In this article we review two ERISA retirement plan cases that the Supreme Court has accepted for review, Sulyma v. Intel and Jander v. IBM, and one that it is considering reviewing, Putnam Investments, LLC v. Brotherston, focusing on what is at stake for plan sponsors in these cases.
Sulyma v. Intel– ERISA’s three-year statute of limitation – what constitutes “actual knowledge?”
Legal issue: ERISA’s statute of limitations bars claims brought after the earlier of:
(1) Six years after the date of the last action which constituted a part of the violation, or
(2) Three years after the earliest date on which the plaintiff had actual knowledge of the violation.
At issue in Intel is limitation rule (2): for purposes of the three-year limit, what constitutes “actual knowledge?”
Background: The target date funds (TDFs) deployed as qualified default investment alternatives (QDIAs) in Intel’s two 401(k) Plans included significant allocations to alternative investments (including hedge funds). The Intel TDF alternatives/hedge fund strategy appears to have been, to some extent, a risk-hedging strategy, e.g., TDF allocations to hedge funds were more significant for older participants than for younger participants. During the period at issue (after the “Great Recession”), the performance of these funds “lagged compared to index funds and comparable portfolios.”
Plaintiff sued claiming (among other things) that (1) the plans’ Investment Committees violated ERISA’s prudence and exclusive purpose rules by investing in these hedge funds and other alternatives, and (2) the plans’ Administrative Committees failed to adequately disclose the risks associated with those investments.
The district court granted summary judgment for Intel, holding that plaintiff’s claim was barred by ERISA three-year statute of limitations. In that regard, it found that comprehensive disclosure provided to defendant of the TDFs’ investment strategy – including “annual notices, quarterly Fund Fact Sheets, targeted emails, and two separate websites” –constituted “actual knowledge.” The Ninth Circuit reversed and remanded, holding that if (as claimed) “Sulyma in fact never looked at the documents Intel provided, he cannot have had ‘actual knowledge of the breach.’”
What is at stake for sponsors: The Supreme Court’s decision in Tibble limited the effect of limitation rule (1) (time-barring claims brought six years after the last action which constituted a part of the violation), by recognizing a separate and ongoing ERISA duty to monitor the prudence of prior fiduciary decisions. That restriction on the application of limitation rule (1) has made limitation rule (2) more important as a restriction on the ability of participants to litigate stale claims.
A rule that – notwithstanding comprehensive disclosure of a fiduciary decision (in this case, the TDF hedge fund/alternatives strategy) – a plaintiff can avoid application of ERISA’s three-year statute of limitations by simply claiming that he never read or “looked at” those disclosures would, to a great extent, nullify the effect of limitation rule (2). The only recourse sponsors might conceivably have would be to require all participants to explicitly acknowledge reading the relevant disclosures – a requirement that would (at a minimum) significantly complicate plan administration.
Jander v. IBM– does ERISA impose an inside information disclosure regime that is separate from the securities laws?
Legal issue: The Supreme Court’s June 2014 decision in Fifth Third Bancorp et al. v. Dudenhoeffer represented a significant jurisprudential departure in the analysis of stock drop cases. The Court rejected the “presumption of prudence” analysis that had been typical of these cases in favor of a reliance on the market price of a (publicly traded) stock as, generally, defining “prudence.”
In Fifth Third the Court held that, absent “special circumstances,” a plaintiff cannot sue a fiduciary claiming the fiduciary should have known, based on public information, that a publicly traded stock is overvalued. As a result, since Fifth Third, most stock drop litigation has focused on claims that plan fiduciaries had non-public (“inside”) information that should have led them to conclude that the stock was overvalued by the market.
The Supreme Court, in Fifth Third, discussed the limits of this sort of inside information-based claim with some specificity: (1) A plaintiff cannot argue that the plan fiduciary (assuming it possessed inside information that the stock was overvalued) should have sold company stock already owned by the plan, as doing so would generally violate the securities laws’ prohibition on insider trading. (2) A court should consider whether the action plaintiffs claim the fiduciary should have taken (e.g., stopping buying stock and/or disclosing non-public information) would do “more harm than good.” That is, while disclosure might help participants who would otherwise have bought shares of stock in the future, it would likely reduce the value of stock already held by the plan. (3) Finally, “courts should consider the extent to which imposing an ERISA-based obligation either to refrain from making a planned trade or to disclose inside information to the public could conflict with the complex insider trading and corporate disclosure requirements set forth by the federal securities laws or with the objectives of those laws.”
Background: The decision in Jander v. IBM tests the limits of this analysis.
1.“Could have” vs. “would have.” There is a disagreement among the courts over the formulation of the Fifth Third “more harm than good” test: as the Second Circuit in Jander describes it, over whether the test is whether an average prudent fiduciary “would have,” or any possible prudent fiduciary “could have,” thought disclosure would have done more harm than good. The Second Circuit did not resolve this issue.
2. Application of the “more harm than good” test where disclosure is inevitable. The Second Circuit did hold that, at the motion to dismiss stage at least, where disclosure of the inside information was “inevitable” in the near future (in this case, in connection with the sale of a division), no fiduciary could conclude that disclosure would do more harm than good.
3. ERISA vs. the securities laws. The Second Circuit dismissed arguments that allowing an ERISA claim on essentially the same facts as related securities fraud litigation would lead to an “end run” around the heightened pleading standards for securities fraud suits. In this regard it noted (1) that the securities fraud pleading standards do not by their terms apply to ERISA lawsuits, (2) that ERISA lawsuits do not involve allegations of fraud and the related “scienter” (intent or knowledge of wrongdoing) requirement, but rather an allegation of fiduciary imprudence, and (3) that ERISA and the securities laws have different objectives.
All or any one of these three issues could be up for grabs in the Supreme Court’s consideration of the Second Circuit’s Jander decision.
What is at stake for sponsors: The Second Circuit’s creation of a rule that, in effect, requires sponsors to disclose information under ERISA before they might be required to disclose it under federal securities laws could significantly disrupt corporate procedures for the disclosure of inside information, in effect requiring a separate ERISA disclosure regime and analysis of such issues as the inevitability of (near) future disclosure.
The court in the Wells Fargo stock drop case observed that this is an “inherently uncertain” task. Creating this uncertainty are both substantive issues, e.g., the seriousness of the alleged fraud, how much disclosure would affect stock price both in the short run and in the long run, how much stock the plan currently owns, and how much additional stock participants will purchase if disclosure is delayed. And process issues: Does the fiduciary have all relevant information to make a “single complete and accurate disclosure?” Should disclosure “wait until the company’s fraud can be disclosed simultaneously with some remedial action?” Might it be better “to disclose the fraud through normal channels rather than through the fiduciaries of a 401(k) plan?”
If the Supreme Court upholds the Second Circuit in Jander, then some sponsors will, in effect, be compelled to engage (perhaps even routinely) in this very uncertain analysis and come to a judgment to disclose/not disclose inside information under an entirely separate statute/set of standards than those applicable under the securities laws, and may be judged to have violated ERISA’s fiduciary rules if they get that judgment wrong.
Putnam Investments, LLC v. Brotherston – waiting for the Solicitor General’s brief
The other major ERISA case affecting corporate plan sponsors that has been appealed to the Supreme Court is Putnam Investments, LLC v. Brotherston, an in-house plan 401(k) fee case. In Putnam, the district court found that “even assuming a fiduciary breach, [plaintiffs] had failed to establish loss causation.” The First Circuit vacated this holding, finding that “loss” had been established by comparing the return on Putnam in-house funds included in the plan fund menu to returns on two “passive comparators” (a Vanguard index fund and a bank collective investment trust). The court further held that “once an ERISA plaintiff has shown a breach of fiduciary duty and loss to the plan, the burden shifts to the fiduciary to prove that such loss was not caused by its breach, that is, to prove that the resulting investment decision was objectively prudent.”
Defendants have petitioned the Supreme Court to review both the shifting of the burden of proof issue (on which there is a split in the Circuits) and on the “the loss-causation question.”
A particularly concerning element of the First Circuit’s decision was its suggestion that plan fiduciaries could avoid this sort of 401(k) fee litigation, in which courts in effect second guess fiduciary plan menu construction choices, by preferring passive investments: “any fiduciary of a plan such as the Plan in this case can easily insulate itself [against these sorts of claims] by selecting well-established, low-fee and diversified market index funds.”
In April 2019, the Supreme Court asked the Solicitor General for a brief on the issues presented by Brotherston. That brief has not (as of this date) been filed, and until it is it is unlikely that the Court will decide whether (or not) to hear this case.
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We will continue to follow these issues.