Justices Wrestle With Monitoring Duties Of 401(k) Fiduciaries During Oral Argument

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By Jacklyn Wille

Feb. 24 — Whether 401(k) plan fiduciaries in monitoring investments must look for cheaper options was the question dividing justices and litigants when the U.S. Supreme Court heard oral argument Feb. 24 in a case involving the time frame in which plan participants can challenge their plan's investment options.

The case asks whether 401(k) participants can hold fiduciaries liable for including higher-cost investment funds in the plan when those funds were initially chosen more than six years before the lawsuit. In recent years, three federal appellate courts have ruled in favor of plan fiduciaries in these disputes, finding that the participants' claims were barred by the six-year limitations period found in the Employee Retirement Income Security Act.

This six-year limitation has become a huge roadblock for retirement plan participants challenging higher-cost funds, because many funds remain in retirement plans for years after their initial selections.

During argument, the justices appeared most interested in deciphering the differences in the opposing parties' positions. While both sides appeared to agree that plan fiduciaries have some ongoing duty to review a plan's investment options, the extent of that duty—along with the circumstances that would obligate a fiduciary to remove higher-cost investments in favor of lower-cost ones—remained murky.

Plaintiff-Side Attorneys Weigh In 

Gregory Y. Porter, a partner with Bailey & Glasser LLP, who filed an amicus brief on behalf of Cambridge Fiduciary Services LLC in this case, told Bloomberg BNA Feb. 24 that the justices “struggled a bit to understand what prudent monitoring looks like.”

However, he added that they seemed to “reach consensus that trial courts should develop the standards and that laying out a standard was not necessary to reversing the Ninth Circuit.”

Porter, who typically represents plan participants, also took issue with some of the arguments raised by defense counsel about how onerous it can be for plan fiduciaries to switch the plans' investment funds.

“Fiduciaries periodically switch funds for a variety of reasons,” Porter said. “I have never seen a plan committee—and I’ve seen a lot of plan committee minutes—discuss the burdens of switching as compared to the fee savings for replacing a fund. That’s not to say it shouldn’t be a consideration, but it’s not a consideration that I have observed in practice.”

He added that the cost of switching funds “is almost always going to be dwarfed by the future fee savings.”

In a joint e-mail to Bloomberg BNA Feb. 24, Karen L. Handorf and Michelle C. Yau of Washington-based Cohen Milstein Sellers & Toll PLLC said the justices' questions during oral argument “demonstrated their appreciation of the significant impact fees have on the retirement security of American workers.”

“While the court’s questioning probed the parameters of the duty to monitor, the justices and both parties appeared to agree that the duty of prudence included a duty to monitor plan investments,” Handorf and Yau wrote. “Justice Kennedy got it right when he noted, during the argument, that the inquiry is dictated by what a prudent fiduciary under the same circumstance would do. There is no bright line test.”

Handorf and Yau, who typically represent plan participants, filed an amicus brief in the instant case on behalf of the Pension Rights Center, which describes itself as “a nonprofit consumer organization committed to protecting and promoting the retirement security of American workers, retirees, and their families.”

Thoughts From Defense Counsel 

Marcia S. Wagner of the Wagner Law Group PC in Boston told Bloomberg BNA in a Feb. 24 e-mail that the justices appeared to be looking for a “compromise position.” She predicted that the test employed by the U.S. Court of Appeals for the Ninth Circuit, which looks to changes in circumstances, isn't “likely to prevail.”

“The petitioners’ counsel adamantly maintained the position that a change in circumstances, as would be required by the Ninth Circuit Court of Appeals, was not necessary to trigger periodic prudential reviews of investments, such as retail class funds,” Wagner said. From their questions, the justices appeared to looking for a compromise position that “would not require constant oversight by the Federal courts,” she said.

According to Wagner, Justice Antonin Scalia offered up a potential exception to the six-year statute of limitations, one that would make an exception for “changed circumstances” or “the obviousness of the imprudence.”

“Despite the plaintiffs’ focus on the lack of attention the defendant had paid to the difference between the pricing of retail and institutional class funds, their counsel failed to take up this offer,” Wagner said.

She added that the justices appeared to be “uncomfortable” with the Ninth Circuit's “change of circumstances” test.

“Based on the line of questioning, the prognosis for full annual prudential reviews of investments chosen outside the statute of limitations six-year window does not look promising,” Wagner said. “However, the Court will either craft a new standard for triggering reviews or remand to the Ninth Circuit to develop such a test. Accordingly, the changed circumstances test of the Ninth Circuit is not likely to prevail.”

Wagner, who represents employers and plan sponsors, wasn't involved in the instant litigation.

Duty to Monitor 

With all parties agreeing that plan fiduciaries must make some effort to monitor the performance and suitability of the plan's investment options, the disagreements sprang up when they tried to articulate what that duty to monitor included.

David C. Frederick, counsel for the participants and a partner with Kellogg, Huber, Hansen, Todd, Evans & Figel PLLC in Washington, argued that fiduciaries must at least monitor the expense ratios and related fees charged by the plan's investment options. For example, in the instant case, the participants accused plan fiduciaries of acting imprudently by keeping higher-cost, retail-class shares in the plan when identical institutional-class shares that carried lower fees were available.

Nicole A. Saharsky, who argued on behalf of the U.S. solicitor general, agreed with Frederick that the ongoing duty to monitor “is not limited to circumstances in which the fund changed so much that it's like a new fund is being put in place.” Rather, plan fiduciaries “have a duty to look on a periodic basis,” Saharsky said. “[R]eally, how are you going to know if there have been changes unless you looked?” she asked.

Jonathan Hacker, counsel for the plan fiduciaries and a partner with O'Melveny & Myers LLP in Washington, conceded that plan fiduciaries are bound by some sort of duty to monitor plan investments. However, he argued that participants seeking to hold fiduciaries liable for improper monitoring must demonstrate flaws in the fiduciaries' monitoring process, rather than merely alleging that lower-cost options existed.

“If you don't come into court and show that there was a problem or flaw in the monitoring process, you can't win a claim,” Hacker said.

At several points, the justices pressed Hacker on whether he agreed with the standard articulated by the U.S. Court of Appeals for the Ninth Circuit, which heard the case below.

According to Justice Stephen G. Breyer, the Ninth Circuit ruled that a claim challenging the initial selection of mutual funds is barred by ERISA's six-year limitations period if the claim “challenges funds that were selected more than six years before, and the claim does not allege that any materially new circumstances arose within the previous six years”.

Hacker declined to specifically endorse the Ninth Circuit's approach, at times taking issue with the justices' characterization of its holding.

Holding Versus Buying 

However, Hacker and certain of the justices appeared to agree that the bar of fiduciary prudence is lower for a fiduciary who is merely monitoring existing plan investments than it is for one making the initial decision to buy a particular fund.

“Life is too short,” Justice Antonin Scalia said during an exchange with Frederick. “You're going to ask every Federal district court not only to determine whether a particular purchase was sensible or not, but to say year by year whether you've done a careful enough review. I mean, I just don't think courts are capable of doing that.”

Justice Sonia Sotomayor echoed this sentiment, finding “some force” to the argument that “you can't have every three months, a sort of general market evaluation of whether something should be selected or not.”

Justice Elena Kagan also appeared interested in the distinction between the initial decision to buy stock and the subsequent decision to hold that stock rather than sell it.

“I would think that it's possible that a decision to buy one of these funds with high expenses would be imprudent in the first place, and yet, it might be prudent not to switch midstream,” Kagan said, adding that she wasn't sure what costs are involved in changing or removing plan investment options.

Arguing for the participants, Frederick minimized the gray areas involved in Kagan's hypothetical. According to Frederick, the retail- and institutional-class funds at issue here were identical except for the fees charged, and that type of fee information is “readily available on the Internet; it is readily available with a phone call or two,” he said.

On the other side of the debate, Hacker argued that it would be “oversimplifying” the issue to assume that fiduciaries could switch from one share class to another with minimal cost or effort.

In particular, he argued that a fiduciary who decided to switch from a more expensive share class to a less expensive one might find himself faced with a lawsuit asking why he didn't switch to an even cheaper investment option.

Scalia Considers Changed Circumstances 

On that point, Scalia appeared supportive of the standard used by the Ninth Circuit, which looks to clear changes in circumstances to determine whether fiduciaries have a duty to remove allegedly imprudent investment funds.

At several points during the argument, Scalia appeared to favor an approach that would allow for fiduciary liability in two circumstances—when a change in circumstances rendered an investment imprudent within the six-year window, or when it became “obvious” that an investment was imprudent, such as when “Any fool would know” that one class of stock was the cheaper option.

“Why not say that where—where there's been a change of circumstances or the imprudence of holding it is obvious?” Scalia said, hinting at the standard he might be likely to impose for finding fiduciary liability.

In repeatedly referencing this “obviousness” standard, Scalia also tipped his hand as to how he felt about another issue raised by the case that didn't make it to the Supreme Court—namely, whether it was categorically imprudent for a 401(k) plan to include higher-cost retail-class funds when lower-cost institutional-class funds were available. The court is not expected to rule on this issue.

Don't Expect Clear Guidance 

Although many court-watchers may be hoping for clear guidance on what the fiduciary duty to monitor plan investments entails, several justices gave hints that such guidance wouldn't be forthcoming. Rather, they seemed more comfortable hearkening back to ERISA's “prudent man” standard of care, which requires fiduciaries to act with the care that “a prudent man acting in a like capacity” would exhibit.

For example, Frederick told the justices that if they “want to decide a little bit more about what the content of this monitoring duty” involved, they could articulate a standard that considered fund expenses, performance and publicly available information.

Sotomayor was quick to cut him off, saying, “I, for one, am not ready to do that, because I'm not a trier of fact for what a reasonable investor would do.”

Justice Anthony M. Kennedy echoed this thought at several points in the argument, saying that an ERISA fiduciary must look for cheaper investment options “if that's what a prudent trustee would do.”

Pro-Plan Circuit Court Trend 

The Tibble case is one of three recent circuit court rulings to reject the “continuing violation” theory of claim accrual for purposes of challenges to plan investments.

Agreeing with the Ninth Circuit, both the Fourth and Eleventh circuits have refused to hold plan fiduciaries liable on challenges to plan investments selected outside ERISA's six-year window (David v. Alphin, 704 F.3d 327, 54 EBC 2437 (4th Cir. 2013)); (Fuller v. SunTrust Banks, Inc., 744 F.3d 685, 57 EBC 2089 (11th Cir. 2014)).

In all three cases, the courts have focused on the absence of any allegations that the complained-of funds became imprudent after their initial selection for inclusion in the plan. Because the plan participants challenged the initial selection of funds—as opposed to the failure to remove them from the plan after intervening circumstances caused them to become imprudent—ERISA's six-year limitations period protected plan fiduciaries from liability, the courts concluded.

The Department of Labor has argued against this trend at both the circuit and Supreme Court level, contending that ERISA fiduciaries have a continuing duty to review the prudence of plan investments, which they breach in several ways: by failing to periodically evaluate the performance and fees of plan investments, by failing to investigate alternative investments, and by failing to remove funds that charge excessive fees.

The Tibble participants echoed these arguments in their brief to the Supreme Court, contending that a new six-year window begins running each time a plan fiduciary breaches its obligation to review plan investments and remove imprudent ones.

In their response brief, the Edison fiduciaries argued that the fiduciary duty to prudently select investments differed significantly from the fiduciary duty to monitor and remove investments. According to Edison, neither trust law nor ERISA requires a “complete diligence review of all investments on a frequently recurring periodic basis after they are selected.”

The participants were represented by David C. Frederick, Brendan J. Crimmins and Jeremy S. Newman of Kellogg, Huber, Hansen, Todd, Evans & Figel PLLC in Washington, and Jerome J. Schlichter, Michael A. Wolff and Sean E. Soyars of Schlichter, Bogard & Denton LLP in St. Louis. Edison International was represented by Jonathan D. Hacker, Anna-Rose Mathieson, Ward A. Penfold, Gabriel Markoff, Brian Y. Chang, Walter Dellinger, Brian D. Boyle and Meaghan VerGow of O'Melveny & Myers LLP in Washington and San Francisco, and Sergey Trakhtenberg of Southern California Edison Co. in Rosemead, Calif.

To contact the reporter on this story: Jacklyn Wille in Washington at jwille@bna.com

To contact the editor responsible for this story: Jo-el J. Meyer at jmeyer@bna.com

Text of a transcript of the oral argument is available at http://op.bna.com/pen.nsf/r?Open=jwie-9u2rju.