Erisa Litigation Newsletter

In Santomenno v. John Hancock Life Ins. Co., No. 13-3467 (3d Cir. Sept. 26, 2014), the U. S. Court of Appeals for the Third Circuit affirmed dismissal of all claims against the defendant insurance company in a case challenging 401(k) plan fees.

Background

The litigation was brought by participants in two 401(k) plans whose plan trustees purchased group annuity contract from the defendant insurer to provide 401(k) recordkeeping and investment options. The plaintiffs alleged that the insurer acted as an ERISA fiduciary and violated ERISA by charging excessive fees, including fund advisory fees, sales & service fees, 12b-1 fees, and revenue sharing. The plaintiffs asserted their claims on behalf of a purported class of all plans and participants who receive services under the insurer’s group annuity contracts. They also sued the insurer’s affiliated investment manager and fund distributors as non-fiduciaries who were allegedly liable for the fund fees.

The U.S. District Court for the District of New Jersey dismissed the case, holding that the insurer did not act as a fiduciary under ERISA with respect to its fees or the investment options that plan trustees elect to make available to their plans. The Third Circuit affirmed. In a unanimous decision of the three-judge panel, the court held, among other things, that the insurer owes no fiduciary duty with respect to the terms of its service agreement so long as the plan trustees had the ultimate authority to accept or reject those terms. The court also held that the insurer is not a fiduciary with respect to the composition of its investment platform and the fees of those investments, which are merely product design features that trustees elect. In rejecting contrary authority, the court explained that “it is unnecessary to impose a fiduciary duty on the service provider.”

The court also rejected the plaintiffs’ argument that the insurer’s ability to delete or substitute funds from its investment platform rendered it a fiduciary. The court concluded that plaintiffs’ overall challenge to fees had no nexus to any change to investments on the platform, and that the trustees retained ultimate decision-making authority over their plans because they could accept or reject any changes that the insurer proposed to make to its investment platform. The court also rejected the plaintiffs’ allegations that the insurer rendered fiduciary investment advice, given that there was no nexus between such advice and the alleged harm, and plaintiffs’ failure to meet the elements set forth in the governing Department of Labor regulation concerning investment advice. 

Goodwin Procter represents the defendants-appellees in this case.

Background

Tatum arose from the following facts. In 1999, RJR Nabisco, Inc. engaged in a corporate spinoff to separate its tobacco business (“Reynolds”) from its food business (“Nabisco”). In connection with this spinoff, a new 401(k) plan was established for employees of Reynolds and assets representing the accounts of those employees were transferred from the 401(k) plan of RJR Nabisco to the new Reynolds 401(k) plan. Prior to the spinoff, employer stock was an available investment option under the RJR Nabisco plan, and as a result the Reynolds 401(k) plan ended up holding substantial amounts of Nabisco stock in two funds (the “Nabisco Funds”). The Nabisco Funds were frozen to new investment, but the Reynolds plan permitted participants to continue to hold the Nabisco stock they had previously purchased under the RJR Nabisco plan.

Reynolds decided to eliminate the Nabisco Funds under its 401(k) plan, effective six months after the corporate spinoff. Several months later, a bidding war developed for Nabisco, which ultimately resulted in a significant increase in the price of Nabisco stock. Nonetheless, the plan was divested of the Nabisco Funds after six months’ time. In 2002, a participant in the Reynolds 401(k) plan brought a class action in federal district court against Reynolds (and other plan fiduciaries), alleging that the decision to eliminate the Nabisco Funds under the Reynolds plan was a breach of ERISA’s duty of prudence. The suit sought to hold Reynolds (and other defendants) liable for the profits he (and other class members) would have realized if the Nabisco Funds had not been eliminated.

District Court Decision

In 2003, the district court dismissed the case, finding that the elimination of the Nabisco Funds as investment options was a “settlor” decision that had been incorporated into the plan’s governing documents, and was therefore not subject to ERISA fiduciary duties. The Fourth Circuit reversed that decision, holding that the plan documents did not require divestment of the Nabisco Funds.
Following remand, the district court held a bench trial, and concluded that Reynolds had breached the duty of prudence by deciding to eliminate the Nabisco Funds, and to do so on a six-month time frame, without proper investigation. The court determined that, as a breaching fiduciary, Reynolds bore the burden of proving that its breach did not cause the alleged harm. The court found, however, that Reynolds was not liable for the claimed damages because it had satisfied its burden by proving that elimination of the Nabisco Funds was “one which a reasonable and prudent fiduciary could have made” after performing a proper investigation.

Fourth Circuit Majority Opinion

In a majority opinion written by Judge Motz (joined by Judge Diaz), the Fourth Circuit reversed and remanded the district court decision.
The majority agreed with the district court that Reynolds had breached its duty of prudence by failing to undertake a proper investigation before eliminating the Nabisco Funds. The court noted that the Reynolds working group that made the decision engaged in virtually no discussion or analysis, and never considered alternatives to eliminating the Nabisco Funds six months after the spinoff. Among other things, the court faulted the working group for focusing exclusively on the risks of maintaining an undiversified, single-stock fund and for failing to consult legal counsel or investment experts in making its decision.

The majority also agreed with the district court’s decision that Reynolds, as a breaching fiduciary, bore the burden of proof regarding loss causation – i.e., whether the breach had caused the harm alleged by the plaintiffs. In the court’s view, this burden-shifting approach is supported by traditional trust law and ERISA case law.

However, the majority disagreed with the district court’s holding that Reynolds could satisfy its burden by proving that a hypothetical fiduciary using a prudent process “could have” reached the same decision as Reynolds, i.e., to eliminate the Nabisco Funds six months after the spinoff. Instead, the appellate court ruled, Reynolds could meet its burden, and avoid liability, only if it demonstrated that a prudent fiduciary “would have” come to the same decision.

According to the appeals court, the trial court erred in finding that Reynolds met its burden by showing that the evidence did not compel a decision to maintain the Nabisco Funds, and that a prudent investor “could have inferred” from the facts and circumstances that it was prudent to sell the plan’s Nabisco stock. The majority held that the trial court should have instead determined “whether the evidence established that a prudent fiduciary, more likely than not, would have divested the Nabisco Funds at the time and in the manner in which [Reynolds] did.” It remanded the case to the district court for application of this standard.

Judge Wilkinson’s Dissent

Judge Wilkinson filed a lengthy dissent, criticizing the majority opinion for putting ERISA plan fiduciaries at risk for personal monetary liability for investment decisions that are objectively prudent. The dissent argued that, because ERISA Section 409(a) makes a fiduciary responsible only for losses that “result from” the fiduciary’s breach, plaintiffs should bear the burden of proving loss causation.

Judge Wilkinson expressed particular concern that the court’s decision exposed Reynolds (and future fiduciaries) to liability for a determination that, in his view, protected plan participants from the dangers of undiversified single-stock funds. He also warned that the majority’s decision would lead to more ERISA fiduciary litigation, thereby effectively increasing plan administrative costs to the harm of both participants and fiduciaries. His admonition to “those who might contemplate future service as plan fiduciaries,” is, simply: “Good luck.”

Subsequent Proceedings

On September 2, 2014, the Fourth Circuit denied the petition for rehearing en banc filed by the Reynolds defendants. In advancing a motion to stay the mandate of the Fourth Circuit (which was denied on September 23, 2014), the Reynolds defendants announced their intention to file a petition for writ of certiorari with the Supreme Court, presenting two questions: (i) “whether the defendant bears the burden of proof for the element of causation on a claim under [ERISA Section 409(a)],” and (ii) “what standard to apply to evaluate whether a fiduciary is liable for damages under [ERISA Section 409(a)].”

Background

The government staked out its position in a filing in Tibble v. Edison International, No. 13-550. In that case, previously described in our March 28, 2013 ERISA Litigation Update, the U.S. Court of Appeals for the Ninth Circuit held, in part, that ERISA’s six-year statute of repose barred plan participants from challenging the prudence of mutual funds selected for their plan if: (i) the challenged funds were selected more than six years before participants filed suit; and (ii) plaintiffs were unable to prove at trial that circumstances changed during those six years.

The participants asked the Supreme Court to decide whether the decision was correct in light of a fiduciary’s ongoing duty to monitor plan investments. Before ruling on the participants’ petition, on March 24, 2014, the Court asked the Solicitor General of the United States to submit the federal government’s views. On August 19, 2014, the Solicitor General, joined by the Solicitor of Labor, filed a brief urging the Supreme Court to grant review and to hold that the six-year statute of repose does not bar claims concerning the suitability of any investment, even those selected for a plan more than six years prior to commencement of suit. (Update: On October 2, 2014, the Supreme Court granted the petition for writ of certiorari, limited to the question presented by the U.S. Solicitor General and Solicitor of Labor.)

The Government’s View of the Statute of Repose

In its brief, the government asserts that “ERISA imposes a continuing duty of prudence on plan fiduciaries” which entails a continuing duty “to review plan investments and eliminate imprudent ones.” The government distinguishes its argument from a “continuing violation” theory, which was rejected by the court below; instead, it argues that a separate and distinct breach of the duty to monitor investments and remove imprudent ones existed after the investments were first selected. The government further asserts that the Ninth Circuit’s decision “effectively exempts plan fiduciaries from important ongoing fiduciary duties concerning investment options first offered more than six years earlier and fails to protect plan participants’ retirement savings.”

The government’s brief recognizes that the only two circuits that have addressed the same question in the last two years have agreed with the Ninth Circuit’s view. The government argues instead that the Supreme Court should follow two appellate decisions from 1977 and 1992, decisions which did not address the prudence of using mutual funds on a plan’s investment platform.

The government’s brief does not address the various arguments raised by defendants in their opposition to certiorari, including the arguments: (i) acknowledging that an ongoing duty to monitor does exist under ERISA, but such duty can only support a claim distinct from a claim based on the selection of the option if there are changed circumstances that did not exist at the time of selection; (ii) ERISA does not allow claims to exist in perpetuity, and allowing participants to sue for harm related to allegedly imprudent funds on a plan’s investment menu under a failure-to-monitor theory would effectively render the statute of repose meaningless and “would allow any artful plaintiff to avoid the operation” of the repose period; and (iii) the congressional aim of reducing costly litigation would be thwarted by denying plan sponsors and fiduciaries the benefits of the repose period Congress enacted.

Timing

The Supreme Court has distributed the certiorari briefing for its end-of-summer conference, to be held Monday, September 29, 2014. A decision to take up the case would ordinarily be released later that week; a denial of certiorari would not be released until Monday, October 6, 2014. The Court almost invariably accepts recommendations by the Solicitor General to grant certiorari, making this case a highly likely addition to the Court’s March 2015 argument calendar. A decision on the merits would come by June 2015. 

The First Circuit recently decided two ERISA cases challenging the use of retained asset accounts in favor of the insurer-defendants. The decisions are Merrimon v. Unum Life Ins. Co. of Am., 758 F.3d 46, 50 (1st Cir. 2014) and Vander Luitgaren v. Sun Life Assurance Co., --- F.3d ---, 2014 WL 4197947, at *3 (1st Cir. Aug. 26, 2014).

Both suits were brought by beneficiaries of group life insurance plans whose sponsors had purchased group life insurance contracts from the insurer-defendants. In both cases, the insurers paid benefit claims under the group contracts through interest-bearing accounts backed by funds that the insurers retained until the account holders wrote checks or drafts against the account. The plaintiffs challenged the practice, which they claimed constituted a breach of fiduciary duty and a prohibited transaction under ERISA. The plaintiffs purported to sue on behalf of all beneficiaries under contracts issued by the insurer-defendant with respect to ERISA-covered benefit plans, where the beneficiary-putative class members had received their benefits through a retained asset account.

In Merrimon, the plaintiffs received their benefits under an insurance contract that specifically authorized the use of retained asset accounts. After a number of lower court rulings and a trial on limited issues, the First Circuit ultimately ruled for the insurer. The appellate court affirmed the granting of partial summary judgment for the insurer on the prohibited transaction claim under ERISA § 406(b), and reversed the trial court’s decision to grant summary judgment for plaintiffs on their breach of fiduciary duty claims under ERISA § 404(a). In its decision, the Court held that assets in the insurer’s general account that back the insurer’s liability on retained asset accounts are not ERISA-governed plan assets, and are not “somehow transmogrified into plan assets when they are credited to a beneficiary's account.” Moreover, the court held that even if ERISA fiduciary duties applied to the decision whether to establish retained asset accounts, there was no breach of duty because the insurer fully discharged any such duty when it established the accounts.

In Vander Luitgaren, the plaintiffs received their benefits under an insurance contract that did not specifically authorize the use of retained asset accounts, but provided instead that benefits “may be payable by a method other than a lump sum.” Notwithstanding this factual distinction, the First Circuit found that the case presented “essentially the same legal question” as Merrimon, and affirmed judgment for the insurer. Building on its Merrimon analysis, the court rejected the plaintiffs’ assertion that “a mode other than lump sum [is permissible] only as long as the choice of an alternative does not benefit [the insurer].” The court concluded that the insurer “can discharge its obligations to the beneficiary by paying the promised benefit through any one of a range of recognized payment modalities” so long as “the chosen modality does not unfairly diminish, impair, restrict, or burden the beneficiary’s rights. . . .” With respect to the plaintiffs’ assertion that the insurer’s receipt of investment earnings on retained assets violated ERISA, the Court stated that “ERISA section 404(a) does not require a fiduciary to don the commercial equivalent of sackcloth and ashes.” Accordingly, “[the insurer’s] choice to pay by means of [retained asset accounts] did not violate its fiduciary duties.”

These First Circuit decisions are consistent with decisions of the Second and Third Circuits that have rejected similar ERISA claims. See Faber v. Metropolitan Life Insurance Company, 648 F.3d 98 (2d Cir. 2011) (discussed in the September 29, 2011 ERISA Litigation Update) and Edmonson v. Lincoln National Life Insurance Company, 725 F.3d 406 (3d Cir. 2013) (discussed in the September 26, 2013 ERISA Litigation Update).

Goodwin Procter is a frequent national presenter on ERISA and related topics. Our upcoming conferences and presentations include:

ACI 18th Forum on D&O Liability Insurance
September 30, 2014 - October 1, 2014
New York, NY

Fifth Third Bancorp v. Dudenhoeffer and the Presumption of Prudence: Challenges to ESOP Fiduciary’s Decisions to Hold or Buy Company Stock
October 15, 2014
Boston, MA

Goodwin Procter Presents: A Webinar on Fiduciary Liability Following Tatum v. RJR
October 16, 2014

8th National Forum on Defending and Managing ERISA Litigation
October 27, 2014 - October 28, 2014
New York, NY

Western Pension & Benefits Council San Diego ERISA Litigation and Washington Update
January 20, 2015
San Diego, CA