John M. Vine (firstname.lastname@example.org) is the senior member, and former head, of the Employee Benefits Group of Covington & Burling LLP, Washington, D.C. His practice has concentrated on employee compensation and benefits for more than 35 years. He acknowledges with thanks the helpful suggestions he received from his colleagues, T.L. Cubbage, Jeffrey Huvelle, and Amy Moore.
© 2012 Covington & Burling LLP
If an employee benefit plan suffers an investment loss, a plan fiduciary may be held liable under the Employee Retirement Income Security Act only if ERISA’s loss causation requirement is satisfied—that is, only if the loss was caused by the fiduciary’s breach of fiduciary duty. If a plaintiff seeks to recover the amount of an investment loss from a plan fiduciary, and the court finds that the fiduciary breached its duty to act in accordance with ERISA’s prudent man rule, the court typically compares the fiduciary’s investment decision with a decision that a hypothetical prudent fiduciary could have made in the same circumstances. If a hypothetical prudent fiduciary could have made the same decision that the fiduciary actually made, the loss was not caused by the fiduciary’s imprudence, and the fiduciary is not liable for the loss.
The U.S. courts of appeal are divided on the question of whether the burden of proof regarding loss causation falls on the plaintiff or the defendant. The language and structure of ERISA indicate that the burdens of pleading and proving loss causation fall on the plaintiff. However, two federal appellate courts have adopted a common-law rule under which the burden is on the defendant to prove that the loss was not caused by the defendant’s breach of fiduciary duty. The application of this common-law rule is unjustified: although the courts are authorized to develop federal common-law rules under ERISA, ERISA does not authorize the courts to adopt common-law rules that conflict with the provisions of the statute.
PRUDENT MAN RULE
ERISA’s prudent man rule requires a fiduciary to
“discharge his duties with respect to a plan … 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.” ERISA Section 404(a)(1)(B).
Section 409(a) of ERISA provides that if a fiduciary breaches a fiduciary duty such as the prudent man rule, the fiduciary is personally liable to make good to the plan any losses that the plan incurs as a result of the breach and to restore to the plan any profit that the fiduciary makes through the use of plan assets:
“Any person who is a fiduciary with respect to a plan who breaches any of the responsibilities, obligations, or duties imposed upon fiduciaries by this subchapter shall be personally liable to make good to such plan any losses to the plan resulting from each such breach, and to restore to such plan any profits of such fiduciary which have been made through use of assets of the plan by the fiduciary, and shall be subject to such other equitable or remedial relief as the court may deem appropriate, including removal of such fiduciary” (emphasis added).
Because Section 409(a) refers only to losses “resulting from” a breach, Section 409(a) imposes a loss-causation requirement. If there were no loss-causation requirement,1 ERISA fiduciaries would be exposed to potential damage awards far exceeding any harm they do to the plans they serve. For example, in the absence of a loss-causation requirement, a fiduciary that breaches its fiduciary duties would be liable for any losses that the plan would have incurred even if the fiduciary had not committed a breach.
Consistent with the loss-causation requirement, if a fiduciary acts imprudently in making an investment decision on behalf of a plan, the existence of any loss (and the size of any loss) on the plan’s imprudently-chosen investments would be determined by comparing the performance of those investments with the performance of prudently-chosen investments. If prudently-chosen investments would have outperformed the plan’s investments, the plan would have incurred a loss, measured by the excess of the performance of prudently-chosen investments over the performance of the plan’s investments. By contrast, if the plan’s imprudently-chosen investments outperformed (or performed as well as) prudently-chosen investments, the plan would not have a compensable loss under ERISA2.
The U.S. courts of appeal are divided on the question of whether the burden of proof regarding loss causation falls on the plaintiff or the defendant.
The loss-causation requirement does not apply to equitable relief under ERISA. Even if the plan does not incur a loss as a result of a fiduciary’s imprudence, and even if the fiduciary does not make a profit through the use of plan assets, the fiduciary may still be subject to equitable relief, such as removal.3
THE HYPOTHETICAL PRUDENT FIDUCIARY
In applying the loss-causation requirement under Section 409(a), courts often rely on the conduct of a hypothetical prudent fiduciary. For example, in its recent decision in Plasterers’ Local Union No. 96 Pension Plan v. Pepper,4 the Court of Appeals for the Fourth Circuit ruled that, if a fiduciary failed to conduct an investigation before making an investment decision, the fiduciary “is insulated from liability [under Section 409(a)] if a hypothetical prudent fiduciary would have made the same decision anyway.”5 In other words, if an imprudent fiduciary makes the same investment that a hypothetical prudent fiduciary could have made, any loss that the plan incurs is not the result of the fiduciary’s imprudence, and the plan does not incur a loss for which ERISA provides monetary relief6.
Similarly, in In re Citigroup ERISA Litigation, the Second Circuit ruled that, in order for plaintiffs’ imprudent-investment claim to survive a motion to dismiss, plaintiffs must allege not only that the fiduciaries had failed to investigate the continued prudence of the investment but also that the fiduciaries’ failure to investigate caused a loss to the plan:
“[T]hat the fiduciaries allegedly failed to investigate the continued prudence of investing in Citigroup stock cannot alone rescue plaintiffs’ claim; plaintiffs have not pled facts that, if proved, would show that such an investigation … would have led defendants to conclude that Citigroup was no longer a prudent investment. … [P]laintiffs must allege facts that, if proved, would show that an ‘adequate investigation would have revealed to a reasonable fiduciary that the investment at issue was improvident.’” 7
BURDEN OF PROOF
The circuits are split on the question whether the burden of proof regarding loss causation falls on the plaintiff or the defendant. The Second, Sixth, and Ninth circuits have ruled that the burden falls on the plaintiff.8 By contrast, the Fifth and Eighth circuits have adopted a common-law burden-shifting rule under which the burden is on the defendant to prove that the loss was not caused by the breach of fiduciary duty. Under the burden-shifting rule, once the plaintiff proves a breach of fiduciary duty and a prima facie case of a loss to the plan, the burden shifts to the defendant to prove that the loss was not caused by the breach of fiduciary duty.9
The application of the common-law burden-shifting rule is unwarranted in this context. Although the courts are authorized to develop federal common-law rules under ERISA, ERISA does not authorize the courts to adopt common-law rules that conflict with the provisions of the statute.10 Several years after the Eighth Circuit first adopted the burden-shifting rule under ERISA, the Supreme Court instructed the courts to consider whether the language, structure, or purposes of ERISA require a departure from common-law standards.11
Insofar as loss causation is concerned, the language and structure of ERISA call for placing the burdens of pleading and proof on the plaintiff. Section 502(a)(2) of ERISA allows the Secretary of Labor or a participant, beneficiary, or fiduciary to bring a civil action “for appropriate relief under section 409,” and Section 409(a) provides relief only for plan losses “resulting from” a breach of fiduciary responsibility. Accordingly, causation is an essential element of a plaintiff’s case under § 502(a)(2), and it is the plaintiff’s burden to plead and prove causation.12
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