ERISA Litigation Update - September 2011 September 29, 2011
In This Issue

Second Circuit Affirms Dismissal of Suit Challenging Insurer’s Use of Retained Asset Account to Settle Life Insurance Benefits

On August 5, the U.S. Court of Appeals for the Second Circuit affirmed the dismissal of the complaint in Faber, et al. v. Metropolitan Life Insurance Company. 

The litigation was brought by current and former beneficiaries of employee welfare benefit plans whose sponsors had purchased group life insurance contracts from the insurer defendant.  The insurer paid benefit claims through interest-bearing accounts backed by assets that the insurer 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 a class of beneficiaries under contracts issued by the insurer defendant who had received their benefits through such a retained asset account. 

The Faber case is one of several suits that have been filed against insurance companies in the last few years challenging retained asset accounts, which are widely used in the life insurance industry. 

In 2009, the district court dismissed the Faber complaint for failure to state a claim on the ground that the insurer discharged its fiduciary obligations under ERISA when it established the retained asset accounts in accordance with the terms of the plans at issue.  The summary plan descriptions for the named plaintiffs’ plans had expressly provided that benefits would be paid through the insurer’s retained asset account program. 

During the appeal, the Second Circuit invited the Department of Labor (“DOL”) to submit an amicus brief addressing certain legal issues in the case.  On February 17, 2011, the DOL submitted a letter brief in which it argued that the insurer had discharged its ERISA fiduciary duties by furnishing beneficiaries with retained asset accounts in accordance with the plan documents and that the insurer did not retain plan assets by holding and managing the assets that backed the retained asset accounts.  In the DOL’s view, given the specific facts of the case, once the insurer creates and credits a beneficiary’s retained asset account and provides a checkbook, the beneficiary “has effectively received a distribution of all the benefits that the Plan promised,” and “ERISA no longer governs the relationship between [the insurer] and the . . . account holders.” 

The Second Circuit agreed with the DOL and affirmed dismissal on the grounds that (i) the insurer discharged its fiduciary obligations as a claims administrator and ceased to be an ERISA fiduciary when, in accordance with the summary plan description, it created the plaintiffs' retained asset accounts, credited the accounts with the amount of benefits due, and issued checkbooks enabling plaintiffs to withdraw their proceeds at any time; and (ii) ERISA no longer governs the relationship between the insurer and a beneficiary once a retained asset account is established in accordance with the plan.

Seventh Circuit Rejects Challenge to Retail Mutual Funds on 401(k) Platform

In a decision bringing together the two opposing judges in the closely watched fee challenge under Section 36(b) of the Investment Company Act of 1940, Jones v. Harris Associates, the U.S. Court of Appeals for the Seventh Circuit held on September 7 that fiduciaries of a 401(k) plan – even one with over $1 billion in assets – did not breach ERISA fiduciary obligations by including retail mutual funds as investment options.

In Loomis v. Exelon, Chief Judge Easterbrook, joined by Circuit Judges Posner and Tinder, affirmed dismissal of a challenge under ERISA to the fees paid by Exelon’s 401(k) plan.  The plan contained 32 investment options, 24 of which were no-load “retail” mutual funds.  The expense ratios of the 32 investment options available under the plan ranged from three to 96 basis points.  Following its earlier decision in Hecker v. Deere & Co., 556 F.3d 575 (7th Cir. 2009), the court held that a plan fiduciary does not breach its duties by offering this range of investment options. 

Notably, the court expanded upon its rationale in Deere by offering further justification for the inclusion of retail mutual funds in a 401(k) investment line-up.  It explained that retail fees are set in a competitive market, giving participants the benefit of such price competition.  It cited economic literature demonstrating that advertising promotes competition and further drives down fees.  The court rejected the plaintiffs’ analogy to a rental car company that receives a “fleet discount” by purchasing cars en masse – instead, in a 401(k) line-up where participants are allowed to direct their own investments, a plan fiduciary does not have the same bargaining power as it cannot guarantee that retirement funds will be invested en masse into any specific investment.  Moreover, the court explained that investment options still have to account for retail-like transactions within a 401(k) plan.  The panel also identified differences between mutual funds and commingled pools, including liquidity and mark-to-market benchmarks. 

Not only did the Seventh Circuit panel identify advantages to retail mutual funds, but the court additionally rejected the participants’ argument that a per capita fee structure would represent a gain for the participants.  The court explained that such a structure might represent higher fees for “younger employees and others with small investment balances.”  The panel also held that even if a fee restructuring would be beneficial, it could not be achieved given the regulation of mutual funds under the federal securities laws, including the Investment Company Act of 1940, and could run afoul of the tax rule against preferential dividends, 26 U.S.C. § 562(c).1

In addition to rejecting the participants’ arguments as to the central issue of whether the fees were excessive, the court also rejected participants’ argument that the employer, rather than the participants, should be required to bear those fees.  The court held that payment of fees for plan services was a question of plan design, and thus was not susceptible to challenge as a breach of fiduciary duty as employers may act in their own interest in designing a plan.



[1] The panel did not address the impact of Section 307 of the Regulated Investment Company Modernization Act of 2010 (Pub. L. No. 111-325), which repealed the preferential dividend rule for publicly offered funds effective after December 22, 2010. 

Third Circuit Upholds Dismissal of Action Asserting ERISA Fiduciary Violations in the Inclusion of Retail Mutual Funds within Menu for Participant-Directed 401(k) Plan

On August 19, a unanimous panel of the U.S. Court of Appeals for the Third Circuit affirmed the dismissal of the complaint in Renfro v. Unisys Corporation.

Renfro involved a 401(k) plan with $2 billion in assets that offered 73 different investment options from which participants could choose – including a stable value fund, an employer stock fund, four commingled (group trust) funds and 67 mutual funds.  The expense ratios of the available mutual funds – which included a number of retail mutual funds – ranged from 10 to 121 basis points.

Two plan participants brought a putative class action in the U.S. District Court for the Eastern District of Pennsylvania against the plan sponsor and the plan’s directed trustee (and certain of their affiliates), claiming they breached fiduciary duties of loyalty and prudence under ERISA §404(a) in selecting and retaining retail mutual funds as investment options under the plan. The plaintiffs asserted that the administrative fees set forth in the plan’s trust agreement and the fees associated with the retail mutual funds on the plan’s menu were excessive in relation to the services provided. They argued that other investment alternatives with lower fees should have been offered in lieu of the retail mutual funds, or that the plan fiduciaries should have used the plan’s size as leverage to bargain for lower fees from the mutual funds.

On a Rule 12(b)(6) motion, the district court dismissed the claims against the directed trustee and its affiliates, reasoning that they did not exercise control over the selection of plan investment options and therefore had no relevant fiduciary duties.  The court also dismissed the claims against the plan sponsor and its affiliates, finding that – because the plan offered a “sufficient mix of investments” for participants – no rational trier of fact could conclude that they had breached their fiduciary duties in offering that array of investment options under the plan.  In addition, the court granted the motion for summary judgment filed by the plan sponsor and its affiliates, ruling that they were protected from liability by ERISA §404(c), as the participants had chosen the investment options to which they allocated their plan accounts.

On appeal, the Third Circuit affirmed. With regard to the directed trustee (and its affiliates) the Court of Appeals noted that under ERISA “an entity is only a fiduciary to the extent it possesses authority or discretionary control over the plan.” The court concluded that neither the trustee nor its affiliates had any discretion over the selection or maintenance of plan investment options, and found in particular that the trustee was directed with regard to the options to be made available. In the Third Circuit’s view, “a directed trustee is essentially ‘immune from judicial inquiry’ because it lacks discretion, taking instructions from the plan that it is required to follow” (citing Moench v. Robertson, 62 F.3d 533 (3d Cir. 1995)). The Third Circuit also concluded that the trustee could not be subject to co-fiduciary liability under ERISA §405(a) based on the sponsor’s alleged breach in agreeing to pay the trustee (and its affiliates) excessive compensation, because the trustee did not act as a fiduciary in negotiating its own compensation and in any event had no actual knowledge of any fiduciary breach by the sponsor.

In addressing the claims against the plan sponsor (and its affiliates), the Third Circuit analyzed two prior circuit court opinions that dealt with complaints challenging fees charged in connection with investments made available under ERISA plans – Hecker v. Deere & Co., 556 F.3d 575 (7th Cir. 2009) and Braden v. Wall-Mart Stores, Inc., 588 F.3d 585 (8th Cir. 2009). In the Third Circuit’s view, these cases indicate that the proper focus in evaluating such a challenge is the “range of investment options and the characteristics of those included options – [e.g.,] the risk profiles, investment strategies, and associated fees.” In the case before it, the Third Circuit found that the plan had a reasonable range of investment options with a variety of risk profiles and fee rates, and therefore held that the complaint’s general assertions of imprudence and disloyalty failed to plausibly allege a claim of fiduciary breach.

Finally, the Third Circuit concluded that – because the district court had properly dismissed the claims against the plan sponsor (and its affiliates) under the reasoning described above – there was no need to address questions related to the grant of summary judgment based on ERISA §404(c) (and in particular whether §404(c) provides a defense against allegations that a fiduciary imprudently selected or monitored investment options).

Regulatory Update

DOL Withdraws Proposed Fiduciary Rule

On September 19, the Department of Labor (“DOL”) announced the withdrawal of its proposed regulation on the definition of a fiduciary under ERISA § 3(21)(A).  Originally proposed last October, the rule drew over 250 comments and was the subject of hearings held before the DOL and the U.S. House Education and Workforce Committee.  Many commentators expressed concern that the proposed rule would have unintended consequences.  The DOL has indicated that it will re-propose the rule in early 2012 after additional input, review and consideration.

DOL Proposed Fee Disclosure Rule in Final Stages

On July 22, the DOL’s final rule to amend the regulations under ERISA § 408(b)(2) concerning reasonable arrangements between a plan and a party in interest to add additional fee disclosure requirements was submitted to the Office of Management and Budget for final review.  The DOL has announced that the rule will become effective April 1, 2012.

Upcoming Conferences

American Conference Institute’s 4th National Conference on Defending and Managing ERISA Litigation
Date: October 20-21, 2011
Location: New York, NY 

Jamie Fleckner will present at this ACI conference on ERISA litigation.  The conference covers the latest developments and trends in ERISA litigation, and provides participants with crucial knowledge and practical strategies needed to defend against ERISA claims.

Thomson Reuters 24th Annual ERISA Litigation Conference
Date: November 9-10, 2011
Location: New York, NY 

Jamie Fleckner will present at this Thomson Reuters conference on ERISA litigation and will participate on a panel addressing misrepresentation claims, the Amara case and remedies.