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On September 20, 2019, the United States District Court for the Northern District of Georgia denied a motion to dismiss by defendant sponsor fiduciaries in Pizarro v. The Home Depot, a case involving claims by plaintiffs that defendants (among other things) violated ERISA’s prudence standard by including in the plan’s fund menu “funds that had a long-term history of underperformance relative to their benchmarks.” The funds challenged included a BlackRock LifePath target date fund (TDF) and a JP Morgan stable value fund.
In this article we review the court’s decision for plaintiffs on this issue.
Background
As we have discussed (see our article on Reetz v. Lowe’s), defendants’ motion to dismiss in these cases is a critical stage in the litigation. If plaintiffs can survive this stage, they can via discovery (e.g., depositions and interrogatories) “fish” for facts supporting their allegations and impose litigation costs, improving their case and making settlement more likely.
The standard for a motion to dismiss is, broadly, whether plaintiffs have alleged “enough facts to state a claim to relief that is plausible on its face.” In these ERISA prudence/underperformance cases, courts are evolving a standard that, to survive a motion to dismiss, plaintiffs do not have to allege facts directly showing a deficiency in the fiduciaries’ process, even though that process is likely to be the basis on which an ultimate decision on the merits would depend. Instead, because they do not generally have access to information about that process, plaintiffs may rely on “circumstantial factual allegations” that (quoting Lowe’s) “give rise to a plausible inference that the process for selecting or monitoring the [fund] was deficient.”
In this regard, many courts are accepting plaintiffs’ claims based on (1) allegations that the challenged funds underperformed appropriate benchmarks plus (2) some additional facts that (allegedly) indirectly show an imprudent process.
With regard to (1) (“underperformance”) this theory of the case raises two problematic issues. First, the “underperformance” analysis is always done in hindsight – in effect inviting plaintiffs and their lawyers to troll plans and single out those funds that, in the event, have “underperformed.” And, second, except in the simplest case, what is an appropriate benchmark is often a matter of dispute and is especially problematic when the “underperforming fund” is a TDF, whose performance can vary significantly depending on whatever glide path and asset allocation strategy is used.
With regard to (2) (“additional facts”), courts seem prepared to set a fairly low bar for plaintiffs. In Lowe’s plaintiffs pointed to the targeted fund’s limited track record, negative rate of return, “novel” investment strategy, and lack of a consistent benchmark. In Anderson v. Intel, plaintiffs pointed to the novelty of the fund’s investment strategy (significant allocations to hedge funds and private equity), the generic problems presented by those hedge fund and private equity investments (e.g., lack of liquidity), and the relatively high fees.
The court’s decision in Home Depot is in line with this approach.
Plaintiffs’ theory of the case
Plaintiffs in Home Depot challenged the prudence of the inclusion of four funds in the plan’s fund menu – a small cap value fund, a small cap growth fund, a JP Morgan stable value fund, and the BlackRock LifePath TDF. With respect to each, plaintiffs produced selected comparison funds and a purported benchmark, which (to a greater or lesser extent) the Home Depot plan funds underperformed during the relevant period (generally 2012-2017).
Plaintiffs’ demonstration of fund underperformance was unusual in (at least) one respect. With the (apparent) exception of the stable value fund, plaintiffs did not have actual performance data for the challenged Home Depot funds. The factual basis for their allegation of underperformance was, for these funds, based on the actual performance of publicly available “comparable” funds of the same fund managers.
Plaintiffs then compared that (extrapolated) performance to the performance of “comparator” funds they had selected in the relevant asset class and to a purported benchmark.
Thus, with respect to Home Depot’s BlackRock LifePath TDF, which was maintained as a collective trust (for which “there is little publicly available information”), plaintiffs extrapolated performance from BlackRock’s LifePath Index F Funds, and then compared it to (1) the performance (for the relevant period) of TDFs provided by State Street, Vanguard, T. Rowe Price, and Voya and (2) (as a benchmark) the Dow Jones Global Target Index.
The underperformance plaintiffs purported to find was not always dramatic. E.g., with respect to the BlackRock TDF, “Six of the eight [Lifepath] funds underperformed their benchmark for the previous five years, and five of the eight funds underperformed their benchmark for the previous one and five years.”
Defendant fiduciaries’ arguments
Defendants challenged each of the elements of plaintiffs’ “underperformance” theory – its use of proxy funds (rather than actual data) for Home Depot fund performance, its use of (what they claimed were) “cherry picked” comparators, and the appropriateness of the benchmarks selected by plaintiffs.
In support of this challenge to plaintiffs’ case, defendants cited the Eighth Circuit decision in Meiners v. Wells Fargo, in which (quoting the court in Home Depot):
[T]he court reasoned that there was no claim where the plaintiffs alleged that one other investment fund performed better than the defendant’s fund and offered no benchmark because “[t]he fact that one fund with a different investment strategy ultimately performed better does not establish anything about whether [the investment choices] were imprudent[.]”
The Home Depot court’s decision
The Home Depot court rejected defendants’ argument, stating that it was “unconvinced that Plaintiffs’ factual allegations of performance data and benchmarks could not lead to a reasonable inference of imprudence in Home Depot’s decision-making process.”
The court found that plaintiffs’ underperformance analysis, together with (two) other alleged issues with the challenged funds – a poor Morningstar rating on the small cap growth fund and alleged “legal troubles” (that is, lawsuits) with respect to JP Morgan’s stable value fund – were enough for plaintiffs to “state[] a plausible ERISA claim for breach of the duty of prudence by sufficiently alleging that Home Depot utilized an imprudent decision-making process in managing the Plan’s investment funds.”
In reaching this conclusion, the Home Depot court emphasized what has become a featured talking point of plaintiffs in these underperformance cases – plaintiffs’ inability at the pleading stage to get the critical information about the defendant fiduciaries’ decision-making process itself – that will be the basis for any ultimate decision on the merits.
Thus, the court states: “As the decision-making process by which Home Depot managed the Plan involves an inquiry into Home Depot’s specific methods and knowledge that Plaintiffs have not yet had access to, this Court agrees with Plaintiffs that the disposition of Count I [challenging the prudence of the targeted funds] is improper at this stage of the litigation.”
Takeaways for plan sponsors
It’s hard not to be taken aback by this decision. The court in Home Depot has allowed a group of plaintiff participants to proceed to discovery on a claim that the use of a BlackRock LifePath TDF in a plan fund menu is imprudent.
There are over $25 billion in assets invested in BlackRock’s LifePath Index Funds. It would seem that plaintiffs’ theory asks the court to conclude that offering the LifePath funds as part of a fund menu is akin to saying that $25 billion worth of investors are imprudent. Which, of course, the Home Depot court is not (on this motion to dismiss) doing – it is simply letting the plaintiffs proceed with discovery, based on its conclusion that such a claim is “plausible.”
As we have noted, measuring the relative performance of a TDF is particularly problematic. TDFs use different glide paths and investment strategies that may be perfectly prudent but that will, in hindsight, produce very different investment results, with some TDFs “underperforming” others based (perhaps entirely) on those different glide paths and asset allocation strategies. In reaching its conclusion, the court in Home Depot did not discuss this issue.
We have seen other courts extend latitude to plaintiffs in pleading an ERISA prudence/underperformance case, e.g., in Lowe’s and Intel. It may be that in these courts sponsor fiduciaries will have to go at least to the summary judgment stage, where they can produce evidence of the substance of their decision to include (or remove) a fund from the plan’s fund menu. As we have discussed, in that event the fiduciaries’ best defense is likely to be to produce evidence that they used a thorough and prudent process in arriving at their decision.
There will be other courts, following (perhaps) the Eighth Circuit in Meiners v. Wells Fargo, that will apply a stricter pleading standard.
Finally, and to repeat what we said above, courts’ sympathy for plaintiffs in these cases stems in part at least from the fact that (typically) plaintiffs do not have access to the dispositive facts – the process the plan fiduciaries actually used in arriving at their decision.
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We will continue to follow this issue.