Plan Sponsor Alert: The Hidden Message in the #Northwestern403b Hearing

There were two issues properly before SCOTUS in the recent #Northwestern403b hearing: (1) the sufficiency of the plan participants’ complaint, and (2) the legal merits of the 7th Circuit’s rationale for dismissing the plan participants’ complaint, the “menu of options” defense. While no one knows how SCOTUS will decide the first question, there would seem to be no question as to the Court’s decision as the second question given Justice Kagan’s questioning and the very language of ERISA Section 404(a) itself.

I believe that Justice Kagan’s discrediting of the “menu of options” defense, combined with the 1st Circuit’s discrediting of the “apples and oranges” defense based upon comment m of Section 90 of the Restatement (Third) of Trust’s, should send a clear message to plan sponsors and and investment fiduciaries-choose your advisers well!

Pension plans that were advised to rely on the 7th Circuit’s “menu of options” defense now find themselves in what the legal profession calls a “SNAFU,” or a real mess. That”mess” has been the leading topic in my conversations with plan sponsors and legal colleagues since the #Northwestern403b hearing.

Plan sponsors now face having to immediately adjust plan investment options in their plans to remove any that are legally imprudent. Even then, they still face potential liability exposure for any losses attributable to fact that those funds were even offered by the plan.

One would guess that plan sponsors will attempt to rely on “reasonable reliance” on plan advisers and other experts to avoid liability. The first issue is the fact that many plan advisers routinely include fiduciary disclaimer clauses in their advisory contracts. While the Supreme Court has ruled that plan advisers can be sued by plan sponsors in certain circumstances under the common law for claims such as negligence, fraud and breach of contract, that remedy will not defeat a breach of fiduciary duties claim against a plan sponsor.

A “reasonable reliance” defense by plan sponsors faces other formidable hurdles as well. Those hurdles have been described in a number of judicial decisions. Some examples include

  • “Over and above its duty to make prudent investments, the fiduciary has a duty to conduct an independent investigation of the merits of a particular investment….A fiduciary’s independent investigation of the merits of a particular investment is at the heart of the prudent person standard.” Fink v. National Saving & Loan, 772 F.2d 951 (D.C. Cir. 1985): Donovan v. Cunningham, 716 F.2d 1455, 1467; Donovan v. Bierwirth, 538 F.Supp. 463, 470 (E.D.N.Y.1981)
  • “The failure to make any independent investigation and evaluation of a potential plan investment” has repeatedly been held to constitute a breach of fiduciary obligations.” Liss v. Smith, 991F.Supp. 278 (S.D.N.Y. 1998)
  • “While a plan sponsor may hire an adviser or other expert, [t]he fiduciary must (1) ‘investigate the expert’s qualifications’;  (2) ‘provide the expert with complete and accurate information’;  and (3) ‘make certain that reliance on the expert’s advice is reasonably justified under the circumstances.'”

“A determination whether a fiduciary’s reliance on an expert advisor is justified is informed by many factors, including the expert’s reputation and experience, the extensiveness and thoroughness of the expert’s investigation, whether the expert’s opinion is supported by relevant material, and whether the expert’s methods and assumptions are appropriate to the decision at hand. One extremely important factor is whether the expert advisor truly offers independent and impartial advice.” (emphasis added)

“Defendants relied on FPA, however, and FPA served as a broker, not an impartial analyst. As a broker, FPA and its employees have an incentive to close deals, not to investigate which of several policies might serve the union best.   A business in FPA’s position must consider both what plan it can convince the union to accept and the size of the potential commission associated with each alternative.   FPA is not an objective analyst any more than the same real estate broker can simultaneously protect the interests of “can simultaneously protect the interests of both buyer and seller or the same attorney can represent both husband and wife in a divorce. ” Gregg v. Transportation Workers of Am. Intern, 343 F.3d 833, 841-842 (6th Cir. 2003)

  • “In determining compliance with ERISA’s prudent man standard, courts objectively assess whether the fiduciary, at the time of the transaction, utilized proper methods to investigate, evaluate and structure the investment; acted in a manner as would others familiar with such matters; and exercised independent judgment when making investment decisions.”

    “[F]iduciaries in other circumstances, are entitled to rely on the advice they obtain from independent experts. Those fiduciaries may not, however, rely blindly on that advice.” Bussian v. RJR Nabisco, Inc., 223 F.3d 286, 298-300 (5th Cir. 2000)

Based upon my experience, very few plan sponsors perform, or even know to perform, a through, independent and impartial investigation of the investment options offered by their. Once again, based on my experience, even more troubling is the fact that very few plan sponsors know how to determine if the advisers and experts they choose can, or have, conducted a through, independent and impartial investigation of the investment options offered by a plan.

Perhaps the largest hurdle for plan sponsors attempting to rely on a “reasonable reliance” defense is their “blind reliance”on such third parties. Despite the warning that plan sponsors cannot blindly rely on the advice of third parties, my experience has been that is exactly what most plan sponsors, since their decision to hire an adviser is based on their inability to perform such duties. However, all is not lost for plan sponsors, as such blind reliance, would not defeat the previously mentioned common civil action against a plan adviser.

For those plan sponsors wanting a quick primer on fiduciary compliance under ERISA, the Bussian decision is recommended reading. For those a more detailed discussion of fiduciary compliance under, the lengthy Enron decision is excellent.

For plan sponsors wanting to know about a simple tool that can help them in performing the legally required independent investigation and analysis, I, humbly, recommend InvestSense’s free proprietary metric, the Active Management Value Ratio (AMVR). The AMVR allows fiduciaries, investors and attorneys to easily and quickly assess the cost-efficiency and prudence of an actively managed mutual fund.

In closing, as I always tell my fiduciary compliance clients, “there are no mulligans in fiduciary law.” For that reason, hopefully plan sponsors will take away the hidden message from the #Northwestern403b case-choose your advisers carefully and learn the rules and limitations regarding the use of their advice.

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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