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In this note, we briefly discuss the Department of Labor’s amicus brief filed in Anderson, Winston, et al. v. Intel Corp. Inv., et al., an ERISA fiduciary prudence “fund underperformance” case currently being considered by the Supreme Court.
Plaintiffs in this litigation challenged the prudence under ERISA of the investment by two Intel defined contribution plans in (plaintiffs claim) “costly and underperforming hedge and private-equity funds.” The lower courts sided with defendants, finding that the benchmarks that plaintiffs used in their complaint to show underperformance were not meaningful “because they had ‘different aims, different risks, and different potential rewards.’”
The Supreme Court has defined the issue before it as:
Whether, for claims predicated on fund underperformance, pleading that an ERISA fiduciary failed to use the requisite “care, skill, prudence, or diligence” under the circumstances and thus breached ERISA’s duty of prudence when investing plan assets requires alleging a “meaningful benchmark.”
This case promises to be critical to how courts handle “underperformance” litigation – cases in which plaintiffs challenge the prudence of fiduciary/committee investment decisions based on a retrospective (“rear view mirror”) analysis of the targeted plan funds vs. other investment options. For more background on this case, see our article Supreme Court Grants Certiorari in Intel Hedge Fund Litigation.
DOL’s brief is interesting in a couple of respects. First, that DOL is weighing in on the side of defendants in this litigation is further evidence that the new leadership at DOL is committed to “reining in” prudence litigation – tightening the rules for what is a good fiduciary prudence claim. And, second, it gives us some idea of DOL’s view of what are proper “benchmarking protocols,” especially in more complicated areas such as the one in the Intel litigation – a target date fund using hedge funds and private equity to mitigate downside risk.
In what follows, we excerpt and discuss some arguments in DOL’s brief bearing on the “meaningful benchmark” issue. Plan sponsors/sponsor fiduciaries may want to consider these arguments in fund menu construction generally and in benchmarking in particular.
As a threshold matter, DOL notes that “[t]he question presented does not require the Court to consider whether the comparators petitioners identified suffice if a meaningful benchmark is required.” So, it’s possible (perhaps likely) that the Court will only address the issue of the requirement of a meaningful benchmark, not the issue of what satisfies that requirement.
Nevertheless, DOL’s brief does give us some idea of its thinking on this issue. Below, we simply excerpt from DOL’s brief some interesting quotes on this issue:
[T]o support a plausible inference that a fund’s relative underperformance reflected a fiduciary’s breach of the duty of prudence, a plaintiff must measure the fund’s performance against a meaningful benchmark – a fund that shares sufficient characteristics to provide a basis for comparison.” [Emphasis added.]
Because differences in the performances of two investments may be attributable to differences in objectives rather than to deficient decision making, pleading such differences is insufficient to state a claim that the fiduciary breached his duty of prudence. Rather, such differences will logically suggest imprudence only if the two investments share enough characteristics to negate obvious alternative explanations for the gap in performance.
Allegations involving a fund’s performance are relevant only insofar as they indicate that the plan’s fiduciaries did not properly evaluate particular investments when selecting or maintaining them.
Where a fiduciary identifies its own benchmark and asserts that it is meaningfully similar to the fund at issue, that benchmark should qualify as a meaningful benchmark for purposes of pleading a claim based on underperformance.
One issue raised by plaintiffs was that the Intel target date fund performed poorly versus the participant disclosure “designated benchmark.” DOL disclosure regulations require benchmarking of TDFs against “an appropriate broad-based securities market index” (which of course would not even be a TDF). DOL’s brief argues that this “general-disclosure benchmark” is only “meant to provide plan participants with a broad picture of the securities market to help plan participants ‘assess [ ] the various investment options available under their plans.’”
Instead, DOL argues that “for ‘investment alternatives that have a mix of equity and fixed income exposure,’ like the [TDF] at issue here, a plan administrator may provide an additional benchmark designed to track ‘the actual equity and fixed-income holdings’ of the fund…. It is that secondary benchmark
that shares relevant characteristics with the funds and may therefore serve as a meaningful comparator.”
Our observation: for TDFs, a custom benchmark tracking intended asset allocation over the glidepath will provide a useful counter to comparisons with generic benchmarks.
Another interesting issue raised by plaintiffs is their claim that Intel’s hedge fund/private equity strategy cannot be “meaningfully benchmarked” because no other ERISA plan is pursuing that strategy. In this situation, DOL suggests that:
[T]here will likely be other funds that use different strategies to pursue the same general objectives. Standard investment-evaluation concepts like risk profile and expected returns are transferable between assets. Thus, where two funds seek to achieve similar levels of risk using different asset-allocation strategies, the challenged fund may be compared to a fund with more conventional assets that bear the same level of risk. Isolating the asset-allocation strategy while holding risk level and other variables constant makes the comparison meaningful and may bolster an assertion that adopting the novel strategy was imprudent.
We are not investment consultants and take no position on whether this approach does or doesn’t make sense, but it does seem to be DOL’s view as to how a “meaningful benchmark” for a “novel strategy” might be identified.
As we said at the top: there is a realistic possibility that the Supreme Court’s consideration of this case may result in a major upgrade in the clarity of the “law of underperformance cases.”
We will continue to follow this issue.
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This is a publication of O3 Plan Advisory Services. If you have any comments, or have questions about regulatory developments, please contact your relationship manager or Mike Barry at mbarry@octoberthree.com.
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