Are We At a “Tipping Point” in ERISA Fiduciary Litigation?

As I went through my daily social media review, I noticed a post indicating that DOL Secretary Acosta has indicated that the DOL is ready to enforce the department’s new fiduciary rule (“Rule”). Excuse me if I’m skeptical, given the Secretary’s seeming opposition to the rule before he was even confirmed as Secretary.

Or perhaps Nevada’s announced intention to adopt its own state fiduciary law, as well as other states’ interest in doing the same, has caused Acosta to make his announcement, since state laws would ensure access to the courts for pension plan participants, making the Rule and accompanying best interests contract exemption, known as BICE, potentially irrelevant.

The Rule and BICE have the potential to address the ongoing abusive practices that drove the adoption of the Rule in the first place. However, the ongoing efforts of the DOL and Congress have raised serious questions as to whether the Rule and BICE will ever be totally effective. Hopefully, the states will follow through and adopt state fiduciary laws to ensure that investors, both retail and pension plan participants, are properly protected against the abusive marketing practices by the investment industry.

A number of recent decisions dismissing 401(k) actions involving fees and breach of fiduciary duties has caused some commentators and investment industry leaders to claim that the tide has shifted and such actions will meet with similar summary dismissals going forward. However, a closer analysis of the decisions suggests that such dismissals may result in nothing more than a false sense of optimism.

In reviewing the recent dismissals, the court’s rationale in dismissing the action typically involve three themes: the number of funds offered by a plan; the fact that a plan’s fees have been “approved” in other 401(k) actions, and/or alleged deficiencies in the plaintiff plan participants’ pleadings. With all due respect, the courts’ use of such issues appear to be inconsistent with prior court decisions and the primary resource used by the courts in fiduciary cases, especially actions involving ERISA issues. Pleading issues can always be addressed and prevented.

Dismissals Based on Number of Investment Options
Courts dismissing 401(k) actions involving fee and/or fiduciary breach issues based upon a plan’s number of investment options have frequently cited the decision in Hecker v. Deere(1) as justification for their decision. In that decision, the court appeared to suggest that the mere number of funds offered by a plan could ensure that the plan was insulated from liability for alleged breach of fiduciary duties.

However, the courts seemingly have ignored the fact that the 7th Circuit Court of Appeals subsequently went back and “clarified” their early decision in what is often referred to as Hecker v. Deere II(2). Most legal experts agree that the court’s “clarification” was actually a reversal of their earlier decision. Responding to concerns from the DOL and others that the court’s first decision was contrary to law and denied plan participants with basic  protections guaranteed under ERISA, the 7th Circuit sated that their earlier decision did not, and was not intended to, insulate plan sponsors and other plan fiduciaries, saying

The Secretary also fears that our opinion could be read as a sweeping statement that any Plan fiduciary can insulate itself from liability by the simple expedient of including a very large number of investment alternatives in its portfolio and then shifting to the participants the responsibility for choosing among them. She is right to criticize such a strategy. It could result in the inclusion of many investment alternatives that a responsible fiduciary should exclude. It also would place an unreasonable burden on unsophisticated plan participants who do not have the resources to pre-screen investment alternatives. The panel’s opinion, however, was not intended to give a green light to such ‘‘obvious, even reckless, imprudence in the selection of investments’’ (as the Secretary puts it in her brief).(3)

So any decision dismissing a 401(k) fees/breach of fiduciary duties based on the number of investment option within a plan, with no consideration of the prudence of same, would be improper.

Dismissals Based on Investment Fees Being Within an Allowable Range
There is nothing in ERISA mentioned any specific allowable range of fees. The whole “allowable range” of fees theory has been derived by the courts and the investment industry based on cases in which ranges of fees were deemed fair and appropriate.

An interesting aspect of this logic is that for years the investment industry consistently argued that evaluating actively managed funds based purely on fees rather than the value provided by such funds was unfair and inappropriate…and they were, and still are, absolutely correct. And yet, that appears to be exactly what the courts are now doing.

As the Supreme Court has noted,

We have often noted that an ERISA fiduciary’s duty is “derived from the common law of trusts.” In determining the con­tours of an ERISA fiduciary’s duty, courts often must look to the law of trusts.(4)

The Restatement of Trusts sets out the common law of trusts. The Restatement’s position is that fees for actively managed mutual funds should be evaluated relative to the incremental return that such incremental fees and costs provide. Noting the extra costs and risks typically associated with actively managed funds relative to comparable index funds, the Restatement states that

those added costs and risks must be justified by realistically evaluated return expectations. Accordingly, a decision to proceed with such a program involves judgments by the [fiduciary] that: (a) gains from the course of action in question can reasonably be expected to compensate for its additional costs and risks;…(5)

This is a significant hurdle for any plan choosing to offer actively managed funds. Analyses such as Standard & Poor’s Indices Versus Active Management (SPIVA) consistently show that most actively managed funds fail to outperformed their relative indices. Academic studies by well-respected parties such as Carhart(6) and Edelson, Evans and Kadlec(7)  go even further, as their findings show that most actively managed funds do not even manage to cover their costs, resulting in a net loss for investors.

The courts’ reliance on the “allowable range” logic is clearly inappropriate and indefensible as it ignores the importance of the requisite inherent value of a fund in terms of the positive incremental return, if any, provided to an investor. A basic axiom of fiduciary law is that “wasting beneficiaries’ money is imprudent.”(8) Before dismissing a 401(k) fees/fiduciary breach action, courts should compare an actively managed fund’s incremental return to the fund’s incremental costs.

Dismissals Based on Pleading Insufficiencies
Many of the recent dismissals involving   401(k) fees/fiduciary breach actions cited pleading insufficiencies such as failure to properly plead wrongful conduct and/or damages. The courts have every right to demand proper pleading from plaintiffs’ attorneys. Fortunately, such errors are easily corrected. Properly pleaded complaints should survive any motion to dismiss filed by the defendants.

Going Forward-Are We At a “Tipping Point” in ERISA Fiduciary Litigation?
In my humble opinion, the answer is “yes.” The rationale behind m opinion is that the courts will have little “wiggle room” to dismiss a 401(k) fees/fiduciary breach action if the action is properly plead and proper negation of the number of funds or “allowable range” of fees arguments in connection with any motion to dismiss.

Given the legal system’s reliance on the Restatement of Trust, investment fiduciaries, including plan sponsors, should know and understand the Restatement’s position on various fiduciary issues, especially Section 90 of the Restatement, more commonly known as “The Prudent Investor Rule.”

I continue to be amazed at how many investment fiduciaries have never looked at the Restatement. The usual response is that they will simply plead lack of knowledge and innocent mistake. For fiduciaries adopting such a strategy, expect to hear one or both of the following fundamental legal axioms – “ignorance of the law is no excuse” and “ a pure heart and an empty head are no defense in actions involving alleged breaches of one’s fiduciary duties.”

I expect to see more 401(k) fees/fiduciary breach actions focusing on the forgotten fiduciary duty, a fiduciary’s duty to be cost-conscious.(8) Restatement Section 88. Based on the SPIVA reports and my years of forensic analyses of actively managed mutual funds, very few actively managed mutual funds meet the Restatement’s requirement of cost-efficiency.

Using resources such as the Restatement and previously mentioned SPIVA reports, the academic studies of Carhart and Edelson, and InvestSense’s metric, the Active Management Value Ratio (AMVR™), plaintiff’s attorneys can easily establish the cost-efficiency of a plan, essentially bulletproofing their cases against successful dismissal actions. Elimination or a significant reduction in dismissal of 401(k) fees/fiduciary breach cases would clearly result in a “tipping point,” as pensions plans and investment fiduciaries would be forced to adopt prudent processes to ensure that they meet the applicable fiduciary standards or face the consequences.

1. Hecker v. Deere (Hecker I), 556 F.3d 575 (7th Cir. 2009)
2. Hecker v. Deere (Hecker II), 569 F.3d 708 (7th Cir. 2009)
3. Hecker II, at 711
4. Tibble v. Edison Int’l, 135 S. Ct. 1823, 1828 (2015)
5. Restatement (Third) Trusts, Section 90 cmt h(2)
6. Mark Carhart, “On Persistence in Mutual Fund Performance, Journal of Finance, 52, 57-82.
7. Roger M. Edelen, Richard B. Evans, and Gregory B. Kadlec, “Scale Effects in Mutual Fund Performance: The Role of Tradings Costs,” available at
8. Uniform Prudent Investor Act (UPIA), Section 7, comment

Copyright © 2017 The Watkins Law Firm. All rights reserved.

This article is neither designed nor intended to provide legal, investment, or other professional advice since such advice always requires consideration of individual circumstances. If legal, investment, or other professional assistance is needed, the services of an attorney or other professional advisor should be sought.

About jwatkins

I am a securities and ERISA attorney. I am a CFP Board Emeritus™ and an Accredited Wealth Management Advisor™. I am a 1977 graduate of Georgia State University and a 1981 graduate of the University of Notre Dame Law School. I am the author of "CommonSense InvestSense: The Power of the Informed Investor" and " The 401(k)/403(b) Investment Manual: What Plan Sponsors and Plan Participants REALLY Need To Know. " As a former compliance director, I have extensive experience in evaluating the legal prudence of various types of investments, including mutual funds and annuities. My goal is to combine my legal and compliance experience in order to help educate investors and investment fiduciaries on sound, proven investment strategies that will help them protect their financial security and/or avoid unnecessary fiduciary liability exposure.
This entry was posted in 401k, 401k compliance, 401k investments, 403b, 404c, 404c compliance, closet index funds, compliance, cost consciousness, DOL fiduciary rule, DOL fiduciary standard, ERISA, fiduciary compliance, fiduciary law, Fiduciary prudence, fiduciary standard, investment advisers, investments, pension plans, prudence, retirement plans, wealth management, wealth preservation and tagged , , , , , , , , , , , , , , , , , , . Bookmark the permalink.