By James W. Watkins, J.D., CFP Board Emeritus™, AWMA®

I have referenced the Matney v. Briggs Gold of North America (Matney) case¹ in a number of recent posts. In my opinion, the significance of Matney lies in the fact that the case presents an opportunity to consider the same issues that were presented in the Brotherston v. Putnam Investments, LLC case² (Brotherston) back in 2018.

SCOTUS ultimately denied Putnam’s petition for certiorari, presumably based on the Solicitor General’s recommendation to deny cert since the petition involved an interlocutory appeal. While the Solicitor General recommended denying the petition, his amicus brief completely supported the First Circuit’s decision.³

Two key issues involved in both Brotherston and Matney – the legitimacy of index funds as comparators in 401(k)/403(b) litigation, and which party had the burden of proof on the issue of causation in such cases. As to the first issue, both the First Circuit and the Solicitor General pointed to SCOTUS’ previous recognition of the Restatement (Third) of Trusts (Restatement) as a valuable resource in resolving fiduciary issues.⁴ Both parties pointed to Section 100, comment b, of the Restatement, which states that comparable indices and index funds are legitimate comparators in addressing questions of fiduciary prudence.

As to the second question, both the First Circuit and the Solicitor General stated that under the common law of trusts, once a plaintiff establishes a breach of fiduciary duty and a resulting loss, the burden of proof as to causation shifts to the fiduciary. This position is based on common sense and necessity since only the fiduciary knows the processes, if any, that were used and relied on in making their decisions. The Sixth Circuit recognized this issue in its TriHealth decision:

But at the pleading stage, it is too early to make these judgment calls. ‘In the absence of further development of the facts, we have no basis for crediting one set of reasonable inferences over the other. Because either assessment is plausible, the Rules of Civil Procedure entitle [the three employees] to pursue [their imprudence] claim (at least with respect to this theory) to the next stage….’⁵

This wait-and-see approach also makes sense given that discovery holds the promise of sharpening this process-based inquiry. Maybe TriHealth ‘investigated its alternatives and made a considered decision to offer retail shares rather than institutional shares’ because ‘the excess cost of the retail shares paid for the recordkeeping fees under [TriHealth’s] revenue-sharing model….’ Or maybe these considerations never entered the decision-making process. In the absence of discovery or some other explanation that would make an inference of imprudence implausible, we cannot dismiss the case on this ground. Nor is this an area in which the runaway costs of discovery necessarily cloud the picture. An attentive district court judge ought to be able to keep discovery within reasonable bounds given that the inquiry is narrow and ought to be readily answerable.⁶

The Opportunity Provided by Matney
While Matney is still pending in the Tenth Circuit, I believe that it is reasonable to assume that the Tenth Circuit’s decision will be ultimately be appealed to SCOTUS given the importance of the issues involved. Just as in Hughes, there is a split in the federal courts, in this case on the both the “apples and oranges” and the burden of proof on causation issues, effectively denying workers a consistent and equitable enforcement of the rights and protections guaranteed under ERISA.

The district court’s decision started out strong, recognizing that the processes used by a plan sponsor are determinative in assessing the fiduciary prudence of their selection of a plan’s investment decisions.

But Plaintiffs do not challenge decisions specific to the options in which they invested. They focus on an allegedly flawed process that resulted in investment offerings Plaintiffs say were imprudent and unnecessarily cost them money…Plaintiffs allege infirmities in the overall decision-making process, and that confers standing to challenge decisions that happened to affect not only their accounts but other accounts in the Plan the fiduciaries managed.⁷ 

The court recognizes that plaintiffs have limited access to information demonstrating the process fiduciaries use to make their decisions. But a plaintiff can survive a motion to dismiss if the court can infer from the circumstantial allegations that the fiduciary’s decision-making process was flawed. (citing Pension Benefit Guar. Corp. ex. rel. St. Vincent Catholic Med. Ctr.’s Ret. Plan v. Morgan Stanley Inv. Mgmt. Inc., 712 F.3d 705, 719–20 (2d Cir. 2013); Braden v. WalMart Stores, Inc., 588 F.3d 585, 596 (8th Cir. 2009).⁸

Nevertheless, circumstantial factual allegations “must give rise to a ‘reasonable inference’ that the defendant committed the alleged misconduct, thus ‘permit[ting] the court to infer more than the mere possibility of misconduct.” (citing St. Vincent, 712 F.3d at 718–19 (emphasis in original) (quoting Iqbal, 5556 U.S. at 678–79)).⁹ 

Then the district court proceeded to make some interesting statements regarding the use of revenue sharing in reducing the expense ratios of funds and other investments, as well as the consideration of other fiduciary prudence factors. The court rejected the plaintiff’s use of collective investment trusts (CITs) as comparators, citing differing strategies and the familiar “apples and oranges” argument.

Importantly, Plaintiffs misstate expense ratios of Plan funds. But they also make “apples to oranges” comparisons that do not plausibly infer a flawed monitoring and decision-making process. “To show that ‘a prudent fiduciary in like circumstances’ would have selected a different fund based on the cost or performance of the selected fund, a plaintiff must provide a sound basis for comparison—a meaningful benchmark.” (citing Meiners, 898 F.3d at 822) The fact that “cheaper alternative investments with some similarities exist in the marketplace” does not provide a “meaningful benchmark” upon which to determine whether the Committee breached its duty. (citing Meiners, at 823) (emphasis in original).¹⁰

The district court seemingly overlooked the fact that the Restatement effectively discredits the “apples and oranges” and recognizes comparable indices and index funds as “meaningful benchmark”. The court seemingly ignored the fact that SCOTUS endorsed the use of the Restatement in cases where ERISA does not provide express instructions/requirements.¹¹

The district court’s attempt to use revenue sharing to reduce a fund’s expense ratio is totally inconsistent with the Seventh Circuit’s acknowledgment that such attempts to offset expense ratios with revenue sharing payments on a one-to-one basis are improper.¹² In another example of the “fundamental fairness” trend, the Seventh Circuit rejected the district court’s one-to-one offset argument.

The problem is that the Form 5500 on which Albert relies does not require plans to disclose precisely where money from revenue sharing goes. Some revenue sharing proceeds go to the recordkeeper in the form of profits, and some go back to the investor, but there is not necessarily a one-to-one correlation such that revenue sharing always redounds to investors’ benefit. Albert’s ‘net investment expense to retirement plans theory’ assumes that there is such a correlation; if that assumption is wrong, then simply subtracting revenue sharing from the investment-management expense ratio does not equal the net fee that plan participants actually pay for investment management.¹³

The Hughes/TriHealth Prescription
The Seventh Circuit’s Hughes decision frequently cited the Sixth Circuit’s TriHealth decision in describing the current 401(k)/403(b) litigation standards.

1. ERISA requires a fiduciary to assess whether a given fund is prudent in light of other investment options in a plan, comparable funds, and the expenses charged, among other factors.¹⁴
2. At the pleading stage, a plaintiff must provide enough facts to show that a prudent alternative action was plausibly allege fiduciary decisions outside a range of reasonableness.¹⁵
3. The duty of prudence requires a plan fiduciary to “incur only costs that are reasonable in amount and appropriate to the investment responsibilities of the trusteeship.”¹⁶
4. At the pleading stage, a plaintiff must provide enough facts to show that a prudent alternative action was plausibly available.¹⁷
5. Every possible alternative explanation for an ERISA fiduciary’s conduct need not be ruled out at the pleadings stage.¹⁸
6. Where alternative inferences are in equipoise – that is where they are all reasonable based on the facts – the plaintiff is to prevail on a motion to dismiss. This is because, at the pleading stage, we must accept all well-pleaded facts as true and draw reasonable inferences in the plaintiff’s favor.¹⁹

Matney provides a perfect opportunity for SCOTUS to further create a uniform, consistent set of standards for 401(k)/403(b) litigation. The recognition of the “apples and oranges” argument is a consistent and inexplicable refusal of some federal courts to ignore SCOTUS and ignore the Restatement’s common sense fiduciary standards.

In Matney, the district court recognized that process, not product, is the key issue in 401(k)/403(b) litigation. Two statements in particular drew my attention:

(1) “circumstantial factual allegations ‘must give rise to a ‘reasonable inference’ that the defendant committed the alleged misconduct, thus ‘permit[ting] the court to infer more than the mere possibility of misconduct,”²⁰ and

(2) “[t]o show that ‘a prudent fiduciary in like circumstances’ would have selected a different fund based on the cost or performance of the selected fund, a plaintiff must provide a sound basis for comparison—a meaningful benchmark.”²¹ (emphasis added)

Change “cost or performance” to “cost and performance” and I believe the letter and spirit of ERISA can be easily, and uniformly, accomplished. People who follow my posts are well aware of my position that the relative cost-efficiency of a fund, not its classification as active or passive, should be the key factor in determining whether a plan sponsor or any other investment fiduciary has breached their fiduciary duties.

In Hughes, the Seventh Circuit noted that “cost-consciousness management is fundamental to prudence in the investment function. The Active Management Value Ratio (AMVR) metric provides a simple method of assessing the cost-efficiency of a fiduciary’s decisions. A sample of an AMVR analysis slide is shown below.

The slide clearly establishes a “reasonable inference” of a fiduciary breach, clearly showing the cost-inefficiency of the actively managed mutual fund relative to a comparable index fund based on the actively managed fund’s incremental cost and return. The combination of the active fund’s relative underperformance (opportunity cost) and the fund’s incremental expense ratio cost could then be used to estimate both the loss and damages caused by the plan sponsor’s fiduciary breach.

The AMVR itself is simply the basic cost/benefit equation, using incremental cost/return as the input data. The AMVR calculation itself is obtained by dividing an active fund’s incremental cost by its incremental return. An AMVR greater than “1.0” indicates that the actively managed fund is cost-efficient.

Plan sponsors, attorneys and courts can then see the extent of the cost-inefficiency, the “imprudence premium,” being reflected in the amount by which a fund’s AMVR score exceeds “1.0,” e.g., 1.50 indicates an imprudent premium of 50 basis points/50 percent. Estimated liability exposure and/or legal damages can then be calculated using the DOJ’s and GAO’s findings that each additional 1 percent in costs/fees reduces an investor’s end-return by approximately 17 percent over a 20-year period.²²

In the example, the fund’s negative incremental return automatically makes the fund an imprudent choice relative to the comparable index fund. While some may want to argue difference in strategies and goals, ERISA focuses on the benefit provided to the plan participants. Whatever the active fund’s strategies and goals may have been, they ultimately were inferior in terms prudence, as the combined investment costs would have resulted in a loss of between $2.07 to $7.00 per share, compounded annually. The AMVR slide also shows that an investment in the active fund would have resulted in a plan participant suffering a projected 34 percent loss in end-return over a 20- period relative to the index fund option.

Going Forward
I believe the next 12-18 months are going to be a pivotal period in defining the future of 401(k)/403(b) litigation, both in terms of pleading standards and results. I believe the Matney could be the final piece of the puzzle.

The good news is that equitable and consistent results are easily attainable in 401(k)/403(b) litigation just by following the Restatement’s standards and SCOTUS’ decisions, as well as by simply applying some common sense, “humble arithmetic,” and fundamental fairness.

Notes
1. Matney v. Briggs Gold of North America, Case No. 2:20-cv-275-TC (C.D. Utah 2022) (Matney)
2. Brotherston v. Putnam Investments, LLC, 907 F.3d 17 (2018) (Brotherston)
3. Brief for the United States as Amicus Curiae, Hughes v. Northwestern University, United States Supreme Court, No. 19-1401.     
4. Restatement (Third) Trusts (American Law Institute) All rights reserved. (Restatement)
5. Forman v. TriHealth, Inc., 40 F.4th 443, 450 (6th Cir. 2022)
6. TriHealth, Ibid.
7. Matney, 14
8. Matney, 8
9. Matney, 8
10. Matney, 19
11. Tibble v. Edison International, 135 S. Ct 1823 (2015)
12. Albert v. Oshkosh Corp., 47 F.4th 570 (2022) (Oshkosh)
13. Oshkosh, 581
14. Hughes v. Northwestern University, No. 18-2569, March 23, 2023 (7th Cir. 2023) (Hughes), 11.
15. Hughes, 20
16. Hughes, 14
17. Hughes, 21
18. Hughes, 18-19
19. Hughes, 19
20. Matney, 8
21. Matney, 19
22. Pension and Welfare Benefits Administration, “Study of 401(k) Plan Feess and Expenses,” (“DOL Study”); “Private Pensions: Changes Needed to Provide 401(k) Plan Participants and the Department of Labor Better Information on Fees,” (“GAO Study”).

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