The following is a summary of an informal discussion of employee benefit practitioners held in Washington, D.C. on October 12, 2011. The topic concerned a recent case, Loomis v. Exelon Corp., No. 09-4081 (7th Cir. 9/6/11).
Dan Brandenburg, Saul Ewing LLP, Washington, D.C.
Mary Kramer, Investment Company Institute, Washington, D.C.
Louis T. Mazawey, Groom Law Group, Chartered, Washington, D.C.
Annemarie G. McGavin, Buchanan Ingersoll & Rooney PC, Washington, D.C.
Keith Mong, Buchanan Ingersoll & Rooney PC, Washington, D.C.
Norma M. Sharara, Luse Gorman Pomerenk & Schick, P.C., Washington, D.C.
Mr. Mong: Last month, in Loomis v. Exelon Corp., No. 09-4081 (7th Cir. 2011) ("Loomis"), the Seventh Circuit affirmed a lower court's holding that the plan fiduciary did not breach its duties under ERISA [the Employee Retirement Income Security Act of 1974 as amended] by offering retail mutual funds as part of the investment options in a participant-directed defined contribution plan. The plan in Loomis offered 32 investment options, 24 of which were mutual funds that were open to the public. The funds were no-load vehicles, charging no fees for buying or selling shares. Instead, fees were deducted from the assets under management as a percentage of assets, thereby reducing the participants' return on such investments. The expense ratios on the investments offered under the plan ranged from .03% to .96%.
The plaintiffs argued that the plan fiduciaries breached their duties under ERISA by, among other things, offering retail mutual funds rather than wholesale or institutional investments. The Court of Appeals found that the facts of Loomis were similar to those in another Seventh Circuit fee case, Hecker v. Deere & Co., and unless Hecker was overruled, the plaintiffs in Loomis should not prevail [556 F.3d 575, reh'g denied, 569 F.3d 708 (7th Cir. 2009)]. In Hecker, the plan offered 25 retail mutual fund options, with expense ratios ranging from .07% to a little over 1% annually. The plaintiffs in Hecker argued that the plans were flawed in offering investments charging retail fees rather than negotiating lower wholesale fees on such investment options.
The Seventh Circuit found that the expense ratios in Hecker were in line with the market and the investments offered were an acceptable array of options. There was no fiduciary duty to find or offer the least expensive funds. There is, however, a duty to offer a wide range of options, which the court found the fiduciaries in Hecker had. Likewise, the Seventh Circuit found the fiduciaries in Loomis were under no duty to offer only non-retail investments, even though the plan in Loomis did offer eight such investments.
There have been approximately 30 fee cases in which the courts have addressed whether there is a fiduciary duty to offer the investments with the lowest fees. Generally, the courts have found in favor of the plan fiduciaries in such situations. There is an exception though - an appeal pending in a case in the Ninth Circuit in which the court did find a breach of the fiduciary duty of prudence with regard to investments in the retail share classes. In Tibble, though, the court found the defendants breached their fiduciary duty of prudence by failing to investigate the merits of the investment in retail, rather than institutional, share classes of those mutual funds at the time the funds were added to the plan [Tibble v. Edison Intl., 49 EBC 1725 (C.D. Cal. 2010)]. The court found that the defendants should have considered the funds and realized that the institutional funds offered the exact same investment, but at lower costs to the participants.
Ms. Kramer: The court in Loomis came up with the right result. The duty of the fiduciary is not to find the lowest-cost investments. It is to offer an array of options that have been prudently selected.
Mr. Mong: The Seventh Circuit considered a few factors in making its decision, including the liquidity of the investment and the reasonableness in the range of fees. The court found that the retail mutual fund investments offered better liquidity than some of the institutional funds. The court also noted that the range of fees was reasonable and in line with those offered in Hecker, with all fees being average or below the market.
Ms. Kramer: Sometimes institutional investments are not the cheapest in terms of fees. Retail mutual funds occasionally offer lower fees than institutional funds.
Mr. Brandenburg: Likewise, it is not always the case that retail mutual funds offer more flexibility for participants or that institutional funds will always be cheapest. It varies based on the investment option. The court noted that the competition of the mutual fund marketplace could provide the plan with better and more suitable investment alternatives.
Ms. McGavin: In assessing the fees, the focus should be on expense ratios and how such fees impact the participants, rather than whether the investment is labeled as retail or institutional or wholesale. For example, the plaintiffs in Loomis had argued in the alternative that the plan sponsor should have used its "buying power" to insist that the mutual funds charge a flat fee per participant instead of a fee based on a percentage of the assets under management. It is not entirely clear that such a fee structure would be beneficial to all participants. It is possible that such fees would result in those with smaller account balances subsidizing the participants with larger account balances.
Mr. Mong: The courts generally focus on procedural prudence to assess the fiduciaries' compliance with their duties under ERISA. Were the fiduciary's actions reasonable in this case?
Ms. Sharara: The opinion itself does not describe the process used by the fiduciaries to select these investment options, but generally, plan administrators hire outside advisers to guide them in the selection of the investments to be offered under the plan. The advisers often suggest a menu of options. The fiduciaries, based on the guidance from the advisers, will then select investments, place some on a watch list, and reject other options.
With this guidance from investment advisers, will the fiduciary be held responsible for selecting the "wrong investments?" The fiduciaries generally rely a great deal on the advisers to assist in the selection of investment options. So, will the fiduciaries be held to a higher "substantive" standard in picking these investments from the menu?
Mr. Mong: Generally, the focus in these cases is on the selection process of the investment advisers. Fiduciaries, however, are not free from liability in their reliance on the advisers. The fiduciaries ultimately must be prudent in their selection of investments.
Mr. Mazawey: As there are thousands of mutual funds available, a fiduciary cannot be held responsible for not selecting the "right investment." The fiduciary is instead required to be prudent in the process it follows for the selection of investments.
Ms. Kramer: And not all investments are available to all plans. The same options do not work for all plans.
Mr. Mazawey: Even so, a clear rule has not emerged from the courts. It will be interesting to see how the Ninth Circuit handles this issue.
This commentary also will appear in the February 2012 issue of the Tax Management Compensation Planning Journal. For more information, in the Tax Management Portfolios, see Horahan and Hennessy, 365 T.M., ERISA-Fiduciary Responsibility and Prohibited Transactions, and in Tax Practice Series, see ¶5530, Fiduciary Duties and Prohibited Transactions.
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