The U.S. Supreme Court has an unusual number of Employee Retirement Income Security Act (ERISA) petitions before it in the 2019-20 term. Two recent decisions may increase uncertainty around the use of actively managed funds, as well as the inclusion of company stock, in a defined contribution (DC) plan’s investment lineup.
Putnam Investments v. Brotherston: More than 30 companies have been sued over the affiliated mutual funds in their 401(k) plans since 2015. In this lawsuit, Putnam was accused of engaging in self-dealing by including expensive, underperforming proprietary funds in its 401(k) plan. Initially, the federal court heard only the plaintiffs’ arguments and, after the plaintiffs had rested their case, Putnam requested that the case be dismissed—arguing that the plaintiffs had not proven that the plan suffered any losses. The court agreed and, as a result, did not rule on whether Putnam had breached its fiduciary duties.
That ruling was vacated in part by the 1st U.S. Circuit Court of Appeals and remanded back to the lower court for further review. Additionally, the appellate court ruled that the burden is on Putnam to disprove that plan losses resulted from the alleged breaches. Of note, the appellate court also suggested in its decision that plans could stave off litigation by steering clear of actively managed funds.
Putnam asked the U.S. Supreme Court to review certain questions of law. The first dealt with which party was responsible to prove the cause of a loss. The appellate courts have split on this issue. The second issue requested that the Supreme Court opine on the comparison of active and passive benchmarks.
The court denied Putnam’s petition, leaving these questions unresolved, and Putnam will now have to defend itself in the lower courts.
IBM v. Jander: The plaintiffs alleged that IBM imprudently managed company stock investments in one of its retirement plans. The lower courts found that IBM had violated guidelines set by the Supreme Court’s unanimous 2014 decision in Fifth Third Bancorp v. Dudenhoeffer.
The Dudenhoeffer decision sought to balance the fiduciary duties outlined in ERISA with the SEC duties of corporate officers with three broad principles:
- ERISA’s duty of prudence cannot require a fiduciary to violate securities laws (e.g., selling company stock in a retirement plan based on insider information).
- Courts must balance ERISA rules with the SEC’s “complex insider trading and corporate disclosure requirements.”
- Courts must analyze whether a plaintiff “plausibly alleged” that a prudent fiduciary would not have viewed an alternative action as more likely to harm the fund than to help.
The U.S. Supreme Court’s decision to vacate and remand the decision was based on the finding that “petitioners (fiduciaries of the employee stock ownership plan at issue here) and the federal government (presenting the views of the SEC as well as the Department of Labor) focused their arguments primarily upon other matters” that should be reviewed by the appellate court. The lack of clarity raises questions about the correct application of Dudenhoeffer at the pleadings stage and may encourage additional litigation.
Bottom Line: The current litigation environment highlights risks and opportunities for plan sponsors. By declining to review Putnam v. Brotherston, the high court leaves the matter of which party has the burden of proof in such suits unresolved. By remanding IBM v. Jander, the court leaves an open question for plan fiduciaries regarding how to balance SEC regulations regarding insider trading and ERISA fiduciary duties with respect to company stock held within an ERISA plan.
Plan sponsors should continue to carefully monitor investment options, review plan fees, and follow any written governance documentation, including the investment policy statement. Additionally, plan fiduciaries should document the process and decisions made around vendor selection and fees to demonstrate their due diligence.
