SCOTUS, We Still Have a Serious Problem: The Continuing Inconsistency in Judicial Interpretations of ERISA

Just when you thought it was safe to go back in the water, the Sixth Circuit issues its decision in Smith v. CommonSpirit Health (CommonSpirit).1 The Sixth Circuit dismissed the plan participant’s action, largely upon the familiar argument that market indices and/or comparable index funds are not “meaningful benchmarks” for the purposes of 401(k) litigation.

That issue was supposedly resolved by the combination of the First Circuit’s Brotherston decision2 and SCOTUS’ subsequent denial of Putnam’s application of certiorari for review.3 When SCOTUS denies an application for certiorari, it is generally understood that the Court approves of both the lower court’s decision and the rationale behind the decision.

In Brotherston, Judge Kayatta offered a well-reasoned decision with regard to why market indices and/or comparable index funds are appropriate for benchmarking purposes in 401(k) litigation.

The recovery from a trustee for imprudent or otherwise improper investments is ordinarily ‘the difference between (1) the value of those investments and their income and other product at the time of surcharge and (2) the amount of funds expended in making the improper investments, increased (or decreased) by a projected amount of total return (or negative total return) that would have accrued to the trust and its beneficiaries if the funds had been properly invested.’ Id. § 100 cmt. b(1). 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

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.’ 29 U.S.C. § 1109(a). 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.’ 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. 

In this instance, the trust law that we have described provides an answer that both requires no stretch of ERISA’s text and accords with common sense.6

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);…7

The Sixth Circuit offered no explanation in its CommonSpirit decision as to why the Brotherston decision, and SCOTUS’ subsequent refusal to review said decision was not applicable. The court simply ignored the First Circuit’s decision regarding the fiduciary prudence and benchmarking argumwent. While Circuit Courts of Appeal are not obligated to follow the decisions of other circuits, one could argue that the First Circuit’s reliance on the Restatement (Third) of Trusts (Restatement), and SCOTUS’ refusal to hear Putnam’s appeal, are compelling reasons to follow the rationale expressed in Brotherston.

As a fiduciary risk management consultant that offers fiduciary oversight services to 401(k) a nd 403(b) plans, the CommonSpirit decision concerns me for several reasons. First, based on the Brotherston decision and SCOTUS’ denial of certiorari, I believe that SCOTUS will ultimately expressly adopt the Restatement’s position and rule that market indices and comparable index funds are appropriate for benchmarking purposes in 401(k) litigation.

Second, if SCOTUS does adopt this position, then plan sponsors will find themselves in the same position they have found themselves in after SCOTUS’ decision in Hughes v. Northwestern University8 – utterly defenseless to breach of fiduciary prudence claims. The fact that a plan sponsor relies on the Sixth Circuit’s decision, or any other court decision subsequently vacated, will not serve as a defense to fiduciary breach claims. Courts face no legal liability for decisions subsequently vacated.

Some plan sponsors have asked me whether they have legal recourse against plan providers/advisers that led them to believe they could rely on a court’s decision. While SCOTUS has ruled that plans may sue plan providers/advisers based on common law principles such as negligence, fraud, and breach of contract, nothing is guaranteed.9

We have seen several instances where plan providers/advisers have voluntarily agreed to cover half of any damages awarded as a result of 401(k) litigation. Whether that trend will continue is uncertain.

Going Forward
My primary criticism of decisions such as the CommonSpirit decision is that they create a false of security, resulting in plan sponsors failing to seek proper legal advice to protect themselves and the plan’s participants. This is especially true in situations such as CommonSpirit, when the applicable legal standard has arguably been previously established and endorsed by SCOTUS.

That said, plan sponsors have a duty to understand and fulfill their fiduciary duties to the plan and the plan’s participants. If a plan sponsor chooses to rely on conflicted plan providers and advisers, rather than experienced ERISA attorneys, then the plan sponsor has to accept the consequences for such decisions.

Unfortunately, it appears that the CommonSpirit decision will not be appealed to SCOTUS. As a result, more 401(k) plans and plan sponsors will needlessly be exposed to unlimited personal liability unless and until SCOTUS does rule that market indices and comparable index funds are appropriate benchmarks in 401(k) litigation under the Restatement.

Notes
1. Smith v. CommonSpirit Health, No. 21-5964, June 21, 2022 (6th Cir. 2022).
2. Brotherston v. Putnam Investments, LLC, 907 F.3d 17 1stt Cir. 2018)
3. Putnam Investments, LLC v. Brotherston – SCOTUSblog
4. Brotherston, 31.
5. Brotherston, 31.
6. Brotherston, 32.
7. Brotherston, 34.
8. Hughes v. Northwestern University, 142 S.Ct. 737 (2022).
9. Shaw v. Delta Air Lines, Inc., 463 U.S. 85, 90 103 S.Ct. 2890 (1983).

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About jwatkins

I am a securities and ERISA attorney. I am a CFP Board Emeritus™ member and an Accredited Wealth Management Advisor™. I am a 1977 graduate of Georgia State University and a 1981 graduate of the University of Notre Dame Law School. I am the author of "CommonSense InvestSense: The Power of the Informed Investor" and " The 401(k)/403(b) Investment Manual: What Plan Sponsors and Plan Participants REALLY Need To Know. " As a former compliance director, I have extensive experience in evaluating the legal prudence of various types of investments, including mutual funds and annuities. My goal is to combine my legal and compliance experience in order to help educate investors on sound, proven investment strategies that will help them protect their financial security.
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