401(k) Plan Excessive Fee Claims Receive a Boost

By Steven W. Kasten

December 11, 2009

ERISA class actions challenging the administration and investment management fees charged to 401(k) plan investors have drawn attention as a significant threat to the retirement plan investment industry.  In these cases, plaintiffs allege that employers who sponsor 401(k) plans, and in some cases outside plan service providers, have failed to assess investment management fees charged to investors in determining the mutual funds that should be offered in the plans; have failed to utilize the collective power of plan assets to drive down management fees; and have improperly allowed revenue sharing payments -- a portion of the investment management fees returned to the plan servicer -- to corrupt the selection of funds and produce excessive administrative expense charged to plan investors.

A “wave” of 401(k) plan fee litigation began in earnest and with some fanfare in 2006 with the filing in Illinois federal court of a dozen or so lawsuits on behalf of employees of several very large corporations who participated in employer-sponsored 401(k) or similar tax-deferral savings plans.  Earlier this year, the United States Court of Appeals for the Seventh Circuit, where the majority of the major cases were filed, rejected the basic theories of liability and damages on which they are based.  See Hecker v. Deere & Co., 556 F.3d 575, rehearing en banc denied, 569 F.3d. 708 (7th Cir. 2009).  The Court held that where a plan offers a diverse array of investment options and management fee structures through mutual funds that are also sold to the general public (thus subjecting overall management fees to competitive market discipline), and where the total management fee charged by each fund in the Plan is disclosed to investors, no ERISA breach of fiduciary duty claim can be stated based on a theory of excessive fees or the failure to disclose revenue sharing payments.  This decision dealt a significant blow to the prospects for plaintiffs to succeed in excessive fee cases.  The plaintiffs in Deere have asked for Supreme Court review.

Three developments last month, however, provide a counterpoint to Deere and will encourage the ERISA plaintiffs’ class action bar to continue its aggressive pursuit of excessive fee cases, including (and perhaps especially) with respect to the ERISA-governed small employer plans. 

Martin v. Caterpillar Settles

On November 5, a class settlement (subject to court approval) was announced in Martin v. Caterpillar, Inc., Case No. 07-1009, pending the United States District Court for the Central District of Illinois.  Under the settlement, Caterpillar will pay $16.5 million, from which plaintiffs’ counsel will seek $5.5 million in legal fees and $375,000 in incurred expenses.  Since this case was pending in a district court within the 7th Circuit, it would be governed by the defendant-friendly Deere decision.  While there were some factual differences between the two cases -- Caterpillar itself established an investment management arm that managed the core mutual funds offered in the Plan and was directly involved in revenue sharing -- the Caterpillar plan offered a range of investment options comparable to the plan in Deere, including a “mutual fund window” giving participants access to a wide array of competitively marketed retail mutual funds. 

Given the venue and similarities to the Deere case, the Caterpillar settlement is notable and may foreshadow in excessive fee litigation the settlement pattern that eventually emerged in the wave of ERISA “stock drop” lawsuits that followed the financial market disruptions and large corporate bankruptcies in 2001.  In those cases, plaintiffs alleged that plan investment fiduciaries breached their ERISA duties by failing to eliminate employer stock investments in savings plans of public companies as (or before) the stock declined in value.  Because the law attaches a “presumption of prudence” to employer stock investments, and because proof of damages is often murky, these are difficult cases for plaintiffs: the cases that have not settled have resulted in verdicts for the defendants.  Corporations targeted in stock drop cases, nevertheless, have regularly agreed to settle the claims for amounts that, while modest compared to the losses alleged, are sufficient to keep plaintiffs’ lawyers interested in pursuing new claims.

Class Certified in Haddock v. Nationwide Life Insurance Company

On November 6, a Federal judge in the District of Connecticut ruled that an ERISA claim brought by the trustees of four retirement savings plans, alleging that their plan vendor breached fiduciary duties by accepting revenue sharing payments from the mutual funds it made available to the plans, should be certified as a class action.  Haddock v. Nationwide Financial Services, Inc., 2009 WL 376339, * 36 (D. Conn. Nov. 6, 2009).  Class treatment means that this claim will now proceed on behalf of what plaintiffs have alleged to be 24,000 similarly situated plans to which Nationwide sold similar investment products beginning January 1, 1996. 

While cases like Caterpillar address the plan sponsor’s fiduciary duty to ensure that plan service providers/investment managers are chosen prudently for the benefit of the 401(k) plan participants, including with an eye to cost, Haddock focuses only on the plan provider.  The case concerns small and middle-market 401(k) plans offered through variable annuity contracts with Nationwide Insurance.  Nationwide provided a selection of mutual funds for potential investment by participants, and entered into group contracts with employers under which the employer could choose to limit investment choices to a subset of those funds.  Under the contracts, Nationwide retained authority to delete or substitute mutual funds.  The Court held that Nationwide’s ability to delete funds, and its use of revenue sharing arrangements with the mutual funds it offered, rendered it a fiduciary of the plans to which it sold its products, rather than a mere contract service provider ordinarily not held to fiduciary standards.

The Haddock case remains a difficult one for the plaintiffs to prove on the merits.  The Court’s approval of class action treatment, moreover, depended largely on the fact that plaintiffs are not seeking to recover consequential investment losses resulting from their choice of investment options, but rather to disgorge any excessive administrative fee that Nationwide obtained as a result of revenue sharing.  Nevertheless, the court’s decision granting class certification and the consequent expansion in Nationwide’s financial exposure will exert significant settlement pressure, and can only invite more fiduciary claims in the small and mid-sized plan market, against plan service providers, employer fiduciaries, and investment advisers involved in choosing investment plans and fund options. 

Eighth Circuit Reinstates Braden v. Wal-Mart Stores, Inc.

Last but not least, just before Thanksgiving, the United States Court of Appeals for the 8th Circuit reinstated an excessive fee case that had been dismissed by the trial court as a matter of law in 2008.  Braden v. Wal-Mart Stores, Inc., 2009 WL 4062105, * 14 (8th Cir. No. 25, 2009).  Braden alleged that Wal-Mart and its officers and directors responsible for selecting investment options in its 401(k) plans breached their fiduciary duties of loyalty and prudence by selecting a Merrill Lynch investment platform without adequately considering Merrill Lynch’s use of revenue sharing.  He alleged that as a result of these failures, the Plan was charged $60 million in unnecessary administrative costs over six years, and lost an additional$140 million by foregoing investments in similar but more cost effective funds available in the market.  The trial court dismissed the Complaint because the plaintiff failed to allege specific facts showing that the defendants did not adhere to a prudent process of investment fund selection. 

The Court of Appeals reversed the trial court for applying an overly stringent standard in deciding whether the complaint alleged a plausible claim under ERISA.  It went on to hold that a claim for breach of fiduciary in selecting a platform of relatively diverse funds (ten mutual funds, a collective trust, a company stock fund and a stable value fund) is plausible, where it is alleged that plan fiduciaries failed to review management fees and revenue sharing arrangements, failed to negotiate lower investment management and/or administrative fees where possible, or failed to replace funds underperforming their benchmarks as a result of unjustified management fees.  The Court’s opinion further diverges from Deere by holding that a fiduciary’s failure to affirmatively disclose to plan investors the amount of revenue sharing embedded in an investment management fee may constitute an actionable breach of fiduciary duty under ERISA.

Braden now provides plaintiffs with a kind of Deere antidote: a cogent appellate decision on which to rely to avoid early dismissal, an essential ingredient to producing financial settlements with plan sponsors in excessive fee claims.

Predicting the Future

The November developments outlined above can only encourage the further proliferation of ERISA breach of fiduciary duty claims challenging the fees charged to 401(k) plan investors.  While trials in some of these cases scheduled for next year will provide additional important information on the prospects for these claims, the pattern of stock-drop cases is apt to repeat itself.  It will become more difficult to obtain dismissal of claims at the outset, creating significant exposure to litigation expense even in questionable cases.  Unlike stock drop cases, however, the universe of potential defendants is not limited to fiduciaries of retirement savings plans sponsored by large, publicly traded companies.  The fee cases can target the fiduciaries of any ERISA-governed savings plan. 

While there are no perfect strategies that guarantee protection against these claims, even small employers who offer 401(k) plans or other equivalent ERISA-governed retirement savings can take certain basic steps that will undoubtedly serve them well when plans claims arise.  This begins with ensuring a clear understanding of the roles and responsibilities of the employer, investment adviser, pension plan administrator, and/or plan investment service provider (trustee or record-keeper) in selecting investment alternatives offered under the plan.  Even where an employer successfully off loads the fiduciary responsibility for selection of the investment array to an investment advisor or plan provider, there will remain a fiduciary duty to monitor that fiduciary, including assuring that administrative costs borne by plan investors are factored into the selection process.  While no court would require employers to offer plans containing only the lowest-fee investment options, employers should be satisfied that the process for selecting the fund providers and administrator involves a reasonable element of competition.  And whether the employer’s responsibility is to select funds directly or to select other fiduciaries who will do so, documenting the selection process and periodic monitoring will enhance an employer’s position in any litigation that does materialize.  Businesses offering these plans or taking on arguably fiduciary roles will also want to consult their insurance agents to assess coverage for ERISA fiduciary claims.

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