes dealing with a fiduciary’s duty re cost-consciousness in selecting actively managed mutual funds. Paragraph 46 from the complaint states that

Pursuant to the prudent investor rule, fiduciaries are required to “incur only costs that are reasonable in amount and appropriate to the investment responsibilities of the trusteeship.” Restatement (Third) of Trusts § 90(c)(3) (2007); see also id. § 90 cmt b (“[C]ost-conscious management is fundamental to prudence in the investment function . . . .”).

The Introductory Note to the Restatement’s chapter on trust investment further states that

[T]he duty to avoid unwarranted costs is given increased emphasis in the prudent investor rule….The duty to be cost conscious requires attention to such matters as the accumulation of fiduciary commissions with agent fees or the purchase and management charges associated with mutual funds and other pooled-investment vehicles. In addition, active management strategies involve investigation expenses and other transaction costs . . . that must be considered, realistically, in relation to the likelihood of increased return from such strategies. Where markets are efficient, fiduciaries are encouraged to use low-cost index funds. Id. § 90 cmt h(1). While a fiduciary may consider higher-cost, actively managed mutual funds as an alternative to index funds, “[a]ctive strategies . . . entail investigation and analysis expenses and tend to increase general transaction costs . . . . [T]hese added costs . . . must be justified by realistically evaluated return expectations.” Id. § 90 cmt h(2).

The investment industry is quick to try to defend a fiduciary’s selection of actively managed mutual funds on the argument that ERISA does not require that a plan fiduciary only select the cheapest investment options. While that statement is true, the referenced quotes from the Restatement also indicate that a fiduciary still has a duty to select only those actively managed funds that provide a plan and plan participants with benefits that are commensurate with the added costs and risks resulting from the actively managed funds.

This requirement poses a significant hurdle for investment fiduciaries given the historical under-performance of most actively managed funds relative to comparable index funds. As noted in my earlier posts, S&P Indices Versus Active (SPIVA) reports have consistency noted significant under-performance of actively managed mutual funds. Even worse, various studies have reported that a large percentage of actively managed funds fail to even produce returns that cover their fund’s costs.

In recent ERISA fee cases that handed down adverse rulings to plaintiffs, the courts made it a point to state that to simply allege that a fund’s expenses were higher than the fees of comparable index funds is not enough to prevent the dismissal of their case. While it could be argued that the damages suffered by plan participants as a result of higher fees is implicit in the allegations, the courts apparently want an express statement of such damages.

As I suggested in my most recent post to this blog, the Restatement provides plan participants and their counsel with the perfect blueprint of providing the courts with an applicable fiduciary standard and proof to defeat any motion to dismiss. Plaintiff’s counsel decision to reference the applicable was brilliant, as they not only quoted the applicable language, but also referenced the Supreme Court’s language from the Tibble decision stating that the courts routinely turn to the Restatement in interpreting fiduciary law under ERISA.

Given the difficulty that plan sponsors and other investment fiduciaries will have in meeting the “commensurate return” set out in the Restatement, could the format of the MFS complaint be the beginning of a trend of including the same quotes regarding the fiduciary duty of cost-consciousness in a plaintiff’s complaint in an ERISA breach of fiduciary duty/excessive fee case? Given the tendency of many cases to settle if plaintiff can survive a motion to dismiss and the strength of the Restatement’s cost-consciousness provisions, this new approach in drafting should not be summarily dismissed as unimportant.

As I pointed out in my earlier posts, the cost-consciousness approach could be even stronger if the evidence supports an argument by plan participants that a significant number of plan’s investment options were “closet index” funds. The argument would obviously be that such funds misrepresented themselves as actively managed funds, but actually were nothing more than overpriced index funds and provided no meaningful benefit to plan participants. Such an argument was used successfully by plaintiff’s counsel in the Northrup Grumman case to defeat a motion to dismiss. The case recently settled for approximately $17 million dollars.

Conclusion
The new approach of including a fiduciary’s duty of cost-consciousness could be a turning point in the future of ERISA fiduciary duty/excessive fee cases, especially if combined with a “closet index” fund situation. Plan participants should be able to survive most motions to dismiss by simply educating a court as the Restatement’s position and presenting evidence establishing that some or all of the investment options in the plan failed to satisfy such requirements.

This new potentially powerful combination of the Restatement’s fiduciary duty of cost-consciousness and “closet indexing” also has implications for the fiduciary duties established under the DOL’s new fiduciary rule (Rule). The cost-consciousness and “closet indexing” combo might significantly reduce the number of investments satisfying the Rule’s “best interest” requirement under both  Impartial Conduct Standards and the Best Interest Contract (BIC) exemption.

Since financial advisers will be required to document their due diligence prior to making any investment recommendations to covered plan participants and retiring employees, at the very least they will be required to address both the cost-consciousness and “closet indexing” issues or face severe penalties. As noted in my two previous posts, my metric, the Active Management Value Ratio™ 3.0 and Ross Miller’s Active Expense Ratio can help plan sponsors, financial advisers, investment fiduciaries and attorneys quantify the cost-consciousness of an investment option.

Notes
1. Velazquez v. Massachusetts Financial Services Company d/b/a MFS Investment Management, In The United States District Court for the District of Massachusetts, Case1:17-cv-11249-RWZ, Filed 07/07/17

 

Advertisements
This entry was posted in 401k investments, BICE, closet index funds, compliance, DOL fiduciary rule, DOL fiduciary standard, ERISA, fiduciary compliance, fiduciary law, Fiduciary prudence, fiduciary standard, Impartial Conduct Standards, investment advisers, investments, IRA, IRAs, pension plans, prudence, retirement plans, RIA, RIA Compliance, wealth management, wealth preservation and tagged , , , , , , , , , , , , , , , , , , , . Bookmark the permalink.