District court grants summary judgment for defendants in fund underperformance case
On March 5, 2020, the United States District Court for the District of Colorado granted summary judgment in favor of defendant sponsor fiduciaries in Birse v. CenturyLink. The case – in which plaintiffs challenged the prudence of the selection of a fund in the CenturyLink 401(k) plan’s fund menu – is particularly interesting for the court’s (favorable) evaluation of the process the defendant fiduciaries used to select the fund and fund managers targeted by plaintiffs.
In this article we review the court’s decision, beginning with some background.
Plaintiffs claim that defendant fiduciaries breached their ERISA fiduciary duty of prudence by creating and maintaining as a plan investment option the “Active Large Cap U.S. Stock Fund” (Fund), a multi-manger fund designed to “obtain excess returns over the Russell 1000 Stock Index (‘Russell 1000’), with increased downside and wealth protection, at a reasonable price over the long term.” The Fund underperformed its benchmark for most of five years but did provide “substantial gains for Plan participants.”
Plan investment decisions with respect to the Fund were made by the CenturyLInk affiliate CenturyLink Investment Management Company (CIM), the defendant ERISA fiduciary. Plaintiffs argued that CIM breached its duty of prudence because the Fund “underperformed immediately and consistently due to its flawed and imprudent design, and CIM failed to appropriately monitor and adjust the Fund because it lacked any formal process or guidelines for doing so.”
Proof of process
The case involved motions for summary judgment from both plaintiffs and defendants, with respect to which the parties submitted certain evidence. Defendant fiduciaries submitted a “declaration” by CIM’s Director of Investment Strategy and Co-director of the Investment Strategy & Implementation Team, outlining the process CIM used in developing and monitoring the Fund.
That process involved structuring the Fund “as an active, multi-manager fund, with a mid-cap bias and a slight value bias. … [The] multi-manager strategy was designed to provide participants with full beta exposure to asset classes, maintain sufficient liquidity to allow for efficient rebalancing, and provide excess returns above the passive benchmark while minimizing downside risk.”
In connection with the design of the Fund, CIM “undertook extensive quantitative and qualitative research regarding how to structure the [Fund], including as to the appropriate strategy and the composition and number of managers … [and] consulted and relied upon industry literature and data and communications with industry experts, peers, and current managers.”
The Fund was also evaluated in “hypothetical past markets” and CIM “conducted numerous back-tests.”
Because “[r]etirement investment funds like those in the Plan are intended to be long-term investment … the [Fund] was intended to generate excess returns and protect against downside risk over a full market cycle.” This approach “could mean [the Fund] would lag in up markets” but would provide “downside risk protection.”
With respect to its ongoing duty to monitor the prudence of including the Fund in the fund menu, CIM’s Investment Committee received monthly performance reports, met at least bi-monthly, and held quarterly performance review and quarterly risk meetings.
Performance reviews were presented to the Committee annually.
Underperformance was “noted and discussed as appropriate during quarterly performance meetings,” along with “additional research, analysis, and diligence … to help the Investment Committee understand the situation,” as the Committee considered alternative actions with respect to the Fund.
In addition, CIM employees interacted with investment managers on a less formal basis “through calls, emails, and/or in-person meetings.”
Defendants’ declaration also provided an alternative benchmark that CIM used to evaluate Fund performance, based on the “long-term outperformance of the passive benchmark on a rolling three-year basis.”
And plan fiduciaries “considered other quantitative information, including absolute fund and manager performance, manager performance against the manager level benchmark determined as part of the design process, fund and manager performance relative to eVestment manager universe data and CIM’s expectations, fund and manager risk statistics and historical performance.”
Plaintiffs’ expert argued that these procedures were inadequate because defendant fiduciaries did not have “any formal, written process in place governing the administration and management of the Fund” and failed to “create any process or guidelines to address the Fund’s underperformance.”
Plaintiffs’ expert argued that defendants’ “lack of a documented process cast[s] doubt upon the prudence of how the [Fund] was constructed.”
The court found that ERISA did not require the written procedures the absence of which plaintiffs’ expert argued failed ERISA’s prudence test.
Instead, it held that “CIM’s highly qualified team of professionals rigorously analyzed the purpose the Fund would serve, how it would accomplish that purpose, and the Fund’s strategic place within the overall portfolio of the Plan.” And that “The evidence indicates that CIM’s evaluation of the merits of the Fund’s design, and its analysis of the Fund’s subsequent performance, satisfies the prudent person standard.”
Takeaways for plan sponsors
The stage of litigation is critical. This was a decision on summary judgment, with the submission of limited evidence to demonstrate “that there is no genuine dispute as to any material fact.” As such it is distinct from many 401(k) prudence cases where the court’s decision is made on a motion to dismiss, in which no evidence may be submitted and only the pleadings are considered.
Prudence is about process. The critical part of the evidence submitted by defendants went to show the prudence of the process they used. As the court emphasized:
Fiduciaries such as CIM have “a duty to exercise prudence in selecting investments ….” To determine whether a fiduciary has breached its duty of prudence in this context, courts apply an objective standard which focuses “on a fiduciary’s conduct in arriving at an investment decision, not on its results ….”
We’ve quoted extensively from the court’s discussion of defendants’ process because it outlines the sort of process that at least one court found exemplary. Of course, this provides no guarantee that other courts would follow the same standard.
The substance of the fiduciaries’ process matters most: The court rejected plaintiffs’ argument that because plan fiduciaries (e.g., CIM) were not subject to formal procedures they failed ERISA’s prudence test. What mattered to the court is what the fiduciaries actually did.
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The court’s decision provides at least one roadmap for defendant fiduciaries to follow with respect to challenges that focus mainly on fund underperformance (an inherently retrospective analysis) – a motion for summary judgment presenting evidence of the prudence of the plan fiduciaries’ process. Whether the additional litigation expenses that moving to the summary judgment stage may involve will deter other sponsors from taking this route remains to be seen.
We will continue to follow this issue.