Fiduciary Litigation 2018: A Pure Heart and an Empty Head Are No Defense

After my recent post, “Are We At A ‘Tipping Point’ in ERISA Fiduciary Litigation,” I received a number of calls and emails from legal colleagues and investment professionals who wanted to discuss the points I raised.  In the post, I suggested that in my opinion, we are at a tipping point due to several key facts.

First, as a result of SCOTUS’ decision in Tibble v. Edison Int’l, we now know that we can look to the Restatement (Third) Trusts (Restatement) for guidance and the applicable standards in fiduciary law, including ERISA related fiduciary matters.

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 duties, courts often must look to the law of trusts.

Second, my LinkedIn colleague, Gina Migliore, recently posted an article,”Hey Plan Sponsor, In Case You Did Not Know, You’re a Fiduciary,” addressing the fact that far too many plan sponsors still do not realize their fiduciary status or understand the legal obligations and liability exposure resulting from this designation.

These two facts lead me to believe that 2018 will not only see an increase in fiduciary related litigation, both ERISA and non-ERISA cases, but an increased in the success of such litigation. Plans and plan sponsors have celebrated recent wins in a few ERISA fee-based cases. However, I contend that those decisions are tenuous at best, at least with regard to the technical ERISA issues, due to what appears to be incorrect interpretations of cases such as Tibble and Hecker I and Hecker II. As a result, I would expect those key ERISA related decisions to be reversed, a sentiment recently expressed by leading ERISA plaintiff’s attorney, Jerome Schlichter.

In my opinion, the primary reason that ERISA fee actions are so successful is a misunderstanding among plan sponsors, plan advisers and financial advisers in general with regard to the evaluation and ongoing monitoring of investment fees. Whenever the issues of fees is raised in ERISA cases, plan sponsors and the investment immediately respond that ERISA does not require that they select the investment options with the lowest fees.

While this is true, is does not equate with an absolute immunity from recommending and selecting investment options that lack any inherent value for investors and pension plan participants. Taking Justice Breyer’s statement with regard to the value of the Restatement in interpreting fiduciary law as a starting point allows us to evaluate the viability of investment options using the clear and simple standards set out in the Restatement. Three standards in particular stand out, two setting out core fiduciary standard, and one setting out the fiduciary standard for actively managed mutual funds, a staple in most 401(k) plans and other types of pension plans.

With regard to a fiduciary’s core duties, Section 88 states that fiduciaries have a duty to be cost conscious. Section 90, comment f, states that fiduciaries have a duty to seek the highest return for a given level of risk and cost, or conversely, the lowest level of cost and risk for a given level of return. With regard to actively managed mutual funds, Section 90, comment h(2), of the Restatement notes that such investments often carry a higher level of costs and risks than comparable index funds. Therefore, the Restatement states that actively managed funds should only be included in a plan’s investment options when the expected return from such fund can reasonably be expected to provide a commensurate level of return o compensate for the additional costs and risk of the actively managed funds.

Simply put, the current menu of investment options within most 401(k) and other pension fail to meet any of these three hurdles. Not only fail to meet them, but fail miserably to meet such standards. As Carhart’s study showed, the returns of most actively managed funds fail to even cover their costs.(1) Our proprietary metric, the Active Management Value Ratio 2.0™ (AMVR), also shows that most actively managed mutual funds are not cost efficient, as their incremental costs exceed their incremental returns, as compared to an appropriate benchmark. As has been mentioned in several ERISA fees cases, losing a client’s money is never prudent.

The fact that many plan sponsors still do not recognize their fiduciary status and resulting fiduciary duties means that they are probably not aware of the standards established by the Restatement and the resulting liability exposure for failure to adhere to same. Ergo, increased litigation and more settlements and decisions in favor of plan participants.

The first time I meet with a prospective ERISA client, I ask them to tell me everything they know about ERISA law. The usual response is either along the lines of knowing that they have to comply with the rules to an immediate “deer in the headlights” stare. They often provide audit notes from a compliance advisor that list the usual 20-25 compliance requirement under the ’40 Act.

More often than not, the compliance adviser is not attorney and does not recognize the need to integrate both compliance and legal risk management standards into a plan to provide the plan with optimum legal protection. Far too often I see plans that offer 40-50 investment options, obviously operating under the mistaken belief that more is better, when in fact just the opposite is usually true. Offering a lot of funds that are highly correlated to each other and/or are cost inefficient, e.g., closet index funds, offers nothing for either the plan or the plan participants except liability exposure for the plan and the plan sponsor.

These very issues were discussed and resolved  in the Hecker decisions. In my experience, far too many compliance consultants and plan providers rely on Hecker I without reviewing Hecker II. As Fred Reish, one of America’s leading ERISA experts, admits, Hecker II effectively reversed Hecker I. As a result, many plan sponsors are left, as we say in the South, “nekkid in the wind,” totally defenseless to any ERISA fee litigation action.

CEOs and 401(k) plan sponsors often call me asking me how they can bulletproof their plan and avoid any liability. First the bad news. Since 401(k) fee cases address thing s that have occurred within the past six years, there is nothing a plan can do about liability arising from actions during that time. You can’t unring a rung bell.

The good news is that plans can implement and monitor an effective risk management program that provides the protection and benefits that both plan sponsors and plan participants want and need. Such risk management programs do not have to be cost prohibitive either. The key is to become and remain proactive in creating such as plan and monitoring the plan to ensure continued effectiveness.

One last factor to consider is the continuing efforts of the DOL, Congress and the Trump administration to block the full implementation of the DOL’s new fiduciary standard. In so doing, the DOL and Congress, as well as the SEC, underestimated the response from the states. Some states already impose a fiduciary duty on stockbrokers and other financial advisers. Nevada and other states have announced plans to protect their own citizens by exercising their police powers under the 10th Amendment to enact their own fiduciary standards. These state fiduciary laws will presumably include full discovery rights for investors, the one thing that the investment industry fears the most due to the possibility that it will expose even greater abuses by the industry. And there is nothing that Congress, the DOL, the SEC or the Trump administration can do to prevent the states from exercising their 10th Amendment rights and powers.

Increased fiduciary related litigation and more settlements and plaintiffs’ verdicts.  That’s my prediction and I’m sticking to it!


1. Mark Carhart, “On Persistence in Mutual Fund Performance, Journal of Finance, 52, 57-82.

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™ member 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 on sound, proven investment strategies that will help them protect their financial security.
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