The last couple of years have seen a wave of ERISA suits aimed at 401(k) plan sponsors and targeting plan fees. In the following guest post, Rhonda Prussack, Head of Fiduciary and Employment Practices Liability at Berkshire Hathaway Specialty Insurance, takes a look at this phenomenon and the factors behind it, as well as the fiduciary liability insurers’ reaction to these developments. I would like to thank Rhonda for allowing me to publish her article on this site. I welcome guest post submissions from responsible authors on topics of interest to this site’s readers. Please contact me directly if you would like to submit a guest post. Here is Rhonda’s guest post.
An unprecedented wave of ERISA suits has been filed in the last two years, including close to 60 fee cases aimed at sponsors of 401(k) and other defined contribution pension plans. What’s triggering this rush to the courtroom and what should we make of it? I’ve shared some thoughts, below. One thing I can say with certainty, though, is that in 27 years of fiduciary liability underwriting, I have not seen this pace of serious, potentially severe class action litigation.
What Set Off this Spate of Suits?
Three things. First, the U.S. Supreme Court’s May, 2015 decision in Tibble v. Edison International, affirming a basic tenet of fiduciary prudence under ERISA – that plan fiduciaries have an ongoing duty to monitor the prudence of plan investments. Second, the widely-reported settlement of two long-standing cases, and the concomitant eight figure fees earned by the plaintiffs’ attorneys. Third, in an effort to fend off litigation, plan fiduciaries in recent years have taken a close look at plan fees and negotiated reductions from investment managers and record keepers, and sent out required notices to employees apprising them of changes. Lawyers for the employees view such notices as tacit admissions that plan fiduciaries had been asleep at the wheel prior to the changes.
U.S. Supreme Court Weighs In
Tibble v. Edison International was a typical fee case, initially filed in 2007 in the U.S. District Court in Los Angeles. Plaintiffs argued that Edison had acted imprudently by offering high-priced retail mutual funds in their 401(k) plan when essentially identical, low-cost institutional funds were available to a plan like Edison’s, with billions in plan assets. The defense, employing a tactic that successfully had been used by defendants in other cases, argued that suits over alleged over-priced investments were time barred under ERISA’s six year statute of limitations for breaches of fiduciary duty, as the funds in question had been added to the plan more than six years before the complaint was filed. The Ninth Circuit agreed, finding no significant changes to the investments had occurred during the six year period that would have created an obligation by the fiduciaries to review and replace such investments.
The case worked its way to the U.S. Supreme Court, which addressed this question: “Whether a claim that ERISA plan fiduciaries breached their duty of prudence by offering higher-cost retail-class mutual funds to plan participants, even though identical lower-cost institution-class mutual funds were available, is barred by 29 U. S. C. §1113(1) when fiduciaries initially chose the higher-cost mutual funds as plan investments more than six years before the claim was filed.”[i] The Court held that the Ninth Circuit was mistaken in disallowing the breach of fiduciary duty claim based on the initial selection of investments. Speaking for a unanimous Court, Justice Breyer stated that “ERISA’s fiduciary duty is “derived from the common law of trusts,”[ii] which provides that a trustee has a continuing duty—separate and apart from the duty to exercise prudence in selecting investments at the outset—to monitor, and remove imprudent, trust investments. So long as a plaintiff’s claim alleging breach of the continuing duty of prudence occurred within six years of suit, the claim is timely.”[iii]
For ERISA practitioners, the Supreme Court’s conclusion was not surprising – fiduciaries have always had an ongoing duty to monitor the performance of plan investments. However, plaintiffs, now armed with a succinct and straightforward decision by the highest court, knew they would likely have greater success with these types of cases, and that defendants would have a harder time defeating them, especially at the earliest stages of litigation, prior to discovery.
Interestingly, after the U.S. Supreme Court sent Tibble v. Edison International back to the Ninth Circuit, and they in turn sent the case back to the District Court, on August 16th of this year – exactly 10 years to the date after plan participants filed their original complaint – a judge in Los Angeles ruled for the plaintiffs, awarding damages of at least $7.52 million[iv].
Big Settlements, Big Fees
In 2015, two of the longest-litigated fee cases, part of an original wave filed in 2006 by Jerry Schlichter of the St. Louis law firm Schlichter Bogard & Denton, were resolved. The first, Abbott v. Lockheed Martin Corp., settled for $62 million, earning the firm an eye-opening $22.3 million in fees and expenses. The firm then collected close to $21 million in the second matter, Spano v. Boeing Co., which settled for $57 million.
In approving the Lockheed settlement, Chief Judge Michael Reagan of the Southern District of Illinois lauded Schlichter Bogard & Denton’s work, gushing that the firm, “has had a ‘humongous’ impact over the entire 401(k) industry, which has benefited employees and retirees throughout the country by bringing sweeping changes to fiduciary practices.” Whether copycat plaintiffs’ firms will receive such generous praise, or fees, remains to be seen.
New Revenue Stream Invites New Lawyers
Needless to say, news of the big fee awards in the Lockheed and Boeing matters did not go unnoticed by lawyers eager for new sources of income. More than a dozen firms are actively pursuing fee cases against employers, following the trail blazed by Schlichter Bogard & Denton.
No Good Deed Goes Unpunished
In recent years, plan fiduciaries have increased their scrutiny of plan fees, demanding reductions from incumbent investment managers and record keepers, or sending out requests for proposals to new service providers. According to a survey by the Investment Company Institute[v], those fiduciaries’ efforts have paid off. In this regard, 401(k) equity mutual fund fees have dropped by 38% since 2000 and bond mutual funds fees by 43% in the same time period. Similarly, record keeping, trust and custody fees in large, corporate 401(k) plans have declined for seven consecutive years, only flattening this year, per a memo published by NEPC summarizing their findings in a survey of large, corporate 401(k) plans[vi].
However, in a perverse twist, fiduciaries’ efforts to reduce plan fees are sometimes awarded with litigation alleging that those endeavors were too little, too late. Post-Tibble, plaintiffs’ lawyers have been careful to devise allegations of wrongdoing that have allegedly occurred for several years, but always within the six year statute of limitations under ERISA. A complaint filed last December against Starwood Hotels & Resorts Worldwide, Inc. illustrates this point. Plaintiff’s lawyers argued that, although Starwood managed to cut plan fees by 40 basis points around the time of the Tibble decision, “for the prior five years, an unnecessary $20 million in fees were incurred by Plan participants — 40 basis points times $1 billion in assets equals $4 million per year in excess fees or $20 million over a five year period.”[vii]
Litigation Is Heading Down Market
Schlichter Bogard’s targets for fee litigation had one thing in common: their size. Every targeted plan had more than $1 billion in plan assets. Big plans equaled a potentially big payday for the firm, but also exhaustive litigation and significant financial risk. The firms that have recently entered the fray have less at stake. They can follow the original roadmap – with only minor tweaks for unique facts – allowing them to go after smaller plans, yet still net sizeable fees. Recent litigations by these firms have targeted plans generally in the $200 million to $1 billion range, although a few have been against relatively small plans, including one $25 million plan sponsored by CheckSmart, and another against a $9.5 million plan of an auto body shop, which was later withdrawn.
Universities In The Cross Hairs
The most recent campaign by plaintiffs’ attorneys is against universities, which make up 16 of the 60 or so recent fee cases. Most of the school suits have targeted 403(b) plans, which are retirement savings plans for 501(c)(3) non-profit organizations. Lawyers are investigating dozens of other schools.
While similar to 401(k) plans, 403(b)’s have certain differences. One, they have been around a lot longer than 401(k)’s, since at least the 1950’s. Another is that, until several years ago, 403(b)’s were only lightly regulated, with minimal reporting and notice requirements. It was only starting with the 2009 plan year that 403(b) plans were required to meet the same filing obligations as their 401(k) brethren, such as 5500 forms and annual independent audits. Prior to 2009, it was common to have hundreds of investment options from multiple mutual fund and annuity providers in a single plan, as it was standard practice to allow plan participants to sign up with the provider of their choice. While many, if not most, such plans have now simplified their investment lineups and streamlined administrative processes, some still retain 100 or more legacy investment options and multiple record keepers.
It’s these scores of investment options and arguably costly and duplicative record keeping services that make 403(b) plans an enticing target for plaintiffs.
In addition to universities, any employer that sponsors a 403(b) plan for its employees, especially large employers, such as hospitals, are vulnerable.
How Are Insurers Reacting?
In a period eerily reminiscent of the current time, in the late 1990’s a case was brought against IKON Office Solutions, alleging breaches of fiduciary duty in the investment in and retention of the company’s stock within IKON’s 401(k) plan. After success in that case, by the early 2000’s, more than three dozen public companies had been sued under ERISA for alleged breaches of fiduciary duty in connection with employer stock investments within the companies’ 401(k) plans. These cases, which often followed on the heels of 10(b)(5) litigation against the companies’ directors and officers, came to be known as “ERISA tag-along” or “ERISA stock drop” suits.
There was much hand-wringing by fiduciary liability carriers at the time, as fiduciary insurance then was a sleepy backwater; the homely cousin to the sexier and more sophisticated D&O coverage. Rates were low, and retentions often non-existent. In fact, fiduciary coverage was sometimes thrown in for free or for a nominal fee. Many insurers at the time were slow to react, but when they did, they took hard stances. Some insurers non-renewed, or effectively non-renewed long-standing client policies by significantly raising rates. Virtually all imposed D&O-like retentions on the securities exposure or added limit tie-ins between fiduciary and D&O policies.
Today, too, many carriers have been slow to react, although that’s starting to change. Now many, if not most fiduciary insurers are at least asking questions designed to shed light on insured’s procedures and processes around plan fees. Few, however, are doing much with the answers. Some, like certain insurers 15 years ago, seem to be over-reacting by abandoning certain segments, such as universities, or severely curtailing limits on renewal, leaving brokers and clients scrambling. Others have responded with separate retentions for specific risks, such as fees associated with proprietary funds of financial institutions.
What’s On The Horizon?
While it’s hard to prognosticate, a search of some ERISA plaintiffs’ lawyers’ websites turned up some interesting insight into what the next wave of claims (or plaintiffs bringing those claims) will look like. For instance, it appears that firms are investigating the fees charged in “brokerage windows,” those accounts in 401(k) plans that allow employees a myriad of investment options beyond the plan’s standard line-up. Also, the continued expansion of social media as an advertising tool has allowed law firms to effectively (and more cost efficiently) reach potential plaintiffs. No longer do such firms need to place ads in print newspapers in regions where specific companies have operations. They can now use Facebook to identify potential plaintiffs, and appeal to them through targeted ads that go directly to their in-boxes and smartphones.
No crystal ball is needed, however, to anticipate that fee litigation will be around for at least several more years, either until most plans of size have reduced fees and developed prudent processes (and thus strong defenses) around the selection and monitoring of plan investments and service providers, or plaintiffs’ attorneys have moved on to the next big thing.
The views and opinions expressed in this article are exclusively those of the author and do not necessarily reflect the official policy or position of Berkshire Hathaway Specialty Insurance. The information contained in this article is for general informational purposes only and does not constitute an offer to sell, or a solicitation of an offer to buy, any product or service. The advice of a professional insurance broker and counsel should always be obtained before purchasing any insurance product or any other service. The information contained in this article has been compiled from sources believed to be reliable. No warranty, guarantee, or representation, either expressed or implied, is made as to the correctness or sufficiency of any representation contained herein.
[i] 135 S. Ct. 1823 (May 18, 2015).
[ii] Central States, Southeast & Southwest Areas Pension Fund v. Central Transport, Inc., 472 U. S. 559, 570
[iii] 135 S. Ct. 1823 (May 18, 2015).
[iv] The parties agreed that $7,524,424 was an appropriate calculation of profits the plan would have earned had the plan been invested in low-cost institutional funds for the period up until January, 2011, when the mutual funds were removed from the plan. The Court then determined that damages from 2011 to the present would be based on the plan’s actual returns during that period. Tibble, et al. v Edison International, et al., Case 2:07-cv-05359-SVW-AGR Document 567 Filed 08/16/17
[v] ICI Research Perspective, June 2017, Vol. 23, No. 4
[vi] “DC Plan Fees Remain Flat in NEPC Report,” September 5, 2017, by NEPC
[vii] Creamer v. Starwood Hotels & Resorts Worldwide, Inc., C.D. Cal., No. 2:16-cv-09321, filed Dec. 16, 2016